Stemming the Tide

Yet another unwelcome effect of the Covid-19 pandemic is a wave of chargebacks. What can acquirers, merchants, and issuers do to limit the damage?

An increasingly serious manifestation of the economic damage caused by the Covid-19 pandemic is chargebacks, and plenty of them.

With the outbreak freezing the economy for most of the spring, consumers canceled trips and tickets for entertainment events. They looked forlornly for goods they had ordered but never received. Others kept getting billed from gyms and other recurring billers that had closed.

In these and many other instances, consumers often couldn’t reach an agreement with the merchant about a credit or refund and instead initiated an expensive chargeback.

“I can tell you we definitely see chargebacks are up,” says Johan Gerber, executive vice president of cyber and security products at Master­card Inc.

PSCU, a St. Petersburg, Fla.-based credit-union service organization serving 1,500 institutions, had seen a 22% rise in chargebacks among its card-issuing members shortly before the pandemic hit, an increase driven mostly by fraud moving to online channels as a result of increased EMV chip card usage at the point of sale, according to chief risk officer Jack Lynch. But now PSCU is bracing for an even bigger increase.

“Now we’re heading up to the higher 35-40% range,” he says.

‘A Massive Loss’

What’s more, the nature of chargebacks has shifted. Until recently, fraud was the most common chargeback reason. “Now we see non-fraud chargebacks as the dominant form of chargebacks,” says Gerber.

Mark Standfield, president of Midigator LLC, a chargeback prevention and reduction firm based in American Fork, Utah, describes the recent chargeback trends and experiences of some of his merchant and payment-processor clients as “seriously out of whack,” “off the charts,” and “catastrophic.”

The worst hits are being absorbed by travel-and-entertainment merchants, which have high chargeback exposure because they typically take orders well ahead of providing the service. Most of Midigator’s T&E clients are online booking sites, agencies and ticket brokers.

“A couple” already have gone out of business, says Standfield. Another had been refunding customers until its bank stopped that practice because no new deposits were coming in. That set the stage for more chargebacks.

“It’s going to be a massive loss for them and a massive loss for the acquirer,” he says.

Many credit card issuers with travel-oriented rewards cards “are seeing pretty marked increases” in chargebacks, adds Trace Fooshee, a senior analyst at Boston-based research firm Aite Group LLC and the former head of fraud strategy at SunTrust Banks.

One driver of chargebacks was the refusal of many consumers who had canceled travel reservations to accept credits for future travel. “Immediately, people weren’t wanting credits, they just wanted their money back,” Lynch says.

Beyond the travel industry’s woes, many retailers struggled to fulfill a tide of online orders from stuck-at-home consumers. For various reasons, sometimes the goods didn’t arrive, Lynch says. Some short-staffed online retailers also had trouble handling returns, generating more chargebacks.

And chargebacks on recurring payments for gym memberships “just skyrocketed” when gyms kept billing customers after they closed, says Lynch, who also holds the title of CU recovery president at PSCU.

Besides gyms, chargebacks have increased from recurring billers ranging from parking garages to dancing schools to child-care centers, according to Gerber.

‘Friendly Fraud’

How to resolve chargebacks, and who is financially responsible for them, is the subject of lengthy network rules. Compliance with Federal Reserve regulations to protect cardholders also comes into play.

Excluding costs to merchants and acquirers, a single chargeback costs a card issuer $25 on average to process, according to a recent Aite report based on interviews with 1,004 consumers and executives at 10 large North American credit and debit card issuers as well as some large e-commerce merchants. Aite estimates issuers’ chargeback costs at $690 million this year, and they’ll grow about 15% annually to $1.05 billion by 2023.

Fraud has played a role in the recent chargeback surge, including “friendly fraud” in which the fraudster is not a hacker or unknown criminal, but the cardholder himself or a someone working with the cardholder. In the wake of Covid-19, some consumers initiated chargebacks on goods they claimed hadn’t come, but the merchant had tracking information saying they had, according to Lynch.

“That also fits back into that friendly fraud thing,” he says.

In fact, the Aite report says friendly fraud “represents a substantial portion of disputes.” Among eight reasons presented for stopping their use of a card or person-to-person payment service, some 16% of the consumer respondents answered, “I disputed a transaction that was mine.”

To ease merchants’ burdens, Mastercard and Visa Inc. this spring temporarily relaxed some of their chargeback-related rules and fees. Both networks said they would not put certain T&E merchants into chargeback-monitoring programs until July 31, according to a Midigator blog post. Merchants get placed into such programs when their chargebacks exceed set thresholds.

Visa also suspended placement of T&E merchants into its fraud-monitoring program until the end of July, and the attendant fees. Mastercard suspended fraud-monitoring fees for e-commerce merchants until Sept. 30.

“Everybody is struggling with the unknown,” says Jessica Velasco, marketing strategist at Midigator. “They [the networks] are probably doing it just to be fair.”

