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July 2008 • Volume 13 Number 7
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Feature of the Month Using Network-Branded Prepaid Cards to Support the Unbanked Transit Customer As discussed in last month's article transit agencies face certain challenges in deploying distribution networks for automatic fare collection at merchant locations. However, they can also enjoy certain advantages, by either autoloading transit media using a credit or debit card as a funding source or charging for fares directly on a credit or debit card. To extend these advantages further, agencies must reach unbanked customers and convert them from paying with cash. This is an effort in which prepaid card products can play an important role. Background Network-branded prepaid card programs evolved to fill a void in serving unbanked individuals. The traditional banking infrastructure—brick and mortar branches and online account acquisition and management—does not work well with a demographic that prefers to conduct financial business with trusted and known parties. The co-branded prepaid card emerged as a way to reach this market. Marketers or program managers partner with financial institutions to bring prepaid card programs to market and provide marketing expertise in reaching unbanked customers. In many cases, program managers partner with affinity co-branders, who attract the groups with which they are associated as potential cardholders. Partnering with a program manager could be one way for a transportation agency to participate in a prepaid card program that is associated with the agency and designed to serve the agency’s unbanked ridership. To determine how best to integrate prepaid cards into an automatic fare collection strategy, transit agencies must first understand the similarities and differences between traditional bank account cards and network-branded prepaid cards. How Prepaid Cards Work A network-branded affinity/co-branded prepaid card is essentially a debit card branded by one of the major payment brands, MasterCard or Visa. A reloadable prepaid card (one in which value can be replenished) is like a debit card tied to a traditional bank deposit account except that the funds used to replenish the card are held in an aggregate account. Funds are held in the aggregate account until the cardholder draws down the available balance. Traditionally, when a card is activated, funds move from the aggregate account into that cardholder’s individual account. While regulations governing the issuance of prepaid cards are still evolving, prepaid cards are subject to many of the same bank regulations as traditional bank deposit accounts and electronic funds transfers. There are important distinctions between a prepaid card and a traditional bank card in three areas:
Reloading Cards. The expression “reload the card” is often used to refer to the process of funding a card, but in reality, it is the bank account that is being funded. Although additional deposits can be made to a prepaid card’s funding account physically at a branch of the financial institution issuing the card, they generally are not. The unbanked, for various reasons, are reluctant to visit bank branches. Prepaid card accounts can also be funded by transferring funds from another bank account or a credit card, but these methods are rarely used when a card is “purchased” by an unbanked individual. Because the unbanked are reluctant to do business at banks, reload networks have been developed that allow the cardholder to make cash deposits at retail outlets for a fee ranging from $3 to $5. One of the largest and best known of these networks is Green Dot, but there are others (for example, PayXone, EmpaSys, Blackhawk, and InComm). MasterCard has partnered with Green Dot and InComm to offer its proprietary reload product, rePower. Visa offers Ready Link. A fare media collection location could become a reload point for an affinity co-branded card as well as other prepaid cards. However, retail merchants that provide reload services are regulated as money services businesses and must have anti-money laundering (AML) programs and procedures in place. Acquiring Cards. Prepaid cards are also most often “purchased” from cashiers or kiosks at retail locations. Prepaid cards are widely advertised with verbiage stating that no credit check is required and no one is turned down. While no credit check (usually CHEX) is performed on the prospective account holder, purchasers can be turned down. Customer Identification Program (CIP) investigations must be performed, and the person must be checked against the U.S. Treasury Specially Designated National (SDN) Office of Foreign Assets Control (OFAC) list. Program Features. Many prepaid card programs offer cardholders non-traditional features such as long-distance prepaid calling card capability and credit builder features. Financial institutions also offer ancillary products associated with their debit cards. One benefit that is commonly offered to prepaid cardholders is the ability to send money using a card-to-card transfer for less cost than what is generally charged by banks and other service providers. Transportation agencies could develop creative loyalty and rewards incentives on their own affinity/co-branded card programs, such as fare discounts. The Costs of Being Unbanked According to a report published in May 2005 by the Federal Reserve Bank of Philadelphia, an unbanked consumer who routinely uses non-bank services (such as check cashers) to cash checks and pay bills pays $789.00 per year in financial services fees. Unbanked consumers not only pay check-cashing services to cash checks, they also purchase money orders to pay bills or visit a walk-in bill payment