The U.S. life insurance industry is undergoing a profound change, brought about by complex and unique market conditions and emerging regulatory requirements.

At the moment, life insurance carriers are spending a lot of time challenging the federal government, especially Washington’s efforts to coordinate and make uniform both U.S. and international regulatory standards.

But states are also intensifying their scrutiny of insurers. The hunt by states for the last dollar on unclaimed property is turning insurance home offices into war zones.

And an emerging issue is that state lawmakers are unofficially supporting life settlements as a means of reducing Medicaid expenditures by having elderly policyholders use the insurance to cover the cost of long-term care.

According to the Wall Street Journal, on June 14, Texas Gov. Rick Perry signed a law that allows state Medicaid officials to tell the program’s applicants that they can sell the life insurance policies they have been holding for some time to third parties to cover the cost of any custodial care. The law allows them to remain eligible for Medicaid when the proceeds are exhausted. The Wall Street Journal said that similar legislation is being considered in at least seven other states.

The fact that insurers are changing their product offerings in the annuity markets to reduce their risk profile is not good news for overall industry market share in the intense financial services marketplace.

For example, overall annuity sales dropped 6.7 percent in the first quarter of 2013 compared to a year ago, continuing a trend that has been underway for some time. Annuity sales are a key fee income generator and a product that insurers have worked incessantly to protect from encroachment by banks and mutual funds.

Exchange-traded funds, soaring demand for oil and gas partnerships and a large real estate investment trust market all constitute competition for insurers. In some cases, insurers are even turning away new money for existing products as they seek to reduce potential liability.

This is not good news. Consumers, rather than focusing on asset accumulation, are increasingly becoming interested in products that provide guaranteed income, according to Jay Wintrob, president of AIG Retirement Services, in comments to analysts at AIG’s most recent earnings conference call. The “vast majority” of variable and indexed annuities now include a guaranteed lifetime withdrawal benefit rider option, Wintrob said.

Guaranteed Investment Contracts (GICs), the default investment option for decades in both defined benefit and 401(k) plans, began to decline as a profitable product starting in 1989 as stock market performance improved. GICs suffered a fatal blow in the Pension Modernization Act of 2006, when Congress, in its wisdom, acted in such a way as to effectively shift this market segment to the mutual funds through target date funds. People who invested in these instruments got clobbered when the stock market collapsed during the Great Recession.

In retrospect, the fixed rates afforded through GICs would have provided a much better return for 401(k) beneficiaries during that period. Moreover, the gradual increase in the estate tax exemption from the $600,000 area in the mid-1990s through the permanent increase to $5 million, indexed for inflation, has had a severe impact on the middle market’s purchase of life insurance for estate planning purposes.

Indeed, law firms from the largest to the smallest are scaling back their trusts and estate practices as a result of the new rules. Furthermore, low interest rates have had a severe impact on the investments of insurance companies, and the transition to a more rational interest rate environment now underway is going to be a tricky one for insurers.

As for agents, selling annuity products is going to be a challenge as the products are likely to provide lower guaranteed returns as insurers modify them to reduce their risk profile. Agents are deeply concerned about the potential impact of a proposal by the Department of Labor, scheduled for release in the fall, that they fear will impose a fiduciary standard on the sale of retirement products that will make it too risky for them to stay in this market. The sale of long-term care products has been affected by the low interest rate environment and staying relevant in the healthcare market as the exchanges open for business starting in October — and insurers reduced commissions on these products — constitute more challenges.

The road ahead is going to be difficult for the life industry, no question about it

For more from Arthur D. Postal, see:

The state of the game.

The road to comprehensive tax reform

Turf wars