Working to find actionable solutions to the nation's key challenges.

Prize-Linked Savings Accounts Are Lotteries with No Losers

By Shai Akabas, Brian Collins

Wednesday, May 14, 2014

Share on FacebookTweet about this on TwitterShare on LinkedInPin on PinterestShare on TumblrEmail this to someonePrint this page

Prize-Linked Savings (PLS) accounts are like standard savings accounts – but instead of accruing interest, savers are entered into a lottery for larger amounts of money. In the U.S., PLS products are available only in some states and on a limited basis, but they are already employed widely in over 20 countries around the world.

A bipartisan bill (the American Savings Promotion Act) that would allow federally chartered banks and credit unions across the nation to offer PLS accounts is currently pending in both the House and Senate. The broad availability of PLS could offer an unconventional, but effective, mechanism to boost the persistently low rate of personal savings in the U.S.

Prize-Linked Savings

At their core, PLS plans are savings devices. Although the details differ by institution, individuals make deposits into a savings account or certificate of deposit (CD).1 In lieu of some or all of the interest that a normal savings account would earn, depositors are entered into a raffle if they do not withdraw the money for a specified period of time. Their original deposits are held risk-free, like a normal savings account or CD. The number of raffle tickets that each individual receives is based on the size of their deposits, and the prizes are paid out of the interest that is accrued (but not paid) across the pool of accounts.

Save to Win (STW), which started in Michigan in 2009, is the first large-scale PLS program in the U.S. STW account holders purchase one-year interest-bearing certificates of deposit (CD).2 For every $25 saved per month, account holders get one entry into a raffle for cash prizes. Each person is limited to ten entries per month.

STW has experimented with a variety of different prize structures. In 2011, the plan offered just one grand prize of $100,000. After finding that winning a prize of any size makes account holders more likely to save more regularly and keep accounts open, STW in Michigan now advertises 50 to 75 monthly prizes that range from $2,500 to $3,750 and six annual prizes of $10,000. Another survey found that 59 percent of respondents believed they would be more likely to participate if there were the chance to win $50 at the time of deposit. As a result, STW in Nebraska has considered instituting “instant prizes” but has not done so yet.

What issue does PLS address?

Savings rates in the U.S. are low. In March of 2014, the U.S. aggregate personal savings rate, which is defined as the ratio of total savings to total after-tax income, was only 3.8 percent. A 2013 survey found that 27 percent of all Americans had no emergency savings whatsoever and another 23 percent had some but could not cover three months of living expenses. Low-income families, in particular, struggle to accrue savings. In 2007, the Urban Institute found that 40 percent of families with incomes below poverty had no checking or savings account, and that among those who did have an account, the median balance was only $310.

But research also shows that low-income Americans can save, especially given the right incentives. For example, Individual Development Accounts (IDAs) are small savings accounts for low-income individuals that match deposits using outside money. IDAs have been shown to modestly increase savings and homeownership among account holders. Unfortunately, IDAs require significant funding (usually from non-profit organizations or the government) to be able to do the matching that incentivizes saving and, contrary to the hope that the program might help participants become lifelong savers, the effects seem to dissipate after matching funds are no longer offered.

Can PLS actually encourage savings?

Pilot programs in the U.S., experimental evidence, and experiences in other countries all suggest that PLS plans could have broad appeal and increase savings among low- and middle-income Americans. In fact, PLS plans seem to incentivize higher savings about as well as IDAs but need no outside funds because they are funded entirely from the interest earned on deposits.

STW started with a pilot of eight credit unions in Michigan in 2009 and has been very successful in attracting deposits.3 The program grew to include 58 member unions and over 15,000 accounts in 2012. Additionally, many STW account-holders were classified as “financially vulnerable” because they were not regular savers (43 percent), were asset poor (31 percent), were low-to-moderate income (31 percent), were single with dependents (8 percent), or had limited rainy day funds of less than three months’ expenses in savings (50 percent). Crucially, these financially vulnerable account-holders kept their accounts open for another year at the same rate (around 65 percent) as the non-financially vulnerable.

STW has since spread to Washington, North Carolina, and Nebraska. Several additional states – including Indiana, Connecticut, New York, Maine, Maryland, and Rhode Island – have laws that allow for PLS products.

There is also experimental evidence suggesting that PLS accounts boost savings. A recent experiment found strong evidence that saving with a lottery component encouraged savings more than a traditional savings account — especially among men, lottery players, and those with low initial savings. The authors estimated that offering interest in the form of a lottery with a one-in-ten-thousand chance of winning would boost savings by 4 percent relative to a standard interest-bearing account even though the lottery winnings were equivalent to the certain interest in expected value.4

Additionally, a number of other countries have long and successful histories with PLS programs. The Million Adventure was a PLS program that ran in 1694 in the U.K. and reportedly attracted tens-of-thousands of investors.5 In more recent times, the U.K. started a “premium bond” program in 1956. Premium bonds are government savings bonds that enter the purchaser into a monthly prize drawing. These bonds are extremely popular—fully 19 percent of U.K. families have a premium bonds account.

Why aren’t PLS programs already widespread in the U.S.?

PLS plans have had difficulty gaining a foothold in the U.S. because PLS products are prohibited under both rules that govern lotteries and those that regulate banks, savings and loans associations, and credit unions. In most states, private entities are not allowed to offer lotteries other than special carve-outs in certain states for state lotteries, charitable raffles, and tribal gaming. Additionally, banks and savings and loans associations are currently forbidden from running lotteries (under the rationale of protecting the banking system). Nine states have passed laws that allow state-chartered credit unions to offer PLS products.6 Unfortunately, because credit unions are only open to members of a particular group – often defined geographically or as employees of a particular firm or group of firms – many individuals do not have access to PLS products even in states that allow them.

The American Savings Promotions Act would not preempt state law in places where PLS products are currently prohibited at state-chartered banks. Rather, it would allow states that pass laws allowing PLS products to also offer them at banks and savings and loans associations – not at state credit unions alone.

In short, permitting PLS accounts nationwide has the potential to increase savings among low- and middle-income Americans at no up-font cost to the government. But doing so would require federal legislation, like the American Savings Promotions Act. Given the impressive track record of PLS products in increasing savings rates – particularly for those who are financially vulnerable – policymakers should seriously consider proposals to expand their availability.

Alex Gold contributed to this post.

1 A CD is a particular type of deposit account. Like savings accounts, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) and are virtually risk-free. In exchange for some degree of reduced liquidity (an agreement that the money is inaccessible for a length of time, usually between one month and five years), depositors receive a higher interest rate than on a standard savings account.

2 Unlike most CDs, the STW CD allows additional deposits throughout the year.

3 A credit union is similar to a bank in the services it provides. But credit unions are member-owned and are often restricted to those with some particular affiliation (such as military service). Those chartered as state credit unions are allowed to run PLS plans where state law permits.

4 The experiment was not a true PLS product. The experiment offered individuals the choice in how to allot $100 between consumption today and in a savings account for four weeks. The amount of money that was saved for those four weeks would be augmented by either 2 percent interest (on an annualized basis) or by entry into a lottery with the equivalent in expected value of 2 percent interest.

5 Yes, the U.K. had PLS accounts 82 years before the American Revolution.

6 Some of these state laws also allow for PLS products at state-chartered banks, but those offerings are currently preempted by the federal prohibition, which the pending federal legislation would remove.

There are some very small-scale PLS products offered as sweepstakes, which are legal in every state. Sweepstakes are “no purchase necessary” lotteries. Therefore, non-savers must be permitted to win (usually by mailing in an entry form) and sweepstakes are much more operationally complex than true PLS programs.