Premiums, Profits, and Costs of Business in Alberta’s Automobile Insurance Industry, 1996-2006

by Christopher Bruce and Jason Strauss

This article first appeared in the winter 2008 issue of the Expert Witness.

Introduction

In February, 2008, Economica Ltd. was retained by the Canadian Bar Association to prepare a series of reports on automobile insurance premiums in five provinces: Alberta, Ontario, New Brunswick, Prince Edward Island, and Nova Scotia. We have now completed this work, having prepared two reports on Alberta and one on each of the other four provinces.

In this article, we summarise the main findings of the first of these reports, Alberta’s Minor Injury Regulation: Automobile Insurance Profits, Premium Rates, and Costs, prepared by Christopher Bruce, of Economica, and Jason Strauss, a Ph.D. student in the department of Risk Management and Insurance at Georgia State University. (The full text of this report can be found at: www.cba-alberta.org)

Our Report had three purposes:

  • to provide a measure of the profitability of automobile insurance in Alberta in the period 1996-2006, (that is, immediately preceding and immediately following the introduction of Alberta’s Minor Injury Regulation, the MIR, in the Fall of 2004);
  • to determine whether the observed changes in profits and premiums in the years prior to the introduction of the MIR had been caused by changes in costs; and
  • to identify what the effects on profits and premiums would be if the MIR was removed.

We summarise the results of our analyses in the three following sections of this article.

1. Profitability of Basic Coverage

As the MIR applied primarily to Basic Coverage, we focus in this section on that line of insurance. The methodology we use to estimate profits is based on the approach developed by the Insurance Bureau’s actuary, Mr. Joe Cheng, for his testimony in the case of Morrow v. Zhang (2008). (It was in Morrow that the constitutionality of Alberta’s Minor Injury Regulation was challenged.)

The most common measure of industry profitability (and the measure used in the Cheng Report), is after-tax “return on equity” (ROE) – that is, the industry’s after-tax profits divided by the value of the investments made in the industry. In Table 1 and Figure 1 (taken from our Report), we show that, prior to 2003, Basic Coverage was not profitable in Alberta, with an ROE ranging from -5.6 to +2.1 percent. In 2003, however, the return on Basic Coverage increased dramatically, to 19.1 percent, and rose above 20 percent in each of 2004, 2005, and 2006.

Table 1

Figure 1

1.1 Claims costs relative to total costs

It is possible that the sudden increase in ROE in 2003 could have arisen from a dramatic change in the costs of claims. The data in Table 2, however, indicate that these costs remained a relatively constant portion of insurance companies’ total costs throughout the entire period 1996 to 2006. That is, the rate at which the costs of claims were rising was not appreciably different from the rate at which insurance companies’ other costs – primarily the costs of administration – were increasing.

Table 2

1.2 Claims costs relative to premiums

Alternatively, profits may have risen in the 2003/2004 period because claims costs fell relative to premiums. We investigate this possibility in Table 3, which reports changes in claims costs per motorist, relative to average premiums. What this table indicates is that, until 2002, premiums tracked claims costs fairly closely. That is, each increase in claims costs per motorist was matched by a similar increase in insurance premiums, resulting in a ratio of costs to premiums that varied only slightly. For example, while the average claim for Basic Coverage was 99.0 percent of the average premium in 1996, that ratio was 92.9 percent in 2002 – because premiums rose by 39.1 percent over that period, while average claims rose by a similar amount, 30.3 percent.

Table 3

In 2003 and 2004, however, premiums rose much more quickly than did claims costs, driving down the claims ratio. Between 2002 and 2004, for example, the average premium rose by 19.3 percent, while average claims actually fell by 21.9 percent. Thus, it appears that the dramatic increase in profit rates over the 2003-2004 period was driven, in large part, by a sudden change in the relationship between the costs of Basic Coverage and the premiums that were charged for that coverage. In the following section, we investigate a number of factors that might have led to this change.

2. Changes in Costs per Vehicle

The price of automobile insurance – the premium – is affected by four components. First, there are the average costs of claims (including adjustment expenses) per vehicle that were discussed in the preceding section. Second, allowance must be made for administration expenses (broker’s commissions, overhead, etc.). Third, insurers earn income from the investment of equity and reserves (premium revenue that will eventually be used to pay claims). Finally, a reasonable rate of profit must be added to net costs.

The question we address in this section is whether the increases in premiums between 1996 and 2004 can be attributed to changes in any of these components.

2.1 Average claims per vehicle

In Table 3, we showed that the cost of claims rose at approximately the same rate as the price of premiums over the period 1996 to 2002. Thus, if there was a need for increased premiums in 2003 and 2004, it was not because the ratio of claims costs to premiums had changed over the preceding six years.

Nevertheless, Basic Coverage is composed of a number of sub-categories, including Third-Party-Liability and Accident Benefits. In turn, Third-Party-Liability (TPL) is composed of TPL-Property Damage and TPL-Bodily Injury, of which only the latter was affected by the Minor Injury Regulation (MIR). Thus, it is possible that even though claims costs for Basic Coverage as a whole did not increase in 2003 and 2004, there may yet have been an increase in the component that was affected by the MIR. To investigate this possibility, we report the data in Table 4.

Table 4

In this Table, it is seen that the claims for TPL-Bodily Injury increased at roughly the same rate as the other components of Basic Coverage prior to the MIR. For example, whereas claims for Bodily Injury increased by 32.5 percent between 1996 and 2002, claims for Property Damage increased by a similar percentage, 27.8.

We are led to ask, therefore, whether a change in some other element of the cost of insurance can explain the sudden increase in premiums that was observed in 2003 and 2004. In sections 2.2, 2.3, and 2.4 we analyze administrative expenses, investment income, and return on equity.

2.2 Administrative expenses

Table 5 reports that the ratio of administrative expenses to premiums (the expense ratio) decreased from 25.5 percent in 1996 to 23.8 percent in 2001. As average premiums increased only slightly over this period, the dollar value of expenses must have been decreasing or relatively stable. Furthermore, in the time period immediately prior to the introduction of the Minor Injury Regulation, 2002 and 2003, expense ratios fell further while premiums increased dramatically. It can be concluded, therefore, that changes in administrative expenses were not the source of the premium increases that occurred in 2002 and 2003.

Table 5

2.3 Return on investment

Insurance premiums are placed in a reserve until claims have to be paid. Those reserves are invested and the investment income generated thereby is credited against the cost of premiums. Hence, an increase (reduction) in the rate of return on investment, ROI, may lead to a decrease (increase) in premiums.

It is seen in Table 6 that the ROI insurers earned on their equity and reserves declined almost continuously over the period 1996 to 2001. Nevertheless, this decrease placed only limited upward pressure on premium rates. Specifically, we estimate that to compensate for the decrease in ROI from 9.0 percent in 2000 to 6.2 percent in 2003, insurers would have needed a $44 increase in the 2003 premiums on Basic Coverage. In fact, those premiums increased by $213, from $537 to $750. (See Table 3.) This confirms that decreasing ROI was not the primary impetus for the premium increases in 2002 and 2003.

Table 6

2.4 Return on equity

Once the net costs of insurance have been calculated, the premium is determined by adding a profit margin, or return on equity, ROE, to those costs. Thus, as the necessary ROE increases, premiums will also increase. We surveyed seven sources of expert opinion concerning the appropriate ROE target for the automobile insurance industry. We found:

  • Dr. Norma Nielson and Dr. Mary Kelly, in a presentation to the Alberta AIRB October 20, 2006, recommended an ROE in the range of 14.31 to 18.26 percent
  • NERA Consulting Economists, in a report for the Newfoundland & Labrador Board of Public Utilities, October 13, 2004, recommended an ROE in the range of 11 to 14 percent.
  • Based on NERA’s report, Dr. Ronald R. Miller of Exactor Insurance Services Inc. recommended an ROE of 12.5 percent.
  • Dr. Basil A. Kalymon, on behalf of the consumer advocate, recommended to the Newfoundland & Labrador Board of Public Utilities that the target return on equity for the setting of automobile insurance rates should be 9 to 10 percent.
  • The consumer representative to the Alberta AIRB, Ms. Merle Taylor, CMA, recommended that the ROE be higher than the allowable rate for utilities (at that time, 8.9 percent). She also stated that a 19.6 percent ROE would be “excessive.”
  • In his testimony in Morrow v. Zhang (2008), actuary Joe S. Cheng, F.C.I.A. stated that a 12.5% ROE was considered by many insurers to be in the low end of a reasonable range; and that the high end of a reasonable range might be 20%.

The Alberta Automobile Insurance Rate Board (AIRB) currently employs a formula that implies that an after-tax ROE of 9.5 percent would be appropriate.

Excluding the report by Merle Taylor, which did not give an exact range or recommendation, the average of the six remaining experts’ opinions concerning a reasonable ROE for automobile insurance is 12.76 percent. This figure is well above the rates earned on Basic Coverage in Alberta between 1996 and 2002, (see Table 1), but is well below the rates earned since then. Most importantly, Alberta insurance companies earned an ROE of 19.1 percent in 2003, the year before the introduction of the MIR.

2.5 Summary and conclusions

  • As indicated in the preceding sections, claims did not dramatically increase in the time period leading up to the Minor Injury Regulation.
  • As also shown above, administrative expenses did not increase but, rather, decreased in the time leading up to the Minor Injury Regulation.
  • Although investment returns decreased in the time leading up to the Minor Injury Regulation, their effect on the increase in premiums was minor.
  • ROE for Basic Coverage averaged -1 percent per year in the period 1996 to 2002 (7.4 percent for All Coverages). During this same period, average premiums for Basic Coverage only increased by 6 percent per year on average (4.5 percent per year on average for All Coverages). This premium deficiency (the difference between premium charged and premium required to reach a reasonable rate of return) appears to have been the primary impetus for the sharp increase in premiums that occurred in 2002/2003, as the “soft” market ended and a “hard” market began.
  • We estimate that without the premium increases in 2002 and 2003, ROE on Basic Coverage would have been -3.8 percent (in 2003).

 

3. Projected Effect of Removing the Minor Injury Regulation

Using the AIRB’s methodology, and controlling for other reforms beside the Minor Injury Regulation (i.e. controlling for the gross to net income reform and the collateral income reform), we estimate that the required average premium increase for Basic Coverage, if the Minor Injury Regulation had been removed, would have been $111.76/year if industry profits were to be maintained at their 2006 level, of 21.8 percent.

Alternatively, using the AIRB’s methodology, we estimate that insurer ROE for Basic Coverage would have been 12.2 percent in 2006 if the Minor Injury Regulation had been removed and premiums held constant. (Furthermore, in this case, the ROE would have been 16 percent for All Coverages.)

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Christopher Bruce is the President of Economica and a Professor of Economics at the University of Calgary.

Jason Strauss is a Ph.D. student in the department of Risk Management and Insurance at Georgia State University.

Fatal Accident Calculations Under the New Legislation

by Kelly Rathje

This article first appeared in the autumn 2007 issue of the Expert Witness.

Recent changes to the Insurance Act in Alberta (amendment R.S.A. 2000, c. 1-3 defined in section 626.1) may affect the treatment of survivor pension benefits in fatal accident calculations. Prior to the legislative change, survivor pension benefits were treated as a collateral benefit – in the sense that they represented insurance proceeds paid for by the deceased’s CPP contributions – and these benefits were not included when estimating the family’s dependency loss. Any deduction for the survivor’s benefit would have been equivalent to reducing a loss of income-dependency award because the survivor had received some life-insurance proceeds.

Under the new legislation, however, the forms of payment to be deducted from the award include:

(d) benefits under a prescribed income continuation or replacement plan or scheme…

Thus, under the new legislation, it may be argued that for fatal accidents occurring on or after January 26, 2004, any survivor benefits should now be deducted from the loss of dependency award as these represent “income continuation or replacement”. However, note that the Act does not specifically address CPP survivor’s benefits, though it does state that CPP disability pensions are to be deducted from an injured plaintiff’s losses. It may be argued that the same reasoning applies in the case of a fatal accident, and the survivor’s pensions will be found to be deductible.

Note that this may also imply that any private pension benefits that are received by a surviving spouse may also need to be included in the dependency loss calculations. For example, if the deceased was a teacher or nurse, presumably the surviving spouse would receive any private pension contributions in the form of a lump-sum payment or monthly survivor pension benefits.

In light of the legislation change, we propose that since survivor benefits are now to be deducted from the dependency losses, they must also be factored into the without-accident income path. That is, in any given year there would have been a possibility that the deceased would have died and the survivors would have received benefits, (had the accident under litigation not occurred). In the past, we would not have considered these benefits to be “income” as they would have been treated as collateral benefits.

Allowing for these changes to the legislation requires that we take a two-step approach to estimating the deceased family’s loss of dependency on income.

In the first step, we undertake the following calculations to estimate the family’s loss of dependency.

  • We estimate the employment and retirement incomes that the deceased would have earned over his life, had the accident not occurred (his “without-accident” income path), and the probability that the family will experience a loss of dependency on that income.
  • We then estimate the survivor benefits that dependents would have received had the deceased died, and the probability that these benefits would have been received.
  • We multiply each year’s loss by the probability of each event occurring in the years following the accident, and add the resulting figures to estimate a stream of losses.
  • Finally, we calculate the present discounted value of the stream of losses.

In the second step, we calculate the present discounted value of the survivor benefits the family is now receiving. The dependency loss is then the difference between the figures calculated in the two steps – the expected value of the loss of dependency and the present value of the survivor benefits.

For the loss of dependency calculations, contingencies that reflect the probabilities that the couple might have eventually separated or that the surviving spouse may remarry, are also usually included. These contingencies have the effect of reducing the dependency loss. If the couple had separated, then presumably the surviving spouse would not have benefited from the deceased’s income, and if the surviving spouse remarries, then presumably he/she will no longer be dependent on the deceased’s income. However, when estimating the probability that the surviving spouse would have received survivor benefits regardless of the accident, we do not include remarriage contingencies. Had the deceased died regardless of the accident, the surviving spouse would have received survivor benefits as long as the couple had not separated by that time. Whether or not the spouse subsequently remarried would not have altered his/her eligibility for survivor benefits. Therefore, remarriage has no effect on the without-accident survivor benefits and does not need to be included in the calculations.

Potential issues

Collateral benefit

The argument that survivor benefits should be deducted from the loss of dependency award is based on the assumption that they represent “income continuation or replacement,” as specified in the new legislation. There is, however, an argument that survivor pensions should be treated as “proceeds from insurance,” not as “income continuation” benefits. If they fall in the former category, they may be considered to be a collateral benefit, which would not be deducted.

For example, suppose the surviving spouse is receiving a pension from a private plan. It may be argued that this pension is a collateral benefit – in the sense that it represents insurance proceeds paid for by the deceased’s acceptance of a reduced direct pension. Presumably the deceased had a choice between accepting a pension with a survivor’s benefit and a higher pension with no survivor’s benefit. Both pensions would be actuarially equivalent. The deceased’s choice of the “survivor’s benefit” option is effectively the same as if she had chosen the option of a higher pension with no survivor’s benefit, and used the additional income (while she was alive) to buy life insurance. Had she done so, it is our understanding that the life insurance proceeds would be considered to be a collateral benefit, and not deducted from any dependency losses. That is, any deduction for the survivor’s benefit would be essentially the same as reducing a loss of income-dependency award because the survivor has received some life-insurance proceeds. The courts do not allow the latter, as we understand the law.

Conservative estimate of survivor benefits without-accident

In our calculations, we assume that the survivor benefits actually received by the family are a reasonable reflection of the benefits they would have received had the deceased not died in the action under litigation. This is likely a conservative estimate that will understate the losses since the longer the deceased would have contributed to a pension plan, the higher the benefits would have been.

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

The Impact of the “Net Income” Provisions of the Insurance Amendment Act, 2003

by Christopher Bruce

This article first appeared in the summer 2004 issue of the Expert Witness.

The Insurance Amendment Act, 2003, adds the following subsection to Section 626.1 of the Insurance Act:

(2) To the extent that an award is for or is determined with reference to loss of earnings, the amount of the award shall be reduced by

(a) income tax, if the award is not subjected to income tax,

(b) contributions by employees, and 50 percent of contributions by self-employed persons, under the Canada Pension Plan (Canada), and

(c) premiums under the Employment Insurance Act (Canada) relating to the state of being employed, that would be or would have been payable on or with reference to the lost earnings, both before and after the award, had the accident not occurred.

The purpose of this paper is to analyse the impact that this subsection will have upon the assessment of personal injury damages in Alberta. Four general topics will be discussed: calculation of “net income,” introduction of the “tax gross-up” claim, consideration of questions that remain unanswered, and impact of the amendment on the size of personal injury claims.

1. Calculation of “net income”

The effect of the Act is to require that a calculation be made of the plaintiff’s “net income” – that is, his or her income after deduction of income taxes, employment insurance premiums, and CPP premiums (payable by the employee) – in both the without-accident and the with-accident scenarios, both before and after trial. This adds two steps to the calculation of personal injury damages: a determination has to be made of the various types of deductions and tax credits that will be relevant to the plaintiff; and income taxes, EI premiums, and CPP premiums have to be calculated in each year of the plaintiff’s loss.

1.1 Income tax deductions and credits: An individual’s income taxes are affected by many factors other than earned income. Taxable income, for example, is found by deducting contributions to private and public pensions, union dues, and moving costs. And individuals are eligible for tax credits that are determined, in part, by age, marital status, disability, CPP contributions, EI premiums, medical expenses, educational expenses (for example, for a child’s university fees), and charitable donations.

Prior to the passage of the Insurance Amendment Act, none of these factors had to be taken into account in claims for personal injury damages. Now, all of these factors will have to be considered, not just for the plaintiff’s current situation, but also for all situations that might arise over the duration of the plaintiff’s injury. For example, if a young person has suffered a permanent injury, it will now be necessary to predict whether they would have married and had children; how many children they would have had, and when; whether they would have contributed to an RRSP; and, if so, how much and when.

1.2 Calculation of income taxes: One of the most important implications of the Insurance Amendment Act is that plaintiffs’ income tax obligations will now have to be calculated for every year of every scenario of their claims, from the date of the injury to the date on which the effects of the injury will have resolved, regardless of the size of those claims. In claims of short duration, it may be possible to obtain a rough estimate of these obligations simply by projecting the plaintiff’s past tax record forward. For example, if the plaintiff’s taxes were 20 percent of income in the year preceding the accident and he/she will now lose one year of employment (at the same employer, at a similar earnings level), it may be possible simply to assume that the lost income would also have been taxed at 20 percent.

However, if the plaintiff’s employment situation would have (or has) changed had the accident not occurred, or if the period of loss extends more than a few years, it will be necessary to calculate taxes for each period of the loss. Fortunately, a number of computer-based programs are available that will simplify such calculations. First, there are commercial packages such as QuickTax. Second, there is a number of free programs available on the internet. The most sophisticated of these is Canada Revenue Agency’s “TOD” program that can be downloaded from:

www.cra-arc.gc.ca/tax/business/tod

Also, a tax calculator that is much simpler to use, but provides less precision, is found on Ernst & Young’s website at:

www.ey.com/global/content.nsf/Canada/Tax_-_Calculators_-_Overview

In general, income taxes amount to approximately 15 to 25 percent of gross income. Hence, for most plaintiffs, the effect of the Insurance Amendment Act will be to reduce the size of their claim by that percentage.

1.3 Calculation of EI premiums: Employment Insurance premiums will also have to be calculated. However, this is relatively straightforward. For all annual incomes below $39,000, the employee pays 1.98 percent of his/her earnings. For all incomes above $39,000, the EI premium is capped at $772.20 per year. Hence, the maximum effect of this element of the Insurance Amendment Act will be to reduce plaintiff’s claims by less than 2 percent.

1.4 Calculation of CPP premium: Section 626.1(2) states that “…the amount of the award shall be reduced by… (b) contributions by employees, and 50 percent of contributions by self-employed persons, under the Canada Pension Plan (Canada)…” Perhaps surprisingly, this provision will have no effect on plaintiff claims, as it has already been the common practice for most financial experts to deduct these contributions.

This practice has been based on two observations: First, the employer and the employee make equal contributions to the CPP. Second, the present discounted value of the benefit payments from the CPP (once the employee has retired) is equal to (approximately) half of the present discounted value of the CPP contribution stream. (Essentially, the other half of the CPP contributions has been used to “top up” the Plan, which had been under funded.) Hence, restitutio requires that only half of the contributions to the employee’s CPP account be replaced. As the employee’s and the employer’s contributions are of equal value, one can replace half of the contributions by compensating the plaintiff for only one of the two sources. For example, one can compensate for only the employer’s contribution but not for the employee’s. This, in effect, is what the common practice has been in Alberta.

Thus, as the new Act mandates deduction of the employee’s contributions, but does not preclude addition of the employer’s contributions (a form of fringe benefit), it leaves the plaintiff in the same position in which he/she would have been before the Act. That is, the CPP provision of the Act will have no net effect on plaintiffs’ awards.

1.5 Sample calculations: In the attached table, I have calculated the impact of the Insurance Amendment Act on the loss of income claims of plaintiffs at various levels of income. In the calculation of income taxes, I have assumed that the individual has the minimum level of deductions and tax credits. Hence, the figures reported in the table should be taken as maxima. It is seen there that the effect of the Act will be to reduce awards by 15 to 25 percent.

Table 1

2. Income Tax

The Supreme Court of Canada has ruled, with respect to both fatal accident claims and claims for cost of future care, that if the annual loss is calculated net of income tax, the plaintiff is entitled to an “income tax gross-up” to ensure that the amounts available from the investment of the lump sum damages are sufficient to compensate the plaintiff for his/her future losses. As the Insurance Amendment Act does not explicitly prevent the courts from allowing a tax gross-up, it appears likely that they will allow this calculation. This means that, in every personal injury case in which the plaintiff’s damages are expected to affect his/her income for some time into the future, a tax gross-up calculation will have to be made.

2.1 The basis of the calculation: Assume that the plaintiff has lost a gross (before tax) income of $50,000 one year from now, that his income taxes on that amount would have been $10,000, and that the interest rate at which he can invest a lump-sum award is 5 percent. Prior to the passage of the Insurance Amendment Act, the plaintiff would have been entitled to an award of $47,619 – as investment of $47,619 at 5 percent will provide a return of $2,381; and $2,381 plus $47,619 is $50,000.

Under the new Act, however, the plaintiff is to be compensated only for his after-tax loss, of $40,000. Thus, if the taxes on interest were ignored, the lump-sum award would be $38,095 – as $38,095 plus 5 percent of $38,095 (= $1,905) is $40,000. However, assume that the interest on the lump sum award will be taxed at 20 percent. In that case, investment of $38,095 at 5 percent would yield a net (after-tax) return of only $1,524 ($1,905 minus 20 percent) and the plaintiff would have only $39,619 with which to replace his $40,000 loss.

The 20 percent tax on investment income has reduced the effective rate of interest by that 20 percent, from 5 percent to 4 percent. (Note that $1,524 is 20 percent less than $1,905, or 80 percent of $1,905.) Thus, if the plaintiff is to have $40,000 available to him one year from now, more than $38,095 will have to be invested today. In this case, that amount will be $38,462 – as $38,462 plus 4 percent of $38,462 (= $1,538) is $40,000. The difference between $38,462 and $38,095 is called the income tax gross-up. NOTE: The gross-up equals the income tax that must now be paid on the interest income that derives from investment of the lump-sum award.

2.2 The magnitude of the tax gross-up: Note that in my simple example, the tax gross-up was very small relative to the size of the lump sum award. This is because there was only one year of losses and, hence, the lump-sum award, (on which interest was to be calculated), was small relative to the size of the annual loss. In cases in which losses are expected to continue for longer time periods, however, both the lump-sum award and the interest earned on investment of that award will be larger relative to the size of the annual payments. In such cases, the gross-up will become a much larger percentage of the award.

