NOTE
Adding Insult to Injury: The Inappropriate Use of Discount
Rates to Determine Damage Awards
Gordon Bale*
It is often assumed that it is necessary to
discount future economic losses in order to
determine the appropriate damage award in a
tort action. The Supreme Court of Canada in
the now-famous 1978 trilogy of damage
cases sanctioned the net discount rate
method of determining the present value of
future economic losses. The net discount rate
is simply the real rate of interest –
the
nominal rate minus the rate of inflation. Be-
cause there is substantial long term stability
in the real rate of interest, the Rules of Prac-
tice in Ontario and Nova Scotia now pre-
scribe a net discount rate of 2.5 %. The
author agrees with criticism that the net dis-
count method results in methodological
error. A recently proposed alternative, the
serial calculation method, is not feasible,
however, because it is faultily premised
upon the ability to forecast rates of inflation
and rates of interest in isolation. The author
contends further that, if the loss is one of
future earnings, there is no justification for
any discounting. Economic experience over
the last fifty years indicates that the growth
of real wages has, on average, exceeded the
real rate of interest. This fact means that any
discounting of lost future earnings adds in-
sult to injury. Discounting proclaims that the
injured person was a substantially below-
average worker who would not have shared
in the productivity gains of the economy had
he been able to continue working.
L’on a souvent cru ncessaire de diminuer la
valeur des pertes 6conomiques h venir afin de
ddterminer le montant addquat des dom-
mages-intdarts h verser dans une action d6-
lictuelle. Dans une trilogie drsormais c6-
lbre d’arr~ts sur Ia question de l’6valuation
des dommages futurs, la Cour supreme a
sanctionn6 la m~thode du taux d’escompte
net, qui pretend 6valuer la valeur actuelle de
pertes dconomiques futures. Le taux d’es-
compte net correspond en fait au taux d’int&
r& reel, soit le taux d’int~rt nominal moins
le taux d’inflation. Vu Ia stabilit6
long
terme du taux d’intrr& reel, les Rules of
Practice de l’Ontario et de la Nouvelle-
Lcosse stipulent un taux d’escompte net de
2,5%. L’auteur se rallie A ceux qui ont sug-
grr6 que le taux d’escompte net est le produit
d’une erreur de mrthodologie. La mrthode
de calcul srquentiel, proposre comme subs-
titut, n’est toutefois pas utile puisqu’elle d6-
pend de la pr6vision exacte des taux d’infla-
tion et taux d’intr&. L’auteur sugg~re 6ga-
lement qu’on ne peutjustifier une diminution
du montant des pertes lorsqu’il s’agit d’6va-
luer des gains futurs. L’histoire dconomique
des cinquante dernires anndes rrv6le qu’en
moyenne Ia croissance des revenus reels a
drpass6 le taux d’int6r& reel. La reduction
des pertes de gains futurs apparait alors
comme un affront h tout r~clamant, puis-
qu’elle insinue que la r6mun~ration d’une
personne blessre dtait bien en-dessous de la
moyenne et que celui-ci n’aurait jamais pro-
fit6 des gains de productivit6 de l’6conomie.
*Of the Faculty of Law, Queen’s University. I wish to acknowledge the substantial
contribution made by Peter Chilibeck in the development of this paper.
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[Vol. 28
Synopsis
Introduction
I.
Methodological Error of the Net Discount Rate
H. Does the Methodological Error Result in Serious
Undercompensation?
III. The Feasibility of Adopting the Correct Serial Method
IV.
Should There Be Any Discounting for Loss of Future Earnings?
Conclusion
Appendix
Introduction
An overdue clarification of the principles of compensation for the loss of
future earnings in personal injury and wrongful death cases was undertaken
by the Supreme Court of Canada in the famous 1978 trilogy. I The trilogy has
stimulated a rich cornucopia of articles 2 and an outstanding treatise on the law
‘Andrews v. Grand & Toy Alberta Ltd [1978] 2 S.C.R. 229, (1978) 83 D.L.R. (3d) 452
[hereinafter cited to S.C.R.];Arnoldv. Teno [1978] 2 S.C.R. 287, (1978) 83 D.L.R. (3d) 609
[hereinafter cited to S.C.R.]; Thornton v. Board of School Trustees of School District No. 57
(Prince George) [1978] 2 S.C.R. 267, (1978) 83 D.L.R. (3d) 480 [hereinafter cited to S.C.R.].
2Bissett-Johnson, Damages for Personal Injuries – The Supreme Court Speaks (1978) 24
McGill L.J. 316; Boyle & Murray, Assessment of Damages: Economic andActuarial Evidence
(1981) 19 Osgoode Hall L.J. 1; Braniff& Pratt, Tragedy in The Supreme Court of Canada:
New Developments in the Assessment of Damagesfor Personal Injuries (1979) 37 U.T. Fac. L.
Rev. 1; Bruce, The Calculation of Foregone Lifetime Earnings: Three Decisions of the
Supreme Court of Canada (1979) 5 Can. Pub. Policy 155; Bruce, The Introduction of
Economic Factors into Litigation Cases: Ontario’s 2 Percent Solution (1982) 60 Can. Bar
Rev. 677 [hereinafter Ontario’s 2 Percent Solution]; Charles, The Supreme Court of Canada
Handbook on Assessment of Damages in Personal Injury Cases (1981-82) 18 C.C.L.T. 1;
Cherniak & Sanderson, “Tort Compensation – Personal Injury and Death Damages” in New
Developments in the Law of Remedies [1981] L.S.U.C. Special Lectures 197; Connell,
DiscountRates- The Current Debate (1980) 2 Advocates’ Q. 138; Dexter, Murray & Pollay,
Inflation, Interest Rates and Indemnity: The Economic Realities of Compensation Awards
(1979) 13 U.B.C.L. Rev. 298; Feldthusen & McNair, General Damages in Personal Injury
Suits: The Supreme Court’s Trilogy (1978) 28 U.T.L.J. 381; Gibson, Repairing the Law of
Damages (1978) 8 Man. L.J. 637; Hasson, “Pensions or Damages?” in I. Saunders, ed., The
Future of Personal Injury Compensation [:] A Symposium held at The Faculty of Law
University of Calgary, January 1978 (1979); Krishna, Tax Factors in Personal Injury and
Fatal Accident Cases: A Plea for Reform (1978) 16 Osgoode Hall L.J. 723; Lipnowski, The
Economist’s Approach to Assessing Compensation for Accident Victims (1979) 9 Man. L.J.
