The insurance industry will not be forced to set up a compensation fund for British victims of terrorist attacks abroad.

There had been fears that the Victims of Overseas Terror Bill would require insurers to contribute to a pooling arran-gement similar to property reinsurance vehicle Pool Re.

But following a recent debate in the House of Lords, Lord Davies, for the government, said: "We don't think it is the government's role to compel insurers to offer cover. We don't believe that there's a market failure which warrants the government to intervene. Decisions on price and cover are ultimately commercial ones for the insurer."

Lord Davies said Treasury ministers would continue to work closely with the industry to ensure that terrorism cover is readily available and that consumers are made aware of where exclusions exist.

He said: "Insurance covering individuals for terrorism in certain cases is available on the market and we regard the task of government to raise awareness of what people are purchasing in travel policies."

Ministers have signalled that the bill was "fraught with problems", meaning it highly likely MPs will block the proposals in the Commons despite an unopposed second reading in the Lords.

Tory Lord Sheikh, chairman and chief executive of broker Camberford Law, said where there were risks of terrorism abroad, insurers would underwrite that separately and the premiums would be high.

He said that for any scheme to be "meaningful" it had to be compulsory like employers' liability and motor insurance for third-party risks – but it would be seen as an unpopular tax on holidays and travel.

The Bill is expected to reach the Commons in June or July.