When the pandemic lockdowns started in March 2020, thousands of people suddenly had plane tickets to cancel.
Anyone stuck trying to get a refund that month remembers how frustrating the experience was. People waited hours to get an airline representative or someone from their bank on the phone just to get their money back.
The help desks at many airlines were swamped, too, because their systems weren’t built to support waves of refund requests.
As legitimate refund requests flooded in, so too did attempts at chargeback fraud. On top of having to provide extraordinary customer support, airlines had to find a way to separate legitimate refund requests from the fraudulent ones. That’s one big reason the support tickets and refunds backed up for months.
That moment in March 2020, when the first countries initiated their lockdowns, left many businesses – airlines and many others – exposed to a specific type of fraud called first-party fraud. Chargeback fraud is an example of this, but there are many other ways to commit first-party fraud.
Below, Paul Evans Subject Matter Expert at Featurespace, explores what first-party fraud is, and how you can protect your business against it.
What is first-party fraud?
First-party fraud is when someone misidentifies themselves or gives false information to appear eligible for a specific exchange of goods, services or money. Often, the person committing fraud is part of an organized crime ring.
There is a whole spectrum of fraud activity covered in first-party fraud. On one end of that spectrum, you might find a person being dishonest about their income or their employment status to secure a better mortgage. On the other end of that spectrum, you might find a network of criminals applying for loans or lines of credit that they never intend to pay back.
How does first-party fraud occur?
First-party fraud is often deliberate and opportunistic. Whether committed by an individual or a criminal organization, the first-party fraudster seizes a chance to misrepresent themselves or their intentions for financial gain.
Sometimes, however, the fraud can be accidental. A common example of this is when a child places an order – e.g., they buy a game on their phone – and the parent disputes the charge when they don’t recognize the purchase. The parent may then initiate a chargeback request, which ultimately costs the merchant money, even though the product was delivered as promised. You sometimes see this called friendly fraud.
The fraud gets further complicated when businesses miscategorized the event as credit loss and write the money off as bad debt. This is often due to an inability to be able to differentiate with legacy systems, rather than incorrect categorization
Types of first-party fraud
First-party fraud can take many forms. Here are some of the most common types businesses should know about:
- Chargeback fraud. This is when a customer requests a refund for a legitimate transaction that they claim they did not make e.g., a refund for a legitimate transaction that the customer claims was completed by a fraudster. Typically, the claim is made from their card issuer rather than directly from the merchant. For merchants, chargeback fraud can be expensive. Beyond the loss of inventory, the defrauded business could incur further penalties by having to pay their merchant acquirer a higher fee for processing card transactions. Similarly with payments there are instances where a customer sends a payment and then claims they didn’t, so they can have the payment refunded.
- Sleeper fraud. Also known as bust-out fraud, sleeper fraud is when a fraudster spends time building up a line of credit. They might ring up a purchase here or there and always pay the card balance on time. To the issuing bank, all appears above board, and so the fraudster gets a bigger and bigger line of credit. Then one day, the fraudster maxes out their credit and disappears.
- Application fraud. Application fraud is when someone misrepresents an important detail such as their level of income to get more favorable terms on a loan or line of credit.
- De-shopping. This is when a customer buys an item with the full intention of using it, then returns the item to the merchant for a refund as if the item were still brand-new.
- Claims of non-delivery. This is when a customer asks for a refund on a purchase that was delivered, though the customer is trying to claim otherwise.
- Fronting. In the auto insurance industry, fronting is a big problem. This is when a higher-risk driver gets added to an insurance policy as a secondary driver, when in fact they are the primary driver. Thus, their risky driving isn’t accurately reflected in the premium paid on that policy.
How does first-party fraud impact businesses?
First-party fraud negatively impacts businesses in several ways:
- Loss of inventory. When fraudsters successfully claim a chargeback or a refund, it’s ultimately the merchant who pays. The merchant must return the funds — either to the fraudulent customer directly or to the merchant acquirer — and will have still lost the item involved in the transaction.
- Risk perception. Businesses that get targeted for first-party fraud are seen as higher risk. Merchant acquirers that process those businesses’ card payments will charge a higher fee for taking on that risk.
- Customer experience. When businesses lack the right tools to effectively manage first-party fraud risk, they set themselves up for strained customer relationships. Go back to the example of the airlines in March 2020. Those businesses were trying to protect themselves from chargeback fraud. But in doing so, they damaged relationships with thousands of customers who could not get timely refunds for their canceled flights.
Solving first-party fraud
Early detection is the key to solving first-party fraud.
Because this type of fraud masquerades as legitimate customer behavior, businesses need a way to differentiate that legitimate behavior from suspicious activity.
That’s where Adaptive Behavioral Analytics comes in. This is the machine-learning technology built into Featurespace’s ARIC™ Risk Hub. Adaptive Behavioral Analytics monitors customer data and third-party data from all angles, which lets the platform learn about customer behaviors. It quickly learns which behaviors are normal and which behaviors are anomalous.
With that perspective, ARIC Risk Hub is able to separate fraudsters from genuine applicants and genuine customers.
Protect your business and your customers