1. Flat premium basis

• The ceding company and reinsurer agree to a premium that should be adequate to cover the reinsurer’s liability and costs, this being paid at commencement and subsequent renewal dates. The premium may be paid by installment, if the treaty so provides.

2. Percentage basis

• The ceding company and reinsurer agree to apply a percentage to the annual gross premium income or net premium income of the business covered by the treaty.

• Gross or net premium income may be determined on a written or earned basis, depending on the terms of the treaty.

Percentage basis

• Thus, the premium due to the reinsurer can be calculated only when the gross or net premium income is known, and this would usually be at the end of the year. However, the reinsurer is liable for losses from the commencement date of the treaty. As it would be unfair on the reinsurer to wait until the end of the year for any premium, both parties agree to the payment of a deposit premium to the reinsurer, either at inception date or in installments.

Percentage basis

• When the actual premium due to the reinsurer is known, an appropriate adjustment is made to the deposit premium.

• Some treaties provide for a minimum premium so that if the adjusted premium is less than the minimum, no refund is made.

Two methods are used for the calculation of adjustment premium under the treaty:

• 1. Flat rate - this is a fixed percentage.

• 2. Variable rate - this is based on the “burning cost” of the results of the treaty and is subject to a minimum and maximum rate.

The basic formula used to determine the burning cost is:

• (Losses paid + outstanding) ÷ (Gross or net premium income) × Loading = Rate

• The calculation is adjusted each year until all losses have been settled. Should the rate calculated fall below the minimum, the minimum rate applies. Similarly, should the rate calculated be above the maximum, the maximum rate will apply.

Burning Ratio

In primary insurance, the ratio of losses suffered to the amount of insurance in effect. Thus, not a "loss ratio," which is the ratio of losses incurred to premiums earned.

BURNING COST

• The ratio of actual past reinsured losses to a ceding company's subject matter premium (written or earned) for the same period. Used to analyze past reinsurance experience or to project the future.