NOTE
How Workable are Net Discount Rates?
William F. Landsea*
The net discount rate, a concept sanctioned
by the Supreme Court of Canada in the now-
famous 1978 trilogy of damages cases, is
shown by the author to introduce serious
error into the process of calculating the pre-
sent money value of lost future economic
values in personal injury and wrongful death
cases. The error typically understates the
present money value and leads to inadequate
damages awards. In situations involving the
replacement of losses occurring over an ex-
tended number of years, successful plaintiffs
may recover as little as one-half of their
future losses. The error introduced by the net
discount concept originates when the netting
of growth rates and discount rates alters a
critical fraction in the present value formula.
The author demonstrates how the problem
can be solved by using a serial calculation
method.
L’auteur d6montre que le taux d’escompte
net, dont l’utilisation fut sanctionnde par la
Cour supreme en 1978 dans la d6sormais
c61 bre trilogie d’arr6ts rendus sur la ques-
tion de ‘6valuation des dommages futurs,
peut produire de s6rieuses erreurs dans I’6va-
luation, en valeurs actuelles, de pertes 6co-
nomiques A venir. Ainsi, ces valeurs ac-
tuelles seraient syst6matiquement sous-
estimdes, produisant ainsi des attributions
inad6quates de dommages-int6r6ts. Par
exemple, obi une affaire exigerait qu’on 6va-
lue la valeur de pertes s’6chelonnant sur une
p6riode 6tendue d’ann6es, un demandeur
pourrait se voir allou6 un montant 6quivalant
A la demie de ses pertes futures r6elles. L’er-
reur se produirait lorsque l’6valuation de
l’effet combin6 des taux d’escompte et d’ac-
croissement modifierait une fraction essen-
la d6termination exacte de Ia valeur
tielle
pr6sente. L’auteur pr6sente une solution qui
saurait pallier au probl~me en utilisant une
m6thode de calcul sdquentiel.
Synopsis
Purpose of Present Money Value Awards
Introduction
I.
H. Methodological Error in the Use of Net Discount Rates
III.
Conclusion
Impact of the Error Induced by Use of Net Discount Rates
*
*
*
*Associate Professor of Finance at the University of Miami, Coral Gables, Florida. Dr
Landsea has given expert testimony on the discounting process in United States Federal District
Court, Administrative Law Court and Florida Circuit Court.
19821
Introduction
NOTE
A discount rate is an important element in the calculation of the present
money value of future economic damages in personal injury and wrongful
death cases. These damage assessment calculations typically incorporate: (a)
an original or current economic value, such as a pre-injury wage potential or
current medical care costs, (b) the expected growth rate of the potential
economic loss (including inflationary expectations), (c) the number of future
time periods over which the loss is expected to persist, and (d) a discount rate.
Discounting is required to reduce future economic losses to equivalent
present money value damage awards. For instance, a plaintiff who will incur
an economic loss of $20,000 a year from now (e.g., because of lost wages)
will be satisfied with a damages award of less than $20,000 paid to him today.
He can invest this lesser amount now so that it will be worth $20,000 by the
end of the year. In this illustration the $20,000 future loss is afuture value; the
lesser amount with which the plaintiff is satisfied today is apresent value. The
financial device used to reduce future values to present values is the discount
rate.
A number of recent articles have noted the recognition given by the
Supreme Court of Canada to a net discount rate concept.’ This concept was
first applied by the Court in three cases decided together in January 1978 and
collectively referred to as the trilogy.2 The net discount rate is a rate deter-
mined by subtracting the anticipated rate of future inflation from the antici-
pated yield on appropriate investment securities. In the trilogy, the Supreme
Court accepted the argument that inflationary expectations (then of 3.5% per
annum) should be netted against currently available long term bond returns
(then in excess of 10%) to produce a net discount rate (then of 7% per annum).
I Dexter, Murray & Pollay, Inflation, Interest Rates andIndemnity: The EconomicRealities
of Compensation Awards (1979) 13 U.B.C. L. Rev. 298; Paterson, Loss of Future Income In
Actions for Damages (1980) 26 McGill L.J. 114; Gibson, Repairing the Law of Damages
(1978) 8 Man. L.J. 637; Braniff & Pratt, Tragedy in The Supreme Court of Canada: New
Developments in the Assessment of Damages for Personal Injuries (1979) 37 U. T. Fac. L.
