CHAN PAK TING v. CHAN CHI KUEN AND ANOTHER

HCPI 235/2011, HCPI 671/2007
& HCPI 228/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

PERSONAL INJURIES ACTION NO. 235 OF 2011

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(HEARD TOGETHER)

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JUDGMENT

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1. On 18 September 2012, I had directed that there be a trial of the following preliminary issue in the captioned cases:

“Whether, having regard to economic developments from 1995 up to the present time, the Cookson v Knowles[1]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.”

I gave my Reasons for Decision in this matter on 16 October 2012. This Judgment should be read in conjunction with those reasons.

2. At the same time, I had granted leave to the parties to adduce expert evidence on the interpretation of historical data of investment returns, net of inflation, of various investment vehicles from 1995 to date, including the net rate of return of such investment vehicles from 1995 to date, and for the last 3 years, 5 years, 7 years, 10 years and 12 years; and the net rate of return of combinations of such investment vehicles for these periods of time. 

3. I also directed that the experts should refrain from offering any opinion on future economic developments but may identify and refer to current economic conditions which may impact on future economic developments.  

4. When I handed down my Reasons for Decision on 16 October 2012, I noted that the rate of return might be different if payroll inflation, instead of price inflation, was taken into account, and I enlarged the directions I had given by directing that the experts ought to ascertain the net rate of return of the investment vehicles, and combinations of investment vehicles, firstly, by taking into account price inflation and, secondly, by taking into account payroll inflation, over the relevant periods being considered.  At the same time, I noted that the choice of investment vehicles and the period of time over which their performance was being reviewed were critical factors that would affect the net rate of return.  That this was so was made abundantly clear in the course of the trial of the preliminary issue when the experts gave evidence before me. 

The parties

5. At the time of my decision on 18 September 2012, the plaintiffs in HCPI 235 of 2011, HCPI 671 of 2007 and HCPI 228 of 2010 had joined in the application for leave to adduce actuarial and economic evidence to test whether the Cookson v Knowles assumption of the net rate of return of 4.5% remained valid in Hong Kong.  Before the trial of the preliminary issue, the plaintiff in HCPI 235 of 2011 was able to reach an amicable settlement with the defendants in that case, leaving only the parties in the other captioned cases to proceed to the trial of the prelimiary issue.  Both of the remaining plaintiffs are minors and sue by next friend.  

6. The plaintiff in HCPI 671 of 2007, Li Ka Wai, is an infant born on 29 June 2000, who sues by his mother and next friend.  As a result of cardio-respiratory arrest on 18 August 2001, Ka Wai, then aged 13 months, suffered severe spastic quadriplegia and cerebral palsy as a result of brain damage following upon the cardiac arrest.  He suffers from severe mental retardation, profound global retardation in development, and severe developmental delay.  He is visually impaired to the extent of being nearly totally blind.  He is unable to move and is totally dependent on others for all activities of daily life.  He attends special school during the week and returns home on weekends and public holidays where he lives with his parents and brother.  The plaintiff will never be able to lead an independent life and will require assistance, care and attention, including medical care and specialized treatments and therapies, for the rest of his life. 

7. The plaintiff in HCPI 228 of 2010, Yuen Hiu Tung, sues by her grandmother and next friend.  Her trial on the issues of liability and quantum commenced on 8 November 2012 and is now part heard.  Hiu Tung was born on 23 December 2000 and is now 12 years old.  She was born with multiple congenital abnormalities suggestive of VATER syndrome (vertebrae, anus, trachea, esophagus and renal abnormalities).  Although many abnormalities were resolved, following surgical interventions in the first year of her life, Hiu Tung continued to require medical care and attention.  In October 2001, as a result of deteriorating pulmonary condition, she was admitted to the Paediatric Intensive Care Unit of the Queen Mary Hospital.  As her condition worsened, it was decided on 21 October 2001 that she should be intubated so as to be able to receive intermittent positive pressure ventilation.  Shortly after the intubation, she suffered two episodes of cardio-respiratory arrest requiring full resuscitative measures.  The cardiac arrest caused severe brain damage resulting in spastic quadriplegia, severe mental retardation, blindness as a result of cortical-visual impairment, and severe developmental delay.  Hiu Tung is totally dependent for all activities of daily living and will be so dependent for the rest of her life. 

8. Whilst the trial of the preliminary issue is being conducted in the context of the claims of these two plaintiffs, the decision on the proper discount rate to be applied in setting appropriate multipliers will impact not only on these plaintiffs but on every plaintiff claiming damages for personal injuries whose claims include claims for future losses and future expenses.

The experts

9. The expert nominated by the plaintiffs is Professor Chan Wai Sum of the Department of Finance of the Chinese University[2].  He is a professor in the Department of Finance at the Chinese University of Hong Kong teaching in areas of actuarial science, financial statistics and actuarial evidence.  He has published widely and is the leading author of Personal Injury Tables Hong Kong 2013, which replaces the 2005 Edition of the same publication.  On the application for leave to adduce expert economic evidence, I had received three reports from Professor Chan, an earlier one dated 25 September 2011 and two later reports, both dated 13 September 2012, based upon which I was satisfied that there had been a substantial change in the economic landscape, since the decision of the Court of Appeal in Chan Pui Ki v Leung On[3], such that I should permit economic evidence to be adduced to test whether the Cookson v Knowles assumption of a net rate of return of 4.5% remains valid today.  Pursuant to the directions I had given on 18 September 2012, Professor Chan worked together with the expert nominated by the defendants, Ms Yvonne Sin, to prepare their joint report on discount rate for my consideration in this case. 

10. Ms Yvonne Sin is currently the General Manager, Risk and Financial Services for Mainland China and Taiwan at Towers Watson (previously Watson Wyatt)[4]. She has been offering investment and pension advice to private and public sector institutional clients in different countries for over 20 years.  During her 14-year tenure at The World Bank, she led technical assistance projects as Head of Global Pensions in Social Protection.  She has widely published on pension financing and social protection issues and is a frequent speaker on these topics and on retirement and social security for the elderly.  She had greater access to historical data on the performance of various investment vehicles, which she shared with Professor Chan in their joint preparation of their report. 

11. I must commend both experts for the extent to which they co-operated with each other in producing their very substantial joint report which contains a substantial amount of agreement between them on the difficult issues thrown up by this inquiry.  They are to be commended for the assistance that they have rendered to me which they did impartially and independently.  It was a pleasure to receive their expert opinion, which they offered to the best of their ability, frankly acknowledging the limitations to the assistance that they could render to me.  At no time did they act as advocates for the parties instructing them.

The Hong Kong economy from 1995 up to the present

12. In Section 2 of their joint report, they provided background information about the Hong Kong economy from 1995 up to the present time, examining historical data for four key indicators: the Nominal Hong Kong Hang Seng Index from 1978 to 2011; Hong Kong interest rate trends from the 1980s to the present time (using 12-month time deposit rates, in nominal terms, as a proxy), quoting the peak of 15.7% in October 1981, the 4-8% range from 1985 to 2000, the substantial slide thereafter to the recent practically flat level of around 0.16% from 2009 to the present; Hong Kong price inflation trends based on year-on-year percentage change of the composite consumer price index, noting the deflationary effects of the 1998 Asian crisis and the impact of SARS in 2003, and the climb thereafter reaching the 4% per annum level recently; and, finally, the annual growth rates of the gross domestic product (“GDP”) in Hong Kong which is often regarded as the most important economic indicator.  Hong Kong enjoyed double digit nominal growth in every year, except 1995, during the pre-1995 period, but has been adversely affected by financial storms thereafter.  The first negative growth in 50 years was experienced in 1998.  In the last two years, Hong Kong has been experiencing a single digit growth figure.  The experts’ review of this economic data led them to conclude, as I did in my decision in September last year, that there had been a substantial change in economic landscape since the judgment of the Court of Appeal in Chan Pui Ki v Leung On in 1996.

Factors that impact on future economic development 

13. In the same section, they also identified several current economic conditions which might impact on future economic developments in Hong Kong.

14. “Quantitative Easing” has now become a recognised economic concept.  The experts have explained the operation of quantitative easing policies adopted by the US and UK Governments and other Governments in these terms:

“Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates. UK interest rates are currently at 0.5% - the lowest level in the Bank of England’s history.

Lower interest rates encourage people to spend, not save. But when interest rates can go no lower, a central bank’s only option is to pump money into the economy directly.

The way the central bank does this is by buying assets – usually financial assets such as government and corporate bonds – using money it has simply created out of thin air.”

The third round of quantitative easing was announced by the US Federal Reserve Bank on 13 September 2012 and is likely to put pressure on the UK to follow suit. In the US, the effects of quantitative easing on the US economy have been the depreciation of the US dollar, sharp rises in commodity prices, rises in the equity market, but a sharp drop in US Treasury bond yields. 

15. The experts have also referred to the “double whammy” effect in Hong Kong caused by the economic impact of imported inflation from China without a free hand in fixing a higher interest rate in Hong Kong because of the currency peg of the HK dollar to the US dollar.  The Renminbi has been rising against the HK dollar for the past ten years.  Strong internal demand within Mainland China has caused an increase in the price of food and other products in China.  A significant amount of food is imported to Hong Kong from China daily.  The rise of the Renminbi against the HK dollar has had a marked impact on consumer price inflation in Hong Kong recently.  The peg is here to stay for a long, long time and the double whammy effect will continue in Hong Kong.

16. The Eurozone sovereign debt crisis and its potential impact on the Hong Kong economy is explained in an extract from the 2011 Economic Background and 2012 Prospects, published in February 2012 by the Financial Secretary’s Office:

“The Eurozone debt crisis, which broke out in early 2010 upon mounting concern over the fiscal sustainability of several peripheral Eurozone economies, has re-intensified distinctly since the second quarter of 2011 and emerged as the biggest threat to the global economy and financial market stability. …

Being a small and highly externally-oriented economy, the Hong Kong economy will inevitably be affected by the vicissitudes on the external front through both the trade and financial channels.  The intensification of the Eurozone sovereign debt crisis since mid-2011 has … also led to a region-wide deceleration in exports and production activities in Asia … .  Against this background, the external environment has turned increasingly difficult and is expected to remain highly uncertain in the period ahead.”  

17. All these economic indicators, and, particularly, the quantitative easing efforts of major economies, suggest to me that the exceptionally low interest rate regime will continue to last for some time.  In the press release of the Financial Secretary’s Office dated 26 October 2012 in connection with the new measures to curb property speculation, which was widely reported, the Financial Secretary, Mr John Tsang, noted that the US Federal Reserve had extended its pledge to maintain exceptionally low interest rates at least until mid-2015.   

18. In his addendum to the joint report dated 15 December 2012, Professor Chan referred to a press release of the Board of Governors of the US Federal Reserve System dated 12 December 2012 and to the third quarterly bulletin of 2012 issued by the Bank of England and stated that these publications suggested that the low interest rate regime would be with us for quite a long time to come.  The following is a summary of the press release from the Board of Governors dated 12 December 2012:

“To support continued progress to its maximum employment and price stability, the Federal Open Market Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recoveries strengthen.  In its December 2012 statement, the Committee indicated that it currently anticipates that a target range for the federal funds rate of 0-¼% will be appropriate at least as long as the unemployment rate remains above 6-½% … “

19. 6.5% was the unemployment rate in October 2008, when the financial crisis occurred.  The latest statistics from the US show unemployment rates ranging from 7.8 to 7.9% in the last quarter of 2012, which is a marked improvement from the 10% unemployment rate that was recorded in October 2009. 

20. I shall return to this evidence at a later part of my judgment but I remind myself, as so sensibly put by Ms Sin, that, in reviewing this evidence, I must be careful to recognize that the past may be a poor indicator of future economic trends, particularly given the impact on those trends by the implementation of monetary and fiscal policies that are difficult to anticipate. 

Risk and Return

21. In Section 3 of the joint report, the experts examined and dealt with the concept of risk and return noting that, in general, the riskier the investment, the greater the investment returns that the investor expected for taking that risk.  That risk is measured by the historical standard deviation (volatility) of past returns.  Historical stock market performance of 16 major share markets from 1 January 1970 to 30 September 2012 showed the Hong Kong stock market as standing almost off the chart with a risk percentage per annum of 36%, signifying high-risk and return percentage per annum of 15%, signifying high return.  The historical equity and bond market performance over the period from 1995 to 2012 showed the Hong Kong Equity and Bond Indices carry a risk percentage of about 26% per annum against a return percentage of just under 8% per annum.

Investment Instruments in Hong Kong

22. In the next section of the joint report, the experts identified the investment vehicles available to Hong Kong investors, ranging from fairly standard types, such as bank deposits, bonds, stocks and properties to highly sophisticated vehicles.  For the purposes of the present case, the experts concentrated on 12-month time deposits, Hong Kong Exchange Fund papers and various constituent retirement scheme funds. 

23. Exchange Fund Notes (“EFNs”) have been issued under the Exchange Fund Ordinance, from the mid-1990s.  They are denominated in Hong Kong dollars, with interest payable semi-annually in arrears.  They are not available to US persons or residents of Canada.  EFNs can be traded in multiples of HKD50,000.  As of 24 September 2012, there were more than 100 registered dealers of EFNs in Hong Kong. 

24. The retirement scheme funds examined by the experts included MPF Funds and funds under the Occupational Retirement Scheme Ordinance (“ORSO Funds”).  As at 30 September 2012, there were 39 MPF schemes providing an aggregate of 443 constituent funds.  The law requires all MPF schemes to offer an MPF conservative fund which is essentially a money market fund that invests exclusively in Hong Kong-dollar assets either in short-term bank deposits or high quality debt securities.  In addition, many MPF schemes offer money market funds, guaranteed funds, bond funds, mixed assets funds, equity funds and index funds.  The MPF Authority has described the potential suitability of these funds as follows:

“MPF Conservative and Money Market Funds are suitable for conservative, risk adverse scheme members, especially those close to retirement or a low-risk bearers[5];

Guaranteed Funds are suitable for risk adverse scheme members, especially those close to retirement who are willing to abide by the guarantee conditions;

Bond Funds are suitable for moderately conservative scheme members with a low risk appetite, and those seeking a stable return over the medium-to-long term;

Mixed Asset Funds[6] are suitable for scheme members who wish to adjust the proportion of stocks to bonds in their portfolios at different life stages;

Equity Funds are suitable to young scheme members with a longer investment horizon and a higher risk tolerance level and other risk tolerant scheme members;

Index Funds track the volatility of the stock market that the funds replicate.”

25. ORSO schemes registered before the establishment of the MPF system that fulfilled certain conditions were exempted from MPF requirements.  Members could choose to remain in the existing scheme or join an MPF scheme.  As at 30 September 2012, there were 4,007 MPF-exempted ORSO schemes covering over 363,000 employees.  Overall performance of ORSO funds has been studied by Towers Watson’s Measurement of Investment Performance Survey (“MIP”) since 1983.  In addition, Towers Watson’s Managed Fund Report (“MFR”) surveys up-to-date performance of managed funds that are available to Hong Kong ORSO retirement schemes under different fund categories.  For comparison purposes, benchmark indices and information such as Hong Kong Hang Seng Index, Hong Kong Tracker Fund, Hong Kong Bond Index, HIBOR (Hong Kong Interbank Offer Rate), and rates of return of High Court Suitors’ Funds were also considered. Except for the Suitors’ Funds, these indices are local market benchmarks commonly used as reference.

