American Express 2013 Annual Report Download - page 50

AMERICAN EXPRESS COMPANY
2013 FINANCIAL REVIEW
basis during the year ended December 31, 2013. Refer to Note 3 to the
Consolidated Financial Statements.
Investment Securities
The Company’s investment securities are mostly composed of fixed-
income securities issued by states and municipalities as well as the U.S.
Government and Agencies.
The fair market values for the Company’s investment securities,
including investments comprising defined benefit pension plan assets,
are obtained primarily from pricing services engaged by the Company.
For each security, the Company receives one price from a pricing
service. The fair values provided by the pricing services are estimated
using pricing models, where the inputs to those models are based on
observable market inputs or recent trades of similar securities. The
pricing services did not apply any adjustments to the pricing models
used as of December 31, 2013 and 2012. In addition, the Company did
not apply any adjustments to prices received from the pricing services.
The Company reaffirms its understanding of the valuation techniques
used by its pricing services at least annually. In addition, the Company
corroborates the prices provided by its pricing services for
reasonableness by comparing the prices from the respective pricing
services to valuations obtained from different pricing sources as well
as comparing prices to the sale prices received from sold securities at
least quarterly.
In the measurement of fair value for the Company’s investment
securities, even though the underlying inputs used in the pricing
models are directly observable from active markets or recent trades of
similar securities in inactive markets, the pricing models do entail a
certain amount of subjectivity and therefore differing judgments in
how the underlying inputs are modeled could result in different
estimates of fair value.
Other-Than-Temporary Impairment of Investment Securities
Realized losses are recognized when management determines that a
decline in the fair value of investment securities is other-than-
temporary. Such determination requires judgment regarding the
amount and timing of recovery. The Company reviews and evaluates
its investment securities at least quarterly, and more often as market
conditions may require, to identify investment securities that have
indications of other-than-temporary impairments. The Company
considers several factors when evaluating debt securities for other-
than-temporary impairment, including the determination of the
extent to which a decline in the fair value of a security is due to
increased default risk for the specific issuer or market interest rate
risk. With respect to market interest rate risk, the Company assesses
whether it has the intent to sell the investment securities and whether
it is more likely than not that the Company will be required to sell the
investment securities before recovery of any unrealized losses.
In determining whether any of the Company’s investment
securities are other-than-temporarily impaired, a change in facts and
circumstances could lead to a change in management judgment about
the Company’s view on collectability and credit quality of the issuer,
or the impact of market interest rates on the investment securities.
Any such changes could result in the Company recognizing an other-
than-temporary impairment loss through earnings.
Derivative Instruments
The Company’s primary derivative instruments are interest rate
swaps, foreign currency forward agreements, cross-currency swaps
and a total return swap relating to a foreign equity investment.
The fair value of the Company’s derivative instruments is
estimated by using either a third-party valuation service that uses
proprietary pricing models, or by internal pricing models, where the
inputs to those models are readily observable from actively quoted
markets. The Company reaffirms its understanding of the valuation
techniques used by a third-party valuation service at least annually.
To mitigate credit risk arising from the Company’s derivative
instruments, counterparties are required to be pre-approved and rated
as investment grade. In addition, the Company manages certain
counterparty credit risks by exchanging cash and noncash collateral
under executed credit support agreements. The noncash collateral
does not reduce the derivative balance reflected in the other assets line
but effectively reduces risk exposure as it is available in the event of
counterparty default. Based on the assessment of credit risk of the
Company’s derivative counterparties, the Company does not have
derivative positions that warrant credit valuation adjustments.
In the measurement of fair value for the Company’s derivative
instruments, although the underlying inputs used in the pricing
models are readily observable from actively quoted markets, the
pricing models do entail a certain amount of subjectivity and,
therefore, differing judgments in how the underlying inputs are
modeled could result in different estimates of fair value.
GOODWILL RECOVERABILITY
Goodwill represents the excess of acquisition cost of an acquired
company over the fair value of assets acquired and liabilities assumed.
In accordance with U.S. GAAP, goodwill is not amortized but is tested
for impairment at the reporting unit level annually or when events or
circumstances arise, such as adverse changes in the business climate,
that would more likely than not reduce the fair value of the reporting
unit below its carrying value. The Company’s approach and
methodology for conducting its goodwill impairment testing is
described in Note 8 to the Consolidated Financial Statements, but is
fundamentally based on the measurement of fair value for the
Company’s reporting units, which inherently entails the use of
significant judgment.
For valuation, the Company uses a combination of the income
approach (discounted cash flows) and market approach (market
multiples) in estimating the fair value of its reporting units.
When preparing discounted cash flow models under the income
approach, the Company estimates future cash flows using the
reporting unit’s internal multi-year forecast, and a terminal value
calculated using a growth rate that management believes is
appropriate in light of current and expected future economic
48