Vocational Economics Inc.
Vocational Economics Inc. staff
 

Net Discount Comparison

 

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.  The relationship between these two rates is the net discount rate, which can take one of three forms:  a positive number (a net discount), zero (total offset), or a negative number (a negative net discount, or a net growth). 

The table below examines the rates over varying time periods for inflation (CPI), wage growth, compensation growth, the return on a risk free, 91-day Treasury bill, and the return on 10-year bonds.  As can be seen, there is considerable variation in the rates depending on which time period is used. 

Growth and Interest Rates through 2004

Period CPI Wage Growth Compensation Growth 91-Day
T-Bill
10-Year Bond
1947-2004 3.8 4.6 5.6 4.9 --
1954-2004 4.0 4.5 5.5 5.4 --
1964-2004 4.6 4.7 5.8 6.1 7.4
1974-2004 4.6 4.3 5.5 6.3 7.9
1984-2004 3.0 3.1 4.2 4.9 6.7
1994-2004 2.5 3.3 4.2 3.9 5.4
  • CPI:  U.S. Bureau of Labor Statistics.  Consumer Price Index, All Urban Consumers (CPI-U), U.S. City Average.  Washington, DC.

  • Wage Growth:  U.S. Bureau of Labor Statistics.  National Employment, Hours, and Earnings:  Average Hourly Earnings of Production Workers.  Washington, DC.

  • Compensation Growth:  U.S. Bureau of Labor Statistics.  Major Sector Productivity and Costs Index:  Hourly Compensation.

  • 91-Day T-Bill:  Federal Reserve Bank.  3-Month Treasury Bill Rate (Secondary Market), Averages of 1947 to 2004 Daily Closing Bid Prices.

  • 10-Year Bond:  Federal Reserve Bank.  10-Year Treasury, Averages of 1962 to 2004 Daily Prices.

The choice of growth and interest rates, (and, therefore, of net discount rates) can make a dramatic impact on present value.  Take, for example, a three-year-old boy with a brain injury severe enough that he is not expected to work as an adult.  Using the earnings and worklife expectancy of a male college graduate and national average fringe benefits, the present value varies as follows:

Net Discount Present Value
0.7% Negative Net Discount $4,942,656
Total Offset $3,646,562
1% Positive Net Discount $2,403,015
2% Positive Net Discount $1,619,559

As can be seen, even 1% differences in the choice of net discount can make a dramatic difference in present value, though this may be considered an extreme example because of the boy's young age.  Calculation of present value over different time horizons, however, yields differences that are still present, though less substantial.  The examples below use a $50,000 earning capacity and national average fringe benefits over the worklife expectancy for all males.  This demonstrates that the impact of the net discount rate is more substantial with longer time periods.

Net Discount Present Value
25-year-old 35-year-old 45-year-old
0.7% Negative Net Discount $2,583,939 $1,897,124 $1,246,013
Total Offset $2,220,499 $1,687,500 $1,143,933
1% Positive Net Discount $1,813,716 $1,440,942 $1,018,325
2% Positive Net Discount $1,507,293 $1,244,636 $913,084

Since the present value sum plus accumulated interest is intended to replace the expected lost earnings over the plaintiff’s worklife expectancy, with no shortfall or overage, a careful consideration of the net discount rate is essential. 

The use of a total offset recognizes historical cycles and acknowledges the uncertainty in the future relationship between growth and interest rates.  For more information on this issue, see the Use of a Total Offset page.

Present Value Data

For more information on growth and discount rates, see the following links:

In addition, the Offset Bibliography page provides further research in this area.