Rev. 1; Feldthusen & McNair, General Damages in Personal Injury Suits: The Supreme
Court’s Trilogy (1978) 28 U.T. L.J. 381; Bissett -Johnson, Damagesfor Personal Injuries-
The Supreme Court Speaks (1978) 24 McGill L.J. 316; McLachlin, What Price Disability? A
Perspective on the Law of Damagesfor Personal Injury (1981) 59 Can. Bar Rev. 1; Connell,
Discount Rates – The Current Debate (1980) 2 Advocates’ Q. 138; Boyle & Murray,
Assessment of Damages: Economic and Actuarial Evidence (1981) 19 Osgoode Hall L.J. 1.
2Andrews v. Grand & Toy Alberta Ltd [1978] 2 S.C.R. 229, (1978) 83 D.L.R. (3d) 452
[hereinafter cited to S.C.R.]; Arnold v. 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. See also Keizer v. Hanna
[1978] 2 S.C.R. 342, (1978) 82 D.L.R. (3d) 449.
McGILL LAW JOURNAL
[Vol. 28
The same concept has found acceptance, albeit not unanimous acceptance, in
the United States as the so-called offset method.3
Other authors argue correctly that an analysis of historical data may
suggest net discount rates different from the 7% per annum accepted by the
Supreme Court in the trilogy.4 Additional factors such as investment expenses
and portfolio distribution effects have also been suggested as reasons for
deductions from the gross investment return for the purpose of determining
the appropriate net discount rate.5
In fact the net discount rate concept suffers from even more fundamental
problems. This note demonstrates that the rate is a mathematically inaccurate
approximation 6 and leads to substantial error in the determination of the
present money’value of future economic losses.
The errors introduced into the calculations by the net discount rate
concept typically understate the present money value. When the present
money value is understated, it follows that future economic losses cannot be
made whole and, as a consequence, serious economic harm will be done to
recipients of the understated judgment amounts. Given factors which are
likely to occur in today’s economy, understatements of present money value
as small as 6% are shown to lead to shortfalls of almost 50% in the replace-
ment of lost future values.
There is, however, a correct method for reducing forecasted future
economic damages to present money values.7 The correct method does not
ignore the factors recognized by the Supreme Court and by the various
authors, but combines them in a manner more likely to make the plaintiff
economically whole. It is to be hoped that the courts will recognize this
essential deficiency in the net discount rate concept and remedy it with the
same regard for precision that was exhibited in the trilogy judgments.8
See Feldman v. Allegheny Airlines, Inc. 524 F.2d 384 (2d Cir. 1975); McCough, Future
Inflation, Prospective Damages and the Circuit Court (1977) 63 Va L. Rev. 105; Wainscott,
Computation of Lost Futurd Earnings in Personal Injury and Wrongful Death Actions (1978)
11 Indiana L. Rev. 647.
4Dexter, Murray & Pollay, supra, note 1, 301-6; Paterson, supra, note 1; Gibson, supra,
note 1, 650-2; Braniff & Pratt, supra, note 1, 25-8; Feldthusen & McNair, supra, note 1,
393-401; McLachlin, supra, note 1,25-6; Connell, supra, note 1; Rea, Inflation, Taxation and
Damage Assessment (1980) 58 Can. Bar Rev. 280, 281-6; Boyle & Murray, supra, note 1, 3-7;
K. Cooper-Stephenson & I. Saunders, Personal Injury Damages in Canada (1981) 269.
5McLachlin, supra, note 1, 27; Connell, supra, note 1, 145-6. Such deductions were made
by Southey J. in Julian v. Northern and Central Gas Corporation Ltd (1978) 5 C.C.L.T.
148, 159-60 (Ont. H.C.) and were not challenged on appeal (1979) 31 O.R. (2d) 388 (C.A.).
6See infra, Part II especially Table 2.
7See infra, Part I especially Table 1 and note 19.
8The trilogy did introduce several advances contributing to greater precision in the assess-
ment of damages. First, the awards made in the cases were itemized rather than merely
19821
NOTE
I.
Purpose of Present Money Value Awards
Generally, the purpose of present money value awards for future econo-
mic losses is to provide a one-time immediate payment to compensate for
expected future losses. 9 For example, if an individual is injured and becomes
permanently unable to earn an income he may seek damages for lost prospec-
tive future wage earnings. An award, if justified by a finding of liability,
would give the plaintiff a sum to invest now to replace the expected future lost
wages. Ideally, the invested sum would produce an annual income that,
together with the timely consumption of a portion of the body of the award,
would equal exactly the amounts lost in future wages at the time they would
have been earned.
