By Carolyn Cohn and Simon Jessop
LONDON (Reuters) - Aviva's potential 5.6 billion pound ($8.8 billion) purchase of Friends Life reflects a need to consolidate and cut costs in Britain's insurance industry, fund managers said.
The two companies said on Friday they had agreed terms of a possible all-share deal at a 15 percent premium to Friends Life's closing price, offering Friends Life shareholders a 26 percent stake in the new company.
The proposed transaction shows how insurers are having to rethink they way they do business after the British government changed rules covering annuities, which provide retirement income, causing a slide in annuity sales.
Some investors were surprised at the timing of the deal given both companies are in turnaround mode.
"Consolidation per se in UK life insurance is not a surprise and is necessary," said David Moss, head of European equities at F&C, which has Aviva shares, according to Thomson Reuters data. "The surprise is perhaps that both businesses are not where they would want to be yet and are in the middle of restructuring programs of their own."
Moss said the pricing did not look overly generous, but that the merger could provide benefits.
Max Anderl, fund manager at UBS Global Asset Management, said he had bought into Aviva after it cut its dividend several years ago, as he saw potential for the share price to grow as new management restructured the company.
"The restructuring story has played out very well under the experienced leadership of Mark Wilson. The plan seems to be to do it all again via a merger. Given there is little growth out there this seems a sensible strategy to me," he said.
Funds which invest in Friends Life for its dividend income may prefer higher dividend paying insurers like Phoenix, Chesnara or Catlin, Ed Shing, global equity portfolio manager at BCS Asset Management, said.
The merger has the backing of Clive Cowdery, who is the 15th largest shareholder in Friends Life, which he founded.
The deal aims to strengthen the balance sheet of Aviva, Britain's second largest listed insurer by market capitalization, as well as boosting assets under management and cutting costs.
Friends Life outsources most of its 100 billion pounds of assets under management, and while not all of that may come back in-house, it could add to Aviva's existing 230 billion pounds in AUM.
Aviva, which has general insurance as well as pensions and life products, expects to more than double its corporate pension book, due to Friends Life's strength there.
"We've been talking about meaningful consolidation in the UK life sector for years. This would be it," Edward Houghton, at Sanford Bernstein, said,
(1 US dollar = 0.6396 British pound)
(Editing by Jane Merriman)