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1Garland Actuarial LLC
Estimating Gift Certificate Liability:
An Actuarial Approach
CAS 2003 Annual MeetingNew Orleans, LouisianaNovember 9-12, 2003
Harry T. Garland, [email protected]
2Garland Actuarial LLC
Terminology
Liability* – Expected value of all future gift certificate redemptions from those already issued.
Breakage – Expected value of issued gift certificates that will never be redeemed.
Breakage Factor – Percentage of total value of issued gift certificates contributing to Breakage.
Escheat Law – Legal basis in some states to claim from the issuer the dollar value of unredeemed gift certificates.
* Auditors may take other factors into account when determining liability for accounting purposes
3Garland Actuarial LLC
The Problem
Let TI = Total value of certificates issued
Let TR = Total value of certificates redeemed
Let L = Liability
Let B = Breakage
Then,
TI – TR = L + B
For unredeemed certificates how do you estimate those that will be redeemed at some future time (L) vs. those that will never be redeemed (B)? And what if the company does not have accurate records to be able to determine TI and TR?
4Garland Actuarial LLC
Actuary
Attorney
Company
Accountant
AnalysisAnalysis
Data
Escheat Law Compliance
Balance Sheet Liability
The Process
5Garland Actuarial LLC
Sample Company Data
Gift Certificate History
0
1
2
3
4
5
6
7
8
9
Oct-00
Nov-0
0
Dec-0
0
Jan-
01
Feb-0
1
Mar
-01
Apr-0
1
May
-01
Jun-
01
Jul-0
1
Aug-0
1
Sep-0
1
Oct-01
Nov-0
1
Dec-0
1
Jan-
02
Feb-0
2
Mar
-02
Apr-0
2
May
-02
Jun-
02
Jul-0
2
Aug-0
2
Sep-0
2
Oct-02
Nov-0
2
Dec-0
2
Jan-
03
Feb-0
3
Mar
-03
Apr-0
3
May
-03
Jun-
03
Jul-0
3
Mill
ion
s
ISSUED
REDEEMED
6Garland Actuarial LLC
Analytical Approach
1) Build a model that predicts monthly certificate redemptions from historical monthly certificate sales.
2) Determine breakage from the model.
3) Determine liability from the model
7Garland Actuarial LLC
Building the Model
1) Assume that certificate redemptions in any month can expressed as a linear combination of certificate sales for that month and all past months.
2) Express the model as a redemption vector with elements RV(0), RV(1), RV(2)… where
RV(0) is the percentage of dollar value issued in the current month contributing to redemptions in the current month.
RV(1) is the percentage of dollar value issued in the immediately preceding month contributing to redemptions in the current month.
And so on. The length of the vector should be determined by when the contribution of certificates issued in more distant months becomes immaterial to current redemptions.
8Garland Actuarial LLC
Techniques for Calculating the Redemption Vector
1) If transaction data on redemptions by issue date is available, build an actuarial triangle of redemptions by age of month of issue.
2) If only cumulative sales and redemption data is available consider multiple regression analysis and/or exponential decay model.
9Garland Actuarial LLC
Redeemed
rm-11 rm-3 rm-2 rm-1 rm rm
Oct-00 428,574 … 517,356 523,851 496,936 577,415 466,258
Nov-00 5,629,747 … 523,851 496,936 577,415 888,371 524,951
Dec-00 415,249 … 496,936 577,415 888,371 6,891,057 2,730,390
Jan-01 392,317 … 577,415 888,371 6,891,057 553,241 2,330,785
Feb-01 431,581 … 888,371 6,891,057 553,241 539,711 1,107,643
Mar-01 597,022 … 6,891,057 553,241 539,711 555,744 869,286
Apr-01 599,215 … 553,241 539,711 555,744 645,149 942,968
May-01 835,034 … 539,711 555,744 645,149 745,722 722,195
Jun-01 517,356 … 555,744 645,149 745,722 1,030,556 869,404
Jul-01 523,851 … 645,149 745,722 1,030,556 581,295 757,378
Aug-01 496,936 … 745,722 1,030,556 581,295 616,551 658,365
Sep-01 577,415 … 1,030,556 581,295 616,551 567,971 543,792. . . . . . .. . . . . . .. . . . . . .
Monthly Dollar Value of Certificates Issued
Example of Regression Matrix
Dollar amount redeemed each month is modeled as a linear combination of the dollar amounts issued in preceding months. The regression coefficients form the elements of the redemption vector. Assumption for this example is that there are no significant redemptions from certificates more than one year old.
10Garland Actuarial LLC
Regression Vector
for Sample Company Data
Gift Certificate History
0
1
2
3
4
5
6
7
8
9
Oct-00
Nov-0
0
Dec-0
0
Jan-
01
Feb-0
1
Mar
-01
Apr-0
1
May
-01
Jun-
01
Jul-0
1
Aug-0
1
Sep-0
1
Oct-01
Nov-0
1
Dec-0
1
Jan-
02
Feb-0
2
Mar
-02
Apr-0
2
May
-02
Jun-
02
Jul-0
2
Aug-0
2
Sep-0
2
Oct-02
Nov-0
2
Dec-0
2
Jan-
03
Feb-0
3
Mar
-03
Apr-0
3
May
-03
Jun-
03
Jul-0
3
Mill
ion
s
ISSUED
REDEEMED
RV = (33.2%, 27.9%, 8.9%, 6.1%, 4.3%, 2.9%, 2.4%, 2.3%, 1.8%, 0.2%. 0.1%, .06%)
For this example, the elements of the redemption vector are the coefficients of the regression.
11Garland Actuarial LLC
Actual Redemptions vs. Model
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Oct-00
Dec-00
Feb-0
1
Apr-0
1
Jun-
01
Aug-0
1
Oct-01
Dec-01
Feb-0
2
Apr-0
2
Jun-
02
Aug-0
2
Oct-02
Dec-02
Feb-0
3
Apr-0
3
Jun-
03
Mill
ion
s
ActualModel
Comparison of Actual Data with Model
12Garland Actuarial LLC
Calculating Breakage Factor
Since each element of the redemption vector, RV(n), represents the percentage contribution to monthly redemption of those certificates issued n months prior to the redemption month, then the sum of all the elements of the redemption vector represents the percentage of certificate sales that is estimated to be redeemed. The breakage factor then is given by:
n
k
kRVctorBreakageFa0
)(1
13Garland Actuarial LLC
Calculating Liability
1) Convolution of the redemption vector with the vector of monthly certificate sales yields the vector of estimated monthly certificate redemptions.
2) Convolution of the liability vector with the vector of monthly certificate sales yields the vector of estimated liabilities (as of the end of each month.)
3) The liability vector models what has not yet been redeemed. It can be derived from the redemption vector as follows:
For a redemption vector with n+1 elements RV(0), RV(1), … RV(n), the liability vector, LV, can be formulated as an n-element vector where each element (x ranging from 0 to n-1) is given by:
n
xk
kRVxLV)1(
)()(
14Garland Actuarial LLC
Summary
We have shown how actuarial techniques can be used to help a company estimate future gift certificate liabilities. This information is needed to help the company determine its balance sheet liability for gift certificates and its escheat obligations (which vary form state to state.)
Companies may have very poor records regarding their paper gift certificate transactions (e.g. no redemption data by issue date.) Companies that have merged or acquired other companies may have incomplete historic data. As a result, a variety of techniques may be needed to accurately model redemptions.
Many companies are replacing their gift certificates with magnetically-striped gift cards. Use of gift cards will facilitate the acquisition of data for actuarial analysis.