The FSA has been investigating issues around loan insurance
Insurance broker Swinton will offer refunds to 350,000 customers after the City watchdog found serious failings in the way it sold insurance.
Swinton has also been fined £770,000 by the Financial Services Authority which found the broker's sales of Payment Protection Insurance to be flawed.
PPI was automatically included in insurance quotes in December 2006 to March 2008 even if it was not needed.
Swinton has apologised to customers but said it had acted in good faith.
PPI is supposed to offer a payout if the policyholder falls ill or loses their job, but very few have been paid out and some people sold policies have found they were ineligible to make a claim.
The FSA said that over the 16 months in question, Swinton's selling technique automatically included PPI in motor and home insurance quotes without finding out if the customer wanted or needed it.
It also failed to make it sufficiently clear that PPI was optional and did not disclose the cost when the insurance was sold.
The policy only cost £1.21, with the remainder of the £15 or £20 charged being taken as a fee by Swinton.
The company, which stopped selling PPI in March 2008, accumulated £7.8m from its PPI sales and will now offer customers a refund.
"These were deliberate breaches. Swinton was fully aware it should establish a customer's need for PPI before recommending it, yet nearly 500,000 policies were sold to customers who did not necessarily require them," said Margaret Cole, of the FSA.
"Swinton's PPI sales fell a long way short of our requirements and the firm clearly failed to treat its customers fairly."
The fine would have been above £1m, but was cut by 30% because Swinton agreed to settle at an early stage of the investigation.
The company apologised and said it had set up a dedicated unit to deal with the PPI cases.
But it put forward a robust defence of its sales process claiming it was "reasonable and proportionate" given the low cost of the PPI.
It claimed that the vast majority of its customers understood that the product was optional when offered to them and less than 50% of its eligible customers bought it.
But Vera Cottrell, of the consumers' association Which?, said: "This is a truly shocking case. As an insurance broker, Swinton is supposed to give tailored advice to its customers. Instead, it saddled thousands of people with unnecessary and unsuitable insurance.
"Customers should get an automatic refund. Too few people are likely to claim back £15 or £20, which would mean Swinton is getting let off lightly, especially given the fine imposed by the FSA is just a 10th of the revenue it generated from PPI sales."
She said that action should be taken against the senior management of Swinton.
Various providers have been fined by the FSA for mis-selling PPI, including Alliance and Leicester which was fined £7m after training its staff to pressurise any customers who disputed the inclusion of the supposedly optional insurance in the quotation for their loan.
Earlier in 2009, the FSA banned the sale of single premium PPI.