Is The Connected World Killing Predictive Modeling?

Can The Lottery Make People Save More?

from the tax-on-the-poor dept

Mon, Jul 20th 2009 3:25pm — Mike Masnick

The lottery has often been described as a "tax on those who don't understand probability." However, it seems some enterprising folks are trying to use that basic fact to help people who have trouble saving money (who often overlap with the folks who don't understand probability) to save more. Apparently some credit unions in Michigan are experimenting with a lottery feature as a part of a savings account:

Psychologists have long known that people tend to overestimate the odds of rare events. Applying that behavioral insight, finance professor Peter Tufano of Harvard Business School has devised a clever program called "Save to Win." Launched earlier this year for members of eight credit unions in Michigan, it is a cross between a certificate of deposit and a raffle ticket. Members who put $25 or more into a Save to Win one-year CD are entered into a monthly "savings raffle" for prizes up to $400, plus one annual drawing for a $100,000 jackpot.

Apparently, this program has attracted $3.1 million in new deposits, many (the article claims) from people who have never been able to save much money. In many ways it is like buying a lottery ticket, except that you don't lose the money paid for the ticket. The credit unions make this work by paying out a slightly lower interest rate on the CD in question, but the net effect works out to benefit everyone. Many who put their money into such an account would never have put their money into a higher rate CD in the first place. In some ways, it's a neat example of efficient price discrimination that expands an overall market.

Thank you for reading this Techdirt post. With so many things competing for everyone’s attention these days, we really appreciate you giving us your time. We work hard every day to put quality content out there for our community.

Techdirt is one of the few remaining truly independent media outlets. We do not have a giant corporation behind us, and we rely heavily on our community to support us, in an age when advertisers are increasingly uninterested in sponsoring small, independent sites — especially a site like ours that is unwilling to pull punches in its reporting and analysis.

While other websites have resorted to paywalls, registration requirements, and increasingly annoying/intrusive advertising, we have always kept Techdirt open and available to anyone. But in order to continue doing so, we need your support. We offer a variety of ways for our readers to support us, from direct donations to special subscriptions and cool merchandise — and every little bit helps. Thank you.

–The Techdirt Team

Filed Under: credit unions, lottery, michigan, probability, savings

21 Comments

If you liked this post, you may also be interested in...

Reader Comments

Subscribe: RSS

View by: Time | Thread

BullJustin (profile), 20 Jul 2009 @ 3:32pm

so in other words
its a customer loyalty scheme with a name that sounds like you're gambling, and thus more "fun"?
[ link to this | view in chronology ]
ChurchHatesTucker (profile), 20 Jul 2009 @ 3:45pm

This is genius
Whomever came up with this should get a Wall Street-sized bonus.
[ link to this | view in chronology ]
- Alphager, 20 Jul 2009 @ 3:48pm
  
  Re: This is genius
  That's a great idea! The guy who came up with the idea can thus enjoy a movie at the cinema (if he doesn't buy popcorn)!
  [ link to this | view in chronology ]
- :Lobo Santo (profile), 20 Jul 2009 @ 3:52pm
  
  Re: This is genius
  Wait... do you mean the Wall-Street bonus where he's put up against the wall and shot?
  
  Or do you mean the Wall-Street bonu$, ob$cene gob$ of ca$h?
  [ link to this | view in chronology ]
Richard, 20 Jul 2009 @ 3:56pm

In the UK we've had premium bonds - basically the same idea - for over 50 years. In this case the only return is the prizes - but if you buy a reasonable amount then you are practically guaranteed a steady stream of small prizes so it does work as an investment too
[ link to this | view in chronology ]
Claus Rasmussen (profile), 20 Jul 2009 @ 4:26pm

Great spin on the story
It's interesting to note how the credit union has managed to put a lovely positive spin on this story, by having it look like it helps people save money. The credit union/banks are interested in having liquidity available at the lowest possible price, and by offering a low chance of some lottery win, they con people into giving them that liquidity at a lower than market price. Excellent scheme ;)

Anyway, as mentioned by Richard, premium bonds have existed in Europe for many years, so it's hardly up-to-standards-Harvard material from the finance professor to come up with this plan. In Denmark, the state has stopped issuing premium bonds, but the private banks have taken over by offering a "Millionærkonto" (millionaires account), on which you get a lottery ticket for each 100 DKK, and a lowered interest rate on your savings.
[ link to this | view in chronology ]
- Claus Rasmussen (profile), 20 Jul 2009 @ 4:37pm
  
  Re: Great spin on the story
  correction: the millionaires accounts in Denmark apparently have zero interest rate - the one million DKK drawing is once a month, and I suspect the FSA review the drawings and number of winners.
  [ link to this | view in chronology ]
- ChurchHatesTucker (profile), 20 Jul 2009 @ 5:30pm
  
  Re: Great spin on the story
  "I's hardly up-to-standards-Harvard material?" No, it's not hemorrhaging money, so I suppose it's not Harvard-caliber.
  [ link to this | view in chronology ]
- scarr (profile), 20 Jul 2009 @ 8:53pm
  
  Re: Great spin on the story
  " by having it look like it helps people save money"
  It's interesting to note how you're putting a negative spin on it. Mike pointed out "many (the article claims) from people who have never been able to save much money". Therefore it is helping them by having them put money in a bank. If the bank gets more for it, the banks will continue doing it. It helps everyone involved. There isn't anything stopping the people reinvesting in normal plans later.
  
