The Growing Threat of Prepaid Card Fraud

Table of Contents

1. What Is a Prepaid Card?
2. What Is Prepaid Card Fraud?
3. What Are the Most Common Scams Conducted Using Prepaid Cards?
4. Are Prepaid Cards Subject to Disputes and Chargebacks?
5. How Can Merchants Prevent Prepaid Card Fraud
6. Emerging Trends in Prepaid Cards

There's been steady and significant growth in the use of prepaid debit cards over the last decade, and industry forecasts expect that growth to continue. Prepaid cards are often used in place of cash or checks, providing funds in a more convenient form. Unlike these older methods of payment, prepaid cards can be used to make e-commerce purchases without first transferring the funds to a bank account.

Merchants, especially those in e-commerce, may benefit from the growth in prepaid cards. Unfortunately, these cards come with one big downside: fraud. What do merchants need to know to combat the threat of prepaid card fraud?

What Is a Prepaid Card?

Like debit cards, prepaid cards carry a balance that gets depleted as funds are spent. Some prepaid cards are purchased for a fixed amount and discarded when empty. Others can be reloaded and used indefinitely.

Prepaid cards branded by Visa, Mastercard, or other card networks can be used with any merchant that accepts that network's cards. Some prepaid cards are used in place of gift cards, allowing the recipient to shop anywhere they like rather than being limited to a single store. Others are used in place of one-time cash or check payments. In 2020, many Americans received their economic stimulus checks in the form of prepaid cards.

For some, a reloadable prepaid card can serve as a replacement for a checking account. Paychecks can be deposited onto the card rather than into a bank account, removing the downsides of minimum balances and overdraft fees.

Worldwide, the prepaid card market is anticipated to exceed $3.6 trillion by 2022, with the U.S. market exceeding 350 billion. Students, travelers, and unbanked customers are among the segments driving this growth, but merchants in every market can expect to see increased usage in the years ahead.

What Is Prepaid Card Fraud?

Prepaid fraud occurs when a fraudster uses stolen prepaid card information to make a purchase or buys a prepaid card with other stolen payment credentials. Prepaid cards are also a common method of payment used in financial scams.

While reloadable cards do require the user to provide some personal information, prepaid cards often aren't easily tied to specific identities. That makes it easy for fraudsters to use them for money laundering. They can purchase prepaid cards with stolen funds, then use them to make untraceable purchases anywhere they like.

As usage increases and prepaid card products become more sophisticated, we may also see greater use of these cards to conduct criminal activity. According to law enforcement agencies, these cards have already been used in drug trafficking operations and in preparation for terrorist attacks. However, their most common use is still simple financial fraud.

In the U.S., there were 38,000 reported cases of crime in 2019 that involved the use of prepaid cards, with the combined losses totaling $103 million.

Of particular interest to fraudsters is the fact that reloadable cards can be used at ATMs, making it possible to convert stolen digital payment credentials into cold hard cash with relative ease.

Instances of hackers compromising the databases of prepaid card systems are becoming more common, especially where issuers have outsourced prepaid card management to third-party processors. Hackers who can gain access to these systems can copy card numbers, inflate balances, and remove withdrawal limits.

What this means is that prepaid card fraud can show up in many different forms. The card itself may have been purchased with stolen funds, or the card, while originally purchased legitimately, may have been stolen or copied by a fraudster. These can result in different dispute scenarios down the line, and it can be difficult for merchants to determine how to identify and prevent these fraud attempts.

Because these cards are designed to be easy to purchase and use—even by people without identifying documentation or a credit history—they don’t come with the same kinds of associated cardholder information that make it possible to detect and filter out traditional forms of payment card fraud.

Here are a few common types of fraud and scams that often involve prepaid cards:

• Card reloading fraud: Fraudsters get gift cards that they didn't pay for and call the company that loads them. They claim to be from the payment processor and trick a representative from the company to keep loading the card so they can use an ATM to offload free money. 
• Advance fee scams: You've probably heard of these before. Someone gets an email telling them there's a lot of money coming their way if they just pay a little fee up front to handle taxes or customs or some other issue. Traditionally these scams have been conducted using wire transfers, but these days many fraudsters ask the victim to buy a prepaid card and use that, making the purchase harder to trace.
• Tax fraud: Many states and the federal government allow refunds to go to prepaid cards. Some fraudsters complete tax forms using information from stolen identities and then load the cards with their ill-gotten refund.
• Repair scams: An individual receives a call from someone claiming to be from a major technology company who asks for remote access to their computer. They then suggest that the computer is full of malware or that their identity has been stolen, and attempt to get the person to buy a prepaid card or to give them access to their bank accounts to check their security. The fraudsters get the information and extract the cash. 
• Swapped cards: A fraudster surreptitiously opens the packaging of a reloadable prepaid card in the store and swaps it with an identical card they've purchased themselves and cloned. When a customer buys the swapped card and adds funds to it, the fraudster steps in and uses those funds, via the cloned card, to make purchases or ATM withdrawals.
• Skimmed cards: A fraudster skims the card information from the magnetic stripe of a prepaid card in the store. When a customer purchases and activates the card, the fraudster uses the skimmed card information to make online purchases.

Because these cards aren't tied to a specific issuing bank or lender, they are hard to track for fraud prevention purposes. However, many prepaid cards are tied to credit card networks, which provides some level of security.

While the dispute and chargeback rules for most payment cards are laid out in the Fair Credit Billing Act and subsequent legislation, these laws do not cover prepaid cards. All that means is that the United States government isn't requiring banks to offer chargebacks on their prepaid cards.

However, card networks like Visa and Mastercard have a vested interest in maintaining customer confidence in prepaid cards, and so they do offer fraud protection and dispute options for customers who purchase prepaid cards carrying their brand name.

• Visa prepaid cards are covered under Visa’s Zero Liability program, but the cardholder must report the card as lost or stolen first, and certain “anonymous prepaid card transactions” are not included. Cardholders are directed to bring other disputes to the prepaid card issuer, which may have their own forms or processes for handling transaction disputes.
  
  
• Mastercard requires cardholders to register their cards before they can file a dispute claim. They too will send cardholders to the card issuer if specific disputes come up that aren’t covered under the general policy.

Chargebacks may also hit merchants who sell prepaid cards when fraudsters purchase those cards for money laundering purposes. The cardholder will dispute the transaction that was used to make the prepaid card purchase, and then the merchant will be left with an incontestable true fraud chargeback.

At the moment, prepaid card fraud may be a big problem for some merchants and a vanishingly small concern for others. Merchants who don’t sell prepaid cards don’t have to worry about chargebacks from victims of money laundering schemes, but all merchants who accept credit cards are vulnerable to disputes resulting from the theft or misuse of prepaid cards.

As usage increases and prepaid card offerings become more widespread and diverse, prepaid card fraud and chargebacks may pose a much bigger problem in the future than they do now.

Merchants in regions or markets that already deal in a high volume of prepaid card transactions may already have firsthand experience dealing with these issues. If you’re not sure where you stand, analyzing your chargeback data can tell you. You should be able to sort out chargebacks by card type and see how many of them are coming from prepaid cards, whether those cards are fixed or reloadable, and which brands and issuers they come from.

An in-depth data analysis can help you identify the sources of your chargebacks so you can tell if particular distributors, customers, or shopping patterns are key indicators that fraud is likely to occur. When you can arm yourself with this information, you can stay a step ahead of the fraudsters and implement changes and policies that will make it harder for them to target you.

Just remember that if you’re having trouble analyzing your data or executing an effective anti-fraud strategy, it might be time to call in the chargeback specialists for some expert advice.