Disaster #11 - Getting the Math Wrong
Part 11 in a series: Disastrous Debt Interactions
Financial executives, lenders in particular, tend to be good at math. Lenders were among the first to use a complex algorithm to manage their business: the FICO score invented by Bill Fair and Earl Isaacs in 1956. In fact, I can think of no other business so proficient in their use of data as the credit industry.
All that said, lenders can make math mistakes – or simply fail to apply their good math skills - and one place this happens is managing the unhappy situation of delinquency. Here are some “bad math” examples I’ve observed over the past 18 years at PCS.
Mistake #1. “Delinquency treatments don’t work most of the time.”
Let’s say you came up with a new cancer drug that just didn’t work most of the time. A failure, right? But, what if it did work in a minority of cases; for 1 in 5 patients, in fact, it resulted in a complete cure. You’d win the Nobel Prize, of course, for cutting cancer mortality 20% and saving millions of lives!
Wouldn’t it be a success to cut your bank’s credit losses by 20%, 15% or even a measly 10%? (For an example of how we get to 20% see #2 below.)
Mistake #2. “Most treatment responders would ‘self-heal’ anyway.”
This is another “most” fallacy. See the example below showing 20% savings even if a treatment doesn’t work for “most” debtors, and even if “most” who do respond would have paid anyway.
20% savings — even if most debtors don’t respond, and most of the ones who do, would have ‘self-healed.’
Mistake #3. “It’s just kicking the can down the road. Heal an account now and it will just go delinquent again later.”
We won’t go into more numbers here, but it’s not a big stretch to conclude that — even if most delinquencies do recur — you’d still come out ahead with a treatment program, unless the “recidivism rate”were practically 100%. That’s because the cost of the program is such a small fraction of the potential credit loss.
Also here’s something to be said in favor of kicking the can down the road right now while we’re in the Covid crisis: the pandemic won’t disappear, but next year the economy’s likely to be in better shape than it is now.
Mistake #4. “Focus treatments on the most seriously delinquent.”
Lenders have a bad habit of rewarding bad habits. What do I mean? Pay just a few days late, and you have to fight just to get a $40 late fee waived. But, blow off a whole half year of payments, and you’ll get a big fat settlement offer wiping 40%, or more, off the bottom line. I say that’s madness, but here’s what the data say: pre and early-delinquency treatments can raise the most money.
A few years ago, PCS analyzed results from five delinquency treatments – targeting pre-delinquent, early, mid-stage, late stage and charge off segments – from a very large universe of 1.3 million credit card accounts with $6.8 billion in receivables. Here’s a chart showing how the data came out
Late stage treatments gained more per account, but early stages earned by far the most overall: nearly 60% of total loss savings….
Overall, the early stage treatments saved over $330 million in credit losses — over 60% of the total savings from the entire range of treatments. This is true even though the typical early treatment saved less than $100 per account, while treating a late-stage delinquent account saves in the thousands.
…because there are usually a lot more early stage delinquencies to begin with
The reason? At any one time, there are usually a lot more early stage delinquent accounts to begin with.
Why else should you prioritize early stage treatments:
1) Early stage treatments use much smaller incentives; for example, waiving a late fee.
2) The earlier you treat delinquency, the more likely you are to save the customer, and the more likely your customer is to save their credit.
No we don’t think you should get rid of late stage treatments such as settlement offers. To the contrary, you’ll always need them, but you won’t need them as much if you focus more on treating at the early stages.
At PCS we believe in incentive-based delinquency treatments, giving smaller incentives to more borrowers at an earlier stage. And we do the math to prove it saves you more money.