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Analyzing Weaknesses in Income Loss Reports


January 31, 2011   by Michael Sigsworth and Darrell Sherman


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Insurers and plaintiff lawyers call upon forensic accountants to provide expert reports, which set out the income loss suffered by individuals as a result of injuries sustained in an accident. There are many factors involved in preparing these reports and as a result many opportunities for the accountant to misstep. For the careful reader, these missteps can reveal a report containing more holes than Swiss cheese.
 
Income loss reports (ILR) will continue to be a significant component of the claims settlement process, especially in light of the expected shift resulting from the recent SABS changes. This article identifies the weaknesses that are commonly found in ILRs, which will enable you to assess your own expert’s report or to critique an opposing expert’s findings.

First reading

A forensic accountant’s report should be easily understood and absorbed on the first reading. If the report needs to be read several times before it is understood, then expect opposing counsel and the trier of fact to have similar difficulties. This is strike one against the report. The report should be clear and logical, using layman’s terminology. A straightforward approach often examines the most critical aspects of the loss, excluding minor variables that will not significantly impact the conclusions. However, while a report may appear strong in substance, small errors (even grammatical) may hint at an underlying problem with the quality of professional effort, the rigour of the analysis and the report’s actual credibility. Therefore, a report should be thoroughly examined for mathematical errors, where even a small error could lead to a significant difference in the quantum of the calculated loss.

Hazards and pitfalls of assumptions

The most basic factor in valuing an income loss is the determination of how much the individual or business would have earned during the damage period, but for the injurious event. Due to the uncertainty that exists in projecting into the future, assumptions are used to determine the level of earnings that could have been achieved. However, it is these assumptions that are often the weakness of ILRs.

The credibility of a report can quickly be destroyed because of weak or incorrect assumptions. Therefore, it is important that the assumptions are identified, that they are reasonable and they are supported by evidence. When such evidence is missing or weak, the assumptions the accountant used get called into question and this leads to the credibility of the entire report being brought into question.

In assessing the strength of assumptions, both economic and medical documentation should be considered. Projected earnings, whether pre- or post-trial, should take into account the plaintiff’s pre-incident earnings as well as their education, career progression, future goals, industry standards, economic environment, historical earning patterns and other qualitative factors. If the assumptions change over time, an explanation as to why the assumptions change, backed by evidence, should be provided to support the changes.

Another area of assumption typically overlooked, and often with significant uncertainty in an ILR, is the period during which a loss will be incurred. It is important that the end date for the damage period is reasonable, especially in cases where plaintiffs are permanently disabled and there is little or no possibility that they will be earning any future income. In some cases, the traditional retirement age of 65 will be considered reasonable. However, in some industries or for some individuals this assumption would be anything but reasonable.  

For example, if an individual who was almost 65, was in good physical health prior to the accident, and had intended to work for another 10 years, using a retirement age of 65 would be unreasonable. Additionally, statistically men and women do not retire at the same age. It is important to note that the farther the end date is from the trial date, the smaller the impact is on the overall numbers, due to discounting to a present value.    

Of course, the ILR must not only include a calculation of the projected earnings, it must also include a determination of the earnings the plaintiff can expect to attain in the future, given their compromised state. The assumptions on which this latter calculation is based are no less important, since the difference between the projected and expected earnings are what form the basis of the loss. Serious thought must be given to whether a person is really permanently unemployable.

From a plaintiff counsel’s perspective, it is becoming ever more important that the assumptions employed by their expert result in realistic conclusions as well. ILRs which overstate the loss due to unsupportable assumptions may result in settlements at amounts significantly lower than indicated in the ILR and perhaps lower than merited, exposing plaintiff counsel to negligent settlement claims by their clients.  

What isn’t considered counts too

An often overlooked weakness in ILRs is not what has been included in the report, but rather what is missing.

As an example, income losses for an employed individual should consider the lost fringe benefits and the loss of pension value, and not just the lost wages. Where this has not been considered, it is likely that the calculated loss is understated.  

Contingencies are also sometimes overlooked, and may have either a negative or positive effect on the calculated loss. Contingencies may include, but are not limited to:

  • Mortality rate
  • Labour force changes (ie. unemployment rates in an industry)
  • Possibility of earnings increases/ decreases beyond inflation
  • Disability period
  • Economic or business conditions, bankruptcy of the employer’s company, etc.
  • Impact of disability on future earnings

These contingencies are often difficult to determine, and in many cases positive and negative contingencies may be considered to cancel each other out.

Trending is also a common tool in determining future losses of a business. By looking at what was happening prior to the accident, projections into the future can be created. But trending can be affected by many variables, and if these are not explored, the impact can be significant. For example, a report may attribute a decline in the post-incident sales entirely to the injuries suffered by the plaintiff. However, upon closer examination it may be revealed that a component of the loss results from the loss of a significant customer immediately prior to the incident, seasonal variations in sales, changes in accounting policies, changing economic conditions or perhaps the injured person was on the verge of being laid off or downsized. These variables, and many others, can significantly impact the assumptions, findings or conclusions and should be kept in mind.

Uncertainty in findings

As previously stated, ILRs are projections into the future. As a result, some degree of uncertainty will always exist. Therefore, it is legitimate, and often helpful, to present one or more alternative scenarios of the loss of income.  

Presenting a single scenario leaves all parties with very little room to negotiate and the trier of fact with no flexibility. Either that finding presented is accepted or not. Normally, providing a range of scenarios permits all parties to assess potential losses while incorporating their view on the underlying issues, including medical findings. However, similar to the assumptions supporting projected earnings, each of the alternative scenarios should be prepared based on supportable assumptions.  

Final considerations

It is common that ILRs are prepared close to mediation or tria
l dates to ensure that the accountants have the most up-to-date information on which to prepare and base their conclusions. Where reports have been prepared well in advance, it is important that any new information be provided to the accountant to re-assess the position, or to re-crunch the numbers. Without this consideration, it may not only be the accountant that loses face.

The hired gun is something that both sides now have to be aware of, especially in light of the Rules of Civil Procedure. At a minimum, opposing counsel and the trier of fact may discount the credibility of the ILRs, when the expert is perceived as an advocate rather than an objective expert.

While there may not be any single correct way to estimate the income lost by an injured individual, we have observed that there are a large number of incorrect ways to perform such calculations. Be on the lookout for the weaknesses in ILRs described above.

Micheal Sigsworth and Darrell Sherman are founding principals at ADS Forensics.