The lure of getting all of your employment needs met, under one umbrella and for a fee, may sound attractive—but may not be the best solution for your company. In today’s world, business owners face the challenge of maintaining compliance with complicated federal and state laws, as well as creating and managing their human resources and payroll programs. Is a professional employer organization (PEO) the right option?
A PEO provides outsourcing of payroll, workers’ compensation, human resources and employee benefits administration. By hiring a client company’s employees, it becomes the employer of record, and then leases them back under contract to the original employer. This practice is known as co-employment, employee leasing or staff leasing.
In a co-employment contract, the PEO becomes the employer of record for tax and insurance purposes, filing paperwork under its own 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. Bob Reynolds, cofounder of Innovative Business Solutions, says, “PEOs grew in popularity when employers who had a bad workers’ comp experience were being hit with double-digit rate increases year after year. A PEO offered a refuge where they could essentially start over and be rated with the rest of the PEO’s employees, thus reducing short-term costs. At this time, California isn’t seeing those types of comp rate increases.”
What companies often don’t understand about a PEO is that they give up control. “We often see situations where clients don’t realize what they’re signing up for when they engage a PEO. After realizing their employees really aren’t theirs anymore, they become upset and the PEO will often make it difficult to transition out,” says Reynolds.
Considerations
Following are several key areas to consider before switching to a PEO.
If a company elects a PEO, all employees are transferred to the PEO’s payroll and the company is now “leasing back” its employees. By doing so, the company gives up control and will pay a premium.
The company loses control to select customized benefit plan designs. PEOs lure customers by stating “employees receive all the advantages of working for a small company combined with the quality benefits and services usually offered only by big companies.” PEO clients can only get access to the PEO’s standard packaged options. In some cases, the company gives up the option to choose plans that are customized to what its employees want.
Barbara Wilson, benefits consultant and broker of record for Creative Insurance Solutions, says, “A PEO, in my opinion, is a Jack of all trades and master of none.” While PEO consultants are trained in most aspects of HR, including benefits, workers’ comp and payroll, the truth is they’re not benefits specialists. PEO sales reps typically “know” the benefits plans they offer, but have little or no knowledge about the health care industry as a whole. As a result, they cannot provide the type of professional advice and consultation a licensed broker can.
“There’s a certain restrictiveness to bundled solutions, namely that client companies don’t have the flexibility to pick the services they really need. All PEOs require clients to use their payroll administration services, accept coverage of their workers’ comp insurance and select from their benefits offerings. It’s an all-or-nothing proposition.”
A PEO may not necessarily decrease the time spent on administrative tasks. The allure of “decreased administrative management” is often replaced with different processes to report changes and actions to the external PEO. Your company will still need someone internally who’s responsible for collecting and reporting data to the PEO (payroll changes, non-exempt hours, new hires, terminations, benefit plan changes, commissions, bonuses and so forth).
A PEO’s one-stop shopping fee is often more expensive than working with a company that offers unbundled services. PEOs charge a service fee typically costing up to 15 percent of total payroll (or around $150 per employee per month). This can be costly if businesses don’t fully use all of the PEO services.
If a company conducts a cost-benefit analysis and calculates the individual cost to administer all the functions a PEO offers, it will probably find it’s paying a premium to use a PEO. In some cases, employers have moved to a PEO only to learn their expectations were not met and then have switched back to a non-PEO format.
Wilson cautions employers to think about the process of termination before signing up. She states, “Termination of the co-employer arrangement can be complicated. Some PEOs make it difficult by slowing down the process of transitioning ‘out.’ The client company needs to fully understand the requirements for severing the relationship because it isn’t always simple.”
In some cases, a PEO may be helpful, such as for companies with large numbers of union employees. Otherwise, it’s important to evaluate the cost, loss of control, limited choice of benefit plans and required use of the PEO database systems and processes.
To make your decision, you can list each expense related to managing services (costs of payroll, benefits and so on). Ask the PEO to give you a breakdown of its fee so you can compare it with your current costs.
To successfully manage your company’s human resources and payroll functions, there are various options. Companies can either hire their own expert staff or can outsource all or parts of it to a human resources outsourcing (HRO) company. Use caution before you decide to put all your eggs in one basket with a PEO.
