knowing when to use a host-based compensation program

Knowing When to Use a

Host-Based Compensation Program

July 2013

Contents © 2013. Reprinted with permission from WorldatWork. Content is licensed for use by purchaser only. No part of this article may be reproduced, excerpted or redistributed in any form without express written permission from WorldatWork.



Determining a compensation package for a do-mestic employee is generally straightforward: A locally competitive pay and benefits package is the usual offer. The process gets more com-plex, however, when it is necessary to determine how to compensate an employee being sent on a temporary overseas assignment. Traditionally, companies have continued to pay expatriates on a home-based compensation scheme called the balance sheet. This allows the employee to retain domestic pay and benefits, facilitates the return home and the employee’s continued participation in home benefits schemes. This no loss, no gain approach allows expatriates to retain their home standard of living while working overseas.

While the balance sheet remains the

predominant choice for most compa-

nies, many are adopting host-based

alternatives for expatriate compensa-

tion. Host-based approaches allow

a company to offer an expatriate a

rate of pay commensurate with that

of a peer in the new work country,

the underlying assumption being that

the expatriate should be able to live

like a local while on assignment. The

approach is often less expensive than

traditional balance sheet options and

has grown in popularity.

In the past, several barriers prevented

the widespread use of host-based

schemes. These barriers were linked

to the nonportability of defined benefit

or other generous pension schemes,

as well as widespread disparity in

wages from one country to another.

But such barriers are being broken

down as defined benefit pensions are

eliminated and wages, especially for

high-level employees, begin to har-

monize globally. This shift is recently

substantiated by Nick Boulter of Hay

Group in his article “State of Pay:

Multinationals Must Get to Grips with

Reward to Succeed in New Markets,”

in which it is indicated that pay levels

have shifted substantially, from being

significantly lower in emerging markets

than the mature markets, to being on a

par — or even higher.

Additionally, attitudes about inter-

national assignments are shifting. In

the past, a move overseas was often

seen as a sacrifice on the part of the

employee, or even as an outright hard-

ship for the employee and the family.

By Morgan Crosby, AIRINC

| July 2013



Attitudes are changing, however. As

companies globalize and international experience becomes a routine com-ponent of employees’ career paths, expensive packages are not always needed to encourage moves.

All these changes have opened the door to increased use of host-based approaches for expatriate pay. That said, an open door should not be seen as an excuse to open the floodgates. Host-based schemes can be quite effective when deployed in the right circumstances, but many barriers to their effectiveness still exist. For exam-ple, they may work well for transfers between like economies with similar wages, taxation rates and living stan-dards, but for moves where there are significant disparities between the home and host countries, the host-based approach can present challenges.

It is critical, therefore, that companies consider host-based schemes carefully and understand when they are most effective. To help guide these deci-sions, this article will first explore the definition of a host-based approach and then address the question of when the approach works.

In Between a Local and an Expat

Host-based schemes are not perma-nent moves to the host location where full host terms and conditions are adopted. They are temporary expa-triate assignments, typically between one and five years, in which assignees receive cash compensation commen-surate with that of their local peers.

Other benefits, such as retirement and long-term incentives, often continue to be tied to the home country plan. Health care is typically linked to tradi-tional expatriate benefits, which allow for global coverage that applies to the home and host countries. The result is a hybrid approach that allows the employee to be oriented toward the host location for compensation, while receiving benefits that are more closely aligned to those of home country or expatriate peers. In other words, host-based expatriates are somewhere on a spectrum that ranges from locals to traditional expatriates.

One major departure from the tradi-tional expatriate package is income tax. With host-based schemes, the employee is responsible for paying income taxes in the host country. In certain cases, some home-country income tax may also be due, and this would also be the responsibility of the employee. This is a major difference from the traditional expatriate package that typically offers tax equalization, in which the employee pays a hypotheti-cal income tax designed to preserve a home-country rate of contribution. The company then pays all other income tax on company source income, with the result that the employee pays about the same income tax as at home, neither losing when host taxes are higher nor benefiting when they are lower.

By contrast, host-based expatriates are on their own for settling income tax liabilities on regular company income, and they may end up paying more, about the same or less than they did at home. The point is not to protect to the home standard, but rather to orient

the net compensation more closely to that of the host location peer. This method of handling taxes is one of the major reasons host-based schemes are less expensive to the company, since tax equalization can be quite costly. The tradeoff, though, is that it places the burden of potentially higher income taxes on the employee.

Host-Based

| July 2013

Expatriate Approach: Understanding the Value

Proposition

First and foremost, host-based ap-proaches work well when there is a win-win scenario for the company and the employee. This is critical. Without the right context, a host-based assign-ment is more likely to fail or result in loss of employee engagement. The host-based approach works best when the employer and the employee can benefit from the assignment. The fact that the approach can be less expensive gives the company more opportunity to send employees on in-ternational assignments. This flexibility can help fulfill long-range talent goals, especially in companies where interna-tional experience is valued.

