Prepaid Cards: Another Step Toward a Cashless Society

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1 Bank of America Merrill Lynch White Paper Prepaid Cards: Another Step Toward a Cashless Society Executive summary As government agencies seek to replace costly paper checks with electronic payments, prepaid cards have proven to be a safer, more reliable and cost-efficient means to disburse payments. This white paper provides insights into how innovative solutions such as prepaid cards are benefiting the public sector and the people they serve. May 2014 Contents Providing meaningful savings to governments and taxpayers... 2 U.S. Treasury s role in promoting electronic payments... 3 Benefits of prepaid cards as a replacement for paper checks to recipients Case study: Houston Housing Authority Spending taxpayer funds wisely Helping families move toward self-sufficiency... 6 A quick buy-in from all involved... 7 Public/private partnerships that benefit all stakeholders... 7 Future uses of governmentbenefit prepaid cards.... 8

2 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 2 For more than two decades, state governments and agencies have been transitioning to electronic payments in order to gain efficiencies by reducing costs on transactions. Currently, nearly all states are using, or are in the process of implementing, prepaid card programs, including: ychild support yunemployment insurance ytemporary assistance for needy families ystate payrolls ystate personal income tax refunds yworkers compensation benefits Child support and unemployment insurance were the first and most widely used areas where prepaid disbursements took hold, because of their recurring nature, the frequency of payment and the high number of benefit recipients. States were spending large amounts of money on printing checks and postage, usually on a weekly or biweekly basis. Prepaid cards helped them realize significant efficiencies and make substantial savings. States were spending large amounts of money on printing checks and postage, usually on a weekly or biweekly basis. Prepaid cards helped them realize significant efficiencies and make substantial savings. Providing meaningful savings to governments and taxpayers With strained federal, state and local budgets, agencies throughout the U.S. are looking to save money wherever they can. Converting from paper checks to electronic disbursement either through direct deposit or prepaid debit cards is a relatively easy and typically cost-free way for state and municipal governments and agencies to reduce costs, while at the same time providing a more efficient and versatile payment mechanism for recipients. According to Steven Evans, head of the public sector prepaid products team at Visa Inc., states and their agencies collectively save millions of dollars annually on the costs associated with paper checks, including: ycheck printing costs yadministrative costs yreplacement checks yhandling fees yreconciliation fees Postage y Lost y or stolen checks ybank processing fees yescheatment ycheck fraud According to Evans, in one Midwest state, the unemployment insurance program calculates that it costs approximately $4 to issue each check after factoring in the associated costs listed above. At the time the state converted its program to electronic disbursement and prepaid cards, it was issuing 1.3 million checks a year. Since that time, the state has been successful in converting all of its unemployment benefits to some form of electronic payment, with only half of 1% of clients still requesting the paper check option.

3 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 3 That translates into a savings of more than $32 million from 2006 to Additionally, a different Midwest state s Child Support Payment Center estimates it previously cost the state 59 cents to process each child support check. By switching to electronic disbursement, those costs were reduced to about a penny each, saving the agency more than $368,000 a year. As these examples show, the cost of writing paper checks, and therefore the actual savings to be realized by converting to a prepaid disbursement system either in the aggregate or on a per-check basis can vary widely. These can range from less than $1 a check to as much as $13 or $14, depending on the program, after all of the various costs are factored in. The factors that play the biggest role include the number of recipients receiving benefits, the amount of money being disbursed per recipient, and the frequency of payment. By switching to electronic disbursement, those costs were reduced to about a penny each, saving the agency more than $368,000 a year. Nevertheless, whether it s a dollar or part of a dollar, by moving from a paper check to electronic disbursement, there are huge savings to be realized by government agencies, says Brian Greehan, director of prepaid card solutions at Bank of America Merrill Lynch. U.S. Treasury s role in promoting electronic payments No government entity sends out more benefit checks or spends more money doing so than the U.S. Treasury. But since May 2011, all new applicants for federal benefits including Social Security, disability, veteran s benefits and the like have had their benefits delivered electronically. For most recipients, that means direct deposit in their bank or credit union checking account. For those individuals who don t want direct deposit or don t have a bank account, or fail to make a choice, they receive their money through the Treasury s Direct Express prepaid card program. As of March 1, 2013, the government no longer sends out paper checks. It will only make electronic payments, either via direct deposit or through the Direct Express program, with some limited exceptions. By moving to electronic payment, the Treasury estimates it will save U.S. taxpayers the $120 million annual expense of printing and mailing checks. By moving to electronic payment, the Treasury estimates it will save U.S. taxpayers the $120 million annual expense of printing and mailing checks. According to Evans, the Treasury estimates that the typical check costs about $1, but by making all benefit payments electronically, that cost will be reduced to about 10 cents, a savings of 90%. For the Social Security and SSI beneficiaries who don t receive their funds by direct deposit, most have opted for the Direct Express prepaid card. That s because there is a large population of so-called unbanked and under-banked households and individuals in the U.S. who don t have bank accounts. In FDIC parlance, an unbanked household is one which doesn t have a bank account or any other relationships with a bank. Under-banked households have bank accounts, but also frequently use non-traditional financial services, such as check-cashing establishments and payday lenders.

