Burning Cost Method for Reinsurance Pricing

Burning Cost Defined

The burning cost method prices reinsurance by analyzing historical losses that would have penetrated the proposed reinsurance layer. It divides layer-specific historical losses by the corresponding subject premium (adjusted for rate changes and exposure growth) to produce a burning cost rate. This experience-based approach works best when there is sufficient historical data and the underlying risk profile has been relatively stable.

Practical Application

To apply the method, the actuary collects individual large losses, develops them to ultimate, trends them to the prospective period, and applies them to the proposed treaty structure. Losses are capped at the reinsurance layer limits. The resulting burning cost is then loaded for expenses, profit margin, and a risk load reflecting volatility. Common challenges include limited data credibility (especially for high layers), changes in the underlying portfolio composition, and the need to incorporate catastrophe losses appropriately. The burning cost is typically compared to exposure-rated results.