Developing a Strategic Roadmap for Automated Underwriting

Presented by Mike Gardner on Wednesday, April 29th 2015 for:

MAC is an organization of Bankcard professionals involved in the risk management side of Card Processing. We have members from Banks, ISOs, Card Associations and

others related to the risk management side of the industry. MAC’s mission is to strengthen the payment ecosystem through ongoing education, communication and

cooperation among acquirers, card brands and enforcement agencies.

Mike Gardner is CEO of Recombo Inc – the makers of Agreement Express, a SaaS based automated onboarding and underwriting solution for the financial services industry. Since joining Recombo in 2005, Gardner has evolved the product into a solution trusted by Fortune 500 financial institutions and top global acquirers. Prior to joining Recombo, Gardner, a 20-year veteran of the software industry, spent six years at Cayenta – an international ERP software vendor for the utility and public sector markets. Between 1998 and 2004 Gardner led Cayenta to profitable growth through challenging economic conditions. His past experience has taken him through several firms including Canadian Pacific (Interlink), Cryptologic, and Price Waterhouse Coopers. Mike has an MBA from Queen’s University, in addition to advanced education in Economics, Statistics, and Business Economic Decision Support Systems.

Mike Gardner CEO, Recombo

Today’s headlines are increasingly frightening…

On March 27, CardFlex Inc., and its principals Andrew Phillips and John Blaugrund, settled FTC charges that they illegally processed more than $26 million in unauthorized consumer charges on behalf of a company called I Works. • CardFlex, Phillips, and Blaugrund are prohibited from acting as a payment

processor, ISO, or sales agent on behalf of several categories of merchants • There is a $3.3. million judgement imposed against CardFlex and Phillips.

Before you say it will never happen to you remember…

The defendants provided I Works with full access to payment networks and did not engage in required underwriting processes when they opened I Works accounts

“You can measure opportunity with the same yardstick that measures the risk involved. They go together.”

- Earl Nightingale

What you will learn today:

1. What the ETA Guidelines for underwriting can do for

your organization

2. How to develop an automated underwriting roadmap based on the ETA guidelines

3. How your underwriting team can contribute to your growth strategy

4. What a strategic underwriting scorecard evaluation looks like

5. What your organization needs to do to move towards automating underwriting

But before we begin…

Most organizations today are underwriting with people, doing a largely manual assessment, to determine if merchants fall into a “bucket” of Pass, Fail or Monitor.

If you try and move from this, directly to automated underwriting, you’re in for a long hard road

• The ETA (Electronic Transactions Association) is the trade association representing the payments market. In 2014 they published a 109 page document providing guidelines for merchant and ISO underwriting. It is important to note that the ETA does not set policy for its members, it provides recommendations. Members are not required to adhere to the guidelines provided.

The ETA Risk Guidelines

Setting the Stage

• Statement of Intent: Organizations applying the ETA guidelines are expected to have a “statement of intent”. In this they declare what types of merchants they desire to do business with, and by that virtue those that they do not. This Statement of Intent should guide the particular Payment Co’s underwriting configuration.

• Underwriting vs. Monitoring: The ETA guidelines cross the divide between underwriting new merchants (score card) and monitoring existing merchants (re-scoring). Emphasis of this presentation is on Underwriting New Merchants.

• Restricted vs. Prohibited Merchants: There is a material difference between a Prohibited Merchant (a merchant that should be blacklisted) and one who is Restricted; be careful not to mix them up.

Underwriting Objectives

• Identity – Know the identity of the merchant and business owners

• Validity – Confirmation you know the business the merchant is really in

• Legitimacy – Ensuring the business is bona-fide business

• Financial Acceptability – Determining if the merchant fits the financial constraints of

the firm

• Risk Level – Evaluating the level of risk associated with the merchant

Qualify

Score

Scoring Evaluation

• Prior processing history – Credit and/or Bank Card processing history

• Products or services being Sold – Seeking to identify prohibited or restricted merchants

• Methods of delivery – Used to establish risk. Certain types of delivery, or delayed delivery,

increases the probability of chargeback or refund

• Type of business and how they conduct business – Seeking to identify high risk or prohibited merchants

Underwriting Policy Application

• The ETA recommends firms employ an underwriting process that has the following attributes:

• Timelines (SLA’s) for underwriting evaluation are established

• High Risk or Restricted Merchants are evaluated by more senior staff (escalation) as appropriate

• Title and/or Position of ALL approvers are captured during underwriting

• Escalation processes/criteria are documented

• The underwriting process is documented and auditable, as well standardized as much as possible.

Why follow the ETA Guidelines?

