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Working with an Expert to
Assess Damages in Civil Litigation

Objective of this session is to provide insight into what an economist may consider when analyzing a loss, especially a loss arising from a tort.

Examples of situations requiring an economic analysis

• Defective product damaged a business (e.g., plaintiff alleges defective equipment interfered with production practices)
• Defective product (e.g., unsafe equipment) resulted in personal injury or death
• Discrimination (e.g., age, race) damaged a career or business
• Professional negligence resulted in personal injury or death (e.g., medical malpractice)
• Professional negligence damaged a business (e.g., lender misrepresented its actions; ineffective sales promotion resulted in reduced profit)
• Negligence resulted in personal injury or death (e.g., automobile accident)

In situations involving personal injury or death, the victim often is a business owner or an employee; occasionally the individual is a homemaker.

Purpose of economic analysis:  what the attorney and expert already understand

• Purpose of an economic analysis is to determine the amount of compensation necessary to return the injured party (or business) to where he or she would have been had the injury or damage not occurred.  General rule -- Return injured parties to where they were prior to the loss.
  • N.D.C.C. §32-03-20. Measure of damages for tort.  For the breach of an obligation not arising from contract, the measure of damages, except when otherwise expressly provided by law, is the amount which will compensate for all the detriment proximately caused thereby, whether it could have been anticipated or not.
• An economic analysis does not address the issue of liability; it analyzes the impact the injury or damage had on the income or earnings of the person or business.
• In preparing an economic analysis, one hopes for a resolution or settlement, but always prepares for trial.

Purpose of economic analysis:  what the client needs to understand

• Clients are often intimidated, emotional, and not sure what might happen next.  There may be feelings of reluctance or despair; that life will never return to normal; that “I just want this to go away.”
  • An explanation of the purpose and process of an economic analysis should help assure the client’s confidence in the attorney, the expert, and the analysis.
• Clients may be reluctant to provide information, or unsure what information to provide, if they do not understand how or why it will be used.
• Clients need to understand that their information and explanation forms the foundation for the expert’s analysis, and that the explanation to the expert must be absolutely consistent with what will be stated when testifying.  Now is the time for the client to begin thinking about and practicing how he or she will explain their situation to others, including a jury.
• The attorney and expert need to discuss and understand who will explain the client’s role when working with the expert.  The attorney and expert need to be consistent in their explanations to the client.  In some situations, a meeting among the three parties may be necessary.
• There must be an understanding that the client will not provide any document or information to the expert unless it is also provided to the attorney.  Recommend that anything the client wants to share with the expert should be sent to the attorney who will then forward it to the expert. 
• Clients often want to discuss the issue of liability; it takes a little time to shift the discussion to damages.  The attorney and expert need to help the client understand the difference between liability and damages. 
  • A court case could be described as a puzzle with numerous pieces provided by different people or information sources.  The economic analysis is just one of the pieces.
• Clients need to focus on how their life has changed.  Some clients may not initially understand why this is necessary or important; others think the impact is so obvious it does not require explanation.  In these situations, the expert and attorney need to decide who will explain the process to the client.  Hopefully, the explanation will help the client understand the analysis, thus easing the process of collecting information.
• Sometimes a draft analysis may help the client understand the analytical process, what additional information the client needs to provide, and how the client’s information will be used. 

Overview of Analysis

An analysis is based on the past activities of the person or business, and how those activities have been altered as a result of the incident.  The analysis can be organized into several periods, such as

1. Events before the incident,
2. Events since the incident,
3. Projected future events as a result of the incident, and
4. Projected events had the incident not occurred. 

A graph may help illustrate the various periods and conceptualize the analysis.

• This graph illustrates a hypothetical situation where an injury or damage occurred in Year 0 and full recovery (return to previous status) is expected within 5 to 6 years.  The analysis is being prepared in Year 2. 
  • There were four years of available records (Years -4 to -1) with which to project the future had the injury or damage not occurred (Years 0 to 6).  This is the upper line on the graph
  • Several years of records (Years 0 to 2) also are available with which to project the remaining recovery time (Years 3 to 6).  This is the lower line on the graph.
  • The triangular area between the two lines represents the amount of damages.

