Royal Bank of Scotland�s efforts to sell its Direct Line and Churchill insurance operations suffered a potentially huge setback last night when Zurich Financial declared it was pulling out.

Royal Bank of Scotland's efforts to sell its Direct Line and Churchill insurance operations suffered a potentially huge setback last night when Zurich Financial, touted widely as the frontrunner in the auction of these businesses, declared it was pulling out.

Swiss-listed insurer Zurich is the latest of an increasingly long line of prospective bidders for the RBS Insurance business to walk away. Famous American billionaire Warren Buffett's Berkshire Hathaway investment vehicle, Generali of Italy, and Chinese insurer Ping An have already departed the scene.

The list of possible suitors is said by industry sources to be limited by the likelihood that the Royal insurance operations' large UK market share would raise potentially insurmountable competition obstacles for any rival which itself has big UK operations. Among UK players, Royal & Sun Alliance signalled early on that it was not interested in bidding.

However, a source familiar with Royal's efforts to sell the insurance business said last night, in the wake of Zurich's withdrawal, that there were other serious bidders still in the frame. The source declined to say how many, but indicated at least two.

This signals that Royal may still be hopeful of a satisfactory outcome. Some banking sector analysts consider it a shame that the insurance operations are up for sale anyway, although this view has to be balanced against Royal's capital requirements.

Others touted as potential bidders for RBS Insurance include Allianz of Germany and US insurers Allstate and Travelers, although Royal Bank has refused to talk about who might be in the frame.

A spokesman for Royal Bank declined last night to comment on the situation, in the wake of Zurich's announcement.

The proposed sale of RBS Insurance forms the centrepiece of Royal Bank's efforts to boost its capital position by about £4bn through asset sales, augmenting the £12bn raised recently in Europe's biggest-ever rights issue as it rebuilds a balance sheet battered by the global credit crunch.

Sources have put the likely price-tag on the Royal Bank insurance operations, which employ about 1800 people in Scotland and more than 18,000 in total, at more than £7bn. However, doubts have increased over whether this can be achieved given the worsening economic backdrop and continuing grip of the global credit squeeze.

The withdrawal of Zurich, given its perceived status as frontrunner, would seem likely to put further downward pressure on the price, and even more so because it follows public declarations by other potential bidders about their decisions not to proceed.

The very public nature of Zurich's withdrawal from the auction would appear likely to have raised eyebrows in the Royal camp, and would appear to have the potential to weigh on Royal's share price this morning.

In a statement issued after the UK stock market closed last night, Zurich said: "Zurich Financial Services Group confirmed today that it has been considering making a bid for the insurance business of Royal Bank of Scotland and has carried out a detailed review of the opportunities.

"Following such review, the group has decided to withdraw from any further discussions.

"Zurich will continue to assess growth opportunities in line with its stated strategic and financial targets, in furtherance of continued shareholder value. In addition, it will recommence purchasing shares under its previously-announced share buy-back programme starting Friday, July 11, 2008."

The Swiss-listed company had been viewed as a bidder with the necessary financial firepower to buy RBS Insurance, which also includes Privilege, NIG, and breakdown service Green Flag and is one of the UK's largest general insurers.

Zurich has been expanding in the UK and, in 2006, it hired Annette Court, who headed Royal's insurance business, to be in charge of its European general insurance operations. She arrived at Zurich in January 2007 and continues to head this business for the Swiss-listed insurer.

Royal Bank of Scotland chief executive Sir Fred Goodwin appeared at pains last month, when the Edinburgh-based institution issued a trading update, not to tie himself down to a timescale on the sale of the insurance operations.

He emphasised back in April that Royal, even though the insurance operations are at the centre of its plans to raise additional capital, would sell only at the right price.

Goodwin said last month: "In relation to RBS Insurance, we are in discussions with a number of potential purchasers. Those discussions are ongoing. Obviously, for a disposal of this size, the discussions will take some time and our determination is to achieve the appropriate value,"

he added.

"So we are not doing this against the clock, we are doing this to achieve the appropriate value and it will be some time before we have any announcements to make in relation to RBS Insurance.

"It is not a thing that gets done quickly. I guess I am just trying to temper expectations a little bit. I wouldn't be holding my breath to hear any more about this."

In April, when Royal confirmed its plans to sell its insurance business, he had said: "It is not going to be sold unless we can attract a very high price for it. We might simply sell a stake in it if it is financially attractive to an investor."