Calculating economic damages in personal injury cases

1. Collect the documents you need to calculate damages

To determine what an individual was capable of earning had an injury not occurred, as well as what they have earned and what they are capable of earning after an injury, you should start by reviewing their historical earnings and benefits documents.

Earnings are most often detailed in W-2s, 1099s, pay statements, and tax returns. The more earnings history you are able to review, the greater understanding you will have of the individual's earnings picture. Ideally that would include at least three to five years of documents before the incident through the present, including the post-injury time period. Use this information along with the individual's descriptions of their earnings to get a full understanding of their earnings, including salary, bonuses, commissions, etc.

To ensure you collect all relevant documents available from your client, review our list of earnings types.

For employer-provided benefits, review the employee handbooks, offer letters, and other benefit contribution descriptions that detail the benefits they received. These may include contributions to health insurance premiums, 401k and pension plans, Social Security and Medicare, etc. Often pay statements and W-2s detail the individual and employer's contributions to health insurance, 401k, and other benefits.

There are dozen of types of employer-provided benefits. Review our list of benefit types to ensure you ask for all relevant documents.

Each analysis, like each client, is different. If a client was a government worker, you may find that there were no contributions to Social Security if the agency offers a pension plan in lieu of Social Security.

In some cases you won't have access to historical documentation of earnings or benefits. For example, waiters who do not declare their cash tips or minor children who have not entered the labor market.

2. Determine the earnings and benefits had they not been injured

The non-incident earnings and benefits are what the individual was capable of earning had they not been injured. In many cases, their historical earnings may be the best guide to what they would have continued to earn for the remainder of their career. Depending on the historical earnings patterns, their earnings capacity may be calculated as an inflation-adjusted average, a straight average, or their last full-year of earnings.

In some instances, the historical earnings may not represent the individual's earnings capacity. For example, if the injured person was a minor child, hadn't finished their education, or had just recently joined the labor force, their recent low or non-existent earnings do not necessarily represent the earnings they could have received throughout their life. In examples like these, it is common to utilize the average earnings of similar individuals, such as by their occupation, industry, or education level.

3. Determine the earnings and benefits now that they have been injured

Post-injury earnings are the earnings and benefits the injured person has received since the date of the injury and what they are projected to receive in the future now that they are injured. Their actual earnings after the injury are documented in tax documents, pay statements, and personal accounts of earnings. Each injury impacts their ability to work differently, so a combination of earnings history, vocational reports, and public data provide further insight into their projected post-injury earnings and benefits.

The earnings and benefits they have received since the injury should be reviewed in the same manner as the earnings and benefits they received prior to the injury. Review the W-2s, 1099s, pay statements, tax returns, and employee handbooks for the time from their injury through the present. If they have not been able to return to work since the injury, there may be no earnings to assess.

Projections of the injured individual's future post-injury earnings and benefits vary greatly from case to case. The individual may have already recovered fully and returned to work. In other cases, they may not have yet returned to work, or have returned to work on light duty or only part-time, but anticipate returning to work full-time in the future. And in other cases, the injured person is expected to never work again. Each injury has a different impact on an individual's earnings potential and should be evaluated in the specific context of that individual. Vocational experts in particular provide timelines of expected recovery, as well as assess the impact the injury will have on job tasks, positions, and future earnings potential.

It is important to note that an impairment rating does not directly correlate with lost earnings capacity. For example, a college-educated person working in finance may loss a leg and have a 50% impairment rating, but still be able to work the same job and earn the same amount as they did prior to their injury. Conversely, someone with the same injury and impairment rating who works in construction and does not have a high school diploma, may be completely and permanently unable to return to the work they performed before.

4. The length of the damages

In personal injury cases, damages continue until the individual's earnings and benefits are projected to no longer be affected by the injury. In other words, damages continue until the injured person is 'made whole', with the calculated damages making up for any economic impact the person suffered from the injury.

Injuries vary by person and by injury. The damage period, or the timeframe until the injured person is expected to fully recover, may be short or long. The period may be from the injury date until they are able to return to work full-time or until they find replacement employment. If they aren't expected to recover, losses may continue for the length of their life.

