Litigation Threatens to Capsize U.S. General Purpose Gift Cards Market

NEEDHAM, MA – Gift card products in the U.S. again saw double-digit growth in 2004. Yet new research from TowerGroup finds that despite extremely strong consumer demand, regulators continue to explore restrictions such as the prohibition of fees that could imperil the survival of prepaid gift cards issued by financial institutions.

“The explosive growth of these products and their high rates of consumer satisfaction are at odds with consumer advocates’ claims that current fee structures are unacceptable,” said John Gould, research director in the Bank Cards research service at TowerGroup and author of the research. “The focus of regulators relative to bank-issued gift cards is misdirected on the regulation of fees, to the point of threatening the viability of a popular and fast-growing consumer payment vehicle. Regulators should instead redirect focus toward ensuring adequate disclosures for both the buyer and ultimate recipient about the terms of each gift card.”

Highlights of the research include:

• While consumer advocates and legislative bodies have tended to lump retailer-issued and bank-issued gift cards together, a central problem with this approach lies in the confusion of two very different payment instruments. Gift cards offered by specific retail merchants as a loyalty product to increase sales. In contrast, prepaid gift cards are issued by financial institutions as “universally accepted” payment products with additional features such as lost card replacement.

• Fees and disclosures are the two primary points of contention on gift cards between regulators and the financial services industry. While service fees on “universally accepted” gift cards are needed to offset legitimate expenses related to offering and servicing these products, there is evidence that consumer disclosures — particularly to the ultimate gift card recipient — have been lacking. The industry must recognize this deficiency and act quickly to correct it, even as it fights to avoid prohibition of fees.

• A dozen U.S. states have already enacted statutes governing gift cards, while over 70 legislative proposals in 31 states are still pending. This legislation will have little impact on gift cards issued by retailers — but rather, will have serious implications for the “universally accepted” gift cards issued by financial institutions.

• Despite all of the regulatory activity and concerns over fees and disclosures, consumer demand for gift card products continues to grow at unprecedented levels. Third-party consumer research by First Data subsidiary ValueLink finds that consumers are buying and using more gift card products year over year — and that consumers rate their satisfaction with gift cards as 9 on a scale of 10.

“On the one hand, U.S. consumers have shown their satisfaction with their wallets, spending an average of US$274 on gift cards in 2004. On the other hand, regulators are introducing legislation that may very well make these products unprofitable and could force financial institutions to withdraw them from the market,” noted Gould. “In the interest of the consumers who want these products, financial institutions and regulators must come to terms on the reasonable level of fees needed to offer and service these products, as well as on the proper levels of disclosure for buyers and recipients. This will enable the propagation of prepaid products and more choice for consumers in the payments landscape.”

The new TowerGroup research report titled, “Legal Maelstroms Threaten to Capsize Gift Cards” is the third in a series of research reports on the legal and regulatory issues for prepaid products. This report and the previous two reports titled, “Emerging Regulatory Issues Facing Prepaid Payments: One Size Does Not Fit All” and “Understanding Prepaid and Stored-Value Payment Products: A Framework For Discussion” are available to qualified members of the press for review. Those interested in purchasing a copy of any TowerGroup report or subscribing to a TowerGroup research service may call +1.781.292.5200 or email service-info@towergroup.com.