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ARTICLE:
The Problem with Assumptions
by BRUCE
RASMUSSEN
Presented to: Tennessee Trial Lawyers Association Memphis,
Tennessee
I. Introduction
In a recent case we tried in Virginia, the two economists
differed by $1,500,000.00 in their testimony on the present
value of the injured plaintiff's future medical costs. Their
differences arose because they chose different time periods
to calculate the past rate of inflation in medical costs.
The defense selected the average inflation rate over the last
five years. During that time period, inflation has been abnormally
low generally and this is particularly true in the area of
health care costs. The plaintiff's economist selected a longer
historical period in order to balance out the short term ups
and downs of the economy.
Needless to say, it was important to cross examine the defense
economist and point out to the jury the bias lying behind
his assumptions. We all know from practical experience and
research that the "special damages" or "economic
damages" are by far the most important factor to jurors
in returning a fair and adequate award. They need to understand
the old adage of "Garbage In - Garbage Out" clearly
applies to economic testimony. In our case, post-trial juror
interviews indicated that they disregarded the testimony of
both economists and instead relied on the black boarded damages
which had not been reduced to present value. In neutralizing
the defense economist, we succeeded in our goal.
Given the present economic climate, we can expect to see
more defense economists testifying. This is certainly true
in states like Virginia where the plaintiff is not required
to produce an economist to reduce future economic losses to
present value. Economic conditions are now more favorable
to defendants than at any time since we have been practicing
law. Inflation is near an all time post World War II low.
Wage increases have been minimal. Inflation in health care
costs has temporarily fallen. At the same time, the rate of
return on stocks, bonds and government securities has remained
unusually high. The real interest rate is presently higher
than at any time in the last twenty (20) years. Inflation
is running at 3.7% while thirty (30) year treasury bills are
yielding 6.2%. This produces a real interest rate of 2.5%,
when historically it has been slightly above 2%. The real
interest rate is the current interest rate minus the rate
of inflation.
If the defense economist employs assumptions for inflation
and interest rates that take into account only the short term
economic conditions, it can drastically and unfairly reduce
the "present value" of your client's future economic
losses. This is critical because we are talking about the
dollars today which are needed to meet the minimal future
medical and family needs of our clients.
The purpose of my presentation is to help prepare us for
the task of cross examining a defense economist by defining
1) some of the basic economic terms, 2) explaining the effect
of key assumptions made by economists, and 3) suggesting avenues
of cross examination.
II. Present Value - What Is This All About?
In a personal injury case the plaintiff may have future wage
losses and require future medical services. When we blackboard
these future losses, we use present or 2000 dollars without
taking into account wage increases, inflation or the money
that can be earned by investing the lump sum award. Present
value calculations attempt to increase the future losses for
the effect of inflation and then reduce these losses by the
amount which can be earned by investing the money today.
The present value of any given future monetary loss is equal
to the amount of money which must be invested today at a certain
interest rate in order to yield or replace that given loss
which will occur in the future. It is the reverse of compounding
interest. The rate of return or interest rate at which the
amount of money is immediately invested is called the discount
rate.
To determine present value, it is necessary to find a sum
of money, which, if received today, is equal in value to lost
income over a person's life expectancy. The present value
of future losses is obtained by discounting each year's losses
at an appropriate interest rate and summing up over future
years. The purpose of discounting is to value the losses incurred
by the plaintiff in the present. Since it is possible to invest
today in order to have a larger capital sum later on, we must
discount damages for losses in the future by some appropriate
interest rate. When this is done, we arrive at the present
value of a future sum or stream of money.
It is important for the jury to understand that on the date
of the plaintiff's projected death, there will be zero left
in the account. All the money will be used up. If he lives
longer, he will have nothing.
Q: Dr., am I correct on January 20, 2020, when Bob is statistically
expected to die, there will be "0" left over by
your own calculations?
Q: If he lives one day longer, there will be no money for
food, clothing, medicine or anything else?
The defense may argue in closing that you can invest the
lump sum award and live off the interest income without ever
invading the principal. This argument must be anticipated
and put to rest in your cross examination.
