The Prudent (Wo)Man's Present Value Discount Factor in Injury and Death Cases
One of the central debates in forensic economics, revolves around the selection of the interest rate discount factor used in present value calculations. It is not uncommon for two economists to arrive at damage calculations that are 20% or more apart, simply due to the choice of the interest rate discount factor in a given analysis.
On the one side of the issue, are those that believe that the 'prudent (wo) man' concept should be applied to the choice of interest rate factors. That is, these economists believe that the interest rate that should be used in a these types of calculations should be equivalent to the rate of return that a prudent investor could earn from a diversified and balanced investment portfolio. On the otherside of the issue are those that believe that the interest rate from a completely risk free treasury security should be applied as a discount factor. In most situations, the 'prudent man' approach will produce lower economic damage estimates. Most economist use the risk free rate.
Below is interesting, but 'unreal' deposition testimony of an economist who used the risk-free treasury approach (excerpt from forensic economics listserv post, thanks) :
Q: Dr. Ross, isn't it true, everything else remaining equal, that the present value lump sums resulting from calculations using treasury securities versus a diversified portfolio of stocks and bonds or index based mutual funds as supported by the prudent investor rule, would be radically different?
A. Yes, the reason for that is the difference in risk associated with the two types of investments.
Q. Is it fair to say that the prudent investor rule is highly regarded in financial planning, and in fact is supported by federal law under ERISA?
A: Yes
Q: Dr. Ross, I would then like you to calculate the present value of the loss in this case based on a return over the last twenty years to a portfolio based on investing in under the prudent investor rule.
(Plaintiff attorney) Objection, such a calculation is not supported by case law.
A: (me)I don't believe it is a correct calculation to make.
Q: Dr. Ross, I didn't ask your opinion on whether you though it was correct, I asked you do the calculation as a hypothetical.
(Plaintiff Attorney: Same objection. You may answer if you can.)
(Dr. Ross complies, and let's just say the difference is $100,000)
Q: So then, if the plaintiff used the prudent investor rule to invest his award, by your own calculations my client would owe $100,000 less than what you say he would owe using your treasury mix?
A: That's right, but I don't believe the law would allow such a calculation.
Q: Thank you, Dr. Ross. When I want your opinion on legal matters I'll let you know.
On the one side of the issue, are those that believe that the 'prudent (wo) man' concept should be applied to the choice of interest rate factors. That is, these economists believe that the interest rate that should be used in a these types of calculations should be equivalent to the rate of return that a prudent investor could earn from a diversified and balanced investment portfolio. On the otherside of the issue are those that believe that the interest rate from a completely risk free treasury security should be applied as a discount factor. In most situations, the 'prudent man' approach will produce lower economic damage estimates. Most economist use the risk free rate.
Below is interesting, but 'unreal' deposition testimony of an economist who used the risk-free treasury approach (excerpt from forensic economics listserv post, thanks) :
Q: Dr. Ross, isn't it true, everything else remaining equal, that the present value lump sums resulting from calculations using treasury securities versus a diversified portfolio of stocks and bonds or index based mutual funds as supported by the prudent investor rule, would be radically different?
A. Yes, the reason for that is the difference in risk associated with the two types of investments.
Q. Is it fair to say that the prudent investor rule is highly regarded in financial planning, and in fact is supported by federal law under ERISA?
A: Yes
Q: Dr. Ross, I would then like you to calculate the present value of the loss in this case based on a return over the last twenty years to a portfolio based on investing in under the prudent investor rule.
(Plaintiff attorney) Objection, such a calculation is not supported by case law.
A: (me)I don't believe it is a correct calculation to make.
Q: Dr. Ross, I didn't ask your opinion on whether you though it was correct, I asked you do the calculation as a hypothetical.
(Plaintiff Attorney: Same objection. You may answer if you can.)
(Dr. Ross complies, and let's just say the difference is $100,000)
Q: So then, if the plaintiff used the prudent investor rule to invest his award, by your own calculations my client would owe $100,000 less than what you say he would owe using your treasury mix?
A: That's right, but I don't believe the law would allow such a calculation.
Q: Thank you, Dr. Ross. When I want your opinion on legal matters I'll let you know.
posted by The Experts @ 5:06 PM
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