19831
NOTE
of damages .3 One of the most recent contributions prompted by the increased
focus on economic and actuarial evidence is Professor Landsea’s note, How
Workable are Net Discount Rates? ‘ He contends that there is a methodologi-
cal error inherent in the use of a net discount rate to determine the lump sum
award for future pecuniary damages and that the error leads to a substantial
understatement of the present value of future economic losses. Because the
Supreme Court of Canada sanctioned the use of the net discount method of
determining the present value of lost future economic values in the 1978
trilogy of damage assessment cases, Landsea’s indictment of this method
warrants careful consideration. His challenge is of even greater significance
in Ontario and Nova Scotia, where the net discount rate concept has been
prescribed by the Rules of Practice. Rule 267a of the Ontario Rules of
Practice stipulates that:
The rate of interest to be used in determining the capitalized value 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 2 /z per cent per annum.5
My response to the Landsea challenge will be divided into four Parts. In
the first Part, I will consider the methodological error, if any, in the concept of
the net discount rate. I conclude that Landsea has made a valuable contribu-
tion in demonstrating methodological error. The second Part will be a consid-
eration of whether Landsea is correct in concluding that the methodological
error results in serious undercompensation of injured plaintiffs. I disagree,
and submit that the net discount rate method is a reasonably good approxima-
tion given the range of probable variables, provided that the nominal rate of
interest decreases to more traditional levels. The third Part will be a discus-
sion of the feasibility of adopting the “correct” procedure, the serial method of
calculation, to determine the present value of future economic loss, as
advocated by Landsea. I am of the opinion that his technique is not viable
because it is impossible to forecast accurately the long term inflation rate and
the long term rate of interest independently of each other. In the fourth Part, I
319; McLachlin, What Price Disability? A Perspective on the Law of Damages for Personal
Injury (1981) 59 Can. Bar Rev. 1; Patterson, Effective Presentation of Actuarial Evidence In
Permanent Disability Cases (1979) 37 The Advocate 13; Paterson, Loss of Future Income In
Actions for Damages (1980) 26 McGill L.J. 114; Rea, Inflation, Taxation and Damage
Assessment (1980) 58 Can. Bar Rev. 280.
3K. Cooper-Stephenson & I. Saunders, Personal Injury Damages in Canada (1981). The
gestation period for this excellent book was undoubtedly longer than the time which has elapsed
since the handing down of the trilogy but the trilogy certainly had a significant impact upon it.
“(1982) 28 McGill L.J. 102.
5Supreme Court of Ontario Rules of Practice, R.R.O. 1981, Reg. 540, r. 267a, originally
0. Reg. 379/80, s. 3. Rule 267a was made pursuant to The Judicature Amendment Act, 1979,
S.O. 1979, c. 65, subs. 5(5). See also the Nova Scotia Civil Procedure Rules, r. 31.10(2),
made pursuant to N.S. Reg. 170/80, which is identically worded.
1018
McGILL LAW JOURNAL
[Vol. 28
will consider whether there should be any discounting at all in determining the
present value of certain losses, specifically the loss of future earnings. I
conclude, on the basis of historical data, that there is little or no justification
for discounting to determine a lump sum damage award for the loss of future
earnings.
I.
Methodological Error of the Net Discount Rate
The compensatory lump sum damage award is determined on the basis
that the sum will be invested in income-earning securities and that the capital
and investment income should be exhausted in replacing exactly the lost
future economic values. There are two critical parameters which must be
quantified to calculate a lump sum award. The first is the gross discount rate
–
the nominal rate of interest which will be earned by the investment of the
lump sum. The second is the rate of growth of the lost future flow of pecuniary
values. To simplify the analysis, I will assume initially that the lost future
flow is an amount which is constant in terms of real purchasing power and
therefore increases in nominal terms in response solely to increases in the
Consumer Price Index.
These two parameters, the nominal rate of interest and the nominal rate
of growth of the economic loss, have an opposing impact upon the calculation
of the lump sum award. The higher the nominal rate of interest which will be
earned from the investment of the lump sum, the smaller the compensatory
lump sum will be. However, the higher the rate at which the lost future flow
would have increased in nominal terms (in this example the rate is assumed to
equal the rate of inflation), the larger the compensatory lump sum must be.
Using the net discount rate method, the lump sum award is calculated by
discounting the lost future earnings flow at a rate which equals the difference
between the nominal rate of interest and rate of inflation –
a rate equal to the
real or inflation-free rate of interest.
It is this netting of the two rates that causes the methodological error.
Landsea is correct in contending that to calculate with precision the lump sum
equivalent of a future flow of increasing nominal income, a serial method of
calculation, which incorporates separately both the nominal rate of interest
and the rate of inflation, is required.6 The mathematics of compound interest
produces the error and, as might be expected, the error is magnified by the
length of time for which the compensation is awarded. Thus, a plaintiff who is
compensated for a loss extending many years into the future is affected more
adversely by the error than is a plaintiff whose loss persists for fewer years.
6 Supra, note 4, 108-12. The methodological error has also been noted by Bruce, Ontario’s
2 Percent Solution, supra, note 2, 683, fn. 24.
19831
NOTE
1019
For a given and fixed net discount rate, the error increases as the nominal rate
of interest, the gross discount rate, becomes higher. This means that in
periods of high inflation, when the nominal yields on investment income will
be high, a plaintiff will be affected more adversely than in times of more
stable prices and lower rates of nominal interest. This problem is exacerbated
by the fact that our Income TaxAct ‘ levies tax on the basis of nominal and not
real interest.
