In the past two years, the Superior Court has issued contradictory rulings on the proper interpretation of Rule 53.09 of the Ontario Rules of Civil Procedure related to the discount rate used in quantifying the present value of future pecuniary losses.
The financial impact of these rulings is potentially quite large. Indeed, it is unusually significant at the present time given the historically low short-term rate of 0.5 per cent currently applied for 2011 trials. A review of the history behind the development of Rule 53.09 is therefore particularly timely.
Rule 53.09 of the Ontario Rules of Civil Procedure states that “the discount rate to be used in determining the amount of an award in respect of future pecuniary damages, to the extent that it reflects the difference between estimated investment and price inflation rates is, for the 15-year period that follows the start of the trial, the average of the value for the last Wednesday in each month of the real rate of interest on long-term government of Canada real return bonds (Series V121808, formerly Series B113911), as published in the Bank of Canada weekly financial statistics for the 12 months ending on August 31 in the year before the year in which the trial begins, less one per cent and rounded to the nearest quarter per cent, and for any later period covered by the award, 2.5 per cent per year.”
There have been two different interpretations put forth with respect to how the last part of the rule is to be implemented.
The position that has been consistently advanced by our firm is that the discount rate to be applied to all lost cash flows beyond the 15th year is 2.5 per cent per year. In Greenhalgh v. Douro-Dummer (Township), the court accepted this interpretation of the rule.
Conversely, the position often advanced by other experts has been that cash flows beyond the 15th year are discounted by the short-term rate for the first 15 years and by 2.5 per cent for all subsequent periods.
This blended approach to the discount rate tends to produce a significantly higher present value calculation in the current interest environment. In Slaght v. Phillips and Wicaartz, the court accepted this blended approach.
The financial significance of such a divergence of interpretation can be illustrated through an example. Consider a young professional who is catastrophically injured in an accident and is 26 years old at the date of trial.
Based on projected annual income of $100,000, the blended approach would calculate a future income loss of $3.03 million, while our firm’s position would result in a future loss of $2.62 million for a difference of $410,000 or 17 per cent. Clearly, this is a financially significant issue.
Given the current state of the judicial debate over this issue, a review of the historical background and economic theory underlying the rule is of assistance.
Ontario’s search for a universally applicable discount rate began in 1980 with the report to the committee of the Supreme Court of Ontario on fixing capitalization rates in damage actions. The committee sought to determine a real risk-free rate in computing future pecuniary losses.
The committee’s conclusion was based on a simple insight. It reasoned that while real risk-free yields on government bonds in Canada historically had experienced significant fluctuations, over the long term they had tended to converge at an average of between two and three per cent.
It was on that basis that a discount rate of 2.5 per cent was adopted in the Rules of Civil Procedure.
The 1980s witnessed high levels of real returns on government bonds not seen since the Great Depression.
As a result, in the 10 years following the introduction of Rule 53.09, there were several attempts by experts to deviate from the prescribed rate of 2.5 per cent on the grounds that it was not reflective of the reality at the time.
In 1990, a committee sought to determine if Rule 53.09 should be updated. It recommended using a rate of 4.25 per cent until Dec. 31, 1999, with a rate of three per cent thereafter. This proposal was not accepted.
The current two-tiered incarnation of Rule 53.09 is based on recommendations from the 1998 report to the subcommittee of the civil rules committee on the discount rate and other matters.
The formula adopted was not a repudiation of 2.5 per cent as the expected long-term average rate appropriate for use in long-term future-loss calculations.
Rather, the purpose was to provide a flexible formula that accounted for both the historical long-term average rate of 2.5 per cent and the inevitable short-term deviations that rendered the long-term number inappropriate for computing short-term future losses.
The implication of this background to Rule 53.09 is reasonably clear. Over an extended period of time, the overall effective discount rate should tend to converge at the long-term average of approximately 2.5 per cent.
For example, an award for future loss of income involving a child ought to result in an average discount rate of approximately 2.5 per cent per year consistent with past historical experience.
While a different rate may prevail over the short term, eventually rates will reverse themselves such that the overall average should be 2.5 per cent.
Under our interpretation, this is indeed what occurs. Over a period of 50 years, Rule 53.09 will equate to a uniform discount rate of 2.16 per cent per year, even with the low discount rate of 0.5 per cent used for the first 15 years for 2011 trial dates. This is well within the range of two to three per cent suggested by the original 1980 committee report.
On the other hand, under the blended approach, the overall discount rate over a 50-year loss period equates to an average of 1.39 per cent for 2011 trial dates.
This appears to be inconsistent with the rationale behind the rule and the economic theory that the long-term rate will approach 2.5 per cent.
Within Canada, the other provinces with a statutorily defined discount rate have prescribed single-tier rates, all of which are within a range of 2.5 to 3.5 per cent. Canadian jurisdictions where there is no mandatory discount rate have often used a rate of 2.5 to 3 per cent.
Ontario’s two-tiered discount rate is no exception. It, too, recognizes that over the long term, the real risk-free rate of return will be approximately 2.5 per cent.
In light of the recent judicial debate over the proper interpretation of Rule 53.09, perhaps it is time to revisit the rule’s wording to more clearly reflect the intentions of the original committee.
