The Flawed Hedonic Damages Measure of Compensation for Wrongful Death and Personal Injury
2008; Volume: 20; Issue: 2 Linguagem: Inglês
10.5085/0898-5510-20.2.113
ISSN2374-8753
Autores Tópico(s)Law, Economics, and Judicial Systems
ResumoHow life is valued depends on the context in which the valuation is done and the purpose of the valuation. A substantial economics literature has framed value-of-life issues in terms of tradeoffs between money and small risks of death, or the value of statistical life. This article is concerned with the use of the value of statistical life (VSL) measure in liability contexts, either in determining damages or assessing liability in personal injury cases.1 The main battleground is with respect to the use of VSL numbers for compensation, based on an approach known as hedonic damages. Although the controversy with respect to adopting VSL measures for compensation purposes in wrongful death cases in not new, some very distinguished scholars have endorsed an expanded use of the VSLs in the courtroom.2 The fundamental issue continues to be whether the legal system should adopt regulatory policy practices for risk prevention and use the VSL as the measure of the welfare loss of a fatality for purposes of risk compensation. The refinement of VSL estimates in the literature to reflect values across the population makes it increasingly important to understand when and how these values should be used.The question of what is the right value of life cannot be answered in the abstract. The correct value will depend on the purpose to which it is being put. This distinction is not simply with respect to which party is using the VSL—in particular, whether the value is being used by the government or by the judicial system. For both the government and the courts, there are different contexts in which there might be consideration of value-of-life estimates, with the chief areas being compensation and valuation of the reduction of the risk of personal injuries for benefit assessment. As I will indicate, the VSL serves a constructive, but highly circumscribed function both in formulating government policy and in personal injury cases. The traditional measures of economic damages also serve a valuable economic role and should remain the approach used in setting compensatory damages.The discussion in Section II outlines the basics of the VSL methodology. Section III reviews the principles underlying conventional personal injury damages approaches, and Section IV presents a model of optimal deterrence. In Section V I examine the recent proposal by Posner and Sunstein (2005) to provide for damages to wrongful death victims that will include, but not be limited to, the VSL for the individual. Section VI explores other attempts to form a bridge of the VSL amounts with indices of happiness and disability. Section VII concludes with a summary of the flawed nature of many attempts to use VSL estimates in the courtroom.A useful starting point is to review the essential elements of the VSL approach and the current use of VSL by government agencies.3 Doing so highlights what this measure is and what it is not. In framing the subsequent discussion of hedonic damages, it is instructive to compare VSL in the courtroom with current usage of the VSL by the government, as well as the purposes for which VSL is not used at all by the government.4A. The Value of Statistical Life ConceptThe VSL is the value of a statistical life, or the rate of tradeoff between risk and money for small risks of deaths. For labor market studies, which comprise most of the VSL literature, the VSL represents the compensating wage differential, or the willingness-to-accept amount that workers receive for facing job fatality risks. The risk levels involved are quite small, as occupational fatality risks currently average 1/25,000 annually for a typical worker. Estimates of VSL from product markets and housing markets pertain to the willingness-to-pay amounts for marginally safer products or houses. For small risk changes, the tradeoff rates implied by the willingness to pay for small risk reductions and willingness-to-accept amounts for small risk increases will be the same. Each will imply the same VSL. Based on labor market evidence, the current median VSL estimate in the literature is about $7 million.Consideration of large risks necessitates a modification of the VSL amount. The VSL will overstate how much people will pay to avoid the certainty of death because the cost of purchasing large decreases in the risk lowers one's wealth and reduces the willingness-to-pay amount below the VSL. Analogously, the VSL will understate how much people must be compensated to face a series of increases in fatality risk that culminate with certain death. Similarly, for large changes in risk levels such as a fatality risk of 1/10, the VSL reference point understates how much people must be compensated to bear the risk and overstates how much they will be willing to pay to eliminate such a risk.It is not appropriate to divide the VSL by the number of years of life to obtain the dollar amount that each year of life is worth. While it is possible to calculate a value of a statistical life year (VSLY) derived by dividing the VSL by the discounted numbers of years of remaining life, the VSLY methodology makes the strong assumption that each year of life has the same value. Nevertheless, the VSLY measures do have a role to play in the economics literature with respect to estimating individual discount rates with respect to the expected duration of life. The VSLY numbers also may be useful in imputing a VSL for retirees and other groups for which a VSL has not been estimated reliably.B. Government Practices for Valuing Risks to LifeThe use of VSLs by the government has become widespread since a quarter century ago when I introduced the use of VSLs to government policy in 1982.5 At that time I had been called in to settle the dispute between the Occupational Safety and Health Administration (OSHA) and