The European Commission has rejected the Government's defence of its policy that allows VHI Healthcare to maintain lower financial reserves than rival health insurers.

EU commissioner Charlie McCreevy said yesterday he would issue a final warning to the State over the derogation that VHI enjoys from strict Irish capital reserves rules.

If the Government did not respond to the commission's concerns about the health insurance market, he would take a case to the European Court of Justice, he added.

"The reply of the Irish Government is somewhat defensive... It wasn't convincing enough and just repeats the existing situation," said Mr McCreevy, who added that he hoped the matter could be resolved before it got to Europe's top court in Luxembourg.

Mr McCreevy also told RTÉ News the commission may comment on the provisions of a new health insurance bill being prepared by the Government.

The Government has told the EU commission that it would be impossible to terminate immediately the derogation enjoyed by State-owned health insurance company VHI in relation to the level of financial reserves that the company must maintain.

The Government has said that to eliminate the derogation overnight would either involve the introduction of a subvention from the exchequer or "an unsustainable increase in prices".

"The only outstanding issue is one of timing. We have made the case that it is not feasible to end the derogation as quickly as the Commission may wish, but discussions were by no means closed on that matter which is under review", it said.

Earlier this year the EU Commission initiated the first stage of legal proceedings against the Government over exemptions to solvency requirements provided to the VHI. This followed complaints lodged by rival health insurer Vivas.

On foot of the derogation from the first non-life directive, which governs solvency requirements and which was introduced in the 1970s, VHI only maintains financial reserves equal to around 23 per cent of its premium income.

Vivas, under rules set down by financial regulatory authorities in Ireland, has to maintain reserves of around 40 per cent of premium income.

Vivas has contended that VHI was only granted the derogation on the basis that it kept to its core business. Vivas has alleged that in recent years VHI has diversified into other areas such as travel and dental insurance.