As the U.S. economy grapples with a broad retreat in inflation, a new financial protagonist is expected to emerge this October: health insurance. Economists predict that health insurance, which has seen a steady decline in prices by 3% to 4% monthly since October 2022, will reverse its course and start to buoy inflation for about a year, beginning with a modest increase of just over 1% month over month in the Consumer Price Index (CPI) for health insurance.

This shift is not only significant but also timely, given that policymakers are currently leveraging inflation data to determine the appropriate adjustments to interest rates. The underlying catalyst for this dynamic is an unusual method employed by the U.S. Bureau of Labor Statistics (BLS) to gauge changes in health insurance costs. Rather than measuring direct consumer costs such as monthly premiums, the BLS assesses health insurance inflation indirectly, with health insurers’ profit margins serving as a proxy for consumer prices.

Health Insurance Prices to Increase Inflation for Next Year

Starting from October, health insurance is set to counteract the current decreasing trend of inflation in the U.S. economy. Economists propose that for approximately a year, health insurance will act as a supporting force, causing a surge in inflation. This comes at a crucial time, when inflation data is being used by policymakers to determine interest rates.

The Intricacies of Measuring Health Insurance Inflation

Health insurance prices are notoriously difficult to quantify. The U.S. Bureau of Labor Statistics, responsible for publishing the consumer price index (CPI), an important measure of inflation, does not consider direct consumer costs such as monthly premiums. The reasoning behind this approach is that insurance plans vary greatly in terms of benefits and risk factors, making a direct comparison challenging and subjective.

Instead, the agency calculates health insurance inflation indirectly, using profit margins of health insurers as an approximate measure of consumer prices. These calculations are updated annually in October.

Impact of Health Insurance Profits on Inflation

During the early stages of the Covid-19 pandemic, health insurers’ profits saw a significant increase as consumers continued to pay premiums but were largely prevented from using their insurance for elective procedures. However, as consumers started using their insurance more frequently in 2021, insurers’ aggregate profits decreased due to an increase in the payout of insurance benefits compared to 2020.

As we move into October, the Bureau of Labor Statistics will update its calculations to reflect insurers’ profits in 2022, which were stronger than the previous year. This change in dynamics will be reflected in the forthcoming CPI update.

The Significance of Health Insurance Inflation

The U.S. Federal Reserve has been raising interest rates aggressively since last year to combat high inflation. Despite significant reductions from a peak of 9.1% during the pandemic era in June 2022 to 3.7%, inflation rates are yet to return to their target.

Any factors that maintain high inflation could increase the chances of the Federal Reserve raising borrowing costs again. Policymakers often prefer to use a measure of inflation that excludes volatile food and energy prices, known as "core" inflation.

For inflation to return to its target, consistent core CPI readings of about 0.2% a month are required. The health insurance index has been reducing the core CPI by about 0.03% a month. However, starting in October, it is expected to increase the core CPI by over 0.01% a month.

Takeaways

Although the impact of health insurance on the core CPI may seem small, it is significant when every basis point on inflation counts. The rise in health insurance prices is set to counteract the current retreat of inflation in the U.S. economy, providing a unique dynamic for policymakers to consider when determining interest rates. This highlights the need for comprehensive and nuanced understanding of the various factors influencing inflation.