Are DWP's plans to provide effective support for Universal Credit claimants about to be blown off course by Europe?

As the Department for Work and Pensions (DWP) prepares to roll out Universal Credit it would do well to keep an eye on the European Union’s plans for the regulation of credit card and debit card payment systems.  In a recent debate on payment systems MEPs have called for the European Commission to bring forward proposals to limit the amounts that credit and debit card networks issuers can charge retailers for their use of the payment networks (VISA and MasterCard). But whilst there are good intentions behind the European proposals the measures could have major implications for the delivery of financial products to Universal Credit claimants.

One of the stated reasons for the introduction of Universal Credit is that it will enable people who are out of work get into the financial habits associated with being in employment. To reflect more closely the in-work situation, Universal Credit payments will:

• Be paid one month in arrears;
• Be paid to the claimant in their entirety (at the moment social tenants have their Housing Benefit paid directly to their landlords).
• Be paid into a transactional account which is capable of taking wages – so negating the need for a claimant to change their account on moving into employment.

However, DWP has recognised that up to 2.5 million Universal Credit claimants could need support in moving to these new arrangements. As a consequence, in September Lord Freud announced that the Department would tender for the provision of ‘new financial products' to help Universal Credit claimants manage their money. The ‘essential features’ of these products were set out in the Prior Information Notice for the tender. These included:

• Being accessible to all claimants, irrespective of credit history;
• Providing help for people to set aside money to cover regular payments for housing and other bills (commonly referred to as ‘jam jar’ or ‘budgeting accounts’); and
• Providing options to help people build up their credit rating.

A possible additional feature that could be added to the product would also enable claimants to make regular contributions to savings products or, where a claimant has outstanding debts, to their creditors – either directly or through a Debt Management Plan.

It occurred to a number of us looking at DWP's Prior Information Notice that the required features could potentially be provided using pre-paid debit or credit cards, as recent innovations allow these to be used in ways which are increasingly similar to a full transactional banking account.   Although there would also be a need to ‘bolt on' the budgeting service, issuers of pre-paid cards include credit unions as well as the commercial sector, and the tender could therefore provide the opportunity for many claimants to be signed up to automatic credit union membership in order to receive their Universal Credit payments.  That would have obvious benefits for people in need of affordable credit as well as transactional accounts.  As DWP is currently leading an investment programme to support credit union expansion, using pre-paid card platforms as the mechanism to support Universal claimants was starting to look very much like a win-win.

However the cost to the end user of pre-paid cards is a major concern, with many of the current cards on the market levying a combination of application fees, charges for purchases made, or for the use of ATM machines. For example, simply obtaining a Virgin pre-paid VISA card requires payment of an up-front fee of £9.95, and the card then also levies charges of 2.95% of the cost of all retail purchases and cash withdrawals. Making pre-paid cards a viable option for Universal Credit claimants therefore requires some form of subsidy, either directly by DWP or from other third parties that could potentially benefit from the bill payment ‘bolt-on’ which is envisaged.

Whilst DWP has indicated that it will provide up to £148 million in subsidy for the products, this support will only last for a period of one year for each claimant – running from the date on which they transitioned onto Universal Credit. Other income streams to support the platform are therefore clearly important and it is likely that these could be brought in from the beneficiaries of the budgeting account features that are proposed. For example, social housing providers may be prepared to pay a fee to the card provider in order to ensure that rent payments are prioritised within the account. This may also be the case for major utility service providers.

However, it is here that the European Commission’s proposals may present a problem. Both the VISA and MasterCard networks are paid for by charges to card issuers (for example a high street bank). A proportion of these charges are then passed on directly to consumers (as detailed in the example of the Virgin pre-paid card above). However, a further proportion of the cost is also recovered, in the case of retail purchases made with a card, by a fee which is charged to the retailer’s bank, known as ‘the multilateral interchange fee’. These fees are subsequently passed on by the retailer’s bank to the retailer themselves through a ‘merchant service charge’. Whilst the multilateral interchange fees are a relatively small cost of the total transaction (MasterCard charges between 0.6% and 0.85% on its interchange fees for UK pre-paid cards) the large number of transactions made on the networks clearly means that this can add up to a significant overall revenue stream for card issuers.

In recent years the European Commission has become concerned that the multilateral interchange fees have become too high, and when the issue was discussed by the European Parliament in November MEPs urged the Commission to come back with proposals to cap the fees. The intention here is to reduce the costs for retailers for participating in payment services networks, and, in the expectation that retailers will pass on these savings to their customers, benefit consumers.

However, there is evidence from Spain that this will have unintended consequences. In December 2005 the Spanish government enforced a reduction in the interchange fees for the period 2006 to 2010. Rather than lower the overall costs for consumers, Spanish researchers have found that card issuers hiked up the direct costs to card users, either by eliminating free cards and charging annual fees or by increasing interest rates or other transaction fees. The implications from this research are pretty clear. If a cap on interchange fees is required by Europe then this will run the risk of increasing the cost of card use for consumers, making it more difficult to achieve a sustainable, and affordable, pre-paid solution for Universal Credit claimants.

This is not to say that there aren't wider problems in the credit card market which regulators need to address (whether at the EU or national level). In the current economic climate, where it is difficult for card users with outstanding balances to switch accounts and exert competitive pressure on card pricing, consumers are particularly vulnerable to card issuers hiking charges. That certainly requires further regulatory investigation. However, capping interchange fees is likely to add further to the problem faced by consumers rather than address them and, in the case of the UK, will also make attempts to provide Universal Credit claimants with supportive financial products at a reasonable cost all the more difficult.

Importantly, given the length of the legislative process at the EU level the negative impacts of any cap on interchange fees is likely to coincide with the withdrawal of DWP subsidy for a large number of Universal Credit claimants. As we move forwards towards the full tender for financial products Lord Freud would therefore do well to timetable some discussions with Treasury colleagues concerning Britain’s approach to the European Commission’s work in this area.