* RBS sells 30 pct of Direct Line at 175p/shr
* Raises $1.3 bln from sale of 450 mln shares
* Retail investors take up 15 percent of offer
* Shares set first-day premium, trade at 184p
(Recasts, adds detail, background and quotes)
By Matt Scuffham and Myles Neligan
LONDON, Oct 11 (Reuters) - Shares in Direct Line set a premium on their stock market debut on Thursday, marking a milestone for parent Royal Bank of Scotland (RBS) which needed a successful float of the insurance unit as a key part of its recovery plan.
Strong demand from private investors helped RBS raise 787 million pounds ($1.3 billion) through the sale of 30 percent of Direct Line's shares at 175 pence per share, near the middle of the initially stated range and valuing the business at 2.6 billion pounds ($4.2 billion).
The shares were trading at 184p by 0900 GMT, a firm performance which also highlighted a recovery in Europe's IPO markets from an extended hiatus.
In the same sector, Germany's third-biggest insurer Talanx AG has also performed well after its recent IPO, with its shares trading 8 percent ahead of the offer price.
RBS is selling Direct Line - whose frequent TV adverts have made its four-wheeled red phone motif a well-known corporate symbol - in return for winning approval from European Union (EU) regulators for a bailout during the 2008 financial crisis that left it 82 percent state-owned.
The bank said on Thursday the sale marked the next important step in its recovery plan, having earlier this year finished paying back emergency loans to Britain and the United States.
It is also poised to exit a government insurance scheme designed to protect its weakest assets later this year.
RBS has said it plans a three-stage sale of Direct Line under which further share sales will take place next year and in 2014. Under the EU directive, it must sell more than 50 percent by the end of 2013 and the rest of its shares a year later.
The successful flotation defies recent concerns that investor appetite would be damaged by a British anti-trust inquiry into allegations of over-charging in the car insurance market in which Direct Line is a major player.
The sale was boosted by strong demand from retail investors, who have been starved of opportunities to participate in large-scale IPOs in recent years. The Direct Line IPO was the biggest retail share offering in Britain since money manager Hargreaves Lansdown Plc five years ago.
On a conference call with reporters, Direct Line Chief Executive Paul Geddis said retail investors had purchased between 5,000 pounds and 6,000 pounds worth of shares on average and had taken up 15 percent of the shares sold.
Geddis added that the offering had been "comfortably oversubscribed".
London Stock Exchange Chief Executive Xavier Rolet said the level of retail interest in the issue had underlined the appeal of London's equity markets to private investors.
Brokerages had on Tuesday reported a surge in late demand for the shares from private investors, with Redmayne-Bentley for instance saying orders had almost doubled since the weekend.
RBS had been under pressure to secure a good price for the business, with taxpayers sitting on a loss of 21 billion pounds after Britain pumped in 45 billion to rescue the bank.
Analyst Eamonn Flanagan at brokerage Shore Capital said the price for Direct Line stock was a "reasonable outcome", although the company's value is below the cut-off point of about 3 billion pounds for membership of Britain's elite FTSE 100 index.
The price was near the middle of the 160 to 195 pence range set by RBS when it launched the IPO on Sept. 28.
Goldman Sachs and Morgan Stanley ran the Direct Line offering, acting as joint bookrunners along with UBS . They are in line to share fees of as much as 17.4 million pounds with the other eight banks involved in the institutional portion of the share sale.
RBS sold 450 million Direct Line shares in the offer, representing 30 percent of the business, with a 15 percent over-allotment option.
($1 = 0.6242 British pounds)
(Addirional reporting by Kylie MacLellan; Editing by Dan Lalor and David Holmes)
Keywords: DIRECTLINE IPO/