Burning Cost Rating
Price a risk from its own claims: adjusted losses over exposure, then loaded for costs.
Burning cost is the simplest way to rate a risk from its own claims history. You add up what the risk has cost in claims over recent years, express it as a rate on the exposure (sum insured, wages, turnover or number of vehicles), and load that rate for expenses and profit. The name comes from the idea of how much of the premium the claims have "burnt".
It suits large commercial accounts with enough history to be credible: a textile group's fire programme, a bank's money policy, a corporate group health scheme, or a reinsurance layer. For a small shop with two claims in ten years, the history says little, and the insurer falls back on its manual rates.
You save ₹300
- Full 100-question mocks
- Chapter-wise practice
- Section-wise sets
One payment, no subscription
The Burning Cost Method, Step by Step
- 1
Collect the claims history
Usually about the last five years of claims, paid plus outstanding, for the risk being rated.
- 2
Adjust the claims
Bring old claims to today's cost for inflation, and remove or cap one-off events that will not recur (or add a loading for ones that will). Allow for claims still developing.
- 3
Collect the exposure
The matching exposure for each year: sum insured for property, wages for employee's compensation, turnover for liability, lives for group health.
- 4
Divide claims by exposure
Adjusted claims for the period divided by total exposure for the period gives the burning cost rate. This is the pure risk rate.
- 5
Load for expenses and profit
Add acquisition costs, management expenses, a contingency margin and a profit margin to reach the office (gross) rate.
- 6
Apply to next year's exposure
Office rate times the expected exposure for the coming year gives the premium.
Worked Example: A Surat Textile Group's Fire Cover
Figures are illustrations. Sum insured in ₹ crore, claims in ₹ lakh.
Year 1
Sum insured (₹ crore)
80
Claims (₹ lakh)
12
Year 2
Sum insured (₹ crore)
85
Claims (₹ lakh)
4
Year 3
Sum insured (₹ crore)
90
Claims (₹ lakh)
30
Year 4
Sum insured (₹ crore)
95
Claims (₹ lakh)
9
Year 5
Sum insured (₹ crore)
100
Claims (₹ lakh)
15
Total
Sum insured (₹ crore)
450
Claims (₹ lakh)
70 (80 after adjusting for inflation)
| Year | Sum insured (₹ crore) | Claims (₹ lakh) |
|---|---|---|
| Year 1 | 80 | 12 |
| Year 2 | 85 | 4 |
| Year 3 | 90 | 30 |
| Year 4 | 95 | 9 |
| Year 5 | 100 | 15 |
| Total | 450 | 70 (80 after adjusting for inflation) |
Working It Through
- check_circleBurning cost rate = adjusted claims ÷ total exposure = ₹80 lakh ÷ ₹450 crore = 0.178%, or about ₹1.78 per ₹1,000 sum insured (per mille).
- check_circleSuppose expenses, commission, contingency and profit together take 30% of the office premium. Office rate = 1.78 ÷ 0.70 = about ₹2.54 per mille.
- check_circleNext year's sum insured is ₹110 crore, so premium = ₹110 crore × 2.54 ÷ 1,000 = about ₹27.9 lakh.
- check_circleNotice that the loading is divided, not added: if 30% of the final premium goes to costs, the claims part is 70% of it.
Quick practice on risk inspection and hazards. No signup.
Terms That Go With It
- Pure premium
- Total losses incurred in a year divided by the number of exposure units, with no loading for expenses, taxes, contingencies or profit. 2,000 two-wheelers with ₹30 lakh of claims give a pure premium of ₹1,500 per vehicle.
- Office premium (gross premium)
- Pure premium plus loadings for acquisition cost, expenses, contingencies and profit. This is what the customer pays before taxes.
- Rate on line (ROL)
- Premium as a percentage of the limit of indemnity, used for high-severity, low-frequency covers such as catastrophe excess of loss reinsurance. ₹50 lakh premium for a ₹20 crore layer is a 2.5% rate on line.
- Payback period
- The reciprocal of rate on line: at 2.5%, it takes 40 years of premium to pay for one total loss of the layer.
- Credibility
- How far the risk's own experience can be trusted. Low credibility means blending burning cost with the insurer's manual or market rate.
How IC-11 Tests This
Expect the number of years burning cost normally uses (about five), the pure premium formula (losses ÷ exposure units, not ÷ premium), and rate on line (premium ÷ limit, as a percentage). The traps: dividing claims by premium gives a loss ratio, not a pure premium; and inverting rate on line gives the payback period, not the rate.
FAQs
What is the burning cost method of rating?expand_more
A rating method that takes a risk's adjusted claims over about the last five years, divides them by the exposure for the same period to get a pure rate, and loads that rate for expenses, contingencies and profit.
How is pure premium calculated?expand_more
Total losses incurred per year divided by the number of exposure units. It carries no loading for expenses, taxes, contingencies or profit.
What is rate on line in insurance?expand_more
The premium expressed as a percentage of the limit of indemnity. A ₹50,000 premium on a ₹2 crore limit is a 0.25% rate on line.
When is burning cost not suitable?expand_more
When the risk is too small or too new to have credible claims history, or when its operations have changed so much that past claims no longer represent the future.
Next steps
- Loss Ratiosarrow_forward
- Risk Inspectionarrow_forward
- Deductiblesarrow_forward
- IC-01: Premium rating methodsarrow_forward
Full-length IC-11 practice, timed to 2 hours and scored.