The financial crisis is set to force major consolidation in Canada's auto and property insurance sector as the two largest providers in the country consider the benefits of combining to create a dominant franchise.
ING Canada Inc., which was recently spun off by its cash-starved Dutch parent, is weighing a bid for the Canadian operations of Aviva PLC, the troubled British insurer, according to people familiar with the matter.
The bid preparations are still at a very early stage and could be called off, but are gathering pace as the credit crisis puts pressure on the British parent to raise capital.
"It would be a blockbuster deal for this market," said an industry analyst in Toronto.
ING Canada is hitting the acquisition trail after beginning life as an independent public company last month with excess capital and zero debt after its distressed Dutch parent sold its 70% stake to Canadian investors in a $2.2-billion deal.
The insurer is led by Charles Brindamour, a young and ambitious chief executive with a history of negotiating successful acquisitions, including the purchase of the Canadian arms of two European insurers -- Allianz and Zurich.
Buying Aviva Canada would be his biggest deal yet, and would create a group with a 20% market share.
The company is also sizing up other smaller targets, as it changes its name to Intact and continues to sell policies to consumers under the brands Belair Direct and Grey Power.
ING Canada is well positioned to make acquisitions after being spun off in a relatively pristine financial state, and is thought to have more than $400-million in surplus capital and the capacity to take on about $600-million of debt, giving it a war chest of about $1-billion.
A bid for Aviva Canada would likely require raising at least an extra $2-billion from shareholders to cover the Aviva unit's book value, which regulatory filings suggest could total more than $3.2-billion.
Analysts said ING is seen as the most likely driver of consolidation in a splintered sector that is feeling the pressure of higher funding costs and investment losses.
"It has a history of being an industry consolidator, its capital position is strong and it has a focus on lines of business where scale matters," said Dennis Westfall, an analyst at RBC Capital Markets.
"We believe the environment for acquisitions is ideal, given the highly fragmented nature of the Canadian property and casualty industry, weakened capital positions of foreign parents and recent declines in industry [return on equity] and valuations," the analyst said.
The extra $3-billion to $4-billion in cash a sale could raise for Aviva would come in handy for the U.K. parent, which saw its share price fall by a third in a single day on the London stock exchange last week after it reported a $20-billion loss for 2008.
The British group had $3.5-billion in surplus capital at the end of last year, though its reserve level is likely to have fallen sharply after a $1-billion dividend pay out and fresh investment losses.
This means that while the Canadian operation is a relatively small part of its international empire, a sale could dramatically improve the U.K. insurer's capital position at a time of extreme market volatility.
However, the Canadian unit is viewed by the parent as a stable asset that generates steady cash flows and has a sound management team led by a chief executive, Robin Spencer, who is highly thought of in the industry. This means the parent is likely to demand a healthy valuation for a unit with an estimated $3.2-billion in written policies on its books.
There was no indication the two sides were close together on price and it was unclear if an agreement could be reached.
People close to both companies did not view regulatory hurdles as a major obstacle because the vast majority of the market would still be split among co-operatives, foreign subsidiaries, and small operators.
There is likely to be considerable support for acquisitions among institutional investors who stepped up to buy shares in ING Canada from its Dutch parent last month partly because of management's track record of creating value through takeovers.
Analysts said the company has shown it can extract synergies through a streamlined process of integrating targets into a platform credited with more efficient pricing because of its scale.
This was a key reason institutional investors participated in last month's bought deal, which was led by CIBC World Markets.
ING Canada has also created space to take on slightly more risk by reducing its exposure to equity markets from 25% to 13% of its investment portfolio, which is now made up of about 50% of fixed-income securities, 20% preferred shares, and 12% cash.
According to the most recent filings Mr. Brindamour has a direct ownership of 31,975 ING shares -- worth about $1-million at current prices, and may have acquired more in last month's float.
This gives the young executive an incentive to grow the company through deals.