This winter’s cavalcade of mega baseball contracts has triggered discussion of a well-worn economic theory: Inflation is behind the game’s huge contracts.
The idea has been cited by practitioners of the dismal science for at least 15 years, after A-Rod opted out of his original $252 million contract with the Yankees in 2007 and signed a new decade-long deal for $275 million. This happens, economists say, because teams during inflationary times see that a dollar tomorrow is worth less than a dollar today, and therefore feel comfortable writing bigger checks. This winter, with inflation the hottest topic in economic headlines and contracts for Aaron Judge ($360 million), Manny Machado ($350 million), Rafael Devers ($331 million) and Trea Turner ($300 million) dominating the sports pages, economists suggested MLB owners were cleverly managing their businesses. After all, if 2022’s 6.4% inflation rate persists, Manny Machado’s $35 million salary in 2033 will be worth just $18 million in today’s dollars.
“That’s a total, complete bull—- argument,” said one baseball executive, who asked not to be named because he can’t comment publicly on deals his and other teams have pursued. Long contracts, those 10 years or greater, “are very bad for teams, but they have to do them because that’s where the market is today,” he said, in a phone call. “Because players age, with contracts that long you never get on the back end the value that you should.”
Instead, he offers a counter-theory on what’s behind the lengthy deals: baseball’s luxury tax. The penalties for going over the tax threshold incentivize teams to write decade-long contracts to lower the average annual value, helping clubs stay below penalty levels. Executives calculate that the trade-off is worth it, even if the player may not be much of a contributor toward the end of the deal. It’s not a problem in the short term since MLB teams keep rising in value, averaging a total worth of $2.4 billion this year.
But there is one way inflation is affecting player contracts: It’s making them harder and more expensive to insure.
Player insurance, which reimburses teams for a large contract that goes bad because of player injury, often allows clubs to feel more comfortable signing big deals by mitigating some financial risk. But now that inflation has pushed interest rates higher, insurance premiums are rising, too. That’s because it’s costlier to borrow money throughout the financial system, according to Chris Lack, a partner at Exceptional Risk Advisors and head of its entertainment and sports insurance division. Higher interest rates have also created competition for the money that used to back insurance deals, drawing financiers away from sports.
“When money was cheaper, you could get a fairly decent return on the insurance payments. Now [investors] can take that money and put it somewhere with a higher interest rate or guaranteed return,” Lack said in a phone call. “The guys and gals who run these businesses are deciding, ‘I’m not going to do that anymore. I’m going to take my money and put it in something else.’”
As higher interest rates pull insurance capacity out of the market, it’s joining inflation in driving up coverage costs for teams while also lowering the amounts they can get covered.
“Teams are struggling to get much north of $100 million coverage [and] the cost of capital often gets prohibitive to doing a deal,” Lack said. “When you sign a guy up to a $300 million deal, if they go down early in that cycle, you can be self-insuring hundreds of millions of dollars that you can’t pay off.”
A similar dynamic is occurring in athlete loss-of-value insurance, in which players buy policies to hedge against injuries ahead of free agency or exiting college sports. “The most we’re seeing lately is $50 million [coverage],” said Lack. “The price to go from $50 to $75 million jumps exponentially.”
There’s never been an easy rule of thumb about what these deals cost, because premiums are based on age, injury history—think Carlos Correa—and position (pitchers are pricier). That’s even more difficult now because cobbling together insurance is much harder, said Lack.
There’s no point in trying to get a few smaller policies with multiple insurers, since ultimately every deal calls on the financial capacity of the same handful of reinsurers—a layer of financial companies insurers use to de-risk their own policy exposure. While insurance helped teams and venues get through the pandemic, the payouts hit insurers hard, leading many to stop writing policies in sports.
“There’s just not enough capacity in the marketplace,” Lack said. “From an underwriting and insurer perspective, we’re desperately trying to find more.”