HUMAN RESOURCES OUTSOURCING FOR FINANCIAL INSTITUTIONS: IS A PEO THE RIGHT CHOICE FOR YOU?

HUMAN RESOURCES OUTSOURCING FOR FINANCIAL INSTITUTIONS: IS A PEO THE RIGHT CHOICE FOR YOU? September 15, 2008 David W. Harrop Director, Financial Services RSM McGladrey, Inc. RSM McGladrey, Inc. is a member firm of RSM International, an affiliation of separate and independent legal entities. 1

DAVID W. HARROP David Harrop is a Director of Financial Services consulting, and is located in RSM McGladrey s Dallas, Texas location. Mr. Harrop provides several services to clients in the financial services industry, including: Profit Enhancement Planning Strategic Planning Workflow Reengineering Productivity and Work Management Development of Policies and Procedures Management/Organizational Studies Credit Administration and Loan Processing Reviews Mortgage Department Operations Reviews Operations, Administration and Organizational Consolidation Studies Mr. Harrop has presented workshops and seminars to financial institutions, and has addressed bankers and other professional groups on a variety of topics including productivity improvement, profit enhancement, and operations consolidation. He served for six years as a member of the faculty of the Graduate School of Banking in Madison, Wisconsin. In addition to authoring a number of articles for publications including Bank Operations and Technology Alert and Independent Banker magazine, Mr. Harrop has also co-authored and edited three manuals, Controlling Operating Costs, Branch Administration Management Service, and Cost Control for Credit Unions, published by Sheshunoff Information Services. In addition to his twenty-one years of financial institution consulting, Mr. Harrop has nineteen years of commercial banking experience in the areas of lending, operations, and finance. EDUCATION University of Kansas, Lawrence, Kansas, Bachelor of Arts Graduate, School for Bank Administration, Madison, Wisconsin Numerous professional courses and seminars RSM McGladrey, Inc. is a member firm of RSM International, an affiliation of separate and independent legal entities. 2

OUTSOURCING FOR FINANCIAL INSTITUTIONS Wikipedia defines outsourcing as subcontracting a process... to a third-party company... [often] in the interest of lowering costs, redirecting or conserving energy directed at the competencies of a particular business, or to make more efficient use of land, labor, capital, technology and resources. For financial institutions, perhaps the most commonly outsourced function is core IT processing. A recent survey by the American Bankers Association indicates that over half (51.2%, with an additional 4.5% using a combination of outsourced and in-house resources) of all responding financial institutions outsource their core data processing. Smaller banks (assets less than $500 million) were the greatest users (54.1%) of outsourced services. While IT is the most commonly outsourced service, over 36% of ABA survey respondents said they outsource other functions traditionally performed in-house. The most commonly outsourced functions or processes include: Internal audit, Loan review, Regulatory compliance review, Item processing, and ATM servicing. Just over 4% of survey respondents (11.9% of the 36% above) outsource Human Resources functions. WHY OUTSOURCE HR? One of the concerns most commonly voiced by financial institution management teams is the increasing difficulty of recruiting and retaining quality staff at all levels of the organization that can help the financial institution translate its plans and goals into reality. While community banks can compete with their regional and national competitors in terms of work satisfaction and base compensation, a major impediment for smaller banks is their inability to provide competitive benefits programs, both in terms of cost and choice. Benefit costs, particularly the costs of health insurance, have in recent years increased annually at double digit rates. Additionally, for smaller institutions, already high health insurance premiums can be dramatically affected with one significant medical expense by a staff member or covered dependent. The ability to partner with an outside provider to offer an improved level of benefits without a significant cost increase may be one reason to look at alternative human resources models. A second reason to consider outsourcing is technology. Many community banks maintain inefficient, paper-based systems for handling functions such as new employee onboarding, employee attendance, and benefits selection and administration. Outsourced human resources providers may provide very efficient human resources information systems (HRIS) that not only convert many of these paper systems to electronic systems, but also allow 3

