Inflation and Insurane

I like this presentation by Bob Hartwig at the III (haven’t finished it yet).

I find his treatment of real vs nominal variables frustrating, though. The CPI measures what people spend on stuff and is ultimately driven by wages, imho.

Wages might drive many insurance prices (rating basis for insurance costs for many companies is their payroll). But, realistically, insurance rates are not set by some theoretical link between the driving variable (wages or whatever) but by claims experience. Any changes from ‘inflation’ are competed away if the claims don’t show up. What drives claims? Well, of course they’re driven by changes in some components in the CPI, among many other things (legislative changes, exogenous shocks, etc). But this year’s claims cost is often driven by the CPI level from when the claim occurred, which may be years in the past. So there’s a lag. Tough to predict.

Bob’s an economist, so he lives and breathes ‘economic’ variables and probably doesn’t often dig into his preconceived notion of what they measure. Inflation is different depending on what you’re doing. I imagine the correlation between changes in the driving variable for an insurance policy (wages or whatever) and the actual claims cost changes is much smaller than one would think. I’d bet real money it’s less than 0.5 in the short/medium term (1-5 years).