CHAPTER 4

Evidence of Loss

Let us be clear—online piracy is a real problem that harms the American economy, threatens jobs for significant numbers of middle class workers and hurts some of our nation’s most creative and innovative companies and entrepreneurs. It harms everyone from struggling artists to production crews, and from startup social media companies to large movie studios.

—Victoria Espinel, Aneesh Chopra, and Howard Schmidt1

Each year American businesses face thousands of claims asserting economic harm. Some claims are valid, and sometimes a business can easily distinguish between valid and invalid ones. In other cases though, the evidence is unclear.

To illustrate the problem of evidence, consider the unsanctioned sharing of music files between people via the Internet. Plummeting record sales during the last decade plus documented cases of music file sharing point to economic harm. Businesses that facilitate such file sharing face big-time claims of harm by the music industry. But has file sharing caused a decline in the purchase of music? And if it has, how much has the music industry lost because of it?2

Most businesses are not experts at gathering and analyzing evidence of economic harm, when faced with a liability claim. The business usually passes on the problem of evidence to their insurance company—who handles the claim. If the claim is not settled, then the evidence may come before an insurance mediator or arbitrator, who may take their own view of the evidence. If it is an arbitrator, then they settle the dispute, but if it is a mediator who cannot get the parties to agree, the case may go to trial, and a judge or jury make take their own view of evidence also. Along the way, at the insurance, arbitration or mediation, and trial stages, experts on evidence may be hired by the business, the insurance company, or the claimant to help with discovery—evidence gathering, evidence analysis, and estimation of economic loss.

For the business that wants to prepare for possible liability claims, it is useful to know something about how others view evidence of economic loss. The view taken by an insurance company, an arbitrator or a mediator, evidence experts, jury, and judge can have a big influence on how much compensation is paid out for economic loss. If a business’s insurance company is covering the liability bill, there may seem little point in having a business pore over the minutia of liability evidence, but the interests of the business and its insurer are not the same, and the business may face some additional costs if there is a big award for economic damages at trial. In particular, as court judgments are a matter of public record, a big judgment against a business in court may be bad for the business’s reputation. In addition, the terms of the insurance contract may not sufficiently cover legal costs to make a strong defense costless for the business. Longer term, a business that is found liable for a big economic loss is not typically the favorite sort of client for the insurance company, leading to higher future insurance costs.

We next turn to evidence of economic loss seen through the eyes of different participants in the process of resolving a business liability claim.

Evidence as Seen through the Insurer’s Eyes

The pursuit of profit drives most businesses to deny and refuse claims of economic loss liability, whenever possible. If they face a significant reputation cost, or if the claim takes the form of a lawsuit, then they will likely pass the claims of unintentional harm to their insurer. The insurance company, like its client, has a profit motive to deny claims, but is bound by policy contracts and government regulation to honor claims that meet certain standards. Legal standards establish thresholds of evidence: Only claims that pass the threshold are honored, and only to the degree mandated by the standard.

A business beset by a claim of economic harm can often rely on their insurer to scrutinize the claim for evidence—or lack of it. Insurers accept evidence only if it meets the requirements of the insurance contract, and they interpret the contract’s evidentiary demands in the strongest terms that are consistent with the legal notion of acting in good faith.3

Liability insurance is a form of third-party insurance—insurance owned by one party that covers losses incurred by another party. By comparison, insurance that covers a business’s own property is first-party insurance—insurance owned by one party that covers losses incurred by that party. Liability claims are made by either the allegedly harmed party or their lawyers, and neither is the insurance company’s client. An important question is: How does the insurance company gather evidence about the claimed loss? For this, the claims adjuster is usually called upon. The insurance company can use an in-house adjuster or claims service representative, or instead hire an outside independent claims adjuster to check out the evidence. The latter may be more cost-effective for the insurer if the location or type of loss is far from the insurer’s in-house team’s location or expertise. The claimant can also hire their own expert, called a public adjuster, to assess evidence of economic loss and advocate on behalf of the claimant.4 In principle, it is possible to have three different views from various claims adjusters looking at the same evidence of economic loss.

Claims adjusters are not the only experts who may provide opinions on loss in an insurance claim. The claimant, the insurer, or their lawyers may also hire additional experts in specialized fields, such as economics, accounting, statistics, medicine, accident reconstruction, or engineering, to provide opinions on specific sorts of loss. These other experts may prepare their own reports, and these may serve as inputs to the negotiation between the claimant and the business’s insurance company. The business itself may or may not be aware of all the opinions and negotiations, but a basic understanding of what is going on is a good idea, and a review of evidence—as it builds up—will help the business to anticipate and possibly alter the outcome of the dispute.

The whole process by which insurance claims of economic loss are handled by insurance companies is regulated by the government. In somewhat grandiose but relevant terms, insurance regulation is part of the societal framework for assessing claims of economic harm. Insurance regulation enforces statutes that guide the proper conduct of insurers. If an insurer wrongly refuses or egregiously under-compensates a claim, the claimant can in principle call the insurer out as a violator of some regulation. However, much of insurance regulatory law is targeted at first-person insurance claims by policy holders, and certain third-party claims such as worker’s compensation.5 Many third-party types of claims against businesses, passing to the business’s liability insurance,6 are not regulated in very exacting terms, particularly if the nature of the claim is more complex. This lack of regulatory specificity creates the potential for profound disagreements between the party claiming loss and the business accused of causing the loss. Such disagreements may multiply, rather than settle, in light of insurance claims adjusters’ estimates of liability and economic loss, particularly if more than one adjuster is involved. To handle such disagreements, the claimant and the insurer can take the evidence to an insurance mediator or arbitrator, or instead the claimant can morph into the plaintiff by filing the case as a complaint with the court.

Evidence as Seen through the Court’s Eyes

Courts have their own evidentiary standards—standards of evidence. Such standards are necessary, as the court is beset with large numbers of complaints, some with very scanty or ill-conceived bodies of evidence. Standards of evidence are a part of procedural law—laws that specify how litigants may present their cases before the court, separate from substantive law—laws that specify how courts may reach a decision on a case, based on the evidence. The courts’ standards of evidence contribute the societal framework for assessing economic harm, just as insurance regulation does.

