Estimating Economic Loss in Personal Injury Cases
By Alan Reinstein and Gerald H. Lander
The three forms of forensic accounting practice—litigation support consulting, expert witness testimony, and auditing alleged incidents of fraud—require finding, analyzing, interpreting, and presenting accounting, statistical, financial, and economic data. The ability to articulate a position is an indispensable quality of an expert witness. An inquisitive and investigative mindset is necessary to identify errors in calculations of financial data.
The Expert Witness
Unlike other witnesses, who cannot draw conclusions, the expert is expected and required to do so. The expert witness’ function is referred to in a federal rule of evidence:
If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education may testify thereto in the form of an opinion or otherwise.
For most economic valuation matters, as W. Wade Gafford points out in “Qualifications of Experts in Valuing Economic Damages in Personal Injury and Wrongful Death Cases” (Journal of Legal Economics, Fall 1997), Rule 702 of the Federal Rules of Evidence requires experts to demonstrate to trial judges that they have the requisite knowledge, experience, skill, training, or education to provide credible evidence.
Expert witnesses should manifest the following set of professional qualities:
The client also bears responsibility for reimbursing services and expenses. Professional fees should generally be assessed on an hourly basis for time spent, not contingent upon the amount of a settlement.
Important Technical Considerations
Identification of economic loss. Robert F. Reilly, in “Valuing Economic Loss: Don’t let Arson, Defamation, Theft, or Copyright Infringement Put You Out of Business” (Management Accounting, July 1993), stresses the importance of proper valuation of economic loss to ensure that owners of destroyed or lost commercial properties receive fair compensation. He points out that the five most common categories of deprivation circumstances and deprivation appraisals are: eminent domain (i.e., municipal condemnation, nationalization of property, and expropriation); property damage (i.e., arson for tangible assets, slander and libel for intangible assets); infringement (e.g., patents, trademarks, and copyright infringements); squeeze-out transactions (which deprive individuals of preferred equity interest, partnership interest, or other ownership interest in some business); and breach of contract (a deprived party that paid consideration in anticipation of the enjoyment of certain legal rights and other economic benefits).
While valuing property at fair market value is generally considered the most fair and equitable treatment, Reilly notes that the widely varying specific definitions of such value require valuators to consider the appropriate definition of value (e.g., considering certain income tax consequences) and the appropriate premise of value in order to determine a compensatory value.
Household production issues. Charles C. Fischer, in “The Valuation of Household Production: Divorce, Wrongful Injury and Death Litigation” (American Journal of Economics and Sociology, vol. 53, no. 2, April 1994), notes that forensic economists generally take a conservative and perhaps overly narrow approach to valuing household production, especially in areas of untimely death, wrongful injury, and divorce. Accurate valuation should consider such factors as opportunity costs, replacement costs, and family profile (e.g., marital status, number of children, valuation of household chores, and work wages versus market equivalents).
Problems with historical data. William R. Hosek, in “Problems in the Use of Historical Data in Estimating Economics Loss in Wrongful Death and Injury Cases” (Journal of Risk and Insurance, vol. 49, no. 2, 1982), questioned using historical data in making projections or extrapolations about future earnings growth paths and future interest rates, noting that historical average growth rates for earnings and historical average interest rates were generally used to estimate future rates. Sampling past data of such variables as wage rates to predict characteristics of the variable’s population, Hosek found that the uncritical use of historical averages and relationships provides a weak basis for estimating future growth rates in income and future rates of interest. He recommended the use of more individual information about the injured party and judgments about the individual’s future prospects.
Harris (1984) refutes Hosek, arguing for the use of historical real-time series data to estimate future real earnings and future real rates. Harris notes that because nominal rates are real series adjusted for inflation, historical nominal earnings and interest rate data can help properly calculate the present value of future lost earnings.
Objective variables. David Schalow and Christine Schalow, in “Determination of Settlement Values in Loss of Earnings Litigation” (National Public Accountant, June 1995), stress that forensic accountants are duty-bound to consider all key variables in performing economic valuations. W. Wade Gafford, in “Qualifications of Experts in Valuing Economic Damages in Personal Injury and Wrongful Death Cases” (Journal of Legal Economics, Fall 1997), notes that these experts should consider relatively objective variables such as expected future earnings, household services, medical expenses, and prejudgment interest. They point out that many problems exist in measuring subjective variables such as pain and suffering, loss of enjoyment, and other hedonic damages.
While relevant data in economic loss cases are thus usually restricted to quantifiable evidence, experts must use care in preparing their testimony. For example, J. Thomas Romans and Frederick G. Floss, in “Measuring Economic Loss for the Self-Employed: The Role of Economic Rents” (Journal of Legal Economics, Fall 1997), urge forensic accountants to consider the opportunity costs (e.g., using a replacement or indirect approach) to measure such nonsalary items as expected increases in the values of the decedent’s small or self-employed business. Natalie Scott, in “Don't Forget Me! The Client in a Class Action Lawsuit” (Georgetown Journal of Legal Ethics, vol. 15, 2002), also urges forensic accountants to consider the unique characteristics of key groups in a class action lawsuit, recommending that they divide the overall class into as many similar groups as possible.
