Giant insurer AIG is still paying $165 million on Sunday to retain certain employees due to contract obligations, despite initial opposition earlier this week from the Obama Administration.

AIG was obligated to pay $220 million in retention pay for 2008, with $55 million of that already paid in December, according Reuters, which said it had reviewed company documents on Saturday.

On Saturday, AIG chief executive officer Edward Liddy told U.S. Treasury Secretary Timothy Geithner in a letter that he found the payments “distasteful.” On March 11, Geithner telephoned Liddy to demand changes to AIG’s plan, an administration official told Bloomberg.

However the U.S. Treasury backed off the request after determining that AIG was legally bound to make them.

“I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them,” Liddy wrote, according to Bloomberg. He said the contracts to pay had been made before he took over the firm. “With the benefit of hindsight, I would have designed these differently and at significantly lower levels.”

The retention pay plan involves 400 employees inside the insurer’s financial products unit which handled the credit default swaps that suffered heavy losses, leading the company to near bankruptcy last year.

Retention payments for 2009 will total $230 million but may be reduced as some parts of the company are sold and employees are cut, Bloomberg noted. Liddy said the company hoped to reduce bonuses for 2009 by 30 percent.

We need to find out whether these bonuses are legally recoverable, U.S. congressman Barney Frank – who chairs the House Financial Services Committee said on the Fox News Sunday program.

Liddy, who was brought in by the U.S. government after bailing out the company, will testify in Congress about the company on Wednesday along with other witnesses.

In Liddy’s letter, he tells Geithner that the company “cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses - which are now being operated principally on behalf of American taxpayers - if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury.”

The U.S. owns 80 percent of the company after its bailout. U.S. government officials saved the company after deciding that its failure would severely disrupt the financial system.

Timothy geithner Aig