American Express 2001 Annual Report Download - page 32

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axp_30
FINANCIAL REVIEW
defines an event of impairment for debt securities as issuer default or bankruptcy. Fair value is generally based on quoted market
prices. However, the company’s investment portfolio also contains structured investments of various asset quality, including Col-
lateralized Debt Obligations (CDOs) and Structured Loan Trusts (backed by high-yield bonds and bank loans, respectively),which
are not readily marketable. As a result, the carrying values of these structured investments are based on cash flow projections
which require a significant degree of judgment and as such are subject to change. If actual future cash flows are less than pro-
jected, additional losses would be realized.
❚AEFA’s deferred acquisition costs (DAC) represent costs of acquiring new business, principally sales and other distribution and
underwriting costs, that have been deferred on the sale of annuity, insurance, and certain mutual fund and other long-term prod-
ucts. DACs are amortized over the lives of the products, either as a constant percentage of projected earnings or as a constant per-
centage of the projected liabilities associated with such products. Such projections require the use of certain assumptions,
including interest margins, mortality rates, persistency rates, maintenance expense levels and, for variable products, separate
account performance. As actual experience differs from the current assumptions, management considers on a quarterly basis
the need to change key assumptions underlying the amortization models prospectively. For example, if the stock market trend
rose or declined appreciably, it could impact assumptions made about separate account performance and result in an adjustment
to income, either positively or negatively. The impact on results of operations of changing prospective assumptions with respect
to the amortization of DACs is reflected in the period in which such changes are made.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
The company believes allocating capital to its growing businesses with a return on risk-adjusted equity in excess of their cost of
capital will continue to build shareholder value.
The company’s philosophy is to retain enough earnings to provide capital such that the company can meet its growth objectives.
To the extent capital available has exceeded investment opportunities, the company has returned excess capital to shareholders.
The company has in place share repurchase programs to both offset the issuance of new shares as part of employee compensa-
tion plans and reduce shares outstanding. Due to the negative impact of the 2001 restructuring and disaster recovery charges and
high-yield losses discussed in the Consolidated Results of Operations, no share repurchases occurred during the second half of
2001 and none are anticipated for approximately the first half of 2002.
In 1999 and 2000, the company entered into agreements under which a third party purchased 29 million company common shares
at an average purchase price of $50.41 per share. These agreements, which partially offset the company’s exposure from its stock
option program, are separate from the company’s previously authorized share repurchase program. During the term of these agree-
ments, the company will periodically issue shares to or receive shares from the third party so that the value of the shares held by
the third party equals the original purchase price for the shares. At maturity in five years, the company is required to deliver to the
third party an amount equal to such original purchase price. The company may elect to settle this amount (i) physically, by paying
cash against delivery of the shares held by the third party or (ii) on a net cash or net share basis. The company may also prepay out-
standing amounts at any time prior to the end of the five-year term. In 2001, the company elected to prepay $350 million of the
aggregate outstanding amount, which resulted in 8 million shares being delivered to the company. Net settlements under these
agreements resulted in the company issuing 12 million shares in 2001 and receiving 2 million shares in 2000.
In January 2002, the SEC issued a financial reporting release, FR-61,“Commission Statement about Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” In this release, the SEC recommended that registrants enhance their
disclosure of matters concerning liquidity and capital resources, including off-balance sheet arrangements, certain trading activi-
ties involving non-exchange traded contracts, and transactions with related and certain other parties. The specific matters signifi-
cant to the company include on-balance sheet funding, off-balance sheet asset securitizations and contingent obligations, such as
Cardmember credit lines, letters of credit and guarantees. These areas are discussed either in this section of the financial review or
in each operating segment’s financial review. The company does not believe it has any significant transactions with related parties.