March 4 (Bloomberg) -- U.S. taxpayers may not be done bailing out American International Group Inc. after the head of the Federal Reserve said a fourth rescue of the insurer was needed to keep the financial system from failing.

Fed Chairman Ben S. Bernanke testified to the Senate yesterday that AIG’s collapse “would be devastating to the stability of the world financial system” and would keep the U.S. government from recouping its investments, which had already ballooned to $150 billion. A day earlier, the Fed had warned that AIG may need more support if markets don’t stabilize and improve.

“We’re not done with AIG by a long shot,” said Phillip Phan, professor of management at the Johns Hopkins Carey Business School in Baltimore. “The problem is we still don’t know the extent of the risk AIG has. We don’t know where the bottom is.”

The rescue, which now leaves taxpayers on the hook for $163 billion at AIG, a government official said, was raised after the New York-based company reported a $61.7 billion fourth-quarter loss on March 2. AIG still has billions of dollars in unrealized losses on assets and faces declining revenue on premiums because of the slump in commercial insurance and the company’s struggle to attract new business.

AIG rose 2 cents to 45 cents a share at 11:18 a.m. in New York Stock Exchange composite trading. The stock has plunged 99 percent in the past year and traded as high as $49.50 last May.

AIG’s Bailout

AIG was first saved in September with an $85 billion rescue, and handed over an 80 percent stake to the U.S. government. The bailout swelled to $122.8 billion and then $150 billion as the government sought to prevent losses at banks that did business with the insurer. The bulk of AIG’s losses, which totaled more than $100 billion in the past five quarters, are related to credit-default swaps sold to investors to protect them from the declining value of financial assets.

Billionaire Warren Buffett, in his annual letter to Berkshire Hathaway Inc. shareholders, addressed the risk posed by companies that have “large and unfathomable derivatives books.” In the Feb. 28 letter, Buffett said it will be at least year-end before the economy recovers from the reckless lending that brought down the financial system.

“Only companies having problems that can infect the entire neighborhood -- I won’t mention names -- are certain to become a concern of the state,” Buffett wrote.

The U.S. agreed to accept a lower interest rate on loans to AIG and to exchange $40 billion in preferred stock for new non- cumulative preferred shares that resemble common equity, the Treasury and Fed said. AIG will pay down the federal loan of about $38.9 billion, partly by turning over its two largest international life insurance units valued at about $26 billion.

Philippine Sale Scrapped

The company today scrapped a sale of its Philippine life insurance unit and will make it part of its AIA group. AIG is seeking to sell American International Assurance Co. to raise money to pay back a portion of the government’s rescue.

Bernanke told the Senate Budget Committee yesterday that because AIG has so many counterparties, its failure “would have had very adverse effects on the banking system.” The company’s growth in risky markets is attributable to a lack of regulation, he said.

“This was a hedge fund basically that was attached to a large and stable insurance company,” Bernanke said. It “made huge numbers of irresponsible bets, took huge losses. There was no regulatory oversight because there was a gap in the system.”

‘Backup Facility’

AIG Chief Executive Officer Edward Liddy replaced Robert Willumstad in September as part of the government rescue. Liddy said on a conference call this week that the five-year $30 billion capital commitment from the Treasury is a “backup facility,” and the company has plenty of cash. AIG is focused on protecting policyholders and paying back the government, Liddy said.

AIG spokesman Christina Pretto didn’t comment beyond Liddy’s statement.

The insurer will probably need more government funds to cover contract liabilities and declines in asset values, according to Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania. At the end of December, AIG had $27 billion in unrealized losses on swaps, options and forward contracts and $25 billion in pretax gross unrealized losses on bonds and equity securities. Credit-rating downgrades on structured finance products may also boost losses, Egan said.

“We expect the U.S. will continue to support AIG until it is no longer too big to fail,” Egan wrote in a March 2 report.

‘No Idea’

Troubled assets on AIG’s books lost about $10 billion in value in the weeks before a bailout in November. The losses were on about $100 billion of assets acquired by two government- supported entities set up by the Fed.

“We now know that the government had no idea what kind of investments these were, and they had no idea what the downside really was,” said Janet Tavakoli, president of Chicago-based Tavakoli Structured Finance and author of several books on complex securities.

The company’s woes are also driving away potential customers. General insurance net premiums written slumped 16 percent in the fourth quarter to $9.2 billion. Within that business, premiums for commercial insurance fell 22 percent to $4.4 billion, AIG said.

“If you’re having more difficulty writing business in your general insurance operations, that’s got implications for cash flow that aren’t positive,” said Bill Bergman, an analyst at Morningstar Inc. in Chicago.

To contact the reporters on this story: Ari Levy in San Francisco at alevy5@bloomberg.net; Hugh Son in New York at hson1@bloomberg.net.

Last Updated: March 4, 2009 12:05 EST