What Is an Annual Premium Equivalent (APE)? Calculation Defined

What Is Annual Premium Equivalent (APE)?

An annual premium equivalent (APE) is a common sales measure calculation used by insurance companies in the United Kingdom. The annual premium equivalent is the sum of the total value of regular–or recurring–premiums plus 10% of any new single premiums written for the fiscal year. If desired, the premiums earned by an insurance company can be extended to include all revenues of a given insurance company.

Understanding Annual Premium Equivalent (APE)

Annual premium equivalent (APE) is specifically used when sales contain both single premium and regular premium business. Single premium insurance policies require a single lump-sum payment from the customer or policyholder. The regular premium policies are annualized by taking the premium amount and multiplying it by the frequency of payments in the billing cycle.

The annual premium equivalent calculation is used by the insurance industry to allow comparisons of new business achieved in a specific period. A single-payment premium actually spreads a sale over a long period of time. By contrast, a recurring premium involves separate annual premiums. The APE metric is used to compare single premium payments to the recurring payment premiums. This process helps accurately compare sales between policies with the two different types of premiums.

Insurance companies commonly take the approach of comparing 100% of regular premiums, i.e. the annual premiums received for a policy and 10% of single premiums. However, this only works under the assumption of an average life insurance policy lasting 10 years. Therefore, taking 10% of a single premium annualizes the single lump-sum payment received over the 10 years the policy is in effect.

Annual Premium Equivalent vs. Present Value of New Business Premiums

The present value of new business premiums (PVNBP) is the terminology used in the insurance industry to indicate the present value of total confirmed premiums that will be received from present to future. Present value is a metric of calculating how much a future stream of payments or cash flows are worth in today's dollars.

Calculating the present value of future insurance premiums is important because a premium received today is worth more than the same premium amount due to be paid in the future. The reason for this is that the money received today can be invested and earn a rate of return. Insurance companies earn a significant amount of investment income from investing premiums received from clients.

Like APE, PVNBP makes it possible to compare the sales of two companies having both single premiums and recurring premiums. However, it actually does the opposite of what APE does when it converts recurring premium income to a single number. Instead, PVNBP is the sum of single premiums and the present value of life insurance premiums paid year after year.

Special Considerations

When estimating any future metric, it is important to consider any unforeseen events and how these events may impact any assumptions and estimations. For example, when forecasting a firm's sales revenues, it's important to consider the competition, their product lines and pricing strategy over the forecasted period. Including the competitors can help fine-tune the forecast, which will hopefully be more applicable and provide a margin of safety.