Will New Regs Cool off Open Loop’s Hot Growth?

Powered in part by surging government programs, open-loop prepaid cards barreled along in 2009, according to new findings from Mercator Advisory Group Inc. Now the question is whether that growth will continue after new payment card regulations kick in some time next year.

Maynard, Mass.-based Mercator estimates users loaded $124.6 billion onto open-loop cards last year, up 61% from $77.5 billion in 2008. Open-loop cards carry the logo of a general-purpose card network such as Visa, MasterCard, American Express, or Discover. In contrast, the closed-loop market, while still much bigger at estimated total loads of $205.4 billion last year, grew only 7.1% from an estimated $191.8 billion in 2008.

Reflecting the weak state of the U.S. economy, prepaid cards offered by states for payment of unemployment compensation led growth in the 18 open-loop segments Mercator tracks. Some $23.2 billion was loaded onto unemployment-compensation cards last year, up 292% from $5.9 billion in 2008. The growth came not only from high joblessness, but also more states abandoning checks in favor of plastic for distributing unemployment benefits. “We’re really at the point now where all the important states are in there except for California,” says Tim Sloane, director of Mercator’s Prepaid Advisory Service. And California, he notes, has issued a request for proposals to start distributing jobless benefits on prepaid cards.

The Social Security segment grew 197% in load volume as the U.S. Treasury Department’s card issued by Comerica Bank continued to add recipients of Social Security benefits. Another high-growth category was the FSA/HSA segment for tax-advantaged flexible spending accounts and health savings accounts, respectively. Driven mainly by the HSA side, loads on prepaid cards in the category grew 150%, Sloane says. HSAs are growing as companies attempt to reduce their health-care costs by switching employees to high-deductible health-insurance policies. Consumers can partially offset the costs of higher medical insurance by diverting some of their pay into employer-supervised HSAs.

A rash of new regulations, some of which just took effect and others that are only in the early stages of planning, could affect open-loop cards going forward, but no one knows just how much. The Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 has provisions affecting some prepaid cards, especially closed-loop and open-loop gift cards. Such cards now have more disclosure requirements and restrictions on dormancy, inactivity, and service fees. Cards may not expire for at least five years, and the law lets more-restrictive state laws take precedence over federal rules. “We believe the impact is going to be relatively neutral in most segments, though it may have some impact on profitability issues,” says Sloane. He adds, however, that gift card issuers might pull out of some states if they perceive laws as too restrictive.

While the CARD Act’s rules are at least in place, payment-industry executives and consumer groups alike are wondering what the Federal Reserve will come up with in carrying out its assignments under the new Dodd-Frank financial-reform law. The law’s so-called Durbin Amendment tells the Fed to devise regulations by mid-2011 that would regulate debit card interchange. As a form of debit card, prepaid cards will be affected, but the law exempts the interchange income of financial institutions with $10 billion or less in assets, and it also exempts government prepaid cards. The law seems to carve out general-purpose reloadable cards from interchange regulation, but it’s unclear how the Fed will interpret Congress’s intent. The Durbin Amendment also frees merchants from some of the card networks’ operating rules restricting their ability to surcharge for card payments or otherwise steer merchants toward cash or checks.

Some large banks play in the open-loop prepaid market, so their interchange income is likely to be affected by whatever controls the Fed devises. But other major players are well below the $10 billion threshold, including Meta Financial Group Inc. and The Bancorp Inc., so their interchange revenues presumably won’t be affected. “When you look at the grand scheme of things, it [the Durbin Amendment] is not very significant relative to the bank side of it,” Sloane says.

Instead, the amendment’s biggest effect might come if it spawns a movement by merchants to steer customers away from card payments and toward cash or checks. “That could have an impact on prepaid, debit, and credit,” Sloane says. But it’s too early to tell how merchants will react, he adds.

Mercator revised many of its estimates upwards after getting detailed information from a major processor and reviewing newly public information from prepaid program managers Green Dot Corp. and NetSpend Inc., Sloane says. Green Dot did an initial public stock offering last month, and NetSpend is planning one.