Economics & ClaimsApplied

Burning Cost

Pricing from the cedent's own history

A pricing method that rates a reinsurance layer purely from the cedent's own historical losses to that layer, indexed and loaded for further development.

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Definition

Burning cost pricing rates a layer using the cedent's own historical losses that would have fallen into it — indexed for inflation and trend, and loaded for further claims development (IBNR) — divided by historical premium or exposure, producing an experience-based rate. It stands in contrast to exposure rating, which prices a layer from first principles using exposure curves rather than the cedent's own claims history. Burning cost works best where the cedent has a long, credible loss history to draw on, and struggles on genuinely new risks or high layers with little claims experience.

It rates a layer purely from what the cedent's own historical losses to that layer would actually have been, not from a market benchmark or exposure curve.
Historical losses must be indexed for inflation and trend, and loaded for further development, since old claims files rarely represent their true eventual cost as originally recorded.
It works best where the cedent has a long, credible claims history, and is far less reliable for genuinely new risks or high layers with little loss experience to draw on.

Worked example

A cedent's five years of historical losses to a $5M xs $5M layer, once indexed for inflation and loaded for further development, average $400,000 per year against $8M of average premium exposed — producing a burning cost rate of 5%.

Scenario · figures in USD

Five years of history becomes next year's rate

A reinsurer prices a renewal using five years of the cedent's own historical losses to the layer, after indexing and development loading.

Indexed, developed losses to the layer over 5 years	$2M total
Average annual indexed loss to the layer	$400,000
Average annual premium exposed over the same period	$8M
Resulting burning cost rate	5% ($400,000 / $8M)
What this rate assumes	That the next year's experience will resemble the indexed, developed history of the last five

So whatBurning cost turns the cedent's own claims history, adjusted for inflation and development, directly into next year's rate — its credibility rests entirely on how representative that history really is.

Check your understanding

What does burning cost pricing use as its primary input?

The cedent's own historical losses to the layer, indexed and loaded for development. Burning cost rates a layer from the cedent's own claims history to that layer, adjusted for inflation and further claims development, rather than from a market or exposure-based benchmark.

When is burning cost pricing least reliable?

For genuinely new risks or high layers with little or no loss experience to draw on. Burning cost depends entirely on having enough of the cedent's own credible loss history — it struggles for new risks or high layers where that history barely exists.

Word problem

A cedent's indexed, developed losses to a layer over four years total $1.6M, against average annual premium exposed of $10M. What is the resulting burning cost rate, and why might a reinsurer be cautious about relying on it if those four years happened to be unusually quiet?

Show a hint

Divide the average annual indexed loss by the average annual premium, then think about what a short, quiet historical window might be hiding.

Reveal the worked answer

Average annual indexed loss: $1.6M / 4 years = $400,000 per year.
Burning cost rate: $400,000 / $10M = 4%.
If the four years used happened to be unusually quiet (no severe losses reaching the layer), the historical average understates the layer's true long-run cost.
A reinsurer would want a longer history, or a blend with exposure rating, before fully trusting a burning cost rate built on a short, possibly unrepresentative window.

The burning cost rate is 4% ($400,000 average annual indexed loss divided by $10M average premium). A reinsurer should be cautious relying on it alone if those four years were unusually quiet, since a short window with no severe losses can understate the layer's true long-run cost — exactly why burning cost works best with a long, credible history rather than a brief one.

Related terms

Part of the Treaty Reinsurance guide, where this term is explained alongside every other treaty metric.