4 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 4 There is a wide continuum in the form that electronic disbursement of government benefits takes at the state and local level. In some cases, Evans says, the entire program defaults to a prepaid card. In that instance, everyone who is receiving benefits is treated the same way and gets their funds via a prepaid card, with no checks distributed. However, in the majority of programs, recipients are also given the option to receive their payment electronically through direct deposit to their bank account. Generally, between 70% and 90% of recipients opt for direct deposit. The remainder either don t have a bank account or don t disclose that information. These people receive their payment on a prepaid card. There are millions of people in the U.S. who have no or only limited interactions with banks. According to the FDIC s 2011 national survey of unbanked and under-banked households, 8..2% of U.S. households are unbanked. That equates to 1 in 12 households in the nation, or nearly 10 million in total. Further, 20.1% of households are under-banked. That represents 1 in 5 households, or 24 million households; 29.3% of households do not have a savings account, while about 10% do not have a checking account. In addition to saving money for governments and taxpayers, prepaid debit cards provide huge benefits for their recipients, particularly those who don t have a bank account. While state governments and agencies have long pushed for direct deposit, there is a substantial population of Americans who do not have a traditional banking relationship that allows them to get direct deposit, Greehan says. There are still millions of checks that go out every week. Benefits of prepaid cards as a replacement for paper checks to recipients In addition to saving money for governments and taxpayers, prepaid debit cards provide benefits for their recipients, particularly those who don t have a bank account. Prepaid cards provide the following benefits over checks: A y more secure, efficient way to disburse funds to under-banked recipients who don t have direct deposit Access y to cash at automated teller machines and commercial banks that are members of Visa and/or MasterCard networks Paper y checks can be lost or stolen Immediate, y free use of funds; no need to cash checks at expensive check-cashing establishments Ability y to use the card to make purchases or access cash at the point of sale at retail establishments with Visa/MasterCard acceptance yability to pay bills electronically Individuals who don t have a checking account at a bank or credit union have few options to cash their checks at little or no cost. Walmart, which is one of the lowest-priced checkcashing establishments in the U.S., charges between $3 and $6 to cash checks. Banks generally charge $5 to $10 to cash checks, if they do so at all. (Many banks will not cash

