American Express 2011 Annual Report Download - page 18

AMERICAN EXPRESS COMPANY
2011 FINANCIAL REVIEW
See Consolidated Results of Operations, beginning on page 19,
for discussion of the Company’s results.
Certain reclassifications of prior year amounts have been made
to conform to the current presentation.
CRITICAL ACCOUNTING ESTIMATES
Refer to Note 1 to the Consolidated Financial Statements for a
summary of the Company’s significant accounting policies
referenced, as applicable, to other financial statement footnotes.
Certain of the Company’s accounting policies that require
significant management assumptions and judgments are set forth
below.
RESERVES FOR CARDMEMBER LOSSES
Reserves for cardmember losses represent management’s best
estimate of losses inherent in the Company’s outstanding
portfolio of cardmember loans and receivables as of the balance
sheet date.
In estimating losses management uses statistical models that
take into account several factors, including loss migration rates,
historical losses and recoveries, portfolio specific risk indicators,
current risk management initiatives and concentration of credit
risk. In establishing the reserves, management also considers
other external environmental factors such as leading economic
and market indicators, including unemployment rates, home
prices and Gross Domestic Product.
The process of determining the reserve for cardmember losses
requires a high degree of judgment. To the extent historical
credit experience updated for external environmental trends is
not indicative of future performance, actual losses could differ
significantly from management’s judgments and expectations,
resulting in either higher or lower future provisions for losses.
As of December 31, 2011, an increase (decrease) in write-offs
equivalent to 20 basis points of cardmember loans and
receivables balances at such date would increase (decrease) the
provision for cardmember losses by approximately $210 million.
This sensitivity analysis does not represent management’s
expectations for write-offs but is provided as a hypothetical
scenario to assess the sensitivity of the provision for cardmember
losses.
RESERVES FOR MEMBERSHIP REWARDS COSTS
The Membership Rewards program is the largest card-based
rewards program in the industry. Eligible cardmembers can earn
points for purchases charged on most of the Company’s card
products. Certain types of purchases allow cardmembers to also
earn bonus points. 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.
The Company establishes balance sheet reserves that represent
the estimated future cost of points earned that are expected to be
redeemed. These reserves reflect management’s judgment
regarding ultimate redemptions and associated costs.
Management uses statistical and actuarial models to estimate
ultimate redemption rates of points earned to date by current
cardmembers based on historical redemption trends, current
enrollee redemption behavior, card product type, year of
program enrollment, enrollment tenure and card spend levels. A
weighted-average cost per point redeemed during the previous
twelve months, adjusted as appropriate for recent changes in
redemption costs, including mix of rewards redeemed, is used to
approximate future redemption costs. 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 earned points expected to
be redeemed is impacted over time by enrollment levels, 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. Management assumes
that a large majority of all points earned will eventually be
redeemed, and therefore the reserve is most sensitive to changes
in the estimated ultimate redemption rate.
Changes in the ultimate redemption rate and weighted-average
cost per point have the effect of either increasing or decreasing
the reserve through the current period provision by an amount
estimated to cover the cost of all points previously earned but
not yet redeemed by cardmembers as of the end of the reporting
period. As of December 31, 2011, 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
$330 million. Similarly, if the 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 $70 million.
FAIR VALUE MEASUREMENT
The Company holds investment securities and derivative
instruments that are carried at fair value on the Consolidated
Balance Sheets. Management makes assumptions and judgments
when estimating the fair values of these financial instruments.
In accordance with fair value measurement and disclosure
guidance, the objective of a fair value measurement is to
determine the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market
participants at the measurement date (an exit price). The
disclosure guidance establishes a three-level hierarchy of inputs
to valuation techniques used to measure fair value. The fair value
hierarchy gives the highest priority to the measurement of fair
value based on unadjusted quoted prices in active markets for
identical assets or liabilities (Level 1), followed by the
measurement of fair value based on pricing models with
significant observable inputs (Level 2), with the lowest priority
given to the measurement of fair value based on pricing models
with significant unobservable inputs (Level 3). The Company
does not have any Level 3 assets. Refer to Note 3 to the
Consolidated Financial Statements.
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