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Fed Move Will Boost Life Insurers in 2014

NEW YORK ( TheStreet) -- Even after an amazing runup this year, life insurance stocks are well positioned to move higher, as long-term interest rates rise and and valuation multiples expand, according to KBW analyst Jeffrey Schuman.

In a report titled "2014 Outlook: Don't Leave the Party Too Soon," Schuman wrote to clients on Sunday, "We remain overweight the life insurers, even after the group's extremely strong performance this year."

Insurance companies are very sensitive to interest rates because they rely heavily on income from conservative investment portfolios.  Investment income and industry earnings have been pressured for many years, because of the Federal Reserve's stimulus policies, which have kept rates at historically low levels.

But life insurers have outperformed this year, even for a bull market, in anticipation of a continued increase in long-term interest rates.

The Dow Jones U.S. Life Insurance Index has risen 57% this year, compared to a 24% increase for the S&P 500 (^GSPC)

The market yield on 10-year U.S. Treasury Bonds has risen to 2.85% fro 1.70% at the end of April, as investors have anticipated a tapering of the Fed's "QE3" purchases of long-term bonds, which have been running at a net pace of $85 billion a month since September 2012.

Most economists believe the Federal Open Market Committee following its two-day policy meeting will on Wednesday announce no change in Federal Reserve stimulus policy, but the economists do expect the tapering to begin by the March 2014 FOMC meeting.

MetLife (MET) in a presentation last week said it expected the yield on the 10-year bond to increase to 3.36% at the end of 2014 and 4.50% by the end of 2016.  Depending on the pace of the Fed's curtailment of bond purchases, MetLife might be quite conservative in thinking it will take that long for the yield on the 10-year bond to climb to 4.5%.

Schuman expects a very solid road ahead for life insurers, with median operating revenue growth of "about 3% in 2014 and 4% in 2015," with even better earnings-per-share growth, when factoring in share buybacks.

"We forecast median operating EPS growth of 7.3% in 2014 and 9.5% in 2015. In both years, expected EPS growth is driven primarily by top line growth and capital management. On average, we expect margins to make a small positive contribution, as mix shift, expense cuts, price increases, and positive equity market leverage more than offset headwinds from interest rates and currency," he wrote.

Two Life Insurance "Stocks to Own"

"We believe book value growth plus multiple expansion can produce another year of 20%+ median returns for the [life insurance] sector, Schuman wrote.

Here are KBW's two favorite life insurance stocks for 2014:

Prudential Financial (PRU - Get Report) has seen its stock return 69% this year through Friday's close at $88.19.  The shares trade for 1.5 times their reported Sept. 30 book value (excluding accumulated other comprehensive income) of $60.12, and for 9.6 times the consensus 2014 EPS estimate of $9.21, among analysts polled by Thomson Reuters.  The shares trade for 8.9 times the consensus 2015 EPS estimate of $9.95.

KBW's price target for the stock is $107, which is "consistent with PRU's 15% ROE," or return on equity, according to Schuman.  "We like PRU's diversified business portfolio, which includes a nice complement of higher return businesses, including the Japanese operations and asset management. PRU has proven an effective acquirer in the U.S. and internationally," he wrote.

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