> Posted by Emma Morse, Project Specialist, CFI

Embed from Getty Images

Mavis Wanczyk, a staff member at Mercy Medical Center in Springfield, Massachusetts and a mother of two, recently became a multi-millionaire, revealing herself as the $758.7 million Powerball jackpot winner – the largest individual winner ever. Wanczyk quit her job of 32 years less than 24 hours later.

Reflecting on her decision, Wanczyk remarks, “I was just there to buy it, for just luck. Just go in, buy a scratch ticket, and say maybe it’s me, maybe it won’t be me. It’s just a chance, a chance I had to take.”

The odds of winning the Powerball jackpot are 1 in over 292 million. In order to purchase all of the possible combinations, an individual would need to spend $584,402,676 on tickets. You are about 100,000 times more likely to be struck by lightning at some point in your lifetime than you are to hit this particular jackpot.

So why do Americans spend $70.15 billion on lottery tickets annually, while very few of us live in fear of being struck by lightning?

The Behavioral Science of Gambling

In order to make sense of this phenomenon, it is important to first understand that humans do not always make rational, utility-maximizing decisions. This is especially the case when it comes to risk. Two principles from behavioral science explain why we gamble when the odds of hitting the jackpot are so low.

  • Availability bias – The overestimation of an event’s likelihood based on the strength of a memory about such an event is referred to as an availability bias. We immediately think about Mavis and her success when evaluating our own decisions to enter the lottery, forgetting the millions who did not win. Hearing about lottery winners in the news shifts the odds in our minds.
  • The “near miss” effect – The feeling of almost winning and wanting to try again (even if you were not even close). This explains why people who get half of the numbers right often re-enter the lottery, even though the digits they had right had no bearing on the overall outcome.

Savings and the Limits of Incentives

Americans are not great savers. The personal savings rate (the ratio of total savings to total after-tax income) was 3.5 percent in July 2017, and this rate has been steadily declining from nearly 14 percent in 1975. Furthermore, 27 percent of Americans have no emergency savings. These trends are even more acute among low-income individuals. Forty percent of families with incomes below the poverty level have no bank account and, among those that do, the average balance is $310.

This presents a lose-lose situation for low income consumers. In order to avoid taking a loss on low-income customers, banks charge them high fees, but these fees drive low-income customers away from banks. Instead, many consumers turn to riskier and costlier alternatives, including gambling.

Policymakers and independent organizations have introduced incentive schemes to encourage greater savings, including matched or subsidized savings such as Individual Development Accounts (IDAs), which are special savings accounts targeted at low-income consumers to save for a specific goal. The success of such initiatives is limited, however. Research suggests that matching and subsidies are largely ineffective: customers enrolled in matching programs only increased savings by one penny for every dollar matched by the U.S. Government. IDAs have been shown to modestly increase savings, but their average cost of $64 per participant per month to maintain typically outweighs any potential benefit to the participant. Furthermore, there is limited evidence to indicate that these accounts change long-term behavior around savings (i.e. when the matching ends).

Financial literacy programs are also seen as tools to encourage savings, but studies examining the impacts of financial literacy programs on financial health find that they can only explain 0.1% of the variance in financial behaviors observed, with the effects being even less noticeable among low-income consumers.

The Promise of Prize-Linked Savings

Considering such limits of financial incentives, behavioral observations from gambling turn out to have important implications for savings. Prize-linked savings (PLS) accounts are similar to standard savings accounts, but in lieu of accruing interest, interest is pooled from all account holders and divvied out based on lotteries. Typically, the number of raffle tickets an account holder receives is proportional to the amount deposited.

Save to Win, first introduced in Michigan in 2009, was the first large-scale prize-linked savings program in the U.S. The program experienced broad appeal and attracted over 11,000 member accounts in its first year. The program has since experimented with prizes of different amounts to determine impact on savings and has found that prize size is largely irrelevant; prizes of any size increase regular savings of account holders. The prospect of winning any amount was just as potent as winning big.

PLS programs became legal nationally with the signing of the American Savings and Promotion Act in 2014. The Act, which enjoyed support from both Republicans and Democrats in Congress, authorized some financial institutions to conduct savings promotion raffles, while requiring state regulators to approve the type of games offered. Many larger banks have been slow to implement programs, but independent organizations such as Save to Win have spread throughout the nation, leading to $100 million in savings since 2009.

The Impact of Prize-Linked Savings    

These programs make a difference in three ways: they increased savings, substitute for other behaviors (saving money that would have been gambled), and contribute to long-term financial health.

  • Experimental evidence suggests that individuals participating in the Save to Win program were enticed to save at a higher rate compared to people with a standard interest-bearing savings account. Demand was highest among low-income, underbanked or unbanked individuals, precisely the demographic that traditionally has the lowest levels of savings.
  • A study of the MaMa program in South Africa found that participants’ lottery expenditure decreased after enrolling in the program, suggesting that participants put a portion of this money into savings. Prize winnings also had an impact on future savings, with prize winners depositing more money into their accounts on average compared to non-winners. Surprisingly, prize-winners often deposited an amount in excess of their winnings into their account.
  • Although evidence is limited, some early research suggests that prize-linked savings are more effective in increasing savings among low-income individuals and less resource-intensive compared to incentive schemes and financial education.

To encourage greater uptake, governments should encourage programs by reducing or eliminating regulations related to lotteries within financial institutions. Furthermore, mainstream banks and other FSPs should consider introducing prize-linked savings as a strategy for reducing the cost of serving low-income customers.

While chances of winning the Powerball jackpot may be slim, we can all still win.

For more applications of behavioral science to financial inclusion, check out Harnessing Behavior Change to End Extreme Poverty and A Change in Behavior: Innovations in Financial Capability.

Have you read?

Mobilizing Savings among Microfinance Institutions in Latin America

Dollar by Dollar or Goat by Goat: How Financial Health Translates Across Oceans

A Change in Behavior: Innovations in Financial Capability – An Interview with Elisabeth Rhyne