Stability in the Present Value Assessment of Lost Earnings

Abstract

Stability in the Present Value Assessment of Lost Earnings Abstract This article recommends a uniform methodology and a benchmark for assessing present value awards for future lost earnings in personal injury litigation. basis of this recommendation is the remarkable stability, over successive periods of loss and across occupations, of the relative difference between the average annual after-tax interest rate on short-term Treasury securities and the average annual growth rate in after-tax earnings. stability of this relationship is consistent with economic and financial theories and is strongly supported by empirical evidence from 1952 through 1982. Introduction desire to adopt a uniform methodology and the need to establish guidelines for assessing present value awards for future lost earnings in personal injury litigation have been widely recognized in the literature and by the courts. Numerous articles have addressed the issues in determining the proper present value of lost earnings. Several of these articles have concentrated on the appropriate interest rate to use in discounting future lost earnings to present value [e.g., 5, 10, 17, 18, 20, 23]. Other articles have suggested benchmarks for assessing awards based on the historical relationship between interest rates and growth rates in earnings [e.g., 4, 7, 15, 16, 22, 24, 25]. Despite this attention, there is no consensus among economists or the courts regarding the best approach to employ in determining present value awards for lost earnings. Methodologies and benchmarks adopted and/or advocated by different courts for assessing these awards have varied dramatically [e.g., 1, 2, 3, 8, 13, 21]. After reviewing much of the literature and many of the court cases pertaining to this issue, the Supreme Court recently called for a study, stating, The legislative branch of the federal government is far better equipped than we are to perform a comprehensive economic analysis and to fashion the proper general rule[21, p. 2557]. In this article the authors report the results of a comprehensive and integrated study of the assessment of present value awards for lost earnings from 1952 through 1982. Thousands of present value awards (awards that would have allowed replication of actual after-tax lost earnings) were calculated for 454 industrial classifications for various periods of loss. This analysis suggests both a relatively simple methodology and a benchmark to use in assessing present value awards for lost earnings for the many cases in which the plaintiff's lost earnings stream is expected to equal the earnings over the period of loss of the average worker in a given occupation. Background current practice in personal injury litigation is to award plaintiffs a present sum of money as compensation for future lost earnings. intention is to make the plaintiff whole in the sense that the award allows the plaintiff, through investment in relatively safe securities, to replicate over time the lost after-tax earnings stream. amount of such an award depends ultimately on the relative difference, over the period of loss, between the after-tax rate of interest the plaintiff is expected to earn through investing the award and the rate of growth in after-tax earnings expected in the plaintiff's pre-injury occupation. This relative difference, which is defined and explained below, will be referred to as the discount or net interest rate. A number of economists have recently argued that the net discount rate is relatively stable over time because both the interest rate and the growth rate in earnings are positively correlated with the rate of price inflation[e.g., 4, 15, 16, 24]. Several authors have advocated using net discount rates, based on historical observations of interest and growth in earnings rates, in assessing awards for lost earnings. …