location. The cost of a money order varies from a low of 49 cents to as much as $3. Walk-in bill payment fees range from $1 to $4. Often, the “hidden” cost to the unbanked is the time spent waiting in line to cash a check, going to another location to purchase a money order, and conducting all of these transactions when the person has the time and the funds. In the Wall Street Journal article, Beyond Payday Loans (January 24, 2008), former President Bill Clinton and California Governor Arnold Schwarzenegger write of a public and private sector initiative to help the unbanked consumer. The article cites a number of statistics related to the cost of being unbanked, including “$8 billion spent annually by unbanked consumers at check-cashing outlets, payday lenders and pawnshops for basic financial services.” The article states that “over a lifetime, the average full-time, unbanked worker will spend more than $40,000 just to turn his or her salary into cash.” The cost of being unbanked includes the need for the unbanked consumer to have “access to the right products at the right terms, and the support they need to make good, responsible financial decisions.” The fundamental attributes of prepaid cards make them good solutions for the unbanked consumer: no minimum balance requirement, no credit check or other minimum financial threshold, worldwide acceptance, and pay-as-you-go fees. Many of the more sophisticated cards on the market offer functionality such as direct deposit, card-to-card transfers, text message alerts, and savings accounts linked to the card. One significant benefit of prepaid cards is that they allow an unbanked cardholder to avoid the costs incurred to cash a check. There are thousands of check-cashing outlets in the United States, used by more than 20 million Americans annually. A total of $60 billion in checks are cashed each year at such locations. Consumers who acquire a prepaid card can have paychecks or other benefit checks deposited directly to the card and save the expense of using check cashers. Economics of Prepaid Cards The pricing model for a prepaid card is significantly different than the model for traditional debit and credit cards. Because the pricing model is so different, using prepaid cards can be a challenge to the transportation agency that wants to offer low- or no-cost alternatives to unbanked riders without having to subsidize the costs. While pricing varies widely, prepaid card programs generally charge cardholders more fees than the traditional bank deposit account with a debit card. Banked consumers are often surprised by the fee structure of prepaid cards, which may charge not only a monthly maintenance fee, but also transaction fees for all transactions, including declined transaction attempts. The fees are set by the program manager and the affinity/co-brand partner (e.g., the transportation agency), but are subject to the approval of the sponsoring financial institution. Although some card programs do take advantage of the consumer by charging excessive fees, the fee structure for network-branded prepaid cards is justified by several important distinctions between a prepaid deposit account and a traditional bank account: the small balances generally held on a prepaid card; the lack of consumer loyalty to a specific prepaid card program; the need to monitor activity and maintain controls to combat fraud and potential money-laundering activity; and the lack of cross-selling opportunities to the cardholder. The Partnership Business Model for Prepaid Cards The business model that is most commonly used to capture the unbanked segment of the population is the program manager affinity/co-branded card model. This model can easily be adopted by transit agencies to market a prepaid card specifically associated with the agency. For transit agencies, this model would involve multiple partners. First, an independent organization that is knowledgeable and experienced in marketing to this market would develop the card program and marketing strategy. Because of regulatory and payment brand restrictions, however, these organizations cannot actually issue the cards. A financial institution must therefore be involved as the issuer. Another partner might also be involved—an affinity co-brander, such as a transit agency, sports team, or celebrity. The roles of all of the partners may overlap. Until recently, program managers have been third parties who enter into contractual arrangements with the issuer. This arrangement continues to be the case with mid-tier banks who have made a business of sponsoring one or more program managers. However, major banks have begun to recognize the value that program managers contribute and have begun acquiring established program manager companies. CapitalOne recently announced an equity investment in NetSpend, and Citibank has purchased eCount. These acquisitions demonstrate that the major banks recognize the enormous revenue potential of prepaid cards marketed to the unbanked. Program Manager Role. The organization that performs as a program manager provides expertise in marketing to the target market and is responsible for defining the product. The program manager has the following responsibilities:
