Tips to Manage Expatriate Allowances
By Olivier Meier, Viviane McLeod-Domon, and Anne Rossier-Renaud
It is easy to start drowning in the details when designing expatriate compensation packages for long-term assignments. The ongoing pressure from management to contain costs, multiple requests for exceptions from assignees, and the ever changing local circumstances increase the complexity of the task for mobility teams. In this article we are providing five pointers to help you design packages and focus on the essentials.
- HAVING A HOLISTIC VIEW OF THE INTERNATIONAL ASSIGNMENT PACKAGE
Having your assignees argue about elements of their packages, item by item, provides a stark reminder that the individual components of the assignment package should not be discussed in isolation.
What’s the total value of the package? All too often employees are not even aware of the total cost (direct and indirect) covered by companies to facilitate their relocation.
What lifestyle will the compensation package enable? If the package includes incentives, what is the windfall that the employee could expect and is it in line with the company’s objectives?
Dismissing these questions too easily could open the door to further negotiations and requests for exceptions.
Explaining the link between the different elements in the package helps justify the total value of the package as well as show how one allowance could compensate for another one that is perceived as low by the employee. It also helps explain the real purpose of some benefits and allowances included in the package.
The value of establishing the correlation between the degree of hardship in a given location (quality of living assessment) and the need for expatriate housing is a good example. Housing is one of the most expensive items in assignment packages. Companies could be tempted to reduce it whenever possible by aligning housing allowances with accommodation costs for locals as opposed to expensive accommodation costs for expatriates based on best city areas. Such an approach is applicable only in the absence of hardship and risks in host locations.
Understanding the interactions between the different components of the expatriate package implies having a clear logic behind each of them.
- FINDING A LOGIC: EQUALIZATION ALLOWANCES AND INCENTIVES
The balance sheet approach is based on a no-win/no-loss logic. In other words, employees should not lose out by going on assignment but they should also not automatically gain just because they are expatriates.
This has implications on the way allowances and benefits are implemented and communicated. A majority of allowances in the expatriate package should be viewed as tools to ensure equalization between the home and the host locations and remove barriers to mobility. Using them as incentive (i.e. a bonus or an opportunity to gain financially) could be problematic.
The cost of living allowance is the most obvious example. Receiving a high cost of living allowance is not good news; the allowance will be used to pay for higher costs in the host location. Conversely, being told that a cost of living allowance is not necessary in the host destination should not be a cause for alarm for assignees. It could reflect the fact that prices are lower in the host location than at home and that the purchasing power of the assignee is not at risk.
Furthermore, cost of living fluctuates widely overs the years. Allowances could go down dramatically as a result of currency or inflation changes, but this evolution is not lowering the assignee’s purchasing power – this is a normal adjustment to keep the assignee’s purchasing power stable. If the cost of living allowance had initially been presented as an incentive, decreasing it could undermine the credibility of the policy.
On the other end, an expatriate allowance (or “foreign service premium”) is designed to encourage employees to accept an assignment abroad and is an incentive and not designed to cover a specific cost. Its purpose is to reward the willingness of employees to relocate to another country. A growing number of companies use this allowance sparingly to encourage specific assignee groups. It is the first allowance to be reduced or cut when companies try to reduce costs. It could also be used as a negotiating tool to sweeten the deal, something that should not be done with an equalization allowance.Once a logic has been established, one of the main objectives of the expatriation package is to ensure that the assignees’ purchasing power is protected throughout their assignment.
- MAINTAINING ASSIGNEES’ PURCHASING POWER
There are two drivers behind the evolution of cost-of-living for international assignees: home/host inflation differentials and currency fluctuations. How pay is actually delivered – in home currency, host currency, or split between the home and the host currency – determines which part of the salary could be at risk.