Historical performance of various investment vehicles in Hong Kong   

26. It is right that the review extended from the MPF funds to the Measurement of Investment Performance Survey, commonly known as the MIP survey, compiled each quarter by Towers Watson, as that survey covers performance data of Hong Kong ORSO schemes with assets of some HKD16.3 billion, and also included the MFR which is designed to display and compare up-to-date characteristics of managed funds that are available to Hong Kong ORSO schemes under different fund categories.  Total assets covered under the MFR survey amount to HKD377 billion.  This is a very substantial amount given that total assets under all MPF schemes amount to HKD412 billion.  Total assets under the Tracker Fund, designed to provide investment returns that closely correspond to the performance of the Hang Seng Index, amount to HKD53 billion.

27. To calculate the real rate of return, net of price inflation, the experts tracked the changes in the Composite Consumer Price Index (‘CPI”) as the proxy for price inflation, as it covers approximately 90% of all households in Hong Kong.  When they repeated the same exercises with regard to payroll inflation, the experts used the nominal wage index as the proxy for payroll inflation, as it reflects the change in the cost of labour assuming normal hours of work and relates to a time-unit such as an hour, a day, a week or a month. 

28. It was common ground that the choice of investment vehicles and the period of time over which their performance was being reviewed were critical factors that would affect the net rate of return. In addition, the experts pointed out that the choice of the end date had a fairly significant effect on the results, which they demonstrated by contrasting the different returns, net of price inflation and before management fees, that were shown in Table 5.1 of the joint report, with the end date of 30 June 2012, as compared with Table 7.2.1, with an end date of 31 March 2012, and Table 7.2.2, with an end date of 31 December 2011.

Wage (or payroll) inflation 

29. The difference between the historical investment performance shown in Table 5.1 and in Table 5.3 is that the former showed the median real rate of return per annum, net of price inflation and before management fees, whilst the latter showed the same, net of wage inflation and before management fees. 

30. In §5.3.4 of their joint report, the experts stated:

“For the past 30 years or so, the wage inflation is normally above the price inflation in Hong Kong. The average differential is 1.1% per annum. For the period from 1995 to 2012, the average is 0.78% per year and for the recent period from 2001 to 2012, the average is 0.43% per annum.”

The differential between wage inflation and price inflation was shown in Table 5.2 which is reproduced here:

Table 5.2  Wage Inflation versus Price Inflation in Hong Kong

(in % per annum)

Year	Wage Inflation	Price Inflation	Differentials
1983	6.7	10.7	-4.0
1984	8.1	5.4	2.7
1985	6.2	3.1	3.1
1986	7.1	4.2	2.9
1987	9.8	7.4	2.4
1988	10.2	8.4	1.8
1989	15.7	10	5.7
1990	12.1	11.5	0.6
1991	10.0	9.8	0.2
1992	11.0	9.7	1.3
1993	10.2	9	1.2
1994	9.2	9.5	-0.3
1995	6.6	7.1	-0.5
1996	6.2	6.6	-0.4
1997	6.1	5.2	0.9
1998	1.2	-1.5	2.7
1999	-0.7	-4.1	3.4
2000	0.6	-2.0	2.6
2001	0.3	-3.5	3.8
2002	-0.9	-1.5	0.7
2003	-1.5	-1.9	0.3
2004	-1.1	0.3	-1.4
2005	1.6	1.3	0.2
2006	2.2	2.3	-0.1
2007	2.8	3.8	-1.0
2008	0.9	2.1	-1.2
2009	0.8	1.5	-0.7
2010	3.3	2.9	0.4
2011	9.3	5.7	3.6
2012*	2.1	1.7	0.5
		Average	1.1

 * Partial year through to 30 June 2012

31. There was a fairly substantial difference between wage and price inflation in the mid to late 80s when wage inflation outstripped the price inflation.  In 1989, the difference was 5.7%.  In the 1990s, there was hardly any difference between the two until the 1998 Asian crisis when price deflation produced a positive differential in favour of wage inflation.  Wage and price inflation kept pace with each other in the first decade of the new millennium until 2011 when minimum wage created a spike in wage inflation producing a differential of 3.6%.  The differential fell to a difference of 0.5% in 2012, in the partial year of 2012 through to 30 June 2012.  

32. The Court of Appeal in Chan Pui Ki v Leung On overturned the assessment by Cheung J, as he then was, of the discount rate which he arrived at by considering the evidence of investment returns of a number of pension funds of 258 companies that had been surveyed by Wyatt Co (Hong Kong) Ltd from 1983 to 1994.  On average, the strategy adopted for Hong Kong retirement schemes had been equity 66%, bonds 21% and cash 13%.  The median rated annualised return of the 258 companies was 15.9%.  For the reason that a disabled plaintiff requires regular income and hence drawing from the fund, whereas a pensioner does not draw until he retires, the trial judge formed the view that it would be more appropriate to structure the investment of the fund to 50% equity, 40% bonds and 10% cash.  The learned trial judge found that the investment return of such a fund would be 0.7% lower than that of the average pension fund and took the investment return to be 15.2%, from which he deducted payroll inflation, based on the evidence that had been adduced before him, of 12.5%, to produce a net discount rate of 2.7%.  

33. The evidence of the prevailing price inflation that was before the trial judge was that it was significantly lower than wage inflation, and ran at 8.1% per annum.  The Court of Appeal held that the trial judge had erred in deducting wage inflation, rather than price inflation, from the investment returns in excess of 15% per annum and that, if he had deducted price inflation from those investment returns, he would have arrived at a net rate of return that was comfortably above the assumed rate of return of 4 – 5% set out in Cookson v Knowles.  

34. In assessing the validity of the Cookson v Knowles assumption, I must deduct price inflation from investment returns to assess the real rate of return.  I must assess a multiplier based on that real rate of return to award damages for future expenditure.  Where, however, those future losses include not only the future cost of aids and equipment but also future loss of earnings and the future cost of care and attention, including nursing care, the argument made in Simon v Helmot, which succeeded before the Court of Appeal[7] and before the Privy Council[8], was that the court should assess different rates of return to assess multipliers for future losses that were not earnings related, and to assess earnings related elements of future losses.   

35. The evidence before the Guernsey Court in Simon v Helmot was that wage inflation exceeded price inflation by an average of 2% per annum.  Given the substantial difference between price and wage inflation, the Court of Appeal concluded that it would set two discount rates, one in respect of future losses which were not earnings related and for which the net rate of return would be set by deducting price inflation, and the other rate for earnings related losses for which the net rate of return would be set by deducting wage inflation.  The Privy Council upheld that decision and Lord Hope, giving the leading opinion, said at §§51 and 52: 

“51. Is it acceptable in principle for there to be different discount rates for different heads of loss? …

52. The answer to [this question] is to be found in the premise that the victim of a tort is entitled to be fully compensated.  If the evidence shows that inflation will affect different heads of loss in different ways and that the differential is capable of being evaluated, the court should not close its mind to using different rates.  To do that would risk giving the victim less than he is entitled to.”

36. I agree with the submissions of Mr James Dingemans QC, who appeared for the plaintiffs, that the decision of the Court of Appeal in Chan Pui Ki v Leung On is no bar to me setting different discount rates for earnings and non-earnings related losses where the evidence adduced before me warranted that conclusion.  The evidence that had been adduced before the Guernsey Court had been described by Sumption JA, sitting in the Court of Appeal, to constitute strong unchallenged evidence of both the existence of a gap between price and earnings inflation in Guernsey of the order of 2%, and the likelihood that, over time, it would persist.  In short, the point that there should be two discount rates, one for earnings related losses and the other non-earnings related losses, was never taken in Chan Pui Ki v Leung On[9] and, accordingly, the decision of the Court of Appeal is not binding on me in my determination of what is, effectively, a new point not taken before in Hong Kong.

37. However, the evidence before me of the difference between wage and price inflation in Hong Kong is very different from the difference prevailing in Guernsey.  The experts agreed that the difference is only to the order of 0.43% in the period from 2001-2012.  Further, it was the evidence of Ms Sin who, whilst accepting that, in a growing economy, wage inflation would outstrip price inflation, pointed out that Hong Kong’s GDP trend was declining and that the structure of Hong Kong’s economy was evolving, with little manufacturing and with most of the labour force being employed in the service sector.  However, to be fair to Ms Sin, she was also at pains to resist any attempt to predict future trends.  That reluctance is certainly in line with the sentiments expressed by Lord Oliver in Hodgson v Trapp[10], drawing attention to the “inherent unscientific” nature of the exercise and pointing out that “to assess the probabilities of future, political, economic and fiscal policies requires not the services of an actuary or an accountant but those of a profit”. As Lord Dyson noted in Simon v Helmot[11], no doubt, he would have excluded economists as well.  Lord Dyson went on to state that:

“113. … The law has never demanded precision in the assessment of future loss. By its very nature, it cannot be an exact science. The court must do its best on the available evidence. Given the evidence is pure speculation and without foundation and fact, the court will reject it. But if evidence as to likely future economic trends is firmly based on convincing historical data, the court may be able to make findings as to the future in which it has confidence to the appropriate standard of proof. In relation to evidence that is based on an assessment of future economic trends, the court will be especially cautious for all the reasons that have been expressed in previous authorities. But there is no reason in principle why such evidence cannot be accepted. Suppose that each year during the past 20 years, earnings have risen between 2% and 3% faster than prices and that the court is asked to assess future care costs of someone with a short life expectancy. There can be no justification for holding that, on these admittedly bare and rather crude facts, damages should be assessed using a discount rate based on [Retail Price Index] inflation. Such an assessment would be bound to lead to under-compensation. Ultimately, however, it is a question of assessing the quality of the evidence in any particular case.”

38. Given the structural changes that have occurred in our economy and, in particular, with the employment of our labour force, in my review of the historical data on the difference between wage inflation and price inflation, it is more appropriate, in my judgment, to have regard to the recent period from 2011 to 2012, showing an average differential of 0.43% per annum, than longer periods of time.  For the purposes of setting the discount rate, it is, of course, right, as Lord Hope remarked in Wells v Wells[12], to round up the figure to no greater degree of accuracy than half a decimal point, so that it would fit readily with the way that the multiplier can be calculated by reference to actuarial tables, which are now generally recognised to be admissible.  However, the rounding up exercise should not be conducted before the evidence is assessed to determine whether there was a significant difference between wage inflation and price inflation such that the court would be moved to set two discount rates, one for earnings related claims, and another one for non-earnings related claims.  

39. In my judgment, the difference of 0.43% is not significant enough for me to set two discount rates.  I find, having regard to current economic conditions, that the current small difference is likely to persist, at least in the near term.  However, this issue must be revisited if changes in the economy produce a difference between wage inflation and price inflation that approaches or exceeds 1%.

Management Fees

40. In making his opening submissions to me, Mr James Badenoch QC, who appeared for the defendants, was driven to take the point that the court should assess the net discount rate by deducting price inflation from the gross return before management fees were deducted.  He referred to the addendum produced by Ms Sin, showing median real rates of return per annum, net of price inflation before the deduction of management fees, of 4.7%, in respect of the historical investment performance for the 10-year period starting from 1 July 2002, of capital stable funds, under the Managed Fund Report, with an equity content of 30%, bond content of 60%, and cash of 10%, and relied on this data to support his submission that there was no basis for the plaintiffs to contend that the Cookson v Knowles assumption over 4.5% real rate of return was no longer valid in the Hong Kong context.  He could not rely on the evidence contained in Ms Sin’s addendum to support this submission, if the discount rate was to be assessed by having regard to the median real rate of return per annum, net of price inflation and after deducting management fees, because, on that basis, the table produced by Ms Sin for the same capital stable funds showed a median real return of 3.7% for that 10-year period. 

41. In support of his submission that I ought not to deduct management fees in arriving at the net discount rate, Mr Badenoch referred me to that part of the decision of the Court of Appeal in Chan Pui Ki where the court made an award in respect of the costs of investment and management advice[13]:

“The object of the lump sum award is to compensate the plaintiff, once and for all, for the lost income stream. But, to achieve that purpose, that sum must be wisely invested. This involves a fair degree of investment and management skills: skills which, by the nature of the head injuries sustained, the plaintiff is mostly unlikely to acquire. It is logical to make some allowance for this in the award, as the plaintiff will clearly need to pay for such advice.

The argument against making any award of this kind is that which found favour with Russell, J in Francis v Bostock (unreported, 8 November 1995): that once the award is made, the plaintiff, on attaining majority, is entitled to spend it as she wishes; the defendants should not be called upon to find further moneys to assist the plaintiff in the proper administration of the award which, in itself, affords adequate compensation.

It is that last proposition which is questionable. The reality is that the award, in the plaintiff’s hands, will not achieve its intended purpose – to compensate her for the lost income stream – unless it be wisely invested. The award for future loss of earnings is of a rather different nature from an award of general damages for non-pecuniary loss, in relation to which the argument in Francis v Bostock would be sound.

The judge erred in his approach (by deducting 1.5% from the discount rate) but was correct in determining that some award should be made.

Exercising the best judgment we can, we have come to the conclusion that a sum of $160,000 (in effect, approximately 10% of the fund to be managed) would have been appropriate under this head.  This too should carry interest at the judgment rate from 30 October 1995.”

42. However, that submission ignores what the Court of Appeal had said earlier[14], when it held that the trial judge had fallen into error by deducting the hypothetical costs of management and trustee fees of 1.5%, that “nothing in the evidence suggests that in the figures for the annualised returns on pension funds, administrative and other fees had not already been taken into account”.

43. In effect, the Court of Appeal concluded that the trial judge had erred by making a double deduction, and, thereby, impliedly concluded that it was, indeed, proper to make a deduction for the costs of management fees before arriving at the net discount rate.  Not only is this conclusion binding on me but it is entirely right, as recognised by the Law Lords in Wells v Wells.  In his speech[15], Lord Lloyd referred to the attempt by counsel for the plaintiff who sought to demonstrate that the real return on equities was little, if anything, above the return on Index-Linked Government Stock (“I.L.G.S.”), “especially if one takes into account the difference in the costs of investment advice, which might amount to as much as 1% per annum”.  Lord Lloyd did not suggest that it was wrong to take that into account when setting the discount rate.  In his speech, Lord Steyn[16] referred to the controversy between the parties about the real return on equities.  For his part, he was content:

“To approach the matter on the basis that a diversified portfolio of equities would yield over a substantial period a better return than index-linked government securities. But I am not satisfied that even on this basis, and ignoring the availability of index-linked government securities, a net rate as high as 4.5% was justified. Bearing in mind the surprisingly high costs of advice that would be need by a plaintiff to invest in a portfolio of equities, my view is that the Court of Appeal took a rather optimistic view.”

Clearly, Lord Steyn was of the view that the costs of advice must be deducted from the gross return in order to arrive at the net discount rate.

44. In his speech, Lord Clyde[17] stated:

“On this approach, the problem which was raised of the need to allow for the costs and charges involved in the management of an investment portfolio substantially disappears. There is certainly no likelihood of costs and charges being regularly involved on the scale which would probably apply to the management of a portfolio of equities. The assumption would be that the index-linked investment would be held to maturity. In relation to such investments, such costs and charges, as they would be, may for practical purposes be ignored.”

