The Continuing Legal Education Society of Nova Scotia Insurance Law Seminar (September 10, 1993) "How Valuable is the Actuarial Report?

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1 The Continuing Legal Education Society of Nova Scotia Insurance Law Seminar (September 10, 1993) "How Valuable is the Actuarial Report?" In dealing with this topic, I will start by giving you a brief outline of some of the reasons why I think an actuarial report can be helpful when it comes to dealing with a personal injury or fatal accident situation. After that, I will talk about some of the questions and concerns that come up from time to time in connection with such reports; following which, hopefully, there will be time for a short question and answer period. First of all, some of the reasons why I feel an actuarial report can be of value in situations of this nature. First, and foremost, I believe that it provides a means by which different cases with different characteristics can be valued on a consistent basis. This is done by using mathematical techniques that have been developed over the past two hundred years plus. The key word here is consistency. We want to be sure that the value developed for case A is reasonable compared to that for case B. In preparing such a report, the actuary will give consideration to a number of factors including the life expectancy of the individual or individuals concerned and various economic factors that have a bearing upon the financial loss sustained. In fact, these are the actuarial techniques, that, when properly applied, have been keeping life insurance companies out of trouble for the past 230 years. It has been my experience that actuarial reports of this nature can often be of considerable assistance as part of the process of negotiating a settlement; thereby avoiding the necessity of going to trial. The objective of the actuarial report is to place a realistic value upon the capital sum that needs to be paid to an individual today such that the investment earnings generated by that capital sum plus the proceeds of the capital sum itself, will be just sufficient to compensate that person for the financial loss sustained. In other words, we want to ensure that financially speaking he or she is no better off, nor worse off, than would have been the case had the accident in question -1-

2 not occurred. As a side issue, actuarial analysis can usually provide useful insight into the extent of the tax savings that will occur where a structured settlement is being put into place to provide compensation for financial losses sustained. In particular it can be extremely helpful in ensuring that both the plaintiff and the defendant get a fair share of any such tax savings. This now brings me to the "question and concern" stage. For ease of reference, I will number these items although the order in which they come in this presentation is not intended to reflect a degree of importance or significance of these questions. (1) The basic data the actuary is using (regarding salary information, date of birth, etc.) may be wrong and therefore, the results shown in the actuarial report are wrong. In general, if it is, it means that you, the person who has retained the services of an actuary to prepare a report on behalf of a client, have not done a sufficiently thorough job in working up the basic facts and figures. I cannot put too much emphasis on the need to make sure that the information you are providing to the actuary is accurate and that when necessary, you will be able to provide exhibits and witnesses to give evidence at trial to confirm the accuracy of this information. If not, it may simply be a case of "garbage in - garbage out". (2) The actuary's report does not address all of the contingencies that apply in this case and therefore, the bottom line figures are overstated. I personally take this as a bit of a red herring. I think it could reasonably be argued that the actuary cannot properly address all of the contingencies unless he or she has the opportunity to be present at trial and hear all of the evidence being given by all of the witnesses. However, the actuary is required to provide a written report not less than 60 days before the date of trial if it is a Nova Scotia case, and therefore cannot possibly have all of the information necessary to be able to properly assess all of the contingencies that apply in a particular case. Aside from this, even if the actuary was somehow able to get all this information ahead of time, I do not think it would be appropriate for the actuary to be trying to "second guess" the Court in terms of how the evidence given by the various -2-

3 witnesses is to be interpreted. Accordingly I take the view point that the function of the actuary should be limited to preparing a report which takes into account only those contingencies that are capable of a reasonable assessment along mathematical (actuarial) lines, and then in general (unless there are special circumstances to which I will refer below) only to the extent reflected by broad statistical averages representative of the population as a whole. This can then, hopefully, provide the Court with a helpful starting point from which to assess the merits and demerits of a particular case. In particular, the Court will then make allowance for all of the various contingencies that have a bearing upon the financial loss sustained as evidenced by testimony before the Court. (3) Actuarial tables are based on statistical averages and therefore it is not reasonable to use these in placing a dollar value upon the financial loss sustained by one single individual. The quick answer to this is that actuaries employed by life insurance companies have been doing this for more than 200 years and on the whole it has worked out quite well. The problem here is that we have to find some way of determining a single capital sum which, when invested, will generate the required series of future payments. Occasionally, we have situations where we are dealing with a person who has (or had) certain well documented health problems which are known to be of a life shortening nature. On a number of occasions in the past, when preparing reports in a situation like this, I have used actuarial techniques which incorporate an adjustment to the mortality table to reflect the individual's shortened life expectancy. Such adjustment would be based on other statistical studies; some of which may have been based on life insurance companies' data, and others based on studies of clinical data. By this means it is possible to make a reasonable allowance for a shorter than normal life expectancy in such cases. This in turn leads to the question of the possibility of situations where a person has better than average life expectancy. Unfortunately, I know of no reliable way of documenting the mortality experience of such individuals, and I am not aware of any generally accepted actuarial studies of such groups of individuals. The -3-