For a business facing liability for economic harm, the key issue about evidence is whether it is substantial enough to merit payment or damages. Insurance companies pay when the evidence meets their standards and courts award economic damages when evidence meets theirs. To illustrate, consider a tort case of negligence by a business. The court will award economic damages against a business if it deems that the business failed to exercise due care. Suppose that the business activities create the possibility that one of its customers suffers an economic loss of size L, and let p be the probability of that loss. The expected amount of loss, created by the business, is then the product pL of probability times loss value. The business is required by law to take due precautions to protect the public from harm inflicted by the business’s operations. If the business spends an amount D on public protection against the loss in question, and if D is at least as large as the expected loss pL, then the business might be considered to have taken adequate steps to prevent the loss, and hence performed its duty of care. If instead D < pL, then the business might be considered liable for negligence. This calculus of negligence is known as the Hand rule, after Judge Learned Hand.7 Let us restate the Hand rule, for later reference: A business is liable for negligence only if they have not spent enough to prevent harm or injury to others

D < pL (4.1)

Example 4.1 Hidden Spiders

Bananas imported from tropical countries sometimes carry uninvited passengers, including tarantula spiders. The tarantula’s bite, while not usually fatal, is quite painful and requires a doctor’s care. For a grocer in the United States who sells imported bananas, one liability risk is that a customer is bitten by a tarantula when trying to buy bananas from the grocer. Applying the Hand rule, if in fact a customer is so bitten the court determines liability by finding out if the grocer spent enough money D on tarantula bite prevention, relative to the expected loss resulting from the bite. Suppose that the annual probability p that a customer is bitten is 0.0001, or 0.01 percent, and that the total loss to the bitten customer is $10,000. The expected loss is then 0.0001 × 10,000 = $1, so if the grocer spends at least $1 of resources annually checking its fruit for insects, then the dollars spent D = 1 exceed the expected loss pL, and the Hand rule says that the grocer is not liable for negligence concerning tarantulas in its produce department.

Business liability implies a fault or responsibility on the part of the business, but not necessarily an intent or disposition to cause harm. The court may find that a business did not intend harm but nevertheless bears strict liability—the responsibility for causing harm, regardless of intent or disposition—in which case the court may go lighter on the business then if it finds that the business committed an intentional tort, contract breach, or taking of property. Furthermore, if a business is one of several entities that may have caused a given harm, the court may assign to the parties joint and several liability—liability shared by two or more parties—which again may lessen the damages the court levies on the business in question. Sometimes a court may find that a business is liable for harm, not necessarily as the cause in fact—the exclusive and conclusive cause of harm, but instead the proximate cause—an event sufficiently related to the harm in question to be held as its cause. A proximate cause is less damning than a cause in fact, and the court may treat it as such when determining liability and damages.

Part of the evidence in a lawsuit against a business goes toward whether the business is liable for the claimed loss. A separate point is the extent of loss, assuming that liability exists. The court’s standards of evidence are designed to make it as easy as possible for the judge or jury to make decisions about liability and the amount of loss, based on the evidence presented. A judge or jury is unlikely to be expert on specific sorts of evidence—such as economic or financial issues, or medical reports—and may have limited ability to tell whether expert opinions included as evidence are of any value or credibility.

To protect the judge and jury against meritless opinions by irrelevant or would-be experts, the court’s evidentiary standards include special rules by which the court can refuse to acknowledge or hear some expert opinions. These special rules include the U.S. Federal Rules of Evidence,8 which allow the court to bar expert opinion if it is deemed to have insufficient probative value—the ability of proffered evidence to prove something important in a trial. At the least, an expert’s opinion should be distinguishable from mere speculation—an opinion lacking foundation in fact or evidence. Also, if a judge or jury could themselves reasonably come to the same conclusion as an expert, based on the same evidence, then the expert is not really adding useful insight, and so is not a useful witness. Even if the expert comes to nonobvious conclusions, his or her methodology must also be considered reliable.9

The standards by which evidence and experts are held depend somewhat on the state in which a lawsuit is brought. If a business were sued in the state of Illinois, for example, the standard of evidence may be less stringent and demanding than if it were sued in Indiana. A reason for such differences is that while federal standards for the admissibility of evidence have become more stringent over time, not all states have attempted to model or follow the newly toughened standards. States that have not done so are sometimes called “Frye” or “Frye plus” states, as their rules for state courts are based on standards that precede the Federal Rules of Evidence statute and subsequent case law, and are based instead on legal precedent that includes a federal court of appeal’s opinion in the case Frye v. United States, in the year 1923, about the admissibility of a polygraph test as evidence. Currently, the Frye states are California, Illinois, Maryland, Minnesota, New Jersey, New York, Pennsylvania, and Washington.

Most states have adapted or applied some version of the modern Federal Rules of Evidence, which were clarified in the courts via some additional case law, including the case Daubert v. Merrell Dow Pharmaceuticals in the year 1993, General Electric Co. v. Joiner in the year 1997, and Kumho Tire Co. v. Carmichael in the year 1999. These states are sometimes called Daubert states, in reference to the Daubert case just cited. States like California and Illinois that have not adopted the Daubert standard of evidence are not necessarily more prone to error in assessing liability and damages, but judges in these states take on added responsibility for preventing such errors when considering the admissibility of evidence and expert witnesses.

If a business is sued for some harm or injury to others, and the plaintiff intends to introduce evidence of harm, the business’s lawyers can ask the judge to deny that evidence by a special filing called a motion in limine. Denial of evidence, at that stage, is based on the relevant legal standard, such as the Federal Rules of Evidence. The court can reject experts, as well as evidence itself, at this stage. The same legal move is available to the plaintiff’s lawyers to suppress evidence presented by the business.

Evidence and Economic Damages

For a business found liable for economic loss imposed on others, in both the insurance and trial stages of dispute, there ultimately must be some evidence-based determination of the dollar amount of economic loss. At the insurance stage, estimates of economic loss are informed by evidence, the insurance policy, and insurance regulations. At the trial stage, estimates of loss are informed by case law and statutes related to the loss in question—such as tort, contract violation, or property loss. At trial, the court-determined amount of economic loss is called economic damages, as discussed earlier. Also, the way that economic losses are tallied in insurance claims negotiations is informed by the way in which the relevant courts determine economic damages, the reason being that insurance disputes that do not settle often end up as cases in court. For these reasons, the determination of economic damages—based on evidence and economic thought—is a useful way to think about the sort of economic losses a business may face when confronted by a liability claim.

Economic damages provide a plaintiff with some compensation, remedy, relief, or award for economic loss. The court often imposes noneconomic damages also, including compensation for pain and suffering, and punitive damages for intentional harm. Economic damages are sometimes called special or pecuniary or “hard” damages, while noneconomic damages are sometimes called general or “soft” damages. While this book does not dwell on noneconomic damages, noneconomic damages can end up as some multiple of economic damages, with the multiplier depending on additional factors, in which case an understanding of economic damages is useful for understanding noneconomic damages too.

The way in which a court determines economic damages depends on the nature of the loss imposed by the defendant—assumed here to be a business—on the plaintiff. Assuming that what is lost is the enjoyment of some economic opportunity, generally the opportunity itself can be valued if it has some reasonable proxy among those opportunities currently existing in the marketplace. Evidence provides the foundation for identifying exactly what opportunity has been lost, and additional evidence identifies the market proxy and its price, when available. In Chapter 3, we discussed pricing formulas for opportunities, which take the form of earnings or payment streams over time, and these are appropriate for determining the price of earnings streams once a market proxy is found.

