AUGUST 2011 Commercial Card Liability Models: Beyond the Myths? Table of Contents EXECUTIVE SUMMARY Summary...2 Debunking the mythology..2 Market trends...4 Choice factors...5 Conclusion............ 6 Commercial card programs have become increasingly popular among US corporations both domestically and globally. Yet despite their popularity, there is still considerable confusion over the implications of using an individual or corporate liability model for a program. RJ Aiello, SVP, Senior Product Consultant at Bank of America Merrill Lynch, cuts through the mythology and outlines factors in choosing the most appropriate liability model for your commercial card program.
Commercial Card Liability Models: Beyond the Myths? 2 Summary Commercial card programs offer a number of benefits in terms of risk, control, analysis and cost. This has understandably made them popular among US corporations. Yet despite this popularity, there is still significant misunderstanding in the marketplace over liability models, to some extent caused by misinformation. Understanding the real difference between individual and corporate liability is an essential step in selecting the most appropriate commercial card program for your organization. Commercial card programs have the potential to deliver multiple corporate benefits. From a risk and control perspective, they can help companies adhere to tighter compliance with corporate travel and entertainment (T&E) and/or purchasing policies. In regards to financial analysis, they can deliver greater granularity of information on company spending patterns. And in terms of straightforward cost reduction they can be used to negotiate preferential rates with regular vendors, such as airlines and hotels. The individual liability model is often misrepresented - it does not completely absolve the corporation from all liability. One of the decisions required when establishing a commercial travel card program is the liability model to adopt corporate or individual. Both have their merits and the final choice will depend upon specific corporate circumstances there is no absolute right answer here. Unfortunately, there is considerable misinformation in this space, which often causes corporations to base the choice of liability model upon a set of largely incorrect premises. This may not only result in adopting the inappropriate model for the corporation s needs, it may also give rise to unexpected and negative consequences at a later date. Debunking the mythology Does individual liability really exist? At a superficial level, the distinction between corporate and individual liability models seems clear cut: ycorporate liability: the corporation is liable for the outstanding balance on the card Corporate liability does not automatically imply total liability - most card issuers offer a liability waiver program to help protect the company against cardholder misuse. yindividual liability: the employee (individual) is liable for the outstanding balance on the card The critical word missing from the commonly assumed definition of individual liability above is initially. The card program provider will indeed pursue the individual employee for any delinquent balance in the first instance, but if that individual cannot or will not pay, the provider will resort to the corporation for
Commercial Card Liability Models: Beyond the Myths? 3 settlement. The individual liability model does not completely absolve the corporation from all liability; it will still be the debtor of last resort. In some instances, issuers may elect to deduct the cost of employee default at year end from the program rebate. Confusion over the exact nature/extent of individual liability also gives rise to a further myth, namely that a credit review at the client level is not required for individual liability programs. In fact, credit is always needed at a corporate level so that the client can reimburse charges allowed on cards. It is important to make clear that the mythology associated with individual liability does not in any way imply that it is the wrong choice; there are a variety of reasons why it may be an appropriate choice for your organization. However, the assumption that individual liability exonerates the corporation of all liability is one of the most common false premises upon which many corporations currently base their selection. It also raises the question as to whether in the strictest sense the individual liability model actually really exists at all. The practical reality is that there is not a true individual liability model; the program provider ultimately has recourse to both the individual and the corporation when attempting to recover the balance outstanding. Liability, billing and payment are three completely separate components in a commercial card program - the use of one does not automatically assume another. Does corporate liability equal total liability? A misconception that causes some corporations to shy away from the corporate liability model is that they believe that it automatically implies that they have total liability, including for any personal charges employees incur. In practice, most card issuers offer a liability waiver program to protect companies against charges reimbursed to the cardholder but not paid, and personal charges on a card that are not paid. (Liability waivers are also available with individual liability programs.) What is the difference between liability, billing and payment? Within a card program, there are three components of the actual payment: yliability who has liability for any balance ybilling who is sent the monthly card statement ypayment who makes the payment to settle the account A common point of confusion is to assume that any one of these elements automatically implies the others. It is not unusual for corporations to assume that if their program follows an individual payment model (i.e. the employee settles the bill directly with the provider and reclaims from the corporation) it automatically also uses an individual liability model. But this is not the case. Liability, billing and payment are three entirely separate arrangements that can exist in corporate or individual forms and in practice are usually combined in any one of five ways (see Table 1).