4 best I can suggest is that if compelling evidence can be put forward to show that an individual has better than normal life expectancy, then this is something which the Court could take into account; possibly in the form of a positive contingency adjustment. In any case however, coming back to the question/concern raised, I think the best that I can say is that in my view a calculation of this nature produces what might be described as an actuarial "best estimate" of what will be required to properly compensate an "average" person in respect of the financial losses sustained. Since neither the Courts nor the members of the actuarial profession have any way of predicting any individual's exact future life expectancy, I believe that this is the best we can do. (4) Why not get an immediate annuity quote from your friendly neighbourhood life insurance agent? By all means get a quote. remember: However, there are a few things you need to (a) (b) (c) You would want to be sure that your insurance agent has "shopped the market" and got the best possible rate available. You would want to read the "fine print" that goes with any such annuity contract in relation to how it allows for future increases in the consumer price index. I mention this because part of what we are trying to do here is to provide compensation for an individual in an amount such that it will give recognition to the impact of inflation rates in future years. In general, you will find that most insurance companies will not give you a quotation that incorporates full cost of living protection. Even when they do, it should be noted that many of these quotations are subject to some maximum amount of increase (perhaps 4%) to be payable in anyone year. This is fine when inflation is below 2% like it is right now; however, what about the future if we find our way back into double digit inflation again? Because of the volatility of current economic conditions most insurance company annuity quotations have a shelf life of only 24 hours these days. This presents a practical problem if one is proposing to use such a quotation as part of the process for putting a dollar value on some -4-

5 person's financial loss. (5) The economic assumptions used by the actuary are unreasonable, unrealistic, etc. (a) (b) Many jurisdictions in Canada now have a set rule concerning the net rate of interest to use in calculations of this nature. This is a net rate in the sense that it is intended to represent the difference between rates of interest available on "safe" investments and the corresponding rate of inflation. In establishing such net rates, consideration has been given to averages running over periods of 30 years or more. Amongst the reasons for the introduction of such rules were the perceived desirability of establishing a consistent basis that could be used in the preparation of all reports of this nature, and (I understand) the wish of the Courts to avoid the considerable amount of time taken listening to and assessing the voluminous evidence with respect to interest rates that typically had been submitted in many such cases that went to trial before such a rule was introduced. Taking this historical aspect of the discussion into account, it could perhaps be argued that the reasonableness or otherwise of the economic assumptions used cannot be blamed on the actuary since in general they tend to be prescribed by the Courts! (6) The results produced by actuarial calculations don't make sense because investment earnings on the capital sum alone will be more than sufficient to replace the lost income. This line of reasoning appears to have a great deal of attraction to defence lawyers. Of course there is a major fallacy here because it overlooks the impact of inflation. Although in the first few years after such an award is made, the investment earnings may be more than sufficient to provide the required level of compensation, the assumption the actuary is making in his or her calculation is that not all of that money will be spent by the plaintiff during the early years. Part of it has to be "ploughed back" in order to augment the initial capital sum so that there will be enough money there later on in the payment period to provide the steadily increasing series of payments required for the plaintiff to be able to -5-

6 maintain his or her standard of living throughout whatever periods of inflation ensue in future years. (7) Actuarial reports cost too much relative to the benefits obtained. This of course is a value judgement, and we may all have different perceptions as to the values here. Some of the reasons why an actuarial report might cost more than expected are: (a) (b) (c) The facts and figures originally supplied by the lawyer may turn out to have been wrong; thereby leading to a need for the whole report to be reworked. The lawyer and the client may have difficulty in making up their minds how to present their case; thereby resulting in the need for a number of costly "reruns". Too much attention may have been focused upon relatively trivial items which make very little difference to the bottom line. For example, it is usually futile to start worrying about loss of future retirement pension for a twenty year old. Admittedly, I think the actuary also has an important duty here to alert the lawyer who retained him (or her) to problem areas of this nature before they get out of hand. Even then, we still sometimes run into situations where the injured party is determined to sue the defendant for every last nickel and dime despite the fact that there may be a law of diminishing returns here. hope you will have found these brief comments helpful in obtaining a better understanding not only of what an actuarial report can do, but also of what it cannot do. Winston Churchill has been quoted as saying "true genius resides in the capacity for evaluation of uncertain, hazardous, and conflicting information". If any of you are retaining the services of an actuary some time in the future, I hope you will not put them in a position of having to try to live up to this Churchillian epithet. We like to think we are intelligent, but we don't claim to be geniuses. -6-