Advantages and Disadvantages of a Professional Employer Organization (PEO)

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First what is a PEO? PEO stands for “Professional Employer Organization”.The trade organization for PEO’s is the National Association of Professional Employer Organizations (NAPEO) which was what the National Staff Leasing Association changed its name to in 1994 after 10 years in business.

According to NAPEO a PEO allows businesses to outsource a number of employee associated functions including Human Resource Management, Employee Benefit Management, Employee Payroll, and Workers Compensation Insurance in a cost effective manner.Thus allowing a business not to have to spend time on those functions and concentrate on other areas.

The NAPEO goes on to say they relieve their clients of the burden of administering critical employee related functions, reduces liabilities, increases competitiveness and improves the bottom line of their clients.

What PEOs really do is provide a way for employers to buy insurance products, payroll processing and possibly some basic HR services in a single package with a high administrative cost added on top.PEOs will say that they “Assume certain employer rights, responsibilities and risk”.Many of the States they operate in disagree.Most States have rules that PEOs are co-employers or joint employers and that the actual employer retains all of the risk.

PEOs began in the 1960s as a way to escape Federal ERISA requirements.If you had no employees you were exempt from ERISA.Those rules have been long since repapered by the Federal Government.PEOs have been used to reduce Workers compensation costs to their clients.Several PEO principles have gone to jail for improperly reporting workers compensation risks and thereby illegally reducing the premiums they were being charged.PEOs were front and center in the State Unemployment dumping scandals to improperly reduce State Unemployment taxes for a company. This all stopped when the anti-dumping law was signed by George Bush in 2004 and similar rules were adopted by most States.

What it comes down to is this:A PEO says it will use the large number of employees it has to negotiate better rates for medical insurance policies than small businesses can.But if you are the small business you have to take the policy that the PEO has negotiated.Since high benefit policies are easier to negotiate, small businesses will (many times) find they are buying a Cadillac health insurance policy when they want to buy a Ford.The Cadillac policy is cheaper than what the small business could buy it for, but it is still way more expensive than the Ford policy they could have negotiated on their own.What Obamacare and State Exchanges are going to do to the PEO insurance field is still way up in the air?

The PEO will do the same thing with Workers Compensation Insurance. Bundle up a whole bunch of risks and try to get a better rate from the insurance company.They may also maintain a staff whose sole purpose is to minimize payouts of workers compensation claims to your employees. Those payouts effect the PEO’s experience rating and drives up their costs.When your employees don’t get compensation for their injuries, like they think they should, are they going to blame the PEO or you, their employer.

PEOs have attracted over the years the worst risks because those risks received the greatest benefit from a better workers compensation rate from the PEO.This of course was a self-defeating proposition for the PEO.Those bad risks drove up the premium cost to the PEO with no benefit to the PEO.In the current environment many States and many workers compensation carriers require individual underwriting of each client company of the PEO.Since the underwriting is just the small businessman’s company and the experience rating just accidents involving his employees and since rates are set by the State; the advantage of being in a PEO employment pool is gone.Just an extra charge for the PEO administering your workers compensation, which administration for many companies is worth little or nothing.

Many of the PEOs brag about their Human Resource departments and what they bring you.For many small business that is little or nothing.They don’t hire people for you.They don’t fire people for you.When an employee has a complaint the PEO is off in some other City or State.When an employee has a personal problem and needs a shoulder to cry on, it is still the small business owner’s shoulder that gets cried on.Since most small business don’t have heavy HR requirements a heavily staffed HR department is a cost that the small business owner neither needs nor wants.Now that your employees are in a much larger pool it makes them subject to more, not less, Federal and State regulations..

One final thing a PEO does is process your payroll.They do pay the taxes and file the forms as the employer of record. If the PEO goes out of business is the IRS is going to write off any unpaid taxes.The small businessman will find that the IRS deems them a “Responsible Party” and they will be forced to pay the taxes the PEO did not.

