Howden Re: secondary market for reinsurance could ‘transform’ capital efficiency

Reinsurance could evolve into a more dynamic form of capital through the development of a secondary trading market, according to a new report from Howden Re, which argues the current system embeds structural inefficiencies that raise costs and limit flexibility.

The reinsurance broker’s report, “A secondary market for reinsurance”, sets out how introducing liquidity into a traditionally illiquid asset class could fundamentally alter how risk is priced, traded and managed across the cycle.

“Reinsurance is a critical form of contingent risk capital. Yet, it remains structurally illiquid, with risk predominantly held to maturity for one year terms, the report argues.

“Other capital markets have the well-established capacity to trade primary and secondary assets… The ability to separate origination from ongoing ownership is a defining feature of mature capital markets, underpinning their depth, efficiency and resilience,” the reinsurance broker added.

That absence of liquidity, the report argues, creates an implicit cost.

In its traditional form, however, reinsurance is structurally illiquid, Howden Re suggested.

Once placed, risk is largely held to maturity, forcing capital to be committed ex ante and priced conservatively to compensate for irreversibility, the broker observed.

“This illiquidity represents an implicit financing friction that raises the effective cost of contingent capital,” the report noted.

Rob Bredahl, vice chair at Howden Re and chair of Howden Capital Markets & Advisory, framed the issue in capital markets terms.

“In credit markets, secondary trading transformed static exposures into dynamic balance-sheet assets. We see the same opportunity in reinsurance,” Bredahl said.

“A functioning secondary market would let participants actively manage risk through the cycle, releasing capital when returns compress and adding exposure when pricing improves,” he added.

Reinsurance as capital

A central theme of the report is that reinsurance should be viewed explicitly as part of the capital structure, alongside debt and equity.

“Reinsurance behaves as contingent capital: it absorbs volatility losses and therefore reduces the volatility borne by equity holders. In this formulation, reinsurance operates as a third capital channel, distinct from but economically comparable to debt, lowering WACC by reducing the required return on equity through loss absorption and volatility reduction,” said the report.

However, unlike debt or equity, Howden Re noted that reinsurance lacks the ability to rebalance exposures once deployed.

David Flandro, head of industry analysis and strategic advisory at Howden, said introducing liquidity would change that dynamic.

“When reinsurance is treated as a third form of capital, the case for liquidity becomes obvious. Secondary trading turns static, hold-to-maturity contracts into flexible instruments with real option value,” Flandro said.

“This, in turn, lowers the cost of capital for cedents while allowing reinsurers to allocate balance sheet capacity far more efficiently.”

The paper draws on real options theory to quantify this shift.

“Introducing secondary trading fundamentally alters this dynamic by embedding real optionality into reinsurance contracts… the ability to defer, expand, contract or exit a position as uncertainty resolves has standalone economic value. In an illiquid, hold-to-maturity market, this option value is negligible; with secondary trading, it becomes material,” the report added.

Lessons from other markets

Howden points to parallels with syndicated loan and credit markets, where liquidity developed over time as infrastructure improved.

“The ambition to establish a sophisticated secondary market for reinsurance finds parallel with successful efforts in the unfunded loan markets and revolving credit facilities.

The history of the unfunded loan market shows that the introduction of a mechanism for secondary trading introduces liquidity and optionality into the market, ultimately lowering the cost of capital.”

Reinsurance already shares some of these characteristics, including syndication, broker intermediation and pre-approved counterparties, but lacks the infrastructure to support post-placement trading.

The logical progression, the report argues, is to build liquidity on top of the broker-led ecosystem rather than in place of it.

An ‘all-market’ solution

The report emphasises that any secondary market must deliver value across the chain, from cedents to reinsurers and retrocessionaires.

“At its core, a successful secondary liquidity pool will emerge from an ‘all-market’ solution that benefits cedents and reinsurers alike. Because reinsurers rarely achieve their optimal portfolio composition at renewals, a secondary market would enable them to rebalance portfolios post transaction in line with internal capital models.”

Cedents would also gain flexibility, Howden Re stressed.

“Cedents could likewise ‘trade risk off’ existing treaties rather than purchasing additional retrocession or direct and facultative (D&F) cover following renewal.”

Over time, this could reshape pricing dynamics.

“Over time, this should increase market liquidity and, consistent with classical corporate finance theory, lead to more efficient and ultimately lower pricing,” the paper added.

From concept to implementation

While the report suggests the economic case is clear, it stresses that implementation is the key challenge.

If achieved, the shift would mark a structural evolution for the market, embedding optionality into reinsurance contracts and reinforcing its role as a core source of global risk capital.

“The barriers faced by an emergent secondary market are those of implementation rather than principle,” said Howden Re.

Introducing a secondary market for reinsurance risk goes further than simply aligning it with other, more liquid forms of capital. It would allow carriers to more efficiently allocate risk and, in turn, improve overall capital utilisation,” the paper added.