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Disputes and Charge Backs White Paper - Rob Hadden Unlocked

Disputes and Charge Backs White Paper - Rob Hadden Unlocked

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09/09/2010

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Cs S N
Case Study
EXECUTIVE SUMMARY 
“In the end, nobody that’s ever taken good care of the customer has ever lost; I mean that is the name of the game.”
Those words from renowned businessman, Chairman and CEO of Berkshire Hathaway WarrenBuffet should be instructive to financial institutions (FIs) struggling to regain and maintain profitability amida continuing economic storm.
 any payment, from anywhere, at any time, through any medium
For credit card issuing FIs, managing cardholder disputes is anessential part of providing excellent customer service. Indeed, itis becoming increasingly important as banks are forced to turnto their already hard hit customers to bolster profits throughhigher fees and interest rates
practices that are being lookedupon unfavorably by consumers and government regulators.The resulting negative perceptions toward the financial sectorcould potentially lead to decreased customer loyalty and,ultimately, hurt FIs’ top line growth in an already tough businessclimate. At the same time, a tsunami of issues
economiccontraction, new legislation addressing credit card lendingpractices, a rise in consumers making minimum payments,a slow down in new account openings and unprecedenteddelinquency rates
has enveloped the industry, compressingFIs’ potential profit margins traditionally generated fromextending credit, interchange fees and interest charges.Unfortunately, many FIs’ current dispute and chargebackprocesses
which begin by placing an item into disputeand end with arbitration or the initiation of a compliancecase
can be inefficient, expensive and contribute little toenhancing customer loyalty. However, if handled properlythese processes could have a significant positive impact oncustomer relations. Dispute and chargeback processes involvemultiple stakeholders
cardholders, merchants, acquiringbanks and card issuers
and are often manual and laborintensive, requiring expert resources and a keen understandingof how to interpret Payment Networks’ (the Association’s) rulesand Federal legislation affecting response time. An exampleof organizations that comprise the Association include Visa,MasterCard, Discover and American Express. Participatingorganizations establish terms for card issuing banks, merchantsand acquiring banks. Furthermore, chargeback and disputeprocessing can be an expensive proposition that requiresongoing investment to sustain technology, manage employeetraining and turnover, and ensure compliance.As the current economic environment continues to squeezeprofit margins, many FIs are missing a golden opportunityto solidify customer relationships, while at the same timemitigating risk and reducing costs by revisiting their disputeand chargeback process models. This paper will outlinesome of the reasons why now may be the time to invest in analternative model that improves the efficiency and effectivenessof FIs’ dispute resolution departments and positions themto more easily weather the changing economic and legalframeworks in which they must operate.In the sections that follow, this report will:• Provide an overview of the current industry environment whileaddressing shifts in chargeback volumes, with an emphasis onfraud-related patterns;• Outline challenges associated with differences betweenFederal regulations and Association guidelines;• Highlight potential risks that could be easily mitigated;• Identify key metrics for evaluating the success of anorganization’s cardholder dispute process, whileunderstanding the hidden costs associated with managingthe process in-house;• Explore the value proposition associated with deploying anoutsourced dispute and chargeback processing model, andidentify key factors that should be considered when choosinga service partner; and• List best practices associated with a highly efficient andeffective dispute department.
INDUSTRY OVERVIEWS U Tjc O Cs PIss Rss Cbck Rs
Consumers are becoming more budget conscious and, in aresponse to decreasing disposable income, they are shifting todebit card use in record numbers. The number of active debitcards has now surpassed that of credit cards.
Nilson reporteddebit transaction volume grew 3 percent from 007 to 008with double-digit growth forecasted through 0.
3
 Naturally, a projected increase in payment card transactionvolume
30 percent over the next five years for credit anddebit
and the revenue generated by these transactionsshould be a welcome sign for industry players, especially giventhe current market constraints.
3
However, increased transactionvolume correlates with an increased percentage of cardholderdisputes and chargebacks. From a resource perspective thedispute resolution process is time and cost intensive and riskyfor issuers, acquirers and merchants, and could reduce therevenue if the transactions are credited back to the card holder.
White Paper
Rsk Bsss: Bs Pccs  M ClDs  Cbck Pcsss  Cll Ts
 
