Car insurers were facing a full-blown inquiry today over claims that their "dysfunctional" practices pushed up premiums by £225 million a year.
The Office of Fair Trading (OFT) plans to refer the market to the Competition Commission after finding evidence that the cost of replacement car hire and repairs in the wake of accidents was artificially high.
It said insurers of at-fault drivers were powerless over the way in which repairs are carried out, leaving them at the mercy of the other party.
This system, which the OFT described as dysfunctional, inflates the cost of providing replacement vehicles by an average of £560 a time, while the cost of repairs were £155 more.
Consumer groups welcomed the announcement as drivers have been hammered by soaring premiums and complex charges for the same or even fewer benefits in return.
Which? executive director Richard Lloyd said: "The Office of Fair Trading found a pattern of complicated fees and charges so we want to see greater transparency and pressure on insurers to reduce prices."
The OFT believes the market would work better if insurers concentrated on the quality and service they provide to drivers, rather than trying to gain the competitive edge by raising rivals' costs and boosting their own revenues, although it warned there will be no "quick fix".
It will reach a final decision on whether to refer the matter by October, following a consultation. The Commission has powers to restructure markets and to make firms sign up to commitments and sell products in a certain way.
The OFT said after crashes, some insurers of not-at-fault drivers refer them to organisations that charge higher rates in exchange for referral fees of up to £400 per hire car and replacement vehicles are sometimes given for longer than necessary.
When it comes to repairs, bills paid by the insurers of at-fault drivers are pushed up because some insurers receive referral fees and rebates from repairers and suppliers.
Some insurers even have agreements with repairers to charge higher labour rates when repairing the vehicle of the not-at-fault driver.
Graham Donoghue, managing director of financial services at comparison website MoneySupermarket, said: "Consumers have experienced large rises in premiums over the last two years as insurers pass on rising costs of claims to their customers.
"The majority of insurers don't actually make an underwriting profit on the policies they sell. Instead, the industry has tried to rely on revenue from the fees generated from referring personal accident claims to solicitors, inflating repair costs and hire car charges.
"Ultimately, this strategy has come back to hit insurers hard as the cost of claims has risen rapidly; costs that have been passed on to customers."
The AA welcomed the report, although it pointed out that its recent research showed that premiums have shown a slight drop.
The average of the five cheapest comprehensive cover quotes in the first quarter of this year was £1,132, down 1.1% over the three months, the AA found, although it said premiums have increased by 7.7% over the previous 12 months.
An AA spokesman said: "The AA is committed to campaigning for more affordable motoring costs for drivers, at a time when the price of fuel, insurance and taxation has soared."
The AA also pointed out that while the costs of the repair and car hire practices looked at by the OFT are estimated to add an extra £10 on each policy, whiplash claims, an area currently being looked at by the Government, are thought to add an additional £90.
The Association of British Insurers' director of general insurance, Nick Starling, said: "For too long, insurers have faced inflated rates for credit hire cars and excessive hire periods which have led to higher insurance premiums for customers.
"Regulation of all players in the market to tackle excessive costs is needed, and we hope that the work by the Competition Commission will bring much-needed reforms that, in turn, will result in lower car insurance premiums for consumers."