On October 17 of this year, the Bankruptcy Reform Act went into effect. One of the new provisions states that consumers must receive credit counseling prior to filing for bankruptcy. While the exact impact of this requirement is still unknown, it is clear that credit counseling agencies will see large increases in the demands for their services. This growing need, along with a perceived one-size-fits-all approach to assistance as well as legislative and regulatory concerns has left this industry at a critical juncture. Credit counseling agencies now must look at ways they are conducting business and must pro-actively address these influencing market factors by adopting new ideas and solutions.

Industry Background and Trends

Credit counseling agencies have been in existence since the mid-1950's. The majority of these organizations are tax-exempt, non-profit institutions. They work with consumers to find the best solution to resolve their financial issues. These solutions can range from financial counseling (e.g. budget planning, consultation on steps to decrease spending and other advice) to arranging Debt Management Plans (DMPs).

In arranging a DMP, counseling agencies work with unsecured creditors to provide concessions to the consumer in the form of reduced interest rates, waived penalty fees and/or lower minimum payments on their outstanding debt. Additionally, the counseling agency then acts as a clearinghouse for the consumer's payments so when a single payment is made, it is distributed to all respective creditors. Industry estimates indicate that approximately 25 to 30 percent of counseling sessions result in a DMP.

Along with financial counseling and DMPs, most agencies provide financial education to the communities in which they operate. This education takes many forms such as community center-based seminars, Internet tools, along with credit usage education for youth.

Until the early 1990's, the counseling industry was relatively small. However, over the last decade the industry has experienced tremendous growth with some estimates indicating a double or tripling in size. These numbers are consistent with the growth in consumer debt seen over the last decade through the proliferation of mass marketing of credit cards and other forms of unsecured debt.

As a result of this tremendous growth, new counseling agencies whose main focus was placing customers on DMPs began to emerge. The combination of more consumers seeking counseling and the emergence of these new agencies created a flood of new DMPs being submitted to creditors.

Industry Pressures

Over the last several years and partially due to the flood of DMPs, the counseling industry has come under much scrutiny and pressure from creditors, legislators and regulators. This scrutiny has highlighted the fact that the industry is in need of change.

Creditors have begun to question the value credit counseling brings to them and have implemented measures to control costs associated with dealing with credit counselors. Creditors provide support to credit counselors in the form of "fair share" contributions. These contributions are based on a percentage of the funds dispersed to creditors by the agencies. For example, if a creditor sets its fair share percentage at 10 percent and receives a $300 payment, they would send $30 to the counseling agency. While the entire $300 is still applied to the customer's account, the portion returned to the counseling agency is a real business expense to the creditor.

These contributions are completely voluntary and as the volume of DMPs have increased in recent years, creditors have steadily lowered their fair share percentages. In the past, these percentages had been as high as 15 percent when credit counseling began and have steadily decreased to an average of 6 to 7 percent. Additionally, due to the large increase in DMP submissions, creditors also have begun to question whether all consumers submitted for DMPs are truly in need of these plans.

As one might expect, fair share contributions make up a large portion of counseling agencies annual revenue. As these contributions decrease while unit volume of consumers needing counseling increases, immense pressure is placed on agency's financial situation. These factors have the potential to reduce an agency's ability to provide community-focused consumer education programs and in-depth counseling sessions.

The potential lack of consumer education programs is an undesirable result. These programs and detailed counseling sessions were shown to have a positive impact on consumer debt behavior in an empirical study published in 2002 by the Credit Research Center of Georgetown University. Additionally, there are several studies underway involving large lenders, concentrating on specific areas of credit counseling and how they impact consumer behavior. Early results from some of these studies are expected in mid-2006.

Another pressure due to the proliferation of agencies in the marketplace is regulation. The credit counseling industry is one that, for the most part, is unregulated. While some states have regulations and licensing laws, they mostly deal with requirements for licensing that mandate that counseling agencies must have non-profit status from the Internal Revenue Service. Self-regulation has been driven by the two prominent industry associations, the National Foundation for Credit Counseling (NFCC) and the Association for Independent Consumer Credit Counseling Agencies (AICCCA). Each of these organizations has very strict guidelines for counseling operations in order to maintain membership.

While the NFCC and the AICCCA can control the actions of their membership, as new, non-member entrants have joined the market, there has been no oversight of their business practices. Some of these new entrants have engaged in questionable practices that have stimulated consumer complaints, bringing scrutiny to the industry as a whole by legislators, regulators and consumer groups. One effect of this scrutiny has been for the IRS to begin to evaluate whether or not these organizations should be classified as non-profit.

The Need for Change

All of the pressures outlined are clear indications that the counseling industry needs to take a closer look at the way it currently addresses the needs of consumers and creditors. There is a need for credit counseling agencies to apply a more empirically derived approach to servicing their customers that would allow for consistent treatment of consumers and improved operational efficiencies throughout the entire credit counseling process.

First, let's look at how counseling agencies could implement a more empirical approach to dealing with consumers and the benefits that would be derived.
For years, financial institutions have used scoring technology to determine everything from whom to target for offers to how to manage accounts - both operationally and from a risk perspective. While credit counselors are by no means lenders, they service the same customers. The natural step to use scoring to better manage the customer experience is a logical progression for this industry.

The implementation of scoring into the counseling process would allow agencies to identify, based on the consumer's profile, what the appropriate solution is for them. For example, a consumer with one profile may need budget planning, while another may need to identify a secondary source of income, while a third may be best served by a DMP.

By implementing scoring into their processes, the counseling agencies will become more efficient, quickly identifying the right solution each consumer. Additionally, consumers will benefit by getting directed to the most effective solution for their specific circumstances. Creditors benefit from a scoring solution as well. The creditors could gain comfort in knowing that only consumers truly in need of a DMP are making their way through the process.

Beyond identification of the appropriate solution, a scoring model should be used within the DMP process itself. Once it is identified that a DMP is the right solution, a score would be used to set the appropriate level of concessions for a consumer. The higher the consumer’s risk level, the more concessions that may be needed to help ensure successful completion of a plan. Each creditor could set their own criteria for acceptable concessions, based on the profile of the consumers.

Using scoring in the DMP process has multiple benefits. First, the consumer receives a plan or road map addressing their needs to ensure success in returning to financial health. Second, the creditors should see improvements in the performance of these customers, thereby facilitating more dollars collected. Finally, if each creditor, based on an industry-accepted score, defines business rules, the entire process could be automated. This would have the potential of reducing operating expenses for the creditor.

Creditors and agencies must work together to ensure the success of a scoring solution in this industry. Obtaining consensus on a standard metric for the industry is critical to success. If there is an agreed upon standard, creditors can feel comfortable that consumers are getting the most appropriate course of action for their situation. An additional benefit to industry-wide acceptance of a single score is related to legislators and regulators. Fewer consumer complaints will make their way to these groups if agencies that are not self-governed can no longer submit large numbers of consumers for DMPs if, as indicated by the score, a DMP is not the right solution for those customers.

It has been shown through sophisticated analytics and modeling efforts that the most effective models to rank performance of credit counseling customers require the use of both interview and credit bureau data. By combining information from both of these sources, the most accurate profile of a consumer's need is generated.

As the industry looks for a single solution it is important that they work with a provider that has strong analytical capabilities and can provide the system architecture to support the solution.
The credit counseling industry provides a valuable service to consumers and plays an important role in the financial health of the country. Through the implementation of an industry-accepted scoring solution, many of the challenges that face the industry today can be addressed and the industry can take the next logical step in progressing forward.