Speaker's Corner: 0% discount rate shows need for rule change

In accordance with Rule 53.09 of the Rules of Civil Procedure, statutory discount rates for trials commencing in 2012 are zero per cent for the first 15 years of future losses.

These are unusual times as there’s no longer an effective discount for the time value of money.

The main reason for the change is the Bank of Canada’s pursuit of a low interest rate policy to help stimulate the economy in light of the prolonged economic slowdown.

The current rate is significantly lower than historical levels that have averaged at about 2.5 per cent in Canada. Accordingly, the new rate means there’s an incentive for plaintiffs and their counsel in insurance litigation and other matters to settle their cases or bring them to trial in 2012.

Discount rates are typically a factor in discounting future losses or obligations when there’s nominal risk associated with the projections as they’re based on yields on government of Canada bonds.

Litigation matters in which these rates apply in order to discount future obligations or cash flows typically involve cases like insurance files where an individual’s loss of future income has been adjusted by an expert in loss quantification for contingencies such as mortality, unemployment, and illness.

The rate also comes up in family law matters involving the calculation of obligations like lump-sum and compensatory support as well as commercial litigation cases involving present-value calculations where there’s nominal risk associated with future losses or obligations.

These rates under Rule 53.09 don’t usually apply for the purposes of business and securities valuation or discounting a loss of profits in commercial litigation as there’s inherently more risk to the future profitability of a business than is associated with a government of Canada bond.

To illustrate the impact of a zero-per-cent discount rate, consider a personal injury case in which the injured plaintiff has the following characteristics:

•    The plaintiff is a male who will be 40 years old in 2012.

•    The injuries have resulted in the plaintiff being totally and permanently disabled from competitive employment.

•    An appropriate contingency adjustment to the plaintiff’s projected earnings would relate to participation and unemployment rates of males residing in Ontario with a college education based on statistical information from Statistics Canada.

•    The plaintiff had an earning capacity of $60,000 per year absent the injuries.

•    The plaintiff likely would have retired at age 65.

Based on those factors, the loss of income for this individual over his working life would increase by approximately $240,000 or 25.8 per cent under a discount rate of zero per cent compared to the long-term historical average in Canada of 2.5 per cent.

Ontario changed its rules of court in 2000 for the selection of the discount rate. Previously, Rule 53.09(1) required the court to use a real interest rate of 2.5 per cent when discounting future earnings.

The new rule, established for trials beginning in or after 2000, divides the future loss into two periods: the first for the initial 15-year period and the second for beyond. In the first period, Rule 53.09(1) requires the court to use the rate observed on real return bonds for the 12 months ending in August of the year preceding the date of calculation less one per cent and rounded to the nearest quarter per cent.

For the second period covering losses beyond 15 years into the future, the 2.5 per cent still applies.

The rationale for this change appears to be that the real rates for the year before the trial commenced are a good indicator of short- to medium-term rates.

Discount rates for the initial 15-year period have ranged from three per cent for trials beginning in 2000 to zero per cent for those starting in 2012.

As a result, Ontario should perhaps consider revising Rule 53.09 because in certain circumstances, the average monthly real discount rates in the year preceding the trial, less one per cent, may not be a good indicator for the next 15 years.

By way of example, the discount rate in 2000 for the initial 15-year period in accordance with the rule was, as noted, three per cent.

The real discount rate from that time to now has on average been about 1.5 per cent. The adoption of this rule appears to result in a shortage of compensation for plaintiffs who brought an action to trial in 2000.

For trials beginning in 2012, it appears that the adoption of a zero-per-cent discount rate may have the opposite effect.

Nevertheless, the court does have discretion to vary the rate. But there’s a reluctance to vary the prescribed discount rate for reasons such as preventing the general injustice of similar cases decided at or around the same time having different results as well as avoiding the expense of calling expert evidence related to discount rates.

It’s also interesting to note that in a submission of comments on June 1 by the Canadian Institute of Actuaries, changes implemented to Rule 53.09 in 2000 were the result of a concern that the previous prescribed discount rate of 2.5 per cent was too low.

Nevertheless, it has turned out that actual events don’t appear to support some of the assumptions made in altering Rule 53.09 in 2000. In fact, the discount rate has been higher than 2.5 per cent only twice. Given this year’s rate, then, it seems it’s a good time for Ontario to reconsider its approach.

Stephen Kertzman is a partner at ap Valuations Ltd. He has been involved in financial litigation and business-valuation matters since 1997 and has provided expert testimony at the Ontario Superior Court of Justice.

For related content, see "Clarity needed on discount rate."

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