2.	Merger with Transatlantic

(a) Overview

On November 20, 2011, Alleghany entered into an Agreement and Plan of Merger (the “Merger Agreement”) with its wholly-owned subsidiary, Shoreline Merger Sub, LLC (subsequently converted into a corporation) (“Merger Sub”), and Transatlantic Holdings, Inc. (“Old Transatlantic”). On the Acquisition Date, Old Transatlantic was merged with (the “merger”) and into Merger Sub, which was renamed “Transatlantic Holdings, Inc.,” and became a wholly-owned subsidiary of Alleghany.

Pursuant to the terms of the Merger Agreement, on the Acquisition Date, stockholders of Old Transatlantic were entitled to receive, in exchange for each share of Old Transatlantic common stock held, either shares of Common Stock or cash consideration with a value equal to approximately $61.14 (“Per Share Consideration”), which was the sum of (i) 0.145 multiplied by the average of the closing sales prices on the New York Stock Exchange for Common Stock during the five trading days ending the day before the Acquisition Date (the “Average Closing Price”) and (ii) $14.22, as more fully described in the Merger Agreement. In total, Alleghany paid to the stockholders of Old Transatlantic consideration of approximately $3.5 billion, consisting of cash consideration of $816.0 million and stock consideration of 8,360,959 shares of Common Stock. The stock consideration is generally expected to be tax free to Old Transatlantic stockholders.

Following the Acquisition Date, the Alleghany board of directors consisted of all 11 members from its pre-merger board of directors and three additional members (the “Continuing Directors”) who had served on the board of directors of Old Transatlantic.

Alleghany incurred due diligence, legal, investment banking and other merger-related costs (“Transaction Costs”) of $33.8 million in the first nine months of 2012, including $18.0 million payable to Alleghany’s investment bankers, in connection with the merger. Alleghany also incurred $19.3 million of Transaction Costs in the fourth quarter of 2011 in connection with the merger. Transaction Costs are reported as a component of corporate administration expense.

The merger was accounted for using the acquisition method of accounting. Based on the relative voting interests of Alleghany stockholders (approximately 51 percent) and Old Transatlantic stockholders (approximately 49 percent) in Alleghany post-merger, the composition of Alleghany’s board of directors and senior management after the merger and other factors, it was determined that Alleghany is the acquiring entity for accounting purposes. Under the acquisition method of accounting, the assets, liabilities and commitments of Transatlantic are adjusted to their fair values on the Acquisition Date. Significant judgment was required to arrive at estimates of fair values.

The excess of the fair value of the net assets acquired over the purchase price was recorded as a gain on bargain purchase of $494.9 million and is shown as a separate component of revenues in the statement of earnings for the nine months ended September 30, 2012. The gain on bargain purchase determination is consistent with the fact that prior to the merger, Old Transatlantic’s shares of common stock, similar to shares of certain other reinsurance and insurance companies, traded at a discount to book value per common share.

(b) Purchase Price

Alleghany’s total purchase price for Old Transatlantic as of the Acquisition Date is calculated in accordance with GAAP as follows (in millions, except per share amounts):


Shares of Old Transatlantic common stock outstanding as of the Acquisition Date		57.6
Multiplied by per share exchange ratio of 0.145 shares of Common Stock per share of Old Transatlantic common stock		0.145

Shares of Common Stock issued		8.4
Multiplied by the Acquisition Date closing price per share of Common Stock⁽¹⁾	$	322.50

Portion of purchase price based on shares of Common Stock issued				$	2,696.4

Shares of Old Transatlantic common stock outstanding as of the Acquisition Date		57.6
Adjustment to Old Transatlantic common stock⁽²⁾		(0.2	)

Old Transatlantic common stock, as adjusted		57.4
Multiplied by cash price per share component	$	14.22

Portion of purchase price based on cash consideration					816.0

Total purchase price				$	3,512.4

(1)	As noted previously, the Merger Agreement determined aggregate consideration paid based on the Average Closing Price. For GAAP purposes, the purchase price is determined based on the closing price of the Common Stock as of the Acquisition Date.

(2)

The $816.0 million cash consideration was fixed as of the date of the Merger Agreement, predicated on the 57.4 million shares of common stock of Old Transatlantic outstanding at that date multiplied by $14.22 per share. Therefore, the additional 0.2 million of Old Transatlantic shares outstanding as of the Acquisition Date do not cause the cash consideration to increase and are adjusted for in this presentation.

