This article first appeared in the winter 2002 issue of the Expert Witness.
We occasionally encounter cases in which it is argued that the injured plaintiff requires an additional award to pay for the services of a financial manager (that is a “management fee” award). I have recently been involved in a couple of cases in which I had to consider this issue in detail, and in this article I will share some of my thoughts on the matter.
Typically (in my experience) these cases involve seriously injured plaintiffs (often children) with large loss of income and cost of care claims. It is anticipated that the plaintiff will be unable to manage his own financial affairs, and will therefore need the assistance of a financial advisor. The advisor (most banks and related financial institutions provide these services) will invest the plaintiff’s money, ensure that his bills are paid, prepare his taxes, and so forth. The annual cost of these services is mainly based on a percentage of the funds under management each year (though the actual cost schedules are often complex). Because the plaintiff will need to spend part of his award on a financial manager, he therefore needs additional funds to cover these costs (that is, a management fee award). The difficulty arises when we consider whether or not the plaintiff will receive a higher rate of return on his investments, due to the expertise of the financial manager. That is, it may be the case that the financial manager’s fee will be at least partially offset by the increased return on investment. (For example, if I am paying a financial manager $5,000 per year, I expect that the return to my investments will be at least $5,000 per year greater than if I did not use a financial manager.)
However, this is not a simple issue. When we determine a reasonable real discount rate to use in our calculations, we assume that plaintiffs will invest their money in simple low-risk investments such as government bonds. It is our understanding that this is their only obligation – they need to do better than keeping their money in a safe deposit box, but they do not need to pursue an “active” (and more risky) investment strategy. However, when the plaintiff uses a financial advisor, what sort of service should we expect that the plaintiff will request? If the plaintiff requests that the manager act very conservatively and invest the money in a similar manner as is expected of a plaintiff-investor, then there will be no increased return to offset the cost of the financial manager. A management fee award will be needed. Alternatively, if the plaintiff is obligated to make full use of the financial advisor, then presumably the advisor will do better than the conservative government bond strategy assumed for a plaintiff-investor, and there will be a higher return to offset the costs. It may be the case that the total net return (after management fees) is higher than the return that can be earned by simply investing conservatively in government bonds. In order to properly estimate the awards in this case, we would need to estimate the expected long-run real rate of return that the manager will earn, re-estimate all our future loss calculations, and then estimate the management fee. Note that in any province with a mandated discount rate, the issue is even more complex, since the economist does not have the option to simply change the discount rate based on the anticipated investment strategy of the plaintiff.
Suppose it is the case that a plaintiff can use a financial manager and earn a net real return that is greater than the “normal” real rate of return earned by a plaintiff-investor. Why then would we not expect that all plaintiffs should use investment advisors, in order to best mitigate their losses? In a province with a mandated discount rate, if a higher net return can be earned using an investment advisor, then why does the mandated rate not reflect this?
These are complicated issues. In my view the preferred approach in most cases is to separate the plaintiff’s need for “financial assistance” from the actual management of her funds. “Financial assistance” would include the day-to-day services needed by a plaintiff who cannot manage her own financial affairs – such as bill-paying, handling spending money, paying taxes, and so forth. These services could presumably be handled by an accountant or a lawyer. The services would not include actual investment management – it would be anticipated that the person assisting with the plaintiff’s financial affairs would arrange for conservative investment of the plaintiff’s award in the usual low-risk vehicles. If it could be determined that this level of financial assistance would cost (say) $5,000 per year, than that cost could simply be incorporated as a normal cost of care, without introducing the difficult and contentious issue of financial management.