Clearly, the converse of what he was saying is that the costs of investment advice must be taken into account if the discount rate were to be set by reference to the returns of a portfolio of equities or a portfolio of bonds and equities.

45. Unlike the residents of the United Kingdom, or the residents of Guernsey, who have ready access to, and are able to acquire I.L.G.S., plaintiffs who receive an award of damages in Hong Kong must look to the investment vehicles available in Hong Kong into which to invest those damages in order to secure a stream of continuing income to satisfy their future needs.  Clearly, if I conclude that those investment vehicles ought to be 12-month time deposits and EFNs, there is no need to deduct management fees as there are none for these investment vehicles and instruments.  However, if I were to conclude that I must look to the performance of a mixed portfolio of bonds and equities, together with 12-month time deposits and EFNs, then that portion of the hypothetical award which would be invested in bonds and equities would attract management fees[18], and which must be deducted when I assess the net rate of return from such a mixed portfolio.

46. In the latter case, would there double recovery if the court selected a multiplier based on a discount rate that had been set after deducting the costs of managing a mixed portfolio of bonds and equities, and if the court also made a specific award in favour of the plaintiff, as the Court of Appeal did in Chan Pui Ki v Leung On, in respect of the cost of managing the investment of the damages he received in respect of his future losses?  As I am only charged with the exercise of reviewing the discount rate, I need not deal with this issue.  However, it appears to me that the current practice is not to make a specific award for the costs of fund management[19].

Historical investment performance in Hong Kong as of 30 June 2012

47. Having dealt with the issues of wage inflation and the deduction of management fees, I set out below Table 5.4 that was produced by the experts to show the median real rate of return, net of price inflation and after the deduction of management fees, in respect of various investment vehicles, as well as the real rate of return per annum, net of price inflation, in respect of various benchmarks.  Price inflation for the various periods under review is set out in the row of the table.

Global Investment Performance Standards (GIPS)

48. Before continuing this review, I must deal with the point raised by Mr Dingemans QC, very early on during the hearing, that it was not clear, from the joint report produced by the experts, whether the median real rate of return per annum, net of price inflation and after management fees, shown on Table 5.4 and indeed, the returns shown on the other tables, was the product of income that was also generated either by way of dividends from equities, or interest coupon payments on bonds, being reinvested, which would not be an acceptable comparable to be used to assess the discount rate for injured plaintiffs who had annual income needs.  This was a matter that had not been picked up by counsel for the plaintiff and his experts at the trial in Wells v Wells[20] and Mr Dingemans QC did not wish to be guilty of the same error.

49. The matter was dealt with by Ms Sin who had specific knowledge of Global Investment Performance Standards, generally known as GIPS.  It was her evidence, which I accept, that large cashflows at ups and downs of the investment vehicle will produce performance differences. Because the object was to compare performance of different asset classes and vehicles, the only way to compare them properly is to make sure that the comparison is like for like, without any influence of cashflows.  The object of GIPS is to strip out the impact of cashflows and to produce a return free from the impact of cashflows.  Table 5.4 and the other tables were produced from Hong Kong Government published data and the unrivalled insight to be obtained from a review of the historical data in the possession of Towers Watson.  These tables constituted the best and most reliable evidence of historical rate of return of various asset classes and vehicle combinations.  These tables had been formatted to comply with the direction given by the court to produce real rates of return of various investment vehicles and combinations of investment vehicles over different periods of time.

50. The calculation of unit value observes accrual accounting and, as stated in the publication on GIPS, interest income earned but not yet received must be included in the value of fixed-income securities, and all other assets that accrued interest income, and, with respect to dividend-paying equities, GIPS recommended that dividends be accrued as of the ex-dividend date.  The same publication provided a formula for the simplest case in which no external cashflows occurred during the period (i.e. no client-initiated additions to, or withdrawals from, invested assets occurred). This formula assumed that income received remained in the portfolio, expressed return as the ratio of the change in fair value during the period to the fair value at the start of the period, and produced an accurate representation of investment results in a single period with no external cashflows.

51. However, because most portfolios had external cashflows, GIPS required the use of time-weighted rates of return, or approximations of time-weighted rates of return, to eliminate the impact of external cashflows on the return calculation.  The publication on GIPS that was produced explained how this is done by reliance on a formula which was the most accurate way to calculate a total return over a measurement period in which external cashflows occurred.  This was done by valuing the portfolio whenever an external cashflow occurred, compute a sub-period return, and geometrically chain-link sub-period returns expressed in relative form according to the stated formula.  Ms Sin explained that any payout from the fund or investment vehicle would trigger a re-calculation of the portfolio in accordance with this formula.  The use of the formula eliminated the impact of the cashflows on the return produced by the investment at the end of the stated period.

52. I am satisfied by this evidence, which I accept, that the problem that had occurred in Wells v Wells, where the returns had been calculated on the assumption that all income remained re-invested, has been eliminated in the present case by the use of the time-weighted rates of return under GIPS to produce the median rates of return shown on Table 5.4.

High – Median – Low Charts

53. In addition to producing Table 5.4, the experts performed a risk and return analysis and produced graphs showing the high-median- low charts for 12-month time deposits and EFNs as well as high-median-low charts for MPF, MFR and MIP funds.  Because 12-month time deposits and EFNs always had positive nominal rates of return, so that their behaviour did not follow a bell-shape curve, normal high-median-low charts based on calculations of standard deviation would not be valid for them.  To overcome these difficulties, the experts produced empirical high-median-low charts sorting out the return from worst to best, the median performer being estimated by the 50^th percentile of historical data, the high performer by the 83^rd percentile, and the low performer by the 17^th percentile.  The returns from the various funds being reviewed were sorted in descending order and ranked in percentiles, the top and bottom 5^th percentiles being eliminated as outliers, with the high referring to the 95^th percentile, the low referring to the 5^th percentile, and the median being the middle position of all returns.  These charts, Figure 5.3A, 5.3B and 5.3C, from the joint report are reproduced below, together with their accompanying notes.

Figure 5.3A: High-Median-Low Charts of various investment vehicles (net of price inflation, after management fees*) for the period 1 January 2001 to 30 June 2012.

Panel A: 12-month Time Deposit and Exchange Fund Notes (10-Year)

*Note: There is no management fees for time-deposit and EFNs

Given that there is no management fees for Time-Deposits and Exchange Fund Notes, this chart is identical to figure 5.1A.

Both the 12-month Time Deposits and the 10-year Exchange Fund Notes delivered positive performance. The 17^th percentile of the 12-month Time Deposits lies marginally at 0%.

Figure 5.3B High-Median-Low Charts of various investment vehicles (net of price inflation, after management fees) for the period 1 January 2001 to 30 June 2012.

Panel B: MPF Funds

This chart shows the performance of various investment vehicles net of price inflation, and after management fees.

Compared to Figure 5.1B where returns are before management fees, the chart shown above has lower returns. The MPF Global Equity Funds, MPF Hong Kong Dollar Money Market Funds, MPF Conservative Funds all experienced negative medians over the indicated period.

Figure 5.3C High-Median-Low Charts of various investment vehicles (net of price inflation, after management fees) for the period 1 January 1996 to 30 June 2012.

Panel C: ORSO Funds

Note: Diagrams in Panel A, Panel B and Panel C of Figure 5.3 are constructed using different methodologies and/or data coverage periods. Therefore, these High-Median-Low charts are only comparable within each Panel.

Please note that the MFR Stable Growth Funds were incepted in 1997, therefore this category is not included in the graph above.

The median, 95^th and 5^th percentile of all funds were in the positive region, with the MFR HK Equity Funds delivering the highest median in the graph above. Again, the largest deviation from the median can be found in funds that have higher equity content. Bonds and Money Market Funds have a relatively narrow range. 

54. As can be seen from Panel B of Figure 5.2, the MPF Global Equity Funds, MPF Hong Kong Dollar Market Funds, MPF Conservative Funds, all experienced negative medians over the indicated period.  The largest deviation from the median could be found in funds that had higher equity content.  Bonds and Money Market Funds had a relatively narrow range.

Historical investment performance in Hong Kong as of 30 June 2012: Table 5.4

55. Returning to Table 5.4, one can see that the first column showing the performance for the period of one year from 1 July 2011 to 30 June 2012 showed negative returns in respect of all investment vehicles, and in respect of all benchmarks, except for the Hong Kong Bond Index which showed a growth net of price inflation of 0.8.  For the period of 3 years from 1 July 2009, real rates of return in excess of 4.5% was only achieved by the MFR Global Equity Funds at 4.7% and by MSCI Hong Kong[21].  The returns from other investments were less than 4.5%, many returning negative returns including MPF Hong Kong Equity, MPF Hong Kong Dollar Bond and Money Market Funds including MFR Money Market Funds.

56. The picture worsens for the five-year period from 1 July 2007, which, of course, was the result of the financial crisis that occurred in October 2008.  Positive returns were only shown for MPF Global Bond, MPF Hong Kong Dollar Bond, MFR Global Bond Funds, which was the best performer at a positive 2.7%, and the Hong Kong Bond Index, which showed a positive return of 2.3%.  A review of the performance over a period of 7 years showed an improvement of returns, some returns being close to above the 4.5% net rate, namely, MPF Hong Kong Equity at 4.2%, MFR Hong Kong Equity Funds at 6.2%, Tracker Fund at 4.8%, the Hang Seng Index at 5%, and the MSCI Hong Kong at 4.6%.  Many returns remained negative although some other returns from other funds were marginally positive.  There was a general improvement across the board in the real rate of return when the period of 10 years and 12 years was considered.

The nature of the portfolio mix

57. In the next section of the joint report, the experts expressed their individual opinions on the nature of the portfolio mix appropriate to the victim of a tort, Professor Chan emphasising the lower risk tolerance of an injured plaintiff and identifying various low-risk financial instruments such as iBonds, EFNs, US Treasury Inflation Protected Securities (“TIPS”) and 12-month Hong Kong Dollar time deposits.  On the other hand, Ms Sin emphasised that the asset-liability matching approach as a financial management strategy could help to draw a frame of reference that the court could use to formulate a reasonable judgment on a suitable discount rate, having regard to the characteristics of different investment vehicles, examining their real net rate of return and past and current economic conditions with implications for future economic developments.  Goals of investing the awarded sum ought to include a generation of sufficient growth within the investment vehicle chosen to minimise the probability that payments would be exhausted pre-maturely; achieving an investment return that would preserve the long-term purchasing power promised by the compensation during the payment period; reducing the risk of market volatility while still being able to enjoy inflation protection plus growth benefits.  With these requirements in mind, she recommended that a moderately conservative investment risk profile would be the most compatible and could be achieved by investing in a portfolio composed of mixed bond and equity holdings in various proportions, with fixed term deposits to take care of emerging cashflow needs.

58. Because of the similarities between managing lump sum compensation and managing a pension fund, she had regard to a recently conducted internal survey by Towers Watson amongst its pension clients to see how corporate pension sponsors funded their pension liabilities.  This survey revealed that the actuaries used the discount rate that generally ranged from 4% to 6% per annum to discount projected benefit payments, with the assumption for salary ranging from 3% to 5% to project future salary levels at retirement.  The survey showed the spread between the assumed discount rate and assumed salary inflation rate ranged from 1 to 2%; this spread was equivalent to a real discount rate, net of salary inflation.  The net discount rate, net of price inflation, was assumed to range from 2 to 3%.  Ms Sin went on to note that in countries with more developed pension markets, the practice on funding pensions tended to be more elaborate and that their funds generally adopted two discount rates – one for the near term to reflect the immediate market trend (using 3 to 5 years) and the second for the mid to long term to reflect the normative long-term trend (5 to 15 years).

Areas on which the experts agreed

59. There was a substantial amount of agreement between the experts.

60. In relation to time horizon, they agreed that given the cyclical nature of the capital markets and the highly unusual events with significant global economic impact in the past two decades, it was important to focus on return statistics over an extended time period.  They also noted that in addition to the need to observe trends over an extended period, consequences from extreme events might unduly distort returns statistics.

61. They also agreed that the annuity markets were very under-developed in Hong Kong and in Asia (except for Japan), and that claimants in Hong Kong would not be able to use commercial annuity products to help them in investment management in the near future.     

62. They also agreed, judging from the historical net return on the Suitors’ Funds, that it was an unsuitable vehicle in which to invest claimants’ compensation.  The historical return from the Suitors’ Fund, which can be seen in Table 5.4, was described by Ms Sin as being “measly”[22].  The reason for these low returns is that 97% of the Suitor’s Funds are deposited into short term commercial bank deposits and rightly so, given the substantial cashflows into and out of the funds[23] that largely comprise of sanctioned payments paid into court and ordered to be paid out.  Damages awarded in favour of infants and mentally impaired persons that remain in the Suitors’ Funds are often paid out, as directed by and with the approval of the Mental Health Judge, to be invested by the Committee appointed under the provisions of the Mental Health Ordinance.

Areas upon which the experts disagreed

63. The main area of disagreement between the experts was in relation to the choice of investment vehicles and the time period of the historical review, Professor Chan pointing out that it was inappropriate to include any equity element in managing the lump sum compensation and that, as decided in Wells v Wells, a determination of the discount rate ought to use historical data for a 3-year period, whilst Ms Yvonne Sin pointed out that the investment vehicles identified by Professor Chan could not be classified as long-term investment vehicles that could provide either proper inflation protection or growth.

Call-over hearing

64. Having reviewed the joint report, I directed the parties, at the call-over hearing which occurred on 3 December 2012, to ask their respective expert to prepare an addendum to the joint report in which they ought to set out their opinion on the investment vehicle, and combinations of investment vehicles, into which a reasonable victim of a tort ought to invest his or her award of damages for future losses, the reasons why the reasonable victim of a tort ought to do so, and what the chosen investment vehicle or combinations of vehicles would produce, in terms of the net rate of return, for the various historical periods that had been identified. 

Addenda to Joint Expert Report  

65. Consequent to this direction, Professor Chan prepared an addendum dated 15 December 2012 and Ms Sin prepared her addendum dated 19 December 2012.  In his addendum, Professor Chan said, quite bluntly, that based on the historical investment data in the joint report, it was not reasonably possible for a claimant to achieve a rate of return of 4.5% after inflation unless he deviated from prudent investment strategies and took substantial equity risks over a very long period, and that, having regard to economic developments from 1995 up to the present time, in his opinion, the current discount rate of 4.5% per annum, after inflation as was applied by the courts to award damages in Hong Kong, bore little relationship to reality.  In his opinion, the only prudent investment strategy suitable for a disabled claimant was investment in a combination of very low risk instruments which he identified to be iBonds, EFNs, TIPS and 12-month Hong Kong Dollar time deposit.  However, he took on board the observations of Ms Sin that TIPS was unsuitable because of inflation differentials between Hong Kong and the US. Professor Chan had suggested TIPS as a possible investment vehicle in the joint report on the basis that the principal was tied to US Consumer Price Index and increased with inflation or decreased with deflation and that, on maturity, the US Treasury paid the original or adjusted principal, whichever was greater.  As interest was payable on the adjusted principal, interest payments rose with inflation and fell with deflation.  Although Professor Chan had also identified iBonds issued by the Hong Kong Government as a possible investment vehicle in the joint report, he excluded them in his addendum because the iBond market in Hong Kong was still in its infancy stage.  The iBond was similar to I.L.G.S. in that the interest was adjusted in accordance with inflation, with the minimum return set at 1%.  However, unlike I.L.G.S., the principal would be repaid in full on maturity without adjustment based on inflation.     