For example, assume again that it has been determined that the plaintiff has lost $50,000 per year before taxes, that taxes on that income would have been $10,000 per year, and that the interest rate is 5 percent. Assume also that the loss is expected to continue for 40 years and that the lump-sum award required to replace this stream, before addition of the gross-up, would have been $500,000. If that amount is invested at 5 percent, $25,000 in interest will be generated in the first year and, at a tax rate of 20 percent, the plaintiff will be required to pay $5,000 in taxes. That $5,000, and comparable (but declining) amounts calculated in all 40 of the future years of the loss, will have to be added to the award to ensure that the plaintiff can replace his/her after-tax losses. These “additions” constitute the gross-up.

In many cases, the addition of the gross-up will increase the award by as much as half of the reduction that resulted from the omission of income taxes. For example, if the lump sum, without the gross-up, has been reduced by 20 percent, the gross-up will often add as much as 10 percent back to the award.

It is interesting to ask whether it is possible that the award with the gross-up could be higher than the award that would have resulted from application of the “old” rules, in which income taxes were ignored. The answer is that it is highly unlikely that this will occur. In the example above, the effect of the Insurance Amendment Act was to reduce the plaintiff’s annual claim by $10,000, from $50,000 to $40,000, due to the deduction of 20 percent income taxes. Before the gross-up calculation could return the lump-sum award to the level it would have had prior to the Act, the taxes on investment income – the amount to be added for the gross-up – would have to equal that $10,000. In my example, that would require that investment income be $50,000 per year as, at a tax rate of 20 percent, that would generate $10,000 worth of taxes. (For example, if the lump sum was $1,000,000 and the interest rate was 5 percent, $50,000 investment income would be generated each year.)

That is, before the tax gross-up calculation would “add back” the income tax that had been deducted as a result of the Insurance Amendment Act, (in this case, $10,000 per year), the interest income in each year would have to equal the loss of before-tax income in that year. In my example, the annual before-tax income was $50,000, on which taxes would be $10,000. In order for the investment of the lump-sum award to create $10,000 in taxes on investment income, (which is the amount to be added for the gross-up), at the same 20 percent tax rate, it would have to generate $50,000 in such income. (Again, at a 5 percent interest rate, the lump-sum would have to be $1,000,000.)

But assume that investment of the lump sum did generate $50,000 investment income. That would exactly equal the amount required to pay for both the tax on that income ($10,000) and the compensation required for the plaintiff’s loss of net income ($40,000). That is, after deduction of the two payments from the interest income, the lump-sum would be left intact. But that cannot be correct. It is clearly the intention of the court that the lump sum award be drawn down each year, to help pay for the annual losses, until there is nothing left at the end of the period of the loss. That can only occur if the investment (interest) income in each year is less than the payments for taxes and the plaintiff’s loss. And that implies that the taxes on the investment income (the gross-up) will be less than the taxes on (gross) employment income. In short, in all but very exceptional cases, the gross-up will not be sufficient to return the lump-sum to the level that would have been awarded in the absence of the Insurance Amendment Act.

3. Unanswered Questions

With respect to the income tax issue, the primary question that will have to be answered by the courts is whether a tax gross-up will be allowed. Some lesser questions may also be raised:

3.1 Collateral benefits: The Insurance Amendment Act requires that many collateral benefits be deducted from the plaintiff’s claim. It is not clear whether the plaintiff will be able to include the interest earned on the investment of such benefits in the calculation of the tax gross-up.

3.2 “Add backs”: Self-employed individuals are often able to write off personal expenses as business expenses for the purpose of calculating taxable income. For example, business owners often claim that a greater portion of their vehicle, telephone, and mortgage expenses are for business use than is actually the case. Commonly, in personal injury claims, the “personal” portions of these expenses are “added-back” to reported income in order to obtain a measure of “true” income.

How should income taxes be calculated on this “add back?” Assume, for example, that the plaintiff had been reporting earnings of $30,000 per year, on which she had been paying income taxes of $4,000. Assume also, however, that this individual had benefited personally from $5,000 worth of business expenses per year. When this amount is added back to obtain the “true” measure of income, $35,000, should the income tax calculation be based on that ($35,000) figure, even though the plaintiff had been paying taxes on only $30,000? Or should the court recognise that, in the absence of the accident, the plaintiff would have received $31,000 (= $30,000 reported income – $4,000 income tax + $5,000 “business” expenses) worth of benefits (after tax) from her employment?

3.3 Replacement cost: It is not clear how the Insurance Amendment Act will affect the determination of damages when damages are measured using the “replacement worker” method.

In many cases involving self-employed individuals it is unclear (a) what their true income would have been if they had not been injured; nor (b) what their income will be now that they have been injured. It is often possible to determine, however, how much it would cost to hire a “replacement worker” whose input would return the plaintiff’s business to its pre-injury level of profitability.

Assume, for example, that the plaintiff’s income would have been $50,000 per year if she had not been injured and that it will be $20,000 per year now that she has been injured, but that neither figure can be calculated with any degree of certainty. Assume, however, that it is known that if the plaintiff was to hire an assistant for $20,000 per year, the firm would be as profitable as it would have been if the plaintiff had not been injured. In that case, it is argued, if the plaintiff was paid $20,000 per year, she would be put back in the position she would have been in had she not been injured.

But notice, if the plaintiff had not been injured, her business would have earned a profit of $50,000 per year, on which she would have paid income taxes. With the hiring of the replacement worker, the business again makes a profit of $50,000 before payment of $20,000 to the replacement worker. But, after the replacement worker has been paid, the plaintiff’s business will show only a $30,000 profit; and it is on that number that taxes will be calculated. Thus, if the plaintiff is awarded $20,000 per year, with which to compensate the replacement worker, her net income “with injury” will be: $50,000 (= $20,000 plus $30,000) minus the taxes on $30,000. This is greater than her net income before injury, which was $50,000 minus the taxes on $50,000.

It is not clear how the court will wish to deal with this anomaly, if at all. Note that any attempt to calculate the tax implications of using the replacement worker method will require that estimates be made of both the plaintiff’s with- and without-income streams. Yet it was to avoid having to make those estimates that the replacement worker approach was devised.

4. Impact of Insurance Amendment Act

The Insurance Amendment Act will reduce damage awards by the greatest amount in the following situations:

  • Those in which the plaintiff had been earning a relatively high income and, therefore, had been paying relatively high income taxes.
  • Those in which the plaintiff’s injuries are expected to continue for a relatively long period of time, as the effect of compensating for only after-tax income will be compounded over the duration of the loss – and as the tax gross-up will not fully offset the reduction for taxes.
  • Those in which the plaintiff is not self-employed. Self-employed individuals are able to write off personal expenses against their business income. Assume that it has been determined that those expenses amount to $5,000 per year. Typically, under the current system, that $5,000 will be “added back” to reported income in order to obtain a “true” measure of income. However, the individual would have had to earn more than $5,000 in order to generate enough income to purchase $5,000 worth of goods if he/she had not been self-employed (because income taxes would have been payable on any such income). Hence, the current practice actually compensates the plaintiff only for his/her loss of after-tax income. As that is what will be required under the Insurance Amendment Act, such plaintiffs will be in the same position under this Act as they were previously.
  • Individuals who have a cost of care claim. The income tax gross-up on a cost of care claim will be higher, the greater is the award for loss of earnings. (The higher is the award for loss of earnings, the greater is the interest that will be earned on investment of that award and, therefore, the higher will be the income tax bracket in which other sources of income – for example, interest on the cost of care award – will be placed.) As the Insurance Amendment Act reduces awards for loss of earnings, it will also reduce awards for cost of care.

5. Conclusion

It is my expectation that Section 626.1(2)(a) of the Insurance Amendment Act will not introduce any significant legal principles that have not already been analysed carefully with respect to fatal accident and cost of care claims. The primary impacts of the amendments are (a) more time and effort will now have to be expended in the calculation of personal injury damages (particularly when a gross-up is required); and (b) personal injury damage awards will now be approximately 15 to 25 percent lower than they were previously.

Footnotes:

* This article is based on presentations Dr. Bruce gave to ACTLA seminars in Calgary and Edmonton on June 21 and 23, 2004. He thanks the participants at those seminars for the excellent feedback that helped him to revise his paper. [back to text of article]

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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).

How are Automobile Insurance Premiums Determined?

by Christopher Bruce

Although automobile insurance rates seem to be in the news constantly, there is often confusion in the media about the process by which premiums are determined. The purpose of this article is to provide a brief introduction to that process. Three topics will be discussed: actuarial rating, rating classes, and experience rating.

1. Actuarial Rating

In Alberta – and all jurisdictions with private insurance – automobile insurance premiums are established through a technique that is generally referred to as “actuarial rating.” Fundamentally, under this system the premium the driver pays is equal to the cost that the insurance company expects the driver will impose upon it. If, on average, insuring a driver will cost the insurer $1,000 per year, the premium it will charge will equal $1,000 (plus an allowance for the company’s profit margin).

Assume, for example, that an insurance company has 10,000 customers; that there is a 10 percent chance that each driver will have an accident that results in an insurance claim each year; and that the average claim is $7,000. On average, therefore, 1,000 customers will make a claim each year, imposing a total cost of $7,000,000 on the insurer. Spread across the company’s 10,000 customers, therefore, the cost of claims, per customer, is $700.

In addition, the insurer will have to pay for its own costs of administration and will have to collect enough money to provide it with at least the minimum amount of profit to keep its shareholders satisfied. Assume that administrative costs amount to $250 per customer per year and that the minimum “acceptable” profit level can be represented as $50 per customer per year.

In this case, the insurer will have to collect at least $1,000 per year from each of its clients – $700 to cover the average cost of accident claims, $250 to cover administrative costs, and $50 for profit. The theory of actuarial rating predicts that this insurance company will set its premiums equal to that $1,000 figure. The “proof” of the theory’s prediction is as follows:

First, imagine that the company was to set a premium that was higher than $1,000, say, $1,050. Now, the company’s expected profit would be $100 per customer (= $1,050 – $700 – $250), twice the $50 figure that insurance companies require in order to remain in business. A second insurer would see the opportunity to make substantial profits by offering to insure the first company’s clients for less than $1,050, say $1,025. At this rate, its profits of $75 per customer would still be higher than the $50 that shareholders demand. But this would attract additional companies who would be willing to offer an even lower rate. As long as profit exceeds the minimum necessary to attract investors – that is, as long as the premiums charged exceeded $1,000, new firms would continue to enter the market, driving the premium down. In the long-run, the premium rate could not remain above the cost of insurance plus the minimum profit level.

Second, imagine that the insurer was to set its premium below $1,000, say at $900. It would soon discover that the costs of insurance exceeded the premiums that were being collected and it would be forced either to raise its premiums or to go out of business. In either event, premiums would rise until they at least equaled insurers’ costs (plus the minimum profit level).

In short, as long as there is competition in the insurance market – that is, as long as firms are able to compete for the business of their rivals; and firms do not collude to prevent such competition – the premium level will always tend towards the cost of insurance plus a minimal profit level. When premiums are set in this way, they are called “actuarially fair.”

2. Rating “Classes”

In the preceding discussion, I assumed that each client had the same probability of making a claim – 10 percent per year. In reality, of course, some customers have a higher claims probability than others. The theory of actuarial rating predicts that insurers will attempt to identify different “classes” of customers, according to those customers’ claims probabilities, and will charge a premium to each group that is a function of its accident risk.

Assume, for example, that the insurance company discussed above realizes that 2,000 of its 10,000 customers have a higher-than-average probability of making an insurance claim, say 20 percent per year. If it is still assumed that the average probability across all 10,000 customers is 10 percent, that implies that the probability that each of the company’s remaining 8,000 customers will make a claim is 7.5 percent. That is, when the 2,000 high-risk customers each have an accident probability of 20 percent and the 8,000 low-risk customers have an accident probability of 7.5 percent, the average probability of an accident across the two groups together is 10 percent. Thus, the expected number of claims is still 1,000 per year – 400 (= 0.20 × 2,000) by the high-risk group and 600 (= 0.075 × 8,000) by the low-risk group.

If the company continues to charge each of its customers $1,000 per year, it will still make an average profit of $50 per customer. (Because its customers have the same number of accidents and pay the same premiums, the same amount is left over for profit). However, if another company notices what is happening, it will realize that it could make a higher profit than average by attracting away some of the first company’s low-risk drivers.

For example, if the second insurer was able to attract 1,000 customers by charging $900 to the low-risk group, it would find that, on average, 75 of those customers (= 0.075 × 1,000) would have accidents. At an average cost of $7,000 per accident, total accident costs would be $525,000, or $525 per client. Assuming that administrative costs remained at $250, this company’s total costs per client would be $775, leaving a $125 profit from the $900 premium.

Soon, other insurance companies would recognize this profit-making opportunity and they would also offer reduced premiums to the low-risk group. By the theory of actuarial rating, the equilibrium premium for drivers in that group would eventually settle at $825 – the $775 cost per driver plus $50 for profit.

At the same time, as low-risk drivers were being attracted away from the first company, that company would find itself with a higher and higher percentage of drivers from the high-risk group. Assume that, ultimately, all of its clients came from that group. If each of those drivers had a 20 percent probability of making a claim and the average claim cost $7,000, then the average value of claims per driver would be $1,400. When $250 is added to this figure for administrative costs and $50 for profit, the firm would have to charge a premium of $1,700 to each of these drivers to remain in business.

But, high-risk drivers have no incentive to reveal to insurers that they have high probabilities of making claims; and low-risk drivers may find it difficult to signal credibly that they are members of the low probability group. (If insurance companies offer low premiums to those in the low-risk group, it will be in every driver’s interest to claim to belong to that group.)

Hence, insurance companies have looked for ways to construct “classes” of drivers based on characteristics that can be observed readily. There are two types of such characteristics – those over which drivers have little or no control, like age, sex, and (to a lesser extent) area of residence; and those over which they have a significant amount of control, like number of “fault” accidents and number of moving violations.

Age and Sex

It is well known that young males – and, to a lesser extent, young females – have a higher probability of making claims against their insurers than do older drivers. In this sense, young males are similar to the high-risk group discussed in the preceding section.

For this reason, in a competitive market, insurers will be forced to charge higher premiums to young males than to other groups. An insurance company that averaged all drivers together when setting its premiums (for example, setting a single premium of $1,000 in the example above) would soon lose all of its low-risk drivers to other firms that offered those drivers premiums that were related to their expected costs ($825 in the preceding example).

Furthermore, even though some young males are low-risk drivers, they will be charged the high premiums associated with their group. The reason is that, from the insurance company’s perspective, all young males look alike. As long as they drive the same kinds of cars, have the same driving records, etc, insurers will be unable to determine which young males are low risk and which are high.

In a competitive insurance market, there is no way around this issue. Any insurance company that offered premiums that were less than its expected costs of covering young males would find, first, that it would attract a very large percentage of young male drivers and, second, that it would, on average, lose money on those drivers. It would soon be forced to change its policy or be driven out of business.

Driving Experience

A second way of classifying drivers into low-risk and high-risk groups is to observe their driving behaviours. For statistical reasons, it is known that those who have had accidents in the current year have a higher than average probability of having accidents in the next year than do those who did not have accidents in the current year.

Assume again that there are two groups of drivers – 2,000 high-risk drivers, who have a 20 percent probability of making a claim in any given year, and 8,000 low-risk drivers, who have a 7.5 percent probability of making a claim. Assume also that the insurance company is unable to determine, on the basis of characteristics such as age and sex, which drivers belong in each category. In that case, the average probability of an accident across the two groups is 10 percent and, in the first year, the actuarial insurance premium will be $1,000.

During the first year, however, 400 of the high-risk drivers and 600 of the low-risk drivers will have accidents. This means that, among the group “drivers who had an accident in year 1,” 400, or 40 percent of the group, have a 20 percent chance of having an accident in year 2 and 600, (60 percent), have a 7.5 percent chance. On average, the drivers in this group have a 12.5 percent chance of having an accident in year 2. Their actuarial premium, (the premium that covers their expected costs plus profit margin), will be $1,175.

The remaining group, “drivers who did not have an accident in year 1,” will be composed of 1,600 drivers from the high-risk group and 7,400 from the low-risk group. Their average accident risk in year 2 will be approximately 9.72 percent and their actuarial premium will be approximately $980.

What is seen here is that the reason there is a premium differential between drivers who have had accidents and those who have not is not because insurers are trying to “recover the payments” they have had to make on behalf of clients who had accidents. Rather, because the group “those who have had accidents” has a disproportionate number of high-risk drivers (because they are the most likely to enter this group), its expected claims costs must be above average – meaning that its premiums will be proportionately higher also.

This means that the premium differential between those who have had accidents and those who have not will increase as the size of the high-risk group increases (thereby increasing their representation in the “have had an accident” group) and as the risk differential between low- and high-risk drivers increases.

3. Experience Rating

Automobile insurance is designed to protect the purchaser from catastrophic loss. The consumer pays an annual premium in return for a promise from the insurer that the latter will pay for any losses incurred by the former.

But insurance also has a second, unintended effect – it reduces the incentive for drivers to avoid accidents. In the absence of automobile insurance, drivers would have to bear the full financial impact of any negligent behaviour – under the assumptions used in the preceding section that would be $7,000 for each accident. This threat could be expected to induce them to take precautions against such behaviour.

In the presence of automobile insurance, however, the financial impact of negligent behaviour is the difference between the premium charged to drivers who have had accidents and those who have not. In the preceding section, it was shown that this amount could be quite small – less than $200 under the plausible assumptions employed there. This significant reduction in financial risk (relative to the no-insurance situation) can be expected to reduce substantially the incentive to avoid negligent behaviour.

In response, many commentators have suggested that the current actuarial rating system should be replaced by one based on experience rating – that is, a system in which premiums are tied closely to occurrences of driver negligence. For example, insurance companies might be required to ensure that the premiums charged to drivers who had had accidents or serious moving violations were at least double those charged to drivers who had “clean” driving records.

Note that experience rating cannot arise independently in a market in which a large number of firms compete for customers. As was shown in Section 1, above, competition forces firms to charge premiums that are based on actuarial rating. Experience rating can only arise in markets in which there is no competition – such as in provinces like British Columbia and Saskatchewan in which the government has a monopoly – or in jurisdictions in which the government establishes legislation to force private insurers to use that rating system.

Among the legislative changes that were contained in Alberta’s recent Bill 53, (see www.autoinsurance.gov.ab.ca/calculate.html), is a proposal to impose a version of experience rating. Although binding regulations have not been announced yet, the current proposal would require that insurers increase premiums by as much as 50 percent in the year following a single “at fault” claim and by an additional 30 to 40 percent in each subsequent year for six years or more; (that is, by as much as 250 percent when added across the six years following a single claim). The proposed system would also require that insurers increase premiums by 200 percent in each of the two years following a criminal code violation – such as impaired driving or criminal negligence causing death.

Economic theory predicts that experience rating systems – such as the one proposed by the Alberta government – will produce substantial increases in the levels of precautions taken by drivers – and corresponding substantial decreases in the number of accidents. It will be interesting to observe (i) whether the Alberta government will have the political willpower to force such a restrictive rating system on an unwilling and politically powerful insurance industry; and (ii) if it does so, whether such a system will yield the anticipated benefits.

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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).

Experience-Rating of Automobile Insurance: A Good Idea that Won’t Work

by Christopher Bruce

This article first appeared on page A21 of the October 16, 2003 Calgary Herald, and then in the summer 2003 issue of the Expert Witness.

Imagine you have two drivers who drive the same kind of car, live in the same city, and have the same driving record over, say, the last three years. Doesn’t it make sense that they should pay the same automobile insurance premiums?

Apparently, it made sense to the provincial government’s Automobile Insurance Reform Implementation Team. Yesterday, they recommended legislation that will require automobile insurance companies to use “experience rating.”

In a nutshell, experience rating refers to a system in which the only factor that determines your premiums is your driving record. All drivers who have no “experience” of accidents, speeding violations, drunk driving charges, etc. pay the same, relatively low base premium. Then, as they experience one or more of these events, their premiums rise accordingly – and, as they have additional years in which they do not experience these events, their premiums decline.

Experience rating has two highly desirable characteristics. First, the individual driver has complete control over his or her premiums. If you drive cautiously, avoiding accidents and driving violations, your premiums will decline to the lowest available rate.

Most importantly, your rate will not be higher than anyone else’s just because you happen to belong to a group, like young males, that has a relatively high accident rate.

Second, it has been shown consistently that when insurance premiums are related to experience, accident rates fall. When individuals know that they can reduce their premiums significantly by driving more carefully, they do so. And, of course, if the number of accidents decreases, so will insurance premiums.

It seems like experience rating is a win-win proposition. If so, then why hasn’t it been introduced before? The simple answer is that it results in a situation in which insurers know they will make substantial profits on some classes of customers and lose money on others. Thus, it gives them a strong incentive to refuse to insure the money-losing group.

In the scheme proposed by the government, that group will be composed primarily of young males.

Insurers will lose money on them because the number of accidents a driver has had in the past is only loosely related to the number that they can be expected to have in the future. What decades of statistics tell us is that a nineteen year-old male with a perfect, three-year driving record is more likely to have an accident in the next year than is a forty-year old male with the same driving record.

And a nineteen year-old who had an accident last year is more likely to have an accident next year than is a forty-year old with the same experience.

This means that insurers will expect to pay out more claims to nineteen year-old drivers than to forty year-old drivers.

Assume, for example, that 10 percent of nineteen year-old drivers who have had a clean record for three years will have an accident in the next year; whereas only 5 percent of forty year-olds with a similar record will have an accident next year. If the average accident costs the insurance company $10,000, then it will expect to pay out an average of $1,000 for each nineteen year-old and $500 for each forty year-old.

If the government forces insurers to charge the two groups the same premium, they will have to charge something between $500 and $1,000 just to cover their expected claims costs. For example, if the two groups were the same size, the premium would be $750 (the average across the two).

But this means that they will expect to make a $250 profit on the average driver in the older group and a $250 loss on the average driver in the younger group.

As insurance companies are out to make profits, we can expect that they will respond by doing their best to attract older drivers – and to turn away younger drivers.

The stakes are high. Those companies that find themselves with a relatively high percentage of young drivers will lose money and will soon be forced out of the market. Companies will use every loophole at their disposal to attract as many drivers in the older age groups as possible.

Advertising will be focused on older drivers – ads will appear primarily in magazines that appeal to middle-aged consumers, for example, and music in TV ads will be taken from the 1960s. Agents will be instructed to make it difficult for younger drivers to obtain insurance. And incentives, like toaster ovens for new clients, will be offered that will appeal primarily to older drivers.

The result is that the government will have to introduce ever-stricter regulations, to ensure that all drivers are able to obtain insurance. It will be interesting to see whether this degree of interference in the private sector is something that a market oriented government is willing to countenance.

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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).

Assessment of damages in wrongful birth cases

by Gerald Robertson, Q.C.

This article first appeared in the summer 2003 issue of the Expert Witness.

Wrongful birth lawsuits are certainly not new in Canada – they have been around for over 25 years1 – and yet many of the fundamental issues relating to assessment of damages in these cases still remain unclear. This type of lawsuit arises in a variety of factual contexts. They include failed sterilization or abortion, negligence in prescribing contraceptives, and negligence in prenatal care or counselling. Although the factual contexts vary, all wrongful birth actions share the same essential characteristic: but for the defendant’s negligence, the child would not have been born.2

The following example is fairly typical. A married couple with four children decide that they do not want to have any more. One of the spouses undergoes a sterilization operation, but due to the negligence of the doctor the operation is unsuccessful, and a fifth child is subsequently born. What damages can the parents claim? In particular, can they claim the cost of raising the child to the age of majority, or beyond? What if the child is born with disabilities: how does that affect the assessment of damages?