(c) Fair Value of Net Assets Acquired and Gain on Bargain Purchase

The total fair value of net assets acquired and the gain on bargain purchase as of the Acquisition Date are calculated as follows (in millions):


Net book value of net assets acquired prior to fair value adjustments	$	4,062.7
Adjustments for fair value, by applicable balance sheet caption:
Assets:
Deferred acquisition costs		(250.7	)
Intangible assets		323.5
Net deferred tax assets		21.5
All other assets		(25.3	)
Liabilities:
Transatlantic Senior Notes		(124.4	)

Fair value of net assets acquired		4,007.3
Less purchase price		(3,512.4	)

Gain on bargain purchase (before all Transaction Costs)	$	494.9

Pursuant to the terms of the Merger Agreement, each outstanding stock option to acquire Old Transatlantic common stock was converted into the right to receive a cash payment based on its Black-Scholes value on the Acquisition Date based on assumptions set forth in the Merger Agreement. As of the Acquisition Date, the value of the Old Transatlantic stock options was determined to be $11.1 million, which amount was paid by Alleghany in March 2012.

Pursuant to the terms of the Merger Agreement, each outstanding Old Transatlantic restricted stock unit (including performance-based Old Transatlantic restricted stock units) held by current or former employees or non-employee directors of Old Transatlantic was converted into the right to receive a cash payment in an amount equal to the Per Share Consideration, with the same terms and conditions as were applicable under such restricted stock unit prior to its conversion, that was: (i) deemed notionally invested in the equity of Transatlantic, referred to as “book value units;” (ii) with respect to the Continuing Directors, deemed notionally invested in Common Stock; or (iii) maintained in a cash account while continuing to vest on the existing vesting schedule. As of the Acquisition Date, the value of the Transatlantic restricted stock units was determined to be $49.5 million, of which $1.1 million was paid by Alleghany in the first nine months of 2012 with the remainder expected to be paid over the next three years.

Prior to the Acquisition Date, Old Transatlantic established a liability for its stock option and restricted stock awards that was previously accounted for as equity, and this liability is reflected in the net book value of net assets acquired prior to fair value adjustments.

An explanation of the adjustments for fair value is as follows:

•

Deferred acquisition costs - Elimination of Transatlantic’s deferred acquisition costs asset.

•

Intangible assets - Establish fair value of intangible assets related to Transatlantic (see below for additional detail).

•

Net deferred tax assets - Adjustment to deferred tax assets, net, related to fair value adjustments. See Note 9 for additional information on net deferred tax assets.

•

All other assets - Elimination of Transatlantic’s carried goodwill, deferred debt issuance costs, allowance for doubtful accounts and the recording of fair value adjustments to other asset categories.

•

Transatlantic Senior Notes - Adjustments of the Transatlantic Senior Notes to their estimated fair value based on prevailing interest rates and other factors as of the Acquisition Date. See Note 8(b) for additional information on the Transatlantic Senior Notes.

The net intangible assets (liabilities) included in “intangible assets” in the table above, and as of September 30, 2012, consist of the following (in millions):


	Amount			Economic Useful Life
Value of business in-force	$	291.4		One Year
Loss and LAE reserves		(98.8	)	15 years
State and foreign insurance licenses		19.0		Indefinite
Trade name		50.0		Indefinite
Renewal rights		44.0		14 years
Leases		(28.1	)	10 years
Gain contingency on dispute previously in arbitration		36.0		As settled
Internally-developed software		10.0		2.5 years

Net intangible assets, before amortization, as of the Acquisition Date	$	323.5
Amortization (from the Acquisition Date through September 30, 2012)		(210.8	)
Settlement of gain contingency on dispute previously in arbitration		(36.0	)

Net intangible assets, after amortization, as of September 30, 2012	$	76.7

An explanation of the intangible assets and related future amortization is as follows:

•

Value of business in-force - Intangible asset resulting from the adjustment of unearned premiums to the estimated fair value of profit within Transatlantic’s unearned premiums as of the Acquisition Date, adjusted for a risk factor. This will be amortized as the contracts for business in-force as of the Acquisition Date expire.

•

Loss and LAE reserves - Adjustment resulting from the difference between the estimated fair value and the historical carrying value of Transatlantic’s unpaid loss and LAE, net of related reinsurance recoverable, as of the Acquisition Date. The estimated fair value consists of the present value of the net loss reserves plus a risk premium. This will be amortized over the estimated payout pattern of net reserves as of the Acquisition Date.

•

State and foreign insurance licenses - Addition of the estimated fair value of identifiable intangible assets resulting from the merger arising from the ability to write reinsurance in all 50 U.S. states and the District of Columbia and various foreign jurisdictions.

•

Trade name - Addition of the estimated fair value of identifiable intangible assets resulting from the merger arising from trade names and trademarks used by Transatlantic in conducting its business worldwide.

