Calculating Personal Damages
A Review of the U.S. Supreme Court’s Pfeifer Decision
For those interested in working in the personal damages area, a review of the U.S. Supreme Courts’ Pfeifer decision is essential. It provides a great outline as to what the courts expect from an expert’s work. This article reviews the Pfeifer decision and the Fifth Circuit Court of Appeals’ Culver II decision, which expands on the definitions for discounting methods approved by the U.S. Supreme Court.
The field of litigation support provides a wide range of options for accounting and financial experts to work. Opportunities abound for work in the fields of commercial damages, business bankruptcy, and divorce. The one area that provides the greatest opportunity for work is the area of personal damages, which includes calculations for lost earnings, lost earning capacity, lost economic support, lost household services, and the present value of future medical and care costs.
Litigation for personal damages creates the largest set of caseloads in the courts. For economic experts, these cases can be simple or very complex. They generally take less time to analyze and complete than the other mentioned fields. This allows an expert more time to focus on other areas of non-litigious work or increase the volume of work in the litigation support area.
For those interested in working in the personal damages area, a review of the U.S. Supreme Courts’ Pfeifer decision provides a great outline as to what the courts expect from an expert’s work. This article will review the Pfeifer decision and the Fifth Circuit Court of Appeals’ Culver II[1] decision, which expands the definition for discounting methods approved by the U.S. Supreme Court.
Pfeifer Decision—General Method for Calculating Lost Earnings
The Pfeifer decision addresses a lawsuit brought by an injured worker under the Longshoreman’s and Harbor Worker’s Compensation Act. The plaintiff won a verdict in district court, which was affirmed by the Third Circuit Court of Appeals. The U.S. Supreme Court vacated the decision and remanded the case instructing the court to recalculate the damages in a manner consistent with the Court’s opinion.
The court’s opening remarks on the damages issue state.
“In calculating damages, it is assumed that if the injured party had not been disabled, he would have continued to work, and to receive wages at periodic intervals until retirement, disability, or death. An award for impaired earnings capacity is intended to compensate the worker for the diminution in that stream of income. The award could in theory take the form of periodic payments, but in this country, it has traditionally taken the form of a lump sum, paid at the conclusion of litigation. The appropriate lump sum cannot be computed without first examining the stream of income it purports to replace.
The lost stream’s length cannot be known with certainty; the worker could have been disabled or even killed in a different, non-work related accident at any time. The probability that he would still be working at a given date is constantly diminishing. Given the complexity of trying to make an exact calculation, litigants frequently follow the relatively simple course of assuming he would have continued to work up until a specific date certain. …”[2]
The court understands the limitations in projecting what would have happened with an injured person’s income stream had he or she not been injured. This is why courts understand and generally accept the “simple course.” That is assuming a specific retirement age or statistical work-life.
The court went on to say,
“With the passage of time, an individual worker often becomes more valuable to his employer. His personal work experiences increase his hourly contributions to firm profits. To reflect that heightened value, he will often receive ‘seniority’ or ‘experience’ raises, ‘merit’ raises, or even ‘promotions.’ Although it may be difficult to prove when, and whether, a particular injured worker might have received such wage increases, [cite omitted] they may be reliably demonstrated for some workers.
Furthermore, the wages of workers as a class may increase over time. [cite omitted] Through more efficient interaction among labor, capital, and technology, industrial productivity may increase, and workers’ wages may enjoy a share of that growth. Such productivity increases—reflected in real increases in the gross national product per worker-hour—have been a permanent feature of the national economy since the conclusion of World War II.
To summarize, the first stage in calculating an appropriate award for lost earnings involves an estimate of what the lost income stream would have been. The stream may be approximated as a series of after-tax payments, one in each year of the worker’s remaining career. In estimating what those payments would have been in an inflation-free economy, the trier of fact may begin with the worker’s annual wage at the time of injury. If sufficient proof is offered, the trier of fact may increase that figure to reflect appropriate influence of individualized factors (such as foreseeable promotions) and societal factors (such as foreseeable productivity growth within the worker’s industry).”[3][4]
This passage reaffirms that the injured person’s pre-injury income stream will start with his (or her) annual wage at the time of injury and if facts allow, the annual income may be increased to reflect anticipated individual and societal pay increases.
