NEW YORK—Transatlantic Holdings Inc., the former reinsurance affiliate of AIG, is merging with specialty insurer and reinsurer Allied World Assurance Co. Holding A.G. in a $3.2 billion stock-for-stock deal, the two companies announced Sunday.

The two companies will operate as separate brands—Transatlantic Reinsurance and Allied World Insurance—under a holding company TransAllied Group Holdings A.G.

Longtime Transatlantic chief Robert Orlich, will retire as president and CEO on the closing of the transaction, which is expected in the fourth quarter.

New York-based Transatlantic was majority owned by American International Group Inc. until the insurer sold its stake to help repay its government bailout in two transactions that were completed in 2009 and 2010.

Allied World was formed in Bermuda in the wake of the 2001 terrorist attacks in the United States. It redomesticated to Zug, Switzerland, late last year.

Transatlantic reported $3.88 billion in net written premiums for 2010, while Allied World reported $1.39 billion in net written premiums for the same period.

On Monday, ratings agency A.M. Best Co. Inc. said that its A financial strength ratings on both Transatlantic and Allied World, and the subsidiaries of each, remain unchanged with a stable outlook. In a statement, Oldwick, N.J.-based Best said that the deal would bring “two complementary organizations together. With Allied World being predominately a primary writer and Transatlantic a pure reinsurer, the merged entity is expected to enjoy an enhanced business profile that will likely inure benefits in the form of an improved competitive position.”

Best also noted that the combined company would benefit from broader distribution channels and products and a large global presence.

Meanwhile, Barclays Capital said in a research note that the deal values Transatlantic at 79% of book value, which could result in other property/casualty insurers and reinsurers bidding for the company.

Transatlantic would have to pay a breakup fee of $115 million if it abandons the deal with Allied World, Bloomberg reported.