PEOs: Breaking It Down
Professional Employer Organizations (PEO) are becoming more prevalent and widely used today. Perhaps you have heard of PEOs or maybe this is a new concept to you. So what is a PEO and how do they work? Why would a business use a PEO?
Lets start with what a PEO is and how it works. PEOs are also known as employee leasing companies. Technically what happens in a PEO is a co-employment agreement between two businesses. In this scenario, the PEO and client company. This co-employment agreement is the magic sauce which makes the whole arrangement work and differentiates a PEO from other forms of outsourcing like a basic payroll service or HR outsourcing company. The PEO becomes the employer of record for certain employer liabilities such as payroll, unemployment administration, workers compensation insurance, and employee benefits administration. The client company is the worksite employer in charge of hiring, firing, scheduling, management, and running the day to day operations as normal. While both the PEO and client company are considered co-employers, the PEO operates in the background while the worksite employer is the “visible” employer dealing directly with the employees. Typically, employees don’t know any different besides the company name on their W2. Every PEO is different and may include some or all of these functions but these are the fundamentals of most PEO arrangements.
So, why would a company use a PEO? Typically, we see businesses entering a PEO arrangement three reasons.
Fundamentally, a PEO provides an avenue to outsource many of the employer related administrative tasks and responsibilities. These core responsibilities are payroll and tax administration, workers compensation insurance, employee benefits, HR administration, and risk management. Most all companies that have employees are required by law to comply with these employer functions in some way. They either have an internal HR and payroll department, an office manager, accountant, or perhaps they are using a payroll service to manage part of the responsibilities. Either way, these are all liability bearing and unprofitable tasks that need to be handled in some way. A PEO is made up of an entire team of professional payroll processors, HR consultants, labor attorneys, insurance professionals and accountants which all specialize in their respective areas.
Some businesses engage a PEO purely for outsourcing of these administrative tasks to this team of professionals so they can focus on the core competency of their business.
While outsourcing is the fundamental concept behind using a PEO, most businesses today are partnering with a PEO for the next two reasons.
Workers Compensation Insurance
Workers compensation is regulated at the state level and is probably the most volatile and potentially costly line of commercial insurance. Especially, for any blue-collar industry such as the construction, manufacturing, and transportation sectors. Each state has different requirements regarding who is required to carry workers comp but it is required by law in all but one remaining voluntary participation state which is Texas. Depending on what state a business is located in, the availability and ultimate cost of workers compensation can vary significantly. Typically, if a business is deemed high risk or high hazard, has not had any prior coverage, or if they have adverse loss history, procuring workers compensation insurance in the standard insurance market is extremely difficult. Much more so than other lines of commercial insurance. That leaves a business owner with very few options since maintaining workers comp insurance is required by law. They could go to the state insurance fund where the rates are astronomical and virtually unaffordable and could put many businesses under. Depending on the particular state fund and classification or industry, workers comp insurance can potentially cost more than the amount of payroll a company processes each year. I know that seems hard to believe but just ask any roofing company in Georgia that is in the state insurance fund. For every $100 of payroll processed in 2017, they would pay $120.29 in workers comp insurance. That’s right, a small roofing company in Georgia with a $100,000 payroll would pay $120,290 for their workers comp insurance in the state fund. The other option for one of these “high risk” businesses needing workers comp is to look to outsourcing service like a PEO.
From a workers compensation perspective, the PEO maintains a large master workers comp policy which covers all of the leased or co-employees of their client companies. Workers comp insurance under a PEO policy can be extremely cost effective and only a fraction of what the state insurance fund would cost. Workers comp through a PEO can even be competitive and more cost effective than the standard insurance market depending on the industry and carrier. PEOs have great rates for a couple of reasons. First, there is an economy of scale or large group purchasing power under a PEO. These master policies typically have thousands, sometimes hundreds of thousands of employees covered and millions in premium. Same concept as Costco… buy in bulk get it for less. The second reason a PEO’s rates are so low is due to risk retention. Most PEOs are on a high deductible policy which means they retain the first $500K or higher of each claim. They essentially self-insure up to a certain point which provides the PEO with extremely deep discounts from the carrier.
