The proposed £5.6bn mega-merger of Aviva and Friends Life will result in thousands of job losses and rock the foundations of the UK pensions, protection and investment industries, experts are predicting.
Last week, the Aviva and Friends Life boards revealed detailed discussions on the biggest pension deal in years.
The Friends Life board has indicated it is willing to recommend a sale to shareholders subject to details being ironed out. The deal would create the largest insurance and savings business in the UK, with 16 million customers.
With key decisions on the future structure of the new insurance giant still to be taken and analysts predicting vicious rounds of cost cutting, Money Marketing looks at what the Aviva and Friends Life merger could mean for the market and advisers.
BNP Paribas says the Aviva and Friends Life tie-up will result in more than £100m worth of cost savings and could see Friends Life’s 3,872 staff savagely cut. The analyst expects 40 per cent of staff costs, or £80m, will be stripped out of the business.
At the end of 2013, one-third of staff were working in Friends UK life business, one-third internationally, 8 per cent supporting outsourced business and 25 per cent in the corporate centre and shared services.
BNP says there could be some savings in cutting Friends’ £50m annual IT bill and ongoing Solvency II costs.
As markets opened on Monday following the announcement, Friends Life shares jumped 6 per cent and Aviva plunged 5 per cent, giving the snap investor verdict.
Friends Life group is a mish-mash of different firms as takeover after takeover has combined brands. The group has customers from Sun Life, Friends Provident, F&C Management, Axa UK Life, Bupa, Resolution, NM Financial, UK Provident, Century Insurance and London & Manchester Group, among others.
Aviva is no less eclectic with customers from General Accident, Commercial Union, Norwich Union, Yorkshire, Northern, North British & Mercantile, Scottish Union and National.
Hargreaves Lansdown head of pensions research Tom McPhail says: “In the 1980s there were dozens of pension companies in the market. Aviva is like a Russian doll having taken over various companies. This type of consolidation has been going on for years.”
One of the stated aims of the proposed Aviva and Friends Life merger is to better cope with the regulatory and political turmoil engulfing private pensions.
Share prices at the UK’s biggest insurers have fared extraordinarily well in spite of the Budget shock on pension freedoms. Just before last week’s bombshell merger announcement, Aviva’s shares had risen more than 20 per cent in the last 12 months, while Friends Life’s value remained static.
Aviva says its corporate pension assets under administration would more than double as a result of the merger and create new opportunities by serving Friends Life’s £2bn of annual pension vestings.
Keefe, Bruyette and Woods equity analyst Greig Paterson says: “This is a business where scale is a key competitive advantage, as the industry has low gross margins and is experiencing a technology arms race, and the merged company will see assets more than double.
“It could have a number one market share, allowing it to take advantage of baby boomer and defined benefit to defined contribution trends.”
But other analysts are more sceptical and question whether such a dominant market position can be sustained.
BNP Paribas equity analyst Alan Hughes says: “Pensions administration quality has never been a strength at Aviva, hence many of Friends Life’s schemes may choose to change provider, as the combined group is unlikely to have as high administration standards, a positive for Standard Life.
“The combined market position in projection is also unlikely to be retained, which is positive for Legal & General.”
The administration burden to combine the firms will be monumental and some worry customer service will suffer at the hands of integration.
Richard Jacobs Pension and Trustee Services IFA Richard Jacobs says: “Aviva’s heritage book is horrific and in a right mess. Goodness knows why it would take on a load more heritage non-computerised life policies.
“Friends Life is not the world’s best administrator either and has lots of other companies’ old policies thrown together. If there is one company that is struggling with its old book it is Aviva, so why they want to take on more I have no idea. It can only be really bad for consumers.”
Year of change
If 2014 was the year of regulatory and political shocks, then 2015 is when the hard work begins.
Auto-enrolment is rolled out to small firms, workplace pension charges will be capped at 0.75 per cent in April and radical new Budget freedoms are due to be introduced.
Analysts say Friends Life is more exposed than most to the risk of lowering the charge cap when the Government reviews the level in 2017.
And now there is the prospect of massive integration and upheaval at two of the market’s biggest players as well.
McPhail says: “Companies like Aviva and Friends Life are dragging along behind them the baggage of legacy systems from other takeovers.
“There will be huge work to do in the backdrop of auto-enrolment, RDR, workplace price cap and pension freedoms. There was a huge amount of work to do anyway and now there is a merger to apply retrospectively to backbooks and other companies’ systems.”
Both Aviva and Friends Life also have a huge presence in the UK insurance and protection market, and the combined group could come to dominate the sector.
Keefe, Bruyette and Woods says protection is a “high margin, high barrier” business and the merger could leave Aviva and Friends well-placed to attack the UK market.
There could be integration issues, however, with the two providers currently targeting different sectors of the market. Moneyfacts data, compiled for Money Marketing, shows Friends Life protection deals are consistently more expensive.
The following example sets out the monthly premiums on the cheapest life assurance over 20 years for a sum assured of £100,000.
For a 35 year old smoker with a single-life policy, Aviva charges £12.20 a month while Friends Life charges £13.94.
For a 35 year old smoker with a joint life policy, Aviva charges £20 a month while Friends Life charges £22.48.
