AIG loses $5 billion on bad credit

American International Group Inc., the largest U.S. insurer, lost more than $5 billion in the fourth quarter as bad credit ate into its investments, the company said Thursday.

AIG has been thrust to the forefront of the credit crisis that is gripping financial markets because of contracts known as credit default swaps. These swaps pledge to cover missed payments on $579 billion in debt.

AIG’s swap portfolio lost $11.12 billion in value during the fourth quarter because decaying credit quality means the insured debt is less likely to be repaid. AIG also lost more than $3 billion in its investment portfolio because of “significant, rapid declines” in the value of mortgage debt.

New York-based AIG lost $5.3 billion, or $2.08 a share, in the fourth quarter, compared with profit of $3.4 billion, or $1.31, in the fourth quarter of 2006. For all of last year, the insurer earned $6.2 billion, or $2.39 a share, compared with $14.1 billion, or $5.36, the previous year.

“AIG’s results in 2007 were clearly unsatisfactory,” said Martin J. Sullivan, the company’s chief executive. “This was a challenging year in which the deterioration of both the U.S. residential mortgage and credit markets significantly affected several of our operations and investments.”

Donn Vickrey, an analyst with Gradient Analytics Inc., said AIG’s management is under pressure to show that the company grasps the risks it has taken.

AIG shares fell $2.10 to close at $50.15.