benefEx Weighs in on the PEO Model
As with many things, the answer to whether a PEO is right for your business comes in the form of a hearty “it depends!”
A PEO (professional employer organization) is defined as a business entity that provides human resources outsourcing services to client companies through the use of a co-employment relationship.
We certainly don’t have an unequivocal aversion to the PEO model – and in fact have recommended PEOs to numerous clients over the years, even utilizing one for our own employees when we founded benefEx back in 2000.
The PEO model – under certain, limited circumstances – may provide a viable option for businesses that view their employee benefit portfolio primarily from a tactical perspective and are interested primarily in delegating their HR and benefits decision to a third party. The intended advantages of such an approach are as follows:
- Administration: Time currently spent deciphering offers from payroll vendors and health, dental, vision, life, and disability insurers is minimized, in that virtually all payroll administration and benefit decisions are made by the PEO.
- Benefits: Small businesses may have access to benefits that are more commonly available to larger employers, and – based on volume discounts and/or administrative cost reductions at the insurer level – employees could potentially see lower cost plans than are readily available in most states’ small employer markets.
- Compliance: The regulatory burden imposed by both federal and state (and sometimes local!) governments continues to mushroom, and many PEOs position themselves as a buffer designed to assist with certain area of benefit compliance, such as COBRA, ERISA, and FMLA.
- Liability: Often offered as an option – and at an additional cost – many PEOs bundle employment practices liability insurance (EPLI), which is designed to protect employers from lawsuits brought by current or former employees on matters related to their employment, such as discrimination, harassment, or hostile work environments.
With so many implied advantages, one might wonder why more small employers have not opted to permit a PEO to handle their payroll, human resources, and benefits. For businesses that are more strategically inclined, there are numerous limitations to and several critical (if subtle) downsides of adopting a PEO, which include:
- Customization: when it comes to payroll and insurance, the notion that bigger is better or less expensive is often a fallacy; moreover, an extraordinary amount of flexibility in designing each element of a benefit portfolio to provide for the specific needs of a given company’s workforce is available to employer groups with as few as five eligible participants – and often at a lower cost than the “one size fits all” approach inherent in a PEO. As importantly, if any one element of a benefit plan outlives its usefulness or suitability, that component can be easily replaced without disrupting the entire payroll and benefits arrangement. With a PEO, a business is largely at the mercy of someone else’s choices related to what benefits are offered, who the insurers are, what networks of providers are available, and the reality that these can change at any time with relatively little warning.
- Costs: A driving factor in many employer’s decision to consider a PEO relates to the costs of their available health insurance options, and many mistakenly believe there are only two alternatives; statutory plans (i.e., those as regulated by the state within which an employer is domiciled) and a PEO. In fact, there are at least two other markets that warrant consideration – plans being offered by associations (some of which are referred to as MEWA plans), and plans available via an ERISA exemption (i.e., regulated primarily under federal guidelines). There is no reliable rule of thumb as to which of these markets is least expensive for any given employer, though exploring each of the four market alternatives significantly improves the likelihood of finding the most competitive rates.
- Compliance: While the regulatory burden related to benefits has increased significantly – and PEO’s typically do a serviceable job in addressing and administering many of these regulations – we cannot lose sight of the degree to which employer size impacts the compliance burden. For example, employers with fewer than 20 employees are typically not subject to COBRA continuation and those with fewer than 50 employees do not generally need to be concerned with FMLA. Paradoxically, joining a PEO – based on the unique nature of the inherent co-employment relationship – may actually subject employers to new regulations that they had not previously been subjected to!
- Liability: Employment practices liability insurance is – as had been mentioned earlier – often an optional component of a PEO offer and we unreservedly acknowledge the need for employers to have this protection. That said, EPLI options available through most PEOs are often restrictive and inadequate, so much so that we advocate for procuring an additional, separate EPLI contract even if one is provided by or purchased through a PEO.
- Transition: Whether you decide on a traditional payroll and insurance arrangement or a PEO, the time will come when you will need to switch from one service provider to another. In the case of leaving a PEO, this experience is often unintentionally enlightening – not to mention both expensive and infuriating – thanks to a subtlety embedded in the transition process known as a “tax restart”. In essence, payroll taxes such as FUTA, FICA and State Unemployment Taxes are capped after a certain level of earnings, and – because when you’re leaving a PEO you are technically changing employers – these taxes may reset at the point of transition and start again from zero! This problem is most acute with employers with high wage earners and is something a PEO may provide accommodations for on the way into the arrangement (as a sweetener of sorts). On the way out though, is an entirely different matter, and the problem is exacerbated if a PEO’s benefit renewal occurs (as most do) on any date other than January 1. Thus, employers leaving a PEO find themselves as having to decide between absorbing an excessive increase for administrative fees or benefit premiums or having to double up on the employer portion of payroll taxes for their highest earners. Those same high earners will also find themselves back at the top of the payroll tax scales, though may take some solace in knowing that overcharges are likely to be refunded when they file their personal income taxes, a benefit that does accrue to the employer portion of those taxes.
As stated earlier, a PEO may offer a practical alternative for certain businesses, though the circumstances under which a PEO is the optimal solution are exceedingly limited. Unless a business views payroll and benefits through a primarily tactical, “necessary evil” type of prism, the additional plan design flexibility and additional strategic considerations available through the Statutory, Association, or ERISA markets help explain why the PEO sector – despite having certain advantages – still serves fewer than two hundred thousand of America’s nearly six million businesses.