In our Client Alerts of 19 September 2012, 19 October 2012 and 31 October 2012, we reported that a trial of the following preliminary issue would take place in three personal injury cases on 8 to 11 January 2013:
“Whether having regard to economic developments from 1995 up to the present time, the Cookson v Knowles assumption of a net rate of return of 4.5% remains valid in Hong Kong and, if not, what is the net rate of return, based upon which multipliers ought to be assessed and awarded.”
Assumption of 4.5% net rate of return no longer valid in Hong Kong
On 7 February 2013, Mr Justice Bharwaney handed down his judgment. Having considered the parties’ expert evidence on the historical data of investment returns (after taking into account price inflation and payroll inflation) of various investment vehicles over several different periods from 1995, he held that the Cookson v Knowles assumption of a net rate of return (or discount rate) of 4.5% is no longer valid in Hong Kong.
Different Discount Rates for Different Needs
Mr Justice Bharwaney held that there should be three different discount rates to cater for plaintiffs with different periods of future needs, as follows:
(1) -0.5% for plaintiffs with needs not exceeding 5 years.
(2) 1% for plaintiffs with needs not exceeding 10 years.
(3) 2.5% for plaintiffs with needs exceeding 10 years.
The lowering of the discount rate will result in higher multipliers for future losses and therefore higher awards of damages in personal injury cases.
Determining the new discount rate
In determining the new discount rate, Mr Justice Bharwaney took the starting point as looking at what the plaintiff needs and asking how the hypothetical reasonable and prudent plaintiff, who is mindful of his current, short-term and long-term needs, would invest and otherwise deal with his award for damages to meet those needs. The needs of a plaintiff who receives a lump sum to cover future expenses include, Mr Justice Bharwaney said, the ability to draw down on the lump sum award so as to meet current expenses, to maintain a certain amount of liquidity to meet urgent and unexpected needs, the need to ensure capital growth and to fend against inflation.
Mr Justice Bharwaney said that given current economic conditions, the investment choice of a reasonable plaintiff must be driven by his future needs. A plaintiff with long-term needs will not invest all of his damages into short-term bank deposits, whilst a plaintiff with short-term needs will not invest all his damages into long-term bonds.
Mr Justice Bharwaney therefore had to decide on the appropriate investment vehicles and combination of investment vehicles into which a reasonable plaintiff ought to invest his award of damages for future loss. In the absence of Index-Linked Government Stocks in Hong Kong, the critical questions for Mr Justice Bharwaney to determine in arriving at the appropriate discount rate were 1) what was the appropriate combination of investment vehicles for the needs of a victim of a tort?; and 2) what was the proper historical period of time over which the performance of the chosen vehicles ought to be reviewed, as giving the best indication of the performance of such vehicles purchased today?
Plaintiffs with needs not exceeding 5 years
Mr Justice Bharwaney found that for plaintiffs with needs not exceeding 5 years, an appropriate investment portfolio would be 20% of the award for future losses in 12 month time deposits and 80% in Exchange Fund Notes (“EFNs”). He said that the performance of EFNs that a plaintiff buys today is best assessed by looking at the performance of such over the last 5-7 years, given the drastic fall in values from recent extreme economic events.
Mr Justice Bharwaney arrived at a discount rate of -0.5%, by taking the average of the real rate of return per annum, net of price inflation, for the preceding 5 years and 7 years respectively for the combination of 20% 12 month term time deposits and 80% EFN.
Plaintiffs with needs not exceeding 10 years
Mr Justice Bharwaney found that plaintiffs with needs not exceeding 10 years, ought to invest 85% of their award for future loss in EFNs and bonds with a rating of BBB+ or better and 15% in 12 month time deposits. As with EFNs, he found that the appropriate review period for bonds was the past 5-7 years.
Mr Justice Bharwaney arrived at a discount rate of 1% by taking the average of the real rate of return per annum, net of price inflation, for 12 month time deposits for the preceding 5 years (-1.9%) and preceding 7 years (-0.6%) i.e. 1.25%. In respect of bonds, he took the average of the real rate of return per annum, net of price inflation, of the Hong Kong Dollar Bond Index for the preceding 5 years (2.3%) and the preceding 7 years (1.8%) i.e. 2.05%.
Unlike EFNs and time deposits, bonds attract a management fee. Mr Justice Bharwaney therefore deducted a management fee of 0.75% from the 2.05%.
Plaintiffs with needs exceeding 10 years
For plaintiffs with needs exceeding 10 years, Mr Justice Bharwaney took an “average” portfolio of 10% in time deposits, 70% in high quality bonds of BBB+ rating or better and 20% in high quality blue chips. The 20% for the equity content was a simple average of portfolios with equity content ranging from 10% to 30%.
As stated above, for bonds, Mr Justice Bharwaney found the appropriate historical review period to be 5-7 years. However, in respect of equities, he found the appropriate period to be 12 years on the basis that the equity element of the portfolio would be held for a considerable period.
In the absence of evidence of the performance of high quality equity funds which fit the requirements of these plaintiffs, such as, for example, Hong Kong Equity Fund A, with the investment objective of achieving long term capital appreciation through investments in Hong Kong equities, Mr Justice Bharwaney assumed that the performance of such a high quality fund over the past 10 years was similar to the performance of the MPF Hong Kong Equity Fund, shown to have a real rate of return per annum, net of price inflation, after deducting management fees, of 7.4%
Mr Justice Bharwaney thereby arrived at a discount rate of 2.5%.
Parties have 21 days to notify court of any error in calculation of discount rates
Mr Justice Bharwaney has given the parties liberty to apply to Court within 21 days to adduce expert evidence in the event that they consider his calculations of the discount rates erroneous.
Periodic Review of Discount Rate
Mr Justice Bharwaney recognised that in these volatile economic times, it may be necessary to review the discount rates again, if economic conditions change and interest rates rise beyond any corresponding rise in inflation or if a differential between price and wage inflation of 1% or more is established for a significant period of time. Such review, Mr Justice Bharwaney said, could be initiated by the judge in charge of the Personal Injuries List, who could select the appropriate cases to test the validity of the prevailing discount rate.
Mr Justice Bharwaney also said that the Plaintiffs’ expert’s suggestion of a Working Party, chaired by the Chief Justice and consisting of judges, lawyers, actuaries and economists to review the issue periodically, also merited attention. That would be a workable suggestion, Mr Justice Bharwaney said, if interested parties, such as liability insurers, the Motor Insurers’ Bureau, the Secretary for Justice and the Hospital Authority, to name few, agree that courts assessing damages for personal injuries should adopt appropriate multipliers by reference to the discount rate set by the Working Party.
Mr Justice Bharwaney also raised the question of whether or not legislation similar to the UK’s Damages Act 1996 should be enacted in Hong Kong, empowering the Chief Justice to prescribe the discount rate, after consulting the Monetary Authority, the advantage being that it would avoid the burden of costs on the losing party(ies), in any case where the discount rate was reviewed.
Implications of the Judgment
As stated above, the lowering of the discount rate will result in higher multipliers for future losses and therefore higher awards in personal injury cases which include claims for future losses and expenses. Accordingly, insurers should review their reserves and the need to increase premiums. As Mr Justice Bharwaney himself stated, there is no denying that the costs of insurance will go up as a result of his judgment.