An expert’s calculations may assume a worker being promoted from machine operator level 1 to machine operator level 2 after a certain number of years working as a machine operator. This would appear reasonable most of the time. But promoting the machine operator to shop foreman requires more than years of service. Documentation in the worker’s employment file regarding his consideration for such a promotion may provide the foundation for such an assumption. An expert must be careful to make sure that “sufficient proof” supports the promotion and pay raise assumptions.
If documented, employer provided fringe benefits may be included as a part of the injured person’s pre-injury income.
Post injury (mitigation) income and projected future income from an injured person’s post injury income should be treated in the same way. Pay raises and promotions must have “sufficient proof” to support the assumptions. The same is true for including employer provided fringe benefits.
Pfeifer Decision—Discounting to Present Value with a Risk-Free Rate
The Pfeifer decision was written during a period of historically high inflation rates (1983). This decision offered a solution to not having to project future inflation rates. It offered an inflation-free discounting method called the below market discount method. Two other methods for discounting were also discussed: the case by case and the total offset method. These discounting methods are not the focus of this article but will be discussed near the end of this article.
Aside from addressing the problem of projecting inflation, this decision speaks to the nature of a risk-free rate being used for discounting future damages to present value.
“Of course, even in an inflation-free economy, the award of damages to replace the lost stream of income cannot be computed simply by totaling up the sum of the periodic payments. For the damages award is paid in a lump sum at the conclusion of litigation, and when it—or even a part of it—is invested, it will earn additional money. It has been settled since our decision in Chesapeake and Ohio R. Co. v. Kelly, 241 U.S. 485 (1916), that ‘in all cases where it is reasonable to suppose that interest may safely be earned upon the amount that is awarded, the ascertained future benefits ought to be discounted in the making up of the award.’
The discount rate should be based on the rate of interest that would be earned on ‘the best and safest investments.’ Once it is assumed that the injured worker would definitely have worked for a specific term of years, he is entitled to a risk-free stream of future income to replace his lost wages; therefore, the discount rate should not reflect the market’s premium for investors who are willing to accept some risks of default. …”[5]
Since 1916, the U.S. Supreme Court has used language such as “safest and best” and “risk-free” when discussing the discount rate to be applied in personal damages matters. This has been interpreted as U.S. Treasury securities. AAA rated, general obligation tax-exempt bonds have also been accepted by many state and federal courts.
Many experts and defense counsel have, over the years, attempted to introduce balanced portfolios of stocks, bonds, and money market accounts, which are claimed to meet the court’s standards. Those arguments have not prevailed over time. Even with the recent downgrade in the U.S. government’s debt rating, I do not believe state and federal judges will move away from the current definition of the risk-free rate and the securities that meet the safest and best criteria.
Culver Decision—Three Methods for Discounting
Later in 1983 (the year of the Pfeifer decision), the Fifth Circuit Court of Appeals revisited its earlier decision in the Culver v. Slater Boat Co. case (1982). In its second decision for this case, the Fifth Circuit provided short definitions for each of the three discount methods discussed in the Pfeifer decision. Below is the section from Culver II explaining the three methods for discounting.
