Prepaid’s Chance to Change the World

By Tim Attinger (Managing Director for Market Platform Dynamics and former Global Head of Product Innovation and Development for Visa Inc.)

Prepaid products, particularly those in general purpose reloadable programs, have begun to transform the lives of millions of consumers. With the full implementation of the Durbin Amendment following the defeat of Tester’s Bill, these programs may stand to see broad adoption by millions of consumers. (Editor’s Note: Portions of this article have appeared previously in the author’s lectures for PYMNTS University.)

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Prepaid cards began as a simple way for merchants and operators of closed business systems to eliminate cash reimbursements and disbursements in their internal processes. Merchants found it more convenient to deliver store credits and refunds via prepaid cards that could only be used in that retailer’s location, eliminating cash promotions, discounts and refunds at the customer service counter. Merchants could realize a number of benefits by implementing proprietary prepaid card programs in their stores, such as: reducing cash management burdens in customer service, providing refunds in the form of electronically-traceable in-store credit, realizing reporting and tracking benefits on consumer spending in-store and capturing residual value in product “breakage” from funds that are loaded but not fully redeemed.

As consumers became more familiar with the cards, retailers began offering them as pre-purchase payment vehicles, primarily in the form of gift cards that replaced gift certificates as the way consumers could buy value at the store and gift it to someone else in the form of a stored-value plastic card. As merchants built these programs, specialty marketers of prepaid programs appeared to extend the distribution of merchant closed-loop prepaid programs by creating merchandising centers within major retailers for gift cards from multiple merchants. As they expanded, these programs grew in scale and scope to include reloadable applications for general purchases at a specific merchant, where a consumer would buy a “gift” card for herself and then use that card in lieu of cash at the point of sale, loading more value onto that card at the register – from a general purpose credit or debit card, cash or check – whenever she needed more funds. Reloadable store cards became a great way for retailers to replace small-value cash transactions at the point of sale and were rapidly adopted by small-ticket merchants, such as McDonald’s and Starbucks.

Prepaid cards grew from simple cash replacement within specific stores to purchase vehicles for those same retailers to broader multi-merchant retail distribution, becoming a substantial business in their own right. It’s no wonder that the prepaid card merchandising unit of Safeway became an independent manager of prepaid distribution and marketing now called Blackhawk. The cash-replacement side business was becoming a real business. The next logical step was to make those individual store cards more valuable to consumers by making them usable across multiple merchants. But how? While some prepaid merchant processors were positioned to manage access to one card from multiple merchants, it was tough to communicate that benefit to consumers. And how to manage the rules and value exchange for issuance and acceptance across multiple merchants? Kind of complex, that. Had anyone ever set up a system to do that before? Hmm….And so entered the general purpose card networks into the prepaid business.

Program managers began to drive issuance of multi-merchant reloadable cards onto general purpose acceptance networks, changing the industry radically. Safeway could now sell a Visa-branded gift card and earn a load fee as before, but sell many more cards every day as consumers saw the opportunity to give gifts of cash usable at multiple merchants. Corporations began to get into the game, providing incentive payments to employees and to customers in the form of multi-merchant gift cards on the Visa and MasterCard networks. From this beginning, the industry application of prepaid cards expanded rapidly into three major categories of business today:

Gift and Incentive: For a long time the bread and butter of the prepaid business, this segment continues to be a solid business of general merchandising and processing for prepaid program managers. The traditional gift business provides retailers with revenues from merchandising and selling gift cards that can be used at millions of merchants. Corporate programs that provide incentives to employees, partners, and customers in the form of prepaid cards create a strong supplement to this business. These cards tended to be one-use products distributed for a fixed amount.