the U.S. Office of Management and Budget (OMB) over the economic merits of the proposed OSHA hazard communication regulation. OMB challenged the regulatory proposal because the calculated benefits did not exceed the costs. In assessing the value of the benefits, I used VSL levels to value the benefits of fatalities that would be prevented by the regulation rather than OSHA's approach based on the present value of lost earnings and medical costs. Doing so turned a regulation that failed a benefit-cost test into an economically attractive regulation by boosting benefits by an order of magnitude. Other agencies soon adopted this methodology, perhaps not simply because of its economic soundness, but also because the use of VSLs made the calculated benefits of government policies much greater than they were before. The use of VSLs to value lives in personal injury cases similarly offers the prospect of considerably larger damages amounts, but unlike the government usage in regulatory analysis to value the prevention of statistical deaths, hedonic damages compensate plaintiffs after a certain death. These functions are quite different.The choice of the VSL number used by Federal government agencies to value regulatory effects has not been uniform. As the statistics in Table 1 indicate, some agencies, such as the Federal Aviation Administration (FAA), use very low values of life, whereas others such as the U.S. Environmental Protection Agency (EPA), now use values in excess of $6 million and are more in line with recent labor market evidence on VSL. In 2008 a controversy developed as the EPA air office began to use a VSL estimate that was lower than the value used by the EPA water office, so that even within agencies discrepancies may exist. The differences across agencies appear to stem largely from organizational differences and the anchoring effects of previous practices. The U.S. Department of Transportation agencies, such as the Federal Aviation Administration (FAA), had long used the relatively lower value of compensation in court cases involving wrongful death when assessing damages. These agencies have adjusted the values upwards to get closer to estimated VSL levels, but the transportation agencies have not adjusted the values of life to a sufficient extent.The main implication of Table 1 for what follows is that there is no official "government number" for the value of statistical life. Suggesting that the courts should follow the practices of the government does not lead them to a well-defined VSL approach because agencies differ widely in the values that they use.What government agencies have in common is that the VSL numbers are only used to value the prevention of small risks of death and are never used for compensation purposes. Even if there were a consensus government VSL number, using such a measure in the courtroom for compensatory damages purposes would be out of line with government practices. There is a fundamental mismatch of the government's VSL approach with using these numbers to set levels of compensation for wrongful death and personal injury.Unlike court cases that pertain to specific individuals, government policies usually affect broad population groups so that using an average VSL amount is appropriate. If the protected populations have risk-money tradeoffs that are similar to the tradeoff rates reflected in VSL studies, then there is little error that arises from using average values. Government agencies invariably use the same VSL to value a policy whether those protected are disproportionately young or old, sick or healthy, or involuntarily exposed to risk or voluntarily choosing the risk. Plaintiffs' experts who use the VSL numbers in their hedonic damages analyses generally have used average VSL numbers as well, which is inconsistent with the importance of linking personal injury damages to the facts of the case.There was a recent attempt by the government to depart from the lockstep approach of using the same VSL irrespective of the population mix being protected. In the EPA's analysis of the proposed Clear Skies Act, it valued the lives of senior citizens over 70 years of age at 37% less than the values used for younger age groups. This 2003 analysis created a political firestorm.6But was EPA correct in asserting that the proper VSL does decline with age? The older you are, the less life you have left. But a reduced life expectancy doesn't mean your VSL has declined. The balance that people strike between money and risk may remain stable or even rise with age as their wealth and personal consumption increase.In a series of recent papers, my colleagues and I have estimated the VSL-age relationship, which follows an inverted-U pattern not unlike the trajectory of lifetime consumption.7 This empirical relationship contradicts approaches that assume a constant value per life-year, because if each life-year did in fact have the same value then the VSL would be a steadily declining function of one's age. Although VSL levels eventually do decline with age, the VSL for a 60-year-old is greater than that of a 20-year-old, implying that remaining life expectancy is not the sole determining factor. Individual wealth and willingness to bear risk both vary with age so that over many decades VSL may increase with age even though you have fewer years to live.8The existence of such empirical refinements in the heterogeneity of VSL is not restricted to age. Recent studies in which I have been involved have estimated variations in VSL by race, gender, and smoking status as well. Additional sources of heterogeneity will surely be documented in future studies, making it possible to obtain a VSL number for a wide variety of demographic profiles. Such values could then be pertinent to the circumstances of a particular personal injury case if use of VSL estimates were justified in such contexts. But even if the problem of not having a VSL that can be linked to the facts of the case can be addressed more successfully than past hedonic