Expatriate International Cost of Living

A Cost of Living Allowance (COLA) is a salary supplement paid to employees to cover differences in the cost of living, particularly as a result of an international assignment.

The amount of COLA should enable an expatriate to be able to purchase the same basket of goods and services in the host location as they could in their home country. The basis for calculating a COLA is the Cost of Living Index (COLI) which indexes the costs of the same basket of goods and services in different geographic locations. COLA is a simple accurate method of measuring fluctuating salary purchasing power and ensuring parity.

Cost of Living Index
Our cost of Living Indexes measure the cost of 230 products and services across 13 different basket groups in 276 cities across the globe. The data is gathered by a team of research analysts who survey comparable items that are available internationally. A minimum of 3 prices for the same brand/size/volume of product is used to determine the average price for each item in each location. The items are priced on a quarterly basis and tend to rise and fall with inflation. The 13 different basket categories are as follows:
• Alcohol & Tobacco: Alcoholic beverages and tobacco products
o Alcohol at Bar
o Beer
o Cigarettes
o Locally Produced Spirit
o Whiskey
o Wine
• Clothing: Clothing and footwear products
o Business Suits
o Casual Clothing
o Children’s Clothing and footwear
o Coats and hats
o Evening Wear
o Shoe Repairs
o Underwear
• Communication
o Home Telephone Rental and Call Charges
o Internet Connection and service provider fees
o Mobile / Cellular Phone Contract and Calls
• Education
o Crèche / Pre-School Fees
o High School / College Fees
o Primary School Fees
o Tertiary Study Fees
• Furniture & Appliances: Furniture, household equipment and household appliances
o DVD Player
o Fridge Freezer
o Iron
o Kettle, Toaster, Microwave
o Light Bulbs
o Television
o Vacuum Cleaner
o Washing Machine
• Groceries: Food, non-alcoholic beverages and cleaning material
o Baby Consumables
o Baked Goods
o Baking
o Canned Foods
o Cheese
o Cleaning Products
o Dairy
o Fresh Fruits
o Fresh Vegetables
o Fruit Juices
o Frozen
o Meat
o Oil & Vinegars
o Pet Food
o Pre-Prepared Meals
o Sauces
o Seafood
o Snacks
o Soft Drinks
o Spices & Herbs
• Healthcare: General Healthcare, Medical and Medical Insurance
o General Practitioner Consultation rates
o Hospital Private Ward Daily Rate
o Non-Prescription Medicine
o Private Medical Insurance / Medical Aid Contributions
• Household: Housing, water, electricity, household gas, household fuels, local rates and residential taxes
o House / Flat Mortgage
o House / Flat Rental
o Household Electricity Consumption
o Household Gas / Fuel Consumption
o Household Water Consumption
o Local Property Rates / Taxes / Levies
• Miscellaneous: Stationary, Linen and general goods and services
o Domestic Help
o Dry Cleaning
o Linen
o Office Supplies
o Newspapers and Magazines
o Postage Stamps
• Personal Care: Personal Care products and services
o Cosmetics
o Haircare
o Moisturiser / Sun Block
o Nappies
o Pain Relief Tablets
o Toilet Paper
o Toothpaste
o Soap / Shampoo / Conditioner
• Recreation and Culture
o Books
o Camera Film
o Cinema Ticket
o DVD and CD’s
o Sports goods
o Theatre Ticket
• Restaurants, Meals Out and Hotels
o Business Dinner
o Dinner at Restaurant (non fast food)
o Hotel Rates
o Take Away Drinks & Snacks (fast Food)
• Transport: Public Transport, Vehicle Costs, Vehicle Fuel, Vehicle Insurance and Vehicle Maintenance
o Hire Purchase / Lease of Vehicle
o Petrol / Diesel
o Public Transport
o Service Maintenance
o Tyres
o Vehicle Insurance
o Vehicle Purchase

Each basket category does not count equally and are weighted in the final calculation based on expatriate spending patterns.