For example, assume that in a particular case lost future wages are
predicated in part upon the injured party’s earnings history. This history
shows wages of $9,090.91 in the income year immediately prior to the
plaintiffs disability. The expected future yearly wages are forecast to be,
successively, $10,000.00, $11,000.00 and $12,000.00 over a three year
period. 0 Assuming that investment returns at the time are 15% per annum, the
present money value of the lost future earnings is calculated to be
$24,969.18.” The present money value in this case is calculated in a series of
disclosed as a single amount. Second, the awards were actuarially calculated; future inflation
rates and investment returns were taken into account. Despite the problems inherent in the net
discount rate method, it is admittedly more precise than the previously used “Lord Diplock”
approach, which assumed economically stable returns and ignored the possibility of inflation
(see Andrews v. Grand & Toy Alberta Ltd, supra, note 2, 254-5).
9The role of the discount rate in calculating present money value awards was explained by
Mr Justice Dickson in Lewis v. Todd [1980] 2 S.C.R. 694, 709-10, (1980) 115 D.L.R. (3d)
257: “It would be useful to recall precisely the function which the ‘discount rate’ is intended to
serve. In the case of a fatal accident the Court is endeavouring to compensate the dependents of
the deceased for loss of a future stream of income which the dependents might have expected to
receive but for the death of the deceased. As it is not open to a Court, in the absence of enabling
legislation, to order periodic payments adjusted to future needs, the dependents receive
immediately a capital sum roughly approximating the present value of the income they would
have received had the deceased survived.” This one-time lump sum award has been widely
criticized. See Andrews v. Grand & Toy Alberta Ltd, supra, note 2, 236-7, per Dickson J.;
Fleming, Damages: Capital or Rent? (1969) 19 U.T.L.J. 295; Gibson, supra, note 1, 638;
Braniff & Pratt, supra, note 1, 4-7; Feldthusen & McNair, supra, note 1,418-25; McLachlin,
supra, note 1, 13-7; McKellar, Structured Settlements – A Current Review (1981) 2 Advo-
cates’ Q. 389.
“I.e., a 10% per annum growth rate is assumed.
“Calculated by the standard present value formula:
N
PV =.-
t = 1
Future Value
(1+ d)
where PV = Present value
= Time period (I through N)
t
N = Number of time periods = 3
d = Discount rate = 15%
Future value = $10,000 in t1 , $11,000 in t2 ,
$12,100 in t 3 .
REVUE DE DROIT DE McGILL
[Vol. 28
steps, each year in turn. These serial calculations are necessary since each
year’s future value is different in amount from the values in other years.
Table 1 illustrates how the lost future wages will be replaced by interest
earned on the award at 15% per annum together with partial consumption of
the award in each period. Note that in the first year the $24,969.18 investment
fund will earn $3,745.38 in interest at the 15%per annum rate. Since the first
year’s forecasted lost wages are $10,000.00, this leaves a $6,254.62 shortfall
to be made up by consumption of a portion of the investment fund. In the
second year the remaining investment of $18,714.56 produces $2,807.18 in
interest earnings. To make up the balance of the $11,000.00 forecasted lost
wages for the second year an additional $8,192.82 of the investment fund
must be consumed. At the beginning of the third and final year, only
$10,521.74 of the investment fund remains. This amount is entirely con-
sumed along with the year’s interest of $1,578.26 to exactly replace the
$12,100.00 of forecasted lost wages.
Assuming that there are no transaction costs on the investment and no
management costs after the investment was made (or alternatively consider-
ing the 15% per annum discount rate to be an investment return net of these
expenses), it can be seen that the investment of the serially-calculated award
at the 15% per annum rate produces enough income, along with the timely
consumption of parts of the award, to provide a future payments stream
exactly equal to the plaintiff’s forecasted lost wage stream.
II. Methodological Error in the Use of Net Discount Rates
Net discount rates, as defined by the Supreme Court in the trilogy, are
being used today to assess the present value of damages in the types of
situations illustrated above.'” The example given in Part I implicitly assumed
a 10% wage growth rate per annum ‘1 and explicitly cited a 15% per annum
gross discount rate. This results in a 5% per annum net discount rate.
