Calculating Economic Damages: Financial Expert Terminology
As an accountant and economist, I love working with numbers. I’ve come to realize that not everyone feels the same way. If you have ever looked at a report from a financial expert and been overwhelmed, you are not alone. The following glossary of terms is intended to provide the reader with a little bit of background on phrases commonly used by a financial expert and how they impact the bottom line when calculating economic damages in personal injury, wrongful death or employment matters. Economic damages calculated by the financial expert in these types of cases commonly include loss of earnings or loss of support, fringe benefits, household services and future medical care.
Worklife Expectancy (vs. Retirement Age): Worklife expectancy is the average number of years that a person in a given demographic will spend working for the remainder of their life. Worklife expectancy tables will typically display data based on cohorts distinguished by: age, gender, educational attainment and work status (active or inactive). A lot of us intend on working as long as possible and have a target retirement age in mind. However, an important distinction is that worklife expectancy and retirement age are not the same thing. Statistics show us that over time, individuals move in and out of the work force for a wide variety of reasons including: illness, injury, relocation, career changes, schooling and personal or family matters. As an example, if we look at the worklife expectancy for a woman who is 45 years old with a high school education, there are tables that indicate a worklife of 15.38 years.1 This does not necessarily mean that this individual will retire at age 60.38 (45+15.38). Rather, this individual may retire at age 65, but in aggregate her total working years will equal 15.38 years. One of the biggest factors in determining worklife is education. Typically the more education an individual has, the more years they will work. In our earlier example if the same woman instead had a professional degree her worklife expectancy would be increased by over 5 five years to 20.98.1 It is important to know if your financial expert is using a worklife expectancy or a retirement age, as this can have a substantial impact on the calculations.
Loss of Earnings: This is what an individual would have been likely to earn over their lifetime, if not for some given incident/injury. Economists often look at the past performance of an individual as well as the industry and occupation as a whole. For an individual with an extensive and established work history this task can be relatively straight forward. A more challenging situation arises when, for example, we are looking at an individual who has just graduated law school and has never participated in the work force. In these situations the economist will typically rely on statistics. There are many sources of information on average earnings from both government and private studies and publications.
Offset of Earnings: This is what an individual will now likely earn over their lifetime, as a result of a given incident/injury. If past performance after the incident exists, an economist will take this into consideration. They also often rely on the opinions of vocational rehabilitation experts who can analyze the individual’s abilities and opportunities in different industries or capacities post-incident.
Discount Rate and Present Value: According to the jury instructions, damages are to be calculated in present value terms. Present value is the concept that a dollar today is worth more to you than a dollar in ten years, because you can invest it now and earn a rate of return on your investment. The discount rate is the rate that is used to calculate the present value of damages. Where this rate is derived from is one of the most hotly debated topics among economists. Jury instructions require that the financial expert look at what the value would be if “reasonably invested.” Therefore you will commonly see economists relying on government securities to determine their discount rate. Economists will often differ in terms of what duration they look at (e.g. a 3-month Treasury bill vs. a 10-year Treasury note). There is an inverse relationship between interest rates and present value. Thus, the higher your interest rate, the lower your calculation of the present value of the damages. So the difference between a 3-month Treasury bill and a 10-year Treasury note can be substantial (.04% vs. 2.6% respectively, based on current rates). 2 Another common difference among economists is whether they are looking at current yields or historical yields. Referencing our earlier example, the 30 year historical yield on 3-month Treasury bills and 10-year Treasury notes is approximately 4% and 6%, respectively.
Growth Rate: A growth rate is used to project how future earnings, benefits, medical care costs or profits will increase over time. Some economists will rely on historical rates and others on projections. The growth rate will vary based on the category of the item you are evaluating. For example, medical care costs for doctor visits and hospitalizations have grown at a much faster rate than wages over the past 30 years. Therefore, it is not uncommon to see an economist using different growth rates for the calculation of earnings and future medical care costs.
Net Discount Rate: Many economists prefer to evaluate damages using a net discount rate rather than the individual discount and growth rate components. In other words, they look at the relationship between interest rates and growth rates/inflation over the same period of time. Alternatively, economists that do not use a net discount rate methodology may be using current interest rates and historical growth rates.
Personal Consumption (Loss of Support): When calculating losses in a wrongful death case, the financial expert should typically take into consideration what the decedent would have consumed of their own earnings. This is done by analyzing studies that track who and what the household spends money on. For example, a common source of information is the Bureau of Labor Statistics’ Consumer Expenditure Survey. This breaks down consumption by household size and income. In a 3 person household with $70K+ in income, the breakdown is: 31.8% indivisible (rent/utilities, etc.), 23.6% male, 24% female and 20.6% child.3 The reduction for consumption can range anywhere from 15-75% depending on individual circumstances and the source relied on by the economist.
Household Services: These are services that include: cleaning, cooking, laundry, yard work, shopping, obtaining services and travel. In the event that an individual can no longer provide household services, an economist can perform this calculation if appropriate. Often times an economist will look at tables that break down the average time spent on services provided, by demographic. For a married female with a child under 13 who works full time the value of these services is approximately $20,000 per year.4 When calculating economic damages, this can be a substantial number in terms of present value over an individual’s lifetime.
Loss of Fringe Benefits: For health insurance and defined contribution plans this calculation can be performed by looking at what the employer contributes to a plan. This information is often found in pay stubs, benefit statements or employee hand books. Other types of fringe benefits are far more difficult to calculate, such as defined benefit plans, stock options, stock grants or profit sharing plans. For defined benefit plans (e.g. CalPERS, CalSTRS or other private retirement plans) the economist can review the Summary Plan Description which outlines how benefits are ultimately determined at a given retirement date. These are typically based on a set formula such as: monthly benefit = years of service x benefit factor x average final compensation. One can then utilize projections as discussed above for earnings and retirement, to come up with the present value of this benefit. If the value of fringe benefits is unknown, economists can rely on what the average employer contributes to employee benefits. A common source for this information is the Bureau of Labor Statistics which indicates this is typically about 15%.5
Future Medical Care Costs: For this category of damages the economist relies primarily on information provided by a life care planner or other medical expert. The economist will be responsible for calculating the present value of the figures in a life care plan, but will otherwise simply be “crunching the numbers.”
Life Expectancy: Jury instructions provide specific guidance on the source to use for life expectancy. The life tables in Vital Statistics of the United States, published by the National Center for Health Statistics, is recommended. Therefore it is rare to see this disputed among economists. However, economists are often asked to make assumptions about a reduced life expectancy based on an individual’s unique circumstance (for example, a preexisting medical condition). This is not something that the economists will typically determine themselves. Rather they will rely on the opinions of medical experts in order to incorporate a reduced life expectancy into their analysis. A reduced life expectancy typically has the biggest impact on the calculation of future medical care costs.
1Skoog, Ciecka and Krueger, “The Markov Process Model for Labor Force Activity: Extended Tables of Central Tendency, Shape, Percentile Points and Bootstrap Standard Errors” JFE, Vol. XXII, No. 2
2Wall Street Journal Online 3/17/14
3Bureau of Labor Statistics' Consumer Expenditure Surveys, Bulletin Tables
4Expectancy Data The Dollar Value of a Day: 2012 Dollar Valuation. Shawnee Mission, Kansas, 20135Employer Costs for Employee Compensation, U.S. Department of Labor, Bureau of Labor Statistics
Victoria Wilkerson is an economist and testifying damages expert. When she's not calculating damages, she golfs with the WLALA Golf League and the WLALA SCGA Advocating Women Lawyers Golf Club, of which she is currently Treasurer.