Protecting expatriate salaries from exchange rate movements
When managing international assignee salary packages, exchange rates can have a huge impact on the overall value.
When managing international assignee salary packages, monitoring exchange rates is essential since currency movements can have a big impact on the value, or perceived value, of the package. A cost of living allowance calculated six months ago, for example, may no longer be enough to protect an assignee’s purchasing power if the currency they are paid in has weakened during that period. Conversely, you may be overpaying if that same currency has got stronger.
With exchange rate movements often in the news, if the assignee is adversely affected it’s likely their global mobility team will hear about it very quickly! There could also be potential cost increases for the company to consider and being agile will help you to remain competitive in the market.
The first step in devising an exchange rate protection policy is to determine which element of the salary package you need to protect. This comes down to how you deliver pay.
If 100% of the salary is paid in home currency, you need to protect remittances to the host country (the money that the expat will be transferring to cover their living costs while abroad).
If you are paying 100% in host currency, you need to protect the money being sent back home to cover ongoing commitments such as mortgage payments or savings contributions.
A minority of companies may pay in a third currency such as the dollar or euro. In this case, the complexity increases as you need to monitor fluctuations between two sets of exchange rates.
ECA’s latest Expatriate Salary Management Survey found that there is no one favoured approach to protecting expatriate salaries from exchange rate movements; it really comes down to what works for your organisation. This blog looks at some of the practical solutions you could consider putting into place.
In theory, split pay means that both the home and host-related elements of the salary are protected. Some companies will simply use a percentage split of the net salary, typically 60:40 (between the host and home components respectively). At ECA we use spendable data to determine a more accurate split, taking into consideration that the portion needed in each location will vary according to nationality, family size and salary level. In order to ensure complete protection, the way in which the pay is split must accurately reflect the assignee’s consumption pattern in each location so that there is no need to transfer money across, effectively taking exchange rates out of the equation.
Indeed, this is the ethos of split pay: for expats to not have to transfer money between the home and host country at all. It is not designed to be an opportunity for the expat to play the “exchange rate game” whereby they might choose to have, for example, 90% of their pay delivered in the currency expected to appreciate, so that they receive a windfall when transferring money over at an increasingly favourable exchange rate. In this scenario, should the rate then become less favourable, or indeed become unfavourable, would you feel obliged as a company to protect further? If you allow the expat to decide the split, the onus should be on them to make sure it is appropriate. We advise you to establish a limit on the number of times the split can be reviewed. Our suggestion would be to let them review three months into the assignment, then on an annual basis.
Given that the employee would be protected against currency fluctuations and could rely on a consistent salary delivery in both locations at the same time, why do only around a third of companies use split pay? One drawback to bear in mind is that it is a more complex method to administer as it depends on a dual payroll capability. Moreover, legislation in certain countries means that split pay is not always a viable solution. In Russia for example, 100% of the salary must be delivered in roubles. So what other options are there?
Guaranteed exchange rate
Guaranteed exchange rates are used by a third of companies applying the build-up approach. In this scenario we are assuming that the employee’s salary is delivered 100% in one currency, either the home or host, and that the company uses a fixed exchange rate when the employee makes a currency swap. The guaranteed exchange rate used can be determined in various ways. It could be a company accounting rate, the rate given with the latest cost of living index, a spot rate, or an average rate over a specified time period.
The advantage of this method is that the employee remains protected against fluctuations without requiring the company to have a dual payroll capability. The assignee doesn’t have to worry about whether the exchange rate will move against them and affect them unfavourably over the time period, as the company will pay whatever is necessary to ensure the guaranteed exchange amount is met.
However, it is administratively burdensome since it potentially needs updating on a monthly basis, depending on how you fix the rate. There are companies that offer assistance with this though, and it may be possible to get the bank to offer a fixed rate for a fixed amount of time. On the whole, this is a better option for those with smaller assignee populations (with fewer home and host locations) as there will be fewer currency combinations to manage.
87% of companies undertake scheduled reviews of expatriate salaries once a year. The interim review approach, used by 37% of companies, involves establishing a trigger point to determine when a currency movement is significant enough to warrant an out-of-cycle review, to ensure that the value of the salary package isn’t eroded. The most commonly cited trigger percentage, according to our survey data, is 10%.
Once a company’s chosen trigger has been surpassed, a ‘wait and see’ time frame is usually established to check that the movement is not a temporary anomaly and to avoid the company intervening prematurely. If the change is sustained for the chosen period (periods of three and six months are most commonly quoted) the company will conduct an interim review and backdate the calculation to when the trigger was originally breached.
While this approach has the advantage of putting across the message that the company is proactively looking to protect the assignee, it creates significant additional administrative work as you need to be prepared to monitor fluctuations regularly. It is also important to note that the employee isn’t protected for all fluctuations. If, for example, the trigger is 10% but the movement falls just short of this at 9%, the employee will likely be unhappy that they will not be compensated for this still sizeable difference.
With this approach, the employee’s salary is delivered 100% in one currency, but the amount received on transfer in the other currency is compared to the expected amount periodically. If the received amount is less than the promised amount, the employee is out of pocket until they are reimbursed, which could be problematic depending on how adverse the rate is and how frequently you reconcile. Typically, this is done every six months or annually. An advantage of reconciliation is that there is no need for dual payroll. However, as it is the most laborious of the four methods it’s perhaps unsurprising that only 14% of companies use this approach. If you are under pressure to save costs this probably isn’t the best option for you, as it’s unlikely that a company will reclaim money when the employee has benefitted from currency movements. Indeed, 71% of organisations that use the reconciliation approach allow the assignee to keep the gains. An alternative would be to apply a threshold so that reimbursements are made only if the loss exceeds a certain percentage.
Unfortunately, predicting currency movements is out of International HR’s control. If we had that kind of insight, I’m sure we would all be investing our money accordingly! What you can do, however, is be proactive and keep an eye on currency volatility so that you are ready to intervene when appropriate.
As exchange rates can have a big impact on the value - or perceived value - of the package on offer, a clear protection approach and good documentation are both key. Our advice is to have an exchange rate protection policy in place, rather than responding on an ad-hoc basis to expat kickback. This will not only promote assignee equity but will also ensure that the application of your chosen protection method is consistent – which will be particularly valuable at salary review time. The best approach for your organisation will very much depend on your payroll capabilities, the countries you operate in and your company culture.