"The government really does not have the option of letting AIG totally blow up," said Robert Haines, senior insurance analyst at CreditSights. "The counterparties on most of the book are (European) banks that would be hammered if the U.S. walked away," he said. "Hopefully, the third bailout will be the charm."
The rejigged bailout, which changes the terms of an earlier $150 billion rescue, is the latest example of how federal authorities are having to revamp aid for top financial institutions as the global financial crisis deepens.
Last week, the government agreed to boost its equity stake in Citigroup to as much as 36 percent in a bid to bolster the bank, already the recipient of billions of dollars in taxpayer funds.
The dollar rose against most other currencies in Asia as news of the deal emerged.
Debt To Equity
Under the deal, the interest rate on AIG's credit line from the government would be cut to match the three-month London Interbank Offered Rate (Libor), now about 1.26 percent, the sources said. This would save AIG about $1 billion a year.
AIG now pays 3 percentage points above three-month Libor on the $60 billion credit line.
The additional equity commitment, which will be funded from the $700 billion Troubled Asset Relief Program, would give AIG the ability to issue preferred stock to the government later, the sources said.
AIG will also give the Federal Reserve a preferred-stock interest in its American Life Insurance (Alico), which generates more than half of its revenue from Japan, and Hong Kong-based life insurance group American International Assurance (AIA) in return for reducing its debt, they said.
The two businesses will be transferred into separate trusts but AIG will still own the common equity, one of the two sources said. The government likely will get a 5 percent cumulative dividend on its preferred-share stake in these trusts, the source with direct knowledge of the matter said.
AIG had been trying to sell Alico and part of AIA. Sales of these assets are still a possibility, with some bids already received, the source said. A second option under consideration is to take these units public when markets improve, the source added.
CNBC sources say though that AIG plans to take AIA and Alico public when market conditions improve. The source adds that AIG and the U.S. have not agreed on valuation for AIA or Alico.
AIG may also securitize some U.S. life insurance policies and give them to the government to further reduce its debt, the sources said. The company may securitize up to $10 billion under that plan, one source said.
The debt-to-equity swap and securitizations could help AIG repay much of the roughly $38 billion it has drawn from its government credit line, that source said.
Spinof For Property-Casualty
Last year, AIG said it planned to sell all assets except its U.S. property and casualty business, foreign general insurance and an ownership interest in some foreign life operations, to pay back the government.
While the company has announced some sales, it has found it difficult to find buyers and get a good price for assets amid the financial crisis.
AIG now plans to spin off up to 20 percent of the property-casualty business in an initial public offering and eventually could spin off the business entirely, one source said.
The business would be renamed to differentiate it from AIG, and have its own management and board of directors.
To aid the auction of at least one major asset, the government could help potential buyers of aircraft lessor International Lease Finance Corp with financing, the sources said.
ILFC has some debt coming due in 2009 and, if needed, AIG could use its new equity commitment to help potential buyers with that, one of the sources said.
An AIG spokeswoman did not respond to requests for comment.
The deal was reached as AIG prepared to report a quarterly loss of about $60 billion.
The loss would include up to $25 billion in investment losses, about $20 billion in writedowns and up to $15 billion in restructuring charges, one source said.
The revised bailout would allow AIG to avoid a credit ratings downgrade that could have had serious ramifications for the insurer's liquidity and hurt its business.
Customers could, for instance, cancel their insurance policies if a minimum rating was no longer maintained.
Moody's Investors Service and Standard & Poor's both have AIG on review for downgrade from the seventh highest investment grade, and have said that the government's support was keeping the ratings from being cut to "junk" status.
AIG, which had 74 million customers at the end of 2007, has said it has been losing business and finding it harder to win new clients since it was first rescued in September after bad mortgage bets left it on the verge of collapse.
The government stepped in at the time with an $85 billion bailout, and subsequently offered additional financing, bringing the support up to about $123 billion.
Then in November, the government had to revise its bailout package, raising its total aid to about $150 billion.
AIG shares closed at 42 cents on Friday. The shares have lost 99 percent of their value over the past 12 months.
—CNBC's David Faber contributed to this report