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[ 34 ]
2006 fi nancial review
american express company
RESERVE FOR MEMBERSHIP REWARDS COSTS
Description Assumptions/Approach Used
Effect if Actual Results Differ
from Assumptions
The Membership Rewards program is the
largest card-based rewards program in the
industry. Eligible cardmembers can earn
points for purchases charged and many
cards offer the ability to earn bonus points
for certain types of purchases. Membership
Rewards points are redeemable for a
broad variety of rewards, including travel,
entertainment, retail certificates and
merchandise. Points have no expiration
date and there is no limit on the number
of points a cardmember may earn. A
majority of spending by cardmembers
earns points under this program. While
cardmember spend, redemption rates, and
the related expense have been increasing,
the Company benefits through higher
revenues, lower cardmember attrition and
credit losses and more timely payments.
The Company establishes balance
sheet reserves to cover the cost of future
reward redemptions for points earned
to date. The provision for the cost of
Membership Rewards is included in
marketing, promotion, rewards and
cardmember services.
The reserve for Membership Rewards
is estimated using models that analyze
historical redemption statistics and
reflect, to a lesser extent, management’s
judgment regarding overall adequacy. The
provision for the cost of Membership
Rewards is based upon points earned
that are expected to ultimately be
redeemed by cardmembers and the
current weighted-average cost per point
of redemption. The estimated points to
be redeemed are based on many factors,
including past redemption behavior of
cardmembers who have left the program
in the past five years, card product type,
year of program enrollment, and card
spend level. The weighted-average
cost per point is affected by the mix of
rewards redeemed.
The Company continually evaluates
its reserve methodology and assumptions
based on developments in redemption
patterns, cost per point redeemed, and
other factors.
The balance sheet reserve for
unredeemed points is impacted
over time by enrollment levels,
the number of points earned and
redeemed, the weighted-average cost
per point, redemption choices made
by cardmembers, reward offerings by
partners and other Membership Rewards
program changes. The calculation
is most sensitive to changes in the
estimated ultimate redemption rate. This
rate is based on the expectation that a
large majority of all points earned will
eventually be redeemed.
As of December 31, 2006, if the
global ultimate redemption rate changed
by 100 basis points, the balance sheet
reserve would change by approximately
$175 million.