In brief, the net discount method treats the lost future wage stream as an
annuity 11 to be discounted at the net discount rate. The usual form of present
1
2 See Lewis v. Todd, supra, note 9.
OSee supra, note 10.
“An annuity is generally defined as a stream of equal payments occurring at regular
intervals.
19821
NOTE
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McGILL LAW JOURNAL
[Vol. 28
value equation for an annuity is then employed ,1 rather than separate serial
calculations for each year as was done in Part I.
The assumption implicit in this procedure is that discounting an annuity
by a net discount rate will produce a present value award equivalent to that
obtained in the preceding example with separate serial calculations. This
assumption is incorrect. To further understand the error inherent in the net
discount method, consider the situation when the method is used to determine
the present money value of the lost wage stream discussed earlier. In that case
the income in the last year preceding the disability was $9,090.91. This
becomes the annual annuity amount to be discounted at the net discount rate of
5% (Dm = 15% and g = 10%) for a 3 year period. The net discount-annuity
method determines the present money value to be $24,756.80. ‘6 Note that this
present value is approximately 1% less than the present money value as
determined previously by the serial calculation method under the same basic
assumptions (DM = 15%, g = 10%, WA = $9,090.91 and n = 3 years) in
Part 1.17
Table 2 demonstrates the incompatability of the two methods of present
value calculation. In Table 2 an investment of $24,756.80 (the net discount-
annuity present value) is made at a yield of 15% per annum and the income is
consumed along with portions of the investment to produce amounts neces-
sary in an attempt to replace the forecasted lost wages. In the third year the
income plus the remaining balance of the investment fund is insufficient to
replace the forecasted $12,100.00 annual wage. The shortfall is $323.00 or
nearly 3% of the forecast income for that year.
The reason for the understatement is that the net discount rate concept
incorrectly combines the gross discount rate with the wage growth rate. This
imprecision thereby alters a critical fraction created in the present value
formula when the growth factor is divided by the discounting factor.,8
“Present money value of an annuity:
PVA= WA
DR L
1 1
(1 + DR)”
where PVA = Present value of annuity
WA = Wage in income year immediately prior to plaintiff’s disability. In the
example of Part I it was $9,090.91.
DR = Net discount rate = 5%.
N = Number of time periods = 3.
6Calculated by formula contained in note 15.
7See supra, note 11.
“The fraction in question shows up as part of the standard formula for the present value of a
particular future year’s wage, where the wage is growing atrateg from an initial amount of WA:
Present Money Value =WA
+ g)N
( + DM)N
19821
NOTE
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REVUE DE DROIT DE McGILL
[Vol. 28
The differences of 1% in the total present value and 3% in the final year’s
wage replacement sum may not seem overly significant in that they are
relatively small compared to the total damages award. Two observations may
be made at this point. First, in this instance and in many other possible
circumstances the differences are small and the results are reasonable approx-
imations of the true present value calculated by the serial method. However,
as shown above, the net discount-annuity present value approximations are
not mathematically accurate calculations. In inflationary times the calcula-
tions systematically undercompensate the plaintiff. There can be little excuse
for a court resorting to an inaccurate approximation when absolute accuracy is
possible with the serial method. It cannot even be argued that the net discount-
the serial method formula can be reduced
annuity method is easier to apply –
to an equally convenient one-step calculation. 9 Perhaps more significant is
that the net discount-annuity method is sometimes a poor approximation.
Table 3 shows the percentage by which the net discount-annuity method
In this formula N refers to the particular future year and Dhl refers to the gross discount rate.
Note that the fraction (1 + g) N divided by (I + DM) N combines elements of both the growth
rate and the discount rate. In the net discount rate method this growth/discount fraction is
changed to: 1/(1 + DR) N. Here the net discount rate, DR, incorrectly combines the growth and
discount processes into one variable. Below, the values of these two versions of the growth/
discount fraction are compared for various time periods under the assumptions of a growth rate,
g, of 10% and a gross discount rate, D?,, of 15%:
Value of Single Year Growth/Discount Fraction
Net Discount-
Annuity Method
Serial Method
Year
1
5
10
20
40
It can thus be seen that substantial individual year present value errors result from the use of the
net discount-annuity method.
