PEOs Behind the Fluff, Are They Viable Options in Today s Benefit World?

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1 PEOs Behind the Fluff, Are They Viable Options in Today s Benefit World? PEO an acronym that can strike fear and anxiety into an insurance broker s inner core may turn out to be one of history s more adaptable and useful creatures. Cloaked within the professional employer organization background and history is an entity that can outsource a myriad of employee management tasks: benefits, payroll and workers compensation insurance, risk / safety programs and others specialize roles. How? By hiring a client company s employees and becoming the employer of record for tax and insurance purposes. The combined numbers result in economies of scale, leaving the client to focus on its core mission and not worry about HR management. Heather Garcia Contributing Editor ETC Partner Heather Garcia has provided business outsourcing guidance for employers since graduating with a BBA in Marketing from Texas A&M University, Kingsville. Heather focuses on employer liability and efficiencies of processes in small to mid-size companies. She is a certified Health Care Reform Specialist, a passionate speaker on the topics of today's Human Resources. Her strength is finding the alternatives. By definition, a Professional Employer Organization (PEO) is a firm that provides a service under which an employer may outsource employee management tasks, such payroll, time and attendance, Human Resources Support, workers' compensation, recruiting, risk/safety management, training and development, group benefits programs and other specialized tasks. It does this by hiring a client company's employees, thus becoming their employer of record for tax purposes and insurance purposes. By combining the employees of several companies into a larger pool, economies of scale result in a number of areas. Client companies are then allowed to focus on its core competencies in lieu of worrying about HR management. This practice is known as co-employment, different than a commonly associated industry known as staffing. Generally speaking, temporary help (staffing) companies recruit employees and assign them to client business to assist with short term work overload or special projects on an as needed basis. In a PEO, the client company turns over the personnel functions to an outside company which administer these operations and co-employ the workforce alongside the PEO.

2 Wondering Where This Whole Idea Started? The early history of PEO was known as employee leasing and was started in the late 1960s by three businessmen and later popularized by Marvin R Selter, who leased employees of a doctor s office in Southern California. The Employee Retirement Income Security Act of 1974 (ERISA) contained an exemption for multiple employer welfare arrangements (MEWA) which provided a loophole for employees to claim they were exempt from ERISA requirements. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) further encouraged employee leasing by providing tax shelters for employers who contributed minimum amount to employee plans. Stricter guidelines came down in the Tax Reform Act of 1986, eliminating many of these incentives and have now removed the loopholes in the law. In the early 90 s, the preferred vernacular for the industry moved from employee leasing to Professional Employer Organization when many of the regulators decided to monitor PEOs more strictly. In 2004, President George W. Bush signed into law the SUTA Dumping Protection Act. Client companies should be cautious in working with PEOs that don t understand this very sensitive law. As the industry itself has become a more viable option and the need for greater oversight has grown, industry associations, today called NAPEO, National Association of Professional Employer Organizations, and ESAC, Employer Services Assurance Corporation, were formed. ESAC s purpose is to verify PEO compliance with important ethical, financial and operational assurances and considerations. In 2012, NAPEO estimated the PEO industry had grown to $92 billion gross revenues, with PEOs operating in the U.S. The largest contributor to the growth of the industry is complicated employment laws paired with a more attractive diverse workforce with higher wages. The average client size in the industry is 20 employees. Again, based on PEO focus and individual state regulations, some PEOs attract much larger clients. Today PEOs employ approximately 2.5 million workers with an average annual salary of $34,000. As PEOs and client companies work to forge long term relationships, NAPEO -PEO members report an 88% retention rate of longer than seven years. In co-employment, the PEO becomes the employer of record for tax purposes, filing paperwork under its own tax identification numbers. The client company continues to direct the employees' day-to-day activities. PEOs charge a service fee for taking over the human resources and payroll functions of the client company. Typically, this is 3-15% of total gross payroll. This fee is in addition to the normal employee overhead costs, such as the employer's share of FICA and State Unemployment. The service fee generally includes workers compensation insurance and fees for other services. The more a PEO offers to do for a client company, the higher the service fee. 2