In order to calculate an accurate cost of living index for a specific individual the basket items that are not relevant to the individual should be excluded from the calculation. For example if education and housing is provided by the employer these basket categories would be excluded from the cost of living index calculation. This increases the accuracy of the cost of living index and makes it possible for each individual to have their own customized cost of living index based on their specific arrangements rather than using an overall “generic” index which is likely to contains costs that are not relevant to the individual.

The formula for calculating the specific cost of living index for an international assignment is as follows:

Cost of Living Index = Customized Cost of Living Index for Host City / Customized Cost of Living Index for Home City

When moving to a higher cost of living host city, the index will be greater than 1 (positive). When moving to a lower cost of living host city the index will be less than 1 (negative). Where the index is negative it means that in real terms the cost of living in the host city is lower than the home city. This means that if the negative index where to be applied to the employee’s salary, they would actually be paid proportionately less spendable salary in the host city. It is important to note that the majority of organizations do not apply a negative cost of living index because it makes it difficult to persuade an employee to take up an assignment as they tend to see it as a reduction in salary.
Examples of Cost of Living Index Calculations using our data:

Example 1) An Australian employee moving from Perth to London where healthcare and communication will be provided by the employer

More Expensive in London:
• Alcohol & Tobacco +4.77%
• Clothing +21.85%
• Education +31.53%
• Furniture & Appliances +16.03%
• Groceries +16.35%
• Household +50.72%
• Miscellaneous +137.47%
• Personal Care +11.18%
• Recreation & Culture -6.82%
• Restaurants Meals Out and Hotels +34.99%
• Transport +19.80%

The overall difference in cost of living moving from Perth and London is +28.06%.

In this case the cost of living index is positive and would be applied as it is.

Example 2) A British employee moving from London to Mumbai where the employer will provide housing and education

More Expensive in Mumbai:
Alcohol & Tobacco -37.53%
Clothing -9.58%
Communication -44.92%
Furniture & Appliances -19.31%
Groceries -24.03%
Healthcare -31.24%
Miscellaneous -72.43%
Personal Care -24.94%
Recreation & Culture -35.73%
Restaurants Meals Out and Hotels -33.11%
Transport is -27.99%

The overall difference in cost of living moving from London Mumbai is -30.53%.

In this case the cost of living index is negative and would not be applied.

Net Spendable Salary

Differences in cost of living only impact the portion of the salary that is spendable in the host country. Items in the home country such as retirement funding, medical insurance and other home based costs are not impacted by the cost of living in the host country.

To determine the Net Spendable Salary establish what amount / portion of the current salary (in home currency) is spent in maintaining the employee’s current standard of living / lifestyle. What will the expatriate need to spend their salary on in the host country? For example will accommodation be provided or will the employee pay rent, will healthcare be provided etc. Deduct all items that are either provided in kind or are spendable in the home country. Deduct the hypothetical amount of tax, social contributions and any other statutory deductions applicable in the home country from the Spendable Salary. What is left is the Net Spendable Salary.

Cost of Living Allowance (COLA)
The formula for calculating the cost of living allowance using the above inputs is as follows:

(Net Spendable Salary X Cost of Living Index X Hardship Index X Exchange Rate) less (Net Spendable Salary X Exchange Rate) = COLA

Examples of COLA Calculations using our data

Example 1) An Australian employee with a net spendable salary of AUD$100,000 moving from Perth to London where healthcare and communication will be provided by the employer

($100,000.00 X 1.2806 X 1 X 0.4768) less ($100,000.00 X 0.4768) = COLA of £13,379.44 (GBP)

Based on all the above factors a person would require a Cost of Living Allowance of £13,379.44 (GBP), in addition to their current salary of 100,000.00 Australian Dollar (AUD) to compensate for relocating from Perth to London. This Cost of Living Allowance compensates for the overall cost of living difference of +28.06% and the relative difference in hardship of 0%.

