American Express 2008 Annual Report Download - page 19

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2008 financial review
american express company
reserves 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 of
the Company’s card products 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 typically do not expire and
there is no limit on the number of points
a cardmember may earn. A large majority
of spending by eligible cardmembers
earns points under the program. While
cardmember spend, redemption rates, and the
related expense have increased, the Company
believes it has historically benefited through
higher revenues, lower cardmember attrition
and credit losses and more timely payments.
The Company establishes balance
sheet reserves that represent the estimated
future cost of points earned to date that are
ultimately expected to be redeemed. These
reserves reflect management’s judgment
regarding overall adequacy. The provision for
the cost of Membership Rewards is included
in marketing, promotion, rewards and
cardmember services expenses.
A weighted average cost per point redeemed
during the previous 12 months, adjusted as
appropriate for recent changes in redemption
costs, is used to approximate future
redemption costs and is affected by the mix
of rewards redeemed. Management uses
models to estimate ultimate redemption rates
based on historical redemption statistics, card
product type, year of program enrollment,
enrollment tenure, and card spend levels.
These models incorporate sophisticated
statistical and actuarial techniques to estimate
ultimate redemption rates of points earned
to date by current cardmembers given
redemption trends and projected future
redemption behavior.
The global ultimate redemption
rate assumption for current participants
is approximately 90 percent. The
Company continually evaluates its reserve
methodology and assumptions based on
developments in redemption patterns, cost
per point redeemed, contract changes, and
other factors.
The reserve for the estimated cost of points
expected to be redeemed is impacted over
time by enrollment levels, the number
of points earned and redeemed, and the
weighted-average cost per point, which is
influenced by redemption choices made by
cardmembers, reward offerings by partners
and other Membership Rewards program
changes. The reserve 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, 2008, if the ultimate
redemption rate of current enrollees changed
by 100 basis points, the balance sheet reserve
would change by approximately $225 million.
17