PPI sales will be banned while customers take out a loan
Banks and other lenders face severe restrictions on their sales of lucrative loan insurance.
Payment protection insurance (PPI) cost borrowers more than £4bn in 2007 and is supposed to repay borrowers' loans if they fall ill or lose their jobs.
The Competition Commission says lenders will no longer be able to sell PPI when they grant a loan, and also for seven days afterwards.
The Commission said customers would have "lower prices and better choice".
"The 'point-of-sale' advantage has meant that leading providers have faced little competition for PPI and, as a result, have charged persistently high prices," said Peter Davis, deputy chairman of the Commission.
"Consumers' interests are not best served when the only choice the vast majority have is whether or not to purchase their credit provider's PPI product.
"The resulting lack of competition means that the only offer consumers get is simply worse value than they are entitled to expect," he added.
Borrowers will, if they wish, still be free to approach their lender to buy its own PPI policy 24 hours after taking out a loan.
The Commission expects requirements for PPI providers to give consumers better information to be met by April 2010, with the other measures coming into force by October 2010.
There are currently more than 12 million PPI polices in force, which have mainly been sold alongside credit cards, personal loans and mortgages.
The Commission's final set of proposals is the culmination of a four-year campaign by consumer organisations, and then regulators, against the mis-selling of the insurance by banks and other lenders.
Louise Hanson, head of campaigns at Which? said the decision sounded the death knell for PPI.
"For too long too many consumers have suffered from shoddy, expensive and inadequate protection," she said.
"It's a great shame that since we began campaigning for better products, many people have wasted millions of pounds on PPI and have been ripped off in the process," she added.
But the Association of British Insurers (ABI) said the Commission's plans could leave borrowers without necessary cover.
"The point of sale ban carries significant risks for borrowers, mainly by leaving them unprotected at a time when unemployment cover has never been needed more," said Nick Starling of the ABI.
"Figures released only yesterday by the ABI show that in November 2008 there were 19,105 new unemployment claims on PPI policies," he added.
The Competition Commission's draft recommendations were first outlined last November.
Then it suggested a 14-day moratorium on PPI sales by lenders, now watered down to seven days, but it is going ahead with its proposal to ban sales of "single premium" PPI policies altogether.
These involve the full premium being added to a loan up-front, thus inflating the borrower's interest bill.
This also tends to lock in customers who might wish to change their PPI policy.
That recommendation has already been taken up by five major UK banks, following pressure to comply from the Financial Services Authority (FSA).
Other measures being enforced by the Commission involve lenders having to provide personal PPI quotes to customers, annual policy statements for the customers, and more information so they can shop around if they want to take out the insurance.
"The Commission has thrown the baby out with the bath water," said Stephen Sklaroff of the Finance and Leasing Association.
"By preventing customers from protecting their repayments at the time they take out a loan, the Commission has made it much less likely that they will do so at all.
"Many more people will go without the safety-net provided by PPI, just when unemployment is reaching record highs," he added.
The sale of PPI has been highly profitable, partly because so few customers have been able to make valid claims.
The Commission found that, in 2006, lenders made excess profits of £1.4bn when selling the insurance.
Its main finding last year was that lenders had a monopoly on the sale of the policies "at the point of sale" when they also granted a loan.
This meant borrowers were deterred from shopping around, and the lack of competition meant that the cost of the insurance was kept artificially high.
Consumer organisations have found that borrowers are often also under the impression that taking the insurance is essential in order to be granted the loan at all.
And some customers have been misled about what the insurance covers, whether they really need it, or if they will even be able to make a claim under the terms of their policy.
In October last year, the FSA fined the Alliance & Leicester £7m for mis-selling PPI to 210,000 people after training its staff to pressurise any customers who disputed the inclusion of the supposedly optional insurance in the quotation for their loan.