Premium Bond

An ERNIE money box.

A Premium Bond is a Lottery Bond issued by the United Kingdom government's National Savings and Investments agency. The bonds are entered in a regular prize draw and the government promises to buy them back, on request, for their original price. The bonds were introduced by Harold Macmillan in his 1956 budget.

The government pays interest on the bond (pegged at 1.3% in October 2013). 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 in which they are bought, e.g. purchase in January, eligible for March. 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] The odds reached 26,000 to 1 by October 2013. Around 23 million people own Premium Bonds, ^{[citation needed]} 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 £10 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 Republic of Ireland, a similar investment scheme called Prize Bond also originated in early 1957.

History

Premium Bonds were first introduced by Harold Macmillan in his budget of 17 April 1956,^[4] with the aim of controlling inflation^[5] and to encourage people to save in the period after the war.^[6] 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.^[7]

Premium Bond odds

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.^[8][9] Investors with smaller although still significant amounts will probably fail to win anything at all.

Based on odds as of July 2010 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^[10] on MoneySavingExpert.com which updates the latest odds following each monthly draw, the odds of winning a prize are:

• Hold £100 over a year and the chance of winning anything is 3.28%.
• Hold £1,000 over a year and the chance of winning anything is 28.3%.
• Hold £10,000 over a year and the chance of winning anything is 96.4%.

Prize fund distribution

Similar prize schemes operate in other countries, for instance this Premium Prize Bond certificate from India.

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 1.3% as of August 2013. The following table lists the distribution of prizes on offer in the August 2013 draw.^[11]

ERNIE

ERNIE 1.

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^[12] and Harry Fensom.^[13] 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 faster than 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. It is the subject of the song "E.R.N.I.E." by the band Madness, from the 1980 album Absolutely.

Premium Bonds in other countries

Premium Bonds (under various names) exist or have existed in various countries. Common variations compared to UK Premium Bonds include:

• In some countries, the Premium Bonds have an official end date 5, 10, 30 or more years after issue, when the principal will be repaid by the debtor (government), until then, the bond can be bought and sold like any liquid security through banks and stock exchanges. Some countries have "extended" the end date, generally by offering that bond holders can choose to collect the principal or let it ride for an additional 10 year period.
• In some countries, the prizes and chances, and hence the average interest rate, is a fixed property of the bond from issue until it is redeemed, making them more predictable as investments. When the prizes and chances of each bond are fixed, redeemed bonds stay in the lottery, but the issuer gets to keep prizes drawn to redeemed or unsold bonds.
• In some systems, holders of bonds with consecutive serial numbers are guaranteed that they will win at least one prize for every N bonds. One of several ways to do this is that for example, the lowest prize in a given month could be drawn to go to all bonds with serial numbers ending in 42 or 92, so anyone with 50 consecutive bonds gets a prize. This way also simplifies the draw itself as just one number needs to be drawn to hand out thousands of the small prizes.
• In some countries, the payments are not tax free, or are taxed at a reduced rate compared to regular income.

Notes on specific countries:

• In The United Kingdom, Premium Bonds function as described in the rest of this article.
• In Republic of Ireland, they are called Prize Bonds and also originated in early 1957.^[14]
• In Sweden, they are called "Premieobligationer", they usually run for 5 years and are traded on Nasdaq OMX Stockholm, the unit (one Bond) is generally 1000 SKr. or 5000 SKr. Holders of 10 or 50 consecutive bonds starting at 1 + N * 10 or 50 are guaranteed one winning per year.^[15] Outstanding bonds currently (Sep 2013) add up to around 28.9 billion SKr.^[16]
• In Denmark, they were also called "Premieobligationer" and usually ran for 5 or 10 years with a fixed prize list printed on the physical bonds. They were physical bearer bonds and most series were extended one or more times by another 5 or 10 years. The last Danish Premium Bond series have now ended and must be redeemed for their principal cash within 10 years of the final ending dates.^[17] Danish Premium Bonds were generally identified by their color, for instance the blue premium bonds were issued in 1948, and were redeemed in 1998 (10 years + 4 x 10 years extension).^[18] The first 200 DKr. of each prize was tax free, the rest taxed by only 15% (compared to 30% or more for regular income).^[19]
• An image of an Indian Premium Bond is shown higher up in the article.

Scientific evidence

Two financial economists, Lobe and Hoelzl, have analysed 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.^[20]

Aaron Brown discusses premium bonds in comparison with equity-linked, commodity-linked and other "added risk" bonds.^[21] 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.

Winning

To check whether you have won go to the National Savings^[22] Premium Bond Prize Checker. It will show you the most recent draw by default; however you can choose to see if you have won anything in the past 6 months or if you have any unclaimed prizes. Older winning numbers (more than 18 months old) can also be checked in the^[23] London Gazette Premium Bonds Unclaimed Prizes Supplement.

References

External links

• National Savings & Investments website
• BBC News story on ERNIE 4
• BBC News story mentioning ERNIE's use in selecting Premium Bonds
• BBC News: Are Premium Bonds worth it?
• Q&A: Premium Bonds
• National Savings & Investments Premium Bond Prize Checker
• Swedish Premium Bonds
• "Premium Bond Prize" an unofficial UK/DK reseller of Swedish Premium Bonds