Are Free Credit Scores Just the Beginning?

The credit card industry is adjusting to a new reality in which extra services like credit monitoring and identity theft protection comprise a smaller piece of revenue.

The main reason this once-lucrative business has dwindled is well understood: the Consumer Financial Protection Bureau has cracked down hard on deceptive marketing practices.

But today a second factor is adding to the troubles of ancillary credit-card products: consumer-oriented websites have begun to offer similar services for free.

Two California companies, Credit Karma and Credit Sesame, currently offer free credit monitoring to their registered users. Earlier this month Credit Sesame began providing a free identity theft protection service, as well.

"The trend is definitely moving toward free, rather than fee-based," says John Ulzheimer, president of consumer education at Credit Sesame, based in Mountain View.

Credit Sesame and San Francisco-based Credit Karma were among the early providers of free credit scores to consumers - they're able to do so because consumer lenders are willing to pay them for leads on new customers - and they are following a similar playbook again today.

Visitors to these websites provide some biographical information, but not a credit card number, and quickly get access to a range of data about their credit profiles. If they've signed up for free credit monitoring, they receive periodic email or text alerts when events that could affect their credit scores get reported.

Credit Sesame's free ID theft protection product includes a monitoring service and, in cases where a user's identity is stolen, access to specialists who will offer help, plus $50,000 in identity theft insurance.

Customers of Credit Sesame and Credit Karma also get shown ads for a range of consumer financial products. When they sign up for a new credit card or auto loan, the websites get paid a referral fee.

Some observers have questioned the value of services like credit monitoring and identity theft protection, but it's harder to lodge an objection when consumers get them for free.

Credit Sesame Chief Executive Adrian Nazari expects that credit monitoring and identity theft protection will eventually be offered at no charge by more providers. "We think that's going to be the trend," he says.

If the card companies do eventually start offering free credit monitoring and ID theft protection, it won't be the first time they followed the lead of websites like Credit Sesame and Credit Karma. In recent months, Discover Financial Services (DFS), Capital One Financial (COF) and Barclays have all begun offering free credit scores to their U.S. credit card users.

Most observers believe that pressure from regulators was the most important factor in the card industry's shift toward free credit scores. But the free scores from Credit Sesame and Credit Karma, as well as from competitors Quizzle and Credit.com, may also be having an influence on the card companies.

"The fact that you can get so many competing scores for free, and you have been able to for some time, to some degree forced them to evolve," Ulzheimer says.

Already, the card issuers have begun competing over the bells and whistles they've added to the scores they're offering to consumers. Discover touts its free financial management tools, while Capital One points to its model for simulating how changes in consumer behavior will affect their scores.

"I think that they just can't worry about the revenue model right now," says Ian Cohen, chief executive officer of Credit.com, referring to card issuers that have begun offering free credit scores. "And I think that's what they think, too."

Cohen envisions a day when credit card companies compete head to head over which offers the best consumer-education tools, in much the same way they compete today over card reward offers.

He notes that already the card companies are using free credit scores as a way to persuade their customers to register online, which drives down the issuers' costs, and provides more opportunities for the companies to make cross-selling offers. So there may eventually be a way for the credit card companies to monetize free services, much as companies like Credit Karma and Credit Sesame have already done.

For now, the big card companies aren't giving up on the substantial revenue they've traditionally derived from credit monitoring, ID theft protection and other extra products.

Some issuers have continued marketing the products to new customers, despite a series of costly enforcement actions by the CFPB. Other companies, including Discover, have stopped marketing, but continued to offer the products to existing customers.

Discover Chief Executive officer David Nelms said in a recent interview that the Riverwoods, Ill.-based company will eventually resume marketing the ancillary products, once it feels comfortable that it can do so responsibly.

In September 2012, the CFPB ordered Discover to refund $200 million to customers who unknowingly purchased card-protection products over the telephone. Discover's annual revenue from protection products dropped from $428 million in 2011 to $350 million in 2013.

Nelms believes that the company's revenue from ancillary products can stabilize once marketing resumes, but he expressed uncertainty about whether growth will resume.

Given the changes in the marketplace over the last several years, other observers doubt that the card companies will be able to put the genie back in the bottle.

"Gone are the days where banks can really advertise these products as quasi-free products and charge for them," says Kenneth Lin, the CEO of Credit Karma.