By Chris Vellacott
LONDON (Reuters) - A flood of investment capital into structures linked to insurance could lead to instability and spark a new financial crisis if left unsupervised, a top official has warned.
Billions of dollars from investment funds has flooded into insurance-linked structures in recent years as an alternative to more traditional investments such as bonds which currently offer poor yields because interest rates are low.
This has allowed insurers and the re-insurance industry in particular to spread risk and drive down prices.
In a speech late on Wednesday, John Nelson, chairman of the Lloyds of London insurance market, said the trend helped fund expansion to keep pace with growing economies and rising demand.
But he warned that if not properly supervised the fund flows could end up undermining the stability of the insurance sector.
Nelson said the insurance industry must avoid capital becoming detached from risk, a mistake which he said caused the banking industry's "systemic problems" from 2007.
The widely discredited 'originate-to-distribute' banking model saw lenders offload to third parties billions of dollars of low grade loans through the sale of special bonds secured on mortgage repayments.
An increasingly popular insurance-linked financial instrument is the so-called "catastrophe bond", bonds which are sold by insurers and reinsurers to share the risk they take on for natural disasters and other events that can lead to costly payouts.
"Some of the structures being used could undermine some of the qualities of the insurance model, which provides a secure and reliable risk transfer market for specialist risk - and indeed the reliable 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 to the underlying transaction so that the risk is properly assessed, properly priced and properly supervised," he said.
(Reporting by Chris Vellacott; Editing by Greg Mahlich)