66. Professor Chan expressed the opinion, in his addendum, that the combination with 30% in 12-month Hong Kong Dollar time deposits and 70% in Hong Kong EFNs best served the needs of a plaintiff.  The choice of 30% was to ensure adequate liquidity.  Investment of 70% on EFNs offered extra returns without sacrificing the prudent investment principle.  He produced a table (A1) in his addendum displaying net rates of return of the recommended combination of vehicles in Hong Kong for the various historical periods[24]. Although the House of Lords in Wells v Wells had decided that the determination of discount rate ought to use historical data for a 3-year period, in view of the recent global financial crisis and the waves of quantitative easing, it was his opinion that it was prudent to look at a longer period, of 5 to 7 years of Hong Kong historical data, as the basis for creating a discount rate for the future.  Using this period, he calculated a net rate of return, net of price inflation, of -0.5% per annum. 

67. Professor Chan concluded his addendum with the observation that there were pros and cons of the current single standard rate, i.e. one rate for all approach versus the approach of varying rates, varying with the time horizon of say, 5, 10, 15, 20 and more years.  The standard rate approach was simple and easy to use with the actuarial tables for computing multipliers.  However, the varying rate approach provided flexibility to accommodate plaintiffs with different remaining life expectancies.  On the issue of future reviews, he quoted from an academic article, of which he was a co-author, published in Law, Probability and Risk 2003 in which it was stated:

“The economic and population landscapes in Hong Kong are ever-changing. Accordingly, the factors and driving forces shaping the appropriate discount rate in Hong Kong are also changing in a dynamic way. As a result, the discount rate for personal injury and fatal accident cases needs to be carefully revised from time to time. Although making the discount rate fluctuate unpredictably, like a share price index, is neither realistic nor desirable, it is prudent for the Hong Kong Judiciary to take steps to monitor the discount rate, at least on an annual or biennial basis. The Chief Justice of Hong Kong should seriously consider setting out a Working Party consisting of judges, lawyers, actuaries and economists. The Working Party will play an active advisory role in reviewing the appropriate discount rate. After consultation, the Chief Justice can keep the members of the legal profession posted on the latest discount rate by means of Practice Directions.”

68. In her addendum dated 19 December 2012, Ms Sin first dealt with the portfolio mix that had been considered by the Court of Appeal in Chan Pui Ki v Leung On.  She quoted from the judgment of Litton VP[25] in which he had stated that “a portfolio which is structured 66% equity, 21% bonds and 13% cash today does not necessarily mean it will always be so” and she confirmed that this 66/21/13 structure mentioned in the judgment was not a static portfolio but an average asset mix over a specified period of time.  She produced a table presenting the historical equities/bonds/cash asset mix from the MIP survey conducted by Towers Watson (previously Watson Wyatt) of Hong Kong ORSO retirement funds since 1 January 1983 which had been the point of reference in Chan Pui Ki v. Leung On and this showed fairly significant shifts in the mix among the three asset types from quarter to quarter.  Such variations might be the result of active decisions by fund managers.  The average equity content of this mix was as low as 44%, and as high as 83%, with an average of 66% for the period from 1983 to December 1994, the period covered in the review that was adduced before the courts in Chan Pui Ki v Leung On, and an average of 70% from 1983 up till June 2012.  Ms Sin did not recommend this portfolio mix, and rightly so, as Table A2 in her addendum showed that these funds exhibited volatility and performed poorly over the one-year, and five-year periods, although their performance over a longer time horizon was more stable and positive.  In her opinion, a structured portfolio composed of mixed assets, a combination of equities, bonds and cash, provided the moderately conservative risk profile suitable for injured plaintiffs.  MPF schemes with mixed asset funds with 20% to 40% in equity showed a median real rate of return, net of price inflation and after deducting management fees, of 2.8% for the 10-year period from 1 July 2002 (although the returns were negative for periods of 5 years or less).  The MFR Capital Stable Funds, with the 30% equity exposure on average, was also considered moderately conservative and showed a median real return rate per annum, net of price inflation and after deducting management fees, of 3.1% for the 12-year period from 1 July 2000, and 3.7% for the 10-year period from 1 July 2002 (but negative returns for periods of 5 years or less).

69. She noted that the investment time horizon played an important role in setting return objectives and defining liquidity constraints and that, under current market conditions, the inherent volatility associated with equities would likely generate less favourable returns over shorter time horizons (usually 3 to 5 years), especially in a down market. Hence, depending upon the particular context, investors seeking short term stability might consider investment in equities to be sub-optimal for their purpose.  In such a case, the likely portfolio proxy might simply be that of a bond fund.  However, an investor seeking long-term growth (taking that for present purposes as being 10 years or longer) without anticipating any sudden need to liquidate the total portfolio for emergencies (such as the case of a reasonable victim of a tort with a pre-determined regular income stream) might reasonably be expected to participate in the growth of the equity market. Without some equity exposure, the investor/victim ran the risk of not generating sufficient returns to catch up with inflation and of pre-maturely exhausting the funds.  She concluded her addendum by noting that while research and behavioural finance and financial modelling technology had advanced since the decision of the House of Lords in Hodgson v Trapp in 1989, forecasting a change in the future discount rate would be more speculative than scientific.  On the other hand, in highly volatile financial markets, it would be imprudent to rely on a retrospective approach for determining future discount rates. 

The oral evidence of the experts

70. Both experts are to be commended for the assistance that they rendered to me and for attempting to answer the very difficult questions thrown up in this case.  In the absence of I.L.G.S. in Hong Kong, the critical question was what combination of investment vehicles would be appropriate for the needs of a victim of a tort.  Equally critical was the question regarding the proper period of the time over which the performance of the chosen vehicles ought to be reviewed in the attempt to assess the appropriate discount rate. 

71. Although both experts maintained their opinions on the investment vehicles that they considered proper for the victim of a tort, both experts also readily conceded that victims with shorter future needs should have a different combination than victims with longer needs.  Professor Chan also revised the liquidity needs of victims with various periods of future need and produced an expanded version of Table A1 which I reproduce below in respect of the real rate of return per annum, net of price inflation[26].  Professor Chan’s evidence was that a combination of 20% in 12-month time deposit and 80% in EFNs was suitable for a victim for future needs not exceeding 5 years, a combination of 15% in time deposits and 85% EFNs was suitable for a victim with needs of 10 years or under, and a combination of 10% time deposits and 90% EFNs was suitable for a victim with needs in excess of 10 years.  Professor Chan’s chosen period of 5 to 7 years, as the appropriate period of review, produced a net discount rate of -0.5% for all 3 classes of victims.

72. Ms Sin went so far as to say that victim of a tort with future needs of only 5 years should invest his award of damages entirely in fixed term deposits so as to avoid short-term volatility in the bond market.  Victims of torts with needs over a longer period of time of up to 10 years should keep 20% in bank deposits, 80% in bonds, and up to 20% in equity.  For victims with needs extending beyond 10 years, the equity component could increase such that a suggested mix of 10% cash, 60% bonds, 30% equity would be appropriate for a victim with future needs spanning over a period of 15 years.

The needs of a victim of a tort

73. In Chan Pui Ki v Leung On, the Cookson v Knowles assumption of a net rate of return of 4.5% per annum was measured against the MIP survey conducted by Watson Wyatt for Hong Kong ORSO Retirement Funds from 1983 to 31 December 1994.  The average asset proportions of the funds surveyed was 66% equities, 21% bonds and 13% cash.  It had not been contended that such an investment mix was unsuitable for the victim of a tort. Nor had the Court of Appeal concluded that such an asset mix of 66% equities, 21% bonds and 13% cash would be suitable for victims of a tort.  Indeed, as noted above, it was stated in the judgment of the court that “a portfolio which is structured 66% equity, 21% bonds and 13% cash today does not necessarily mean it would always be so”.  Therefore, I consider that I am not bound by higher authority on the question of what investment vehicle or combinations of investment vehicles would be suitable for victims of torts.

74. That question was asked, and answered, by the House of Lords in Wells v. Wells.  As Lord Hope noted in Simon v Helmot[27], the investment scene had radically altered when Wells v Wells was decided.  The breakthrough had come with the introduction of Index-Linked Government Securities (“I.L.G.S.”) and the appreciation that there was at last a tool that could be used to provide protection against inflation, that was tailor-made for investors who wanted a safe investment for the long term, and that guaranteed the availability of money to meet costs as and when required. However, there were no I.L.G.S. available in Hong Kong in 1995 and 1996, when Chan Pui Ki v Leung On was decided, and there are no I.L.G.S. available in Hong Kong today.  If I may borrow from, and paraphrase, the speech of Lord Hope in Simon v Helmot[28], the solution today in Hong Kong is still dependent on surmise and speculation, as it was when the issue was being discussed in the UK 3 decades ago.

75. The starting point must, of course, be the needs of the victim of the tort.  What the actual plaintiff does with his award of damages is, of course, irrelevant.  He may choose to invest it, he may choose to spend it, or he may even choose to gamble it away.  It is the personal choice of the actual plaintiff to invest his award of damages for future loss in a vehicle promising higher returns but, of course, he would do so at higher risk to himself.  However, as Lord Clyde observed in Wells v Wells[29]:

“Whether he is proposing to invest it or spend it, or, more particularly, exactly how he is going to invest it or spend it, does not affect the calculation of the award. No distinction is recognized here between misers and spendthrifts. While it may be evident that there are certain ways in which he could prudently invest the award in other ways in which he could be impairing his own future comfort by his employment of the award, the quantification of the sum to which he is entitled in compensation takes no account of the course which he may in the event choose to adopt.[30]”.

One needs to ask how the hypothetical reasonable plaintiff who is mindful of his current, short-term, and long-term needs will invest and otherwise deal with his award to meet those needs. 

76. In reviewing the authorities on this issue, the starting point must be the judgment of Lord Scarman in Lim Poh Choo v Camden & Islington Area Health Authority[31]:

“… The victims of tort who receive a lump sum award are entitled to no better protection against inflation than others who have to rely on capital for their future support. To attempt such protection would be to put them in a privileged position at the expense of the tortfeasor, and so to impose upon him an excessive burden, which might go far beyond compensation for loss.”

However, that statement must be understood in the context of the Cookson v Knowles solution to the problem of future inflation, namely that it “is taken care of in a rough and ready way” by rates of interest which were 4 to 5% higher than the prevailing rate of inflation.  The return from gilts[32] was ample protection for the plaintiff.

77. It is also instructive to have regard to the observations of Lord Salmon in Cookson v Knowles who said[33]:

“There is one matter that I should like to emphasis, namely that in my view, it is impossible to lay down any principles of law which will govern the assessment of damages for all time. We can only lay down broad guidelines for assessing damages in cases where the facts are similar to those of the instant case and where economic factors remain similar to those now prevailing. For example, it was at one time regarded as axiomatic that, in assessing damages in cases of death, for loss of earnings, or maintenance, it could safely be assumed that if a substantial part of the sum awarded was invested in equities, the plaintiff would be amply protected against inflation because this would be balanced by the rise in equities which would automatically follow inflation. This theory which was regarded by most financial experts as being beyond doubt is now exploded. But it has not made much difference because sums awarded as damages, if invested in Gilts, now produce interest up to the rate of 14% a year[34]. And so, although in assessing damages, the courts still use about the same multiplicand and multiplier as formerly, the result, by chance, is much the same. Just as the price of equity ceased to keep pace with inflation so, one day, may the interest rates of Gilts. I entirely agree with Lord Reid when he said in Taylor v O’Connor [1971] AC 115, 130A that in assessing damages, it would “be quite unrealistic to refuse to take [inflation] into account at all”.

78. That prophetic observation had become fact.  The interest on gilts had fallen with the extent that it could not produce a net rate of return in the UK, net of tax and net of inflation, of 4.5% per annum. It was against the different economic conditions prevailing at the time of the decision of the House of Lords in Wells v Wells, in July 1998, that the observations of their Law Lords on the needs of a victim of a tort, who is a risk-adverse investor entitled to protection against inflation without exposure to undue investment risks, is to be understood. 

Lord Lloyd stated[35]:

“Granted that a substantial proportion of equities is the best long-term investment for the ordinary prudent investor, the question is whether the same is true for these plaintiffs. …

The plaintiffs are not in the same happy position … in the sense that they can wait for long-term recovery, …

So it does not follow that a prudent investment for the ordinary investor is a prudent investment for the plaintiffs. Equities may well prove the best long-term investment. But their volatility over the short term creates a serious risk. …

… What the prudent plaintiff needs is an investment which will bring him the income he requires without the risks inherent in the equity market; which brings us back to I.L.G.S..”

Lord Steyn stated[36]:

“Typically, by investing in equities an ordinary investor takes a calculated risk which he can bear in order to improve his financial position. On the other hand, the typical plaintiff requires the return from an award of damages to provide the necessities of life. For such a plaintiff it is not possible to cut back on medical and nursing care as well as other essential services. His objective must be to ensure that the damages awarded do not run out. It is money that he cannot afford to lose. The ordinary investor does not have these concerns. It is therefore unrealistic to treat such a plaintiff as an ordinary investor. It seems to me entirely reasonable for such a plaintiff to be cautious and conservative. He does not have the freedom of choice available to the ordinary investor. If a comparison is to be made – and in this field all comparisons are inexact – the position of plaintiffs is much closer to that of elderly, retired individuals who have limited savings which they want to invest safely to provide for their declining years[37]. Such individuals would generally not invest in equities. But for plaintiffs the need for safety may often be more compelling.”

Lord Hope stated[38]:

“There is much to be said for the view that a better return can be obtained by the ordinary investor who invests his money in equities. But the rises and falls in the market value of equities are unpredictable both as to their timing and to their amount. … the plaintiff who is receiving the amount of his future loss in the form of a lump sum is not an ordinary investor. … in his case the only form of investment which could be described as a prudent investment is one which will as nearly as possible guarantee the availability of the money as and when it is required. He cannot afford to wait until the market moves in his favour, or to sustain the loss of capital which would result if he were forced to sell at a price which did not match the inflation rate.”

Lord Clyde stated[39]:

“The question is not one of asking what the ordinary investor would do but rather what form of investment will most nearly secure the notional annuity able to meet these hypothetical requirements. … the exercise is not concerned with an ordinary investor nor, indeed, … with any intentions of the particular plaintiff. Thus the general duty on a plaintiff to minimise his or her loss is not relevant … It does not extend to the way in which he or she may dispose of the award.

… [the calculation of] the appropriate capital sum … depends upon the choice of investment to be adopted.  Here one can look to the markets for a solution.  Between the rival suggestions put forward in the present appeals, namely investing in equities or investment in index-linked government stocks, it seems to me plain that the latter are the preferred choice.  The problem which has been of concern in past years of meeting the risk of inflation, a problem which cannot reasonably be wholly disregarded for the future, is substantially met by the nature of an index-linked investment.”

