International Compensation Data User s Guide

Transcription

1 ORC International Mobility International Compensation Data User s Guide This User s Guide contains the information and data that human resources managers and practitioners need in the day-to-day administration of international compensation issues. The guide explains how to apply s balance sheet approach and cost-of-living data to expatriate pay packages, and provides answers to many of the typical questions expatriates ask about their pay.

2 A. Glossary of International Compensation Terms Ad Hoc Tax Policy. Treatment of expatriate tax on a case-by-case basis when there is no formal policy in place. Allowance. Supplemental payments for items such as hardship, relocation, and education for dependent children. Distinct from differential. Area (or Location) Premium. An ongoing monthly payment, usually tax-free to the expatriate, that reflects the total premium (e.g., foreign service plus hardship premium) and can increase or decrease during the assignment if the hardship component changes. As and Bs. Coefficient representing a mathematical relationship in regression analysis. In a Home- Country Profile, A represents spendable income or what individuals would pay for housing, and B represents how much more the individual would spend if income rises. (See Sections 2E, 4B.) Assignee. See expatriate. Assignment (or Contract) Letter. A document that describes the terms and conditions of an international assignment, usually stipulating the length of the assignment, components of the compensation package, vacation and home leave policies, pre-assignment visit, repatriation, and various other employment terms. Assignment Location. The location (usually a city) in the assignment country in which the expatriate is based. See host country. Assignment-Location Spendable Income. Usually denominated in assignment-location currency, the portion of salary needed in the assignment location for goods and services to equal purchasing power in the home country, assuming a certain salary level and family size. Under the balance sheet approach, assignment-location spendable income equals the sum of home-country spendable income and the goods and services differential. (See Sections 2G, 7B.) Balance Sheet. Worksheet for an individual expatriate that breaks down the components of salary according to the balance sheet approach, splitting pay between home- and host-country currencies. (See Sections 4A, 6A.) Balance Sheet Approach. An international compensation system based on an employee s designated home country (often the employee s actual home country), assignment location, and separately identified base salary to which cost, or income, equalizers (e.g., goods and services differentials) and other additions and deductions are applied to ensure that purchasing power abroad is comparable to that at home. (Consistency in treatment of all equalized elements is important.) (See Sections 1A, 4A, 7B.) Base Salary. The salary paid for the employee s position on the basis of its level and salary range in the home country, quoted before any addition or deduction of differentials, allowances, or incentives for foreign service. Base salary may also be related to host-country salary levels. Business Traveler. An employee who remains outside the home country for a period, usually less than three months. Business Trip. International travels, usually related to the employee s regular responsibilities, during which the employee remains in any one location for only a limited period, almost always less than three months. Cap on Allowances. A maximum amount used when determining various allowances. Certificate of Coverage. A certificate issued by a country with whom a totalization agreement exists, serving as proof of exemption from social security tax on the same earnings in another country.

3 Commuter. An assignee who lives and works in the assignment location during the workweek, but typically returns home on the weekend. Compensation Worksheet. A summary compensation statement, or balance sheet, that shows the breakdown of allowances and deductions that comprise the assignee s international assignment compensation. Completion Bonus. A special lump-sum payment awarded on the successful conclusion of an international assignment. Composite Index. See multiple currency purchases index. Consumer Price Index. A statistical indicator of the cost of living usually published by an official government statistical agency, measuring the changes in prices of a fixed market basket of goods and services purchased by a hypothetical family and including housing and usually education costs (except in countries where education is mostly financed by the government). (See Sections 2C, 7B.) Cost Equalization. A pay philosophy intended to ensure that an expatriate on foreign assignment will be no better or worse off in terms of income merely because of the differences in costs between the home country and assignment location. See balance sheet approach. Cost-of-Living Allowance. See goods and services differential. Cost-of-Living Index. See goods and services index. Cost Projection. A detailed estimate of expected total expenditures to send assignees to a specific host location for a determined period, and usually includes: salary, allowances, housing, tax, and other assignment-related costs. Cross-Cultural Training. Training for the assignee and family to familiarize them with the new environment in which they will live and work; it usually includes counseling to address family and business concerns. Customized Index. A goods and services index custom-designed to meet an organization s special needs (see Section 5E). Danger Pay. A special payment (usually a percentage of base salary) made in designated assignment locations where a high level of political or criminal violence is prevalent. Dependent. Family member supported by an expatriate. Destination Services. Assistance provided to the assignee on arrival in the host country helping the family find a residence, arranging school for dependent children, and providing guidance on shopping, transportation, driver s licenses, and so on. Differential. An amount of money that compensates for the difference in costs (e.g., housing, goods and services) between the home country and assignment location. See negative differential. (See Sections 2E, 7B.) Education Allowance. A payment to cover the cost of educating dependent children in kindergarten, primary, or secondary schools, either in the assignment location or, if necessary, elsewhere. Typically includes all costs of tuition, uniforms, fees, books, supplies, local transportation, and, at boarding school, room and board, and excludes costs for extracurricular activities. Efficient Purchaser Index (EPI). Based on an EPI pricing, a comparison of the prices of goods and services between the home country and assignment location that assumes that the expatriate is familiar

