Whether you’re an international mobility professional or an assignee, you will have very likely heard the term ‘COLA’. But what actually is it?
COLA stands for Cost of Living Adjustment (although some refer to it as an allowance) and it accounts for the difference in the cost of living between the assignee’s home and host locations. As the cost of living can be either higher or lower in the host location, this amount can be either positive or negative. As such, ECA recommends calling it an adjustment; to recognise the fact that there will not always be an additional allowance due to the assignee.
When is it used?
COLA is used by companies adopting a home-based approach, which anchors the remuneration structure to the home country and protects the purchasing power the assignee had in the home location. This is achieved by adjusting the package for cost of living differences via a cost of living index, so that assignees are no better or worse off while on assignment in the host country than if they had stayed at home.
How is it calculated?
1. Start with the notional home gross salary, deduct hypothetical tax and social security = the net income
2. Take the net income and determine the home spendable portion (there is more on how this is reached here)
3. Apply the cost of living index to the home spendable to reach the host spendable (there is more on how cost of living indices are calculated here)
4. The difference between the home and host spendable is the COLA
So how does the COLA fit into the build-up calculation? As you can see above, the cost of living adjustment is considered alongside the spendable income in the host package, then the remaining part of the net salary (typically housing and savings) is added back on, along with any assignment specific salary components to reach the assignment net salary. This is then grossed up for host country tax to arrive at the total gross assignment package.
What if it’s negative?
Depending on the country combination, the cost of living in the host country may be lower than in the home country, resulting in a negative COLA. The majority of companies do not currently deduct this negative COLA from the home spendable; however, not doing so:
- creates erratic windfall
- is more expensive for the company
- inhibits mobility and repatriation
- prevents employee equity
ECA advises companies to apply the negative COLA for the reasons listed above. This is also explored further here.
COLA will change! As economies and prices continue to change, cost of living indices do in parallel. The two factors that impact a cost of living index are exchange rates and relative inflation, as illustrated below:
More on this, including a worked example, can be found here.
Remember the bigger picture! COLA is not meant to be viewed in isolation as the assignee is not supposed to live off COLA alone. The COLA is an adjustment to the home spendable which forms the host spendable and should be viewed as such. This host spendable is intended to be spent in the host location and therefore should be considered in host currency terms. Often a reduction in COLA will result in a maintained (if not increased) host spendable once it has been converted across to the correct currency. This would be the case when the home currency has strengthened, so of course you also have to consider how you deliver pay.
Don’t forget the home location! As COLA is a component of the home-based approach, it is important to remember that it will be impacted by price changes in the home location too: for example, if home peers are subject to high inflation rates (higher than in the host), this will decrease the index and the resulting COLA. This is often forgotten about, as it is something that the assignee is unlikely to directly notice while they are away in the host.
Communication is key! Whether you need to explain why an index has changed or how a reduction in COLA means the assignee is still no worse off, or you simply need to present the package to an assignee, clear communication is essential to help improve the employee experience. ECA can support you with this, via either our dedicated account management team or our bespoke consultancy service, so please do get in touch!
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ECA’s Cost of Living Survey measures the cost of a wide range of goods and services used by expatriates in over 480 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.