America Online, the world's largest Internet service provider, has agreed to reform the way it handles customers who want to cancel service, New York State Attorney General Eliot Spitzer (search) said on Wednesday.

Spitzer, announcing settlement of a lawsuit, said AOL (search) is also required to provide refunds of up to four months of service to all New York consumers who claim harm based on improper cancellation requests and pay New York state $1.25 million in penalties and costs.

Spitzer's office, responding to about 300 New York customer complaints, conducted a probe into AOL's customer service policies and procedures. AOL, owned by media conglomerate Time Warner Inc. (TWX) serves about 1.9 million customers in the region.

With the settlement, AOL agreed to alter incentives it offers customer representatives who try to dissuade customers from canceling their subscriptions.

As part of the settlement, AOL has agreed to eliminate customer service quotas on how many customers it dissuades from canceling and record all cancellation requests. Cancellation requests will need to be verified by a third party monitor by June 2006.

"AOL is pleased to have reached an agreement with the state of New York on customer care practices that we believe will increase quality assurance and assist with the verification of certain member intentions online," an AOL spokesman said.

Time Warner shares were down 11 cents at $17.78 on the New York Stock Exchange.