Ephraim Stulberg is a supervisor and Matthew Mulholland is a senior manager with Matson Driscoll & Damico Ltd. Their practice is focused on personal injury and other economic damage quantification matters.
The financial impact of these rulings is potentially quite large. Indeed, it is unusually significant at the present time given the historically low short-term rate of 0.5 per cent currently applied for 2011 trials. A review of the history behind the development of Rule 53.09 is therefore particularly timely.
Rule 53.09 of the Ontario Rules of Civil Procedure states that “the discount rate to be used in determining the amount of an award in respect of future pecuniary damages, to the extent that it reflects the difference between estimated investment and price inflation rates is, for the 15-year period that follows the start of the trial, the average of the value for the last Wednesday in each month of the real rate of interest on long-term government of Canada real return bonds (Series V121808, formerly Series B113911), as published in the Bank of Canada weekly financial statistics for the 12 months ending on August 31 in the year before the year in which the trial begins, less one per cent and rounded to the nearest quarter per cent, and for any later period covered by the award, 2.5 per cent per year.”
There have been two different interpretations put forth with respect to how the last part of the rule is to be implemented.
The position that has been consistently advanced by our firm is that the discount rate to be applied to all lost cash flows beyond the 15th year is 2.5 per cent per year. In Greenhalgh v. Douro-Dummer (Township), the court accepted this interpretation of the rule.
Conversely, the position often advanced by other experts has been that cash flows beyond the 15th year are discounted by the short-term rate for the first 15 years and by 2.5 per cent for all subsequent periods.
This blended approach to the discount rate tends to produce a significantly higher present value calculation in the current interest environment. In Slaght v. Phillips and Wicaartz, the court accepted this blended approach.
The financial significance of such a divergence of interpretation can be illustrated through an example. Consider a young professional who is catastrophically injured in an accident and is 26 years old at the date of trial.
Based on projected annual income of $100,000, the blended approach would calculate a future income loss of $3.03 million, while our firm’s position would result in a future loss of $2.62 million for a difference of $410,000 or 17 per cent. Clearly, this is a financially significant issue.
Given the current state of the judicial debate over this issue, a review of the historical background and economic theory underlying the rule is of assistance.
Ontario’s search for a universally applicable discount rate began in 1980 with the report to the committee of the Supreme Court of Ontario on fixing capitalization rates in damage actions. The committee sought to determine a real risk-free rate in computing future pecuniary losses.
The committee’s conclusion was based on a simple insight. It reasoned that while real risk-free yields on government bonds in Canada historically had experienced significant fluctuations, over the long term they had tended to converge at an average of between two and three per cent.
It was on that basis that a discount rate of 2.5 per cent was adopted in the Rules of Civil Procedure.
The 1980s witnessed high levels of real returns on government bonds not seen since the Great Depression.
As a result, in the 10 years following the introduction of Rule 53.09, there were several attempts by experts to deviate from the prescribed rate of 2.5 per cent on the grounds that it was not reflective of the reality at the time.
In 1990, a committee sought to determine if Rule 53.09 should be updated. It recommended using a rate of 4.25 per cent until Dec. 31, 1999, with a rate of three per cent thereafter. This proposal was not accepted.
The current two-tiered incarnation of Rule 53.09 is based on recommendations from the 1998 report to the subcommittee of the civil rules committee on the discount rate and other matters.
The formula adopted was not a repudiation of 2.5 per cent as the expected long-term average rate appropriate for use in long-term future-loss calculations.
Rather, the purpose was to provide a flexible formula that accounted for both the historical long-term average rate of 2.5 per cent and the inevitable short-term deviations that rendered the long-term number inappropriate for computing short-term future losses.
The implication of this background to Rule 53.09 is reasonably clear. Over an extended period of time, the overall effective discount rate should tend to converge at the long-term average of approximately 2.5 per cent.
For example, an award for future loss of income involving a child ought to result in an average discount rate of approximately 2.5 per cent per year consistent with past historical experience.
While a different rate may prevail over the short term, eventually rates will reverse themselves such that the overall average should be 2.5 per cent.
Under our interpretation, this is indeed what occurs. Over a period of 50 years, Rule 53.09 will equate to a uniform discount rate of 2.16 per cent per year, even with the low discount rate of 0.5 per cent used for the first 15 years for 2011 trial dates. This is well within the range of two to three per cent suggested by the original 1980 committee report.
On the other hand, under the blended approach, the overall discount rate over a 50-year loss period equates to an average of 1.39 per cent for 2011 trial dates.
This appears to be inconsistent with the rationale behind the rule and the economic theory that the long-term rate will approach 2.5 per cent.
Within Canada, the other provinces with a statutorily defined discount rate have prescribed single-tier rates, all of which are within a range of 2.5 to 3.5 per cent. Canadian jurisdictions where there is no mandatory discount rate have often used a rate of 2.5 to 3 per cent.
Ontario’s two-tiered discount rate is no exception. It, too, recognizes that over the long term, the real risk-free rate of return will be approximately 2.5 per cent.
In light of the recent judicial debate over the proper interpretation of Rule 53.09, perhaps it is time to revisit the rule’s wording to more clearly reflect the intentions of the original committee.
Ephraim Stulberg is a supervisor and Matthew Mulholland is a senior manager with Matson Driscoll & Damico Ltd. Their practice is focused on personal injury and other economic damage quantification matters.
