The £5bn payment protection insurance (PPI) market is "failing consumers" and is highly likely to be referred to the Competition Commission.
Payment protection insurance is available on credit cards and loans
The Office of Fair Trading (OFT) made the announcement following a five-month investigation into the market.
PPI is designed to help people repay loans, mortgages or credit card debt if they fall ill or lose their jobs.
But the OFT said PPI offered a "poor deal and often less protection than [consumers] think".
In its report, the OFT said it acknowledged that PPI could provide "worthwhile cover" for some consumers.
"However, evidence suggests that how consumers purchase their PPI, their understanding of the product and the quality of information available to them hinders competition," the report added.
The OFT highlighted several market failings, including:
- Consumers do not shop around for the best deal on PPI
- The complex nature of PPI makes comparison between different policies difficult
- Consumers in some cases assumed, were told or given the impression that taking out the PPI would help the application for credit.
The OFT's original decision to investigate followed a so-called "super-complaint", made in September last year by Citizens Advice, that PPI was too expensive and was often sold to people who did not need it.
It is now likely to be up to the Competition Commission to decide what enforcement action needs to be taken, if any.
At the same time as the OFT report was published the Financial Services Authority (FSA) released the findings of visits to 40 PPI providers.
The FSA said that firms are not giving customers clear enough information about what PPI covers.
In addition, the city watchdog said some firms are still failing to establish that the PPI policies they recommend are suitable because they are not collecting sufficient information from the customer.
The FSA said it will now work with firms to ensure that they improve sales standards.
In response, consumer group Which? said it was "disappointing" that the FSA had not named and shamed poor performing PPI providers.
"The FSA, OFT and Competition Commission need to work together to transform this industry. Merely providing consumers with more information is not the solution, " Pula Houghton, a Which? policy adviser said..
According to price comparison website, uSwitch, any clampdown on PPI could have a major impact on the interest rates offered by personal loan providers.
"The profits made from PPI are enabling credit providers to offer such competitive deals.
"Going forward, we would expect the clamp down on PPI to have a knock on effect and we could see these deals disappear or increase considerably," Tracy North, spokeswoman for uSwitch told BBC News.
Ms North added that her analysis suggested that PPI claim rates were considerably lower than those for motor or home insurance and this allowed providers to make bumper profits.