Overview of damage components
In calculating damages for a personal injury or wrongful death case, you typically start with the economic damages and then progress to the non-economic damages. The non-economic damages are often the largest damages, but you start by quantifying what you can and then move on to non-economic damages.
For economic damages, the largest positive value is loss of earnings or earning capacity. Loss of or damage to property may also be involved, and in some jurisdictions some consequential damages such as loss of insurability or loss of credit are potentially quantifiable and recoverable, because they are losses of a positive value proximately caused by the defendant.
The negative costs incurred for economic damages consist of past and future medical costs, rehabilitation costs, and special accommodation costs resulting from the defendant’s breach of duty. Funeral costs are commonly included in a wrongful death case.
For non-economic damages, there is a semantic issue of whether they are regarded as positive values lost or as negative costs incurred. It is often more powerful to speak of them as positive values lost, because jurors are more receptive to placing a significant value on health and wellness than on pain and suffering. The non-economic damages are pain, mental suffering and anguish, physical disfigurement and impairment, mental impairment, loss of enjoyment of life, and loss of society and companionship.
Steps for computing lost earnings and earning capacity
Loss of earnings or earning capacity is often the largest component of the economic damages in a personal injury or wrongful death case.
At its simplest level, loss of earnings is the difference between the earnings an individual would have received but for the defendant’s breach and the actual earnings received or likely to be received, reduced to present value. However, this concept can be complicated by the fact that many jurisdictions allow for recovery of loss of earning capacity even if there has been no loss of actual earnings.
The basic steps for computing future loss of earnings or earning capacity are:
- Estimate by year the future earnings that likely would have been available but for the occurrence.
- Estimate the number of years (the work life expectancy) during which earnings likely would have been available.
- Estimate the actual (mitigating) earnings available after the occurrence.
- Estimate the present value of future net earnings loss (the difference between “but for” earning capacity and mitigating earnings).
- For wrongful death cases, estimate the personal consumption expenditures of the decedent.
Step 1: Future earnings
If the plaintiff or decedent was fully employed at the time of the occurrence, start with the individual’s base earnings at that time. It is important to account for all categories of earnings that were affected, including:
- Salary or hourly wage;
- Overtime compensation;
- Incentive compensation such as commissions or bonuses;
- Fringe benefits such as health care and allowances for housing or transportation; and
- Deferred benefits such as pensions or stock options.
Go back through several years of earnings history to establish fully what the individual was making, was capable of making, and what increases in earnings might reasonably be expected in the future. Also ask about future employment plans and opportunities for advancement. Several factors drive increases in future earnings:
- Promotions or changes in responsibilities or jobs that bring increased earnings.
- Merit increases in compensation within the same job.
- General wage inflation within the company, the industry, or the economy as a whole.
For individuals with an inadequate earnings history (e.g., individuals not fully employed or who have only been fully employed for such a short time that past earnings provide an inadequate basis for projecting future earnings) project a life-cycle pattern of earnings based on generally accepted demographic information. Average increases vary based on race, level of education, age, occupation, geographical location, and a host of other possible variables.
For instance, there is an age-earnings cycle that varies for different demographic groups, but within a given demographic group it is common for earnings to increase on average until a certain age, at which point the average earnings for that demographic group level out or start to fall.
Use government statistics to develop a rough damages model. The numbers will only be averages, but those averages can be used to project percentage increases or decreases in average wage rates for the demographics of the plaintiff or decedent at various ages.
To obtain the latest governmental income population statistics, go to www.census.gov and then:
- Click on “People & Households: Income.”
- Click on “Income Statistics.”
- Click on “Tables of Income by Detailed Socioeconomic Characteristics.”
- Click on “Person.”
- Click on Table No. “PINC-04 (Educational Attainment – People 18 Years Old and Over, by Total Money Earnings in 2008, Work Experience in 2008, Age, Race, Hispanic Origin, and Sex”).
- Choose the demographics that match the plaintiff or decedent, and then use the different averages at different ages to roughly calculate the average age-earnings cycle (the extent of average percentage increase or decrease in earnings by age for a given demographic group) for the plaintiff or decedent.
Apply this resulting age-earnings cycle to the base earnings information you have to make a rough approximation of future earning capacity of the individual.
