A flood of investment capital into structures linked toinsurance could lead to instability and spark a new financialcrisis if left unsupervised, a top official has warned.

Billions of dollars from investment funds has flooded intoinsurance-linked structures in recent years as an alternative tomore traditional investments such as bonds which currently offerpoor yields because interest rates are low.

This has allowed insurers and the reinsurance industry inparticular to spread risk and drive down prices.

In a speech late on Wednesday, John Nelson (pictured), chairmanof the Lloyd's of London insurance market, said the trend helpedfund expansion to keep pace with growing economies and risingdemand.

But he warned that if not properly supervised the fund flowscould end up undermining the stability of the insurance sector.

Nelson said the insurance industry must avoid capital becomingdetached from risk, a mistake which he said caused the bankingindustry's “systemic problems” from 2007.

The widely discredited 'originate-to-distribute' banking modelsaw lenders offload to third parties billions of dollars of lowgrade loans through the sale of special bonds secured on mortgagerepayments.

An increasingly popular insurance-linked financial instrument isthe so-called “catastrophe bond”, bonds which are sold by insurersand reinsurers to share the risk they take on for natural disastersand other events that can lead to costly payouts.

“Some of the structures being used could undermine some of thequalities of the insurance model, which provides a secure andreliable risk transfer market for specialist risk – and indeed thereliable payment of claims,” Nelson said.

He added the industry and financial regulators must be“extremely watchful”.

“We must make sure that the capital remains properly attached tothe underlying transaction so that the risk is properly assessed,properly priced and properly supervised,” he said.