4 with local brands and shops in local outlets in the assignment location. An average EPI is 15 to 20 percent lower than an expatriate index for a given location. See expatriate index. (See Sections 5A, 7B.) Efficient Purchaser Index (EPI) Pricing. ORC s pricing method in which the data reflect purchases that assume that the expatriate is familiar with local brands and shops in local outlets in the assignment location. See expatriate pricing. Exchange Rate. The conversion relationship between home-country currency and assignment-location currency. (See Sections 1A, 7B.) Expatriate. An employee assigned to live and work abroad, other than for a short-term assignment or permanent transfer, whose typical assignment lasts from one to five years in any one foreign location. Expatriate on Local Terms and Conditions. An assignee on a finite-duration assignment, who is paid on a local compensation package from the onset of the assignment (the employee does not receive any of the traditional expatriate package elements). (See Section 5I.) Expatriate Index. Based on an expatriate pricing, a comparison of the prices of goods and services between the home country and assignment location that assumes a preference for internationally recognized brands and outlets. See efficient purchaser index (EPI). Expatriate Pricing. ORC s pricing method in which the data reflect purchases that assume that the expatriate is less familiar with local purchasing and prefers internationally recognized brands and outlets. See efficient purchaser index pricing. Expatriate Purchase Patterns Survey (EPPS). A survey completed by expatriates who work for ORC clients, providing information on the supply of goods and services, retail outlets, domestic service usage, transportation, and so on. (See Section 7B.) Expenditure Patterns. A description of how average consumers spend income on goods and services, housing, and taxes in their home country. (See Sections 4B, 7B.) Family Size. The assignee and number of dependents residing in the host country; it is one of the variables used in calculating allowances and reimbursements. Foreign Service (Expatriation) Premium. An incentive to encourage an employee to accept a foreign assignment, paid on an ongoing basis (normally monthly), typically tax free to the employee. FX Points. Number of points contributing to index movement based on exchange rate fluctuation. (See Section 2B.) Goods and Services. All items purchased, including services, of which the ORC market basket is a representative sample for comparison purposes. Excluded are most items and expenditures associated with housing (mortgage interest, real property taxes, insurance, repairs, rent, and utilities), personal income taxes paid to federal and local governments, and reserve (savings, investments, education expenses, alimony, mortgage principal). See market basket. (See Sections 1A, 2C 2G, 5A 5C, 5E, 7B.) Goods and Services Differential. See differential. Goods and Services Index. A number representing the relative cost of an ORC market basket when items based on expenditure patterns in the home country are compared with the costs of the same or similar items in the assignment location on the same date (e.g., an index of 120 means that costs in the assignment location are 20 percent higher than those in the home country; see Sections 2C, 2D, 5A 5C, 5E, 7B). Goods and Services Spendable Income. The portion of salary spent on goods and services by the expatriate, assuming a certain salary level and family size. See assignment-location spendable income and home-country spendable income. (See Sections 2E, 2F, 4B, 7B.)

5 Grandfathering. Practice whereby certain individuals are allowed either indefinitely or for a designated period to continue to follow existing policy provisions when a new policy is introduced. Gross-up. Increases in company-provided payments to cover taxes due on those payments. Hardship Allowance. A payment, usually calculated as a percent of base salary, recognizing that a specific international assignment location can involve a harsh environment, isolation, political unrest, or special health problems. (See Section 5J.) Headquarters Country. The country in which the employer s main corporate offices are located. Home Country. The country designated as the expatriate s point of origin for employment and compensation purposes. Often it is the actual home country, but it can also be the headquarters country or a third country. Home-Country Profile. A report that describes how income is spent by average individuals in the expatriate s home country, with data on home-country spendable income, housing norms, hypothetical tax, and weights. (See Sections 4B, 7B.) Home-Country Spendable Income. Usually denominated in home-country currency, the portion of salary needed in the home country for goods and services, assuming a certain salary level and family size. Under the balance sheet approach, the sum of home-country spendable income and the goods and services differential equals assignment-location spendable income. (See Sections 2F, 4B, 7B.) Home Leave. A period of vacation granted the expatriate to return home to renew social, professional, corporate, and family contacts. Host Country. The country in which the expatriate is working, always different from the home country. See assignment location. Host-Country Housing Guidelines. The amount designated by the employer as appropriate for the cost of housing in the host location; such data may be provided by a data provider, host-country operations, destination services provider, and others. Host-Country Spendable Income. See assignment-location spendable income. Housing Differential. An amount equal to the difference between the costs of housing in the assignment location and the home country. (See Sections 2H 2I.) Housing Norm. The portion of base salary normally paid for housing and utilities by the expatriate at home, assuming a certain salary level and family size. When foreign housing costs are paid in full by the company, this amount is typically deducted from salary as the individual s contribution toward housing costs. (See Sections 2H 2I, 4B.) Hypothetical Tax. The estimated income taxes an expatriate would pay on company-source income in the home country. (See Section 4B.) Incentive. Any one of a variety of additional payments made as an inducement to either accept, remain on, or complete a foreign assignment. Inpatriate. Foreign national on assignment in the headquarters country. International Index. An index used for highly mobile employees with no link to a specific home country; its weighting pattern reflects a group of major industrialized countries rather than a single home country. (See Section 5L.) Laissez-Faire Tax Policy. Noninvolvement of a company in the income tax obligations of its expatriates.

