One of the largest concerns involving the rapidly growing prepaid card market is that money deposited onto prepaid cards does not have the same protections as money held in mainstream bank checking accounts. Specifically, prepaid cardholders are not covered under Regulation E of the Electronic Transfer Fund and therefore do not have protections against lost or stolen cards like those afforded to checking account debit cards. Nor are prepaid card companies required to provide consumers with important information such as statements, receipts, and notifications. Additionally, prepaid cardholders lack the benefit of having Federal Deposit Insurance Corporation (FDIC) insurance of up to $250,000 on their accounts.
According to the Consumer Financial Protection Bureau (CFPB), from 2007 to 2011 the dollar amount loaded onto prepaid cards grew 477% ($12 billion in 2007 compared to $57.2 billion in 2011), and this year Americans are expected to load over $200 billion onto these cards. Prepaid cards essentially function that same as debit cards, but without the underlying banking account, and are frequently touted as the same thing as a checking account despite the fact that important consumer protections may be missing from these products. These cards are typically marketed to the 34 million Americans who lack access to mainstream banking services: the so-called unbanked and underbanked.
While some prepaid card providers are able to offer their customers FDIC insurance by complying with the FDIC’s requirements for “pass-through insurance,” many prepaid cards do not. Moreover, it is often impossible for a consumer to know whether or not a prepaid card has such insurance because issuers do not have disclosure requirements. In addition, most consumers probably do not even understand the ramification of not being FDIC-insured. Yet, since the establishment of the FDIC in 1933, no depositor has ever lost money from FDIC-insured funds.
Money Transmitter Laws regulate any entity that acts as an intermediary of a transfer of money between two parties. PayPal, for example is considered a money transmitter because it serves as an intermediary for a large portion of online purchases. Thus PayPal must comply with all 50 state money transmitter laws. In addition, PayPal has pass-through insurance, meaning funds held by PayPal are insured by the FDIC up to $250,000. PayPal is not legally required to purchase pass-through insurance in order to protect consumer funds, however it is required to comply with state money transmitter laws. A recent report by the Pew Charitable Trust details the state-by-state requirements for complying with money transmitter laws in terms of insuring consumer funds. According to the report, requirements for insuring consumer funds vary across all 50 states, and in general, consumer protections required by money transmitter laws are much worse than the protections offered by FDIC insurance. For example Montana, South Carolina, and New Mexico money transmitter laws do not require transmitters to insure consumer funds at all, whereas New York transmitter laws require the transmitter to purchase a $500,000 surety bond. If companies were to comply with the floor state money transmitter requirements across all 50 states they would be required to purchase on average a $75,000 surety bond in each state. Thus, if the money transmitter went under, there would be insurance to cover an average of only $75,000 losses per state, not to mention the fact that three states do not even require the transmitter to purchases insurance.
The Pew report also points out that prepaid cardholders without FDIC-insured funds would likely be required to navigate burdensome legal processes in order to obtain their funds in the event of a money transmitter default. However, it is unclear what this legal process would like; it is implied that most prepaid cardholders would lose their money in the event that the uninsured company became insolvent.
Even when prepaid card companies have FDIC pass-through insurance, the protections for consumers are thin at best. One of the largest prepaid cards on the market today is the Bluebird card issued by American Express and Walmart. When Bluebird was first launched, it did not have FDIC pass-through insurance. Only recently, after criticism, did they decide to provide this feature. The FDIC insurance only covers the funds in the event that the bank in control of the custodial accounts (Wells Fargo or American Express Centurion Bank) becomes insolvent. If American Express becomes insolvent, consumer funds are not protected.
In addition, the Bluebird card has limited coverage for cardholders who lose their cards. While Regulation E protects mainstream credit and debit cardholders against lost or stolen cards, prepaid cardholders are afforded no such protections, and most companies do not voluntarily offer such protection. According to Bluebird’s cardmember agreement, lost or stolen cards are replaced with a value equal to the available funds on your card at the time you notify Bluebird of the loss or theft. By that time a cardholder’s funds have likely been taken. Also, the cardmember agreement details a laundry list of exclusions comprising almost any imaginable situation in which a card would be lost, stolen, or damaged. So in reality, if you lose your Bluebird card, you lose the money on the card.
To ensure that the growing number of prepaid card users are protected, the federal government should require that all prepaid card issuers offer FDIC insurance and comply with Regulation E. While the prepaid market may be new, there is no reason that the same, tried-and-true protection given to debit cardholders can’t also be required for prepaid cardholders.
[Editor's Note: The Illinois Asset Building Group will sponsor a free webinar on prepaid cards on May 21, 2013. Learn more.]