B Rb H, TSYS M Svcs
 
2
U.S. payment card purchase volume
from commercial andconsumer general-purpose credit and debit cards
exceeded$3 trillion in 008.
4
If one applies a conservative chargebackrate of 0.05 percent to the $3 trillion, the annual value of chargebacks is estimated to be $5 billion.This hypothetical estimate is exclusive of the necessary timeand monetary resources required to support the dispute andchargeback operations.
F Dvs Dbl-D G O Dss A Cbcks
Some of the events that trigger chargebacks includeprocessing errors, products that are never delivered, low-quality products or fraudulent transactions that are notauthorized by the cardholder. Fraudulent transactions
 transactions without the authorization of the cardholder
 are one of the most common and costly reasons forchargebacks. Consumer adoption and the growth of onlinecommerce are fundamental factors.
5
 
The  CyberSourceFraud Survey
found that 5 percent
6
of chargebacks areattributed to fraud, while up to 60 percent of disputes haveresulted in chargebacks for larger entities, according tohistorical data observed across multiple VISA portfolios.According to data from 5 small- to mid-size issuers supportingdifferent payment mechanisms
consumer, commercial anddebit
displayed in Table A, a significant spike in fraudulenttransactions is evident over a  month period between008 and 009.
8
It is speculated that this trend may bepartially attributed to an increase in first-party fraud, or fraudintentionally committed by the cardholder. As delinquencyrates rise, first-party fraud does as well. A recent TowerGroupreport focused on first-party fraud reported that between 5percent and 35 percent of bad debt write-offs can be attributedto first party fraud.
7
Additionally, the research group estimatesthat “intentional cardholder losses from abuse and fraud maycost the industry as much as $0 billion.
7
 
more >>
White Paper
| Best Practices for Managing Cardholder Dispute andChargeback Processes in Challenging Times
2.
Card issuer returnstransaction to Acquirerthrough Credit CardNetwork
3.
Credit Card Networkforwards chargebackto Acquirer
4.
Acquirer receiveschargeback andresolves dispute orforwards to merchant
5.
Merchant receiveschargeback andeither accepts orrepresents it to acquirer
6.
Acquirer forwardsrepresentation toCredit Card Network
7.
Credit Card Networkreceives representationand, if appopriate,forwards it to cardissuer.
8.
Card Issuer receivesrepresentation and,if appropriate, repoststo cardholder’s account
9.
Cardholder receivesinformation resolvingdisputed transaction
1.
Cardholder disputestransaction andcontacts card issuer.
Cbck Lccl
 
