The Financial Services Authority (FSA) has fined Hastings Insurance Services £735,000 for "failing to treat its customers fairly" when it cancelled thousands of motor policies.
The company, which operates Hastings Direct, cancelled around 4,550 car insurance policies last year when it discovered in July and again in September that a system error had led to inaccurate quotations.
The error led to significantly underpriced premiums and Hastings reacted by cancelling the policies.
However, the FSA found that the firm had invoked a cancellation clause to cancel the policies which the regulator considers was not generally intended to be used in circumstances such as these.
Margaret Cole, FSA director of enforcement, said: "The firm failed to consider properly what effect cancelling policies might have on its customers which illustrates that the fair treatment of customers had not been embedded into its corporate culture as our TCF principle clearly requires."
Hastings agreed to settle the case at an early stage, otherwise the fine would have been over £1 million, the FSA added.
A Hastings Direct spokesman, Jeffrey Roberts said the insurer will pay the fine and has agreed to write to customers to explain they may be entitled to compensation.
Mr Roberts said: "Whilst Hastings does not consider the use of a cancellation clause is of itself unfair, it does accept that in this instance these particular processes and procedures could have been better and has acted quickly to rectify them.
"Hastings is pleased the FSA has acknowledged the breach was not deliberate. The company has taken substantial remedial action in relation to its systems and management."