Pre-paid funeral plans could be hit with tougher regulation under government plans to deal with bad practice in the sector.

The Guardian understands that the government is due to launch a consultation on regulating the funeral sector, where around 1.3 million people in the UK have a pre-paid plan.

But the schemes are not regulated by the Financial Conduct Authority (FCA) and several providers are not even registered with the industry’s voluntary regulator, the Funeral Planning Authority (FPA), which has limited powers of a maximum £5,000 or expulsion from the regulator.

Some companies have been accused by campaigners of misleading advertising and aggressive cold-calling and telesales, and offering little customer protection for their investment if the firm folds.

A report last year by consumer group Fairer Finance said some operators were running a “quasi-Ponzi scheme”, where they allegedly use money from new customers to pay current claimants.

The government consultation, due to be announced by the Treasury, will consider evidence on whether to bring the plans under the FCA’s remit or beef up the industry regulator’s powers, although there is thought to be limited appetite for creating a new statutory body.

Dignity, one of the biggest funeral providers, which sponsored the report last year, said it had long lobbied for stricter regulation of the sector. The firm’s research found 75% of people with funeral plans mistakenly believed their plan to be regulated by the FCA.

The firm’s head of insight, Simon Cox, said persistent and pushy cold-calling was rife from some companies, with no oversight.

“There are a growing number of new providers taking advantage of a regulation gap and are not regulated at all,” he said. “There are a number of options open to the government and we will be recommending that the FPA is put on a statutory footing to compel all organisations selling funeral plans to be regulated.

“However, what is most important is that the regulation gap in the sector is filled. If this option is not possible, then a body with statutory powers such as the FCA is infinitely better than the status quo.”

Pre-payment plans cost between £3,000 to £4,000, typically paid for via monthly instalments. Campaigners have raised concerns that many people may not be aware of hefty administration fees, which can be as high as £1,000, charged by some providers acting as middlemen between the customer and the funeral director.

Though a pre-paid plan is similar to an insurance product, the law exempts the providers from regulation by the FCA if they put customers’ money either into a trust or a “whole of life” insurance policy. The vast majority of providers make use of that exemption.

If customers are mis-sold a plan by an unregulated provider, they are unable to complain to the Financial Ombudsman Service and have no protection if a provider goes out of business.

The SNP MP Neil Gray, who has campaigned in parliament for a crackdown on firms, said he was “absolutely delighted” that a consultation was in the works and that he believed ministers were taking the issue seriously.

“Funeral plans are a good thing. They are an anti-poverty measure and an effective way of planning for the future, but if a provider goes bust or there are hidden fees, there is currently very little that individuals can do.”