Overestimating Inflation

I’ve worked through a number of full economic cycles in the industry, including a number of recessions, that include:

  • The double-dip recession of 1980–1982 that was worsened by the Iranian revolution and the oil crisis.
  • A recession in 1990 was caused by accumulated consumer debt and another oil price spike.
  • The recession in 2001 was driven by the dot.com (and telecom) crash and worsened by September 11.
  • The great recession of 2007 – 2009 was the result of the subprime mortgage crisis and the meltdown of Wall Street.
  • A short recession in 2020 was caused by the COVID pandemic.

Most of these recessions were followed by periods of economic turmoil, which saw fluctuating interest rates and periods of inflation – like we are experiencing now as the delayed impact of the pandemic.

There are two interesting economic phenomena that recur in times of economic turmoil. The first is that people and businesses don’t believe that interest rates will rise. This current period of rising interest rates is a great example. Anybody that’s been paying attention has been hearing from the Federal Reserve for nearly a year that it would likely have to increase interest rates. With that much warning, people and businesses with adjustable-rate mortgages and loans had a lot of warning to refinance the debt to a fixed rate – and yet many did not do so. Mortgage rates recently hit 6% and are likely to increase further, and we’re soon going to be seeing stories of families and businesses defaulting because of the increased debt payments. For whatever reason, most people and businesses don’t refinance, even with persistent warnings that higher interest rates are on the way. This seems to be a recurring theme every time we enter a period of increasing interest rates.

The other phenomenon that I’ve seen repeated over and over is that businesses overact to inflation. Once they start seeing cost increases, they begin acting like inflation will be permanent and will continue to climb steadily. It has never done that in the U.S. economy. Costs spike, but the rate of inflation invariably slows down and goes back to normal. We’re already seeing inflation slowing due to falling fuel prices – which makes sense since escalating gasoline prices was one of the drivers of inflation.

What do I mean when I say that businesses overact to inflation? One way that I see it is in helping ISPs build business plans. I have clients that want me to build perpetual inflation into future forecasts. Building never-ending inflation into a forecast can quickly make a good idea look terrible. It is extremely unlikely that inflation will continue unabated – it never has in the U.S. economy. There are parts of the world where hyperinflation is normal, such as Nigeria that has seen inflation rates of 15% – 20% annually for many years. The country adjusts for this with currency manipulation, and businesses give big pay raises every year – and the real-life impact of inflation is barely noticed. It’s just how the economy works. But we have monetary policies in the U.S. and most of the top economies that are able to quash continuous hyperinflation.

The other overreaction to inflation also comes from vendors who raise prices in anticipation of inflation instead of reacting to actual cost increases. Economists will tell you that anticipation of inflation is one of the major drivers of inflation. It becomes a self-fulfilling prophecy when enough of the players in an industry raise prices in anticipation of future higher costs, which then becomes a driver of continued inflation. There was a lot of recent talk about price gouging and excess profits, and at least some of that came from businesses and industries that raised prices in anticipation that underlying costs would increase. There is a fine line between raising prices to be safe and price gouging. This is a phenomenon that happens in every recession, and the good news is that this also self-corrects over time when people flock to sellers that didn’t raise prices, and market prices eventually stabilize and stop climbing.

One of the most interesting things about the current period of inflation is that I’m not seeing ISPs increasing to keep up with inflation. I’m sure some ISPs have raised rates, but most broadband prices have not climbed in the past six months, as might be expected from looking at prices in other industries.

There are good reasons for this that are not related to inflation. The biggest cable companies have suddenly stopped growing, and they are probably afraid that raising rates will push folks to competitive alternatives – we’ll find out for sure at the end of the year. And most smaller ISPs take direction from the behavior of their large competitors – nobody wants to raise rates if they are competing against a bigger company that isn’t raising rates.

