Prepaid cards can offer significant potential to corporates looking for an innovative way to reduce the costs of expensive paper-based payment models. In this article we describe how prepaid cards work and discuss their potential applications in corporate and other sectors. We also identify the challenges associated with this emerging payment technique.
Prepaid cards, as the name suggests, are cards which allow the user to access a pre-funded amount of money which is ‘loaded’ onto the card. Unlike debit cards, the prepaid card does not provide access to an account held in the user’s name; rather, the value is usually recorded remotely on a server supported by a financial services provider.
The money is ‘loaded’ onto the card prior to the transaction and is debited from the total value loaded onto the card at the Point of Sale (POS). Different cards have different restrictions, but some common features include:
The card user can only spend funds that have been loaded onto the card as there is no overdraft facility or credit line.
No credit check is needed although proof of identity may be required.
Card users do not need to have a bank account in order to obtain a prepaid card.
Card users may or may not be able to load additional funds onto the card, depending on the card in question.
Like debit or credit cards, prepaid cards may be used to make purchases over the internet or telephone or to withdraw funds at an ATM, although this will vary depending on the particular product and fees may apply for individual transactions.
A growing market
So far, prepaid cards have enjoyed the most success in the US. In contrast, Europe is still in the early stages of take-up and it is only now that businesses are starting to realise the benefits that prepaid cards have to offer. Proponents of prepaid cards are optimistic about the future of this product however, and research conducted by Boston Consulting Group in 2007 suggested that spending on prepaid cards in Europe could reach $164 billion by 2010, 25.4% of the global total.
The prepaid card market is currently dominated by consumer gift cards, which act as a replacement for paper gift vouchers. However, prepaid cards can fulfil a wide range of other roles, including applications for businesses and governments.
How do they work?
Prepaid cards are conceptually quite simple; value is loaded onto a card and is debited when a purchase is made. Value is usually stored on a remote server, so if a card is stolen it can be cancelled and replaced.
However, for some types of prepaid cards the funds are stored on a chip in the card itself and cannot therefore be replaced if the card is lost. This type of card is sometimes referred to as a stored value card, although the term is also sometimes applied to prepaid cards on which value is not actually stored.
There are two separate systems that support prepaid cards: closed loop and open loop.
Single load gift cards represent the earliest and simplest form of the prepaid model, an example being retailer provided gift cards, which have mostly replaced the issuance of paper vouchers. The use of closed loop cards is specific to a certain retailer or group of retailers, usually with relatively small amounts available to the card holder. Like paper vouchers, they provide what is known as a ‘sales lift’, which happens when a consumer spends more than the value loaded onto the card, supplementing the extra cost with cash. On the other hand, if the consumer does not spend all of the funds on the card some of the funds may never be used – this is known as ‘breakage’.
‘Open loop’ cards, in contrast, are cards branded by MasterCard, Visa or another card network. These cards can be used anywhere that accepts the network brand, offering the consumer greater flexibility in terms of acceptance and a familiar way of paying for products. Depending on the purpose of the card, however, the card issuer may choose to restrict the types of expenditure permitted. For example, it is possible to set up cards that cannot be used in betting shops or to purchase alcohol.
Open loop cards are operationally more complex than closed loop cards because of the added costs of consumer protection, processing and distribution. They also often carry purchase and activation fees as well as cancellation and replacement costs.
Currently the majority of prepaid cards in Europe are closed loop cards, although open loop cards are on the increase. PSE Consulting estimated that over 90% of prepaid cards were closed loop cards in 2006 but has predicted that by 2015 open loop cards will account for 45% of the European prepaid market.
In this article we focus on open loop prepaid cards for which value is stored remotely and not on the card itself.
Reach of prepaid cards
Prepaid cards have so far seen a broad range of applications for consumers, governments and businesses.
Consumer-funded prepaid cards
Consumers purchase the cards and preload the amount they would like to spend. One of the earliest marketed uses was as a payment method for young people who are unable to obtain a credit or debit card. Other potential uses include:
Travel (as an alternative to traveller’s cheques).
Expense or per diem subsistence allowances.
Household budgeting tool (eg keeping shopping funds separate from funds intended for paying bills).
Online purchases (the absence of any credit line may be more attractive for shoppers concerned about internet security).
Sending money to family abroad. For example, Lloyds TSB offers a Money Transfer Card as part of an account package aimed at immigrant workers in the UK. The account holder can send the card to a recipient abroad, who can withdraw cash or use the card at retailers that accept Visa. The account holder can top up the card from their account but the recipient cannot top up the card themselves.
In a recent survey of European consumers, conducted by ase Market Intelligence on behalf of MasterCard in May 2008, 71% of respondents said they appreciated the potential that prepaid cards had to offer, compared to cash or cheques, in controlling spending. Awareness of prepaid products currently stands at 62%, with knowledge of what prepaid cards can offer particularly high among 35-44 year-olds.
Government-funded prepaid cards
Governments have been quick to recognise the benefits of prepaid cards, predominantly for the distribution of state benefits previously paid by cheque. In the past, governments have either relied on paper-based payment methods, which are costly and inefficient, or on electronic payments, which require the beneficiary to have a bank account. Prepaid cards can be used to distribute single or multiple benefit payments to the unbanked, thus widening coverage and promoting inclusion.