A loss of economic opportunity is a contrast between the opportunity that the harmed or injured party currently has and the one they would have had but for the harm. The dollar value associated with economic loss is then the market value of the preinjury opportunity minus the value of the postinjury opportunity. Let us label the preinjury opportunity as Opp1 and the postinjury opportunity as Opp2. Then the value of the lost opportunity is the difference in price between Opp2 and Opp1

price(LostOpp) = price(Opp1) – price(Opp2) (4.2)

Sometimes the value of a lost opportunity is fairly obvious. For example, if a commercial truck plows into a parked Honda Accord car, destroying it, then for the owner of the car the property loss is the current market value of a Honda Accord minus the value of the destroyed car—which is likely its scrap value at the junk or metal yard. Honda Accords have an active used car market, so market value has a straightforward estimate or proxy, and a check of scrap value is likewise easy to complete. The Honda Accord’s owner may have suffered some other harm from the car’s destruction, in terms of economic opportunity, but barring this complication there is no problem determining economic loss or damages.

Some people may be less impacted by a given accident or destructive event than others are, either because they are better able to cope with the event or they have some insurance or community support that helps them deal with it. Such special resources are often considered as protected and confidential information—and hence not evidence—in court cases, and called a collateral source of recovery. A collateral source may improve the postevent opportunities (Opp2, earlier); they do not lower economic damages because the court ignores them—the idea being that the injured party should not be penalized for being exceptionally prepared for calamity.

Economic damages get more complicated when the opportunities in question are themselves complex or lacking an obvious market proxy. In the example just discussed, if the crushed car was not an ordinary Honda Accord but instead one of comedian Jerry Seinfeld’s famous collector cars, its market value might take more time to estimate, both because a collectible car may not have a very active and visible market and also because a car owned by Jerry Seinfeld might sell at a premium, relative to other cars. Determining the value of such a car may require the specialized knowledge of an expert in the celebrity car market.

Economic damages are complex when the opportunities in question take place over multiple periods, some of which extend off into the future. We can use the pricing formulas in Chapter 3 to estimate these sorts of damages. In fact, Chapter 3 provided numerous examples of economic loss and estimated the amount of economic loss in each case. With attention to the issue of evidence, consider another example.

Example 4.2 Lost Contract

Suppose that a bakery hires a truck delivery company to deliver its baked goods to restaurants, under a 5-year contract. One year into the contract, the bakery realizes it could save money by delivering the goods itself and stops using the delivery company’s services. One more year goes by and the delivery company files a lawsuit for breach of contract by the bakery. Evidence supports the idea that the bakery paid the delivery company 15 percent of sales, and that sales in the first year of the contract were $200,000. What are the reasonable economic damages in this case? More information may be needed to project any trend in bakery sales, but suppose that sales would have been $200,000 annually in years 2, 3, 4, 5 of the contract, and that delivery expenses would have been 5 percent of sales, yielding a profit of 200,000 × 0.15 − 200,000 × 0.05 = 20,000. Also, at the time the lawsuit was filed, suppose that the interest rate on low-risk bonds was 2 percent while the premium for holding risky assets was 6 percent. A discount rate of 6 + 2 = 8 percent can then be applied to future earnings, which at the time of trial are those earnings in the third, fourth, and fifth year of the contract. The present value of earnings in all loss years—which here are years 2 through 5 of the contract, is the price of the opportunity Opp1. Interpreting the discount rate of 8 percent to be the implicit rate of return on the delivery business opportunity, formula (3.18) from Chapter 3 gives the opportunity’s price

price(Opp1) = 20,000 × (1 + 1 + 0.08)^-1 + (1 + 0.08)^-2 + (1 + 0.08)^-3

which is $71,541.94. Given the bakery’s contract violation, the distributor likely still has opportunities to deliver items for other bakeries or similar companies, but has lost the profit stream from the bakery contract in question, making the price of the remaining opportunity in that deal equal to zero

price(Opp2) = 0

In this case, economic damages are, according to formula (4.2), the difference in opportunity prices, this being $71,541.94 − 0 = $71,541.94.

In a trial situation, a case like Example 4.2 would need some additional evidence to support prices or rates that serve as inputs to the analysis. For example, an assumed interest rate or risk premium in financial markets should be substantiated by reference to current rates or premia available in the markets. An alternative approach, sometimes seen in court cases, is to use an average of rates, premia, or prices observed over a stretch of time in the past: The immediate effect of such averaging is to render the market data somewhat dated, but as courts often test the reasonableness of price or rate assumptions based on whether they lie within the range historically observed, the use of historical averages at trial for financial rates or premia may pass some basic test of admissibility.10

Another issue of evidence, inspired by the bakery delivery example (Example 4.2), concerns the sketchiness of data. An estimate of economic damages should be based not only on data of good quality, but also on data plentiful enough to make the estimate reasonably reliable. In the bakery delivery example, is 1 year of recorded bakery sales enough to form a reliable estimate or forecast of subsequent years’ sales? Economic forecasts are themselves often inaccurate, but a well-founded forecast is expected to do better than a sketchy one. A better forecast of bakery sales might be available if more past years of sales are brought into the analysis. Just as data on the bakery may be sketchy in Example 4.2, data on the bakery’s distributor may be sketchy as well. What sort of other deliveries has the distributor been able to do, in the absence of the bakery’s contract? What if the bakery’s contract cancellation freed the distributor up to sign another—more lucrative—contract with a different company? In that case, the lost contract would still represent a loss of profit associated with the contract itself, but there would be no (positive) opportunity cost—the difference in value between a given opportunity and the next best available opportunity. Instead, there would be an opportunity gain following the contract violation, and economic damages would be zero.11

A Taxing Matter

Rules of evidence can affect the estimation of economic damages in some surprising ways. For instance, in lost profit cases like Example 4.2, the court often interprets profit to be after-tax, a simple reason being that profits are usually taxed, so any loss of actual profit is likely on an after-tax basis. Since the difference between profit before and after tax can be substantial, with after-tax profit sometimes being 70 percent or less of before-tax profit, the issue of tax adjustment can be a big deal.

On the other hand, for a personal injury case like Example 3.3 where a person suffers a physical injury and loses wages because of it, courts typically interpret earnings loss on a before-tax basis. A possible rationale here is that the U.S. federal government does not ordinarily tax economic damage awards received by people as compensation for their personal physical injuries,12 granting a sort of windfall to the injured party, and a like-minded court may grant the same windfall. The granting of a windfall may be an act of mercy to people who have sustained wrongful physical injuries and are using the economic damage proceeds to recover their lives and livelihoods. A good chunk of such proceeds, between 30 and 40 percent, is typically paid to the injured party’s lawyers, leaving a much reduced sum which taxation would further reduce—substantially if the damage award is substantial.13 The windfall itself is exceptional, as a person’s income or wage is ordinarily taxable.14

The windfall granted to personal injury plaintiffs may mean that a business pays more when found liable for a certain amount of economic harm if that harm is caused by physical injury to a person rather than by some other means—such as business interruption, contract violation, or property rights infringement. There is another distinction of this sort, in terms of present value and discounting. While future lost profits in a case like Example 4.2 are typically brought to present value using a discount rate that reflects the risk of business activity and profit, future lost labor earnings—or front pay—for a person physically injured are typically brought to present value using a lower discount rate—for a low-risk investment. The effect of this contrast in discount rates is to increase economic damages in a personal injury case relative to those in a commercial case—lost profit and so on.