6 Letter of Assignment. A letter, usually agreed to and signed by the assignee and company representative(s), that outlines the terms and conditions and pay elements of an assignment; also called Letter of Understanding or Letter of Agreement. Localization. The process of changing an employee s status from an expatriate to a local national, which involves reevaluating the accompanying salary package to align the individual s pay with that of peer local-national employees. Local National. An individual who lives and works in his or her home country. Long-Term Assignment. A foreign assignment typically lasting more than 12 months and usually less than five years. Lump-Sum Payment. Delivery of a compensation element, such as a mobility premium, paid in one (or more) sum(s), as compared to a foreign service premium, which is typically paid to the individual on an ongoing basis throughout the assignment. Also refers to payment of more than one component of expatriate-related compensation without separate identification of the components. Market Basket. ORC s sample of representative goods and services priced in both the home country and assignment location in order to determine the difference in costs and compute the goods and services index. The market basket contains the following categories: food at home (meat, fish, and dairy; groceries; fruits and vegetables); tobacco and alcohol; personal care; furnishings and household operations; clothing; medical care; recreation; transportation (public and private); domestic service; and food away from home. (See goods and services; Sections 1A, 2C-2G, 5F, 7B.) Miscellaneous/Relocation Allowance. An amount covering the costs of settling into the residence (for incidentals and items necessary to begin household operation such as voltage converters, tips, excess shipping, registrations, membership loss, passport photos); generally paid as a lump sum, with no receipts necessary for documentation. Mobility Premium. An incentive paid to encourage an employee to accept an international assignment, to transfer to another foreign country, or to return home. Although similar to a foreign service premium, it is a lump-sum payment at the start, end, or both points of an assignment (or at designated intervals) rather than ongoing during the assignment. Modified Index. A goods and services index from which full or partial categories of goods and services that are employer-provided or -protected are removed from the market basket and therefore excluded from the index calculation. (See Sections 5B, 7B.) Multiple Currency Purchases (MCP) Index. A composite index that tracks the cost of goods and services in various currencies to account for purchasing from different sources home country, assignment location, neighboring countries, international catalogs, or the Internet because the items are unavailable or not of an acceptable quality. These component indexes, which reflect expenditures from different sources, are weighted and combined to arrive at the MCP index. (See Sections 5C, 7B.) Negative Differential. The result obtained when the cost of goods and services (or, less commonly, housing) is higher in the home country than in the assignment location. (The goods and services index would be less than 100, so that, for example, an index of 80 means that costs in the assignment location are 20 percent lower than those in the home country; see Section 2E.) Net-to-Net Comparison. Comparison of home-country and assignment-location compensation-related elements to arrive at an appropriate salary level. One method compares disposable income after housing and taxes are deducted. (See Section 5I.)