Based on recent cases, both from Canada and elsewhere, it is clear that one of the key issues in wrongful birth cases is whether the child is born healthy or disabled.

Healthy Children

The initial reaction of most courts (including Canadian) in wrongful birth cases was that it would be contrary to public policy to award damages for the cost of caring for a healthy child.3 However, this position changed in Canada in the 90’s (although much earlier in England)4, with a number of Canadian cases awarding substantial damages under this head.5 However, in recent years that position has changed. In particular, in 1999 the House of Lords in the case of McFarlane v. Tayside Health Board6 held that in wrongful birth cases involving a healthy child, no damages should be awarded for the cost of caring for the child to the age of majority. McFarlane did recognize that damages ought to be awarded for a number of various items, and this has been followed in subsequent Alberta cases.7 These include items such as pain and suffering during pregnancy, labour and delivery, and loss of income during pregnancy and for a reasonable period after the birth.

The reaction to McFarlane in other countries has been mixed. In Canada, there have been a number of recent cases (including those from Alberta) which have adopted its position that no damages should be awarded for the cost of caring for a healthy child.8 Indeed, in Alberta it has been held that, even if the cost of future care were claimable, it would be almost entirely offset by government benefits.9

However, one recent Alberta case – M.S. v. Baker10 – has taken a different view, holding that cost of care damages should be awarded if financial reasons influenced the parents’ decision to have no more children.11 In addition, the High Court of Australia (Australia’s highest court), in a decision rendered in 2003,12 declined to follow McFarlane. Therefore, overall the position in Canada remains unclear.

Disabled Children

Most courts, even those who have denied damages for the cost of raising a healthy child, have accepted that these damages should be awarded if the child is born with disability.13 This type of case usually arises in the context of prenatal (or preconception) counselling or care; for example, where a woman is not informed of the risk of fetal abnormality associated with the woman’s medical condition or genetics, thereby preventing the woman from making an informed choice as to whether or not to initiate or terminate a pregnancy. The recent case of Arndt v. Smith14 provides a useful example. In that case the defendant doctor was held to have been negligent in failing to advise the patient of the risk of serious fetal abnormality arising from her having contracted chicken pox during the 12th week of pregnancy; the baby was born with severe disabilities.

The Supreme Court of Canada has recently addressed the question of assessment of damages in wrongful birth cases involving disabled children. In Krangle v. Brisco15the doctor responsible for prenatal care negligently failed to advise the patient of her increased risk of having a Down’s Syndrome child. The child was subsequently born with Down’s Syndrome. It was accepted that the parents were entitled to damages for non-pecuniary loss for the pain and suffering associated with giving birth to, and raising, a disabled child. Other items which were not in dispute included the cost of care to the age of majority. However, the contentious issue was whether the parents were entitled to damages for the cost of caring for the child beyond the age of majority. The Supreme Court held that they were not.16

It should not necessarily be assumed that the Krangle decision applies in all provinces, even though it is a decision of the Supreme Court of Canada. The reason for this is that the decision is based on the particular wording of the British Columbia legislation, under which parents are not legally responsible to care for their children after the age of majority,17 even if the child is disabled. In many other provinces, such as Alberta,18 the statutory position is different, and parents are legally obliged to care for their disabled children after the age of majority. Hence, in those provinces, a claim for cost of care after majority may well be available, despite the decision in Krangle.

Footnotes

1. The earliest cases include Colp v. Ringrose (1976) 3 L. Med. Q. 72 (Alta. T.D.); Doiron v. Orr (1978) 86 D.L.R. (3d) 719 (Ont. H.C.); and Cataford v. Moreau (1978) 114 D.L.R. (3d) 585 (Que. S.C.). [back to text]

2. See generally, E.I. Picard & G.B. Robertson, Legal Liability of Doctors and Hospitals in Canada (3rd ed., 1996) at 212-217. [back to text]

3. See Colp v. Ringrose, supra note 1; Doiron v. Orr, supra note 1. [back to text]

4. See in particular Emeh v. Kensington & Chelsea & Westminster AHA [1985] 2 W.L.R. 233 (C.A.). [back to text]

5. See, for example, Joshi v. Wooley (1995) 4 B.C.L.R. (3d) 208 (S.C.); Suite v. Cooke [1995] Q.J. No. 696 (C.A.). [back to text]

6. [2000] 2 A.C. 59 (H.L.). [back to text]

7. M.Y. v. Boutros [2002] A.J. No. 480 (Q.B.). [back to text]

8. See, for example, M.Y. v. Boutros, supra note 6; Mummery v. Olsson [2001] O.J. No. 226 (Super. Ct.). [back to text]

9. M.Y. v. Boutros, supra note 6. [back to text]

10. [2001] A.J. No. 1579 (Q.B.). [back to text]

11. The Court followed the reasoning in the Ontario case of Kealey v. Berezowski (1996) 30 O.R. (3d) 37 (Gen. Div.). For a critique of the Kealey decision see Picard & Robertson, supra note 2, at 215. The reasoning in Kealey was expressly rejected in M.Y. v. Boutros, supra note 6. [back to text]

12. Cattanach v. Melchior [2003] H.C.A. 38. [back to text]

13. For Canadian cases see H.(R.) v. Hunter (1996) 32 C.C.L.T. (2d) 44 (Ont. Gen. Div.); Cherry v. Borsman (1992) 94 D.L.R. (4th) 487 (B.C.C.A.), leave to appeal to S.C.C. refused (1993) 99 D.L.R. (4th) vii (S.C.C.). See also Rees v. Darlington Memorial Hospital NHS Trust [2002] E.W.J. No. 582 (C.A.). [back to text]

14. (1997) 148 D.L.R. (4th) 48 (S.C.C.). See also E. Nelson T. Caulfield, “You Can’t Get There From Here: A Case Comment on Arndt v. Smith” (1998) 32 University of British Columbia Law Review 353. [back to text]

15. [2002] 1 S.C.R. 205. [back to text]

16. For later B.C. cases on the same issue see Zhang v. Kan [2003] B.C.J. No. 164 (S.C.); Jones v. Rostvig [2003] B.C.J. No. 1840 (S.C.). [back to text]

17. Family Relations Act, R.S.B.C. 1996, c. 128. [back to text]

18. Maintenance Order Act, R.S.A. 2000, c. M-2, s. 2. [back to text]

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Gerald Robertson is a Professor of Law at the University of Alberta, and a practising barrister and solicitor in the areas of civil litigation and personal injury. He is co-author of Legal Liability of Doctors and Hospitals in Canada (3rd ed.). He is also a director of the Robertson Personal Injury Newsletter, an on-line weekly digest of all personal injury judgments in Canada decided over the previous week, along with current developments in the area of personal injury litigation. More information about the Robertson Personal Injury Newsletter can be found at www.rpin.ca.

Duty to Care for Orphaned Minors

by Christopher Bruce

This article was originally published in the April 24, 1998 issue of The Lawyers Weekly. We reproduced it in the Summer/Autumn 2002 issue of the Expert Witness because the topic had arisen in one of our cases.

In a number of recent cases, the courts have been asked to calculate the loss of dependency of orphaned minors. In all of the reported cases, these children have been taken into the care of relatives – aunts, uncles, grandparents, or stepparents. An important issue that is raised by this arrangement is whether the expenditures incurred by the surrogate parents should be set off against the children’s loss of dependency on their natural parent(s).

In the leading Ontario case of Butterfield v. Butterfield Estate (1996) 23 M.V R. (3d) 192 (Ont.C.A.), for example, two children aged six years and six months, respectively, were taken into the care of their aunt and uncle. The defendants argued that the children’s claim of dependancy on their mother’s income should be reduced by the value of the expenditures which their aunt and uncle (who planned to adopt them) would make on them.

Similarly, in the leading British Columbia case of Skelding (Guardian ad litem of) v. Skelding (1994) 118 D.L.R. (4th) 537 (B.C.C.A.), the defendants argued that the children’s loss of dependency on their mother was extinguished because their father (with whom they lived) had remarried.

The differing approaches that have been employed to resolve this issue provide evidence of a fundamental division in our courts with respect to the purpose of tort law. Two conflicting paradigms can be identified.

In what I will call the ex post approach, the court takes the view that, as the tortious act has already occurred, that act cannot be undone. Rather, the best the court can do is to ensure that the victims are restored, as best as possible, to the position they would have been in had the act not occurred.

In the competing, ex ante approach, the court recognises that any decision that it makes in the current case may influence the behavior of parties in similar, future cases. Hence, what is important in the current case is to set a precedent which will direct future parties to behave in the socially desirable manner.

The appellate court in Skelding clearly adopted the ex post approach. Relying heavily on the Supreme Court decision in Ratych v. Bloomer (1990) 69 D.L.R. (4th) 25, the majority concluded that the stepmother had replaced the natural mother. Hence, no further claim was necessary to return the children to the position they would have been in had their mother lived.

Notably, this decision is exactly consonant with a well-developed line of cases which have concluded that a widow(er)’s loss of dependency may be extinguished upon marriage to a new spouse whose income is similar to that of the deceased. Particularly important for Skelding was the B.C. case of Ball v. Kraft (1966) 60 D.L.R. (2d) 35 in which both the widow and her children were denied compensation after the date of her remarriage.

In addition to its reliance on Ratych, the B.C.C.A. also defended its decision by reference to B.C.’s Family Relations Act. This Act imposes a legal requirement on parents to provide “reasonable … support and maintenance of the child.” As “parents” are defined in the Act to include stepparents and guardians, the court found that the services which Mr. Skelding’s new wife provided to his children were not “gratuitous.”

Interestingly, in making the latter decision, the court came into direct conflict with its own decision in Grant v. Jackson (1986) 24 D.L.R. (4th) 598 which it had made only eight years earlier. In Grant the court had held that services provided by a father to his children, following the death of their mother (his wife), were not required by the Family Relations Act.

Despite Skelding’s grounding in Ratych, the vast majority of cases dealing with orphaned children have been careful to distinguish themselves from Skelding. Most of these cases employ what I called the ex ante approach to justify their decisions. In particular, they argue that the precedent established by Skelding may create perverse incentives for the friends and families of orphaned children.

The leading statements of this view appear in Tompkins (Guardian ad litem of) v. Byspalko (1993) 16 C.C.L.T. (2d) 179 and Ratansi v. Abery (1995) 5 B.C.L.R. (3d) 88. In both cases, the trial judges argued that if Skelding was followed, the risk would be created that “… in some cases, family members who would otherwise take orphaned children into their care may decline to do so until or unless an award has been made in the children’s favour.”

And in Tompkins, Spencer, J. went further, arguing that “… a surviving parent may refrain from remarriage, advantageous from the children’s point of view, because the presence of a new spouse who replaces services to the children may reduce their award”.

These cases, therefore, adopt the view that the finances and services provided by family members are in the nature of collateral benefits and should not be deducted from the children’s dependency on the deceased parent.

Most of the cases that adopt this view also respond to the argument in Skelding that the Family Relations Act (or its equivalent in other provinces) imposes a legal requirement that a “parent” provide reasonable support.

In Butterfield (cited above), for example, the Ontario Court of Appeal implied that an aunt and uncle had no legal obligation to provide for the children, even though they intended to adopt the children formally. And in Ratansi (cited above) and Schellenberg v. Houseman (1996) 18 B.C.L.R. (3d) 209, the courts concluded that support provided by family members who had been appointed legal guardians was also to be treated as a collateral benefit.

Yet, B.C.’s Family Relations Act would have defined the family members in all three of these cases to be “parents.” Either these cases were in error or Skelding was.

Finch, J.A., the dissenting judge in Skelding, offered a resolution to this dilemma. He noted, first, that fatal accident legislation generally requires that the damages must have “resulted” from the death of a family member. Conversely, he argued, support received from a third party could not be considered to have offset the plaintiffs’ loss unless that support also resulted from the death in question. He concluded, therefore, that, as the marriage of Mr. Skelding to his second wife could not be considered to have resulted from the death of his first wife, the support provided by the second wife to Mr. Skelding’s children must be considered to be a collateral benefit.

This argument notwithstanding, the minority view in Skelding faces another challenge. Finch, J.A. argued that the income of Mr. Skelding’s new wife should not be offset against the children’s loss of dependency on their natural mother; yet it is well-settled law in Canada that the new wife’s income should be offset against Mr. Skelding’s loss of dependency on his first wife. This discrepancy remains to be “explained.”

To summarise, the courts’ treatment of claims by orphans for loss of dependency offers insight into a question that goes to the foundations of tort law. Should the courts concentrate strictly on the facts of the case at hand – the ex post approach? Or should they take into account the impact that the decision in the current case will have on the future behaviour of other individuals – the ex ante approach? Although the response to Skelding (and to Ratych) suggests that most courts are leaning towards the ex ante approach, the issue is far from settled.

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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).

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 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.

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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

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.

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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).

No-Fault Automobile Insurance

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.

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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 of Accelerated Inheritance

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.

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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).

Case Comment: Boston v. Boston

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.

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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)

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.

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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.

Case Comment: Madge v. Meyer

by Scott Beesley

This article was originally published in the Summer 2000 issue of the Expert Witness.

In Madge v. Meyer, (Calgary Court of Queen’s Bench, 9601-01261, Judgment: December 31, 1999) Justice Brooker concluded that the plaintiff, Madge, had suffered a very serious head injury and would therefore be unable to operate his farm any longer. The plaintiff was assumed to be able to provide one third of his pre-accident value of work in the late pre-trial period and an average of 15 percent of that value in the future. (His abilities were expected to decline over time.) A farm expert assessed the pre-accident value of Mr. Madge’s work at $60,000 per annum in 1998 dollars. This loss of income calculation itself was a standard type of replacement cost analysis.

My comments on the case are related to Justice Brooker’s statement that

Madge’s situation presents the difficult issue of valuing a self-employed plaintiff’s loss of future income or work capacity when his business has not actually lost any income in the past nor seems likely to lose any in the near future due to his injuries (italics added).

This statement appears inconsistent with the evidence presented in this case to the effect that the plaintiff’s ability to continue in his previous capacity, as the manager of a large farm, was seriously compromised. In particular, it was clear that the management of the farm had been taken over by the plaintiff’s son, and that Mr. Madge’s contribution was now limited to part-time work at fairly menial tasks. Even for those tasks he had to be prompted by his wife and son. The evidence seems at odds with Justice Brooker’s comment that the business in which the plaintiff was the driving force had not lost any income.

Justice Brooker did go through the process of estimating the annual value of the plaintiff’s labour, and then deciding how much of that had been lost and would be lost in the future. I note, however, that Justice Brooker reached his final decision using the concept of loss of “income earning capacity,” (i.e. the loss of a capital asset), when that concept is really not necessary, or more accurately is redundant. When the courts ask economists to value the loss of earning capacity of an individual, the only method we have is to estimate what the annual figures would have been, and will be, and discount the difference back to the date of trial. The “capital asset” is valued by the present value of the stream of income that asset can produce.

The apparent lack of a loss at the level of the business in such situations usually simply means that family members or friends have assisted and were not fully paid, or paid at all, for those efforts. In addition it is possible (especially on a farm) that some long-term land or equipment maintenance, business development, or other work might simply not be done, with little apparent effect on immediate financial results. It seems likely that this is what has occurred in Madge. Even if Mr. Madge’s son had not been paid anything for his extensive assistance, the collateral benefit rule suggests that the loss should be assessed using the market value of any labour that replaced the plaintiff’s. The fact that no loss may have appeared at the corporate level is irrelevant. To suggest that there is no loss (as the defense apparently did in this case) because family members provided free labour to the plaintiff is in my view false. I presume that the defense would not argue directly that the son must provide such free labour indefinitely, and that the plaintiff’s future loss should be reduced by the value of that help. Yet that is what is implied whenever someone says “the business shows no loss and therefore the plaintiff has no loss.”

Note that if an injured party is provided with direct financial assistance from family members or friends, it is quite clear that that is a collateral benefit, and should be ignored in the loss calculations. (If the injured person then receives a damage award, it is possible they will repay the amounts provided, but whether or not they do so is irrelevant to the estimation of loss.) There is no reason to treat free labour any differently, yet it is common to hear the argument (or implication) that such assistance should: (A) benefit the defendant; and (B) be assumed to continue indefinitely. This false claim can only be made in the case of a self-employed plaintiff, who reports business income or has a corporation or partnership. The help provided by family and friends does not typically increase labour costs by much, if anything, and so the claim can be made that little or no change has occurred. Worse, the falsely reduced annual amount is then used to assess future loss. Another analogy can be found in household services losses. If an injured person is helped by a neighbour who cuts the lawn and shovels snow for a while, we would never reduce the household services claim by the value of that assistance. It would also be false to presume that the neighbour should provide that help until the injured party’s age 80 (when we typically end our household services loss calculations). Again, while we might expect the injured person to compensate the friend after settlement, that is a non-issue in the calculation.

This issue was addressed in an article in the Winter 1997 Expert Witness, in which Christopher Bruce and I discussed the D’Amato case. We noted that if the courts were to ignore the collateral benefit principle, and treat assistance freely given by friends and family as income (in D’Amato the issue was assistance in the form of overpayment from a business partner, and presumably friend), then not only would loss of income be severely underestimated, but the friends and family would be badly treated as well.

Imagine a plaintiff who cannot, for example, perform half of his previous work. His wife, who did not work at the time of the accident, begins to do that which he cannot, and takes no income from their jointly owned company (or takes the same amount she had been taking previously, if they had been income-splitting). If the wife’s work is identical in quality and there are no other losses (decreases in revenue, increases in costs), then the statements of the company are unchanged. The couple’s own personal tax returns would be unchanged as well. Yet it should be quite clear that the husband’s loss is half of his income. First, his earning capacity has been reduced by half; and, second, the apparent stability in his income has arisen only because his loss has been replaced with a collateral benefit – an altruistic “gift” from his wife. The presence of a collateral benefit should not, of course, reduce the estimated loss.

The problem is avoided with exact payments equal to the value of labour provided. Assume, for example, that the husband formerly received $80,000, and the wife did not work and received no income. After the accident she works and is paid $40,000, while his income falls by that same amount. The size of his loss of personal income is clear, even though there would be no change on their company’s financial statements. If the documentation was as simple as this, and the payments reflected the exact market value of each party’s labour, then the correct assessment would be easy. Unfortunately, this is rarely the case.

More realistically, assume that in the pre-accident case the wife had been receiving $20,000 per annum merely as an income-splitting measure. The husband’s reported income would have been $60,000. His labour actually had produced $80,000 in income, and now each of the spouses produces half of that. We would expect that their post-accident tax returns would report $40,000 each, simply because equal incomes are usually optimal for tax reduction. A shallow analysis would indicate that he had lost only $20,000 (= $60,000 – $40,000). Indeed, in an extreme case, the couple could still report the entire $80,000 on the husband’s return (there might be tax reasons to do so), and a cursory investigation would suggest that there was no loss.

There is really no substitute for actually estimating the share of company/family income that was due to the injured person’s labour, and then estimating how much of that has been lost. The fact that there may be little or no apparent change at the corporate, or even personal, level does not imply that no loss has occurred.

It bears repeating that if a proper analysis is not done, and the help provided by a friend or family member is mistakenly treated as income earned by the injured person, then a serious wrong could result. First, the person who provided the help might go uncompensated, since the plaintiff might not have the resources to pay them later. Second, the underestimation of the annual pre-trial loss could produce an extreme underestimation of the future loss. Oddly enough, in D’Amato, it appears that the Supreme Court correctly treated a large fraction of the plaintiff’s annual income as lost in the future, but did not compensate the partner for assistance provided in the pre-trial period. That decision essentially told partners (and family members and friends) that in helping an injured person you might not only be working for free, but you could also be undermining their loss of income case in doing so. Although D’Amato did receive full compensation for his future loss, it would appear that the overpayments made by his partner did cause an unjustified reduction in the pre-trial award. That uncompensated loss will be borne by D’Amato (if he pays back his partner), the partner (if he does not), or both of them. It would also seem to be quite possible that in other cases pre-trial and future losses will both be cut because of the failure to treat unpaid assistance as a collateral benefit.

At paragraph 175, Justice Brooker wrote “I cannot conclude that there has been an actual loss of farm profits to date.” He then stated shortly thereafter that “In my opinion, regardless of the profitability of the farm, Madge has suffered a loss of income or more accurately, income earning capacity for which he must be compensated.” Justice Brooker went on to note that Madge’s son should be entitled to more of the farm profits, since he had taken on “many of Madge’s work and responsibilities” since the accident. I would suggest that it would have been perfectly acceptable for the Justice to estimate the fraction of Mr. Madge’s work now done by his son and spouse (or not done at all!) and then presume that the annual loss is that fraction of his estimated annual income.

Note that if Madge had simply paid his son (and wife) exactly the amounts their additional labour had been worth, then his own personal income (or his business income, if the farm appeared as gross and net business income on his return) would have fallen by the precise amount of his loss. There are many reasons, however, why it is rare to have the loss appear in so clearcut a manner. First, the injured party simply may not have the money to pay a replacement, at least not in full. It is easy to say in hindsight that little help was paid for, so little could have been needed, but that is specious. The dollars which would have paid for replacement help are part or all of the plaintiff’s income, and in many cases the plaintiff can ill afford to give that up. That is exactly why friends and family will provide free or cheap assistance in many cases. Second, the assessment of what has changed as a consequence of injury can be complicated by issues like the income-splitting discussed earlier. Third, simply estimating labour income itself can be complicated, especially for farmers – some fraction of income is hidden, some is a return to capital employed, some is left in the business in any year while some is taken out. Depreciation taken could be more or less than the true economic loss of value of vehicles and equipment. Fourth, even just estimating what fraction of his or her former work the plaintiff can still do may not be easy. Fifth, one might only have financial information for a short period, containing years which are better or worse than a long-term average year. Sixth, the loss may not be fully valued unless things like long-term maintenance are considered (as mentioned earlier, are some things not being done which will create costs later?). Finally, any business analysis must separate changes caused by the plaintiff’s injuries from unrelated ones. If the business climate improved at roughly the time of the accident, it should be plain that that is not due to one person’s injuries, but I have seen a case treated that way.

Given the myriad difficulties associated with determining farm labour income precisely, and then estimating the fraction of income lost, I believe Justice Brooker’s approach to determining the loss in this case was reasonable. My purpose has been only to emphasize that that approach is not really in principle different from a standard assessment – it just uses an approximation for a hard-to-specify income figure. I also want to emphasize that to properly assess loss of income, the expert must consider the corporate and personal levels of tax, deal with the uncertainties listed above, and be sure not to treat freely given (or loaned!) assistance as income earned by the plaintiff.

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

The Current Status of Survival of Actions Act Claims

by Christopher Bruce

This article was originally published in the autumn 1999 issue of the Expert Witness.

In Duncan v. Baddeley, Alberta Court of Appeal ruled that claims for loss of earnings were to be permitted under the Survival of Actions Act. Since that time, two trial court decisions have commented on the method by which this claim is to be assessed – Duncan v. Baddeley (Justice Doreen Sulyma) and Brooks v. Stefura (Justice Paul Belzil). In this note, I will argue that, although these two decisions clarify many of the outstanding issues in this area, a number of crucial problems remain unresolved.

Issues Clarified

The Duncan and Brooks trial decisions provided clear signals concerning the elements of the Court of Appeal decision that would be given greatest weight. In particular, two paragraphs from the latter decision were quoted by both Sulyma, J. and Belzil, J.

