Measuring Damages Involving Individuals

What is an Injured Party Worth?

The Forensic and Valuation Services division of the AICPA and CIMA issued a Practice Aid in 2020 on Measuring Damages Involving Individuals. This Practice Aid supersedes AICPA Forensic and Valuation Services Practice Aid 98-2, Calculation of Damages from Personal Injury, Wrongful Death, and Employment Discrimination. This NACVA QuickRead article provides a summary of the updated Practice Aid.

Introduction

The Forensic and Valuation Services division of the AICPA and CIMA issued a Practice Aid in 2020 on Measuring Damages Involving Individuals. This Practice Aid supersedes AICPA Forensic and Valuation Services Practice Aid 98-2, Calculation of Damages from Personal Injury, Wrongful Death, and Employment Discrimination. This NACVA QuickRead article provides a summary of the updated Practice Aid.

Calculation of Losses Involving Individuals

Overview

Damages involving individuals include damages from personal injury, wrongful death, and lost employment. The forensic practitioner who is engaged to calculate damages involving individuals determines monetary amounts that would have been realized “but for” the wrongful incident. Reductions are then applied for amounts realized or received, or for amounts that would have been received had the claimant mitigated damages. Certain jurisdictions allow for a reduction for personal consumption (an individual’s expenses that do not benefit other family members), and deductions for personal maintenance, or an individual’s basic living expenses. Consideration for income taxes depends upon the jurisdiction.

The loss period is generally the claimant’s work life expectancy, or life expectancy, or other period depending on the facts and circumstances of the injury and the loss. The loss is projected with appropriate growth rates applied and shown as pre-trial and post-trial losses. Post-trial losses are discounted to the trial date, and prejudgment interest on pre-trial losses may also apply.

Lost Earnings and Lost Income

Quantification of the losses requires evaluation of what the individual was earning or could have earned, and what the individual is expected to earn or could have earned over the individual’s work period. But for earnings are earnings that would have been realized but for the wrongful event. Actual earnings and expected future earnings may be referred to as impaired earnings. The difference between the but for and impaired earnings comprise the loss amount. These are segregated into pre-trial and post-trial lost earnings.

Establishing the Earnings Base

The earnings base is generally the starting point of the lost earnings calculation. The earnings base is used to project future earnings. The earnings base is represented to be the earnings that a person can earn as of the date of the wrongful incident.

Past employment history may establish an earnings base. Other considerations for individuals may include:

• Not entered the workforce
• Recently entered the workforce
• Been on leave from the workforce
• Planned to change their vocation
• Seasonal employment
• Earnings that include overtime
• Self-employment income
• Inadequate documentation of historical earnings

The earnings base provides the basis to apply growth of amounts that are segregated into pre-trial and post-trial losses. Post-trial losses are discounted to the present and provide the loss as of the trial date or other applicable date.

The Practice Aid provides two cases (a straightforward calculation and a more complex calculation) to illustrate factors to consider when performing damage calculations involving individuals.

Case 1 (Straightforward Calculation)

Bill Walker was 40 years old when injured in an accident. He is no longer able to perform any type of work and is not expected to recover. Mr. Walker testified in his deposition that he planned to work until age 62 with no breaks other than annual vacations and holidays. He also testified that he had no plans to change jobs or change employers for the rest of his work life. The work life tables you consult reflect a remaining work life of 22 years for a male with Mr. Walker’s level of education. You are provided with Mr. Walker’s income tax returns for the past five years along with W-2 forms from his employer. His salary had increased 2 percent above the rate of inflation each year and he had worked for the same employer, Jones Corporation, since graduation from college. Jones Corporation provided Mr. Walker with health insurance but provided no other fringe benefits. In this situation, the practitioner will likely need to answer questions such as the following:

• Is it appropriate to use Mr. Walker’s annual wage in the year before the accident as the earnings base?
• What growth rate should you use to project earnings over work life?
• What work life should you select?
• Should you subtract any replacement earnings for Mr. Walker’s remaining work life?

Case 2 (More Complex Calculation)

Alex Ford was 40 years old when he was injured in an accident. Reports from two vocational experts conflict. Report one states that Mr. Ford may return to work in three years with several different employment scenarios. Report two states Mr. Ford was totally disabled and cannot return to work. Mr. Ford worked for numerous employers during the previous five years but was not employed at the time of the accident. Mr. Ford testified in his deposition that he also earned income from his lawn-care business and that he failed to report on his tax return because he was paid in cash. Mr. Ford also testified in his deposition that he was taking night courses at the local trade school so that he could become an electrician and “earn a lot more money.” He also testified that he expected to double or triple the amount of money he was making in the lawn-care business. In this situation, the practitioner will likely need to answer questions such as the following:

• Which employment do you use for the wage base?
• What growth rate do you use to project earnings over work life?
• How do you account for the lawn-care business?
• What consideration do you give to the new career Mr. Ford was preparing for?

