The revision would be the latest sign of how federal regulators are having to tweak bailout packages for financial institutions deemed too big to fail as the economy and markets worsen.
The board of the troubled insurer is due to meet Sunday to vote on the deal, which could be announced when AIG reports its quarterly results Monday, the source said.
That would be just days after the government agreed to boost its equity stake in Citigroup Inc (C, Fortune 500) to as much as 36 percent in a bid to bolster another financial giant that taxpayers had already poured billions of dollars into.
The revised AIG agreement is expected to include an additional equity commitment of about $30 billion, more lenient terms on an existing preferred investment, and a lower interest rate on a $60 billion government credit line, the source said.
The new equity commitment would give AIG (AIG, Fortune 500) the ability to issue preferred stock to the government at a later date, the source said.
The London Interbank Offered Rate floor on the interest rate AIG pays on the government's credit line is expected to be removed under the new terms, which would save the insurer about $1 billion a year, the source said. The company currently pays 3 percentage points above Libor.
AIG will also give the U.S. Federal Reserve ownership interests in American Life Insurance (Alico), which generates more than half of its revenue from Japan, and Hong Kong-based life insurance group American International Assurance Co (AIA) in return for reducing its debt, the source said.
The insurer had been trying to sell Alico and a part of AIA in a bid to raise money to pay back the government.
AIG may also securitize some U.S. life insurance policies and give them to the government to further reduce its debt, the source said.
Last year, AIG said it plans 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 been difficult for it to find buyers and get a good price for assets amid the financial crisis. Credit for deals remains difficult to arrange due to the crisis and many would-be buyers are struggling with their own problems.
"From a purely pragmatic angle the U.S. government needs to do whatever is necessary to get the system back on its feet and solvent, (and) then make certain that the funds are returned," said Peter Kenny, managing director at Knight Equity Markets.
"The one part of this that is an unattractive but necessary element is further management involvement by D.C.," Kenny said. "Washington hasn't been capable of balancing its own books for years and now they are going to play banker to a broken-down Wall Street, Detroit, and just about everyone else with their hand out."
Both the Federal Reserve and AIG, once the world's largest insurer by market value, declined to comment.
Massive lossA new deal would come as the insurer prepares to post the largest quarterly loss in corporate history -- a roughly $60 billion fourth-quarter loss, produced in large part by write-downs on certain tax assets and commercial mortgage backed securities, the source said.
The loss -- which works out to about $460,000 per minute -- is mostly non-cash, the source said.
The revised bailout would allow the insurer to avoid a credit ratings downgrade that could have had serious ramifications on the insurer's liquidity and hurt its businesses, the source said.
Customers could, for instance, cancel their insurance policies if a minimum rating was no longer satisfied.
AIG, which counted 74 million customers at the end of 2007, has said it has also 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 $123 billion.
Then in November, the government had to revise its bailout package, raising its aid further, to about $150 billion.
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