•

Renewal rights - Addition of the estimated fair value of identifiable intangible assets resulting from the merger arising from renewal rights. This will be amortized over the net earnings pattern of renewed reinsurance contracts, estimated as of the Acquisition Date.

•

Leases - Adjustment resulting from the difference between the estimated fair value of Transatlantic’s operating leases for its office space and its operating lease commitments, as of the Acquisition Date. This will be amortized on a straight-line basis over the future remaining terms of the operating leases as of the Acquisition Date.

•

Gain contingency on dispute previously in arbitration - Estimated minimum recovery, net of estimated legal costs, from a dispute between Transatlantic and American International Group, Inc. (“AIG”) previously in arbitration, which was subsequently settled in the third quarter of 2012. See Note 12(a) for further discussion of the dispute previously in arbitration.

•

Internally-developed software - Addition of the estimated fair value of identifiable intangible assets resulting from the merger arising from internally-developed software. This will be amortized on a straight-line basis over its economic useful life.

(d) Financial Results

The following information summarizes the results of Transatlantic since the Acquisition Date that have been included within Alleghany’s Consolidated Statements of Earnings and Comprehensive Income (in millions):


	Three Months Ended September 30, 2012			For the Period from March 6, 2012 to September 30, 2012
Revenues
Net premiums earned	$	881.1		$	2,017.5
Net investment income		66.3			155.5
Net realized capital gains		(7.7	)		(0.7	)
Other than temporary impairment losses		—			—
Gain on bargain purchase		—			—
Other income		24.0			24.7

Total revenues		963.7			2,197.0


Costs and Expenses
Net loss and loss adjustment expenses		562.5			1,271.0
Commissions, brokerage and other underwriting expenses		181.1			377.3
Other operating expenses		28.6			53.6
Corporate administration		—			—
Amortization of intangible assets		72.5			210.8
Interest expense		12.4			28.1

Total costs and expenses		857.1			1,940.8


Earnings before income taxes		106.6			256.2
Income taxes		21.1			50.9

Net earnings	$	85.5		$	205.3

(e) Supplemental Pro Forma Information

Transatlantic’s results have been included in Alleghany’s Consolidated Financial Statements from the Acquisition Date to September 30, 2012. The following pro forma financial information for the nine months ended September 30, 2012 and 2011 is presented for informational purposes only and is not necessarily indicative of the results that would have occurred had the merger been consummated at the beginning of each period presented, nor is it necessarily indicative of future results. Significant assumptions used to determine pro forma results include amortization of intangible assets related to the merger and the assumption that Alleghany’s acquisition of Transatlantic occurred on January 1 of each of the respective periods (“Pro Forma Acquisition Dates”). Transaction Costs and gain on bargain purchase that are included in Alleghany’s financial statements have not been included in the unaudited pro forma consolidated information. The table presents unaudited pro forma consolidated information for the nine months ended September 30, 2012 and 2011 (in millions, except per share data):


	Pro Forma Nine Months Ended September 30,
	2012		2011
Total revenues⁽¹⁾	$	3,802.9	$	3,953.8
Net earnings (losses)⁽¹⁾⁽²⁾		358.1		(10.8	)

Basic earnings per share	$	21.16	$	(0.62	)

(1)	Among other adjustments, reflects an increase in amortization expense on Transatlantic’s AFS debt securities resulting from the adjustment of amortized cost to their fair value as of the Pro Forma Acquisition Dates. Such adjustment reduced the net investment income of Transatlantic.

(2)

Among other adjustments, reflects adjustments to amortization expense on the Transatlantic Senior Notes resulting from the adjustment to their fair value as of the Pro Forma Acquisition Dates. Such adjustment reduced the interest expense of Transatlantic. See Note 8(b) for additional information on the Transatlantic Senior Notes. Also reflects adjustments to amortization expense associated with intangible assets arising from the merger.

The decrease in pro forma revenues in the first nine months of 2012 from the first nine months of 2011 reflects a decrease in Transatlantic’s revenues primarily due to lower net premiums earned and lower net investment income, partially offset by an increase in Alleghany’s revenues primarily due to higher net realized capital gains and an increase in net premiums earned from the insurance segment.

The increase in pro forma net earnings in the first nine months of 2012 from the first nine months of 2011 reflects significantly lower catastrophe losses incurred by Transatlantic, and, to a lesser extent, an increase in Alleghany’s net realized capital gains in the first nine months of 2012, partially offset by a reduction of Transatlantic’s revenues primarily due to lower net premiums earned and lower net investment income.