[37] The flaw in the “lost saving” approach is that it is heir-centred, not victim-centred. It asks what the heirs lost, not what the victim lost. But the suit here is not for the loss to the estate, it is a suit by the victim for his loss, a claim that by operation of statute survives his death and can be made by his estate for him. Worse, it has the air about it of an attempt to undermine the statute. As a result of this flaw, the approach will fail to take into account what has been called “discretionary” spending, like holidays and entertainment and other “treats.” It will also fail to take into account gifts to children and spouses, and thereby underestimate even an heir-centred award.

[42] In sum, Ms. Taylor in her excellent submission persuades me to accept in large the “available surplus” approach accepted by the U.K. Court of Appeal in Harris v. Empress Motors; Cole v. Crown Poultry Packers, [1983] 3 All E.R. 561, and adopted by the British Columbia Court of Appeal in Semenoff et. al. v. Kokan et. al. (1991) 4 B.C.A.C. 191; 84 D.L.R. (4th) 76. But it seems to me that it follows that a further deduction should be for expected income tax…

Lost Savings

In Galand, the Court of Appeal had directed that in Survival of Actions Act cases the estate was to be compensated for the value of the deceased’s (after-tax) income net of “personal living expenses.” Following Galand, some defendants argued that, as all expenditures could be considered to be directed to personal living expenses, the only portion of an individual’s income that would remain after deduction of those expenses was savings. Hence, the Survival of Actions claim was simply for lost savings.

Both Belzil, J. and Sulyma, J. concluded that the Court of Appeal decision in Duncan v. Baddeley required that “personal living expenses” were to be something less than total expenditures on consumption; and that the Survival of Actions claim was to be for something more than “lost savings.”

Available Surplus

In particular, that “something more” was to be calculated by deducting the “available surplus,” as calculated in Harris, from total after-tax income.

Justice Sulyma clarified that the “available surplus” approach was to be employed in the following manner. First, determine the deceased’s expected marital status and expected number of children. Second, estimate the percentage of the after-tax income of the deceased that would have been spent on: items specific to the deceased; and the percentage that would have been spent on items common to all members of the family (often called “indivisibles.”) Third, divide the indivisibles figure by the number of individuals in the family. Finally, deduct the sum of that figure and the figure for the deceased’s expenditures on him or herself from after-tax income. The result is the “available surplus,” that is, the amount to be compensated.

As an example, assume that it has been determined that a deceased male would have married and had two children. Assume also that evidence has been led to indicate that, of his after-tax income, 20 percent would have been spent on items that benefited the deceased alone (for example, expenditures on food and clothing) and that 30 percent would have been devoted to indivisibles. One quarter of the latter, or 7.5 percent, would be attributed to the deceased. Hence, it would be concluded that 27.5 percent of the deceased’s after-tax income would have been devoted to his maintenance and the estate would be compensated for the remaining 72.5 (= 100 – 27.5) percent, (the available surplus).

Two Technical Issues

At least two “technical” issues remain unresolved. First, the court has not turned its mind to the question of how to vary the available surplus over the individual’s lifetime. For example, if it has been assumed that the deceased would have had two children, it would seem reasonable to reduce the available surplus once the children left home. The general assumption is that, for a couple without children, 30 percent of family income is devoted to items that benefit one partner alone and 40 percent is devoted to indivisibles. Hence, once a couple’s children have left home, the available surplus should be assumed to fall from 72.5 percent to 50 percent (= 30 + (0.50 x 40)).

Second, it might be argued that the appeal court’s ruling that the available surplus was to be more than “lost savings” implied that all of the deceased’s expected “savings” should be included in the award. As a significant portion of the indivisibles represents purchases of capital assets, such as the family home, it might be argued that expenditures on those purchases are “savings.” As such, they should not be deducted from the award. This issue has not been resolved.

Two Conceptual Issues

In addition, the Court of Appeal decision in Duncan raises two conceptual issues that have not, as yet, been dealt with satisfactorily. First, that decision concludes both that the award should be something more than lost savings and that the available surplus approach is to be used. But, in certain circumstances, the latter approach yields results that are identical to the lost savings approach.

In particular, assume that the deceased was not married and that evidence has been led to suggest that he or she would never have married. In that case, the available surplus approach requires that all of the individual’s expenditures on personal items, plus all of his or her expenditures on indivisibles, be deducted from after-tax income. But the residual from that calculation is simply the individual’s savings. Does the Court wish us to compensate this individual’s estate for his/her savings, after explicitly rejecting the lost savings approach? The answer is not clear.

Second, note that the Court of Appeal ruled that the lost saving approach was flawed, in large part, because it “… will fail to take into account what has been called ‘discretionary’ spending, like holidays and entertainment and other ‘treats,’ … [and because it] … will also fail to take into account gifts to children and spouses.” [para. 37]

The simplest interpretation that can be given to this wording is that expenditures on holidays, entertainment, and other “treats” are not to be deducted from the estate’s claim. That is, if the lost saving approach is flawed because holidays, entertainment, and other treats are excluded, it surely must follow that, in the non-flawed approach, those items are to be included.

But the available surplus approach excludes these expenditures from the claim. The percentage of income that is devoted to expenditures exclusively for the benefit of the deceased includes expenditures that the deceased would have made on holidays, entertainment, etc. And the available surplus approach explicitly deducts expenditures made for the sole benefit of the deceased. Again, the Court ruling is found to be internally inconsistent.

Conclusion

The long saga that was initiated with the Court of Appeal ruling in Galand continues. Although the recent trial court decisions in Duncan and Brooks provide some clarification concerning the manner in which Survival of Actions Act claims are to be calculated, many issues remain to be resolved. Further rulings, perhaps from the Court of Appeal, will be required before a clear picture emerges.

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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).

Duty of Care

by Christopher Bruce

This article was originally published in the winter 1998 issue of the Expert Witness.

This is the third in a series of articles in which I examine the application of economic reasoning to questions of liability in torts. In the previous two articles, I argued that the principles of tort liability can best be understood if it is assumed that the goal of the courts has been to deter future inefficient behaviour – rather than to compensate victims for past harms.

One corollary of that analysis is that if the threat of tort damages is not the most effective means of preventing a particular type of harm, the courts should refuse to treat the case under the rubric of tort law. In short, one would expect that there would be a “gatekeeper” doctrine in law that would allow the courts to divide the cases appearing before them into two streams: “tort cases” and “not tort cases.”

Economists argue that “duty of care” rules act as this doctrine. That is, to say that a party owes a duty of care is tantamount to saying (i) that any (potentially) negligent behaviour in which the party engages could be deterred by threat of tort damages; and (ii) that tort law is the most efficient technique for deterring any such behaviour. The advantage of viewing duty of care as having this gatekeeping function is that it provides a relatively simple framework in which to understand one of the most complex and misunderstood areas of tort.

Foreseeability

In some cases, it is clear, even before the court has heard evidence concerning the actions of a party, that the threat of tort damages could not have induced that party to change his or her behaviour. The clearest instance of this situation is that in which the party in question could not have foreseen that its actions had the potential to cause an injury.

In the classic Canadian case of Nova Mink v. Trans-Canada Airlines [1951] 2 D.L.R. 241, a low-flying airplane so scared the animals in a commercial mink farm that they ate their young, causing the owner considerable harm. The airline was held to owe no duty of care to the mink farm and, therefore, was not required to pay damages.

This decision is consistent with the view that tort actions are to be allowed only when they can deter harmful behaviour. (And it is strongly inconsistent with the view that the function of tort law is to compensate “deserving” plaintiffs.)

To have ruled in favour of Nova Mink would have established a precedent to the effect that injurers owe a duty even when they cannot foresee the consequences of their actions. Yet when those consequences could not (reasonably) have been foreseen no precautions against such consequences could have been taken. Therefore, any court action in such a situation could have produced no change in the behaviour of the parties. It could only have resulted in a transfer of income from the defendant to the plaintiff, at a great cost (in terms of judicial expenses) to society.

The Misfeasance/Nonfeasance Distinction

Even if the defendant has foreseen the harmful event, he/she will often not be found to owe a duty of care if his/her failure to act is one of nonfeasance rather than misfeasance. If it is the actions of the defendant which create the circumstances in which a third party may be harmed, failure to take precautions to avert that harm is called misfeasance. In that circumstance, the defendant will be held to owe a duty of care. If, however, the defendant has merely observed that a third party may be harmed if a certain precaution is not taken, and has not taken that precaution, that failure to act is termed nonfeasance. In that circumstance, the defendant may be found to owe no duty of care (assuming that he/she did not create the circumstances – i.e. that he/she was not also a misfeasor).

For example, if A knocks down a stop sign and lack of that sign subsequently contributes to the injury of B at that intersection, A may be found to have owed a duty of care to B – and may be found negligent for having failed to report the initial accident. On the other hand, if, after A has knocked over the stop sign, C notes the absence of the sign and fails to report that fact, C will not be found to have owed a duty of care to B.

On economic grounds this distinction initially appears arbitrary. If it is efficient for a person who knocks over a stop sign to report that fact to the authorities, it must also be efficient for an individual who observes that a stop sign has been knocked over to report that fact. How, then, can the difference in legal duty between these two situations be reconciled?

The answer may lie in the relative difficulty of identifying potential defendants. When A has knocked over the stop sign it will be much simpler to identify him as the defendant, ex post, than it will be to so-identify “innocent” passerby C. Whereas there will be only one individual like A (or at least a very limited number of such individuals), who will generally leave evidence of their involvement; there may be a very large number of individuals like C. Furthermore, very few individuals like C will leave any evidence of their presence at the scene. And most, if identified as being present, will be able to deny plausibly any knowledge of the potential harm, or may be able to argue that they thought someone else was attending to the matter. Thus, whereas the pursuit of efficiency may require that the individual whose actions initiate a harmful situation owe a duty to those who are (potentially) harmed, that pursuit may require that some alternative mechanism be employed to induce third parties to offer their assistance.

One such alternative would be to offer third parties incentives to induce involvement, rather than deterrents to prevent non-involvement. That is, the common law might provide a means by which those who performed “good deeds” – benefactors – would be able to force those who benefited from those deeds – beneficiaries – to provide them with rewards. The advantage of this approach, in terms of the analysis of the preceding paragraph, is that the problem of identifying potential benefactors, ex post, would be avoided. Those who observe a (potentially) harmful situation and feel that the benefit of their actions will exceed the costs will present themselves as “rescuers”, that is, they will become involved in the attempt to rectify the harmful situation.

In fact, we observe that if the costs of identifying benefactors are low relative to the benefits of the rescue, the law does operate in this manner. Awards are provided to those who rescue salvage at sea; doctors can charge fees to individuals whom they have rescued from imminent danger; and individuals who have stored lost property can claim for their expenses.1

The preceding analysis also helps to explain why a duty of care is found in one class of (apparent) nonfeasance – that in which it is inexpensive to identify the potential benefactor, ex post. In particular, a duty is often owed in situations in which the nonfeasance occurs on the property of the potential benefactor and in cases in which the benefactor has a pre-existing legal and/or contractual relationship with the beneficiary. For example, a homeowner has a duty to visitors to keep his sidewalks clear of ice; a municipality may have a duty to the users of its roads to ensure that stop signs are erected (and maintained) at dangerous intersections2; and shopkeepers may have a duty to their customers to ensure the safety of their premises. In each case, there is a party who is clearly-identifiable, ex post, who could have acted to protect the plaintiff.

There is also an efficient exception to this exception. Various altruistic groups – usually governments and charities – offer free services that may be interpreted as the provision of warnings concerning potential “harms”. For example, a local government may offer to send out its engineers to check earthen banks to ensure that there is no danger of them becoming unstable.3 Failure to respond to a request to provide these services clearly constitutes a nonfeasance. Yet, although the nonfeasor is easily identified, no duty of care is found. The reason that this ruling may be considered to be efficient is that if the “altruist” is found liable for failing to provide a service, the response of the altruist can be expected to be to withdraw that service. Such an outcome cannot generally be considered to be in society’s best interest.

Conclusion

The economic analysis of torts leads to the suggestion that the function of duty of care rules is to act as a “gatekeeper,” separating tort cases from non-tort cases. If the harmful behaviour of either party could have been deterred through the threat of tort sanctions, (and if such sanctions are the most efficient method for altering that party’s behaviour), the case should be considered to fall within the rubric of tort law. Otherwise, the gatekeeper should redirect the case away from the tort system.

Footnotes

1. For an economic analysis of the laws concerning “rescue”, see W. Landes and R. Posner, “Salvors, Finders, Good Samaritans, and Other Rescuers….,” 7 Journal of Legal Studies (January 1978), pp. 83-128. [Back to text]

2. See Anderson v. County of Ponoka (1980) 12 A.L.R. 320. [Back to text]

3. See Windsor Building Supplies v. Art Harrison Ltd. (1980) 14 C.C.L.T. 129. [Back to text]

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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).

Issues Arising in the Calculation of Damages Under the Survival of Actions Act (Part 1)

by Scott Beesley

This article was originally published in the winter 1998 issue of the Expert Witness.

Note that this article is the first of a two-part article. You will find part 2 here

Under the Fatal Accidents Act, it is only the dependants of the deceased who can claim for loss of income. The recent Alberta Court of Appeal decisions in Galand and Duncan, however, have created the possibility that the Survival of Actions Act may be used to allow the estate to claim for loss of income.

A fundamental debate triggered by this interpretation of the Survival of Actions Act concerns the size of the “lost years” or “necessities” deduction. This concept arises from that class of personal injury cases in which the plaintiff has suffered a reduced life expectancy. In such cases, one portion of the award derives from the income that would have been earned in the years beyond the (now) reduced lifespan, i.e. in the “lost years.” In this calculation, a deduction is made to account for the fact that some expenses will not be incurred, once the plaintiff dies.

This is the original lost years deduction. The net amount left after that deduction represents, in principle, spending from which the plaintiff would have received pleasure or enjoyment. Note that while there is still room for debate about the appropriate size of this deduction (and it seems not to be a settled issue), the rationale for an award is very clear: The plaintiff has been severely injured, such that their expected survival is now reduced, but during their remaining years they can obtain pleasure from an award which replaces some of their lost income.

A fatal accident can be thought of as an event which results in a life expectancy of zero, i.e. as the limiting case of a reduced expectancy. Yet for any significant remaining life expectancy (beyond a few days or weeks?) these situations are fundamentally very different, and there is no reason why the lost years deduction in the two types of cases should be the same. One can only note that the award in a reduced life expectancy case should certainly be at least as large as a deterrence-driven award in an equivalent fatal case.

In the case of Survival of Actions Act claims, the intriguing fact is that the Court of Appeal made its precedent-setting decisions without stating any underlying rationale. Why should a claim continue when no survivors exist? Why should even a reduced claim, with a lost years or necessities deduction applied, continue? The traditional view, which obviously still has many adherents, suggests that indeed it should not continue, since to allow such claims would provide windfall gains to those who would not otherwise have benefited from the earnings of the deceased. The only obvious rationale for the continuance of these estate claims is deterrence and/or punishment, and I believe that does provide a sufficient rationale for such claims.

Each year, thousands die in traffic accidents in Canada, and to that we can add hundreds more in industrial mishaps and other types of accidents. The pain, grief and economic damage done is enormous, as are the health-care costs involved. One might also argue that the present system leaves parents and siblings under compensated for the loss of a family member, since in many cases children assist their relatives, and in particular the deceased might have helped his or her parents as they aged. It seems odd that if one victim had a spouse and three children, and another was single, the amount payable by the defendant’s insurer was (historically) very significant in the former case and negligible in the latter. Yet the negligence involved was the same, the annual income lost was the same, and the economic loss to society (usually a productive worker) was the same. If we wish to deter reckless driving, and careless behaviour in other areas of life, then it appears there should be consistent penalties for similar wrongs. At one extreme of opinion, this would imply virtually the same award in the two cases given, and no necessities deduction at all.

In the alternative, it has been suggested that a very large deduction should apply, with virtually all the projected spending of the deceased being deducted. The arguments advanced for this viewpoint have focussed on the “no windfall gains” argument, either by making that case directly or by citing precedents which in turn rely on that idea. This amounts to implying that deterrence should be only a minor consideration, and that compensation is to be the overriding standard in the determination of any award. This argument is often made by defendants, and the typical conclusion is that only lost savings should be awarded, or equivalently (as noted above), all consumption spending should be deducted. The sum calculated roughly estimates the present value of what the deceased would have left to his or her heirs, had there been any, which is often very little in current dollars.

I am unaware of any article or judgement that argues from first principles why all consumption spending should be excluded. In each case the discussion turns on interpretation of prior judgements with a view to justifying as small an award as is possible. I believe, in fact, that one would be hard pressed to find a rationale which supported any particular scale of deduction, because the balancing of the idea of no windfall gains with that of deterrence is inherently subjective. The extremes are pleasantly clear: Award nothing (deduct it all) if you virulently oppose windfall gains, and award all lost income (deduct nothing) if you want to put all the emphasis on deterrence.

(Like any economist, I should note that theory would say we should somehow tabulate the costs of accidents and the cost of prevention, and minimise overall social costs. But this in itself is extremely difficult, and very sensitive to assumptions which vary with the beliefs of the investigator. Further, minimising social costs would require knowing how people would react to each possible level of deterrence, and we cannot easily predict such behaviour. Finally, the problem cannot be converted to one of mathematics without assessing the intrinsic value of a life, and I for one would argue that lifetime income alone would provide too low a weighting in such a calculation.)

In Duncan, Justice Kerans provided some guidance regarding the size of the deduction, and the ration-ale involved. Note the following statement: “My 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”. He referred also to the correct deduction as the “expenses that the victim would have incurred in the course of earning the living we predict he would earn” (emphasis added). The difficulty is that these phrases still leave enormous room for argument. Do they infer that only whatever is required to stay alive is to be deducted, since all other spending produces some pleasure? Perhaps a somewhat higher deduction is implied, assuming that success in a particular career path requires a certain standard of dress and even lifestyle. If Justice Kerans had written “expenses that the victim would have incurred in order to earn the living we predict he would earn,” then, clearly, a relatively minimal deduction would apply. But as written, it is not clear, for example, whether income which would have supported a family in the future is to be viewed primarily as a necessary expense (and deducted) or as something which would have provided pleasure (and should under some interpretations be compensated). Perhaps in another case it will be apparent that the deceased would never have married. Does that then imply much greater spending on him or herself, and again is that spending counted in the award or deducted? It is asking a lot of the courts to assess the marital prospects (and chance of divorce) of each fatal accident victim, if it is found that such considerations should be analysed in every case. Justice Kerans, referring again to the amount of the deduction, noted (in Duncan):

…That sum will vary with the kind of employment, and the state in life of the victim. Neither “poverty-line” expenses nor “lost savings” are a reliable indicator of that sum. Rather, it should be a fair calculation of the likely future cost of lives.

With respect, I note that the second amount Justice Kerans refers to (lost savings) should actually be described as “all expenses except savings,” since that is what is argued for by those who wish to minimise awards. (Most people involved in these cases know the respective positions of those at the extremes of the debate, but the quote as it is may confuse anyone new to the topic, so a clarification seems in order.) The idea that the deduction will vary with the state in life of the victim is at odds with the idea that the deduction reflects necessities, strictly defined, since the latter would not vary with income. If the deduction is to change with income, then should it be a fixed percentage, or some other form of variation? Should any other variables matter? The answer depends entirely on the rationale which is eventually settled upon.

After canvassing a number of alternative methods for calculating this deduction, in Duncan, Justice Kerans settled on an approach which he attributed to Constance Taylor, the plaintiff’s counsel. This method, which Justice Kerans refers to as the “available surplus” approach, was first enunciated in the U.K. Court of Appeal in Harris v. Empress Motors [1983] 3 All E.R. 561 and later adopted in one of the first Canadian cases concerning the “lost years deduction,” Semenoff v. Kokan (1991) 84 D.L.R. (4th) 76. In the latter case, the court concluded that the “conventional deduction” was 33 percent of before-tax income. But Justice Kerans also suggested that the income taxes the deceased would have paid should form part of the deduction, and he concluded:

…Cases suggest a discount of 50% to 70%. My sense of the matter is that this is an apt range. But I suggest that expert evidence could help the judge to assess this cost. The plaintiff actuary here did no calculation. He instead accepted 50% or that “suggested by the cases”. Again, that calculation should include one for tax.

Justice Kerans, then, appears to be suggesting a discount of 50 to 70 percent of before-tax income (i.e. composed of 30 to 40 percent in tax and, presumably, 20 to 30 percent for necessities). Note that for Albertans at average income levels, income tax is lower than Justice Kerans suggested, at approximately 25 percent of gross income. Using a necessities deduction at the midpoint of Justice Kerans’ range, 25 percent, the implied total deduction is 50 percent of before-tax income.

We note also that Justice Kerans explicitly rejected an approach which awards only lost savings, stating:

…The flaw in the “lost savings” approach is that it is heir-centred, not victim-centred. It asks what the heirs lost, not what the victim lost. But the suit here is not for the loss to the estate, it is a suit by the victim for his loss, a claim that by operation of statute survives his death and can be made by his estate for him. Worse, it has the air about it of an attempt to undermine the statute. As a result of this flaw, the approach will fail to take into account what has been called “discretionary” spending, like holidays and entertainment and other “treats”. It will also fail to take into account gifts to children and spouses, and thereby underestimate even an heir-centred award.

Finally, if it is eventually decided that only savings will be awarded in these cases, it should be realised that an accurate definition of savings should include the principal component of mortgage payments, as well as financial and capital asset accumulation. We note that the Harris decision cites another English case, Sullivan v West Yorkshire Passenger Transport Executive, which used a savings-only award but (in my view correctly) included mortgage principal payments in assessing the relevant percentage.

Case Review

I cited earlier a quote from Duncan in which Justice Kerans implied that spending which would have provided pleasure is to be compensated. Assuming that expenditures which are necessary for the maintenance of life do not provide “pleasure,” restitution implies that compensation is to be provided only for that portion of income which remains after the deduction of necessities. A clear statement of this principle is found in Toneguzzo-Norvell v. Burnaby Hospital [1994] 1 S.C.R. 114 where Madam Justice McLachlin concluded at page 127:

…There can be no capacity to earn without a life. The maintenance of that life requires expenditure for personal living expenses. Hence the earnings which the award represents are conditional upon personal living expenses having been incurred. It follows that such expenses may appropriately be deducted from the award.

The deduction used in Toneguzzo was 50 percent of before-tax income, a figure confirmed by the Supreme Court of Canada.

I note that the dispute would not be resolved by any clearer statement that pleasure is to be compensated, while necessities are not, since the line between the two is subjective. Is one car a necessity, a pure luxury beyond transit, or something in between? How much of spending on food provides pleasure? Housing? And so on through virtually all common purchases. Only a few luxury items, gifts, expensive vacations etc. seem to clearly have no necessities component, while conversely almost every ordinary expense for an average income person contains an element of pleasure (i.e. a component of cost which is the excess over the “necessities-only” equivalent). In defending a large deduction, what is implied is that either there is no pleasurable component in ordinary spending, or (and this seems to be the case) that pleasure lost is not what is being compensated. What is being replaced, according to Duncan, is what would have been the deceased’s “available surplus.” As mentioned above, Justice Kerans suggested that a 50 to 70 percent total deduction seemed correct, and after adjusting for his slight overestimation of tax, a 40 to 60 percent range results. The implied surplus is the remaining amount, roughly “60 to 40” percent, of before-tax income. Alternatively, one can deduct estimated tax and then deduct another 20 to 30 percent of before tax-income for necessities. We can compare the roughly 50 percent (from before-tax) deduction implied in Duncan with the figures cited in other cases (below).