Landsea is certainly correct when he states that the net discount method
of determining the present value of future economic values contains a
methodological error. This error has been recognized by some advocates of
the net discount rate method. An advisory committee 8 which was set up to
assist the Committee of the Supreme Court of Ontario on Fixing Capitaliza-
tion Rates in Damage Actions stated that: “A precise calculation of the lump
sum amount that is equivalent in value to a future stream of increasing
payments or costs would require a formula incorporating the gross rate of
interest and the rate of increase as separate parameters.” 9
II.
Does the Methodological Error Result in Serious
Undercompensation?
Acknowledging that there is a methodological error in the net discount
rate technique, the issue is whether it results in serious error. Landsea
contends that the net discount rate formula “is a mathematically inaccurate
approximation and leads to substantial error in the determination of the
present money value of future economic losses”.10 However, the Ontario
advisory committee advocated the net discount rate method and concluded
that:
[V]ery close approximations within the range of past and foreseeable future economic
scenarios will result from a simpler formula where the stream of payments or costs.., is
discounted at a net capitalization rate equal to the excess of the gross rate of interest over
the assumed rate of increase.”
7S.C. 1970-71-72, c.63, as am. Rea, supra, note 2, 287 states: “If inflation increases the
interest rate, the increased nominal interest income is taxed as if it were real income… There-
fore, the tax rate, expressed as a percentage of real investment income, will increase as the rate
of inflation increases…
Indexing the tax brackets does not eliminate this additional tax on
capital.”
8The advisory committee was composed of Dr Jack Carr, Murray A. Segal and Ronald M.
Walker.
9Report to the Committee of the Supreme Court of Ontario on Fixing Capitalization Rates in
Damage Actions (14 February 1980) 2.
1Supra, note 4, 104.
“Supra, note 9, 2.
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REVUE DE DROIT DE McGILL
[Vol. 28
Is Landsea right in stating that the net discount rate method produces
substantial error when compared with the serial method of calculation? Or is
the advisory committee right when it contends that the net discount method
produces very close approximations for probable economic variables? Land-
sea is certainly correct in noting that the net discount rate method is sometimes
a poor approximation. However, the advisory committee, after studying data
relating to the interest rate on long term Government of Canada bonds and the
Consumer Price Index, concluded that the real rate of interest or the net
discount rate “will be in the range of 2% to 3% per year for the foreseeable
future”.12 Accepting this range of net discount rates, many of the figures
which Landsea presents in his Table 3 entitled “Understatement of Present
Money Value Caused by Use of the Net Discount-Annuity Method” 13 become
irrelevant. The largest percentage understatements shown there can be
reasonably ignored. The only relevant part of Landsea’s Table is produced in
Table 1 below. When the gross discount rate is 10% and the net discount rate
is 3%, the percentage error varies from 1.00% to 3.69% for economic losses
over periods of 10 to 50 years. Given the inaccuracy of damage assessment in
general, these percentage errors are not particularly disturbing. Of greater
concern is the percentage error which occurs when the net discount rate is 3%
but the gross discount rate is 15%. The error varies from 1.63% to 6.02% for
economic losses over periods of 10 to 50 years. Furthermore, as Landsea
emphasizes, an understatement in the present value has a serious impact upon
future values because “[t]he present value understatement leads to shortfalls
of much larger proportions in the replacement of future losses because of the
cumulative effect of the loss of interest that would otherwise accrue on the
present value shortfall”.14
It should be recognized that the Ontario advisory committee reported on
14 February 1980. The committee was thus dealing only with data up to the
2Ibid., 5.
“Supra, note 4, 111.
4Ibid., 113. Landsea does tend to exaggerate the loss which flows from the methodological
error. He goes on to state: “For example, at an 8% growth rate, 15% gross discount rate, and 40
year period of economic loss, the present value damage award is understated by 5.96%.
However, in that case, the insufficient award dooms the plaintiff to a recapture of only 51% of
lost future wages –
a shortfall of 49%.” This is not a very meaningful calculation because it
involves comparing apples with oranges. With an inflation rate of 8%, the dollars being
compared over a 40 year period represent vastly different amounts of purchasing power.
However, Landsea does qualify his statement, at 113: “It should be noted, however, that this
49% shortfall in dollar value does not mean correspondingly that the plaintiff will not be
receiving payments for the last 49% of the years of his 40 yearperiod of economic loss. In fact,
his losses will be replaced fully for 31 years of the 40 year period, and partially replaced in the
32d year.” The methodological error causing the present value understatement of approximate-
ly 6% in this example does have a compound effect and deprives the plaintiff of compensation
for approximately 20% of the years in which he should be indemnified.
19831
NOTE
UNDERSTATEMENT OF PRESENT MONEY VALUE CAUSED BY
USE OF THE NET DISCOUNT-ANNUITY METHOD*
TABLE 1
Gross Discount Rate
Growth Rate
Net Discount Rate
10%
9%
1%
15%
14%
1%
10%
7%
3%
15%
12%
3%
Number of Years
of Economic Loss
10
20
30
40
50
0.44%
0.83
1.20
1.56
1.91
0.66%
1.24
1.78
2.32
2.83
1.00%
1.81
2.52
3.15
3.69
1.63%
2.95
4.11
5.13
6.02
*Relative Understatement = (PV s – PVA)/PVs
where PVs = Present value calculated by serial method
PVA
– Present value calculated by net discount-annuity method.
end of 1979. If one accepts the assumption that the gross discount rate is
measured by the average yield to maturity on long term Government of
Canada bonds,’5 the highest average annual rate of 10.20% was achieved only
in 1979.6 Before that, in the 49 previous years that the committee surveyed,
there had not been a single instance of a double-digit rate. However, in 1980,
the annual rate rose to 12.48% and in 1981, to 15.27%, before it fell to
10.81% in 1982.1″ The committee would not necessarily have had these
substantially higher gross discount rates in mind when it stated that the net
discount rate method provides “very close approximations within the range of
past and foreseeable future economic scenarios”.’ 8 Thus, although Landsea’s
Tables present net discount rates outside the range of probable values and
11 The yield on long term Government of Canada bonds is the appropriate gross discount rate.
The judiciary endeavours to reduce the future economic loss to a certainty through contingency
deductions. If the loss is certain, the plaintiff is entitled to have the lump sum award calculated
on the basis that it will be invested in risk-free securities. The closest equivalent to a risk-free
investment is a Government of Canada bond. This approach has been challenged recently by
Bruce, Ontario’s 21 Percent Solution, supra, note 2, 682-4. He argues that the rate should be
based on five-year guaranteed investment certificates issued by trust companies. However,
recent events have illustrated that such certificates are not risk free.
