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Professional Employer Organizations

By February 6, 2020 Insurance

Professional Employer Organization’s (PEO’s)

Do a quick google search of “PEO Pro’s & Con’s” and you will be bombarded with “educational articles” focused mostly on the benefits of these platforms. In my research, I have found very few articles that represent a true non biased analysis of these platforms. Part of this may be because most of the literature found on the first few pages of Google is either written by PEO companies or authors that represent their interests.

As a licensed insurance consultant (2-15 & 2-20) with Bachelor’s degrees in both Finance and Risk Management from Florida State University, I have the technical experience conducive to giving an accurate analysis of these products. Additionally, over the last 5 years I have been consulting my clients and prospective clients as to whether or not the PEO platform makes fiscal and/or administrative sense. In some cases, it does. In others, it does not. Arriving at either of these conclusions should be done through the use of a cost benefit analysis.

This walkthrough is designed to be a mechanism for business owners, CXO’s, insurance agents and human resources professionals. It can be used to weigh the considerations of the PEO platform in order to determine its feasibility versus standalone Workers Compensation and Health Insurance programs with internal/external payroll processing mechanisms.

Focus & Efficiency

This category is applicable to business owners that shoulder the majority of the burden in self-performing their own payroll, insurance, taxes and other human resources functions. For these folks, working with a PEO allows them to focus on the task at hand. Most mid-large sized companies have different departments within their organizational structure to address issues like: payroll logistics, insurance requirements, regulatory changes and tax burdens. For companies in this situation, doing a cost/benefit analysis to determine whether or not outsourcing these functions makes fiscal and operational sense can be done with a Venn-Diagram.

Some PEO consultants out on the street will try and advocate for firing your in-house Human Resources professional since, “We will take care of that for you”. This can be a good idea if you cannot justify a salary for an HR person but, keep in mind that a PEO may still be charging you a percentage of your total payroll which is normally 2-4%.

Furthermore, the HR services that PEO’s provide are only valuable if you have the time to use them and have someone on staff who knows how to use them.

Another consideration is that having someone in the office and speaking to someone over the phone are two very different things. When you need to get an answer on something right away it is far more convenient being able to yell across the room than to pick up the phone and be put on hold for 15 minutes.

The last point that I am going to make about this particular circumstance is one of perspective. Why would you trust your essential HR functions to someone that has never stepped foot into your office? How can you realistically expect this person, or team of persons, to understand your business having only just met you and your company? No two companies are alike and training and retaining a capable Human Resources person can take years to accomplish. Do not give up your most valuable in-office asset without thoroughly thinking it through.

With that being said, no two PEO’s are alike… There are some that provide Human Resources functions much better than others. Having both an in-house HR professional and an outsourced HR department through the PEO model is where larger companies can really get ahead of their competition in the HR department. They have both an in-house expert and a third party consultant with valuable resources that can help them with employee handbooks, forms, policies and procedures, etc.

COBRA

One unique benefit of the PEO platform is that if you are at a distressed company and your business fails or goes into bankruptcy, the employees may still have access to COBRA benefits continuation through the PEO platform. If the company had a private benefits plan this may not be the case. On the other hand, some PEO’s do not offer COBRA as an option for employees after the employer leaves the PEO.

The interactions between COBRA and the PEO are complex. There is difficulty with establishing who the actual employer is. Is it the PEO or the business? There are two tests that exist for figuring this out. One is the common-law employee test and the other is the leased employee test. I am not going to dive into the specific details of each of these tests because they would probably put you to sleep. For more information on this topic you can visit: Key Issue for PEOs and COBRA: Who’s the Boss?

Regulatory and Professional Compliance

One of the most important advantages PEO’s provide to a business owner are in helping with regulatory compliance. This could be IRCA, EEOC, payroll burdens, D.O.T. issues, etc. Not all companies have staff that are well versed in these areas and taking the time to properly train them in an ever evolving regulatory environment can be cost prohibitive. PEO’s have trained professionals on staff that can help your company with these issues.

Cash Flow

For small businesses, you can be required to give up the at least several days of cash flow when signing up for a PEO. Some PEO’s require cash up front before releasing the first payroll cycle to employees. This scenario can happen for companies using standalone insurance carriers too. Some businesses are required to pay large down payments up front on Workers Compensation policies. The bottom line here is that you need to know the cash flow implications before you sign up with a new provider… You may be saving $10,000 a year but, if you need to put 25% of that up front when you are used to now having a down payment, it could be a deal breaker for both standalone Workers Compensation or the PEO model.

Administrative Pricing Structure

Most leasing companies charge their clients a percentage of their total payrolls which can be anywhere from 1-15%. The most common percentages that I see are between 2-4%, the majority of which are structured towards the latter part of the scale. Some PEO’s charge on a per employee basis which can be a huge advantage over the former option for companies with large payroll registers.  