General Purpose Reloadable (GPR): When tied to a reload capability, a prepaid card on a general purpose acceptance network becomes a highly flexible and valuable asset. Many networks have coupled the debit capabilities of core GPR with the merchant-category spend controls and daily limits of commercial products, creating a powerhouse product with strong central-control capabilities attractive to commercial enterprises. In all of this, the key to these products have been their PoS and ATM supplemental load capability, supported by general purpose and private label networks deployed at merchant and financial institution points of interaction. These load capabilities create a network of access points for additional “deposit” into the core prepaid purse by the consumer – in the form of cash or check-from other income streams. By combining these assets, the industry has created a powerful alternative to traditional retail deposit accounts, through a card product that replicates the benefits of electronic deposit access via alternative delivery channels. As can be imagined, the opportunities for deployment of this product have been phenomenally diverse, such as:

Payroll: For commercial applications, particularly with employers who have a large population of high-turnover hourly workers, it can serve as a direct-deposit replacement, providing a way for companies to pay employees directly, swiftly, fairly and economically with an access vehicle that gives consumers without ready deposit accounts a way to hold and track funds while accessing the benefits of electronic payments.

Government Disbursement: On the state and federal level both in the United States and increasingly in international markets, prepaid products have seen high utility as a way for state agencies to distribute funds to beneficiaries in a way that is swift, secure, leaves an audit trail for taxpayer reconciliation and provides for acceptance controls to ensure, as in the case of food programs, that the funds loaded on the product are being used as and where intended.

Healthcare: The combination of GPR prepaid capabilities deployed in payroll and the spend control capabilities of government disbursement prepaid programs create the optimal product construct to capture the growing trend in health benefits toward consumer-directed healthcare. Through the provision of 1) health savings accounts for general healthcare benefits, and 2) flexible spending accounts for supplemental health plan benefits, such as vision, dental and prescription, employers have seen a significant decline in cost of care for benefit plans in concert with a rise in employee engagement in the management of those costs.

Prepaid programs have evolved from relatively simple closed-loop retailer programs to complex and highly lucrative businesses. A host of new industries have sprung up around the current “killer app” for prepaid products: general purpose reloadable prepaid. That application has found a host of ingenious uses in segments that were tough to serve with traditional credit, debit and commercial products. Along the way, a diverse set of stakeholders have engaged in the provision, distribution and servicing of those product applications, building significant businesses around the complex evolution of a piece of plastic built to replace gift certificates and store credit receipts. The largest distributors of prepaid products – retailers, governments, employers – may see major change in the adoption of their prepaid programs as regulatory changes in the traditional debit marketplace may introduce a new era of opportunity for prepaid.

Could GPR prepaid evolve from its current status as a debit alternative to the new standard for debit in the U.S. marketplace? Maybe. Let’s start with a hypothesis: as the Fed implements the revised provisions of the Durbin Amendment to the Dodd-Frank Act, the debit transaction revenues that were the foundation for most banks’ deposit management P&Ls are dramatically reduced. In an effort to keep their retail deposit businesses afloat in the face of a dramatic shock, financial institutions of all sizes are forced to re-price their product/service offerings and prune low-balance customer segments, driving a large swath of the current deposit population out into the marketplace in search of a funds management and access solution that will support a $500 average daily balance, deliver anytime access, and doesn’t come with onerous monthly fees. (By the way, that average balance is a bigger share of the population than you’d like to think).

Many in the prepaid industry anticipate exactly that outcome, and they stand at the ready with prepaid programs and products designed to serve low-balance and former bank customer needs profitably, taking advantage of what is expected to be a significant opportunity in the wake of the financial reform bill. A favorite pastime in the industry is armchair quarterbacking the likely winners in this race. Let’s take a look at the contenders and have you decide who might be best positioned to reap the benefits of a possible mass exodus from banks accounts to prepaid programs. No one type of organization necessarily has all the pieces in place, but some might be in better position than others to take advantage of what many believe will a major period of significant growth in the prepaid business. At the end of the class, we’ll put it to the student body to predict who will come out on top. The contenders are:

The Orchestrators: A number of folks have their bets placed on program managers as the most likely winners. These organizations define products, develop and manage distribution channels, secure processing and network partnerships, package solutions and customize service offerings for distribution clients. They have evolved from merchandisers to managers of complex prepaid network ecosystems, managing a product and program platform that ties together a host of horizontal competitors in retail, processing and financial services. Funny enough, they rarely own any processing or network assets, instead customizing the application of established infrastructure and product constructs from other players. As the organizers of others’ activities and assets, program managers have traditionally enjoyed the greatest share of overall revenue generated by prepaid account activity.

