Inflation Watch - January 2018

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’s Bureau of Labor Statistics (BLS). The media are beginning to report increases in inflation. A recent Wall Street Journal headline blared, “Inflation Gauge Increases” next to another headline, “Overheating Economy Not a Worry, Cohn Says”, but it is hard to see what the excitement is about. For example, the Producer Price Index of prices for final demand, seasonally-adjusted, rose by 0.4 percent in January 2018 over December 2017, but in the previous month (December 2017 over November 2017), final demand prices were flat. Most economists prefer a year-over-year time frame to avoid the additional complication of seasonal adjustment; by that measure the PPI final demand index rose 2.7 percent in January. It has been in the middle 2 percents for about a year.

The CPI-U—the popular measure of consumer prices, sometimes called headline inflation—rose by 2.1 percent in January 2018 vs. January 2017. Core inflation—the overall index minus the effects of price changes for food and energy—rose 1.8 percent for the 12 months ended January 2018. (Most economists prefer to use the core—not the headline–-inflation measure to avoid the “noise” of volatile prices for those items.) The BLS year-over-year core CPI rate has been 1.8 percent or 1.7 percent since May 2017. By most measures, the U.S. economy is still growing, but capacity constraints might increase the likelihood of near-term price increases. Many forecasters project headline CPI for 2018 to range between 1.9 and 2.7 percent.

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 outpaced both headline inflation and the overall price index for medical care, and this is still true today. In January 2018, seasonally adjusted on a year-over-year basis, prices for inpatient hospital care rose by 4.2 percent. Seasonally adjusted prices for outpatient hospital services rose by 4.9 percent in January 2018 over January 2017. Price increases for prescription drugs have been moderate lately, rising by 2.4 percent in January 2018 over January 2017—barely ahead of core inflation.

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, fell by 0.3 percent in January 2018 vs. January 2017. Prices for motor vehicle repair rose by just 0.9 percent for the 12 months ended January 2018. Prices for motor vehicle body work rose by 2.4 percent year-over-year (not seasonally adjusted). The BLS survey of consumer prices for motor vehicle insurance in December 2017 rose by 8.5 percent year-over-year. Of course, many factors other than prices for auto repair—such as the continuing drop in insurer investment income, and continuing above-CPI growth in the cost for intensive medical care, and an unusual upturn in the collision rate, which is related to the increase in the number of people employed (and adding cars to rush hour)—likely are affecting these increases.

Some prices relating to property insurance claims have varied recently. For example, the Census Bureau computes a price index for new, single-family houses under construction. The latest data for December 2017 shows a 2.4 percent increase over the index in December 2016.

The inflation fears referred to above are partly traced to concern that, since the economy is nearing or is full employment, further wage increases will morph into consumer price increases. The Bureau of Labor Statistics reported that, on a year-over-year basis, average weekly earnings of production and nonsupervisory employees—which is the vast majority of workers—grew by 2.4 percent in January 2018 over the prior January, but these economy-wide numbers obscure significant variations in particular industries. For example, average weekly earnings in January 2018 vs. January 2017 rose 3.1 percent in the construction industry, 2.8 percent in manufacturing, and 4.5 percent in the mining/drilling/logging industries. On the services side, they rose 3.9 percent in the leisure/hospitality industry, 1.6 percent in the financial activities industry, but only 0.7 percent in the information industry. Wage growth affects workers compensation and indirectly, liability and PIP claims. Wage growth above inflation means consumers have increased buying power, which could lead to stronger economic growth near-term.

One additional price bears watching: the price of money (interest rates). The Federal Reserve Open Market Committee is likely to continue through 2018 to raise the short-term “fed funds” rate, which often drives interest rates for longer-term loans. Long-term interest rates will likely also rise because of substantial additional borrowing by the federal government, both because of the recently-enacted federal income tax changes and the subsequent budget agreement. 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 the 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 low-yielding bonds fall.