Displayname user attribute counts middel initial as a word.
When using User Properties in the Password policies, the displayname user attribute counts middel initial as a word. So any password using the middle initial will be rejected.
Here is an alternative/workaround to using the displayname.
If you deselect the "displayname" and instead select the "sn" (which is sir name, or last name) and also select givenname, (which is the first name) and therefore ignoring the middle initial, you will get the desired result.
This way we can exclude middle initial, but first names and last names will still be prohibited as passwords