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Nov 1993

Basics of hedonic damages. (The CPA Consultant)

by Bjorklund, Paul R.

    Abstract- Hedonic damages lawsuits arise when a plaintiff seeks compensation for 'the loss of enjoyment of life.' In such a litigation scenario, hedonic studies are applied to calculate for the value of a human life. This matter is increasingly becoming an alarming concern for CPAs specializing in personal-injury and wrongful-death damages as a result of three apparent trends: the burgeoning of the number of hedonic damage cases, the magnanimity of the awards for the loss of enjoyment and the acceptance of the validity of hedonic damages in some courts. However, economic and accounting theories do not support the assumptions behind the computations used in hedonic damages. There are no corroborating evidence that the value of life is measurable, that hedonic studies commonly applied in government cost-benefit policy decision is appropriate for assessment of damages and that hedonic damage calculations are generally accepted.

A discussion of hedonic damages is timely because:

1. Plaintiffs appear to be claiming this kind of loss more frequently;

2. Awards for the loss of enjoyment of life are so large that some believe they could threaten the stability of the insurance industry; and

3. Although hedonic damages have no basis in economic or accounting theory, they have been erroneously accepted as valid in some jurisdictions.

When you hear the word "hedonism," you might think of "eat, drink, and be merry." Originally, hedonism was one of the ancient Greek schools of philosophy which extolled the virtues of pursuing life's pleasures.

Today, when applied to litigation, the definition of hedonic damages is the loss of the enjoyment or value of life. Some also call it the lost intangible value of life. Those who advocate hedonics state that life is inherently worth more than just the amount of money an individual can earn. Accordingly, they believe that court awards for lost pay and for pain and suffering fall short of making the plaintiff whole.

Although musings on the value of life have historically been the domain of poets, philosophers, and theologians, more recently economists and accountants have tried to put a value on human life. On the economic front, there were early attempts in the first half of this century to evaluate human life for economic policy making and for life-insurance purposes. From the 1960s through the 80s academic accountants have tried to develop ways to add the value of human assets to a company's balance sheet.

In the early 1980s, Ronald Reagan issued a presidential executive order which required Federal regulators to do cost/benefit studies to justify government regulations. As a result, agencies such as the Environmental Protection Agency, Consumer Product Safety Commission, Food and Drug Administration, and others began using a dollar value of human lives saved to support their regulations. These hedonic dollar values then were intended to be used to save lives and to promote public health and safety.






Until the middle 1980s, none of these dollar values of human life were used in litigation. Then, a small group of forensic economists began to develop ways to apply these cost/benefit studies to tort damages. Articles and books were written and the so-called "hedonics expert" was born.

In the area of law, although most all jurisdictions have not or will not consider the loss of enjoyment of life, hedonics advocates point to a notable wrongful death case which allowed testimony on hedonic damages.

Concepts and Studies

The raw material used in a hedonic damages calculation is a hedonic study which computes the value of a human life. These studies are based on the economic concept of willingness to pay (WTP). This is the amount of money you would be willing to pay to reduce your risk of death. The willingness to pay concept has a twin--willingness to accept (WTA). This is the extra amount of compensation you need to take on a greater risk of death. For convenience, both concepts are referred to as willingness- to-pay methodology.

An example of a WTP study would be the one that looked at purchases of smoke detectors. By comparing the price consumers were willing to pay for smoke detectors to the infinitesimal expected reduction in the risk of death, hedonic values between $101,000 and $676,000 were calculated.

Those studies that use the WTA concept are usually labor market studies. They compare the extra wages required for riskier occupations, such as police officers, miners, and others, to the extra risk of death. In a 1983 EPA study, these results varied from $400,000 to $7,000,000 (in 1982 dollars).

Although these hedonic values of life are calculated by using complicated mathematical techniques, the underlying idea is simple and can be explained by looking at the accompanying graph. As shown in this example, it costs an extra $500 to pay workers in this graph to increase their odds of death from .0002 to .0003. Accordingly, if you divide $500 by the extra risk of .0001 you come up with a hedonic value of $5,000,000.

Hedonic Damages Applications

To apply hedonic studies to litigation, the hedonics witness will go through the following process:

1. Choose a value or range of values from the hedonic studies discussed above;

2. Present a percentage loss of the enjoyment of life from a psychologist witness;

3. Multiply for the resulting hedonic damages.

Although some hedonics advocates go through complex discounting processes, for others the mathematics of a hedonics damages calculation are simple. Of course, in a wrongful death case the psychologist will not be needed to provide a percentage loss, since it will normally be assumed at 100%.

Invalid Assumptions

While the intentions behind asserting hedonics claims may be worthy, unfortunately these damage calculations are not as yet supported by valid economic or accounting theory. In fact, hedonic damages are based on invalid assumptions. Some are:

1. Value of life can be measured;

2. Hedonic studies used for government cost/benefit policy decisions can be used to assess damages; and

3. There is general acceptance of hedonic damage calculations.

No accountant or economist today can measure the actual value of life using willingness-to-pay methodology. This can be explained by looking at the graphs in Exhibits 2 and 3.

As shown earlier, the value of life was calculated by drawing a straight line from a microscopic change in risk to the point where the worker would experience 100% odds of death. It states that the worker would be willing to accept $5,000,000 in return for giving up his life. It assumes that a rational human being will act exactly the same way in confronting small odds of death as he will with virtual certainty of death. We know intuitively that this is not true.

As shown in Exhibit 3, the expected behavior of a worker is that the closer he gets to 100% odds of death, the greater the wages he will demand, and at some point no amount of wages will be enough for him to take on any more risk. The shape of the line which explains this behavior is a power curve going to infinity, rather than a straight line. Accordingly, the value of life cannot be measured using this WTP method.

The second assumption listed above is that human life values can be applied from those used in the government policy setting area. Generally, the authors of these hedonic studies emphatically state that:

1. The purpose of their studies is to measure the value of reducing risk for public health and safety;

2. Since the studies are based on WTP methodology, they cannot measure the value of a human life; and

3. Their studies were not intended for, and cannot be applied to wrongful death and personal injury cases.

The last assumption is that using hedonic values in damage claims is generally accepted. There is no evidence to support this view.

Not There Yet

While measuring the value of human life would be an important achievement of either the economics or accounting professions, it still remains out of reach. If it becomes possible to prove a hedonic value on a scientific basis, economists and accountants could find many useful applications. Until then, hedonic damages have no valid foundation for use in personal injury or wrongful death cases.

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