Example 2) A British employee with a net spendable salary of £18,000 moving from London to Mumbai where the employer will provide housing and education

Note: Because the Cost of Living Index is negative it is not applied.

(£18,000.00 X 1 X 1.3 X 67.2852) less (£18,000.00 X67.2852) = COLA of 363,340.32 Indian Rupee

Based on all the above factors a person would require a Cost of Living Allowance of 363,340.32 (INR ), in addition to their current salary of £18,000.00 British Pound (GBP ) to compensate for relocating from London to Mumbai. This Cost of Living Allowance compensates for the overall cost of living difference of [-30.53%] and the relative difference in hardship of 30%.

COLA Payment
The COLA is paid as a salary supplement (i.e. as an additional allowance) net of tax in the host country. If the COLA is a taxable allowance in the host country it should be grossed up in order that the full amount of calculated COLA is paid net of tax given that the basis of the calculation is Net Spendable Salary. The COLA is often accompanied by other allowances and benefits such as flights home, relocation / settling in allowance, and furnishing allowance.

Exchange Rate Fluctuations
Significant changes in the exchange rate can make a considerable difference in the COLA calculation. In 2008 some of the major global exchange rates changed by as much as 30-40%.

The cost of living index reflects the changes caused by inflation and exchange rates. In the short-term there may be disequilibrium between inflation and the exchange rate (the one pushes the other), however over time the cost of living index provides the most accurate view of the cost of living.

It is important to remind expatriates that when the cost of living difference is negative, and the negative value has not been applied, they have higher purchasing power in the host country than they would at home.

Where a negative cost of living index has not been applied (our recommended approach), and a change in the exchange rate indicates an upward adjustment in COLA may be required, it is recommended that the COLA should not be adjusted upward until the cost of living index becomes positive i.e. the cost of living reflects that there is a “real” increase in cost of living between home and host countries. This may mean that their would be no increase in the COLA as a result of exchange rate fluctuations for some considerable time. During this time the employee’s purchasing power decreases. But it is important to remember that until the cost of living difference becomes positive, the individual will still have a higher purchasing power than they do in their home country.

It is advisable to stipulate a currency protection rule, rather than reacting to every fluctuation in the exchange rate. For example the rule may state that COLA will be reviewed if exchange rates or local inflation move by more than +10% during a year. It is important to keep in mind that the prices of goods and services are unlikely to drop in local currency. This would only occur in a period of deflation (negative inflation). Therefore the currency protection rule would normally make provision for upward adjustments in COLA and not downward adjustments during an employee’s assignment. Downward adjustments to an existing COLA due to exchange rate fluctuations without a corresponding drop in the prices of local goods and services puts immense pressure on an employee’s host currency budget commitments and can lead to the employee experiencing financial difficulty.

Using an independent service provider provides an independent, objective basis for determining an employee’s COLA.

We recommend therefore that a COLA is calculated by applying the specific (customized) cost of living index to the net spendable salary at the beginning of the assignment and monitoring exchange rate fluctuations thereafter in addition to the annual salary review.

Steven Coleman runs the most comprehensive international cost of living website available Xpatulator.com an internet service that provides free cost of living and hardship information for 276 global locations to registered users. The premium content calculators allow you to customise your own cost of living index by choosing your own basket groups and includes a COLA calculator. Follow Steven on twitter
steveninseattle.

The challenges of ensuring expatriates are paid fair salaries across different countries, in the current economic climate, of the credit crisis together with rapid currency and inflation fluctuations are increasingly complex.

The current economic climate has made it necessary to constantly review expatriate salaries. Rapidly fluctuating exchange rates and inflation can increase or decrease the amount of salary paid, and significantly impact purchasing power both positively and negatively in a very short period of time. The approach many organizations have taken is to convert a spendable percentage (typically 60%) of the expatriate’s salary into the host country currency on a monthly basis and to provide non-cash benefits such as accommodation, transport, education of children etc. This can result in employers paying too much or too little salary in these volatile times.

