The European Commission has come down on the side of Bupa in the continuing battle between it and its competitor, the State health insurer VHI.
The Brussels body has sent a letter to the Government warning it that it could be in breach of EU rules if it triggers the so-called risk equalisation scheme (RES), intended to fund community-rated charges for health insurance.
The letter, which has the full backing of internal market commissioner Charlie McCreevy, says the amount that would have to be paid under the scheme risks being "disproportionate".
"The aim of the RES is to ensure community rating.
"In this context, we would be inclined to take the view that a requirement to pay under the RES an amount so significant that it would force an operator to exit the market would seem to discourage other operators from entering the market and does, in any event, seem disproportionate," it says.
The letter in effect takes Bupa's side of the case. Bupa, which lodged a complaint with the commission, has argued that the estimated €34 million it would have to pay next year under risk equalisation would drive it out of business.
Under the scheme, profits from young health-insurance subscribers are used to offset losses from older customers, who are more likely to claim on insurance.
This would mainly benefit VHI as it has 80 per cent of the market and the biggest number of customers more than 49 years old.
The commission asks the Government to send it, within one month, any "further information" it considers useful.
A spokesman for Mr McCreevy said the commissioner wanted to "see competition maintained" in the health insurance area.
The commission believes the nub of the problem is the fact that the Government decides every six months whether to introduce risk equalisation on the basis of reports by the Health Insurance Authority. This creates too much uncertainty for health-insurance providers.
The letter points to the EU's third non-life insurance directive, which governs the setting up of private health coverage in member states.
This directive says that member states may have basic requirements to protect the general good such as "open enrolment" or "rating on a uniform basis", but they cannot "unduly restrict" the setting up of insurance companies.
The commission's letter lends weight to Minister for Health Mary Harney's June decision not to introduce risk equalisation. At the time, she indicated it was because she wanted more competition in the health-insurance market.
Bupa declined to comment directly, not having seen the letter, but marketing director Sean Murray said the company would welcome "any initiative which would preserve and promote competition in the Irish health-insurance market".
For its part, VHI has warned that not introducing RES would mean that it is at risk of going under.