the employees themselves to take over such functions as benefits selection and time and attendance tracking thereby allowing HR staff to concentrate their efforts on non-clerical activities. A third reason to consider outsourcing is the ability of the service provider to offer improved skill levels and competencies within the human resources arena. Often in community financial institutions the HR function is a part-time responsibility of the Chief Financial Officer or Senior Operations Officer. This lack of human resources expertise can create significant risk for the organization. An HR outsource provider may offer a staff of trained human resources specialists who can assist, guide, and counsel their clients through increasingly complex areas of human resources laws and regulations. The fact is that it s not really about outsourcing human resources. For most community banks, much of the HR function is already outsourced. Banks use a benefits broker, a workers compensation broker, a payroll company, a third party administrator for 401(k) and other retirement programs, a labor law attorney, and sometimes an outside HR consultant. But while these functions are often already outsourced, there is no functional integration and none of the efficiency or effectiveness that would be available through an integrated program. Additionally, the banks maintain all of the risks and liabilities associated with these functions. An increasingly popular means of pursuing these human resources opportunities is the Professional Employer Organization, or PEO. The PEO model allows the bank to move to a single vendor solution that works together in an integrated environment that also, as we will discuss below, provides relief from certain risks and legal liabilities. WHAT IS A PEO? DEFINITION AND DESCRIPTION The National Association of Professional Employer Organizations defines a PEO in the following way: A PEO provides integrated services to effectively manage critical human resource responsibilities and employer risks for clients. A PEO delivers these services by establishing and maintaining an employer relationship with the employees at the client s worksite and by contractually assuming certain employer rights, responsibilities, and risk. The relationship between the client and the PEO is often referred to as co-employment, in which the PEO actually co-employs the client s workers and assumes certain employer responsibilities as contracted with the client. WHAT IS CO-EMPLOYMENT? As a company enters into a contract with a PEO, a co-employment relationship, in which the PEO and the client company co-employ the client s employees, comes into being. In this relationship the client and the PEO share and divide employment-related liabilities and responsibilities. The client company retains responsibility for managing and directing the company s fundamental business in the case of financial institutions, the responsibilities for pricing and gathering deposits, making loans, providing banking services to customers, etc. The PEO takes on much of the responsibility and liability for employment-related issues: human resource management, benefit plan sponsorship and administration, payroll and related tax compliance, and compliance with the entire range of state and federal employment laws, regulations, and the agencies that oversee them. The client the bank always maintains direction and control. The bank performs all of the duties that employees look to the employer to perform: hiring, firing, salary and wage administration, performance evaluation, monitoring of vacation and sick time, etc. The PEO assists in these matters by helping the bank onboard new employees, providing a comprehensive benefits platform, assisting with employee handbooks, managing time and attendance systems, and performing the entire payroll function including payroll tax filings. In addition, some PEOs provide technology-driven solutions for performance management, compensation studies, recruiting, training, as well as providing a fully 4

integrated electronic delivery system that removes much of the paper laden, manual effort that the bank dealt with prior to contracting with their PEO vendor. In addition, entering into a co-employment model, the bank is completely absolved of many specific employer liabilities. With regard to government reporting of payroll taxes, all liability from sponsoring the employee benefits platform, COBRA, HIPAA, etc. the PEO becomes the single contact point for state workforce commissions claims, Department of Labor, Equal Employment Opportunity Commission as well as employer-related IRS inquiries. The PEO may also become a liable party to all harassment, discrimination, and other Title VII claims filed against the bank. Since the PEO s core business is performing HRO duties, they can be an invaluable partner for the bank should any of these issues surface. A frequently asked question deals with whether or not the client company loses control of its business. The answer is no. Although the relationship between the client and the PEO is that of co-employers, the PEO is given employer status only to perform the human resources duties that employers must perform: compliance with both state and federal employment laws and regulations, payroll administration and related tax filings, and so forth. As stated above, the client retains responsibility for and oversight of the fundamental business processes. In addition, while the PEO takes on much in the way of human resources responsibility and liability, the client retains control over all decision making functions regarding hiring and firing issues and remains responsible for workplace safety and compliance with applicable workplace laws and regulations. The PEO generally assumes responsibility and liability for purposes of general HR administration, payroll, taxes (income, FICA, and state and federal unemployment taxes), and benefit coordination and administration, and often provides an upstream consulting professional for all HR issues including employee discipline and terminations. The PEO clients we surveyed stated there was no infringement by their PEO in the managing of the business, including employee recruitment, hiring, performance management, discipline, and, when necessary, firing. All commented, however, that in all of these employee-related areas the PEO was able to provide invaluable consulting, counseling, and other assistance as necessary. 5

