Burning cost (and burning cost ratio)
Experience-based cost of a reinsurance layer: past losses, each restated as-if to today's conditions, divided by the premium base. It is the first number in an excess of loss quote.
A layer's burning cost is the sum, over the observed years, of what the layer would have paid, divided by the premium base (GNPI, gross net premium income) of the same years. It is stated as a percentage of that base, hence the other name, burning cost ratio, and the shorthand burn cost. It only makes sense as-if. Each loss is trended by a claims inflation index to the cover year, and the base is restated to current rate and exposure levels, otherwise you are pricing the experience of a book that no longer exists. It is often confused with the loss ratio, which sets all of an insurer's losses against its premium; burning cost counts only what falls into the layer, and in reinsurance it is the experience rating method that gives the pure premium before loadings. It only sees what has happened, so a high layer untouched in five years comes out at zero, which says nothing about its cost. That is why it is supplemented, on rarely hit layers and in cyber where history is short, by exposure or scenario rating, and why the result is read together with the chosen index, which on its own can bring a loss into the layer.
Example on a fictitious program, layer 500 XS 500 in thousands of euros, cover year 2026. Two trending assumptions: claims follow inflation of 5% a year, and the book's rate level has risen 3% a year. Original losses: 700 in 2021; 450 and 1,300 in 2022; none in 2023; 900 in 2024; 620 in 2025. Trended to 2026 (factors 1.2763; 1.2155; 1.1025; 1.05), they come to 893, 547, 1,580, 992 and 651. The layer would have paid 1,220 at original values and 1,584 as-if: the 2022 loss of 450, below the retention as it stood, enters for 47 once trended, and the 1,300 loss exhausts the layer either way. The original base, 7,000, 7,600, 8,200, 8,800 and 9,500, or 41,100, is brought to the 2026 rate level with factors from 1.1593 down to 1.03: 44,750. Burning cost at original values: 1,220 / 41,100 = 2.97%; as-if: 1,584 / 44,750 = 3.54%. The loadings come next, also assumed: 10% for IBNR on the recent years, giving 3.89%, then brokerage, expenses and margin at 20% of the final rate, so 3.89 / 0.80 = 4.87% of the base. The method stumbles on the 1,300 loss: take it out and the as-if burning cost drops to 2.42%, and five years cannot tell whether an exhausted layer comes back one year in five or one in thirty.
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