Deutsche Bank's Abbey Life sale faces delay over regulatory inquiry - sources

* UK watchdog investigation could lead to fines,compensation

* Swiss Re, Phoenix, Legal & General performing duediligence

* Deutsche Bank could take on risk of any compensationpayment

By Pamela Barbaglia, Carolyn Cohn and Arno Schuetze

LONDON/FRANKFURT, June 03 (Reuters) - Deutsche Bank's sale of its British insurer Abbey Life Assurance Cois facing delays as bidders struggle to decide on a valuationdue to an investigation by Britain's financial watchdog into thefirm, sources familiar with the matter said.

They said Swiss Re unit Admin Re, Phoenix and Legal & General have made it to the final stages ofan auction which kicked off at the beginning of the year.

The German lender started weighing the sale of its Britishinsurance unit in October, attracting interest from a series ofrival insurers including China's Anbang Insurance Group.

But in March the Financial Conduct Authority (FCA) launchedan investigation into Abbey Life's treatment of long-time lifeinsurance customers which could result in compensation paymentsto policyholders or fines to the British insurer.

"This is a large risk," one of the sources said. "It's toobig to solve it just by offering a discount. Unless this probeis out of the way the sale won't go ahead."

Deutsche Bank, Swiss Re, Phoenix and L&G declined comment.

Abbey Life is valued at around 1 billion pounds ($1.5billion), the sources said. It has made no comment on the FCAinquiry.

Swiss Re, Phoenix and L&G recently got access to thecompany's books but are looking to hedge themselves against therisk the British watchdog could impose a fine or compensation,causing a delay to the process, the sources said.

The inquiry, which targets five other British insurers, istrying to establish whether insurers have treated customerslocked into pension and other savings plans fairly compared withnew customers.

Abbey Life, along with Old Mutual, is also subject to afurther investigation on whether it contravened other regulatoryrequirements related to the treatment of long-standingcustomers, the FCA said in March. Old Mutual has said it iscooperating with the review.

VALUATION RISK

Stricter European capital rules for insurers which came intoforce this year have encouraged financial services firms tooffload insurance businesses.

Deutsche Bank, which bought Abbey Life from Lloyds TSB for 977 million pounds in 2007, is now keen to find anew owner for the business as part of its restructuring efforts.

Swiss Re, Phoenix and L&G have consistently showed interestin buying closed books of life assurance business in Britainwith the Swiss firm securing control of Guardian FinancialServices in a 1.6 billion pound deal in September.

The three insurers are now expected to ask Deutsche Bank totake on the risk of any compensation payments that the FCA wouldimpose on Abbey Life while negotiating on price, the sourcessaid.

One of the sources said the process was still far from thefinishing line as the bidders have several weeks of duediligence ahead and need to factor in the possible consequencesof the regulatory inquiry.

Phoenix and L&G have been busy with other deals in recentweeks, potentially adding to any delay, two of the sources said.

On May 27 Phoenix bought French insurer AXA's UKlife business for 375 million pounds, while on May 23, L&Gbought from Dutch insurer Aegon a 3 billion pound bookof annuities, which pay pensioners a fixed income for life, foran undisclosed sum. ($1 = 0.6878 pounds) (Editing by Rachel Armstrong/Mark Heinrich)