damages analyses have done, there remains the fundamental issue that VSL numbers do not provide an appropriate basis for determining the level of compensation.While the government uses VSL numbers to assess the prospective economic benefits of risk reduction policies, the government has never used these values for purposes of compensation. I have been involved as a consulting expert to the U.S. Department of Justice in several wrongful death cases involving the FAA in which the government was the defendant. The U.S. Department of Justice never raised the possibility of using VSL as the compensation measure and explicitly opposed hedonic damages when a plaintiff's expert adopted this approach.The widely publicized compensation structure of the September 11th compensation fund likewise does not adopt the VSL for any purpose.9 The families of the victims of this terrorist attack received payments for their income loss as well as some pain and suffering compensation. While this compensation scheme had some controversial elements, such as the dollar values set for noneconomic loss and the deduction for collateral source payments, the overall thrust of the compensation scheme was in the general spirit of traditional wrongful death calculations, not VSL. When the government is faced with payment of compensation for wrongful death, VSL plays no role. It is dishonest to suggest, as some plaintiffs' experts have done, that the use of VSL for compensation in hedonic damages cases simply reflects government practices. It does not.A. The Components of DamagesThe components of compensation in personal injury cases are quite standard, but are worth summarizing briefly to draw a comparison with the use of VSL numbers both for valuing the benefits of government regulation and for economic damages calculations. The two compensatory damages components are economic damages and noneconomic damages.10 There may be interest payments included in these components. If awarded, punitive damages are in addition to these awards components. Economic damages include the present value of the lost earnings for the accident victim, where this amount is reduced by the deceased's consumption in the case of a fatality. Some jurisdictions also deduct for taxes. Economic damages also may include other case-specific expenses, such as medical costs and rehabilitation expenses.The economic damages component is pertinent to the financial loss to the individual, though in many cases the prospective economic loss is based on the average performance of one's demographic/occupational group. Because of the linkage to the injured party's earnings and expenses, the damages are individual-specific. People who earn less will receive lower damages for themselves or their heirs, whether the earnings gap is due to low education, few job skills, age, race, gender, or a decision not to work. Children and the retired will consequently fare particularly badly in terms of court awards, but they would receive a much larger payment based on VSL estimates, especially if these estimates make no adjustments for individual heterogeneity. The variations of economic damages with individual circumstances are widely accepted for economic damages calculations so that use of a uniform VSL level for all personal injury cases, as is often done in hedonic damages analyses, is inconsistent with this approach.The underlying law and economics rationale for calculating economic damages based on financial harms is that these damages are pertinent to the insurance objective of compensation, which is to address the income loss associated with an accident or injury.11 Thus, the task for setting these damages values is not to determine how much the person's well-being is worth to society or how much should be paid to prevent the injury, but rather what amount of compensation is needed to fully insure the income losses associated with the accident.B. Noneconomic Damages and InsuranceNoneconomic damages also will vary based on the case characteristics, which will then provide for compensation for the pain and suffering of the accident victim and the grief and welfare loss to the family. Noneconomic damages extend beyond the financial harm. From an economic standpoint, one would only choose to insure such losses fully if the accident did not reduce the marginal utility of income. For example, risk-averse people will fully insure monetary losses if offered actuarially fair insurance. As I have shown for both fatal and nonfatal injuries that are comparable in severity to the typical job injury, serious accidents reduce the marginal utility of income.12 Consider the thought experiment in which a person is free to structure insurance compensation after an accident subject to the constraint that the available insurance is purchased on an actuarially fair basis. The optimal insurance amount the person would select not only does not provide for noneconomic damages compensation above and beyond the value of economic loss, but may provide for less than full replacement of earnings if the accident reduces the marginal utility of income sufficiently. In the case of accidents whose severity is comparable to that of job injuries, my empirical estimates based on a survey of workers' valuation of job risks is that the optimal income replacement rate for work injuries is approximately 0.85, assuming that these benefits are not subject to taxation. Workers themselves would structure workers' compensation payments to provide for less than full income insurance because serious job injuries impede one's ability to derive welfare benefits from additional consumption. There is generally no rationale at all for noneconomic damages from the standpoint of optimal insurance if the accident reduces the marginal utility of money and the financial losses are fully addressed, net of all deductions from the award, such as legal fees.Should noneconomic damages even be part of conventional damages measures, as they now are, and if so, how should they be set? For