‘Frankenstein’s Monster’

There is plenty companies can do to prevent chargebacks, a major source of which is unclear information about purchases listed on a customer’s online card or bank statement that spurs inquiries to issuers’ call centers. More detail could deflect many of those disputes from becoming chargebacks, according to the Aite report.

“Twenty-seven percent of consumers report that, once they connected with the institution, the charge wound up being correct, which indicates that a substantial portion of call volume could be eliminated if the online statement provided more descriptive detail,” the report says.

Most cardholders did some research before calling to resolve a transaction they didn’t recognize or agree with, but only 23% of credit card holders and 22% of debit card holders called the merchant first. More than 70% of cardholders first called the issuer—the entity that gets the formal chargeback process going.

Aite’s Fooshee says confusing transaction descriptors on statements are a legacy of the imperfect translation of merchant information issuers receive from networks into something cardholders will understand.

“It’s sort of this inherited Frankenstein’s monster of data elements,” he says. “It’s makes plain-English descriptions a real headache.”

Payments firms also are deploying more technology to settle disputes before they get to the chargeback stage. Mastercard is trying to steer as many contested transactions as possible to Ethoca, a dispute-management tech firm it acquired last year.

“Ethoca is designed to facilitate cooperation among the parties, outside the chargeback process,” says Gerber. As part of that effort, Mastercard has temporarily waived merchant fees for using Ethoca, he says.

“What they’ve really done is broker between issuer and acquirer,” says Lynch.

Visa, which did not make an executive available for an interview for this story, provides a similar service through Verifi, a company it acquired in 2019.

Distracted Fraudsters

A third major tactic for reducing chargebacks is to continue attacking fraud, including friendly fraud. Aite’s Fooshee notes that despite the long-term—and with Covid-19 turbocharged—growth of e-commerce, which traditionally has been more fraud-prone than point-of-sale card payments, the level of fraud “hasn’t been as big as everybody thought it was.”

But fraud-control executives “are waiting for the other shoe to drop,” Fooshee says. That’s because many fraudsters apparently have turned their attention to new opportunities presented by the Paycheck Protection Program and related federal stimulus efforts to counteract the Covid-induced economic downturn. They’ll get back to card fraud once those programs are over, he predicts.

So when will the chargeback scene return to something resembling the normal days before the pandemic? Not for months, or perhaps even longer if people don’t stay healthy.

“I don’t think we’re going to get to pre-Covid levels until some time next year,” says Gerber. “We should see an improvement going on from here onwards, unless we have a second wave.”

 

Please Pass the Cash—Or Else

The unwelcome message some merchants are getting from their acquirers in these Covid-19 days is that they must pony up more cash to reserve against potential chargebacks.

Payments and fintech attorney Darvin R. Davitian, counsel at the Washington, D.C., office of Perkins Coie LLP, estimates 15% to 20% of his merchant clients recently have received notices from their processors that they want to at least discuss the possibility of adding to their reserves. He didn’t have figures on how many actually have had increases.

Davitian and two of his Perkins Coie colleagues recently wrote a blog post about reserves, a sensitive topic for both merchants and payment processors in the Covid-19 era. Airlines, hotels, resorts, and others that take orders well ahead of delivery of goods and services have experienced huge increases in cancellations, and many retailers have struggled with shipment delays, leading to canceled orders.

That affects their processors, which face financial exposure from chargebacks and related merchant problems.

For example, merchant acquirer Square Inc. increased its provision for transaction losses by 300% in the first quarter to $79.3 million from $19.8 million a year earlier, according to a Square regulatory filing.

But hard-pressed merchants might not have enough cash lying around to satisfy a demand for more reserves. Such demands often come with just three to five days’ notice, otherwise the processor might hold back settlement proceeds.

“The merchant may not be in a position to do that,” Davitian says. “It puts the merchant in a real pickle.”

A mid-June story in The Wall Street Journal detailed how some small merchants using Square, Stripe, and PayPal for payment processing have been hit with holdbacks—one Square merchant had 30% of its transactions held for 120 days—for extended periods to cover possible refunds or chargebacks.

The Perkins Coie post lists eight reasons for so-called reserve triggers: excessive chargebacks; material deterioration of a merchant’s financial condition; default under the processing agreement; the merchant entering into a chargeback-monitoring program; violations of payment card network rules; an increase in the merchant’s time between taking payment and fulfilling orders; compliance violations; and the processor’s determination of a merchant’s insecurity or risk.

Agreements on the amount of a reserve can vary widely, though a frequent benchmark is three times average monthly chargebacks. As usual, small merchants have less clout to negotiate than big ones.

“Basically the processor can just pick a number,” Davitian says.

But with Covid-19 still wreaking havoc, Davitian senses more processors are willing to talk with merchants about financial risks. “No matter what the rights of processors are, or no matter what the rights of merchants, it’s really in their best long-term interest to sit down and have a conversation,” he says.