The answers to similar questions will frequently depend upon the facts and circumstances of the case.

Earning Capacity

Earning capacity measures the potential earnings and is based upon earnings that an individual could earn. It considers the individual’s education, training, and experience, or whether the individual is ever engaged in such employment.

Earning capacity represents what a person was capable of earning but for the injury. Earning capacity also encompasses work skills acquired; however, simply desiring to attain a particular employment with no other evidence may be considered speculative. The following are examples.

Example one: Deborah is a 38-year-old high school science teacher with a PhD in biology. She earns $36,000 per year teaching but could earn twice that amount working as a research biologist for a pharmaceutical company. Rather than use her actual earnings of $36,000 per year, many jurisdictions would allow her to recover losses based on her earnings capacity of $72,000 per year. However, without sufficient evidence that the research biologist job was attainable by Deborah, use of $72,000 instead of $36,000 as the base to calculate lost earnings may be considered speculative and not a reasonably certain estimate of her loss.

Example two: Burt was killed in an automobile accident and his heirs file a wrongful death action. Burt was in his final year of medical school. His employment history only reflects jobs paying slightly above minimum wage. Most jurisdictions would allow a scenario showing lost earnings that are based on the amount Burt could have earned as a doctor.

Example three: Mary was employed as a waitress when she was injured and totally disabled in an automobile accident. She had considered going to nursing school, but at the time of the accident had not applied to any nursing schools and lacked the education to qualify for admission to nursing school. Most jurisdictions would consider this to be a speculative claim and not evidence of her earnings capacity.

The forensic practitioner may also work with and utilize data regarding employment alternatives from a vocational rehabilitation expert. The vocational expert may provide information about:

• The vocational potential of the injured worker
• A labor market survey about what jobs are available
• Salary ranges in the local market
• An analysis of when the injured worker may return to work

Age-Earnings Profile

The age-earnings profile considers the effect of age on earnings. Studies show that earnings generally increase at greater rates for younger individuals and that earnings growth reaches a peak and may decline for older individuals.

Sources and studies useful for determining age-earnings profiles may include:

• Bureau of Labor Statistics (BLS), “Usual Weekly Earnings of Wage and Salary Workers First Quarter 2013,” News Release, April 18, 2013, bls.gov/news.release/pdf/wkyeng.pdf.
• “Accounting for Age-Earnings Profiles in Net Discount Rates,” by Eric Christensen, Journal of Forensic Economics, vol. 12, no. 3, 1999.
• “Age-Earnings Profiles Estimates: Do they Change over Time?” by Stephan F. Gohmann, Myra J. McCrickard, and Frank Slesnick, Journal of Forensic Economics, vol. 11, no. 3, 1998, pp. 173–188.
• “The Relationship between Age, Earnings and the Net Discount Rate Revisited,” by Charles W. deSeve, Journal of Forensic Economics, vol. 5, no. 1, Winter 1991, pp. 67–70.
• “Empirical Age-Earnings Profiles,” by K. M. Murphy and F. Welch, Journal of Labor Economics, vol. 8, no. 21, 1990, pp. 202–29.
• “Estimates of Earnings Growth Rates Based on Earnings Profiles,” by R. F. Gilbert, Journal of Legal Economics, vol. 4, no. 2, 1994, pp. 1–19.
• “Income Distribution Issues Viewed in a Lifetime Income Perspective,” by Milton Moss, National Bureau of Economic Research. www.roiw.org/1978/119.pdf.

Other Considerations

Lost Income from Other Sources

Income from other sources, such as rental properties, interest, dividends, or royalties, may be examined to determine if it was affected by the loss event. Similarly, the loss event may cause the individual to incur additional expenses that would not have been incurred but for the loss event.

Fringe Benefits

Lost employer-provided or other fringe benefits may also represent an element of loss. These may include stock options, profit sharing, retirement plans, health and other insurances, expense accounts, vacation, holiday and sick pay, and other benefits.

Fringe benefit information may be obtained from the injured party’s employer, or union contract if injured party is a union member. National studies are also available from the Department of Labor, “Monthly Labor Review,” and U.S. Chamber of Commerce, “Employee Benefits.”

Lost Retirement Benefits

Lost retirement benefits are employment fringe benefits of employer-funded retirement plan contributions. The calculation of the loss involves comparing the benefit to be provided as a result of the wrongful act with the benefit that would have been provided from retirement through life expectancy.

Household Services

Household services that can no longer be performed due to the wrongful incident may include home maintenance and repairs, managing finances, childcare, housekeeping, cooking, and shopping. The measurement of the loss is typically based on the replacement cost to employ someone to perform the services the injured party can no longer perform.

Medical and Rehabilitation Expenses

Medical and rehabilitation costs related to the injury may be an element of loss. Past costs are usually based on actual costs incurred whereas future costs may be computed using reports and data provided by medical and rehabilitation experts.