16 See infra, Appendix.
7Ibid.
“Supra, note 9, 2.
1022
McGILL LAW JOURNAL
[Vol. 28
thereby exaggerate the inaccuracy stemming from the net discount rate
method, it is probably fair to say that the net discount method is a reasonably
good approximation, provided that the nominal rate of interest decreases to
more traditional levels. This result will occur only if the rate of inflation is
reduced.
HI. The Feasibility of Adopting the Correct Serial Method
Landsea states that “[t]here can be little excuse for a court resorting to an
inaccurate approximation when absolute accuracy is possible with the serial
method”.’9 This is a powerful argument, even if it could be proven that the net
discount method was a good approximation for all reasonable values of
nominal interest and inflation. Also, if plaintiffs were affected equally by the
understatement, use of the net discount method would not be so disturbing
because adjusting compensation could be provided. However, all plaintiffs
are not affected equally. The plaintiff who suffers many years of economic
loss is affected more adversely than is the plaintiff whose loss is restricted to
fewer years. The net discount rate formula is simpler and present value tables
are readily available. However, given the availability of computers and
calculators, Landsea appears to be right in dismissing the argument that the
net discount method is easier to apply because “the serial method formula can
be reduced to an equally convenient one-step calculation”.2
1
The case for the adoption of the correct serial method instead of the net
discount rate formula appears to be overwhelming. There is, however, one
insurmountable obstacle confronting the adoption of the serial method. The
serial method is viable only if it is possible to forecast accurately the long term
rate of inflation and the long term rate of interest independently of each other.
However, these two rates cannot be forecast independently. No reputable
economist would attempt to forecast them separately for more than two or
three years into the future. Landsea’s prescription for combating and elimi-
nating error by replacing the net discount method with the serial method
contains the very real potential of introducing far greater error than it elimin-
ates.
The potential for serious error is exemplified well by the decisions of the
Supreme Court of Canada in the trilogy. For instance, in Arnold v. Teno,
judicial notice was taken of a pronouncement that the expected rate of
inflation over the long term future was 3.5%.” This statement was attributed
to Dr John Deutsch. Such a forecast was never made. 22 It appears that the
“9Supra, note 4, 110.
“Ibid.
2 Supra, note 1, 327.
‘It appears that the “Deutsch forecast” was introduced as evidence by Ms Doris Dadir, a
home economist who testified in the trial of Andrews v. Grand & Toy Alberta Ltd, supra, note
19831
NOTE
1023
3.5% figure was derived from a report of a Commission of Inquiry 13 to which
Dr Deutsch was appointed on 4 September 1973. The purpose of the inquiry
was to resolve a dispute about the cost of an agreed improvement in railway
pension benefits. The costing of the pension improvement was based upon
assumptions and not upon predictions of the future. Examining historical data
from the ten previous years, Dr Deutsch assumed that consumer prices would
increase by 3.5%; that wages would increase by 6.5% –
representing a
productivity gain of 3% plus an inflationary increase of 3.5%; and that the
interest rate on long term Government of Canada bonds would be 7% –
composed of a real rate of return of 3.5% and an inflationary component of
3.5%. These assumptions were, in no sense, predictions of each of the
variables in isolation. They were assumptions based upon the relative stability
of the interconnection between the various rates. Any individual error in the
assumption would tend to be cancelled out by compensating changes in the
other assumptions.24 If Dr Deutsch’s report had been studied carefully, the
Court would have appreciated that the long term inflation rate and the long
term interest rate cannot be predicted independently. Had all of Dr Deutsch’s
assumptions been used in Arnold v. Teno, the net discount rate would not
have been 7%.11 Instead, the net discount rate would have been either 3.5% or
0.5%. The 3.5% net discount rate would have been appropriate provided that
the lost future income was regarded as a flow of a fixed amount of real income
–
a nominal income stream which increased at a rate equal to the inflation
rate. This net discount rate of 3.5% would be the real rate of interest or the
inflation-free rate. The rate of 0.5% would have been the appropriate net
discount rate if the lost income stream were assumed to grow at a rate equal to
the rate of inflation plus a real growth rate of 3%. This net discount rate of
0.5% would represent the real rate of interest reduced by the real growth rate
1. When Dr John Murray, an economist called by the plaintiff in a subsequent case, contacted
Ms Dadir by phone, she was unable to recall the source of the documents. SeeLan v. Wu [1979]
2 W.W.R. 122, 128, (1978) 7 C.C.L.T. 314 (B.C.S.C.), leave to appeal to the S.C.C. refused
[1980] 2 S.C.R. ix. No reference to Dr Deutsch’s original statement was provided in the
transcript of the Andrews case. In Thornton, supra, note 1, 279, Mr Justice Dickson stated:
“Another expert witness, Mr. D. R. Badir, introduced into evidence the fact that the Economic
Council of Canada have [sic] gone on record as suggesting that over the next 40-year period the
average rate of inflation will be in the neighbourhood of 31/2 to 4 per cent.” Dexter, Murray &
Pollay, supra, note 2, 304, fn. 13, state: “The evidence is incorrectly attributed to a ‘Mr.
Badir”‘ instead of Ms Dadir.