Commercial Card Liability Models: Beyond the Myths? 4 Table 1: Possible program combinations of Liability, Billing and Payment Liability Billing Payment I I I C C C I I C C I I C I C I = Individual; C= Corporate (Note that not all providers may be able to offer all combinations) Using an individual liability model does not affect employees credit scores - only soft checks are performed, which do not appear on their credit reports. Without understanding the discrete nature of liability, billing and payment and the ways in which they can be combined, corporations risk making an inappropriate choice of liability model. The most obvious example of this is where corporations reject the corporate liability model because they assume that this will automatically leave them unable to drive accountability and be sure cardholders process their expense reports in a timely manner. This assumption is not correct. Combining corporate liability with individual billing and payment responsibility takes care of this eventuality by allowing the corporation to provide cards to employees with the limits they need to fulfill their role - while also ensuring that they comply with corporate expenses policy. Is there an impact on employee credit scores and limits? An individual liability model necessitates employee credit checks, which has given rise to the fallacy that if a corporation adopts individual liability, individual employees personal credit scores will suffer as a result of these checks (multiple credit inquiries will normally pull a credit score down). The credit checks performed for this purpose typically do not impact the credit report (so are termed soft checks), nor do any past due balances, as they are generally not reported to credit bureaus. A related myth is that cardholders on an individual liability program can set their own credit limits. Attractive as this may sound, reality is rather more prosaic; particularly in the aftermath of the credit crunch. Cardholder credit limits are established by the card issuers and are typically based on the results of the soft credit check. If additional credit is needed, corporate guarantees may be required. Market trends At present, there are two trends that may influence the choice between corporate and individual liability models internationalization and consumer privacy. Internationalization The way in which overseas markets have become an increasingly important part of US corporations strategy also has implications for the choice of liability
Commercial Card Liability Models: Beyond the Myths? 5 model. For instance, in certain European and Asian countries the individual liability model may not be available. Furthermore, the progressive harmonization of employment law in Europe appears to be driving a trend in the region towards the corporate liability model. For US corporations that use an individual liability model within the U.S. market, this situation adds a layer of complexity. Depending on the location of their overseas entities, they may find themselves having to operate two card programs one for each liability model and having to capture and manage two different data sets. Adding to the complexity, employees that relocate to other countries may require switching between programs and issuing new cards. This will also have connotations in terms of change management and ensuring that cardholders understand the appropriate policies for their card program. In certain countries, individual liability is not available - those corporations operating on individual liability in the US may have to run a separate corporate liability card program elsewhere, which may increase costs. If two liability models have to be operated, there may also be a cost implication. If local administrators manage each region where different models apply and they are only managing a single model, then costs are unlikely to change significantly. However, if a single administrator is handling all programs globally, then program administration costs will probably increase as a result of having to manage an additional program. Consumer Privacy Consumer privacy is an area in which employee anxieties can cause them to resist the use of an individual liability model, with social security numbers being a case in point. In an individual liability program, employee social security numbers are submitted to the provider so it can perform the soft credit check previously mentioned. Corporations may experience employee pushback as employees may perceive that their privacy is at risk. Employee social security numbers are not required to be submitted to providers under the corporate liability model. Choice factors The need to submit employee social security numbers to the provider in an individual liability program may cause employee pushback due to privacy concerns. There is no single right answer regarding choice of liability model for your card program. However, there are a variety of factors that may make one or the other more appropriate for your organization. Factors that may favor individual liability ylower/deferred corporate liability: the issuer will attempt to obtain payment from the individual first, which may considerably defer the point of recourse to the corporation - and the employee may actually pay in the meantime. Furthermore, issuers may elect to deduct the cost of employee default at year end from the program rebate. By contrast, in a corporate liability program, recourse to the corporation will usually be made at 90 days past due and there is no liability cap.
Commercial Card Liability Models: Beyond the Myths? 6 Factors that may favor corporate liability yease of use: under corporate liability, once the program is established, companies can quickly and easily disburse cards, as no personal credit checks are needed. RJ Aiello SVP, Senior Product Consultant Bank of America Merrill Lynch yreduced privacy concerns: as the corporation is not collecting or sharing sensitive employee data such as social security numbers, there may be fewer privacy concerns and less likelihood of employee resistance. yconsistency: if your organization is operating in countries where individual liability is not available, efficiencies/savings may be possible by operating corporate liability programs globally. Conclusion Historically, US corporations had favored individual liability programs, but this has changed in recent years. In 2004, more than 60% of corporations opted for individual liability versus around 30% for corporate liability. However, by 2009 these percentages had almost completely reversed, with 60% of corporations selecting a corporate liability program and only 35% choosing individual liability. Choice of liability model will always depend on each corporation s specifications, but the most crucial point in making that choice is to base any final decision upon fact, not fiction. 1 Source: RRMG Research Group Bank of America Merrill Lynch is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation ( Investment Banking Affiliates ), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., all of which are registered broker-dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured May Lose Value Are Not Bank Guaranteed. 2011 Bank of America Corporation. AA-AB-0355ED 09-2011