(AIG story updated with stock price change )
NEW YORK (TheStreet) -- AIG (AIG) said Thursday it entered an agreement with the U.S. Treasury in which the Treasury would receive about 1.655 billion common shares of AIG in exchange for $49.1 billion of preferred shares allowing AIG to repay all its debt to American taxpayers and allowing the U.S. government to wind down its stake in the giant insurer.

Shares of AIG have jumped 5.5% to $39.50 in morning trading. Earlier they were surging by 11.5% to $41.76 in pre-market trading.

Under the plan, the U.S. Treasury will own 92.1% of AIG common stock, but this won't be executed until AIG's credit facility with the Federal Reserve Bank of New York is repaid in full.

After the exchange is complete, it's expected that the U.S. Treasury will sell its stake in AIG over time on the open market.

AIG currently owes the Federal Reserve Bank of New York $20 billion in senior secured debt under the FRBNY credit facility, which AIG is expected repay in full under the plan. The credit facility will be terminated in the process.

AIG expects to pay back the New York fed in part via the initial public offering of its Asian life insurance business -- American International Assurance -- and the pending sale of its foreign life insurance unit American Life Insurance to MetLife ( MET).

AIG said the plan will also help the U.S. government exit its interest in two special purpose vehicles that hold American International Assurance and American Life Insurance.

The New York Fed holds preferred interests in the two special purpose vehicles totaling about $26 billion.

AIG owed the government about $132.1 billion in aid as of the end of June. This amount included $49.1 billion in Treasury Department loans.

-- Written by Andrea Tse in New York.

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