7 Per Diem. Average prices of daily business travel expenses: hotel, meals, miscellaneous. (See Section 5G.) Permanent Transfer. Transfer of an employee from one country to another on local employment terms and conditions on a permanent basis from the onset of the transfer. (See Section 5I.) Phaseout. Practice of phasing out allowances or incentives over time, typically used for international assignments exceeding five years. Point of Origin. The city/country of primary residence in the assignee s home country prior to the assignment; the location to which the company agrees to return the assignee for home leave and at repatriation. Preassignment Visit. A trip during which expatriates typically visit the assignment location, participate in orientation programs, and locate housing. Premium. See Incentive. Price-Linked Cities. Locations within a given country other than the primary city for which ORC conducts pricings every six months. When pricings are conducted in the linked cities (at least every two years) and the main priced city, a comparative price relationship is created between market basket items. (See Sections 1B, 7B.) Price Points. Number of points contributing to the index movement based on changes in prices measured by a new pricing survey. (See Section 2B.) Price Ratio. Result when the assignment-location cost of an item is divided by the home-country cost of that same item, both in home-country currency. Pricing Agent. Individuals hired by ORC to conduct pricing surveys on a regular basis; they are not employees of ORC clients. (See Section 1B.) Purchasing Power. Financial ability to purchase goods and services based on an individual s income. Reenlistment Bonus. Payment to encourage expatriates to remain in an assignment beyond the originally agreed-upon duration. Relocation (or Resettlement) Allowance. Payment to cover the costs of settling into a residence abroad, often in a lump sum, based on the company s past experience in the assignment location or a fixed amount (e.g., typically one month s salary). Some companies also pay this amount upon repatriation to the home country. Remote Site Allowance. Special payment if work location is isolated or difficult to reach and family members usually do not accompany expatriates. Remuneration. Term interchangeable with compensation, relating to all moneys, perquisites, and benefits delivered to an employee in exchange for services. Repatriation. The process of return and readjustment to personal and professional life in the home country following an international assignment. Reserve. Elements of income other than goods and services, housing, or taxes that typically include savings, insurance, pensions, social security payments, and investment portfolios. (See Section 1A.) Rest-and-Recreation (R&R) Leave. Time off granted periodically in situations where living conditions are particularly difficult. Considered distinct from regular vacation and home leave, R&R s typical duration is one week once or twice a year, and usually involves travel and per diem expenses for a suitable change of environment.

8 Retail Price Schedule (RPS). Tool used by pricing agents to collect prices of goods and services in the assignment location; it includes size, quantity, price in local currency, brand name, description, and sales tax not included in price. (See Sections 1B, 7B.) Short-Term Assignment. Typically an international assignment lasting longer than a business trip but less than 12 months. Although corporate policies differ, the minimum duration is typically three months. Eligibility for allowances and differentials varies by company policy and sometimes by duration. (See Section 5F.) Single Status. A married or unmarried assignee with no dependents in the host location. Spendable Factor. A factor applied to home-country spendable income that reflects the percentage of goods and services paid for by the employee in the assignment location (e.g., a spendable factor of 1.0 assumes the expatriate pays for all goods and services; 0.9 assumes the expatriate pays for 90 percent, and the company covers the remaining 10 percent). (See Sections 2B, 5B, 7B.) Split Pay. System whereby part of an employee s compensation is delivered in home-country currency and part in assignment-location currency. (See Sections 2G, 4A.) Spousal Allowance. Allowance paid to the assignee s spouse to help defray the costs of résumé preparation, visas, continuing education, hobbies, and so on. Spouse. The employee s marital partner, live-in or common-law partner, etc., depending on company interpretation. Standard Index. A number representing the relative cost of a full market basket (that includes all categories of goods and services) when items in the home country are compared with the costs of the same or similar items in the assignment location on the same date. (See Sections 2B 2D.) Tax Equalization. An approach to income tax liability whereby expatriates pay no more or less in taxes than they would have paid at home. The employer typically deducts from salary a hypothetical tax equal to that paid by home-country peers with the same income and family size. (See Sections 1A, 4B.) Tax Protection. An approach to income tax liability whereby any taxes paid as a result of the international assignment that exceed the home-country level of hypothetical tax are reimbursed by the employer. If assignment-location taxes are less than the hypothetical tax, the expatriate keeps the windfall. (See Sections 1A, 4B.) Third-Country National (TCN). A citizen of one country, employed by a company based in another country, who is sent on an international assignment to a third country (e.g., an Italian national sent by a U.K. based company to work in Switzerland). Totalization Agreement. Agreement between two nations to avoid duplication of taxes and social security contributions. Transportation Allowance. Amount to cover transportation expenses associated with car leasing or purchasing, or public transport where company cars are not furnished. Weight. Percentage that indicates the relative importance of a given goods and services item within the market basket. (See Sections 1A, 4B.)

