By Telis Demos

Car-insurance rates can be one key to slowing inflation. But auto insurance may be among the financial products ultimately most sensitive to tariffs, because of the effect those levies can have on car parts and used vehicles.

Besides threatening tariffs against North America trading partners, President Trump also has announced tariffs on steel and aluminum, and said he is planning levies on imported semiconductors. Last week, he said he would soon implement "reciprocal tariffs" that would seek to equal the tariffs that other countries are imposing on the U.S.

If these tariffs were to drive up the cost of imported auto parts, they can in turn affect what it costs to repair a car. And if new cars become more expensive, that can drive up demand and prices for used cars as well, which again can make it costlier to insure and replace a vehicle.

Car-insurance costs have surged in recent years. As recently as the middle of last year, the cost of motor-vehicle insurance was rising by 20% or more year-over-year, as measured by the monthly U.S. consumer-price index. Insurance cost increases have slowed but were still rising more than 11% as of December. Motor-vehicle insurance represents about $3 out of a $100 basket of goods measured in the CPI.

Cost increases for motor-vehicle parts and equipment surged at the end of 2021 and in 2022 but have sharply slowed since then. Increases in motor-vehicle repair costs overall, which reflect the labor involved, also have slowed but accelerated slightly in December.

The tricky thing about insurance is that pricing changes can be a long and slow cycle. Claim costs that jump today might only begin to show up in premium rates a year or two later. The Federal Reserve has been watching this lag effect carefully, often noting it as one reason that inflation measures still appear a bit stubbornly high.

This is because in standard, state-regulated insurance policies, like most auto and home policies, it isn't easy for insurers to pre-emptively add to their pricing based on a future risk. They have to point to things driving up their costs right now when asking regulators for higher rates in the future. Plus, once a policy is written, that is the price until it is up for renewal.

In response to an analyst's question about tariff policy, Michael Klein, the president for personal insurance at Travelers, said on an earnings call in January that "as opposed to trying to predict it, we're looking at our prospective view of rate adequacy." He added: "We'll reflect any changes in our pricing when and if we know what they are, and then factor that into the calculus at that point in time."

The American Property Casualty Insurance Association, an industry group, in a recent statement noted that about six out of every 10 auto replacement parts used in U.S. shops are imported from Mexico, Canada and China. Basing its analysis on 25% across-the-board tariffs for imports from Canada and Mexico and 10% for Chinese imports, the association estimated that the potential on increased claim costs for personal auto insurers could be well over $7 billion.

Much depends not just on the level of tariffs, but also their duration, as well as any carve-outs that might be negotiated, such as any specific to autos. Relatively brief tariffs might not lead to major price increases, as existing inventories are tapped, or temporary substitutions are found.

But even what might seem like relatively modest tariffs can have an impact, if they hit key products. The Insurance Information Institute, or III, performed a stress-test analysis of replacement costs for property-and-casualty lines using a global baseline tariff of between 3% and 7% on key goods and commodities relevant to repair and replacement. According to this analysis, the average replacement cost across the lines would increase by as much as 7.7 percentage points above consumer-price index inflation over the 24 months following such an official tariff announcement.

The analysis didn't contemplate long-term double-digit tariffs. "The impact of double-digit tariffs is less about forecasting cost increases, and more about determining how long before impacted goods are no longer economically viable to produce or purchase," said Michel Leonard, III's chief economist and data scientist.

Some things could help offset tariff increases in claims' costs or in rate increases. For one, insurers already have sought higher rates in recent years, so perhaps they will have some adequate cushion, and would rather aim to compete to gain market share with relatively steady rates. Another would be if car-repair labor costs were to decline, or if repairs moved more quickly, reducing the amount of time insurers had to cover the costs of, say, renting a replacement car.

But the bottom line is that if tariffs make it more expensive to produce, repair and insure cars in the U.S., the impact on insurance in particular could linger for years.

Write to Telis Demos at Telis.Demos@wsj.com

(END) Dow Jones Newswires

February 12, 2025 05:30 ET (10:30 GMT)

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