The pro forma results include Transatlantic’s pre-tax catastrophe losses, net of reinsurance and reinstatement premiums, of $54.0 million and $682.5 million in the first nine months of 2012 and 2011, respectively. Of the $54.0 million of catastrophe losses incurred in the first nine months of 2012, $53.7 million were incurred by Old Transatlantic prior to the Acquisition Date and are not included in Alleghany’s GAAP net earnings for the nine month period ending September 30, 2012. In addition, Transatlantic recorded pre-tax losses and LAE of $19.0 million in the first nine months of 2012 related to the capsizing of the luxury liner, Costa Concordia, off the coast of Italy, of which $15.8 million was incurred by Old Transatlantic prior to the Acquisition Date and are not included in Alleghany’s GAAP net earnings for the nine month period ending September 30, 2012.

(f) Goodwill and Intangible Assets

The amount of goodwill and intangible assets, net of accumulated amortization expense, reported on Alleghany’s consolidated balance sheets as of September 30, 2012 and December 31, 2011 is as follows (in millions):


	September 30, 2012									December 31, 2011⁽¹⁾
	Gross Carrying Value			Accumulated Amortization			Net Carrying Value⁽²⁾			Gross Carrying Value		Accumulated Amortization		Net Carrying Value⁽²⁾
Insurance segment⁽³⁾ – Goodwill	$	48.1		$	—		$	48.1		$	48.1	$	—	$	48.1

Insurance segment – Intangible assets:
Agency relationships		21.7			7.8			13.9			21.7		7.1		14.6
State insurance licenses		25.8			—			25.8			25.8		—		25.8
Trade name		35.5			—			35.5			35.5		—		35.5
Brokerage and reinsurance relationships		33.8			20.8			13.0			33.8		19.1		14.7
Renewal and distribution rights		24.3			24.2			0.1			24.3		24.0		0.3
Other		4.1			4.1			—			4.1		4.1		—

Total insurance segment intangibles		145.2			56.9			88.3			145.2		54.3		90.9

Total insurance segment goodwill and other intangibles	$	193.3		$	56.9		$	136.4		$	193.3	$	54.3	$	139.0


Reinsurance segment⁽³⁾ – Intangible assets:
Value of business in-force	$	291.4		$	222.2		$	69.2		$	—	$	—	$	—
Loss and LAE reserves		(98.8	)		(13.3	)		(85.5	)		—		—		—
State and foreign insurance licenses		19.0			—			19.0			—		—		—
Trade name		50.0			—			50.0			—		—		—
Renewal rights		44.0			1.3			42.7			—		—		—
Leases		(28.1	)		(1.6	)		(26.5	)		—		—		—
Gain contingency on dispute previously in arbitration⁽⁵⁾		—			—			—			—		—		—
Internally-developed software		10.0			2.2			7.8			—		—		—


Total reinsurance segment intangibles	$	287.5		$	210.8		$	76.7		$	—	$	—	$	—


Corporate activities⁽³⁾⁽⁴⁾ – Goodwill	$	34.4		$	—		$	34.4		$	—	$	—	$	—

Corporate activities⁽⁴⁾ – Intangible assets:
Trade name		0.4			—			0.4			—		—		—
Other		0.3			—			0.3			—		—		—

Total corporate activities intangibles		0.7			—			0.7			—		—		—

Total corporate activities goodwill and other intangibles	$	35.1		$	—		$	35.1		$	—	$	—	$	—


Alleghany consolidated goodwill and other intangibles	$	515.9		$	267.7		$	248.2		$	193.3	$	54.3	$	139.0

(1)	See Note 4 of Notes to Consolidated Financial Statements set forth in Item 8 of the 2011 10-K for additional detail on goodwill and other intangible assets.

(2)	Goodwill and intangible assets have been reduced by amounts written-down in prior periods. See Note 4(a) of Notes to Consolidated Financial Statements set forth in Item 8 of the 2011 10-K for additional detail on amounts written-down in prior periods.

(3)	See Note 13 for additional detail on Alleghany’s segments of business.

(4)	Represents goodwill and other intangible assets related to the acquisition of Bourn & Koch on April 26, 2012, which was purchased for $55.0 million, including estimated contingent consideration of $8.0 million based on future profitability.

(5)

In connection with its accounting for the acquisition of Transatlantic, Alleghany established an asset of $36.0 million, representing an estimate based on the minimum recovery previously agreed to by the parties, net of estimated legal costs. On January 26, 2012, Transatlantic reached an agreement with AIG to settle and mediate a dispute previously in arbitration. On July 20, 2012, in accordance with the agreement between the parties, a mediator awarded Transatlantic a settlement payment of $75.0 million. A pre-tax net benefit of approximately $23.5 million resulting from this settlement was recorded as other income in the third quarter and first nine months of 2012, representing the portion of the settlement payment above the minimum recovery, net of additional estimated legal costs.