American Express 2002 Annual Report Download - page 32

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I30 AXP IFINANCIAL REVIEW
Investment securities valuation
Generally, investment securities are carried at fair value on the balance sheet with unrealized gains (losses) recorded in equity,
net of income tax provisions (benefits). Gains and losses are recognized in the results of operations upon disposition of the
securities. In addition, losses are also recognized when management determines that a decline in value is other-than-temporary,
which requires judgment regarding the amount and timing of recovery. Indicators of other-than-temporary impairment for debt
securities include issuer downgrade, default or bankruptcy. The company also considers the extent to which cost exceeds fair
value, the duration of time of that decline, and management’s judgment about the issuer’s current and prospective financial con-
dition. Fair value is generally based on quoted market prices. However, the company’s investment portfolio also contains struc-
tured investments of various asset quality, including collateralized debt obligations (CDOs) and secured loan trusts (backed by
high-yield bonds and bank loans), which are not readily marketable. As a result, the carrying values of these structured invest-
ments are based on cash flow projections which require a significant degree of management judgment as to default and recov-
ery rates of the underlying investments and, as such, are subject to change. If actual future cash flows are less than projected,
additional losses would be realized.
Deferred acquisition costs
AEFA’s DAC represent the costs of acquiring new business, principally direct sales commissions and other distribution and
underwriting costs, that have been deferred on the sale of annuity, insurance and certain mutual fund products. For annuity
and insurance products, DAC are amortized over periods approximating the lives of the business, generally as a percentage of
premiums or estimated gross profits or as a portion of the interest margins associated with the products. For certain mutual
fund products, DAC are generally amortized over fixed periods on a straight-line basis.
For annuity and insurance products, the projections underlying the amortization of DAC require the use of certain assump-
tions, including interest margins, mortality rates, persistency rates, maintenance expense levels and customer asset value
growth rates for variable products. Management routinely monitors a wide variety of trends in the business, including compar-
isons of actual and assumed experience. Management reviews and, where appropriate, adjusts its assumptions with respect to
customer asset value growth rates on a quarterly basis. Management monitors other principal DAC assumptions, such as per-
sistency, mortality rate, interest margin and maintenance expense level assumptions, each quarter. Unless management identi-
fies a material deviation over the course of the quarterly monitoring, management reviews and updates these DAC assumptions
annually in the third quarter of each year. When assumptions are changed, the percentage of estimated gross profits or portion
of interest margins used to amortize DAC may also change. A change in the required amortization percentage is applied retro-
spectively; an increase in amortization percentage will result in an acceleration of DAC amortization while a decrease in amor-
tization percentage will result in a deceleration of DAC amortization. The impact on results of operations of changing
assumptions with respect to the amortization of DAC can be either positive or negative in any particular period, and 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 earnings sufficient to enable it to
meet its growth objectives, and, to the extent capital exceeds investment opportunities, return excess capital to shareholders.
The company has indicated that, assuming it achieves its financial objectives of 12-to-15% EPS growth, 18-to-20% return on
equity growth and 8% revenue growth, on average and over time, it will seek to return an average of 65 percent of capital gen-
erated each year to shareholders.
Liquidity refers to the company’s ability to meet its current and future cash needs primarily by issuing debt and securitizing
receivables and, to a lesser extent, by selling investments. In addition, the company maintains committed back-up lines of
credit. The company’s liquidity is managed by its Treasury department. Additionally, the company’s liquidity needs are
reviewed on an ongoing basis including analyses of severe stress scenarios.