The cost of car insurance could finally be kept in check if a government ban on fees that encourage compensation claims has its desired effect.

The Ministry of Justice today announced it will outlaw 'referral fees', to help tackle the soaring cost of insurance, specifically motor insurance, which the AA says has risen by up to 40% over the past year.

These fees are often paid by lawyers or claims management companies to third parties, such as garages or insurance companies, for information on injured parties following an accident, sometimes so they can cold call victims to encourage often spurious claims.

The Government says referral fees have led to high costs, encouraged a compensation culture and led to the growth of an industry which pursues claimants for profit.

When a successful claim is made, referral fees are usually charged back to the loser, which is normally the defendant's insurance company. The insurance company then increases its prices to recover these fees.

While some claims are genuine, the Association of British Insurers trade body argues insurers are forced to spend millions on defending spurious claims due to the development of this compensation culture.

When will the ban happen?

It is unclear when the ban will come into force, though the Government says it is "months, not years away".

Justice Minister Jonathan Djanogly says: "The 'no-win, no-fee' system is pushing us into a compensation culture in which middle men make a tidy profit which the rest of us end up paying for through higher insurance premiums and higher prices.

"Honest motorists are seeing their premiums hiked as insurance companies cover the increasing costs of more claims.

"Referral fees are one symptom of the compensation culture and too much money sloshing through the system. People are being encouraged to sue, at no risk to themselves."

Success fees cap

The referral fee ban comes on top of moves already in place to cap fees charged by successful lawyers to losing defendants. The cost of referral fees is often built into the 'success fee'.

The Government is changing the law so in future the person making the claim will have to pay the success fee.

Again, it is unclear when this will come into effect, though a similar timescale is expected.

Otto Thoresen, head of the ABI, says: "Insurers are committed to keeping motor insurance competitively priced but we urgently need reform of our compensation system if premiums are to fall.

"Rising claims costs from personal injury claims and excessive legal costs have unfortunately led to rising motor insurance bills for many customers."

OFT probe

Separately, the Office of Fair Trading is to investigate soaring car insurance costs. It has issued a call for evidence to establish if reported rises are a reality and, if so, why.

It will also consider whether further work is needed to improve the industry.