The most commonly contested part of an expatriate's salary package is the cost of living allowance. How do companies cope with the even trickier issue of applying a negative index? Scott Cullen reports.

HR managers faced with applying a negative index to salaries of expatriates moving to countries with a lower cost of living need to balance the issues of staff morale with the need for a consistent and fair approach to salary calculations.

Companies that don't apply negative indices argue that to do so would decrease staff morale and may also make it difficult to move staff to cheaper locations.

However not applying a negative index will give staff moving to those locations a windfall gain.

Consider an assignee with a spendable income of 20 000 euro, sent to a location 40 percent cheaper than his home location, thus having a COL index of 60.

If the negative index is not applied they will effectively receive a net gain of 8 000 euros.

Fine, you might say, to give them an additional incentive to take the assignment at no cost to the company. There are drawbacks, however.

First there is a cost to the company. If the assignee's salary is tax equalised there will be an additional tax burden for the company, as tax paid by a company is usually regarded as a benefit in kind.

There are other problems. If you move the assignee to a more expensive location then he will suddenly feel 40 percent worse off because cost of living is not increased.

At this point you may have a very unhappy assignee on your hands. The situation might also arise whereby employees all want to go to the cheaper locations because they know they will gain. You may find it hard to find volunteers for other locations.

Another problem arises when there is inflation in the assignment country. Cost of living may increase 20 percent but the index is still negative.

It is likely at this stage that you will have assignees demanding more cash.

Interestingly, 50 percent of ECA's members do apply negative indices so the argument between consistency and morale is pretty finely balanced. This is not the whole story though.

Reducing salaries in theory; keeping them the same in practice

On the face of it applying a negative index is reducing the salary of the assignee, however in practice this rarely happens.

Companies that apply a negative index usually give some sort of expatriate allowance or a mobility incentive.

This is given to all assignees and ensures that those going to cheaper countries do not experience a drop in salary.

What this achieves is consistency between assignments: no assignment is financially more attractive purely because of windfall gains (something that is outside the company's control).

This may however not be enough. There is an argument that reducing salary, even if adding some more on elsewhere, is still enough of a disincentive to stop staff going.

Hiding the index

A possible way around this is to 'hide' the negative index.

Instead of applying the negative index and then giving a 15 percent incentive, don't apply the index but reduce the incentive by the same amount.

This effectively applies the negative index without showing it has been used. But allowances will then vary from location to location and will need to be adjusted at salary review time.

Another interesting fact is that the percentage of companies applying a negative index falls to 35 percent when the COL is expressed separately from spendable income, while it rises to 66 percent when combined to create a host spendable.

Combining the COLA again makes the application of a negative index less obvious and may well be the best choice in this case.

Also, if the spendable income plus COLA is quoted in host currency the effect of a positive or negative index will be blurred, with exchange rate fluctuations additionally hiding the effects.

As usual though, there is no correct answer.

Not applying negative indices may well work for your company and there are reasons why a separately expressed COLA may be advantageous.

You should however be aware that not applying them could lead to more problems and cost than applying them. If you decide not to apply negative indices it is a good idea to show assignees just how much they are gaining to allay complaints when inflation occurs.

This article was first published in ECA International's monthly newsletter for members — Newsline.