5 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 5 checks for non-depositors.) And private check-cashing establishments charge 1% to as much as 20% of the value of the check, depending on state law. Hurricane Katrina was one of the primary drivers of the shift away from paper checks to electronic payment by the federal government. Many people in the path of the storm were reluctant to leave their homes because they feared missing the delivery of Social Security, disability and other subsistence checks. With an electronic solution, people can be wherever they are and the payments are going to get there on time. Case study: Houston Housing Authority The Houston Housing Authority s new Utility Allowance Payment (UAP) program provides a real-life example, if not a model, on how prepaid cards provide benefits for both the agency and its constituents, all of whom are low-income households. The Houston Housing Authority (HHA) is the local administrator of the federal Low-Rent Public Housing Program and the Housing Choice Voucher Program for low- to moderateincome families. The agency s programs provide affordable homes and services to more than 60,000 low-income people. The average household income of the families it serves is about $13,000 a year. Among its various programs, the HHA provides assistance to about 3,600 eligible families to help them pay their utility bills through its Utility Reimbursement Payment (UAP) program. The authority had been sending out paper checks of about $70 per month to each of those families. But effective December 1, 2012, the authority switched over to a prepaid debit card. It no longer prints paper checks. According to Thiele, the authority had been spending 70 cents to print and mail each check, so switching to a prepaid card saves the authority about $32,000 a year. By the time of the first payment, the authority had about 3,500 cards in use, and by mid- February that number had increased to 3,900, says Mark Thiele, the HHA s vice president of the Housing Choice Voucher Program. That means more than 90% of the cards had been activated just two months into the program. According to Thiele, the authority had been spending 70 cents to print and mail each check, so switching to a prepaid card saves the authority about $32,000 a year. The prepaid card costs the authority virtually nothing to operate. Spending taxpayer funds wisely In speaking with Thiele, one comes away impressed by how seriously he takes the idea of spending taxpayer funds wisely. It is incumbent on people entrusted with taxpayer dollars to figure out how to spend it most efficiently. We re very respectful and judicious on how we spend the money, he says. Our challenge every day is to deliver this service more efficiently. [The prepaid card program] is a perfect example of that. That challenge is never more critical than today, as public agencies like the HHA are getting a shrinking percentage of their operating funds from the federal government.

6 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 6 To help run the Housing Choice Voucher Program, the HHA gets a per unit administrative fee of about $60. When Thiele started at the agency in 2010, it was getting about 94% of that payment from HUD. That was subsequently reduced to 84% in 2011 and to 80% a year later. That was scheduled to be cut again to 75% this year, but the budget sequestration reduced it even further, to 69%. So saving money where it can is highly important to the agency. But while saving money and running its programs as efficiently as it can are very important, perhaps an even bigger driving force for the agency is removing barriers for the low-income families and individuals it serves in order to help them work toward self-sufficiency. Obviously we re saving money on writing checks and the postage. But that s not really why you do it, Thiele says. You do it because it s more convenient for our low-income families. It s more about saving time for our families. Helping families move toward self-sufficiency What we re really trying to do is come up with ways to help families move to self-sufficiency, he says. When your income is so low, a big part of your day is spent just managing your operations. So to the extent we can make that easier and free up their time to get job training and apply for jobs, resume building, skill building, that s the sort of thing we re trying to do. That s our mission. The prepaid utility card program is a convenient way to help them manage their day-today operations, Thiele adds. That is the real thinking. Time is a particularly vital issue in a far-flung place like Houston, which Thiele says is the third largest municipal jurisdiction by area in the country. It takes three hours to drive around the circumference of the city s borders. Making it even more complicated is that Houston wasn t built for public transportation. It s hard to get around. So running around cashing checks can be a time-consuming process for many people. The agency was able to implement the program in a very short period of time. The idea was presented last summer and was implemented by November, with the cards sent out November 15. It can also be an expensive one, and not just because of transportation costs. Houston is the sixth most unbanked major metropolitan statistical area in the country, according to the FDIC, with nearly 12% of the population not having a bank account. That compares to 8.2% nationally. That means people usually can t cash checks for free at a bank and must instead rely heavily on check-cashing services, which usually charge high fees. The prepaid card program is one of those things where we could make our families lives just a little bit easier, he said. Why do I want low-income families driving around cashing checks? They don t have an extra dime to spend on getting around to cash checks. Why can t I just put the money in their pocket? So we did it. The agency was able to implement the program in a very short period of time. The idea was presented last summer and was implemented by November, with the cards sent out November 15.

