The EU Commission has initiated the first stage of legal proceedings against the Government over exemptions to solvency requirements provided to the State-owned health insurer, the VHI.

The commission yesterday said it had sent "a letter of formal notice" to the Government, the first stage of infringement procedures under the EU treaty. If pursued, the case could end up at the European Court of Justice. The Government now has 30 days to respond to the letter.

Depending on its analysis of the reply, the commission will decide on whether to issue a "reasoned opinion", formally calling on the Government to amend the relevant legislation. The commission's move follows a complaint lodged by Vivas Health that the VHI was unlawfully pursuing insurance activities without being subject to the first non-life insurance directive.

The VHI was initially granted a derogation from the directive, which governs solvency requirements, in 1973 on the basis that it kept to its core activity of health insurance. Vivas has contended that in recent years the VHI has diversified and provides travel and dental insurance and the Swiftcare emergency clinics.

At present, Vivas has to maintain reserves equal to around 40 per cent of subscription income. The VHI's reserves stand at around 23 per cent of income.

Minister for Health Mary Harney told the VHI last year it would have to bring its reserves up to normal commercial levels by 2012. In its statement yesterday, the commission said: "It is clear from the number of amendments to the relevant legislation introduced in 1996, 1998 and 2001 that the capacity of the VHI has changed significantly."

"For these reasons, the commission is of the view that the exemption from the scope of the application of the First Non-Life Insurance Directive may no longer be valid. In that case, the VHI should be made subject to the provisions of EU non-life insurance legislation and hence, be subject to the same regulatory framework as other operators on the market," it said.

The commission said it had requested the Department of Health to provide further clarification so it could assess whether the exemption was still valid. A spokesman for Ms Harney said issues raised by the commission were being dealt with by the department.

He said legislation aimed at placing the VHI on a commercial footing was being drafted. He added that the department was awaiting a report from the Competition Authority and the Health Insurance Authority on the future of the VHI and the market.

The VHI said yesterday it was committed to complying with the directive.