Return-on-equity expectations for 2013 lowered from 20% to mid-teens

Expectations about the post-flotation performance of Royal Bank of Scotland Insurance (RBSI) have been lowered after highly ambitious financial targets were scrapped.

RBS Group’s annual report set a target of more than a 20% return on equity (ROE) for RBSI, the owner of Direct Line, Churchill and Privilege.

The target was privately met with disbelief from investors and analysts, as the usual industry standard measure is around 15%.

But in its first presentation to banking and insurance analysts ahead of its planned initial public offering (IPO) in the second half of 2012, RBSI chief financial officer John Reizenstein said that a sensible ROE figure for the business would be in the mid-teens.

Parent group The Royal Bank of Scotland’s cost of capital is 12%, which indicates that the insurer needs to make an ROE of at least that amount for it to make a return.

Back to business: RBSI’s return on equity

Analysts previously complained about a lack of information on RBSI’s financial performance, but by setting realistic ROE targets, it appears the insurer is bringing itself in line with City expectations.

Collins Stewart analyst Ben Cohen said that no indication had been given at the presentation that the company would make a 20% ROE by 2013. “I don’t think that would be a realistic target,” he said.

RBSI posted a negative ROE of 8% in the full year of 2010 and a positive ROE of 9.5% in the first half of 2011.

The company also confirmed that RBSI would not be disposed of in one go. RBS group investor relations head Richard O’Connor said that under current plans a minority of the business would be floated, with a secondary offering the following year.

When asked if the company would be given more time to float if market conditions were not conducive, O’Connor said there were fall-back plans but declined to comment further.

The company also revealed that it made £15m from referral fees in the first half of 2011 and that it would look to pay its parent a dividend of between £500m and £1bn before divestment.

Analysts gave the presentation a lukewarm reception, arguing that the numbers and plans look good, but more detail and clarity is needed.

Panmure Gordon analyst Barrie Cornes said: “There is still detail concerning claims triangulations and things like that that we are no wiser on but it is a step in the right direction - it is starting to give more detail.”

In particular, Cornes welcomed the breakdown of results by unit, which show separate underwriting results and gross written premium for RBSI’s broker commercial lines unit NIG.

Cohen added: “I thought they were making reasonable claims about what they can do as a business and what they would look to do as an independently listed company, particularly about the growth that the business could achieve and the return on equity they would look to make.”

However, question marks about the company’s future remain. While acknowledging that the first-half 2011 result was far better than the first-half 2010 loss, Cornes said: “It is a bit early to tell whether that is a long-lasting improvement in underwriting performance and the business has really turned a corner.”

In addition, there are still questions about whether NIG will remain part of the group post-flotation. Cornes said: “We were not given a firm steer one way or the other whether it would necessarily be in or out of an IPO,” Cornes said. “The jury is firmly out.”

RBSI has previously strongly denied any suggestion that it would hive off NIG.