Year: 2001

Winter 2001/02 issue of the Expert Witness newsletter (volume 6, issue 4)

Posted on By economica

Contents:

  • Selecting the Discount Rate – An Update
    • by Christopher Bruce, Derek Aldridge, Scott Beesley, and Kelly Rathje
    • In this article the consultants at Economica have combined to review the most recent information concerning the “discount rate;” that is, the rate of interest at which plaintiffs are assumed to invest their award.
  • Destruction of evidence
    • by Christopher Bruce
    • In this article Christopher Bruce discusses situations in which information required to establish negligence remains in the possession of one of the parties. In the absence of any penalties, a party who believes that this evidence may suggest that he or she should be held liable will have an incentive to destroy the evidence.

      The purpose of Dr. Bruce’s article is to develop a model of the legal process that will offer insight into the determination of legal remedies for the destruction of evidence by a defendant. He bases this model on the assumption that the first role of such remedies must be to discourage the defendant from destroying any information that might reasonably be expected to assist the court in the determination of liability.

  • The awarding of costs and payment of legal fees in a case brought before the Court: is there a potential injustice?
    • by Derek Aldridge & Ronald Cummings, QC
    • This article shows that there may be a potential injustice due to the tax treatment of an employee-plaintiff versus a corporate-defendant. We show that the costs imposed on a losing employee-plaintiff impose a greater burden than the same level of costs imposed on a losing corporate defendant. This is because the employee-plaintiff must such pay costs with after-tax dollars, but the corporate defendant can use before-tax dollars.

The awarding of costs and payment of legal fees in a case brought before the Court: is there a potential injustice?

Posted on By economica

by Derek Aldridge & Ronald Cummings, QC

This article addresses an issue that was brought to our attention last year by Ronald Cummings, QC (Cummings Andrews & Mackay). It eventually led to an article that was published in the June 2001 issue of The Barrister. For the purposes of this article (published in the Winter 2001/02 issue of the Expert Witness), we focus on one particular issue contained in the earlier article.

Suppose that a defendant insurance company has incurred costs totalling $50,000 in the course of defending itself in a civil lawsuit. For simplicity, let us assume that the plaintiff’s costs were also $50,000. For simplicity, we will also ignore the size of the claim. If the plaintiff is successful in his action and is awarded costs, the defendant will not receive any relief from its $50,000 in expenses and it will also need to give $50,000 to the plaintiff to cover his costs. Thus, its total profit for the year will be $100,000 less than it would have been if it had been successful in the lawsuit and the plaintiff had been ordered to pay the insurance company’s costs. Clearly the defendant insurance company will need to generate $100,000 in revenue in order to pay for these costs.

Alternatively, let us suppose that the plaintiff was not successful in his lawsuit, and the Court requires that he pay the defendant’s $50,000 in costs. Thus, the plaintiff needs to have an additional $100,000 on hand to cover his own bill and that of the defendant. However, assuming that 25 percent of the plaintiff’s employment income goes toward income-tax, he will need to earn $133,333 in order to have $100,000 in after-tax dollars with which he can pay his bills. Because the plaintiff is an employee and not a business, he effectively faces a greater burden of costs if he loses the case than the defendant insurance company faces if it loses.

It is clear that there is an injustice due to the tax treatment of the employee-plaintiff versus the corporate-defendant. In this example, despite incurring the same costs ($50,000 each), a losing plaintiff will need to earn $133,333 to pay his bill, compared to a losing defendant which will only have to earn $100,000 to pay its bill.

Also, note that the tax treatment may affect a potential plaintiff’s ability and/or willingness to advance a “just-case”. Because these tax-effects clearly raise a plaintiff’s costs (both direct costs and potential costs if he loses his case), some just-cases “at the margin” will not be advanced because of unmanageable costs. Some of these cases would be advanced if the tax disincentives we have described were eliminated.

The fairest solution would be to allow the plaintiff to treat his payment of these costs as a deduction from his income (for tax purposes), so he would face the same burden as the defendant insurance company or a plaintiff-corporation. Of course this would require changing the tax laws – an option that is not available to the Court.

Note that the tax system has already been adjusted to allow income from structured settlements to escape tax. So if the plaintiff wins his case, favourable tax policies are already in place to ensure that his monetary compensation is not diminished by tax. A reasonable next-step would be to ensure that tax policies do not influence potential plaintiffs when they are deciding whether or not to advance a just-case.

leaf

Derek Aldridge is a consultant with Economica and has a Master of Arts degree (in economics) from the University of Victoria.

Ronald Cummings, QC is a partner in the firm Cummings Andrews & Mackay (www.camllp.com)

Destruction of evidence

Posted on By economica

by Christopher Bruce

This article was originally published in the Winter 2001/02 issue of the Expert Witness.

In many cases, the information required to establish negligence remains in the possession of one of the parties. In the absence of any penalties, a party who believes that this evidence may suggest that he or she should be held liable will have an incentive to destroy the evidence.

The purpose of this article is to develop a model of the legal process that will offer insight into the determination of legal remedies for the destruction of evidence by a defendant. I base this model on the assumption that the first role of such remedies must be to discourage the defendant from destroying any information that might reasonably be expected to assist the court in the determination of liability.

Three Questions

I believe that any legal analysis of the destruction of evidence by a defendant must investigate three questions:

  • Did the defendant have reason to believe that it was the subject of litigation?
  • Did the defendant believe that the information in its possession could assist the court in the determination of negligence or liability?
  • Did the defendant intentionally or negligently destroy the evidence, or was that destruction “accidental?”

Was the Defendant the Subject of Litigation?

Businesses and individuals destroy private information every day. That destruction only becomes of concern to the court when it has an impact on the court’s ability to assess liability (and assign damages). For that reason, no legal “remedy” is required if a party had no reason to believe that destruction of information would have a bearing on any legal proceeding.

For example, if a factory has no reason to believe that its emissions have any harmful effects on its neighbours, destruction of information concerning those emissions should not subject it to penalties. To rule otherwise would require that all individuals and all businesses save all information indefinitely. Only if a subjective test concludes that the defendant should have been aware that its actions might be the subject of a legal action should it be held responsible for preserving records of those actions. This test should be stronger, the greater was the likelihood that the actions in question might become the subject of litigation.

Was the Information Determinative of Liability?

Assume that the first question has been answered in the affirmative – the defendant has been found to be aware of the possibility of litigation. Assume also that it could be determined ex post that the defendant knew that information in its possession would prove it to be negligent and liable; and that the defendant has intentionally destroyed that information.

The appropriate legal remedy would be to impose the same level of liability and damages on the defendant as would have been imposed if the information had been preserved. Such a ruling would simultaneously retain the plaintiff’s right to compensation and remove the incentive for the defendant to destroy the information.

Thus, if the court was able to determine ex post that the destroyed evidence would have contributed to the determination of liability, its appropriate response would be to reach the same conclusion that would have been reached had the information been preserved.

Conversely, if the court was able to determine ex post that the destroyed information would not have contributed to the determination of liability, its appropriate response would be to excuse the destruction of that information.

But when evidence has been destroyed, the courts often cannot determine whether that evidence would have been determinative of liability. (If liability could have been determined without that information, the issue of destruction of evidence would not have arisen in the first place.)

It is always in the defendant’s interest to argue that the information that it has destroyed was irrelevant to the case at bar. Once that information has been destroyed, it will be difficult, if not impossible, to lead either objective or subjective evidence to contradict the defendant’s argument.

The court is left with a dilemma. If it knew that the destroyed evidence would have proven the liability of the defendant, it should set damages as if liability had been proven. Whereas if it knew that the destroyed evidence would not have been of assistance to the court, it should ignore that destruction. But the defendant will always argue the latter and the court (and the plaintiff) will not be able to prove otherwise.

The issue then, is how can the court induce the defendant to preserve evidence that might prove to be relevant to the determination of liability? The simplest rule would be to place the onus on the defendant to prove that the destroyed evidence did not bear the importance that the plaintiff has claimed for it. That is, the normal onus of proof would be reversed.

Under this rule, if the defendant was of the honest opinion that the information it proposed to destroy was not relevant to the case, it would be induced to preserve that information until the trial date, if it was inexpensive to store. Or, if the information was expensive to store, it would be induced to offer to obtain the permission of the plaintiff to destroy that information. (If the plaintiff refused, the defendant might be allowed to claim storage costs against the plaintiff if the plaintiff’s case was not successful.)

And if the defendant was of the opinion that the information was relevant to the determination of liability, it would have an incentive to preserve that information. If it preserves the information, there may be some chance that it will be able to convince the court that it was not negligent or liable. Whereas if it destroyed the evidence, the proposed rule would find it liable with certainty.

That is, under all circumstances, the proposed rule would induce the defendant either to preserve potentially damaging evidence or to obtain the plaintiff’s permission to destroy that evidence. As this is the desired outcome, the rule may be said to be efficient.

Did the Defendant Destroy the Evidence “Intentionally?”

In the preceding section, I argued that if the defendant intentionally destroyed evidence, it should be found responsible for the same level of damages that would have been awarded had it been found liable. But what would the efficient rule be if the evidence was destroyed for reasons that were beyond the control of the defendant? Or if the evidence was destroyed as a result of the negligence of the defendant?

In the former of those cases – the destruction was “an act of God” or was, for other reasons, unforeseeable – the imposition of damages could not have the desired effect discussed above, of encouraging the defendant to preserve the information.

For example, if the defendant had stored information on a type of video tape that would disintegrate over time, the threat of damages could not induce the defendant to alter that behaviour if it had no reason to suspect that the tape had that characteristic. Similarly, the threat of damages could not induce it to protect itself against unforeseen floods or acts of terrorism.

In such cases, therefore, the courts’ rulings could not have the desired effect that I discussed above; namely, that of encouraging defendants to preserve valuable information. Rather, the only effect that imposition of damages could have in such cases would be to make the defendant the “insurer” of the plaintiff – a result that the courts have often rejected. Therefore, in cases of unforeseen destruction of evidence, the defendant should be excused from any liability to the plaintiff.

The more complex cases are those in which defendants recognised that their actions (or inactions) might lead to the destruction of evidence, but failed to alter their behaviour accordingly. For example, the defendant might have recognised that information would be lost if certain documents became wet but failed to provide storage facilities that were protected against moisture.

The efficient rule in this situation is to place the onus on the defendant to prove that the evidence does not have the import claimed by the plaintiff if it can be shown that the defendant’s actions (or inactions) were negligent. As with the rule concerning the intentional destruction of evidence, discussed above, this rule would leave the decision concerning the destruction of information in the hands of the party that is able to determine the probability that that information will be relevant to the assessment of liability.

As long as the defendant is aware that the information in its possession may be relevant to the determination of liability, this rule will normally induce the defendant to take all those precautions necessary to avoid a finding of negligence. That is, rather than face the prospect of being found liable for the plaintiff’s damages, the defendant will normally prefer to meet its standard of care. As this is the desired outcome – the court would never ask the defendant to take more precautions than necessary to meet its standard – this is the efficient rule.

Spoliation

In some jurisdictions the courts have been asked to treat the destruction of evidence as a tortious act, independently of whether that destruction affected the determination of liability. Under this tort, often called spoliation, the plaintiff asks that the defendant be punished for the harm it has caused to the legal system.

Implicitly, the argument in this article has been that no independent tort need be established. The harm caused by the destruction of evidence is that both the compensatory and deterrent effects of tort law are impaired. If the underlying function of the law is to ensure that innocent victims are compensated, for example, the destruction of evidence may prevent that function from being performed.

If a set of rules can be designed that induces defendants to take all reasonable steps to preserve relevant information, the basic function of tort law will also be preserved. But that is precisely what the rules described in this article can be expected to do. Hence, no additional rules – such as punishing the defendant for the destruction of evidence that could not reasonably have been expected to assist the court in its deliberations – are necessary.

Summary

My argument in this article has been that the goal of rules concerning the preservation of evidence must be to induce defendants to avoid the intentional or negligent destruction of any information that they believe may be useful in the determination of liability (or damages). I have argued in this paper that a sufficient rule is that a defendant that has intentionally or negligently destroyed evidence be treated as if liability had been found against him or her.

