Attempts to impose a minimum financial strength rating for professional indemnity insurers will stifle competition and put small law firms at risk, the Law Society has warned.

The Solicitors Regulation Authority is consulting on plans to ban unrated insurers from the solicitors market to avoid the problems caused by insolvent providers in recent years.

The collapse of firms such as Quinn, Lemma and Balva has raised concerns over the protection of clients of law firms, forcing the SRA to consider raising barriers to entry.

But the Law Society, in its response to the consultation, said the proposal risks having a ‘destabilising effect’ on the profession and in particular smaller high street firms that have relied on unrated insurers for cover.

Those most at risk will be the one-to-four partner segment, which has a higher representation of black and ethnic minority (BME) and female-led firms.

It argued that ratings do not guarantee an insurer’s financial solvency or suitability for a particular client.

The Society’s response added: ‘We are concerned that the proposed remedy may give rise to serious competition law concern by restricting the number of insurers and raising barriers to entry.'

It also fears the impact of the ban on premiums, as well as the increased risk of exit by smaller firms, may have been underestimated.

Evidence gathered from the Law Society’s annual PII survey for the 2014 renewal period showed three unrated insurers still accounted for 22% of the solicitor market – the majority of those firms with no more than four partners.

The net effect of an insurance firm seeking a rating standard is expected to be a 5% increase in premiums due to extra administrative costs.

The Law Society also pointed out that a rating requirement would remove any source of competition. It said a proper transition period must be established before any changes can be made, which may preclude reform of the system before the 2015 renewal period.

It also wants a second round of consultation based on input from a recovery accountancy practice and the results of a competition impact assessment to ensure the SRA’s response is practicable and proportionate.

But there is acknowledgement that the regulator should act quickly to understand why the PII market is so unstable and what has caused so many insurers to fail.

‘There is an urgent need to address the systemic risk of market failure posed by unrated insurers and a repetition of the type of disruptive effects that many law firms have suffered in recent years, often with drastic consequences for their business and their clients. It is for the SRA to address that risk.’

The SRA has admitted that premiums could increase by as much as 15% for affected firms if all three unrated insurers exit the market.

According to SRA figures for 2013/14, more than 2,500 firms have policies with unrated insurers. However, the two biggest providers of the three are considering seeking a rating, leaving 134 firms potentially affected directly by the proposed rule change.