There are many different ways to calculate salary packages for expatriates. Companies using a home-based approach generally aim to maintain their assignees’ home country purchasing power while on assignment in the host country, so they are no better or worse off. In order to achieve this, a comparison of the cost of living in the home and host country is made. The term COLA stands for Cost of Living Adjustment and it accounts for the difference in cost of living between the assignee’s home and host location. As the cost of living can be either higher or lower in the host location, this amount can be either positive or negative.
How do I calculate COLA?
1. The majority of companies using the home-based approach use a balance sheet or build-up calculation that starts with the notional home salary. This is the typical salary you would get paid in the home country for doing the same job.
2. The notional home salary is netted down by deducting hypothetical tax and social security contributions.
3. Part of the resulting net salary is then protected for the difference in cost of living. In order to establish how much of the home net salary should be protected, the majority of companies use spendable tables or calculators which are derived from government statistics and vary according to nationality, family size and salary. These calculate the amount typically spent on day-to-day living, which is referred to as the home spendable. Some companies will use a fixed percentage (e.g. 60% of the net salary) rather than spendable tables.
4. Once the home spendable has been established, the cost of living index is applied. Those companies using ECA data have a choice of three index types which take into consideration different assumptions for the consumption pattern and price comparison. Generally, the choice of index type used will depend on the company's philosophy, and some may have intra-regional policies where a different index type is used for assignments within particular regions. The home spendable that has been adjusted for cost of living is referred to as the host spendable.
5. Lastly, the home spendable is deducted from the host spendable to arrive at the COLA.
When the COLA is used as part of a build-up calculation, the portion of home net salary not indexed is added back to the host spendable along with any assignment-related allowances and benefits, then grossed up for host country tax to arrive at the total gross assignment package.
What if the COLA is negative?
Depending on the country combination, the cost of living in the host country may be lower than in the home country, resulting in a negative COLA. The majority of companies do not currently deduct this negative COLA from the home spendable, thereby giving their assignee a windfall in the amount of the COLA and effectively increasing their standard of living in the host country.
|31% of companies apply negative indices. BUT not doing so:
|Creates erratic windfall
|Is more costly
|ECA's Expatriate Salary Management Survey 2015
Although many employers recognise that not applying negative indices conflicts with the desire for equity, they also state that it is difficult to explain a negative adjustment to the assignee. Larger international employers sending assignees to and from many countries are significantly more likely to apply negative indices as they recognise that to ignore them would significantly undermine both the equitability and cost-effectiveness of their approach.
Changes in the COLA
Apart from changes to the portion of the salary which the cost of living index is applied to, there are two other factors which affect the COLA – the exchange rate and price changes in the home and host country.
As the cost of living index and the exchange rate are linked, any changes to the exchange rate will also affect the index and thereby the COLA. If, for example, the home country currency weakens against the host country currency, more home country currency will be needed to maintain the same standard of living in the host country and the COLA will increase. For more information about how to protect your expatriate salaries from currency fluctations, please read my previous article on the topic.
Looking at price changes, the effect on the COLA will depend on the difference in price changes between the home and host country. If, for example, inflation in the home country is higher than in the host country, the difference in cost of living between the two countries is reduced and the COLA decreases.
If you need help understanding COLA or simply want to know more about ECA’s Cost of Living data, please get in touch.
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