However, Sir Gus O'Donnell, the leader of the Cabinet Office, also said he found no evidence that the central government had put any pressure on Scottish authorities to grant the release.
Abdel Baset al-Megrahi, the only man convicted in the terrorist attack, was granted a compassionate release from a Scottish prison in August 2009 on the ground that he was suffering from prostate cancer and would die soon.
He is still alive.
The bombing of the U.S.-bound Pan Am jumbo jet killed 270 people, most of them Americans, and al-Megrahi's release has been criticized by members of the U.S. Congress.
Prime Minister David Cameron, leader of the British coalition government that took power in May, asked O'Donnell to conduct the review. Cameron has strongly criticized al-Megrahi's release in the past.
Cameron's office said he discussed the issue with U.S. Secretary of State Hillary Clinton on Saturday at a security conference in Munich and that they had "strongly agreed" the prisoner release was a mistake.
"He was convicted of the biggest mass murder in British history, and in my view he should have died in jail," Cameron told the House of Commons.
O'Donnell said British policy regarding al-Megrahi developed after former Prime Minister Tony Blair negotiated a prisoner transfer agreement with Libyan leader Moammar Gadhafi in 2007.
Policy then developed that the government should "do all it could" to facilitate an appeal by the Libyans to the Scottish government for Megrahi's transfer to be released under the prisoner transfer agreement or on compassionate grounds, O'Donnell said.
"Nonetheless, once Mr. Megrahi had been diagnosed with terminal cancer in September 2008, (government) policy was based upon an assessment that U.K. interests would be damaged if Mr. Megrahi were to die in a U.K. jail," O'Donnell said.
"The development of this view was prompted, following Mr. Megrahi's diagnosis of terminal illness, by the extremely high priority attached to Mr. Megrahi's return by the Libyans, who had made clear that they would regard his death in Scottish custody as a death sentence and by actual and implicit threats made of severe ramifications for U.K. interests if Mr. Megrahi were to die in prison in Scotland."
Blair's successor, Gordon Brown, met Gadhafi in July 2009, a month before the release, and had said he could not interfere in the Scottish decision, O'Donnell said.
The U.S. Senate Foreign Relations Committee held hearings last year on whether the British-based oil company BP had sought al-Megrahi's release to help get a $900 million exploration agreement with Libya moving. Former BP Chief Executive Tony Hayward refused to testify before the committee last year.
BP has acknowledged that it had urged the British government to sign a prisoner transfer agreement with Libya, but stressed it didn't specify al-Megrahi's case. O'Donnell said he found no evidence that BP pressured the Scottish government to release al-Megrahi.
"It's clear to me, those who think there was some sort of conspiracy cooked up between BP, the British government and the Scots ... that's not right," Cameron said.
The bombing aboard the Pan Am 747 jumbo jet on Dec. 22, 1988, killed all 259 people aboard the aircraft and 11 people on the ground in Lockerbie town, where much of the wreckage fell.
Al-Megrahi was convicted by a Scottish court in 2001 and sentenced to 27 years in jail.
O'Donnell said Blair's and Brown's governments had been "primarily motivated by a desire to build on previous success in normalizing relations with Libya and to safeguard the substantial gains made in recent years, and specifically to avoid harm to U.K. nationals, to British commercial interests and to cooperation on security issues."
"The desire to see such a result developed and intensified over time as Mr. Megrahi's health declined and the imminence of his death appeared greater," O'Donnell said.
U.S. State Department spokesman Mark Toner thanked Cameron for ordering the review, which American officials are now studying. He added that the U.S. has always opposed and regretted the decision to release al-Megrahi.
American Bob Monetti, whose 20-year-old son Richard was on the flight, said Monday he blames Britain for the release of the convicted terrorist.
"The Brits seem to be in fear of the Libyans because they have so much business involved it trumps everything, including justice," said Monetti, of Cherry Hill, New Jersey.
But American Bert Ammerman, whose brother Tom was killed in the crash, said the U.S. also deserves blame for not doing more diplomatic work to prevent al-Megrahi's release in 2009.
"It is a national disgrace what our State Department did regarding the release of al-Megrahi," said Ammerman, of River Vale, New Jersey.
AP writers David Stringer in London and Geoff Mulvihill in Haddonfield, N.J., contributed to this report.