What’s it Worth? Send for the Actuary!
MA Bar Association Lawyers Journal October 1996

by Sheldon Wishnick, FSA

The key issue in most litigation is monetary damages, yet relatively few attorneys incorporate the services of an actuary or other financial expert to calculate and document the amount of loss involved. This paper will briefly explain the background and training of an actuary and then present an illustration of the losses generated in a hypothetical case of wrongful employment termination.

In very general terms, an actuary can be described as someone who calculates the current value of financial events that either occurred in the past or are expected to occur in the future. The Society of Actuaries is the national organization that actuaries join in order to achieve professional recognition. Achieving Fellowship in the Society of Actuaries (FSA) requires passing a comprehensive series of exams covering topics ranging from probability and statistics and risk theory to demography, financial modeling, employee benefit design and social insurance.

Wrongful termination allegations have become increasingly prevalent in an era of corporate downsizing and charges of sexual or age discrimination.

To illustrate the support an actuary can provide, consider the case of Mr. Jones, age 45, who was wrongfully terminated after 10 years of service with his employer, OLD Company, at a final salary of $50,000. He worked free lance during the following year and earned $50,000. Exactly one year and one day later, he found full time employment with NEW Company with benefits and promotion opportunities comparable to OLD Company at a salary of $48,000.

If Mr. Jones were to walk into a law office with intending to sue OLD Company for wrongful termination, many attorneys would advise him that the losses were too minor to justify a suit. As you are about to see, however, the actuary would have a very different view of the losses incurred.

Actuarial calculations are built upon a series of assumptions about future events that are derived from economic statistics and the financial data existing from the plaintiff himself. These assumptions would vary for different individuals and time periods. For purposes of this example, I have chosen the following assumptions: Interest is 6%; the annual salary increase is 5%; and a census mortality table.

Although not immediately apparent, Mr. Jones has suffered a major salary loss. At the 5% growth rate assumed, he would have earned $52,500 at OLD at the time he earned $50,000 free lance, for a loss of $2,500. In the following year, he would have earned $55,125 at OLD, but earned $48,000 at NEW, losing $7,125. This loss grows by 5% in each succeeding year, reaching $17,147 in the year preceding retirement. Discounting each year's loss at the assumed interest rate of 6% generates a present value of salary loss of $117,427. The present value of salary loss should be interpreted as an immediate lump sum payment that would grow with interest over time to approximate the entire salary loss anticipated over his future working lifetime. Most attorneys, and even their clients, would be quite surprised by the magnitude of this salary loss. Yet there are several additional elements of loss to be calculated.

In this example, both employers are assumed to maintain identical defined benefit pension plans based upon the average salary earned during the last 5 years of service. The benefit formula provides 2% of this final average salary for each year of service. A 30-year employee would therefore receive a pension benefit of 60% of final average salary. Although Mr. Jones was fully vested in his OLD Company accrued pension benefit, he suffered a major pension loss for the following reasons:

• he didn't earn pension credit for the year of free lance work;
• his salary base was lower, as previously discussed; and
• the OLD Company pension salary base was his 5 year final average as of the termination date, rather than the average before normal retirement date.

The last item is the most significant, by far. His 20% pension (10 years of service times .02) from OLD is based on an average salary of $45,460 while the pension earned at NEW is 38% (19 years of service) multiplied by a final average salary exceeding $100,000.

In total, Mr. Jones will receive a combined pension benefit at age 65 from both companies of $49,002 compared to the $72,371 he would have received based on continued employment at OLD. The present value of this annual $23,368 pension loss is $72,441.

Employee benefits are composed of health insurance, life insurance, holiday and vacation pay, etc. Mr. Jones lost these benefits during the year without full time employment. At OLD, the value of these benefits can be estimated at 28% of the salary of $52,500, or $14,700.

If the loss calculation were completed at this point, the opposing counsel could easily challenge the results since it implies with certainty that Mr. Jones would have receive this income and benefits had he enjoyed continued employment to retirement date. For illustrative purposes, a simplified adjustment factor is used to estimate the combined probability of the following events occurring prior to Mr. Jones' retirement date:

• The continued existence of OLD Company as an employer,
• the absence of any layoffs likely to impact Mr. Jones,
• the continuation of the OLD Company Pension Plan,
• the survival of Mr. Jones, etc.

To see the development of the cumulative loss impact of $188,597, see the table below. Losses incurred before the trial date are accumulated with current interest up to the date of trial. Future losses are shown separately since their calculation requires estimating future interest rates and discounting each anticipated future loss to the trial date. While the current mortality status of Mr. Jones and OLD Company are known at the date of trial, their future status must be anticipated. Therefore the adjustment factor is applied to future losses only.

Loss to trial date

Future Loss

This is a hypothetical case, structured to illuminate the existence of significant losses when they were not apparent. The example should not be interpreted as encouraging the litigation of marginal cases. In fact, if some of the basic data were changed, such as frequent layoffs in the past by OLD company, a pension plan based upon career average salary (instead of final average salary) or an unstable future business environment, the losses incurred would be much lower.

However, if Mr. Jones were unemployed for a longer period of time, didn't do any free lance work or found full time work with lower benefits, the losses would have been higher.

Too many attorneys might have misunderstood this client's losses. Keep in mind that these are real losses, calculated from sound mathematical models that were driven by reasonable assumptions. While the illustration used a case of wrongful termination, the techniques applied are equally valid for wrongful death, personal injury or pension valuation in a divorce action.

Regardless of the type of case, the expert witness is not hired to inflate claims, in fact, similar financial results should be developed whether the expert is employed by the plaintiff or by the defense. The real goal of the analysis is to educate the court on the true present values of all the losses incurred, based on his best opinion.

The attorney's expertise in the practice of law was developed over many years of study and practice. Similarly, the actuary develops special skills through education and the experience of reviewing and evaluating financial events. It is in the client's best interest to use the synergy generated by the attorney and actuary working together.