For credit unions, an optimized credit card program strikes a balance between profit and calculated risk. One of the best ways to achieve this equilibrium is to utilize a risk-based pricing strategy, which according to the CFPB defines interest rates and other loan terms based on members estimated risk.
Employing a risk-based pricing strategy helps a credit card program maintain a solid footing in spite of rapid change and uncertainty in the credit card market. In the near term, the credit card environment faces rising funding costs, increasing charge-offs, and a growing demand for fiercely competitive rewards incentives all of which can eat away at profit and make a credit card program less successful.
Despite the benefits, risk-based pricing has traditionally been an underutilized tool for credit unions that offer credit cards because the cost of resources needed to run such a program can be daunting, especially since the credit card business line typically represents a small portion of total assets. However, when a proper investment is made, the cost of operating a risk-based pricing strategy is outweighed by the benefits which include:
- Maximized profit
- Control of calculated risk
- The ability to reward members who practice low credit risk behaviors
- The ability to serve segments of the market that are typically underserved
Defining Risk-Based Pricing
With risk-based pricing, credit unions offer different APR pricing terms based on a risk profile derived from members FICO scores, debt-to-income ratios, and employment history.
A well-managed credit card pricing strategy must go beyond the customary FICO and debt-to-income ratios to gain a competitive edge. Ideally, a credit risk profile would include past quantitative behavioral data indicators and forward-looking qualitative life cycle needs and wants.
Effectively executing this strategy requires sophisticated databases and experienced underwriting and compliance staff with the knowledge to specifically tailor to the fluidity of credit card pricing. To realize the benefits of risk-based pricing without becoming buried by expenses and compliance risk, many credit unions outsource their credit card program to third parties.
Major Regulations Governing Risk-Based Pricing
There are two major governing regulations regarding credit card pricing. First and foremost, the Equal Credit Opportunity Act (ECOA), which is commonly referred to as Regulation B. While credit card issuers can legally use a members risk profile to offer different pricing terms, the Regulation B says risk-based pricing strategy should not be confused with discriminatory lending.
The second major governing regulation is the Fair Credit Reporting Act (FCRA). Section 615(h) of the FCRA states that a notice must be sent if results are materially less favorable based on any part of the credit report (this rule is applicable to consumer segment only).
The Benefits Of Risk-Based Pricing
Utilizing risk-based pricing, credit unions can reward members who have lower credit risk behaviors with better pricing terms. These favorable terms reinforce and encourage credit card account holders low risk behavior, creating a positive cycle in which credit unions attract and retain credit-worthy cardmembers while mitigating the overall credit card portfolio risk.
Risk-based pricing practices also allow credit unions to confidently broaden services provided to conventionally underserved members, including individuals with limited credit history or higher risk factors. Leveraging database management and credit underwriting expertise, credit unions can align the controlled risk associated with this market segment with expected profit.
Additionally, credit card issuers can expect reputational benefits after implementing risk-based pricing. The positive experiences created by this pricing strategy encourage cardmember engagement and deepen relationships with credit unions.
Lets look at an example of risk-based pricing in action:
Standard Pricing Model
ABC Credit Union offers two credit card products with standard pricing at 9.99% and 14.99%. They want to keep a portfolio with high credit quality, and frequently turn down applicants with credit scores outside of their underwriting ranges. These procedures keep charge-offs low, but push the credit unions approval rate and APR below the industry average.
Risk-Based Pricing Model
If ABC Credit Union were to transition to a risk-based pricing model, they would accept applications with a wider range of FICO scores. This would increase the credit unions approval rates. To compensate for the additional risk of higher charge-offs, ABC Credit Union charges less credit worthy cardmembers a higher APR.
For less than a 10% increase in approval rating, the cost per new loan booked fell 15%. ABC Credit Union maintains a high credit quality portfolio and earns an APR closer to the industry average. Transitioning to risk-based pricing increased APR, improved potential finance charge income, and lowered costs.
The portfolio now contains some riskier accounts that may charge off in the future, but risk-based pricing weighs the risk and returns of approving these accounts so the credit union can run a profitable card portfolio. In this example, ABC Credit Union appropriately prices riskier accounts so the Risk-Adjusted APR (Average APR less Average NCL) is higher than in a standard pricing model. Plus, ABC Credit Union rewards and caters to the needs of members working to improve their credit.
Partnering With Elan Financial Services
When you partner with Elan Financial Services, your credit union can offer a credit card program with a risk-based pricing strategy. Elan has the state-of-the-art technology needed to fluidly tailor credit card program pricing in a manner that rewards members who practice low credit risk behavior and reaches a typically under-served segment of the market.
In addition, Elan offers other desirable assets for partner credit unions, such as comprehensive fraud prevention, and marketing, promotional, and training materials for members and staff. Elan assumes much of the liability associated with providing credit card solutions to members, taking that liability burden off of credit unions. Elan also takes on the compliance and regulatory burdens associated with running a credit card program, so credit unions can focus on their members.
About Elan Financial Services
For 50 years, Elan has delivered best-in-class credit card products and services to its valued financial institution partners. Today, Elan helps nearly 1,400 financial institutions manage the changing fraud landscape, using the strategies mentioned above, along with many other industry leading trends. Year after year, our partners remain pleased with the Elan solution, as Elan has seen a more than 95% renewal rate. For more information, visit www.cupartnership.com.