The Facilitators: Electronic payments don’t happen without technology companies managing network and account management processing infrastructure. Specialty processors have grown by building customized issuer account processing capabilities, striking advantaged relationships with (or buying into) financial institutions on the back-end to hold and manage funds. Unlike issuer processing in other parts of the payments industry, the processor is very much the driver of business direction here over the financial institution holding the account. Some of these processors have also built and managed load networks that provide direct acceptance and reload capability for private label prepaid programs with many of the largest retailers. Some of these networks have been modified to manage GPR prepaid reloads as well. A select few of the prepaid specialty processors are also established in the program management business, capturing a larger share of the revenue from program activity than their processing peers. The major bankcard networks certainly have also built programs capabilities into their processing networks to support the key features – spend controls, acceptance screens, validation check transactions and load capability -that successful GPR prepaid programs require. However, these networks typically do not see more income from these services than their traditional network processing fees have generated.

The Distributors: There is no doubt that one of the most compelling benefits from the rise of GPR prepaid and its suite flexible services has been the expansion of the traditional payments stakeholder universe to include a host of new companies, bringing new participants to the payments network business model who have in turn brought new segments of consumers into the benefits of electronic payments. Corporations and employers now have a range of cost-effective and convenient options for paying and incentivizing employees. In concert with health plan carriers and administrators, those same employers can also deliver health benefits through prepaid programs, fueling the rise in consumer-directed healthcare while capturing the savings and reporting benefits of electronic access to pre-funded health savings and flexible spending accounts. Governments have found in GPR prepaid a new way to deliver state benefits that is traceable, controllable and cost-effective while highly convenient and immediate for the benefits recipient. Money services businesses and money transfer operators have discovered a product that helps them establish an ongoing relationship with customers, providing a reloadable product that serves as a repeatable destination for funds from sources, such as cashed checks and money transfers. In addition to accruing GPR commercial application benefits as employers, retailers may now earn revenues from merchandising and reloading packaged financial services products. Many large retailers have engaged in money services businesses of their own, establishing an equivalent of branch banking in their stores with check cashing, money transfers and financial account acquisition and management. GPR prepaid has been the foundation for this.

Reading this list of key prepaid participants may lead you to wonder: where are the banks in all of this? Funny enough, as the prepaid business evolved, many financial institutions either jumped on board the GPR prepaid bandwagon as their commercial clients began to demand it or took a back seat to the specialists in the space, serving primarily as back-end repositories of the funds held in GPR accounts. And many of those financial institution repositories are not large independent operators but rather smaller organizations who aligned themselves with specialty program managers or processors. If GPR prepaid evolves to become the primary debit vehicle for the consumer mass market, where will traditional deposit banking ultimately live?

The landscape for retail deposit is shifting to create perhaps significant and fundamental change in the wake of a wave of financial reform legislation, price controls and regulatory oversight. Might one of the unintended consequences of that regulation be to create a new deposit paradigm where a diverse population of specialty marketers, processors and distributors are the new “banks” for a significant population of consumers, with prepaid as the access vehicle? How might mass-market deposit consumers be served by that ecosystem? Is it possible that the same retail industry that pushed for regulation of debit card fees now stands to become the new banking industry for the vast majority of low- to middle-income consumers? Might this be another unintended consequence of the new regulatory construct? Is anyone at the Fed thinking about how it might maintain oversight of consumer finance if the flow of consumer retail deposit funds moves from the traditional financial institutions the Fed has always managed into this model? Are the major retail banks thinking about how to co-opt the prepaid model to recapture deposits, or are they content to see a potentially large share of the mass market move to prepaid specialists? Good questions, all….