Should Your Online Business Purchase Chargeback Insurance?

Should your business purchase chargeback insurance? Determining when to get just about any type of insurance can be a bit difficult. If you never use your insurance policy, you’ll be “wasting” money on premiums. On the other hand, if you find yourself on the hook for high liabilities or damages, and your insurance protects you, the money spent will have been well-invested. 

Credit cards are very popular for online businesses.

There’s one thing to keep in mind with insurance: essentially all insurance providers are in the business to make a profit. In the long run, insurance companies must take in more than they pay out. If they don’t, their business model won’t be sustainable. This means that on the whole insurance customers are paying more to insurance companies than they are getting back. 

From that perspective, any insurance, including chargeback insurance, could be seen as a bad deal. However, that’s only a limited perspective. Some parties will benefit from having insurance and the money they spend on premiums will be wisely spent. Before determining whether you should get chargeback insurance, however, I need to briefly clear up a common misconception.

Understanding the Difference Between Chargeback Insurance and a Chargeback Warranty

First, very few retailers will actually ever acquire “chargeback insurance” but will instead use a “chargeback warranty.” Chargeback insurance is actually a policy for acquiring banks to protect themselves from uncollected chargeback fees. A chargeback warranty, on the other hand, will provide coverage to companies who are hit with a chargeback. 

However, these days the terms “chargeback insurance” and “chargeback warranty” are often used interchangeably. So for the rest of the article, if I use “chargeback insurance” you can assume that I’m actually talking about a chargeback warranty. 

Most online retailers are actually signing up for a chargeback warranty, not insurance.

So should you get a chargeback warranty? Before answering that question, let’s briefly look at chargebacks and when you might be responsible for them.

So What Are Chargebacks?

Quite simply, chargebacks are “disputed” transactions. The customer claims (often truthfully) that the charge was fraudulent, a mistake, or something happened with the order itself (i.e. wasn’t received). The credit card company will then process a chargeback, transferring funds back to the customer.  Usually, the money comes out of the retailers pocket! 

Sadly, securing online transactions is no easy task.

Chargebacks aren’t meant to punish companies but instead are designed to protect customers. Regardless, online retailers often find themselves footing the costs. Let’s say you sell a $500 tablet with a $100 dollar markup. When a customer initiates a chargeback, you’ll lose the $400 spent on the tablet and also the $100 markup profit you were lined up to receive. 

Obviously, these costs could quickly add up and overwhelm a small business. That’s why some companies turn to chargeback insurance. This insurance will cover the company in the event of a chargeback, reimbursing them. Of course, insurance companies don’t provide coverage out of the goodness of their heart. Instead, they provide coverage in exchange for a fee. 

However, many chargeback insurance coverage programs are actually quite limited in the coverage they provide. Chargeback insurance rarely provides umbrella coverage and instead will only issue a reimbursement in select circumstances. If you don’t happen to meet the sometimes narrow requirements, chargeback insurance may offer only a limited value.

Let’s take a deeper look at how chargeback warranties/insurance works.

Chargeback Warranties Often Require Extra Verification

First, many chargeback warranties or insurance programs offer verification programs that will help you identify potentially fraudulent activities. This gives you, the retailer, an opportunity to approve, reject, or ask for extra verification before approving the transaction. 

Chargeback warranties often offer tools for you to verify and approve transactions.

Obviously, this provides the retailer with a  lot of control that they might otherwise lack. However, if you approve a transaction and it turns out to be fraudulent, you could be on the hook for the chargeback. After all, you gave the go-ahead.

Chargeback insurance also usually only covers obviously criminal activity, such as someone using a stolen credit card. Should you suffer from “friendly fraud” or other non-criminal activities, your chargeback insurance may not cover it. 

Friendly fraud occurs when a customer receives a product and then requests a chargeback, perhaps claiming that the product wasn’t delivered. The credit card company has no way of knowing, so they take the customer’s word for it.

Further, if you want access to a fraud filter, you don’t need to use chargeback insurance. Some companies provide fraud filters, minus the insurance coverage, usually at a lower cost. You can also use services like 3D Secure to verify transactions and in many cases to shift liability to the acquiring bank. You can also use 2 factor identification to reduce the risk of fraud.

Chargeback Insurance Involves a lot of Manual Labor

As you may have already figured out, both chargeback insurance and fraud filters often involve a lot of manual labor. You might be expected to contact the customer directly to ask them to provide additional identification. Or you might have to get on the phone with the customer to quiz them. 

Not only could this end up being very labor intensive but you could also alienate your customers. If the customer is legitimate, they probably won’t appreciate you questioning their identity. Loyal customers might even abandon your business.

When Chargeback Insurance Makes Sense

So is chargeback insurance a waste of time? Not necessarily. First, if your company is for whatever reason falling victim to a lot of fraudulent charges, a chargeback warranty may provide enough protection to justify itself. Sometimes, companies simply have bad luck. 

Also, if the value of individual transactions is high (say $300 or more), chargeback insurance may be worth both the costs and the manual labor required to process the chargeback. Either insurance or a stand alone filter may be worth it. If you’re selling expensive watches and a suspicious transaction comes through your system, it might be worth the time and effort to verify it. 

If you sell expensive watches, chargeback insurance makes more sense.

On the other hand, if your average transaction value is just $10, it might not even be worth your time to verify a transaction. If you spend half an hour trying to secure additional verification all just to lock up a $10 dollar sale, your time might be better spent elsewhere. 

Chargeback Insurance/Warranties Only Makes Sense in Some Cases

Fact is, chargeback insurance might not be all that much benefit for you and your online business. Keep the many limitations and the manual work on your part in mind. And consider alternative technologies, such as 3D Secure

This isn’t to say that no company will benefit from chargeback insurance. In fact, many of them can and will. However, you need to look at your company’s own position before assuming chargeback insurance will be a benefit.