Oct. 26 (Bloomberg) -- American International Group Inc., the insurer that lost half its highest-paid executives in the past year, may face further defections after the Treasury’s pay master slashed salaries and limited bonuses.

Cash salary was reduced by 91 percent for twelve of the New York-based insurer’s top executives under recommendations by Kenneth Feinberg, according to documents issued last week. Bonuses will be withheld for five managers in the Financial Products unit of AIG responsible for terminating the derivatives trades that fueled most of the company’s almost $100 billion in 2008 losses, Feinberg said.

“If there’s a lot of difficult work ahead in unwinding the AIG Financial Products book, restrictions might prove counterproductive because you’ve got complex pieces of business that require a high level of specialization,” said David Havens, managing director at investment bank Hexagon Securities LLC. “Most of the people that have that don’t come cheap.”

Chief Executive Officer Robert Benmosche must retain staff to unwind derivatives and preserve the value of units he is trying to sell to repay loans including in AIG’s $182.3 billion bailout. Feinberg has jurisdiction over the 25 highest-paid employees at AIG and six other firms that got U.S. bailout funds. Thirteen managers who would have been under Feinberg’s jurisdiction have left AIG, he said.

‘Counterproductive’

More than 40 managers including restructuring chief Paula Reynolds, vice chairman Matthew Winter and property-casualty executive Kevin Kelley have left AIG since the insurer’s September 2008 bailout. Winter joined Allstate Corp. as head of the life insurance business and Kelley became CEO of Ironshore Inc. Christina Pretto, an AIG spokeswoman, declined to comment.

“It could be counterproductive in the short-term, they may lose people they wanted to keep, but from the longer-term perspective, it could be the right move” to make an example of the AIG unit, said Bill Bergman, an analyst at Morningstar Inc.

Feinberg ruled last week that cash salaries at the insurer couldn’t exceed $500,000 a year unless “good cause” was shown. Compensation would include stock units tied to four major AIG divisions that are paid out in three annual installments.

An exception is Benmosche: his salary is $3 million in cash, $4 million in shares, and as much as $3.5 million in long- term incentive awards. Benmosche told employees in an Aug. 4 town hall-style meeting that securing compensation agreements with Feinberg was a top priority.

“I want to make sure we all get paid competitively,” he said, according to a recording of the event. “If you shoot the lights out in a given year, we should have enough flexibility to give you a big increase.”

‘Proper Balance’

Feinberg said his AIG ruling sought to balance the goal of curbing excessive pay with the need to retain staff.

“With AIG as with the other companies, I believe we struck that proper balance between public dissatisfaction with principled decisions on compensation that will keep people at their chairs, attract talent and let the company prosper in order to pay the taxpayer,” Feinberg said Oct. 23 in a Washington speech. “That’s the real goal.”

Feinberg doesn’t have jurisdiction over the “vast majority” of AIG employees and employee turnover has stabilized, Benmosche said in an Oct. 21 letter to employees.

Feinberg, who formerly oversaw the September 11th Victim Compensation Fund, is also responsible for setting pay at Citigroup Inc., Bank of America Corp., Chrysler Group LLC, Chrysler Financial Corp., General Motors Co. and GMAC Inc.

To contact the reporter on this story: Hugh Son in New York at hson1@bloomberg.net

Last Updated: October 26, 2009 08:40 EDT