I Government of Canada, Department of Labour, The Report of the Commission of Inquiry
Appointed by the Minister of Labour Relating to an Agreement reached on Increased Benefits
by the Unions and Railroad Companies (1973) (a report to the federal Minister of Labour).
21See Feldthusen & McNair, supra, note 2, 393.
2The Court arrived at the 7% rate by subtracting Dr Deutsch’s inflation rate assumption of
31A% from long term bond returns, then in excess of 10%. Thus, Dr Deutsch’s inflation rate
assumption was utilized independently of his 7% long term bond yield assumption on which it
was based, as if the inflation rate figure was a prediction which could be used in isolation.
1024
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[Vol. 28
PRESENT VALUE OF $10,000 PER YEAR
TABLE 2
Rates of Discount
Number of Years
10
20
30
40
50
0.5%
3.5%
7.0%
$97,304 $189,874 $277,941 $361,722 $441,428
83,166
234,556
138,007
70,236
142,124
105,940 124,090
183,920 213,551
133,317
UNDERSTATEMENT OF PRESENT VALUE CAUSED
BY SELECTING INAPPROPRIATE NET DISCOUNT RATES
7% instead of
3.5%
7% instead of
0.5%
15.5%
25.5%
32.5%
37.6%
41.2%
27.8
44.2
55.4
63.1
68.7
of wages. As can be seen by comparing Table 1 with Table 2, the error caused
by the methodological inaccuracy of the net discount rate technique pales into
insignificance when one considers the horrendous error resulting from choos-
ing the wrong net discount rate by forecasting the rate of inflation and the rate
of interest independently of one another.
The only feasible approach to the problems caused by forecasting infla-
tion and interest rates separately is to estimate the long term real or net rate of
interest on the basis of historical data and to assume that this rate will hold true
for the future. This approach means putting considerable faith in history, but
there is no alternative. If inflation turns out to be greater in the future than it
has been in the past, the error will tend to cancel out, because nominal interest
rates will also be higher. The nominal yield on a financial security is made up
of three components –
a real rate of return, a risk premium and compensation
for any erosion in value of the principal caused by expected inflation. As
inflation increases, the nominal rate of return will increase and vice versa, but
the real rate of return will tend to remain relatively stable. Thus, the net
discount rate or the real rate of interest can be estimated on the basis of past
experience without the need for an independent forecast of future inflation
and interest rates. 26
26 Parts of this note dealing with the net discount rate are based on the author’s chapter
entitled “Encouraging the Hearse Horse Not to Snicker: A Tort Fund Providing Variable
Periodic Payments for Pecuniary Loss” in F. Steel & S. Rodgers-Magnet, eds, Issues in Tort
Law (1983), 91.
19831
NOTE
1025
By contrast, the serial method of calculation proposed by Landsea
requires an independent forecast of the long term rate of inflation. As it is
impossible to predict long term inflation in isolation, it is not feasible to adopt
the serial method. Therefore, I am in fundamental disagreement with Landsea
when he hopes “that the courts will, in the future, adopt the more accurate
method”. 7 This is not, fortunately, an option available to courts in Ontario
and Nova Scotia where the net discount rate of 2.5 is mandated by the Rules of
Practice. For those provinces which could adopt the serial method, my
conclusion is that it could be an unmitigated disaster because it is faultily
premised upon the ability to forecast rates of inflation and rates of interest in
isolation.
IV.
Should There Be Any Discounting for Loss of Future Earnings?
We are all predisposed to assume, as does Landsea, that “[d]iscounting
is required to reduce future economic losses to equivalent present money
value damage awards” .’ We have been mesmerized unduly by the wonders of
compound interest. There is no denying that a dollar in the future is not worth
as much as a dollar today because today’s dollar can be invested and,
therefore, will be worth more than a dollar in the future. Discounting is
required if one is to provide exact compensation for a future single loss or a
future flow which is fixed in amount. If, however, the future loss is a flow of
income which is not constant in terms of nominal dollars, it is not as clear that
discounting is required. If the lost future flow of income increases at a rate
equal to the rate of inflation, as has been assumed so far in my analysis, the
present value should be determined by discounting at the real rate of interest
or the inflation-free rate of interest. However, if the lost future flow of income
increases at a rate which is greater than the rate of inflation, there is no reason
to believe that discounting is required. It is clearly not required if the growth
in real wages is equal to the real rate of interest. Therefore, one should focus
upon the relationship between the growth of real wages and the real rate of
interest. We must balance our knowledge of inflation and the effects of
compound interest with information about the average growth of real wages
over time.
The growth of average wages and salaries was considered by the Ontario
advisory committee. The committee, after studying the Canadian economic
experience from 1930 to 1979, concluded that “[e]mpirical evidence confirms
that average wages and salaries have consistently increased at a faster pace
than general price inflation”.2 9 This fact was attributed mainly to productivity
increases of the economy and, in part, to redistribution in favour of wages and
27Supra, note 4, 115.
Ibid., 103.
29Supra, note 9, 3.
1026
McGILL LAW JOURNAL
[Vol. 28
salaries. The committee concluded that wage increases will continue to
outpace general price inflation as “a permanent feature of our economic
system”.30 The economy may stumble and splutter, as it has done for the last
several years, but there is little reason to believe that there will not be real
growth in the long run which will result in real increases in wages and salaries.
The critical issue for the purpose of determining whether a discount rate
is warranted is the relationship between the real rate of interest and the real
growth of wages and salaries. The empirical evidence presented in Table 3 31
suggests that there is no justification for discounting to determine the present
value of the loss of a future flow of wages or salaries, if that future flow
conforms to the economic experience of the last 50 years. Only if Column 4,
which represents the excess of real wage growth over the real interest rate,
were to contain a preponderance of negative numbers would discounting be
appropriate. The preponderance of positive numbers indicates that the loss
should be compounded rather than discounted. For instance, the 50 year
experience from 1933 to 1982 indicates that the present value of a flow of
wages should be determined by compounding at a rate of 0.82%. The 25 year
experience from 1933 to 1957 would also point to a compounding at 2.05%
rather than to a discounting, whereas the 25 year experience from 1958 to
1982 would indicate a net discount rate of 0.41%. As might be expected, the
experience for 10 year periods is more variable: two periods, 1930-1939 and
1960-1969, indicate discounting of 3.77% and 1.09% respectively; whereas
three periods, 1940-1949, 1950-1959 and 1970-1979, indicate a compound-
ing of the loss at 4.58%, 1.72% and 0.90% respectively. The most recent 10
year experience points almost conclusively to a zero discount rate as one
could hardly expect anything closer to zero than minus 0.02%.
