The takeover, which marks a further stage in the rationalisation of the UK insurance industry, would also substantially raise the profile of Friends Provident within the sector. The company currently has pounds 24bn under management and is presently ranked 11th among all insurance companies in the UK, publicly-owned or mutual.
One insurance analyst, who would not be named, said yesterday: "If this were to be true, it would raise the question of whether Friends is preparing for a flotation. But this is hard one to call."
A Friends Provident spokesman yesterday said: "Our policy is that we are not prepared to comment on market or City speculation."
However, he added: "It certainly is our publicly-stated position, one that we have consistently stated, that we intend to remain mutual because of the benefits to our policyholders."
Earlier this year, London & Manchester was handed a record pounds 525,000 fine by the Personal Investment Authority, the financial services regulator, for failing to take adequate steps to offer compensation to almost 6,000 within permissible time limits. The Exeter-based company said at the time it was "disappointed at the disproportionate fine".
The deal, which values L&M's shares at about pounds 6, would signal a further contraction in the door-to-door insurance sales market, following the merger of United Friendly and Refuge Group in 1996. The company was last year tipped to join forces with Britannic, another home service insurer. Shares in L&M closed last night at 508p.
In addition to its home service side, which employs some 700 salespeople, the company also operates an 80-strong estate agency chain in the south of England. It recently restructured its activities, creating 18 regional centres and also has a network of tied agents, who sell only its own pension and insurance products. The company is particularly strong in the group pensions market area.
Friends Provident, has itself been regularly tipped as a takeover target, most recently of Prudential, the UK's largest insurer. It was also said to be in the sights of Sun Alliance, the insurer which decided two years ago to merge with Royal Life instead.
But it has strongly resisted hostile approaches. It has preferred instead to concentrate on building Eureco, a loose alliance of five European mutual insurers, sharing similar aims. Some observers have suggested a merger between Friends Provident and at least one of these overseas mutuals.
It has carved out a strong niche in the fast-growing ethical investment market, where its pounds 1bn Stewardship fund makes up almost half the total UK sector.
In 1997, the mutual life insurer, recorded a sharp growth in new business figures, with total premium income growing by 28 per cent to pounds 958m.