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Premium Bond
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A Premium Bond is like 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.
Premium Bonds were introduced by the government in 1956, with the aim of encouraging saving and controlling inflation, with the first bonds going on sale on 1 November of that year.
The government pays interest on the bond 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 selected bond-holders whose numbers come up.
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A Premium Bond is like 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.
Premium Bonds were introduced by the government in 1956, with the aim of encouraging saving and controlling inflation, with the first bonds going on sale on 1 November of that year.
The government pays interest on the bond 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 selected bond-holders whose numbers come up. The machine that generates random numbers for the lottery is called ERNIE, which stands for Electronic Random Number Indicator Equipment. There are many different prizes ranging from £50 to the top prize of £1,000,000, of which there have been two per month since the summer of 2005 (and one per month prior to that).
The prize draw is conducted so that the winners of the two jackpots can be notified on the first working day of the month although the actual date of the draw varies for administrative reasons. The 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 is 36,000 to 1. 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 are currently sold in multiples of 10, 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.
The Premium Bonds operated from a site in Lytham St Annes from its inception for over 40 years, later moving to new buildings in Blackpool.
ERNIE
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. It was unveiled in 1957, generating its bond numbers based on the signal noise created by a bank of neon tubes.
ERNIE 2 replaced the first ERNIE in 1972.
ERNIE 3 was introduced in 1988 and 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 the number of prizes to be allocated each month from September 2004. 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 could generate only 2000 numbers an hour and was the size of a van.
ERNIE 4 uses thermal noise in transistors as its source of entropy for generating random bond numbers; the original ERNIE used a gas neon diode. In each case the randomness of electrons and natural unpredictable variance of the physical processes involved mean that systematic trends and similar cumulative effects that affect any pseudorandom number generator are reduced greatly, if not eliminated. 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 and still referred to as "he" on the NS&I web site, regularly receives cards and letters from the general public.
Prize fund distribution
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 is 1.8% as at 1 January 2009. The following table lists the distribution of prizes on offer in the January 2009 draw.
| Prize band | Prize value | Estimated number of prizes |
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| Higher value | £1,000,000 | 2 | | 4% of the prize fund | £100,000 | 1 | | | £50,000 | 1 | | | £25,000 | 2 | | | £10,000 | 7 | | | £5,000 | 13 | | Medium value | £1,000 | 232 | | 1% of the prize fund | £500 | 696 | | Low value | £100 | 29,070 | | 95% of the prize fund | £50 | 1,050,169 | | Total estimated value | £58.3 million | 1,080,193 |
Scientific evidence
Two financial economists — Lobe and Hoelzl — have analyzed the main driving factors for the immense success of Premium Bonds.
Every third Briton invests in Premium Bonds. The thrill to invest is significantly boosted by enhancing the skewness of the prize distribution.
Using data collected over last fifty years they find that the bond bears relatively low risk by conventional risk measures.
Aaron Brown discusses premium bonds in comparison with equity-linked, commodity-linked and other "added risk" bonds. 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.
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 "credit crunch", leading to strong criticism from members of parliament, financial experts, and holders of premium bonds. Many claim that Premium Bonds are now "worthless", and somebody with the maximum £30,000 invested who has "average luck" will win only 10 prizes per year, compared to 15 in the previous year. Investors with smaller although still significant amounts will probably fail to win anything at all.
According to the much Premium Bond Probability Calculator on MoneySavingExpert.com which updates the latest odds following each monthly draw, it shows the odds of winning premium bonds (as at Jan 2009) to be as follows:
Hold £100 over a year and the chance of winning anything is one-in-33.
Hold £1,000 over a year and 70% of people win nothing.
Hold £10,000 over a year and you have a 0.6% chance of winning £500 or more.
This state of affairs is especially perplexing because many have recently invested in Premium Bonds because of recent bank failures. Rates are expected to fall even further in coming months.
Other meanings
A "premium bond" is also a generic term for any bond selling for more than 100% of par value, i.e., at a price greater than 100.00, which typically occurs for high coupon bonds in a falling interest rate climate.
Cultural reference
The Premium Bond and ERNIE are mentioned in Jethro Tull's song Thick as a Brick:
- In the clear white circles/ of morning wonder / I take my place with the lord of the hills / And the blue-eyed soldiers / stand slightly discoloured / (in neat little rows) sporting canvas frills / With their jock-straps pinching / they slouch to attention / while queueing for sarnies at the office canteen / Saying — how's your granny and / good old Ernie: he coughed up a tenner on a premium bond win.
Also the popular 80s band Madness wrote the song E.R.N.I.E. which is on Absolutely, their second album.
In a scene in the sitcom Hancock's Half Hour, Tony Hancock composes a letter to 'Dear Ernie' asking why his bond numbers still 'have not been included in the winning list'.
A scene in the sitcom Some Mothers Do 'Ave 'Em saw Frank Spencer refer to his mother regularly sending 'Ernie' a Christmas card, in the hope that she would be favoured in the draw.
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