The economic experience of the last 50 years does not justify the view
that discounting is required but, conversely, demonstrates that it should not be
used. Plaintiffs who have been injured and who have lost future earnings have
not been compensated adequately. We have been too cognizant of the won-
ders of compound interest and have been unjustifiably oblivious to the
benefits derived from increases in general productivity of the economy. The
growth in real wages has, on average, been greater than or equal to the real
rate of interest. Therefore, discounting is not justified in determining the
present value of a lost average income flow.
Advocating a zero discount rate is neither novel nor radical. Business
professors, Dexter, Murray and Pollay, have concluded that a net discount
rate of zero is appropriate for lost employment income. They state:
3 Ibid.
31 Table 3 is reproduced from Appendix B of the Ontario advisory committee report, ibid,
9- 10, with the addition of column (4). All the data on which theTable is based are reproduced in
the Appendix to this note, infra, and have been updated for the period 1980-82.
1983]
NOTE
1027
TABLE 3
OR DISCOUNT
THE APPROPRIATE RATE OF COMPOUNDING
TO DETERMINE THE PRESENT VALUE
OF LOST FUTURE EARNINGS
(1)
(2)
(3)
(4)
Real Wage Growth
[Excess of increase
in wages & salaries
over increase in
prices]
(%)
Real Interest Rate
[Excess of
interest rate
over increase
in prices]
(%)
Excess of real
wage growth
over real
interest rate
[Col. (2) – Col. (3)]
(%)
2.33
2.08
2.53
2.12
2.47
1.69
1.86
2.70
3.04
2.04
2.01
0.39
1.86
1.26
1.55
2.17
0.42
2.10
5.63
(1.88)
1.32
3.13
1.11
0.41
0.47
0.82
0.98
(0.05)
2.05
(0.41)
(3.77)
4.58
1.72
(1.09)
0.90
(0.02)
Period
Annual Average
for 50 year
period from:
1930-1979
1933-1982
Annual Average
for 25 year
periods from:
1930-1954
1955-1979
1933-1957
1958-1982
Annual Average
for 10 year
periods from:
1930-1939
1940-1949
1950-1959
1960-1969
1970-1979
1973-1982
1028
REVUE DE DROIT DE McGILL
[Vol. 28
It is unreasonable to expect an investment portfolio designed to replace a relatively stable
income stream to achieve a real rate of return in excess of 2 to 3%, based on an analysis of
the last 40 years. In as much as real wages have also risen at an average rate of 2 to 3%
annually, a net discount rate of zero to 2% seems more appropriate, depending on the
extent to which lost labour income is an issue.3″
Law professors, Feldthusen and McNair, also recognize that a zero discount
rate is economically justifiable for lost earnings:
If, as has been argued, the 7% rate used by the court is not valid and should be replaced by
a real interest rate of, say, 3%, this would be entirely offset by anticipated productivity
gains. As a result, the appropriate discount rate would be 0%, that is, the award for future
earnings loss would be calculated by a simple addition of the amount earned at the present
level for the number of earning periods lost as a result of the accident.”
Connell concurs and states: “It is quite justifiable mathematically in many
cases to utilize a 0% discount rate.” 31 He believes a net discount rate of zero to
be appropriate for determining the loss of wage income because the growth in
[rneal wages, resulting from the excess of wages over inflation, is expected to continue at
the 2% level. As noted earlier the expected annual increase in real wages offsets the
expected annual increase in real interest rates so we deduct one from the other, to arrive at
a rate equivalent to discounting at approximately minus 1% to plus 1%.1
Professor Fleming has also concluded that there is economic justification for a
zero discount rate for lost future wages.36 He notes further that, by eliminating
discounting for lost future wages, damage awards would become more
predictable and settlements would be encouraged.37 Professor Sherman, on
the basis of the American economic experience, has also concluded that a zero
discount rate is appropriate for lost wages:
The conclusion, based upon the historical pattern of the past 32 years, is that future wage
increases of the injured party should at least match the present value discount factor
(interest rate). Therefore, future wages would be calculated, if one simultaneously ignores
the offsetting factors of wage increases and discount factors, by an arithmetic calculation
of the last annual wage… times the number of working years remaining. 8
He later says that “it makes the most sense when determining the present value
of future earnings simply to use the figure that results from multiplying the
current wage by the deceased’s actuarial life expectancy”. 9
32Supra, note 2, 306.
33Supra, note 2, 414.
4Supra, note 2, 138.
3 Ibid., 148.
16Fleming, The Impact ofInflation on Tort Compensation (1977) 26 Am. J. Comp. L. 51,
“Ibid.
38 Sherman, Projection ofEconomic Loss: Inflation v. Present Vahle (1981) 14 Creighton L.
69.
Rev. 723, 731.
39Ibid., 733.
1983]
NOTE
1029
It is not, however, academic writers only who have been persuaded that
there should be no discounting to determine the present value of a lost flow of
wages. In Olacke’s Estate v. Kenting Aircraft Ltd, Mr Justice Moore of the
Alberta Court of Queen’s Bench used a discount rate of zero. He stated: “In
my view, based on the evidence of an assumed return on investment of a fixed
income of 10%, less an allowance of 8% for future inflation and less an
allowance of 2% for future productivity, a zero discount rate should be
used.” 10 The Supreme Court of Alaska in Beaulieu v. Elliott 4 had earlier used
a net discount rate of zero.
