By Kevin Mendizabal
Frates Insurance and Risk Management
Misinformation abounds when it comes to chargeback insurance policies for acquirers, which are for ISOs that contractually assume chargeback liability. In this article, I will discuss what the acquirer-level chargeback insurance policy does and clarify some misconceptions. Merchants seeking "chargeback insurance" are typically looking for chargeback remediation solutions. Merchant-level chargeback programs exist for card-not-present merchants who pay losses for fraudulent transactions, but those are outside the scope of this article.
A chargeback policy pays chargeback losses the acquirer is held liable for if its merchant(s) are unable to pay or do not pay. Some loss scenarios stem from merchant insolvency, fraudulent merchants, merchants bankrupted by fraudulent transactions, or merchants shut down by a regulator. The cause of loss does not dictate whether a claim will be paid; coverage is triggered when a merchant fails to pay the chargeback liability.
Just like the card brands and banks set rules for the payments industry, insurance providers set the conditions and exclusions for insurance. Dispensing with these would be akin to the card brands and banks permitting any type of merchant to be boarded without standard underwriting practices, such as reviewing financials, chargeback history or the MATCH list.
Exclusions clarify and limit a policy's scope of coverage. For example, a general liability policy will have a professional liability exclusion. This is because general liability is neither designed nor rated to cover such losses; hence the need for a separate professional liability policy. Exclusions on a chargeback policy limit the scope of coverage to transactions. If a merchant has unpaid chargebacks of $1 million, the policy covers the $1 million in transactions. Subsequent liability, however, such as being sued for damages, is out of the policy's scope and would be picked up by a different type of policy. An acquirer-level policy provides broad coverage.
That's why it's a red flag if an acquirer seeking a policy immediately brings up policy exclusions or says the coverage seems too restrictive. This indicates the acquirer has poor underwriting in place and routinely boards merchants with excessive chargeback histories. Such acquirers typically create an environment of adverse selection, eliminating controls because they have insurance, which is the antithesis of best practice and indicative of a company no insurance carrier would want to do business with.
It is essential for an insurer to know who is being covered in a chargeback policy; hence the condition of reporting. Reports include merchant identification numbers and sales volumes. While most merchant categories are automatically included without additional information from the acquirer, certain types of merchants may require additional detail before the underwriter agrees to add them to the policy.
The cost, or rate, of the policy is a function of a few factors: portfolio composition, transaction size, policy limits, deductible, underwriting practices and loss history. This information is provided on the application, which gives the underwriter a snapshot of what is being covered. Individual merchants or certain groups of merchants can also be covered as opposed to an entire portfolio.
A policy's cost can become negligible when compared to reserves and the additional revenue potential afforded by the policy. Because upfront and rolling reserves have a negative impact on a merchant's return on assets and revenue, reducing or eliminating them can help give an acquirer a competitive advantage. Additional revenue can also be achieved by exploring new verticals and increasing processing capacity while still mitigating risk. Further, merchants with reduced reserve requirements may be willing to pay a premium to do so.
As long as merchants have been previously approved or are reported to the underwriter, there is no reason why a claim would not be paid. Essentially, all the underwriter requires from the acquirer is to know whom it is insuring. Given how competitive the payments industry is, any tool that gives acquirers a competitive advantage should be explored.
Kevin Mendizabal, Director of Financial Institutions at Frates Insurance and Risk Management, specializes in the electronic payments industry. Prior to joining Frates, Kevin was part of the Financial Institution division at AIG. Previously, he held underwriting and leadership roles in the mortgage banking sphere, as well as at Bank of America. Kevin has a degree in computer science from Rutgers University. You can reach him at firstname.lastname@example.org or at 405-290-5610.
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