Inflation Watch - February 2019

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 1.5 percent in February 2019 vs. February 2018. 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 February 2019—the seventh month in a row in which the core 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 food and energy. The core PCE deflator—the inflation measure that the Federal Reserve prefers—rose by 1.9 percent on a year-over-year basis in December 2018 (the latest available reading). This is the 10th 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 1.5 and 2.2 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 disappeared. In February 2019, seasonally adjusted on a year-over-year basis, prices for inpatient hospital care rose by 1.2 percent. The February 2019 year-over-year increase is the lowest year-over-year increase in inpatient hospital prices in more than 20 years (BLS data go back only to February 1997). Price increases for outpatient hospital care rose by 2.1 percent in February 2019 over the prior February. This is the lowest year-over-year price increase for outpatient hospital services in more than 30 years (BLS data on outpatient hospital prices go back to January 1987). A price index for prescription drugs on a year-over-year basis as of February 2019 fell by 1.2 percent. This is quite rare: since September 1973, before December 2018, it happened only once before (in July 2013). Year-over-year prices for prescription drugs fell often in 1971 through 1973. A falling year-over-year price for prescription drugs has now occurred three months in a row. The prescription drug price index is now back to where it was in mid-2017.

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 1.9 percent as of February 2019 vs. February 2018. Although this is a moderate rate of increase, it could be an early phase of a seriously adverse trend. Beginning in December 2017, parts and equipment prices generally rose by roughly 0.3 percent in most months. Some believe that 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 severity seems likely to be affected. Prices for motor vehicle repair rose by 1.1 percent for the 12 months ended February 2019. Prices for motor vehicle body work rose by 2.6 percent year-over-year (not seasonally adjusted). The BLS survey of consumer prices for motor vehicle insurance in February 2019 rose by 2.0 percent year-over-year. This is the lowest year-over-year increase in motor vehicle insurance prices in more than 10 years (April 2008, +1.7 percent). The year-over-year increase has been dropping because the most recent monthly changes were decreases (in November, down by 0.2 percent vs. October, in December, down by 0.1 percent vs. November, and in January, down by 0.2 percent vs. December). Of course, factors other than prices for auto repair—such as the dropping prices for hospital care—likely are affecting these auto insurance price calculations.

The Census Bureau computes a price index for new single-family houses under construction. The latest data (for December 2018) show a 4.7 percent increase over the index in December 2017. However, the producer price index for construction materials rose in January 2019 by 6.0 percent over the index a year earlier; it has been above 6.0 percent every month since May 2018.

Media stories about inflation are partly traced to belief that, since the unemployment rate for February 2019 was 3.8 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 3.1 percent in February 2019 over the prior February. 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. However, it is possible that higher wages will not lead to inflation; this could happen if higher wages are accompanied by higher worker productivity, which is what happened in 2018. Productivity last year grew by 1.8 percent, roughly triple the growth rate since the Great Recession. This is a one-year statistic and it is so different from the prior decade that this could simply be a mis-measurement, but if it is sustained we could see low unemployment and rising wages simultaneously. And retirees have more purchasing power than last year: 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 had 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 February 2019 was 2.68 percent, down from 2.86 percent a year earlier. Many forecasters project yields on 10-year U.S. Treasury notes for 2019 to average between 2.7 and 3.1 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).