property damages, optimal insurance is the "make whole" amount because property losses do not alter the structure of utility functions. In contrast, it is not optimal for people to be fully compensated for pain and suffering damages that they have suffered due to a serious or fatal injury insofar as their marginal utility of money has declined as a result of such an injury. Very minor injuries, such as temporary hand burns, are tantamount to income losses and do not alter the marginal utility of income, whereas catastrophic injuries do. The reason why making accident victims whole after catastrophic losses is not optimal is that people generally will not wish to buy insurance to compensate themselves or their heirs fully for the noneconomic losses associated with accidents. Similarly, people do not purchase insurance to compensate for the grief that will result from the death of a spouse or child.13Setting compensation for noneconomic damages based on the "make whole" amount also raises intractable issues for health losses. How much money do you need to make you indifferent from a utility standpoint to being healthy or becoming a quadriplegic? What is the value of a parent or spouse? Such thought experiments are surely not what guides jury behavior, nor would people generally choose to purchase enough insurance so that they wouldn't mind being disabled or having a spouse or parent die.A more appropriate role for noneconomic damages is the compensation of claimants for the value of their attorney fees. Attorney fees constitute a form of economic damage or financial loss that is incurred in bringing the lawsuit, but because these costs are not included as part of standard economic damages components, the level of economic damages compensation will not be sufficient to cover the entire economic loss. If we assume a one-third contingency fee share, if people are awarded 1.5 times the value of the economic loss, then subtracting a third of this award will still leave them fully compensated for their economic harms, fully insuring their financial loss. In the absence of noneconomic damages payments, the economic damages value will not provide for full insurance. The value of noneconomic damages for products liability cases varies by injury type but often is in the range of about 40%. For medical malpractice cases, noneconomic damages are quite large, comprising 75% of total compensation for medical malpractice fatalities for adults.14 If in fact it is true that people would not purchase insurance for noneconomic damages, which is likely to be the case for severe injuries and death, then from an insurance standpoint, awards would be better structured if they could provide more reliably for the coverage of attorney fees rather than attempting to link the payment to the perceived noneconomic harms.C. Noneconomic Damages and DeterrenceHow insurance and deterrence functions relate to compensatory damages depends on the nature of the harm. If the losses are purely financial or are equivalent to financial losses in terms of how they enter the utility function, they consequently will not alter the structure of individual utility functions. Within the context of this financial equivalent world, optimal insurance of the loss also will generate incentives for optimal deterrence. However, these twin functions cannot be satisfied by any single damages payment in the case of personal injury cases that decrease the marginal utility of any given level of income.15 There will be an inevitable tradeoff between optimal insurance and efficient incentives if the only incentives for safety are generated by the tort liability payment.For personal injury cases, I assume that punitive damages address the creation of incentives for optimal deterrence when there is a shortfall in deterrence and the legal criteria for awarding punitive damages are met. In setting the deterrence amounts, all financial incentives for safety that already exist should be taken into account. The usual conclusion that there might be a deterrence-related rationale for punitive damages often stems from an entirely tort-centric perspective with respect to the creation of incentives for the injurer to take care. What is not considered is that there are often other financial incentives that will alter behavior.16How these societal forces function depends on the injury context. For risks involving a market exchange, these will be effects of accidents on people's willingness to buy dangerous products or work on risky jobs. Accidents involving strangers, such as most auto accidents, may lead to revision of a driver's insurance rates after an accident. For accidents involving strangers as well as those involving market exchanges, there are often incentives provided by government regulations, ranging from traffic tickets to regulatory sanctions.Perhaps the best case scenario for market-based incentives involves well known product market risks. After major airplane disasters, consumers are reluctant to return to the affected airlines, often leading to significant price cutting.17 These adverse events will have stock market repercussions more generally, as investors lower their assessed value of the firm.18Economists have estimated the VSL amounts implied by consumer purchases of used cars, smoke detectors, bike helmets, and other safety-related products, as these price effects represent market sanctions for dangerous products and a market premium for safe products. The market itself will provide for this compensation ex ante, which involves the same kinds of risk-money tradeoffs embodied in the labor market decisions generally used to estimate the VSL levels. Indeed, if people are fully cognizant of the risks, there is no rationale whatsoever from a deterrence standpoint to bolster these incentives through additional ex post compensation.If people face continuous risk choices across the different domains of choice, they will equate the VSL levels across these different domains. The market itself will generate