.952
.784
.614
.377
.142
.957
.801
.641
.411
.169
Difference as a
Percentage of
Serial Value
0,5%
2.2
4.2
8.3
16.0
‘9Present money value with serial calculations:
PVS W [
(1I
g)N ]
DR
(1 + DM)N
PVs = Present value calculated by serial method
W
= Lost wage in first future period [or wage in income year immediately prior to
plaintiffs disability multiplied by (I + g)]
= Growth rate in wages
g
DM = Gross market discount rate
N
DR =DM – g
= Number of time periods
19821
NOTE
understates the present value as compared to the serial method for various
combinations of gross discount rates, growth rates and number of years of
economic loss. From the Table a number of generalizations can be made.
UNDERSTATEMENT OF PRESENT MONEY VALUE CAUSED BY
USE OF THE NET DISCOUNT-ANNUITY METHOD*
TABLE 3
(A) With a 15% per annum gross discount rate:
Gross Discount Rate
Growth Rate
Net Discount Rate
15%
14%
1%
15%
12%
3%
15%
10%
5%
15%
8%
7%
15%
6%
9%
15%
4%
11%
Number of Years
of Economic Loss
10
20
30
40
50
0.66% 1.63% 2.20% 2.38% 2.23% 1.77%
1.24
1.78
2.32
2.83
3.82
5.12
6.15
6.94
2.95
4.11
5.13
6.02
3.99
5.16
5.96
6.50
3.60
4.49
5.02
5.32
2.75
3.31
3.60
3.74
(B) With a 10% per annum gross discount rate:
Gross Discount Rate
Growth Rate
Net Discount Rate
10%
9%
1%
10%
7%
3%
10%
5%
5%
10%
3%
7%
Number of Years
of Economic Loss
10
20
30
40
50
0.44% 1.00% 1.15% 0.94%
0.83
1.20
1.56
1.91
1.81
2.52
3.15
3.69
2.01
2.70
3.24
3.66
1.58
2.04
2.36
2.57
* Relative Understatement = (PVs – PVA)/PVs
where PVs = Present value calculated by serial method
PVA = Present value calculated by net discount-annuity method.
McGILL LAW JOURNAL
[Vol. 28
First, as would be expected, longer time periods result in greater distor-
tion. The maximum percentage understatement found occurs at fifty years –
the longest time period calculated on the Table. The hardest hit by the
inaccuracies of the net discount rate concept will be the young plaintiff whose
life expectancy has not been reduced significantly by the disability suffered. 0
Second, the understatement caused by the net discount-annuity method is
greater when the gross discount rate is high. This can be seen by comparing
figures in (A), where a 15% per annum gross discount rate was assumed, with
those in (B), based on a 10% rate. This holds true even when the net discount
rate is identical (e.g., the understatement is greater when the net discount rate
is 1% if this 1% is the result of a gross discount rate of 15% and a growth rate
of 14%, rather than 10% and 9% respectively). Thus, in long periods of high
interest rates, damage awards calculated under the net discount rate method
will be understated more seriously.
Third, when growth rates approach the gross discount rate (i.e., when
net discount rates approach zero) the relative understatement caused by the
net discount rate method is minimized. Recent economic literature suggests
that conditions leading to this result are rather commonplace.” Finally, when
the growth rate moves down from the gross discount rate (i.e., when the net
discount rate grows larger) the relative understatement at first increases, then
decreases as the growth rate approaches zero. Table 3 shows that the approx-
imation of present value afforded by the net discount-annuity method varies
from one set of circumstances to another, and that in some cases it produces
understatements of almost 7% from the true figures.
I. Impact of the Error Induced By Use of Net Discount Rates
Though a 7% understatement in the present value damages award may
strike some observers as of little consequence, 2 it does amount to a deficiency
of over $40,000 on a total award of $600,000
– not an insignificant
amount.
on the basis of 57 years, see Arnold v. Teno, supra, note 2, 335.
10One fund for the provision for future care of an infant plaintiff, Diane Teno, was calculated
211lbbotson & Sinquefield, Stocks, Bonds, Bills and Inflation: Year-by-Year Historical
Returns (1926-1974) (1976) 49 J. Bus. U. Chi. 11,40; lbbotson & Sinquefield, Stocks, Bonds,
-Bills and Inflation: Updates (1979) 35 Financial Analysts J. 40, 43.
“Especially given the imprecision inherent in the estimation of gross investment rates,
inflation rates and the level of economic losses themselves.
3The average amount awarded for pecuniary damages in the trilogy was $586,183.
