Cuna Mutual, the world's biggest credit union insurer, is working with UK lenders to provide a 'debt waiver' facility for borrowers which ensures they do not have to make repayments on loans if they fall ill or lose their jobs.

The product increases the attractiveness of loans offered by credit unions and comes at a time when they are being urged to grow at the expense of payday lenders such as Wonga, which charges an annual interest rate of 5,853 percent.

Paul Walsh, Cuna's chief executive who was previously an insurance executive at Barclays (>> Barclays PLC), says adopting the waiver could heighten their popularity.

"I think it's a very credible way of transforming the attractiveness of their products. It makes them more innovative and more relevant to certain types of customers," Walsh said.

Cuna has been offering similar waiver products in the United States for the past 75 years, where it has been adopted by the Navy Federal Credit Union, a savings club attached to the United States military, which has a $35 billion loan book.

Credit unions, or community-run savings clubs, are less developed in Britain but are expected to grow in number as the authorities see them as an alternative to payday lenders, which have surged in popularity since banks tightened lending activity after the 2008 financial crisis.

Britain is clamping down on the previously lightly-regulated short-term lending market and the Archbishop of Canterbury has vowed to drive them out of business by using the Anglican church to build up a network of credit unions. Last week, he hired Britain's former top financial regulator to lead a task force as part of the campaign.

According to data from the Association of British Credit Unions, around 1 million Britons currently use them, with over 600 million pounds ($986.66 million) loaned to members as at September, 2012. In comparison, payday lenders lent between 2-2.2 billion pounds in the 2011/12 financial year.

Cuna's product provides an alternative to payment protection insurance (PPI), which was sold by banks and other lenders to millions of customers but which was discredited when it emerged many borrowers were ineligible to claim on it - leaving the industry with a 20-billion-pound compensation bill.

Walsh was a commercial director at the insurance division of Barclays, Britain's third-biggest retail bank, between 2004 and 2007, a time when PPI was being mis-sold across the industry. However, he wasn't involved in the marketing of the product, for which Barclays has set aside 4 billion pounds to compensate customers for mis-selling.

Since 2010 banks and other mainstream lenders have stopped offering PPI or any alternative protection, fearful of further mis-selling scandals, leaving millions of borrowers with no security should they fall upon hard times.

The waiver was developed for credit unions and customer-owned lenders rather than banks so it would only partly plug that gap. Walsh estimates that more than 95 percent of UK mortgages are sold to customers without any insurance.

"There is a growing protection deficit in the United Kingdom. It is going to come home to roost. Consumers don't have any creditable way of protecting their loan," he said.

Public policy think tank ResPublica, whose advisory board members include Anthony Browne, chairman of the British Bankers Association, said in a report last year that the government should encourage state-backed Royal Bank of Scotland (>> Royal Bank of Scotland Group plc) and Lloyds Banking Group (>> Lloyds Banking Group PLC) to adopt the waiver.

Cuna launched its first payment waiver product in Britain last year in partnership with Plane Saver, a credit union with 8,000 members set up by British Airways staff in the 1990s. Plane Saver, the 4th biggest credit union in the country, with 31 million pounds of assets, has seen a 23 percent rise in lending since introducing the waiver last September.

Cuna has agreed similar partnerships with Clockwise, a credit union linked with Leicester City Council and the Scottish Police credit union.

The waiver facility is written into the loan agreement and no third party is involved. The lender purchases a business-to-business insurance policy which transfers the risk of default from its balance sheet onto the insurer.

Walsh said Cuna is also talking to building societies, including one of Britain's top 10 mortgage lenders, about offering the facility alongside mortgages.

($1 = 0.6081 British pounds)

(Editing by Carmel Crimmins and Louise Heavens)

By Matt Scuffham