Captive insurers, whose investment strategies have demonstrated an increased tolerance for risk over the past few years, are rethinking their market moves in anticipation of a potential correction.

Some captive owners already have begun restructuring their portfolios not only to protect their investments from a market plunge but also to take advantage of the opportunities a downturn would present. While traditional insurers have to worry about demonstrating to the public the liquidity of their investments in case assets are needed to pay claims, captives can afford to be more heavily invested in stocks.

"They just have to worry about their own parents," said Sean Mooney, senior vp at the Insurance Information Institute in New York.

"In general terms. . .a captive that's not a publicly traded entity (but has) the same capitalization as a publicly traded entity can afford a somewhat riskier and more long-term oriented investment strategy," said Anders Ekernas, president of ABB International Management Corp. in Stamford, Conn. ABB is an investment manager whose clients include captives and other insurers.

And, "a strongly capitalized single-parent captive can be more aggressive than a group captive," he added.

Indeed, many captives have been taking advantage of the bull market.

"We've run a more aggressive portfolio over the past five years," said Marc Werner, president of Boulder, Colo.-based Manufacturers Indemnity Insurance Co., the captive subsidiary of climbing-products manufacturer Werner Holding Co. (PA) Inc. in Greenville, Pa.

But Manufacturers Indemnity's aggressive investment strategy came to an abrupt end at the beginning of this year.

With the market up more than 50% in the past 24 months, Mr. Werner decided to harvest some of his company's profits "to protect us in case there's a 25% downturn," he said. "Although the market may remain buoyant for the next year or two, we've restructured our entire investment portfolio to be more conservative."

As part of that new conservative strategy, Manufacturers Indemnity as of Dec. 31, 1996, liquidated many of its holdings in outside money management companies and limited partnerships as well as its hedge and arbitrage funds, Mr. Werner explained.

Since the beginning of this year, 75% of the captive's assets have been redeployed into more conservative instruments, such as short-term money market funds and U.S. Treasury bonds maturing in two years or less.

The objective is to stay as liquid as possible so that Manufacturers Indemnity can take advantage of the drop in equity prices if a stock market correction occurs, Mr. Werner said.

"We're not buying any stocks and are staying liquid so that we'll have the money available to invest when the correction occurs," he said. "From a stock trading standpoint, we'll be more nimble."

By contrast, however, the remaining 25% of Manufacturers' portfolio will be more aggressively invested, according to Mr. Werner.

He has his eye on small-cap stocks, which are those issued by small companies, and on doing some private placements with companies-"things that aren't as liquid."

Mr. Werner also plans to maintain his strategy of investing in property tax delinquent liens, which yield returns averaging 12% to 15% on investment.

"That's been a real success for us," he said. "They have a good return, short maturity and have the same risk profile as Treasury bills."

Some financial experts think Mr. Werner's strategy is prudent.

"It's smart, said Mr. Ekernas. "They are willing to forego the higher returns in an effort to minimize or avoid the potential losses if the market were to correct," he said.

For the most part, captives usually don't spread their investment risks as well as they spread their underwriting risks, said Hugh Lamle, executive vp of M.D. Sass Investors Services Inc. in New York. The company manages funds for many large corporations, including insurers and captives.

"They tend to invest in mid-term bonds and some equities rather than in more conservative and more risky instruments," Mr. Lamle said. "It has to do with what your liquidity needs are and how well-funded you are."

"We try to have sufficient cash and short-term bonds to pay for immediate needs, such as reserves. Then, the rest goes into long-term, high-yield instruments," he said. "By combining short-term, mid-term and long-term investments, we can make the same returns as having all long-term investments," Mr. Lamle said.

For example, as interest rates rise, the interest earned on cash investments can offset any losses from the decline in bond prices that usually accompanies interest rate increases, he explained.

Mr. Lamle also advises captive clients to spread their investment risks on a "timing" basis so each instrument matures at a different time.

"It's called diversification across time and across asset classes," he said.

Investing a captive's additional resources also can be advantageous from a tax standpoint, Mr. Lamle pointed out. A captive's stock market windfall is not subject to the same capital gains tax liability as its parent company's return on such investments would be, he explained.

But no matter what kind of hedging strategy captives like Manufacturers Indemnity employ, it's impossible to time the market, experts agree.

In fact, some investors who tried to take advantage of past anticipated stock market corrections have been burned.

"Those who've made changes in the past anticipating a correction lost a lot of money," recalled Mr. Ekernas. "They obviously have been severely penalized."

As a result, "investors have capitulated in most cases and said, 'We can't time the market and there's no point trying, so we're just going to go with the flow,'*" he said.

Indeed, in the current bull market, "the environment has been such that anything but an aggressive equity investment strategy is a losing strategy," he acknowledged.

"As we have logged 35% returns in the equity markets, the temptation to try to capture that return has pulled money out of more conservative investments," he said.

Still, "this would be an extremely inappropriate time to throw caution to the wind and invest heavily in equities," Mr. Ekernas cautioned.

Mr. Lamle agreed. "We've done our own analysis, and for the stock market to get the same return as it has for the past 30 years-an average of 10.7%-earnings will have to average 8.7%-higher than ever before.

He said the highest sustained annual growth in corporate earnings to date has been 7%.

"It's unlikely we'll see the same returns," he said. "We're in for a period of slower growth."

Judy Greenwald contributed to this report.