NEW YORK ( TheStreet) -- American International Group ( AIG) said Tuesday it is finally starting to pay off some of its government debt, although not with cash.

AIG is cutting $25 billion off its tab with the Federal Reserve Bank of New York by issuing preferred equity stakes in two life insurance subsidiaries. AIG now owes the Fed $17 billion, and the amount of credit available under its government credit facility has been lowered to $35 billion from $60 billion.

The move will result in a $5.7 billion, fourth-quarter amortization charge for AIG. And while it is an incremental step toward independence, the government will still have a nearly 80% stake in the insurer through its ownership of preferred stock.

The Fed will receive positions in American International Assurance and American Life Insurance, which are being primed for public offerings or a sale, depending on market conditions and regulatory approvals. AIG also said that it has furthered the separation of American Life Insurance by placing it in a special purpose vehicle.

"Today's announcement ... sends a clear message to taxpayers: AIG continues to make good on its commitment to pay the American people back," AIG CEO Bob Benmosche said in a statement.

The deal is part of a previously announced plan to start repaying the government and strip the insurance conglomerate down to a core property and casualty business. So far, AIG has recognized $11.7 billion in amortization expenses from the Fed credit facility, as it has declined from $85 billion in the fall of 2008 to $35 billion today.

The Fed also has purchased roughly $50 billion worth of AIG's toxic debt, including credit-default swaps that were extinguished with large banks such as Goldman Sachs ( GS), Bank of America ( BAC), Wells Fargo's ( WFC) Wachovia, Deutsche Bank ( DB), UBS ( UBS), Credit Suisse ( CS) and Societe Generale. The Treasury Department also took a $40 billion preferred stock investment in AIG and extended a $30 billion credit line.

-- Written by Lauren Tara LaCapra in New York

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