The UK car insurance market is to face an investigation by the Competition Commission after a watchdog report found that artificial charges could be pushing up premiums by £225m a year.

The Office of Fair Trading (OFT) has provisionally decided to refer the "dysfunctional" private motor insurance market to the competition regulator, who could spend up to two years probing the issues.

ts report revealed that insurers of not-at-fault drivers and some garages are given financial incentives to pass on the handling of accidents to credit hire organisations who tend to charge higher daily rates, inflating costs.

In particular the OFT found that on average repairs were being increased by £155 each time and the cost of replacement vehicles was being inflated by almost £600, because they were being hired for longer periods than necessary.

Although customers do not meet those costs directly, premiums are being pushed up by around £225m a year, which equates to an annual increase of £10 to all motorists.

John Fingleton, chief executive of the OFT, said: "Competition in this market does not appear to work well for drivers.

"We believe the focus that insurers have on gaining the competitive edge through raising their rivals' costs means that drivers pay more than they need to for their motor insurance policies."

Malcolm Tarling, spokesman for the Association of British Insurers (ABI) said he would welcome reform of the market.

"At the moment we are seeing far too many cases of excessive charges that far outweigh what would be a reasonable charge for a replacement vehicle.

"And these are charges that ultimately insurers are facing."

But Martin Andrews, director general of the Credit Hire Organisation (CHO), which represents the industry, denied credit hire companies were influencing insurance premiums.

He said: "The provisional findings by the OFT today conclude that the cost of any market dysfunctionality in the UK represent less than 2% of the insurers' total annual spend of approximately £13bn.

"Quite clearly then the costs of any market dysfunctionality are not the reason for the recent rise in the cost of premiums."

Mr Fingleton added that there was no "quick fix" for the problems but a more in-depth investigation by the Competition Commission, which has further powers to act on any findings, may be necessary.

Earlier in the year Prime Minister David Cameron held a summit with leading insurance firms in an attempt to clamp down on high numbers of compensation claims for whiplash injuries.

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