The cost of living allowance (COLA) enables expats to maintain their 'home' purchasing power while abroad. But how or even whether to implement a negative COL differential depends on the overall expat programme.

Imagine being offered a transfer to your company's headquarters in the USA.  You've been there on business, eaten out in restaurants, even been to a few grocery stores.  Things seem expensive.  But when the Letter of Understanding lands in your inbox, there's a shock waiting—a negative sign in front of the cost of living differential. 

Employees appreciate your keeping track of the negative amount

As a consequence of the relative strength of European currencies, euro- and pound-based differentials have been dipping below the 100 line for months. Companies throughout Europe are once again faced with the immediate question of whether or not to implement negative COL indices. 

According to a recent AIRINC survey of 31 leading companies with large expatriate programmes, 8 of the respondents (26 percent) implemented negative indices on a regular basis.  Other surveys place the number of companies implementing a negative COL Index as low as 14 percent.

What leads these companies to choose to implement negative differentials?  How do they manage to do it effectively?  And how do they manage to recruit expatriates to accept international assignments in the face of a COL 'Deduction'?

Ignoring a negative differential

By ignoring a negative COL differential, a company is consciously adding to the cost of an assignment.  Moreover, they are taking the 'balance' out of the balance sheet calculation used by more than 80 percent of companies. 

And yet, the most common way for companies to handle negative differentials today is to ignore them altogether.

Clearly, the main reason for ignoring a negative cost of living differential is to side-step a potentially thorny employee relations issue at the beginning of the assignment.

Moreover, many companies attempt to turn the non-implementation of the negative differential into a positive.  According to AIRINC's survey information, almost 40 percent of the companies who do not implement negative differentials nonetheless communicate to the expatriate that the differential should have been negative. 

Some go so far as to track the development of the un-implemented COLA on a time-to-time basis and communicate that figure to the employee.

Not only, the theory goes, does the company side-step the issue of a negative COLA, but it also gives the employee the benefit of the doubt and wins some public relations points in the process.  By tracking the negative amount every six months, the employee has a recurring reminder of the company's largesse on his or her behalf.

Why implement a negative differential?

Despite the difficulties in implementing negative differentials, though, more than a quarter of the world's leading companies do, in fact take money away from their assignees when cost of living is lower at the host location.  Why take the risk?

Believe it or not, the decision is not always driven purely by the desire to reduce overall programme costs.  Implementing a negative differential allows the company to respond to increasing costs on site, even when the index remains negative.

Consider, for example an employee earning EUR 90,000 per annum transferred from the Germany to Rio de Janeiro, Brazil.  The index has been calculated at 79.2.  Over a period of a year, the inflation in Rio is 10 percent.  Although this is off-set by German inflation of 1.8 percent over the same time period, the index should still increase by 8.1 percent, rising to 85.6. 

Company A decided not to implement the negative differential in the initial stages of the assignment.  In the face of 10 percent local inflation, they are unable to increase the COL subsidy, as the index remains negative.  While they are able to point out to the employee that he continues to receive more money than he should, the fact remains that the employee's standard of living has been reduced in the face of local inflation, and the company is unable to respond.

Company B, however, took the initial risk and implemented the negative differential.  When the index rose from 79.2 to 85.6, they were able to implement the change, delivering more than EUR 2,700 to the assignee on an annual basis.  They can respond to employee's eroding purchasing power in the host location as circumstances on the ground change.  And they still enjoy lower overall costs to the assignment thanks to their initial decision to implement the negative differential.

How do you implement negative differentials?

Successful implementation of a negative COL differential is driven largely by pay delivery mechanics.  Companies typically choose between one of two methods for delivering a COLA differential. 

Method one foresees the payment of the differential as a discrete amount, most commonly in home currency.  The employee sees the COL differential as a separate line item on his payslip.  The differential for purchasing goods and services is paid net of tax, and the employee is expected to transfer the money he would have spent on a similar basket of Goods and Services to the host location from the home bank account.

Method two delivers the entire host-spending amount – typically in host currency – into a bank account in the host location.  The differential is 'hidden' in that the host spending is composed of home spendable income + COL differential, converted to host currency.  The assignee, rather than seeing a discrete 'top up' figure as in method one, is presented with a budget for buying goods and services in the host location.

Companies employing a host spending, or pay-split delivery model, are much more likely to have success in implementing a negative COL differential than those who pay the COL differential as a discrete line item on the pay sheet.

However, for companies which do pay according to method one, several successful scenarios for implementing a negative differential exist. 

The most common of these is to offset some other positive allowance – housing subsidy, global mobility premium, etc. – with the negative COL differential.  Like other elements of the expatriate package, this requires regular updating and on-going implementation of new COL figures.

Conclusions

The balance sheet approach is designed to encompass the implementation of negative differentials.  Doing so keeps the notion of 'no better and no worse off' in tact.  It also allows companies to respond to changing cost levels fluidly.

However, the decision about whether or not to implement negative COL differentials is one of overall programme architecture. 

Is the expatriate package generous with other premiums, such as a global mobility premium, location premium?  Are there problems recruiting staff for international assignments?  What are the update parameters around expatriate COL data?  What are the cost constraints coming from Line Management?

Lastly, what service expectations have been established among expatriates in the system?  Are they likely to demand a high level of service and care, or are they content to have the assignment proceed with minimal on-going involvement?

The decision about how or even whether to implement a negative COL differential must make sense as part of a holistic approach to programme management.

April 2005

John Pfeiffer is the managing director of AIRINC Europe (www.air-inc.com).

Subject: Cost of living, compensation.