The use of embryonic stem cells for cell-replacement therapy in diseases like diabetes mellitus requires methods to control the development of multipotent cells. We report that treatment of mouse embryonic stem cells with inhibitors of phosphoinositide 3-kinase, an essential intracellular signaling regulator, produced cells that resembled pancreatic β cells in several ways. These cells aggregated in structures similar, but not identical, to pancreatic islets of Langerhans, produced insulin at levels far greater than previously reported, and displayed glucose-dependent insulin release in vitro. Transplantation of these cell aggregates increased circulating insulin levels, reduced weight loss, improved glycemic control, and completely rescued survival in mice with diabetes mellitus. Graft removal resulted in rapid relapse and death. Graft analysis revealed that transplanted insulin-producing cells remained differentiated, enlarged, and did not form detectable tumors. These results provide evidence that embryonic stem cells can serve as the source of insulin-producing replacement tissue in an experimental model of diabetes mellitus. Strategies for producing cells that can replace islet functions described here can be adapted for similar uses with human cells.