7 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 7 A quick buy-in from all involved If you re motivated, you could do it quicker, Thiele says. It s really an out-of-the-box solution from the Houston Housing Authority s perspective. The program was an easy sell internally, and putting it into practice was made easier by the fact that the authority s information technology function reports to the director of finance, who bought into the idea early on. If you have someone over finance and IT who is into the idea in the first place, that s going to move a lot of resistance out of the way internally in terms of getting things done, Thiele says. However, that doesn t mean it will be similarly easy at other housing agencies. Housing authorities tend to be risk averse, he says. I m not sure what the argument would be against it; it s more of a fear of change. Of course, the opposite is true: Things are hard and getting harder and we have to do new things. The authority continues to do outreach to get the remaining people to activate their cards. The agency also has a call center as well as a help page on its website with FAQs. The buy-in from the authority s beneficiaries was equally quick. The agency sent out a one-page notice with the last paper check that went out in November, alerting recipients that they would no longer be receiving checks and had 30 days to activate the card. By November 15, more than 3,300 cards had been activated, and only about 300 had not been activated by the end of the year. Thiele noted that recipients are keenly motivated to activate the card to get their money. Even though the average payment is only $70, that s a critical $70 when the average income is about $12,000 a year, he says. You can t walk away from $70 a month, so you re going to get your card activated. The authority continues to do outreach to get the remaining people to activate their cards. The agency also has a call center as well as a help page on its website with FAQs. Thiele says the authority is currently looking at using prepaid cards and direct deposit for its landlords. We are looking at this as a larger package of efficiencies. Thiele says the prepaid voucher program also provides benefits to the agency in the form of positive public relations. Every time we interact with our clientele, we have the opportunity to change people s perception of the housing authority, he says. If we drip kindness and innovation and new ideas every single time, that has a cumulative positive effect. And that really is what we re trying to do: to have the most positive impact on families. So that, at the end of the day, we end up with a better Houston and a better Harris County. Public/private partnerships that benefit all stakeholders Since public sector prepaid card programs like the HHA s cost the agency little or nothing to operate, while relieving them of the expense of writing and sending out paper checks, it s fair to ask, who does bear the cost of these programs?

8 PREPAID CARDS: ANOTHER STEP TOWARD A CASHLESS SOCIETY 8 These programs are typically operated by large or regional banks, who take over the task of remitting funds to beneficiaries. The bank earns money through traditional payment card economics, relying on point-of-sale usage, deposit balances and increasingly minimal fees. In those instances where the bank charges a fee for operating a prepaid program, it s far less than what the agency would have been spending on paper check delivery. This is a great example of the public sector working with the private sector to have a mutually beneficial relationship to serve customers and constituents, and it s working really well, says Greehan. Future uses of government-benefit prepaid cards The success of the various state and local card programs already in use makes it more likely that prepaid options will continue to evolve in municipal finance. More importantly, perhaps, the federal government s decision to go all-electronic in Social Security benefits and other payments further validates the effectiveness of prepaid options for reaching the financially underserved. While states have been in the electronic payment disbursement business longer than the U.S. Treasury, it is the federal government s more recent mandate that will empower more state and municipal agencies to continue down the path of electronic payments. Unemployment and child support benefits are already mature in the prepaid space, but many other types of payments by a variety of increasingly smaller entities will be ripe for migrating to prepaid solutions. The cost benefits there may not be as attractive as among the bigger and older programs, since they don t write as many checks or as frequently, but the savings will nonetheless be meaningful. Indeed, the primary driver will be the tight budgetary constraints with which nearly all governments and agencies must contend. As a result, governments are considering prepaid solutions for programs that weren t necessarily top priorities before. The success of the various state and local card programs already in use makes it more likely that prepaid options will continue to evolve in municipal finance. Among the many areas ripe for prepaid usage going forward are: Payroll y yincome tax refunds yschool district supplies ytax refunds Adoption y and foster care benefit payments ypension payments yhousing authorities yjuror payments Higher y education: financial aid, per diems, grants Any time a government is writing a check, it should consider prepaid, Greehan says. Ultimately, the goal is to eliminate all paper check payments. Bank of America Merrill Lynch is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation ( Investment Banking Affiliates ), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., both of which are registered broker-dealers and members of SIPC, and, in other jurisdictions, by locally registered entities. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp. are registered as futures commission merchants with the CFTC and are members of the NFA. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured May Lose Value Are Not Bank Guaranteed Bank of America Corporation