When relying on a home-based balance sheet approach, cost-of-living issues are addressed through the provision of cost-of-living allowances. When using a local approach however, the absence of a link to the home country doesn’t mean that assignees will not face issues linked to exchange rate and inflation differentials. Most mobile employees still expect to retire in their home country and have their savings in a preferred currency – without proper communication and planning, assignees might discover that their hard-earned savings have melted away.
|Optional approaches to pay delivery of a package based on a home-based approach||Pay Currency||Risk?|
|Host currency approach||Spendable income||Host||No risk if protected by Cost-of-living allowance|
|Non-spendable income||Host||At risk if subsequently converted into the home currency|
|Home currency approach||Spendable income||Home||Limited risk if converted abroad|
|Non-spendable income||Home||No risk if spent at home; limited risk if spent abroad|
|Split pay||Spendable income||Host||No risk if protected by Cost-of-living allowance|
|Non-spendable income||Home||No risk if spent at home; limited risk if spent abroad|
HOST CURRENCY APPROACH
The first option is to pay the entire salary in the host currency. The spendable income portion of the salary is protected by the cost-of-living adjustment, but the remaining portion is exposed to currency fluctuations that might result in loss and gains for the expatriate.
There is also something flawed in the logic of this approach: in a home-based approach, by definition, a large part of the non-spendable income amount (savings or reserve) is to be spent or used in the home country and it does not really make sense to provide this part of the salary entirely in host currency.
HOME CURRENCY APPROACH
The second approach is to pay the entire remuneration in the home currency. This approach, favored by many American companies, has some advantages. The non-spendable income part paid and spent in the home country is protected. The home currency approach provides stability, provided that the home currency stays strong.
Nevertheless, there is still a risk with the home currency approach. The expatriate must convert the spendable income into host currency to pay for daily living expenses. The timing of the exchange could lead to a loss or gain for the expatriate. The loss or gain is especially pronounced when currency volatility is high.
The third approach is the split pay approach: spendable income (which is spent in the host country) is paid in the host currency while the non-spendable income (which is meant to be spent at home) is paid in the home currency.
When setting payment policy, you also have to take into account country laws and currency transfer restrictions. As with many expatriation issues, there is no perfect delivery solution that will fit all situations. However, a clearly defined policy will reassure employees and make your job easier.
- KNOWING WHEN TO USE LUMP SUMS AND BENEFITS IN KIND
Several factors such as tax considerations and ease of management drive how allowances and benefits are delivered. This is the case with housing. Providing housing as a benefit in kind can sometimes reduce or eliminate the tax liability in some countries.
The preferences of company’s management and the expectation of the assignees also play a role. In a context of increasing policy segmentation and diversity of the workforce, meeting the expectations of the different groups of assignees can be difficult. Companies are trying to strike a balance between removing barriers to mobility for all employees and not going too far in terms of segmentation. From that perspective, using lump sums can be a way to address the needs of all employees while simplifying assignment management processes.
A traditional limitation of the lump sums is not disappearing though; employees are quick to forget the initial purpose of cash amounts they have received. The sums paid in cash to the expatriate might originally have been designed with a specific purpose in mind but that purpose could be quickly forgotten. After a few years, employees might even turn back to the company and complain that the difficulties they have faced have not been properly handled and their cost not properly reimbursed. Spousal support is an example of a benefit that cannot be easily delivered as a lump sum. Providing practical and visible support is much more effective to facilitate the relocation of a couple than just providing a cash amount, even if that amount is significant.
- ALIGNING PACKAGES WITH EMPLOYEE’S NEEDS AND EXPECTATIONS
While they are sometimes disparaged for being overpaid compared to their local peers, international assignees rarely anticipate all the financial hurdles they may have to go through later in their career. International assignees are at risk of having a fractured pension history, healthcare coverage gaps, and savings issues.
These challenges are leading a growing number of companies to provide financial education, training, and advisory services to their employees, not only expatriates.
Furthermore, a lot of assumptions are made about what international assignees value. Companies need to articulate a clear Employee Value Proposition (EVP) for their assignees – a proposition which is not limited to the allowances and benefits in the remuneration package and represents the total value an employee receives from the company: compensation, benefits, career management, workplace/lifestyle, and employee pride.
When dealing with the intricacies of expatriate allowances, it is easy to lose sight of the bigger picture. After having spent a lot of time setting competitive and consistent packages, don’t let the absence of clear value proposition undermine your efforts.