9 III. Resources

10 B. Frequently Asked Questions Q&A Categories: The Balance Sheet Approach Spendable Income and Differentials Goods and Services Indexes - Miscellaneous - Types - Links Foreign Exchange Rates and Inflation ORC s Market Basket ORC Pricing and Analysis Home-Country Profiles - Miscellaneous - Goods and Services Spendable Income - Housing Norms - Income Tax THE BALANCE SHEET APPROACH Q. What is ORC s balance sheet approach? A. ORC developed the balance sheet approach to help employers ensure that their expatriates would maintain their home-country purchasing power while on assignment in a foreign location. The goal is to keep such purchasing power broadly comparable to what assignees would have enjoyed at home, assuming the same salary level and family size. Companies therefore use the balance sheet to minimize any changes to an expatriate s standard of living while on international assignment. Under the balance sheet concept, an expatriate s base salary is divided into four expenditure categories: Goods and Services. The employer balances differences in the costs of goods and services abroad, whether higher or lower than at home, through calculation of a cost-of-living index and differential. The cost-of-living index measures the percentage that the cost of goods and services is higher, or lower, as compared to the expatriate s home country. When the cost is determined to be higher than that of the home country, then the employer provides a differential to the expatriate to cover the additional costs and supplement base pay. Housing. The employer typically pays for foreign housing costs above those represented by a home-country housing norm. The housing norms are based on family size and base pay, and are meant to reflect the expatriate s reasonable contribution toward the cost of foreign housing compared to what they would typically be expected to pay at home. Income Taxes. Payment of worldwide tax on employment-related income is the responsibility of the employer, who will therefore apply a hypothetical home-country tax deduction to base pay, similar to the approach used for housing. Again, these deductions are based on family size and income level.

11 Reserve. An expatriate s reserve (or savings) remains unaffected by an international assignment and is left to the expatriate s discretion. The goal of the balance sheet approach is to ensure that the expatriate neither gains nor loses financially by taking the assignment, an approach termed keeping their purchasing power whole. SPENDABLE INCOME AND DIFFERENTIALS Q. What is the difference between home-country spendable income, the goods and services differential, and the total assignment-location spendable income? A. Home-country spendable income is the portion of base salary that expatriates normally spend on goods and services at home. It is expected that they will spend the same amount in the assignment location and retain their purchasing patterns. The goods and services differential is the amount paid by the employer to the expatriate while on assignment that represents the difference between prices in the home country and assignment location. This differential provides the supplementary income necessary for expatriates to retain their purchasing power in the assignment location. ORC bases the difference in cost-of-living and prices on a regular pricing comparison of items included in ORC s goods and services market basket. Total assignment-location spendable income is the sum of the home-country spendable income and the goods and services differential, multiplied by the exchange rate. The two amounts combined represent the total cost of the goods and services in the market basket at the assignment location in local currency. Q. Why does ORC recommend that assignment-location spendable income be paid in local currency? A. The employer expects the expatriate to use the total assignment-location spendable income (i.e., home-country goods and services spendable income + the differential) in the country of assignment. By receiving this amount all in local currency, expatriates have minimal exposure to currency fluctuations, which, in turn, protects their purchasing power while abroad. Q. How does a split-pay system work? A. Split pay delivers an expatriate s pay package in two parts, paying a portion of the remuneration in home-country currency and the rest in the assignment-location currency. Typically, an employer would pay all assignment-location costs goods and services spendable income (home-country spendable income plus the differential) and housing in local currency. This method protects expatriates from currency and exchange rate fluctuations, while ensuring their purchasing power remains stable. Meanwhile, the balance of the expatriate s package (i.e., incentives and reserve), less the housing norm and hypothetical taxes, would then be paid at home in home-country currency, since the expatriate theoretically has no need to convert it into local currency. Q. How can a goods and services differential go down when inflation in the assignment country is going up? A. This decrease can occur when home-country inflation is higher than assignment-location inflation, thereby offsetting the increase, or as a result of devaluation in the assignment-location currency.

12 Q. How can the differential go down when the cost of item x has skyrocketed? A. The price movement of one item in ORC s market basket, although it may be significant, often will not show up on the bottom line. Unless a significant level of price increases in the assignment location occurs for a majority of the items and categories that make up the index, no change will be apparent. This lack of obvious change is due to the fact that no single item usually carries enough weight to significantly move the overall index, as illustrated in the following example. To determine the price differences between the home and host locations, ORC bases the comparison on a market basket of approximately 180 individual goods and services purchased by consumers in each location. They make up spendable income the amount spent on goods and services which varies according to salary level and family size. These major groupings are further broken down into subcategories, each of which represents a proportion of total spendable income (a weight). For example, an expatriate might spend 10 percent of income on the overall Clothing category, but the subcategory man s two-piece business suit might represent 3.2 percent of all Clothing. ORC tracks price differences for the market basket items between the home country and assignment location through periodic surveys conducted by pricing agents around the world. The following simplified steps illustrated in Chart 1 ( Calculation of Sub-index for the Recreation Category ) for only the items in the Recreation category of the market basket result in determination of an index, which measures the home-host price relationship for Recreation items. Chart 1 Calculation of Sub-index for the Recreation Category Recreation Market Basket Item Home Country A Price (in A Home Country A Weight (%) Host Country B Price (in A units) Price Ratio Price Ratio x Weight units) Television Compact disc Tennis balls Golf balls Paperback book Local newspaper Weekly newsmagazine Movies Health club Barbie doll Crayons Soccer ball Computer paper Blank CDs Windows for PC upgrade Recreation Category Subindex