Some business owners are unaware of this pricing component. Those that are aware generally do not get overly concerned because these charges are tacked on per pay period and are generally between $20.00 and $100.00 per employee on a bi-weekly basis. As you can imagine, this percentage can be a very large annual number for an employer with over 20 employees.

Even an employer is paying the minimum wage ($8.05 in Florida) to 20 employees at 40 hours a week we arrive at a number between $6,697.60 and $13,395.20 depending on the 2-4% being charged.

In the industries that I work with (Construction, Marine & Hospitality) I see an average annual wage of about $28,000 which translates into annual administrative charges between $28,000 and $56,000 depending on the 2-4% being charged. As a general rule I do not work with companies that have less than 50 employees, which is why you see the payroll disparity form the previous example. This is where a PEO that charges on a per-head basis can be a huge advantage.

When we contrast these expenses with the salary of hiring a Human Resources professional we can see that at the 50 employee mark is generally when the PEO model stops making sense as far as the administrative expenses, unless of course that particular PEO has an extremely advanced Human Resources division that takes care of complex industry specific regulatory issue and essential HR functions (which does exist). For those PEO’s with lots of buying power in regards to health insurance the 50 employee mark can be misleading. It makes sense in certain situations.

Better Service

At the end of the day, there is still a bunch paperwork that PEO’s require including new-hire packets, garnishments, data entry, time and attendance reporting for payroll and initial CSA’s but, this is mostly done upon signing up and greatly reduced throughout the co-employment term. The streamlined level of service they offer coupled with the “One-Stop-Shop” mentality makes life easy for the business owner who isn’t interested in expanding his already overflowing hat rack.

Some PEO’s have true back office HR departments and companies are only required to submit payroll documents. The back office handles the data entry for you. For companies that already outsource their payroll this is the exact same process they are used to. Some PEO’s require that you do all of the data entry up-front. This is a major consideration to take into account because, while it may not affect the business owner for a mid-sized business, it will definitely affect the HR department or whoever is in charge of data entry, collecting documents and reporting fiscal figures.

Transparency

Most PEO’s give a breakdown of the “overhead” costs between taxes, insurance, administrative fees, etc. It can get tricky to distinguish what you are being charged however when they just lump all of your costs into one grand total, which is a percentage based number, and do not offer an explanation for the different expense items. Most PEO’s that are established will clearly outline your different expense areas. I would be wary of using one that is unwilling to provide a clear picture of what they are charging you and where.

Unused and/or Unneeded Services

PEO’s offer a variety of different services that business owners can choose from. While many of these services can be useful, they may not all be needed. Most of them are not needed for the small business owner but, it depends on the company. Some PEO’s package together way too many unneeded services and charge for them whether or not they are used. Common examples of these are: Recruitment & Selection services, Human Resources Services, Legal Advice, etc. Be sure to evaluate what extra charges are being added to the policy before you commit. Most small business owners just care about the bottom line and are never going to use any of the fancy stuff that PEO’s are offering… So why pay for it? Some larger companies will definitely use what they are offering and are willing to pay the big bucks for it.

Mid-term switches

If switching from a PEO to another PEO mid-term generally all of your SUTA taxes reset. This can be a problem for companies with over 20 employees. Another aspect to take into consideration is your turnover. If you choose to leave the PEO platform you will be carrying your own SUI rate which will either be lower or higher than what you were given with the PEO. This is based on how much employee turnover your company has and the percentage is anywhere between 2.7% and 5.4%. This could be another problem for your company if you experience a large amount of turnover. Some PEO’s run promotions that ignore the SUTA reset at year end in order to drum up new business. This can be a good time to switch.

Insurance Considerations

In regards to Workers Compensation being with a PEO is seen as a black mark by some insurance carriers. As an agent, the first question I get asked when submitting a particular account coming from the PEO platform is, “How bad are their losses?”… This clearly reflects the fact that many businesses are in the PEO world in order to dodge a punitive experience modification factor. As an agent marketing an account that has been with a PEO it is extremely important to clearly outline why that particular company chose to get into the PEO platform. Otherwise, the insurance companies you are submitting to may make assumptions that could hurt your chances of getting a competitive quote.

For those of you that are unfamiliar, and experience modification factor (EMR) is a number that represents either a credit or debit that is applied to your Workers Compensation premium. The EMR is calculated by comparing actual losses to expected losses for the policy period based on the industry that the business is in. Roofers are compared to roofers. Engineers are compared to engineers, and so on… Companies that have had unfortunate loss scenarios and bad loss history are penalized for it and because of this, their EMR’s are less than favorable. For companies in these situations it can make sense to switch to a PEO in order to take advantage of their EMR which may be significantly lower than the rate that their company has earned through past experience. We have seen hundreds of thousands of dollars saved by “renting” the PEO’s experience modification factor. For companies that are not in this situation, the exact opposite affect can take place. If you have an outstanding EMR like a 0.60 but switch to a PEO with a 1.00 EMR you are essentially increasing your Workers Compensation costs by 40%.