Q: Now Dr., by your own calculations, in the early years Bob
will earn more in interest than he is projected to need for
medical care and wage replacement?
Q: But as time goes by and inflation increases, the earned
interest will not be enough and he will have to start spending
his savings from the account?
Q: And then in the later years he will eat into the account
more and more just to survive and pay his bills?
Q: Until finally, there will be "0" left upon
his statistical date of death?
Q: And Dr., the pattern of earnings and spending from this
account has a pattern like a saw tooth, so the account's balance
goes up initially, but then drops to "0". It looks
like this, doesn't it Doctor?
$2,000,000.00 0.00
1998 2025
It is also important for the jury to understand what the
present value calculation does not account for. This gives
you an opportunity to drive home several points to the jury.
Q: Dr., your figures here on the value in today's dollars
of Bob's future needs, they only take into account those medical
needs which we can predict today as being probable?
Q: They do not take into account any emergencies, operations
or treatments which may occur or we just don't know about?
Q: And Doctor, your calculations don't take into account
Bob's personal or non-economic damages, not at all, not one
red cent for:
1. The fact that he cannot have relations with his wife?
2. He cannot even control his own bodily functions?
3. He cannot play football with his children?
4. He will never walk down the aisle to give Katie's hand
away in marriage?
Q: Your calculations don't consider these personal damages
at all, do they?
III. Who Benefits From What Assumptions?
The defense economist will likely be making those assumptions
which yield a low inflation rate and a high discount rate
or interest rate. The plaintiff must bring out in cross examination
the effect those assumptions have on the money necessary to
meet your client's basic future needs.
Think of inflation (wage growth and medical expenses) and
the interest rate (discount rate) as the two opposite sides
of a teeter totter. A higher interest rate drives down the
present value. A lower inflation rate drives down the present
value. The goals of the plaintiff and defendant can be graphically
demonstrated as follows:
Defense Goal
Higher Rate of Return
(interest rate, discount rate)
Lower Inflation
(medical costs/wages increases)
Plaintiff's Goal
Higher Inflation
Lower Rate of Return
The lower the rate of inflation in medical expenses and
lost wages, the less money has to go into the account today
to cover future needs. The higher the interest rate, the more
money the account will generate and the less money will be
needed today to yield that income in the future.
In today's economy, expect that the defense economist will
select investments which yield a high rate of return and a
short term historical inflation period. If the defendant is
a publicly traded company, you may consider comparing the
wage inflation rate chosen by the economist with the inflation
rate of the company's president.
Q: Now Doctor, I understand that you have used a figure
of 3% growth in the wages of Bob for the next twenty (20)
years?
Q: Let me show you the annual statements of XYZ Corporation
for the last three (3) years. Do you see where Mr. Smith,
the defendant's president, has gotten wage and benefit increases
averaging over 25% per year and last year earned $750,000.00?
Q: So, although XYZ gives it's president 25% increases,
you say that Bob will only earn a 3% increase?
IV. Research The Defense Economist
It goes without saying that the forensic history of the economist
is critical. Obtain copies of his earlier reports and testimony.
It is common to see the same economist testifying over and
over again.
If an economist has a defense bias, it is unlikely that
he has testified on behalf of an injured person. Discover
the percentage of work he does for both sides and the percentage
of his income derived from forensic work. The economist has
probably testified earlier when inflation rates were high.
Look to see the historical period chosen in order to forecast
future inflation rates. You may find some interesting inconsistencies.
If you are going to forecast twenty (20) years in the future,
it is basic economic theory that you would use the past twenty
(20) years to calculate inflation rates.
V. Talk English to The Jury
There is nothing more boring than most direct and cross examinations
of economic witnesses. Once you have learned and understand
the basic economic jargon, you need to translate it into language
that the jury can understand.
The present value of a future income stream is nothing more
than a bank account today that has enough dollars in it to
meet the medical needs and family needs of Bob in the future.
The discount rate is the interest rate. Discounting is simply
the reverse of compounding of interest.
