Think before you pay: How employers are the key to solving serious financial health problems

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Over the past 40 years, the top 1% of the United States saw their income grow 4x faster than the bottom 20%[1] of the country. This widening gap between employers and their employees is alienating them from each other. Many employers are out of step with the challenges their hourly workers face daily when it comes to things like paying bills or short-term loans.

This difference is making it more difficult for them to design compensation packages that appeal to hourly workers, while remaining cost effective – but technology is enabling a different way to pay.

The financial health of low-income Americans is being driven by three aspects:

Access to fair financial services

Middle- and upper- class Americans are simply getting a better deal on their financial services, because they reward their banks through profitable financial behavior (high deposits, high use of debit and credit cards, mortgages). Meanwhile, the lower class has been pushed in between a rock and a hard place. Either they are charged extremely high fees, to make it worthwhile for banks to service them (estimated at ~$300 per year!), or they must move part of their financial life “off-the-grid”, by using costly alternative financial services such as check-cashing or money orders. Today, almost 40% of young Americans find themselves in the 2nd situation[2].

Liquidity gaps

Liquidity has always been the winning feature of being wealthy. Whether it’s as simple as purchasing an apartment to avoid paying rent, or as profound as affording a preventative visit to the doctor instead of hoping for the best, having money today to avoid paying tomorrow generates a virtuous cycle.

The exact opposite is true for those that lack liquidity, and this problem is compounded by today’s banking models. As an example, when an account balance is negative, most traditional banks charge an overdraft fee of $35 for every transaction that occurs while in the red.

If your balance is $8 and your paycheck is coming tomorrow, your lunch, MetroCard and dinner will cost you $35 each in fees, implying $105 in fees for less than $40 spent.

Another, more serious example, is the $40B[3] payday loan industry, that runs by charging >300% interest rates[4] to individuals willing to forfeit more than they should, for money they have already earned.

The ability to save

These previous factors come together to produce an inability to save in the long-term. 40% of Americans don’t have enough money saved to cover a $400 expense[5]. This is equivalent to just four days’ work at New York minimum wage, and barely enough to feed a household over two weeks.

 

“American employers have more visibility on the financial lives of Americans than the most advanced financial institutions.”

 

Employers are the key to financial peace of mind

Changing the way we provide financial services can give an immediate boost to the quality of the financial lives of low-income workers. Many challenger banks such as Chime or Revolut are proving this by moving away from nonsensical fees, removing the fixed-cost burden of brick & mortar branches, and gaining revenue through interchange fees (a fee paid by merchants selling goods and services to customers, typically processed by networks such as Mastercard or Visa).

However, employers can play a drastically more important role. As the source of income for the 80 M hourly workers in the country today, American employers have more visibility on the financial lives of Americans than the most advanced financial institutions. They know when workers will get paid, what amount the paycheck will be, what money employees are owed at any point in time, and how long they are likely to keep their job for.

What these employers lack is the right partner to capture this value.

 

Emerging partners are bringing workers and employers together to solve the problem

Several service providers are starting to prove the importance of the data one can get from an employer. DailyPay and Even Financial are services that layer onto an employees’ existing bank account, and allow them to withdraw their wages early in times of need, against a nominal fee. Both products have a proven track record of reducing attrition by 20% to 40%[6], which implies almost $1,000 of annual savings per worker for businesses, while simultaneously allowing workers to avoid paying overdraft fees or using payday loans.

SalaryFinance allows employees to take out a loan based on their tenure, and to pay it back by withdrawing from their upcoming paystubs. Their typical customer would have a 550 FICO score, implying they would access consumer credit at an average interest rate 192%. By structuring the repayment process, defaults have fallen as low as <5%, allowing the company to charge 12% interest rates. Though this remains high, it is a far cry from the 192% average, and a clear demonstration of what can be done with access to employee payroll data, and the flow of funds.

These demonstrations should be seen as the beginning of a new era in retail banking – one that consists of getting a deeper understanding of the worker to provide more inclusive financial services, with products designed to better the financial lives of the end customers.

 

Alex Kostecki is the COO of Clair. Learn more about Clair at www.getclair.com

Photo by Micheile Henderson on Unsplash

 

References:

[1] CPBB.org

[2] FICO

[3] The Economist

[4] Paydayloaninfo.org

[5] Federal Reserve

[6] The Power of the Salary Link (2018, Harvard)

 

 

 

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