Burning cost rating

Category: Pricing & rating · Reviewed by Simon Temme, Account Executive · Last reviewed

Burning cost rating

Burning cost rating is the application of the burning cost approach (historical losses to a layer divided by historical exposure base) to determine the premium for the forthcoming period. It is the dominant pricing technique for working-layer non-proportional reinsurance and for large self-insured account quotation.

Process

1. Compile the loss history for the layer being rated (typically 5–10 years).
2. Index losses to current cost levels (claims inflation).
3. Develop immature losses to ultimate using chain-ladder or BF.
4. Express developed, indexed losses as a percentage of the exposure base for each year.
5. Compute a weighted average burning cost.
6. Load for:
7. Risk margin (volatility).
8. Brokerage.
9. Reinstatements (where applicable).
10. Internal expenses.
11. Cost of capital.
12. Apply to the projected exposure base for the rating period.

Credibility considerations

A burning cost requires multiple loss events within the layer to be credible. For higher layers with no historical losses, the technique becomes ambiguous and exposure rating is preferred. Some markets combine the two — credibility-weighted burning cost and exposure rate — for an indicated technical price.

References

• Swiss Re. Pricing methods in non-proportional reinsurance.
• IFoA. Practical Guide to GI Pricing.

Cross-references

• Burning cost
• Exposure rating
• Excess of loss pricing

Maintained by Matt Bartlett, Director, Apex Insurance Brokers Limited. FCA FRN 724952. Companies House 07014570.