Sri Lankan insurers are expected to separate life and general businesses under regulatory changes.
"Fitch expects poor underwriting discipline to continue as insurers strive to gain critical mass in both the life and non-life segments before rules requiring the separation of these two businesses are implemented," the rating agency said.
"This will pressure the financial performance of the more aggressive players while challenging the market shares of others."
Though there were operational challenges and uncertainty, Fitch said regulatory changes in separating life and non-life businesses, implementing risk-based capital (RBC), increase in minimum capital and public listing as positive for the industry.
The agency said higher minimum capital and splitting of businesses may also encourage consolidation if there is strong enforcement of regulations.
Consolidation of smaller insurers with low capital bases would be positive to the industry Fitch said.
"The entry of foreign investors to the market demonstrates confidence in the growth potential of the Sri Lankan insurance industry, where the penetration levels are very low compared to the rest of Asia," the report said.
"Fitch believes that greater penetration will depend largely on an increase in disposable income in this market where insurance is viewed as a discretionary product by many."The outlook could change to negative if there was a sharp fall in capitalization or solvency ratios and composites before or after the split, sharp falls in the value of stock portfolios, or increased price competition in motor.