A March 20, 1997 judgement from the Alberta Court of Queen’s Bench, in the case Brown v. The University of Alberta Hospital, concluded that the 50 percent deduction of Toneguzzo was not a strict precedent but instead a rough guideline, to be altered as evidence suggested in each case. Mr. Justice Marceau wrote:

…Having rejected the lost savings approach, I turn now to determine the proper deduction that should be made for personal living expenses. In this regard, it is significant that all four of the post-Toneguzzo decisions find that the latter does not stand for the proposition that a 50% deduction must be made; rather, the cases all take the position that the proper deduction must be assessed on a case-by-case basis.

Mr. Justice Marceau went on to cite an Ontario case, Dubé v. Penlon Ltd., in which a 33 percent lost years deduction had been applied under circumstances similar to those in the case he was judging, and he referred to that deduction as “conventional.” We note that the deductions in Toneguzzo and Dubé were from before-tax income, implying that the deductions from after-tax income were quite modest, along the lines of 15 to 35 percent.

Note that a 50 percent deduction from before-tax income is consistent with the decisions in Andrews v Grand & Toy Alberta Ltd., [1978] 2 S.C.R. 229, Harris, Toneguzzo, Bastian v Mori [1990; BCSC], and an Ontario case, Duncan v Kemp [1991]. The 33 percent deduction from before-tax income was used in Semenoff, Dubé and Brown.

Expert Evidence

In Brown v. The University of Alberta Hospital, Justice Marceau noted that a 33 percent lost years deduction is “conventional,” but he also stated, “the proper deduction must be assessed on a case-by-case basis.” In Duncan Estate v. Baddeley, Justice Kerans suggested, “expert evidence could help the judge to assess this cost.” Also, he noted, “the plaintiff actuary here did no calculation.”

To determine the appropriate lost years deduction, a calculation must be made of the amount of income that is necessary to maintain the person at a reasonable standard of living. Note that this does not suggest that one can simply add together a person’s expenditures on traditional “necessity” items such as food, clothing, and shelter; then conclude that this is the amount required to maintain a reasonable standard of living; then claim that it is therefore an appropriate lost years deduction. What this approach fails to recognise is that a significant percentage of Canadians’ expenditures on these items provide pleasure.

For example, whereas Canadian families earning $20,000 spend approximately 19 percent, or $3,800, of their incomes on food, families earning $50,000 spend approximately 15 percent, or $7,500, on that category. Any claim that all expenditures on food are “necessary” suggests that none of the extra $3,700 spent by high income families provide pleasure. Clearly this is not the case. When families’ incomes rise from $20,000 to $50,000 they do not “need” additional food. Instead, they increase their expenditures on “non-essential” items. Similar arguments can be made with respect to shelter, clothing and transportation.

Recognizing that, in our view, “basic necessities” (and therefore, the lost years deduction) do not vary with income, the question remains: how are they to be measured objectively? Fortunately, an economics professor, Christopher Sarlo, has calculated detailed measures of the “personal expenses required for the maintenance of life” for families of various sizes in different regions of Canada. He defines an expenditure to be “necessary” if it is

…required to maintain long term physical well-being. For able-bodied persons, the list would consist of a nutritious diet, shelter, clothing, personal hygiene needs, health care, transportation, and telephone. . . . It is assumed that the type and quality of each item . . . is at least at the minimum acceptable standard within the community in which one resides. (Sarlo 1992, page 49)

The above definition coincides extremely closely with the use of the phrases “basic necessities” and “. . . expenditures necessary to earn . . . income” used by the courts. Therefore, the estimates which he provides can act, we submit, as objective measures of those concepts.

In Alberta, Sarlo found that, in 1994, a single person could meet his or her needs with approximately $6,351 per year (approximately $6,964 in 1999 dollars). This implies that if an individual’s after-tax income would have been $20,000 per year during the lost years, 34.38 percent would have been spent on necessities; whereas if the individual’s after-tax income would have been $50,000, only 13.75 percent would have been spent on those items. The remainder – 65.62 percent in the first case and 86.25 percent in the second – would have been available to purchase goods and services which have provided pleasure. It is this amount which has been lost to the estate, if it is assumed that it is a loss of pleasure which is to be compensated.

In light of the above information, a smaller deduction, on the order of 20 percent of after-tax income, could be supported. As noted above, this lower deduction finds support in Semenoff, Dubé and Brown, each of which used 33 percent from before-tax income as the entire deduction. Justice Kerans’ comments, as noted earlier, imply that a deduction of 20 to 30 of before-tax income should be made for necessities, in addition to the deduction of income tax itself. Given average earnings of approximately $40,000, the implied necessities deduction of $10,000 (25 percent of pre-tax) is noted to equal 33 percent of the $30,000 in after-tax income. (Coincidentally, the tax and necessities components of the overall deduction are equal at roughly $10,000, given an average person’s income and following the percentages suggested in Duncan.) The figure of 33 percent is therefore the after-tax “necessities” fraction which, when combined with tax on an average income, produces an overall deduction of 50 percent of before-tax income, as used in Toneguzzo and closely matched in Harris, Andrews, Bastian and Duncan v. Kemp. Finally, it is possible that the courts may wish to use a larger necessities percentage, such as a deduction of 40 percent of after-tax income. In our recent cases, we have therefore used an annual deduction which ranges from 20 to 40 percent of after-tax income, as well as providing the figure at 33 percent.

One final comment regarding the previous cases is in order. The cases cited generally involve either a reduced life expectancy or the existence of dependants. In the former event, we noted earlier that a reduced life expectancy case is fundamentally different from one in which the person is dead. The injured party can at least enjoy any funds awarded for their remaining lifetime. When actual (as in Harris) or hypothetical (as in Semenoff) dependants are involved, some courts have considered funds which support a family to be eligible under the Survival of Actions Act, (SAA), while other decisions treat all such funds as part of the deduction.

This question is the source of a good part of the uncertainty in these estate claims. In a case which actually has dependants, this difference is not too important, since the family support in question is going to be paid under a dependency claim. It is in cases such as Duncan itself that this issue is important should income (or much of it) which would have gone to a hypothetical family for support be awarded under the SAA, on the grounds that it would have provided pleasure to the deceased? Or, in the alternative, should such income be deducted, on the grounds that as a necessity or obligation, it would not have been part of available surplus, however defined? Semenoff, for one, analysed a severely injured, newly married man as if he would have had two children, and deducted 25 percent which he would have spent on himself only, plus a further 8 percent, representing roughly ¼ of common expenses of 33 percent. Note that the implication is that a large majority (a fraction of 67/75) of the funds that the deceased would have spent on his wife and children was awarded, even though no children will ever exist. But Semenoff was a reduced expectancy case, not a case exactly like Duncan, so it is not clear what sort of precedent it sets.

Though I cannot claim to have searched for all relevant prior cases, the examples commonly cited during the debate on this issue are remarkable in that no cited case appears to match the circumstances of Duncan. That is, there are no precedents which address the question of what is a reasonable estate award in the case of an unmarried person who has died immediately as a consequence of an accident, and why that award is reasonable.

It is intriguing that this discussion has continued with repeated references to cases which are so different from the “pure” estate claim Duncan represents. I would suggest that, ideally, the legislature should address this issue from first principles, and resolve the conflict between compensation and deterrence.

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In our next issue, I will discuss the methodology of these calculations and the issue of dual claims under the Survival of Actions and Fatal Accidents Acts.

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

The Economics of Negligence Rules

by Christopher Bruce

This article was originally published in the autumn 1998 issue of the Expert Witness.

In the summer 1998 issue of this newsletter, I introduced the academic discipline of “the economic analysis of tort law.” I argued in that issue that the traditional legal analysis of torts employs an ex post orientation. That is, legal scholars traditionally assume that the function of tort law is to compensate victims for harms that have already occurred. Economists, on the other hand, argue that the evolution of torts can better be understood if one uses an ex ante paradigm. In this paradigm, the courts behave as if they are less concerned with the resolution of the cases before them than they are with the establishment of precedents that will affect future behavior. In particular, economic analysis “predicts” that the courts will prefer those rules that encourage parties to select cost-minimising behaviors.

In the summer 1998 article, I provided examples of a number of situations in which the courts appeared to have made explicit use of ex ante reasoning. In this article, I will argue that the economic approach can also be used to cast light on the development of the tort rules of negligence.

Legal Versus Economic Analysis

If one adopts the proposition that the function of tort law is to compensate accident victims, it is difficult to rationalise the rules of negligence. Those rules require that the victim show that the defendant was negligent before compensation will be ordered. But as many defendants are not negligent, many victims are not compensated. Why would a body of law whose purpose was to compensate victims contain a major “escape clause” which would deny compensation to a large percentage of victims?

One could begin to answer this question by modifying the traditional argument. Perhaps tort law is not designed to compensate all accident victims, just those who are deemed “worthy.” But this begs the questions of who is worthy and why it is that the “worth” of the victim should be defined by the behavior of the defendant.

I will argue in this article, that negligence rules can better be understood if we view their purpose as being cost-minimisation. Under this approach, a party will only be found to have been negligent (and therefore potentially liable to pay damages) if he or she had failed to take some precaution for which the cost was less than the benefit (measured in terms of accident costs avoided). That is, I will argue that the function of the tort rules of negligence is to send signals to potential (future) “injurers” that if they fail to take appropriate precautions, they will be made to bear the costs that result.

Negligence Rules: an Economic Exposition

The economic model can best be understood using a numerical example. Assume the following “facts,” (based, loosely, on Anderson v. County of Ponoka [1980] 12 ALR 320):

  • One of the stop signs at the intersection of two country roads is knocked over sometime on Saturday evening.
  • The County responsible for those roads becomes aware of this on Sunday morning but decides to wait until Monday morning to replace the sign, in order to save $100 overtime pay to its road crew.
  • Sunday evening, Mr. A, unaware that the sign is missing, assumes that he has the right-of-way, enters the intersection without slowing, and collides with Ms. B’s car.
  • The two cars and their occupants suffer damages which total $25,000.
  • At trial, the court accepts the evidence of a traffic expert that the probability, per day, that such an accident will occur is 3/1,000 if there is no stop sign in place and 1/1,000 if there is a stop sign.

Was the county negligent? Economic analysis predicts that the court will say “no.” Why? Assume that rural stop signs are frequently knocked down on Saturday evenings. If the relevant highway departments wait until Monday to replace the stop signs, there will be three accidents every 1,000 times a sign is knocked down. Hence, there will be $75,000 damages for every 1,000 such occurrences. ($75,000 = 3 x $25,000.) If the counties replace the stop signs immediately, the number of accidents will fall to one in every 1,000 occurrences, reducing the accident costs to $25,000, a saving of $50,000. But, in order to obtain that “saving,” counties will have to send out 1,000 repair crews at an overtime cost of $100 each, or $100,000 in total. The $50,000 “saving” will have cost $100,000.

Put another way, the average cost of precautions, per event, will be $100 and the average benefit of those precautions (measured in terms of accident costs saved) will be (2/1,000) x $25,000, or $50. As the economic model predicts that the court will only encourage behaviour whose cost is less than the benefit, the economic prediction is that the court will not find the county to be negligent in this case.

It can be seen from this case that three factors are predicted to enter the court’s calculations:

  • the cost to the defendant of taking a precaution to avoid the accident, (C);
  • the probability that a precaution which could have been taken by the defendant would have prevented the accident, (P); and
  • the expected cost of the accident, (A).

In particular, it is predicted that the defendant will be found to have been negligent if there was some precaution, not taken by the defendant, whose cost was less than the cost of the accident multiplied by the decrease in the probability of an accident which would have occurred had that precaution been taken. In algebraic terms, the party is found negligent if C < (A x P).

Is the Law Consistent With the Economic Model?

In the U.S., this prediction was confirmed in one of the leading cases on negligence, U.S. v. Carroll Towing. In that case, Justice Learned Hand concluded that negligence was to be found only if the burden (cost) of precautions was less than the probability of the accident multiplied by the gravity (cost) of the accident — precisely the formulation which I derived above from the economic model.

In British/Canadian jurisprudence, confirmation of the prediction is less direct, but persuasive nevertheless — sufficiently persuasive that in recent editions of Canadian Tort Law Allen Linden has organised his discussion of the rules of negligence around the “Learned Hand rule.” In Wagon Mound No. 2, for example, the court concluded that a party could be found negligent even if the probability of an accident was low as long as the cost of the accident was high. Arguably, it was the court’s view that the cost of the accident multiplied by the probability that it could be avoided should be weighed against the cost of avoidance in order to determine negligence — again, precisely the prediction made by economic reasoning. Other leading cases which are consistent with the economic model include Bolton v. Stone, Priestman v. Colangelo, and Reibl v. Hughes.

Applying Economic Analysis to the Law

Many “day-to-day” cases also employ reasoning which is consistent with the economic approach to the determination of negligence. For example, in Hewson v. City of Red Deer (1977) 146 DLR (3d) 32 (Alta. CA), a City employee left the keys in the ignition of a bulldozer. Subsequently, the bulldozer was stolen and driven into the side of Hewson’s house. The City was found not to be negligent largely because (a) the bulldozer was left two blocks from Hewson’s house; (b) it was left at midnight; and (c) the operator was absent for only 25 minutes. All three of these factors suggest that the probability of an accident was quite low. And the first factor suggests that the average damages which might occur if the bulldozer was stolen were low (because the bulldozer would have to be driven a long distance before causing any harm.)

In Weaver v. Buckle (1982) 35 AR 97 (Alta. QB), Weaver (a child) ran out in front of Buckle’s car and was injured. The court implied that it would not normally have found Buckle to be negligent for causing this accident. However, as the road was narrow, it found that he should have been driving more slowly, to take account of the general conditions of that road. The court concluded that if he had been driving more slowly, the probability that this accident would have occurred would have been reduced substantially. Buckle was found 60 percent liable. In economic terms, this finding suggests that it is not simply this accident which determines the “costs of an accident” (A, in my terminology). Rather, it is all accidents which might have been prevented had the defendant taken additional precautions.

In Jordan v. Schofield (1996) 148 NSR (2d) 104 (NSSC), Schofield’s 7 year-old son played with a lighter and caused a fire in an apartment building belonging to Jordan. The court concluded that Schofield was not negligent. Although parents are responsible for taking “reasonable” precautions to watch their children and to put harmful things out of their way, at some point the costs of additional precautions become prohibitive. Parents will not be found negligent for failing to take precautions beyond that point. For example, parents will not be negligent for leaving children unattended around “ordinary” dangers (such as knives or scissors) for a few minutes. They may, however, be negligent for leaving their children unattended around such dangers for longer periods of time, or for leaving them for only a few minutes around more dangerous items (such as fires burning in fireplaces). In economic terms, the cost of taking additional precautions is to be weighed against the probability that an accident will occur if those precautions are not taken.

To conclude, given that no Canadian court has formally adopted the “Learned Hand rule” it would be difficult to base an argument before our courts on economic reasoning alone. Nevertheless, if one accepts that the three components of the “Learned Hand Rule” (C, P, and A) play an implicit role in the determination of negligence, an understanding of their function may help to clarify the legal analysis in difficult cases.

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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).

Applying Economic Analysis to Tort Law

by Christopher Bruce

This article was originally published in the summer 1998 issue of the Expert Witness.

Economists have made important contributions to the analysis of many areas of the law – particularly competition law, labour law, regulation, and international trade – during the last 200 years. It is only in the last quarter century, however, that economists – and legal scholars using economics – have turned their attention in a systematic way to the analysis of torts, contracts, and criminal law. In spite of the youth of the sub-discipline that investigates these branches of the law, it has quickly become a major force within U.S. and, to a lesser extent, Canadian and European law schools. All of the major U.S. law schools – Harvard, Yale, Princeton, Chicago, Stanford, and Berkeley among them – now offer courses in the Economic Analysis of Law and have professors with Ph.D.s in Economics on faculty. (Only the University of Toronto, among Canadian schools, has followed suit.)

Those reading this newsletter will be familiar with some elements of the economic analysis of personal injury damages – for example, through my textbook Assessment of Personal Injury Damages (Butterworths, 1992). But economics, being the imperialistic science that it is, has not stopped there. Economic models have been applied to virtually every aspect of tort law – negligence rules, causation, onus of proof, intentional torts, informed consent, volenti, to name only a few. I do not wish to claim that the economic analysis of these doctrines should supplant the traditional legal analysis. However, I do think that there may be situations in which practitioners may find it useful to consider some of these issues from a different angle.

In this article, and a number of others to follow it, I would like to provide some insight into one such angle – the economic analysis of torts. In this introductory article, I begin by identifying the primary characteristics that distinguish the economic approach from more traditional methods of legal analysis. I then use this approach to discuss collateral benefits and negligence rules.

Characterising the Economic Analysis of Torts

Two fundamental characteristics distinguish the “economic” analysis of torts from other approaches to the study of tort law.

First, economists take a “positive,” or “scientific” approach to the identification of legal doctrines. Instead of trying to determine what the law “should be,” economic analysts attempt to determine what the law “is.” That is, they use the deductive approach to derive hypotheses about the principles which underlie judges’ reasoning and then test those hypotheses by comparing their predictions against the decisions which judges have made. As a simple example, economic analysis can be used to “predict” that the courts will, under most circumstances, reject the defence of “custom.” That prediction can be “tested” by observing whether the courts do or do not accept that defence.

Second, all economic analysis of tort law begins from the working hypothesis that judges behave as if they were attempting to devise legal rules which would encourage individuals to maximise social benefits net of social costs. (For example, if there is some accident-avoiding behaviour whose cost is less than the resulting saving in accident costs, the courts are predicted to adopt rules which will encourage adoption of that behaviour.) It is not argued that judges consciously act in this way; simply that the doctrines that have been selected by the common law courts have developed as though this was the goal of the courts.

This view of the functioning of the courts suggests that the courts will behave as if they were employing an ex ante (or “forward-looking”) approach to decision-making. In this approach, the courts recognise that any decision they make in the current case may influence the behavior of parties in similar, future cases. Hence, it becomes important to set a precedent which will direct future parties to behave in the socially desirable manner.

This approach can be contrasted with the traditional view of the court’s decision-making process, which I call the ex post (or “backward-looking”) approach. In this approach the court is assumed to take the position that, as the tortious act has already occurred, that act cannot be undone. Rather, all the legal system can do is to ensure that the victims are restored, as well as possible, to the position they would have been in had the act not occurred. Contrary to the economic assumption, no thought is given to the impact which decisions will have on future behaviour.

The ex post view is common to most textbooks and was given its most famous expression by the Supreme Court of Canada in Ratych v. Bloomer. There, Justice McLachlan concluded that the function of damages in tort law was to “restore the plaintiff to his pre-accident position.” Further, she emphasised that

[t]he law of tort is intended to restore the individual to the position he enjoyed prior to the injury rather than to punish the tortfeasor whose only wrong may have been a moment of inadvertence. [Emphasis added]

That is, the Court has said that tort damages are intended strictly to compensate harms that occurred in the past, not to deter negligent behavior that might occur in the future.

The response which those who rely on “positive” analysis of the law make to this argument is that the most reliable way to determine what someone thinks is to observe what they do, not what they say. In short, the best way to identify the underlying principles of tort law is to review the courts’ decisions, not their arguments. What I propose to argue in the following sections is that the courts’ decisions can often be more easily understood if it is assumed that they are trying to influence future behavior than if it is assumed they are attempting to “right past wrongs.”

The Collateral Benefits Rule

A clear example of the courts saying one thing and doing another arises in their interpretation of the “collateral benefits rule.” On the one hand, the Supreme Court has made it clear that it prefers the ex post approach. On the other hand, the trial courts have consistently adopted the ex ante approach.

1. Orphaned Children: Consider for example the situation in which orphaned children have been taken into the care of relatives.* Although Ratych would appear to suggest that the children’s claim for loss of dependency was thereby extinguished, most of the decided cases have rejected this view. The trial courts have recognised that the plaintiffs would be “double compensated” but have argued that to deny compensation would be to establish a dangerous precedent for future cases.

The leading statements of the latter view appear in Tompkins (Guardian ad litem of) v. Byspalko (1993) 16 C.C.L.T. (2d) 179 and Ratansi v. Abery [1995] 5 B.C.L.R. (3d) 88. In both cases, the trial judges argued that if Ratych was followed, the risk would be created that

… in some cases, family members who would otherwise take orphaned children into their care may decline to do so until or unless an award has been made in the children’s favour.

And in Tompkins, Spencer, J. went further, arguing that “… a surviving parent may refrain from remarriage, advantageous from the children’s point of view, because the presence of a new spouse who replaces services to the children may reduce their award”

2. Charitable Donations: Similarly, the rationale that is commonly given for the “charity exception” is that to deny a plaintiff compensatory damages because he or she had received a charitable donation would discourage individuals from making those donations. A clear example of this principle was stated in the Northern Ireland case of Redpath v. County Down Railway [1947] N.I.L.R. 167 where Andrews L.C.J. noted that if

the proposition contended by the defendants is sound the inevitable consequence in the case of future disasters of similar character would be that the springs of private charity would be found to be largely if not entirely dried up.

Surprisingly, further confirmation of this view comes from the author of Ratych, Madam Justice McLachlan. In her dissent in Cunningham v. Wheeler (1994) 113 D.L.R. (4th) 1 she argued that “… people should not be discouraged from aiding those in trouble.”

3. Implications: The common thread running through all of these decisions, I would argue, is that the courts will often consider the impact that their current rulings can be expected to have on individuals’ future behavior. In this view, the function of torts is not merely to compensate particular plaintiffs for past wrongs, but is also to protect potential plaintiffs from future harmful behavior. Children whose parents have been killed are to be protected against the possibility that their relatives may delay the adoption process; and victims of catastrophic events are to be protected against the possibility that donors may be discouraged from providing assistance.

This view opens a number of interesting possibilities for argument in similar future cases. For example, the practice has been to assume that a widow(er)’s loss of dependency comes to an end once she (he) remarries (assuming that the new spouse has a similar income to the first spouse). It could be argued, however, that this rule may encourage widow(er)s to postpone any relationships with the opposite sex until after the fatal accident case has been settled. As it cannot be in the public interest to discourage dating and marriage, a legal rule which has the effect of providing that discouragement may well be contrary to public policy.

In each case, economic analysts of the law would argue that the courts were behaving as if their goals were to encourage (socially) desirable behaviour and to discourage (socially) undesirable behaviour. In the next section, I will argue that it is rules of negligence which distinguish desirable from undesirable behaviour.

Negligence Rules

Assume the following facts:

  • One of the stop signs at the intersection of two country roads is knocked over sometime on Saturday evening.
  • The County responsible for those roads becomes aware of this on Sunday morning but decides to wait until Monday morning to replace the sign, in order to save $1,500 overtime pay to its road crew.
  • Sunday evening, Mr. A, unaware that the sign is missing, assumes that he has the right-of-way, enters the intersection without slowing, and collides with Ms. B’s car.
  • The two cars and their occupants suffer damages which total $5,000.
  • At trial, the court accepts the evidence of a traffic expert that the probability, per day, that such an accident will occur is 3/10 if there is no stop sign in place and 1/10 if there is a stop sign.

Was the county negligent? Traditional, ex post legal analysis has difficulty answering this question definitively. On the one hand, ex post analysis holds that the function of tort law is to compensate “worthy” victims, creating a presumption that the county should be found responsible. On the other hand, that analysis also argues that a defendant should only be found liable if he or she failed to take those actions that would have been taken by a “reasonable” person. But what actions would have been reasonable in this case? I will argue that the answer the courts will usually give to this question is consistent with the ex ante, or economic, analysis of the law.

