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Credit and debit card issuers in the U.S. are updating their rewards initiatives to reflect changes in the economy and in consumer behavior. But they also are preparing for a possible industry upheaval that could affect how they fund rewards.

Between 60% and 70% of U.S. card spending is tied to loyalty initiatives, which mushroomed over the last two decades, analysts say.

Card rewards enable consumers to earn points or miles redeemable for cash, merchandise or travel, and they are not going away any time soon. But as issuers rethink their goals of offering rewards and how they pay for them, changes are likely to occur.

Experts expect issuers to add more incentives for revolving-balance cardholders, such as cash-back bonuses for paying credit card bills on time. Issuers also are restructuring rewards so points earned with debit and credit cards may be combined, and family members can pool points or air miles.

"Card rewards are ubiquitous, but issuers need to hone their programs to fit reality," says Brian Riley, a senior analyst with TowerGroup, the research arm of MasterCard Worldwide. "The economy has declined a bit, consumer behavior is changing, and issuers are shifting the gears of rewards programs to get different results."

Issuers also worry that legislation that would cut their interchange revenue could affect card-rewards funding.

Acquirers, which pay issuers interchange to help fund rewards and to offset their operations costs, including risk, incorporate their interchange expenses into the discount rate they charge their merchants.

"Downward pressure on interchange fees will make it harder for issuers to continue to fund rewards programs in the U.S. as they are structured today," says Megan Bramlette, managing associate in the London office of Westbury, N.Y.-based Auriemma Consulting Group. "Issuers looking at their rewards programs with an eye to the future must take into account the possibility that interchange revenue may decline."

Even the annual fees that were common a decade ago and helped to offset the cost of funding rewards largely have disappeared. In a recent survey of cardholders, Auriemma found that about 13% of respondents pay an annual fee on the card they use most frequently, down from 18% who did so in late 2006 See chart.

An exception is co-branded airline cards, where annual fees remain prevalent and, in some cases, are rising (see story on page 44).

Outside the U.S., issuer-funded card rewards are somewhat less common, says Aneace Haddad, founder and chairman of Welcome Real-time SA, a rewards software company based in Aix-en-Provence, France, that administers card rewards in 27 countries.

"The trend outside the U.S. is toward merchant-funded rewards programs and promotions," Haddad tells Cards & Payments.

Reductions in interchange revenue in many countries, including Australia and Mexico, threaten issuer-funded rewards, he notes. When Australian bank regulators initiated interchange cuts in 2003, analysts say, some banks there cut back on rewards and raised annual fees.

In the U.S., the norm today is reward credit cards that carry no annual fee but provide one or two points or air miles per dollar spent, says Mark Shipley, MasterCard senior vice president for loyalty and rewards solutions.

On a lesser scale, major issuers also offer rewards programs for debit cards. "About a third of card issuers offer rewards for debit card usage, and that ratio is growing with the rising popularity of debit cards," Shipley says.

Issuers do not receive interest revenue from debit cards, and interchange rates for the cards are lower than those applied to credit cards.

Despite the variety of reward options available to cardholders, new research from Auriemma found that consumers' attitudes toward credit card rewards are changing.

In a January survey of U.S. consumers, Auriemma found that penetration of rewards-based credit cards declined to 61% among respondents compared with 69% penetration in December 2006, the last time Auriemma conducted the survey. The survey also found that the percentage of consumers who reported not having a rewards card increased to 39% this year from 31% in 2006.

In the recent survey, Auriemma found that 35% of respondents said rewards specifically drove their most-frequent rewards card use, down from 40% who said so in 2006. However, 33% said a lower annual percentage rate was the reason they used a rewards card most frequently, up from 25% who said so in 2006.

"In less than two years, the [annual percentage rate] has gained nearly equal importance as the actual rewards for rewards cards," Bramlette says. "This trend suggests that in the slowing economy, consumers are becoming more cost-conscious and that rewards currency is losing some of its perceived value."

According to Riley, in these tougher economic times consumers tend to be more interested in survival than in luxuries. This creates an opportunity for issuers to offer rewards based on responsible financial management that would benefit both themselves and their customers.

Discover Financial Services took a step in this direction when it introduced the Motiva card (see story on page 34). Motiva rewards revolving-balance customers for making on-time payments, Riley says.

Total System Services Inc., or TSYS, a Columbus, Ga.-based transaction processor, enables its issuing clients to allow cardholders to aggregate rewards points and air miles.

Rod Boyer, president of TSYS Loyalty, tells Cards&Payments the company is developing technology for new enterprise-wide rewards for top issuers to enable their customers to aggregate points earned with

multiple products such as debit, credit, checking and savings accounts, and mortgages. He declined to name the issuers involved.

"The goal is to put rewards at the center of a more holistic issuer-customer relationship, giving customers the opportunity to earn rewards through all their contacts with a financial institution and more reasons to stick around," Boyer says.

In another twist on point aggregation, JPMorgan Chase & Co. is developing a rewards credit card that would enable friends or members of households to aggregate their points in a single rewards account, Gordon Smith, CEO of Chase's Card Services unit, told analysts earlier this year. Chase expects to unveil the initiative during the second half of this year, but the issuer declines to reveal further details.

Rewards remain popular. But in a changing economic landscape, issuers are tweaking rewards to be more relevant and to ensure they address strategic goals.  CP

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