American International Group Inc. laid out a plan on Thursday that sets the company on a path for an accelerated payback of taxpayer bailout money, but also increases the risk for the government.

The plan, which comes a little over two years after AIG was rescued from the brink of collapse, will see the Federal Reserve Bank of New York getting repaid in full and ending its involvement in AIG, leaving the company to deal with just the Treasury Department.

The Treasury will convert some of its AIG securities into common shares, increasing its ownership stake to 92.1 percent from nearly 80 percent. That stake will be sold off over time.

The Treasury will also effectively buy out the Fed’s interest in two large AIG units that are being sold.

The deal is expected to close by the end of the 2011 first quarter and will give taxpayers an instant paper profit of more than $10 billion.officials on Wednesday, shows the insurer is making progress in disentangling itself from the government and positions the company to tap the capital markets again.

But at the same time, it increases the risk for taxpayers, as AIG draws down more of the funds authorized under the $182.3 billion bailout and the government swaps preferred stock for common, which can yield a profit but also a loss if the company does not perform well.

The announcement of the plan comes as the government faces pressure to show it is extracting itself from the financial industry, which was offered more than a trillion dollars of taxpayer support in 2008.

The Troubled Asset Relief Program, set up amid the 2008 financial crisis to shore up the industry, expires on Sunday, and when Americans go to the polls for mid-term elections in November, the state of the financial system and the economy will be a big issue.

AIG Chief Executive Robert Benmosche said in an interview the deal helps the company avoid another “firestorm of negative publicity.” AIG has been on the receiving end of widespread public anger.

“Now the debate is how much the government will make on AIG,” Benmosche said. “Is it a billion, is it $10 billion? They are not talking about a $30 billion loss anymore. That builds confidence for this organization.”

AIG shares were up 3.2 percent at $38.66 in midday trading.

THE PLAN

Under the repayment plan, the Treasury will get about 1.66 billion AIG common shares, worth $62 billion at Wednesday’s closing share price, in exchange for the $49.1 billion of AIG preferred shares it now holds.

Benmosche said the Treasury had estimates ranging from a year to a year and half for selling down its stake in the company once the exchange is completed.

The plan also calls for AIG to repay a $20 billion Fed credit facility, using funds from operations and disposal of assets like its Asian life insurance businesses — American Life Insurance Co (Alico) and American International Assurance (AIA).

The exchange of the Treasury’s preferred stock will not be executed until the Fed credit facility is repaid in full.

The Fed also owns preferred interest worth about $26 billion in AIA and Alico. AIG plans to draw down up to $22 billion from an existing Treasury equity line to buy out part of that stake, and then transfer the interest to the Treasury.

AIG plans to use the proceeds from future asset sales, including the sale of two Japanese life insurance units, to retire the remainder of the Fed’s preferred interest.

Prudential Financial Inc clinched a deal for AIG Star Life Insurance Co Ltd and AIG Edison Life Insurance Co for $4.2 billion in cash. The plan also has a sweetener for existing shareholders. AIG plans to issue them up to 75 million warrants with a strike price of $45 per share.

The warrants are a way to make the deal more palatable for existing shareholders, who will see their holdings diluted. Benmosche said it was a way to be fair to them, “if it is such a windfall for the government at the expense of the current shareholders.”

AIG’S FUTURE

Benmosche, speaking at his office at AIG’s headquarters in Manhattan, said the plan creates clarity for clients and employees and allows the company to move forward.

Having the Fed out of AIG would allow the company to again persuade banks to give it loans.

“You are not going to be able to go out and negotiate a contingent credit line from a bank when they have to sit behind the Fed,” he said.

AIG is already in talks with banks and expects to have about $3 billion of bank credit lines come in as the Fed exits, Benmosche said.

AIG is also moving forward on asset dispositions.

MetLife Inc plans to close its purchase of Alico, AIG’s foreign life insurance business, by the end of the year. The deal was originally worth about $15.5 billion.

AIG also plans to list AIA in Hong Kong next month. Benmosche said the company expects about $12 billion in proceeds, although the valuation was being worked out. He dismissed concerns about the offering that surfaced after U.S. insurer Liberty Mutual Agency Corp postponed a $1.2 billion IPO.

Benmosche said AIG may at some point consider a partial IPO of other businesses, such as aircraft lessor International Lease Finance Corp and mortgage insurer United Guaranty.

It would also be open to a sale of the units at the right time and price, he said.

AIG also plans to absorb whatever is left at AIG Financial Products, the unit behind its near collapse in September 2008, into the parent company and further reduce the risk, Benmosche said.

“The question becomes more about how do we get AIG to have access to the capital markets and how do we begin to show AIG as a strong investment-grade company that’s single A or better,” Benmosche said.