In particular, if the function of the law is to encourage behaviour that maximises social benefits minus social costs (the economic prediction), a “reasonable” action will be one for which the benefits exceed the costs. That is, economic analysis predicts that the county will be found negligent only if the cost of ensuring that the stop sign was re-erected exceeded the benefit of doing so. In this section, I will show that the factors that enter the determination of those costs and benefits are the same as those that the courts usually take into account when determining negligence.

Assume that rural stop signs are frequently knocked down on Saturday evenings. If the relevant counties wait until Monday to replace their stop signs, there will be three accidents every 10 times a sign is knocked down. Hence, there will be $15,000 damages for every 10 such occurrences. ($15,000 = 3 x $5,000.) If the counties replace the stop signs immediately, the number of accidents will fall to one in every 10 occurrences, reducing the accident costs to $5,000, a saving of $10,000. But, in order to obtain that “saving,” counties will have to send out 10 repair crews at an overtime cost of $1,500 each, or $15,000 in total. The $10,000 “saving” will have cost $15,000. Put another way, the average cost of precautions per event (knocked over stop sign) will be $1,500 and the average benefit of those precautions (measured in terms of accident costs saved) will be (2/10) x $5,000, or $1,000. (Note: the reduction in the probability of an accident, when the county sends out a repair crew, is only 2/10 because the crew does not reduce the probability of an accident to zero.) As the economic model predicts that the court will only encourage behaviour whose cost is less than the benefit, the economic prediction is that the court will not find the county to be negligent in this case.

It can be seen from this example that three factors were predicted to enter the court’s calculations:

  • the cost to the defendant of taking an additional precaution to avoid the accident, (here, $1,500);
  • the probability that an additional precaution would have prevented the accident, (here 2/10); and
  • the expected cost of the accident, (here, $5,000).

In the U.S., this prediction was confirmed in one of the leading cases on negligence, U.S. v. Carroll Towing. In that case, Justice Learned Hand concluded that negligence was to be found only if the burden (cost) of precautions was less than the probability of the accident multiplied by the gravity (cost) of the accident – precisely the formulation which was derived from the economic model.

In British/Canadian jurisprudence, confirmation of the prediction is less direct, but persuasive nevertheless – sufficiently persuasive that in recent editions of Canadian Tort Law Allen Linden has organised his discussion of the rules of negligence around the “Learned Hand rule.” In Wagon Mound No. 2, for example, the court concluded that a party could be found negligent even if the probability of an accident was low as long as the cost of the accident was high. Arguably, it was the court’s view that the cost of the accident multiplied by the probability that it could be avoided should be weighed against the cost of avoidance in order to determine negligence – again, precisely the prediction made by economic reasoning. Other leading cases which are consistent with the economic model include Bolton v. Stone, Priestman v. Colangelo, and Reibl v. Hughes.

Conclusion

Economists often define their discipline to be the analysis of “the allocation of scarce resources among competing ends.” When this approach is applied to common law, it suggests that one of the functions of torts might be to establish rules that encourage individuals to use resources effectively. Common law precedents should not discourage relatives from adopting orphans, for example. Nor should they find defendants to be liable if they have taken all precautions for which the benefits (of those precautions) exceed the costs.

In this article, I have argued that this “law and economics” method of analysing the common law predicts that

  • the courts will employ the ex ante approach when resolving tort disputes; and
  • they will base the determination of negligence on: the probability of an accident occuring, the costs of the accident, and the costs of avoiding the accident.

I have also provided evidence that, at least in some cases, the Canadian courts have followed this approach.

I do not wish to conclude from this that the courts should follow the economic approach, nor that they will always adopt it. I merely offer it as another tool for those who are looking for an underlying rationale to the courts’ behaviour. Perhaps in some cases, the advocate and the court will find it of value to think explicitly in terms of the signal which the decision in the current case will send to others in situations similar to those in which the plaintiff and defendant found themselves. In future articles in this series I will discuss the economic analysis of such doctrines as custom, causation, duty of care, volenti, and restitutio in integrum.

Footnotes

* The foregoing analysis is based on an article that I wrote for The Lawyers Weekly (April 24, 1998). This article is also available, as “Duty to Care for Orphaned Minors,” on this website. [back to text of article]

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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).

The Role of the Expert Witness in Developing “New” Law

by Christopher Bruce

This article was originally published in the spring 1998 issue of the Expert Witness.

One of the most exciting aspects of working in civil litigation is that participants in the legal system have the opportunity to influence the evolution of the law. Although some changes in tort law are imposed by legislatures, most developments are litigation-driven.

This raises a question which I have not seen asked anywhere else: Should arguments about changes in the direction of the common law be left to those trained in the law – judges and lawyers – or is there a role in this process for the testimony of “expert witnesses?”

I raise this issue as a result of my experiences with the evolution of two principles in damage assessment: the calculation of the dependancy rate in fatal accident actions and the calculation of the lost years deduction in serious personal injury claims.

Briefly, the two issues are these: In the case of the calculation of the dependancy rate, it is commonly accepted that the surviving spouse would have benefitted from approximately 70 percent of the (after-tax) incomes of each of the deceased and the survivor – with the remaining 30 percent having benefitted the deceased alone. What is not agreed, however, is whether the 30 percent of the survivor’s income which would previously have benefitted the deceased should now be deducted from the survivor’s loss of dependancy. (When this deduction is made, it is said that a “cross dependancy” approach has been used; whereas when the deduction is not made, it is said that a “sole dependancy” approach has been used.)

In the case of the calculation of the lost years deduction, the argument is that a plaintiff whose life expectancy has been shortened will not need to be compensated for the full value of the income lost during the years which he/she will not now live. Numerous theories have been put forward for the determination of the deduction which should be made – ranging from the deduction of only those components of income absolutely necessary to the maintenance of life to the deduction of the entire value of the plaintiff’s projected expenditure on consumption (i.e. deduction of the entire value of income except savings).

My purpose here is not to argue in favour of one or the other of the approaches to each of these issues. I have done that at length elsewhere*. Rather, my purpose is to ask what the role of economists – and other financial experts, such as accountants and actuaries – should be in the presentation of these issues to the court.

The Role of the Expert: Two Approaches

At least two contrasting approaches to the role of the expert can be defended. The first, which I will call “constructive” (but which others might call “interventionist”), recognises that legal arguments are often informed by developments in other disciplines – notably, philosophy, sociology, accounting, psychology, and economics. Where the arguments being made rely on sophisticated applications of these other disciplines, therefore, there may be a role for experts from those disciplines to testify concerning recent developments in the relevant literatures.

Some proponents of the constructive approach would go so far as to argue that such experts should be allowed to testify concerning what the law “should be.” A more appropriate role, I would argue, is that experts would merely be allowed to explain how the tools of their disciplines could be used to cast light on the issue facing the court.

The second approach, which I will call the “passive” approach, suggests that it is only those with formal training in the law who should be allowed to present arguments concerning potential changes in, or interpretations of, the common law. Hence, the opinions of non-legal experts should not be heard in court. The expert’s only role is to apply the existing law as best as he or she can.

The Constructive Approach

The primary advantage of the constructive approach, as I indicated above, is that theoretical and statistical developments in other disciplines will often be of value to the court in making its decisions. If extensive knowledge of these disciplines is required in order to fully understand the nature of the arguments, it may be preferable to have the presentation made in court by experts.

With respect to the lost years deduction, for example, economists, sociologists, and statisticians have considerable expertise with respect to both the definition and measurement of concepts such as “consumption” and “basic necessities.” And with respect to the measurement of dependancy rates, economists, sociologists, and psychologists have all written extensively about interpersonal relationships between spouses within marriage.

The primary danger associated with the constructive approach is that the expert will be tempted to stray beyond his or her area of expertise and begin to comment on matters requiring legal training. The first step in avoiding this problem is for the lawyer who has retained the expert to recognise that certain types of expert testimony can be construed as legal argument. Much of the testimony of experts in Canada concerning dependancy rates and lost years calculations, for example, has implicitly represented an argument concerning what the law “should be” – not because the expert saw that as his or her role but because the expert (and the retaining lawyers) had not recognised that that was what the expert’s testimony implied.

The Passive Approach

There are two advantages to the passive approach. First, it avoids the problem that the expert will stray outside the boundaries of his or her discipline. Second, if the law is well established, the expert will be able to avoid unnecessary testimony concerning possible alternative scenarios which have previously been ruled to be irrelevant. (For example, no Canadian economist would consider “wasting” the court’s time arguing that a tax gross up should be allowed on a loss of income claim, as the Supreme Court has clearly ruled that such a gross up will not be allowed.)

On the other hand, if the law is still evolving, the passive approach encounters two debilitating problems. First, any attempt to extract a straightforward rule from the decided cases is virtually doomed to failure. This is clear in the cases of both the dependancy and the lost years calculations. In both cases, there have been virtually as many different rulings as there have been judicial decisions. For anyone, lawyer or expert witness, to suggest that they can identify what “the” law is on either issue is presumptuous, if not preposterous. Nor would it be useful simply to adopt a “median” position. In issues like the dependancy rate there is no median position; and in issues like the lost years deduction there is no compelling reason to assume, ex ante, that the median position will prove to be the “correct” one.

Second, as a review of the decided cases on both dependancy rates and lost years deductions will reveal, when litigants first attempt to convince the courts to adopt a new legal principle, they often do not concern themselves with the finer details of those principles.

It is clear in the decided cases with respect to lost years, for example, that litigants and the courts have focussed primarily on the questions of whether such a deduction is required and, if so, whether it is “necessities” or the “costs of living” which should be deducted. Virtually no consideration has been given to the deeper issues of what the terms “necessities” and “costs of living” mean, nor of how one might measure those concepts. In the path-breaking Supreme Court case of Toneguzzo-Norvell v. Burnaby Hospital, the only evidence given by the plaintiff’s expert was as follows:

Q. …But would you agree that your average person … would spend something between 50 to 75 percent of their income on necessities…

A. Surely

No attempt was made to define the word “necessities” for the expert, nor was the expert asked to undertake any statistical research into the issue. Similarly, in another case which is widely quoted, the judge indicated that he had based his decision (concerning the lost years deduction) on the testimony of an expert economist. But when I contacted the economist in question he informed me that his entire testimony on that issue consisted of a brief response to a question put to him in cross-examination – a question to which he had not turned his mind prior to that time.

In the early stages of the development of new legal doctrines, it is common for “loose ends” to be left in this way. It would be inappropriate in my view for subsequent courts to rely too heavily on the “precedents” thereby established. Only when it can be shown that a superior court has turned its mind specifically to an issue, and ruled on it, would it be advisable for lower courts to rely on previously-made decisions in a developing area of law.

Furthermore, until the law has been clearly enunciated, it would seem inadvisable to insist that the expert rely strictly on “precedent” if that expert’s discipline has developed tools which would be of value to the court. Provided the expert testimony is presented as an aid to the court, rather than as an exposition of how the court “should” rule, that testimony may have a legitimate role to play.

Conclusion

It is not uncommon to find areas in the common law in which no clear precedent has yet been established. In some situations, like that of the argument concerning cross versus sole dependancy, this is because very few cases have been taken to court. In others, it is because the issues are so complex that the courts simply have not been able to turn their minds to all of the possible nuances. In these situations, I would argue that it would be irresponsible for an expert to argue that she or he had based a damage assessment on the “decided cases.”

At the same time, the expert must also recognise that his or her role in court is not to identify what the law “should be.” Rather, the expert must restrict her or his role to the presentation of theories or facts drawn from her/his disipline which can be expected to assist the court in making an equitable decision.

Footnotes

*On cross- versus sole-dependency, see Assessment of Personal Injury Damages, 2nd Edition (Butterworths, 1992); “Calculation of the Dependancy Rate in Fatal Accident ActionsExpert Witness, Winter 1996; and “Determination of Personal Consumption Expenditures in Fatal Accident Actions: A Note” Journal of Forensic Economics, 10[3], 1998.

On the lost years deduction, see “Shortened Life Expectancy: The ‘Lost Years’ Calculation“, Expert Witness, Spring 1996; “The ‘Lost Years’ DeductionThe Barrister, December 1996 issue (number 42); and “The ‘Lost Years’ Decuction” Lawyers Weekly, March 28,1997. [back to text of article]

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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).

D’Amato v. Badger – Complications Arising when the Plaintiff is a Business Partner

by Christopher Bruce and Scott Beesley

This article first appeared in the winter 1997 issue of the Expert Witness.

Some of the issues arising when an injured party had been a partner in a small business were recently discussed by the Supreme Court of Canada in D’Amato v. Badger, [1996] 8 W.W.R. 390 (S.C.C.). In that case, D’Amato had been one of two partners in an autobody repair shop. As a result of injuries suffered in an automobile accident, D’Amato’s ability to contribute to the operation of the business was severely and permanently restricted. D’Amato continued to provide some managerial services, but his primary services, as a skilled autobody repairman, had to be replaced with hired workers.

Nevertheless, between the time of D’Amato’s injury, in August 1987, and the trial, in March 1993, D’Amato’s partner, Namura, continued to pay D’Amato his pre-accident salary of $55,000 per year. Although the company recouped some of this payment from the services of replacement workers, the court found that the company’s profits were significantly lower during the pre-trial period than they would have been had D’Amato been healthy.

In this article, we wish to add to the analysis of the D’Amato decision by providing an economist’s perspective on the issues which were raised there. We do not, however, represent ourselves as experts on the legal doctrines which were discussed, in some detail, by the court.

Can a Company Claim When a Partner Is Injured?

Although the trial judge in D’Amato, Mr. Justice Vickers, awarded damages to D’Amato’s company, Arbor Auto Body, the Court of Appeal and the Supreme Court, ruled that the claim had to be made on behalf only of the injured partner. There was some suggestion from both of these courts that, as a public policy goal, claims from shareholders resulting from employee injuries should be discouraged (in order to encourage companies to insure themselves against such losses, and prevent frivolous claims). From an economist’s perspective, the critical factor in deciding whether or not a corporation (or partnership) suffers a loss when an employee is injured is simply whether or not that person’s labour can be replaced at constant cost. If the company can easily hire a replacement, or combination of replacements, who can produce identical business results at identical cost, then the company has suffered no loss at all. As this is almost always the case, few shareholder loss claims, for lost market share or profit, would succeed.

In practice, however, the business may incur additional costs associated with hiring and training and either lower quality or reduced productivity of replacement help. The loss claimed by Arbor (in particular the half of it claimed by Mr. D’Amato’s partner) was simply an attempt to recover an overpayment of salary relative to work provided, not an attempt to claim that the business was seriously impaired by Mr. D’Amato’s limitations.

In general, for medium-sized and larger companies, the employer’s loss in this type of case would be small, and the cost of putting forth a claim could be considerable, thereby limiting the number of claims. For a smaller business, however, any potential claim related to a loss of business volume would be greater, in a relative sense. It is quite plausible that the loss of a skilled technician like Mr. D’Amato could result in a loss of business, or that the added costs imposed on the company to find, train, and supervise replacement workers could be significant. As long as courts demand that the company in question provide firm evidence of any loss of business, or additional costs, then there would be no overcompensation. An additional factor which would create a tendency to modest awards is the short-term nature of this loss: Reputations can be re-established, training takes only so long, and hiring costs are a one-time item in most cases.

Should a Business Partner be Altruistic?

A complicating factor in D’Amato, which does not appear to have been considered explicitly by the Supreme Court, was that D’Amato’s partner continued to pay D’Amato his pre-injury salary after the injury, even though D’Amato’s productivity had been reduced significantly. According to Mr. Justice Vickers’ decision, D’Amato’s post-injury value to the company was only 25 percent of the salary which was paid to him. Had D’Amato been paid the actual value of his work, his pre-trial claim would have been roughly 75 percent of $55,000, or $41,250, per year. The business’ only losses, if any existed, would be from loss of volume, since customers would know Mr. D’Amato was not doing the work, or from the additional costs of hiring and training discussed above.

But Namura/Arbor did continue to pay D’Amato his pre-injury income. Hence, although the total loss which was incurred was the same as if Namura/Arbor had paid D’Amato only according to his post-accident productivity, the nexus of the loss was shifted – from D’Amato to Namura and Arbor. In spite of the fact that the total value of the loss was unaffected by this shift, the Court, by refusing to compensate Arbor for its overpayments to D’Amato, allowed the defendants to benefit from an altruistic act on the part of Namura.

From an economist’s perspective, if an injured employee’s compensation exceeds the value of his work in the open market, then restitutio requires that the excess amount paid will be claimable from the person who caused the injury. The difficulty is not in the principle, but in the details: it may not be instantly clear what the amount of the “overpayment” is. Replacement cost is one simple way to address the issue since, if the injured party is receiving his/her full prior salary, the cost of replacements represents the value of the services which the injured can no longer perform. Evaluation of replacement cost generally provides a reliable estimate of the employee’s decline in market value. When this overpayment has occurred, the correct redress is quite clear: the employer receives the amount by which the employee was overpaid, and the employee receives the amount they lost relative to his/her pre-accident level (so he/she receives nothing if the company continued to pay his/her full income).

An alternative view of the situation is that the overpayment provided by a partner (or any well-meaning employer) could be considered to be a gift or charitable donation and, hence, a form of collateral benefit, as receipt of the “gift” would not reduce the injured party’s claim. In that case, the replacement cost method should still be used to estimate the injured person’s true loss of income. Note that if a court judged annual pre-trial losses to be small, because the injured person received such benevolent overpayments, and based a future loss estimate on those artificially low figures, then the plaintiff’s loss could be seriously under-estimated, as the partner or employer is very unlikely to continue to overcompensate the plaintiff indefinitely. (This did not occur in Mr. D’Amato’s case, however, as the Court in that case implicitly assumed that Namura would cease to make overpayments after the trial.).

Furthermore, a finding by the Court that the plaintiff could be denied recovery if he had been “compensated” by his partner would send a strong signal to partners that they should refrain from assisting their colleagues when the latter had been injured. It does not seem likely to us that this is the signal which the Supreme Court intended to send, yet this is undeniably the signal which savvy partners will receive.

Two Examples

Two examples, based on D’Amato, will hopefully clarify these points. In both, we assume that, pre-accident, a partner in a business received compensation of $55,000 from the company for his physical and managerial labour, as full and fair compensation for those services. (The individual was also entitled to 1/2 of any business profit, as his return on capital. However, we ignore this as we assume that it is not affected by the injury.) After the accident, the injured party is able to contribute only the managerial component of the previous position, the market value of which contribution would approximate 25% of the pre-accident salary, or $13,750. In both cases, the total loss, $41,250, is identical. In both cases, as well, it is assumed that the business’ additional costs are limited to the cost of hiring replacement labour. Thus, the potential for a loss to the company, based on additional costs for hiring or training replacement labour, or decreased business volume due to loss of reputation, is not considered. The main point of difference between these cases concerns the post-accident compensation to the injured party, which results in different distributions of the total loss. If we assume that there are no other costs associated with hiring and training, and no loss of business due to loss of reputation, etc., then the financial position of the company is unchanged.

Case 1: Assume that the company pays the injured party only fair market value for his work, and that the balance of pre-accident salary of $41,250 (equivalent to $55,000 – $13,750) is paid to a replacement worker. Since other additional costs are not being considered here, it can be assumed that the financial position of the company remains unchanged. The injured person claims an annual loss of $41,250, from the dependant continuing into the future if the annual loss of income is not expected to change. Both the partner’s income and the injured person’s partnership income are also the same as prior to the injury.

Case 2: Assume the facts are as in Case 1, with one exception: the company continues to pay the full $55,000 per year to the injured employee, and therefore they are paying $41,250 “too much,” in order to assist the injured. The replacement labour must still, of course, be hired. The injured person can claim no loss there, unless, as discussed above, the excess payment is viewed as a collateral benefit. Company profit will fall by $41,250, the additional labour expense which has been incurred. Each of the partners bears half of the total loss of profit of $41,250 per year, and the economic analysis suggests that the business should be able to claim that amount from the defendant. The “overpayment” of salary to the injured party, of $41,250, is mitigating income which, in our analysis, represents a loan which required compensation. Should the court find that this overpayment is not compensable, the company would incur a loss of $41,250 per annum – a loss which it could have avoided by refusing to compensate the injured party.

Some Additional Complications

The above examples only discuss one form of loss, the physical inability to work. The situation is more complex at times. For instance, the injured person’s skills may be unique and, hence, irreplaceable. All business profit earned on the activity in question is now lost, in addition to the person’s own income as an employee. If other revenue is contingent on the presence of the injured party (e.g. painting after autobody work), then losses could in principle occur on all of that revenue also. Yet this would be a rather unrealistic extreme, since few if any of us are virtually irreplaceable. It is more realistic to imagine that the loss of a senior and extremely skilled person, who has a reputation for superior work, would indeed cause some loss of business volume, in addition to a proportional loss in an associated field within the business. In Mr. D’Amato’s case, it is not hard to imagine that most senior technicians who could work at his level already would own their own shops, in partnerships or otherwise. They might not be enticed to work for Arbor by anything less than Mr. D’Amato’s base employee income and a profit share, if they would move at all.

Correct determination of loss in such a case would require accurately estimating the loss of volume and profit which has resulted from the absence of the injured person. This may be uncertain, given that other changes in the operating climate occur at the same time, but if industry statistics suggest the company did indeed lose revenue in relative terms, then the difference between predicted and actual revenue may in turn have caused a loss of profit. We still suggest that the entire loss should be recoverable, by both the injured party and all other shareholders. If the partner’s employee income falls, that should in principle be recoverable as well (though that loss would be much smaller, since it would be mitigated by the fact that the partner can still work at something, even if his/her most lucrative opportunity is foreclosed by the absence of the injured person).

A further difficulty with D’Amato, in all three judgments, is that there was no discussion of the components of the company’s estimated pre-trial loss of $73,299. This figure may be interpreted primarily as replacement costs, in which event the analysis in the two cases discussed above applies, and the loss is really just D’Amato’s loss mitigated by a loan from Namura. Or is a significant part of that figure the result of decreases in business volume? The suggestion, that the loss reflects replacement expenses, is never confirmed. The denial of 50 percent of the pre-trial award to Namura suggests that in either case, the BCCA believed the company could not recover its loss. We disagree, particularly in the first instance, since it seems quite unfair to artificially lower a loss estimate because the partner or employer provided assistance in the form of a loan after the injury. In the loss of profit situation, we would still argue that both loss of labour income (suffered by the partner), and net business profits (suffered by the injured and the partner) should be recoverable.

Finally, we note that the judgments in D’Amato remain puzzling numerically. The trial justice and the Supreme Court each concluded that Mr. D’Amato’s future loss was best valued at 3/4 of $55,000 per year, or $41,250. There was no suggestion of any significant worsening of his condition on or about the time of the initial trial. That suggests that his pre-trial loss was also approximately the same annual amount, yet the plaintiff’s accountant reached a total pre-trial loss of $73,299, or only about $13,000 per year (over roughly 5.5 years). Even assuming that all of the $73,299 is actually Mr. D’Amato’s loss of value of work, the gap between pre-trial and post-trial is very large. Assuming no major changes occurred in Mr. D’Amato’s condition, then either the pre-trial loss was seriously underestimated, the future loss overestimated, or some combination of the two. A more exact determination of the value of Mr. D’Amato’s post-accident labour would be required to reach the correct figures, and similarly an estimate of business volume lost, or other costs imposed, would be needed to deduce the loss suffered by the business, in addition to “losses” which are actually just loans to a partner.

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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).

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

Implications of Duncan v. Baddeley

by Christopher Bruce

This article first appeared in the summer 1997 issue of the Expert Witness.

