Saving whilst Gambling: An Empirical Analysis of U.K. Premium Bonds

Peter Tufano
Publication Date: 
January 9, 2008

For over three centuries and across the globe, lottery-linked savings (LLS) programs have offered individuals the opportunity to save, and in lieu of paying traditional interest, have given savers periodic chances to win money or prizes. Despite their long history, LLS programs are relatively unstudied by scholars.1 In this paper, I detail a LLS program that the U.K. government has continuously offered since 1956, the U.K. Premium Bond (PB) program. PBs guarantee holders risk-free return of nominal principal. In aggregate they pay a market-related return, distributed to holders each month by a lottery-like mechanism. Premium bonds are popular savings vehicles in the U.K. Over £31.1 billion of PB were outstanding as of March 2006, and public reports suggest that they were held by between 22% to 40% of U.K. citizens. The 60.2 million residents of the U.K. had £517 invested in PBs per capita. If held in the banking sector, PB holdings would have accounted for 3.9% of household sterling deposits in U.K. financial institutions. LLS programs, such as PBs, are fascinating not just because of their size, but because of their appeal to non-savers, especially low income families. Guillén and Tschoegl (2002), reviewing LLS programs in Latin America, concluded: “The bankers we spoke with believe that (LLS) are especially successful with low-income depositors, and in cases where there are lots of people outside the banking system.” In South Africa, a new LLS program raised over 1.2 billion Rand and enrolled 750,000 participants across a wide spectrum of the economy in two years. In the U.K., while PBs are held by about the same fraction of the population holding stocks, PBs have a stronger appeal to the lower-income British households. PBs are held by a larger fraction of British households than are stocks and shares for all households, except those earning over £52,000 annually. (Department for Work and Pensions, 2007). Are PB holders saving, gambling, or engaging in both activities? This question is not just academic because national laws and regulations in many countries bar private LLS programs on the basis that they are prohibited gambling activities. For example in South Africa, the government has tried to shut down the popular LLS program mentioned above; in the US, these programs would violate state gambling laws and federal banking regulations. In this paper, I analyze the time series of net sales of the PB program and conclude that the program appears to be a hybrid of gambling and savings, but with a clear savings element.