• An analysis generally considers the change in activities, income, and expenses.
• The analysis also should describe the original goals of the person or business, and how the incident has impacted or forced the goals to be altered.
• The analytical method generally involves preparing budgets; more on this in a subsequent section.
• Economists use a partial budget analysis to calculate a change in profit or earnings.
  • Partial budget analysis – change in profit is 1) the sum of negative impacts (decreased income plus increased cost) minus 2) the sum of positive impacts (increased income and decreased cost).
  • However, explaining the analysis as a partial budget sometimes complicates the understanding, rather than clarifying it. 
• Again, the attorney and expert (and possibly the client) should work together to determine which explanation of the methodology would be the easiest for others to understand.

Sources of information

• To prepare a budget to analyze the situation, the expert must understand the business, industry, person, career, or family that is being analyzed.
• Personal data and facts are the preferred sources of information to assure the analysis reflects the actual situation.  However if that information is unavailable or not credible, the alternative is to use relevant public or private information.
• Always use the best available information.

Plaintiff’s Description

• An initial step in completing the analysis is for the expert to “listen” to the plaintiff’s description:
• How has the plaintiff’s situation changed?  What is the plaintiff doing differently?  In the case of personal injury, what were the plaintiff’s activities and responsibilities before the incident, and what are the plaintiff’s activities and responsibilities since the incident?  How has the plaintiff changed his or her retirement plans?  How has plaintiff changed his or her business plans?  How has the plaintiff’s career or professional activities changed?  How have the plaintiff’s family, community, and social activities changed?
• Although these questions may seem simple, they may need to be discussed with the client several times to assure confidence in the responses.
• Explaining how the client’s information is going to be used in the analysis helps the process of assembling the information.
• Is this information revealed in the plaintiff’s deposition? 
  • The plaintiff’s deposition and responses to interrogatories are important for both the plaintiff and defendant’s experts.
• The experts need to confirm the reasonableness of the plaintiff’s description.  For example, be certain the number of hours purportedly worked by business owners is realistic.

Plaintiff’s Records and Documents

• Attorney and expert will collaborate in determining what records would be most useful.
  • Records of production, sales, or business activities; employment records
  • Income statements (revenue, expenses and profit)
  • Balance sheets (assets, liabilities and equity)
  • Record of cash flows may not be too helpful in some situations, but it depends on the situation
  • Plaintiff’s tax returns but consider whether they understate income 
  • Consider using financial statements prepared by a lender as part of a loan application (generally good information)
• Request records for four to six years prior to the incident and any records since the incident.

Rely on Attorney

• Some information about the plaintiff may be available from the defendant based on prior transactions or interactions between the plaintiff and defendant.
• Some information about the plaintiff may be available from third parties; leave it to the attorney to determine what can be requested and from whom.
• Another source of information is other experts for the client. Understand what they will testify to and how that information impacts the economic analysis. Be certain the economic analysis is consistent with the conclusions/opinions the other experts will present.

Sources of Information about the industry, similar businesses, similar family situations, and public data; examples:

• Consumer price index -- http://woodrow.mpls.frb.fed.us/research/data/us/calc/hist1913.cfm
• Bureau of Labor statistics -- http://www.bls.gov/
• Interest rates -- http://research.stlouisfed.org/fred2/data/GS10.txt
• Life expectancy -- http://www.cdc.gov/nchs/data/nvsr/nvsr53/nvsr53_06.pdf
• National Agriculture Statistics Service (USDA) -- http://www.usda.gov/nass/
• NASS data for North Dakota -- http://www.nass.usda.gov/nd/pubstoc.htm
• Industry information, e.g., Dun and Bradstreet -- http://www.dnb.com/us/

Respond to Report by Plaintiff’s Expert

• Review 1) the methodology, 2) the description and quantitative measures of the impact of the incident on the plaintiff, and 3) the industry or market trends relied on to make the projections.

