Chargeback Prevention

Chargeback Insurance Pros and Cons

CB Insurance_Blog Image

Table of Contents

  1. What is chargeback insurance?
  2. How does chargeback insurance work?
  3. What does chargeback insurance cover?
  4. Are there conflicts of interest with chargeback insurance?
  5. Alternatives to chargeback insurance
  6. Are chargebacks legal?
  7. What happens if you lose a chargeback?
  8. How many chargebacks are you allowed?

Merchants have a lot of options these days when it comes to addressing the issue of chargebacks, and with the sharp increase last year in the number of chargebacks being filed, it's more important than ever for eCommerce businesses to find a way to prevent chargebacks from draining their revenue.

One of the solutions some merchants turn to in the hopes of addressing this problem is chargeback insurance. What is chargeback insurance, how does it work, and is it a good option for merchants dealing with chargebacks? Let's talk about it.

What is chargeback insurance?

Chargeback insurance is a policy that offers to reimburse merchants for the costs associated with certain chargebacks in exchange for a flat or percentage-based fee on each transaction.

Like any other kind of insurance, chargeback insurance offers to cover the big, sudden expenses in exchange for a small, regular payment.+

If you're an online merchant who is struggling with an influx of chargebacks eating into your profits, that might sound like the perfect solution for you. Unfortunately, that's not always the case.

The most common type of chargeback insurance is also sometimes referred to as a chargeback guarantee or warranty.

How does chargeback insurance work?

Chargeback insurance is typically tied to a fraud prevention tool that automatically analyzes and approves or denies attempted transactions as they're made. If the tool approves a transaction that turns out to be fraudulent, the provider will reimburse the merchant for the chargeback.

What does chargeback insurance cover?

Chargeback insurance usually only covers chargebacks due to fraud on transactions that were explicitly approved by the attached fraud prevention software, and only if the merchant followed all the provider's policies and procedures.

The end result is that only a small percentage of total chargebacks are covered by chargeback insurance. Chargebacks due to friendly fraud or merchant error won't be reimbursed.

In most cases, chargeback insurance won't cover a chargeback if the item was received broken, or was never received.  It also won't cover chargebacks rooted in clerical errors, such as being overcharged or duplicated charges for the purchase.  Nor will insurance cover delivery of digital goods, such as game applications, entertainment downloads, e-books, webinars, etc.

Download your copy of An Introductory Guide to E-Commerce Fraud PreventionThese policies also don't necessarily cover all the costs of a chargeback, and merchants must examine the terms closely to see what the payout will actually be when a covered chargeback occurs.

The other problem is that the impact of a chargeback isn't just financial. Credit card networks track a merchant's chargeback ratio, and there can be severe consequences if it climbs too high.

This isn't meant to penalize the merchant, but it is meant to reflect potential problems in the merchant's operations. Too many chargebacks suggest lax fraud prevention, repeated merchant errors, or bad customer service.

The issue with insurance, then, is that it's far from a one-size-fits-all solution. Merchants who aren't doing anything to correct chargeback problems will face serious consequences even with insurance. Merchants who do take chargebacks seriously will often have several prevention and recovery measures in place to protect themselves, making insurance a bit redundant. 

Are there conflicts of interest with chargeback insurance?

Like any insurance, chargeback insurance comes with an inherent conflict of interest. The client wants any claim they make to be paid, whereas the insurance provider wants to pay as few claims as possible.

Most people have at least heard stories of insurance companies finding every possible angle to avoid paying a claim, and many have experienced that frustration first-hand.

While chargeback insurance providers don't tend to finagle their way out of claims as often as, say, health insurance, the incentive to do so whenever possible is still there.

This conflict of interest also means that in order to reduce the number of claims they pay out, the fraud prevention tools that come with insurance will usually err on the side of rejecting any transaction that's too close to call. That means merchants may see a higher rate of legitimate customers being rejected due to false positives than with a score-based fraud prevention tool that doesn't offer insurance, but that allows the merchant to make their own decisions about what transaction to reject.

Merchants most likely to see an ROI on chargeback insurance are those with average orders of $250 to $500 or more — especially those selling the kinds of luxury items that can easily be re-sold by a fraudster with stolen payment credentials. Selling expensive goods without a high profit margin means that a single chargeback can severely harm the business, and the payout from chargeback insurance can be a lifesaver. For most merchants, however, there are better options.

Alternatives to chargeback insurance

While fraud prevention tools are something we'd recommend for most eCommerce businesses, merchants should choose the right tool for them based on its effectiveness and efficiency rather than based on any insurance it provides.

Download the eGuide, 4 Reasons to Hire a Chargeback Management CompanyAs far as chargebacks go, the way to deal with them is through a combination of prevention and recovery. Analyzing the root causes of your chargebacks can provide insight into how to effectively prevent them, and tools like chargeback alerts can stop chargebacks before they start.

Recovery means fighting any illegitimate chargebacks you receive and having the knowledge and experience to do so effectively.

If you think that sounds like an intimidating task, you're not alone. Chargebacks are complicated, which is why it's becoming more common for all kinds of merchants, from small businesses to major international corporations, to outsource chargeback management to a team of professionals.

FAQ

Are chargebacks legal?

Chargebacks are legal, so long as the cardholder is requesting a reversal due to fraud or merchant error.

What happens if you lose a chargeback?

If a merchant loses a chargeback, they lose the money from the transaction, the fee for the transaction, and any overhead from the sale. They also take a hit against their chargeback ratio.

How many chargebacks are you allowed?

Merchants should stay below 0.9%-1.5% chargebacks as a percentage of their monthly transactions, depending on the card network.


Thanks for following the Chargeback Gurus blog. Feel free to submit topic suggestions, questions or requests for advice to: win@chargebackgurus.com

Get the guide, Chargebacks 101: Understanding Chargebacks & Their Root Causes