Furthermore, no distinction should be made between those cases in which the defendant argues that the evidence would not have been of value to the court and those in which it admits that the evidence would have been relevant. The only defences available to the defendant should be (a) that the destruction of the evidence was unforeseeable; or (b) that the destruction of the evidence had occurred even though the defendant had met its standard of care.

leaf

Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary. He is also the author of Assessment of Personal Injury Damages (Butterworths, 2004).

Selecting the Discount Rate – An Update

Posted on By economica

by Christopher Bruce, Derek Aldridge, Scott Beesley, and Kelly Rathje

This article was originally published in the Winter 2001/02 issue of the Expert Witness.

In the Autumn 2000 issue of this newsletter, we conducted an extensive review of the various methods of measuring the real rate of interest, or discount rate, and presented evidence concerning the movement of those measures over the period 1995-2000.

At that time, we concluded that our best estimate of the long-run discount rate was 4.0 percent. But we added the caveat that, as interest rates in 2000 had deviated significantly from the average of the preceding years, it would be important to maintain a close watch on those rates – to determine whether 2000 was an aberration or whether it represented the beginning of a new trend.

In particular, we concluded that article with the statement:

If bond rates do not rise relative to the rate of inflation in the near future, we will be revising our real rate of interest forecast downward.

The purpose of this article will be to provide five additional quarters (15 months) of data to determine whether such a revision is appropriate.

Revised data

Tables 1 and 2 provide updates of the information contained in Tables 1 and 2 of the Autumn 2000 article. Four changes have been made to the latter tables. First, we have added data for the fourth quarter of 2000 and for all four quarters of 2001. Second, in some cases, the relevant statistical authorities have revised their estimates of the figures we reported previously. In those cases, we have provided the revised figures.

Third, we have added information concerning interest rates on five-year Government of Canada bonds. Finally, in the interest of space, we have omitted the estimates of the real rate of interest that relied on information concerning the “standard” inflation rate.

Table 1

Table 1 reports the “raw” data from which some of the real interest rate figures in Table 2 have been calculated. The first column reports the “core rate of inflation” – a measure of the rate of inflation that removes the effects of change in those components of the price index that often move erratically – such as food, energy, and taxes. It is often argued that this measure offers a more reliable predictor of future changes in prices than does the “standard” measure of price inflation.

The next three columns in Table 1 report the rates of return on Government of Canada 5-year and 10-year bonds and on 5-year Guaranteed Investment Certificates (GICs). The former represent the minimum rates of return that investors can expect on safe investments. The rate of return on GICs, on the other hand, represents the interest rate available on a mixed, low-risk portfolio of stocks and bonds.

Table 2 reports seven measures of the real rate of interest – that is, the rate of interest net of the expected rate of inflation. The first of these is the market-determined rate of return on “real rate of return bonds” – bonds whose value is denominated in terms of the real rate of interest. These bonds are of particular importance because they are purchased by sophisticated investors and because they tend to be held for long periods of time.

The second, fourth, and sixth columns report the 5- and 10-year government bond interest rates and 5-year GIC rates net of the core inflation measure.

Finally, columns three, five, and seven report the government bond and GIC rates net of the Bank of Canada’s target rate of inflation of 2 percent. As the Bank has managed to keep the core rate of inflation within a small band around this target for the last six years, it is widely believed that 2 percent is the rate that is expected by most investors. That is, investors are believed to act as if the real rate of interest is the observed, nominal rate less 2 percent.

Table 2

Interpretation of the data

The data in Table 2 indicate that real rates of interest are lowest on the shortest-term investments, GICs and 5-year bonds, and highest on the longest-term investments, 10-year bonds and real rate of interest bonds. This suggests to us that investors believe that the current slowdown in the economy, which has induced central banks to lower interest rates very significantly, may continue for two or three years but will not continue in the long term.

For this reason, we believe that it would be appropriate to adopt a two part forecast of real interest rates. Based primarily on the observed rate on 5-year Government of Canada bonds, we propose to use a rate of 2.50 percent for the first five years of all calculations. Based primarily on the observed rate on 10-year Government of Canada bonds, we propose to use a rate of 3.50 percent for all subsequent years. Note that the latter rate is close to the average real rate of return on GICs over the period 1964 to 1998, (3.58 percent), reported in Bruce, Assessment of Personal Injury Damages, Third Edition, at page 231.

Once again, however, in recognition of the uncertainty facing our economy, we will revisit this question at the end of this year.

leaf

Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary. He is also the author of Assessment of Personal Injury Damages (Butterworths, 2004).

Derek Aldridge is a consultant with Economica and has a Master of Arts degree (in economics) from the University of Victoria.

Scott Beesley is a consultant with Economica and has a Master of Arts degree (in economics) from the University of British Columbia.

Kelly Rathje is a consultant with Economica and has a Master of Arts degree (in economics) from the University of Calgary.

Autumn 2001 issue of the Expert Witness newsletter (volume 6, issue 3)

Posted on By economica

Contents:

  • The Deduction for “Expenses Related to Earning Income” in Rewcastle
    • by Christopher Bruce and Derek Aldridge
    • In this article Christopher Bruce and Derek Aldridge discuss the court’s decision in the recent case of Rewcastle v. Sieben. The case concerned an estate claim brought under the Survival of Actions Act. In his decision, Justice Hutchinson introduced a new method for calculating the deduction for “expenses directly related to earning income.” In their article Dr. Bruce and Mr. Aldridge summarise Justice Hutchinson’s method and comment on its broader applicability.
  • No-Fault Automobile Insurance
    • by Christopher Bruce & Angela Tu Weissenberger
    • In this article Christopher Bruce and Angela Tu Weissenberger respond to a recent paper which recommends that Alberta adopt a no-fault automobile insurance system. In their response, Dr. Bruce and Ms. Tu Weissenberger examine the deterrent effect of tort rules; the high cost of no-fault insurance systems; arguments concerning the role of lawyers; evidence concerning the costs of bodily injury claims; and evidence concerning insurance fraud. They identify several weaknesses in the usual arguments that are made in support of a no-fault regime.

No-Fault Automobile Insurance

Posted on By economica

by Christopher Bruce & Angela Tu Weissenberger

This article was originally published in the Autumn 2001 issue of the Expert Witness.

In a recent paper, Norma Nielson and Anne Kleffner, of the Faculty of Management, University of Calgary, recommended that Alberta adopt a no-fault automobile insurance system.

The purpose of this article is to provide a response to Nielson and Kleffner. The article is divided into five sections, in which we discuss:

  • the deterrent effect of tort rules,
  • the high cost of no-fault insurance systems,
  • arguments concerning the role of lawyers,
  • evidence concerning the costs of bodily injury claims, and
  • evidence concerning insurance fraud.

The Deterrent Effect

Although Nielson and Kleffner argue that one of the functions of an ideal “…system for compensating accident victims [is to] … provide individuals with incentives to behave in a way that minimizes accidents and the resulting injuries…” they choose to ignore this function in their paper. As the majority of recent empirical studies have shown that accident rates are higher in no-fault regimes than in tort-based regimes, their failure to address this issue seriously biases their conclusions.

For example, recent evidence suggests that fatal accident rates are between 5 and 10 percent higher in no-fault jurisdictions than in tort-based jurisdictions. This means that, at the 1998 highway fatality level of 429, the introduction of no-fault insurance would result in the deaths of between 21 and 42 Albertans per year.

We have identified five studies published in the 1990s that offer rigorous analyses of the effects of no-fault insurance on automobile accident rates. These studies argue that no-fault may reduce the deterrent effect of insurance in two ways.

First, insurers have historically provided a deterrent to accident-causing behaviour by increasing drivers’ insurance premiums when they have been found to be at fault for accidents. Under no-fault insurance systems, however, fault is not measured. As a result, insurance companies find it more difficult to tie premiums to driving behaviour and the deterrent effect is weakened.

Second, in tort systems, the party that has been found to have “caused” an accident is required to bear most of his or her own costs. The threat of having to bear these costs is presumed to act as a deterrent to accident-causing behaviour. In no-fault systems, on the other hand, the parties are compensated fully for all of their costs, regardless of fault. Thus, the threat of having to bear those costs is removed and the deterrent effect of insurance is once again weakened.

A concern of all of the studies identified by us is that, because the incentive to report accidents may vary among insurance regimes, changes in the reported number of accidents may not reflect true changes in the underlying accident rate. Accordingly, three of the studies restricted their analyses to fatal accident rates, as these rates are not subject to reporting error. All three studies found that the incidence of fatal accidents increased following the introduction of no-fault.

In the first of these, Devlin (1991) found that the number of fatal accidents increased by 9.62 percent after the introduction of no-fault in Quebec.

Similarly, Cummins et. al. (1999) found that fatal accident rates were between 5.5 and 9.9 percent higher in US states that had no-fault insurance than in those that permitted full access to the tort system.

And Sloan et. al. (1994) estimated that for every 10 percent of drivers who were denied access to the tort system (by no-fault insurance), the fatal accident rate rose by 7.2 percent. (For example, a move from a system that permitted full access to tort law to one that allowed access to only 80 percent of drivers would increase the fatal accident rate by 14.4 percent.)

A second approach was adopted by Cummins and Weiss (1991). They argued that, as no-fault insurance systems did not alter the legal rules involving property damage claims, there should be no direct effect of no-fault on those claims. However, if no-fault affected driving behaviour through changes to the rules concerning personal injury claims, an indirect effect on property claims would be expected. That is, if no-fault reduced the incentive to take precautions to avoid personal injury, that reduction should increase both personal injury and property damage claims.

Accordingly, Cummins and Weiss compared property claims between tort and no-fault states. Their finding that property claims were 4 percent higher in no-fault states led them to conclude that the introduction of no-fault had reduced the deterrent effect of automobile insurance and increased the number of automobile accidents.

Finally, Devlin (1997) investigated the effect of no-fault insurance on the severity of automobile accidents in the United States. She found that the probability of sustaining a serious accident was significantly higher, and the probability of sustaining a minor accident significantly lower, in no-fault states than in tort states. That is, even if the overall accident rate was the same between two states, the average severity of accidents would be higher in the no-fault state than in the tort state.

These studies show convincingly that no-fault insurance reduces the incentive for drivers to take precautions. The result is that, under no-fault insurance, there is an increase in the number of fatalities, in the overall number of automobile accidents, and in the average severity of accidents. Although these effects were ignored by Nielson and Kleffner, it is clear that they must be taken into account when changes to the insurance system are being considered.

The High Cost of No-Fault Insurance

Empirical analyses of no-fault insurance jurisdictions indicate that there are virtually no cost savings to be obtained by switching from tort law to no-fault insurance. Indeed, experience in no-fault states and jurisdictions around the world indicate that the system is not effective in reducing the overall cost of accident compensation.

Our review of the research indicates that there has been no realization of lower insurance premiums as a direct result of the adoption of no-fault insurance.

  • According to the National Association of Insurance Commissioners data (1988-1998), liability premiums in the US no-fault states are amongst the highest in the country. New Jersey (a no-fault state) has the highest average liability premiums and exceeds the national average premium by 71%.
  • In their analysis and evaluation of no-fault Laws, the Foundation for Taxpayers and Consumer Rights (1997) point out:
    • Though many states have experimented with various forms of no-fault plans, few have been shown to obtain reduced insurance premiums.
    • No-fault states have the highest average automobile insurance premiums.
    • Between 1989 and 1995 premiums in mandatory no-fault states rose nearly 25 percent more than in no-fault states.
    • Premiums fell immediately in states that repealed no-fault insurance.
  • The Insurance Bureau of Canada (1991) reports that during the first year following the implementation of the no-fault scheme in Ontario, insurance industry profits increased by $750,000,000 with no appreciable decrease in premiums.
  • Nielson and Kleffner (2001) report that no-fault has not reduced auto insurance costs, but rather, costs are higher due to the very generous benefits paid out (e.g. in Quebec and Manitoba there is no time or amount limit on medical payment benefits). This further raises the question of how a no-fault system implemented in Alberta can realize significant cost savings.
  • The few jurisdictions that cited savings due to no-fault attribute the reduction in costs to the elimination of non-economic loss award for persons whose injuries do not exceed a prescribed threshold (Carroll and Kakalik, 1991). Regardless of the threshold level, non-economic loss is real. Eliminating or restricting individuals’ compensation for losses concerning pain and suffering and mental anguish means denying them the funds necessary for physiotherapy, psychological treatment etc. which are critical to reparation for non-economic loss. This is at odds with the very intent of no-fault insurance, which is to compensate an individual adequately for losses arising from the accident regardless of fault.
  • Nielson and Kleffner claim that no-fault plans match compensation more closely with economic loss by increasing the fraction of economic loss that is compensated and by reducing the amount of compensation paid people in excess of their economic loss. In other words, they recommend reducing victim compensation in order to save money.

