How does one know when inflation will begin to fall?
Inflation data has been surprising to the upside for several months now. However, the October 2022 Consumer Price Index (CPI) release, set for November 10, may show some relief. The source of that relief may be a significant decline in the medical care cost component of the index.
Medical Care and Health Insurance Large Components of CPI
Medical care is one of eight major groups in the CPI, accounting for approximately 8.9% of the index. Health insurance is a major category weight within the medical care, accounting for approximately 13% of the 8.9% (1.2% of total CPI).
Health insurance pricing is a figure that is extremely complicated to calculate, and because of the methodology, lags actual numbers by approximately one year. Because of the challenge in calculating an accurate number, the Bureau of Labor Statistics (BLS) bases the number on the retained earnings of health insurance companies.
Healthcare Price Index Rose During COVID; Set to Reverse
In 2000, people in the U.S. significantly reduced the number of elective doctor and hospital visits. Elective procedures that could wait until covid risks declined, simply were not getting done. However, at that time, insurance premiums continued to rise as they typically do. The result was that insurers had revenues (premiums) continue to rise, while costs (reimbursements for medical procedures) decline materially. The net result was that health insurance company retained earnings (revenues – costs) were at or near record highs. Health insurance inflation was effectively set at 2% per month for twelve months starting October 2021.
Beginning In 2021, people started returning to their doctors and hospitals for elective procedures. Health insurance payouts began to rise and retained earnings fell dramatically. That led to a significant decline in earnings vs. the pandemic peak period of 2020. Because of the one-year lag in recoding the adjusted retained earnings, the lower profits will not be reflected until the October 2022 CPI release. That release will occur on November 10, 2022.
Decline in Medical Care Cost Set to Lower CPI
The change in health insurance cost, on an annualized basis, could lead to as much as a 1% annual decline in annual inflation. Many economists are probably not factoring this into their estimates. Obviously, such a big surprise could have a very large impact on risk assets. Equity markets could rise quite significantly after the October CPI report if inflation seems to be more under control. Lower inflation, particularly if prolonged, could giving the Fed reason to pause.