  Bottom line: even savings with zero interest are a better investment than giving your money away to the state lottery.
  [ link to this | view in chronology ]
  - Rob O. (profile), 21 Jul 2009 @ 11:18am
    
    Re: Re: Great spin on the story
    It's sad that you need to con people with such a shifty-sounding scheme to get them to save, but I've gotta agree with Scarr that if this encourages -ANY- savings, that's far better than people squandering their money on state lotteries.
    [ link to this | view in chronology ]
Jesse, 20 Jul 2009 @ 4:41pm

Legality of 100k Raffle
Pretty sure the bank is walking a thin line on this one. If it's a sweepstakes there are rather strict legal requirements for a prize this size. If it's actually a lottery, I'm pretty sure it's illegal.

To me, looks more like a lottery, $25 per ticket. Guessing there is a rule on how many entries. Basically if you're investing multiples of $25, should just put into multiple save-to-win CDs.
[ link to this | view in chronology ]
- Anonymous Coward, 20 Jul 2009 @ 6:03pm
  
  Re: Legality of 100k Raffle
  Pretty sure the bank is walking a thin line on this one.
  
  You're forgetting who owns the gov't.
  [ link to this | view in chronology ]
Anonymous Coward, 20 Jul 2009 @ 5:51pm

Michigan law grants licenses to private entities to operate raffles (under certain restrictions). I'd imagine the credit union has filed the appropriate paperwork.
[ link to this | view in chronology ]
E-Rocker, 20 Jul 2009 @ 6:59pm

This was all done assuming no additional contributions per month and the real-world would absolutely be different, this is just a theoretical look. It also assumed the $3.1M occurs all at once at the beginning of the raffle period. If you notice an error, by all means point it out. I'd like to learn where I went wrong as finance is not my forte.

Far as I can tell, the raffles give out (12 x $4,000) + (1 x $100,000) = $148,000. It would take roughly 4.5% "skimmed" (yearly, compounded monthly) from $3.1 million by these credit unions in order to fund the raffles.

The link provided in the article states:
This unusual CD is federally guaranteed by the National Credit Union Administration and pays between 1% and 1.5% annual interest.

That would mean the typical savings account is between 5.5% to 6% (if the credit unions have to skim 4.5% to enable this program). This seems rather high...

At $3.1 million, there are at most 124,000 unique participants. This raffle system increases average yearly wealth of those people by ($148,000 + $3.1M @ 1.5%) / 124,000 = $25.37 per person.

A typical savings account would increase the average yearly wealth of those people by ($3.1M @ 5.5%) / 124,000 = $26.41 per person. A total difference of $128,984.

I wasn't sure going into this what the difference would be, it still favors people just saving the ol' fashioned way, but the difference doesn't seem to be too excessive to discount the raffle approach. And, at least this way, it is giving people [false] incentive to save money which they normally would have just spent and would not have gone towards increasing average yearly wealth anyways. And, of course, the one person that wins the $100,000 will swear by this method.

[ link to this | view in chronology ]
- kirillian (profile), 20 Jul 2009 @ 7:38pm
  
  Re:
  Ah...yes...however, there will be a critical point (am too tired to do the math right now) Where a single person opening up multiple $25 accounts will actually increase his chances of winning said prizes to the point where the Expected Value of his winnings plus his lowered interest rate will actually result in an increase in his yearly earnings...
  [ link to this | view in chronology ]
- E-, 20 Jul 2009 @ 10:24pm
  
  Re:
  [ link to this | view in chronology ]
- E-Rocker, 20 Jul 2009 @ 10:28pm
  
  Re:
  Small mistake on my part. Used $4,000 instead of $400. The article mentioned prizes "up to $400", which may mean multiple prizes totaling more than $400. Either way, re-calculating with $400 drops the average yearly wealth by $0.35, or $25.02, per person. Increasing the difference total between the two methods by $172,384.
  
  Again, it doesn't appear to be the largest difference and, if the alternative for this money is being spent (as opposed to being saved normally), this seems like an overall positive (As long as people don't withdraw too much and the credit unions are earning enough interest to pay off their raffles. Unless, they are earning money some other way for this?)
  [ link to this | view in chronology ]
Lawrence D'Oliveiro, 20 Jul 2009 @ 8:01pm

Quite Common In Some Regions
Oddly enough, this is how many Islamic banks work. Some Muslims interpret the ban on “usury” in the Quran as meaning that interest payments on loans and deposits are not allowed. But there doesn’t seem to be a similar prohibition against gambling, so banks giving out lottery prizes to depositors is acceptable.
[ link to this | view in chronology ]
cofiem (profile), 21 Jul 2009 @ 3:45am

What does CD mean? certificate of deposit?

Certainly a good way to promote saving without explicitly promoting saving.
[ link to this | view in chronology ]
l f file, 25 Jul 2009 @ 1:30pm

Premium Bonds
Premium bonds in the U.K. and elsewhere are designed to provide a set return through prizes. The bonds are in such small denominations that investing a few hundred pounds used to provide about 3% return (back in 2003 - not sure what it is now) to the average investor through the small prizes and still provide a chance at the big prizes. Limits are placed on how much an individual can invest (used to be 30,000 pounds). Financial advisors in the U.K. generally recommend premium bonds for most portfolios.
[ link to this | view in chronology ]
Peter (profile), 31 Jul 2009 @ 1:05pm

We've had them in Ireland for decades too, they're called Prize Bonds
[ link to this | view in chronology ]