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 1956.

The government pays interest on the bond (1.35% in May 2015). Interest is paid into a fund from which a monthly lottery distributes tax-free prizes, or premiums, to bond-holders whose numbers are selected randomly. The machine that generates numbers is ERNIE, for Electronic Random Number Indicator Equipment.^[1] Prizes range from £25 to £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 2009 drop in interest rates. A second £1m prize was re-introduced in August 2014.

Investors can buy bonds at any time; they have to be held for a calendar month before they qualify. Numbers are entered each month, with an equal chance of winning, until the bond is cashed.

Winners of the jackpot are told on the first working day of the month, although the actual date of the draw varies. 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 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, over one third of the UK population. As of June 2015, each person may own bonds up to £50,000.^[4] Bonds can be bought in units of £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 introduced in 1957 they were popular – the only other similar games were football pools; the National Lottery did not exist until 1994. In Ireland, the Prize Bond originated in early 1957.

History

Premium Bonds were introduced by Harold Macmillan in his budget of 17 April 1956,^[5] to control inflation^[6] and encourage people to save after the war.^[7] On 1 November 1956, 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 they moved to Blackpool in the late 1990s.^[8]

Premium Bond odds

In December 2008, NS&I dropped the interest rate (and therefore the odds of winning) due to the drop in the Bank of England base rate during the credit crunch, leading to criticism from members of Parliament, financial experts and holders of bonds; many claimed Premium Bonds were now "worthless", and somebody with £30,000 invested and "average luck" would win only 10 prizes a year compared to 15 the previous year.^[9][10] Investors with smaller although significant amounts would possibly win nothing.

Based on odds as of June 2015 of 1/26000,^[11] the expected number of prizes for the maximum £50,000 worth of bonds is 23 per year. The calculation is 1/26000 x 12 (draws per year) x 50,000 (number of bonds held).

According to the Premium Bond Probability Calculator^[12] on MoneySavingExpert.com, which updates odds each month, the odds of a prize as of February 2014 are:

• Hold £100 over a year and the chance of winning anything is 4.51%.
• Hold £1,000 over a year and the chance of winning anything is 37%.
• Hold £10,000 over a year and the chance of winning anything is 99%.

Prize fund distribution

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

The prize fund is equal to one month's interest on all bonds eligible for the draw. The annual interest is set by NS&I and was 1.35% as of August 2014. The following table lists the distribution of prizes on offer in the August 2015 draw.^[13]

ERNIE

ERNIE 1.

ERNIE 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^[14] and Harry Fensom and it is based on Colossus, the world's first digital computer.^[15][16] It was introduced in 1957,^[1] and generated bond numbers based on the signal noise created by neon tubes. ERNIE 1 has been on display in the Science Museum since 2008.^[16] ERNIE is an acronym for "Electronic Random Number Indicator Equipment"

ERNIE 2 replaced the first ERNIE in 1972.^[1]

ERNIE 3 in 1988 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 prizes each month from September 2004.^[1] Developed by LogicaCMG, it is 500 times faster than the original and generates a million numbers an hour; these are checked against a list of valid bonds. By comparison, the original ERNIE generated 2,000 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 can not. The randomness of ERNIE's numbers derives from random statistical fluctuations in the physical processes involved. ERNIE's output is independently tested each month by an actuary appointed by the government, and the draw is only valid if it is statistically random.

ERNIE, anthropomorphised in early advertising, receives Valentine cards, Christmas cards and letters from the public.^[1] It is the subject of the song "E.R.N.I.E." by 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, 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.^[17]
• 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.^[18] Outstanding bonds currently (Sep 2013) add up to around 28.9 billion SKr.^[19]
• 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.^[20] 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).^[21] The first 200 DKr. of each prize was tax free, the rest taxed by only 15% (compared to 30% or more for regular income).^[22]
• 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.^[23]

Aaron Brown discusses premium bonds in comparison with equity-linked, commodity-linked and other "added risk" bonds.^[24] 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

Bond holders are able to check whether they have won any prizes via the National Savings & Investment Premium Bond Prize Checker website, which provides lists of winning bond numbers for the past 6 months.^[25] Older winning numbers (more than 18 months old) can also be checked in the London Gazette Premium Bonds Unclaimed Prizes Supplement.^[26]

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