April 30, 2002, 12:00 AM

The newest twist in reducing online fraud risk: Insurance

Two companies are offering insurance to online retailers against excessive credit card fraud.

>Retailers have a new weapon in their arsenal against online fraud: insurance policies. Two products have hit the market in the last seven months-one from Oklahoma City-based Creative Risk Management Solutions LLC and another from London-based James Hampden Insurance, both of which tout the usage of neural networks to identify fraud trends. And the James Hampden company just released an enhancement to its product.

Big fraud hits, including the highly publicized one that brought down online currency company Flooz.com last year, have spiked demand for such coverage, observers say. “Almost three years ago we started getting more merchants asking about this kind of coverage, but it was considered hazardous,” says Tom Mulligan, president of Creative Risk Management Solutions. “So we started to look at how we could protect the merchant as well as mitigate losses on the insurance side. The ideal situation is to have multi-level fraud protection that includes a neural net system.”

The insurance has proven necessary because, Mulligan says, no anti-fraud system is impregnable with today’s online crooks. “Fraud detection systems and business rules to prevent sketchy transactions from occurring are not fool-proof,” Mulligan says. “Fraudsters are not afraid of Verified by Visa or any other anti-fraud system. Tomorrow, they could figure out a way to crack any system. With this type of insurance, the merchant is covered regardless of what system they use.”

The Web Merchant Guard policy covers the online merchant for unauthorized credit card charges in the cases of forgery and theft. Merchants must submit their fraud score from a neural net system in order for Creative Risk Management’s carrier, AIG International, to determine the merchant’s premium.

The cost of the Web Merchant Guard insurance ranges from 3 to 10 basis points of annual sales, Mulligan says. Hartford, Conn.-based RC Knox & Co., the insurance agency subsidiary of People’s Bank, is selling the Web Merchant Guard product as part of an insurance package. Two undisclosed retailers-an online seller of consumer electronics and a multi-channel clothing retailer-are using Web Merchant Guard, which the company launched in December.

In another development, Hampden Insurance announced in April that it will reduce premiums by up to 25% for retailers who use ClearCommerce Corp.’s ClearCommerce Risk Management software. It has been offering the insurance since October. The insurance reimburses merchants for the value of goods or services lost, shipping costs, plus any penalty charges imposed by the card companies and acquiring bank for unusually high occurrences of fraud.

“This is a nice little coup for ClearCommerce,” says Ken Kerr, senior research analyst in the financial services practice of the Stamford, Conn.-based Gartner Inc. “The fact that an insurance company would endorse its product is good validation.”

James Hampden says the ClearCommerce Risk Management solution was attractive because the terms of the insurance policy itself can be integrated as screening rules, highlighting for the business when a transaction falls outside of the policy terms In particular, ClearCommerce’s product allows retailers to screen out transactions from certain countries that have an established high risk for online fraud, says Katherine Hutchinson, vice president at ClearCommerce.

“So far, the most interest in the product has come from retailers who have already been hit with fraud,” says Hutchinson. But, she notes, online fraud is a growing problem. “Online fraud is a very real problem and it’s getting more sophisticated,” she says. “Online businesses need this balance sheet protection in order to stay in business.”

While online fraud insurance can help merchants recover from instances of fraud, analysts reiterate the need for multiple anti-fraud measures. “Even if you go with insurance, you have to have other things to protect yourself online,” says Kerr “It’s not an either/or choice.” m

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