Friends Life is more expensive in both scenarios if the person is a non-smoker.
Highclere Financial Services partner Alan Lakey says: “How does Aviva deal with these two conflicting plans? Friends Life operates at the quality, top end of the market whereas Aviva tried to strike a balance because it has many banks and building societies using its plans. Aviva is more interested in cost than quality.
“It suggests the quality of Friends Life products might be watered down to keep the premiums at a reasonable level.”
Most of the fixed income assets are managed in-house by Friends Life, but a £12.2bn multi-asset and equity mandate and a further £2.3bn in fixed income continue to be managed by F&C Asset Management.
While an agreement was reached in March to transfer the £14.5bn to Schroders by the end of the year, it is unclear whether that cash would be re-routed to Aviva Investors if the acquisition goes ahead.
Schroders are the second largest shareholder in Friends Life, so voting in favour of the deal may mean losing a multi-billion-pound flow of assets.
Schroders, Aviva and Friends Life would not comment.
Tilney Bestinvest managing director Jason Hollands says: “What does this mean for Schroders, who had essentially won those mandates? It all depends on what contractual terms have been signed and agreed and whether that can be unpicked and the assets moved over.”
Combining the two insurers will create the scale necessary to cut costs, with particularly the large fixed income assets offering significant sums of cash without the need to take on more staff, Hollands adds.
Chelsea Financial Services managing director Darius McDermott says Friends Life funds should benefit from the greater capability of the larger Aviva Investors.
“If they end up as part of a larger group there’s a chance of a better outcome for investors.”
Friends Life, and its parent Resolution, has had more strategic twists and turns in its lifespan than Chubby Checker. First it was going to be a closed book consolidator, then it was going to do open funds, then international acquisitions, then it was split into ‘open co’ and ‘heritage co’, all amounting to a kind of hopscotch game from one strategy to another. Over the last few years it has been a case of “I’m a shareholder, get me out of here”.
Meanwhile Aviva’s strategy had been all over the place, with various international businesses which nobody really understood. It was a kind of Frankenstein’s monster of life offices, what with the CU, GA, Norwich Union, Provident Mutual etc. It has had a job of work to bolt all this together.
Unfortunately this means if the merger goes ahead between Aviva and Friends Life there will eventually be a lot of broken bones in terms of headcount reduction. It will also be a big job to carry out a further integration of all the back book business Aviva and Friends Life are each carrying.
The deal may well present opportunities in terms of capital and tax efficiency to somehow make the numbers stack up. But these strategic wins by restructuring only happen once.
Following Aviva’s rash of acquisitions, at one stage it had over 200 systems to run the life business. When doing deals like this, you can end up with significant amounts of management’s energy and time getting bogged down in the stodge of integration. You cannot just leave it to rot, but these systems are not a piece of cake.
These things are a pain to undertake. Let’s hope Aviva has the stomach for it.
Ned Cazalet is chief executive of Cazalet Consulting
Insurer share prices rocket despite Budget pensions turmoil
UK insurers have seen their share prices rocket in the last 12 months despite a tumultuous year of political change and huge drops in annuity sales.
In the past year, the nation’s biggest pension providers have left the stagnating FTSE 100 in their wake, rising by up to 20 per cent.
After the Budget bombshell on pensions flexibility, the share prices at UK insurers tumbled for those reliant on individual annuity sales.
But Aviva, Legal & General, Standard Life and Prudential have delivered huge double digit growth to shareholders.
On 22 November 2013, Aviva’s share price was 439p but had rocketed 22 per cent to 535p at the close of markets on 19 November 2014.
Using the same time period, L&G’s share price was 212p rising 16 per cent to 245p, Prudential shares rose 19 per cent from 1265p last year to 1505p and Standard Life is up 18 per cent from 350p to 414p.
Friends Life’s share price has remained static over the year despite good results and is down 3 per cent from 345p to 336p.
Scottish Widows, part of Lloyds Banking Group, and Aegon have also seen their share prices hold steady.
Equity analysts predict new sales on individual annuities will drop 50 per cent this year and another 50 per cent next year – 75 per cent in total.
But big insurers who are not reliant on new annuity business can still churn massive profits from their existing books.
The UK has annuity stocks of around £200bn but in 2013, before the Budget, there was only £13bn of new annuity business.
Any decline in new business will have a more gradual impact as profits fall away over decades rather than the next few years.
For example, up to 25 per cent of L&G profits come from UK annuities but only 1 or 2 per cent of that was delivered by new business.
Deutsche Bank equity analyst Oliver Steel says: “The pension changes have seriously changed the model for the at-retirement market. The more reliant on individual annuities, the more likely you are to be hit. But assuming you were an asset-gathering insurer then you are likely to have gained.”
Sanford C Bernstein equity analyst Edward Houghton says: “Firstly, has the death of annuities been exaggerated? When we move into higher interest rates will people be tempted to by annuities again? Maybe.
”Secondly, will these companies be able to diversify? There is a huge potential bulk annuity market which should continue to grow as rates rise and deficits reduce on DB pension liabilities. Just Retirement and Partnership are inevitably looking at bulk as an alternative way of driving profits.”