Lord Hutton stated[40]:

“I consider that the introduction of I.L.G.S. … has changed the problem which Lord Scarman was addressing in Lim’s case … the plaintiffs in the present cases are not in the same position as other persons who have to rely on capital for future support. Unlike the great majority of persons who invest their capital, it is vital for the plaintiffs that they receive constant and costly nursing care … and any fall in income or depreciation in the capital value of their investments willaffect them much more severely than persons in better health who depend on their investments for support. …

… I consider that a plaintiff who decides to invest his damages in I.L.G..S. by reason of the reduced risk could not be said to be investing in a manner which was imprudent or unreasonable.”

79. These observations echo the observations of the U.S Supreme Court in Jones & Laughlin Steel Corp. v Pfeifer[41]that:

“The discount rate should be based on the rate of interest that would be earned on “the best and safest investments”.  Once it is assumed that the injured worker would definitely have worked for a specific term of years, he is entitled to a risk-free stream of future income to replace his lost wages; therefore, the discount rate should not reflect the market’s premium for investors who are willing to accept some risk of default.”

80. More specifically, Lord Steyn noted[42] that the Working Party chaired by Lord Ogden QC had “observed that whereas in the past, the plaintiff had to speculate by investing in equities, or in a basket of equities and gilts or a selection of unit trusts, he needs speculate no longer if he buys index-linked government stock.  After in-depth research, the Law Commission took a similar view… This is the changed landscape in which three trial judges felt free to depart from the conventional rate of 4 to 5 percent…”.   

81. It may not be helpful to classify exactly where the victim of a tort belongs in a world of disparate investors with different needs and objectives.  The investment choices of each class of investor are driven by those needs and objectives.  What are the needs of a victim of a tort who receives a lump sum to cover his future expenses?  Those needs must include 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 the capital preservation of the lump sum award and, finally, the need to ensure its growth to fend against inflation.

How does a prudent plaintiff invest to meet these needs? 

82. Given current economic conditions, the investment choices of the reasonable victim of a tort must be driven by the duration of his future needs. A plaintiff with long term needs will not invest all his damages into short term bank deposits whilst a plaintiff with short term needs will not invest all his damages into long term bonds.

Plaintiffs with future needs of 5 years or less  

83. There was much common ground between the experts on the investment choices of a plaintiff with needs not exceeding 5 years.  It is the opinion of Professor Chan that such a plaintiff ought to deposit 20% of his damages for future loss in 12-month time deposits and that he should invest the balance in EFNs.  Ms Sin went so far as to say that he or she should put the entire award in 12-month time deposits.

Plaintiffs with future needs not exceeding 10 years

84. The experts started to have divergent views when they considered the investment options of a victim of a tort with needs not exceeding 10 years.  Professor Chan varied his mix of 12-month time deposits and EFNs to allow for 15% of the award to be invested in 12-month time deposits and the balance 85% in EFNs.  Ms Sin varied her mix to 20% in cash, 60% in bonds, including EFNs, and 20% in equity.

Plaintiffs with future needs exceeding 10 years

85. Professor Chan again varied his mix of 12-month time deposits and EFNs for plaintiffs in this category and proposed a mix of 10% in 12-month time deposits with 90% in EFNs.  Ms Sin also reduced the cash element to 10% but she also reduced the bond element (including EFNs) and increased the equity element suggesting that, for a plaintiff with needs extending to some 15 years, a mix of 10% in cash, 60% in bonds and 30% in equities was appropriate, and that the equity element could increase to as much as 40% for plaintiffs with needs exceeding 20 years.

Cookson v Knowles assumption no longer valid in Hong Kong

86. It was clear, when the evidence from the experts was concluded, and even taking the defendants’ case at their best, that the Cookson v Knowles assumption of a net rate of return of 4.5% per annum was no longer valid in Hong Kong, as Mr Badenock QC so very fairly and very properly conceded.  In determining the new discount rate to be applied here, the critical questions were the constituents of the portfolio that a prudent plaintiff should invest in, and the period of review of the historical performance of such a portfolio. 

Equity v Bonds (including EFNs)

87. We come to the heart of the dispute in these proceedings.  Notwithstanding Lord Salmon’s statement in Cookson v Knowles[43], that the theory, that if a substantial part of the sum awarded was invested in equities, the plaintiff would be amply protected against inflation because this would be balanced by the rise in equities which would automatically follow inflation, is “now exploded”, the point was not taken, either at trial or in the Court of Appeal, in Chan Pui Ki v Leung On that equities should be removed from the equation.  The trial judge found[44]:

“On average, the strategy adopted for Hong Kong retirement scheme has been equity 66%, bonds 21%, cash 13%. Because a disabled plaintiff requires regular income and hence drawing from the funds, whereas a pensioner does not draw until he retires, and most pension funds are receiving more in contribution than they are paying out as pensions, it would be more appropriate in the present case to structure the investment of the fund to be awarded in this case as follows: 50% equity, 40% bonds and 10% cash. Because of the altered composition of such a fund, it would result in an investment return of 0.7%, lower than that of the average pension fund.”

88. The Court of Appeal was critical of the trial judge and found that the 0.7% reduction by him was highly artificial.  Although it was predicated upon an investment profile different from that of the “average investment scheme”, having equity 66%, bond 21% and cash 13%, it did not follow that the reduction in the portfolio of equities by 16%, an increase in bonds by 19%, and a decrease of cash by 3% must necessarily have resulted in a diminution of the overall yield by 0.7%[45]. The Court of Appeal also noted[46] that there could be a switching of assets, as investment decisions were made from time to time, and that a portfolio which was structured 66% equity, 21% bonds and 13% cash, did not necessarily mean it would always be so.  The important point to note from that decision is that, given the absence of I.L.G.S. in Hong Kong, the Court of Appeal was not critical of an investment portfolio with a substantial investment in equities.

89. Notwithstanding the observations of Lord Salmon in Cookson v. Knowles[47], in May 1978, that the theory regarding equities had “now exploded”, equities were once again accepted as an investment vehicle for prudent plaintiffs[48].  In the 16^th edition of Macgregor on Damages[49], the author stated: 

“The 4.5 per cent rate was considered to be the rate appropriate for a stable currency and therefore adequate to protect against inflation, however severe. If, the thinking went, the plaintiff were to put the damages awarded into gilts or another form of investment generating fixed interest, the high rate of interest he would obtain in inflationary times should be in advance of inflation, hopefully by about 4.5 per cent; if he invested in equities, while his dividends might not exceed 4.5 per cent, the capital growth should keep up with inflation. The fixed interest on the one would be matched by the total return on the other, leaving a real rate of return in each case in the region of 4.5 per cent.”

The Court of Appeal in Wells v Wells[50] overturned the decision of the trial judges in the 3 cases concerned, holding that the plaintiff should be in no better position than an ordinary investor and that the defendant was entitled to the benefit of a presumption that the plaintiff would adopt a prudent investment strategy, which would include investment in a substantial portion of the funds in equities, which was the conclusion of the Court of Appeal upon the acceptance of the evidence of the expert witnesses that had been called by the defendants. In his judgement, Lord Hirst LJ stated[51]:

“Undoubtedly, equities are more risky than I.L.G.S. Undoubtedly in some individual years, investing in equities would have yielded a negative return in the ensuing period (the same applies albeit less severely to I.L.G.S.). However, the figures produced by the defendants’ experts, and in particular, the B.Z.W. tables, seemed to us to demonstrate that, over longer periods of years, equity investment has been sound.”

In arriving at that decision, the Court of Appeal was influenced by the practice of the Court of Protection of constructing a portfolio comprising of some 70% in UK equities, with the balance in cash and gilts for an individual with long-term needs, on the footing that “some risk is acceptable” and that only in the short term cases of 5 years or less was a portfolio based on short-dated gilts adopted, on the footing that in this limited class of case, “very little risk is acceptable”[52]. For these reasons, they concluded that the conventional discount rate of 4.5% should continue to apply.

90. The House of Lords overturned the decision of the Court of Appeal.  As Lord Lloyd noted in his speech[53]:

“In the past, the court has solved this problem by assuming that the plaintiff can take care of future inflation in a rough and ready way by investing the lump sum sensibly in a mixed ‘basket’ of equity and Gilts. But the advent of the index-linked government stock (“I.L.G.S.”) (they were first issued in 1981) has provided an alternative. … The virtue of I.L.G.S. is that it provides a risk-free investment.”

The question for decision by the House of Lords, as pithily put by Lord Lloyd, was[54]:

“… Whether the judges were right to assume that the plaintiff would invest in I.L.G.S. with a low average net return of 2.5%, instead of a mixed portfolio of equities and gilts. The Court of Appeal has held not. They reverted to the traditional 4 to 5%.”

Further, as Lord Clyde noted[55], the rival suggestions being put forward in the appeals before them, was investment in equities or investment in I.L.G.S. stocks.  The observations of the Law Lords, must, therefore, be considered in the context of the stark question that was posed before them.  If I.L.G.S. had not available in the UK and the question posed before them was whether a prudent plaintiff ought to invest in a mixed basket of equities and gilts, or only in gilts, would the Law Lords also have excluded equities, as they appeared to have done in the following passages from their speeches?

91. Certainly, I think Lord Steyn would have.  He said[56]:

“The basis of the conventional rate

Although decisions of the House of Lords adopted the 4 to 5 per cent discount rate, those decisions did not single out equities as the appropriate investment vehicle justifying that rate. Negatively this is clear from a study of the judgments in Mallett v McMonagle [1970] A.C. 166, Cookson v Knowles [1979] A.C. 556 and Lim Poh Choo v Camden and Islington Area Health Authority [1980] A.C. 174. Moreover, although the issue in Wright v British Railways Board [1983] 2 A.C. 773 was different, Lord Diplock’s discussion, at pp.781G-782C, in the context of Cookson v Knowles of government stock as giving the “going rate” makes clear that he did not have in mind equities as the appropriate investment vehicle. But in the present cases the Court of Appeal, relying on general observations in earlier decisions about prudent investment and the need for advice, has sought to justify a rate of 4 to 5 per cent on the basis of plaintiffs investing in a spread of equities.”

92. In the passage cited by Lord Steyn, Lord Diplock had referred to “the interest rates obtainable on government stocks and other securities in which other risk elements are minimal”, and he also referred[57] to “various kinds of government or other securities in which the risk element apart from inflation is minimal”.  In his speech in Cookson v Knowles, Lord Fraser also referred[58] to the return from “gilt-edged securities”, noting that:

“At the date of trial in this case (May 1976), it was possible to obtain interest at a rate of approximately 14% in gilt-edged securities, and so long as inflation continues at this present rate of approximately 10%, experience suggests that the interest element in the widow’s assumed annuity will be appreciably higher than the 4 or 5% on which the multiplier is based. What she loses by inflation will thus be roughly equivalent to what she gains by the high rate of interest, provided she is not liable for a high rate of income tax. In that sense, it is possible to obtain a large measure of protection against inflation by prudent investment, although the theory that protection was to be had by investment in equities is now largely exploded.”

I have already quoted from the speech of Lord Salmon[59], to a similar effect, in which he referred to gilts producing interest up to the rate of 14% a year.

93. The strongest opposition to the inclusion of equities appears in the speech of Lord Lloyd who said[60]:

“If the equity market suffers a catastrophic fall, as it did in 1972, he has no immediate need to sell. He can abide his time, and wait until the equity market eventually recovers.

The plaintiffs are not in the same happy position. They are not “ordinary investors” in the sense that they can wait for long-term recovery, remembering that it was not until 1989 that equity prices regain their old pre-1972 level in real terms, for they need the income, and a portion of the capital, every year to meet their current costs of care. A plaintiff who invested the whole of his award in equities in 1972 would have found that their real value had fallen by 41% in 1973 and by a further 62% in 1974. The real value of the income on his equities had also fallen.

… Equities may well prove the best long-term investment.  But their volatility over the short-term creates a serious risk.  This risk was well understood by the experts.  Indeed Mr. Coonan conceded that if you are investing so as to meet a plaintiff’s needs over a period of 5 years, or even 10 years, it would be foolish to invest in equities.  But that concession, properly made as it was on the evidence, is fatal to the defendant’s case.  For as [counsel for the plaintiff] pointed out in reply, “every long period starts with a short period.  If there is a substantial fall in equities in the first 5 or 10 years, during which the plaintiff will have had to call on part of his capital to meet his needs, and will have had to realise that part of his capital in a depressed market, the depleted fund may never recover.”

94. I wholly agree with these observations, insofar as they relate to a plaintiff with needs extending to up to 10 years, and I do not accept the evidence of Ms Sin that plaintiffs with needs up to 10 years should also invest a small portion of their award in equities.  She sought to support that opinion by stating that, with a portfolio that stretches beyond 5 years, one should take advantage of current low prices of equities to get some appreciation, to offset losses in the bond portfolio, which one might have to endure in the short term of 0 to 5 years when interest rates go up.  She accepted that holding equity for less than a period of 10 years could be a dangerous thing for an injured plaintiff to do but she suggested that investment managers engaged to construct a protective portfolio could look after the interest of individuals and decide when was the right time to buy.  I do not accept either of these reasons.  The inherent volatility of stocks outweighs any offset advantage against falling bond prices, particularly when the purpose of acquiring those bonds is to hold them to maturity to receive the principal on maturity. Further, the recipient of an award of damages does not enjoy the luxury, enjoyed by an ordinary investor, of waiting until market conditions improve: the award is made to him based on a certain rate of return; if he does not invest that award but keeps it in cash to wait until markets improve, he may never achieve that assumed rate of return.  It appears to me that Mr Sin was somewhat hard pressed to justify the acquisition of equities for plaintiffs with needs of 10 years or less: even in §14 of her addendum, she had only suggested that a plaintiff seeking long term growth, being 10 years or longer, should acquire equities. 

95. However, I am impressed by the evidence of Ms Sin, and accept her evidence that, in the absence of I.L.G.S., no matter how big the capital one might get, or how big one may make the lump sum to be, inflation is not within our control, and it could be so high that, even though one might have a very much large amount of capital, it could still be depleted.  In her opinion, the only way one could hedge against that possibility was to generate some internal growth by investing in an asset category that, by definition, had growth indefinitely.  In §14 of her addendum, she had stated that “an investor seeking long-term growth (taking that for present purposes is being 10 years or longer) without anticipating any sudden need to liquidate the total portfolio for emergencies (such as the case of “a reasonable victim of a tortfeasor” with a pre-determined regular income stream) may reasonably be expected to participate in the growth of the equity market. Without some equity exposure, the investor/victim runs the risk of not generating sufficient returns to catch up with inflation and of pre-maturely exhausting the funds.”  I accept her evidence that, in the absence of I.L.G.S. or some other means to protect against inflation, it is prudent for a plaintiff, with needs longer than 10 years, to invest a part of the award of damages for future loss in equity to hedge against possibility that inflation rises beyond the level of inflation based upon which the discount rate had been set.

