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PEO: Myths vs Truths

Myths vs Truths – What PEOs Don’t Want You To Know

There are many myths vs truths when it comes to PEOs. This is designed to be an abbreviated description of PEOs with a focus on what they are not likely to disclose. If you are currently in a PEO we have synthesized this into a checklist for you to audit your administrator. If you are trying to get out of PEO we have also synthesized this into a checklist of what you need to do to develop a functional exit strategy.

This report is not intended as an attack on PEOs but rather as a set of tools to help you with an understanding of the larger picture of PEOs. PEOs have their place, and like everything else, there are good and bad ones. The amount of control, however, that a business owner grants to a PEO provides ample avenues of abuse – financial, litigious, and upon employees. With your local broker, agent, or advisor out of the big picture, you alone must be vigilant and keep an eye on your PEO. The temptation for financial abuse with PEOs is most evident in the litany of business disasters caused by PEOs and published by the news media.

If you are one who has been abused then rest assured that you are not the first to go through this. We have helped many employers put their business back in order. If you need to audit your PEO or terminate it, we suggest you assemble a team of local professionals that you trust and/or are comfortable with. Unlike the PEO, having a team of independent professionals gives you flexibility – if one doesn’t work out you can replace them with little disruption.

Definition: Professional Employer Organization (PEO) – an employee leasing company that employs the staff of a company and then leases them back to that company. In doing so they create a “co-employer” arrangement whereby the PEO provides compensation, payroll, HR support, Workers’ Comp, and employee benefits when requested. The PEO charges a fee in return for the service. The “co-employer” arrangement means that there are two employers where one employs staff for labor used by the other.

Application: The industry began by filling the needs of professionals such as doctors, lawyers, and dentists. The need here was relatively clear where you had a professional providing their services full time and not having time to run a business with employees as well. Over time it also grew into a way to “pool” the cost of workers’ compensation and employee benefits and 401(k) for small businesses and relieve the small employer of HR responsibilities. In the 90’s the application flourished in the franchise and start-up or business incubator service – especially with the dot-com explosion.

How They Function: Simple Example – Brick House Industries at 210 Brick House Way needs to hire an employee for a position that calls for $20 per hour plus benefits. They go to MyPeeps PEO. MyPeeps hires the employee and leases them to Brick House for $33 per hour (broken down as $20 wage, $6 benefits, $2 taxes, $3 wk/comp, $2 admin).  The employee works at 210 Brick House Way and reports to Mr. House but works for MyPeeps PEO (who coincidently pays the employee, withholds and pays the taxes, provides the workers’ comp., benefits, and retirement plan).

How They Are Sold: Today’s PEOs are primarily sold as HR outsourcing solutions. The basic message is “You make widgets and we’ll do the rest.” They claim to relieve employers of the responsibility and liability of HR, compensation, payroll, benefits, and workers’ comp. They claim to save money on the cost of benefits and workers’ comp. and 401(k). The implication is that the “happy” owner can relax and focus on their product or service while the PEO takes care of the rest.

Detailed Examination:

Here’s a closer examination of each feature/benefit mentioned in the standard PEO sale.

General. The claim is that, in general, the owner will be happier because they’ll have less responsibility and liability and the employees will be happier because of the better benefits and efficiency of the PEO.

The truth is that the loyalty, pride, recognition, and sense of belonging that both employee and employer expect to nurture are lost or confused at best. Benefits, including 401(k) matching, are provided under the PEO name, not the company. Tax matching and contribution is also provided under the PEO name and not the company. There may be confusion in the lines of authority and benefactor as well.

Human Resources. The claim is that the PEO is going to handle all your HR needs and take full responsibility and liability.

The truth is that you will still have to recruit, hire, train, evaluate, motivate, manage, discipline, maintain records, and terminate your staff. (They will provide an HR representative for questions or assistance by phone. They will, on occasion, send an HR rep out to provide an OSHA auditor present a management seminar on harassment as required).

You will still be legally liable for all employee litigation from compensation to harassment and all labor law in between. You will have to hire and pay your own employment law counsel.

Workers’ Compensation.  The claim is that you can save substantially on workers’ comp by pooling with all their other PEO clients and that they take full responsibility and liability.

