Recently Economica undertook a detailed re-evaluation of our recommendations concerning the discount rate. We argue that plaintiffs have available two alternative methods of investing their awards for future losses. In the first, which we call the annuity approach, plaintiffs use their awards to purchase life annuities or structured settlements. In the second, which we call the active management approach, plaintiffs invest their awards in portfolios of secure financial products, such as government bonds and “blue chip” stocks.
We find that the real rate of return is higher using the active management approach than the annuity approach – approximately 2.5 percent versus zero percent. At the same time, however, the risk that plaintiffs’ investments will be depleted before they die is much greater if plaintiffs manage their investments than if they purchase annuities. Accordingly, it may be that risk averse plaintiffs would prefer to purchase annuities than to manage their own portfolios even if they earn a lower rate of return.
We conclude that, as economists cannot know how risk averse individual plaintiffs are, our role should be to calculate two values for each future loss – one using zero percent and one using 2.5 percent. It will then be for the court to decide which discount rate is relevant to the particular plaintiff facing it.
Category: Discount rates
Implied Rates of Return on Structured Settlements
In this article, Derek Aldridge and Christopher Bruce contrast our recommended discount rates with those used by one important set of sophisticated investors, the insurance companies who write structured settlements. They find that our recommended rates are greater than those being offered by these companies, suggesting that our rates may be too high.
Read More...The Discount Rate Simplified
In this article, which was written collaboratively by Christopher Bruce, Laura Weir, Kelly Rathje, and Derek Aldridge, we begin by setting out a number of criteria that we believe should be met when selecting the discount rate. We ultimately conclude that a portfolio of Government of Canada bonds of varying maturity dates meets our criteria. We then argue that forecasts of Government of Canada bond rates that are based on historical statistics are unreliable for many reasons. Finally, we argue that the rates of return that are currently available on government bonds represent reliable predictions of future rates. Short-term interest rates can perform this role because they represent rates that are actually available currently; and long-term rates reflect the forecasts that have been made by sophisticated financial institutions that have substantial investments in the market.
Read More...The Discount Rate Revisited (Spring 2008)
This article reports on our latest survey of discount rates. We conclude that no changes to our existing discount rate assumptions are warranted, though a reduction in our long-term rate may be necessary in the future if the observed long-term rates remain significantly lower than our assumed rate.
Read More...Forecasting the long-term interest rate on Government of Canada bonds: “market-based” versus “conservative” investment
In the article Christopher Bruce examines a subtle issue relating to interest rates. He explains the difference between the interest rates realised by buying bonds and holding them to maturity, and selling and re-buying before maturity. These approaches will result in different estimates of historical interest rates.
Read More...The Discount Rate Revisited (Summer 2006)
In this article Derek Aldridge reports on our latest survey of discount rates, and outlines the revisions we have made to our standard assumptions. We conclude that some small changes to our short-term discount rate assumption are warranted, though we have not changed our assumptions concerning long-term rates. The overall impact on our calculations will be negligible in most cases.
Read More...The Discount Rate Revisited
In this article we review the recent evidence – both statistical and theoretical – concerning the discount rate (or real rate of interest). We review a number of different interest rates for each quarter since 1995 and find that every series has trended downward virtually continuously over the entire period. We then review the theoretical arguments that have been put forward to explain why this trend has been observed; and ask whether it is better to base a forecast of future rates of interest on the rates that are currently being observed or on averages of historical rates. We conclude that it would be inappropriate to rely on historical figures and instead we recommend use of multiple rates, based on the rates currently available for a variety of short- and long-term government bonds.
Read More...Selecting the Discount Rate – An Update
This article extends the work done by us in issues 5(3) and 6(4) of The Expert Witness, we conclude that it would be appropriate to revise our existing 2½ and 3½ percent two-part forecast of real interest rates. We propose to use a rate of 2¼ percent for the first five years of all calculations. For all subsequent years we propose to use a rate of 3¼ percent.
Read More...Selecting the Discount Rate – An Update
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.
Read More...Selecting the Discount Rate
In this article we begin by providing clear definitions of a number of fundamental concepts. These include: real interest rate; nominal interest rate; discount rate; real return bonds; and core rate of inflation. We then summarise the recent statistical data for various measures of inflation and interest rates in Canada. Finally, we use those data to calculate the “real interest” rate and to forecast a long-run discount rate. We conclude from this analysis that that rate appears to be 4.0 percent. However, as there has been some recent volatility in interest rates, we propose to revisit our forecast a year from now.
Read More...Ontario’s Mandated Discount Rate – Rule 53.09(1)
In this article Chris Bruce discusses the recent changes to Ontario’s mandated discount rate – as specified in their Rule 53.09(1).
Read More...Selecting the Discount Rate
This article completes a two-part series on the discount rate. In this issue, we review a number of different methods for estimating the future discount rate, explain why we prefer one of them over the others, and apply that method to the selection of a 4.25 percent rate.
Read More...What is a “Discount Rate”?
In this article Christopher Bruce provides a simple introduction to a concept which litigators must use every day – the discount rate, or “real rate of interest.” This article is the first in a series which will discuss the underlying concepts employed in the derivation of the lump sum values of future streams of losses.
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