The recent decision in Duncan v. Baddeley (Alberta Appeal #9503-0408-AC), provides important direction for both fatal accident and “lost years” claims. In this article, I review a number of the implications of this decision for the assessment of tort damages. The first part of the article deals with fatal accident claims. The remainder discusses “lost years” claims.

Fatal Accident Claims

Justice Kerans ruled that, regardless of whether the deceased had any dependants,

. . . in Alberta a claim for loss of future earnings does survive the death of the victim. And, with two important qualifications, that claim should be assessed as would any claim for loss of future earnings (Duncan, at 2).

The two qualifications to which he referred are that deductions are to be made from the deceased’s projected annual income for (i) income taxes and (ii) the “cost of personal living expenses.”

The purpose of this section is to assess the impact of the Duncan decision on the calculation of damages in fatal accident cases. This assessment is conducted in three parts. In the first of these, I review the calculation of the two deductions. In the second, I consider the arguments concerning a “tax gross up” in calculations based on Duncan. Finally, in the third, I identify whether there are any cases in which dependants, who are eligible to sue under the Fatal Accidents Act, might find it advantageous to base their claim on Duncan (that is, on the Survival of Actions Act).

Method of Calculation

Justice Kerans ruled that the income taxes which would have been paid by the deceased must be deducted from gross income when calculating the loss to the estate. Although he appears to believe that the deceased would have paid “. . . taxes in the area of 30 to 40 percent of his income,” Statistics Canada data suggest that the average Canadian household pays only 20 percent of its income as income taxes — with a range from about 10 percent to 30 percent.

Second, an amount is to be deducted from after-tax income for the “costs of personal living expenses.” After canvassing a number of alternative methods for calculating this deduction, Justice Kerans settled on an approach which he attributed to Constance Taylor, the plaintiff’s counsel. This method, which Justice Kerans refers to as the “available surplus” approach, was first enunciated in the U.K. Court of Appeal in Harris v. Empress Motors (1983) 3 All E.R. 561 and later adopted in one of the first Canadian cases concerning the “lost years deduction,” Semenoff v. Kokan (1991) 84 D.L.R. (4th) 76. In the latter case, the court concluded that the “conventional deduction” was 33 percent of income.

Kemp and Kemp on the Quantum of Damages explains how the available surplus approach is to be applied, using an example similar to the following: assume that a deceased male would have married and had two children. Of the family’s after-tax income, approximately 22 percent would have been spent on items which benefitted the deceased alone. In addition, approximately 40 percent of family income would have benefitted all members of the family equally. Thus, if one-fourth of that portion of income, or 10 percent, is allocated to the deceased, the total fraction of family income which would have benefitted the deceased is approximately 32 percent.

Two points need to be made with respect to the available surplus approach. First, it should be noted that if this approach was to be applied to an individual who had no reasonable prospect of being married over the period of her or his loss, the value of the damages which would be calculated would equal those calculated using the “lost savings” approach. That is, as all of a non-married individual’s expenditures are spent on him or herself, once personal expenditures have been deducted from after-tax income it is only savings which will remain. As Justice Kerans was highly critical of the lost savings approach, it appears that the available surplus approach may not stand up to scrutiny. Indeed, although Justice Kerans indicated that it was the plaintiffs who had argued for the available surplus approach in Duncan, a review of their submissions suggests that it is the “conventional approach” which they preferred. (See the discussion of “lost years,” below.)

Further, as Scott Beesley argued in “Shortened Life Expectancy: The ‘Lost Years’ Calculation” (Vol. 1(1) of The Expert Witness), it is difficult to argue that wealthy individuals spend as much as 32 percent of their incomes on the “costs of personal living expenses.” Rather, as incomes rise, an increasing portion of expenditures is devoted to items which could only be categorized as “luxury”. Thus, at least for high income earners, one would assume that the appropriate deduction would be less than 32 percent — and for low income earners it would be greater than 32 percent.

Income Tax “Gross Up”

Whereas an income tax “gross up” is allowed in most fatal accident cases, it is not allowed in personal injury claims for lost earnings. The usual rationale which is offered for this is that the effect of basing (personal injury) damages on gross (before-tax) income is to produce an award which is approximately equal to that which would have been obtained by “grossing up” a lump sum award based on after-tax income.

In Duncan, even though income tax was deducted, as in other fatal accident cases, no allowance was made for a tax gross up. It is my view that no gross up will be allowed in cases brought under a Duncan type of claim. The reason for this is that the tax gross up is only required if the plaintiff is expected to invest her or his award in order to replace a future stream of lost income. In Duncan claims, however, there is no presumption that the estate will invest the award in such a way as to replace the deceased’s income stream on a year-by-year basis. Hence, it appears that no gross up will be necessary.

Distinction Between the “Fatal Accidents Act” and the “Survival of Actions Act”

It appears from Justice Coté’s concurring decision in Duncan that overlap between Fatal Accidents Act and Survival of Actions Act claims will be possible in only extremely exceptional circumstances. Hence, it will be important to determine which of these Acts will yield the higher award to the plaintiffs in those cases in which they are eligible to select between those two causes of action — that is, in cases in which the plaintiffs are also dependants of the deceased.

It appears that in most circumstances dependants would receive a higher award under the Fatal Accidents Act than under the Survival of Actions Act. There are three reasons for this. First, whereas it is only that portion of family income which the deceased spent directly on him or herself which is deducted in a traditional fatal accident claim, in a Duncan type of claim, it is this amount plus the deceased’s share of common family expenses which is to be deducted. Second, no claim for loss of household services can be made in a Duncan claim. Finally, it appears that no tax gross up will be allowed in the latter claim.

There are, however, two factors which might make it advantageous for dependants to file their claim under the Survival of Actions Act. First, if the Alberta courts should decide that it is the cross dependency approach which is to be employed when calculating losses under the Fatal Accidents Act, a deduction will be made for the portion of the survivors’ incomes which was spent on the deceased. No such deduction was contemplated in Duncan. As this deduction can be very substantial — particularly when the survivors earn more than the deceased — high income survivors may be able to make a larger claim under the Survival of Actions Act than under the Fatal Accidents Act. (It should be noted, however, that many experts recommend use of the sole dependency approach. See, for example, my article, “Calculation of the Dependency Rate in Fatal Accident Actions” [Vol. 1(4) of The Expert Witness].)

Second, damages in fatal accident claims are reduced for the possibility that the surviving spouse may remarry. In cases in which this possibility is very high — usually those involving individuals less than 35 years old — the survivor may find it advantageous to claim under the Survival of Actions Act.

Alternatively, it has recently been suggested to me that it may be possible to add together a “standard” claim under the Fatal Accidents Act and some portions of the deceased’s income which cannot be claimed by dependants under the Fatal Accidents Act but which are permissible under the Survival of Actions Act. One such portion might be the “non-necessary” element of the deceased’s expenditures on him or herself. This portion would be deducted in a standard fatal accident claim but might be claimable under the Survival of Actions Act.

“Lost Years” Actions

Duncan also has important implications for the assessment of damages in “lost years” claims; that is, in personal injury claims in which the plaintiff’s life expectancy has been shortened significantly. In these cases, the courts have ruled that a deduction for the cost of necessities is to be made from the income which the plaintiff would have earned during his/her lost years.

Although Justice Kerans appeared to accept the “available surplus” approach to the calculation of this deduction, this approach necessarily becomes identical to the “lost savings” approach when the deceased could have been expected to remain single — and Justice Kerans had explicitly rejected the latter approach. With respect, I suggest that Justice Kerans’ discussion in Duncan is more consistent with the application of what is known as the “conventional deduction” approach than it is with the “available surplus” approach.

First, Justice Kerans expressed his approval of the B.C. Court of Appeal’s reasoning in Semenoff v. Kokan, in which the court appeared to have had in mind the “conventional deduction” approach. Second, the 20-30 percent deduction recommended by Justice Keran in Duncan was consistent with the 33 percent deduction adopted only two months earlier in the Alberta trial division decision: Brown and Fogh v. University of Alberta Hospital. In that decision, Justice Marceau explicitly adopted the “conventional deduction” approach.

Together, it appears that Semenoff, Brown, and Duncan signal a preference for a conventional deduction of approximately 30 percent in both fatal accident and lost years actions.

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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).

The “Lost Years” Deduction

by Christopher Bruce

This article first appeared in the spring 1997 issue of the Expert Witness.

In a series of recent cases, defendants have argued that if an injury has shortened the plaintiff’s expected work life, full compensation should not be paid for the earnings forgone during the “lost years.”

Resolution of this issue has forced a re-examination of the legal foundations of personal injury damage assessment. At one extreme, restitution has been invoked to support the position that the plaintiff should be compensated for the full value of the income which would have been earned. In Andrews v. Grand & Toy (1978), 83 D.L.R. 452, for example, Dickson J. ruled that compensation must be awarded for “… the loss of that capacity which existed before the accident.” (at 469) This also appears to be the ruling in most American jurisdictions.

At the other extreme, McLachlin J., in Toneguzzo-Norvell v. Burnaby Hospital (1994) 1 S.C.R. 114, expressed concern that the plaintiff’s estate not be unjustly enriched. Her position was that, as the plaintiff would be adequately cared for from other heads of damage (e.g. the cost of care award), any funds paid in compensation for lost earnings would simply benefit the plaintiff’s heirs. Such enrichment may be sufficiently contrary to public policy that it would override the principal of restitution and justify the denial of compensation for lost earnings.

Legal decisions can be found to support virtually every position on the spectrum between these two extremes. Only two that I have been able to identify adopt Madame Justice McLachlin’s reasoning. In both Granger v. Ottawa General Hospital (June 14, 1996, Doc. 18473/90, Ont. Gen., Div.) and Marchand v. The Public General Hospital, ([1993] O.J. No. 561 (Ont. Ct. – Gen. Div.)), the plaintiffs were awarded only that portion of their incomes which would have been devoted to savings – apparently on the view that it was only that portion which would be lost by the plaintiffs’ heirs. (In Granger, savings were held to amount to 30 percent of earnings, whereas in Marchand 15 percent was assumed.)

Nevertheless, most experts testifying in Canadian cases have relied on the principle which underlay Justice Dickson’s decision in Andrews – that the plaintiff is to be compensated for the pleasure which will be forgone during the lost years. In particular, at least since Semenoff v. Kochan, (1991), 59 B.C.L.R. (2d) 195 (B.C.C.A.), there appears to have been agreement that the plaintiff should be compensated for that portion of his/her income which remains after deduction of “personal living expenses” or “necessities.” In principle, the pleasure which consumption of this residual would have provided during the years which have been lost can be replaced by consumption during the plaintiff’s now-shortened lifetime.

Where the experts disagree is with respect to the measurement of “personal living expenses.” First, although most of the reported cases assume that all expenditures on food, shelter, clothing, transportation, and health care are “necessary,” two alternative views have been proposed concerning the size of the family on which to base the calculations.

In both Semenoff, and Sigouin v. Wong, (1991) 10 C.C.L.T. 236 (B.C.S.C.), it was assumed that the plaintiff would have married and, therefore, it was only that portion of family income which would have been spent on the plaintiff which should be deducted. On that basis, the plaintiff was awarded 67 percent of the income which would have been earned during the lost years.

In subsequent cases – including Toneguzzo (where Madame Justice McLachlin did not apply her own argument concerning unjust enrichment), Pittman v. Bain, (1994) 112 D.L.R. (4th) 482 (B.C.S.C.), and Webster v. Chapman [1996] M.J. No. 384 (Man. Q.B.) – the courts have based their awards on the percentage of personal income which would have been devoted to necessities. This has led to awards lying between 50 and 60 percent of the lost years income.

A second source of disagreement concerns whether income taxes should be included as personal expenses. In a number of recent cases, the defendants have argued that taxes should be considered in this way. Should the courts agree, awards would fall to approximately 25 percent of the lost years income.

Finally, it has been argued that it is inappropriate to assume that all expenditures on broad categories, such as food and shelter, are “necessary.” According to this view, for example, only a small fraction of the expenditures which individuals devote to transportation could be considered to be necessary. Whereas individuals with incomes of $50,000 commonly spend $8,000 to $10,000 per year on automobiles and travel, they could meet their “necessary” travel needs by spending $500 to $1,000 on public transit.

All expenditures above the latter minimum could be considered to have provided pleasure. Hence, on the doctrine of restitution, they should be recoverable. When this approach is applied, it is found that it is only 15 to 30 percent of income which is devoted to necessities, leaving the remaining 70 to 85 percent to be compensated in damages. (This issue is discussed in greater detail in an earlier “Lost Years” Deduction article)

It is not yet clear what the resolution of these issues will be. All that can be said with certainty is that they have not yet received a full airing in the courts. My expectation is that in cases in which the plaintiff is not severely brain damaged, between 25 and 50 percent will be deducted for necessities during the lost years. In cases of severe brain damage, in which the plaintiff may not be able to benefit from an award for the lost years income, it is possible that the courts will follow Granger and Marchand and award only 15 to 30 percent of that income.

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Note: This article has been reprinted with permission from The Lawyers Weekly (March 28, 1997).

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).

Damage Calculations in Fatal Accident Actions After Galand

by Christopher Bruce

This article first appeared in the autumn 1996 issue of the Expert Witness.

In an article published in the summer 1996 issue of this newsletter, I reviewed the theoretical arguments raised by Coté, J. A. in Galand Estate v. Stewart (1992), 6 Alta. L. R. (3d) 399 (Alta. C.A.). What Justice Coté concluded in his decision was that, in certain circumstances, the estate of a deceased could rely on the Survival of Actions Act to make a claim for loss of earnings. What was less clear in Galand were the types of cases in which such claims would be allowed; and the methods by which damages were to be calculated. The purpose of this article is to identify some of the issues which can be expected to influence the decisions concerning these two issues.

Cases in which Claims will be Allowed

There are at least four types of cases for which it appears that claims will be allowed. First, it appears that an estate will be able to claim under survival of actions legislation when a plaintiff dies after a personal injury trial but before legal proceedings have been completed. In the British case of Pickett v. British Rail Engineering Ltd. (1980), A.C. 136 (H.L.), for example, the plaintiff died after a personal injury trial but during the appeal process; and in the Canadian case of Hubert v. De Camillis (1963), 41 D.L.R. (2d) 495 (B.C.S.C.), the plaintiff died after trial but before the decision had been rendered. In both cases, the estate was successful.

Second, in Galand, Justice Coté noted that

…by the date of trial some of the wage loss of a deceased person may well be past and already incurred and exactly quantified…. So even on the respondent’s view of the law, this cause of action may exist and survive (at 405).

Third, Justice Coté also argued that in a case in which a beneficiary of the deceased was not a dependent and

…the premature death of the deceased clearly deprived the beneficiary of part of his inevitable inheritance… [t]here is a plain financial loss (at 406).

Finally, two of Justice Coté’s examples pointed to the conclusion that he would have been willing to award damages under the Survival of Actions Act in a case in which the deceased had a “…completely secure salary and employment … at the time of his injury or death” (at 403). He referred specifically to the case of a tenured university professor (at 403) and to Wayne Gretzky when he was single (at 406).

The only Alberta case to award damages for lost income under the Survival of Actions Act since Galand is McFetridge Estate v. Olds Aviation Ltd. (unreported, Edmonton, April 12, 1996). In that case, the deceased had been a successful businessman whose future income stream Justice Lee found to be easily quantifiable. That is, it appeared to have fallen into the fourth of the categories identified above.

What is not yet known is how the Appeal Court will deal with cases of a more speculative nature, such as those involving the loss of lifetime income of an individual who was a minor at the time of his or her death. This issue may be decided later this year when the appeal is heard in Duncan Estate v. Bradley (1994), 161 A.R. 357 (Alta. S.C.).

Assessment of Damages

Section 5 of Alberta’s Survival of Actions Act states only that:

5. If a cause of action survives under section 2, only those damages that resulted in actual financial loss to the deceased or his estate are recoverable… (emphasis added)

What is not indicated is how the courts are to assess “actual financial loss” to an estate. Nor does the decision in Galand offer a great deal of assistance as the court was asked only to consider the issue of whether a cause of action survived a plaintiff’s death – not what that “action” might be.

Nevertheless, the courts have provided some information concerning the approaches which they prefer. Three of these will be considered here.

The loss of inheritance approach: In Toneguzzo-Norvell v. Burnaby Hospital, [1994] 1 S.C.R. 114, Madame Justice McLachlin (at 127-128) cited approvingly from Cooper-Stephenson and Saunders (Personal Injury Damages in Canada (1981) at 244) who argued that:

…the award of damages to a very young child for prospective loss of earnings during the lost years should reflect only that portion of the entire lifetime earnings which the court estimates would have been saved by the child for his estate, at the end of his pre-accident life expectancy (emphasis added).

The rationale which Cooper-Stephenson and Saunders offered for this position was that “…the prime purpose of the award during the lost years is to make provision for [the deceased’s] dependants” (at 243). In short, as the purpose of tort damages is to compensate the plaintiffs, an award based on a more liberal approach would result in a “windfall” for the dependants.

In Alberta, there is a number of weaknesses to this approach. First, the “windfall” argument has already been rejected by the majority in Galand. Second, as will be noted below, there is reason to believe that Galand sets a precedent for use of the “lost years” approach.

Also, Section 5 of the Act states that “…damages that resulted in actual financial loss to the deceased or his estate are recoverable” (emphasis added). On a plain reading, “loss to the deceased” would appear to imply something more than “loss of inheritance.” Finally, in Galand Justice Coté cited Pickett as precedent for the view that an estate should be able to “…recover for tortious loss of earnings or earning capacity of the deceased” (at 407, emphasis added).

The lost years approach: Assume that the plaintiff’s injuries have reduced her life expectancy from 40 years to 10 years. During the 30 years which have been “lost,” the plaintiff would have received income which would have been offset, to a certain extent, by expenditures on “necessities.” The theory behind the “lost years approach” is that, during those 30 years, the plaintiff has lost the pleasure associated with the difference between her income and her living expenses. (This issue was discussed in greater detail in the first issue of this newsletter.) During the remaining 10 years, she will be entitled to her full loss of earnings (as she will have to incur her full living expenses during those years).

Now assume that, instead of having a reduced life expectancy of 10 years, the plaintiff’s life expectancy has been reduced to two years. In a personal injury action, she would be entitled to damages equal to her income during those two years plus the difference between her income and her expenses in the remaining 38 “lost” years.

By simple extrapolation, it is seen that if the plaintiff’s life expectancy has been reduced to one year, or one month, or one week, a similar calculation can be made. And if we take the argument to its logical conclusion, if the plaintiff’s life “expectancy” has been reduced to one second, the “lost years” approach would suggest that damages should equal the difference between her projected lifetime earnings and her projected lifetime expenses in the 40 years which have been “lost.”

Both the Pickett and Hubert cases discussed above offered support for use of the lost years approach. If the estate of a plaintiff who has died soon after a trial is to be awarded damages based on the lost years approach, it would seem to be difficult to justify a different approach in the case of a plaintiff who has died soon before (or during) a trial. Furthermore, both Justice Coté’s approval of Pickett and his comment that “…the deceased had a cause of action for loss of future earnings because life expectancy was shortened.” (Galand at 404, emphasis added) seem to suggest that the Alberta Court of Appeal is prepared to employ the lost years approach.

Nevertheless, an inconsistency arises when the lost years approach is extrapolated from personal injury cases to fatal accident cases. One rationale for the lost years approach in the former is that the plaintiff could, in principle, replace the pleasure foregone during the lost years by spending her award during her remaining years. That is, the award in such a case can be seen as compensatory to the plaintiff. This rationale is missing in fatal accident cases (although it is also missing in personal injury cases involving plaintiffs who have become “vegetables”).

Loss of a capital asset: In a leading Supreme Court of Canada case, The Queen v. Jennings ((1966), 57 D.L.R. (2d) 644), Judson, J. concluded that if a plaintiff “…has been deprived of his capacity to earn income… [i]t is the value of that capital asset which has to be assessed” (at 656, emphasis added). Further, in Andrews v. Grand & Toy (1978) D.L.R. (3d) 452 (S.C.C.), Mr. Justice Dickson argued that this asset should be assessed at the value which it possessed before the injury; that is, unreduced for the lost years.

The controversial question then arises whether the capitalization of future earning capacity should be based on the expected working life span prior to the accident, or the shortened life expectancy…. When viewed as the loss of a capital asset consisting of income-earning capacity rather than a loss of income, the answer is apparent: it must be the loss of that capacity which existed prior to the accident (at 469-70).

But if one’s future earning capacity is to be treated as a capital asset, how is that asset to be valued? Two possibilities present themselves. First, as Mr. Justice Dickson implies, one could simply capitalize the future stream of income into a commuted value.

Alternatively, however, one could recognise that the value of a physical asset is not the capitalized value of its future stream of total earnings, but the value of those earnings net of the expenses of operation and maintenance. In that case, the loss of the capital asset, “future earning capacity”, would be found by capitalizing the individual’s future stream of earnings net of expenditures on necessities. That is, the capital asset approach may produce a result similar to that obtained using the lost years approach. Interestingly, this rationale for the lost years method does not encounter the objection raised above – that it assumes the plaintiff will live long enough to consume the award.

Implicitly, Justice Lee accepted the capital asset approach in McFetridge. There, the estate was awarded damages equal to the reduction in the value of the deceased’s businesses.

Comment

If the Court of Appeal does not reverse the Galand decision entirely when it hears the Duncan appeal, I believe that the law will develop as follows: First, the arguments made in the preceding section seem to suggest that it is the lost years approach which will be used to value damages, although the court may couch its decision in terms of the capital asset approach.

Second, over time, I believe that the courts will apply survival of actions legislation to all types of cases, including those involving minors. The reason for this is that once the courts allow actions in cases involving plaintiffs with “well-established” career patterns, such as tenured university professors, they will encounter difficulty distinguishing those situations from cases in which the deceased was “secure” in his or her career, such as a 35 year-old mechanic or engineer. This will give the courts difficulty distinguishing the latter from recent university or technical school graduates, graduates from high school students, and high school students from infants. Eventually, therefore, the estates of all fatal accident victims will be able to claim under the Survival of Actions Act.

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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).

Distinguishing Between Loss of Income and Loss of Earning Capacity: The B.C. Case of Pallos v. I.C.B.C.

by Scott Beesley

This article first appeared in the summer 1996 issue of the Expert Witness.

In its recent decision in Pallos v. Insurance Corporation of British Columbia (1995, B.C.J. No. 2), the British Columbia Court of Appeal awarded $40,000 for “loss of earning capacity” to a plaintiff who had no “loss of earnings.” The basis of the claim was that, although the plaintiff had returned to his previous employment, at a salary commensurate with that earned prior to the accident, the injury had diminished his future job prospects.

Pallos raises an important issue which is often given less attention than it deserves in personal injury actions: how should the court deal with uncertainty concerning the course of the plaintiff’s future earnings stream? In Pallos the uncertainty was of an extreme form, as it was unclear whether the plaintiff would have sought alternative employment had he not been injured nor was it certain what effect the injury would have on the post-accident probability that he would be able to keep his job or to find another one.

Other cases present the courts with varying degrees of uncertainty. In this article, I consider four types of uncertainty, in increasing order of complexity. The fourth case represents the situation which was dealt with in Pallos.

At the lowest level of complexity, the court has determined what career path the plaintiff will follow (or would have followed) but is uncertain concerning factors specific to that career, such as the rate of growth of earnings, the level of fringe benefits to be paid, the probability of unemployment, or the age of retirement. This common form of uncertainty can be, and is usually, dealt with simply by using averages. Although different automobile mechanics may experience different rates of growth of earnings, for example, it is generally appropriate to assume that the plaintiff’s income would have experienced the average rate of growth of earnings, for mechanics with characteristics similar to those of the plaintiff (such as education, specialisation, and work experience).