Assume the individual in this example was permanently injured in early 2007. If this individual is a white male with a bachelor’s degree, aged 24 at the beginning of year 2007, with one year of full-time earnings before injury in the amount of $32,000, you would have gone to the table PINC-04 for the year then available (2006) and have obtained these average earnings numbers for white males whose highest educational attainment is a bachelor’s degree:
|18 to 24 years of age||28,250|
|25 to 29 years of age||48,384|
|30 to 34 years of age||70,327|
|35 to 39 years of age||79,691|
|40 to 44 years of age||82,310|
|45 to 49 years of age||84,238|
|50 to 54 years of age||88,873|
|55 to 59 years of age||76,263|
|60 to 64 years of age||67,053|
|65 to 69 years of age||54,123|
|70 to 74 years of age||45,115|
Using these numbers, you would have then approximated the average age-earnings cycle for this demographic group by seeing how much percentage increase there is in average earnings as age increases past the base year of age 24. The resulting table looked like this:
|18 to 24 years of age||28,250||100%|
|25 to 29 years of age||48,384||171%|
|30 to 34 years of age||70,327||249%|
|35 to 39 years of age||79,691||282%|
|40 to 44 years of age||82,310||291%|
|45 to 49 years of age||84,238||298%|
|50 to 54 years of age||88,873||315%|
|55 to 59 years of age||76,263||270%|
|60 to 64 years of age||67,053||237%|
|65 to 69 years of age||54,123||192%|
|70 to 74 years of age||45,115||160%|
Then you would have plugged in $32,000 for the base year (age 24) income and applied these same percentages. This provided a starting projection of expected future earnings based on the average age-earnings cycle. This is only a “starting” projection because you have not yet applied two key limitations of work-life expectancy and present value.
|Age||Earnings||Percentage increase||Projected future earnings by age|
|18 to 24 years of age||28,250||100%||32,000 (actual)|
|25 to 29 years of age||48,384||171%||54,807 (projected)|
|30 to 34 years of age||70,327||249%||79,662 (projected)|
|35 to 39 years of age||79,691||282%||90,269 (projected)|
|40 to 44 years of age||82,310||291%||93,236 (projected)|
|45 to 49 years of age||84,238||298%||95,420 (projected)|
|50 to 54 years of age||88,873||315%||100,670 (projected)|
|55 to 59 years of age||76,263||270%||86,386 (projected)|
|60 to 64 years of age||67,053||237%||75,954 (projected)|
|65 to 69 years of age||54,123||192%||61,307 (projected)|
|70 to 74 years of age||45,115||160%||51,104 (projected)|
These projected earnings are then spread on a year-by-year basis. The example assumes that the client was age 24 at the beginning of the year 2007.
Step 2: Work life expectancy
There are two significant things about the Step 1 numbers showing projected earning capacity by age:
- In real life, earnings do not typically make a large jump or dive every fifth year. A valuation expert will make more refined calculations.
- These numbers are derived from averages of people who are still in the workforce at each of these ages. However, the odds are against any one person still being in the workforce at age 74. Therefore, the next step is to estimate the worklife expectancy of the individual.
Personal characteristics of the individual may indicate that the plaintiff probably would not have remained in the workforce for the period of average worklife expectancy. Defense attorneys will look for arguments that an average worklife expectancy is inapplicable in this particular case by examining the pre-occurrence health history of the individual, as well as family-related (e.g. a plan to stay home with children) or work-related (e.g. a plan for early retirement) circumstances.
There are worklife expectancy tables that recognize the impact of (pre-occurrence) disability on the computation of worklife expectancy. The best known set of tables is a publication authored by A.M. Gamboa, Jr., Ph.D. and published by Vocational Economics, Inc., titled The New Worklife Expectancy Tables (6th ed. 2006). It is not imperative to have the latest edition of this book because experts will perform the final evaluation. Averages do not vary greatly from one edition to the next.
Using The New Worklife Expectancy Tables with the previous example of a 24 year old white male with a bachelor’s degree, the average worklife expectancy is an additional 36.9 years. This means you would only compute lost earnings through age 61.
As a result, the computation of future lost earnings now cuts off at age 61 and looks like this:
Step 3: Actual (mitigating) earnings
In cases of debilitating injury or death, the actual earnings now available in the future will be zero. In cases where the injury is less profound, there will continue to be some residual earning capacity that is available to mitigate the loss.
The projection of likely future earning capacity is often a major battleground area. There are a variety of possible approaches to computing these future earnings. If the individual has returned to work, the new employment can provide new base earnings to do another computation of future earning capacity. However, the prospects for advancement and future increases in earnings may now be more limited, which means that the age-earnings cycle may be flatter now, with fewer and smaller percentage increases.
For purposes of a rough estimation on the front end, a plaintiff’s attorney may want to simply assume a percentage of work disability. The expert involved at trial will probably not do such a simplistic computation, but it is in the plaintiff’s attorney’s interest to get a basic grasp on the range of damages, not to defend the methodology and numbers like the expert will be doing.
In the example, if you simplistically assume that the individual will be able to resume gainful employment at age 26, but will suffer a permanent work disability that you guess to be in the range of 50%, you would add a column to the numbers to reflect a 50% mitigation or offset for earnings that can still be earned.
