(Adds analysts comments, deal details, background)
By Maggie Lu Yueyang
SYDNEY Dec 16 (Reuters) - Insurance Australia Group Ltd (IAG) is set to become Australia's biggest insurer by market share after it agreed to buy the insurance underwriting businesses of Wesfarmers Ltd for A$1.85 billion ($1.66 billion).
The deal allows IAG, previously Australia's second-biggest insurer, to cement its No. 1 position and surpass QBE Insurance Group Ltd, which flagged a yearly loss last week due to its struggling North American businesses.
"IAG appears to have taken an attractive step because it cements its position in the Australian market both in totality and importantly within the commercial insurance business," said Toby Langley, an analyst of insurance and wealth management at Nomura.
IAG is acquiring Wesfarmers' commercial underwriting businesses under the Lumley and WFI brands, and a personal lines business through Coles Insurance with a 10-year distribution agreement with Coles, IAG and Wesfarmers said in statements on Monday.
"This is a unique opportunity which is expected to deliver significant long-term value for IAG shareholders and unlock further growth potential for our businesses in Australia and New Zealand," IAG managing director and chief executive Mike Wilkins said in the statement.
The deal will deliver modest earnings-per-share growth in the first full year, and at least five percent in the second year, excluding integration costs, IAG said.
"It looks like it has a sound industrial logic to bring these two businesses together. They appear to be quite complementary," Langley said, noting that IAG was previously dominated by personal insurance and the deal would help to balance out its commercial side.
David Spotswood, an insurance analyst at Shaw Stockbroking Ltd, said IAG had done a good deal without paying too much.
"They've paid about 1.15 times (Wesfarmers insurance) revenue, and currently IAG is trading at 1.25 times its revenue, they paid less than IAG is currently trading on," Spotswood said.
"It (the deal) leads to increased concentration in the industry, so that's positive for the companies operating in there. It provides a growth path for IAG," he added.
Media reported in late October that Zurich Insurance was in advanced talks to buy Wesfarmers' insurance business and had started due diligence.
Analysts said both QBE and Suncorp Group Ltd had also considered the business but pulled out.
Normura's Langley said he expected further consolidation in Australia's insurance sector, particularly in the more fragmented commercial insurance space.
"There remain a number of sub-scale players in the Australian market and, with players like IAG building even greater scale, they may come under further pressure in future," Langley said.
Wesfarmers, a coal-to-retail conglomerate, said that the sale was consistent with its focus on disciplined portfolio management.
The sale does not include Wesfarmers' insurance broking operations and its premium funding businesses, Wesfarmers added.
IAG said the acquisition would be funded from a combination of ordinary equity, subordinated debt and internal funds, which included a fully underwritten A$1.2 billion institutional placement at A$5.47 per share.
IAG shares were put on a trading halt on Monday morning, after closing at A$5.70 on Friday, while Wesfarmers rose 0.9 percent to A$41.66 by 0207 GMT against a 0.1 percent slip in the broader market.
($1 = 1.1166 Australian dollars) (Editing by Stephen Coates)