LONDON (ShareCast) - FTSE 250 insurer Direct Line has agreed to sell its life insurance arm to closed book specialist Chesnara and return the profit to shareholders.

The pair have agreed a £62m fee for Direct Line Life Insurance (DLL), with Chesnara paying £39.3m cash that parent Direct Line said it expected to result in a £12m gain.

The insurer, which has recently looked to cut costs with more than 1,000 planned job losses, said that it was appropriate to return the gain to shareholders as the proceeds of the sale would represent inorganic capital generation.

The deal, which includes a pre-closing dividend of £23m and represents 85% of the embedded value of DLL, is conditional on approval of regulators and Chesnara shareholders that is expected within two months' time.

Direct Line said it would then declare a special dividend of 4p per share.

The company added separately that it was testing the water with new life assurance products and was currently testing a distribution-only 'white-label' pilot for term assurance.

Former owner RBS recently sold down its stake in Direct Line to 28.5% after floating the company in October 2012.

Chesnara said DLL would be acquired at an effective 74.7% of its estimate of the residual embedded value of £52.6m once a capital extraction of £23m had been completed by Direct Line immediately at completion.

The capital extraction would mean Chesnara will acquire the business with a lower solvency margin than its long term target of 150%, and the FTSE Small Cap company said it will therefore immediately on completion inject around £10.4m of new capital.

"This increased funding requirement is temporary and is expected to be released by way of a Part VII transfer of Direct Line Life into Chesnara's existing UK life book, Countrywide Assured Plc, by the end of 2014," it explained.

Analyst Barry Cornes at broker Panmure Gordon said the deal appeared to be an "excellent acquisition" for Chesnara.

"It is not a large transaction and in our view will not hamper the search for other suitable transactions. It does however tick all the boxes that investors like to see – a UK company, closed to new business, enhancing of the dividend policy in the medium term, and acquired at a healthy 25.3% discount to enterprise value."

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