Updated from 9:40 a.m. ET with comments on non-bank SIFIs from Sterne Agee analyst John Nadel. NEW YORK ( TheStreet) -- Life insurance stocks are hot, and the party isn't over, according to Deutsche Bank analyst Yaron Kinar. The KBW Insurance Index closed at 188.26 Thursday, 49% this year. That's an amazing return, even in the midst of the bull market, when compared to a return of 21% for the Dow Jones Industrial Average
, a return of 26% for the S&P 500 ( SPX.X) and a return of 29% for the KBW Bank Index ( I:BKX). The stellar return for life insurance stocks reflects the importance of higher interest rates for the group, since the companies rely so much on interest income from investments. The benchmark rate on 10-year U.S. Treasury bonds was rising steadily heading into the September meeting of the Federal Open Market Committee, but many investors were surprised when the FOMC decided to allow the Federal Reserve's net monthly purchases of $85 billion in long-term bonds to continue. The next FOMC meeting is on Dec. 17-18. Based on comments by Federal Reserve vice chair Janet Yellen during her testimony before the Senate Banking Committee on Thursday and other recent comments by Fed officials indicating December data may be suspect because of the partial government shutdown in October, it seems unlikely that the Fed will begin tapering bond purchases following its next meeting. The market yield on the 10-year bond was 2.69%. That's up from 99 basis points from the end of April, but down from a closing peak of 2.98% on Sept. 5. Current valuations for life insurance stocks imply a yield for the 10-year bond of roughly 3.00% 12 months from now, according to Kinar. However, a decision by the FOMC to begin tapering the Fed's bond purchases in March 2014 "would likely mean that yields move into 3.5% territory or above, and expectations of further increases would rise," the analyst wrote in a note to clients Thursday. Kinar went further, writing that "if the Fed undergoes a normal hiking cycle, 10Y yields should currently be 3.65%." If that seems like a stretch, consider how quickly the yield on the 10-year rose, from 1.70% at the end of April, to its recent peak in September, heading into the expected March 2014 taper.
Among eight large-cap life insurers covered by Deutsche Bank, Kinar expects MetLife ( MET) "to offer the most upside," under his expected scenario for long-term interest rates, even though the shares have returned 60% this year. Shares of MetLife closed at $51.39 Thursday. The shares trade for 1.1 times their reported adjusted Sept. 30 book value of $47.99, and for 8.9 times the consensus 2014 earnings estimate of $5.75, among analysts polled by Thomson Reuters. The consensus 2015 EPS estimate is $6.16. MetLife's adjusted book value excludes accumulated and other comprehensive income (AOCI). Kinar on Thursday maintained his "buy" rating and raised his price target for MetLife to $59 from $57.00. His price target is based on an expected valuation of 1.15 times adjusted book value 12 months from now. MetLife is under review by the Financial Stability Oversight Council, which may designate the company as a "non-bank systemically important financial institution." That means the company could come under Federal Reserve oversight and be required to submit annual plans for capital deployment, as large banks subject to the regulator's stress tests are already doing. MetLife has been holding off on share repurchases, pending further clarity on its possible SIFI status. But Kinar continues "to expect $800 million in buybacks" during the second half of 2014. During her testimony on Thursday before the Senate Banking Committee, which is considering her nomination by President Obama to succeed Ben Bernanke as Federal Reserve chair, current Fed vice chair Janet Yellen said non-bank SIFIs shouldn't be regulated the same bay large bank holding companies are regulated. "Insurance certainly has some very unique features that make them very different from banks and we are taking the time to try to study what the best way is to craft regulations that would be appropriate for those organizations. There certainly are critical differences in terms of their business models that we want to understand and respond to." Sterne Agee analyst John Nadel in a client note on Friday wrote that "the momentum clearly is building toward the creation of a distinct framework for measuring risk for the insurance company SIFI's, as opposed to simply applying the bank framework. In our view, this is clearly a positive development that should begin to lift some of the overhang discounted in
American International Group ( AIG), Metlife and Prudential Financial ( PRU) shares relative to the rest of the peer group." Kinar on Thursday downgraded Prudential Financial to a "hold" rating from a "buy" rating, while keeping his price target for the shares at $96.00. Prudential's stock closed at $89.05 Thursday, returning 70% this year. The shares trade for 10.5 times the consensus 2014 EPS estimate of $9.18. The consensus 2015 EPS estimate is $9.97. Kinar indicated the downgrade was driven "purely by valuation." Kinar's price target "values the company at 1.5x 12-month forward BVPS (ex. AOCI and adjusted for f/x) and at 9.5x our above-consensus 2015E EPS," the analyst wrote. Shares of MetLife were up 0.7% in afternoon trading to $51.78, while AIG was up 0.5% to $49.54 and was down 1% to $88.18. -- Written by Philip van Doorn in Jupiter, Fla. >Contact by Email. Follow @PhilipvanDoorn