3
Non Fraud Related 
Disputes 9%Chargebacks 6%
Fraud Related 
Fraud Cases%Chargebacks%
Table A: 008-009 Year-over-year % change of average monthly disputeand chargeback volumes.
8
The above data suggests average monthly dispute andchargeback volumes experienced a double-digit increasefrom 008 to 009.
8
In an example scenario, if it is assumedthat an issuer’s annual dispute volume is 80,000 and that aminimum of .5 hours is required to address the investigation,documentation and submission of each dispute. Applyingthese conservative assumptions, this volume of disputeswould require an annual minimum labor force of 6 full-time-employees, a substantial effort. In the example scenario,dispute volume experiencing 9 percent year-over-yeargrowth would require an incremental 0,000 work hours or theequivalent of an additional  full-time employees. In order tohandle the process both efficiently and effectively,this growth would entail immediate attention from highlyskilled chargeback representatives with deep industryexpertise coupled with training covering the latest industry-specific rules. An organization’s ability to scale-up quicklybecomes paramount.
INDUSTRY CHALLENGES
FIs face many challenges with their dispute and chargebackoperations. These challenges are centrally focused on ensuringcompliance and containing operational costs, two areas of inherent risk that can be managed, limited or eliminated insome instances. Furthermore, with ever-changing Federalregulations and Association guidelines, compliance can bedaunting and can present costly penalties. Many in-houseoperations continue to manage the chargeback and disputeprocess in a manual fashion, which is not only inefficient, butalso error ridden, time-consuming and expensive, resultingin a substantial negative impact to the bottom line.
Clc  R. Z  R. E
The following high-level overview of Reg. Z and Reg. E isspecific to the dispute and chargeback process for consumercredit card and debit transactions. The summaries of both of these regulations are based on the appropriate sections of theFederal regulations.
9
Regulation Z (Reg. Z), also known as the Truth in Lending Act,has undergone recent changes by the Federal Reserve Board.Reg. Z is intended to ensure fair treatment and protection tocredit card consumers. According to Federal Reserve GovernorElizabeth A. Duke, “The rule bans several harmful practices andrequires greater transparency in the disclosure of the termsand conditions of credit card accounts.”
0
Other requirementscover fees associated with exceeding one’s credit limit andthose associated with a variety of actions including, but notlimited to, subprime credit cards and unexpected increasesin APR, to protect consumers from unexpected increases incredit card interest rates.
0
Recent findings from the Pew SafeCredit Card Project claimed, “7 percent of cards includedoffers of low promotional rates, which issuers could revokeafter a single late payment.

This sentiment of protectingand treating consumers fairly extends to practices governingdebit cards. Regulation E (Reg. E) governs transactions madeelectronically, including those made by debit card. Reg. E alsoreferred to as the Electronic Funds Transfer (EFT) Act, “providesa basic framework that establishes the rights, liabilities, andresponsibilities of participants in electronic fund transfersystems, such as automated teller machine transfers,telephone bill-payment services, point-of-sale (POS) terminaltransfers in stores, and preauthorized transfers from or to aconsumer’s account.”
9
Two sections of Reg. Z directly affect the dispute andchargeback process.. Section 6.(b)(3) states, “The card issuer may notautomatically deny a claim based solely on the cardholder’sfailure or refusal to comply with a particular request,including providing an affidavit or filing a police report;however, if the card issuer otherwise has no knowledge of facts confirming the unauthorized use, the lack of informationresulting from the cardholder’s failure or refusal to complywith a particular request may lead the card issuer reasonablyto terminate the investigation.
9A
 . Section 6.3(c)() states, “The phrase two complete billingcycles means two actual billing cycles. For example, if acreditor on a monthly billing cycle received a billing errornotice mid-cycle, it has the remainder of that cycle plus thenext two full billing cycles to resolve the error.
9B
Additionally,Sections 6.3 addresses the error resolution proceduresand the requirement to complete the investigation todetermine whether an error occurred within two completebilling cycles. Section 6.3(c)() states, “Thus, for example,the creditor would be prohibited from reversing amountspreviously credited for an alleged billing error even if thecreditor obtains evidence after the error resolution timeperiod has passed indicating that the billing error did notoccur as asserted by the consumer.
9B
more >>
 
Rl Z Ovv:
>
Protect consumers from unexpected increases in creditcard interest rates
>
Prohibit creditors from issuing a credit card to aconsumer who is under the age of 21 unless certainparameters are met
>
Require creditors to obtain a consumer’s consent beforecharging fees for transactions that exceed the credit limit.
>
Limit the high fees associated with subprime credit cards
>
Ban creditors from using the “two-cycle” billing method toimpose interest charges
>
Prohibit creditors from allocating payments in ways thatmaximize interest charges 
Source: Federal Reserve Bank, Sept 29, 2009.
White Paper
| Best Practices for Managing Cardholder Dispute andChargeback Processes in Challenging Times

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