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Health insurance has put upward pressure on the main measure of inflation, but is now swinging into reverse. This swing will act as a much-needed, albeit small, drag on inflation currently running at four-decade highs, economists say.
“With the magnitude of each forthcoming Fed hike this year hanging heavily on the latest consumer-price index print, the swing in healthcare insurance’s steady contribution could help provide the ‘compelling evidence’ of inflation slowing on a consistent basis that the FOMC is looking for to ease up on its current pace of tightening,”
Sarah House,
senior economist at Wells Fargo said in an email, referring to the Federal Open Market Committee.
However, this swing—the result of a methodological quirk—might be offset by broader price pressures building in medical services as labor costs climb.
Health insurance has contributed significantly to the sharp rise in core inflation, which strips out volatile food and energy prices, to 6.6% in September from 6.3% in August and 5.9% in July. Health-insurance prices rose 28.2% from a year earlier in September, the sharpest increase in the history of the index going back to 2006, as measured by the Labor Department’s consumer-price index. That added just less than 0.4 percentage point to September’s rise in core CPI.
But that will morph into a deflationary drag with October’s CPI, to be released on Nov. 10, as the Labor Department updates the health-insurance index’s data, an effect that will last for the next 12 months.
Omair Sharif, founder of Inflation Insights LLC, estimated the health-insurance index will decline 38% by September of next year from this past September. That would mean health insurance would go from adding around 0.38 percentage point to the 12-month increase in core inflation as of last month, to subtracting about 0.42 percentage point by next September, Mr. Sharif said.
The change to the one-month rate that shows up in October will continue at a fairly consistent pace for the next 11 months. “When we establish that new trend, this trend is likely to persist for a full year,” said Ryan Wang, U.S. economist at
HSBC.
“That’s one of the aspects of this methodological quirk.”
The Labor Department bases the price of health insurance in large part on health-insurer profits, which are reported with a lag of about 10 months. Thus, data in the October 2022 CPI reflect what happened in 2021.
This lag is currently amplifying big swings in medical-care spending. In 2020, lockdowns, limited healthcare capacity and consumer reluctance to seek care translated to lower healthcare spending and thus reduced benefits paid by insurers and commensurately increased net premium income. That showed up as skyrocketing health-insurance prices starting in October 2021, when the 2020 data were incorporated.
This year’s updated data are based on 2021, when consumers caught up on preventive care and elective procedures, eating into insurers’ premium income, which should translate to a drop in health-insurance prices in the CPI.
A swing this big will take much-needed pressure off core inflation, but it is just one concern guiding for the Federal Reserve right now, said HSBC’s Mr. Wang. “The Fed is also concerned about how broad-based inflation is.”
Moreover, the methodological quirk only affects the CPI. While that is closely watched by investors, the media and consumers, the Federal Reserve officially bases its 2% inflation target on the Commerce Department’s separate personal-consumption expenditure price index.
That index is designed to capture a broader range of prices than the CPI which focuses on consumers’ out-of-pocket expenditures. The PCE price index draws from the producer-price index, said Oscar Munoz, macro strategist at TD Securities, which includes expenditures by governments, such as through Medicare and Medicaid. Moreover, health services have a much bigger weight in the PCE price index than in CPI. The healthcare category of the PCE price index rose about 2.5% in August from the same month in 2021.
The lagged nature of the CPI’s health-insurance index means that it may not reflect current underlying price pressures in medical-care services. Those are likely building, thanks largely to labor costs. Medicare’s recently negotiated 4.3% reimbursement rate for inpatient hospital services for fiscal 2023 was the biggest increase in around 15 years. A large share of how Medicare calculates those rates is based on employment cost index data for hospital wages, said Mr. Sharif. That measure rose at an annual rate of 5.6% in the second quarter, up from 2.3% in the last quarter of 2020. The increase is likely to spill over into negotiations now under way between private insurers and hospital groups, he said.
“It feels like we’re likely to see higher medical services inflation in 2023 than we have in the last few years,” said Mr. Sharif. “The magnitude of how much higher it is, we just don’t know yet—and that is going to determine how much of the health insurance drag is going to get offset.”
Write to Gwynn Guilford at [email protected]
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