13 Here are the steps: For each item (e.g., a television, paperback book), ORC calculates an assigned weight that represents a proportion of spendable income according to typical spending patterns by localnationals in the home country. In Chart 1, the weight associated with going to the movies is 10.91, which means that the expatriate spend percent of Recreation expenses on items such as going to a movie. The actual good or service included in the market basket represents all such items of a similar nature for example, a sporting event, theater, and so on. ORC compares the prices of each item at home and abroad, calculating a price ratio for each item that is, the assignment-location price expressed in home-country currency divided by the home-country price. In Chart 1, the price ratio for movies is The price ratio for each item is multiplied by its assigned weight to represent that item s contribution to the overall sub-index for Recreation. For movies, multiply by to get , which represents the movie s portion of the Recreation category sub-index. An overall sub-index for Recreation items that is, the total of all item sub-indexes is calculated at the exchange rate in effect at the time. Chart 1 indicates that the index for the Recreation category is , which means that the cost of Recreation items in the host location is 60 percent more expensive than what is paid for those same items at home. When ORC is calculating an index that measures the price relationship between the home and host locations for all 180 market basket goods and services, these steps are performed for each item. That resulting overall index is then applied to spendable income amount to calculate the differential that the company provides to bridge the gap when host prices are higher than home. So what happens when the price of one good or service skyrockets? The price movement of one item in ORC s market basket, although it may be significant, often will not impact the overall index to any large extent unless a significant level of price increases in the assignment location occurs for a majority of the items and categories. No single item usually carries enough weight to significantly move the overall index. For a practical example, consider Charts 2 and 3. Chart 2 ( An Increase in the Price of Blank CDs ) uses the same Recreation items from Chart 1, but applies a 200 percent increase to the host-country price of blank CDs raising the price (in A units) from to The impact on the Recreation category sub-index is an increase of 11.2 percent, from to But remember, that represents a change only in the Recreation category, not the overall index that reflects the price comparison for all 180 market basket items. So, what happens to the overall goods and services index?

14 Chart 2: An Increase in the Price of Blank CDs Market Basket Item Home Country A Price (in A units) Home Country A Weight (%) Host Country B Price (in A units) Price Ratio Recreation Category Price Ratio x Weight Television Compact disc Tennis balls Golf balls Paperback book Local newspaper Weekly newsmagazine Movies Health club Barbie doll Crayons Soccer ball Computer paper Blank CDs Windows for PC upgrade Recreation Category Subindex Chart 3 lists the 13 major categories: Chart 3 Comparison of All Major Categories in the Market Basket Category Name Recreation Category Sub-Index Based on Chart 2 Recreation Category Sub-Index Based on Chart 3 Meat, fish, dairy Groceries Fruits and vegetables Tobacco and alcohol Personal care Furnishings and Percentage Difference household operations Clothing Medical care Recreation percent Private transportation Public transportation Domestic service Food away from home Total index percent

15 The numbers reflected in columns 2 and 3 represent the category sub-indexes multiplied by the category weights. The two key points that result from these calculations (not shown here for simplicity) are the following: For the Recreation category, Column 2 is based on the original price of blank CDs, and Column 3 is based on the 200 percent price increase in blank CDs. The difference between the two columns for blank CDs is 11.2 percent. However, the overall goods and services index for all 180 market basket items increased from to only 1.3 percent. Q. What happens when goods and services costs are lower in the assignment location than at home? A. When the cost of goods and services is lower in the assignment location than in the home country at the given exchange rate, the differential figure is considered negative. While many employers do not take this factor into account, ORC recommends that they should deduct the differential from another positive allowance (e.g., a housing differential, but not base salary or any incentive). In this way, expatriates still retain the same spending ability that they would have in the home country, rather than being the recipients of a windfall of extra income. GOODS AND SERVICES INDEXES Goods and Services Indexes: Miscellaneous Q. What is a goods and services index? A. A goods and services index represents the relationship between the prices of goods and services in the assignment location and that of similar goods and services in the expatriate s home country on the same date. Because the home-country costs are set to equal 100, an index of 120 means that prices in the assignment location are 20 percent higher than in the home country. The index is then applied to the home-country spendable income in order to arrive at the goods and services differential, as follows: If the index is 120 and spendable income is A20,000, then Index x spendable income = differential x A20,000 = A4,