Attorney Involvement

Nielson and Kleffner suggest that attorney involvement in claims is a key contributor to the escalation of bodily injury costs. Their conclusions are based on a study conducted by the Insurance Research Council that examined medical utilization in cases that did and did not involve attorney representation. That study concluded that represented claimants were more likely than non-represented to seek treatment from medical practitioners and that the former had a higher average number of visits to practitioners than did the latter.

Nevertheless, the authors suggested that claimants represented by lawyers were no better off than those who were not represented. In particular, despite the fact that average gross compensation to the represented claimants was higher than that to claimants not represented; the former netted less for their injuries than did the latter. The difference is explained by the fact that represented claimants incurred higher costs – including legal fees and court costs – than did non-represented claimants.

The All-Industry Research Advisory Council (1988) shows households that hired attorneys had longer settlement times for injury claims than those who did not. Households that reported large economic loss were more likely to have hired an attorney. Further, although 80 percent of households that did not hire lawyers were satisfied with the overall amount that they received from all benefit sources, only 58 percent of claimants who did hire attorneys were satisfied.

These studies do not support Nielson and Kleffner’s claim that lawyers provide no valuable function in the claims settlement process.

  • The studies ignore the fact that cases requiring legal representation are usually more complex than those that do not require representation. Individuals who choose not to hire lawyers usually do so because they have relatively simple cases. Nielson and Kleffner have the causal relationship reversed. It is not that lawyers “cause” cases to take longer to settle; it is that plaintiffs seek legal representation when they recognise that they have complex cases.
  • Households are not forced to use lawyers. The fact that many choose to do so indicates that they believe that lawyers provide a valuable service. Hiring a lawyer to assist in the pursuit of a damage claim is analogous to hiring a realtor to help in the sale of a property. Individuals have the option of selling their property privately. The fact that many people choose to hire realtors provides strong evidence that people perceive value in doing so – otherwise they would not do it. Similarly, purported “evidence” that claimants obtain little or no value from the hiring of lawyers must be set against the undeniable evidence that most claimants do hire lawyers.
  • Satisfaction and payout of benefits cannot be compared on a consistent basis. Such comparisons assume that the severity and complexity of injuries is the same. It also assumes that all people hire lawyers for the same reasons.

Nielson and Kleffner conclude that since attorney involvement in settling claims “results” in lower net settlement amounts and longer time to settlement, it would appear that reducing attorney involvement would be one way to increase satisfaction of claimants.

But there is no empirical evidence to show that reducing attorney involvement would increase satisfaction of claimants. On the contrary any restriction on such involvement would be expected to lead to more dissatisfaction as the claimant no longer has a choice or a place to turn for representation should he or she not agree with the claim offered by the insurer.

Increasing Proportion of Accidents Producing Injury Claims

According to Nielson and Kleffner, in Alberta the number of bodily injury claims has been rising much faster than property damage claims. During 1986-1999: the number of vehicles insured increased 24 percent, the number of bodily injury claims increased 157 percent, property damage claims frequency decreased from 4.94 to 3.04, and the number of property damage claims decreased 22 percent from 59,353 to 45,996. Claims cost for bodily injury losses (cost per insured vehicle) increased 200 percent while the consumer price index increased only 43 percent.

Nielson and Kleffner attribute the dramatic rise in bodily injury costs to a purported change in the claiming behaviour of motorists and passengers. They suggest that many of these claims are in fact not legitimate. However, the statistics that they report do not allow them to draw this conclusion.

  • The argument assumes implicitly that all drivers are identical and suffer exactly equivalent injuries in any accident. It ignores the fact that increased costs to treat injuries could be attributed to an increase in severity of injuries due to more crowded road conditions, increased number of passengers per vehicle, and/or the requirement to compensate for rising income losses.
  • That bodily injury claims costs increased more rapidly than the consumer price index does not provide any evidence of fraud or increased litigiousness. First, over the period investigated by Nielson and Kleffner (1986-1999) per capita medical costs rose by more than 75 percent in Canada (almost double the rate of inflation over that period). Second, wages and salaries also increased more rapidly than inflation, thereby increasing claims costs for lost earnings. Third, and most importantly, the Supreme Court rulings in the “trilogy” cases in 1978 led to a dramatic change in the way that damages were assessed in Canada. These changes allowed plaintiffs to obtain damages that much more closely reflected the losses they had incurred than had been possible previously. The result was that, over the 1980s, bodily injury damages rose while the lower courts absorbed and applied the Supreme Court’s new rules.
  • Bodily injuries can arise independently of property damage. While there might be fewer fender benders, the increase in bodily injury claims and costs may be attributed to an increased severity of automobile accidents and increased number of passengers per vehicle.
  • Furthermore, with improvements in the quality of automobile bodies, there may have been an increase in the number of accidents that do not cause significant property damage yet result in serious personal injuries (particularly to the neck and back).

Changes in Claims Behavior

Nielson and Kleffner cite two studies that purport to show that no-fault insurance reduces the propensity to exaggerate claims for personal injuries – studies by Cassidy et. al. (2000) and by Carroll et. al. (1995). Both of these studies are so seriously flawed as to be of no value.

Nielson and Kleffner identify the Cassidy study as the most important Canadian research examining the link between claiming behavior and treatment patterns. In this study, funded entirely by Saskatchewan Government Insurance, Cassidy et al examined 7462 whiplash injury claims filed in Saskatchewan in the six months before, and the twelve months after, that province converted from a tort liability to a no-fault system.

They claimed to have found that plaintiffs recovered from their injuries much more quickly under the no-fault system than under tort. The purported evidence for this finding was that insurance files for whiplash claims were “closed” much more quickly under no-fault than under tort. The implication drawn by Cassidy et. al. was that plaintiffs were more likely to exaggerate the extent of their injuries in a tort system, where parties are allowed to obtain compensation for “pain and suffering,” than in a no-fault system where such a claim is usually denied.

There are several flaws with this study:

  • It is clear that the primary reason the whiplash files closed more quickly under no-fault than under tort was that claimants were provided with a forum in which they could appeal the insurance company’s rulings in the latter but were denied that opportunity in the former. Under Saskatchewan’s no-fault automobile insurance system, decisions about the claimant’s treatment and compensation are made administratively, by the insurer. Under the previous tort system, the plaintiff had the opportunity to appeal the insurer’s decision to the courts, and often did. It was the removal of the freedom to appeal that resulted in claims being closed more quickly, not a sudden decrease in drivers’ willingness to defraud the insurer.
  • The study did not give conclusive evidence regarding whether people were physically better or worse off as a result of no-fault. All the research was able to show was that claims closed faster under no-fault than under the tort system.
  • The tort claims investigated by the authors were restricted to the period six months prior to the implementation of no-fault. But in the US it has been found that claims filings increase substantially in the six months to a year before no-fault is introduced as claimants expect to be dealt with more fairly in a tort system than under no-fault. As a result, claims experience in the six months prior to the introduction of no-fault cannot be assumed to be representative of all claims under tort.

The second paper cited by Nielson and Kleffner in support of their claim that drivers have been making “excessive” claims against their insurers is Carroll, Abrahamse, and Viana (1995). We have carefully reviewed this paper and conclude that it provides no support for Nielson and Kleffner’s claim.

First, many of the results in the Carroll paper are conditional on the assumption that general (non-pecuniary) damages are highly correlated with damages for economic loss. It is their assertion, for example, that if the loss of income resulting from a broken leg in one accident is twice as large as the loss resulting from the same injury in a second accident, the general damages (damages for “pain and suffering”) in the first will be approximately twice as large as in the second. The result, Carroll et. al. argue, is that individuals have a double incentive to exaggerate the extent of their economic losses.

Nielson and Kleffner imply that this incentive to exaggerate economic losses exists in Canada. It does not, for three reasons.

  • The Supreme Court of Canada has set an absolute limit on the size of general damages, of approximately $260,000. The lower courts have interpreted this limit to imply that general damages on “lesser” injuries (for example, a broken leg) must be proportional to those on the most serious injuries, like quadriplegia (that is, on those eligible for the maximum damages). Thus, general damages for a broken leg cannot exceed a relatively low amount, no matter how large the attendant economic damages might become.
  • General damages in Canada are determined by the physical nature of the injury, not by the level of economic damages that are consequent on the injury.
  • In cases of serious injury (the cases that Nielson and Kleffner argue constitute the bulk of dollar claims in Canada), claims for economic damages are subject to intense scrutiny by phalanxes of lawyers, economists, medical practitioners, vocational consultants, and numerous other expert witnesses in a process that is carefully monitored by both the courts and the insurance industry. The opportunities for exaggeration are severely constrained by both the professionalism of the participants and the adversarial nature of the process.

Second, Carroll et. al. argue that there will be fewer incentives to exaggerate economic damages in states with no-fault insurance if plaintiffs must meet a “verbal” threshold (i.e. must show that their injury is present on a list of eligible injuries) before they can sue under tort than if the plaintiffs must meet a “dollar” threshold (i.e. must show that economic damages exceed a pre-specified level). They conduct two tests of this hypothesis.

First, they calculate the ratio of “soft” injuries (those, such as soft tissue injuries, that are relatively easy to disguise) to “hard” injuries (those, such as broken bones, that are objectively verifiable) in each of the U. S. states. When they find that the two “verbal” threshold states – Michigan and New York – have among the lowest ratios, they “conclude” that their hypothesis has been confirmed. Plaintiffs in the “non-verbal” threshold states are exaggerating their “soft” claims.

This conclusion cannot be supported by the data. It is clear that the reason the ratio of soft to hard injury claims is low in New York and Michigan is that the verbal thresholds in those states exclude most soft injuries from the approved list. Plaintiffs suffering from non-approved injuries are denied the opportunity to make tort claims. Thus, the ratio of soft to hard injury claims is low in the verbal threshold states primarily because plaintiffs have been excluded by administrative fiat, not because claimants refrained from exaggerating the extent of their injuries in the latter.

Furthermore, the second test that is offered by Carroll et. al. is inconclusive. They argue that, because general damages (for “pain and suffering”) are correlated with pecuniary damages (for medical expenses and lost earnings), individuals have an incentive to exaggerate the level of their pecuniary damages. They predict, therefore, that the average level of damages will be higher in tort states than in no-fault states – particularly those no-fault states that require claimants to meet a verbal threshold before general damages can be awarded.

The evidence they provide, however, shows clearly that there is only a tenuous correlation between damages for soft injury claims and the nature of the legal system. Indeed, if the figure on page 18 of their report shows any correlation it is that average damages are higher in verbal threshold states than in tort states.

To conclude, the Carroll study, like the Cassidy study, provides no reliable evidence that injured parties are more likely to exaggerate their claims in a tort system than they are in a no-fault system.

References

All-Industry Research Advisory Council. (1988) Attorney Involvement in Auto Injury Claims, December, 1988. Oak Brook, IL.

Carroll, Stephen, Allan Abrahamse, and Mary Vaiana. (1995). The Costs of Excess Medical Claims for Automobile Personal Injuries. Santa Monica, CA: RAND, Institute for Civil Justice.

Carroll, Stephen J. and James S. Kakalik. (1991). “No-Fault Automobile Insurance: A Policy Perspective.” Santa Monica, CA: RAND, Institute for Civil Justice.

Cassidy, J. David, Linda Carroll, Pierre Cote, Mark Lemstra, Anita Berglund, and Ake Nygren. (2000). “Effect of Eliminating Compensation for Pain and Suffering on the Outcome of Insurance Claims for Whiplash Injuries,” New England Journal of Medicine, 342 (16), 1179-1186.

Cummins, J. David, and Mary Weiss. (1991). “Incentive Effects of No-Fault Automobile Insurance: Evidence from Insurance Claim Data,” in G. Dionne, (ed.) Contributions to Insurance Economics. Norwell, MA: Kluwer Academic Publishers, 445-470.

