Draft guidance published by the Financial Services Authority (FSA) stresses that letters must explain clearly why the customer may have been mis-sold a policy and set out what the customer should do to respond to the bank and within what time frame.
It has also clarified that banks can decide a claim is 'time barred' and reject it where the customer purchased the policy more than six years ago, or if the claim was made more than three years after the customers became aware or ought to have become aware that they had a cause to complain.
Banks are preparing to write to between four and 12 million customers who may be entitled to compensation but are yet to make a claim, according to the FSA.
The letters are part of the "root cause analysis" currently being undertaken by PPI firms to establish why there have been so many complaints about the policies, the regulator explained. Taking action to ensure customers that have not complained are treated fairly is part of the process that authorised firms must carry out when they identify systemic problems in their sales processes.
The FSA has asked firms to make sure that letters sent to customers are free from financial 'jargon' or marketing material, and to ensure records are kept of customer responses and any action taken by the bank. They should also make it clear that the letter contains "important information" and should be read carefully.
New rules on selling PPI, which is intended to cover repayments due on loans for people who cannot afford to pay because of an accident, sickness or death, were issued by the FSA in 2010. They stated that customers could make retrospective complaints about insurance packages they were mis-sold.
In April last year a High Court judicial review into PPI complaint-handling procedures dismissed attempts by UK banks to challenge the rules on the grounds that they imposed stricter selling standards than those in place at the time the PPI sales were made.
Last year banks had to pay a total of £1.9 billion in compensation to thousands of customers who paid for PPI but later found that they were ineligible to make claims, according to the FSA. However, managing director Martin Wheatley said that these payments had mostly come as a result of complaints received before, or put on hold during, the judicial review process. The new guidance would, he said, ensure customers due compensation replied to their banks' letters in time.
"We think that the redress due from this process may well exceed what has been paid so far, and that is why we are acting now to clarify our expectations. By ensuring that firms are clear about the problems they have identified and the potential redress due, we are aiming to prevent people running out of time if they choose to complain," he said.
"Historically, response rates for these types of exercises are low – sometimes as low as one in ten. Therefore, if you receive a letter, it's important to consider your PPI purchase carefully and if you feel you have been a victim of poor practice – please do respond to the firm."
Earlier this year the independent Financial Ombudsman Service (FOS), which deals with individual consumer complaints about financial service providers, confirmed that businesses facing multiple PPI complaints will have to pay an additional £350 per case from next financial year. The FOS said that it was anticipating a "record" number of cases involving mis-sold PPI.