16 Q. What is the difference between the ORC goods and services index and the local consumer price index released by host governments? A. The two measures monitor spending activities of different consumers: CPIs usually attempt to measure costs for a cross-section of the total population, including lower-income residents, the unemployed, and retirees. ORC data reflect costs more relevant to an expatriate s situation, with pricings conducted from the perspective of professional corporate employees representing middle and upper management in their organizations. Also: ORC Index Prices in two places Point-in-time comparison Measures only goods and services Expatriate market basket Responds to exchange rate changes CPI Prices in one place Movement-over-time comparison Measures goods, services, housing, other Local-national market basket Calculated for one currency Q. How can the index for Location A to Location B be positive, when the index for Location B to Location A is also positive? A. According to ORC methodology, the goods and services index is a weighted average based on the following three basic elements: home-country/local-national prices, host- country/expatriate prices, and weights. Local-national prices reflect the costs of items that a local national would typically pay for goods and services. Because of their familiarity with the location, they are assumed to be more efficient shoppers than a recently arrived expatriate, who seeks out familiar, imported goods in outlets that are locally prominent, but not necessarily cost-efficient. Host-country expatriate-level prices are, on average, higher than local-national prices because they represent brands that new arrivals would typically purchase. Expatriates tend to buy familiar imports, rather than a locally manufactured item they have not tried. They also are likely to shop in higher-priced outlets located in or near expatriate neighborhoods. When computing cost-of-living indexes for the U.K. to Hong Kong and Hong Kong to London, the comparison of prices would be as follows: U.K. to Hong Kong: Hong Kong to London: Hong Kong expatriate prices U.K. local-national prices London expatriate prices Hong Kong local-national prices The Hong Kong expatriate prices in the first scenario are different from the Hong Kong local-national prices used in the second scenario. The assumption is that the brand and outlet choices of the Hong Kong national will differ from those of a U.K. national living in Hong Kong. Another point of difference is the weights on which the indexes are based: Each home country has weights representing the average expenditure pattern of that nationality. Americans allocate their

17 spendable income differently than Italians, Japanese do so differently than Swedes, and so forth. In the previous example, the U.K.-to-Hong Kong index is based on U.K. weights, and the Hong Kong-to- London index is based on Hong Kong weights. The following example calculating two hypothetical indexes based on a very abbreviated market basket shows the basic differences that result in the nonreciprocity of the indexes. Index 1: Location A to Location B Item Location A Price in Home Currency Location B Price in Home Currency Price Ratio (B Price/A Price) Location A Weight Price Relative Milk TV Suit Haircut Gasoline *Total index = the sum of the price relatives = Index 2: Location B to Location A Item Location B Price in Home Currency Location A Price in Home Currency Price Ratio (A Price/B Price) Location B Weight Price Relative Milk TV Suit Haircut Gasoline *Total index = the sum of the price relatives = The total indexes are not reciprocals of one another; in fact, both are positive a result of the differences in prices and weights. Items with heavy weights and high (or, very low) price ratios will significantly influence the level of the index. This point is clear in the second example, where the relative cost of the suit alone contributes 68.3 points to the total index. Q. Are indexes based on city-to-city, country-to-city, or city-to-country? A. Generally, ORC indexes are country-to-city based (e.g., United States to Rome). The traditional link for cost comparisons under the balance sheet approach is the relationship between an expatriate s home country and the host city. The use of home-country data determined by national averages is generally preferable to city-specific data for a number of reasons: Many companies recruit expatriates from more than one city and prefer not to differentiate compensation on the basis of city of origin. A majority of employers ignore state taxes when they tax equalize because it is hard to select a particular state to use as a representative calculation.

18 Since tax levels influence housing, along with goods and services, there should be consistency in the data used for goods and services, housing, and taxes. When expatriates come from many different cities within a country, employers generally select nationally based data, which helps to avoid problems arising from assignees from the same home country in the same host location receiving different levels of allowances. ORC does, however, offer city-specific home-base data for a number of locations in the United States, Canada, and the UK where there has been sufficient demand (e.g., New York Metro, Toronto). For the most part, employers tend to use city-specific expenditure data when: All or an overwhelming majority of expatriates originate in one city; and The city s expenditure patterns differ significantly from those in the country at large. Q. Does ORC have home-host data for small cities? A. ORC offers small city data for Urban United States on both a home- and host-location basis. These data are best used where a client has facilities located in small towns and cities where the population is less than 125,000 and the cost of living is lower than that represented by ORC s traditional U.S. Urban Average data. Q. How does ORC incorporate domestic service into the index? A. All home-country data include a small component that represents home expenditure on domestic service spending on such items as babysitters, gardening help, snow removal, and part-time cleaning assistance. When expatriates move to industrialized locations, they replicate this home-country pattern. For moves to less-developed countries, however, expatriates typically hire full-time or nearly full-time help. Clients have several policy choices in such locations, so that they may: Refuse to pay for such domestic service and treat it as a discretionary item (a rare practice, leading to dissatisfaction in locations where hiring domestic help is common). Pay for domestic help through a separate allowance. Pay for domestic service through the goods and services allowance, thus automatically providing a home-country norm deduction. Two key elements are necessary to build domestic service into the goods and services index: How much usage (hours per week) is appropriate for the assignment location? How much are domestic service wages in the assignment location? To determine the amount of domestic help customary for expatriates in the assignment location (as well as other data), ORC conducts the Expatriate Purchase Patterns Survey (EPPS, discussed in the Pricing and Analysis Section of the FAQs). Compiled information includes: Type of domestic help employed and paid out-of-pocket (to ensure that ORC pricing agents report wages and associated costs such as social security, bonus, medical, and so on for appropriate types of help) Number of hours employed each week (to determine the number of hours to build into the index) ORC then determines an appropriate cost ratio that compares wages in the assignment location to the home country. The ratio represents the category index for domestic service. Using EPPS data, ORC