96. Notwithstanding the decision in Wells v Wells, I accept the opinion of Ms Sin that plaintiffs with needs in excess of 10 years ought to invest a portion of their award in equities.  This conclusion finds some support in the Consultation Paper[61] issued by the UK Ministry of Justice on how the discount rate under the Damages Act 1996 should be set, which began on 1 August 2012 and concluded on 23 October 2012.  The discount rate under that Act currently prevailing in the UK is 2.5%, and was set by the Lord Chancellor in 2001.  The Lord Chancellor has been under substantial pressure to reset the discount rate, given the changed economic circumstances and the fact that, since 2001, for a variety of reasons, the 3-year average yield on I.L.G.S. had declined from 2.46%, pre-tax, to about 0.2%, pre-tax, in mid 2012.  One of the options thrown up for consideration in the Consultation Paper was Option 2 which posited the possibility that the hypothetical claimant might invest in another adequately secured way, instead of investing in I.L.G.S..  The key question under this option was whether the mixed portfolio investments would satisfy the low level of risk identified in Wells v Wells and how accurately such a portfolio would compensate claimants.  Amongst the possible alternatives identified for consideration in the Consultation Paper were:

a)    Money Market: being funds invested in sterling (or hedged back to sterling) and money market instruments defined as bank deposits, certificates of deposits, and fixed interest securities or floating rate notes;

b)    Sterling Fixed Interest: being funds which invested at least 80% of their assets in sterling-denominated (or hedged back to sterling), broad investment grade fixed interest securities, such as government bonds, local authority bonds and corporate bonds (broad investment grade being defined as (or equivalent to) BBB- or above as measured by Standard & Poor’s and by Fitch; and Baa3 or above as measured by Moody’s[62];

c)    Mixed Investment: comprising of different investments, including money market funds and fixed interest securities and with a maximum of 35% investment in equity. 

The rationale for considering this option, which carried some degree of risk, was that the hypothetical claimant who invested in I.L.G.S. was also exposed to some degree of risk, arising from the possibility that he might not be able to construct a portfolio I.L.G.S. held to maturity, and that inflation measured by the Retail Price Index (to which I.L.G.S. is linked) might not match inflation applicable to the costs actually to be borne.

97. The Table set out in option 2 of the Consultation Paper[63] described the risks of various portfolio types: 

Portfolio Type	Assumed future returns	A. Risk to Capital Value	B. Risk of insufficient investment growth
Mixed investment 0-35% shares	I.L.G.S. + 1%	Moderate	Slight
Sterling fixed interest	I.L.G.S. + 0.75%	Slight	Moderate
Money market	I.L.G.S. + 0.5%	Negligible	Slight
100% I.L.G.S.	I.L.G.S.	Slight	Slight
100% I.L.G.S. held to redemption	I.L.G.S.	Nil	Nil

98. It is relevant to consider these observations in the context of victims of torts in Hong Kong who are unable to invest in I.L.G.S..  Despite the best efforts of the court to assess compensation based on a discount rate that will not result in under-compensation, the court cannot entirely shield a plaintiff from all risks.  The object of prudent investment is to achieve the needs the prudent plaintiff with a minimum of risk. 

99. In my judgment, prudent investment by a plaintiff with needs extending from 10 to 15 years ought to include an equity content ranging from 10-15% of the award of damages made in respect of future losses;  and an equity content ranging from 15-20% for a plaintiff with needs extending to 20 years; and an equity content of 20-30% for needs extending beyond 20 years.  That equity content should comprise of blue-chip stocks described by Ms Sin as “widows and orphans” stock, which are suitable for investment by endowment funds, and by trusts set out for the benefit of widows and children.  The volatility of the stock markets and the risks of loss of capital can be offset by an investment strategy to hold such stocks, which pay dividends, for the long term.

100. It was, of course, rightly pointed out that the price of HSBC shares, a stock that could qualify as a “widows and orphans” blue chip, was over HK$120 at the end of 2007, dropping to below HK$40 in early 2009 before recovering to HK$85+ today.  This supports my decision that plaintiffs with needs of less than 10 years ought not to invest any part of their award in equity.  The historical movement in the price of HSBC stock also supports the view that plaintiffs with needs in excess of 10 years who invest some of their award in stocks are also subject to risks, such as, for example, the hypothetical plaintiff who bought HSBC shares at over $120 per share at the end of 2007, and who would have lost about one-third of their capital value as at today.  However, since such equity ought to be held for a period in excess of 10 years, unless a substantial rise in their value makes it sensible to sell them before that time, it remains to be seen whether that hypothetical plaintiff will still suffer a loss in his holding of HSBC stock come the end of 2017.  The risk is real for such plaintiffs but, in my judgment, it is reasonable for a plaintiff with needs in excess of 10 years to assume such risk, for the reason that a plaintiff with needs in excess of 10 years who invested only in bonds is likely to face a higher risk arising from the possibility that future inflation greatly exceeds the rate of inflation based upon which the discount rate had been set. 

101. The author of a recent article in the Solicitors Journal[64] commented that option 2 in the Consultation Paper from the Ministry of Justice imposed greater risk on plaintiffs than the minimal risks posed by I.LG.S. and that to adopt the option of an investment of mixed basket of securities up to a maximum of 35% in equity, in assessing the discount rate, was tantamount to a departure from the principles set out in Wells v Wells.  I agree.  However, I would add two further observations, the judgment of their Law Lords in Wells v Wells is, of course, persuasive authority but not binding on me; and more importantly, I.L.G.S. or some Hong Kong Government equivalent is not available to plaintiffs bringing proceedings in Hong Kong.  Life is never risk-free, and the need of a plaintiff, who requires an income stream extending beyond 10 years, not only to  preserve the capital value of his award but also to ensure its growth to fend against future inflation, makes it reasonable, in my judgment, for him or her to invest a portion of the award for future losses in equities. 

EFNs v Bonds

102. Professor Chan opted for EFNs for the reason that they were a high-quality and low-risk investment, being directly issued by the Hong Kong Government which had maintained a AAA rating by Standard & Poor’s since 2011.  The Court of Appeal in Chan Pui Ki v Leung On could not consider this investment vehicle in 1996 as the Exchange Fund Bills and Notes Issuance programme only started in 1997.  They can be traded in multiples of HK$50,000 via registered dealers and, as at 24 September 2012, there were more than 100 such registered dealers in Hong Kong.  There were no management fees associated with EFNs.  Concern, however, was expressed about the availability of EFNs on the secondary retail market, particularly of EFNs of longer duration.  The table showing the turnover of exchange funds bills and notes in the secondary market which was appended to the addendum produced by Ms Sin[65] showed a total EFN turnover value of HK$320.5 billion in November 2012, and that some 1,078 transactions were recorded in that month.  At the same time, exchange funds bills and notes with remaining tenor amounted to the value of HK$657 billion.  Of these, outstanding exchange funds bills of the remaining tenor of 1 year or below amounted to HK$588.6 billion.  The outstanding EFNs amounted to some HK$68.4 billion.  Of this amount of outstanding EFNs, some HK$17 billion were of remaining tenor of up to 1 years, some HK$25.6 billion were of remaining tenor of up to 3 years, whilst EFNs with remaining tenor of up to 5 years amounted to some HK$11.2 billion.  EFNs with a tenor in excess of 5 years up to 15 years (the maximum tenor of EFNs issued by the Hong Kong Government) make up the balance.

103. The relatively smaller quantity of EFNs with longer tenor is reflected in the table of turnovers which shows 41 trade, in November 2012, of EFNs of remaining tenor of over 10 years with a value of just above HK$1 billion, as compared to over 200 trades in the same month for EFNs with remaining tenor of up to 5 years, the total value of over HK$9 billion. This evidence persuades me that the plaintiffs whose needs exceed 5 years may have difficulty purchasing EFNs in the secondary market to satisfy those needs.  I also conclude that, until and unless the Hong Kong Government issues EFNs of longer tenor than 15 years, plaintiffs with needs in excess of 15 years will be exposed to re-investment risks were EFNs to be used as the primary vehicle for long-term investment, as Ms Sin noted in §6.2.5 of the joint report, citing an instance of such a risk being falling interest rates, which would result in a rate of return that was lower than the rate of return obtained from the original investment.

104. The UK Consultation Paper also gives an explanation of mismatch risks, i.e. the risk that the result of making the investments does not match the individual investor’s objective in making those investments.  It is stated[66] in the Consultation Paper that there would be a mismatch risk if the investor could not purchase a bond and pays out at the time he needs the money.  If the plaintiff needed a lump sum in 10 years’ time and bought a 5-year bond, there was the risk that bond prices would rise and that he would not be able to get a good return when he re-invested to a second 5-year bond.  If, on the other hand, that plaintiff bought a 20-year bond, there was a risk that bond prices would fall so that he will not get back enough money when he sold that 20-year old bond in 10 years’ time.  The same principles apply to the plaintiff who needed to receive a stream of payments from a portfolio of bonds of different maturity. 

105. I am satisfied from this evidence that a reasonable plaintiff with future needs extending beyond 5 years ought to invest his award of damages for future loss not only in EFNs, but also in high-quality bonds such as the constituent issues of the HSBC Hong Kong Bond Index.  A distribution of those issues, by credit rating, is seen on the document produced by Ms Sin[67], showing that of the 402 constituent issues, most were A- or better in rating, with only one issue rated at BBB+, one issue at BBB, and one issue at BBB-. She explained that the non-rated issues actually came from companies that had high ratings, such as Barclays Bank, ICBC Asia, DBS, China Development Bank, Credit Suisse London, Wing Lung Bank, Bank of China and CLP, but that, because they could sell the particular bond issue without having that issue rated, they did not want to incur the additional costs of having the issue rated.  Some 94 of the constituent issues have a rating of AAA- and better, into which class EFNs issued by the Hong Kong Government would fall.  Although some of the issuers were overseas-based, all these issues were in Hong Kong dollars.  

106. In his final submissions, Mr Badenoch QC conceded that a prudent plaintiff ought to invest in bonds rated BBB or better.  I agree but only to the extent that a prudent plaintiff ought to invest in bonds rated BBB+ or better.  Whilst these bonds would carry more risk than EFNs issued by the Hong Kong Government, I am satisfied, in the context of the Hong Kong market, that it is reasonable for the victim of a tort to assume such risks which would enable him to purchase bonds of longer maturity, to match his future needs, as well as avoid the re-investment risk inherent in purchasing bonds of a maturity that did not match the future needs of a plaintiff.

107. I would go on to state that it would be reasonable for him or her to invest in a bond denominated in US dollars, provided that they are rated BBB+ or better, as I am satisfied to the requisite standard of proof that the peg of the Hong Kong dollar to the US dollar will continue for a long, long time, and that, accordingly, there is minimum currency risk in investing in US dollar bonds.

The proper period to consider in setting the discount rate 

108. The length of the period of the review of the historical returns from these different investment vehicles is the next critical question to consider and resolve.  In Chan Pui Ki v Leung On, the trial judge and the Court of Appeal reviewed historical data of the performance of Hong Kong ORSO retirement funds going back some 12 years from 1983 to the end of 1994.  In concluding that the conventional discount rate of 4.5% should continue to apply, the Court of Appeal in Wells v Wells had regard to returns, from the same period, from investments in equities, conventional gilts, index linked gilts and cash.  When the House of Lords decided that the discount rate ought to be set by reference to the returns from I.L.G.S., they had regard to the average gross redemption yield for the preceding 3 years on I.L.G.S. with maturity dates extending beyond 5 years, on the assumption that the I.L.G.S. would be purchased with maturity dates which matched the plaintiff’s future needs and, thereby, avoiding the risk, or minimising the risk, of having to sell them before maturity at possibly depressed prices[68].

109. Lord Hope[69] made three observations on how that rate should be assessed:

“First, I think that it would be wrong to link the discount rate too precisely to the figures showing the average gross redemption yield on I.L.G.S. which are published each day in the financial press. These figures fluctuate almost daily, albeit within a relatively narrow band. Frequent changes in the discount rate are undesirable. In the interests of maintaining a reasonable element of stability to assist settlements, a broad view needs to be taken having regard to the range of figures over a substantial period. Secondly, a figure should be selected which will match the rates of interest on which the multipliers in the Ogden Tables are based, as the admissibility and relevance of the information contained in these Tables is now generally recognised. This means that the figure should be expressed to no greater a degree of accuracy than one-half of a decimal point. Thirdly, the rate should be one which has regard in a general way to taxation on the index-linked income return on the investment, after the appropriate allowances, up to and including the standard rate[70]. …

In my opinion the evidence as to the average gross redemption yield for the last three years on I.L.G.S. with lives over five years[71], assuming an inflation rate of 5 per cent., indicates that for the time being 3 per cent. is the appropriate rate of net return to be expected from the investment of pecuniary loss.  Adjustments may have to be made to that rate in the light of significant changes in the yield on I.L.G.S. in the future.”

110. Lord Steyn agreed[72] that, for his part:

“I would derive that rate from the net average return of I.L.G.S. over the past three years. Whilst this figure of about 3 per cent. should not be regarded as immutable, I would suggest that only a marked change in economic circumstances should entitle any party to re-open the debate. … The effect of the decision of the House on the discount rate, together with the availability of the Ogden Tables, should be to eliminate the need in future to call actuaries, accountants and economists in such cases.”

111. Lord Clyde agreed at in setting the discount rate, the average return of I.L.G.S. for a period of three years preceding the date of the appeal, net of tax, ought to be taken[73] as did Lord Hutton[74].  Lord Lloyd preferred the average return of various I.L.G.S., of different maturity dates, for the one-year period preceding the date of the appeal.  He said[75]:

“What then should the figure be? The average gross redemption yield on I.L.G..S. has fallen steadily over the last year. In May 1997 it was 3.68 per cent., by May 1998 it was only 2.8 per cent. Less tax at, say, 15 per cent., this would give a net return of 2.38 per cent. Logically, therefore, we should take 2.5 per cent. as the guideline figure, since the assumption is that the plaintiff will purchase in the market at that price. The higher-yielding stock is no longer available. If therefore the calculation is done at 3 per cent., instead of 2.5 per cent., he would be substantially under-compensated.

But since it is undesirable that the guidelines should be changed too often, it may be better that the average gross return should be ascertained over a period of months rather than on a particular day; and since, as I have said, the average return has been falling over the last year, one would expect the average return over that period to be higher than the current return. Such proves to be the case. …

I would not, however, accept that the average should be taken over as long a period as three years.  For if the rate of return had been falling steadily over the whole period (in fact this has not been the case) it would work very unfavourably to the plaintiffs; and vice versa if it had been rising steadily over three years.  A year would seem to be the best compromise period.  Once the net return has been established to the nearest 0.5 per cent., it is a simple enough matter to find the correct multiplier from the Ogden Tables.”

112. When the Lord Chancellor set the discount rate in 2001, pursuant to Section 1 of the Damages Act 1996, he did so by reference to the average yields on I.L.G.S. over a three-year period up to mid 2001, concluding that it was proper to take an average over all I.L.G.S. rather than to exclude I.L.G.S. with less than 5 years to maturity.  The assumption made in Wells v Wells was that the claimant would generally hold all his I.L.G.S. until redemption and that, in each year of loss, a proportion of the capital would have to be used.  For these two assumptions to be consistent, it would be necessary for the claimant to purchase I.L.G.S. which would mature in the short term, as well as in the long term, to avoid the need to sell longer term I.L.G.S. to fund shorter term needs. 

113. The fall in the returns on I.L.G.S. since 2001[76] has compelled the current review of the discount rate under Section 1 of the 1996 Damages Act. As required by that provision, the Lord Chancellor consulted with the Government Actuary and the Treasury who advised[77] that averaging the I.L.G.S. yields over the last 3 years was likely to be misleading as an indicator of future returns because the return to investors, who hold their I.L.G.S. to maturity, will be the yield on the day they invest, not the yields available in the past, which is consistent with the observations of Lord Lloyd. 

