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 2.5 percent in October 2018 vs. October 2017. The core CPI—the overall index minus the effects of price changes for food and energy—rose 2.1 percent for the 12 months ending October 2018—following five months in a row in which the 12-month increase was between 2.2 percent and 2.4 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 2.0 percent on a year-over-year basis in September 2018 (the latest available reading); this is the seventh 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 2018 to range between 2.4 and 2.6 percent and for 2019 to range between 1.7 and 2.7 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 virtually disappeared. In October 2018, seasonally adjusted on a year-over-year basis, prices for inpatient hospital care rose by 2.9 percent. This is the lowest year-over-year increase in inpatient hospital prices in nearly 20 years (since December 1998). Price increases for outpatient hospital care rose by 3.0 percent in October 2018 over the prior October. This is the lowest year-over-year increase in outpatient hospital prices since July 2016. Price increases for prescription drugs over the last 18 months have been quite variable. Prescription drug prices fell in each of the first three months of 2018 and in July 2018, were flat in August, and fell in September and October; as a result, the increase in October 2018 over October 2017 was only 0.8 percent.
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 1.2 percent in October 2018 vs. October 2017. Parts-and-equipment prices have been flat or falling consistently since 2012 and are now about the level reached in May 2011. Prices for motor vehicle repair rose by 0.8 percent for the 12 months ended October 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 October 2018 rose by 6.7 percent year-over-year. This is near the lowest year-over-year increase in motor vehicle insurance prices in two years. Of course, factors other than prices for auto repair—such as the continued low level of insurers’ investment income, and the 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 September 2018) shows a 2.6 percent increase over the index in September 2017. However, the producer price index for construction materials rose in October 2018 by 6.7 percent over the index a year earlier. Moreover, it is easy to forecast that the prices of materials to rebuild the homes 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 October was 3.7 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 3.4 percent in October 2018 over the prior October. Moreover, these economy-wide numbers obscure variations in particular industries. For example, average weekly earnings in October 2018 vs. October 2017 rose by 3.6 percent in the construction industry but by 1.2 percent in manufacturing. On the services side, average weekly earnings rose by 4.9 percent in the financial activities industry, by 4.6 percent in the information industry and by 3.0 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 will have more purchasing power soon: The Social Security Administration has announced that Social Security checks will go up by 2.8 percent beginning in January 2019.
One additional price bears watching: the price of money (interest rates). The Federal Reserve’s Open Market Committee is likely to continue raising 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. The average yield on 10-year U.S. Treasury notes in October 2018 was 3.15 percent, up from 2.36 percent a year earlier (and the highest monthly average since May 2011). Many forecasters project yields on 10-year U.S. Treasury notes for 2019 to range between 2.9 and 3.8 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 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 currently-held low-yielding bonds fall).