Refund fraud: what it is, why it’s increasing, and how to stop it

Refund fraud is on the rise. In 2023, merchants lost a collective $101 billion to return abuse and fraud, according to a report from the National Retail Federation (NRF). For every $100 in returned merchandise, the report said, retailers lose $13.70 to return fraud.

Below, we explain what return fraud looks like, why it’s so pervasive, and how you can prevent it.  

What is refund fraud? 

Refund fraud occurs when a fraudster exploits a retailer’s return process to get themselves money or products. Refund fraud can take many forms; here are some of the most common:  

1. Fake refund requests: These occur when a fraudster claims they never received an item or that their product was damaged upon delivery. The fraudster requests a refund while keeping the item they bought, taking advantage of the fact that some e-commerce companies issue refunds without requiring customers to return lower-cost items.

2. Stolen card refunds: In this case, a fraudster uses a stolen credit card to purchase a product, then returns that product for a refund to their own account or card.

3. Double dipping: Double dipping, also called chargeback fraud, happens when a fraudster initiates a return with a retailer, then disputes that charge with their credit card issuer, essentially getting a double refund. 

4. Empty box scam: A fraudster initiates a return for an online purchase by claiming the box they received was empty. If a company doesn't check returns thoroughly, the fraudster can get a full refund while keeping the product.

5. Price arbitrage: This occurs when a fraudster buys two similar items at different prices, then returns the cheaper item as the more expensive one. 

6. Tender liquidation: This is when a fraudster uses a stolen credit card to buy an item, then returns the item for store credit. 

Why is refund fraud increasing? 

In most brick-and-mortar stores, customers have to present physical receipts and IDs to return an item. But many e-commerce companies either skip or automate these steps, making it easier for fraudsters to manipulate the system. 

Other factors — like lenient return policies and anonymous transactions during checkout — can also make refund fraud even easier to carry out.   

Where does identity verification fit in? 

As is the case with most fraud, no single tactic is powerful enough to stop it. Most companies interested in controlling refund fraud end up combining multiple approaches. Some of these are more standard fraud prevention measures: issuing digital receipts, keeping order history records to track returns, maintaining a strict return policy, and clearly communicating that refund policy throughout — and after — the purchase process.

One of the most effective strategies for reducing fraud is implementing identity verification (IDV) at key points in the buyer lifecycle. IDV is the process of confirming someone is who they say they are. By verifying a customer’s identity at key touchpoints — whether it’s during account creation, checkout, or refund requests — you can prevent fraudsters from exploiting your company’s return policies. 

Here are three key ways IDV can help stop refund fraud: 

Related: 4 questions to consider when evaluating an IDV solution

1. Reduce guest checkout exploitation by adding friction

Many e-commerce sites let customers check out as guests so they don’t have to create accounts. But fraudsters can take advantage of this convenience, using guest checkouts to make anonymous purchases. 

With IDV tools, however, companies can ensure that guest users provide some verified information, like email addresses, phone numbers, or mailing addresses. It’s true that adding these steps does give users more friction, which may introduce some dropoff. You can, however, significantly reduce dropoff by adding verification steps only for risky transactions — if an individual submits a phone number or email address that raises flags, for example. 

Does your company have a Know Your Customer (KYC) process in place? Explore our guide to implementing a KYC strategy.  

2. Flag fraudsters at the refund request point

Regardless of the type of fraud they’re pursuing, most fraudsters have to pass through the process of either initiating a return and/or requesting a refund. Using IDV at this moment can help you identify and stop potential fraudsters. For example, you can: 

• Detect risky identities: An IDV solution can run customer details like email addresses and phone numbers against comprehensive risk databases to ensure a customer’s information isn’t linked to a previously flagged account.

• Flag risky behavior based on passive signals: IDV helps e-commerce companies track passive risk signals, like when multiple refund requests originate from the same IP address, physical address, or device. If fraudsters attempt to use different accounts or aliases, businesses can identify connections through a link analysis tool (like Persona’s Graph). 

• Identify duplicate accounts: Fraudsters often create multiple accounts with slight variations in details (like different email addresses or similar addresses), so they can request multiple refunds without drawing attention. By using IDV during account setup, companies can see when multiple accounts link to the same individual, and reduce the risk of refund abuse.

3. Reduce chargeback abuse

Many fraudsters combine refund fraud with chargeback abuse, filing a refund request and disputing a transaction through their bank or credit card issuer. Using an IDV tool helps companies dispute fraudulent chargebacks by ensuring that the person requesting the refund is legitimate. In addition to stopping the fraudster, this can help protect your company from financial losses and penalties from their payment processor.

Here’s what else you need to know about chargeback fraud. 

Fight refund fraud with Persona

In an increasingly digital shopping landscape, online returns are a necessary part of doing business. By integrating dynamic IDV into your refund process, you can give customers the seamless returns they want — while adding the friction necessary to prevent fraudsters from exploiting your policies.

For help building out your IDV strategy, check out Persona’s step-by-step guide. Or consider adopting Dynamic Flow, our customizable workflow that lets you collect identity information and adjust friction based on real-time risk signals. 

Need more support? Reach out to us any time to ask questions and schedule a demo.