Be realistic – if the expert stretches the numbers, the jury will bring them back to reality.

Identifying Loss

• “Listen” to the client’s description – in person or through discovery.
  • What was the incident and what was the outcome of the incident? What impacts did the incident cause and what other factors, unrelated to the incident, contributed to the outcome?
  • There are two questions to address -- what impact did the incident cause and was the impact really a loss?
• The analysis must be consistent with the client’s description and the points the attorney will emphasize.
• Strategize with the attorney; be sure the expert’s assessment of what was lost aligns with the attorney’s perception.  Be sure the expert’s understanding of the loss is consistent with the law and the facts.  Be sure the points that will be emphasized by the expert are consistent with the points that will be emphasized by the attorney, client and other experts.
• Obvious impacts
  • Lost hours of work; increased living expenses (e.g., medical costs); inability to perform household tasks that are now hired, performed by someone else or left undone; additional care being provided by family members or others; lost business revenue; increased business expenses.
• Is a “lost business opportunity” a loss?  Will an equivalent opportunity be available when the compensatory damages are paid? 
• Impact on family’s social and community activities – will not quantify or value, but may mention them and allow the jury to value, or serve as a negotiating point for the parties.
• Sometimes the expert has to explain why the impact is not a loss; e.g., lost an opportunity to buy land.
• But is there “another level” especially when analyzing a business?  Can economic theory help with the thought process?
  • Identify what was damaged in terms of economic resources – land, labor, capital, information or expertise, and risk bearing capacity (willingness and ability); then translate the impact into lost return of rent, wages, interest, royalty, or profit.

• Labor includes management, skilled, and unskilled activities
  • Value of a business owner’s labor – is it the change in the business profit or the value of owner’s labor as an employee of another business? 
  • Does time spent managing (making contacts, supervising, organizing inputs) have a different value than time spent on other business activities (such as operating equipment)?
• Entrepreneurial ability
  • Risk includes both willingness and ability to assume risk.  Has the incident impacted the business owners’ willingness or ability to assume risk?
  • Has the incident impacted the collaborative arrangements among co-owners?  Is the impact on one owner also impacting the business’ risk-bearing capacity?
  • Has the incident impacted the business’ ability to innovate? 
  • Risk, innovation, and collaboration are not the same as management (which is a type of labor); these fit into the category of entrepreneurial ability.  Did the business incur a loss because the synergy among the team members was more valuable than the total of the individual contributions of each participant?
• Again, consider the impact on business, personal, and family goals; role of goals in projecting future activities; how have the goals been altered as a result of the incident.
• Will there be a full recovery or will the damages extend for the remainder of a lifetime?  What period will be considered in preparing the analysis – time to recover, expected work-life, or expected lifetime?

Quantifying Loss

• An economic analysis (especially an analysis of business profit) usually involves preparing one or more budgets; e.g., expected income minus expected expenses; actual income minus actual expenses; additional costs minus reduction in costs; expected earnings minus actual earnings.
• The analysis generally involves preparing a budget for each year if the incident had not occurred; and a budget for each year of the period being analyzed.
  • Directly or indirectly, the analysis is projecting quantity and price of production and inputs for each future year being analyzed.
  • A change in quantity of input or production involves projecting impact of relevant future technology.
  • Change in price involves projecting shifts in market; for example, will the markets for the product and inputs experience change in prices that are less than, equal to, or greater than the general rate of inflation?
  • What events would alter the past trend in technology and price changes?  How likely are those events?  What would be the impact of such events on the industry and market, and consequently, on the situation being analyzed?
• To simplify the analysis, years with similar projections are grouped together.  For example, years remaining until retirement may be one group, and years of expected lifetime after retirement may be a second group.  A distinct group is needed to reflect differences in projections.
  • Prepare the analysis in such a way that each year can be considered individually if necessary and if adequate information is available.
  • Expert might be able to prepare a distinct analysis for each of the current years, but as the analysis projects further into the future, individual characteristics of each year may be more difficult to distinguish or describe (except for major events such as projected retirement, or change in health based on a credible source such as a life-care plan).
  • Use the individual’s goals as an indicator for projecting retirement, but always balance against expert’s experience and observations.
  • For example, project partial retirement for several years before full retirement, if appropriate.

