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July 5, 2011

Dispelling prepaid card myths: Not all cards are created equal

Prepaid cards are garnering quite a bit of attention these days. According to the 2010 Federal Reserve Payments Study, consumers conducted 6 billion transactions on prepaid cards with a dollar value of $140 billion during 2009. These figures represent annual growth of more than 20 percent a year from 2006 to 2009. Perhaps an even better indication that prepaid cards have moved into the mainstream: a recent Today Show report focused on the pros and cons of prepaid cards.

With large numbers of individuals who are un- and underbanked, and with the implementation of the Durbin Amendment looming over the debit card industry, it is reasonable to assume that prepaid cards will continue to see significant growth. In fact, American Express recently announced it was offering a new general-purpose reloadable (GPR) prepaid card in an attempt to attract debit card users.

It is easy to understand that confusion exists among consumers and the media when it comes to prepaid cards and their risks given the variety of prepaid cards and their different consumer protections. Although GPR cards do not always have to offer the same consumer protections as do debit cards, market dynamics and industry competition have resulted in these cards having more robust consumer protections than closed-loop prepaid cards, such as gift cards.

In our continued effort to dispel some of the confusion that exists in the payments industry, this post looks at two myths pertaining to prepaid cards.

Myth: Consumers are not protected when prepaid cards are lost or stolen and used by others to make fraudulent transactions.

Nonreloadable gift cards, whether closed loop (for use at a specific retailer) or open loop (network-branded), are generally not registered in the name of the account holder and therefore lack consumer protections. However, in the unfortunate event that a GPR card is lost or stolen, the consumer is subject to the same voluntary zero liability protection policies that applies to credit and debit cards of the payment networks as follows:

  • American Express: Consumers are not liable for fraudulent transactions as long as the transactions are reported within 60 days of discovery.
  • Discover: Consumers are protected with a $0 fraud liability guarantee.
  • Visa: Consumers are not liable for either signature or PIN fraudulent transactions over the Visa and Interlink networks unless it is determined that the cardholder was grossly negligent or fraudulent in the handling of the card.
  • MasterCard: Consumers are protected with zero liability only on signature transactions and as long as the card is in good standing, the consumer exercised reasonable care to protect the card, and the consumer reported no more than two incidents of unauthorized use over the previous 12 months. Fraudulent PIN transactions are not protected.

If a fraudulent transaction occurs that is not subject to zero-liability protection—that is, a PIN transaction over an EFT network or a MasterCard PIN transaction—many issuing banks voluntarily offer cardholders the same protection that debit cardholders receive under Reg. E: a $50 maximum liability if the cardholder notifies the bank within two days of discovering the unauthorized use and a $500 maximum liability if he or she notifies the bank within 60 days. Although issuing banks are not mandated to offer this protection on prepaid cards, competition in the industry has led to many prepaid cards with liability protection. Consumers should read the cardholder agreements to better understand each issuer's liability policy for unauthorized transactions.

Myth: Consumers who use prepaid cards have no guarantee that they will be able to recover their money in the event of a bank failure.

While cardholders are at risk of losing the balance of a closed-loop prepaid card should the issuing business or retailer fail, this risk does not exist for GPR cards. Based on a November 2008 FDIC legal opinion, if the issuing bank of a GPR card fails, the funds on the prepaid cards are subject to FDIC assessments and are insured.

Reality: Prepaid cards often safer than cash

Just as the type of prepaid card varies, so does the accompanying consumer risk. While closed-loop prepaid cards pose certain risks related to the stored value on the card, GPR cards do not carry those same risks. These cards pose less risk to the consumer than cash and, for a majority of issuers, are on par with debit cards.

By Douglas A. King, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed

July 5, 2011 | Permalink


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