At the second level of complexity, there is a dispute concerning the plaintiff’s career choice. Commonly, for example, the defendant will argue that an injured automobile mechanic should return to his previous employment (perhaps at a reduced capacity), whereas the plaintiff will argue that the plaintiff should retrain as a partsman. Often, this type of dispute can be resolved on the basis of an appeal to the facts. That is, it is often open to the court to argue that the facts indicate that one of the two (or more) courses of action is much more reasonable than the other. (The court might find, for example, that the plaintiff’s back injury is so severe that it is highly unlikely that he could resume his career as a mechanic.)

In the third situation, there are (or were) two or more careers open to the plaintiff, each of which is (or would have been) plausible. For example, it may be unclear whether the plaintiff would have taken a drafting diploma at a technical school or an engineering degree at university had she not been injured. The present, or lump-sum, value of the former would have been $700,000, whereas that of the latter would have been $1,100,000.

The court could employ the second approach identified above, and make a finding of fact concerning which of these streams the plaintiff would have followed. But the better course, I would suggest, is to weight each possibility by the probability that it would have occurred. This provides what is commonly referred to as a “weighted average” (or, technically, an “expected value”). For example, if it was felt that pre-accident there was a slightly higher probability that the plaintiff would have become a draftsperson than an engineer, the court might conclude that the probability of the former was 60 percent and that of the latter 40 percent. In this case, the weighted average of the two possible income streams would be:

Weighted average (pre)

= (0.60 x $700,000) + (0.40 x $1,100,000)
= $420,000 + $440,000
= $860,000

It is from this figure that the lump sum value of the post-accident income stream would be deducted in order to obtain the lump sum loss of future earnings.

The weighted average calculation, also referred to as the use of “simple probability,” has a long history of acceptance in Canadian courts. An early example is Bradenburg v. Ottawa Electric Railway (1909), 19 O.L.R. 34 at 36 (C.A.). Subsequent cases include MacDonell v. Maple Leaf Mills Ltd. (1972), 26 D.L.R. (3d) 106 at 109 (Alta. C.A.), Schrump v. Koot (1978), 18 O.R. (2d) 337 (C.A.) and Janiak v. Ippolito (1985), 16 D.L.R. (4th) 1 at 20 (S.C.C.). In the latter case the Supreme Court noted that “In assessing damages the court determines… what would have happened by estimating the chance of the relevant event occurring, which chance is then to be directly reflected in the amount of damages” (emphasis added).

Recent cases which apply this principle include Graham v. Rourke (1991), 74 D.L.R. (4th) 1 at 12-13 (Ont. C.A.) and Steenblok v. Funk (1990), 46 B.C.L.R. (2d) 133 (C.A.). Many other references, and a detailed discussion of related issues, can be found in Ken Cooper-Stephenson’s book Personal Injury Damages in Canada (2nd ed., Carswell, 1996), and I would like to acknowledge that the above citations were found in this text.

Use of the weighted average approach avoids a common problem in personal injury litigation – that the plaintiff may appear to be “better off” following the accident than before. For example, assume in the case above that the effect of the accident has been to increase the probability that the plaintiff will become a draftsperson from 60 percent to 80 percent – and decrease the probability that she will become an engineer from 40 percent to 20 percent. The defendant could argue that the plaintiff might have become a draftsperson before the accident and will now become an engineer after the accident, leaving her better off by ($1,100,000 – $700,000 =) $400,000.

The answer to this is that the defendant has ignored both the probability that the plaintiff would have become an engineer had the accident not occurred and the probability that she will become a draftsperson now that the accident has occurred. The best way to deal with this issue, we suggest, is for the court to weight each of the career opportunities by the probability that it would (will) occur and then to deduct the weighted average of the post-accident figures from that of the pre-accident. We already know in the case discussed above that the weighted average of the pre-accident earnings was $860,000. The comparable figure for the post-accident stream is:

Weighted average (post)

= (0.80 x $700,000) + (0.20 x $1,100,000)
= $560,000 + $220,000
= $780,000

Hence, the loss becomes ($860,000 – $780,000 =) $80,000. [Note: this calculation can readily be extended to cases in which there are three or four possible streams and to cases in which the numbers of streams pre- and post-accident are different.]

The final situation is that in which it is extremely difficult to attach probabilities to the possible future outcomes. This is the situation which was encountered in Pallos. There, the plaintiff had returned to his pre- accident employment, at an income which was similar to that which he had been earning prior to the accident. The court found that the nature of the plaintiff’s injuries was such that he would now have much greater difficulty obtaining employment with an alternative firm than he would have prior to the accident. What was unclear, however, were the probabilities that he would have sought alternative employment prior to the accident or that the firm would now lay him off, forcing him to seek alternative employment post- accident.

It might be possible to resolve this conundrum employing the weighted average approach; but the difficulties of obtaining appropriate probabilities make such a solution problematic. Implicitly, the two alternatives considered by the court were (i) to make no award; and (ii) to make a “fair assessment.” The B.C.C.A. chose the latter; Finch J.A. awarded $40,000 for what he called “loss of earning capacity.”

Although we sympathise with the approach taken by Mr. Justice Finch, we submit that it may be inferior to the weighted average approach. Given Mr. Pallos’ education and work experience, the number of opportunities realistically open to him had he left his current employer was limited. (Technically, the number may be unlimited, but most of his alternatives would have provided similar income levels.) Hence, the primary uncertainty to be resolved was the probability that he would have sought alternative employment. This is a probability which the courts in general could select, based upon the facts of the case. Similarly, the probability that a plaintiff like Mr. Pallos will be laid off from (or otherwise) leave his employer, post- accident, could also have been selected by the court. Although the selection of these probabilities may have to be based on subjective factors, I would suggest that the process of that selection would make the decision much more transparent and easier to translate to other cases.

This difficulty of translation has already become apparent. In Nelson v. Kanusa Construction et al. (1995, B.C.J. No. 958), a B.C. trial decision which followed Pallos, the plaintiff was awarded $50,000, also for “loss of earning capacity,” even though the award given to Ms. Nelson for loss of earnings appeared to have compensated her adequately.

Nevertheless, a substantial subset of cases may remain in which the plaintiff’s prospects are so uncertain that it is extremely difficult either to identify them all or to attach probabilities to them. In these cases, the Pallos approach – of providing a lump-sum to compensate the plaintiff for a loss of earning capacity – may be appropriate.

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

Fatal Accident Cases After Galand

by Christopher Bruce

This article first appeared in the summer 1996 issue of the Expert Witness.

The Alberta Court of Appeal decision in Galand Estate v. Stewart (1992), 6 Alta. L. R. (3d) 399 opened the possibility that the estate in a fatal accident action could claim for the deceased’s loss of earning capacity (both past and future). Subsequently, two trial decisions – Duncan Estate v. Bradley (1994), 161 A.R. 357; and McFetridge Estate v. Olds Aviation Ltd. (unreported, Edmonton, April 12, 1996) – have been rendered which offer interpretations of the Galand decision.

In this, the first of two articles on the Galand decision, the arguments raised in these three decisions are summarised. A second article, to be published in the next edition of this newsletter, will discuss the implications of these decisions for the calculation of damages in fatal accident actions.

Galand Estate v. Stewart

In Galand, the estate of the deceased based a claim for the “…value of the present capital loss of earning capacity of the deceased…” on sections 2 and 5 of Alberta’s Survival of Actions Act:

2. A cause of action vested in a person who dies after January 1, 1979, survives for the benefit of the estate….

5. If a cause of action survives under section 2, only those damages that resulted in actual financial loss to the deceased or his estate are recoverable… (emphasis added)

The defendants raised two substantive arguments against the existence of the plaintiff’s cause of action. First, they argued that a loss of earnings could not constitute an “actual financial loss,” as required under section 5; and, second, they questioned the policy of providing a “windfall” to persons who are not dependents, on the ground that such a provision was not consistent with tort law’s fundamental goal of compensation.

Actual Financial Loss

In Galand, Coté J.A. (with Belzil J.A. concurring) considered and rejected three versions of the defendant’s position concerning actual financial loss. First, he did not accept the argument that a loss of future earnings was not “actual” because it was necessarily “speculative” or “contingent.” He countered with the example of a fatal accident victim with no dependents who had a completely secure salary and employment, such as a tenured university professor. Second, he rejected the proposition that “actual” and “real” necessarily implied “present,” not “future.” Finally, he did not agree that s. 5 barred claims for “general damages,” such as losses of future earnings. In his words, “[h]ad the Legislature meant ‘special damages’, it would have said so” (at 407).

Hembroff J. made it clear in Duncan that he did not agree with the majority reasoning in Galand. In particular, he quoted Black’s Law Dictionary as defining “actual” to mean

“… having a valid objective existence, opposed to that which is merely theoretical or plausible; opposed to hypothetical or nominal…”

[Randolph Langley, in a paper entitled Wrongful Death Claims, prepared for the Legal Education Society of Alberta, notes, however, that Black’s definition of “Damages: actual damages” includes:

“… Synonymous with “compensatory damages” and with “general damages” (emphasis added, Black’s 6th Edition, at 390).]

Windfall Gain

Coté J.A. also rejected the argument that actions for loss of future earnings should be denied because they represented a windfall to the beneficiaries of the estate rather than compensation. First, he noted that in some circumstances an individual who was the beneficiary of an estate might not be a dependent under the Fatal Accidents Act. Such an individual would be deprived of part of his inheritance from the deceased if he could not make a claim based on the Survival of Actions Act. Second, he noted that if the deceased had lost an income-producing machine at the moment of death, there would have been no doubt that his estate was entitled to claim full compensation for destruction of that machine. Yet such compensation might also represent a windfall to his estate.

Again, Hembroff J. dissented, citing Madam Justice McLachlin’s argument, in a case involving a young girl who had a severely shortened life expectancy, (Toneguzzo-Norvell v. Burnaby Hospital [1994] 1 S.C.R. 114), that

“… the award for lost earning capacity will serve but one purpose: to enrich her heirs” (at 127, emphasis added).

Similarly, Hembroff J. concluded that the “..tragic loss of a son should not be the notional income producing machine that puts money, ‘windfall or otherwise’ into the hands of his parents” (at 83).

Comment

Justice Hembroff’s objections notwithstanding, Justice Coté’s decision concerning “actual financial loss” was enunciated sufficiently clearly that most lower courts will find they are forced to conclude that estates do have a cause of action for general damages – it is only the measure of damages (to be discussed in the next issue of this newsletter) which remains uncertain.

A similar conclusion must be reached with respect to the treatment of beneficiaries of the estate of a deceased who are not also dependents. Here, Justice Coté was also clear, that the estate’s claim is to survive.

The decision in Galand with respect to “windfall gains” was stated much less clearly, however. The only assistance which Justice Coté provided to the trial courts derived from his analogy between the earning capacity of Wayne Gretzky and that of an “income-producing machine;” and from his decision that a loss of earning capacity could be considered to be an actual financial loss.

Two conclusions seem possible from this ruling. The first is that compensation is to be awarded only in those cases in which the deceased had a well-established earnings stream. The second is that compensation is to be awarded in all cases in which it can be shown, on balance of probabilities, that the deceased would have been a productive member of society. (Justice Coté’s decision concerning actual financial damages would appear to preclude the conclusion that damages are never to be awarded.)

Of these possible interpretations, Justice Coté appears to prefer the former. The examples which he provides in support of his conclusion that a loss of earnings is an actual financial loss all concern situations in which the individual’s earning capacity was well established – see his examples concerning tenured professors and Wayne Gretzky. Furthermore, his apparent reluctance to award damages “…in the case of the death of young children without a job or other source of income…” (at 407) could reasonably be interpreted to result from the difficulty of calculating such damages.

To conclude, it appears that the estate will be able to claim damages for loss of earnings when the deceased had a well-established earnings stream. It is not yet known, however, where the line will be drawn between these cases and those in which no clear earnings pattern has been established. The Court will have an opportunity to clarify this issue later this year when it is scheduled to hear an appeal of Duncan.

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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).

Loss of Earnings for Wrongful Confinement and Wrongful Sterilization: The Case of Leilani Muir

by Christopher Bruce

This article first appeared in the spring 1996 issue of the Expert Witness.

In Muir v. Alberta damages were awarded to the plaintiff on two grounds: first, that she was wrongfully confined, at the age of 10, in a home for the mentally defective; and, second, that while so confined, she was wrongfully sterilized. On the first of these claims, she was awarded $250,000 plus $115,500 interest for pain and suffering but was denied both aggravated damages and damages for loss of income. On the second claim, she was awarded $250,280 for pain and suffering and $125,000 for aggravated damages but was denied punitive damages.

Madam Justice Veit denied the claim for loss of earnings primarily on the ground that Ms. Muir had come from a dysfunctional family, leading her to suffer from severe emotional problems prior to her wrongful confinement. The confinement itself was found not to have exacerbated these problems.

Does this imply that all individuals in Ms. Muir’s situation will be denied damages for loss of earnings? We think not. Three sources of claims for lost earnings appear to have survived the decision in Muir.

  • First, if the plaintiff did not come from a dysfunctional family, a claim for loss of earnings could arise from the wrongful confinement.
  • Second, it might be argued that, had the plaintiff been placed in a foster home or group home for the care of emotionally disturbed children (possibilities which were canvassed by Madam Justice Veit), she would have overcome the effects of her dysfunctional upbringing. Hence, a loss of earnings would have arisen from the government’s failure to take advantage of one of these alternatives.
  • Finally, it is possible that a claim for loss of earnings could arise from the action for wrongful sterilization. Madam Justice Veit concluded that the “…sterilization had a catastrophic impact on Ms. Muir.” (Emphasis added, p. 59) She also accepted a psychologist’s opinion that sterilization can have “profound detrimental effects on … education…” (p. 46) and a psychiatrist’s testimony that the impact of sterilization on “…a young woman … would be hard to over-estimate.” (p. 38) On these bases, it could be argued that a wrongful sterilization had impaired the capacity to earn income.

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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).

Shortened Life Expectency: The “Lost Years” Calculation

by Scott Beesley

This article first appeared in the spring 1996 issue of the Expert Witness.

It is not uncommon for a plaintiff’s injuries to have reduced his or her life expectancy sufficiently that he/she is now expected to die before the “normal” retirement age. In such cases, the court will be forced to determine compensation for the income which the individual would have earned between the (reduced) age of death and the (former) age of retirement. A number of recent Canadian cases have wrestled with this issue. The purpose of this article is to offer a rationale for the calculation of compensation in these cases; and to compare that rationale with the methods adopted by the courts.

A Rationale for the “Lost Years” Calculation

Assume that a 45-year old woman has suffered an injury which will reduce her life expectancy such that she is now expected to die at age 52. Had she not been injured, she would have worked to age 62, earning $30,000 per year. The defendant might argue that, as she will not live beyond age 52, the plaintiff will not need to be “compensated” during those lost years. The plaintiff might be expected to respond that, as the defendant has denied the plaintiff the opportunity to earn income from ages 52 to 62, restitutio would require that she be compensated for the entire value of her foregone income during that period in this case, a lump sum value of approximately $180,000.

Although both arguments have merit, both are flawed. The defendant’s argument ignores the fact that the plaintiff has lost the opportunity to enjoy the income which she would have earned between 52 and 62. The plaintiff’s argument, on the other hand, ignores the fact that the plaintiff would not have “enjoyed” the full value of her income had she lived. Some portion of that income would have been used simply to keep her alive. Now that her life expectancy has been shortened, she has “saved” this amount.

These considerations suggest an approach to the calculation of the plaintiff’s damages for reduced life expectancy. In each year in which the plaintiff would have lived, but will not now, calculate the dollar cost of “necessities,” that is, of the amount which would have been required to keep her alive. Deduct this amount from the plaintiff’s income in each of those years. The remainder is the amount which would have been available to spend on “pleasure” and which has now been lost. It is this loss which is to be compensated.

The appeal of this approach is that it gives the plaintiff an amount which she could, in principle, use to replace the loss of pleasure which she has suffered due to the reduction in her life expectancy. That is, the level of compensation calculated using this approach is truly restitutionary, as the common law requires.

The primary difficulty which arises when applying this approach concerns the measurement of the value of “necessities.” A popular method is to approximate this figure using the average family’s expenditures on such categories as food, clothing, shelter, and transportation. Typically, these expenditures are found to constitute approximately 55 percent of family income. Two problems arise with respect to use of this figure, however. First, it is clear that a significant percentage of the expenditures on each of these categories is for items which would not normally be considered to be necessities. Restaurant meals are included in the food category, for example; as are expenditures on steak and frozen dinners. Similarly, the clothing category commonly includes expenditures on items which few of us would consider to be truly “necessary.” Instead, much of the 55 percent figure identified above is devoted to expenditures which provide the individual with “pleasure.” If it is the loss of expenditures on pleasure items which is to be compensated, those elements of food, clothing, shelter, and transportation which provide pleasure should not be deducted from the plaintiff’s damages.

Second, if the plaintiff is a member of a family, not all of her income would have been spent on herself. Indeed, we know from fatal accident litigation that the total amount which most individuals spend on goods and services which benefit them alone is approximately 30 percent of after-tax income. As only some portion of that percentage is spent on necessities, the deduction for personal necessities may be as little as 10 – 15 percent.

These arguments suggest that it would be preferable to employ a technique which measured the cost of necessities directly. Fortunately, in Canada such a technique is readily available. Christopher Sarlo, in his book Poverty in Canada (The Fraser Institute: Vancouver, 1992) and in a subsequent article, “Poverty Update” (Fraser Forum, January 1996, 25-31) has undertaken a detailed analysis of the cost of maintaining long term physical well-being. For able-bodied individuals, he proposes to include in the list of required items “….a nutritious diet, shelter, clothing, personal hygiene needs, health care, transportation and telephone.” (Poverty in Canada, p.49) Wherever possible, he uses objective criteria to determine the required amounts and to price those amounts. For example, he bases his estimate of food requirements on the Canada Food Guide and his shelter and clothing requirements on recommendations developed by the Montreal Diet Dispensary (a Montreal social services agency). His 1995 estimates of the cost of necessities for families of one, two, and three individuals in each of Saskatchewan, Alberta, and British Columbia are presented in Table A. It is Sarlo’s figures which we believe most accurately measure the concept of “necessity” implied in the lost years calculation.

TABLE A – Annual Costs of Necessities by Family Size and Province: 1995
Province Family Size
1 2 3
Saskatchewan $ 5,948 $ 9,093 $12,086
Alberta 6,478 9,253 12,241
British Columbia 8,108 11,223 15,007

Some have suggested an alternative approach, in which the plaintiff is considered to have “reduced needs” and hence will not require any of the lost income for themselves. Advocates of this method argue that the only compensation payable is that which replaces the plaintiff’s support of dependants. Essentially all other uses of income are considered “personal living expenditures.” This argument certainly protects dependants, but leaves plaintiffs completely uncompensated for their loss of pleasure in spending income which would have been earned in the lost years. Consider a thirty year-old plaintiff who is expected to die at 45. There are many ways in which such a person could enhance their remaining years of life by spending money awarded as compensation for “lost years” income. The defendant has already taken perhaps 30 years of the plaintiff’s life. To suggest that there should be no compensation for all the income and pleasure lost is, we submit, unreasonable.

Those arguing for the “dependants-only” approach admit that in principle, an aware plaintiff could use awarded monies to enhance their life in the time left to them, yet they do not support any such award. It is hinted that such awards are somehow undeserved, unless the plaintiff spends the money on foster children (in lieu of those they cannot now have) or another worthy charity. Even then, it is claimed that those making awards should be aware that they are draining the defendant’s bank account or the liability insurance pool. I submit that it is precisely the function of dam age awards to transfer costs to those who have caused the harm, and in doing so deter whatever reckless behavior resulted in injury. There is also an admission that household services may be a legitimate claim, but that is just another way of protecting dependents from loss.

Note that there are myriad practical difficulties with basing awards on support of dependants and little else. Should the award be based on a hypothetical (statistically likely) pre-accident family, or on the actual post-accident situation? It may be that the plaintiff is still capable of having a relationship and/or children, but has no dependants as of the trial. Any such case would make it difficult to assess lost dependency. If future dependency is assessed in a manner akin to current fatal accident cases, the future income of the spouse will have to be assumed.

Should the courts wish to deduct more than the low percentage implied by our approach, it has been suggested in previous cases that a deduction of 33 to 53 percent is appropriate. A discussion of some cases is provided below. The alternate approach described above, on the other hand, would result in very large deductions, at or near 100 percent in cases where the plaintiff was without dependants.

Recent Court Decisions

Four court cases, all from British Columbia, have dealt explicitly with the “lost years” deduction in personal injury cases. In the first of these, Bastian v. Mori, (Vancouver Registry No. C876136 [1990] B.C.J. No. 1324) Hood J. relied upon expert evidence to conclude that

….it is appropriate to deduct from the amount ascertained the amount that Danny would have expended on the basic necessities of life while earning that income.

…In any event I am satisfied on the evidence before me that 53% rounded off fairly represents Danny’s “cost of living” which he would have expended while earning his future income from age 30 to age 65 (pp. 53, 58-59, Emphasis added).

In Semenoff et al. v. Kokan et al. (1992) 84 D.L.R. (4th) 76, the British Columbia Court of Appeal was provided with no expert evidence; yet deducted 33 percent for hypothetical living expenses from damages for the lost years. Melvin J. then followed Semenoff in his decision in Sigouin (Guardian in litem of) v Wong (1992) 10 C.C.L.T. (2d) 236, again deducting 33 percent for “living expenses.” Interestingly, however, whereas the court in Semenoff had reduced the lost years deduction because the plaintiff was a married man, the plaintiff in Sigouin was an infant.

Finally, in Toneguzzo-Norvell v. Burnaby Hospital, (1994) 2 W.W.R. 609, the Supreme Court of Canada deducted 50 percent for “personal living expenses” in the case of an infant. Yet it quoted approvingly from Cooper-Stephenson and Saunders (Personal Injury Damages) who had argued that

…the award of damages to a very young child for prospective loss of earnings during the lost years, should reflect only that portion of the entire lifetime earnings which the court estimates would have been saved by the child for his estate, at the end of his pre-accident expectancy. It may result in a very small award… (Toneguzzo at 618. Emphasis added.)

As in both Semenoff and Sigouin, the court in Toneguzzo had only received the benefit of very casual evidence with regard to the cost of personal living expenses. Apparently, the expert’s complete evidence amounted to the following:

Q. …But would you agree that your average person, depending on their in come, would spend something between 50 to 75 percent of their income on necessities, the lower amount being at the higher income levels and the higher percentage being at the lower income levels?

A. It doesn’t as you said, without being too precise, it doesn’t sound like an unreasonable range.

Q. Within your own experience, that 50 to 75 percent sounds roughly correct?

A. Surely. (Toneguzzo-Norvell v. Burnaby Hospital (1993) 73 B.C.L.R. 116 (B.C.C.A.) at 129-130).

It can be concluded from these decisions that the need for a lost years deduction has become accepted by the Canadian courts in personal injury cases. Nevertheless, there is still uncertainty concerning the basis on which that deduction is to be calculated. The courts have said nothing more than that the deduction is to allow for “personal living expenses.” Expanding that definition as a means of limiting awards is in my view unreasonable. The core of the issue is whether or not plaintiffs are compensated for the pleasure they have lost as a result of not being able to spend the income earned in the lost years. I believe that some such compensation should be paid, and that a deduction along the lines of Sarlo’s necessities estimate is correct. However, there has yet to have been a full airing of expert opinion concerning the value of these expenses. Whether such an airing will result in the use of the approach recommended by Sarlo remains to be seen.

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