114. In their joint report, the experts expressed their agreement on the factor driving the choice of the time period as follows:

“Time horizon – Given the cynical nature of the capital markets and the highly unusual events with significant global economic impact in the past two decades, it is important to focus on return statistics over an extended time period.

Choice of time period – In addition to the need to observe trends over an extended period, we recognize that consequences from extreme events may unduly distort return statistics.”

115. These considerations led Professor Chan to offer the opinion in his addendum that notwithstanding that the House of Lords in Wells v Wells had decided to use historical data for the three-year period preceding the date of their decision, that one should look at a longer period, say 5 to 7 years of the Hong Kong historical data in setting the discount rate “in view of the recent global financial crisis and waves of quantitative easing”.  In so concluding, Professor Chan was perhaps more generous to the defendants than Mr Dingemans QC who submitted, with some force, that current market prices would have taken into account, and is, therefore, the best indicator of, future market trends.

116. In her addendum, Ms Sin pointed out the severe limitations in using past or current data as a basis of forecasting future developments, noting that, in highly volatile financial markets, it would be imprudent to rely on a retrospective approach for determining future discount rates, and referring to the standard disclaimer demanded by regulators that past performance is no guarantee for future results.  That may be so but, in the absence of a crystal ball, the court has no choice but to look at historical data of gross returns, and to deduct from those returns, management fees and current inflation, to arrive at a discount rate for the court to use now and in the future.  Notwithstanding relatively stable times in July 1998, Lord Lloyd differed from the other Law Lords in the choice of the period of review.  In his statement of 27 July 2001[78], the Lord Chancellor agreed that a 3-year period was an appropriate period over which to take an average in setting the discount rate for the foreseeable future, noting that Lord Lloyd preferred 1 year, and confirming “the need for judgments to be made in determining the appropriate average yield”.

117. When asked by Mr Badenoch QC what she thought was the safest, and best, and fairest way to use historical data for the purpose of setting the discount rate, Ms Sin reiterated that she was quite wary of using past performance to try and identify a rate for the future, and that she was very hard pressed to say what was the appropriate past period that we should draw from because it was very difficult to project what was going to happen in the short-term, citing the example that interest rates might start to rise from 2016 if US unemployment rates improved, but then, that they might not improve.  However, in the long-term, since we had sufficient history of how different asset classes behaved, we could surmise what might be the real returns from different assets classes.  She pointed out that we were at an interest rate cycle which was at a historical low, and that it had nowhere else to go but up.  To summarise her evidence, she said that because past performance was a poor guide for the future, and because future trends were difficult to predict, and given the recent volatility in the market, it was safer to look at returns for a longer period of 12 years or more to set the discount rate.

118. In the course of his evidence, I asked Professor Chan to consider a scenario whereby interest would gradually rise from 2016 and he responded that, in that case, it was fair to look back another 3 or 4 years and assess the discount rate by looking at historical returns over a 10-year period.  He went on to clarify that, for a plaintiff with future needs of 5 years, he would consider his 5 to 7-year period of historical review to be the relevant period.  He would maintain the same period for a plaintiff with future needs spanning from 5 to 10 years. However, assuming the scenario that interest rates would rise from 2016, he would opt to look at the historical returns over a period of 10 years for a plaintiff whose future needs extended beyond 10 years. 

119. I accept the cogent and compelling evidence of Ms Sin that there are too many imponderables.  When interest rates are at historical lows, people’s speculation is that it has nowhere else to go but up.  The question mark is when.  The indicators for US economic growth were very much dependent on manufacturing indicators, car sales, new house starts, new house sales, and, if the US economy picked up, it affected the employment figures.  The US unemployment rate of about 10% in 2009 had improved to about 7.8%.  However, these were just economic indicators.  The formulation and implementation of monetary and fiscal policy, on the other hand, is something that nobody could predict.  Although the historical low interest rate environment had sustained for some time already, the belief was that it should revert to more normative conditions. 

120. I should state at this point in my judgment that I am not satisfied to the requisite standard that interest rates will start to rise in 2016.  Certainly, there is a quiet optimism that this will happen, and even suggestions that interest rates will rise earlier than 2016 but, given the current economic environment and continuing concerns about Eurozone, one can say no more than that. 

121. A plaintiff who receives an award of damages does not have the luxury of waiting for these 3 or more years to see if markets improve.  He has little choice but to accept reasonable advice and start investing in a sensible way by adopting an “asset-liability matching approach”.  It was assumed in Wells v Wells that the plaintiff would generally hold all his I.L.G.S. until redemption and that, in each year of loss, a proportion of the capital would have to be used.  If held to redemption, I.L.G.S. would produce the expected return that was protected against inflation, with negligible market risk.  Lord Hope said[79]:

“This form of investment is, it should be added, not entirely without risk. The prices at which I.L.G.S. are available on the market from time to time rise and fall according to the market’s expectation of the future pattern of inflation as against the movement of interest rates. If they are bought and sold in the short term, these price movements may result in a gain or a loss of capital. In the long term however, particularly if held to the redemption date, they produce a return which is inflation-proof and can be relied upon.”

To avoid reinvestment risk, securities of short-term maturity should not be used as a vehicle for longer term needs.

122. I have already accepted the evidence of Professor Chan that a plaintiff with needs up to 5 years should maintain 20% of his award for future loss in 12-month time deposit, and 80% in EFNs.  I have found that plaintiffs with needs ranging from 5 to 10 years ought to invest 85% of their award for future loss in EFNs and bonds rated BBB+ or better.  In both cases, the prudent plaintiff would need to purchase EFNs and bonds with different maturity dates which match his future needs.  The performance of these EFNs and bonds that he buys today is best assessed by looking at the performance of these investment vehicles in the last few years, and not the last 12 years.  I agree that a 3-year period of review would be appropriate in the more stable conditions that prevailed when the House of Lords arrived at their decision in Wells v Wells in July 1998.  I accept the evidence of Professor Chan that a period of review going back 5 to 7 years from today would be more appropriate at the present time, given the drastic fall in values from recent extreme events which, hopefully, would not be repeated any time soon. The sharp difference in the returns from the MPF Global Fund in the past year[80], as opposed to the past 7 years[81], that can be seen from Table 5.4, makes good this point.  The same point can be made by comparing the benchmark returns from the Hong Kong Bond Index and the Exchange Fund Note (10-year benchmark) for the 1-year period, and the 7-year period.

123. A plaintiff with needs in excess of 10 years should invest 60% of his award on EFNs and bonds.  Even though he acquires these instruments with longer maturity dates, he must acquire them within a reasonable time of obtaining his award of damages.  A glance at the business section of any daily Hong Kong newspaper will show that the yield to maturity of longer term HK dollar good quality bonds can barely keep pace with inflation. Accordingly, in my judgement, the historical review of returns, even for these longer term bonds, ought not to extend beyond the period of 5 to 7 years proposed by Professor Chan. 

124. The same, however, does not apply to the equity element of the portfolio of plaintiffs with needs extending beyond 10 years. Just as he would need to acquire EFNs, and bonds with different maturity dates, within a reasonable time of receiving his award of damages, so must he acquire a portfolio of good quality blue-chip stocks which qualify as “widows and orphans” stocks within a reasonable time of receiving his award.  However, in the case of equities, the strategy is to hold them long-term as a hedge against future inflation which might exceed the inflation rate that had been used to set the discount rate.  In my judgment, for the reason that the equity element of the portfolio would be held for a considerable period of time, it is appropriate, in setting the discount rate for plaintiffs with needs exceeding 10 years, to review the historical performance of equities over a period of 12 years preceding the date of review. 

125. The setting of the discount rate by reviewing the performance of EFNs and bonds over a period of 5 to 7 years might result in under-compensation of plaintiffs who are about to receive their award of damages and cannot acquire such instruments with returns that match their performance in the last 5 to 7 years.  That risk is, somewhat, balanced by the risk of over-compensation of plaintiffs who receive their award of damages a few years from now.  Market conditions may improve to the extent that the yields on EFNs and bonds exceed their historical 5 to 7 year performance upon which the discount rate has been based and set.  A better way to lessen the risk of over-compensation for future plaintiffs is to conduct regular reviews until such time that markets stabilise.

Periodical reviews of the discount rate

126. In stable economic times, once the issue of the discount rate has been resolved, it is right that there ought to be few occasions in the future to re-open the issue[82]. In these volatile times, a review might be necessary if economic conditions change, hopefully for the better, and interest rates rise beyond any corresponding rise in inflation, or if the differential between price and wage inflation of 1% or more is established for a significant period of time.  The need to adhere to the primary principle governing the assessment of damages in tort, namely, to award a sum of money as will amount to no more and, at the same time, no less than the net loss[83] overrides the desirability of, and the uncertainties that would be created by frequent reviews of the discount rate.  Clearly, when markets stabilise, one hopes to return to the “good old days”. The experts produced that following table to track the 1 year nominal US Federal Reserve Interest rate from 1953 to 2012.

As can be seen from the table, the interest rate has ranged from 2% to 8% for most of this period.  The current low interest rates are unprecedented.

127. A review could be initiated by the judge in charge of the Personal Injuries List who could select appropriate cases to re-test the validity of the prevailing discount rate.  The suggestion by Professor Chan of a Working Party chaired by the Chief Justice and consisting of judges, lawyers, actuaries and economists to review the issue periodically also merits attention.  It is a workable suggestion if interested parties, such liability insurers, the Motor Insurers Bureau, the Secretary for Justice, and the Hospital Authority, to name a few, agree that courts assessing damages for personal injuries should adopt appropriate multipliers by reference to the discount rate set by the Working Party.  Unless this rate was higher than the rate set by court, plaintiffs are likely to agree as well.  The bigger question is whether or not legislation similar to the Section 1 of the Damages Act 1996 should be enacted empowering the Chief Justice to prescribe the discount rate after consulting the Monetary Authority.  The benefit of such a course is that it avoids the burden of costs on the losing party or parties, in any case where the discount rate is being reviewed. 

128. The UK Damages Act 1996 goes beyond providing a mechanism for the Lord Chancellor to review and reset the discount rate.  By the Act, the courts are also empowered to make periodical payment orders[84], which overcome the dual uncertainties of predicting of future inflation and predicting life expectancy, particularly in cases, such as the captioned cases, involving infants suffering from cerebral palsy[85]. For my part, absent statutory intervention, I would be inclined to resist the temptation offered by Lord Clarke in Simon v Helmot[86] to develop the common law to provide for periodical payments.

Different rates for different needs?

129. In his statement of 27 July 2001, the Lord Chancellor concluded that he should set a single rate to cover all cases, that this accorded with the solution adopted by the House of Lords in Wells v Wells, and that doing so would eliminate uncertainty and argument about the applicable rate[87]. However, in Simon v Helmot, Lord Hope posed, and answered, the question whether it was acceptable in principle for there to be different discount rates for different heads of loss:

“52. The answer to the … [question] is to be found in the premise that a victim of a tort is entitled to be fully compensated. If the evidence shows that inflation would affect different heads of loss in different ways and that the differential is capable of being evaluated, the court should not close its mind to using different rates. To do that would risk giving the victim less than he is entitled to.”

For the reason that there was a substantial (2%) differential between price inflation and wage inflation, Privy Council concluded that it was right that a different discount rate be set for price-related future losses and earning- related future losses.  Applying the same principle to the present case, I conclude that it is appropriate to set different discount rates for plaintiffs with different future needs provided, of course, that the assessment of the discount rates for these different plaintiffs produced a significant difference in the assessed rates. 

130. Ontario is an example of a jurisdiction with different discount rates.  As early as 1984, Ontario had a system of prescribing a net discount rate which, in 1984, was set at 2.5%.  It was later recognised that this was too low and, in 1998, a committee looking into the matter identified the consensus that it was appropriate to use a 2.5% discount rate for losses in the long-term but no consensus as regards the shorter term. It concluded that the discount rate for losses up to an initial period of 15 years ought to be set by reference to “Real Return Bonds” which are not dissimilar to I.L.G.S., and that, for the subsequent second-tier period exceeding 15 years, the long term historical rate of 2.5% should continue to be used[88]. The rate currently prescribed in Ontario under Rule 53.09(1) of the Ontario Rules of Civil Procedure is a rate of -0.5% for the initial 15 years, and 2.5% after the initial 15 years.

Calculation of discount rate for different portfolios 

131. The starting point is to recognise that it is not wrong, in principle, to have a “negative” discount rate, i.e. to award, not less than the number of years of future loss, but more than that number.  In Simon v Helmot, Lord Hope said:

“14.  The effect of such an adjustment is to increase, rather than reduce, the number of years used as the multiplier.  The use of the word “discount” is not an apt way of describing that exercise.  But in principle there can be no objection to such an adjustment if the evidence shows that it is needed to ensure that the lump sum will continue to be large enough to meet losses to be incurred in the future.  Otherwise the effects of accelerated receipt, which are inevitable where the award is by means of a lump sum, will not be properly recognised.

…

54 … the answer to this question [whether it is open to the court to apply a discount rate which is not a discount rate at all] is to be found in the principle that the victim should, so far as it is possible to do so, be fully compensated. … It is, in essence, simply a process of adjustment.  And in principle there can be no objection to its operating in the reverse direction if the evidence shows that an adjustment which increases the multiplier is needed to ensure that the lump sum will continue to be large enough to meet losses to be incurred in the future.”

The discount rate for plaintiffs with needs not exceeding 5 years

132. Because of the consensus between the experts on the needs of such a plaintiff, this assessment poses no difficulty.  The discount rate for such a plaintiff is -0.5%, a figure I arrive at by taking the average of the real rate of return per annum, net of price inflation[89], for the period of 5 years and 7 years, respectively, appearing in Table A1 expanded version for the combination of 20% 12-month time deposits and 80% EFNs. My calculation is as follows: (-1.2% + -0.1%) ÷ 2 = -0.65%, which, rounded off, becomes -0.5%.

The discount rate for plaintiffs with needs not exceeding 10 years

133. A proper portfolio for such a plaintiff, as I have found, is 15% 12-month time deposits and 85% EFNs and bonds of BBB+ or better.  The real rate of return per annum, net of price inflation, for 12-month time deposits can be seen in Table 5.4 to be -1.9% for the preceding 5-year period and -0.6% for the preceding 7-year period, giving an average of -1.25%.  In my judgment, the composition of the HSBC Hong Kong Bond Index[90], meets the requirement of plaintiffs with an excess of 90% of those bonds of the quality of A- or better, and although some 6% of the balance of the bonds in this Index are not rated, the issuers of those bonds are well rated, and are able to sell the unrated bonds without the need to bear the administrative costs to having them rated.  I accept the evidence of Ms Sin that, if these unrated bonds were actually rated, it was likely that they would achieve a rating of BBB+ or better.  As defined in §6.12 of Appendix 6 of the joint report[91], the HSBC Hong Kong Dollar Bond Index shown on Table 5.4 is the abbreviation of the Hong Kong Dollar Bond Index comprising of government and non-government issues in the ratio of roughly 40% - 60%.  Of course, the government portion of the bonds would include EFNs.  Table 5.4 shows the real rate of return per annum, net of price inflation, of this Bond Index of 2.3% for the preceding 5 years, and 1.8% for the preceding 7 years, making an average of 2.05%.  However, being an Index, these returns would not reflect any deduction for management fees, such as shown in the upper part of the same Table 5.4.  For instance, the MPF Hong Kong Dollar Bond Fund shows returns of 0.3% and -0.3%, for these two periods, net of price inflation and after deducting management fees.  Having regard to the evidence of Ms Sin on the range of management fees that can be charged, and the relatively simple task of an investment advisor purchasing EFNs and high quality bonds maturing at different times to meet the needs of plaintiffs with future needs not exceeding 10 years, I find that the management fee for this exercise ought not to exceed 0.75% of the values of the EFNs and bonds to be acquired.  Deducting this management fee from the average return of 2.05%, produces a discount rate of 1.3% (2.05% - 0.75%).  The discount rate for plaintiffs with needs not exceeding 10 years is, therefore, 1% [(15 x -1.25% = 14.8125) + (85 x 1.3% = 86.105) = 100.9175, rounded off to 101 = 1%].

