American Express 2010 Annual Report Download - page 27

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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 on many card
products. Many of these 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 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
liabilities that represent the estimated
future cost of points earned to date that
are expected to be ultimately redeemed.
These liabilities 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 historical redemption
trends and projected future redemption
behavior.
The global ultimate redemption rate
assumption that drives the Company’s
balance sheet reserves for expected
redemptions by current participants is
91 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, 2010, if the ultimate
redemption rate of current enrollees
increased by 100 basis points, the balance
sheet reserve and corresponding provision
for the cost of Membership Rewards would
each increase by approximately $283
million. Similarly, if the effective weighted-
average cost per point increased by 1 basis
point, the balance sheet reserve and
corresponding provision for the cost of
Membership Rewards would each increase
by approximately $60 million.
25
AMERICAN EXPRESS COMPANY
2010 FINANCIAL REVIEW