American Express 2013 Annual Report Download - page 49

AMERICAN EXPRESS COMPANY
2013 FINANCIAL REVIEW
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 CARD MEMBER LOSSES
Reserves for Card Member losses represent management’s best
estimate of the probable losses inherent in the Company’s outstanding
portfolio of Card Member loans and receivables, as of the balance
sheet date.
In estimating these losses, management uses statistical and
analytical models that take into account several factors, including loss
migration rates, loss emergence periods, historical losses and
recoveries, portfolio specific risk indicators, current risk management
initiatives and concentration of credit risk. Management also
considers other external environmental factors in establishing reserves
for Card Member losses.
The process of estimating these reserves 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 Card Member losses in any quarter.
As of December 31, 2013, a 10 percent increase in management’s
estimate of losses inherent in the outstanding portfolio of Card
Member loans and receivables evaluated collectively for impairment at
such date would increase reserves for Card Member losses with a
corresponding change to provision for Card Member losses by
approximately $165 million. This sensitivity analysis is provided as a
hypothetical scenario to assess the sensitivity of the provision for Card
Member losses. It does not represent management’s expectations for
losses in the future, nor does it include how other portfolio factors
such as loss migration rates or recoveries, or the amount of
outstanding balances, may impact the level of reserves for Card
Member losses and the corresponding impact on the provision for
Card Member losses.
LIABILITY FOR MEMBERSHIP REWARDS EXPENSE
The Membership Rewards program is the Company’s largest card-
based rewards program. Card Members can earn points for purchases
charged on their enrolled card products. Certain types of purchases
allow Card Members 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 Card
Member may earn.
The Company records a Membership Rewards liability that
represents the estimated cost of points earned that are expected to be
redeemed by Card Members in the future. The Membership Rewards
liability 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 Card Members, reward
offerings by partners and other Membership Rewards program
changes. The liability reflects management’s judgment regarding
ultimate redemptions and associated redemption costs. Actual
redemptions and associated redemption costs could differ significantly
from management’s judgment resulting in either higher or lower
Membership Rewards expense.
Management uses statistical and actuarial models to estimate URRs
of points earned to date by current Card Members based on
redemption trends of current enrollees, card product type, enrollment
tenure, card spend levels and credit attributes. A WAC per point
redeemed during the previous 12 months, adjusted as appropriate for
certain changes in redemption costs that are not representative of
future cost expectations, is used to estimate future redemption costs.
Management periodically evaluates its liability estimation process and
assumptions based on developments in redemption patterns, cost per
point redeemed, partner contract changes and other factors.
Changes in the Membership Rewards URR and WAC per point
have the effect of either increasing or decreasing the liability through
the current period marketing, promotion, rewards and Card Member
services expense by an amount estimated to cover the cost of all points
previously earned but not yet redeemed by current enrollees as of the
end of the reporting period. As of December 31, 2013, an increase in
the estimated URR of current enrollees of 100 basis points would
increase the balance sheet liability and corresponding expense for the
cost of Membership Rewards by approximately $290 million.
Similarly, an increase in the WAC per point of 1 basis point would
increase the balance sheet liability and corresponding expense for the
cost of Membership Rewards by approximately $86 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 based on the principal or, in the absence of a
principal, most advantageous market for the specific asset or liability.
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 did not have any Level 3 assets measured on a recurring
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