So how does the PEO bill you?Normally they calculate their costs, plus an administrative fee, plus a profit margin and they add that as a percentage to your payroll costs.Each pay period you turn in your hours and salaries and the PEO tells you what you have to wire to them so they can process the payroll.The administrative fee can run from 4% of the real costs too much higher.The PEO will normally be very reluctant to discuss their actual costs so that you can really see what you are paying for.Our experience with PEOs that runs back to when they were still called staff leasing. That experience has shown us that PEOs try to make their bills absolutely impenetrable, and we are CPA’s and experts at deciphering this financial stuff.They also neglect to lower your cost as your employees max out for SUTA, FUTA, and even FICA.

Our experience over the last 20 years is that it is never cheaper to use a PEO.If you negotiate your own medical and workers compensation insurance, have a good online HR service when needed and use a good payroll processing service bureau with CPAs on staff – you, will, save money.

In our experience the savings are always at least $1000.00 per employee per year and sometimes more than twice that.One of our best customers, owned by doctors, with 150 or so employees got talked into looking at a PEO a few years ago.One of the doctor owner’s golfing buddy was in the PEO business.The business manager was a very sharp person and had minimized costs for years.The PEO quote was $300,000.00 per year higher for the same services that the business was getting.Needless to say the doctor changed his mind.

Before going with a PEO analyze what they are offering you and what it is really worth to you. With the SHOP exchanges and the rest of the Affordable Care Act, a one stop shop is going to be very enticing. But if you have 20 employees you may be talking a $50,000 hit to your bottom line and getting little or nothing out of it.

Talk to a payroll company with CPAs on staff.They should be able to bring in one or more independent insurance agents and one or more online HR services. We do that for our clients.We think you will be surprised.If you are already in a PEO we suggest the same thing.We think you will be amazed at the available savings.Why do you think the big payroll companies are pushing their PEO divisions so hard; it is because they are much more profitable than any other service they provide?

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  • HROplus

    Obviously, this gentleman is anti-PEO, and for some businesses the model is not appropriate. However, if a PEO can save you $100 per employee per month on health benefits and manage your payroll and 401k and other benefits for $70 per employee per month, I see a savings of $30 per employee per month. I would think a CPA would be able to figure that math out.

    Of course, he could be talking specifically about a certain PEO that does charge $250 per employee per month, which they disclose quarterly as they are publicly traded. But most PEO’s charge, on average, at most half that amount.

    My recommendation would be to get a few quotes from various providers and let the chips fall where they may.

    • Charles Read

      Dear HROplus: My recommendation is that your get a CPA who understands payroll and gather a group of professionals in the various disciplines and put a independent developed quote from special providers in Insurance, payroll, HR and what else you need and then see if any PEO comes even close.


  • Bill

    Hi Charles. You paint with a pretty broad brush. The PEO that I work for is a local PEO and have been in business for over 25 years. We actually do hire and fire employees for our clients. We alao have also have an attorney specializing in labor law on our staff who is available to our clients at no extra cost. Our safety manager does site visits and assists with safety meetings and trainings. We deal with our customers primarily in person. We also have a very high customer retention rate even when they have gone the route of shopping everything on an individual basis. Not all PEOs operate the same and companies disatisfied with the level of service provided for the associated cost should look at all of their options including another PEO. You just might find that PEOs are the best option at times. As one of my clients who has been in business for years and with us for a couple put it ” after a cost benefit analysis. Its a no brainer”

About The Author...

Charles Read About Charles Read

Charles Read is a former U.S. Marine and combat veteran. He helped convert the joint military unified pay system in 1968 before becoming a Certified Public Accountant and launching a financial industry career spanning 35 years and involving the processing of more than $1 billion in payroll for small businesses across the country. He is the author of the book, “Starting a New Business: A Simple Guide to Financial, Tax and Accounting Consideration.” Charles is a member of the Texas Society of Certified Public Accountants and the American Institute of Certified Public Accountants (AICPA). He is a founding member of the Independent Payroll Processors Association (IPPA).