Human pancreatic islet transplantation at present is the preferred therapeutic option for type I diabetes treatment. However, this therapy is not widely utilized because of the severe shortage of donor islets. The capacity for self-renewal and differentiation of human embryonic stem (hES) cells makes them a potential new source for generation of functional pancreatic islet cells for treating type I diabetes mellitus. Here, we report a simple and effective protocol, carried out in a serum-free system, which could induce human ES cells to differentiate into functional insulin-producing cells. Activin A was first used in the initial stage to induce definitive endoderm lineage differentiation from human ES cells. And all-trans Retinoic Acid (RA) was then utilized to promote pancreatic differentiation. After maturation in the final induction stage with bFGF and Nicotinamide, the differentiated cells expressed islet specific markers. The secretion of insulin and C-peptide by these cells corresponded to the variations in glucose levels. Our method provides a promising in vitro differentiation model for studying the mechanisms of human pancreas development and illustrates the potential of using human ES cells for the treatment of type I diabetes mellitus.