By Steven Weisbart, Chief Economist
The Insurance Information Institute (I.I.I.) Inflation Watch spreadsheet contains the latest consumer price data from the U.S. Department of Labor Bureau of Labor Statistics (BLS). The CPI-U—the popular measure of consumer prices, sometimes called headline inflation—rose by 1.9 percent in December 2018 vs. December 2017. The core CPI—the overall index minus the effects of price changes for food and energy—rose 2.2 percent for the 12 months ending December 2018—the fifth month in a row in which the 12-month increase was either 2.1 percent or 2.2 percent. Most economists prefer to use the core, not the headline, inflation measure to avoid the “noise” of volatile prices for those items. The core PCE deflator—the inflation measure that the Federal Reserve prefers—rose by 1.9 percent on a year-over-year basis in November 2018 (the latest available reading); this is the eighth month in a row in which the core PCE deflator was between 1.9 percent and 2.0 percent. Many forecasters project headline CPI for 2019 to range between 1.4 and 2.5 percent. However, price trends for items that more directly affect property/casualty (P/C) insurance claims do not necessarily follow broad-based price indexes.
Prices for items such as intensive healthcare affect claims under third-party coverages such as workers compensation and bodily injury liability, as well as first-party coverages like Personal Injury Protection (PIP), med pay and obviously, medical expense insurance. For many years these price increases have far outpaced headline and core inflation, but the gap has nearly disappeared. In December 2018, seasonally adjusted on a year-over-year basis, prices for inpatient hospital care rose by 2.8 percent. Except for the November 2018 year-over-year increase (+2.6 percent), the December 2018 year-over-year increase is the lowest year-over-year increase in inpatient hospital prices in nearly 20 years (since June 1998, when it was +2.4 percent). Price increases for outpatient hospital care rose by 4.0 percent in December 2018 over the prior December. Month-over-prior-month changes in outpatient hospital prices have been quite variable in 2018: they rose sharply in January, March, June, November and December (up 1.4 percent, 0.7 percent, 0.8 percent, 1.0 percent, and 0.6 percent, respectively) but dropped in April, August, and September (down by 0.1 percent, 0.3 percent, and 0.6 percent, respectively). Price increases for prescription drugs on a year-over-year basis as of December 2018 fell by 0.6 percent. This is quite rare: in the last 30 years, it happened only once before (in July 2012). Indeed, in 2018 monthly price changes for prescription drugs have been quite variable. Prescription drug prices fell in each of the first three months, rose in the next three months, fell or were flat in the third three months, and in the final quarter fell in October, rose in November, and fell in December.
Price increases relating to auto insurance property claims have been quite moderate recently. Prices for motor vehicle parts and equipment, which affect not only comprehensive and collision claims, but property damage liability as well, rose by 2.2 percent as of December 2018 vs. December 2017. Although this appears to be a moderate rate of increase, it could be the start of a seriously-adverse trend. Beginning in December 2017, parts and equipment prices have generally risen by roughly 0.3 percent each month (except for a June-September span when prices were basically flat). Some this rise might have been caused by the tariffs that the U.S. has placed on imported parts; other explanations might be that more sophisticated parts needed for new cars are more expensive due to advanced technology. Nonetheless, auto claims seem likely to be affected. Prices for motor vehicle repair rose by 0.8 percent for the 12 months ended December 2018. Prices for motor vehicle body work rose by 3.2 percent year-over-year (not seasonally adjusted). The BLS survey of consumer prices for motor vehicle insurance in December 2018 rose by 4.6 percent year-over-year. This is the lowest year-over-year increase in motor vehicle insurance prices in more than four years (September 2014, +4.3 percent). The year-over-year increase has been dropping because the most recent monthly changes were decreases (in November, down by 0.5 percent vs. October, and in December, down by 0.2 percent vs. November). Of course, factors other than prices for auto repair—such as the continued low level of insurers’ investment income and continued above-CPI growth in the prices for hospital care—likely are affecting these increases.
The Census Bureau computes a price index for new single-family houses under construction. The latest data (for October 2018) show a 3.4 percent increase over the index in October 2017. However, the producer price index for construction materials rose in November 2018 by 6.7 percent over the index a year earlier; it has been above 6.7 percent every month since May 2018. Moreover, it is easy to forecast that the prices of materials and labor to rebuild the homes, businesses, and other structures destroyed by the California wildfires will rise due to the sharp increase in demand that will occur as soon as it is safe to begin rebuilding.
Media stories about inflation are partly traced to belief that, since the unemployment rate for December was 3.9 percent, the economy is believed to be close to full employment, so employers will have to hike wages further to attract needed workers, and that these wage increases will morph into consumer price increases. And overall, wages have been rising above the rate of inflation, however it is measured. The Bureau of Labor Statistics reported that, on a year-over-year basis, average weekly earnings of private sector employees grew by 3.2 percent in December 2018 over the prior December. However, these economy-wide numbers obscure variations in particular industries. For example, average weekly earnings in December 2018 vs. December 2017 rose by 3.9 percent in the construction industry but by 2.2 percent in manufacturing. On the services side, average weekly earnings rose by 3.9 percent in the financial activities industry and by 6.3 percent in the information industry, but by only 2.3 percent in the education and health services industry. Wage growth affects workers compensation and, indirectly, liability and PIP claims. On the plus side, wage growth above inflation means consumers have increased buying power, which could lead to continued economic growth near-term. Similarly, retirees have more purchasing power: Social Security checks went up by 2.8 percent in January 2019.
One additional price bears watching: the price of money (interest rates). The Federal Reserve’s Open Market Committee has been raising the short-term “fed funds” rate, which affects mainly short-term interest rates, but long-term interest rates will likely have greater effects on the economy. The average yield on 10-year U.S. Treasury notes in December 2018 was 2.83 percent, up from 2.40 percent a year earlier. Many forecasters project yields on 10-year U.S. Treasury notes for 2019 to range between 2.8 and 3.4 percent. Higher long-term interest rates can be expected to have a dampening effect on economic growth, but this could be offset by the short-term enhancing effects of more money in consumer and business pockets from income-tax cuts. Higher interest rates will help P/C insurer investment income but could weigh on the capital gains element of investment gains (as the prices of currently-held low-yielding bonds fall).
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