The good news for the industry is that everything will return to normal in a year or two – it always does. Interest rates will reach a peak and then slowly drop when the Federal Reserve no longer needs to be tweaking borrowing. Inflation will slow and will return to normal trends, and everybody will forget about it until the next crisis. This doesn’t mean that there won’t be casualties. There will be ISPs that will get into trouble if they hold a lot of variable rate debt – and some may fold. There will be some new projects that get derailed when costs climb higher than expected. But overall, the broadband sector will hunker down and wait out the current trends.

 

 

Watching Health Care Costs

English: President Barack Obama's signature on...

English: President Barack Obama’s signature on the health insurance reform bill at the White House, March 23, 2010. The President signed the bill with 22 different pens. (Photo credit: Wikipedia)

I know in my own company and that at every one of my clients that health care costs are a big concern. We have gone through a decade long period where the inflation in health care costs has been in the double digits each year, much faster than any other of the costs we face.

The rate of inflation of health care costs nationwide has finally slowed. This year the nationwide rate of health care cost increase is expected to be at 5.5%. Next year the prediction is for 4.5%. Both of these rates are still higher than inflation, but a welcome relief after years of really large increases. I know in my own firm, which has been around for fifteen years that health care costs per employee have nearly tripled since we opened for business.

And those current inflation rates do not tell the true story for many firms. The 5.5% increase in health care costs this year reflects the cost of health care to employers, not overall insurance costs. And so the slower rate of health care inflation is due in part to companies are pushing higher deductibles and copays to employees as a way to keep their share of health insurance under control. Last year the amount of copays by employees rose 13% which shows that the overall increase in health insurance was a lot more than the published 5.5%.

There are some trends in the industry that hint at a possible slowing in the cost of health care. For example, there is a large industry now of out-patient health clinics that charge as much as two-thirds less than a normal doctor. There is hope that the large statewide pools that are being created under Obamacare will lower overall insurance premiums by bringing more young people (and healthier people) into the insurance pool.

There is also becoming a bigger emphasis in many health care plans of preventive care, meaning that many ailments will be nipped in the bud before they become big problems. Over time preventive care will significantly lower overall health care costs.

And hidden underneath all of these numbers is the very numbing statistic that 30% of our nationwide health care each year is spent for the process of people dying in hospitals and hospices. In recent years just about two-thirds of people die in an institution rather than their home. But this is down ten percent over a decade ago. Almost nobody wants to die in an institution and perhaps as a country we will be able to find a way to allow more people to die at home.

But for most of my clients, even if health care cost inflation slows to 4% – 5% they are facing an ugly future. Trend those increases out ten years and see if you aren’t very concerned.

There is also something to keep in mind which is that in 2018 there is going to be a tax on ‘cadillac’ health care plans. These are plans today that would cost over $10,200 for an individual or $27,500 for a family. That may sound like high caps, but these amounts count the contributions made by both the company and the employee. The tax is a whopping 40% charged to the employer on anything over the cap.

The average health care insurance cost for last year was $10,522, so there are already many plans that would be considered Cadillac. These amounts will be increased over time by inflation, but if health care costs continue to climb faster than the rate of inflation, then more plans each year will fall under the premium category and incur the premium tax.

I know that all of my clients want to provide good health care to our employees. The decision to increase copays or deductibles is a painful one for all of us. There are a few creative ideas that some companies are trying that are worth considering. One of the most interesting is the idea of handing your employees the money to buy their own health insurance. There are now ways to do this as a defined health care plan. Since having health insurance is mandatory for employees in 2014 you need to demand proof that an employee is really using the money for health care. But companies who try this say that their employees are finding ways to get cheaper plans than they could buy at the company level.

The bottom line is that health care costs are going to continue to increase faster than the rate of inflation. Add to that the worry of crossing the premium tax threshold and it is going to get harder and harder for you to pay for your employee’s health care costs. I wish I had some magic bullet to recommend, but for now the best I can offer is to do the math and see if there is anything you can do to keep this under control at your own company.