When moving your employees to a new country, understanding the impact of cost of living on their disposable income is crucial. Basic expenses can vary greatly depending on the location, and this is where Cost of Living Adjustments come into play. In this blog, IPM’s Operations Director, Scott Niven, sheds light on the importance of factoring the Cost of Living into your Global Mobility program to protect your organisation and assignees.
What is a Cost of Living Adjustment, and How can you Calculate it?
The cost-of-living adjustment or allowance refers to an amount required to be paid to maintain the same purchasing power as at home. For moves between countries, there are a number of vendors (the three primary providers being Mercers, ECA and AirInc) that produce data two times a year that measures the prices of a basket of goods and services in each location. The items in the basket are then weighted in order of frequency in the consumption pattern (for example basic foodstuffs such as bread have a higher weighting than a cinema ticket), By applying this data between any two locations, an index can be derived which calculates whether the new location is more expensive than the home location (positive index) or cheaper (negative index), and by what % percentage increment.
It should be noted that such indices are very different to comparing to the Consumer Price Index (CPI) in a location as these will be calculated on a different basis in each country, and will include factors such as housing. Housing is usually excluded from international assignment indices as it is either going to be paid by the employer, or factored in some way into their pay. The other issue is that housing rents, especially in developing countries, are often high compared to the general cost of living for goods and services.
Cost of Living allowances are sometimes seen as contributing to “expensive” remuneration packages, but the impact of the cost of living on disposable income cannot be ignored. Cost can be controlled by reviewing which sorts of index are on offer from the vendor, as several results are produced depending on whether average prices in each location are used for example, as against average at home and high at host.
Applying the index ensures that employees can have the same purchasing power in their new country as in their previous one. To calculate the adjustment or allowance in monetary terms, the index can be applied to an agreed percentage of the employee’s net take-home pay in the home location. This percentage of net pay will never be 100% as it should only be applied to that percentage of income spent on goods and services typically around 60%. They would then multiply the figure by the exchange rates. This sum provides the net take-home pay in the new location.
Once host net pay is calculated the employer, can then either gross up for tax and social security and pay that amount (the build-up method), or use this net pay to compare against the net pay that would be derived from a local host salary for the role.
Whilst every employee is unique, and may occasionally dispute the items or weightings included in the way in which indices are calculated, the use of such data does give the employer, (when applied with tax calculations), a defined methodology to either set pay, or at least, evaluate it against what they wish to offer.
Negative Cost of Living Differences
Compensation for Cost of living often arises during salary discussions when the new location is perceived to be more expensive at home, and less so when it is cheaper or negative. A negative index, means that a deduction can be made from net pay, without the purchasing power being affected, as the individual needs less net income to buy the same goods and services. Many companies do not apply negative indices, as they wish to incentivise the employee to take the role, and feel that a deduction in the calculation does the opposite. However, the issue here can be if, for example, inflation goes up in the host location by 10%, if the host location remains cheaper than the home location, there will still be no cost of living allowance payable.
What if you are Relocating your employee permanently?
With permanent transfers, an employee will be offered a salary in the host market, and usually with no way offered by the company to evaluate what that means to them in terms of purchasing power.
If the employer provides a calculation showing the cost of living difference between the two locations, and the estimated tax and social security to be deducted from the gross salary offered, then the employee can see what the offer means for their net pay and purchasing power. Such calculations can also benefit the organisation. For instance, if you assign an employee to New York and offer a local salary of $170,000, and the suggested calculation above shows $150,000, you are aware of the extra income the employee will earn, which can be helpful in negotiations and discussions. It may also help to decide where to place them in the local pay range if there is some flexibility. It is better that all this information is on the table before they go rather than a shock with their first pay packet!
Can Incorporating Cost of Living into your Corporate Relocation Packages Make or Break Your Global Mobility Program Success?
Adding COLA to corporate relocation packages can significantly impact the success of your global mobility program. According to a study by AIRINC, employees who received a COLA adjustment were “50% more likely to report that their assignment was successful” compared to those who did not receive a Cost of Living Adjustment.
Providing a fair and consistent Cost of Living Adjustment can also help employees feel valued and supported, leading to higher job satisfaction and engagement. Further research by Deloitte stated, “An individual’s emotional wellbeing fluctuates extensively across their relocation journey”. As a result, “employee willingness is considered the number one barrier to managing a global workforce”.
In the volatility of the world economies over the last twelve months, the term “cost of living” has come to the fore. Whilst this refers to a much broader definition than we discuss here, it clearly has an impact. A cost of living index is affected by two things – price inflation in both locations between each survey and the movement of the exchange rate between the two countries. In periods of economic stability, whist both the home and host location may have different rates of inflation, any increase or decrease has not been rapid year on year, and therefore the relativity between the two has not increased dramatically. Much more under discussion in the past have been exchange rates. If for example the GBP bought USD1.3 and now only buys USD 1.2, the US has become more expensive, as the GBP buys less USD. In the last twelve months however, we have seen many European economies go from low inflation rates into double digits. If inflation in the host country has not grown by the same inflation rate, then the index will also go down. This may mean a re-evaluation by employers of which countries have traditionally been perceived as more expensive or cheaper than the home location, especially if they have not “underpinned” such perceptions with statistical cost of living data.
In summary, understanding the cost of living in a particular location is essential when moving to a country, for both the employee and the employer The cost of living can vary greatly depending on the country, but the relativity between two locations can also change year on year. By factoring the Cost of Living into your Global Mobility program, you can protect your organisation and assignees and ensure a successful relocation.
Integrated Mobility Solutions from IPM Global
At IPM Global, we understand the importance of maintaining a human touch in global mobility programs, even as technology advances. Our highly experienced mobility consultants have supported companies through recessions and world crises. We understand the speed and urgency needed when companies adapt. Juggling your assignee population while maintaining organisational compliance is a challenging feat. That is why we rely on more than our previous experience. Our team stays current on shifts and trends in global mobility, from changes to the Cost of Living Index to Political Turmoil. This commitment lets us strategically advise clients and help them achieve their commercial objectives. So if your company is considering implementing or expanding a Global Mobility program, contact us today for a friendly, no-obligation discussion.