Consumers are being overcharged by up to £1 billion in payment protection insurance, the Office of Fair Trading has claimed, due to lack of competition in the market and poor customer service.

It is referring the PPI market to the Competition Commission for investigation. This decision comes after a period of public consultation following the OFT's earlier proposal to refer the PPI market to the commission on October 19.

In its report on the market the OFT says: “PPI is a sizeable market with gross premiums estimated at £5.5 billion. There are indications consumers receive poor value in the low proportion of premium income paid out in claims (of the order of 20%) and we have indentified features of the market which adversely affect competition and appear to lead to poor value. The evidence suggests that how consumers purchase their PPI, their understanding of the product and the quality of information available to them hinders competition.

“We have estimated the potential savings from making the market more competitive could be around £1 billion.”

The situation is made worse by consumers’ reluctance to shop around and have poor understanding of PPI.

During the consultation over 20 responses were received from parties including businesses, consumer organisations and trade associations.

John Fingleton, OFT chief executive said: “Our examination of the evidence presented to date gives us reasonable grounds to suspect that there are features of this market which restrict competition to the detriment of consumers. Despite some evidence of a degree of consumer satisfaction with aspects of the product, the evidence as a whole suggests consumers get a poor deal. This referral will enable the Competition Commission to undertake a thorough investigation of the market and, if necessary, ensure that appropriate remedies are put in place.'”

In reaching this decision OFT says it has taken account of the work which the Financial Services Authority (FSA) is doing to “remedy the problems relating to selling standards and to ensure customers are treated fairly, as well as the various industry initiatives which are underway in response to the FSA's work. However the OFT and FSA agree that FSA action targeted at selling practices alone cannot remedy the lack of competition the OFT has identified in the PPI sector”.

But the Finance and Leasing Association is critical of the decision. Director general Martin Hall said: "We are disappointed that the referral was taken after hasty research without full and detailed consultation with the industry about possible remedial steps, and even without any recommendations to the commission about what steps or changes may be needed to solve the problems identified by the OFT.

"The commission will need to work closely with the FSA, the regulatory body for insurance, to make sure that by the time it closes its investigation and makes its judgement, the necessary changes haven’t already been made."