PEO SERVICES AND BENEFITS Basic services provided by a PEO include: General employment administration. Payroll administration and responsibility for payroll tax remittance, including retention of payroll data and all payroll tax filings. Compliance with relevant employment laws and regulations, on both a state and federal level. For multistate companies, this is a huge benefit. It allows the bank the freedom to build out-of-state branches and never worry about the differences in employer and payroll laws in multiple locations, saving time and money. In addition, the PEO will insure that the benefits offered to employees in all locations are consistent with applicable state laws. Sponsorship and administration of health insurance and other benefit plans. The PEO assumes the sole responsibility for all liability that comes with being the sponsor of the employee benefit platform in all domestic and international locations. Some PEOs offer foreign national and expatriate administration services, as well as world wide workers compensation and medical coverage. Onboarding of new employees (new employee orientation, benefits enrollment, and set-up on payroll). A PEO that offers new employee on-boarding through a paperless Human Resources Information System that can eliminate the half day or more of paperwork to get an employee processed, provides the greatest onboarding efficiency for its clients. HRIS (Human Resources Information System) technology: Delivery system the PEO supplies to client companies Features may include automation of many manual tasks and integration with payroll systems and insurance platforms, eliminating the need to complete paper forms to set up payroll records and enroll in the employee benefits plans. Existing employees can often self-direct on benefit selection and enrollment issues, perform provider search information, and have 24/7 access to policies and procedures and employee handbooks. Other potential HRIS benefits include the employee s ability to update tax withholding and direct deposit information in real time and obtain answers to their questions or concerns on all employee benefit insurance coverages, thus eliminating any need for other Bank staff to be involved on any of these issues. 6

In addition, much employer-mandated training can be self directed through this technology platform. Human Resources consulting services including regulatory and legal compliance, employee assistance, and employee training Employee discipline and termination: The PEO HR consultant is available in an advisory role to review options and assist the Bank with an assessment of any potential liabilities that could result from handling a situation incorrectly. In addition, the HR Consultant can be an extremely useful with assisting the bank in preparing for, or participating in, the actual termination meeting. Additional services may include: Recruiting assistance, 401(k) plan administration, Coordination of performance management systems and processes, and Comparative local and regional salary information by position. PEOs provide a very comprehensive suite of Human Resources capabilities. As one vendor stated in a marketing piece, [You] Focus on [your] business. We ll handle HR. 7

WHY CHOOSE A PEO? THE CLIENT EXPERIENCE To gain an understanding of why clients particularly financial institutions chose a PEO for human resources outsourcing, and to learn what their overall experience and level of satisfaction has been, we interviewed clients of four PEOs ranging in asset size from a de novo bank which opened in March, 2008 to an established bank with assets exceeding $1.0 billion. The clients reasons for choosing a PEO included: Cost savings on employee benefits particularly health insurance both initial and ongoing. These savings are possible because of some but not all PEOs abilities to aggregate its clients employees into a single very large group for insurance purposes. PEOs abilities to do this are a function of two primary factors: First, the homogeneity of the PEO s client base. Because of different work-related risk factors, for instance, combining accountants and steel workers into a common group for health insurance and/or workers compensation does not create the same cost savings opportunities as if the group were all accountants. The second factor is the size of the PEO the number of individuals covered and its ability to aggregate a large enough group of homogeneous workers to gain the potential savings. One banker experienced an initial savings of $168 per month per employee, while at the same time being able to provide a wider range of insurance options with improved features for the employees. Another financial institution, because of employees recent medical problems, could find affordable health insurance only through a PEO, and only because the PEO was able to aggregate the bank s staff and their medical issues into a much larger group. A second reason, mentioned briefly in the preceding bullet, is the increased number of plan options that may be available through a PEO. A large PEO, for example, may offer as many as 14 different medical options for each employee to choose from far more options than a community bank would typically be able to offer. Interviewees saw as much benefit in the increased benefit options available as they did in the savings opportunities. Improved human resources expertise and professionalism was the benefit most valued by the sampled clients. Specifics include improved knowledge and understanding of local, state, and federal employment laws and regulations; the ability to structure an effective and efficient human resources function within the bank; the ability to counsel effectively with managers, supervisors, and employees; and the ability to advise the employer on the best ways to handle difficult employment situations without risking lawsuits or violations of law. In conjunction with the increased professionalism was the resulting opportunity to redirect the efforts of existing HR staff into other activities within the banks. These include improved training in sales and functional skills, employee development, etc. An on-line, web-based, easy-to-use delivery system (available from some PEOs) allows employees to assume greater management of their benefits while providing management with a variety of useful reports. 8