The discount rate for plaintiffs with needs exceeding 10 years

134. I conclude that I ought to calculate the discount rate for plaintiffs with needs exceeding 10 years by taking an “average” portfolio of 10% in time deposits, 70% in high quality bonds of BBB+ or better, and 20% in high quality blue-chips that qualify as “widows and orphans” stock.  The figure of 20% for the equity content is a simple average of portfolios with equity content ranging from 10% to 30 %.  In the absence of data to show that there are more plaintiffs with future needs of 15 years than plaintiffs with longer or shorter future needs, it is not possible to produce a weighted average.  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[92], I shall assume that the performance of such a high quality fund over the past 10 years is similar to the performance of the MPF Hong Kong Equity Fund, shown on Table 5.4 to have a real rate of return per annum, net of price inflation after deducting management fees, of 7.4%.  I assess the discount rate for plaintiffs with needs in excess of 10 years to be 2.5% [(10 x -1.25% = 9.875) + (70 x 1.3% = 70.91) + (20 x 7.4% = 21.48) = 102.265, rounded off to 102.5 = 2.5%][93].

Liberty to apply

135. I am wary of the criticism made by the Court of Appeal in Chan Pui Ki v Leung On that the trial judge’s reduction of the yield by 0.7%, by an artificial reallocation of the assets comprised in the notional fund (by reducing the equity content and increasing the bond content) was not an exercise that the judge should have entertained[94].  Likewise, I do not want to “second guess” whether the historical yield from higher quality bluechip stocks that qualify as “widows and orphans” stock would be more or less than the performance of the MPF Hong Kong Equity Fund shown on Table 5.4.  In attempting these calculations, I assumed that “widows and orphans” stock would have performed as well as the MPF Hong Kong Equity Fund shown on Table 5.4.  In this regard, I note the evidence of Ms Sin that the theory would be that, on looking at the performance of two funds, the one which is more conservative and less speculative may not perform as badly as the other and also may not perform as well as the other, but that it would be too speculative to say that was true in every case.  In the circumstances, I conclude that the best way forward on this issue would be to grant liberty to the parties, if they so wish, to apply, within 21 days of this judgment, to adduce expert evidence that my assumption that “widows and orphans” stock would have performed as well as the MPF Hong Kong Equity Fund shown on Table 5.4 is erroneous.

136. I grant similar liberty to the parties, if they so wish, to apply, within 21 days of this judgment, to adduce expert evidence to demonstrate that my calculations of the discount rates are erroneous.

Different rates for different plaintiffs

137. Is there a sufficiently significant difference in the discount rate of plaintiffs with different future needs as would justify a departure from the principle, founded on simplicity and the ease of assessment, that a one rate should apply to all?  The Court of Appeal in Wells v Wells[95] were concerned that a single guideline to apply across the board might unfairly disadvantage plaintiffs in short term cases where they would be likely to invest in gilts rather than in equities.  However, their review of the Ogden Tables showed that the rate of the percentage discount made practically no difference for plaintiffs with needs not exceeding 7 years.  The difference in the multiplier for these plaintiffs was less than 0.5, when the multiplier based on a rate of return was 4.5% was compared to the multiplier based against a rate of return of 2.5%.  I replicate Table 28 from Personal Injury Tables Hong Kong 2013 at p.57 to make a similar comparison.

138. The comparison I have made shows, similarly, that there is hardly any difference to the multiplier for plaintiffs with future needs of up to 5 years, for whom the discount rate has been calculated to be -0.5%, and the multiplier for plaintiffs with future needs of up to 10 years, for whom the discount rate has been calculated to be 1%.  The difference in the multiplier for these plaintiffs was substantially less than 0.5 for terms not exceeding 8 years, whether their multiplier was based on -0.5% or based on 1%. 

139. However, there is a sufficiently significant difference in the discount rate of plaintiffs with future needs of more than 10 years, and the discount rate of plaintiffs with future needs of less than 10 years, as would justify different discount rates for these two categories of plaintiffs.  I, therefore, adopt a discount rate of 2.5% for plaintiffs with needs of more than 10 years.  As I have decided to adopt a different discount rate for plaintiffs with needs of more than 10 years, in order to be consistent, I should also adopt a different discount rate for plaintiffs with needs of less than 5 years, which I assess to be -0.5%, and less than 10 years, which I assess to be 1%. 

The effect of my decision on future insurance premium

140. There is no denying that the costs of insurance will go up as a result of this judgment.  Should that consideration stay my hand in the assessment of the discount rates to be applied?  Notwithstanding the observations, of Lord Woolf in Heil v Rankin[96]:

“Awards must be proportionate and take into account the consequences of increases in the awards of damages on defendants as a group and society as a whole. The considerations are ones which the court cannot ignore. They are the background against which the fair, reasonable and just figure has to be determined. … Similarly, in setting the tariff the court should not ignore the economic impact of the level of damages which it selects. The economic consequences of a level of damages will not dictate the decision, but they will inform the decision. They are part of the background facts against which the decision must be taken. The court is not interested in the detail but it is interested in the broad picture.”

and of Lord Denning MR in Fletcher v Autocar and Transporters Ltd[97]:

“It is true that in these days most defendants are insured and heavy awards do not ruin them. But small insurance companies can be ruined. Some have been. And large companies have to cover the claims by their premiums. If awards reach figures which are ‘daunting’ in their immensity, premiums must be increased all the way round. The impact spreads through the body politic.”

I agree with it, and follow, the principle that is relevant to the assessment of the discount rate, as expounded by Lord Hutton in Wells v Wells[98]:

“The consequence of the present judgments of this House will be a very substantial rise in the level of awards to plaintiffs who by reason of the negligence of others sustain very grave injuries requiring nursing care in future years and causing a loss of future earning capacity, and there will be resultant increases in insurance premiums. But under the present principles of law governing the assessment of damages which provide that injured persons should receive full compensation plaintiffs are entitled to such increased awards. If the law is to be changed it can only be done by Parliament which, unlike the judges, is in a position to balance the many social, financial and economic factors which would have to be considered if such a change were contemplated.”

Unlike the question dealt with by the House of Lords in Wells v. Wells, the Court of Appeal in Heil v Rankin was concerned with the question whether or not awards for non-pecuniary loss ought to be increased, and the Court of Appeal in Fletcher v Autocar and Transporters Ltd was concerned with the question of the overlap of awards for loss of earnings and for loss of amenities.

Costs

141. I make a costs order nisi of the costs of the trial of the preliminary issue, and of the applications leading up to it, to be paid by the defendants to the plaintiffs, with certificate for three Counsel.  I order that the plaintiffs’ own costs be taxed pursuant to the Legal Aid Regulations.

142. I cannot conclude this judgment without expressing my gratitude to Counsel for the assistance they have provided to me. 

[1] [1979] AC 556

[2] Professor Chan graduated from the Chinese University in 1984 with a major in Accounting.  He pursued a doctorate in Business Studies at Temple University, Philadelphia, USA, receiving his PhD in 1989 in applied statistics, time series analysis, and business forecasting.  In 1995, he was admitted as a Fellow of the Society of Actuaries in USA, and he is also qualified as a Chartered Statistician in the UK.

[3] [1996] 2 HKLR 401

[4] She received her BSc degree in Mathematics from the University of Toronto and graduated from The World Bank’s Pensions Fellowship Programme.  She is a Research Fellow at the Peking University and sits on various Advisory Boards.  She is a member of various Actuarial Institutions in Canada and America and the Actuarial Society of Hong Kong. 

[5] Ms Sin explained that the reason for this arose from the current requirement that members reaching retirement age had to cash out their entitlement in full so that the prudent thing for these members to do was to transfer their account balances into these conservative funds in order to protect themselves from adverse market movements shortly before their retirement.

[6] The Mixed Asset Funds can have equity content from as high as 80% to as low as 20%.

[7] Civil Appeal 414, 14 September 2010, Judgment 31/2010

[8] [2012] UKPC 5

[9] See the judgment of Cheung J in Chan Pui Ki v Leung On [1995] 3 HKC 732 at pp.741A-B, 745A-E and 746G.

[10] [1989] AC 807 at 833C

[11] At §100

[12] [1999] 1 AC 345 at 393C

[13] At p.422H-423B

[14] At p.418J

[15] At p.366D

[16] At p.387B-C

[17] At p.397C

[18] There has been recent criticism of the high level of charges levied by providers of MPF Funds.  It is instructive to consider Ms Sin’s explanation for the current state of affairs.  She said that Hong Kong’s average level of fund expense ratio is higher than that of Chile at 0.56, and UK, Australia and Singapore at 1.19, 1.21 and 1.41 respectively (so effectively 1.2 to 1.4).  The reason for the differences is that Hong Kong’s MPF is the least mature of all these countries.  MPF has been here for only about 12 years, so the size of the assets under management, compared to those other countries, is relatively small in absolute dollar terms.  Clearly, Hong Kong is a relatively small place and the number of participants in the MPF is relatively small when compared to UK, Australia and Chile, which have had central provident funds for longer period of time.  Economy of scale is very important and the larger the base the smaller will be the expense as a percentage of the assets under management.  Further, these countries, and Singapore, are highly computerised.  Hong Kong would be able to cut costs if paper communications are replaced by electronic communications.  Although management fees in Singapore are about 1.4%, their central provident fund is not just a pension fund, but also covers housing, medical, loans and, therefore, incurs administration costs for these other social purposes. 

[19] As an example, see the judgment of Seagroatt J in Chan Yuk v Dragages et Travaux Publics (HK) Limited & Ors HCPI 1066/1998, 2 February 2000, at p.17.

[20] See the speech of Lord Lloyd at p.366B-C.

[21] Morgan Stanley Capital International Index of the Hong Kong equity market

[22] At §6.2.12 of the joint report.

[23] In excess of HK$2 billion in any given year, and with an average pool investment balance also in excess of HK$2 billion in any given year since 2004.

[24] As there were management fees on time deposits and EFNs, these returns were only calculated net of inflation. 

[25] At p.417C

[26] These investment vehicles do not attract any management fees.

[27] At §47

[28] At §47

[29] At p.394H-395B

[30] See also Lord Lloyd at p.365C

[31] [1980] AC 174 at p.194B

[32] Gilts or gilt-edged securities are bonds issued by certain national governments. The term is of British origin and originally referred to bonds and debt securities, issued by the Bank of England, which had a “gilt or gilded edge”.

[33] At p.574A-D

[34] Against a prevailing inflation of 10% a year: see the judgment of Lord Fraser at p.577B.

[35] At p.366F to 367C

[36] At p.368D-G

[37] Ms Sin agreed that the position of an average pensioner in Hong Kong was very similar to that of a plaintiff because his only source of income would come from the MPF unless he had other savings. 

[38] At p.392C-F

[39] At p.396A-E

[40] At p.403B-H

[41] 462 U.S. 523 (1983)

[42] At p.385B-D

[43] Quoted above in §77.

[44] [1995] 3 HKC 732 at p. 758H

[45] At p.417F-G

[46] At p.417C

[47] Quoted above in §77.

[48] Come the 1990s, the crash of 1972 was largely forgotten.

[49] Law stated as at the end of 1996.

[50] [1997] 1 WLR 652

[51] At p.677D-E

[52] At p.668D-E and 677F-H

[53] At p. 364H-365B

[54] At p.365D

[55] At p.396D

[56] At p.384E-G

[57] In another passage at p.783B-C.

[58] At p.577B-D

[59] Quoted above in §77.

[60] At p.366F-367B

[61] TP12/2012

[62] A comparative table of ratings of various agencies is given below:

[63] At p.38

[64] Richard Edwards, Vol 157, No 03, 22 January 2013

[65] At p.465A of the Bundle

[66] At pp.28 and 29

[67] At p.465M of the Bundle

[68] As explained by Lord Lloyd at p.367D-E.

[69] At p.393B-F

[70] Investment income is not taxable in Hong Kong so the third observation is not relevant for our purposes.

[71] i.e. with maturity dates in excess of 5 years. The House of Lords considered I.L.G.S. maturing at various dates between 2001 and 2030: see p. 367D.

[72] At p.388D-E

[73] At p.398A

[74] At p.404F

[75] At p.375G-376C

[76] The 3-year average yield having declined from 2.46%, pre-tax, to about 0.2% ,pre-tax, in mid 2012.

[77] See §§53-56, and 59 of the Consultation Paper.

[78] See p.52 of the Consultation Paper

[79] At p.392B

[80] -2.0

[81] 0.2

[82] As stated by Litton VP in Chan Pui Ki v Leung On at p.420H; and Lord Steyn in Wells v Wells at p.388E who suggested that only a marked change in economic circumstances should entitle any party to re-open the debate.

[83] See Lord Oliver in Hodgson v Trapp [1989] AC 807 at 826, Lord Hope in Wells v Wells at p.390B and Lady Hale in Simon v Helmot at §60.

[84] Referred to in §§5 and 6 of my decision of 16 October 2012.

[85] However, as Ms Sin pointed out at p.72 of the joint report, at p.337 of the Bundle, in the current economic times, PPOs may impose an extraordinary burden on defendants.

[86] At §88

[87] See p.50 of the Consultation Paper

[88] See §§541 and 542 of Greenhalgh & Ors v Corporation for the Township of Douro-Dummer & Anor Peterborough Court File No.238/06, 17 December 2009.

[89] As these investment vehicles do not attract management fees.

[90] Shown at p.465M of the Bundle

[91] At p.392 of the Bundle

[92] Shown on p.465N of the Bundle.

[93] In Ontario there has been litigation on whether a “blended” approach should be adopted so that cashflows required for the first 15 years should be discounted by -0.5% and only cashflows needed after the 15 year and beyond should be discounted by 2.5%: see the article on the subject from the publication, MDD Forensic Accountants, listed as No 63 of the plaintiffs’ list of authorities. No such problems arise here as my calculation of a 2.5% discount rate for plaintiffs with needs exceeding 10 years applies to cashflow needs from year 1 up to the final year of need. 

[94] At p.417I

[95] At p.678G-679C

[96] [2000] 2 WLR 1173 at 1188H-1189E

[97] [1968] 2 QB 322 at 335-6

[98] At p.405D-F