A blunder by the Financial Services Authority (FSA) could mean that the UK policyholders of Gibraltar-registered insurance companies are not covered by the Financial Services Compensation Scheme (FSCS).

Pre-N2, policyholders would have been covered by the Policyholders' Protection Board (PPB).

That would mean that in the event of an Independent-style collapse, thousands of policyholders would be left stranded.

The potential error has prompted motorcycle intermediary Carole Nash to suspend business with Gibraltar-based Zenith Insurance, until Zenith can prove that it has adequate policyholder protection for Carole Nash's customers.

It is understood that during the switch from the PPB to the FSCS, which took place when the FSA assumed its full responsibility in December 2001, the FSCS forgot to include Gibraltar under the scheme. It included Guernsey, Jersey and the Isle of Man.

This is despite the Gibraltar-based insurers being compulsory contributors to the PPB because they wrote UK compulsory business.

Gibraltar was overlooked because it is not a separate European Economic Area (EEA) member state, but part of the UK's membership.

The chief executive of Gibraltar-registered insurance group Markerstudy, Kevin Spencer said Gibraltar's Financial Services Commission (FSC) had been in contact with the FSA and the FSCS to rectify the situation.

He added that, legally, it would be very hard to prove that Gibraltar could not rely on the FSCS.

"I think the situation has been caused by a badly-worded piece of legislation... This is one part in the legislation that does not include Gibraltar, the whole of the rest of it says Gibraltar is involved."

An FSA spokesman said Gibraltar's unique position within the EEA meant that it was being treated slightly differently under the Financial Services and Markets Act.

He added that the FSA was talking to the FSCs and that there could be "an issue or two to be settled".