China's insurance industry is likely to grow at a slower pace and face lower profit margins next year because fierce competition, industry observers have said.

"Insurers are no longer just focusing on pure growth. Many players are becoming more profit oriented, with a higher awareness of risk management and willingness to diversify into new product areas," said Standard & Poor's credit analyst Connie Wong. "And that should mean more sustainable growth in the longer term."

Fitch Ratings' analysts also believe that the life insurers' increasing product diversity and greater emphasis on margin improvement, instead of market share, will support quality growth in the sector in 2014.

However, S&P expects a continued negative bias in credit trends for life insurers over the next 12 months because of the slower growth, volatile operating performances and the modest capitalization of many complanies.

The industry may need additional capital to support the continued growth of assets and cover the level of underwriting exposure, liabilities, and other operational risks, S&P added.

"We estimate that the insurance industry could face a shortfall of 200 billion yuan ($32.88 billion) to 270 billion yuan over the next two years to support growth based on our assumptions and benchmark calculation for a BBB capital adequacy confidence level," said Wong. "The shortfall could be even higher if the potential funds from the capital markets dry up or are much lower than we anticipate."

On the non-life insurance sector, the country's continued urbanization drive and rising household wealth will sustain the growth dynamics, but intense rivalry will further weaken the sector's underwriting margins in 2014, Fitch said in a report on Friday.

In light of the falling underwriting margins, Fitch believes small insurance companies with limited operating scale and less diversified insurance books will post weaker operating results in the coming year.

Major listed Chinese non-life insurers will still maintain positive growth in underwriting surplus, albeit at a slower pace, because of diverse revenue streams and better spread of risk.

"Ongoing business expansion coupled with slower surplus growth will continue to pose a strain on insurers' capital adequacy, although many insurers improved their solvency adequacy through fresh equity injection or subordinated debt issuance over the past year," said Terrence Wong, director of insurance at Fitch.

Non-life players are likely to see premium growth of 15 percent to 20 percent over the next 12 to 24 months, S&P said.

But the segment's performance can be volatile and subject to unexpected natural disasters. Inadequate pricing, or underestimated risk profiles, of commercial property and marine lines in China are likely to continue because of stiff competition.