Cummins, J. David, Mary Weiss, and Richard Phillips. (1999). The Incentive Effects of No Fault Automobile Insurance. Wharton School, University of Pennsylvania. Working Paper 99-38.

Devlin, Rose Anne. (1991). “Liability Versus No-Fault Automobile Insurance Regimes: An Analysis of the Experience in Quebec,” in G. Dionne, (ed.) Contributions to Insurance Economics. Norwell, MA: Kluwer Academic Publishers, 499-520.

Devlin, Rose Anne. (1997). No-Fault Automobile Insurance and Accident Severity: Lessons Still to be Learned, Department of Economics, University of Ottawa. Working Paper 9707.

Foundation for Taxpayers and Consumer Rights. (1997). A Failed Experiment: Analysis and Evaluation of No-Fault Laws.

Insurance Bureau of Canada. (1991). Quarterly Industry Analysis Survey, Fourth Quarter.

National Association of Insurance Commissioners, Research Division. (1988-98). State Average Expenditures and Premiums for Personal Automobile Insurance.

Nielson, Norma and Anne E. Kleffner. (2001). “Recommended Reforms to Alberta’s Auto Insurance System”. Unpublished paper, April 23.

Sloan, Frank, Bridget Reilly, and Christoph Schenzler. (1994). “Tort Liability versus Other Approaches for Deterring Careless Driving,” International Review of Law and Economics 14, 53-71.

leaf

Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary. He is also the author of Assessment of Personal Injury Damages (Butterworths, 2004).

Angela Tu Weissenberger is principal of ATW Economics Group Inc. where she is a specialist in strategic market positioning and industry analysis with an emphasis on economics and finance. Prior to founding the ATW Economics Group, she led a team of analysts responsible for the risk assessment of energy companies at one of Canada’s largest financial institutions. Angela holds B.A. in Economics and an M.A. in Economics with a specialization in Law and Economics from the University of Calgary. Her graduate work focused on the deterrent effect of no-fault automobile insurance systems.

The Deduction for “Expenses Related to Earning Income” in Rewcastle

Posted on By economica

by Christopher Bruce & Derek Aldridge

This article was originally published in the Autumn 2001 issue of the Expert Witness.

The recent case of Rewcastle v. Sieben (9801 16002, Calgary, July 20) concerned an estate claim brought under the Survival of Actions Act (SAA). In his decision in that case, Justice Hutchinson introduced a new method for calculating the deduction for “expenses directly related to earning income.” In this article, we summarise Justice Hutchinson’s method and comment on its broader applicability.

The Decision

As is true in many fatality claims brought under the SAA, Bryana Rewcastle was a teenager when she was killed. Hence, when determining the value of her estate’s claim, Justice Hutchinson first recognised that her family status would have changed a number of times over her lifetime.

He found that from her teenaged years until her mid-twenties, she would have been single. Then she would probably have married and had children. Eventually, her children would have grown up and left home, leaving her, with her husband, a part of a two-person family.

Following a number of previous Court of Appeal decisions, Justice Hutchinson concluded that the percentage of Bryana’s income that would have been available to her would have been smaller, the larger was her family. For example, this issue was addressed in the October 2000 Alberta Court of Appeal decision in Duncan Estate v. Baddeley (2000 ABCA 277):

…Under the Harris approach, the deceased’s proportionate share of joint family expenses are included in personal living expenses. Duncan bore a one-fourth share of joint family expenses based on the trial judge’s finding that had Duncan lived, he would have had a wife and two children; had it been four children, only one-sixth of the shared family expenses would have been deducted. (Duncan [2000] at paragraph 22.)

In particular, Justice Hutchinson accepted evidence that 100 percent of her income would have been available to her when she was single, 50 percent when she was married but had no children, and 25.8 percent when she was married with two children. (The latter figure was not 25 percent as it was assumed that the children would not share in family expenditures on cigarettes and alcohol.)

He also accepted evidence that she would have been single for 6 years of her life (ages 22-27), would have been married with no children for 14 years (ages 28-30 and 51-62), and would have been married with two children for 20 years (ages 31-50). He found, therefore, that across those three stages of her life, an average of 45.4 percent of her income would have been available for expenditure on goods and services that would have benefited her.

But not all of that income would have been spent on “expenditures directly related to earning income.” Specifically, he accepted evidence that only 72.8 percent of family expenditures are spent on such items. [See Rewcastle, para. 171].

Hence, the living expenses deduction in her case was calculated to be 72.8 percent of 45.4 percent, or 33.05 percent. It is the latter figure that Justice Hutchinson deducted from the present value of Ms. Rewcastle’s lifetime after-tax income in order to obtain her estate claim.

We accept Justice Hutchinson’s general approach. However, we do question some of the specific numbers that he has employed.

Personal Expenditures

Justice Hutchinson concluded that a woman would have 100 percent of her own income available to her when she was single, 50 percent when she was married with no children, and 25.8 percent when she was married with two children.

Clearly, the 100 percent figure is correct.

We also accept that the 50 percent figure is correct. Following from Harris, the usual assumption is that the husband and wife each benefit personally from approximately 30 percent of family income and benefit equally from the remaining 40 percent. That is, total personal benefit is 30 percent plus half of 40 percent, or 50 percent.

The 25.8 percent figure is more problematic, however. The reason for this is that it is usually assumed that children consume a slightly lower percentage of family income than do adults. Thus, for example, assume (as is common) that the deceased parent’s personal expenditure would have amounted to 22 percent of family income and that expenditures common to the whole family would have amounted to 30 percent of family income (with the remaining 48 percent being divided among the other spouse and the two children).

In that case, the deceased would have benefited from 29.5 percent of the family’s income – 22 percent plus one-quarter of 30 percent.

This is a relatively minor point, however: if 29.5 percent is used instead of 25.8 percent in the Rewcastle case, the percentage of income available over Bryana’s lifetime would only have increased from 45.4 percent to 47.25 percent.

Expenditures Related to Earning Income

We have greater concern with Justice Hutchinson’s conclusion that 72.8 percent of income is devoted to items that are “related to earning income.” In particular, that figure was obtained by summing the percentages of income spent on: food, shelter, clothing, transportation, household furniture, household operation, health care, personal care, and education. (The omitted categories were: recreation, reading, tobacco and alcohol, miscellaneous, security, and gifts and contributions.)

But take just one of those categories, transportation, on which Ms. Rewcastle was assumed to spend 15.7 percent of her after-tax income. As that income was assumed to average approximately $35,000 (after tax), the assumption is that the entire $5,495 (= $35,000 x 0.157) she would spend annually on transportation would be “related to earning income.”

More specifically, as the Court of Appeal has ruled that expenditures on luxuries and on discretionary items are not to be included in the items assumed to be “related to earning income,” Justice Hutchinson’s decision requires that none of Ms. Rewcastle’s $5,495 annual transportation expenditures represented discretionary or luxury items. None, for example, would have provided her with discretionary “extras” on her automobiles or with luxury trips to sunny resorts.

Similarly, his decision requires that none of her $5,285 expenditures on food (15.1 percent of after-tax income), $7,735 on housing, and $1,785 on clothing were for discretionary or luxury items.

This assumption appears implausible to us. Surely some of her expenditures on clothing would have been for luxury goods, some of her expenditures on food would have been for restaurant meals, and part of her expenditures on housing might have paid for a main floor family room or a luxurious en suite bathroom.

If, reasonably, it is assumed that as little as 25 percent of her expenditures were for discretionary or luxury items, the percentage of her income devoted to items “related to earning income” would fall from 72.8 to 54.6, and the overall deduction for those expenditures would fall from 33.05 to 24.79 percent.

Conclusion

The Rewcastle decision has provided additional information concerning the method that is to be used to calculate losses in Survival of Actions cases. Nevertheless, some important questions, particularly those concerning the evaluation of discretionary and luxury items, remain unanswered. It is our understanding that the defendants in Rewcastle have sought leave to appeal. If they are successful, it is possible that the appellate court will resolve some of these questions.

leaf

Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary. He is also the author of Assessment of Personal Injury Damages (Butterworths, 2004).

Derek Aldridge is a consultant with Economica and has a Master of Arts degree (in economics) from the University of Victoria.

Summer 2001 issue of the Expert Witness newsletter (volume 6, issue 2)

Posted on By economica

Contents:

  • The Deduction of Accelerated Inheritance
    • by Christopher Bruce
    • In this article Chris Bruce discusses a requirement established by the Court of Appeal in its October 17, 2000 ruling in Brooks v. Stefura. This was that “accelerated inheritances” should be deducted from each plaintiff’s dependency award.

      The Court did not, however, state clearly what it meant by “accelerated inheritances,” nor did it specify how those inheritances were to be calculated. In this article, Chris offers some observations that may cast some light on these issues.

  • The Deduction (?) of “Accelerated Inheritance” (Scott Beesley’s view)
    • by Scott Beesley
    • In this article Scott Beesley discusses a requirement established by the Court of Appeal in its October 17, 2000 ruling in Brooks v. Stefura. This was that “accelerated inheritances” should be deducted from each plaintiff’s dependency award.

      The Court did not, however, state clearly what it meant by “accelerated inheritances,” nor did it specify how those inheritances were to be calculated. In this article, Scott offers some observations that may cast some light on these issues.

  • Avoiding Overlap Between Fatal Accident Act and Survival of Actions Act Claims
    • by Scott Beesley
    • This article points out that while the method set out by the Court of Appeal in Brooks v. Stefura does prevent double-recovery, it does not prevent double-payment, that is, the payment of the same dollar to one plaintiff under the FAA and to another under the SAA. The text of the judgment makes it clear that the Court does not wish this to occur. The article suggests a refinement of the Court’s method which would prevent such double-payments. Four detailed examples are provided.
  • Case Comment: Boston v. Boston
    • by Scott Beesley
    • The Supreme Court of Canada recently ruled in the case of Boston v. Boston. This was a case involving the variation of spousal support at the time of the husband’s retirement. He retired in 1997 and began to receive his pension. He applied to have the original support payment reduced, on the grounds that he was now paying support from his pension, which had already been considered in the original division of assets. It was argued that the wife had traded off her right to half the pension, and in return had received the bulk of the physical and other assets. He succeeded in having the monthly payment lowered from $3,200 to $950, but the Ontario Court of Appeal increased the figure back to $2,000. The husband was appealing that last OCA decision in the Supreme Court.

      The SCC’s decision allowed the husband’s appeal and restored the motions judge’s decision to reduce support to $950 per month. This was in my view correct, as it would appear to be unjust that the wife should receive half of an asset at separation, and then be allowed to claim part of the husband’s half of that asset later.

Case Comment: Boston v. Boston

Posted on By economica

by Scott Beesley

A much briefer version of this article appeared in the Summer 2001 issue of the Expert Witness. The brief version appears as the overview at right. The full article is below.

The Supreme Court of Canada recently ruled in the case of Boston v. Boston. This case concerned a divorced couple who had reached a consent agreement in 1994 which divided their assets roughly equally. In estimating the value of their assets at the time of separation, the original court had included the present value of the husband’s large pension, using its present value (PV) at that time. That present value in fact constituted the bulk of the assets he received at separation ($333,329/$385,000, or 86.6 percent of his total). The wife received almost all of the family’s physical and other financial assets, amounting to $370,000. In addition she was to receive support payments of $3,200 per month, fully indexed to inflation.

The husband retired in 1997 and began to receive his pension. He applied to have the support payment reduced, on the grounds that he was now paying support from his pension, which had already been considered in the original division of assets. It was argued that the wife had traded off her right to ½ the pension, and in return had received the bulk of the physical assets. He succeeded in having the monthly payment lowered to $950, unindexed, but the Ontario Court of Appeal increased the figure back to $2,000 and restored the indexing. The husband was appealing that last OCA decision in the Supreme Court.

The SCC’s decision allowed the husband’s appeal and restored the motions judge’s decision to reduce support to $950 per month, without indexing. This was in my view correct, as it would appear to be unjust that the wife should receive half of an asset at separation, and then be allowed to claim part of the husband’s half of that asset later. There are two primary issues, in my view. The first is that when a support order is made, that order should specify that the support in question should continue only until a particular assumed retirement age. That retirement age should of course be the same one assumed in calculating the present value of the pension being divided. I understand that support orders are generally indefinite, which creates the potential for double-dipping that arises in this and other cases.

