Why would ING give away free money?

It never expected to pay the majority of the benefits it offered.

The 5 percent was added to the death benefit, which was held in a separate account known as a shadow account. The insurance company only paid the shadow account if the policyholder died and the money — the million dollars — in the real account had shrunk to a lesser value.

The companies' models of customer behavior, which were based on data collected before the 2008 financial collapse, predicted that the death benefit would rarely be paid. Something would happen. Policymakers would take the money out for a big purchase, surrendering their account. If the policyholder annuitized — started taking a stream of monthly payments — the shadow account disappeared. In any event, the rising market made it likely that the account would outperform the promises.

But the models turned out to be the insurance industry equivalent of the housing bubble. When the market crashed, consumers began acting differently than they had in the past.

Perhaps the gaudiest of the benefits the companies never expected to pay was known as the "rachet." The idea was perfect for a steadily rising market. Say you had $1 million in your account in 2007 and your investment did well, boosting the value to $1.2 million. That amount would be set on a given date as your death benefit which you would be paid no matter what had happened to your investment.

If stocks cratered, as they did in 2008, and your account fell to, say, $600,000? The insurance company would still owe you $1.2 million when you died.

ING offered a quarterly ratchet — it set every four months — and charged only about a quarter of a percent annual fee to customers who wanted it. Many companies, including Nationwide Life and Annuity Insurance Company and Transamerica Life Insurance Company, offered monthly ratchets.

To differentiate themselves, companies also sold exotic investment options into which the buyers of the annuity could invest their funds. ING featured funds managed by reputable companies like Pimco, Fidelity and T. Rowe Price. Each fund carried a fee that ING split with the fund manager. While ING provided aggressive growth and real estate funds, many annuity companies went beyond that to give consumers a choice of funds that used derivatives to bet for or against the market, sometimes with multipliers, so-called double betas. For example, if the stock market plunged, investors could double their money.

"Double betas were crazy funds," says Caramadre. "It hyper inflates the problem."

Caramadre's first step was to make sure his clients qualified for every incentive. If there was a monthly ratchet and bonus, he might invest the funds in a money market account until the ratchet set with the bonus.

It was as if Caramadre was playing with the house's money and going straight to the blackjack tables. With decent gains locked in, he would take flyers on the riskiest investments possible. Sometimes, he would invest his clients' money in two variable annuities, one that paid out if the market went up and the other if it declined. It didn't matter. When the annuitant died, Caramadre's client, at the very least, would get both principals back plus the gains from whichever fund paid out.

Caramadre kept increasing the number of annuitants and placing big bets.

"It was pretty fun being in the market without the risk," he says.

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