All the defense's calculations, tables, charts and fancy
language are nothing more than forecasting or guessing about
the future based upon what happened in the past. It is looking
into the economist's future crystal ball. The predictions
can never be any better than the assumptions selected from
the past.
Q: Doctor, the present value calculations you have performed
- they are telling us in today's dollars what Bob will need
so that he can have enough dollars over the next thirty-seven
(37) years of his life to replace the lost income and meet
his basic medical needs?
Q: We are talking about the present cost to take care of
him medically over the next thirty-seven (37) years?
Q: What does a house cost today compared to twenty (20)
years ago?
Q: What does a pound of ground beef cost today compared
to twenty (20) years ago?
Q: What does an operation cost today compared to twenty
(20) years ago?
Q: What does a doctor's visit cost today compared to twenty
(20) years ago?
VII. Areas to Watch For in Defense Testimony
Look for those areas which unfairly raise the discount (interest)
rate and lower the inflation rate.
A. If the economist selects the current interest rate payable
on thirty (30) year treasury bills as the discount rate, this
can, in fact, raise the appropriate discount rate by ½%
to 1%. The thirty (30) year treasury bill rate is based upon
one payment thirty (30) years in the future, but your client
will not be paid in this way. There is a thirty (30) year
strip treasury bill rate which pays an amount each year or
periodically. This rate approximates the payment schedule
needed by your client. The ½% to 1% increase in the
discount rate can have a dramatic affect on the present value
of the recovery.
B. Pay attention to the historical period chosen by the
defense for calculating inflation rates. The shorter the period,
the more it will prejudice calculations in favor of the defense.
C. Work life expectancy tables probably understate the actual
working life of your client. The tables are based upon the
most recent historical data, but by their nature are not really
current. More importantly, recent changes in the Social Security
System mandate that younger people work over the age of 65
to receive full benefits. These legislative changes are not
reflected in the current work life expectancy tables. Individuals
born between 1943 and 1954 must work until the age of 66 to
receive full Social Security benefits. Those born after 1960
must work until age 67. These numbers will increase in the
future.
D. Some states require an adjustment for the effect of income
tax. Watch for the defense economist who reduces plaintiff's
future wage earnings for taxes, but does not reduce or adjust
the discount (interest) rate for taxes that must be paid on
the earnings. The plaintiff must pay taxes not only on his
lost wages but also on his investments. This adjustment may
reduce the discount rate from roughly 6.5% to 4.9% or a reduction
of 25%. Again, this can have a dramatic affect on present
value.
VIII. Prejudgment Interest - An Opportunity in Cross Examination
In those states which allow the jury to allocate the pre-judgment
interest, cross examination may be useful in laying the groundwork
for your closing argument.
Q: Dr., you have decreased Bob's future wage loss and medical
bills to their present value?
Q: And that's because a dollar today is worth more than
a dollar one (1) year from now and certainly four (4) years
away?
Q: And, it's only fair to make those adjustments, to get
everything to today's dollars?
Q: Anything less would be unfair in your view?
Q: Dr., I would like to talk with you about Bob's past wage
losses of $95,000.00 and his medical bills of $325,000.00.
Am I correct by your theory of present value that if Bob were
to receive $95,000.00 today, it would not be equal in economic
terms to his receipt of that amount in increments four (4)
years ago, three (3) years ago, two (2) years ago, and one
(1) year ago?
Q: And the same would be true of his past medical bills?
Q: Bob incurred $275,000.00 in medical bills four (4) years
ago, isn't that correct?
Q: So to adjust those medical bills to today's dollars,
or their present value, we would have to apply an interest
rate and compound that rate each year?
Q: Now, if we select your interest rate (discount rate)
of 6% and compound that amount over the last four (4) years,
can you tell us what the present value would be of Bob's $275,000.00
in past medical bills?
Q: And what would be the total present value of his lost
wages and medical bills over the past four (4) years, from
the date of the collision until today?
Q: And what we are doing here is getting the past and future
losses on an equal footing?
Q: And this can be done by awarding pre-judgment interest?
Q: That's the way the jury could be consistent in applying
your present value theory?