The rationale for using a relatively low discount rate on future labor earnings is perhaps twofold. First, labor earnings tend to be more stable over time than business profit, and so do not need as much discounting for risk. Second, the court may desire that the physically injured party have the opportunity to enjoy a stable and predictable income based on safe investments, to aid in their recovery, even if their actual labor earnings were not so predictable.15

If there are two advantages granted to personal injury plaintiffs, in terms of tax treatment and future loss discounting, there is one disadvantage, namely that any losses of past earnings are usually counted as a straight sum part of the economic damage award, with no allowance for interest on past earnings. By contrast, a damages award for past lost profit often includes an allowance for the interest that could have been earned on the lost profit, from the time it was generated until the time of trial.16 The absence of accumulated interest on personal injury past earnings—or “back pay”—makes them less expensive to the liable business than the wrongful loss of past profit, all else equal. A reason for this difference is that businesses normally reinvest a portion of their profits into ongoing business activity, earning a return on past profit, while an individual is normally assumed to consume most of their labor income, leaving little upon which to earn a return.

The Economist’s Voice

Given the complexity involved in determining economic damages, both in terms of economic principles and issues of evidence, it is not surprising that economists are sometimes called upon to voice their opinions on economic loss or damages at trial and also at pre-trial stages of dispute.

If the plaintiff’s counsel views the evidence as a slam dunk in terms of establishing the pecuniary loss, the defendant’s cause of the loss, and the total dollar amount of loss, then plaintiff’s counsel would only waste time and money by using an economics expert to opine on the matter. Likewise, if the defendant’s counsel views the evidence as a slam dunk, defense counsel has no use for an economics expert. In order for a lawyer to benefit from using an economics expert, there must be some uncertainty or risk in the lawyer’s own ability to estimate economic damages. The uncertainty may arise because the defendant’s causative role in pecuniary loss is unclear or because the pecuniary value is unclear.

Faced with uncertainty, there is still no point in using an economics expert unless the expected amount of economic damages is sufficiently large. This is because the economics expert, often an economist with a doctorate (PhD) degree, typically charges an hourly rate on par with lawyers, and so adds a cost to the case, which can only be justified if there are sufficient dollars at stake in the case. Experts of this sort are frequently called forensic economists, with the adjective “forensic” capturing the idea of someone who can see, produce, or interpret evidence in a way that clarifies its meaning to the parties in a dispute.

For the lawyer with a high-stakes case and some uncertainty about economic damages, the economics expert serves to reduce uncertainty. The economist does so via the credibility of his or her opinions on the nature, cause, and extent of pecuniary damages. The expert’s opinion need not be the same as the retaining attorney’s initial view of damages, and may well be substantially different. However, if the expert and the lawyer are ultimately on the same page, then the lawyer enjoys more confidence and certitude about economic damages. This adds value so long as the lawyer is risk-averse. Even if the lawyer is risk-neutral, he or she may act in a risk-averse way if their client is risk-averse.17

High-stakes cases include class-action lawsuits with many millions of dollars at stake and antitrust cases involving proposed mergers of corporate giants. But stakes need not be that high to justify the use of economics experts. Consider, for example, a simple divorce case with one spouse a physician and the other spouse demanding sufficient resources to generate a $100,000 yearly income after the divorce. Can this demand be met, given the couples’ wealth and the doctor’s current and future earnings? An economist could usefully opine on this issue, significantly reducing uncertainty, at a cost of perhaps $1,000 to $2,000 or so.

Furthering the divorce theme, suppose that in 2013 an attorney divorces his spouse and the judge tasks him with paying for his child’s college education 10 years hence, at a price of $30,000 yearly in year-2013 dollars. Fast-forwarding 10 years, suppose he refuses to pay for college, leaving the bill to his ex-wife. How much can she demand of him in that year (2023) in terms of college dollars? An economist could usefully opine on the kind of college education affordable for $30,000 in 2013, and the cost of such an education in 2023, reducing uncertainty, at a cost of $1,000 or so.

Moving from divorce to tort law, consider the high-stakes personal injury or wrongful death case. Suppose that plaintiff’s counsel is pursuing a claim in court that includes an estimated $750,000 of economic damages. It is a big number, and as such defense counsel will rightfully work hard to discover any fault in its foundation. In addition, with the prospect of big errors surrounding big numbers, the responsible judge will want to facilitate vigorous scouring of the foundations. An economics expert has more work to do here than in the divorce cases described earlier and charges more money, but delivers considerable assurance at a cost of a few thousand dollars. Plaintiff’s counsel may consider this a bargain and the defense may hire their own economics expert for similar reasons.

This raises the prospect of dueling economics experts, with conflicting opinions, which would seem to nullify the risk-reducing role of economists at trial. However, differences in economics expert opinions are likely to be small relative to the risk initially surrounding economic damages. That is, disagreements among economists about economic loss are likely smaller than the range of values that a jury or judge might assign to economic damages.

Consider also the high-stakes tort case of wrongful termination from work. An openly gay vice president of a bank is terminated by the bank’s new president, and the vice-president sues the bank on grounds of discriminatory wrongful termination. Here there may be uncertainty about the cause of termination and also about the amount of earnings that the plaintiff might reasonably have expected to earn but for the termination. On both points an economics expert, particularly one with expertise in economics and statistics, can opine in a manner that reduces uncertainty.

Contract law is also replete with high-stakes cases, in the millions or billions of dollars, in which economics experts can clear some fog away from the numbers. An equipment company in a rural area leases some equipment to a contractor who then starts work on an office building. The equipment breaks, the leasor fails to repair, and the contractor sues for business interruption and loss of reputation. The economics expert, particularly one with a background in financial matters, can reduce uncertainty about the extent of economic damages.

Infused in the foregoing examples are two simple economic ideas about civil courts and how they work. The first idea is that both plaintiff and defense seek an outcome for their case that leaves their pocket books in the best possible shape. The second idea is risk aversion: Litigants do not like surprises when big money is on the line. In this economic theory about civil courts, there is a natural role of the economics expert in high-stakes cases.

