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Life Insurance Exchange Option

10/23/23

The Exchange option on term life insurance policies is one of the newer options available in Canada today.

The exchange option lets you trade your existing term life insurance policy for a new, longer term policy. You can consider this as ‘resetting’ your term to a new policy. The reset is done at premiums based on your age when you do the exchange (so they’ll be higher, because you’re older). However the exchange is also done without any medical requirements, there’s only a few documents to sign in order for this to happen.

i.e. you purchase a term 10 policy at age 40 and maintain it for 2 years. At age 42, you take advantage of the exchange option and switch your 2 year old term 10, for a brand new 20 year term policy which will provide coverage from age 42-62. Premiums on the new term 20 policy will be based on a 42 year old. 

Budget reasons

The first reason this option is useful is to overcome temporary budget constraints. If you would like to have a term 20 or term 30 life insurance policy but your budget suggests a lower premium, then you can use the exchange option to sidestep the problem. You could purchase a term 10 policy (at lower premiums, now within your budget). Eventually your budget frees up, and you use the exchange option to switch to a term 20 or term 30, no medical exam required. 

The tradeoff here is that your new term 20 or term 30 will be at slightly higher premiums than if you’d purchased it originally, because your new policy is at an older age. But, in the meantime you’ve selected the right amount of life insurance coverage and enjoyed lower, more affordable premiums in the interim.

Smoking

If you’re seeking a term 20 or term 30 life insurance policy, as a smoker your premiums will be higher than a nonsmoker. If you’re planning on quitting smoking in the next couple of years, then you can use the exchange option to your advantage.

What you could do is purchase a term 20 or term 30 at higher smoker premiums. Then when you quit smoking for a year, re-qualify down to nonsmoker premiums – leaving you ultimately with a nonsmoking term20 or term 30; but having paid term 20 or term 30 smoking premiums until then.

An alternative would be to instead purchase a term 10 policy at smoking premiums. Those premiums will be substantially lower than term 20 or term 30 smoking premiums. Once you quit smoking re-qualify your term 10 policy to nonsmoking premiums. Then at the same time, use the exchange option to switch to a term 20 or term 30 policy, now at nonsmoking premiums. In this case you end up with a nonsmoking term 20 or term 30, but in the interim you’ve paid the much cheaper term 10 smoking premiums.

Ratings

If you’ve received a temporary rating, or a rating that you can request reconsideration for (i.e. weight, and you expect to lose the weight), then you can use the same strategy outlined in the smoking section above. Purchase a shorter term 10 policy with the rating, eventually get the rating removed, then use the exchange option to jump to the term 20 or term 30 policy without the rating. 

Term Stacking

Term Stacking is an advanced strategy developed by The Term Guy that takes advantage of the exchange option and some idiosyncrasies in pricing structure of some term policies in Canada. It can save you money on your term 20 and term 30 policies, and extend your term policies out another year or two. For full details, see our article on term stacking.LINK TO TERMSTACKING ARTICLE.

Constraints

There are a few things you should be aware of with the exchange option. First, not all companies offer this, so if you’re considering it you should ensure that the policy you select has this option. 

Companies have various ‘start’ and ‘end’ time frames where the exchange option is available. Most companies offer the exchange option in years 1-5 of your term policy. So you’d need to have the policy in force at least one year before being able to take advantage of it, and the option would no longer be available after 5 years. Other companies offer the exchange option past 5 years, a few companies offer it starting at time 0 so you don’t have to wait a full year to take advantage of it.

Typically the exchange option is not guaranteed in the contract, it’s considered ‘administrative only’. That means that the companies offer it, but don’t guarantee that they’ll continue to offer it in the future. We assess the risk of the exchange option becoming unavailable, as low risk in the short term, but would not recommend that you depend on it being available over the long term.

The last risk to consider, is that premiums on your new policy when you do the exchange are based on your age at that time – and the premiums for that policy type at that time. In other words, if term life insurance premiums suddenly skyrocketed in the next year then when you did the exchange option your new policy would be faced with those higher premiums. Again, we consider the risk of this happening to be very low in the short term.