May 8 (Bloomberg) -- American International Group Inc., the world's largest insurer by assets, plans to raise $12.5 billion after posting its second straight record quarterly loss, sending the shares down 7.7 percent.

AIG had a first-quarter net loss of $7.81 billion, or $3.09 a share, compared with earnings of $4.13 billion, or $1.58, a year earlier, the company said in a statement. Standard and Poor's lowered AIG's credit rating after the insurer reduced the value of contracts it sold to protect fixed-income investors by $9.11 billion and marked down other holdings by $6.09 billion.

Chief Executive Officer Martin Sullivan's job may be on the line unless he stems losses from the subprime mortgage collapse and reverses a 12-month stock decline of 38 percent. Sullivan in December said writedowns from the housing market would be ``manageable.'' In February, the New York-based insurer said losses by the unit that sells the fixed-income contracts won't be ``material'' over time.

``There aren't a lot of positives to take away from this,'' said David Havens, a credit analyst at UBS AG in Stamford, Connecticut, in a note to investors. ``Management capability issues, which have been smoldering for a while, are likely to flare up.''

Excluding capital losses and the change in the value of some derivatives, the first-quarter loss was $1.41 a share, missing the average 34-cent loss estimate of 17 analysts surveyed by Bloomberg.

Stock Decline

The insurer dropped $3.40 to $41.07 at 6:04 p.m. New York time in extended trading.

AIG has already started raising capital, offering $7.5 billion in stock, debt and equity units that obligate holders to buy shares. The insurer will issue another $5 billion in fixed- income securities later, spokesman Chris Winans said.

The financial products business, co-founded by Joseph Cassano in 1987, guaranteed more than $500 billion of assets for fixed-income investors at the end of 2007, including $61.4 billion in securities tied to subprime mortgages. Cassano stepped down after AIG reported a $5.29 billion loss in the fourth quarter.

AIG today named Chief Financial Officer Steven Bensinger its new vice chairman overseeing financial services, which includes the unit Cassano used to head. The company said it's conducting a search for a new CFO, and will also create a chief administrative officer position.

Beyond Expectations

``The severity of the unrealized valuation losses and decline in value of our investments were beyond our expectations,'' Sullivan said in the statement.

Standard and Poor's lowered AIG's credit rating to AA- from AA, saying the level of the losses exceeds expectations.

``Weaker operating performance in several units and unrealized investment losses somewhat reduce the ability of subsidiaries to provide dividends to AIG,'' the ratings firm said in a statement.

AIG hasn't had two consecutive quarterly losses since its initial public offering in 1969.

The world's largest financial institutions reported at least $318 billion in asset writedowns and credit losses tied to the worst U.S. housing slump in more than a quarter century.

Accounting Rules

Sullivan, 53, has been trying to persuade regulators to relax accounting rules tied to the writedown. So-called mark-to- market rules require companies to estimate a value on holdings that haven't traded, with the change recorded as an unrealized gain or loss even though the asset wasn't sold.

The 24-company KBW Insurance Index has dropped about 9.6 percent this year as most insurers in the group reported first- quarter profit declines or losses. Rates charged by commercial insurers fell 14 percent in the first quarter from a year earlier as insurers competed for revenue, according to a survey by the Council of Insurance Agents & Brokers in Washington.

AIG's mortgage insurer, United Guaranty Corp., had a $352 million operating loss, compared with profit of $7 million a year earlier. The unit, which reimburses lenders when borrowers don't pay their loans, may post operating losses through this year, Sullivan told analysts in a February conference.

U.S. homeowners with private mortgage insurance defaulted on 37 percent more loans in March than a year earlier, according to the Washington-based Mortgage Insurance Companies of America.

Commercial Insurance

Profit at AIG's U.S. commercial insurance unit fell 48 percent to $958 million on workers' compensation costs and expenses from tornadoes.

U.S. catastrophe losses for insurers more than doubled to $3.35 billion in the three months ended March 31 as storms pushed claims costs to their highest first-quarter levels in 14 years. Tornadoes that struck from Texas to Ohio in February cost insurers $955 million, according to Insurance Services Office Inc., a Jersey City, New Jersey-based firm. Winter storms on the U.S. West Coast caused $745 million in insured property losses.

AIG, which gets about a third of its revenue from sales of life insurance and retirement savings products outside the U.S., said profit in that division fell 4.1 percent to $1.46 billion, on a decline in so-called partnership investments, which typically include private equity or hedge funds.

AIG, founded in Shanghai in 1919, is competing with rivals MetLife Inc. and Prudential Financial Inc. to sell products that replace income or protect wealth for aging populations in nations including South Korea and Japan.

Mortgage Lending

Operating profit at AIG's American General Finance fell 78 percent to $11 million as the mortgage lender increased its allowance for loan losses.

Sullivan succeeded Maurice ``Hank'' Greenberg as CEO in March 2005. Two months later, then-New York Attorney General Eliot Spitzer sued AIG and Greenberg, accusing him of ordering improper transactions to hide losses and inflate reserves.

Greenberg denies any wrongdoing in the case, which is still pending. Spitzer dropped portions of the lawsuit in 2006 that included four other allegations tied to the investigation.

Citigroup Inc. and JPMorgan Chase & Co. are managing AIG's offerings.

(To hear AIG's first-quarter conference call tomorrow at 8:30 a.m. New York time, visit LIVE.)

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

Last Updated: May 8, 2008 18:39 EDT