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New proposal values Direct Line at 275 pence per /share

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Direct Line rejected earlier 250 pence per share bid

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Aviva has until Dec. 25 to make a firm offer

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Combined company would be UK's biggest home, motor insurer

(Adds details, context throughout)

By Yadarisa Shabong and Tommy Reggiori Wilkes

LONDON, Dec 6 (Reuters) - British insurer Aviva

has agreed to buy smaller rival Direct Line in a

sweetened 3.61 billion pound ($4.60 billion) cash-and-stock deal

that will create the UK's largest home and motor insurer.

In a joint statement on Friday, the companies said a

preliminary agreement had been reached and that Direct Line

was set to recommend a takeover by Aviva if its bigger

rival makes a formal offer.

A deal would create a nearly 16.65 billion pound ($21.23

billion) London-listed insurer, bigger than Legal & General ( LGGNF )

and only slightly behind No.1 Prudential in

terms of market value.

The transaction would be Aviva CEO Amanda Blanc's biggest

acquisition to date as she tries to expand in core markets of

Britain, Canada and Ireland after selling a series of overseas

assets to simplify the business and revive its fortunes.

Direct Line also fits with Blanc's desire to grow in less

capital-intensive businesses like motor and home insurance.

Aviva in April completed a deal for AIG's UK life insurance

business and in March re-entered the historic Lloyd's insurance

market with a 242 million pound acquisition of insurance

platform Probitas.

"This (the Direct Line offer) represents a swift conclusion

... at a fair price, which we see as the best possible outcome,

as it avoids the need for Aviva to pursue a hostile bid,"

Jefferies analyst Philip Kett said in a note to clients.

The combined company would have a more than 20% share in

both home and motor insurance in the UK and be "significantly

larger" than its next biggest peer, JP Morgan analysts said,

although they added that they did not expect any competition

concerns from regulators.

The new proposal values Direct Line at 275 pence per share,

compared with a 250-pence cash and share bid that was rejected

last week triggering speculation among analysts about a bidding

war for the motor and home insurer.

Direct Line shareholders would get 129.7 pence in cash and

0.2867 new Aviva shares per Direct Line share, leaving them

owning about 12.5% of the combined company.

Shares in Direct Line hit a 2-1/2 year high on Friday and

were trading at 253 pence at 0903 GMT, up 7.2%. Aviva stock

dipped 0.3%.

LSEG's data shows that this would be the third-biggest deal

for a London-listed company this year after International

Paper's ( IP ) 5.8 billion pound takeover of DS Smith ( DITHF ) and Thoma Bravo's

deal for Darktrace.

Direct Line's shares soared more than 40% last week on news

of the takeover interest. It had previously rejected a

239-pence-per-share bid from Belgian rival Ageas in

June.

According to British takeover rules, Aviva has until Dec. 25

to make a firm offer or walk away.

Direct Line, under CEO Adam Winslow who joined the company

from Aviva in March, has made efforts to energise a business

hurt by an underperforming motor insurance arm.

"A potential combination of Aviva and Direct Line in UK

retail motor insurance and UK house insurance would

significantly increase market concentration in these key markets

and likely lead to more rational pricing," Berenberg analyst

Michael Huttner said.

($1 = 0.7844 pounds)