Burning cost (reinsurance)

Category: Reinsurance pricing · Reviewed by Matt Bartlett, Director · Founder · Last reviewed

Burning cost in reinsurance is the application of the burning cost technique to determine the loss cost for a specific layer of a non-proportional treaty. It is the workhorse pricing method for working layers in property per-risk, casualty per-occurrence and motor excess treaties.

Standard process

1. Compile loss listings for the cedent’s portfolio for the historical period (typically 7–10 years).
2. Index each loss to current cost level (claims trend).
3. Re-state losses at current treaty structure (current attachment, limit, currency).
4. Develop immature years using chain-ladder or BF.
5. Calculate the loss to the layer for each historical year.
6. Express layer losses as a percentage of the cedent’s exposure base (premium income, sums insured, payroll).
7. Compute simple and weighted-average burning costs.
8. Apply to projected exposure.

Trending

The two trend lines that must be applied are often in tension:

• Claims trend — moves losses up (typically 4–10% per year for casualty).
• Exposure trend — moves exposure up (typically 3–6% per year for premium / payroll / SI).

The net effect can be material — failing to trend either side can mis-state the burning cost by 30%+ over a 10-year history.

Reinstatements

The burning cost for layers with paid reinstatements should be calculated net of reinstatement premium that would have been collected on the historical losses.

References

• Swiss Re. Non-proportional reinsurance pricing.
• IFoA. Reinsurance practical guides.

Cross-references

• Burning cost
• Burning cost rating
• Excess of loss pricing

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