risk-money tradeoffs based on the VSL levels so that awarding hedonic damages in addition to economic and noneconomic damages will duplicate this function and create excessive incentives for safety. If, however, markets do not work perfectly or the accident does not involve a market context, the task of court awards will be to address the extent of the shortfall in incentives. This shortfall may not be complete. Even in the extreme case of environmental risks in which there is no market exchange with the potentially injured party, there may be market forces at work. Consumer boycotts of Exxon followed the Alaskan oil spill, and many companies have been the target of stock divestiture actions because of the perceived riskiness or perceived political incorrectness of their activities.Product and labor markets are not the only market forces at work. Insurance markets come into play as well. Insofar as insurance premiums are experience-rated, firms and individuals with poor records of safety performance and with characteristics correlated with high risks will pay higher premiums, providing an incentive for safer behavior.Another institutional actor that creates safety incentives is the government. Many government regulatory agencies are concerned with risks such as product safety, job safety, and environmental quality. In addition to imposing regulatory standards for future products and activities, these agencies can impose penalties on firms for hazardous products. They can also initiate recall actions with respect to these products. State and local government entities impose penalties on risky driver behavior and other risky actions as well.Viewed more broadly, even if one restricts the role of tort awards to full insurance of the losses to accident victims, that does not mean that compensation levels based on optimal insurance will generate inadequate levels of deterrence. That judgment will depend on the entire set of incentives created by a wide variety of social institutions and not on the tort system alone.A. A Simple Deterrence ModelTo see more formally why imposing damages equal to VSL may be excessive from a safety incentive standpoint, consider the following model. Suppose that L* is the optimal deterrence economic incentive value needed to lead the corporation to select the efficient level of care. The value of L* equals VSL when the risk is that of a fatality. Let L be the expected damages payment paid by the company in the absence of punitive damages. This loss consists of two components, the first of which is the expected non-punitive liability cost M1. This value consists of the expected compensatory damages as well as any damages associated with administrative compensation schemes, such as workers' compensation. The second component of the loss imposed by the company consists of the expected incentives provided by institutions other than the courts, which I will designate by M2. Risks to workers will generate compensating wage differentials, and products perceived to be risky will command a lower price. There also may be sanctions imposed by government regulations when the corporate behavior violates formal regulatory guidelines. Thus, the total financial cost incurred by the company consists of two parts, which gives rise to the formulation thatThe focus here will be on the optimal value of punitive damages, which will be designated by D. In particular, when will it be appropriate to set D equal to VSL? If there are accident costs M2 beyond the compensatory damages amount, there will be excessive deterrence provided by the compensatory damages amount if the courts adopt a hedonic damages approach and set M1 equal to L*. A tort-centric perspective generally will produce excessive deterrence, not simply an imbalance between the competing objectives of deterrence and insurance. Punitive damages will only have a potentially productive role if the legal criteria for awarding punitive damages are met and there is a positive spread between the deterrence values and actual losses imposed by the company, or If this inequality holds, one can establish appropriate incentives for deterrence by setting the punitive damages amount according to Note that whenever L is greater than zero, D is below the value of VSL. Thus, the essential trigger for there to be any beneficial role for punitive damages in any context is that there must be some gap between the optimal deterrence amount and the loss imposed on the company by compensatory damages and by parties other than the courts. Setting D equal to VSL will impose too great a penalty whenever L > 0, which includes all cases where compensatory damages are positive or other incentives are operative.In general, there will not be a deterrence function of wrongful death awards since punitive damages seldom come into play, and it is compensation, not deterrence, that is the main function of wrongful death awards.19 However, even if deterrence is a valued objective, because compensating tort victims according to their VSL will provide excessive insurance to accident victims, using these awards to satisfy simultaneously the economic objectives of deterrence and compensation is not feasible.The main law and economics rationale for punitive damages is when there is a low probability of detection. For simplicity assume that the value of M2 is zero. Let there be some compensatory damage amount m1 that will be levied on the company with a probability s so that the expected liability cost M1 is given by If the accident were tantamount to a monetary equivalent, then the compensatory damage amount would have established efficient incentives for deterrence if s=1. However, when there is an enforcement error so that there is some nonzero probability that the fine will not be imposed, then punitive damages can potentially eliminate this gap. Assuming that punitive damages will also be imposed with a probability s, one has the requirement that punitive damages w
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