This is just cosmetic, right? It's just the colored outer layer that's flaking off and the compression layer is fine. Or is it more than that?

It is cosmetic for now , but it is a sign to say replace soon . As it wear down it will let water in and that will cost more problems if not taking care of . You will also lose paint off the headtube in time too because of the rubbing . I would replace the housing now and find something to protect the paint too .

So, get out your length of Heat Shrink Tubing and shrink it around that section ..

What is under the outer layer? Brand/model of cable housing?

I would have expected steel spirals.

As bikeman715 said, it is mostly cosmetic, but at least with the steel spiral housing, it will rust if there is water contact. I'm not sure about yours.

I've put a layer of packing tape over the tubes on one bike where cables were most likely to rub, but I think there are special plastic sticky tabs for that too.

I was hoping I could put it off until I needed new handlebar tape too.

You can try wrapping the area with electric tape for the time being until you replace your handlebar tape .

I would replace the cables and housing.
You might need the brakes to work good on a downhill sometime.

Yeah, I'm fond of braking... this is my normal ride:



The housing says JAGWIRE REINFORCED WITH KEVLAR so I'm guessing that white layer is the Kevlar. That's starting to flake off too though and I can see another layer of something under that. Probably like this:

If it were my bike I'd replace it with Shimano Dura Ace cable and housing. My opinion alone but I view brakes on a road bike the most important component. Dura Ace online are far cheaper than in a LBS and they really work well.

Looking at the diagram above.

5 parts:

• Inner Liner (for slickness)
• Linear Strands for compression.
• Inner Layer???
• Kevlar
  Apparently one is not supposed to use linear strands for brakes. Spiral winding has more compression, but the strands don't split apart.
  The purpose of the Kevlar for the brake cable is to hold the linear strands in place.
• Outer layer. Protection?

So, if it was linear stranded shift cable housing, then once the outer cover is compromised, the shift cable housing is compromised.

With the brake cable, the outer layer does not give structural support. However, if the kevlar is compromised, then the housing becomes compromised.

If you had cheap spiral wound housing, then the only thing to worry about is rust.

I'd probably replace it with that much damage, but it is up to you to evaluate it and decide. Maybe the electrical tape idea would hold for a while.