What is a PEO and is it Right for My Company?

What is a PEO?

PEOs, or "Professional Employer Organizations," are businesses created to take over several of the administrative duties that typically fall within a company’s HR department. Sometimes called “employee-leasing firms,” PEOs can be a good fit for smaller companies, but there are reasons that most medium and large companies do not utilize their services.

Before committing to a PEO, understand the benefits and risks, as well as what the process looks like if you ever terminate that relationship and bring services in house.

PEOs handle functions like payroll, benefits, and collecting for workers’ compensation coverage for many smaller companies. The way they work is sometimes tricky. When you identify an employee you want to hire, the PEO actually hires the employee and then “leases” them back to you. They then manage all of the HR functions previously described.

Originally conceived as a service for businesses like medical practices and independent law offices, PEOs were designed to allow these companies to focus on their core practice areas while offloading some of the more generalized responsibilities that come with running a small business.

As PEOs grew with each new client, partner company or ‘co-employer’ that they served, the size of their employee pool grew proportionally, which led to an additional advantage that PEOs could offer the companies with which they were contracted. Specifically, PEOs were able to capitalize on the larger size employee pools that were formed in order to attain better insurance and benefit rates that come with economies of scale, thereby providing another direct and tangible benefit to their clients beyond their existing service offerings.

Benefits of Working With a PEO

There are a number of benefits that employers are typically seeking when exploring the possibility of working with a PEO. These benefits or advantages typically fall within one of several categories, including administrative support, employee benefits pooling perks, liability protection, and regulatory compliance.

• Administrative Support: Arguably the most readily apparent potential advantage of working with a PEO (and the reason such organizations were originally conceived) was to provide administrative support functions. This includes managing payroll, benefits, and workers’ compensation.
• Employee Benefits Pooling: Increasing the size of employee pools by combining the employees of several small companies under the umbrella of a single PEO can give smaller companies the advantages and leverage during rate and cost negotiations that are typically only available to much larger companies.
• Limiting Liability Exposure: For companies interested in essentially outsourcing many traditional HR responsibilities, often times limiting negative outcomes is even more important than pursuing positive benefits that come from a co-employment arrangement.
• Regulatory Compliance: Along the same lines as limiting liability exposure and given the seemingly ever-changing regulatory environment, having a PEO that stays up-to-date with current compliance rules and best practices can be a significant motivating factor.

Downsides to Working With a PEO

With several obvious benefits that can accompany working with a PEO as a co-employer, it’s understandable why many companies choose to contract with PEOs. However, PEOs are certainly not a perfect solution for all companies in all situations. There are several trade-offs and potential detriments that any company thinking of exploring the possibility of such an arrangement should consider.

While PEOs can certainly help with administrative support, employee benefits pooling, liability and regulatory compliance issues as discussed above, many times the services actually provided differ from what may be imagined or desired by the contracting company at the outset.

Further, by entering into a contractual arrangement with a PEO, companies will likely have less access to data concerning their employees and benefits, as well as less flexibility in terms of the carriers and policies providing those benefits and when/how those arrangements can be adjusted or terminated.

• Administrative Support: PEOs may take over many of the areas traditionally covered by internal HR, but many traditional HR responsibilities remain with the company – including the hiring, firing, motivating, evaluating, and managing of all employees. Even with payroll, the company on whose behalf the employee is actually working will have to keep track of hours worked, bonuses, changes in compensation rate, and overtime, for example. As a result, PEOs are far from the complete outsourcing of HR responsibilities that they are sometimes promoted to be.
• Employee Benefits Pooling: While PEOs can aggregate the employees of several companies into larger pools than any of the smaller companies could create independently, such pooling typically does reduce the options available to each company individually. Further, it can make terminating any carrier or benefit arrangement more difficult, and whether or not a company will be able to access any data collected about their employees during the PEO contracting period is likely to be resolved on a case-by-case basis depending on the unique terms of each PEO contract. Further, pooling across different companies is not always possible – for example, workers’ compensation funds typically must be maintained independently for each co-employer under a given PEO's umbrella, thereby diminishing some of the perceived advantage.
• Limiting Liability Exposure: Protecting against liability exposure is frequently a main motivation for companies looking into PEO arrangements. However, often times the ultimate liability remains with the contracting company, even for functions that are primarily – if not exclusively – maintained by the PEO. PEOs may collect and even file taxes on behalf of the contracting company, like payroll taxes for example, but the responsibility for assuring the accuracy of those taxes and the timeliness of the filings remains with the contracting company.
• Regulatory Compliance: Assistance ensuring that all relevant regulations are being adhered to is a one aspect of working with a PEO that can be especially helpful, but similar to limiting liability generally, it is not a one-step cure-all. While a PEO will certainly be helpful in determining which regulations specifically apply in what cases (e.g. self-funded medical plans tend to be federally regulated while fully funded plans fall under state regulation which a local PEO can help navigate), awareness of the relevant regulations is only the first aspect of the issue to be addressed. For example, the regulatory responsibilities for administering pension packages and the accompanying fiduciary duties cannot be off-loaded onto a PEO any more than an act of gross negligence on behalf of the company could be signed away in a waiver. Thus, it’s very important that a company does not become complacent with such regards just because they’ve contracted with a PEO.

Is a PEO Right for My Company?

The decision whether or not to engage a PEO must be assessed by each company individually. While start-ups and smaller companies remain the primary source from which PEOs draw co-employment partners, this is mostly because larger companies who may wish to enter into an arrangement similar to a PEO are able to create such an entity independently and tailor its services specifically and exclusively to the needs of their company.

For any start-ups, partnerships, or small businesses that are thinking about contracting with a PEO co-employment partner, it is absolutely vital to consider both how quickly the company expects to grow (as per-employee administrative fees can add up quickly with a rapidly growing workforce) as well as the future dissolution of that PEO arrangement in terms of how, when, and with what data the company will be able to walk away from the contract at some point in the future (which is typically covered in the PEO contract itself).

With these concerns in mind at the outset, exploring potential PEO arrangements can be an important and beneficial step for a company to take that can absolutely be worth pursuing.

About Mployer Advisor

At Mployer Advisor, our focus is creating transparency in the insurance and insurance broker, consultant and advisor space to the advantage of the employer. Analytics is our core and we will bring to light new information, tools and resources to aid employers in making more cost-effective decisions. As a phase I, we are here to help employers find the right broker or consultant and the right insurance company for them. Giving choice and initial transparency is a first step in creating an employer centric insurance marketplace.

‍