Q: We would be making apples equal to apples?
Q: And in your view, present day valuation of losses is
the fair thing to do?
It is effective to have the defense economist accept your
assumptions and then base his calculations on them. The jury
can rapidly see the dramatic difference in the end result.
However, these calculations need to be made during the pre-trial
deposition of the defense economist when he has his computer
and forensic software available.
XI. The Nature of Economics And The Problem With Assumptions
It is important for the jury to understand that economics
is not a certain science. The calculations performed by the
defense witness can appear to be precise when their conclusions
are not.
Q: Doctor, is it fair to say that economics is a social science?
Q: Economists disagree on their views as to what the economy
is going to do in the future, including inflation rates, the
stock market and just about everything else?
Q: What you are doing is taking historical data and attempting
to forecast the future?
Q: This is somewhat like what the weatherman tries to do
in looking at historical patterns and from those patterns
predicting our weather?
Q: Dr., would you agree that the historical record for predicting
the economy, like the weatherman, is not perfect?
Q: Indeed, your crystal ball has been cloudy in the past.
Like the 1929 crash and depression, the inflation of the 1970's
and 80's, and even today's economy was unpredicted?
Q: So reasonable economists may differ in their opinions
as to interest rates, discount rates, inflation rates and
other assumptions that go into these equations that you are
using?
Q: Is it not true that there are different assumptions that
economists use in calculating the future economic losses?
Q: And what you've done here today involves a lot of assumptions?
Q: Many economists don't even agree on what discount rate
they would use for the present value calculations?
Q: Economists don't even agree on what inflation rate should
be used to calculate future costs of various goods and services
that Bob will need?
Q: And reasonable economists can disagree on what historical
period is best to use in making these assumptions?
Q: And different inflation rates and different discount
rates, when used in these calculations for this much money
over the twenty (20) years of Bob's future, can make a huge
difference?
Q: Interest rates are variable, they go up and down all
the time, but your calculations use a fixed interest rate?
Q: And from past experience we know that the number is not
going to be right in the future?
Q: And when you come up with a number like $359,875.00 which
has a very precise ring to it, the science of economics isn't
that precise is it, Dr.?
Q: And we know sitting right here today, you and I know
that a lot of assumptions will not be right. They will be
wrong one way or the other?
Q: And the discount rate, the interest rate and the inflation
rate, which you assumed for this period, those numbers are
not going to be right, are they?
Q: And if I ask you to make a change in your assumptions,
for Bob's work life expectancy, the inflation rate, the discount
rate, then your numbers would change?
Q: These numbers would change dramatically depending on
which assumptions you make, don't they?
Q: They will change every time you change an assumption?
Q: Have you ever totaled how many assumptions are going
into your calculations?
Q: Would you agree that there are many?
Q: And every time you make an assumption, there is a chance
of being wrong?
Q: And the more assumptions you make, the more chances there
are of your being wrong?
If the defense economist projects a discount rate on anything
other than government securities, then he is exposing your
client to investment risks. Educate the jury on the potential
consequences of this risk to your client.
Q: Dr., would you agree with me that government bonds are
risk free but investing in the stock market carries with it
greater risk?
Q: And the amount of risk an individual can afford to accept
varies with the amount of money an individual has and the
need for that money just to pay the basics of life?
Q: And would you agree with me that Bob needs to be in the
lowest risk category possible?
Q: Bob can't afford to be wrong in his investment decisions?
Q: And in putting part of Bob's money in the stock market,
you are willing to increase his risk?
Q: He is going to require someone to pick the right stocks?
Q: But nobody is perfect, are they Dr.?
Q: And over the years, a lot of individuals have lost money
in the stock market?
Q: And in 1929, a lot of people invested in stocks which
they thought were sure things?
Q: Dr., over the years some very large and successful companies
in the United States have actually gone bankrupt, haven't
they? Such as Best & Co, Executive Life Insurance Co.,
and TWA?
Q: Now Dr., what if Bob took part of the money he needed
just to pay for operations and medicine and put it in the
stock market and the stock market crashed, what then Dr.?
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