Common COLA misconceptions

20 May 2021 Georgia Wilson

For global mobility (GM) professionals managing long-term assignees on a home-based remuneration approach, the world of cost of living adjustments (COLAs) can be tough to navigate.

Around nine in ten companies using the home-based salary system account for cost of living differences when calculating their assignees’ packages, so COLAs are something with which most mobility teams and assignees are familiar. Yet for something so ubiquitous, they can be the most contentious points of an assignment salary offer or mid-assignment pay review. Unlike, for example, assignment allowances and location allowances, which typically follow simple rules and are calculated as fixed percentages of home salary, the methodology behind calculating COLAs and the way they are applied is significantly more complex.

There are a number of misconceptions around COLAs that commonly make it hard for assignees to understand their pay, and which can be challenging for GM teams to address and explain. We have tackled some of the most common misconceptions below:

1. The COLA is designed to cover an assignee’s spending on goods and services on assignment

Assignees can mistake COLA for an allowance that is meant to cover their expenditure on goods and services in full on assignment, resulting in concerns that the amount is too low.

A COLA is actually an adjustment – positive or negative – made to an assignee's spendable income to account for the difference in the cost of living between the assignee's home and host locations, and thereby protect the assignee's purchasing power. When the cost of living is more expensive in the host location than in the home, the COLA is simply a necessary ‘top-up' amount and does not cover the assignee's expenditure on its own.

The host spendable is in fact the portion of the assignment salary intended to cover the assignee's spending in the host location. This is the sum of the assignee's home spendable and COLA.

Essentially the COLA should always be considered as a top-up (or sometimes a deduction) to spendable. The COLA amount should not be looked at in isolation.

On a similar note, some companies may wish to try to simplify their allowances and provide the same COLA for all assignees in the same location. However, the COLA is designed as an adjustment to the assignee's spendable income to ensure they are no better or worse off. Therefore, the spendable will vary by nationality, income level and marital status and so too should the COLA.

2. COLA is an allowance and all assignees on a home-based package are entitled to one

While COLA is often thought to stand for ‘cost of living allowance', we encourage companies to consider it a cost of living adjustment, as this is a more truthful reflection of how COLA works. COLA is not something to which everyone on a home-based package is automatically entitled.

Protecting a portion of an assignee's salary with a cost of living index simply means protecting the purchasing power that they had in the home location. Sometimes, the cost of living in the host location will be lower than the cost of living in the home location. In this case, the assignee would not receive a positive COLA amount and a negative adjustment to the assignee's spendable income is advised.

Applying a negative COLA does not make the assignee worse off. It simply ensures that their purchasing power will be the same in the host location as it was in the home location. This helps maintain their link with the home location, and equity between assignees going to different locations. However, asking assignees to understand and accept a negative deduction on their balance sheet can be hugely challenging, especially if GM are trying to make a pay offer as attractive as possible.

Not applying a negative COLA means there is no adjustment to the assignment salary to account for cost of living differences. This means the assignee will enjoy more purchasing power than they are used to; they essentially receive a windfall that their peers on assignment to locations with a higher cost of living do not.

Our blog on negative cost of living indices explains the main pros and cons of each approach, and why clear communication with assignees is key, whether you apply these or not.

3. COLA can be used as an incentive to make an assignment package offer more attractive

If an incentive allowance is needed to make assignment salary packages seem more lucrative to potential assignees, then considering a mobility allowance (also often called a foreign service premium or expatriate allowance, among other things) in your policy is the best way to do this.

Incentive allowances and the protection of purchasing power are completely unrelated and should ideally be kept separate. Transparency and consistency are important if assignees are to understand their assignment packages.

4. If a COLA review results in a decreased amount, this makes the assignee worse off

A cost of living index will decrease if the assignee's home currency appreciates against the host currency, or if the price levels of the ECA shopping basket increase more in the home location than the host location – as explained here.

As an example, let's consider a pay review case where relative price levels haven't changed and the index decreases due to the appreciation of the home currency against the host currency. This results in a smaller COLA in home currency terms, but it is important to bear in mind that this lower COLA is converted into host currency at a new, more favourable exchange rate. The decreased index and the new exchange rate cancel each other out, and the COLA amount in host currency – the currency in which COLA is intended to be spent – does not change.