What are reasonable assumptions about discount rates and earnings growth rates? These are topics of active discussion and research by forensic economists; see, for example, the books by Martin (2012), Brookshire, Slesnick, and Ward (2007), and Marshall and Ireland (2006). Also see the peer-reviewed research articles in the Journal of Forensic Economics and the Journal of Legal Economics. The national and regional meetings of professional organizations, including National Association of Forensic Economists (NAFE) and the American Academy of Economic and Financial Experts (AAEFE), include presentations on state-of-the-art research concerning the key inputs to present value and economic damages in personal injury cases. Leading forensic economists regularly attend these meetings and present their own research at such venues.

Just as a business has more in mind than economic damages when handling a business liability case, an economics expert has more in mind than the rough sketch of economic damages presented here. Much remains to be filled in to complete a damage estimate. Fortunately, a qualified forensic economist pursues these details with zeal. At the end, they report an estimate informed by sound economic and statistical practice and stand ready to explain their opinion at trial.18 To get some additional idea of how an economist operates in this sort of work, the Appendix to this chapter briefly describes the process common in personal injury cases.

Scientific Evidence

If you use an economics expert in your case, you should gain confidence about the estimate of economic damages that you ultimately present to opposing counsel and the court. Despite the fact that economics is a social science, evidence based on economic analysis is not generally comparable to evidence based on the “hard” sciences. Hard sciences achieve greater exactitude than soft sciences, and it is easier to establish things like error rates in the former. So, when an economist states their opinion to a “reasonable degree of economic certainty,” it is commonly understood that this degree of certainty is likely coarser than for an engineer, say. For this reason, while evidentiary standards, rules, and case law create the possibility that a competent economics expert’s opinion will be refused at court via a Daubert or Frye challenge,19 the success of such challenges is rare.

Damn Lies, Statistics, and Liability Evidence

A famous saying of the late author Mark Twain is that there are “lies, damn lies, and statistics.” When a business is faced with a liability case, some evidence may come in the form of statistics, or some conclusion about economic damages may hinge on the use of some statistical procedure. The courts, as well as other dispute-resolution institutions like insurance arbitration hearings, can benefit from the evidence-enhancing power of statistics, or instead fall prey to the beguiling misuse of statistics—as hinted at by the Twain quote earlier. Having long been exposed to the merits and pitfalls of statistics, the courts have developed procedures and evidentiary standards that attempt to keep the good while minimizing the bad.

One use of statistics is to shed light on fault for some action. For an employee who was fired from their job, did the employer fire them for business reasons or for some reasons that might be discriminatory against women, or disabled workers, or gays? If it is just a single employee under consideration, the information about their specific employment history might be enough to assess the likely cause of termination. But if we are talking about a large company and the set of all employees fired over a period of time, a pattern or tendency in termination may be apparent for the group of fired workers as a whole, a pattern that may not be obvious by looking at their employee files one by one. A formal statistical test of discrimination and nondiscrimination hypotheses may be available if the sample of workers is sufficiently large and may produce some conclusion about a business’s liability for discrimination against its workers.

Statistical tests for business liability, as in the afore-described case of a class action for wrongful termination, require a sufficiently large sample of data, an expert trained in statistical testing, and some mathematical assumptions about the relevant variables in the data sample. Experts in this area include scholars with a PhD in statistics or allied fields like econometrics—the application of statistics to economics—or biometrics—the application of statistics to biology.20 The reasonableness and robustness of the relevant mathematical assumptions is something that the expert must consider carefully, as must the eventual trier of fact—the person or persons responsible for determining facts from evidence in a dispute.

A view from the literature on statistics in the courtroom reflects Mark Twain’s sentiment in the quote earlier, which is that statistics-based evidence of liability should be welcomed for its promise of discovery but scrutinized for its ability to mislead. My own interest in economic damages began as a student at the University of California, Berkeley, in a statistics class taught by the late Professor David Friedman who recanted tales of his statistical consulting work and who also served as a major voice for clear and reliable application of statistics to legal disputes and social science.21

Aside from testing for fault or liability, statistics are also useful for determining economic damages when a business liability is found. Descriptive statistics serve to summarize a data set in some useful way and can simplify the task of considering a large amount of evidence. Also, descriptive statistics such as the sample average may be useful in predicting future outcomes, assuming that future outcomes are “drawn” from the same pool of possibilities as past outcomes. For a business that wrongfully causes the loss of some economic opportunity, if the lost opportunity would have been affected by one or more known variables, regression models—of the expected value of one variable, given other variables—may be useful in estimating or forecasting the extent of the opportunity and its market value. A simple linear regression model relates one variable y, called the dependent variable, to a second variable x, called the independent variable, plus an error called e, as follows

y = α + βx + e (4.3)

where α is a constant known as the regression intercept and β is a constant known as the regression slope. In the linear regression model, the expectation of the variable y, given the observed value of the variable x, is

(4.4)

If values can be assigned to the regression intercept and slope, then the expectation formula (4.4) can be applied to get expectations, predictions, or forecasts of y, given a known value of x.

Example 4.3 Expected Sales

Continuing the bakery delivery example from Example 4.2, suppose that bakery sales y are related to year x, for x = 1, 2, 3, 4, 5 via the simple linear regression model (4.3) with intercept α = 50,000 and β = 50,000. Applying the expectation rule (4.4), expected sales in years 1, …, 4 are 100,000, 150,000, 200,000, 250,000, and 300,000. Applying the same discount rate as earlier, economic damages are now $78,766.96.

Fuzzy Evidence: The Case of Hedonic Damages

We have been discussing evidence of business liability and economic loss, with the idea that what is lost is some economic opportunity like a car, job, or business contract. But that is not the whole scope of potential economic loss. Earlier we talked about society’s well-being, or social welfare, via the utility of its collective consumption of goods at all dates and states of nature. We symbolized this utility-of-consumption function as U(C) and argued that a business causes economic loss to society by any action that lowers the social utility number U(C). Utility itself embodies the pleasure and benefit we enjoy from consuming goods. If we could agree on what value utility U(C) takes in all relevant situations, we may be able to determine the dollar value of economic loss or damages by making a liable business pay the harmed party money sufficient to restore their own utility of consumption to the level it was at before the harm.

Example 4.4 Malpractice

To illustrate, suppose that a doctor makes a mistake while tending to an injured motorcyclist’s leg, causing the patient to lose a leg that otherwise should have healed fine. Economic loss may include the work opportunities that a two-legged versus one-legged person may have access to, but the injured person’s disability implies more economic loss than just wages. Enjoyment of sports, ability to find and keep a spouse, ability to parent, and ability to enjoy life generally may be lowered by the loss of a leg. If the doctor pays to replace only the disabled person’s labor earnings loss, arguably too little has been paid.

Utility ideas, and a utility function of the sort U(C), are frequently applied in economics, but without clear guidance on how to quantify the value associated with the pleasure or enjoyment of life. If the disabled motorcyclist lost $1 million in labor earnings, in present value terms, perhaps they lost an additional $2 million associated with an inability to otherwise have or enjoy the same quality of life as before. But maybe the lost additional value is more like $5 million or $10 million. Who knows?