Conclusion
There is very strong empirical evidence indicating clearly that no rate of
discount should be used to determine the present value of a lost future flow of
earnings sustained by an average wage earner. If the net discount rate is zero,
there will be, of course, no error in the calculation of the present value of such
a lost income stream. Its present value is calculated by simply adding the lost
current annual earnings for the appropriate number of years. There will be no
methodological error of the kind indicated by Landsea.
In all provinces that have not adopted a Rule of Practice specifying a net
discount rate, it is submitted that no discounting should be employed to
determine the present value of a lost flow of future earnings suffered by an
average wage earner. In Ontario and Nova Scotia, the Rules of Practice
specify a net discount rate of 2.5%. However, it should be noted that this
interest rate is relevant only “to the extent that it reflects the difference
-(1979) 20 A.R. 215, 220 (Q.B.).
41434 P. 2d 665 (1967) (S.C. Alaska). More recently, the Supreme Court of Pennsylvania in
Kaczkoivski v. Bolubasz, 421 A. 2d 1027 (1980) approved of the total offset or zero discount
method of the Beaulieu case. Nix J. stated, at 1038-9: “[We] find as a matter of law that future
inflation shall be presumed equal to future interest rates with these factors offsetting. Thus, the
courts of this Commonwealth are instructed to abandon the practice of discounting lost future
earnings.” The Kaczkowski case does not establish simply that in Pennsylvania the present
value of lost future earnings is to be determined without resort to discounting. The case goes
much further because it disapproves specifically of the restrictive recognition of productvity
gains accorded by the Alaska Court in Beaulieu. Thus, in addition to no discounting, Nix J.
states that courts are to consider the victim’s lost future productivity as a further factor. If expert
evidence establishes that the plaintiff would have achieved real wage gains, the damage award
for loss of earnings will be determined by compounding the first year’s wage loss at a rate equal
to the real wage growth for the appropriate number of years. See Shoot, Lost Earnings: The
Discount/Inflation Problem (1983) 15 Trial Lawyers Q. 27; and Humey, Tort Damages: The
Adjustment of Awards for Lost Future Earning Capacity to Compensate for Inflation and
Increased Productivity (1981-82) 7 U. Dayton L. Rev. 139.
1030
McGILL LAW JOURNAL
[Vol. 28
between estimated investment and price inflation rates”.42 Because the rule
mentions only investment rates and price inflation rates and not the growth of
real wages, the rule establishes only the real or inflation-free rate of interest.
The rule therefore provides only the appropriate net discount rate to determine
the present value of a future flow of income which is increasing at the same
rate as inflation. It is not the appropriate rate to determine the present value of
the lost future earning of an average wage earner because his wage will rise in
response both to inflation and to rates of growth in productivity.’ 3 The
advisory committee report helps to clarify this point. The report, after con-
cluding that the real rate of interest is between 2% and 3%, stated that:
[To estimate the lump sum equivalent of a stream of future amounts that… would have
been expected to increase at the same pace as average wages and salaries, it would be
appropriate to discount those amounts … on the basis of a capitalization rate that is about
2% per year less than the [real rate of interest], i.e., at around 1% per year.'”
Thus, in Ontario and Nova Scotia, a zero discount rate will be appropriate for
a lost flow of future earnings, provided it can be established that those
earnings would have increased in real terms at a rate of approximately 2.5%.
In Lewis v. Todd, Mr Justice Dickson accepted productivity as a relevant
factor in assessing a damage award and noted that this factor had not been
raised in the trilogy.45 He found that there was evidence to support a 2%
Scotia Civil Procedure Rules, r. 31.10(2).
“2Supreme Court of Ontario Rules of Practice, R.R.O. 1981, Reg. 540, r. 267a; and Nova
43
1It is unfortunate that a separate sub-rule was not established to determine the present value
of an average flow of future wages. This would have eliminated the confusion which appears to
be developing in Nova Scotia. In Whitehead v. Misner (1981) 48 N.S.R. (2d) 416, (1981) 92
A.P.R. 416 (S.C., T.D.), counsel for the plaintiff argued that the discount rate should be
adjusted to reflect real wage growth and had adduced evidence that pay increases averaged
more than 1% higher than the increase in the Consumer Price Index. Madam Justice Glube
refused to vary the 2.5% net discount rate and, at 445, stated that “to tamper with this rate based
on individual circumstances would present great difficulties”. On appeal, the damage award
was reduced. See (1982) 51 N.S.R. (2d) 111, (1982) 102 A.P.R. 111 (S.C., App. Div.).
MacKeigan C.J.N.S. used the 2.5% net discount rate prescribed by the Rules, but did not
discuss whether evidence of real wage growth might justify a lower discount rate. No
adjustment for real wage growth was permitted in Shaw’s Estate v. Roemer (1981) 46 N.S.R.
(2d) 629, 686, (1981) 89 A.P.R. 629 (S.C., T.D.). A preferable approach has been adopted by
Mr Justice Hallett in Comeau v. Marsman (1981) 47 N.S.R. (2d) 550, 560, (1981) 90 A.P.R.
550 (S.C., T.D.), who states that “the judges did not intend that the only discount rate that
could be appropriate in any particular case would be 21/%. The fixing of the discount rate at
21/2% is intended to reflect only the difference between interest rates and the rate of inflation. In
any given case, there could be factors that would indicate that this discount rate would be
inappropriate.”
“Supra, note 9, 5-6.
“s[1980] 2 S.C.R. 694, 712, (1980) 115 D.L.R. (3d) 257.
