Show notes
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.