Discounting the cost of future care:
Current methods overestimate the present value.
Note: A Microsoft Excel spreadsheet for correct computations is available for download:
A. Factors determining the size of an award
Three factors determine the present value of the costs of future care, and hence
determine the quantum of damages.
The first factor is determined by the Court, and the second is usually specified by
law for the country, state, or province. We focus here on the third, the life table,
as it is here that the consistent overestimation of present value occurs.
- The annual costs of care (or other payments) to be received by the plaintiff.
These are specified in a life care plan. For simplicity we assume here that the
annual payments are equal, or nearly so.1
- The net discount rate, representing the difference of the rate of return on
investment and the inflation rate. The net rate is often in the vicinity of 3%. This
means, for example, that a payment to be received in one year's time has a present
value of about 97% (1/1.03).
- The plaintiff's life table.2 More precisely, what is required is the
plaintiff's chance of surviving one more year, two more years, and so on.
B. The current procedure
- Currently, the Court hears arguments about the plaintiff's life expectancy or
median survival time3 and makes a determination. For example, the Court may accept
that the life expectancy is 20 additional years.
- This figure (together with the life care plan and the specified discount rate) is
provided to an actuary or economist, who computes the expected present value (EPV) --
the amount of money today which is actuarially equivalent to the life-time stream of
- It is not currently recognized in legal circles that the life expectancy alone is
insufficient to determine the EPV; in fact, the complete life table is required. There are infinitely
many life tables that yield a given life expectancy, and all result in a different EPV.
- An expert opinion on life expectancy should include the complete life table, not just the
single number (the life expectancy) that is computed from it. In practice, however, it
is generally left to the economist or actuary to invent a life table that corresponds
to the given life expectancy.
- It is here that the problem arises: the economist/actuary is not provided with the
correct life table, and the standard methods used to invent one all lead to overestimation
of the EPV.
C. The standard methods to create a life table corresponding to a given life
The most common methods are the following:
As noted, all of these methods overestimate the EPV. The first -- the expectancy
method -- results in the greatest overestimation of all. This is noteworthy because
it is perhaps the most common approach in the U.S., and we understand that it is the
method required by law in Australia.
- The Expectancy Method assumes that the plaintiff will live exactly to his or her
life expectancy and then die. With a 20 year life expectancy, for example, one would
assume the plaintiff will live exactly 20 more years. The life table implicit in this
method is the "degenerate" one in which there is no variability at all in the survival
time -- it is assumed to be exactly 20 years.
- Rating Up advances the plaintiff's age to a "rated age" chosen so that the life
expectancy in the general population is the required life expectancy. For example,
if a boy with cerebral palsy has a life expectancy of 20 years, his rated age is 58
years -- the age at which a normal man has this life expectancy. The child's life
table is then assumed to be the ordinary life table for a man of 58.
- In The Ratio Method the age-specific death rates are all multiplied by a constant
chosen to result in the required life expectancy. The suitable constant is easily found
by trial and error.
The discrepancy between the expectancy method and use of the correct life table has
been noted in the literature. Jordan (1967, p.174) refers to a "widespread misconception"
that the two quantities are equal. Ben-Zion and Reddall (1985) state that the expectancy
method is (a) widespread and (b) demonstrably incorrect.
Strauss et al. (2001) document the magnitude of the error resulting from all three of the
above methods, and also demonstrate mathematically why all the methods overestimate the
EPV rather than underestimate it. The example below, from Strauss et al. (2001), may be
Table 1. Expected Present Values of lifetime care for a
5-year old boy with cerebral palsy. Life expectancy is 20
years, costs are $100,000 per year, and a 4% net discount
rate is assumed.
# Method EPV
1. No discounting at all $ 2,000,000
2. Assuming the child lives exactly 20 years $ 1,385,947
3. "Rating up" (using the life table for a $ 1,296,538
normal male aged 58 years)
4. Ratio method $ 1,298,388
5. Using the correct life table $ 1,149,194
D. What is to be done?
We would suggest the following:
- First, the legal community needs to be aware that a life expectancy opinion
itself is not sufficient to determine the damages, and that a full life table is required.
- When the plaintiff has a normal or near-normal life expectancy, the general
population life table can and should be used (possibly with some modest "rating up"
adjustment for smoking, obesity, and other factors). There is no possible justification
for the commonly used expectancy method.
- Where the life expectancy is reduced, as in the case of severe cerebral palsy,
for example, an actuarially based life table is required. This is not within the
expertise of the physician. An approximate life table can be obtained from analysis
of the literature on survival rates for persons with cerebral palsy etc., but an
actuarial analysis of a large data base is much more reliable. Methods for constructing
the life table for persons with chronic disabilities are available in the literature
(Strauss & Shavelle, 1998).
- If this is not the case, then the magnitude and direction of the error in the
methods discussed below cannot be predicted and individual calculations will be required.
- See, for example, Schoen (1988), chapter 1 for a discussion of the life table.
- Technically, a person's life expectancy is the average (mean) time survived
by a cohort of individuals like himself. If one third of such people live exactly one more
year, one third live exactly two more years, and one third live exactly nine more years,
the life expectancy is (1 + 2 + 9)/3 = 4 years. The median survival time in this example
is 2 years, the survival time of the "middle" person.
Ben-Zion B, Reddall R (1985). Life expectancy and actuarial present values: A note to forensic economists. Research in Law and Economics, 7: 161-171.
Jordan CW (1967). Life contingencies, Second Edition, p.174. Chicago: Society of Actuaries.
Schoen R (1988). Modeling multigroup populations. New York: Plenum Press.
Strauss DJ, Shavelle RM (1998). Life expectancies of persons with chronic disabilities. Journal of Insurance Medicine, 30: 96-108.
Strauss DJ, Shavelle RM, Pflaum C, Bruce C (2000). Incorporating the effect of reduced life expectancy into awards for future costs of care. The Expert Witness, Winter 2000, volume 5, number 4.
Strauss DJ, Shavelle RM, Pflaum C, Bruce C (2001). Discounting the cost of future care for persons with disabilities. Journal of Forensic Economics, 14:79-87.