Some life insurance policies are starting to haunt the living. When I warned about "premium financed" life insurance policies in a column three years ago, I called it "not exactly a scam, but dangerous." Today, that warning seems mild.

More than $20 billion of these insurance policies were sold -- and now they're starting to implode. But many policyholders don't even realize the trouble they're facing.

It was called "Spin Life" -- and the concept seemed simple when policy sales were rampant several years ago. Some agents encouraged older people to take out huge life insurance policies on themselves, even though they didn't need the insurance and couldn't afford to pay the premiums.

The salesperson promised that investors would lend them the 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.

Why would any person willingly take out an insurance policy and then let a stranger become the owner of a policy on your life? It's a macabre idea -- and I said so at the time. But the answer is simple: MONEY!

Pre-death bonus

The senior citizen was tempted by an upfront "bonus" -- ranging 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 after two years to investors.

At first, those loans to pay the first two years' premiums were "non-recourse" -- so there was no risk to seniors. But by 2006, the insurance companies -- torn by the desire to sell more policies but worried about what was going on -- decided that the insured should guarantee at least 25 percent of the premium loan.

Sales agents convinced the seniors that there was no risk. Well-known names in financial services were raising money to buy these policies -- essentially a bet that they would continue to pay premiums for a few years, and then collect on death -- sooner rather than later.

Among the big names in this "premium financing" industry: LaSalle Bank (now Bank of America), Credit Suisse, and funds managed by Berkshire Hathaway and Goldman Sachs.

Death bet gone wrong

Then along came the credit crunch. The pools of investor money predicted to buy these policies dried up -- along with all other financial liquidity. When the two years expired, the insureds turned to their brokers to fulfill their promises to sell the policy and collect their bonus. But there was no money to complete this deal.

Suddenly, seniors were faced with paying premiums on insurance they didn't need and couldn't afford. It wasn't unusual for a senior to take out a $5-million policy (after being coached to say it was for estate tax purposes and they had no intent to sell). The premium on that policy could be $200,000 a year. Continued...