Which compensation approach is the most widely used in expatriate compensation?

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Organizing the expatriation of an employee is a complex process, particularly when it comes to calculating an expatriate compensation package. Employers must consider a range of factors including an employee’s personal circumstances, the desirability of the relocation destination, and the overall cost of living.

A failure to grant adequate compensation could result in a lack of employee motivation and satisfaction, ultimately impacting the organization’s retention rate and lessening the chance of success for the overseas assignment.

The balance sheet approach, which is used by more than 85% of U.S. multinational companies, is a good way to regulate the costs of expatriation and ensure the fair payment of employees.

How the Balance Sheet Approach Works

The balance sheet approach determines an expatriate’s salary based on the going rate for the same — or a similar — position in their home country. Organizations will typically allocate additional allowances or reimbursements as appropriate, which ensures employees can maintain their usual standard of living once they relocate. Ultimately, this method preserves the employee’s current purchasing power, no matter where they end up working.

Step 1: The organization determines the employee’s net salary based on their home country’s going rates.

Step 2: The employee’s salary is broken into four categories:

• Taxes
• Housing – including rent, bills, utilities, etc.
• Goods and services – including expenses such as food, clothing, recreation, medical care, and transport
• Reserve – including savings, benefits, pension contributions, education, etc.

The employee is expected to contribute a portion of their salary to each of these four categories, equivalent to what they would typically pay for each one at home. If, for example, rent in the host country is more expensive than an employee’s home country, the organization will pay the difference. This serves to protect employees from cost differences between the home and host countries.

In some cases, when an expatriate is relocating to a country where living costs are considerably cheaper, their employer will decrease the compensation accordingly.

Step 3: The organization provides additional benefits or allowances, based on specific circumstances. For example, an employee relocating with their partner and/or children might receive an additional allowance, particularly if a partner is unable to work in the host country.

The provision of a hardship allowance, sometimes called a quality of living allowance, is also fairly common to incentivize employees to accept a relocation proposal. This takes into account factors in the host country that might make it unappealing to expatriates, such as political instability, safety, health care, natural disasters, and the quality of schools.

Advantages of the Balance Sheet Approach

• Employees receive equivalent compensation to their colleagues back at home.
• Repatriation or a subsequent relocation is straight-forward because employees understand that they will be adequately compensated and will not struggle financially when they return to their home country.
• The balance sheet approach takes a holistic approach to expatriate packages, taking all the necessary factors into account to ensure employees don’t experience major gains or losses when they relocate.
• Whether an employee is moving to a higher or lower wage country this method can still be applied.

Disadvantages of the Balance Sheet Approach

• This method is time-consuming and complex to administer due to ever-changing economic conditions.
• It intrudes on an employee’s personal financial situation.
• If known, pay disparities between expatriates and host country employees may cause tension in the workplace.

The balance sheet approach is perhaps most appropriate for mid- and senior-level employees, where the return on investment is higher. Employers should be mindful of fluctuations in the exchange rate as well as inflation, and they should consistently monitor their compensation packages. Consulting firms, such as Mercer and Airlnc, can also be used to help companies with their balance sheet calculations and keep an eye on changing circumstances in host countries.

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Although companies have evolved many different remuneration methods to determine the salaries they offer to employees who are being sent on long-term international assignments, most expatriate salary systems can broadly be defined as host-based, home-based or some combination of the two. In this post we look at the home-based approach.

Also known as the Build-up or Balance Sheet, over two-thirds of companies responding to our Expatriate Salary Management Survey use this approach as their primary method for calculating assignee salary packages.  

What is the home-based approach?

The aim of the home-based approach is to maintain assignees’ home country purchasing power, so they are no better or worse off while on assignment in the host country, than if they had stayed at home.

Home country salary

The starting point is usually to work out the employee’s notional home country gross salary. This is the salary that would be paid for the employee’s job on assignment if it were done in their home country, before any deductions are made.

Then, an estimation is made on what the employee would pay in tax and social security in the home country. This hypothetical amount is then deducted from their gross salary, leaving us with a figure that represents their estimated take-home pay or home net salary.

The reason it is an estimation is that it is often not possible to recreate personal tax liability after the first assignment year as tax residence in the home country will be broken and the exact tax liability cannot be established.

Home net salary

An employee’s home net salary can be split into three elements, or three major areas of expenditure. Most companies base this proportion on spendable income tables which are derived from government statistics and take into consideration the employee’s home country, income level and family size.