In personal injury cases, a jury typically considers a range of possible damages, both traditionally economic damages—including lost wages—and other damages like the loss of consortium or relation with other people. As a jury deliberates over damages, they may come up with a number value for the general loss of enjoyment of life—sometimes called “hedonic damages,” separate from regular economic loss, based on the evidence and also the jury’s collective life experiences. Economists will agree that jury members are endowed with their own utility or utility “functions,” and so may make as good an assessment of hedonic damages as is feasible.

Juries may be the best people to contemplate the loss of enjoyment of life in a business liability case, but that has not stopped some economists from trying their hand at it. Attempts in this direction have suffered, though, from a fuzzy or subjective application of evidence. A major hurdle for the economist estimating hedonic damages is that the relevant utility function is unobserved and not altogether identifiable. A possible remedy, in a personal injury case, is to ask the injured person how much money they would need in order to be just as happy as they were before their injury. In Example 4.4 earlier, the motorcyclist who lost his leg due to medical malpractice may give some answer, say $10 million or $100 million, but with a bit of forethought about the consequences of their answer, the answer might be in the billions or more. Since an economist cannot likely know the biker’s true utility function or preferences, they cannot distinguish between an honest assessment of hedonic loss and a rationally aggrandized assessment.

The economist might also ask a bunch of healthy people how much they would need to be paid in order to become disabled in some way—such as losing a leg. The economist might then use the average response of these people as a measure of hedonic damages in a given case of liability against a doctor or business. As is easy to imagine, people may require an enormous amount of money to suffer a serious lifelong disability, and some may refuse any amount offered. The possibility of extremely large, or infinite, values makes a sample average of such values a possibly unreliable estimate of the typical person’s willingness to take on a serious disability in exchange for money.

Rather than asking people directly about their preferences toward money and health, an economist can attempt to ferret out such preferences from peoples’ behavior in the marketplace. In the labor market, some people take on risky jobs like firefighter or high-rise construction worker, typically receiving some amount of hazard pay relative to people who take safe jobs like retail sales clerk. Taking on an increased risk of disability or death, in exchange for extra pay, is similar in principle to trading a guaranteed disability for pay, but is cast in probability terms.

Example 4.5 Window Washer

Suppose that a window washer of high-rise office buildings has a 0.1 percent chance of dying on the job, in a given year, and receives an extra $10,000 for taking on this risk, relative to pay available for washing windows on the ground floor only. How much money would the window washer be willing to accept for a 100 percent chance of dying? If taking on 0.001 (or 0.1 percent) probability of death pays $10,000, perhaps the window washer would accept the same payment per unit of death probability, from 0.001 to 0.002, and so on, to 1, with total payment of 1,000 × $10,000 = $10 million.

The logic in the Window Washer example is that market data tell us about the amount of money people are willing to pay to take on some measurable probability of death or disability, and this same market data can then be used to make inferences about a person’s willingness to accept a 100 percent certainty of death.22 A problem with the logic is that it suggests a person is willing to take on additional chances or probability of death, each at the same price, until certainty (100 percent) is reached, whereas a person would likely insist on higher and higher prices for additional risks. If so, the window washer might rationally refuse $10 million in exchange for death and might also refuse any amount of money for it.

A subtle twist on the Window Washer example is to suppose that the issue of interest is society’s dollar value placed on a typical window washer’s life, rather than the value that a particular window washer would place on their own life. The market for fatality risk provides the price per unit of death probability, sometimes stated as the value of a statistical life (VSL)

(4.5)

where ∆P stands for the change in probability of death—with probability measured in decimal numbers rather than percentage numbers—and ∆W stands for the change in wages associated with an increased chance of death.

If society wants to consider social loss associated with the addition of 100 percent probability of death, where death risk spreads across the population, then VSL gives a sensible answer. This answer might usefully inform government policy makers who spend money to prevent accidents—like window washers falling off high rises—since then they can put money where the benefit gained at least meets the funding cost. This public policy focus makes VSL a potentially useful economic tool, though the range of estimated values for VSL is extremely broad and includes both negative and positive values.23

Returning to the business faced with a claim of liability for personal injury, in the Window Washer example we find that VSL = $10 million and would like to compensate the biker for hedonic damages associated with his lost leg. How do we take the value of a whole life and figure out how much of that value corresponds to just one leg? Is it 25 percent? More? We can ask the injured biker to describe his sensed loss relative to the hypothetical loss of his own life, but we then run into the sorts of subjectivity problems mentioned earlier. We can survey a bunch of noninjured bikers, with the same sort of question, but then face the prospect of extreme variation of response—and nonrepresentativeness of the same—mentioned earlier.

Despite the grounding of the VSL statistic in the literature on public policy, the economist is currently left with only a fuzzy view of what hedonic damages might be in a personal injury case, based on evidence that might typically be available.24 In other words, evidence of hedonic damages is fuzzy, not because the economist has missed some clever insight but because hedonic damages ultimately involve preferences, enjoyment, and social utility of consumption U(C), which economists well understand to be imprecisely known—and necessarily so. This means that a business hit with a claim of hedonic damages will find that claim founded on evidence that is pretty fuzzy, yet the claimed damages may run into the millions of dollars, hence deserving careful scrutiny.

APPENDIX

The Economist in a Personal Injury Case

This book is about two broad ideas: business liability and economic damages; but in actual claims of business liability, the narrow details also require attention. This appendix covers one such detail—the common sort of work that an economist does in personal injury cases. An understanding of this detail by businesses can improve their grasp of how liability evidence makes its way through the courts.

Personal injury claims against insurance companies are typically settled without a lawsuit. The greater the medical costs and lost wages associated with the claim, the less certainty the claimant has about the final offer an insurance company is likely to make in order to settle the claim.25 By hiring a lawyer, the claimant can reduce uncertainty and also avoid the work of completing the negotiation himself. Applying economic principles, the rational claimant should hire a lawyer if the expected pecuniary loss from the injury is sufficiently great and uncertain.

An insurance claim is big, by some measure, if it becomes a lawsuit. Most personal injury cases involve damage elements that lawyers can assess with confidence, perhaps with the assistance of medical experts and accident reconstruction experts. However, some cases call for special economics expertise.

Consider a personal injury that leads to a loss of future wages, or requires a long-term health care plan. If the injury is at work and caused by the employer, workers’ compensation statutes presumably apply. But in other cases with substantial long-term pecuniary loss, there is generally no silver bullet in terms of compensation and lawyers face significant uncertainty about economic damages. Even in the case of injury on the job, claims may be levied at parties other than the employer.26

Imagine that you are a lawyer who has a big personal injury case and you must try to estimate economic damages, including those associated with future lost earnings or medical costs. Where do you begin? As a lawyer you have access to your own past cases and perhaps those of colleagues, plus your legal expertise and knowledge of case law and relevant statutes. You may also have access to some economics expert depositions via a local courthouse or lawyers’ association. If with these resources you yourself can estimate economic damages with a reasonable degree of confidence and economic certainty, then you are done. But is such confidence well-placed?

