What Is Present Value, and Why Should Life Care Plans be Quantified in Present Value?

A present value assessment of a life care plan accounts for two real-life phenomena not accounted for in most life care plans: inflation and interest.

Why Present Value Matters in Life Care Planning

Most life care plans are formulated in nominal value, i.e., value which accounts for market prices that prevail at the time a life care plan is produced. Nominal value is a valid form of economic valuation, but it does not account for two real-life phenomena that affect a person’s ability to afford future care: 1) inflation, and 2) a person’s capacity to earn interest.

Understanding the Time Value of Money

Present value is a time value of money concept, and the time value of money is the foundational concept of financial theory. It maintains that money today is worth more than money tomorrow. We know this is true because money can earn interest. Time value of money calculations seek to equate the present value of money (what it’s worth today) to the future value of money (what it’s worth in the future), and vice versa.

To accurately calculate the amount of money the subject of a life care plan will require today, to afford medically related goods and services which will be required in the future, the impact of inflation, and a person’s capacity to earn interest must be accounted for.

The present value of a life care plan is the amount of money the subject of a life care plan would require today, assuming the subject can earn a known rate of interest, which would then enable the subject to afford all the goods and services contained within the life care plan, at their future, inflationary-adjusted values.

Is There a Published, Reliable, and Regularly Employed Methodology Used to Formulate the Present Value of Life Care Plans?

Yes. The most regularly employed methodology used to reliably formulate the present value of life care plans is Discounted Cash Flow Valuation. Discounted Cash Flow Valuation is one of the most commonly employed forms of fundamental financial analysis in the world, and it is a subject of nearly all introductory courses in the field of finance.

The application of Discounted Cash Flow Valuation goes far beyond formulating the present value assessments of life care plans. Discounted Cash Flow Valuation is performed countless times per day, in countless disciplines, industries, and scenarios throughout the world. For example, it is regularly used to formulate the present value of businesses, contracts, investments, assets, liabilities, leases, loans, etc.

When applied within the discipline of life care planning, the purpose of performing a Discounted Cash Flow Valuation, i.e., a Present Value Assessment of a Life Care Plan, is to measure the present value of an ill/injured person’s prospective future cash outflows, i.e., those associated with acquiring the future medically related goods and services contained within the life care plan.

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What Are the Steps in Performing a Discounted Cash Flow Valuation of a Life Care Plan?

The Discounted Cash Flow Method for formulating the present value of a life care plan is a simple two-step process:

Calculating the future (inflationary-adjusted) value of a life care plan’s medically related goods and services.
Calculating the present value of a life care plan’s medically related goods and services, i.e., calculating the amount of money the subject of a life care plan would require today, assuming the subject can earn a known rate of interest, that would then enable the subject to afford all the goods and services contained within the life care plan, at their future, inflationary-adjusted values.

Formulation of Future Value

To formulate future (inflation-adjusted) value, a standard financial formula is employed: Future Value = Nominal Value x (1 + r)n. In the preceding formula, “nominal value” is the value of a medically related good or service expressed in today’s prices; “r” is a rate of inflation, and “n” is the number of compounding periods.

For example, if we wanted to formulate the future value of a visit to a doctor’s office that is forecast to occur 16 years in the future, and that costs $100 today, assuming a 2.3% rate of inflation, we would calculate: $100 x (1 + 2.3%)16, which equals $143.88.

Regularly relied upon sources of inflation rates used to formulate the inflationary-adjusted values of life care plans include the United States Bureau of Labor Statistics, the United States Social Security Administration, and the United States Congressional Budget Office.

Formulation of Present Value

To formulate present value, another standard financial formula is employed: Present Value = Future Value ÷ (1 + r)t. In the preceding formula, “r” is a “discount rate” (a rate of return on an appropriately risk-adjusted investment), and “t” is the number of discounting periods.

Following the previous example, if we wanted to formulate the present value of a visit to a doctor’s office that is forecast to occur 16 years into the future at a cost of $143.88, assuming a 2.1% rate of return (interest), then we would calculate $143.88 ÷ (1 + 2.1%)16, which equals $101.06.

Regularly relied-upon proxies for “appropriately risk-adjusted rates of return” include AAA-rated tax-exempt general obligation municipal bonds and United States Treasuries.

Why Don’t Most Life Care Planners Formulate Life Care Plans in Present Value?

Life care plans are a valuable tool for case management, elder care, and discharge planning. Most life care plans are, however, commissioned to formulate and quantify the future medically related needs of ill/injured individuals in the context of personal injury torts. Because the formulation of present value requires specialized education, training, and skills in the field of finance, and because most life care planners do not possess such education and training, most life care planners correctly quantify life care plans in nominal value, i.e., most life care planners do not quantify life care plans in present value.