Once it is recognized that no labour income is earned in retirement, the appropriate division procedure is quite clear. A correct division accounts for all of the assets held at the time of the breakup, including the present value of pension entitlement, based on agreed retirement ages. Once that (usually 50/50) division is made, then to allow another claim on the assets that were divided is by definition double-dipping and seems to me unjust. The second part of the process is the awarding of support as a share of income the payor will earn after the time of separation. In the case in question, as noted above, the wife received spousal support in addition to the 50 percent share of assets. She is perfectly entitled to a share of that future income, based on the standard arguments regarding her own career sacrifice, the raising of children, etc. The problem is that that future income ceases to be earned at retirement, but (I gather in this and most cases) the support payments do not.

There is a logical inconsistency if support in such cases carries on after the agreed retirement age, because the only source of such payments is the savings accumulated before and after separation. The wealth accumulated before separation was already divided in the original agreement; the income earned after the separation was already divided (presumably fairly) when the monthly support was set. Unless the courts set up spousal support such that payments end (or are reduced) at the paying spouse’s retirement, there will always be the potential for double-payment of the same money.

It is not complicated to prevent such double-dipping while ensuring that the spouse who is supported receives a fair settlement, inclusive of continuing monthly payments. The steps are as follows:

  1. At the time of separation the parties should divide assets owned already, including the present value of pensions earned to that time, using whatever formula the court sees fit to apply. This may not be equal, most often because one party brought in assets exceeding the other at the time of the marriage. For the purpose of creating an example I will, however, assume an equal division.
  2. The court then can assess what share of the higher-income spouse’s future income should be paid out in the form of continuing support. In the case in question, the original award of $3,200/month or $38,400 per year represented 33.25 percent of the husband’s before-tax income, or 48 percent of his after-tax future income.
  3. Finally, the court should assess what fraction of the payor’s incremental pension income should be awarded to the payee. This seems to be a point of contention. By incremental we simply mean that part of the pension that is accumulated after the separation. In the Boston case this amount was reported as $2,300 out of a total teacher’s pension of $7,600 per month (it appears that there was no corresponding amount earned before marriage, so I presume they were already married when he began his pensionable service). The decision by the motions judge granted $950 per month, which appears to be consistent with the rough 50/50 split that had been applied all along, in that it is on the order of half of the after-tax value of the $2,300.
  4. At the time of the separation it is possible to estimate the value of current assets, including the PV of pensions, and the present value of future income, including additional pension entitlement which will accumulate between the time of settlement and the agreed retirement age. Such pension growth is merely part of the payor’s future income, and if the lower-income spouse is entitled to a share of such income then the pension is properly part of the calculation of that income. The court can then award a percentage of existing assets to each party, as well as a percentage of the future income stream to the recipient spouse. The key point is that once all current assets and future income are considered, and shares awarded, then no other payment is required. If the future income is not paid as a lump, but is to be paid as continuing monthly support, then the amount should decline at the agreed retirement age. Assume the spouse’s share remains at 50 percent for the future support calculation. Monthly support should then be 50 percent of after-tax income until retirement only, declining then to 50 percent of the monthly value of the (also after-tax) incremental pension amount. In Boston, the motions judge apparently understood all of this reasoning and made the correct award, in my view.

The problem of double-dipping occurred in this case because the original separation agreement awarded $3,200 per month indefinitely, which would only be correct if the payor would never retire! While such an award may be conventional, it is clearly incorrect, when such payments can only be made after retirement using assets that were already fairly divided. If the above procedure is followed then all of the payor’s income, including future pension increases, would be considered in reaching a settlement. The problem of double-dipping would not occur, nor, conversely, would the award to the lower-income spouse wrongfully ignore future pension gains that they have a legitimate claim upon. Also, note that once a retirement age is agreed to at the time of separation, the present values of future income and future pension increments are based on retirement at that age. Ten or twenty years later, the paying spouse is still free to retire before or after that date, but there should be no change in the support payment stream (it should decline as scheduled, not before, so there is no incentive to retire earlier and therefore pay less to the former spouse).

It may be helpful in thinking of these issues to imagine a divorce that occurs at retirement. In that event there is no future income stream, and no future pension increment. The court will simply divide the assets already owned, and divide the pension using the standard formula. Say the spouse’s asset share is 50 percent while the pension share is also 50 percent. Assume in the first case that the 50 percent asset division has been made. The court can then award continuing support in the amount of 50 percent of the monthly pension payments. The recipient has no further claims – all the family’s assets have been divided.

In the alternative (second) case, the court can combine the lump-sum calculations. For example, assume $400,000 in current assets and a pension PV of $200,000. The spouse is entitled to a total of $300,000 (i.e. half of the $400,000 plus half of the pension amount of $200,000). If the goal is to have a “clean break” at the time of the settlement, then this is one way to get it. The recipient spouse receives $300,000 of the current total of $400,000, and then has no further claims. The pension-holder keeps the remaining $100,000 in assets and all of the pension ($200,000), for a total of $300,000. It should be obvious that the spouse who receives the greater share of assets will eventually have to convert some of those assets into income, and conversely the pension-holder may be renting indefinitely, no longer having (typically) the use of the family residence. While the spouse may feel entitled to both sole owner ship of the family home, RRSP’s, etc. and half of any pension, one can see that that is unrealistic under a typical 50/50 division. Finally, note that in the Boston case, the division was roughly 50/50, following the motions judge’s decision. The support awarded in the original settlement would have paid Mrs. Boston significantly more than 50 percent of the overall total, which the motions judge presumably would have thought unjust.

The critical point in such cases is that an agreed share of future income (base income plus pension gains) can either be awarded as a lump-sum or as a share of monthly or annual income. If the same dollar is paid out twice then double-dipping is the result, while if (for example) future pension increments are not counted in future income, the support provided will be too low.

leaf

Scott Beesley is a consultant with Economica and has a Master of Arts degree (in economics) from the University of British Columbia.

Avoiding Overlap Between Fatal Accident Act and Survival of Actions Act Claims

Posted on By economica

by Scott Beesley

This article first appeared in the summer 2001 issue of the Expert Witness.

In its October 17, 2000 rulings in the Duncan v. Baddeley and Brooks v. Stefura cases, the Court of Appeal was concerned about overlapping claims between the Fatal Accidents Act (FAA) and the Survival of Actions Act (SAA).

Although the Court set out explicit instructions for avoiding double recovery under these Acts – that is, awarding one plaintiff the “same” dollar of the deceased’s income twice – it also expressed concern about the possibility of double payment – that is, paying the “same” dollar to two different claimants.

The purpose of this article is to describe the Court’s method for avoiding double recovery, to discuss some of the circumstances in which claimants might obtain double payment, and to suggest a methodology for avoiding double payment.

Avoiding Double Recovery

At paragraph [14] of Brooks, the Court set out the following methodology for avoiding double recovery:

  1. Calculate the dependency (FAA) award to each person. For example, a widow would receive a dependency claim for the length of her, or her husband’s, life expectancy and a dependent child would receive such a claim until he or she would have ceased to be dependent.
  2. Calculate the lost years (SAA) award. For example, a widow and the deceased’s children (not just those who were dependent) would share in the deceased’s expected lifetime income, after deduction of taxes and the “personal consumption deduction.”
  3. Allocate the lost years award using the will or the Intestate Succession Act (ISA). Under the ISA, the widow or widower would receive the first $40,000 of the lost year award and the remainder would be divided equally among the eligible family members.
  4. Compare the dependency and lost years awards for each claimant and reduce the dependency awards by the amount of the lost years award (if the former exceeds the latter). For example, if the widow was eligible for $150,000 under the FAA and $80,000 under the SAA, this step would calculate a differential of $70,000. Whereas if the child’s dependency (FAA) claim was $30,000 and lost years (SAA) claim was $50,000, no differential would be calculated
  5. If the lost years award is greater than the dependency claim for any plaintiff, that plaintiff receives only the lost years award. In the example developed here, the child would receive only his or her lost years award, $50,000.
  6. If the dependency award is greater than the lost years award, the plaintiff receives the full lost years award plus the difference between the two as the dependency award. In the example developed here, the widow would receive her lost years award, of $80,000 plus the differential calculated in step 4, $70,000. That is, she would receive her full dependency award of $150,000.

Neither party has received the “same” dollar twice. The widow’s award has come strictly from the dependency claim and the child’s award has come strictly from the lost year’s claim.

Avoiding Double Payment

Note that in the example developed above, the maximum FAA claim (alone) would have been $180,000 (the widow’s $150,000 plus the child’s $30,000) and the maximum SAA claim would have been $130,000 (the widow’s $80,000 plus the child’s $50,000). Yet, applying the Court’s method, the claimants would receive $200,000 (the widow’s $150,000 FAA claim plus the child’s $50,000 SAA claim). That is, they would receive more than would have been allowed under either of the Acts alone.

This is one form of what the Court of Appeal called “double payment.” Most of the dollars in the $130,000 lost years claim come from the same source as the $180,000 dependency claim – that is, from the deceased’s income after-taxes and after-personal consumption. In that sense, the child’s lost years claim represents a second claim on the “same” dollars as the dependency claim.

It is even possible to imagine situations in which the sum of the plaintiffs’ awards would exceed the deceased’s total (after-tax) income. For example, assume that the present value of the deceased’s lifetime (after-tax) income was $500,000 and that the widow’s dependency on that amount was 70 percent, or $350,000.

Assume also that the deceased’s personal consumption deduction was 40 percent, leaving 60 percent, or $300,000, for the lost years claims. If the will divided the estate equally among the widow and her two (non-dependent) children, each of them would be entitled to $100,000. In this case, the Court of Appeal’s method would allocate $350,000 (the FAA claim) to the widow and $200,000 (the two SAA claims) to the children. The total, $550,000, would exceed the deceased’s entire income.

The Court, in its paragraph [19] appears to have recognised this problem; for there it notes that:

If the dependants and the heirs are not the same people, the lost years’ award would be paid to the beneficiaries of the deceased’s estate, rather than to the dependants…. [A] defendant could potentially pay double damages by having to pay full dependency and lost years’ awards, with no accounting.

The Court, however, offers no method for dealing with this problem. I suggest the use of a method that is based on a concept that I call the overall limit. The value of this limit is calculated in the following way. First, determine the total dependency claim of all dependent members of the family. In the first example developed above, for example, this value was $180,000 ($150,000 for the widow and $30,000 for the dependent child). Second, determine the total lost years claim of all beneficiaries of the deceased’s estate ($130,000 in the example developed above – $80,000 for the widow and $50,000 for the child). The overall limit is the larger of these two numbers – here, $180,000.

I assume that the total award granted under both the FAA and the SAA cannot exceed the largest award that would be granted by one Act – that is, it cannot be larger than the “overall limit.” Therefore, I propose that the following method be used to determine the parties’ awards. First, estimate the total FAA and SAA awards and define the overall limit as the greater of the two total awards. Second, award the surviving spouse his or her FAA or SAA entitlement, whichever is greater. Finally, award any children their FAA amount, plus their share of any greater SAA, up to the limit imposed by the overall limit. For one child this is simple, as I show in the examples below. For two or more I assume the extra SAA dollars would be allocated equally, in proportion to each child’s FAA award, or using some other formula.

Numerical Examples

In this section, I provide four examples of the application of my suggested method. For the purpose of these examples I will assume a personal consumption deduction of 35 percent. This was endorsed by the Court of Appeal in Duncan, and the approach used in Duncan was endorsed in Brooks, though a particular percentage was not specified. [I note with all due respect that, following these decisions, there remains a conflict between the idea that the estate’s award should not depend on the victim’s future spending decisions (Brooks at paragraph [29]) and the statement that the deduction does depend on the number of children in the victim’s hypothetical future family (Brooks at paragraph [28]). This conflict has been present since the original Court of Appeal decision in Duncan, and we have covered the issue in earlier newsletters.]

I also assume in my examples that the FAA awards are calculated using a 78 percent dependency rate for a surviving parent and two children, a 74 percent rate for a parent and one child and 70 percent for the parent only. The problem of double payment will be present at any conventionally used rates. Finally, note that the FAA award is calculated using joint mortality while the estate calculation uses only the mortality contingency of the deceased.