Projecting Price Changes -- Analyzing future years involves projecting a rate of change in price, cost, or earnings.  For prices likely to change at the general rate of inflation, the analysis can use the consumer price index (CPI).  For price changes likely to vary from the CPI, the rate of price change for those particular items should be considered separately; e.g., medical costs.  See http://www.bls.gov/.

Preparing alternative scenarios – how much would the “bottom line” of the analysis change if a projection is altered?  Economists refer to this as sensitivity analysis; how sensitive is the outcome of the analysis to a change in one of the projections.  However, rather than creating a complete scenario for each variation, it may be easier to describe the sensitivity of a factor by comparing it to a baseline scenario or analysis.

Example: The baseline scenario indicates a loss of $325,000 when projecting the plaintiff’s salary would have increased for the next 10 years at a rate 1% greater than the general rate of inflation and costs would increase at the general rate of inflation. 

• However, if the projection about salary increases is raised to 2% greater than inflation, the total loss increases by $34,000.
• Likewise, if costs are projected to increase by 1.5% faster than the general rate of inflation, total damages would be $28,500 more than shown in the baseline analysis.

If the analysis identifies three or four distinct factors, and reports the impact of altering those factors, the parties could perhaps consider them in negotiating.

Mitigating factors – which economic resources remain and what income are they expected to generate? 

• Example:  following the death or disability of a business owner, the land and equity capital will likely remain; rent from the land and interest from investing the equity capital would be used to offset the lost business earnings.
• Example:  consider and quantify the type and amount of work an individual is able to perform following a personal injury.  The analysis may also adjust this mitigating factor to reflect anticipated recovery or further decline in ability due to the incident. Preparing an analysis to reflect time periods facilitates varying/adjusting mitigating factors over time.

Additional thoughts

• Be sure not to “double count.”  The expert needs to be able to explain where a particular loss is incorporated into the analysis.
• What is the alternative to preparing budgets if information is inadequate?

Calculating Present Value

Economic theory (and law) expects a loss to be stated as a value at the present time.  This is necessary because payments have different values when received at different times due to 1) inflation, 2) risk of not being paid, and 3) preference to consume now.  Factors considered in determining discount rate include the general rate of inflation and the nominal interest rate.

• Real interest rate: difference between nominal (market) rate of interest and the general rate of inflation (often defined as the CPI).
• Past losses are adjusted to present value by using a nominal interest rate reflecting the individual’s debt.  That is, if there is debt, the cash would have been used to reduce the amount of debt; if there is no debt, the cash would have been invested in an interest-bearing account.
• Future losses are adjusted to present value by using the real rate of interest.  This calculation is projecting that all projected payments will be equally impacted by the general rate of inflation.

Summary

• Explain the purpose and the methodology of the analysis so clients understand why their information is needed and how it will be used in the analysis.
• Address the impact of the incident on the goals of the injured person or business.
• Gather as many relevant financial documents as possible; it is rare that there would be too many business or personal records.
• Do not overlook the importance of the plaintiff’s deposition to both sides of the case.
• Use economic theory to explain resources impacted by the incident, including the risk component of entrepreneurial ability.
• Consider whether information about the sensitivity of the analysis to certain projections would facilitate negotiations.
• Understand the relationship between the general rate of inflation, discount rate, and rate of inflation for specific income or expense items.
• Do not just “let the expert go.”  Work with the expert to assure the expert, client, and attorney’s “messages” are consistent, but without diminishing the credibility of the analysis.

Presented at UND Homecoming CLE in Grand Forks on September 30, 2005.

E-Mail agecinf@ndsuext.nodak.edu
Published by Agribusiness and Applied Economics
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North Dakota State University, Fargo, ND 58105-5636
Phone: (701) 231-7441
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