The Health Insurance Authority (HIA) believes that introducing a system that would force VHI's competitors to subsidise it could hit competition by deterring new players from entering the Irish market.

The HIA's views are contained in a report seen by The Irish Times, that recommends that the Minister for Health, Mary Harney, introduce such a system, known as risk equalisation.

The controversial scheme will force independent players, Vivas and Bupa, to compensate the State-owned VHI for the fact that its customers are older, more at risk, and therefore less profitable, than theirs.

Both have warned that if the Government introduces risk equalisation, it will put off potential new players from entering the market and limit competition. The HIA report agrees that if risk equalisation is introduced, fewer new companies will enter the market.

"The health insurance market in Ireland should still attract some new entrants, but fewer than if risk equalisation payments are not implemented," the authority's report says.

The authority's staff also conclude that if risk equalisation is implemented "the market would become less attractive to new entrants".

However, it also argues that because new entrants will not have to be assessed for risk equalisation for three years, and will have a further 12 months before making full payments, the market would still have the potential to attract new business.

The HIA is recommending that risk equalisation be introduced because the Government wants health insurance charges to continue to be based on a community rating. This means that two people with the same level of cover pay the same premium to an insurer, no matter what the level of risk. This is contrary to the insurance industry practice of charging the highest premium where the risk is greatest, and the lowest where it is least.

In theory, risk equalisation will apply to all companies operating in the Republic's market. However, as the VHI has the greatest share of customers aged over 49 years, the point at which the risk of ill-health increases, it will be the only beneficiary until its competitors' customers age considerably.

The HIA recommendation, which was flagged several weeks ago, has prompted the VHI's biggest competitor, British-owned Bupa, to threaten to leave the Irish market. It claimed that risk equalisation could cost it €34 million this year, twice its projected 2005 profit. The report also agrees that it would increase competitive pressure on Bupa.