John E. Scarbrough, in “Measuring Human Life Value from the Courtroom to the Living Room” (Journal of the American Society of CLU and ChFC, January 1998), notes that valuation experts should exercise careful judgment in measuring the values of such variables as the plaintiff's household services and nonwage income provided for their families, nonconstant rates of increases of wages and fringe benefits, and varying rates of income and estate taxes. Moreover, Wolfgang W. Franz, in “A Solution to Problems Arising from Inflation When Determining Damages” (Journal of Risk Insurance, June 1978), stresses that virtually all such cases will entail the issue of present value, which the U.S. Supreme Court raised in 1916 in Chesapeake and Ohio Railway vs. Kelly.
In response to these issues, Earl Cheit, in “Measuring Economic Loss Due to Death and Disability” (Injury and Recovery in the Course of Employment, New York: Wiley, 1961), used classic consumption tables to show how to reach a valuation for the decedent’s “personal consumption allowance.” Alan Reinstein and Robert E. Hansen, in “Valuing Economic Loss of Untimely Death: An Expert Witness Opportunity for CPAs” (The Ohio CPA Journal, Summer 1984), also recommend valuing a decedent’s lost household income based upon his normal wages and the market wages for performing chores around the house.
Determining a Basis for Value
The following data afford a more complete understanding of the economic condition of a personal injury victim and descendants:
These data help to derive pertinent statistics, such as life and work-life expectancies since the accident, personal consumption expenditures over an expected lifetime and career, and values associated with the economic lifestyle.
The next step is to collect data on the decedent’s responsibilities affected by the personal injury:
The benefits lost are determined from a victim’s income characteristics and the support characteristics of benefits and wealth no longer provided to heirs and dependents. A spouse’s life expectancy may serve as a beneficial support period. For dependent children, support life may be computed from the decedent’s date of death until each child reaches the age of majority (usually 18) or through the age of baccalaureate education if a college education is normally expected at that socioeconomic level.
From these data, a forensic expert constructs a profile of past and present economic facts from which to begin projections of value lost in future years. This entails developing statistical data based on reliable tabulations of such averages as life expectancy tables, earnings of individuals in the same age group, earnings according to education level and occupation, consumer price index (local or national), productivity index, or other well-defined statistics from government or well-known private sources. Pitfalls arise in using statistical data to develop future data, because statistics get “old,” demographics shift, statistical tabulations include heterogeneous subgroups, and statistical summaries may be based on different averaging techniques or different time periods. Therefore, an expert witness must be prepared to demonstrate that:
To compute economic loss, an expert should consider other factors, such as inflation, proper discount rates, productivity gains, and job promotions. Including fringe benefits, such as profit-sharing, employer Social Security contributions, group insurance, and vested pension rights, can also help counter opposing counsel’s “what if” questions. Because many such cases are settled prior to trial, these computations are critical for pretrial negotiations. Expert witnesses should supplement testimony with adequate, illustrative visual aids. Charts of consumer price indices, economic support of children, and graphical data on earnings can help the triers visualize the complex economic data presented in testimony.
The expert witness’ report should be made available to opposing counsel before negotiations begin or before the trial opens. Expert witnesses should carefully review their results with the legal counsel that hired them, and be prepared to justify using appropriate earnings growth rates, plaintiff’s or decedent’s expected lives, and inflationary discount rates. After performing these tasks, the final report should include a cover letter, a summary of findings, supporting tabulations and computations, and conclusions.
Applied Case Example
The plaintiff’s attorney asked Sarah Hopkins, forensic accountant, to estimate damages due to the economic losses incurred from an automobile accident involving Majestic Healing, Inc., and the plaintiff, Sanchez Gomez (born October 1, 1940). Before starting on the case, Hopkins issued an engagement letter (Exhibit 1).
Although Gomez’s insurer, Allnation Insurance Co., covered much of his first two years of claims, the defendant, Majestic, is liable for certain other damages. Like all engagement letters, this one helps minimize the CPA’s liability, sets the terms of the contract, and clarifies the parties’ responsibilities. Hopkins obtained information from various sources of data as follows:
Majestic Hauling’s vehicle struck the plaintiff on January 4, 2000. The plaintiff was entitled to receive $1,540 per week for lost wages and $160 per week for replacement services (household expenses) for two years (104 weeks) from his no-fault insurance carrier. At the time of the accident, the plaintiff worked as an outside contractor counselor for Health Care Unlimited at a rate of $40 per hour plus 1.5 times this rate when he worked more than 40 hours per week.
Other assumed/imputed facts. The plaintiff planned to work until he reached age 65 (October 1, 2005). The plaintiff expected to receive about a 5% annual raise in pay. The plaintiff worked 46 hours per week for about 47 weeks per year. The plaintiff sought to obtain a full-time position (which should have taken about two years to accomplish) that would pay health care, retirement, and other fringe benefits worth about $60 per week.
The plaintiff's counsel engaged a forensic accountant to calculate the plaintiff's economic loss, making and justifying whatever reasonable assumptions she deemed necessary. Hopkins came to the solution shown in Exhibit 2. It calculates the plaintiff’s estimated annual earnings base. Potential replacement services and fringe benefits are also included in the final calculation.
The example considers the two years of replacement wages (at $1,540 per week) and of replacement services (at $160 per week) that Allnations was to have paid the plaintiff. The potential fringe benefits are assumed to have arisen two years after the plaintiff was involved in the accident.
This report—like all projected economic evaluations—contains several ordinary limitations, such as a lack of objective evidence of the number of hours worked. It also, however, contains conservative assumptions:
As such, this report represented Hopkins’ best reasonable estimate of the plaintiff’s economic loss. The assumptions she used to come to the estimate are reasonable within the inherent limitations of such economic projections and can be defended through expert witness testimony.
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