The latest inflation scourge: Car insurance

It’s always something. The overall rate of inflation is getting back to normal, and some prices are actually dropping. But American drivers have a new budget-buster to deal with: soaring car-insurance costs.

Car insurance costs were 20.3% higher in December than they were a year earlier, with the average annual premium costing $2,542, according to Bankrate. That’s the biggest jump in car insurance costs in government data going back to 1985.

While the global COVID pandemic that started four years ago is over, some economic distortions are still moving through the pipeline, and auto insurance is one of them. Car insurance inflation has actually gotten so high that it’s now affecting Federal Reserve decision-making about when it’s safe to declare victory over inflation and start thinking about interest rate cuts. The answer seems to be: not quite yet.

Like a multicar pileup, COVID triggered a chain reaction of supply and demand distortions in the automotive industry that’s still uncoiling. Supply chain snafus and a semiconductor shortage caused a dearth of new vehicles in 2021 and 2022. The result was the usual outcome when demand exceeds supply: soaring prices. The average cost of a new car spiked by 22% from March 2021 through December 2022, according to Cox Automotive. Americans were paying nearly $50,000 on average for a new car.

More expensive cars cost more to maintain and repair, as you can see by clicking through the charts below. Maintenance and repair costs began to surge about a year after car prices took off.

Other factors not related to supply and demand are part of the story too. Newer cars are stuffed with sensors and other electronics that cost more to fix when there’s a problem. Global warming is causing more severe weather and more vehicles destroyed in floods and storms. Also, Americans actually drove faster during COVID when the roads were clearer, a habit that seems to have stuck around and is now causing more severe accidents.

Insurers are now catching up and raising premiums to account for unforeseen losses of the last several years. Car insurance isn’t usually a headline item economists focus on, but it’s enough of the typical family budget to cause problems when it’s rising by a lofty 20%. Car insurance accounts for 2.5% of the goods and services the government measures when calculating inflation, just slightly less than gasoline — which gets much more attention.

The good news about inflation is that goods have begun to fall in price, with a slight drop in the cost of all goods from August through December of last year. That’s likely to continue. The rising costs of services is the only thing keeping inflation from dropping back to the Federal Reserve’s 2% target. Service inflation is still 4.9% year over year, keeping overall inflation at 3.4%.

The biggest service category is housing, which is still rising at an uncomfortable 4.8% per year. But there’s real-time data showing that the cost of new leases has been declining for several months, which will soon start to show up in the lagging government data as a moderation or even outright decline in rent and housing inflation.

That makes car insurance and other auto-related types of inflation far more important than usual. Tom Lee of investing firm Fundstrat points out that in the latest inflation data, the rising cost of auto insurance alone accounted for one-fifth of the rise in “core CPI,” which is the underlying level of inflation excluding volatile food and energy prices. “That is punching way above its weight,” Lee wrote in a January research note.

After the Fed’s latest interest rate meeting, Chair Jerome Powell pointed out that while goods inflation is falling, services inflation is not. “The services sector would have to contribute more,” he said, meaning that lower services inflation will be necessary for the Fed to relax about inflation. He didn’t single out car insurance, which counts as a service, but he certainly could have, given that it may be the only major category where inflation is in the double digits and getting worse, not better.

The cost of homeowners insurance is also rising, for some of the same reasons, namely rising home value and worsening weather that’s causing more destruction. In government data, the cost of homeowners insurance is bundled in with shelter and not broken out, so it’s hard to measure as easily as car insurance. Bankrate, however, says the average annual homeowner’s premium rose by 18% during the last year, to $1,687. That takes a smaller bite out of the typical paycheck than car insurance, but it stings all the same, creating a double whammy for people who have to insure both a car and a home.

Automotive costs do seem to be turning a corner. The cost of a new car has drifted down by about 2.3% from the peak it hit at the end of last year. Maintenance and repair costs are flattening out. Since insurance costs lag, they could start to moderate or drop within a year or two. Once prices have gone up, of course, businesses like to keep them there, so it could take aggressive consumers price shopping and demanding discounts to bring insurance costs back down. Tell them the Fed sent you. 

Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman.

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