Opinion: Just before Christmas, Minister for Health Mary Harney made a brave and necessary decision when she introduced risk equalisation for the health insurance industry. This, as everyone knows by now, involves Bupa Ireland transferring funds to its main rival VHI, but also to the ESB health insurance.

The move was brave because she faced the expected ire from Bupa subscribers and from Bupa itself, which threatened to leave the market and immediately launched legal challenges.

It was necessary because, for community rating (equality in the cost of health insurance regardless of age) to work effectively, risk equalisation is necessary.

The system operates in a number of countries, including Australia, where Bupa is a market leader with more than 10 per cent of a diverse market of some 20 players.

What is surprising is that the risk equalisation issue did not come to the fore before now. Legislation for it was enacted in 1994, before Bupa entered the market - a point made by Justice Mary Finlay when she rejected Bupa's demands to suspend the introduction of risk equalisation payments to VHI from the beginning of this year.

Vivas, the new entrant, will not have to pay under risk equalisation for about two years, but it is also opposed to the payment. It has about 2 per cent of the market, but this is bound to increase, judging by its marketing campaign directed at the young and by the annual 6 per cent it pays to brokers.

It could be argued that those who are against community rating are, in effect, advocating that the sick should pay more. Thankfully, community rating and risk equalisation are accepted, and indeed promoted, by most political opinion.

So operators in this area have to accept, or leave, unless Bupa succeeds in its legal action to test the constitutionality of the scheme in the High Court early next month, and later before the European Court of First Instant.

Bupa has made it clear that it will leave the market if risk equalisation is introduced. Despite the huffing and puffing, an exodus is unlikely. While it has been estimated to benefit VHI to the tune of €30 million per annum, the payments, set every six months, should go down as Bupa's portfolio of customers ages.

Also, it does not all come in at once. Based on industry estimates, the half year payment in September or October could be about €7.5 million; it will not be surprising if Bupa holds this in escrow, pending the outcome of the court actions.

But what would happen if Bupa, with about 20 per cent of the market, was to terminate its business here? Bupa has said that a number of its younger members would leave the market rather than subscribe to VHI. Even if this were the case, it would be a delightful scenario for VHI, which could mop up an attractive portfolio.

However, having such a dominant share of the market would hardly be in the best interests of the health insurance market. Indeed, a market with many players would be healthier.

The decision to convert VHI from a statutory body with a board of directors into a commercial semi-State company is a welcome one. The new structure will give VHI more freedom. It will, for example, be able to set price increases without reference to the Minister. A wise political move. And it will shortly be able to set up subsidiary companies. This is important because up to now it has had to bring in outside investors, as in the case of VHI Swiftcare.

But has the State a valid claim to consolidating its ownership of VHI? It has not funded VHI. Indeed, at one stage, it raided its meagre coffers by insisting on a dividend payment.

The creation of a mutual society, or a provident society, like Bupa in the UK, would have been much more equitable. In this scenario, the State would get nothing and any future surpluses could be retained for the benefit of healthcare.

But even the transfer into a commercial semi-State body is not straightforward. Back in 1999, the Government approved plans to invest up to £60 million (€76 million) to change it into a commercial semi-State company.

Nothing was done and this time there are no plans to inject funds into VHI. Indeed, it will not be a fully fledged commercial group for six years. In the meantime it could be argued that VHI will have an unfair advantage because it is operating with a lower solvency ratio.

Without a substantial financial injection VHI would not be sufficiently solvent, as a commercial body, to get an insurance licence from Ifsra, the financial regulator.

Its solvency ratio at the moment is about 30 per cent - well below the regulator's minimum of 40 per cent. To attain this it would need an injection of about €100 million. And with projected operating losses of around €30 million for the year to end of February 2006, even more would be required.

It is ironic that the proposed payments from Bupa to VHI should, in practice, go a long way to sorting out VHI's inadequate insolvency ratio. However, it is designed, and needed, to redress the higher claims costs of its older customer base.

Bupa could make itself more profitable by reducing its cost base. Its administrative costs as a percentage of earned premiums is about 13 per cent compared with VHI's 8.6 per cent. And the latest figures from Bupa in Australia show management costs as a percentage of revenue at 7.7 per cent.

VHI has, of course, economy of scale - about 80 per cent of the market.

It also has a large corporate wage roll which is relatively cheap to run and does not pay brokers commissions.

But these advantages are dissipated by the high ratio of claims due to its older customer base; hence its need for risk equalisation.