Workers Compensation Cost Control

Managing the EMR can be a difficult task. Many large and established companies have their own internal Risk Management and Loss Control departments whose primary purpose is to control risk exposures. For smaller companies that do not have this luxury it is important to find a partner who can provide this service. Many Insurance Carriers, Brokers & PEO’s offer “Loss Control” and “Safety Services” but, in reality there are only a few that do this task well and achieve results.

For the majority of mid-sized businesses that are in the PEO platform there is a lost sense of control when it comes to Workers Compensation claims and the EMR. There are only a few PEO’s that offer claims consultants that have the capability to advocate on your behalf. Because of this claims can get closed and/or settled without the businesses consent. This can be extremely frustrating to someone who feels they are experiencing fraudulent claims. This exact same phenomena happens in the standalone Workers Compensation market. This is where the importance of having a broker with these services is paramount.

This lack of claims advocacy might not matter if you are sharing in the collective EMR with your PEO pool of risks. But, if you ever decide to get out, this can serve as a set of “golden handcuffs” for the business. If the PEO decides to settle on every single instance of fraudulent claim activity for business “ABC” and later on “ABC” wants to procure standalone Workers Compensation coverage, they may find it difficult when a multitude of different claims show up on their loss history that should have never been paid in the first place.

With that being said, there can also be advantages to clients of PEO’s that have their own Workers’ Compensation insurance carriers. An example of this is a PEO who is able to offer rates lower than what standalone carriers can offer. Keep in mind; you may be losing your dividend potential with a PEO, so that still needs to be a factor in the equation.

Deductibles

 Unlike standalone Workers Compensation, some PEO’s carry high deductibles. I have seen them as low as $0 and as high as $10,000. These are generally put to use when a company has a poor loss history and is making the switch to the PEO model to escape a less than favorable EMR. In order to protect their own EMR, the PEO will issue a policy with a deductible that will then become a self-insured retention for the client. Sometimes it is easy to overlook a deductible of $5,000 dollars but, for a company that experiences a large amount of claims this can have a huge impact on the bottom line. This can actually have a positive impact on the business as they will begin to see immediately what the impact of having claims does to their company financially.

Qualifying for Bids

Some larger General Contractors will not entertain bids on specific jobs from companies that have Workers Compensation from PEO’s. Some PEO’s do not have A rated insurance carriers and this can affect your business relationships. The majority of PEO’s have A rated carriers but, you need to check this before you sign up with a new provider if you are in the construction industry. When submitting for a bid on a job, some large scale GC’s will ask you to provide your Experience Modification Rate on the bid proposal. This can create some problems if you are with a PEO.

Dividends

At the end of the year, many of my clients get checks in the mail ranging from between 5% – 40% of their total Workers Compensation premium. These numbers are based on total loss ratios (the ratio of claims paid to premiums earned) throughout the policy period. The lower your loss ratio is, the higher your check is. This is a big advantage that standalone Workers Compensation policies have over most PEO platforms. Some PEO’s offer carve outs of Workers Compensation (meaning they will handle the payroll and benefits) which can offer the best of both worlds if you are able to receive a dividend.

Loss sensitive Workers Compensation plans (Paid Loss and Incurred Loss) are additional methods for administering Workers Compensation that may not available under the PEO platform. These plans have distinct cash flow advantages over both regular Workers Compensation and the PEO platform. They also carry a higher amount of risk for the company.

Employee Benefits

This is probably the single greatest advantage that a PEO can bring to your company. Here is a simple example. Let’s say that your company has 50 employees and about half of them decide to participate in open enrollment. Your buying power is based on about 25 people. On the other hand, if you are in a co-employment relationship with a PEO your buying power can be well over 1,000,000 depending on the size of the PEO you are with. This translates into more robust benefits packages at lower price points because of their increased buying power.

Some established PEO’s also offer 401(k)’s for employee’s which can coincide with the payroll they administer to streamline this process making it quick, clean and simple. You can set up your employees to have funds automatically withdrawn from their checks and deposited into their retirement plans. With that being said, most payroll companies can provide this same service.

The Bottom Line

PEO’s can and should be utilized by businesses and insurance agents, however, they can be difficult to analyze because of their complicated nature. There are so many different facets at play when it comes to comparing apples and oranges (PEO’s vs. Workers Comp. / Health / Payroll / Retirement Benefits / Taxes). Hopefully this guide will give interested parties a birds eye view of the important issues at play so that informed decisions can be made and sustainability can be achieved.