The Competition Commission claimed that in most cases the party managing the accident claim - typically the non-fault insurer or intermediary - was not the party liable to pay the costs of the claim.
The commission estimates the extra premium costs due to the separation of control and liability on replacement cars and repairs to be between £150 million and £200 million a year.
It is considering whether to make a driver's own insurer responsible for providing a replacement vehicle or to give at-fault insurers greater opportunity to take control over managing claims.
There may also be caps on the cost of providing a replacement vehicle and on repair costs, as well as compulsory audits of repair quality after the watchdog found that following an accident too many repairs were not completed to the required standard.
Whiplash victim Gavin Redman said: "I've been injured three times. If you've been involved in an accident, it's not your fault, why should you be made to suffer. It's just not fair.
"Each time I've been injured I've been to see a consultant who's gone through quite a rigorous examination of me, told me to explain all my symptoms. He's then made the diagnosis of how long it's going to take me to get better, nobody else."
James Dalton, head of Motor and Liability at the Association of British Insurers said: "Half a million whiplash claims a year. That's about 1,500-1,600 claims a day.
"The reality is that that is driving up people's car insurance premiums and the government is today announcing a set of proposals, that it is putting out to consultation to really crack down on the whiplash culture."
An independent medical panel will be set up to accredit doctors who wish to act as insurance examiners.
The system is designed to prevent doctors being faced with unfair pressure to support fraudulent claims.
The threshold for small claims courts is being raised from £1,000 to £5,000, so that they can handle all but the most serious cases.
It will also include banning "referral fees" where companies can profit from selling on someone's personal injury claim and stopping claims management companies from offering money or goods as an inducement to make a claim through them.
They will include rebalancing no-win no-fee deals so losing defendants will no longer have to pay a success fee or legal insurance premium to the claimant's lawyer.
Today's consultation complements law changes which will come into effect in April 2013.
We are pleased that the Government recognises that tough action is needed to protect honest motorists from the UK's whiplash epidemic. For too long, whiplash has been seen as the "fraud of choice".
More effective diagnosis of whiplash will help genuine claimants get paid out quickly and reduce the scope for fraud, so helping to ensure that honest motorists do not end up footing the bill for the cheats through higher insurance premiums.
– James Dalton, head of motor and liability at the Association of British Insurers