This article needs additional citations for verification. (January 2008)
The principle behind Premium Bonds is that rather than the stake being gambled, as in a usual lottery, it is the interest on the bonds that is distributed by a lottery. The bonds are entered in a monthly prize draw and the government promises to buy them back, on request, for their original price.
The government pays interest into the bond fund (1.00% per annum since December 2020) from which a monthly lottery distributes tax-free prizes to bondholders whose numbers are selected randomly. The machine that generates the numbers is called ERNIE, for Electronic Random Number Indicator Equipment. Prizes range from £25 to £1,000,000 and (since December 2020) the odds of a £1 bond winning a prize in a given month are 34,500 to 1.
Investors can buy bonds at any time and they must be held for a whole calendar month before they qualify for a prize. As an example, a bond purchased mid-May must then be held throughout June before being eligible for the draw in July (and onwards). Bonds purchased by reinvestment of prizes are immediately eligible for the following month's draw.
Numbers are entered in the draw each month, with an equal chance of winning, until the bond is cashed. As of 2019, each person may own bonds up to £50,000. Since 1 February 2019, the minimum purchase amount for Premium Bonds has been £25. As of May 2021 there are 107.75 billion eligible Premium Bonds, each having a value of £1.
When introduced to the wider public in 1957, the only other similar game available in the UK was the football pools, with the National Lottery not coming into existence until 1994. Although many avenues of lotteries and other forms of gambling are now available to British adults, Premium Bonds are held by more than 22 million people, equivalent to about 1 in 3 of the UK population.
The modern iteration of Premium Bonds were introduced by Harold Macmillan, as Chancellor of the Exchequer, in his Budget of 17 April 1956, to control inflation and encourage people to save. 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. The Premium Bonds office was in St Annes-on-Sea, Lancashire, until it moved to Blackpool in 1978.
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 and Harry Fensom and it derives from Colossus, one of the world's first digital computers. It was introduced in 1957, with the first draw on 1 June, and generated bond numbers from the signal noise created by neon tubes. The name is an acronym for Electronic Random Number Indicator Equipment. ERNIE 1 is in the collections of the Science Museum in London and was on display between 2008 and 2015.
ERNIE 2 replaced the first ERNIE in 1972.
ERNIE 3 in 1988 was the size of a personal computer; 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. Developed by LogicaCMG, it was 500 times faster than the original and generated a million numbers an hour; these were 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.
ERNIE 4 used thermal noise in transistors as its source of randomness to generate true random numbers; the original ERNIE used a gas neon diode. In contrast, pseudorandom numbers, although sometimes simply referred to as random, are produced deterministically by the algorithm used to generate them. The randomness of ERNIE's numbers derived from random statistical fluctuations in the physical processes involved. ERNIE's output was independently tested each month by the Government Actuary's Department, the draw being valid only if it was certified to be statistically consistent with randomness. At the end of its life it was moved to Bletchley Park's National Museum of Computing.
ERNIE 5, the latest model, was brought into service in March 2019, and is a quantum random number generator built by ID Quantique. It uses quantum technology to produce random numbers through light, replacing the former 'thermal noise' method. Running at speeds 21,000 times faster than the first ERNIE, it can produce 3 million winners in just 12 minutes each month.
In popular culture
ERNIE, anthropomorphised in early advertising, receives Valentine cards, Christmas cards and letters from the public. It is the subject of the song "E.R.N.I.E." by Madness, from the 1980 album Absolutely. It is also referenced by Jethro Tull in their album Thick as a Brick.
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 is updated by the third or fourth working day of the month. Winners of the top £1m prize are told in person of their win by "Agent Million", an NS&I employee, usually on the day before the first working day of the month. However, in-person visits have been suspended during the 2020 COVID-19 pandemic.
Bond holders can check whether they have won any prizes on the National Savings & Investment Premium Bond Prize Checker website, or the smartphone app, which provides lists of winning bond numbers for the past six months. Older winning numbers (more than 18 months old) can also be checked in the London Gazette Premium Bonds Unclaimed Prizes Supplement.
Odds of winning
In December 2008, NS&I reduced 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. Investors with smaller, although significant, amounts would possibly win nothing.
From 1 January 2009 the odds of winning a prize for each £1 of bond was 36,000 to 1. In October 2009, the odds returned to 24,000 to 1 with the prize fund interest rate increase. The odds reached 26,000 to 1 by October 2013 and then reverted to 24,500 to 1 in November 2017. It is currently 34,500 to 1
With odds as of February 2021[update] of 1/34500, the expected number of prizes for the maximum £50,000 worth of bonds is 17.4 per year. The calculation is 1/34500 x 12 (draws per year) x 50,000 (number of bonds held). Assuming 17 x £25 prizes this is an effective interest rate of 0.85%.
- Individual bond over a year and the chance of winning something is 0.035%.
- Hold £1,000 over a year and the chance of winning something is 29.38%.
- Hold £10,000 over a year and the chance of winning something is 96.92%.
Prize fund distribution
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 1.40% as of December 2017[update], reducing to 1.00% as of December 2020[update]. The following table lists the distribution of prizes on offer in the May 2021[update] draw.
|Prize band||Prize value||Estimated number of prizes each month|
5% of the prize fund
5% of the prize fund
90% of the prize fund
In other countries
This section needs additional citations for verification. (December 2014)
Premium Bonds under various names exist or have existed in various countries. Similar programs to UK Premium Bonds include:
- In the Republic of Ireland, Prize Bonds also originated in early 1957.
- In Sweden, "Premieobligationer" usually run for five years and are traded on Nasdaq OMX Stockholm. The unit (one Bond) is generally 1000 SEK or 5000 SEK. Holders of 10 or 50 consecutive bonds starting at 1 + N * 10 or 50 are guaranteed one win per year. Outstanding bonds as of September 2013[update] were around 28.9 billion SEK.
- In Denmark, "Premieobligationer" usually ran for five 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 series have now ended and must be redeemed for their principal cash within 10 years of the final ending dates. The bonds were generally identified by their colour, for instance the blue premium bonds were issued in 1948, and were redeemed in 1998 (10 years + 4 10-year extension). The first 200 DKK of each prize was tax free, the rest taxed at only 15% (compared to 30% or more for ordinary income).
- In New Zealand, "Bonus Bonds" were established by the NZ Government in 1970 and sold to ANZ Bank in 1990. In August 2020 it was announced that the scheme would close due to low interest rates reducing the prize pool. At the time of the announcement there were 1.2m bondholders with NZD $3.2 billion invested.
In 2008 two financial economists, Lobe and Hoelzl, analysed the main driving factors for the immense marketing success of Premium Bonds. One in three Britons invest in Premium Bonds. The thrill of gambling is significantly boosted by enhancing the skewness of the prize distribution. However, using data collected over the past fifty years, they found that the bond bears relatively low risk compared to many other investments.
Aaron Brown discusses in a 2006 book Premium Bonds in comparison with equity-linked, commodity-linked and other "added risk" bonds. His conclusion is that it makes little difference, either to a retail investor or from a theoretical finance perspective, whether the added risk comes from a random number generator or from fluctuations in financial markets.
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- "SSRN-Why are British Premium Bonds so Successful? The Effect of Saving With a Thrill by Sebastian Lobe, Alexander Hölzl". Papers.ssrn.com. 19 March 2008. SSRN 992794. Cite journal requires
- Aaron Brown, The Poker Face of Wall Street, John Wiley & Sons, 2006.