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Jul 24

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The Appropriate Discount Rate in a Lost Earnings Claim

Damage experts don’t always agree regarding the appropriate discount rate and underlying methodology for a lost earnings claim and certain commonly applied methods actually provide a windfall to Plaintiffs.  The chosen rate can make a meaningful difference in the economic damages conclusion.  A recent article, “Lost Compensation Settlement Tool Allows You To Assess Economic Damages Accurately And Efficiently, Under Various Scenarios” demonstrates the significance of the applied rate on damages.

In some jurisdictions, a particular rate is mandated, but that is not the case in California ( for a more though discussion of California and other states’ requirements regarding discount rates in personal injury matters, see this related article).  A recent survey in the Journal of Forensic Economics (JFE) indicates that their members generally tend toward rates that are quite low and declining, possibly because of the common practice of using a risk-free rate.  Results of the 1999, 2003, 2009, and 2012 survey regarding discount rates are provided in the following table:

1999

2003

2009

2012 (current)

Mean

2.13%

1.89%

1.76%

1.61%

Median

2.00%

2.00%

1.75%

1.50%

A low discount rate benefits the Plaintiff as it results in a higher ultimate damages result (all else equal).  The JFE survey article also reports that historically (since 1999), approximately two-thirds of survey respondents’ earnings in forensic economics were derived from Plaintiff-side work.  However, the surveys’ published results do not allow analysis of the correlation between rates employed and Plaintiff versus Defendant work.  

In many instances, a risk-free government securities method/rate may be economically irrational and would not comply with California legal instructions. In cases with longer damage periods, no competent investment advisor would invest 100% of anyone’s long-term portfolio in this way. Instead, a proper investment approach matches the time horizon for the investment with the underlying use of the moneys being invested. The use of U.S. government securities is appropriate for (but only for) damage periods that are only a few years from the date of trial.  If the lost income period is 30 years, then one should be investing moneys with a 30-year time horizon (and thereby discounting them to present value accordingly).  Application of a risk-free rate over this length of time provides an impermissable windfall to a Plaintiff. 

 

About the author

Nicole Liska

I am a Principal at Fulcrum Inquiry, an accounting and economic consulting firm that performs damage analysis for commercial litigation, forensic accountings, financial investigations, and business valuations. I hold an ABD and MA in economics from the University of California, San Diego. I perform damages analyses and serve as a damages expert witness. My resume is on Fulcrum's website.

Permanent link to this article: http://betweenthenumbers.net/2013/07/the-appropriate-discount-rate-in-a-lost-earnings-claim/

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