Banks that have sold payment protection insurance (PPI) could face a wave of compensation claims after the Competition Commission said that 14 million consumers had been overcharged by an estimated £1.4 billion, or an average of £100 a year.

In a damning report the commission said that lack of competition meant customers were overpaying an average £100 a year in a market worth £3.5 billion. Consumer groups, highly critical of the sale of PPI, said yesterday that the report could open the door to a wave of compensation claims, which could mirror the highly successful revolt over bank charges.

Pula Houghton, economic policy manager for Which?, the consumer group, said: “PPI is a poor value product and often mis-sold. This should spur policyholders on into considering if it is an appropriate product or not and whether they should seek redress.”

The commission's preliminary report, which comes after a 15-month investigation, concluded that consumers faced higher prices and less choice than they would if there were effective competition. It found that PPI providers made it difficult for customers to compare policies or switch to a better deal, while some used expensive insurance to subsidise cheap loan rates to win over customers.

Peter Davis, the inquiry chairman and Competition Commission deputy chairman, said: “We've found serious problems with the PPI market and customers are paying for the lack of competition.”

PPI has been under intense scrutiny since Citizens Advice referred a complaint to the Office of Fair Trading in 2005, with previous investigations concluding that PPI was being mis-sold on a huge scale.

The insurance is sold alongside loans, credit cards and mortgages and is supposed to pay out if borrowers are unable to make repayments because of accident, sickness or unemployment. Which? estimates, however, that up to two million borrowers have wasted money, as many policies are riddled with exclusion clauses and are difficult to claim upon.

A study by Citizens Advice found cases in which people who were unemployed or suffering from mental-health problems were talked into taking out PPI by high-pressure salesmen even though they would never be able to claim.

Advisers are rewarded handsomely for pushing PPI, taking up to 80 per cent of the first year's premiums as commission, according to the commission's report.

Martin Lewis, of the financial website MoneySavingExpert.com, said: “Bank staff are drilled to push this insurance, even when it's not necessary or worse still when the cover is totally inappropriate and doesn't actually buy any protection. I wouldn't be surprised if half the PPI policies in the UK had been mis-sold and would urge anyone who has taken out a loan in the last six years to check whether they were mis-sold PPI at the same time.”

The Financial Ombudsman Service (FOS), which settles disputes between firms and customers, said that it had seen a jump in complaints about PPI, with these soaring sixfold in the year to the end of March to more than 10,600, up from only 1,800 during the previous financial year. It is upholding many of the customer complaints, with an average refund of £3,000.

Martin James, of the FOS, said: “About a third of our cases are generally upheld in favour of consumers, but with PPI this rises to 45 per cent of recent complaints.”

Among proposals being considered by the Competition Commission are a ban on the sale of PPI policies when consumers take out loans and temporary price caps on premiums until competition brings prices down. The commission's final recommendations will not be issued until December. In the meantime, borrowers who believe they they have been mis-sold PPI or overcharged are being urged to take action. Downloadable complaint letters are available from sites such as MoneySavingExpert.com and Which?

Mr Houghton advises anyone who believes they have a case to approach their lender directly, and then the FOS, rather than using claim-management companies - or “ambulance chasers” - which will take about 25 per cent of the total refund as a fee.

There have been warnings that limiting PPI sales may lead to costlier personal loans. PPI is one of the last big moneyspinners for banks. Lloyds TSB, Barclays and HBOS top the tables for PPI sales. The commission said it was aware of a risk that loan costs might rise and would take this into account before making final recommendations.

Key proposals

— A cap on premiums for a limited period

— Ban on selling PPI at the same time as loans, credit cards or mortgages

— Clear information to encourage consumers to shop around for the best policy

— Ban on single premium policies, where interest is added to the cost of the loan

— Policies to be renewed annually

How policyholders are failed

— PPI is supposed to cover mortgage, card or loan repayments if the policyholder is unable to work because of accident, sickness or job loss, but it is expensive and riddled with exclusions

— Anyone who is self-employed or has a pre-existing medical condition is excluded from claiming, for example, yet many will have been sold a policy. Workers on fixed-term contracts and those over 65 cannot claim

— Other problems include delays in receiving help with repayments, with payouts beginning only 30 or 60 days after the holder has stopped working. Once the policies do start to pay out, the cover generally lasts for a set period of time only, such as one or two years, and the insurer will sometimes cover only the minimum repayments required during this period

— Policyholders often fail to realise they are excluded until they come to claim because the small print is rarely explained at the point of sale, even though the cover has one of the poorest payout records in the industry: only 14 per cent of premiums are paid, on average, compared with 80 per cent for car insurance