PEO services employed by the sample include: Payroll administration and payroll processing, Group health insurance, including a complete line of supplemental coverages, HR consulting and general oversight, Employee training, The HRIS system, and 401(k) and 125 plan administration. PEO clients are generally very satisfied with the quality of the services they are receiving, and with the level of support provided by their PEO. The individuals with whom we spoke gave their PEO an average rating of 8.6 on a scale of 10.0. 9

IS A PEO RIGHT FOR YOUR ORGANIZATION? IF SO, WHICH ONE? How do you decide that a PEO will benefit your financial institution? What can you do to ensure that you re one of the satisfied majority of PEO users? First, determine what you want to accomplish. What are the benefits you hope to gain? What perceived inadequacies of your current HR program do you wish to improve? Second, understand what a PEO is and what it is not. A PEO is a potentially cost-effective way to provide a high level of HR services to employees: expanded employee benefits choices with more efficient management of related costs, payroll services, workers compensation, and improved HR expertise. A PEO is not an employee leasing or temporary staffing source. Like any other outsourcing arrangement, the PEO enables the client to focus on the core competencies of running its business, while handing off the outsourced function to a team of experts. Third, understand and become comfortable with the concept of co-employment. Co-employment makes the PEO concept work for the client and the client s employees. Co-employment does not mean that the client gives up control of the business - it means sharing the responsibilities and liabilities of being an employer. Fourth, understand how PEOs get paid for their services. We are aware of two primary payment strategies: percentage of payroll, and per-head administrative fees. Learn how these different systems work and understand how fees are calculated under each method. In our conversations with PEO users past and present, the area that generated the greatest dissatisfaction was the fee structure and the users inability to gain an understanding of how their charges were calculated. Interviewees who had experienced both methods found the per-head strategy (the pass-through of actual payroll and insurance premium costs plus a per-employee administrative fee) easier to understand and preferable to the percentage of payroll approach. Finally, talk to a selection of PEO clients. At this point it s less about individual PEO pros and cons than it is about the general concept and whether it s right for you. PEO clients can share their experiences, their satisfactions, and their dissatisfactions. Nobody s perfect, but it is important to have a sense of the highs and the lows before jumping into something. 10

WHICH PEO IS RIGHT FOR US? Throughout the United States approximately 700 PEOs co-employ between 2 million and 3 million workers. In each of the last six years PEOs have grown by over 20 percent per year. How does a financial institution choose the right one? The following resources may be helpful in beginning the search: The website of the National Association of Professional Employer Organizations (NAPEO.org) offers an online directory of members that can be searched by state to help you begin to narrow the field. Your state association(s) may also be a source of information about PEOs active in your state or region. Your CPA or audit firm may know of clients using one or more PEOs. Hopefully one or more of the resources mentioned above will give you a listing of several PEOs with which to begin talking. Perform preliminary research to confirm those vendors viability: Talk with / meet with the vendors. Talk with users. Determine: How many clients does each vendor serve? Do those clients look like your employees? Are their employees primarily white collar, blue collar, a mixture? What are the average salaries of employees? How many financial institution clients does each vendor have? What services are offered? How varied and how rich are the benefit offerings? Can the vendor aggregate your employees into a single large benefits group, or is each client individually underwritten? How does the PEO bill for its services percentage of payroll or per-head administrative fee? What have users experienced in terms of periodic price adjustments? How does each PEO deliver its services? Do they provide automated, largely paperless systems? Do they eliminate manual tasks? 11

