Debt issue of about £500m planned to free up equity capital ahead of next year’s IPO

RBSI chief executive Paul Geddes is refusing to let the business be derailed by speculation over a £4bn private equity bid, insisting that the bank-owned insurer remains on course for a preferred flotation next year.

In an interview with Insurance Times, Geddes said he had no idea where talk of a £4bn CVC bid came from, but admitted there will probably be more speculation.

“We think the right planning assumption is an IPO [initial public offering]. We think it’s the most likely but not the only option. What we can’t afford to do is be distracted by every rumour. We’ve got a lot to deliver and we know what we’re doing and we’re cracking on and doing it,” he said.

RBSI is making tangible progress in separating itself from its parent group. It has signed a cheque that commits it to building its own human resources system, and is developing an independent investment and treasury function.

The insurer has also hired ex-Brit investor relations head Neil Manser to run investor relations.

RBSI is focusing on return on equity (ROE) as its main performance measure. The company achieved a 10% ROE for the first nine months of 2011, and an 11% return for the third quarter alone. This compares with negative ROEs of 8.6% and 3%, respectively, for the corresponding 2010 periods.

While encouraged by the improved results, Geddes is not satisfied with the current ROE levels. “The return on equity needs to go up from being just into the double digits to being more firmly into the double digits,” he said. “Clearly, from the 11% today we want to get some more.”

At its first presentation to equity analysts last month, RBSI said a sensible return on equity for the company as a standalone business would be in the mid-teens.

In its full-year 2010 results, RBS estimated the insurer would be making an ROE of more than 20% by 2013. Geddes said the group would refresh its ROE targets in the spring.

As well as expanding its ROE by improving operating performance through re-underwriting, pricing and improvements to the claims function, RBSI is aiming to give its returns an additional boost by issuing subordinated debt ahead of the IPO it is planning for the second half of next year.

RBSI finance director John Reizenstein said the issue would be about £500m. Because subordinated debt qualifies as solvency capital, the issue would allow RBSI, which currently has no debt, to free up some of its equity capital. This would be paid to RBS in the form of a dividend.

In turn, the reduction in equity would boost the ROE number by as much as three percentage points, the company estimates.
As part of the plan to issue debt, RBSI is seeking a credit rating from one of the main rating agencies, and as a first step is looking to obtain an insurance financial strength rating.

RBSI has turned itself around, making a profit of £329m in the first nine months of 2011, compared with a £286m loss in the same period last year.

The company has been consistently profitable in 2011, after 2010’s £295m total loss.

But Reizenstein admits the company could struggle to maintain investment return levels in the short term amid low UK interest rates.

RBSI’s investment income was £205m in the first nine months of 2011, up from £200m in the same period last year.

But Reizenstein says: “We have been fortunate so far. Yields in the UK are falling a lot and you get hit when you reinvest. We haven’t had to reinvest that much in the past few months. It is challenging to maintain that number.

“We’re not immune from the issues everyone else is facing, we have just been shielded from them so far.”

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