1983]
NOTE
1031
productivity growth rate figure. In Ontario and Nova Scotia, this factor would
result in a net discount rate of 0.5%.1
Unrealistically high net discount rates are still being used by some courts
to determine the lump sum damage award for loss of future income of average
wage and salary earners. 47 We are only paying lip service to the principle that a
tort victim is entitled to full indemnity for all pecuniary losses. 4 Reality
denies the mythology of full compensation. Applying any discount rate, and
certainly a net discount rate which is greater than 0.5% or 1.0%, to lost future
earnings, implies clearly that the court is denying the right of a victim to share
in the future growth of wages stemming from the productivity gains of the
economy. Discount rates, particularly unrealistically high net discount rates,
are adding insult to injury. Such discount rates proclaim that the injured
person was a substantially below-average worker who would not have shared
in the productivity gains of the economy if he had not been injured.
the courts are reluctant to modify the net discount rate prescribed by the Rules, the
simplest solution would be to build the rate of growth of real wages into the lost future income
stream before any discounting occurs. One can then continue to use the 2.5% discount rate and
yet still recognize the growth of real wages. This would be analogous to the serial calculation
which Landsea advocates. Such a serial calculation is possible because the growth of real
wages and the real rate of interest can be forecast independently.
47 The use of discount rates is certainly appropriate in the determination of the present value
of a discrete amount of future loss or of a loss of a flow of future values which increases solely in
response to inflation. A discount rate will have to be applied to determine the present value of
such a lost value stream. However, the net discount approach will produce a methodological
error as described by Landsea which is always adverse to the plaintiff, but the quantum of
which defies prediction. This error is something which judges should bear in mind when
assessing damage awards, particularly for very long term economic losses. Although there is
no precise way of compensating for this methodological error, a judge should perhaps be less
inclined to apply contingency deductions against such plaintiffs unless the deductions are
clearly justified.
4If
4 The principle has been set forth by the Supreme Court in Andrews, supra, note 1,240-2.
CANADIAN
APPENDIX
INTEREST, PRICE AND WAGE RATES 1930-19821
Interest
Rate’
(%)
4.56
5.42
4.83
4.62
3.46
3.67
3.11
3.21
3.03
3.50
3.11
3.06
3.06
3.00
2.99
2.83
2.60
2.56
2.93
2.75
2.99
3.50
3.62
3.68
3.14
3.07
Annual
Increase
in Prices’
Annual
Increase
in Wages
and Salaries4
(%)
-0.61
-9.81
-9.19
-4.69
1.39
0.72
1.80
3.20
1.07
-0.77
4.07
5.83
4.85
1.75
0.48
0.52
3.39
9.46
14.18
3.16
2.93
10.52
2.40
-0.85
0.65
0.15
(%)
0.62
-3.28
-7.20
-5.02
0.96
2.86
1.85
7.50
2.96
0.41
3.89
8.86
8.32
9.01
3.22
2.82
9.52
11.86
12.72
4.49
5.50
12.89
7.22
4.62
3.22
2.76
Real
Interest
Rate
(%)
5.17
15.23
14.02
9.31
2.07
2.95
1.31
0.01
1.96
4.27
-0.96
-2.77
-1.79
1.25
2.51
2.31
-0.79
-6.90
-11.25
-0.41
0.06
-7.02
1.22
4.53
2.49
2.92
Real
Wage
Growth
(%)
1.23
6.53
1.99
-0.33
-0.43
2.14
0.05
4.30
1.89
1.18
-0.18
3.03
3.47
7.26
2.74
2.30
6.13
2.40
-1.46
1.33
2.57
2.37
4.82
5.47
2.57
2.61
Year
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
1950
1951
1952
1953
1954
1955
‘1930-79 data from Report to the Committee of the Supreme Court of Ontario on Fixing
Capitalization Rates in Damage Actions (14 February 1980) Appendix. The Table was updated
to 1982 by David Arrowsmith of the Industrial Relations Centre, Queen’s University. The
1979 values were also revised.
2Measured by average yield to maturity on long term Government of Canada bonds.
3Measured by the Statistics Canada Consumer Price Index.
4Taken from industrial composite wage and salary index shown in Canadian Insitute of
Actuaries, Sub-Committee on Economic Statistics, Report on Canadian Economic Statistics
1924-1978.
Annual
Increase
in Prices3
Annual
Increase
in Wages
and Salaries
(%)
1.48
3.15
2.63
1.09
1.31
0.87
1.20
1.75
1.79
2.46
3.74
3.57
4.09
4.51
3.37
2.84
4.77
7.61
10.86
10.81
7.51
7.99
8.96
9.13
10.15
12.49
11.69
(%)
4.94
5.25
3.90
4.24
-0.35
3.91
2.94
3.39
3.87
5.21
5.81
6.74
6.93
7.20
7.60
8.57
8.41
7.53
10.99
14.18
12.15
9.61
6.17
8.62
10.11
12.09
9.65
Real
Interest
Rate
(%)
2.12
1.04
1.65
4.14
3.80
4.19
3.90
3.34
3.39
2.74
1.94
2.33
2.64
3.05
4.60
4.11
2.46
-0.06
-1.99
-1.81
1.71
0.70
0.28
1.07
2.33
2.78
-0.88
Real
Wage
Growth
(%)
3.46
2.10
1.27
3.15
-1.66
3.04
1.74
1.64
2.08
2.75
2.07
3.17
2.84
2.69
4.23
5.73
3.64
-0.08
0.13
3.37
4.64
1.62
-2.79
-0.51
-0.04
-0.40
-2.04
Interest
Rate2
(%)
3.60
4.19
4.28
5.23
5.11
5.06
5.10
5.09
5.18
5.20
5.68
5.90
6.73
7.56
7.97
6.95
7.23
7.55
8.87
9.00
9.22
8.69
9.24
10.20
12.48
15.27
10.81
Year
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
‘1930-79 data from Report to the Committee of the Supreme Court of Ontario on Fixing
Capitalization Rates in Damage Actions (14 February 1980) Appendix. The Table was updated
to 1982 by David Arrowsmith of the Industrial Relations Centre, Queen’s University. The 1979
values were also revised.
2Measured by average yield to maturity on long term Government of Canada bonds.
3Measured by the Statistics Canada Consumer Price Index.
4Taken from industrial composite wage and salary index show in Canadian Institute of
Actuaries, Sub-Committee on Economic Statistics, Report on Canadian Economic Statistics
1924-1978.
