THE life insurer Resolution had been wooing Friends Provident for almost a year with no result. Then, three months ago, Clive Cowdery, chairman of Resolution and the enfant terrible of the sector, received the call he had been waiting for from Sir Adrian Montague, the City grandee and chairman of Friends Provident.

Montague was ready to play ball and hammer out the terms for a merger to create an £8.3 billion insurance giant. The combative and controversial Cowdery must have rubbed his hands with glee.

Relations had not been cordial. Only months before, Philip Moore, Friends Provident’s chief executive, was understood to have been strongly opposed to any deal. At one stage last year, Moore’s predecessor, Keith Satchell, was said to be so incensed by the idea of the 175-year-old insurer merging with Resolution, an upstart acquisition machine, that he banned discussions with Cowdery and his banking advisers.

Friends Provident, however, had run into deep problems. In March, Moore was forced to admit that the insurer would struggle to achieve its ambitious plans, announced only five months earlier, to triple its profits from new business by 2008. Put simply, Britain’s fifth-biggest listed insurance group did not have the cash to fund its expansion.

One option was to raise capital – revealed as £500m last week – through the debt markets. The other was a deal with Resolution, whose collection of life funds that no longer write new policies is throwing off bucket loads of cash. The two sides acted fast, sealing an £8.3 billion nil-premium merger by the last week of July.

The marriage of Resolution’s financial strength and Friends’ new-business generation and strength in the pensions and the protection markets makes strategic sense.

But the deal has also created a battle-ground, pitching some high-profile individuals in the insurance industry against each other. Meanwhile, the merger is at risk of being gatecrashed, prompting suggestions that it could spark a wave of consolidation in Britain’s life-and-pensions market. Insurers have repaired their balance sheets, damaged by the 2000-3 bear market, and become increasingly confident about doing deals.

Intriguingly, Resolution finds itself both in the role of kingmaker and potential target of a rival bid. Over the past 12 months, Resolution has also been in on-off talks with both Standard Life and Prudential – until only a few weeks ago.

Resolution is thought to have come close to a deal with Standard in the first half of this year. However, with Standard’s share price riding high, the two sides were unable to agree terms. Since then the valuation gap has narrowed.

A tie-up would allow Standard to use Resolution’s cash to drive its fast-growing new business in life-insurance products such as self-invested personal pensions. Resolution, which has 7m customers, also has a strong position in the protection market through a tie-up with Abbey, the mortgages and savings bank. A deal would also help to manage Standard’s substantial existing business and cut costs.

Some bankers believe that Sandy Crom-bie, Standard’s chief executive, could view buying Resolution as too good a chance to miss. The big issue is whether Standard, valued at £6.9 billion, could get the backing of shareholders since any bid is likely to be partly funded by a rights issue.

Cowdery had attempted to convince Prudential to inject its British business into Resolution, but was rebuffed. Prudential’s boss, Mark Tucker, is trying to turn round the life insurer’s ailing UK operations and has so far ruled out a demerger or sale. Many believe a deal could yet happen.

One senior banker said: “Tucker wants to clean up the UK business before he does a deal. The Resolution-Friends merger means it would not happen so soon, but it’s just a question of timing.”

If Resolution has options, it also faces threats. Hugh Osmond, the former pizzas-and-pubs entrepreneur, has built a 16.5% stake and opposes the Friends merger. Osmond runs Pearl Group, another closed-fund consolidator, and has not ruled out making a cash bid for Resolution. That could be tricky given the turmoil in the debt markets, although Osmond is said to be confident he could secure financing.

Another option for Osmond could be to win over other shareholders to scupper the deal and pick off Resolution later. He could also offer to swap his stake for some of Resolution’s closed-life-fund assets. However, any suggestions of a sweetheart deal would anger Resolution’s other shareholders.

Osmond, who has an intense rivalry with Cowdery, has not clarified his intentions, but is likely to fight hard. “Make no mistake, this is a head-to-head game of high-stakes bluff,” said one industry executive.

A rival bid for Friends could also emerge. Analysts believe an offer would have to be more than 240p a share – well above Friends’ current 180Äp price. The French giant Axa and Switzerland’s Zurich Financial Services (ZFS) both lack scale in the UK and have been seen as possible bidders. Axa appeared to distance itself last week from a bid, though ZFS has remained silent. German giant Allianz and Italy’s Generali are watching the situation closely.

Sceptics argue that Friends has been vulnerable for years and that big insurers have had plenty of opportunity to pounce. “A premium offer is a bit like the abominable snowman – everyone talks about it, but where’s the evidence?” said one analyst.

Others argue that the merger is a special case. Bruno Paulson, analyst at Sanford Bernstein, said: “Resolution ran out of strategic road because there was nothing else for it to buy. Friends ran out of money and confidence. They were the two companies most likely to need a deal.”

One key issue is how the global and foreign players, including Aegon, will react if the merger goes through. These mid-tier UK players could face a tough choice of either finding their own British partners or quitting the market. That decision may depend on wider issues. “The real consolidation play is what the global groups do– an Axa deal with Zurich, for instance. Or whether the Americans come to the UK,” said one senior industry executive.

Many industry watchers believe that five dominant players will emerge in Britain in the next few years. Resolution and Friends may not by themselves transform this country’s insurance landscape, but the battle to seal or break the deal could be bloody. Whatever happens, the two are unlikely to remain independent.

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