To test your current grasp of economic damage estimation methodology, as it applies to personal injury cases, have a look at the reference guide on economic damages by Allen, Hall, and Lazear (2011), in the venerable Reference Manual on Scientific Evidence (third edition), freely available online. In that guide is a section (XII.A) on claims for lost personal income. It sets out a hypothetical personal injury scenario and then identifies two possible damages estimates, one produced by the plaintiff’s legal team and one produced by the defense’s team. Tables 4 and 5 in that work give a detailed breakdown of damage elements. If, after reviewing these tables, you find that you yourself can produce damages estimates with similarly detailed data, documentation, and discussion, then so much the better. If instead you look upon these tables—and attendant labels like “Probability of Surviving,” “Probability of Working,” and “Discount Rate Index”—with curiosity rather than professional knowledge, then you also likely feel uncertain about your ability to produce such damages estimates without the help of an economics expert.

In the remainder of this appendix, will assume you are a lawyer who handles big personal injury cases or who is interested in taking on such cases. I will also assume that your expertise in law does not extend to economic matters, at least not so much that you are in full command of the methods of economic damage estimation. With these assumptions, I will describe the working relationship between the lawyer and the economics expert working on a typical personal injury case, including key discussions, needed documentation, and work at deposition and trial. I will then describe in more detail the basic logic of the expert’s estimation of damages and some variations in how that logic is routinely applied.

You and the Economics Expert

Suppose that you have a big personal injury case and have decided to use an economics expert—a forensic economist—to opine on economic damages in the case. How do you find one?

A colleague may recommend someone with whom they have had good experience. Alternatively, you might search for someone online in a commercial listing of expert witnesses; however, forensic economists have a national profession association—the NAFE—that lists its members and their contacts online.27 You can also see on the NAFE website which of its members have made professional presentations at NAFE meetings and published in NAFE-related peer-reviewed journals. The total NAFE membership is about 600 people, of which about 100 or so are economics professors with PhD degrees and active NAFE participation. With some luck you will find in this list some experts in your location. Typically the NAFE-associated economics expert will be happy to briefly discuss your personal injury case over the phone and tell you about their availability and basic requirements—including fees.

Fees

Forensic economists charge mainly for their time spent in researching a case, preparing written reports and oral presentations, and testifying at trial and deposition. The hourly rate varies but is typically on par with lawyers’ rates, and is likely between $250 and $400 per hour. Payment is collected in advance or as services are delivered. This represents an up-front cost in your case, as the economist gets paid before the case settles or finishes in court. A typical personal injury case may require the economist to spend a day or more to produce a report, and hence charge $2,000 to $3,000 for it. Retainer fees, up front, of $500 or more are common. Fees for testimony may also be charged in advance of deposition or trial. Other charges, such as fees to cover travel costs, are possible, but the forensic economist usually spells out all such charges in a written agreement provided to you.28

Documents

To estimate economic damages related to lost income, lost household services, and future medical costs, the forensic economist will need relevant data and documentation. To get an idea of the scope of economic damages, the economist will likely ask to review the original complaint filed by plaintiff’s counsel, as well as subsequent responses and discovery documents, including reports by other experts. If the case involves a loss of future income the economist will usually want to see records of work activity. These can include tax records—including W2, 1040, and 1099 forms, pay stubs, employee evaluations completed by employers, workers’ union records, pension and fringe benefit records, and records of special compensation like stock options.

To project future income, the economist will first establish base earnings—the earnings that would be expected just subsequent to the injury, if the injury had not taken place. For this, the economist will want records on earnings activity for at least 5 years prior to the injury, if possible.

The natural progress of earnings is for them to rise over time, and the plaintiff lawyer may see an advantage in documenting only the most recent available year of earnings. If, however, evidence of earnings in earlier years is lacking, then it becomes more difficult to establish a reliable number for base earnings. Do not be surprised, then, if your forensic economist makes a big deal out of getting multiple years of earnings records.

A typical person’s future earnings hinge in part not only on their work history but also on their educational background, gender, family structure, and unique circumstances such as past injuries or special achievements. Much of this will hopefully be evident from interrogatories and depositions—copies of which you have supplied to the forensic economist. However, your economist may ask for additional documentation or details about these matters. For cases involving long-term disability, if you are using medical or vocational experts, the forensic economist may ask you for more details about their reports and opinions and may also wish to contact them directly.

Discussion

After reviewing documents, the forensic economist may have questions and want to discuss with you some damage elements, record availability, and legal guidelines (case law and statutes) that impinge on the damage analysis. Important issues may arise concerning the scope of damages to be estimated—including loss of earnings, pension, social security benefits, and household services. Is the court in which the case will be heard especially conservative in its views on economic damages? If so, is this disposition documented in case law? The forensic economist will want to know about all relevant legal guidelines and may want to discuss them with you in detail.

Report

Once documents have been produced and reviewed and the economist has discussed with you any issues related to damages, he or she will be ready to estimate economic damages and deliver a report to you. Implicit in the report is an expert opinion on the nature and extent of economic damages in your case.

For a personal injury case, the forensic economist’s report to plaintiffs’ counsel is typically a written document some 5 to 15 pages in length. For defense counsel, reports are often oral rather than written, but may also include written suggestions for cross-examination of plaintiffs’ witnesses. In the process of creating reports, the economist will likely accumulate records on the case, including e-mails to and from you, notes about phone calls, hand-written notes on the case, electronic spreadsheets, statistical information obtained from published sources, and a copy of the report (print or electronic). To the extent that such records are discoverable, you may wish to maintain the option of having some of them destroyed prior to disclosing your witness. However, forensic economists who are members of the NAFE organization tend to maintain exceptionally high professional and ethical standards as expert witnesses and may refuse to destroy their records of the case. A clear agreement up front is therefore in order, about how records will be handled.

If, after getting your economist’s report, you have questions or comments, you should not hesitate to make them known to the economist. The forensic economists who are NAFE and AAEFE members will make reports that are clear and also reproducible by other economists, but will also be happy to revise their reports in light of new information. If the reports are in written form, then the economist will provide you with a new document entitled “revised report” or something similar.

With or without revision, the economist’s estimate of economic damages is unlikely to be exactly the same as the ball-park estimate that you may have conceived early on in the case. Also, reputable forensic economists will not “bend” their methods to get a damages estimate that lines up with what you have in mind. If you see a big difference between your initial expectations and the damages report, ask your economist to explain this difference to you. Explaining economic damages is, after all, an important part of their job.

