Reserves for Credit Losses Cash and Cash Equivalents At December 31, 2002 and 2001, cash and cash equivalents included $1.1 billion and $1.0 billion, respectively, segregated in special bank accounts for the benefit of customers. The company has defined cash equivalents to include time deposits with original maturities of 90 days or less. Reserves for credit losses related to cardmember loans and receivables is one of the largest operating expenses of the company. The company’s reserves for credit losses represents management’s estimate of the amount necessary to absorb future credit losses inherent in the company’s outstanding portfolio of loans and receivables. Management’s evaluation process requires numerous estimates and judgments. Reserves for these credit losses are primarily based upon models which analyze portfolio statistics and management’s judgment. The analytic models take into account numerous factors, including average write-off rates for various stages of receivable aging (i.e., current, 30 days, 60 days, 90 days) over a 24-month period, average bankruptcy rates and average recovery rates. In exercising its judgment in setting reserve levels, management considers levels derived from these models, and external indicators, such as leading economic indicators, unemployment rate, consumer confidence index, pur- chasing manager’s index, bankruptcy filings and the regulatory environment. Loans are charged-off when management deems amounts to be uncollectible, which is generally determined by the number of days the amount is past due. To the extent historical credit experience is not indicative of future performance or other assumptions used by management do not prevail, loss experi- ence could differ significantly, resulting in either higher or lower future provisions for credit losses, as applicable.  Generally, investment securities are carried at fair value on the balance sheet with unrealized gains (losses) recorded in equity, net of income tax provisions (benefits). Gains and losses are recognized in the results of operations upon disposition of the securities. In addition, losses are also recognized when management determines that a decline in value is other-than-temporary, which requires judgment regarding the amount and timing of recovery. Indicators of other-than-temporary impairment for debt securities include issuer downgrade, default or bankruptcy. The company also considers the extent to which cost exceeds fair value, the duration of time of that decline, and management’s judgment about the issuer’s current and prospective financial con- dition. Fair value is generally based on quoted market prices. However, the company’s investment portfolio also contains struc- tured investments of various asset quality, including CDOs and secured loan trusts (backed by high-yield bonds and bank loans) which are not readily marketable. As a result, the carrying values of these structured investments are based on cash flow projections which require a significant degree of management judgment as to default and recovery rates of the underlying investments and as such are subject to change. Investments Separate Account Assets and Liabilities Deferred Acquisition Costs Separate account assets and liabilities are funds held for the exclusive benefit of variable annuity and variable life insurance contract holders. The company receives investment management fees, mortality and expense assurance fees, minimum death benefit guarantee fees and cost of insurance charges from the related accounts. American Express Financial Advisors’ (AEFA) deferred acquisition costs (DAC) represent the costs of acquiring new insurance, annuity and certain mutual fund business, including, for example, direct sales commissions, related sales incentive bonuses and awards, underwriting costs, policy issue costs and other related costs attributable to sales. The costs for universal life and variable universal life insurance and certain installment annuities are amortized as a percentage of the estimated gross profits expected to be realized on the policies. DAC for other annuities are amortized using the interest method. For traditional life, disability income and long-term care insurance policies, the costs are amortized in proportion to premium revenue. For mutual fund products, DAC are generally amortized over fixed periods on a straight-line basis. For annuity and insurance products, the projections underlying the amortization of DAC require the use of certain assump- tions, including interest margins, mortality rates, persistency rates, maintenance expense levels and customer asset value I 60 AXP I NOTES TO CONSOLIDATED FINANCIAL STATEMENTS