Takeover talk is rife as insurers draw up plans for extra cash

Aug 15 2007 by Russell Lynch, Liverpool Daily Post

THE takeover spotlight has fallen on insurance firms this week as investors scan updates from a host of major players for clues over consolidation prospects in the sector.

The latest round of speculation has been sparked by life and pensions firm Friends Provident’s £8.6bn plans to merge with Resolution, the UK’s biggest holder of closed life "zombie" funds.

It also comes as companies report broadly positive first-half results, despite the recent flooding chaos hitting profits in general insurance.

The proposed merger reawakens takeover talk after a quieter period of M&A activity in the sector since Norwich Union owner Aviva failed to pull off a £17bn bid for Prudential last year.

But all this could be about to change.

No sooner had the Friends- Resolution deal been announced than a host of rivals – including entrepreneur and Pearl Assurance owner Hugh Osmond, Standard Life, Zurich and private equity firm JC Flowers were rumoured to be plotting a potential move to break up the deal.

Differing reasons have been cited for the renewal of consolidation hopes among insurance firms. One is the forthcoming introduction of new European regulations, known as Solvency II, which are likely to reduce the amount of capital insurers will need to retain in relation to the risks they underwrite.

Some predict that insurance firms could go on the acquisition trail with the extra cash at their disposal, although others say that Solvency II has a limited bearing on the current excitement over the sector as the new rules will not come into force until 2012. They have a simpler explanation – the shares are too cheap.

A glance at the charts seems to add weight to this view, showing the life insurance sector under-performing the FTSE All-Share by 6% this year.

Panmure Gordon analyst Barrie Cornes said: "Generally speaking consolidation in the sector is desirable and inevitable, and not a real surprise. Aviva and Prudential probably stand apart but lower down the scale you could not rule anything out – they are all in the melting pot."

Mr Cornes added: "The shares have completely fallen out of bed since the start of the year, and have been particularly cheap in the last month.

"Equity markets have been selling financials (stocks) on perceived sub-prime exposure, but the size of the fall has been completely unwarranted."

Another cited reason for the under-performance of the sector are concerns over the increased reserves that firms with large annuities businesses – the likes of Prudential, Aviva and Legal & General – might have to store up because people are living longer.

But in a cheap-looking field, experts believe that Friends Provident appears vulnerable to a bid if Pearl, a 16% shareholder in Resolution, breaks up the merger.

Friends was keen to talk up the strength of its individual business this week – saying pointedly that it was a "strong standalone business with excellent prospects".

The slightly defensive comments came after a 7% increase in pre-tax profits to £264m, amid a growing belief among company watchers that the deal may not go ahead.

One unnamed analyst said: "People who liked Friends liked the steady growth they were getting out of it, and those who liked Resolution were happy with the strong cashflow.

"It may be they get both under this deal, or possibly neither."

As speculation over the potential spin-off of Prudential’s traditionally under-performing UK business subsides following hints of recovery at home, Legal & General is another seen as a potential takeover target, as well as general insurer Royal & Sun Alliance.

L&G cheered investors with a £1bn share buyback at the end of July as the firm unveiled a 5% increase in pre-tax operating profits to £589m, although flood claims cost £40m.

Collins Stewart analyst Tim Young said of the company: "Operationally, it is one of the most efficient companies in the UK, it has got its back office in order and it uses capital more efficiently than anybody else in the UK. It has also built a fantastic stand-alone investment management business."

Of R&SA, he added: "It’s a great company but there is no industrial logic to a business based in the UK, Canada and Scandinavia.

"It would be the perfect entry to the UK non-life market."

The More Than insurer has said it expects losses of around £120m from the floods chaos in June and July. But despite the extreme weather, R&SA posted better than expected pre-tax profits of £237m for the first half of the year.

Five players in the non-life sector, including R&SA, have estimated flood losses at around £1bn so far, although according to the Association of British Insurers, there will be around 50,000 claims from the weather conditions costing the industry more than £2.5bn.

Aviva courted unpopularity after it announced it was raising its premiums by an average of 10%, partly as a result of the flooding, and other insurers are expected to follow suit.

But while the business saw overall group profits dip 8% the Norwich Union owner still made £1.54bn in the first half – fractionally below forecasts but creditable in the circumstances.

Charles Stanley analyst Nic Clarke said: "Apart from the exceptional losses from the UK general insurance division, the rest of the business appears to be performing reasonably well with strong sales growth in most regions."

Meanwhile, among the life and pensions firms, the sales impetus given by last year’s A-Day pension reforms is still lingering.

While some investors have expressed concerns about over-reliance on single products – such as the heavy growth in self-invested personal pensions (SIPPs) driving Standard Life’s new business sales – companies are still benefiting from the reforms.

Friends said the changes were "still helpful" in the pensions market, while Prudential said sales of advanced voluntary contribution (AVCs) pension top-ups "continued to flourish" following the overhaul of retirement savings legislation in April 2006.

Mr Cornes added: "There were concerns that A-Day might run out of steam, but if you look at the figures for second quarter of this year, there has not been as big a tailing off as we thought."

Underlying the vagaries of a British climate behind the worst floods in living memory, there are healthy signs for the insurance sector in its profits performance and continued life and pensions growth not currently reflected in share prices. And while markets under-rate the value in the sector, the recent consolidation moves look set to gather pace.