Why do High Risk Merchant Accounts come with higher fees and stricter requirements?

Due to the heightened financial risk of doing business in certain models and industries, high risk merchant accounts have higher fees and stricter requirements. While various factors come into play for risk assessment and when developing financial infrastructure, understanding the type of risk can help merchants deal with the intricate nature of payment processing.

Increased Chargebacks

High risk businesses usually have chargeback rates that are far greater than those of traditional businesses. A chargeback occurs when someone disputes a transaction; this means that the merchant must issue a return of funds and may face additional penalties due to the chargeback dispute. The chargeback rate is very industry-specific, and for many high risk industries, like travel services, entertainment, and subscription businesses, chargeback rates often surpass 1-2% (serious chargeback rates are above what may be considered acceptable industry norms (0.5-1%). Depending on the business, a payment processor may have to pay a portion of the funds as lost revenue and absorb the loss, as well as the administrative cost of submission and implementation. In turn, the payment processor will charge (mark-up) higher fees for processing, and as with risk, monitor the account more intensely.

Increased Regulatory Compliance Costs

Most high risk businesses are in heavily regulated industries. For example, merchants are subject to compliance measures, as are financial service companies that have made drastic compliance changes for anti-money laundering (AML) in recent years. Compliance can become so intense that payment processors have to hire specialized compliance teams, payment monitoring systems, and staff attorneys to navigate the legal landscape of compliance to changing regulations over time. Regulatory infrastructure costs are generally passed along to merchants as increased fees. And in many high risk industries, the risks for staying compliant only get higher.

Fraud Prevention and Risk Management

High risk merchants present abundant opportunities for fraud. Whether it is because of the industry, business model, or demographic, fraudsters gravitate towards high risk merchants. Pay-to-play was attractive to fraudsters since they could exploit payment systems for online gambling. Similarly, entertainment merchants and merchants selling high-ticket items are often attractive to fraud criminals. In addition to fraud assessment and the underwriting process, processors still have to develop a fraud detection model, perform manual reviews, and assess added security. This technology, added bodies, and policy will ultimately create increased staffing and operational costs, which can lead processors to increase rates for merchants.

Industry Volatility and Financial Stability

A few industries, such as travel, have revenue volatility based on their business model that can affect their liquid capital in a short period. Travel commerce, dependent upon global affairs, may plunge in a period of weeks. Subscription services must successfully retain customers, or the revenue stream will quickly diminish. Revenue volatility will naturally bring closure of merchant accounts, disputes, and write-offs for processors. To reduce risk, payment processors apply more stringent underwriting, higher reserves, and increased processing rates to take into account the lack of reliability in revenue from the merchant.

Limited Processing Options

There are limited options for processing payments available to high risk merchants, which creates a less competitive situation. Traditional payment processors are often unwilling to work with high-risk businesses, which may leave them beholden to specialized, high risk processors. When there is less competition available to the best high risk merchant account, it is expected to see higher fees and stricter rules, as these merchants have limited choices when negotiating contracts.

Reserve Requirements and Impact on Cash Flow Payments

In addition, payment processors often require high risk merchants to maintain rolling reserves or holdback funds to cover any potential chargebacks or disputes. Typically, rolling reserves or holdback payments can range anywhere from 5-20% of their monthly processing. These rolling reserves and the impact on cash flow can be substantial. In addition, managing the administrative tasks from the billing department side adds additional operating costs, which, in turn, payment processors essentially recover with higher fees and complicated contract policies.

Conclusion

The higher fees and stricter requirements of high risk merchant accounts are in response to the legitimate financial risks and operational challenges that payment processors will incur when dealing with high risk merchants. As prospective charges or losses can seem significant, they will desperately need to have these approaches to protect against merchant fraud or other forms of loss. Education and learning about some of the underlying factors will better enable a merchant to budget accordingly, and to work adequately with their payment processors to minimize risk and improve their financial management.