“As the Court noted in Pfeifer, three methods are available for adjusting damage awards to account for the effect of inflation. In the case-by-case method, the factfinder is asked to predict all of the wage increases a plaintiff would have received during each year that he could have been expected to work, but for his injury, including those attributable to price inflation. The prediction allows the factfinder to compute the income stream the plaintiff has lost because of his disability. The factfinder then discounts that income stream to present value, using the estimated after-tax market interest rate, and the resulting figure is awarded to the plaintiff.[6]
In the below market discount method, the factfinder does not attempt to predict the wage increase the particular plaintiff would have received as a result of price inflation. Instead, the trier of fact estimates the wage increases the plaintiff would have received each year because of all factors other than inflation. The resulting income stream is discounted by a below market discount rate. This discount rate represents the estimated market interest rate, adjusted for the effect of any income tax, and then offset by the estimated rate of general future price inflation.
The third method is the ‘total-offset’ method. In this calculation, future wage increases, including the effects of future price inflation, are legally presumed to offset exactly the interest a plaintiff would earn by investing the lump-sum damage award. Therefore, the factfinder using this method awards the plaintiff the amount it estimates he would have earned, and neither discounts the award or adjusts for inflation.”[7]
Pfeifer Decision—Final Thoughts on Calculating Lost Earnings Awards
Included among the technical discussions in the Pfeifer decision, there are tidbits of general information which every expert should take to heart. The court notes the following:
“For our review of the foregoing cases leads us to draw three conclusions. First, by its very nature, the calculation of an award for lost earnings must be a rough approximation. Because the lost stream can never be predicted with complete confidence, any lump sum represents only a ‘rough and ready’ effort to put the plaintiff in the position he would have been in had he not been injured.”[8]
The court cites Judge Newman in the Doca v. Marina Mercante Nicaraguense, S.A., 634 F.2d. 30, (CA2 1980). “The average accident trial should not be converted into a graduate seminar on economic forecasting.”[9]
And finally, in its closing paragraph, the court provides one final admonition. “We do not suggest that the trial judge should embark on a search for ‘delusive exactness.’ It is perfectly obvious that the most detailed inquiry can at best produce an approximate result.”[10]
Conclusion
Many accountants and financial consultants seek to expand their work into the field of litigation support. Because of their training and education, they pursue work in the areas of commercial damages and/or divorce. These cases, in general, require more time for document review, analysis, and report writing than cases relating to personal damages. In this area, the courts, Congress, and state legislatures have set out clear guidelines for making loss calculations. With the large number of personal damages cases filed annually around the country, it is a market always looking for new experts. This article has provided a snapshot of the U.S. Supreme Court’s position on calculating lost earnings and discounting those personal damages to present values and the limits to the exactness of such an undertaking. It has also been an effort to get others to consider taking such assignments in the future.
[1] Culver v. Slater Boat Co., 722 F.2d 114, (1983).
[2] Jones Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523, 533–534, (1983).
[3] Ibid., 535–536.
[4] The Longshoreman Act calls for deducting federal income taxes from the projected income streams (pre-injury and post injury). An expert should confer with the hiring attorney regarding the handling of income taxes when calculating lost earnings in a particular jurisdiction.
[5] Jones Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523, 536–537, (1983).
[6] The Culver case was another federal case in which income taxes were to be deducted from the income streams. Thus, the language in this decision calls for the after-tax market interest rate.
[7] Culver v. Slater Boat Co., 722 F.2d 114, 118, (1983).
[8] Jones Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523, 546, (1983).
[9] Ibid., 548.
[10] Ibid., 552.
Allyn Needham, PhD, CEA, is a partner at Shipp Needham Economic Analysis, LLC, a Fort Worth-based litigation support consulting expert services and economic research firm. Prior to joining Shipp Needham Economic Analysis, he was in the banking, finance, and insurance industries for over 20 years. As an expert, he has testified on various matters relating to commercial damages, personal damages, business bankruptcy, and business valuation. Dr. Needham has published articles in the areas of financial and forensic economics, and provided continuing education presentations at professional economic, vocational rehabilitation, and bar association meetings. In 2021, Dr. Needham received a NACVA Outstanding Member Award. He is also a member of NACVA’s QuickRead Editorial Board.
Dr. Needham can be contacted at (817) 348-0213 or by e-mail to aneedham@shippneedham.com.