However, if the assignee is receiving the host spendable in home currency, this may be where they are at risk of losing out if there are further exchange rate fluctuations. Having a policy in place to protect assignees from exchange rate changes is the most effective way to guard against this.

But what about the opposite scenario: the exchange rate hasn't changed, but price rises in the home location outpace those in the host location, pushing the index down. This would indeed result in a lower COLA, in either home or host currency. Rest assured, this still doesn't make the assignee “worse off”.

Living costs are increasing for the assignee's peers back home and we need to remember that the index is designed to maintain the same purchasing power they would be experiencing if they were not on assignment. If a company wishes to account for the effect of home inflation on an assignee's pay, generally this is captured by reviewing the assignee's notional home salary – as they would for the assignee's home country peers. A higher notional home salary will mean the COL index is applied to a larger home spendable, consequently increasing the resulting COLA.

5. The COLA does not need to be reviewed regularly

As the previous point highlights, although some companies may not wish to apply the changes if a COLA review results in a decreased amount, fearing that it will have a negative impact on the employee, we also find that some companies do not review the COLA at all after it has been determined at the beginning of the assignment. However, there are two main reasons why COLA should be reviewed regularly:

Firstly, without regularly reviewing the COLA, assignees are likely to be either better or worse off over the course of an assignment – defeating the main purpose of providing the COLA in the first place. Both exchange rate fluctuations and inflation in the home and host location will have an impact on the COLA, and by not reviewing the COLA the amount provided will no longer fit the situation.
Secondly, regularly reviewing the COLA ensures fairness for assignees working in the same location. For example, an employee sent on assignment this year will have a certain COLA. If this is not reviewed next year but another employee gets sent on assignment to the same location next year with the same base salary, they will receive a different COLA (which could be more or less). The employees will both need to buy the same items, based on the same salary but one will have a higher COLA than the other leading to a clear disparity.

COLA should be reviewed on at least an annual basis (more regular reviews may be required in locations where exchange rates and inflation are more volatile, and indeed ECA publishes data more regularly for these locations to enable just this) and ideally conducted at the same time as any annual salary reviews.

6. The COLA can be benchmarked against what other companies provide

Often companies want to benchmark the value of the COLA they provide to their assignees to check if theirs is competitive. It may be that they are coming from a compensation and benefits background where most allowances are based primarily on benchmarking, or perhaps the company does not wish to spend time formulating a mobility policy on how to calculate an assignment package.

However, in the case of COLA, benchmarking is not possible since it will vary in accordance with assignee nationality, salary, marital status and the company's policy regarding how the COLA is calculated. While companies do have options in terms of how they determine the COLA (by changing things such as the spendable income reference, index type, and basket of goods) these can only be benchmarked on a policy level rather than by looking at the precise values.

Because of this, benchmarking a COLA value is impossible. Companies can, however, benchmark their policy on how the COLA is determined and this is something that can be done courtesy of ECA's Expatriate Salary Management Survey.

7. COLA is the most important part of the assignment package to focus on

COLA is arguably the most challenging and complex part of a home-based assignment salary calculation. It can be difficult for assignees and GM professionals alike to understand its purpose, how it's calculated and why it changes. But it is important to always put the COLA into context. COLA is just one component of the net assignment salary. Assignees are likely to receive allowances, like mobility allowances and location allowances, that also add to their net salaries. On top of this, most assignees on a home-based package also receive valuable benefits, such as accommodation, education for children, transport and medical insurance, to name a few. Ultimately, it is not the COLA that determines how attractive an assignment pay and benefits package is overall.

FIND OUT MORE

ECA’s Cost of Living Survey measures the cost of a wide range of goods and services used by expatriates in over 485 locations around the world. Find out more about how ECA's cost of living data can help you, or take a look at our full range of services.

ECA’s Consultancy team can assist in benchmarking, critiquing and writing policies, so that companies can ensure they are both competitive with market practice and aligned to business objectives.

Please contact us to speak to a member of our team directly.

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