Fairfax Financial chief executive Prem Watsa said the acquisition would provide the company with an immediate presence in a market where it had limited exposure.
"The key factors in Fairfax's ability to present an attractive proposal to Tower were the speed at which the transaction could be conducted, the reputation of Fairfax for closing transactions and treating stakeholders fairly," Watsa said.
The deal is subject to approval by the Reserve Bank, the Overseas Investment Office, Pacific Islands regulatory authorities, and Tower shareholders.
Tower will call a special meeting, scheduled for April, to obtain shareholder approval.
Approval must be by at least 75 per cent of votes cast, representing more than 50 per cent of the total voting rights of the company.
The Tower board said the deal would not affect Tower insurance policies or the rights of policy holders.
The insurer's shares jumped 41 per cent to $1.11 on the news.
Massey University senior lecturer in finance and insurance Michael Naylor said Tower had been facing difficulties for some time now, with the share price dropping drastically for several years.
Tower had ongoing disputes with re-insurer Peak Re, as well as the government's natural disaster insurer EQC, he said.
Another large earthquake would likely bankrupt the company, Naylor said.
"So they had to do something. It would be hard to raise enough funds via a rights issue so a sale is the most obvious way out."
The deal should be good for New Zealand's quake claimants as it provided a deep-pocketed owner who would want to get all the claims off the books as fast as possible.
It was sad that another New Zealand firm would be lost but given the country's earthquake risk, Naylor questioned whether a "small-country" firm such as Tower were still viable.
"It's better for customers than a sale to the two major Aussie firms," he said.
Shareholders Association chairman John Hawkins said the deal was concerning but not a huge surprise.
"Tower has sold off a lot of its divisions and it's probably marginal now whether it's large enough to be a standalone company, so it does make it perhaps an attractive target for as an add-on for another organisation looking to increase its insurance business and it was probably inevitable that somebody was going to be looking at it," Hawkins said.
"It is an issue for the NZX that another company is subject to a takeover. We are losing companies faster than we are gaining them on the stock exchange and that is a concern for the future," he said.
Tower had ongoing problems resulting from the escalating costs of Christchurch earthquake claims, and also significant problems with its IT systems.
"And, of course, the company's results of late have not been great. There's been a steady decline in the share price, they suspended their dividend at their last annual results presentation. So it's been a bit of a perfect storm and this was seen as a good opportunity for someone to get in and make an offer."
Insurance Council chief executive Tim Grafton said the deal could be good news for consumers.
"I think what we're seeing is something that would be business as usual for consumers with the possibility of stronger capital support and the potential for fresh innovation coming into the market. So I think that clearly signals benefits," he said.
