Mandated Discount Rates in Civil Litigation—the CIA’s Role

 

By Craig A. Allen, FCIA

The last Wednesday in August is just behind us, which means it’s time for the CIA to assist Ontario’s Ministry of the Attorney General in setting the next year’s discount rate for future pecuniary damages.

Pecuniary damages are losses that can be quantified in monetary terms, such as the loss of future employment earnings or the cost of future care, in the event of a personal injury. Such losses are usually calculated by taking the present value of a stream of cash flows. Ontario is one of eight provinces in Canada that mandates the discount rate to be used in performing this present value calculation. Only Alberta and Newfoundland and Labrador do not mandate such rates.

Mandated Discount Rates and the Actuarial Profession

The work of Canada’s actuarial profession is directly affected by the magnitude of these mandated discount rates. Where legal proceedings are undertaken to recover pecuniary damages, actuarial evidence practitioners use the mandated discount rates in their calculations of the present value of economic loss. These calculations assist the parties in litigation to arrive at settlement agreements and to assist the courts in determining awards in those matters that go to trial.

Through their impact on settlements and judgments in litigation, the mandated discount rates also have an effect on the severity of liability claims incurred by property and casualty insurance companies. Thus, the rates have an impact on the claims costs underlying the pricing and reserving work done by property and casualty actuaries.

Two Different Discount Rates

In Ontario, the mandated discount rates blend responsiveness to current economic conditions with stability. This is achieved through the use of two different discount rates. The first rate is a responsive rate that is calculated every year, and applies to cash flows in the 15-year period from the beginning of trial. The second rate, which is a stabilizing influence, is not recalculated every year, and is applied to cash flows more than 15 years from the date of trial.

The Ontario discount rates are net of inflation. The method specifies that the discount rate for the first 15-year period is the average of Government of Canada long-term real return bonds, quoted on the last Wednesday of each of the six months March through August, less a 0.5 percent allowance for the liquidity premium on real return bonds, owing to their small market. This calculated rate cannot be less than 0 percent and is rounded to the nearest 1/10 percent. For the period after 15 years, the net discount rate is set at 2.5 percent.

The CIA assists Ontario’s Ministry of the Attorney General by performing three independent calculations of the discount rate before it is promulgated.

Beyond Ontario

However, beyond this role, the CIA has also proactively reached out to other jurisdictions in Canada on the issue of mandated interest rates. In particular, in 2013, the CIA reached out to nine provincial and territorial governments, pointing out that nominal rates of return and inflation had declined substantially since those jurisdictions had first introduced mandated interest rates in the early 1980s. The CIA has also made full submissions to two provinces, BC and Nova Scotia, as part of those provinces’ review of their mandated discount rates. The submissions made the following recommendations:

Given the importance of mandated interest rates to the operation of the civil justice system and the insurance system, the CIA has good reason to be involved in the issue of mandated interest rates.

Craig A. Allen, FCIA, is Chair of the CIA’s Actuarial Evidence Committee.

Canadian Institute of Actuaries/Institut canadien des actuaires
http://www.cia-ica.ca/