The classy outside back's re-signing comes just days after Ben Smith's contract extension and gives Hansen another option at fullback for the next World Cup in Japan.
"There's no doubt that there were some attractive offers to consider," the 61-test Dagg said in a media release.
"But at the end of the day I love my life here in New Zealand with my family, friends and team mates and I'm not ready to give that up.
"I still feel blessed every time I pull on the jersey for the All Blacks, Crusaders or Magpies so I consider it an honour to be able to keep working hard to earn that right for the next three years," added the 28-year-old.
A World Cup winner with Graham Henry's side in 2011, Dagg missed out on selection for the 2015 tournament in England after a horror run of injuries but clawed his way back into the side last year.
Playing mostly on the wing, Dagg enjoyed a stellar season, scoring 10 tries from his 12 tests.
"To have a player of Israel's ability and versatility re-sign is a major lift for all levels of New Zealand Rugby," said Hansen.
"We appreciate the decision 'Izzy' and his wife Daisy have made and to be able to plan the future, knowing that we'll have him involved makes life so much easier for us all, and we look forward to the challenges ahead."
(Reporting by Ian Ransom in Melbourne; Editing by Peter Rutherford)