How do the PEOs retain employees information? Is employee data immediately available to you online, or must it be requested through the PEO? What are the hiring qualifications for their HR consultants? Have the HR consultants received industry certifications? Do the HR consultants have adequate private industry experience? What is their average tenure? Based on these meetings and discussions, revise your prospective vendor list as necessary. Try to cut the number of vendors to a maximum of four. Create and issue a Request for Proposal (RFP) that includes: A statement of the goals you hope to achieve through the PEO relationship Information on your institution and its staff Projected growth, including expected staff growth Request for vendor information, including Location of head and branch offices Length of time in business Most recent annual report Most recent quarterly financial statements, or other verifiable indication of financial condition A list of references, with a focus on financial institution clients The average monthly number of worksite employees paid Average annual client retention rates A summary of the vendor s staff and their background, experience, and professional certifications A listing of the services to be provided The pricing for those services, and the manner by which fees are determined Additional services available beyond the basic services requested Other information that will aid in understanding the vendor and the prospective relationship 12

Evaluate the proposals received. As much as possible normalize the vendors responses so that you can create a side-by-side comparison. Balance the strategic requirements (the have to s ) against the nice to s those features that would be nice to have but which are not absolutely required. Select the best two or three vendors for system demonstrations. Perform due diligence. Talk with clients to determine their satisfaction level. Review the vendor systems to understand features and functions. Include selected staff members in the review. They re the ones who will actually be using the system. Meet your anticipated service representatives and learn about their backgrounds and experience. Rank those vendors you believe will offer the best opportunity for a successful relationship. Begin contract discussions with the top choice. 13

CONCLUSION: SHOULD FINANCIAL INSTITUTIONS CONSIDER PEOS FOR HUMAN RESOURCES OUTSOURCING? Based on this author s forty years in banking, including twenty years of consulting work with community financial institutions, there is no question that a professional employee organization can be an excellent resource for improving the institution s human resources capabilities. Particularly in smaller banks and credit unions it is very difficult to afford to recruit and maintain a quality HR staff and contain the costs of the benefits platform. With small staff sizes, even when utilizing the group insurance capabilities of a state banking association or other professional association, the costs of health insurance continue to rise each year, and one or two employees with expensive surgeries or other procedures can result in drastic cost increases. As we were told by all of the clients interviewed, their insurance cost experience became much more favorable after joining with the PEO. Initial premium costs were generally lower than was previously experienced, and annual premium increases were lower than they had previously seen. But even as costs went down, the flexibility and quality of health insurance offerings was significantly improved, creating significant benefits to the organization and the individual employees. Another significant benefit received has been the increased quality of the entire human resources function over what the institution could offer prior to the PEO. Although cost reduction and cost control are certainly important to all employers in the current market conditions, it is the improved human resources knowledge and professionalism that the PEO brought to the client that seems to be the most appreciated PEO benefit. Finally, those institutions whose PEOs offered an integrated Human Resources Information System praised the improved efficiency of the HR process through the elimination of unnecessary paperwork and the increased control provided employees to gain information and make their own benefits selections. Is a PEO the right solution for every financial institution? Certainly not. In conversations with several of our banking clients we encountered those that were uncomfortable with the notion of co-employment and with the notion of outsourcing human resources at all, but these were a decided minority. The vast majority of the financial institutions sampled were very pleased with the service and the savings they were receiving through their PEO association. So, is a PEO a resource that a financial institution should consider for its human resources function? Based on what we have learned, particularly for those institutions with staff sizes under 500, and potentially up to 1,000, the answer must be a resounding YES! 14