But while financial benefits are im-portant, they are not the only consid-eration. Assignments should also be opportunities for employees to gain international experience and enhance their careers. On the company side, this experience should be leveraged to build a pipeline of talent with diverse experiences and a global mindset. Employees who move overseas and successfully complete assignment ob-jectives become more valuable to the company and are more likely to move up in the organization. This process can create a cycle of opportunity for the company and its employees. However, this cycle can be broken if the company does not make the effort to know when a host-based scheme is appropriate. The approach places a certain element of risk on employees,

who are expected to live like locals, forgo tax equalization and, in many cases, break ties with some of the terms of their home-country employ-ment. As a reward for this risk, the company should deploy the approach wisely and make sure to connect as-signments to opportunities within the company.

When to Deploy the Host-Based Approach

Evaluate net compensationImagine a scenario where an employee in a developed country is tapped for an international assignment in anoth-er developed country. At home, the employee grosses $100,000 and pays a 20 percent income tax rate, netting $80,000 a year. In the assignment country, the gross salary is higher at $125,000, but so is the income tax rate of 35 percent. The higher gross wages are offset by the higher income taxes, and in the new country the employee will still net about $80,000. Although wages and income tax rates are different in the two countries, there is economic affinity because the employee will experience a similar level of net income. This is a situation where a host-based assignment is likely to work well.

But this parity does not always exist between a given pair of locations. For example, using the same scenario but changing the host location to one in a newly developing country, assume that the gross rate of pay is lower at $80,000 and the income tax rate is higher at 30 percent. The net is then only $56,000, whereas at home it was $80,000. Because the employee

would net significantly less in the host country, there is no economic affinity and a host-based assignment is not a good option for the employee.

A net compensation comparison is a key component of assessing the feasibility of a host-based assignment. Income tax rates differ widely around the world, ranging from zero in many Middle Eastern countries to more aggressive rates in some European and other countries. In addition, there may be ongoing home-country income taxes due if the home country assess-es income tax on worldwide income.

Since income tax has a potentially large impact on employees’ take-home pay, looking at salary and income taxes is advisable in evaluating the appropriateness of a home-based as-signment. The key point is that the em-ployee should not net too much less than at home, and probably should not net significantly more either. An employee who will net less won’t want to go on assignment, while an employ-ee who will net more will never want to come home. Without economic affinity between the home and host locations, a host-based solution is unlikely to be effective.

Add extras Although an underlying assumption of the host-based approach is that employees should be able to live like locals, the reality is that such employ-ees are still expatriates. Living tempo-rarily in a foreign country, they will need help with living expenses and family needs. The most common extra items provided above the local salary are a housing allowance, children’s educa-tional support and home leave.

Source: AIRINC 2013 “Host Based Assignments” survey

| July 2013

Companies typically reserve these ex-tra elements for employees at mid-lev-el and above; extra elements are less likely to be offered to junior level assignees or employees going on developmental assignments. This approach allows companies to make

smaller investments in assignments in situations where the potential value to the employee is higher.

According to a survey conducted in 2013 by Associates for International Research (AIRINC), host assignments

with extras provided are most com-monly reserved for mid- and execu-tive-level employees.

All Levels of EmployeesAre Eligable Developmental

Junior Level

Mid-Level

Executive Level

Host

Host Plus

44.44%

45.71% 25.71% 28.57% 40.00% 31.43%44.44% 33.33% 11.11% 11.11%

Source: AIRINC 2013 “Host Based Assignments” survey

Figure 1: Use of Host Assignments by Job Level

When the Host-Based Approach

Doesn’t Work

The concept of economic affinity between the home and host locations applies here. When the employee would lose or gain significantly, the host-based solution should not be considered, but even in situations where there is similarity in net compen-sation, other factors may come into play to make a host-based approach inappropriate.

Host location conditions

Host countries that are unstable,

whether economically or politically,

are usually not good candidates for

host-based assignments. High infla-

tion, currency restrictions and volatility

in exchange rates all result in poor

conditions for the use of host-based

approaches. In such locations, more

traditional approaches, such as the

home-based balance sheet, are rec-

ommended.

Company context and culture In addition, the culture and context

of the company should be right for

the use of a host-based scheme.

Companies that send large groups of

expatriates to difficult and challenging

locations are better served with the

home-based balance sheet approach.

Not surprisingly, the use of the host-

based approach is largely favored by

companies that tend to send a large

portion of expatriates to well-devel-

oped locations. Financial and profes-

| July 2013

sional services firms are far more likely

to use a host-based approach than oil and gas companies, for example.

A culture that embraces and promotes equality in the host country can help support the approach. On the other hand, companies that value and reward employees based on their contributions to the home office or that have very dis-parate reward structures from country to country are not typically prepared to promote host-country equality through mobility.

Conclusion

The host-based solution can be an ap-propriate tool for expatriate compen-sation when the right conditions exist. Companies that deploy the approach effectively understand when the solution works best. These companies have established clear eligibility criteria, and they rely on tools designed to help them make the right decision about the appropriateness of a host-based compensation package in a given situation.

Knowing when to use a host-based approach, communicating the appro-priate guidelines clearly and helping the business select the right approach for each employee helps ensure program success. With these pro-cesses in place, the assignment can be a win-win for the company and the employee.

Morgan Crosby is the Director of Advisory Services at AIRINC in Cambridge, MA. She can be reached at [email protected].

Contents © 2013. Reprinted with permission from WorldatWork. Content is licensed for use by purchaser only. No part of this article may be reproduced, excerpted or redistributed in any form without express written permission from WorldatWork.

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