Shares of American International Group, the world's largest insurer, plunged 21 per cent Tuesday as concerns grew over the company's ability to raise enough money to avoid a liquidity crunch.

AIG shares closed down $1.01 to $3.75 US on the New York Stock Exchange after staging a late rally from a daily low of $1.25. They had traded as high as $70.13 in the past year.

The insurer's woes could lead to even more global financial turmoil that has been fuelled by the bankruptcy filing by investment bank Lehman Brothers and the sale of Merrill Lynch to Bank of America.

AIG insured many of the trades handled by investment banks on Wall Street, including derivatives instruments linked to morgages, which have rapidly dropped in value.

On Monday night, S&P, Moody's and Fitch all cut their ratings on AIG at least two notches, which could require it to post billions of dollars in collateral on derivatives contracts.

In a regulatory filing last month, AIG estimated that a one-notch downgrade in its long-term senior debt ratings by both S&P and Moody's would force it to post $13.3 billion in extra collateral.

The insurer has been working with regulators to create a financing plan.

New York state has already relaxed its regulations to allow AIG to use $20 billion US of assets held by its subsidiaries to provide cash needed to remain in business.

S&P credit analyst Rodney Clark said that arrangement is a "helpful starting point," but AIG will "definitely need added capital and liquidity."

"Getting some kind of liquidity facility in the next couple of days will help confidence," Clark said.

With files from the Associated Press