Insurance giant American International Group settled sweeping state and federal fraud probes yesterday by agreeing to pay $1.64 billion in fines and restitution, twice the highest penalty ever previously imposed on a U.S. company.

But the cost to AIG's reputation cut deeper. The company said an independent consultant's review had uncovered a $1.7 billion deficiency in its underwriting loss reserves, half related to its previously underestimated exposure to environmental and asbestos claims.

All told, AIG will record nearly $2.3 billion in after-tax charges to its fourth-quarter 2005 earnings. That comes atop a $1.3 billion reduction to its previously reported 2004 earnings last year, amid government investigations and the forced resignation of former chairman and CEO Maurice Greenberg.

New York Attorney General Eliot Spitzer, whose inquiry into insurance industry sales and commission practices led to Greenberg and a wide range of alleged abuses, called AIG "a solid company that didn't need to cheat. It finds itself in this position solely because some senior managers thought it was acceptable to deceive the investing public and regulators."

Mark Schonfeld, director of the Securities and Exchange Commission's Northeast Regional Office, which joined the state's investigation, said, "We have sought to balance AIG's historical misconduct with its new approach to compliance and cooperation with regulators and law enforcement."

However, Greenberg spokes-man Howard Opinsky said many of the regulators' allegations previously had been "debunked" in a report by the former CEO's legal defense team last year that termed the company's financial restatements "exaggerated and unnecessary" and argued that Greenberg, now 80, had relied on trusted advisers.

Insurance rating company A.M. Best said the latest reversals of fortune compromised the capital levels of AIG's domestic brokerage group, which "were not considered robust before and therefore provided little cushion for the restated earnings and reserve charge."

"It's a big amount of money even for a huge company like AIG to have to pay out," said Celent insurance analyst Donald Light.

The settlement dwarfs the $850 million Spitzer's office levied last year against insurance brokerage Marsh & McLennan.

Greenberg and former CFO Howard Smith still face civil fraud charges in New York state court. Another former AIG executive, Christian Milton, faces a criminal charge related to the company's dealings with Berkshire Hathaway subsidiary General Re.