Some life insurance policies are starting to haunt the living. Three years ago, I said "premium financed" policies were "not exactly a scam, but dangerous." Today that warning seems like an understatement.
More than $20 billion of these so-called "spin life" insurance policies have been sold and now they're starting to implode. Many policy holders don't realize the trouble they face.
The concept seemed straightforward when sales were rampant several years ago. Agents promised clients that investors would lend them money to pay the premiums for the first two years, until the policy was past the "contestability period." Then the policy would be sold to an investor, who would continue to pay the premiums, hoping to collect on this "bet" on the senior's longevity.
Agents were encouraging elderly people to buy huge life insurance policies on themselves, even though they didn't need the insurance, and couldn't afford the premiums.
Why would any person let a stranger become the owner of a policy on his life? The answer is simple: money.
Pre-death bonus: Seniors were tempted by upfront "bonuses" that ranged from thousands of dollars to expensive cruises just for letting the investor bet against the insurance industry's mortality tables, and eventually collect the policy proceeds. And they were promised more money when the policy was sold.
At first, there was no risk to seniors. The loans to pay the premiums were "non-recourse." However, three years ago, insurance companies decided that customers needed to guarantee at least 25% of the premium. The insurers potentially sensed problems brewing, but still wanted to sell policies.
Sales agents collected fat commissions by convincing seniors there was no risk. Household names in financial services were raising money to buy these policies, betting they would pay premiums for a few years and then collect on death. Among them were LaSalle Bank (now part of Bank of America (Stock Quote: BAC)), Credit Suisse Group (Stock Quote: CS) and funds managed by Berkshire Hathaway (Stock Quote: BRK.A) and Goldman Sachs (Stock Quote: GS).
Death bet gone wrong: Then came the credit crunch. Demand for the policies dropped as investors struggled to borrow. When the two-year premium period expired, the insured expected brokers to sell the policies, allowing them to collect their bonuses. But there was no money to complete deals.