Too Much: The expatriate experiences short-term upside, as a result of a change in the exchange rate. A fall in the value of the host country currency against the home country currency, without an increase in the prices of goods and services in the host country, results in the expatriate having increased purchasing power. It may appear for a while that all is well. The expatriate has an unexpected windfall. A wise expatriate will save this windfall knowing that the situation will not be permanent. Either the exchange rate will adjust back to where it was or prices and inflation will begin to increase until economic equilibrium is achieved. The reality is, that in the short-term the employer will be faced with increased overall salary costs, and will eventually have to deal with disappointed expatriates when the trend inevitably reverses itself and their purchasing power drops again to realistic levels.

Too Little: The expatriate experiences short-term downside as a result of a change in the exchange rate. An increase in the value of the host country currency against the home country currency, without a decrease in the prices of goods and services in the host country, results in the expatriate having reduced purchasing power. This is when the employer faces complaints from expatriates unable to make ends meet. Prices of goods and services have remained the same in the host country but as a result of the change in the exchange rate, the expatriate receives less salary in local currency. In the long term either the exchange rate will adjust back to where it was, or prices and inflation will begin to decrease until economic equilibrium is achieved. The reality is that in the short-term the employer will be faced with decreased overall salary costs and will have to deal quickly with unhappy expatriates.

Clearly the approach on converting a portion of the salary into host country currency on a monthly basis does not work any more.

The expatriate compensation questions that employers must consider:

-What amount of salary will ensure that the expatriate will have the same purchasing power overseas as they have at home?

-What process / tool will be used to ensure the salary retains its purchasing power when inflation and exchange rates change?

New Approach: The ideal approach is for the employer to decide on a process / tool that establishes and maintains the expatriate’s salary purchasing power. The Salary Purchasing Power Parity (SPPP) approach is one such approach and involves the following steps:

-Committed Salary: Decide what amount / portion of the current salary (in home currency) will remain in the home country to meet committed expenses such as mortgage commitments, retirement funding, savings etc.

-Home Gross Spendable Salary: Establish what amount / portion of the current salary (in home currency) is spent in maintaining the expatriates current standard of living / lifestyle. What will the expatriate need to spend their salary on in the host country? For example will accommodation be provided or will the expatriate pay rent, will healthcare be provided etc.

-Home Net Spendable Salary: Establish the net spendable salary by deducting the amount of tax, social contributions and any other statutory deductions applicable in the home country to the Home Gross Spendable Salary.

-Host Net Spendable Salary: Use the established amount of Home Net Spendable Salary in home currency, to calculate the amount of Host Net Spendable Salary required in the host country, in order for the expatriate to have the same amount of purchasing power as they have in their home country. The calculation comprises 4 factors:
1) The difference in the cost of living index for the same basket of goods and services between the home and host country applicable for the spendable salary.
2) The difference in hardship that the expatriate and their family are likely to experience.
3) The exchange rate between the home and host country.
4) The Net Spendable Salary

-Host Gross Salary: The Host Net Spendable Salary is “grossed up” by the amount of tax, social contributions and any other statutory deductions applicable in the host country, to establish the host gross salary that will provide the expatriate with the same standard of living as they had in their home country.

The Host Gross Salary is established in local host currency. As a result it is no longer subject to changes in the exchange rate. Over time the salary may be eroded by local inflation which will be reflected in the cost of living indexes. It is recommended that the Host Gross Salary be reviewed on a quarterly basis, to monitor the impact of any change in cost of living and the exchange rate.

Steven Coleman runs the most comprehensive international cost of living website available Xpatulator.com an internet service that provides free cost of living and hardship information for 276 global locations to registered users. The premium content calculators allow you to customise your own cost of living index by choosing your own basket groups and includes a COLA calculator. Follow Steven on twitter
steveninseattle.