The motor insurance industry is to face a full-blown investigation after competition watchdogs said the market was not working well for consumers and found premiums were being pushed up by £225 million a year.
The Office of Fair Trading (OFT) has referred the industry - worth an estimated £9.4 billion in the UK - to the Competition Commission after discovering at-fault drivers had little control over the way in which repairs are carried out and replacement vehicles provided to not-at-fault drivers.
It said the practices were ramping up premiums, potentially by around £10 per policy.
The OFT, which provisionally decided to refer the industry to the Competition Commission in May, said there was "no quick fix" to the problems identified and that further investigation was needed. The commission now has up to two years to report its findings.
Clive Maxwell, chief executive of the OFT, said: "Competition appears not to be working effectively in the private motor insurance market. The insurers of at-fault drivers appear to have little control over the bills they must pay, and this may be leading to higher costs for them and ultimately higher premiums for motorists."
News of the referral comes as Royal Bank of Scotland puts the finishing touches to the stock market flotation of its Direct Line Group insurance arm. But the investigation is not expected to throw the plans off track.
In May, the OFT said the motor insurance market was "dysfunctional", with signs that insurers of at-fault drivers are being taken advantage of by insurers of not-at-fault drivers and others involved in providing repairs and courtesy cars.
This is thought to be inflating the cost of providing replacement vehicles by an average of £560 a time, while the cost of repairs was £155 more.
It said after crashes, many insurers of not-at-fault drivers, brokers and repairers, refer the drivers to organisations that tend to charge higher rates in exchange for referral fees of around £250 to £400 per hire car. The bills paid by the insurers of at-fault drivers can be inflated further because not-at-fault drivers are given replacement vehicles 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. And some insurers even have agreements with repairers to charge higher labour rates when repairing the vehicle of the not-at-fault driver.