Allied World Assurance Co Holdings agreed to buy Transatlantic Holdings for $3.2 billion in stock, creating a specialty insurer and reinsurer with broader reach and product offering.

Shareholders of Transatlantic, which was once controlled by American International Group Inc, will receive 0.88 Allied World share each, or $51.10 per share, representing a 16.1 percent premium over Transatlantic's close on Friday.

The deal allows New York-based Transatlantic to change domicile to Switzerland, where Allied World is headquartered and which is more favorable from a tax perspective, a source familiar with the situation said.

The deal also bolsters Transatlantic's management.

Allied World Chairman and CEO Scott Carmilani will be the president and chief executive of the new company. Transatlantic CEO Robert Orlich will retire when the deal closes, which is expected in the fourth quarter of this year.

AIG owned a majority stake in Transatlantic until it was forced to sell it off as part of its efforts to repay the U.S. governments for a massive crisis-era bailout.

Experts have been anticipating more reinsurer deals, especially in Bermuda, for a while now, predicting that a soft pricing environment would prompt well-capitalized companies to merge.

But these deals have been relatively rare, in part because the social question -- who will lead the combined company -- is often not resolved.

Allied World and Transatlantic held one-on-one talks, which started earlier this year, the source said.

With Transatlantic's Orlich willing to retire, this deal announcement could prompt a rival bidder to emerge.

DEAL TERMS

The combined company will operate under a holding company structure, with the corporate name TransAllied Group Holdings, offering specialty insurance and reinsurance products and services via two brands -- Transatlantic Reinsurance and Allied World Insurance.

Transatlantic shareholders will own about 58 percent of the combined company, with Allied World shareholders owning the rest. Both boards have approved the deal.

The new company will have an 11-member board, with six seats appointed by Transatlantic and the rest by Allied World.

The combined entity will have total invested assets of $21 billion, total shareholders' equity of nearly $7 billion and total capital of $8.5 billion.

Goldman Sachs and Moelis & Co acted as financial advisers to Transatlantic, and Gibson, Dunn & Crutcher and Lenz & Staehelin acted as U.S. and Swiss legal counsel.

Deutsche Bank acted as financial adviser to Allied World, and Willkie Farr & Gallagher and Baker & McKenzie acted as U.S. and Swiss legal counsel.

(Reporting by Nadia Damouni; Editing by Dale Hudson)