Our experts discuss how high prices for auto insurance have been
driving inflation, and the implications for consumers and the Fed
now that price increases are due to slow.
----- Transcript -----
Seth Carpenter: Welcome to Thoughts on the
Market. I'm Seth Carpenter, Morgan Stanley's Global Chief
Economist.
Diego Anzoategui: I'm Diego Anzoategui from
the US Economics team.
Bob Huang: And I'm Bob Huang, the US Life
and Property Casualty Insurance Analyst.
Seth Carpenter: And on this episode, we're
going to talk about a topic that -- I would have guessed --
historically we weren't going to think about too often in a macro
setting; but over the past couple of years it's been a critical
part of the whole story on inflation, and probably affects most
of our listeners.
It's auto insurance and why we think we're reaching a turning
point.
It's Thursday, July 18th at 10am in New York.
All right, let's get started.
If you drive a car in the United States, you almost surely have
been hit by a big increase in your auto insurance prices. Over
the past couple of years, everyone has been talking about
inflation, how much consumer prices have been going up. But one
of the components that lots of people see that's really gone up
dramatically recently has been auto insurance.
So that's why I wanted to come in and sit down with my
colleagues, Diego and Bob, and talk through just what's going on
here with auto insurance and how does it matter.
Diego, I'm going to start with you.
One thing that is remarkable is that the inflation that
we're seeing now and that we've seen over the past several months
is not related to the current state of the economy.
But we know in markets that everyone's looking at the Fed, and
the Fed is looking at the CPI data that's coming out. We just got
the June CPI data for the US recently. How does this phenomenon
of auto insurance fit into that reading on the data?
Diego Anzoategui: Auto insurance is a
relatively small component of CPI. It only represents just below
3 per cent of the CPI basket. But it has become a key driver
because of the very high inflation rates has been
showing. You know, the key aggregate the Fed watches
carefully is core services ex-housing inflation. And the general
perception is that inflation in these services is a lagged
reflection of labor market tightness. But the main component
driving this aggregate, at least in CPI, since 2022 has been auto
insurance.
So the main story behind core services ex-housing inflation in
CPI is just the lagged effect of a cost shock to insurance
companies.
Seth Carpenter: Wait, let me stop you
there. Did I understand you right? That if we're thinking about
core services inflation, if you exclude housing; that is, I
think, what a lot of people think is inflation that comes from a
tight labor market, inflation that comes from an overheated
economy. And you're saying that a lot of the movement in the past
year or two is really coming from this auto insurance phenomenon.
Diego Anzoategui: Yes, that's exactly true.
It is the main component explaining core services ex-housing
inflation.
Seth: What's caused this big acceleration
in auto insurance over the past few years? And just how big a
deal is it for an economist like us?
Diego Anzoategui: Yeah, so believe it or
not, today's auto insurance inflation is related to COVID and the
supply chain issues we faced in 2021 and 2022. Key cost
components such as used cars, parts and equipment, and repair
cost increased significantly, creating cost pressures to
insurance companies. But the reaction in terms of pricing was
sluggish. Some companies reacted slowly; but perhaps more
importantly, regulators in key states didn't approve price
increases quickly.
Remember that this is a regulated industry, and insurance
companies need approvals from regulators to update premiums. And,
of course, losses increased as a result of this sluggish response
in pricing, and several insurance started to scale back
businesses, creating supply demand imbalances.
And it is when these imbalances became evident that regulators
started to approve large rate increases, boosting car insurance
inflation rapidly from the second half of 2022 until today.
Seth Carpenter: Okay, so if that's the
case, what should we think about as key predictors, then, of auto
insurance prices going forward? What should investors be aware
of? What should consumers be aware of?
Diego Anzoategui: So in terms of
predictors, it is always a good idea to keep track of cost
related variables. And these are leading indicators that we both
Bob and I would follow closely.
Used car prices, repair costs, which are also CPI components, are
leading indicators of auto insurance inflation. And both of them
are decelerating. Used car prices are actually falling. So there
is deflation in that component. But I think rate filings are a
key indicator to identify the turning point we are expecting this
cycle.
