A Premium Bond is a lottery bond issued by the United Kingdom government's National Savings and Investments scheme. The government promises to buy back the bond, on request, for its original price. They were introduced by Harold Macmillan in his 1956 budget.
The government pays interest on the bond (pegged at 1.5% in July 2010). But instead of the interest being paid into individual accounts, it is paid into a prize fund from which a monthly lottery distributes tax-free prizes, or premiums, to those bond-holders whose numbers are selected randomly. The machine that generates random numbers for the lottery is called ERNIE, for Electronic Random Number Indicator Equipment.[1] There are many different prizes ranging from £25 to the top prize of £1,000,000 (between 2005 and 2009, there were two £1m prizes each month and the minimum prize was £50, but prizes were reduced after the large 2009 drop in interest rates). Investors can purchase bonds at any time; bonds need to be held for a full calendar month after the month you buy them, e.g purchase in January eligible for March, their bonds are eligible for the draw: their numbers are entered each month, with an equal chance of winning any prize, until the bond is cashed in.
The prize draw is conducted so that the winners of the jackpot can be notified on the first working day of the month, although the actual date of the draw varies for administrative reasons. The online prize finder[2] is updated by the third or fourth working day of the month.
From 1 January 2009 the odds of winning a prize for each bond number held was 36,000 to 1. In October 2009, the odds returned to 24,000 to 1 with the prize fund interest rate increase.[3] Around 23 million people own Premium Bonds, over one third of the UK population. Each person may own up to £30,000 in Premium Bonds. Bonds can now be purchased by the £1 after the first £100, with a value of £1 per bond and a minimum purchase of 100 bonds (or 50 bonds when paying by standing order). When they were first introduced in 1957 they were very popular — perhaps because the only other similar games of chance available to the general public were the football pools; the National Lottery did not exist until 1994. In Ireland, a similar investment scheme called Prize Bond also originated in early 1957.
Contents |
ERNIE (which stands for Electronic Random Number Indicating Equipment) is a hardware random number generator. The first ERNIE was built at the Post Office Research Station by a team led by Sidney Broadhurst. The designers were Tommy Flowers[4] and Harry Fensom.[5] It was unveiled in 1957,[1] and generated its bond numbers based on the signal noise created by a bank of neon tubes. ERNIE 1 is currently on display at the Science Museum in London.
ERNIE 2 replaced the first ERNIE in 1972.[1]
ERNIE 3 was introduced in 1988 and was the size of a personal computer;[1] at the end of its life it took five and a half hours to complete its monthly draw.
In August 2004 ERNIE 4 was brought into service in anticipation of an increase in the number of prizes to be allocated each month from September 2004.[1] ERNIE 4 was developed by LogicaCMG, is 500 times as fast as the original ERNIE and generates a million premium bond numbers an hour; these are then checked against a list of valid bonds to determine the winning bonds before any prizes are awarded. By comparison, the original ERNIE generated 2000 numbers an hour and was the size of a van.[1]
ERNIE 4 uses thermal noise in transistors as its source of entropy for generating true random numbers; the original ERNIE used a gas neon diode. Pseudorandom numbers, often called simply random, can be recreated by anybody who knows the algorithm used to generate them as they are produced in a deterministic way; true random numbers cannot. The randomness of ERNIE's numbers derives from the inherent and unavoidable random statistical fluctuations in the physical processes involved. ERNIE's output is independently tested each month by an independent actuary appointed by the government, and the draw is only valid if the output passes tests that indicate it is statistically random.
ERNIE, anthropomorphised in early advertising, regularly receives cards and letters from the general public.
The size of the prize fund on offer is equal to one month's interest on all bonds eligible for the draw. The annual rate of interest is set by NS&I and was 1.5% as of July 2010[update]. The following table lists the distribution of prizes on offer in the November 2011[update] draw.[6]
| Prize band | Prize value | Estimated number of prizes |
|---|---|---|
| Higher value | £1,000,000 | 1 |
| 6% of the prize fund | £100,000 | 4 |
| £50,000 | 10 | |
| £25,000 | 17 | |
| £10,000 | 44 | |
| £5,000 | 88 | |
| Medium value | £1,000 | 1,068 |
| 5% of the prize fund | £500 | 3,204 |
| Low value | £100 | 31,397 |
| 89% of the prize fund | £50 | 31,397 |
| £25 | 1,713,547 | |
| Total value (November 2011) | £53,423,225 | 1,780,777 |
Premium Bonds were first introduced by Harold Macmillan in his budget of 17 April 1956,[7] with the aim of controlling inflation[8] and to encourage people to save in the period after the war.[9] On 1 November 1956, at a ceremony in front of the Royal Exchange in the City of London, The Lord Mayor of London, Alderman Sir Cuthbert Ackroyd bought the first bond from the Postmaster-General, Dr. Charles Hill for £1. Councillor William Crook, the Mayor of Lytham St Anne’s, bought the second. Premium Bonds were based in St Annes-On-Sea until the late 1990s when they moved to larger buildings in Blackpool.[10]
Two financial economists—Lobe and Hoelzl—have analyzed the main driving factors for the immense success of Premium Bonds. One in three Britons invest in Premium Bonds. The thrill of investment is significantly boosted by enhancing the skewness of the prize distribution. Using data collected over the past fifty years they find that the bond bears relatively low risk by conventional risk measures.[11]
Aaron Brown discusses premium bonds in comparison with equity-linked, commodity-linked and other "added risk" bonds.[12] His conclusion is that it makes little difference, either to an investor or from a theoretical finance perspective, whether the added risk comes from a random number generator or a financial security price.
In December 2008, NS&I dropped significantly the interest rate (and therefore the odds of investors winning a prize) due to the corresponding significant drop in the Bank of England base rate during the "credit crunch", leading to strong criticism from Members of Parliament, financial experts, and holders of premium bonds; many claimed that Premium Bonds were now "worthless", and somebody with the maximum £30,000 invested who has "average luck" would win only 10 prizes per year compared to 15 in the previous year.[13][14] Investors with smaller although still significant amounts will probably fail to win anything at all.
Based on odds as of July 2010[update] of 1/24000 the expected number of prizes per year for someone holding the maximum of £30,000 worth of bonds has now returned to about 15 per year (The calculation is 1/24000 x 12 (draws per year) x 30,000 (number of bonds held)).
According to the Premium Bond Probability Calculator[15] on MoneySavingExpert.com which updates the latest odds following each monthly draw, it shows the odds of winning premium bonds to be as follows: