An "ethical insurer" has devised an alternative to payment protection insurance (PPI) which is now being offered in Scotland for the first time.

CUNA Mutual has tied up with the Scottish Police Credit Union to provide its 8750 members with automatic protection against being unable to make loan repayments because of absence from work through illness.

The PPI scandal has so far prompted the banks to set aside £13 billion for compensation payments, and the financial ombudsman is sitting on 400,000 unresolved complaints about PPI.

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However, the collapse of PPI has created a "huge gap in the number of people who have their income protected, when it is among the most important and relevant thing for people to insure", according to insurer LV=, which last year launched a simplified "sick pay insurance" policy. CUNA Mutual's research found "a protection gap which is leaving 86% of Scottish residents in trouble when they lose their income".

CUNA Mutual has devised "payment waiver protected" loans, based on a "business-to-business" policy between the insurer and the credit union.

The SPCU said: "A drastic move away from the PPI model, the payment waiver is simply a feature of the loan, and comes at no additional cost to the borrower.

"It will mean that if a Scottish Police Credit Union member is unable to work due to an accident or sickness, they simply contact the lender and the payments are waived for up to 18 months. No arrears are built up, no credit scores are affected and throughout the process the loan amount continues to decrease while the person is off work, providing peace of mind."

Paul Walsh, chief executive of CUNA Mutual Europe, said the idea offers credit unions "an ethical way for their members to be financially protected without having to dig deeper in their pockets".

Sir Stephen House, Chief Constable of Police Scotland, said: "I'm a huge fan of credit unions which is why I am a member of the Scottish Police Credit Union. It has been serving the police family for a quarter of a century by providing a convenient way to save, allied with sensible borrowing which is carefully managed."

Walsh added: "SPCU has already been commended by Parliament for its flexiloan, and its work raising awareness of the dangers of payday lending. Credit unions provide access to competitive loans with manageable repayment plans."

SPCU chief executive George Nedley said: "It is vitally important that credit unions step in to provide people with affordable and easy-to-access alternatives to payday lending - and in a responsible and safe way. We have already provided this alternative, and are now going one step further. All responsible lenders should be seeking to enhance their loans in this way, it's just the right thing to do for borrowers."

SPCU is now going head-to-head with payday lenders by launching the credit union sector's first smartphone app. It said: "This will mean that in a similar model to payday lenders, those wishing to borrow funds can access a loan calculator and apply for loans 24 hours a day, seven days a week."

Protection broker Lifesearch said: "It was the small print that prevented many PPI claims from being paid, so the small print here is just an important. Either way it is no substitute for proper income protection which would provide a more comprehensive solution to covering payments such as this, and indeed many other financial commitments."