On the right discount factor in injury cases...
What is wrong with using a high discount factor in present valuing the lost earnings of an injured person?
Nothing; unless it requires the investor to injured person become a successful stock market speculator!
For most economists, the ultimate goal of a present value calculation is to determine how much money would have to be invested today to replace the earnings that a person would have earned over their work life. The key term is invested.
In an injury case the person will be given a lump sum of money and will have the responsibility of investing that money into an investment that will earn a rate of return. The person’s estimated lost lifetime of earnings will replaced by periodically withdrawing some of the lump sum and some of the interest that is earned on the investment.
According unless there is some incredibly compelling reason, it should not be assumed that the injured person will have either the desire or the ability to earn extraordinary rates of return on their chosen investment.
What does this mean? It means that economic analyses should not use an unreasonably high discount rate (and unrealistically lower economic damages) because it would in fact require the injured person to in effect become a successful stock market speculator. For instance, while some economists use a mix of low risk and low return investments such as treasury bills others use discount factors based on the returns from stocks and bonds.
Courts have generally agreed that interest rates should be based on low risk/return investments (i.e. investments with below market returns) and not stock market based returns. A number of courts have flat out rejected discount factors based on stock market and mutual fund returns. Here is one example.
Hogans v. United States, 2005 U.S. Dist. LEXIS 32359 (W.D.Tex. 2005).
This case involved Dr. Don Huddle as an economic expert for the plaintiff and Dr. Stan Smith as an economic expert for the defendant. The Court held that Dr. Huddle’s method: “followed the ‘below market’ rate method required by the Fifth Circuit as stated in Culver v. Slater Boat Co., 722 F.2d 114 (5th Cir. 1983). His discount rates of 1.2 percent for future medical cost and 1.0% for future lost earnings fall squarely within the example of proper below-market discount rates set forth in Culver.”
The Court said of Dr. Smith: “The methodology employed by defendant’s economic expert, Dr. Smith, violates Culver because Dr. Smith relied primarily on a market methodology specifically disapproved by the Fifth Circuit Court of Appeal’s below market requirements. Dr. Smith’s high discount rate of 7.42% fails the Culver test because Dr. Smith’s methodology employs a 2/3 (65%) reliance on the stock market’s average over the highest performing period in the market’s history, and Culver maintains a below method that distinguishes a seriously injured plaintiff’s need to sustain his or her future economic needs after suffering a serious injury from speculating investors willing and able to accept some risk for a potentially higher return on their investments.”
Nothing; unless it requires the investor to injured person become a successful stock market speculator!
For most economists, the ultimate goal of a present value calculation is to determine how much money would have to be invested today to replace the earnings that a person would have earned over their work life. The key term is invested.
In an injury case the person will be given a lump sum of money and will have the responsibility of investing that money into an investment that will earn a rate of return. The person’s estimated lost lifetime of earnings will replaced by periodically withdrawing some of the lump sum and some of the interest that is earned on the investment.
According unless there is some incredibly compelling reason, it should not be assumed that the injured person will have either the desire or the ability to earn extraordinary rates of return on their chosen investment.
What does this mean? It means that economic analyses should not use an unreasonably high discount rate (and unrealistically lower economic damages) because it would in fact require the injured person to in effect become a successful stock market speculator. For instance, while some economists use a mix of low risk and low return investments such as treasury bills others use discount factors based on the returns from stocks and bonds.
Courts have generally agreed that interest rates should be based on low risk/return investments (i.e. investments with below market returns) and not stock market based returns. A number of courts have flat out rejected discount factors based on stock market and mutual fund returns. Here is one example.
Hogans v. United States, 2005 U.S. Dist. LEXIS 32359 (W.D.Tex. 2005).
This case involved Dr. Don Huddle as an economic expert for the plaintiff and Dr. Stan Smith as an economic expert for the defendant. The Court held that Dr. Huddle’s method: “followed the ‘below market’ rate method required by the Fifth Circuit as stated in Culver v. Slater Boat Co., 722 F.2d 114 (5th Cir. 1983). His discount rates of 1.2 percent for future medical cost and 1.0% for future lost earnings fall squarely within the example of proper below-market discount rates set forth in Culver.”
The Court said of Dr. Smith: “The methodology employed by defendant’s economic expert, Dr. Smith, violates Culver because Dr. Smith relied primarily on a market methodology specifically disapproved by the Fifth Circuit Court of Appeal’s below market requirements. Dr. Smith’s high discount rate of 7.42% fails the Culver test because Dr. Smith’s methodology employs a 2/3 (65%) reliance on the stock market’s average over the highest performing period in the market’s history, and Culver maintains a below method that distinguishes a seriously injured plaintiff’s need to sustain his or her future economic needs after suffering a serious injury from speculating investors willing and able to accept some risk for a potentially higher return on their investments.”
posted by The Experts @ 1:53 PM
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