• Housing: average household expenditure on housing costs, including mortgage payments, property taxes and charges, repairs and maintenance, expenses for moving house, insurance and rent
• Savings: the amount a household is typically able to save each year from the given salary
• Spendable: the total annual day-to-day expenditure on items such as food, clothing, motoring, furnishings, holidays etc.

Home spendable amount

Now we have a clear picture of an employee’s income and expenditure at home, we must work out how much it would cost them to live a comparable life in the host country. To do this, we can use a cost of living index to compare items and costs between the employee’s home and host locations. This will then tell us what adjustment needs to be made to protect the employee’s salary from any differences in the cost of living between locations. When the home spendable income has been adjusted by applying a cost of living index, the new amount is called the host spendable, which is equivalent to the home spendable plus or minus the COLA (Cost of Living Adjustment). This is the starting point from which the assignment salary in the host country is built up.

Assignment net salary

The housing and savings elements are added back onto the host spendable. Following this, assignment-related allowances are added by a majority of companies as well:

• Mobility (or “expatriate”) allowance: most commonly between 5% and 15% of home gross salary
• Hardship or location allowance: typically up to 30% of the home gross salary

These elements together (home net salary protected for cost of living differences plus assignment-related allowances) make up the net assignment salary.

Assignment gross salary

The assignment net salary is grossed up for host country taxes and social security contributions to arrive at an assignment gross salary. In addition, assignment benefits can all be included to arrive at the total gross package..

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Why use the home-based approach?

Easier re-integration

The home-based approach maintains the link to the compensation structure in the home country, making it easier for assignees to be re-integrated from a monetary perspective when they return home.

Fairness

Applying the cost of living and tax differential ensures that assignees earn no more or less at the net level than they would have at home. Additionally, all employees from the same home country are treated the same way on assignment.

Promotes mobility 

The assignee does not suffer financially, regardless of which location they are assigned to. This helps to prevent “good” and “bad” postings emerging in companies that operate in a broad range of countries.

When should you use the home-based approach?

Between any two countries

The methodology of maintaining the home country purchasing power means that the home-based approach can essentially be used between any two countries. However, for moves from countries with very low pay levels to high-salary countries, the resulting salary level may be too low to provide a suitable standard of living or even to meet immigration requirements; a top-up may be needed.

This is a growing issue, as more and more companies are now expatriating out of developing countries with low salaries. That said, companies might find that expatriation at high seniority levels from the same countries results in assignment salaries much higher than those of employees in the host, due to the shortage of talent at the highest levels in some developing countries.

Market rate adjustment and the hybrid approach are methods some organisations use in order to navigate around those issues.

To meet different assignment objectives

The level of allowances provided within the calculation can be varied (e.g. choice of cost of living index, provision or not of mobility allowance), meaning the home-based approach can easily be adapted to suit different purposes. For example, career development assignments may require lower levels of incentivisation than assignments to fill skills gaps.

Fixed-term assignments

As the home-based approach maintains the link with the home country salary structure, it is more suitable for assignments where the employee will return home than for permanent transfers or global nomads who move from one country to the next without having the intention of returning home or a designated home country anymore.

To achieve equity with home-country peers

Application of the home-based approach ensures that all assignees from the same home country are treated the same. However, it can lead to disparity with expatriate peers in the host country, as it produces different pay levels depending on the assignee’s home country. The assignment pay may not fit in with the local salary structure either, meaning further disparities when comparing to local staff. 

Summary of the home-based approach

By providing a means of calculating fair pay for an assignment between almost any two countries, it is no surprise that the home-based approach continues to be the most widely used method of remunerating expatriates. As with any remuneration approach, whether or not it is the right choice for your organisation depends on the patterns of mobility required and the demographics of your assignee population. 

Advantages

Disadvantages

Maintains link to home country compensation structure - easier re-integration

No tie to the local national salary structure

Treats everybody from one country the same way

Generates different pay levels among peers in the host location

Home country purchasing power protected

Complex administration

Assignee earns no less at net level than he or she would have at home

Complexity grows with the number of countries

Promotes mobility - assignee does not suffer financially regardless of assignment location

  FIND OUT MORE

ECA’s Build-up Calculator and ECAEnterprise enable you to calculate home-based salary calculations quickly and accurately using ECA’s latest data. Individual calculations are also available on-demand through our Consultancy & Advisory service. For more information or if you need help understanding the different approaches to assignee pay, please get in touch. 

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