Seth Carpenter: Can you walk through what
that means -- rate filings? Just for our listeners who might not
be familiar?
Diego Anzoategui: So, rate filings
basically summarize how much insurers are asking to regulators to
increase their premiums. And we actually have access to this data
at a monthly frequency. Filings from January to May this year --
they are broadly running in line with what happened in 2023. But
we are expecting deceleration in the coming months.
If filings start to come down, that will be a confirmation
of our view of a turning point coming and a strong sign of future
deceleration in car insurance inflation.
Seth Carpenter: So Bob, let me turn to you.
Diego outlines with the macro considerations here. You're an
analyst, you cover insurers, you cover the equity prices for
those insurance, you're very much in the weeds. Are we reaching a
turning point? Walk us through what actually has happened.
Bob Huang: Yeah, so we certainly are
reaching a turning point. And then, similar to what Diego said
before, right, losses have been very high; and then that
consequently resulted in ultimately regulators allowing insurance
companies to increase price, and then that price increase really
is what's impacting this.
Now, going forward, as insurers are slowly achieving
profitability in the personal auto space, personal auto insurers
are aiming to grow their business. And then, if we believe that
the personal auto insurance is more or less a somewhat
commoditized product, and then the biggest lever that the
insurance companies have really is on the pricing side. And as
insurers achieve profitability, aim for growth, and that will
consequently cost some more increased pricing competition.
So, yes, we'll see pricing deceleration, and that's what I'm
expecting for the second half of the year. And then perhaps even
further out, and that could even intensify further. But we'll
have to see down the road.
Seth Carpenter: Is there any chance that we
actually see decreases in those premiums? Or is the best we can
hope for is that they just stopped rising as rapidly as they have
been?
Bob Huang: I think the most likely scenario
is that the pricing will stabilize. For price to decrease to
before COVID level, that losses have to really come down and
stabilize as well. There are only a handful of insurers right now
that are making what we call an underwriting profit. Some other
folks are still trying to make up for the losses from before.
So, from that perspective, I think, when we think about
competition, when we think about pricing, stabilization of
pricing will be the first point. Can price slightly decrease from
here? It's possible depending on how intensive the competition
is. But is it going to go back to pre-COVID level? I think that's
a hard ask for the entire industry.
Seth Carpenter: You were talking a lot
about competition and how competition might drive pricing, but
Diego reminded all of us at the beginning that this industry is a
regulated industry. So can you walk us through a little bit about
how we should think about this going forward?
What's the interaction between competition on the one hand and
regulation on the other? How big a deal is regulation? And, is
any of that up for grabs given that we've got an election in
November?
Bob Huang: Usually what an insurer will
have to do in general is that for some states -- well actually,
in most cases they would have to ask for rate filings, depending
on how severe those rate filings are. Regulators may have to step
in and approve those rate filings.
Now, as we believe that competition will gradually intensify,
especially with some of the more successful carriers, what they
can do is simply just not ask for price increase. And in that
case, regulators don't really need to be involved. And then also
implies that if you're not asking for a rate increase, then that
also means that you're not really getting that pricing -- like
upward pricing pressure on the variety of components that we're
looking at.
Seth Carpenter: To summarize, what I'm
hearing from Bob at the micro level is those rate increases are
probably slowing down and probably come to a halt and we'll have
a stabilization. But don't get too excited, consumers. It's not
clear that car insurance premiums are actually going to fall, at
least not by a sizable margin.
And Diego, from you, what I'm hearing is this component of
inflation has really mattered when it comes to the aggregate
measure of inflation, especially for services. It's been coming
down. We expect it to come down further. And so, your team's
forecast, the US economics team forecast, for the Fed to cut
three times this year on the back of continued falls of inflation
-- this is just another reason to be in that situation.
So, thanks to both of you being on this. It was great for me to
be able to talk to you, and hopefully our listeners enjoyed it
too.
Bob Huang: Thank you for having me here.
Diego Anzoategui: Always a pleasure.
Seth Carpenter: To the listeners, thank you
for listening. If you enjoy Thoughts on the Market, please
leave us a review wherever you listen; and share this podcast
with a friend or a colleague today.
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