Testimony

After the forensic economist completes their report (written or oral), if testimony from them is then planned at deposition or trial, the expert may want to discuss with you the upcoming event. They may also ask for a list of attorneys scheduled to be present and a list of known experts working for opposing counsel. Prior to testimony, you and the forensic economist should agree on exactly which opinion or opinions are being advanced, so that the scope of the testimony is clear. At deposition, if opposing counsel clearly understands the scope of opinions up front, then everything runs more smoothly. At trial, this organized approach is also crucial. You and your economist are a team in the sense that you jointly agree on the economic issues to be opined upon. This is true despite the fact that all reputable forensic economists are neutral experts—not affiliated with parties in the case.

Which aspects of the opinion(s) are most likely to be cross-examined heavily? You should discuss these with your economist. A practice session, in person, over the phone, or online using Skype or a similar method, may also be useful.

1Government staff in the Obama administration; the comment appeared on the White House Blog online (January 14, 2012).

2Tim O’Reilly—tech guru—has asked for evidence of harm to the music and related industries.

3Without a show of good faith, the insurer crosses the line and runs afoul of contract law, via contract breach, and also faces regulatory penalties.

4For simple third-party claims, such as a fender-bender car accident where the driver at fault has third-party liability insurance that pays to fix the other driver’s fender, an independent adjuster or public claims adjuster would likely be a wasted resource as the evidence is fairly obvious.

5Insurance regulation covers much more than oversight of the claims adjustment process, but in terms of claims adjustment, the government is particularly worried about American families who lose their homes or cars, or are sick or injured, and who then encounter a dishonest, manipulative, or predatory insurance company who wrongfully prevents recovery.

6A fairly general sort of business liability insurance policy is called commercial general liability insurance.

7See the federal court case United States v. Carroll Towing Company.

8An online copy of these Rules of Evidence, most recently updated in the year 2014, is available at www.uscourts.gov.

9Federal guidelines for the admissibility of expert witness testimony include Rule 702 of the aforementioned Federal Rules of Evidence.

10Historical averages of earnings growth rates may be preferred to a current growth rate if the goal is to estimate the future rate of growth in coming periods, so the use of historical averages does not always imply that the resulting analysis is somehow dated. For interest rates, the use of current versus historical average rates at trial is a topic of debate among economists; see, for example, the article “Dueling Economists in Personal Injury and Wrongful Death Litigation,” published in the Illinois Bar Journal, 2014, by Scott Gilbert.

11It is possible the actions of the defendant in a court case end up improving the economic opportunities of the plaintiff, contrary to a claim of lost opportunity. In such cases, damages formula (4.2) suggests that damages should be negative, implying that the plaintiff should pay the defendant for opportunities gained. This reversal of fortune does not play out in court, though, so long as the plaintiff has no obligation to pay for such gains.

12See Internal Revenue Service (IRS) Code Section 104(a)(2), available online from IRS. The tax-free status of economic damage awards covers compensation for economic loss, but not some other awards such as punitive damages.

13A large damage award that contributes to a person’s income would tend to put them in a higher tax bracket, and so make their overall earnings taxable at a higher percentage rate, if not for the personal injury exception in the IRS code. Currently, the highest tax bracket on personal income is about 40 percent of income and kicks in when an individual earns about $400,000 or more.

14While a personal injury award may not be taxable when received, interest earned when that income is invested on bonds and so on may be taxable, in which case an injured person’s manifest compensation for the loss of an earnings stream need not be wholly tax-free. For relevant discussion, see the articles “Taxes and the Present Value Assessment of Economic Losses in Personal Injury Litigation: Comment” (Journal of Legal Economics 19, No. 2, pp. 27–42) and “A Theory of Tax Effects on Economic Damages” (Journal of Legal Economics 20, Nos. 1–2, pp. 1–13), both by the author Scott Gilbert.

15The U.S. Supreme Court has weighed in on the issue of discounting in personal injury (and related) cases. Important cases include Chesapeake and Ohio v. Kelly (1916) and Jones & Laughlin Steel Corp. v. Pfeifer (1983).

16In Example 4.2, for simplicity no mention was made of interest owed on past lost profit. The actual amount of interest may depend on the court—which may set its own rules for the relevant interest rate.

17In Chapter 3, we discussed the preferences of financial market participants toward risk, introducing the idea of risk-neutral and risk-averse investors, and applied these ideas to the valuation of earnings streams and economic loss. Since law firms are usually profit-making business entities, ideas of risk preference also apply to lawyers. The author’s experience with lawyers suggests that they often describe themselves as conservative and risk-averse, but some are involved in business pursuits beyond the courtroom and those representing a plaintiff in a big personal injury suit may take on significant costs before any payment is received, a risky venture.

18For a business faced with a liability suit, their lawyers may engage an economist to analyze evidence and present an oral opinion on economic damages and any reports by opposing witnesses, but often such economists are not asked to provide written reports or to testify at trial.

19At trial, a Daubert challenge is a “motion in limine” type of legal proceeding in which an expert’s suitability as witness is challenged by invoking evidentiary legal precedents (and possibly statues) like the Daubert v. Merrell Dow Pharmaceuticals case cited earlier. A Frye or “Frye +” challenge is similar but based on legal precedents like the Frye v. United States mentioned earlier.

20An econometrician is typically a PhD in economics with specialization in the econometrics field. For example, I received my PhD in economics from the University of California San Diego in 1996, with specialization in “nonparametric regression models”—an econometric research topic.

21See, for example, the two works listed at the end of this book authored (or co-authored) by Professor Friedman: Reference Guide on Statistics and Statistical Models and Causal Inference: A Dialogue with the Social Sciences.

22In addition to data on labor markets, similar estimates are available from the markets for seat belts, smoke detectors, and other devices that lower the risk of death by some known amount.

23There is an extensive literature on the value of life and its relation to risk-reducing public policy expenditures; see, for example, the article “The Value of Individual and Societal Risks to Life and Death” by W. Kip Viscusi, published in the Handbook of the Economics of Risk and Uncertainty, by North Holland, in 2014. See also Viscusi’s book Pricing Lives: Guideposts for a Safer Society, published in the year 2018 by Princeton University Press, which identifies problems in the application of VSL methodology to hedonic damages estimation in personal injury and wrongful death cases and cites some related articles in the forensic economics literature. For additional discussion, readers may see my review of this book forthcoming in the Journal of Legal Economics.

24This is not to say that the view could not in principle be made clearer. Perhaps more survey-based estimates of willingness to accept disabilities will bear fruit, despite issues of sample reliability and possible confusion about the meaning of the relevant survey questions.

25For an interesting recent discussion, see the how-to book on filing personal injury claims: How to Win Your Personal Injury Claim (Nolo Press, 2012) by attorney Joseph Mathews.

26For example, the construction worker injured at a construction site may not only collect workers’ compensation insurance from the contractor, but also seek compensation from the company that hired the contractor.

27Some members of NAFE also appear on commercial listings of expert witnesses, such as Seak and Jurispro listings, but not all do. Another, related, association is AAEFE, which also provides a listing of its members online.

28A significant expense for distant travel is possible, but many forensic economists do not charge for local travel.