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🔥 '''Burning cost ratio''' is a retrospective measure of loss experience that compares actual historical losses to the [[Definition:Premium | premium]] base or exposure measure over a defined period, serving as a foundational input for pricing [[Definition:Excess of loss reinsurance | excess-of-loss reinsurance]] and high-[[Definition:Attachment point | attachment-point]] insurance layers. Unlike frequency-severity models or stochastic simulations, the burning cost approach relies on observed data — what has actually "burned" through a portfolio — to estimate the rate needed to cover expected future losses at a given layer. It is one of the oldest and most intuitive actuarial tools in the [[Definition:Reinsurance | reinsurance]] pricing toolkit.

📐 To calculate it, an [[Definition:Actuary | actuary]] or [[Definition:Underwriter | underwriter]] collects historical losses that would have penetrated the layer in question, adjusts them for [[Definition:Loss development | loss development]] and [[Definition:Inflation | inflation]] (known as "trending" and "developing" the losses), and divides the adjusted losses by the corresponding subject [[Definition:Earned premium | earned premium]] or an appropriate exposure base. The result is expressed as a percentage — for instance, a burning cost of 12% means that, based on historical experience, losses at the relevant layer have averaged 12 cents for every dollar of subject premium. [[Definition:Reinsurer | Reinsurers]] then load this figure for [[Definition:Expense ratio | expenses]], [[Definition:Profit margin | profit]], and a risk margin to arrive at a quoted rate. The method works best when the loss history is credible and the portfolio composition has remained reasonably stable; for lines with sparse large-loss data or rapidly changing risk profiles — such as [[Definition:Cyber insurance | cyber]] — burning cost analysis alone may be insufficient and is often supplemented with [[Definition:Catastrophe model | exposure-based models]].

💡 Market practitioners value the burning cost ratio for its transparency and simplicity: both [[Definition:Ceding company | cedants]] and reinsurers can examine the same historical loss record and debate adjustments openly, which facilitates negotiation. During [[Definition:Renewal | renewal]] discussions, a cedant with a favorable burning cost trajectory can argue for rate reductions, while a reinsurer facing deteriorating burning costs has concrete evidence to push for increases. The metric also appears in [[Definition:Experience-rated | experience-rated]] contracts, [[Definition:Retrospective rating | retrospective rating]] arrangements, and [[Definition:Sliding scale commission | sliding-scale commission]] structures, where actual loss experience directly influences the final economics of the deal. Across markets from London to Bermuda to Singapore, the burning cost ratio remains a common language that bridges different actuarial traditions and negotiation styles.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Excess of loss reinsurance]]
* [[Definition:Experience rating]]
* [[Definition:Loss development]]
* [[Definition:Rate on line (ROL)]]
* [[Definition:Subject premium]]
* [[Definition:Retrospective rating]]
{{Div col end}}

Definition:Burning cost ratio - Revision history

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