Royal Bank of Scotland's insurance arm Direct Line is planning to raise debt in a signal it is on track to be spun off and separately listed later this year, potentially returning cash to its taxpayer-backed parent.

The business, which was founded in 1985 and includes leading UK brands Direct Line, Churchill and Privilege as well as Green Flag breakdown service and operations in Germany and Italy, could be valued in its initial public offering (IPO) at near 3.2 billion pounds ($5.1 billion), analysts have estimated.

That would make it one of Britain's biggest stock market listings in years.

Direct Line Group, the new name for RBS Insurance, has mandated RBS, Citigroup and HSBC to arrange meetings with fixed- income investors to sell subordinated debt, bookrunners said. Direct Line declined to comment.

A benchmark deal could see between 250 million and 500 million pounds of debt sold.

Direct Line does not have any debt but is expected to take some on as part of a reorganisation of its structure before its listing. It could return cash to RBS in the form of a dividend, or allow the parent group to reduce its own debt.

Direct Line Finance Director John Reizenstein said in October he expected the insurer to pay RBS Group a dividend of between 500 million pounds and 1 billion pounds, funded in part by hybrid debt issuance.

RBS, which is 83 percent owned by the UK taxpayer, wants to sell a minority stake in Direct Line in the second half of this year. European regulators have said it must sell a majority stake by the end of 2013 as payback for Britain's bailout of RBS more than three years ago.

RBS tried to sell the business in 2008 but scrapped the sale when the financial crisis deepened and it failed to get offers near the 6 billion pounds it had hoped for.

RBS could make a gain on the insurance sale of 800 million pounds, analysts at Autonomous estimate. ($1 = 0.6314 British pounds)

(Reporting by Steve Slater; Editing by Erica Billingham)