3 The Value Proposition for the Client Company The value proposition for the client company is that the key services usually provided by a PEO potentially can be lower than a client company on its own in these areas: 1) workers compensation insurance; 2) state unemployment insurance; 3) human resources processing; and 4) group and ancillary benefits. Before ACA, in some rare cases, group medical actually produces some savings to the client company. Before ACA, in some rare cases, group medical actually produces some savings to the client company. Many factors such as what carrier is involved, the PEO s negotiating power, and the PEO s ability to have a self-insured product where it absorbs some of the risk are all factors to take into account when reviewing health care options. In most long term cases, the year to year, five year trend is far better with a PEO than with a stand-alone client company as it really does have substance and negotiating power. This does not mean that client companies will not have annual increases that are in line with their own claims experience; but can mean that generally they begin with a lower starting point and take reasonable increases year over year. With the small group community rating rules today, a small client can also find solace in the PEO s ability to bring them in to a large group plan with large group rules. The Affordable Care Act s rules and regulations have made a PEO a viable option for a client company. If a client company has fewer than 50 employees, the open market healthcare options requires modified, adjusted community rating, which will allow only demographics, location and tobacco use to effectively quote the group. A small group with no medical concerns which once paid appropriate rates for the risk could potentially be impacted negatively by the new rating requirements. PEOs, with large group plans, are allowed to underwrite a small case, thus giving risk appropriate rates. When considering the best interest of the client, moving to a PEO for health plan reasons doesn t solely justify the decision; however when paired with the other services that a client company could potentially receive the PEO could be a win for both the client company and the referring broker. 3

4 Potential Savings for Client Company Use of a PEO potentially saves time and staff that would be used to prepare payroll and administer benefits plans, and may reduce legal liabilities or obligations to employees that it would otherwise have with a well written client contract or agreement of services. The PEO can put together a package of services that assists a small employer with a look and feel of a larger employer and in theory would assist in attracting more skilled workers. The PEO model is therefore attractive to small and midsized businesses and associations, and PEO marketing is typically directed here.. Each state in the U.S. has different regulations for workers compensation and state unemployment insurance and because PEOs are typically regulated at the state level, all states and workers need to be reviewed before decisions can be made as to whether a move to a PEO is a good fit for a client company, Variations on a Theme: the ASO Several variations on the PEO model exist, differing in the nature of the relationship formed between PEO and Client Company. One such arrangement is an administrative services organization (ASO). An ASO is an rganization that provides outsourced solutions to meet the administrative and HR needs of the client, with the client retaining most if not all employment-related risks and liabilities. The term ASO was established by the PEO industry in the late 1990s in order to distinguish between selective administrative support and full-scale PEO services. The principal difference between the two types of service is that, in an ASO arrangement, the employer remains the employer of record for tax purposes. Ultimately, with this structure, tax and insurance filings are done through the administrative firm, but under the client company s federal tax ID number. All W-2 and insurances remain in the client company name and the responsibility of the client company. Some of the more common administrative services offered are: payroll processing and tax filing benefits administration human resource support technology and system support and others as outlined by the provider The benefits of an ASO are not as easily quantifiable since the policies and tax rates remain the client company s. There are not financial gains in hard dollar costs moving to this model; however, administrative firms performing ASO duties conceptually save business owners time and money through economies of scale and level of expertise. 4

5 Strength in Numbers Professionals who might be somewhat out of budget for just one small company can come together and service multiple companies as a much needed resource to a possibly overworked or less experienced staff. Many businesses, especially small businesses or start-up companies, are not prepared for the administrative duties involved with running a business. The knowledge and capabilities of small and mid-sized businesses are usually limited to occupational expertise, instead of having legal or administrative expertise. One of the most significant advantages of using an ASO is the benefits from cost saving techniques and bargaining abilities that the ASO can provide due to their large number of workforce employees. Although the ASO and PEO business models are similar, an ASO does not include co-employment as described above. A Scaled-Down Option Finally there is a scaled down version of outsourcing to attain efficiencies and legal expertise which the industry calls a la carte. Many of the large national firms are very good at components of the employee lifecycle. From recruiting to termination, there are many services, technologies, and liabilities inside of that tenure. Firms like ADP and Paychex have historically owned that market; however, as of the last few years, many of the regional and local service bureaus have risen to the service level demands of a client company. One of the toughest decisions an owner has today is how to run his business efficiently and cost effectively. Having vendors who either work together or finding a single turnkey solution that does this work for you so while understanding the actual business needs is paramount to attaining the goal of success. In summary, the outsourcing industry has proven a very viable business option for many owners of both small and large businesses. The trick is to find the right fit for your business. The fit can be culture understanding, industry understanding, ability to adapt, technology, services, or a number of different things. For a trusted advisor to a client company, now is the time to learn what is on the other side and go beyond the way we have always done it in order to deliver solutions to a client company. Today presents an employer community and is in a state of change to say the least. The idea that we actually know what the employment lay of the land will be in 18 months is sadly gone. Forecasting and projecting are guesses at best versus our usual educated guesses. So as a client company, trusted advisor, or person thinking about entrepreneurship it s time to evaluate all the options. 5