Monday, 28 February 2011

Can lottery linked savings give people the thrill of winning with the benefits of saving?

An article posted in December titled Who Could Say No to a ‘No-Lose’ Lottery? by the Freakonomics team is triggering debate about the merits of Prize or Lottery Linked Savings schemes.  The concept of lottery and prize linked schemes is not new in many countries, especially the UK which has been running them for decades.  The UK’s prize linked saving scheme, called the Premium Bond scheme, was launched in 1964, and was described by the then Prime Minister Harold McMillan as ‘savings with a thrill’.  People 'invest' (and kind of gamble) up to £30,000 in bonds, with more bonds increasing the chances of winning the prizes, ranging from £50 - £1m.  The price or cost to the investor for having the chance of winning a prize is a guaranteed return on your principal or investment at below market interest rates.
So why the recent interest in these schemes and lotteries?  Peter Orszag, former director of the US Office of Management and Budget under Barack Obama, has argued in a recent article in the Financial Times that lottery linked saving schemes could be an innovative means by which to encourage people to save in the post-recession era.  Professor Peter Tufano of Harvard University, an expert in mutual fund and lottery linked savings schemes, agrees with Orszag.  And people love lotteries!  Seth Godin’s recent blog explains this succinctly; in terms of practical mathematics the chances of winning a lottery are very slim, which means people play the game for a thrill. 
In his paper Saving whilst Gambling: An Empirical Analysis of U.K. Premium Bonds, Tufano explains that lottery linked saving schemes are fascinating because of their appeal to non-savers, especially low income families, many of whom play the lottery.  He argues there is evidence to suggest that in Latin America these schemes have gone a long way in helping the unbanked population to save, arguing they wouldn’t have saved if such schemes hadn’t existed.  There is also a psychological appeal, in that because the principal payment (i.e. investment) is riskless, it appeals to people’s loss averse nature to gambling and investments (see our earlier post Can Loss Chasing be Explained by Behavioural Economic Theory? to read more about the behavioural factors that drive our financial decision making processes).  Tufano has been putting his theory into practice with eight credit unions in Michigan with the launch of a product which turn savings accounts into a game called ‘Save to Win’.  By the end of 2010 there had been $28m in savings racked-up and two winners.  Alabama has recently lauched a Save Now Win Later product.

So what is driving people to these schemes and are they encouraging greater gambling behaviour?  Tufano says there is evidence to suggest that UK Premium Bond demand mixes both gambling and saving incentives, with sales correlated to the size of the largest prize, similar to a lottery.  However the UK's recent Gambling Prevalence Survey doesn't include such schemes in its list of gambling activities, which is interesting considering these schemes would violate state gambling laws in the US according to Tufano.  Whilst there is no evidence yet to suggest such schemes are encouraging greater gambling involvement Tufano is now looking closely at the results of Save to Win to assess whether the savings accounts are giving rise to new gambling behaviour.  Others also argue that such schemes are regressive and that governments should be encouraging citizens to save by promoting the benefits of saving, rather than taking away the benefits of saving (i.e. interest) and replacing this with a slim chance of winning a prize.

The attraction of lottery or prize linked saving schemes is undeniable.  In the UK it is estimated up to 40% of the population could hold Premium Bonds.  The attraction of the lottery is undeniable.  In the UK 59% of the population bought lottery tickets in 2010.  The question is whether such schemes will take-off in new markets, such as the US, a key factor being whether the benefits outweigh the potential pitfalls.  Also the math behind such schemes requires large participation to make them attractive.  Whilst historical evidence in other countries suggests they could become very popular, overcoming the legal hurdles associated with offering hybrid savings and gambling products may mean that US citizens have to wait a little while longer before schemes such as Save to Win become widely available.