Many interest rates in the U.S. are close to zero and even negative in some parts of the world, like Japan. Not unexpectedly, U.S. savings rates are also quite low as individuals ask themselves: “Why save a lot of money at a bank if I get no return?” This situation has many commentators wringing their hands because low savings rates are a problem for many reasons. Individuals who don’t save face spending their golden years of retirement in poverty, instead of plenty. In addition, people with no savings face financial problems and potential ruin when unexpected large expenses occur and cannot help out their children with large bills like college or a down payment on a first home. In the absence of a rapid increase in interest rates, which appears unlikely, is there anything we can do to change this problem and get people to save more? As odd as it may sound, gambling could be part of the answer.
A simple solution: prize-linked accounts
One innovative idea for boosting low savings rates is through prize-linked savings accounts, also known as lottery-linked deposits.
The idea of prize-linked accounts is simple. Instead of receiving the full amount of interest on their savings, most people are given less money than they would otherwise and the remainder is distributed as prizes awarded randomly to some savers chosen by a lottery.
Pretend the average person receives US$2 each month in interest on a standard savings account. A bank offering a prize-linked account might instead give the account holder $1 of interest plus a small chance – slightly better than scratch tickets – to win $10,000. The bank would gather the $10,000 prize money by pooling the extra dollars of interest held back from many savings accounts.
These lottery savings accounts are an innovative idea because interest rates today are very low and offer little or no incentive for people to save money. Low savings rates cause people to abandon traditional savings accounts and lead some people to seek higher rates of return in very risky investments.
Prize-linked accounts have the advantage of ensuring savers never lose their initial funds, unlike other forms of gambling where losers can go home empty-handed.
One example of how prize-linked accounts work is the save-to-win program, promoted by a nonprofit with a mission to boost financial security among the poor. Savers deposit their money in a special 12-month account. Every $25 deposited gets the saver one more lottery ticket. Each month some prizes are awarded, and in some locations there is also an annual grand prize of $10,000 for those people who kept money in the bank for all 12 months.
These rules encourage people to open accounts, leave money untouched and build savings. Evaluations of these accounts since they began in 2009 suggest they are effective at boosting savings especially among the poor.
History of prize-linked accounts
Prize-linked savings accounts are not a new invention. The first lottery savings account was created in England in 1693 to help fund the Nine Years’ War against France.
It was a great success and raised a million British pounds for the government, which was about one-sixth of all public spending that year. Savers bought tickets for £10 each. Each ticket had a chance to win a grand prize of £1,000 per year for 16 years.
Tickets that won nothing in the lottery, however, paid interest of £1 per year for 16 years, providing the English Crown with a medium-term loan whose proceeds were used to fight a war. This was a huge success for savers because each £10 ticket returned a total of £16, plus a chance of winning a jackpot.
Controversy has surrounded prize-linked accounts ever since their introduction in 1693. Initially, criticism was leveled against the accounts because they encouraged people to gamble, which many people viewed as immoral.
More recently, governments have been against the accounts because they divert funds from state-sanctioned lotteries. South Africa’s First National Bank created a very successful account in which winners received a maximum payout of about $150,000. This program boosted savings by the poor and unbanked in South Africa. However, that country’s Supreme Court ruled the accounts were illegal after the state lottery commission complained that its own sales were reduced as a result.
The successful introduction of these accounts in other states like Nebraska resulted in President Barack Obama signing into law in December 2014 the “American Savings Promotion Act,” which enabled credit unions and banks to offer these accounts across the country. President Obama and Congress needed to revise the laws, because prior to the bill it was illegal for banks to engage in risky activities such as sponsoring a lottery.
States, however, also have to change their laws for this program to become widespread. One of the most recent states is Oregon, which passed legislation in June 2015 enabling banks to offer the accounts this year.
Very interesting but preliminary research is being done by University of Colorado Finance Professor Tony Cookson, who examined people in Nebraska and found that the introduction of lottery-linked savings leads consumers to reduce casino gambling. This means that these lottery-style accounts can not only boost savings rates but also encourage people to gamble less in casinos. While this is a win for consumers, it is problematic for states that are dependent on casino and lottery revenue to balance their books.
A ‘special’ boost
Prize-linked savings accounts are not the complete solution to low savings problems in the U.S. and elsewhere. Nevertheless, these accounts can help.
My bank recently sent me a mailing trumpeting the fact that because I am a long-term “valued” customer, my savings account got a special interest rate boost to encourage me to save more. Even with the “special” boost, I earned a grand total of $1.27 in interest for the month. This tiny sum gives me no incentive to spend less and save more.
However, a prize-linked savings account that did away with all of my paltry interest but gave me a small chance at earning enough money to actually buy something of value would definitely encourage me, and likely many others, to save more.