As economists and government officials declare the recession over because of an artificially funded rise in GDP, the orphaned byproduct of the downturn - high unemployment - remains alive and well and will extend its tentacle of impact on consumer collections for many months.
The question is, how long will high unemployment be the norm in the United States? Opinions range wildly but data from the last two months indicates that unemployment has leveled out at around 10% on a national average. The economy, however, remains in a precarious state that, at a minimum, should lock unemployment and underemployment at a relatively high percentage for some time to come.
The Unemployment Hangover
Normal economic drivers such as consumer demand generally influence unemployment cycles but unemployment tends to slope differently and have a “hangover” effect after other economic indicators level out or recover.
The credit crunch and lack of credit availability around the housing sector reduced a number of real estate and adjacent purchases, driving down demand. Consumers were not re-financing their homes to make big-ticket purchases because refinancing credit tightened and the property valuations were at a level that disallowed this practice, which was common in the preceding years.
This lag in demand quickly trickled into many other markets and ultimately initiated the current unemployment downturn. However, even with the recent upturn in GDP, employment scenarios are going to lag as businesses continue to be weary of the general volatility of the economy and are not investing as they did before the downturn. Further, forced to reduce workforce size, many businesses simply learned to operate more efficiently with less, which has positive margin ramifications.
With 10% of the nation’s workforce jobless and countless others earning less due to reductions, non-reported unemployment and underemployment, one of the legs of the consumer capacity to pay chair has been unceremoniously broken. However, this is not the first time that the collection and recovery industry has had to entertain this sort of unemployment volatility.
In the recession of the early 1990s, unemployment topped off north of 8%. In 1975, unemployment ranged from 8.1% to 9.0 %. From 1982 to 1983, the longest bout of sustained high unemployment post-1950s, unemployment ranged from 8.3% to 10.8%.
One statistical note about the unemployment spike in 2009 is that it was both sudden and deep; specifically, unemployment jumped nearly 25% from the start of 2009 to the end of it, which is the strongest 12-month unemployment surge in recorded U.S. history (unemployment in 2009 ranged from 7.7% to 10.1%).
How Will Collectors Offset Unemployment?
What does this mean to the collection and recovery departments of consumer credit organizations and collection agencies? What is the impact of unemployment and how can collectors best offset the negative ramifications of high unemployment?
The biggest impact of high unemployment is the negative consequences that it has on a consumer’s capacity to pay. Income from working is one of three primary factors of determining a consumer’s capacity to pay.
A lot of intelligent people have tried to provide enhanced analytics and complex algorithms to explain the collection environment. But, at its core, collecting is the intersection of contacting a consumer, delivering a targeted collection message, and doing both at a time when the consumer has the capacity to pay.
The first two points of the consumer collection intersection will be covered in future columns but, for now, let’s zero in on the third point— capacity to pay. Capacity to pay indicates a consumer’s availability of or access to funds to pay for a debt. It is important to note that there is a difference between capacity to pay and willingness to pay. Most collectors have several routes of recourse to address willingness to pay.
There are three contributing factors to a consumer’s capacity to pay. First, employment or income; a person’s income is sometimes not sufficient to pay an account in full but it is a steady stream solution for an outstanding debt.
The second component of capacity to pay is assets. Assets are things of value that can be readily converted into cash. In the collection space, this has historically meant savings or investments, such as a 401k or equity in a home.
The third, and final, component of a consumer’s capacity to pay is credit; or more specifically, the consumer’s ability to secure credit to pay off debt.
Unemployment rates have been higher at other times in our economic history but the current unemployment scenario is more of a sting because consumers are dealing with multiple challenges in addition to the employment situation.
More specifically, assets have been negatively impacted; most notably by reductions in home valuations. Some geographic regions are obviously affected worse than others but it is now very hard for a consumer to have significant equity in their home (compared to the not-too-distant past) and be able to actually leverage that equity if it does exist.
In addition to high unemployment and negatively impacted assets, consumer credit is still contracted. More so, the availability of credit for consumers trying to manage their way through a compounded high debt/unemployment scenario is virtually non-existent. Additionally, certain regulatory measures have been enacted via credit reform that challenges consumers managing debt cash flow through other credit lines.
The unemployment situation, combined with a reduction in assets and available credit, greatly diminishes the consumer’s capacity to pay. It is this lethal combination that reduces liquidity and extends delinquencies.
While this does not paint a rosy picture for collectors, there are some tools available that can help minimize the impact to profits and collections.
Like collections in general, most things start pre-delinquency. Creditors need to be conscientious to secure up-to-date employment and income information at all natural touch-points with their customers so that they can begin to build a capacity-to-pay scorecard. Creditors can take proactive steps even before delinquency to curb the impact of a consumer’s decreased capacity to pay.
In addition to securing more data relative to consumer employment, creditors and collection agents should more strongly consider geographical elements - such as regional job availability and foreclosure rates - when segmenting their accounts and building their scorecards.
In the past, creditors monitored consumer inquiries to determine if they were at risk of losing a customer and risk groups monitored consumer performance with their other creditors; the latter being more important than ever.
Billing cycles, available credit per card, and interest rates have a lot to do with the delinquency sequencing that consumer’s experience. Therefore, if a creditor is alerted that a customer is in trouble with another account, that should not only factor significantly on their scorecard, but also be a call for immediate review and treatment consideration.
Customer or account segmentation is also critical. The day of adhering to a time-based “bucket” system of delinquency has passed. All accounts should be segmented by their capacity to pay and probability of collections or recovery.
Lastly, collectors want to review, and where appropriate modify, treatment strategies to align them with current economic scenarios. Aggressive settlement plans, non-standard partial payment arrangements and other flexible methods of term modification will pay dividends for collectors in comparison to the returns seen with business-as-usual practices.
Make no mistake, high unemployment is going to likely enjoy a lengthy stay within the U.S. economy and when coupled with reductions in equity and assets and a long-standing credit contraction, will have a powerful and lethal impact on a consumer’s capacity to pay.
Simply but assuredly, this means that collectors are going to have to be smarter and more flexible then they have ever been through this economic cycle.
Dan Buell is the vice president of Credit Services Marketing at Experian.