When federal and state government agencies supplement direct deposit with an option to receive funds loaded on a prepaid debit card, they lower costs, improve security and enhance services by replacing traditional checks, concludes a report issued this week by the Association of Government Accountants.

"[T]he unbanked benefit from prepaid debit cards because check cashing fees are eliminated, they do not have to carry around large amounts of cash, and they have the ability to make purchases using the card," says the report, which was based on a Visa Inc.-sponsored survey of 10 state and federal prepaid programs.

"Our issuers are in the business of electronification from the prepaid standpoint," says Carrie Vriheas, Visa's head of U.S. prepaid strategy, planning and infrastructure. "Many of them have these treasury relationships and these agencies are already their clients, so being able to drive costs out of the system and drive efficiencies in their processes in these new areas of opportunity is a value-add."

The U.S. Treasury Department estimates that it costs an average of $1.05 to issue a check, while the Automated Clearing House transfers used to reload prepaid cards costs $0.09. As of February 2013, the monthly volume of checks that Treasury issued dropped to 3.5 million, from a monthly volume of 11 million in January 2011. In 2010, the Treasury Department estimated it will save $1 billion over 10 years by moving Social Security, Supplemental Security Income and other paper check payments to prepaid cards.

In addition, governments do not typically incur an expense to establish a prepaid debit card program because issuers cover their costs and turn a profit through interchange fees, interest and cardholder fees.

The 15 issuers that provide prepaid card programs to governments made $208 million in interchange fees from merchants during 2011, the Federal Reserve reported to Congress last year. That's an average of 1.1% of transaction amounts and was consistent with the Fed's findings for 2010.

At the same time, underbanked benefits recipients pay less in fees with prepaid cards than paper checks. Issuers reported to the Fed that they did not charge fees on approximately 60% of cash withdrawals at ATMs, or on 87% of cash withdrawals at bank tellers.

"We were relieved to hear that the value proposition for both the state, as well as the consumer was as positive as it was," says Vriheas.

Still, issuers made $120 million in cardholder fees during 2011, which the Fed calculates to an average of $6.33 per card, or 0.3% of the dollars disbursed annually through government payment prepaid debit cards, which the AGA report concludes is significantly less than the 1% to 4% fee that check cashers charge.

"[I]ndividuals who received unemployment compensation benefits through prepaid debit cards collectively saved between $100 million and $389 million in fees per year in the 26 states" that offer prepaid cards, the report says.

Since the advent of state Electronic Benefits Transfer programs in the 1990s, prepaid cards have moved beyond the Supplemental Nutrition Assistance Programs where they first appeared. The state agencies surveyed reported savings associated not just with the costs of issuing an initial check, but also from reduced instances of lost or stolen checks, as well as other administrative costs, while also providing access to card-related services that are impossible to offer via paper checks.

"Given that governments are seeking to reduce costs while maintaining service levels, it is not surprising that for the majority, cost was the primary reason for moving to prepaid debit cards," the reports says.

State agencies have deployed prepaid card programs to distribute unemployment and retirement benefits, child support payments and income tax refunds.

"What's really been interesting to see in the past few years is just the movement; as one state has implemented one program and seen the benefits, they're starting to now see multiple programs in each state," says Vriheas.

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