Revelations on Service Contract Act H&W Inflation and the CPI Rate
“It is difficult to remove by logic an idea not placed there by logic in the first place.”
– Gordon Livingston
There is something puzzling going on with the U.S. Government’s numbers when it comes to fringe benefit costs.
Back in August of 2022, my colleague Howard Wolf-Rodda wrote a blog about the annual increase in Service Contract Act (“SCA”) health and welfare (“H&W”) fringe benefits. https://www.awrcounsel.com/blog/2022/8/17/upward-ho-new-service-contract-act-health-and-welfare-rates. He noted that the new H&W rate was increased in June 2022 to $4.80 an hour from a former level of $4.60. (Of course, if there is a sick leave executive order clause in your contract, the level increased to $4.41.) This ostensible $0.20 an hour increase in H&W rates under the SCA came to an escalation of 5%.
At the time, I told Howard I thought that increase was curiously low, because the general Consumer Price Index (“CPI”) inflation rate had just nosed over 8% - 9%. And I had seen some contemporaneous reports that the CPI sub-index had a medical services insurance component which was running close to 20% increases. Howard tried to run this to ground before posting his blog, but could not confirm what I told him, and so we punted on this subject for the August H&W blog.
On November 1o, 2022, the new CPI data was released for October 2022 and the rate was widely reported as 7.7% year over year inflation and only 0.4% core inflation for the month. This reduction in the inflation rate kicked off a wild rally on that day in the stock market, animated by bullish sentiment arising from recurrent hopes that the Federal Reserve will now moderate and then pause its interest rate hikes, and eventually pivot back to decreasing interest rates.
But if you look beyond the headline numbers and dive deep into the CPI component you will see that this biggest stock market rally in years is built at least in part on pillars of sand. Specifically, a significant portion of the supposed reduction in the inflation rate is an artifact of a massive mega-adjustment by the Bureau of Labor Statistics in the CPI sub-factor for health insurance. Here is how Wolf Richter of the Wolf Street blog, my favorite source of financial information, wisely put it:
Everyone knows that the costs of health insurance didn’t plunge in October from September. But because of the periodic adjustment, the CPI for health insurance plunged 4.0% in October from September, a 6.1 percentage-point swing from September (+2.1%), according to data from the Bureau of Labor Statistics today. This was by far the biggest month-to-month plunge in the BLS data going back to 2005, and far outstripped the adjustments in prior periods…
Inflation in health insurance is difficult to figure because numerous factors change, not just the premium but also co-pays, deductibles, out-of-pocket maximums, what is covered and what isn’t covered, etc., and there are all kinds of insurance plans out there.
So the BLS uses a different method to estimate price changes, the “retained earnings method,” which the BLS explains here, and once a year or so, it has to adjust the index as more data become available.
Normally the annual adjustment isn’t such a huge deal, but this time, the adjustment was gigantic.
The adjustment will carry forward for the next 12 months, meaning that health insurance CPI will be negative on a month-to-month basis for the next 12 months to work down the overstatement for the past 12 months.
Year-over-year, the health insurance CPI was still up 20.6%, but the year-over-year increases will be slashed for the next 11 months. It was also negative from month-to-month from August 2020 through August 2021.
Accordingly, the bottom line is that BLS has supposedly been overestimating health insurance premium increases and is now reversing that allocation by netting the excess off the future CPI calculations. This is part of the so-called hedonic adjustment in the CPI index. The health insurance weight overall in the CPI is 0.918%, and Mr. Richter says: “According to my calculations: If health insurance CPI had increased in October at the same rate as in September, YOY services CPI would have risen to 7.4%, eking past the prior month and setting new 4-decade high. In terms of core CPI, it would have increased to 6.4%.” Id.
So, therein lies the explanation for my puzzlement back in August over the tepid SCA H&W inflation rate. The CPI overestimated health insurance costs and perhaps medical service inflation in general. The SCA H&W perhaps was closer to reality. Although, I still don’t see how this explains the wide divergence in the two indexes. But as my wife frequently says to me – “Whatever.”