Also recognize that this is now a disabled employee, and disabled employees have a shorter worklife expectancy. Using The New Worklife Expectancy Tables for disabled white males aged 26 with at least 16 years of education, you see that worklife expectancy has now dropped to 21.4 years, so you cut off future mitigation after age 47.
The resulting computations now look like this:
|Year||Age||Projected Earnings||Future Mitigation||Net Loss (Undiscounted)|
Step 4: Present value of future net earnings loss
There are many methodologies for reducing future losses to present value, but they are all founded on the same premise. That is, given a choice between obtaining a dollar today or a dollar a year from now it is more valuable to obtain the dollar today for two reasons:
- The dollar today can generate additional income by earning interest over the course of the next year.
- If the dollar is received today, there is no risk of it not being received a year from now.
Therefore, most present value methodologies assume that it should take less dollars today to pay for a future loss than it would take to fully pay for that loss in the future. The question is how big the discount should be.
In litigation involving lost profits of a start-up business, defendants are often successful in attacking the plaintiff’s discount rate as being too low because it fails to consider all the risk inherent in a new business. However, in personal injury litigation the question of risk is more easily dealt with because government statistics draw from such a large sample of workers, suggesting that risk has already been adequately dealt with in the averages. As a result, in computation of the present value of future lost earnings, experts often use long-term U.S. Treasury Bonds as the basis. This provides a useful shortcut for plaintiff’s attorneys to use in making a rough estimation of present value at the outset of a case.
Although there are a variety of methodologies for deriving the discount rate on future lost earnings, simply using the historic average difference between the average annual return of long-term treasury bonds and the average annual inflation rate gives a rough benchmark guess of a discount rate. An expert will use a much more refined methodology than this, but this simple number gives you a good guess about the discount rate the expert will ultimately use.
Over the period of years from 1926 to 2003, the average annual return on long-term U.S. Treasury Bonds was 5.5%. Over those same years, the average annual inflation rate was 3.1%. The difference between those two averages (i.e. 2.4%) reflects the average annual real rate of return on U.S. Treasury Bonds (i.e. the amount of interest earned over and above the amount of inflation).
As a result, if you assume that a dollar received today will be worth a dollar plus an additional 2.4% in one year, you can estimate how many dollars it will take today to equal ten dollars in ten years.
So the shortcut for making a rough estimate of the present value of future lost earnings is to simply assume a discount rate of 2.4%. Pick a date (or the year) that you believe is a likely trial date. Start discounting to present value for the years after that projected trial date.
Using the prior example, if you assume that the trial date was mid-year 2009, approximately two years post-injury, for your rough calculations you would start discounting the present value of the first years of losses post-injury, until 2010. The rough computations now look like this:
|Year||Age||Projected Earnings||Future Mitigation||Net Loss (Undiscounted)||PV Percent||Present Value|
Step 5: Personal consumption expenditures
For a personal injury, the plaintiff’s personal consumption expenditures do not need to be estimated because the plaintiff still needs to eat. You will want to compute additional costs made necessary by the injury, such as rehabilitation costs or special needs costs, but for purposes of estimating future lost earnings, the reduction of future earnings to present value is the final step.
However, for wrongful death cases, most jurisdictions permit the defendant to deduct the normal personal consumption expenditures of the defendant. With the death of the decedent, future earnings are lost, but the loss of those future earnings is partially offset by elimination of the personal expenses solely attributable to the decedent. The wrongful death claimants or the estate of the decedent are entitled to seek recovery of the net reduction in future earnings. Typically this is done by estimating the percentage of earnings that would have been consumed solely by the expenditures of the decedent.
If you assume the example case is one for wrongful death rather than personal injury, and assume that the 24 year old decedent was married with one child (personal consumption percentages vary based on both income and family size), you would eliminate mitigating earnings from your calculations, but then deduct a percentage (based on the “Patton-Nelson Personal Consumption Tables, 1997-98 Update”) for the personal consumption of the decedent that will no longer be occurring.
There are different methodologies for computing personal consumption percentages, but for your rough estimation you will simply follow the Patton-Nelson Personal Consumption Tables during the normal worklife expectancy, assuming a three-person family until the age the child is expected to complete the same educational attainment as the parents, and then reverting to the assumption of a two-person family for purposes of personal consumption expenditures. At the end of worklife expectancy, for the remainder of life expectancy, the authors of the Patton-Nelson Personal Consumption Tables recommend assuming that personal consumption is equalized and offset by pension and Social Security receipts (and therefore does not need to be part of your computations).
The resulting rough estimations look like this:
|Year||Age||Projected Earnings||Future Mitigation||Net Loss (Undiscounted)||PV Percent||Present Value||% Personal Consumption||Net PV Loss|
|2029||46||95,420||–||95,420||0.622302||59,380||16.3% [Year when child is assumed to no longer be a dependent.]||49,701|