19 determines an appropriate multiplier to apply to the base weight to arrive at the weight that represents the number of hours one typically employs domestic help in the assignment location. As an alternative to including domestic help in the index, ORC can instead exclude all domestic service or exclude the additional amount of domestic service above home-country usage. ORC can also publish the average wage and usage in the international compensation table, separate from the index, letting clients pay a separate domestic service allowance and control the amount of usage they subsidize. Q. What elements of transportation costs are included in the goods and services category? A. ORC includes all costs associated with vehicle operation, insurance, and maintenance (excluding capital and purchase costs), together with public transportation costs. Goods and Services Indexes: Types Q. What is an expatriate goods and services index? A. The expatriate index is based on an expatriate pricing, which assumes that an expatriate is not familiar with local shops and products and will be purchasing goods and services primarily from outlets that tend to carry international brands. Q. What is an efficient purchaser index (EPI)? A. The EPI is based on an EPI pricing, which assumes that an expatriate is, or has become, familiar with local shops and products and will purchase comparable-quality locally made goods in local outlets. Q. How does an expatriate index compare with an EPI? A. The following comparison lists the differences between the two indexes regarding pricing methods and assumptions: Expatriate EPI Point of view Recently arrived Experienced expatriate expatriate Local markets Not priced Priced Value Doesn t seek best Seeks best value value for quality for quality Cultural/economic affinity with locals Low Medium Use of local outlets/brands Low Medium/High Likely in less developed locations Yes No

20 Q. What if the employer already provides elements of the ORC market basket as a separate cash allowance or in kind? A. Any index can be changed to exclude the cost of those goods and services that the employer provides directly or does not wish to protect. For example, a company providing a car (including maintenance and gasoline) to an expatriate might wish to take out either part or all of the private transportation portion of the index. When a whole or part of a category of the market basket is removed in this way, it is called a modified index. Q. What is a spendable factor? A. It is a mathematical factor applied to home-country spendable income that represents the amount of spendable income remaining as the employee s expenditure after removing those items or categories of expenditure paid for or reimbursed by the company (through a modified index). In other words: A spendable factor of 1.0 assumes that the employee pays for all goods and services. A spendable factor less than 1.0 occurs when using a modified index. That is, an employer that pays expatriates directly in cash or kind (or, does not provide) for certain items that are included in ORC s market basket of goods and services wants to exclude those items from the index calculation. A spendable factor of less than 1.0 means that the employer pays for the goods and services represented by the reduction in the spendable factor. For example, a spendable factor of 0.9 assumes that 90 percent of spendable income is the expatriate s expenditure, and 10 percent is covered by the company. ORC reduces the home-country spendable income the portion of salary spent on goods and services at home by the percentage allocated to those excluded categories. Q. What index is used when an expatriate must purchase goods and services outside the assignment location? A. In locations where goods and services are unavailable or unreliable, expatriates are usually forced to buy what they need in another country or currency, at home, through international mail catalogs, or the Internet. A multiple currency purchases (MCP) index tracks the cost of goods and services in various currencies at multiple purchase points. This method reflects a more realistic spending comparison and ensures more equitable differentials. The result is that the expatriate s purchasing power remains comparable to that of home-country counterparts. Q. What compensation is appropriate when an employee goes abroad for a short period? A. ORC s per diems and allowances are suitable for short-term assignments characterized as follows: Duration is longer than a few months but typically shorter than one year (longer than a business trip but shorter than a full-fledged expatriate assignment). The employee maintains a permanent household at home and needs to meet certain financial obligations at home some may decline (e.g., movie tickets), while others increase or arise (e.g., lawn care, home repairs, babysitting). The employer provides furnished host housing, with full kitchen facilities, and private transportation. The employee is typically on single status, and brings clothing items from home.