Example #1 – Without Divorce and Remarriage

The first example assumes that a man has died, leaving his wife and one child. For simplicity I consider only future losses, though the analysis is the same in the pre-trial period. The deceased would have been 50 years old at the date of settlement, the surviving spouse will be the same age, and the child will be 15. The child is assumed to be dependent until the age of 22, which is the parents’ age 57. The deceased would have earned a before-tax income of $40,000 and an after-tax income of $30,000, with no changes until retirement at 62. Contingencies are balanced and are therefore ignored, and I apply Economica’s usual 4.00 percent discount rate and 1 percent rate of productivity increase. Following the steps listed in Brooks, we would calculate the figures provided below:

  1. The dependency awards are $171,897 to the parent and $33,818 to the child, for a total of $205,715. The present value of all after-tax income is $283,433, so the total FAA loss to the family is 72.58 percent of the deceased’s after-tax income.
  2. The estate award is valued at $188,613, which is 66.55 percent of the joint mortality value of after-tax income.
  3. Using the ISA, $114,306.50 is allocated to the surviving spouse and $74,306.50 is allocated to the child. (The parent receives $40,000 more than the child.)
  4. For the parent, the dependency award is reduced to $57,590.50 (= $171,897 less $114,306.50). In the child’s case the SAA award is larger and no reduced FAA is calculated.
  5. The child receives their lost years award of $74,306.50.
  6. The parent receives $114,306.50 under the SAA and $57,590.50 under the FAA, implying a total equal to the original FAA award of $171,897.

Notice that the overall award to the family would be $246,203.50, which is 86.86 percent of the present value of joint mortality after-tax income. I would set an overall limit of $205,715 (since the combined FAA award is larger than the combined SAA award of $188,613). The difference between the given total and the overall limit is $40,488.50, and that is the amount of the double-payment in this example. That amount is deducted from the $74,306.50 awarded to the child at step 5, such that the child’s final joint award is simply their original dependency award of $33,818.

Example #2 – As in Example #1 but With Divorce and Remarriage

I now alter the above example to apply standard divorce and remarriage contingencies to the spouse’s FAA claim. All other assumptions remain unchanged. The revised figures are provided below:

  1. The dependency awards are now $151,775 to the parent and $33,818 to the child, for a total of $185,593. Note that the total FAA loss to the family has been reduced to 65.48 percent of the deceased’s after-tax income.
  2. The estate award is still valued at $188,613 (66.55% of after-tax income).
  3. Using the ISA, $114,306.50 is allocated to the surviving spouse and $74,306.50 is allocated to the child.
  4. For the parent, the dependency award is reduced to $37,468.50 (= $151,775 less $114,306.50). In the child’s case the SAA award is larger and no reduced FAA is calculated.
  5. The child receives their lost years award of $74,306.50.
  6. The parent receives $114,306.50 under the SAA and $37,468.50 under the FAA, implying a total equal to the “divorce and remarriage” FAA award of $151,775.

Notice that the overall award to the family would be $226,081.50, which is 79.75 percent of the present value of joint mortality after-tax income. I would set an overall limit of $188,613 (since the combined SAA award is now larger than the combined FAA award of $185,593). The difference between the given total and the overall limit is $37,468.50, and that is the amount of the double-payment in this example. It is not a coincidence that that is the amount of the spouse’s FAA award – by definition a double payment is that part of a combined award to one party in excess of the amount they would receive under the Act which sets the overall limit. (To go back to the no-divorce version, note that the double payment of $40,488.50 can also be calculated as the child’s FAA award of $74,306.50 less their SAA award of $33,818.) Of course, the double payment can be eliminated on either side – if the spouse’s FAA award is deemed to take precedence then the double payment is deducted from the child’s combined award, while the reverse should be done if the courts decide that the SAA amount takes precedence.

Example #3 – Without Divorce and Remarriage

The third example assumes that the deceased would have been 30 years old at the date of settlement, the surviving spouse will be the same age, and the child will be 5. The child is assumed to be dependent until the age of 22, which is the parents’ age 47. The deceased would again have earned a before-tax income of $40,000 and an after-tax income of $30,000, with no changes until retirement at 62. The resulting calculation is:

  1. The dependency awards are $355,957 to the parent and $72,682 to the child, for a total of $428,639. The present value of all after-tax income is $589,892, so the total FAA loss to the family is 72.66 percent of the deceased’s after-tax income.
  2. The estate award is valued at $390,215, which is 66.15 percent of the joint mortality (FAA) value of after-tax income.
  3. Using the ISA, $215,107.50 is allocated to the surviving spouse and $175,107.50 is allocated to the child.
  4. For the parent, the dependency award is reduced to $140,849.50 (= $355,957 less $215,107.50). In the child’s case the SAA award is larger and no reduced FAA is calculated.
  5. The child receives their lost years award of $175,107.50.
  6. The parent receives $215,107.50 under the SAA and $140,849.50 under the FAA, implying a total equal to the original FAA award of $355,957.

Notice that the overall award to the family would be $531,064.50, which is 90.03 percent of the present value of joint mortality after-tax income. I would set an overall limit of $428,639 (since the combined FAA award is larger than the combined SAA award of $390,215). The difference between the given total and the overall limit is $102,425.50, and that is the amount of the double-payment in this example.

Note that as in the first example, when one Act (here, the FAA) determines the limit then the double payment is the difference between what one person (the child, in this case) receives using the Brooks formula ($175,107.50 under the SAA) and what they would receive under just the Act which sets the limit ($72,682).

Example #4 – With Divorce and Remarriage

The fourth example assumes that the deceased would have been 40 years old at the date of settlement, the surviving spouse will be the same age, and that there are two children aged 8 and 12. The children are each assumed to be dependent until their age 18, which is the parents’ ages 46 and 50. The deceased would have earned a before-tax income of $60,000 and an after-tax income of $44,000, with no changes until retirement at 62. Divorce and remarriage apply. The resulting Brooks-Stefura calculation is:

  1. The dependency awards are $274,407 to the wife, $37,217 to the older child and $62,027 to the younger child, for a total of $373,651.
  2. The estate award is valued at $444,776.
  3. Using the ISA, $174,926 is allocated to the surviving spouse and $134,925 is allocated to each child.
  4. For the parent, the dependency award is reduced to $99,481 (= $274,407 less $174,926). In the children’s cases the SAA awards are much larger and no reduced FAA is calculated.
  5. The children each receive their lost years award of $134,925.
  6. The parent receives $174,926 under the SAA and $99,481 under the FAA, implying a total equal to the original FAA award of $274,407.

Notice that the overall award to the family would be $544,257. I would set an overall limit of $444,776 (since the combined SAA award is larger than the combined FAA award of $373,651). The difference between the given total and the overall limit is $99,481, and that is the amount of the double-payment.

Note that again, when one Act (here, the SAA) determines the limit then the double payment is the difference between what one person (the spouse, in this case) receives using the Brooks formula ($274,407 under the FAA) and what they would receive under just the Act which sets the limit ($174,926 under the SAA).

The correction for the given double-payment can again be made in either of two ways. If the SAA award is deemed to take primacy, then the spouse is simply awarded $174,926 while the children receive their estate amount. If the FAA is primary then the spouse receives the full $274,407 and the children’s SAA total of $269,850 (= $134,925 x 2) must be reduced by the overpayment amount. The children’s combined award would therefore be $170,369 (= $269,850 – $99,481). This could be divided between them equally or in proportion to the shares they would receive under the FAA (which I would argue is sensible, since the FAA is being deemed primary in this case). In that event the younger child would receive $106,481 and the 12-year-old would receive $63,888.

In considering the four examples presented, it is apparent that for younger surviving spouses, the amount available under the Survival of Actions Act will often be significantly larger than a “divorce and remarriage adjusted” Fatal Accidents Act claim. If we assume (as I would expect) that the courts will consider the FAA awards paramount, then in example #1 and the first part of example #2 the double payment will be deducted from the child’s SAA amount. For the children of a younger couple, the award available to them under the SAA can become very significant when their estate claim “recaptures” dollars lost to divorce and remarriage contingencies under the FAA.

The examples above suggest that when joint FAA/SAA claims are made, one way to proceed is as follows: First, estimate each person’s FAA and SAA award and define the overall limit as the greater of the two total awards. Second, award the surviving spouse their FAA or SAA entitlement, whichever is greater. Finally, award any children their FAA amount, plus their share of any greater SAA, up to the limit imposed by the overall limit.

Of course, when all of the family members involved receive higher awards under one act or the other, then there is no need for any further calculation. For example, when there are no children, and absent divorce and remarriage, the spouse’s 70 percent dependency under the FAA will generally be greater than their 65 percent entitlement under the SAA (though they are closer than the rates would seem to indicate because the SAA uses sole mortality while the FAA adds the survivor’s mortality as well).

leaf

Scott Beesley is a consultant with Economica and has a Master of Arts degree (in economics) from the University of British Columbia.

The Deduction (?) of “Accelerated Inheritance” (Scott Beesley’s view)

Posted on By economica

by Scott Beesley

This article was originally published in the Summer 2001 issue of the Expert Witness.

The Court of Appeal has stated that other “accelerated inheritances” should be deducted from each person’s dependency award (at paragraph [15] in Brooks). I have two comments to make on this topic.

First, as a relatively minor point I would mention that the deduction used must be the present value gain involved, not the amount inherited at the time. The “gain” now is reduced somewhat by the loss of the same amount in the future, at the deceased’s without-accident expected age of death. Of course for a young spouse this latter present value is small, but it is not zero. The Court was probably aware of this issue but as the paragraph was written one would simply deduct what was received shortly after the premature death.

Second, and far more importantly, I would argue that to deduct any accelerated inheritances would be an enormous and unjustified change to existing practice – note that for a middle-aged couple with significant assets, the deduction from a normal dependency award could be very large. For example, if they have assets of $400,000, the supposed gain to one spouse from early receipt of the partner’s half of those assets would be a large fraction of the $200,000 (about ¾ of it, or over $150,000, for a couple aged 40). Assuming a gross dependency award of perhaps $450,000 (= $30,000 times a multiplier of 15), the loss would be reduced by more than a third. I suggest with all due respect that this would be incorrect and unjust.

In a fatal accident case we have always been concerned with assessing the spouse’s (and children’s) loss of labour income. We are not supposed to consider the assets (or lack thereof) of the family, except to the extent they are relevant in estimating lost labour income. In particular it would seem quite unfair that two families who had suffered identical losses of labour income would receive very different dependency awards, should the Court’s suggestion be adopted. (It is perhaps even more bothersome to consider that between those two families, the one that had failed to save much of their income would be granted the larger award!) Similarly, a child who might normally be entitled to a dependency award in the tens of thousands could receive nothing, if his or her share of the estate’s assets was significant.

I have in fact seen at least one attempt to apply such a deduction, disguised within a cross-dependency methodology. The expert in question simply counted interest income along with each person’s labour income in estimating the family total, and of course this led to the survivor “gaining” something that partially offset the loss of dependency on labour income. I do not recall the exact figure but it was of the same order of magnitude as the following example: Assume interest income of $10,000 per year ($5,000 for each spouse). Using cross-dependency with 30 percent consumed by each person and 40 percent going to indivisibles, the survivor formerly benefited from $7,000 of that income. To be formal about it, the survivor received $4,000 (40 percent of their own $5,000 and the same amount from the deceased) for indivisibles and $3,000 (30 percent of each side’s funds) for exclusive personal consumption. After the death, the cross-dependency methodology presumes that she gains $3,000, consisting of the deceased’s supposedly saved personal consumption (30 percent x $5,000 x 2). All of these are annual figures only and the present values over decades would be much larger. The deduction of almost half the family’s assets (as opposed to just the interest on those assets) would be even worse. As discussed previously in this newsletter, we strongly disagree with the cross-dependency method – even when it is applied only to labour income it can imply that the survivor is better off without their spouse. The courts are free to use this method if and when they see fit, but I would ask that at the very least they refrain from allowing the deduction of accelerated inheritances, since that falsely reduces a future loss of labour income using assets the family already owns. In a great many cases this method would eliminate any dependency losses (consider a couple within ten or fifteen years of retirement – their assets are already substantial and there are relatively few years of labour left). One would like to think that survivors will not be asked to pay the defense the amount by which they have been made “better off,” but we have already seen cases where this has occurred across different years (i.e. a cross-dependency “gain” in some years is left in a multiyear calculation in order to offset losses occurring in others).

