What are prepaid cards?

In the history of payment methods, nestled between the credit card boom of the mid-20th century and the current wave of payments digitalization, there was a different trend that emerged in the 1990s: the prepaid card. First appearing in the ‘70s, closed-loop prepaid gift cards are issued by a business and represent a liability. Funds from these gift cards are kept by the business and can be spent to sustain its operations. Cardholders can only spend up to the amount of money loaded in advance onto the card, hence the term “prepaid.”

More recently, businesses have established specialized subsidiaries located in states with lenient escheatment laws. In the case of business insolvency, gift card holders have a claim against the company in court as a class. In some instances, competitors have agreed to accept the gift cards in an effort to win new customers.

Closed loop vs. open loop

There are two main categories of prepaid cards: open loop and closed loop, although those terms can encompass more than just prepaid cards. Open-loop prepaid cards can be referred to as multi-purpose or general-purpose cards because they can be used with multiple payees through network (Visa, Mastercard, American Express) rails.

Closed-loop prepaid cards, or single-purpose cards, are used with only one specific payee. Although closed-loop prepaid cards usually do not bear the logo of a credit card network or bank, the merchant offering the card may partner with a financial institution for issuance. From a recent Mercator report: “Mercator Advisory Group defines closed-loop cards as cards that can run and be authorized on a private network, and can be redeemed only at the issuer’s designated locations.”

Common uses for closed-loop prepaid cards

The earliest forms of closed-loop prepaid cards are still the most commonly recognized today: gift cards that are redeemable only with specific merchants. Target, Best Buy, Apple, Disney, Starbucks, Dunkin’ Donuts, and more all offer prepaid gift cards that are only accepted in their respective stores or on their websites.

Closed-loop prepaid cards take on a variety of forms. The list below is not fully inclusive, and some examples are available in both closed-loop and open-loop formats:

  • Employee and partner incentives cards used for B2B or internal rewards programs
  • Customer incentives cards that reward consumers for displaying particular behaviors
  • Campus cards that are accepted for school-hosted services such as food or laundry
  • Gaming, video game sales, and in-game purchases with stored value cards
  • In-store gift cards, run on a private network, redeemable only at a particular retailer
  • Store credits/returns offered as appeasement by merchants (e.g., restaurants and hotels)
  • Government-issued nutrition assistance cards such as SNAP and WIC
  • Transit cards accepted for travel on buses, light rail, and commuter trains
  • Transponders such as E-ZPass that allow drivers to pay for tolls and parking
  • Fuel cards that can be purchased at gas or service stations (different from fleet cards, which are typically either credit, debit, or decoupled debit products)
  • Utilities cards in which money is pre-loaded to pay for services such as electricity
  • Prepaid mobile minutes with money loaded onto cards used for cell phones

Pros and cons of closed-loop prepaid

Closed-loop prepaid cards offer advantages for both consumers and merchants. The primary advantage for consumers is that they receive promotions and incentives that may not otherwise be available to customers shopping at a particular retailer.

Merchants can track how often a prepaid card is depleted and reloaded (if the card is reloadable), and offer rewards for increased usage. Consumers can also take advantage of savings that companies offer during holiday periods to incentivize sales. Furthermore, prepaid cards are available to a wider pool of consumers, including the underbanked/unbanked population because there are no qualifications to obtaining one.

These consumer benefits are directly tied to the primary advantage for merchants: increased customer loyalty. Additionally, the processing costs for merchants may be lower than with other payment cards as there is only one node separating the merchant and customer – the acquiring bank or processing network.

There are also some negatives for consumers using closed-loop prepaid cards. The most obvious downside is the lack of flexibility – unlike most other payment methods, closed-loop prepaid cards are limited in their applicability. Any unspent money on a prepaid card, otherwise known as “breakage,” may disappear at the end of a set expiration period.

New use cases and the future of closed-loop prepaid cards

The COVID-19 pandemic impacted nearly every part of the economy, including closed-loop prepaid load values – though the effects are constantly adjusting and still being evaluated. Decreases in closed-loop prepaid loads can be attributed to a plurality of effects from COVID-19, such as physical store closures and decreased consumer discretionary spend.

Although overall closed-loop values have fallen, certain segments, such as digital content, have risen as result of the pandemic. In addition, there is an increase in the number of digital closed-loop cards purchased as opposed to physical cards. Pandemic-induced use cases include state governments offering prepaid incentive cards to increase vaccination rates.

This article provides an overview of closed-loop prepaid cards. For thorough analysis of recent trends and data-driven forecasts for the future, see Mercator Advisory Group’s recent report, 18th Annual U.S. Closed-Loop Prepaid Cards Market Forecasts, 2020-2025.