Reinsurance broker Howden Re has released a new report in which the firm sets out a framework for introducing a secondary reinsurance market, noting that it would allow carriers to more efficiently allocate risk, which would ultimately improve and drive greater overall capital efficiency.
“However, unlike debt or equity, reinsurance does not typically benefit from an active secondary market. Capital must be committed ex ante and priced to reflect the inability to rebalance exposures mid-term. This irreversibility introduces an implicit financing friction and increases the effective cost of contingent capital,” Howden Re said.
As per the broker’s report, introducing secondary trading reshapes this dynamic, as the ability to defer, expand, contract, or exit a position as uncertainty resolves carries measurable economic value.
Rob Bredahl, Vice Chair, Howden Re and Chair, Howden Capital Markets & Advisory, commented: “In credit markets, secondary trading transformed static exposures into dynamic balance-sheet assets. We see the same opportunity in reinsurance. A functioning secondary market would let participants actively manage risk through the cycle, releasing capital when returns compress and adding exposure when pricing improves.”
In addition, Howden Re explained that a more open, liquid market for primary and secondary risk trading would bring important advantages to the reinsurance market by introducing optionality to the value chain, benefiting cedents, reinsurers, brokers and capital providers.
In turn, this could potentially lower the cost of reinsurance while also making reinsurance more economically profitable for underwriters.
“Reinsurers can find value in a secondary market through being, in effect, released from full-year exposures, where an acceptable price exists for trading part of their position. In doing so, reinsurers may rebalance their portfolios following unexpected original placement allocations, release collateral ahead of the timeframe permitted under the original treaty terms, or express a pricing view that differs from prevailing market levels. Ideally, transactions would occur on existing contractual terms so that reinsurers would be able to adjust their exposure with minimal basis risk,” Howden Re’s report explains.
It is crucial to highlight that the only true, liquid secondary market for reinsurance risks is currently in catastrophe bonds. As readers of Artemis know, in catastrophe bonds, the secondary market facilitates the trading of positions between investors and fund managers, aided by a broker.
Therefore, an expansion of secondary trading options for reinsurance may ultimately foster and enhance participation from capital markets investors.
However, in its new report, Howden Re acknowledges that by separating origination from ongoing ownership, as other mature capital markets have done, reinsurance could embed optionality into its contracts, improving capital efficiency and supporting more efficient pricing.
“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. Increased liquidity should, in all likelihood, lower pricing and incentivise reinsurers to adopt and offer multiyear covers,” the report explains.
Adding: “That would, in and of itself, reflect the expected flexibility and greater optionality a deep liquidity pool would offer participants in a market that facilitates trading risk on and off to their needs. Such a development would support a healthier ecosystem by accommodating a participant’s financial backers through its potential for collateral release.”
The broker also emphasises that the barriers faced by an emergent secondary market are those of implementation rather than principle.
Therefore, realising the market entails a deliberate and guided approach, mindful of prior challenges, Howden Re explains that the market demands a broker-led process, safeguarded by comprehensive risk management that is ultimately cognisant of the industry it is attempting to reform.
“Bringing reinsurance risk in line with more established secondary markets, necessitates learning the lessons of those antecedents. Standardising terms and proliferating secondary-friendly language in treaties are welltested tools readymade to aid this transition. Taken together, these measures would allow the market to evolve, consistent with its unique characteristics, and ultimately, expand its role as a supplier of contingent capital,” Howden Re added.
David Flandro, Head of Strategic Advisory & Business Intelligence, Howden Re, said: “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. This, in turn, lowers the cost of capital for cedents while allowing reinsurers to allocate balance sheet capacity far more efficiently.”
