For litigation seeking recovery of lost earnings, “present value” refers to the amount of money needed today which, when prudently invested, will replace the future stream of those earnings.  The present value sum plus accumulated interest should provide periodic cash payments to replace the expected lost earnings over the plaintiff’s worklife expectancy, with no shortfall or overage.  Determination of the present value of a wage stream is dependent upon two key rates: the rate of expected annual increases in compensation and the rate of return at which to invest the lump-sum award.

Compensation Growth

Essential to the estimate of future compensation is an estimate of the rate at which current compensation levels will increase over the plaintiff’s worklife expectancy.  Over the past 50 years, fringe benefits have grown considerably faster than wages, resulting in an average annual increase in total compensation roughly one percent larger than the growth rate in wages alone.  Therefore, average growth rates in total compensation are usually more relevant for computing present value than the average growth rate for wages alone. 

Discount Rate

In addition to a growth rate to reflect future increases in compensation, an expert needs to discount the future value cash flows to reflect the interest to be earned by conservative investment of the lump-sum award.  If plaintiffs invest to replace future losses in labor market compensation, then a safe, short-term government treasury, such as a 91-day Treasury Bill, is a logical investment vehicle because it provides the best return on investment with minimum risk. 

Use of the 91-day T-Bill is based in part on the decision by the U.S. Supreme Court in Jones and Laughlin Steel v. Pfeifer (462 US 523; 1983).  In this decision, the Court discusses appropriate discount rates for calculating present value for a future earnings stream:

The discount rate should be based on the rate of interest that would be earned on “the best and safest investments.”  Once it is assumed that the injured worker would definitely have worked for a specific term of years, he is entitled to a risk-free stream of future income to replace his lost wage; therefore, the discount rate should not reflect the market’s premium for investors who are willing to accept some risk of default. 

Net Discount Rate

Once an expert identifies the appropriate data regarding growth and interest rates, the main issue is the relationship between the two, or the net discount rate.  Long-term interrelationships between compensation growth and interest rates show that, overall, the average long-term return on a 91-day Treasury Bill has been roughly equal to average compensation growth rates.  This offset relationship also holds when looking at a short-term (5-year) horizon.  The use of a pure offset method reflects this overall relationship and acknowledges the uncertainty in the future relationship between growth and interest rates.   

For a fuller discussion of use of a pure offset, please see the Use of a Total Offset page in the Data section of this site.