Key Pricing Methods

Burning Cost Method

The burning cost method is the simplest and most intuitive pricing approach. It uses actual historical claims experience to predict future costs.

How it works:

Step 1: Collect claims data for the risk or portfolio over a period (typically 3–5 years)
Step 2: Adjust historical claims for inflation (a GHS 10,000 claim from 3 years ago might cost GHS 15,000 today)
Step 3: Calculate the loss ratio = total claims / total premium
Step 4: If the loss ratio is too high, increase the rate. If it's acceptable, maintain.

Example: Motor fleet:
A transport company insured for 5 years. Total premiums paid: GHS 500,000. Total claims incurred: GHS 350,000. Loss ratio: 70%.

If your target loss ratio is 60%, you need to increase the rate by approximately (70% - 60%) / 60% = 17%.

Limitations in Ghana: The burning cost method requires credible historical data. For a new product, a small portfolio, or a risk class with few policies, there simply isn't enough data. You need alternative methods.

Exposure Rating

When you don't have enough claims data for a specific risk, you use exposure rating: pricing based on the characteristics of the risk rather than its actual claims history.

How it works:

Start with a base rate for the risk class (e.g., 2.5% for standard commercial fire). Then apply factors based on the specific risk's features:

→Construction type: concrete = 1.0 (base), wooden = 1.5, mixed = 1.2
→Fire protection: full sprinklers = 0.7, extinguishers only = 1.0, none = 1.3
→Occupancy: office = 0.8, retail = 1.0, manufacturing = 1.3, hazardous = 1.8
→Location: urban with fire station nearby = 0.9, rural = 1.3

Example:
A wooden retail shop in Kumasi with fire extinguishers only:
Base rate 2.5% × 1.5 (wood) × 1.0 (extinguishers) × 1.0 (retail) × 1.0 (urban) = 3.75%

On a sum insured of GHS 200,000: premium = GHS 7,500.

Exposure rating is the bread and butter of Ghanaian underwriting because so many risks lack adequate claims history.

Experience Rating & Credibility

In practice, the best pricing combines both approaches. Experience rating blends a risk's own claims history with the broader class experience, weighted by credibility.

Credibility answers the question: how much should I trust this specific risk's own data versus the market average?

A fleet of 200 trucks with 10 years of history: high credibility: their own experience is a reliable predictor.
A single vehicle insured for 1 year: zero credibility: one year of no claims doesn't mean it's a good risk.

The formula: Premium = (Z × own experience rate) + (1-Z) × class rate

Where Z is the credibility factor (0 to 1). For the 200-truck fleet, Z might be 0.7. For the single vehicle, Z is 0.

This is a simplified version of what actuaries do, but understanding the concept helps anyone in the industry appreciate why two seemingly similar risks can have very different premiums.