Breakage & liability

When an airline gives you points, it hasn't earned that money yet: it owes you a future reward. This model follows a year of points from the day they are issued until they are redeemed, expire or are simply forgotten, and shows what the accounts see along the way: a liability that builds up, and revenue that arrives later.

Illustrative numbers: the programme on this page is made up and doesn't describe any airline. Only the benchmark panel uses published figures.

1Points are issuedPart of what the customer paid is set aside for the points. It isn't revenue yet: it goes on the balance sheet as deferred revenue, a liability.

2Points are redeemedWhen a member books an award, the value of those points leaves the liability and becomes revenue: the airline has now delivered what it promised.

3Some points are never usedThat share is breakage. Rather than wait for points to expire, IFRS 15 releases the expected breakage little by little, in step with redemptions.

Redemption speed

Points expire after

Value per point issued

cents, the share of the fare (or partner payment) allocated to each point

Points issued per month

Growth per year

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How a month of points gets used

One cohort, followed from the month it was issued

Redemption curve

Cumulative share of a cohort's points redeemed, by months since issue. The gap left at the top is breakage.

What happens to 100 points

With the settings above, over the full life of a cohort.

The points liability

Deferred revenue at month end, by the year the points were issued

Revenue recognised each month

Revenue follows redemptions, not issuance

Monthly roll-forward

Opening + issued − redeemed − breakage recognised = closing

Year

Scenario: the breakage estimate is revised

The catch-up adjustment

Breakage is an estimate, and it gets revised as redemption data comes in. Here the programme has been booking revenue as if 18% of points would never be used, then discovers members redeem more than expected. In the month of the change, the revenue already booked on past redemptions is recalculated with the new rate and the difference is reversed in one go.

Estimate used until now % Revised estimate % From

Revenue recognised each month

Scenario: the expiry policy changes

For example, points stop expiring

A new rule applies to every balance that hasn't expired yet. Fewer points will lapse, so expected breakage falls: the programme re-estimates it, books a catch-up, and from then on carries a larger liability.

New rule From

Points liability

Deferred revenue at month end.

Revenue recognised each month

Redemptions plus breakage, including the catch-up.

Benchmarks: loyalty deferred revenue in annual reports

What four large programmes carry on their balance sheets, as published. Amounts are in millions of each airline's reporting currency and aren't converted, so compare shapes, not sizes. The current part is what the airline expects to recognise within twelve months.

How it works

The points

Points are grouped in monthly cohorts: all the points issued in a given month. Issuance follows the monthly volumes above (a seasonal pattern that peaks in summer), repeated every year and grown by the chosen rate. The model starts fifteen years before Y1 so the liability is already in a steady state when the charts begin.

Each cohort splits into two kinds of balance. Most points (the share 1 − d) belong to engaged members, who stay active and redeem along a curve; their activity keeps resetting the inactivity clock, so their points never expire. The rest (d) belong to members who go quiet after earning. A share r of them eventually come back and redeem, after an average of μ months; the others never do. With an inactivity rule of N months, quiet balances expire N months after they were earned unless the member came back first; with no expiry they stay on the books.

Engaged, cumulative share redeemed by month a: (1 − d) × (1 − exp(−(a/λ)^k)) Quiet members who come back by month a: d × r × (1 − exp(−a/μ)) (only while a ≤ N) Breakage b = 1 − total share ever redeemed (points followed for 15 years)

The accounting (IFRS 15)

A loyalty point is a separate promise inside the sale that created it, so part of the price is allocated to it and deferred. The model uses one allocated value per point, v. Loyalty 101, chapter 04 shows how that allocation is worked out from a ticket price; its example lands at about one cent a point.

Issued: D = points issued × v Redeemed (each month): v × points redeemed Breakage recognised: v × points redeemed × b / (1 − b) Closing liability: opening + issued − redeemed − breakage recognised

So each redeemed point releases v / (1 − b) in total, a little more than its own value, because it also carries its share of the points that will never be redeemed. When the last expected redemption happens, the cohort's whole deferred amount has been recognised and its liability is zero. This is what IFRS 15 asks for when an entity expects breakage: recognise it "in proportion to the pattern of rights exercised by the customer" (IFRS 15, paragraphs B39–B47 on customer options and unexercised rights). US airlines apply the same idea under ASC 606: United and Delta both describe recognising mileage breakage "proportionally" as the remaining miles are redeemed. A point that expires is not a revenue event of its own: its breakage was being recognised all along.

Change in estimate. When the breakage rate changes from b₀ to b₁, every open cohort is restated as if b₁ had always been used, and the difference goes through revenue in that month:

Catch-up = v × points already redeemed × [ 1/(1 − b₁) − 1/(1 − b₀) ] (capped so that a cohort's liability stays between zero and D)

Air Canada's financial statements describe this treatment: in the period of change, the balance is adjusted "as if the revised estimate had been used in prior periods", the offset goes to passenger revenue, and the new estimate is used from then on. In the expiry scenario, each open cohort is re-estimated to the breakage its remaining life implies under the new rule; cohorts whose points have already expired keep their old rate.

Sources

IFRS Foundation, IFRS 15 Revenue from Contracts with Customers, application guidance B39–B47.

Limitations

The programme is stylised and every model input is an assumption chosen to look plausible, not an estimate of any real programme.
One value per point for all points. Real programmes allocate different values to points earned on flights and points sold to banks and partners, and part of a partner payment (marketing, brand) is recognised immediately rather than deferred.
The value per point doesn't react to breakage. In practice the standalone selling price of a point already reflects the chance it will be used, so a lower breakage estimate would also raise the value allocated to new points.
Inactivity is measured from the month the points were earned. Members don't react to expiry in the model; real ones often redeem or earn a few points just before their balance would lapse.
Redemptions aren't seasonal and there's no financing component, currency, or tax. Revenue is shown gross, before the cost of providing the award.
The benchmark figures are as published and not adjusted: Air Canada's line includes other deferred revenues, and Air France-KLM's covers both Flying Blue and BlueBiz.

This is a personal project and isn't affiliated with any airline. For the business side of breakage, read Loyalty 101: Breakage & the Points Liability.

Grégoire Maillard