Low cost is only one of the benefits of a PEO’s workers comp policy. The PEO provides pay as you go coverage which eliminates any large up front deposit premium and the year end audit as in a standard workers comp policy. This is a huge cashflow tool for many businesses. The premiums are calculated each payroll period based on the wages processed so there is no discrepancy at the end of the policy year. PEOs also provide valuable claims administration, investigation, risk management and loss control to their clients. The PEO has more skin in the game than party in the arrangement due to the high deductible. They have every reason to fight fraudulent claims, close claims quickly, and encourage a safe workplace for their clients to help avoid future costly claims. Any business owner that has dealt with a fraudulent workers comp claim knows that a standard insurance carrier will settle and pay it out because it is cheaper than investigating and fighting in court. Not true with a PEO. PEO clients have an advocate and team of big guns with deep pockets to help fight erroneous claims and employees wanting to milk the system.
So, to sum up workers comp through a PEO; it is cost effective, big improvement on cash flow through the pay as you go policy, and offers far more support than a standard workers compensation policy alone. Many of these same concepts tie in to the third and final reason companies partner with a PEO.
The Affordable Care Act (Obamacare) has added an insane amount of red tape, regulation, administration, and cost for small businesses. Companies with 50 or more employees are required by law to provide health insurance that meets certain minimum coverage and minimum value requirements established by the ACA or they can face substantial monetary penalties. I don’t want to get in to all the minutia of the ACA or whether it is good or bad. However, the implementation of this law has driven or forced many employers to engage a PEO for two reasons.
First, as if health insurance wasn’t already costly enough, premiums have doubled and even tripled over the last 6 -7 years since the law was passed. Just like with workers compensation, health insurance and employee benefits are far more cost effective through a PEO master policy due to the economy of scale. A PEO with 50,000 worksite employees on their policy gets far better rates than a small business with 50 employees. They have more negotiating power and insurers willing to compete for their business. A PEO also will offer a full suite of supplemental and voluntary employee benefits such as vision, dental, short and long term disability, group life insurance, and retirement plan options. Many small businesses just don’t have the capacity, money, or administrative support to offer a quality benefits package on par with a Fortune 500 company. This helps smaller businesses attract and retain top talent.
Along with offering these benefits comes a bombardment of administrative and compliance issues for a company to deal. Which brings us to the second reason businesses engage a PEO from a benefits perspective. The PEO fully administrates these policies from the open enrollment, required reporting, regulatory compliance, and payroll deductions, and premium remittance. The compliance and reporting requirements brought on by the ACA essentially created an entire sub industry in the healthcare space just to help businesses navigate and administrate the complex requirements. Many companies have partnered with PEOs over the last several years just to help alleviate the administrative burden of this process.
In conclusion, PEOs can be a valuable resource and avenue for businesses needing administrative support, workers compensation insurance, and employee benefits. Not all PEOs are created equal and they may not be the right fit for every company. However, with the thousands of businesses I have worked with through the years, 90% of them could use and benefit from something that a PEO offers.
The key with evaluating and ultimately selecting the right PEO is to use a knowledgeable PEO broker or consultant that understands the marketplace and can explain the pros and cons of every option. In my professional opinion, the least effective way to select a PEO is to deal directly with commissioned sales reps from the PEO who all have an agenda and are pushing their own program. I say this as a PEO broker who has also worked as a PEO sales rep and program manager for several PEOs in my career. It is no secret that PEO brokers get paid and work on commission as well. Everyone is in business to make money. The difference is that a PEO broker works for the client company and is paid directly from the PEO as an independent consultant which costs the business owner nothing. The client gets a professional advocate that knows how to negotiate on their behalf and an unbiased recommendation on the best outsourcing solution for their needs.
Here comes our shameless plug….
If you are a business owner that is currently with a PEO or is considering a PEO as an option for your company, we would love to be a resource for your company. Or, if you are an insurance agent needing a reliable wholesale PEO broker to assist with your clients, you may contact us directly anytime. You can rest assured your company will be working with an experienced team that intimately knows the industry. With long term established PEO relationships, substantial book of business, and exclusive marketing agreements, Reliance Brokers will be a transparent window and advocate for your company through the decision-making process.
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