Program managers can also form alliances with strategic business partners who may act as affinity co-branders, distributor channels, or both. (One example of this model would be a joint venture arrangement in which a program manager joins with an Hispanic grocery store chain that wishes to have a card program with its brand image.) All partners in this type of arrangement must be approved by the issuing financial institution and registered with the institution as member service providers. Issuer Role. The program manager enters into a contractual relationship with an issuing financial institution. Because there are currently a relatively small number of issuers in comparison to the many program managers who need a bank sponsor, the issuer principally dictates the terms of the financial arrangement. It is not unusual for the issuer to hold the program manager responsible for all costs and risks (e.g., fraud losses) associated with the card program. In return, the program manager receives all cardholder revenues. The issuer generally retains the earnings on deposits (float) and receives compensation from the program manager, usually a “per transaction” fee or an “account on file” fee. The financial arrangement between the issuer and the program manager is negotiated and varies among issuers. The issuer is the owner of the prepaid card program. Regulators and consumers hold the issuer accountable for any issues or problems with the program. The issuer provides oversight of the program that ensures compliance with all banking regulations and payment brand rules. The issuer protects its reputation with consumers by reviewing and approving the cardholder fees, the marketing strategy, and the program materials. The issuer, as a member, liaises with the payment brands. Third-Party Processors. Unless the program manager organization is vertically integrated and owns its own processor, the program manager contracts with a third-party processor and provider of prepaid platform support services. Many companies offer end-to-end prepaid card program support services: card fulfillment, financial transaction processing, customer web interface, and customer service. These providers are both certified by the issuing bank and registered with the payment brands. Processors must be compliant with Payment Card Industry (PCI) standards. Approaches to Implementing the Prepaid Card Partnership Model for Transit Transit agencies can choose from among several approaches to implement the prepaid card partnership model. One approach would be for the transit agency (in partnership with the issuer) to implement a multi-application co-branded prepaid card with a chip which contains both the transportation application and the financial payment account. Such a card would be the prepaid equivalent of the Barclaycard OnePulse card which combines the Transport for London Oyster transit application with the Visa PayWave credit/debit application. This approach works well for transit agencies that have readers dedicated to fare collection, rather than contactless credit/debit card terminals at the point of entry. The cash reload for the transit application could be independent of the cash reload for the financial payment card and thus priced differently. Functionality could also be implemented to enable card-to-transit funds transfers. Issuing such a card is expensive, and a business case would have to be made that justifies the added costs of personalizing a card with two separate applications. Another approach is for the transit agency to install terminals that deduct the fare from a bank account that includes bank-issued reloadable prepaid cards. In this case, the transit agency is acting as a merchant and follows the same rules as any retail merchant, including compliance with PCI standards. Unbanked consumers would use their own prepaid cards to pay for their fare. By promoting existing prepaid card programs, transit agencies have the opportunity to increase adoption and offer a convenient payment option. Transit agencies do need to consider, however, the prepaid card fees and the impact the fees may have on consumers' decisions to purchase cards. While prepaid cards can support agencies immediately by allowing patrons to purchase transit fare media through ticket vending locations, it is likely to take some time for issuers to accept the cost of adding a contactless chip to the card. This migration is likely to parallel the introduction of chips on credit/debit cards. Agencies can support this by working with banks and state agencies in their area to gain support for conversion at the time they implement programs to accept bank cards. It is clear that with appropriate thought and planning, agencies can tap into the new channels for prepaid cards to help reach the unbanked and lower costs for fare collection systems accordingly.
About this Article This article is an extract from the newly-published white paper, Serving Unbanked Consumers in the Transit Industry with Prepaid Cards, that was developed by the Smart Card Alliance Transportation Council to provide the transit and financial industries with an educational overview of the various methods available for providing and re-loading fare media to individuals who do not have credit or debit cards, nor checking or savings accounts, and generally lack relationships with traditional banking institutions. The full white paper is available on the Smart Card Alliance web site at http://www.smartcardalliance.org. About the Transportation Council The Smart Card Alliance Transportation Council is focused on promoting the adoption of interoperable contactless smart card payment systems for transit and other transportation services. Formed in association with the American Public Transportation Association (APTA), the Council is engaged in projects that support applications of smart card use. The overall goal of the Transportation Council is to help accelerate the deployment of standards-based smart card payment programs within the transportation industry.
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This article is the third and last in a series looking at approaches to serve the unbanked consumers in the transit industry. This month's article reviews how network-branded prepaid cards could be used to serve the unbanked transit customer.