Burning cost

Category: Actuarial fundamentals · Reviewed by Simon Temme, Account Executive · Last reviewed

Burning cost

The burning cost is a simple ratio used in commercial insurance and reinsurance pricing: the historical losses to a layer or programme expressed as a percentage of the historical exposure base (premium income, payroll, turnover, sums insured) for the same period.

Formula

Burning cost = Σ losses to the layer (suitably trended and developed) / Σ exposure base (trended)

The result is multiplied by the projected exposure base for the forthcoming period and loaded for development and risk margin to produce an indicated premium.

Adjustments

Raw burning costs must be adjusted for:

• Loss trend — claims cost inflation between the historical period and the projection period.
• Exposure trend — wage inflation, building cost inflation, turnover changes.
• Loss development — IBNR and IBNER from open years.
• Layer-specific changes — retentions and limits that have changed over time.
• Underlying business mix — share of high-risk vs low-risk exposures.

Use

Burning cost is the default approach for:

• Working-layer non-proportional reinsurance pricing where loss experience is credible.
• Large account property and casualty pricing for risks with material historical claims.
• Pricing layer extensions within an existing programme.

It is less suitable for catastrophe layers or new risks with no usable history — for those, exposure rating is preferred.

References

• Swiss Re (various). Non-proportional reinsurance pricing.
• IFoA. Practical Guide to GI Pricing.
• CAS. Pricing on Loss Development Triangles.

Cross-references

• Burning cost rating
• Burning cost reinsurance
• Exposure rating

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