1982]
NOTE
Even more serious, however, is the effect this understatement in present
value has on future values. The present value understatement leads to short-
falls of much larger proportions in the replacement of future losses because of
the cumulative effect of the loss of interest that would otherwise accrue 24 on
the present value shortfall. For example, in the illustration given in Table 2,
the $323.00 future value shortfall is a greater proportion of the total future
wage loss of $33,100.00 (the total of the Column (4) amounts) than the
present value understatement of $212.38 is of the correct present value of the
loss, $24,969.18.
As shown in Table 4, when losses occur over an extended number of
years and the gross discount rate is high, the understatement of present value
caused by the use of the net discount method creates a very large shortfall in
the replacement of future lost wages. 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 insuffi-
cient award dooms the plaintiff to a recapture of only 51% of lost future wages
–
a shortfall of 49%.26
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 year period 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. Because the growth rate results in geometrically
increasing annual payment amounts, the last 8 and a fraction years (i.e. just
over 20% of the years) account for 49% of the total future dollar loss.
An examination of the shortfall in future values presented in Table 4
dramatizes clearly the inadequacy of the net-discount method. It is submitted
that the focus on future value shortfalls (as opposed to the relatively smaller
present value understatements shown in Table 3) is justified since the object
of present value discounting is to arrive at present money values which
compensate for all lost potential future values. Large shortfalls, such as are
illustrated in Table 4, are particularly troublesome because full compensation
is now the rule in the assessment of pecuniary damages. 2 The net discount
approach is clearly not an acceptable method of calculation.
“Theoretically at the gross discount rate.
“See Table 3, supra.
‘Even this figure is conservative in that it does not compensate the plaintiff for the lost
opportunity cost of future funds not collected due to the net discount method’s initial under-
statement of present value.
‘Andrews v. Grand & Toy Alberta Ltd, supra, note 2, 240-2.
REVUE DE DROIT DE McGILL
[Vol. 28
SHORTFALL IN FUTURE REPLACEMENT VALUE PAYMENT
AMOUNTS CAUSED BY USE OF THE NET DISCOUNT-ANNUITY
TABLE 4
METHOD*
(A) With a 15% per annum gross discount rate:
Gross Discount Rate
Growth Rate
Net Discount Rate
15%
14%
1%
15%
12%
3%
15%
10%
5%
15%
8%
7%
15%
6%
9%
15%
4%
11%
Number of Years
of Economic Loss
10
20
30
40
50
1.15% 2.92% 4.00% 4.43% 4.24% 3.43%
3.55
9.17 12.57 13.92 13.53 11.28
7.63 19.34 26.44 29.58 29.18 25.43
13.46 32.81 44.19 49.09 48.86 43.68
20.47 48.22 62.54 67.86 67.00 60.81
(B) With a 10% per annum gross discount rate:
Gross Discount Rate
Growth Rate
Net Discount Rate
10%
9%
1%
10%
7%
3%
10%
5%
5%
10%
3%
7%
Number of Years
of Economic Loss
10
20
30
40
50
0.66% 1.51% 1.77% 1.46%
1.82
4.13
3.69
8.82
6.40 14.97 18.15 16.20
9.91 23.33 28.77 26.44
4.20
4.95
8.64 10.25
* Shortfall = Deficiency in future value calculated by net discount-annuity method as a
percentage of total future value loss. [E.g., in terms of the illustration in Table
2: $323 divided by $33,100 x 100].
Conclusion
The 1978 trilogy of personal injury cases introduced major advances in
damage assessment techniques. Unfortunately, the cases also marked the
Supreme Court’s acceptance of the net discount rate –
a concept with
considerable common sense appeal.
1982]
NOTE
115
However, the net discount rate has been shown to be an inaccurate
approximation of the combined effect of gross discount rates and economic
growth factors, as used in present value calculations. In inflationary times,
use of the net discount rate will systematically undercompensate the plaintiff,
conceivably up to 7% of the present value damages award to which he is
entitled. The present value error leads in turn to a shortfall of even larger
proportions in the replacement of future lost values, to the extent that plain-
tiffs could conceivably recover as little as 50% of their future losses.
Fortunately there is a correct procedure for reducing future economic
damages to present money values –
the serial method of calculation pre-
sented herein. This method takes into account all the factors recognized by the
Supreme Court in the trilogy and applies them in a mathematically correct
fashion. Furthermore, the serial method is just as easy to apply as the net
discount rate approach. It is to be hoped that the courts will, in the future,
adopt the more accurate method.