• What’s really good about the guidelines – Comprehensive

– Create a defensible framework

– Safety in numbers

• What’s the challenge with the guidelines – Not easy to fully automate

– Directional in nature but not prescriptive

– Danger of over specification of risk model

Developing your Roadmap

15

People are People

• The most “unfair” assumption you can make is that your underwriters are all coming to the same conclusion every time.

• No two underwriters are going to underwrite exactly the same way so don’t expect them to!

Crawl, Walk, Run

Statement of Intent Process Flow

Evaluation Criteria

Assisted Scoring

Increased Automation

Automated

Underwriting

Crawl, Walk, Run

Process Flow

Evaluation Criteria

Assisted Scoring

Increased Automation

Automate the flow to create a consistent, auditable process

Codify each data-point into a weighted numeric value

Tune and adjust automated score values to match manual evaluations

Monitor and adjust while replacing manual feeds with automatic

Why not straight to auto?

• It’s faster to get to “close” than to perfect

• Your underwriters probably won’t have the faintest idea how to codify some of your existing underwriting elements (and that’s OK)

• You don’t want to invest in integrations until you know you’ve got the right mix of services

Contributing to Growth Starts with Evaluation

Once you begin to collect scores you will begin to develop a profile of your merchant applicants

Too Risky to do Business With

Risk isn’t a point – it’s a range. A risk score is just an ESTIMATION of risk with a margin of error, and your risk threshold is also just a theoretical point. In reality you MUST look at a range High Risk

Low Risk

Your Threshold of Risk

0 100 Your Risk Score

The picture that emerges will tell you a lot about your business and your underwriting

Risk Tolerance is set too high OR

Sales are being too conservative

Risk Tolerance is set too low OR

Sales are being too aggressive

Consider the following:

How much time, if any, is your organization spending reviewing the merchants you declined, rather than looking for new merchants?

Before Full Automation

Remember that underwriting is like a court room; your merchants are presumed innocent, and your underwriting team is a prosecuting attorney

As the case stacks against merchants, the closer they come to your risk threshold

Rep

uta

tio

n

45

pts

Del

iver

y M

eth

od

68

pts

Val

ue

20

Pts

Reputation 45pts

Delivery Method 68 pts

Value

20 Pts

Iden

tity

75

pts

Sorry, too risky

High Risk

Low Risk

Your Threshold of Risk

0 100 Your Risk Score

But when we use lots and lots of data sources in our underwriting, we increase the probability that our data potentially “overlaps.”

This is a “specification error” and I can almost guarantee that if you’re scoring, you’re over specifying.

If we COULD calculate that overlap area (which we can’t), and we took out that double counting, we’d find our merchant is actually within our threshold of risk – but we turned him down!

Reputation 45pts

Delivery Method 68 pts

Value

20 Pts

Hey, I’m not risky; I’m a false positive.

If you’re declining merchants “on the margin” it’s costing you money. Do Your Own Math:

Assume the following: • Average monthly value of a merchant $2500

• Average merchant applications per month 100

• 80% of merchants get approved

The cost of false positives in your risk model:

5%: $30,000/annum

15%: $90,000/annum

25%: $150,000/annum

As you tune your underwriting model you are looking to do the following:

• Match your risk threshold of your calculated scores as close as possible to the threshold your underwriters are manually approving/declining

• Observe and analyze the shape of the distribution of your underwriting scores to see what it tells you about your business

• Determine if your model is properly specified, and if your risk threshold is appropriate

• Assess which services you should be using (and therefore automating) to minimize your model complexity and cost

The ETA recommends that companies maintain an “agile approach to underwriting…constantly reflecting improvement”.

If you rush your automated underwriting process you will either be leaving money on the table, or assuming too high of a level of risk

One Step at a Time

Statement of Intent Process Flow

Evaluation Criteria

Assisted Scoring

Increased Automation

Automated

Underwriting

Remember that prescription without diagnosis is malpractice! Get better first, not just faster

To learn more about Rapid Customer Onboarding, and how it impacts and shapes underwriting in the payments market, come visit us at www.recombo.com or contact me directly at mgardner@recombo.com

To access the ETA Risk Guidelines visit www.electran.org

Thank you!

MAC Mission Statement

Strengthen the payment ecosystem through ongoing education, communication and

cooperation among acquirers, card brands and enforcement agencies.

Who we serve: Acquiring Bank

Acquiring Savings & Loan

Acquiring Credit Union

Gateway Provider

Internet Service Provider

ISO/MSP

Merchant Acquirer

Processor

Risk Management Professional

Your membership in MAC is an investment that should not be overlooked.

If you are not a member of MAC… JOIN TODAY!

https://www.macmember.org/