The recovery timeline after an injury is one of the most important aspects of the individual's economic damages. Doctors, life care planners, and vocational experts provide estimates about if and when someone is expected to recover. Their analyses also suggest if the individual will be able to return to work, and in what capacity.

When damages continue through the individual's life, expectancies may be utilized. For earnings and benefits damages, this is commonly the work life expectancy or assumed age of retirement. Work life expectancies are the amount of time someone is expected to be employed in the workforce throughout their life.

In some cases, using a specific age as the worklife expectancy is more appropriate. For example, older workers closer to a retirement age may have a plan for retirement in place that they would likely have followed. This is common for government employees planning retirement with a pension plan.

For household services damages, while the injured individual may have been able to perform household services through their projected life expectancy, the spouse's age should also be taken into account as they may have a shorter life expectancy. Further, children who were living with their parents at the time of the injury may continue to live with their parent until the normal age when they would leave the household.

5. Project a growth rate for future earnings and benefits

Once the non-incident and post-incident earnings and benefits have been determined, the next step is to project them through the expected length of damages. In general, the longer someone works, the more they earn. Projecting future losses of earnings and benefits should account for these increases with the use of a growth rate.

In some cases, the individual's own historical earnings may indicate a growth rate. However, some caution is warranted as there may only be a small sample of years of earnings from which to determine a historical growth rate.

The most common method for determining future earnings and benefits is the application of a growth rate based on historical increases for all workers or within an occupation, industry, or education level. Bureau of Labor Statistics data is a commonly utilized source.

There may be circumstances where future growth is predetermined. If the individual was a government or union employee at the time of their injury, there may be pay schedules that specifically detail the earnings they would have received over time. Pay schedules are commonly based on the individual's 'step', 'grade' and/or 'longevity' with the employer, and are generally set for a few years into the future. These pay schedules should be applied first into a projection of earnings had the individual not become injured. For years beyond the pay schedules, the projected future growth may then be based on average growth rates or by determining the historical growth rate of the pay schedules.

6. Adjust for income taxes, if relevant

Depending on the jurisdiction, income taxes may need to be incorporated into an analysis of economic damages. The application of income taxes to an analysis may be relevant to one or more factors in an economic damage analysis, depending on the jurisdiction rules. Jurisdiction rules should be reviewed before applying any income taxes to the analysis.

The primary and most obvious application of income taxes is from the earnings the individual would have received had they not been injured and they are projected to receive now that the injury occurred. By adjusting the projected earnings for the income taxes owed on those earnings, the resulting effect is a reduction to economic damages.

Income taxes may also need to be applied to the discount rate being used to adjust the economic damages to present value. Discount rates in analyses of economic damages account for the interest that will be earned from the potential award after it is received and invested. If income taxes should be applied to the interest earned, the result would be a reduction in interest received on the damage award, and therefore an increase to economic damages.

It is sometimes appropriate to apply income taxes to the award itself. This may be the case when the award is taxable. If income taxes are required to be paid on the award, the individual would be left with less money to invest towards their losses. The economic damages may need to be adjusted upwardly to account for income taxes on the potential award.

7. Determine the past and future losses

Economic damages may be relevant for two time periods: from date of the incident to the present, and from the present into the future. These are referred to as past losses and future losses.

To calculate the past losses, the earnings and benefits they have received since the injury are subtracted from the earnings and benefits they are projected to have received had they not been injured.

Similarly, future losses are calculated by subtracting the earnings and benefits they are projected to receive now that they have been injured from the earnings and benefits they are projected to have received had they not been injured.

8. Discount future losses to present value

Most settlements and awards are paid as a single lump sum. However, the economic damages may be calculated for future earnings and benefits that they would have received through their full working life. Any future damages should be adjusted to present value, otherwise they would be over-compensated.

The present valuation of future damages accounts for the time-value of money. In short, money received today is more valuable than money received in the future, as money received today may be invested and earn interest over time.

To convert the future damages to present day value, a discount rate is applied. The discount rate accounts for the interest the individual could expect to receive from investing their lump sum in a risk-free investment. The use of a risk-free investment is necessary as it is assumed the investment will be secure and ensuring the annual funds needed to cover the projected future economic losses in each year they are expected to occur.

U.S. Treasury Securities are the most commonly used interest rates when adjusting economic losses to present value, as they are backed by the U.S. government.