Insurance merger between Aviva and Friends Life divides the City

The £5.6bn tie-up looks likely to trigger a wave of consolidation, but experts are divided over the deal

When George Osborne stood up to deliver March’s Budget, few were prepared for the turmoil that was about to spread across the financial markets.

Billions of pounds were wiped off the value of life insurers within hours, after the Chancellor announced radical reforms to the UK pensions market. These handed retired workers more freedom with their money and meant that, from next April, they no longer have to buy an annuity when they finish work.

Unsurprisingly, annuity sales fell by almost a third during the first half of 2014 and are expected to tumble further. Companies like the newly listed Partnership Assurance and Just Retirement – which both specialise in selling annuities to people who are ill – are having to completely overhaul their operations in order to survive.

Experts are now predicting a wave of sector consolidation led by Aviva and Friends Life, who agreed terms on Tuesday for a £5.6bn merger that will create a company worth more than £20bn with 16 million customers, if the deal is backed by shareholders.

“Insurers had not been planning for the annuities reform announced in the Budget,” said Jason Whyte, a partner at EY. “Reforms of this scale will always be a catalyst for significant change, but the suddenness of the Chancellor’s announcement means it has taken time for insurers to work through the implications and deal with the most immediate challenges. It is only now that we are starting to see the industry make moves to respond strategically. In 2015 we expect to see much more activity in this space as industry players continue to re-evaluate their market positions under the new rules.”

The deal leaked last month and Aviva and Friends were yesterday finally able to make the case for the tie-up, which Aviva’s boss, Mark Wilson, said would lead to £225m in annual cost savings by 2017 – after £350m of one-off costs – and £600m in extra cash, to be used to pay higher dividends.

“It is one of those rare transactions where the two organisations fit with surgical precision, building on each other’s strengths and addressing the challenges,” said Mr Wilson, who ran AIA during Prudential’s aborted bid for the company.

“It will increase our cash flows and reduce our leverage and support continued growth in our dividend. It secures our leadership position in our home market and gives greater flexibility to drive growth in other parts of the Aviva group.”

Analysts have so far been divided about the deal. Shore Capital’s Eamonn Flanagan warned: “We remain puzzled why Aviva felt the need to do it now. Is it a camouflage for issues within its own internal restructuring and turnaround story?”

Experts at Credit Suisse were more positive: “We believe the deal would strengthen Aviva’s UK life and savings business. It would deliver increased scale in protection with a broadened distribution footprint, providing a high-quality corporate benefits business, and the large, mature savings business would be an important source of new business for Aviva’s post-retirement offering.”

But it will be investors who decide the fate of the deal, and those contacted by The Independent indicated they would back Mr Wilson, who has impressed since becoming Aviva’s chief executive at the start of last year. Not only have shares risen by 35 per cent since then, but he has restored confidence in a company that had appeared rudderless and disjointed in recent years.

If the deal is completed Mr Wilson and his finance director, Tom Stoddard, together with Sir Adrian Montague, Aviva’s incoming chairman, will all keep their jobs. Friends’ boss, Andy Briggs, will join Aviva’s board and run its UK Life business, while its chairman, Sir Malcolm Williamson, will become senior independent director.

As well as strengthening its team, the deal would prove transformative for Aviva’s fund management arm, Aviva Investors, which has underperformed compared with peers like Legal & General Investment Management and Standard Life. Aviva said the combined business would boost assets in its fund management arm, Aviva Investors, by about £70bn to £309bn at a time when more savers than ever are likely to use its savings products instead of buying an annuity.

However, one downside of the deal is that it is likely to lead to job cuts: Aviva employs 12,000 workers in the UK and Friends Life a further 3,500.

Mr Wilson and his team will now embark on a tour of key investors to sell the deal. Even though some have doubts about its merits, few seem to bet against him pulling this off successfully. Having watched at close quarters as Prudential botched its takeover of AIA in 2010, Mr Wilson will be determined not to suffer a similar fate.

The follow-on: Merger targets

Friends Life was created by entrepreneur Clive Cowdery, who merged Friends Provident with parts of Axa and Bupa in 2010.

Its proposed tie-up with Aviva is expected to lead the way for further consolidation in the industry and experts have named Partnership and Just Retirement as potential targets. Others single out Phoenix, which almost merged with a unit of Swiss Re earlier this year.

Chris White, head of UK Equities at Premier Asset Management, pointed out that Phoenix, a fellow closed-book life assurer, “still trades on a 30 per cent discount to embedded value and has a 7 per cent dividend yield. This looks highly attractive given that the deal values Friends Life at a small premium to embedded value.”