Academic journal article Journal of Legal Economics

Comment: The Valuation of the Loss of Future Pension Income

Academic journal article Journal of Legal Economics

Comment: The Valuation of the Loss of Future Pension Income

Article excerpt

Introduction

In a recent article in this journal, Barry Ben-Zion (2001-02) argues that the method generally used by forensic economists to estimate the value of lost pension benefits results in an overstatement of the value of these benefits. In addition, he perceptively points out that the official life tables frequently used in the estimation process inappropriately fail to incorporate anticipated changes in survival probabilities into the analysis. However, his only illustrative numerical example contains no comparison between the results obtained with the questionable method and data base to those derived with the proper method and a more appropriate data base.

The primary purpose of this comment is to demonstrate that when simultaneous changes in methodology and data base are considered over an expanded set of illustrative examples, the proper method combined with a more appropriate data base very often results in higher rather than lower estimates of value for lost pension benefits. Brief discussions of some aspects of the estimation procedures and data bases will precede the presentation of the empirical results.

Definition of Life Expectancy

In formulating his illustration of the method often used by forensic economists, Ben-Zion (2001-02, 1O)1 defines life expectancy by noting "...that 50% of the 40 years old would be dead by a certain age (say, age 77) while the other 50% would still be alive. That median age is referred to as the life expectancy." A report of the National Center for Health Statistics notes that life expectancy "...at any given age is the average [emphasis added ] number of years remaining to be lived by those surviving to that age on the basis of a given set of age-specific rates of dying (Anderson-DeTurk 2002, 3).

The calculation procedure outlined on page 3 of the 1999 U. S. life tables indicates that the life expectancy is precisely given by the total number of person years to be lived by those attaining a given age divided by the number who attained that age. In general, this standard measure will not be equal to the Ben-Zion median figure.2 Since no rationale is provided supporting the substitution of the median survival time for the standard life expectancy measure, the standard figure will be used in this comment.

Differences in Methodology and Data Bases

Ben-Zion notes that many forensic economists use an estimation procedure, which is termed annuity certain for life expectancy. Once the base value of the pension loss has been established, the annuity certain approach first determines present value of the pension loss at the retirement date by using an appropriately selected interest rate to discount the future pension payments from retirement to the end of the life expectancy. The present value at the retirement date is then further discounted back to the trial date.3 Ben-Zion contends that the proper measure of the value of a pension is the actuarial value of a life annuity. The actuarial value method begins by discounting each monthly pension loss from the retirement date to the age where the probability of survival effectively reaches zero. Two discount factors are used: an appropriate interest rate and the probability of survival from the retirement age to each subsequent age. This produces the actuarial present value of the pension, or life annuity, at the retirement date. This present value is then discounted back to the trial date using an interest rate and the probability of survival between the trial and the retirement dates (Ben-Zion 2001-02, 13-16).

When the appropriate net discount rate is greater than zero, the actuarial value method will always produce an estimate that is less than the value generated by the annuity certain approach. Past studies have demonstrated that, in many cases, the error involved in using the improper annuity certain approach is too large to be ignored.4

With respect to the appropriate data base, Ben-Zion indicates that the official 1999 Life Table commonly used by forensic economists in effect ". …

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