Personal Consumption and Personal Maintenance

Personal consumption is the amount spent on behalf of the decedent that would not be available to the decedent’s survivors. Personal consumption may include food, clothing, medical, entertainment, and vacation expenses allocable only to the decedent. Depending upon the jurisdiction, these personal consumption and personal maintenance expenses may provide a reduction in the calculation of damages in wrongful death cases.

Past Losses and Future Losses

Losses are usually calculated as of the trial date. Losses sustained from the date of injury to the trial date are referred to as past losses, or pre-trial losses. Losses sustained from the trial date through the loss period are referred to as future losses, or post-trial. The loss period may extend through the claimant’s expected work life or life expectancy and will depend upon the facts and circumstances of the case. Pre-trial losses are not discounted or increased to present dollar amounts. Depending upon the jurisdiction, prejudgment interest may be added to pre-trial losses. Post-trial losses are computed from the trial date through the remainder of the loss period and then discounted back to the trial date, based on the appropriate discount rate.

Work Life Expectancy

Work life expectancy represents the number of years the claimant would have worked but for the wrongful event. This is generally obtained from tables provided by the U.S Department of Labor, Bureau of Labor Statistics (BLS), “Worklife Estimates: Effects of Race and Education,” Bulletin 2254 (Feb. 1986). The BLS data is based upon statistical studies of years that individuals spend in the workforce. The U.S. Department of Labor developed work life tables based upon BLS data, but its most recent tables rely upon data from 1979 to 1980.

Another source is the work life tables of Skoog, Ciecka, and Krueger. These tables represent the average time a person is expected to be in the labor force regardless of occupation.

Consideration may be given to the occupation of the individual and circumstances with respect to that occupation. An individual’s personal situation may also be evaluated to determine if modification should be made to the work life expectancy determined from the work life tables.

Life Expectancy

Life expectancy represents the statistically based number of years the injured party would have lived but for the loss event. This is generally determined from tables prepared by the Vital Statistics Division of the National Center for Health Statistics, Department of Health and Human Services (see www.cdc.gov/nchs). These tables vary according to age, ethnic background, and gender. The life expectancy tables show the average number of years of life remaining for persons who have attained a given age and the probability of dying from one to 100 and 100 and over.

Other Loss Measurement Periods

A period other than work life or life expectancy may be appropriate in measuring damages involving individuals. The particular facts and circumstances of the case will dictate if a different loss measurement period is appropriate. Employment discrimination and wrongful termination cases, for example, may consider losses over a specific period with hiring counsel providing the period to consider.

Growth Rate

A growth rate is generally applied to the base elements of the loss claim to calculate the loss over the loss period. The rate of growth may be established by analysis of current economic data, reference to historical information of the injured party, employer or industry data, and national and international statistics. The consumer price index (CPI) published by the BLS represents the rate of change in prices (see www.bls.gov/cpi). The yearly change in the CPI represents the annual rate of price inflation and provides inflation and growth in wage and price information.

Earnings growth may be projected at the level of expected inflation or may include projections for merit or productivity increases. The employment cost index (ECI) (see www.bls.gov/news.release/eci.toc.htm.) attempts to measure the total change in wages and compensation throughout the workforce.

“Employment and Earnings,” published monthly by the Department of Labor, provides historical wage and earnings information. The “Economic Report of the President” is published annually and may also provide growth information. The “U.S. Industry & Trade Outlook” is published annually by the Department of Commerce and provides information on U.S. industries.

Different growth rates may be used on various components of a claim. For example, medical expenses may be projected based on the medical care cost index published by the Department of Labor. Household services may be projected based on the CPI.

Consideration of Income Taxes

The jurisdiction governs the treatment of taxes in calculating damages, and counsel may be consulted to determine if calculations should be adjusted for income taxes. The U.S. Supreme Court addressed this issue in 1980 in Norfolk & Western Railway Co. v. Liepelt and held that lost earnings in a wrongful death action should be estimated on an after-tax basis. Some jurisdictions allow damages to be presented without regard to taxes because there may be an offsetting effect.

Discounting Losses to Present Value

The post-trial losses are discounted to present value. The discount rate generally represents the rate at which the claimant or the survivors can invest the lump sum with no risk of loss. Courts have referred to this as the rate of the “best and safest investments.” The period of loss may be used as the measure to select the security term, although some may use short-term securities regardless of the period of loss.

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Jack W. Harris, CPA, is a forensic accounting expert with a focus on commercial damages, cost analysis, lost profits, accounting and auditing, construction contract damages, construction cost audits, and related areas. He has 45 years professional experience and has worked on numerous domestic and international projects. Mr. Harris serves as an independent expert and consultant, and has also been admitted as a neutral panelist for the American Arbitration Association for commercial, accounting, and construction matters. He has also served as an arbitrator, mediator, and special counsel.

Mr. Harris can be contacted at (303) 324-5812 or by e-mail to jack@jackwharris.com. Please visit his website at www.jackwharris.com.