I hope that the Court will in the future clarify which, if any, accelerated inheritances they would like to see deducted from dependency awards. In addition, it would be preferable to have the sole vs. cross dependency debate settled definitively – it hardly seems fair when two otherwise identical families in similar fatal accident cases can receive very different awards, depending on the method favoured by each of the judges involved. The same discrepancy could be made even more pronounced if some judges deduct accelerated inheritance while others do not. Ideally, I would prefer to have the legislature consider each of these issues and impose some uniformity.

leaf

In a companion article, Christopher Bruce considers these same issues, and offers a different perspective.

Scott Beesley is a consultant with Economica and has a Master of Arts degree (in economics) from the University of British Columbia.

The Deduction of Accelerated Inheritance

Posted on By economica

by Christopher Bruce

This article was originally published in the Summer 2001 issue of the Expert Witness.

In Brooks v. Stefura, the Court of Appeal stated that “accelerated inheritances” should be deducted from each plaintiff’s dependency award. The Court did not, however, state clearly what it meant by “accelerated inheritances.” In this article, I offer a number of observations that may cast some light on this issue.

First, note that the “gain” in the present is to be reduced by the loss of the same amount in the future, at the deceased’s without-accident expected age of death. When the asset inherited “today” is physical in nature – for example, a house or piece of land – one must be careful to take into account the probability that the value of that asset would have increased significantly before the deceased’s natural death. The greater would this rate of increase have been, the lesser will the “gain” be from having inherited “early.”

For example, assume that a child inherits a house with a value of $100,000 (after payment of outstanding debts) today instead of at his mother’s natural date of death 20 years from now. If the rate of inflation of house prices is 3 percent per year, the house would have been worth $180,000 at the mother’s date of death. Assuming a rate of interest of 6 percent, it would be necessary to invest $56,300 today to generate $180,000 20 years from now. Thus, receiving $100,000 today instead of $180,000 20 years from now yields a gain of $43,700.

If, however, the rate of inflation of house prices is 4 percent, the house would have been worth $219,000 20 years from now. At a rate of interest of 6 percent, that amount could be replaced by investing $68,300 today. In that case, the receipt of $100,000 today, instead of $219,000 20 years from now, provides a benefit to the survivor of only $31,700.

More importantly, when the asset that is inherited today is financial in nature – for example, stocks or bonds – there is no gain at all from early inheritance. For example, assume that the asset is a secure bond that pays 8 percent per year for the next 10 years. Assume also that the deceased had a 10-year life expectancy. It is unlikely that the heirs could sell the bond and invest it in a secure financial instrument that pays more than 8 percent. Hence, they have gained nothing by receiving ownership of the bond today rather than 10 years hence.

Second, the deduction of “accelerated inheritances” results in the dependants of spendthrifts receiving larger awards than will the dependants of frugal individuals, everything else being equal. For example, assume that two individuals both earn $50,000 per year after taxes and both own houses valued at $200,000 that they purchased 10 years ago. Individual A has been devoting $20,000 per year to the payment of his mortgage, whereas individual B has been devoting only $10,000. As a result, at the time of his death A has paid off $140,000 of his mortgage while B has paid off only $60,000. The decision of the Court of Appeal would result in a much larger deduction from A’s estate than from B’s.

Third, in most cases, the most important inheritance will be the equity in the family home, left to the surviving spouse. It is not clear, however, that receipt of this equity “accelerates” the benefits enjoyed by the survivor. Assume, for example, that the home in question is worth $200,000. In most cases, the surviving spouse would have owned half of the home. Thus, it is the deceased’s half of the house that, presumably, the survivor has “gained.” But if the deceased had lived, the survivor would have had the benefit of that half of the house. It is difficult to see, therefore, what it is that the survivor has “gained” and, therefore, why there should be some deduction of the “accelerated’ inheritance.

The leading doctrine in damage assessment is restitutio in integrum, restoration of the plaintiff to his or her “original position.” The original position of the survivor is that he or she enjoyed use of 100 percent of the family home and some percent (usually, approximately 70 percent) of the other spouse’s (after-tax) income. For the Court to rule that some portion of the equity in the home should be deducted from the survivor’s claim against the dependency on income is tantamount to a ruling that the survivor should not be returned to his or her original position.

leaf

In a companion article, Scott Beesley considers these same issues, and offers a different perspective.

Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary. He is also the author of Assessment of Personal Injury Damages (Butterworths, 2004).

Spring 2001 issue of the Expert Witness newsletter (volume 6, issue 1)

Posted on By economica

Contents:

  • Estate Claims Following the Appeal Court Decisions in Duncan and Brooks
    • by Derek Aldridge
    • In this article Derek Aldridge, investigates a number of issues concerning the valuation of estate claims under the Survival of Actions Act. These issues arise from two recent decisions of the Court of Appeal, in Duncan v. Baddeley and Brooks v. Stefura.
  • Evidence About “Customary Practice”
    • by Christopher Bruce
    • In this article Christopher Bruce summarises some recent research that suggests that doctors systematically err when estimating the standards of “ordinary, or common, practice.” In particular, this research finds that doctors overestimate the speed with which patients are treated and diagnosed in emergency rooms. Hence, they systematically bias malpractice suits in favour of plaintiffs.

Evidence About “Customary Practice”

Posted on By economica

by Christopher Bruce

This article was originally published in the Spring 2001 issue of the Expert Witness.

The standard of care that is expected of a commercial enterprise is often determined by examining the “customary practice” followed by businesses in the defendant’s industry. Obstetricians are compared with other obstetricians; taxi drivers with other taxi drivers; and police departments with other police departments.

The determination of what constitutes the customary practice in an industry is usually left to the testimony of experts drawn from that industry.

In a recent University of Chicago Law School working paper, William Meadow (Associate Professor of Pediatrics) and Cass Sunstein (Professor of Jurisprudence) warn that such expert testimony is likely to be systematically biased. (“Statistics, Not Experts,” John M. Olin Law & Economics Working Paper No. 109, (2d Series) 2000.)

Their argument is not the traditional one – that experts will be reluctant to testify against their colleagues and, therefore, may understate the level of precautions “normally” taken. Rather, they argue that experts will systematically overstate the level of precautions that are normally taken, thereby raising the implicit standard against which defendants will be measured.

M & S base their argument on the oft-noted observation that “most normal people tend to be risk optimists, in the sense that they believe themselves to be relatively immune from risks that are faced by similarly situated others.” For example, they report that 90 percent of drivers believe themselves to be less likely than the average to be involved in a serious accident; and most heavy smokers believe they are not at increased risk of cancer or cardiovascular disease.

M & S report that physicians have been found to be particularly susceptible to this “optimism bias.” In one study, for example, 88 percent of doctors overestimated length of survival for seriously ill patients, by roughly a factor of three. In another, doctors made inaccurate predictions in 80 percent of cases, with overestimates in 63 percent. In a third study, physicians accurately predicted the survival time of cancer patients in only 10 to 30 percent of cases, and the rest of the time they overestimated survival by a factor of two to five.

M & S predict that this proclivity to optimism will affect doctors’ (and other experts’) ability to provide correct estimates of “customary practice.” In particular, they predict that this optimism will lead doctors to overestimate the ease with which they and their colleagues can recognise and treat symptoms and to underestimate the time required to react to medical emergencies.

To test this hypothesis, M & S asked a large number of emergency room physicians to estimate the average time that would elapse between the arrival of a child with bacterial meningitis in their emergency room to the start of antibiotic therapy for that child. They contrasted these estimates with statistics of actual times elapsed that they were able to obtain from their own study of two Chicago area medical centres and from two studies reported in the academic literature.

What they found was that the actual elapsed times were almost double the estimated times. Whereas the physicians’ average estimate was 65 minutes, the statistical studies revealed an actual average of 120 minutes.

Imagine now that a hospital has been sued in negligence for failing to treat a child within a “reasonable” time. If that hospital had treated the child within 110 minutes, it would actually have outperformed the average. But the average “expert” witness would have testified that most hospitals would have treated the child within 65 minutes. The behaviour of the defendant would be found to have fallen below the standard of “ordinary practice.”

(Of course, this does not necessarily mean that the defendant would be found negligent, as the court could conclude that the average hospital took less time to treat children than was required. However, this would be an unusual outcome.)

M & S further argue that this overestimation of the standard of ordinary practice will be common not only to physicians but also to experts within most other disciplines – from engineers to truck drivers – because they believe that most experts share doctors’ optimism. The result is that use of such experts will systematically bias the finding of negligence in favour of the plaintiff.

They conclude that:

  1. The courts should be very skeptical of testimony that attempts to identify ordinary practice based solely on the estimates of “expert practitioners.”
  2. Wherever possible, statistical evidence should be used in preference to practitioner evidence when determining ordinary practice.

leaf

Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary. He is also the author of Assessment of Personal Injury Damages (Butterworths, 2004).

Estate Claims Following the Appeal Court Decisions in Duncan and Brooks

Posted on By economica

by Derek Aldridge

This article was originally published in the Spring 2001 issue of the Expert Witness.

Introduction

In October 2000 the Alberta Court of Appeal released its decisions in Duncan Estate v. Baddeley (2000 ABCA 277) and Brooks v. Stefura (2000 ABCA 276). These decisions helped clarify a number of questions that had arisen concerning the calculation of loss of future earning capacity under the Survival of Actions Act. Although these clarifications will be of great assistance to counsel, a number of questions remain outstanding. I consider some of these here.

Calculation of the deduction for “living expenses” (the “lost-years deduction”)

The October 2000 decision in Duncan was the second Court of Appeal decision in that case. In that decision, the Court confirmed its 1997 ruling that five principles were to be applied when calculating loss of future earning capacity for a deceased individual who had no dependants. These are:

  1. The loss of earning capacity is to be calculated net of income tax.
  2. The Court should deduct from after-tax income an allowance for “living expenses,” which are defined as “the expenses that the victim would have incurred in the course of earning the living we predict he would earn.” (Duncan v. Baddeley [1997], 196 A.R. 161 at 172.)
  3. “The ingredients that go to make up ‘living expenses’ are the same whether the victim be young or old, single or married, with or without dependants.” (Harris v. Empress Motors, [1983] 3 All E.R. 561 at 575.)
  4. “A deduction of expenditures made for the benefit of dependants, however strong the bond and obligation to support them, is not permitted.” (Duncan [2000], at para. [21].)
  5. “[T]he deceased’s proportionate share of joint family expenses are included in personal living expenses.” (Duncan [2000], at para. [22].)

The Court then “concluded” that the appropriate living expenses deduction in the case of Dean Duncan was 35 percent (but noted the defendant had not submitted an alternative approach which followed the correct principles). I have two concerns with the latter result.

First, there are two components to the living expenses deduction – the portion of the deceased’s after-tax income that he would have spent on himself; and the deceased’s share of joint family expenses. We cannot find that these two factors add to 35 percent under normal assumptions.

When calculating losses in fatal accident claims, it is usually assumed that, in a family of two adults and two children (it was found that Dean Duncan would have had such a family), family income is divided approximately: 22 percent to each of the husband and wife, 26 percent to the children (together), and 30 percent to joint family expenditures. Under these assumptions, the living expenses deduction would have been, at most, 29.5 percent (22 percent plus one-quarter of 30 percent).

Second, there is reason to believe that the 22 percent figure used in fatal accident actions exceeds the figure that the Court of Appeal wishes to apply in estate claims. In fatal accident claims, the 22 percent figure represents the percentage of family income that is spent on (all) items that benefited the deceased alone. Thus, that percentage includes many “discretionary” or “luxury” items. It is clear from both Duncan and Brooks, however, that discretionary expenses and expenses on pleasure are not to be included in “living expenses”:

  1. In its 1997 decision in Duncan, the Appeal Court rejected the so-called “lost saving” approach to the calculation of living expenses because “[m]y life-savings would not tell one what I spent during my life on pleasure, as opposed to what I had to spend in connection with the earning of my income.” (Duncan [1997], emphasis added.) That is, the Court distinguished “pleasure” from living expenses.
  2. In its 2000 decision in Duncan, the Appeal Court again rejected the lost saving approach, in large part because it did “not differentiate between expenses incurred in order to earn a living, and discretionary spending.” (Duncan [2000] at para. [12], emphasis added.) That is, the Court ruled that expenses to earn a living do not include discretionary expenses.
  3. In Brooks, the Court of Appeal explicitly excluded the deceased’s expenditures on a motorcycle and electronic equipment from his living expenses because they were “discretionary items that were not necessary to maintain Brooks in order to earn his anticipated level of income” (Brooks [2000] at para. [29]).
  4. If the courts were to apply the reasoning used to construct the 35 percent figure in Duncan to a case of an individual who could have been expected to remain single, they would find that the living expenses deduction would approach 100 percent. That is, the “Duncan” method would approach the “lost saving” method. (A single individual spends all but his savings on his own consumption.) But the Court has explicitly rejected the lost saving method.

