Dominik Hagedorn, co-founder at Tangency Capital, answers SCI's questions

Q: How and when did Tangency Capital become involved in the ILS market?
A: Tangency Capital was launched in the autumn of 2017 by Michael Jedraszak, Kai Morgenstern and me, with the aim of offering institutional investors access to natural catastrophe risk akin to how reinsurers access the market and beyond what traditional ILS funds offer. Following an initial set-up and capital raise, we launched our commingled fund in May 2018, with US$50m of invested capital.

The three co-founders have 50-plus years of experience in the industry, each with a different background and prior experience: Kai, a geophysicist and former portfolio manager at Bermuda reinsurance firm ReinaissanceRe; Mike, a seasoned underwriter and former cio of Hiscox’s ILS platform Kiskadee Investment Managers; and myself, a former investment banking professional, with a focus on the insurance industry. We all bring together different qualities required to run a successful ILS platform.

The name of our firm is derived from the ‘tangency point’ on the efficient frontier, which is the most efficient point of the risk-return spectrum. Our firm is called Tangency Capital to convey the idea that by diversifying and investing in a non-correlated asset class, such as ILS, investors can improve the efficiency in their portfolio.

Q: What are your key areas of focus today?
A: Our fund is focused on partnering with reinsurance firms via non-life quota share arrangements. Quota shares allow us to take pro-rata shares of reinsurance companies’ natural catastrophe business, thus earning premiums and paying claims in the same way our reinsurance partner companies do.

By taking a minority stake in such portfolios, the interests of our investors are aligned with those of the reinsurers. Such agreements allow reinsurers to achieve capital relief for those parts of their business that are passed on to us.

Unlike traditional debt and equity, transactions can be re-sized annually in an easy manner to reflect current capital needs. Reinsurers are increasingly using quota shares to manage their capital, as evidenced by new programmes coming to the market and existing programmes continuously expanding.

Our clients are institutional investors, such as pension funds, insurance companies and asset managers.

Q: How do you differentiate yourself from your competitors?
A: Currently, we are the only institutional investor-focused ILS manager that invests predominantly in quota shares. It’s less common for an ILS fund to focus on the quota share segment, as reinsurance companies often view ILS funds as competitors and are therefore reluctant to share details on their portfolio with such funds. We do not compete with reinsurers and are therefore seen as a true partner.

The fee structures of traditional ILS funds are also hard to reconcile with the expenses of accessing the quota share market.

Additionally, unless they enter into fronting arrangements, ILS funds collateralise every dollar of exposure because there is no rated entity as counterparty – which eliminates the potential for leverage. In contrast, reinsurers hold capital based on economic reserves for certain exposures – which means they need to hold less capital than the exposure they underwrite, thereby creating a leverage effect. This benefit is passed on to quota share investors.

Quota shares appeal to investors because they trust in the idea that it’s right to partner with the entities that have been successful in this business for decades in a market that isn’t that easy to access and - unlike most traditional ILS funds - are regulated, rated and listed entities, with extensive oversight and independent research available.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: Essentially, our role is to diligence investment opportunities on behalf of our investors and establish a portfolio of quota shares that broadly reflects the real reinsurance market. At Deutsche Bank, I helped reinsurance companies identify investors for quota share arrangements and I found that while investors liked the partnership concept, they were often held back by the need to ensure that a particular quota share investment was the right fit for them. By creating a portfolio of quota shares, ensuring alignment of interest and acting as independent fiduciary, we alleviate those concerns.

The expectation is that we’ll grow the fund to a more meaningful size over time. We’re currently invested in a small handful of quota shares; the aim is to diversify, but grow with the companies we like most.

For the moment, we’ll concentrate on building out the quota share strategy, although we may set up some separately managed accounts. We want to keep it simple as a story.

Q: What major developments do you expect from the market in the future?
A: I expect reinsurers to increasingly use quota shares and sidecars for risk and capital management purposes. We are already seeing more and more companies setting up programmes or expanding existing ones. 

The reinsurance market saw some losses in 2017, following a more active hurricane season than in prior years. This allowed investors to review their allocation in the ILS space and confirm whether the investments, as advertised by ILS funds, performed in line with expectations and competitors. As a result of that, we may see some re-allocations in the sector.

The traditional ILS space covering cat bonds and collateralised reinsurance feels a little overcrowded, with margins continuously shrinking. End investors may therefore look for alternatives within the ILS space.

CS