Poland and the Netherlands have both rolled out public schemes that use prepaid cards. Poland launched the Maestro branded Municipal Card in 2005, which is now used to pay a variety of benefits including unemployment, scholarship and disability allowances. Local governments participating in this programme receive incentives from the central government and have also found that it simplifies their administrative tasks.
Potential uses of prepaid cards by governments include:
Alternative to petty cash.
Disaster recovery. American Red Cross offers a prepaid Client Assistance Card enabling disaster victims to purchase essential provisions, for example following the devastation to New Orleans caused by Hurricane Katrina in 2005. Certain types of purchase are blocked, such as alcohol, tobacco and weapons, and the card expires after 15 days.
Prepaid cards for corporates
Businesses can use prepaid cards for payments to staff as well as to other businesses. Prepaid card solutions offer organisations savings potential in a variety of contexts from expenses to remittances, as well as customer-based payments such as gifts or incentives.
Corporate prepaid cards can be branded with the company’s logo, reinforcing brand awareness with each transaction. This can be useful both for customer uses and for prepaid cards given to staff.
Payroll cards can be used as an alternative to other costly paper-based payments. In the US, where 20% of the adult population is unbanked or underbanked, prepaid payroll cards provide a useful way to access a large part of the population that does not have access to a bank account. An employee, on joining a company, receives a customised, reloadable card. At the end of the month, the employee’s pay can be loaded onto the card and be available to spend immediately at various retailers that accept the payment network brand.
By issuing a generic payroll card, employers can mitigate the potential for fraud and reduce the costs of replacing lost or stolen cheques. The benefits for employees are also important. Staff without bank accounts or with limited access to banking facilities will avoid the costs incurred by cashing cheques with a third-party and enjoy immediate access to funds.
Prepaid cards can also be useful in the area of expenses. By issuing prepaid cards to employees, businesses can exercise significant control over expenditure, while avoiding the necessity of out-of-pocket expenses and inefficient reimbursement procedures. Purchases can be limited to certain goods and services that are pre-determined by the company. In addition, records of transactions are processed electronically and automatically, allowing for greater transparency which can be useful for auditing purposes.
Prepaid cards also represent an internationally accepted payment instrument that can be loaded with a particular currency, reducing the time and expense of currency conversions.
Rewards and incentives
Companies can provide consumers with easily accessible cash rewards through the use of prepaid cards. In a retail situation, when a particular product is purchased, customers could be offered a ‘cash back’ deal and issued with a prepaid card to be used at a later date.
Prepaid cards also offer considerable opportunities to companies that use them to distribute rewards or incentivise the workforce. Rewards can be loaded onto the prepaid cards instantly when targets have been met, instead of supplementing wages at the end of the month. It is argued that this approach maximises the impact of receiving a particular incentive for the recipient. There is also great potential for joint ventures between financial institutions and businesses based on marketing agreements and other publicity ventures.
The market potential for prepaid cards is huge, but there are challenges to be overcome.
Law enforcement agencies are concerned that money laundering may present a serious security risk to prepaid cards, particularly the more anonymous prepaid card schemes, since the cards could easily be sold or transferred after purchase to an unidentifiable party. The problem is particularly acute as common Know Your Customer (KYC) principles can be hard to implement, especially as the issuing financial institution may not be the direct seller of the card.
Many authorities and industry participants are taking steps to confront and control the emerging risks. Some strategies include more detailed identification techniques, establishing value load limits and placing restrictions on card sales and usage. These developments may have an effect on profit margins.
From the consumer point of view, prepaid cards may be more secure than cash as lost cards can be cancelled and a PIN may be needed in order to access funds. However, other types of security associated with credit cards may not apply to prepaid cards. In the UK, for example, under the Consumer Credit Act card issuers are jointly liable for purchases made using credit cards and consumers can therefore reclaim funds from the card issuer, for example if the merchant goes bankrupt. This does not apply to prepaid cards – nor does it apply to debit cards.
However, prepaid cards also carry a number of benefits in terms of security. Often used as a replacement for cash, prepaid cards can be stored in an unactivated, unauthorised form. When a card is needed, it can be activated and loaded with funds. Storing the cards is therefore far less risky than
The scope of prepaid cards is potentially very large but because some of these potential applications are very sensitive to consumers, such as in the areas of payroll and the distribution of state benefits, roll-out procedures need to be technically sound and sustainable. Branded payment networks have begun to release guides for consumers about the implications of prepaid cards and how to use them.
The role of the treasurer
One of the market drivers of prepaid cards is their efficiency and cost-cutting potential. With treasury at the forefront of cost savings in the organisation, treasurers could benefit from such a proposition. Treasurers will play an important role in corporate take-up and would be expected to manage the relationship between the card issuer and the organisation, explaining the benefits and drawbacks of any such scheme.
Organisations will need to identify a set of goals and ascertain what they expect to achieve with prepaid cards. Some may define utility solely in terms of profit, while others may look at improved customer service. Either way, establishing expectations early on in the process will help corporates to leverage the potential of prepaid cards.
The range of uses offered by the prepaid card model is significant and varied. Businesses can benefit from both internal and external applications such as administrative efficiencies and branding potential. At the same time, the ability to reduce costs and address security obligations will also be crucial factors in determining corporate take-up. Despite these hurdles, at a time of financial restraint, prepaid cards could offer both businesses and consumers improved control and transparency over their finances.
We would like to acknowledge the assistance of Carol Heath, Head of Prepaid Business Development, Visa Europe in researching this article.