If the living expenses deduction is not to include discretionary or luxury expenses, that deduction could be expected to be somewhat less than 22 percent commonly used in fatal accident cases. If we select 15 percent as a “reasonable” estimate of non-discretionary expenses that (would have) benefited the deceased alone, then the living expense deduction becomes approximately 22.5 percent (15 percent personal expenses plus one-quarter of joint family expenses). Even this figure may be too high, because some of the joint family expenditures (30 percent of the deceased’s income) would have been discretionary expenses.

Varying the “living expenses” deduction over the deceased’s lifetime

The loss of income claim by the estate of Dean Duncan was 65 percent of the present value of his lifetime net employment income. Recall that Dean Duncan was 16 when he died, with no dependants – although the Court found that he would have eventually married and had two children. It remains unclear to what extent the 35 percent living expenses deduction might differ for people who were at a different stage of life. For example, would a 35 percent deduction also apply for a woman who was 45 years-old and single (without prospects of marriage or children) at the time of her death?

In the most recent decision in Duncan, the Court implied that the correct approach is to tie the living expenses deduction to the size of the deceased’s (without-accident) family at different stages of his life. Using this approach, the size of the living expenses deduction would be less in periods in which there is a large number of people in the household than in those in which there are few people in the household. (As the household size increases, less of the deceased’s income would have been spent on himself, leaving a larger portion to be claimed by the estate). For example:

…Duncan bore a one-fourth share of joint family expenses based on the trial judge’s finding that had Duncan lived, he would have had a wife and two children; had it been four children, only one-sixth of the shared family expenses would have been deducted. (Duncan [2000] at para. [22].)

This statement clearly suggests that the lost-years deduction will depend on the deceased’s family size. However, the message is mixed. One problem with tying the lost-years deduction to family size is that that approach does not appear to have been used in Duncan. As noted, in Duncan, the lost-years deduction was set at 35 percent and it was applied to Dean Duncan’s lifetime income. Employing the same reasoning that the Court used to obtain the 35 percent deduction, it is my understanding that a deduction of approximately 50 percent would have been appropriate for the period when Dean Duncan would have been married without children, 44 percent when he was married with one child in the home, and 35 percent when he was married with two children in the home. Since the Court did not use this approach in Duncan, it is not clear whether the Court has specified that a flat deduction should be used over the deceased’s entire (without-accident) life, or whether the deduction should vary over time. If the deduction should vary over time (with family size), then why did the Court not use that approach?

One might argue that, in Duncan, the Court chose a single unvarying deduction as a simple approach that would produce roughly the same result as using the slightly more complicated approach of varying the deduction over time. This argument fails, however, if it is found that the Court intended that the “conventional” deductions discussed above should be used as, in that case, the single deduction would have been much higher than 35 percent. Note that the “conventional” deductions are 50 percent for a one- or two-member family, 44 percent for a three-member family, and 35 percent for a four-member family. Given the findings of fact concerning Dean Duncan, if the Court had wanted to apply a flat lost-years deduction as a proxy for the time-varying deduction, it would have used a deduction close to 42 or 43 percent. If a 35 percent deduction applies to a four-person household, and the deductions are greater for households with fewer than four people, then the equivalent flat deduction must be greater than 35 percent. Since the Court used a flat 35 percent deduction, it is difficult to justify using a different approach, without contradicting the Duncan decision.

There is a circumstance in which a fixed 35 percent deduction might be justified, however. Earlier in this article, I argued that the appropriate deduction in a four person family was no more than approximately 22.5 percent, not 35 percent as is commonly argued. The equivalent figure for a three person family would be approximately 37.7 percent and for a two person family would be approximately 50 percent. It is possible that these figures could average 35 percent over the family’s life cycle.

If it is found that the living expenses deduction is to reflect non-discretionary expenses, then I believe that this would support a deduction that does not vary with family size. Although it is normally assumed that expenses on a spouse and children are “non-discretionary” (suggesting that the deduction would vary with family size), I believe that a case can be made for the supposition that they are discretionary.

Consider the example of a young couple that is deciding whether or not to have children. If they choose to have, say, two children, it is usually assumed that the children will create a new category of “non-discretionary” expenses. However, remember that the couple chose to have their children – in that sense, therefore, their expenses on those children are discretionary. That is, if one takes a short-run view, it appears that the parents have no choice but to spend a portion of their income on their children. But if one takes a lifetime view, it is apparent that the parents had a choice whether or not to spend that money, as they could have chosen not to have children. In this sense, expenditures on one’s spouse are also discretionary, in the sense that one could have chosen to remain single. According to this view, the portion of an individual’s income that would have been spent on truly non-discretionary expenses does not depend on whether he would have chosen to remain single, to marry, or to have children.

If the above rationale is ultimately rejected, and it is found that the size of the deduction does vary with family size, then in some cases great importance will be placed on the Court’s finding concerning a (deceased) young person’s without-accident lifestyle decisions. Suppose there is a case involving a deceased 17 year-old boy, who would have earned the income of an average university graduate. And suppose the Court is weighing two (drastically) alternative without-accident lifestyle scenarios for the boy: He would have remained single all his life, or he would have married and had five children. A finding for the latter scenario would lead to a loss probably more than double the result from the former scenario. And as noted above, I believe that (taking a long-term view) the deceased’s discretionary expenses would have been the same for either scenario (since he would have chosen to have zero or five children). Furthermore, although an “heir-centred” approach was explicitly rejected in Duncan in favour of a victim-centred approach, an approach which depends on without-accident family size is necessarily dependent on without-accident heirs.

Given the victim-centred approach, is it the case that a young victim who dies with (unfulfilled) plans to have a large family has lost more than if he planned to be forever single?

The choice between an award for loss of dependency and an estate-claim award

The Brooks v. Stefura appeal decision addresses the situation in which an heir to the estate (who is a potential recipient of the estate-claim award) is also one of the deceased’s dependants (and therefore is a potential recipient of an award for loss of dependency). Brooks offers the following guidelines at para. [14]:

  1. calculate the dependency award for each dependant, including prejudgment interest if it is granted;
  2. calculate the lost years’ award, including prejudgment interest if it is granted;
  3. allocate the lost years’ award to each beneficiary in accordance with the deceased’s will, or if the deceased died intestate, in accordance with the ISA;
  4. compare the dependency award with the allocated lost years’ award for each claimant, and reduce the dependency award by the amount of the lost years’ award, which represents an accelerated inheritance;
  5. if the lost years’ award is greater, the claimant receives only that amount; and
  6. if the dependency award is greater, the claimant receives the full lost years’ award together with the difference between the two as the dependency award.

In other words, each surviving dependant is entitled to receive either his/her share of the estate claim or his/her loss of dependency claim, whichever is greater. This seems fairly straightforward, but there are at least two important difficulties.

First, when comparing an heir/dependant’s losses under the Fatal Accidents Act (FAA) and the Survival of Actions Act (SAA), it is not clear from Brooks whether the loss of household services is to be considered separate from or together with the loss of dependency on income. Thus, suppose the heir’s share of the estate claim (from the SAA) is greater than her loss of dependency on the deceased’s income (from the FAA), but less than her loss of dependency on the deceased’s income and household services combined. Should she receive an award amounting to her loss of dependency on income and household services? Or can she instead receive her share of the lost-years claim and her loss of dependency on the deceased’s household services?

One possibility is that the heir/dependant has an “all or nothing” choice. Either she claims under SAA and takes her share of the estate claim, giving up any FAA claim (dependency on income or household services); or she takes her full claim under FAA and forgoes her share of the SAA claim. Another possibility is that the deceased’s without-accident income and household services are claimable separately, with the income claimable either under SAA or FAA. The spouse would then be entitled to her household services claim (under FAA), as well as either her dependency on his income (FFA) or her share of the estate claim (SAA).

The second difficulty is that strict application of Brooks could lead to total compensation that exceeds 100 percent of the deceased’s lifetime income. Consider the case of a deceased man who leaves behind a dependant wife and two children. Suppose both children are 17 at the date of their father’s death and they will only experience a loss of dependency for one year. And suppose the wife and two children are each entitled to one-third of the deceased’s estate (which would roughly be the case if the deceased died intestate). In almost all cases the children will have a larger estate claim (SAA) than a dependency claim (FAA). (This is because their dependency claim extends for only one year of their father’s without-accident work-life, but their share of the estate claim extends for their father’s entire work-life.) However, if the children receive awards representing their share of the estate claim, and the wife receives an award representing her loss of dependency on the husband’s income, it is quite possible that more than 100 percent of the deceased without-accident income will be allocated to the survivors.

There are at least three possible approaches that the Court could ultimately approve to resolve this difficulty. First, it is possible that the Court will allow this potential “overclaiming” of the deceased’s potential income. This seems unlikely, given the Court’s concern with “double-damages” in Brooks (see Brooks [2000] at para. [19]). Note however, that in a loss of dependency claim where there is no household services loss, the tax gross-up could also lead to more than 100 percent of the deceased’s income being allocated, and the Court has not taken steps to prevent this. Second, the Court might impose a constraint, such that the total awards allocated as estate claims and as losses of income dependency cannot exceed the total present value of the deceased’s after-tax income. A third possibility is that the Court could decide that the heirs/dependants as a group must choose between claiming under FAA or SAA. So in the example above (surviving wife and two 17 year-old children), it would be decided whether to claim under SAA or FAA and each heir would make his/her claim under that head. This could lead to some difficult situations since in many cases one heir might prefer a claim under SAA while another prefers to claim under FAA.

This is an issue that we will deal with in greater detail in the next issue of The Expert Witness.

Single individual

A question that the courts have not faced is how they should deal with individuals who would have been expected to remain single for the remainder of their lives. This might reasonably be the case, for example, if the deceased had been a confirmed bachelor in his or her 50s or 60s.

In that case, the approach favoured by the Court would have calculated the living expenses deduction by adding the deceased’s expenditures on personal expenses to the deceased’s “share of joint family expenditures.” But in a one person “family” the individual’s share of joint family expenditures is 100 percent. Hence, the method favoured by the Court would find that the deceased had spent 100 percent of his or her income on “living expenses” and the deduction would be 100 percent (or close to 100 percent). But this is just the “lost savings” approach that the Court has explicitly rejected. In short, the method favoured by the Court produces a result that the Court itself does not support.

This is not a result that the Court could reasonably have been expected to recognise without expert advice. However, as far as I know, it has not been addressed by any other economist. Nonetheless, it will need to be considered in order to establish a defensible approach.

Further issues

There are two additional issues that warrant further consideration. I mention them here briefly.

Could household services play a part in estate claims? Clearly the estate claim is one for lost earning capacity, but consider the case of a person who would not have earned any income, but would have performed valuable services. Could his estate make a claim under SAA? For example, suppose a young female lawyer is killed, but had she lived, she would have been a stay-at-home mother for five years. Is the estate’s loss over those five years zero? Negative? Of course in such a case the primary claim would be for loss of dependency, but in light of Brooks it is probably necessary to compare the size of the estate claim to the dependency claim.

Should the living expense deduction be a percentage deduction or a dollar deduction? Given that 35 percent was used in Duncan, would that same percentage have applied if the Court had found that he would have worked as a specialist physician (earning far more than the $35,000 per year that Dean Duncan would have earned)? A flat dollar deduction might be more appropriate, but it would also lead to more complicated calculations than a simple percentage deduction. And we would still be left with the problem of how (or whether) to vary the deduction with a person’s age, income, occupation, and so on.

leaf

Derek Aldridge is a consultant with Economica and has a Master of Arts degree (in economics) from the University of Victoria.