Credit card issuers wanting to improve profitability in the wake of the recession could get better results by looking more closely at their own fraud cases to determine what type of fraud criminals are perpetrating, new research from Experian PLC suggests.
First-party fraud, defined as fraud that occurs when consumers apply for credit with no intention of repaying funds, represents as much as 25% of total U.S. consumer credit card charge-offs and continues to outpace third-party frauds such as that associated with data breaches and card skimming, according to a new white paper from Experian.
Yet many financial institutions fall short when it comes to correctly classifying first- and third-party fraud, leading to missed opportunities in blocking potential criminal activity, Keir Breitenfeld, senior director of fraud and identity solutions at the credit bureau's Costa Mesa, Calif.-based U.S. headquarters, said.
Experian's white paper also contends many issuers erroneously lump fraud cases in with general credit card charge-offs.
The firm based its paper on data from its U.S. consumer credit files collected during 2009 from among millions of anonymous consumer credit card accounts.
"At a lot of financial institutions, fraud definitions are broad and varied and, as a result, a large segment of fraud losses are classified as defaults, which creates confusion and waste," Breitenfeld said. "Recovery efforts are far more successful when you're sending collections after actual defaulted accounts, not fraudulent accounts."
Although first-party fraud levels have stayed "fairly steady" in recent years, the problem is still significant, Breitenfeld said.
First-party fraud rates on an annual basis range from 0.75% to 1.5% of receivables for credit card portfolios, triple that of third-party fraud, which tends to range from 0.25% to 0.5% of portfolio receivables, Experian estimates.
Two main types of first-party fraud include "never pay" fraud, when a single account is exploited and never repaid, and "bust-out" fraud, when a fraudster runs up charges on multiple credit accounts in a short period of time and does not repay them, Breitenfeld said.
Perpetrators commonly commit first-party fraud by applying for credit using a synthetic identity, such as a fabricated or slightly altered true name, along with an indirect address they can monitor, such as a business address or a post office box.
Other common first-party fraud tactics include applying for credit using a genuine Social Security number issued to another person, adding a fake identity as an authorized user on an existing credit card account or colluding with a creditor to fraudulently submit a fake identity to a credit-reporting agency.
Issuers first should strive to correctly identify and define these types of fraud within their card portfolios, Breitenfeld said.
"There is a lack of consistent definitions of fraud at many financial institutions, which gets in the way of determining which cases actually are fraud and not defaults and what strategies can be applied to help block certain types of fraud," Breitenfeld said.
By applying various fraud-analysis tools credit bureaus offer that are designed to flag potential fraudulent applications, issuers can more accurately spot potential fraud earlier in the process and stop it, he said.
Such tools ideally should be applied across multiple accounts within an institution and across multiple institutions, focusing on the fraudulent identity instead of the specific fraudulent accounts, Breitenfeld advised.
Issuers also may reap better fraud-prevention results by analyzing regions where the two main types of first-party fraud occur.
Never-pay fraud rates in the U.S in 2009 were highest in southern states, according to Experian's data, with Mississippi ranking highest at 1.8% of the total studied accounts. Bust-out fraud rates were highest in the west, with Nevada ranking highest at 2.2%.
"Combining better definitions of fraud with closer analyses of regions and identities involved in fraud could create an opportunity to get ahead of a lot of fraud and also to improve collection rates," Breitenfeld said.