The truth is in most states they can only pool a self-insured portion of their workers’ comp. In most states, the workers’ comp must be underwritten for the client company or jointly. There may be a premium savings offered by their carrier if they have enough volume to provide overall risk modification and the risk proves better than average. This is particularly true for a vertical market but not necessarily the typical mixed industry PEO.

Regardless who’s name(s) are on the contract, the person who owns the place of employment will be held liable and responsible for all litigation. That includes things that may or may not be out of your control such as policy, contract, classifications, safety, industry ratings, premiums, and you may even be financially responsible to share in any large claim against any self-insured portion by another employer in the PEO.

Questionable practices: 1) We have seen a situation in which the PEO client was co-named on the workers’ comp policy and later found out that they had received dividends (returned premium for overpayment) amounting to well over $100,000 which were cashed and kept by the PEO. 2) We have news articles about PEO’s who collected workers’ comp premiums and never bought a policy. 3) We have news articles about

PEO’s who had their workers’ comp policies canceled and were sued for fraud by the carrier for misrepresenting employee classifications – leaving their clients without comp and unable to get their own policy because they are considered a new business. 4) We have reports from prior PEO users that they (or their employees) received no support with claims issues and litigation and that this was one of their motivations for getting out of the PEO and back to a local broker. After all, the PEO’s primary focus is the “body” rather than the “individual”.

Payroll.  The claim is that the PEO will be employing your staff and providing the entire payroll service responsibility and liability.

The truth is that you will still need to keep time and attendance and be responsible for reporting payroll, overtime calculations, wage and compensation changes, bonus,

commission, expenses, and all the regulations surrounding them. (The PEO may provide HR assistance with these via phone or email). You, not the PEO, will be held liable for compensation issues and resulting litigation.

Employee Benefits and COBRA.  The claim is that the PEO will provide your employees with complete employee benefits and benefits administration including the responsibility and liability for them. In addition, they claim that by pooling a large number of employees they can significantly reduce the rates for most insurance.

The truth is you are still responsible to manage eligibility, assure enrollment, notification of changes, COBRA eligibility and qualifying events, assurance that premiums are paid and that COBRA is properly administrated, and you may be held responsible to share in the risk of a large claim from another employer in the PEO’s self-insured health plan.

Reducing rates by pooling large numbers employees in a single plan is a myth. The quickest way to describe why can be summed up in two fundamental statements about pooling. First, the basic tenet of pooling is that the premiums of the many pay for the claims of the few. Second, the quality of the pool can be defined as – only as good as each individual in the pool. Therefore, if the individuals in the pool are higher than average utilizers then the cost of the pool will be higher than average (regardless of size) and vice-versa.

Generally speaking, those that make up a typical multi-employer PEO are smaller employers or start-up companies. Those that are not start-ups are generally looking for some price breaks on workers’ comp and insurance. Chances are good that they are doing so because they are higher risk/higher utilizers of both comp and health plans and are seeking shelter. Those that are start-up companies are unknown risks and vulnerable to failure. Therefore the prospects of having a quality pool with less than average rates (expenses) are not very good. Most underwriters are reluctant to even consider PEOs for quoting because of their experience with them.

Consider this:  If bigger was better, then the huge government and school pools would be the cheapest instead of the most expensive. Don’t kid yourself, you can’t lose money on every individual and make it up in volume.

Questionable practices: 1) In one situation we have seen a PEO providing their group employee benefits to ASO clients (no co-employer arrangement) which may constitute operating an illegal multi-employer trust (not legal in most states) – and if so you may be responsible for employee benefits and outstanding claims. 2) In many situations, we have seen that the PEO will bill their client (or sweep their account) for the full cost of employee benefits and the gross payroll. If employees are required to contribute to their benefits you will want to be sure you get a credit against gross payroll for that contribution. Otherwise, the PEO may be taking the credit and charging you for it as well. 3) As an owner and not an employee of the PEO, you may not be eligible for benefits from the PEO and might be surprised by the extra cost and difficulty in obtaining health, life, and disability for yourself.

Pension/401(k).  The claim is that because they are able to “pool” all employees into a single 401(k) that there is better investment potential, greater economy of scale, better service, and lower costs.

The truth is that although your employees defer compensation to this plan and you may also match contributions, it is not your 401(k). In fact, if you are not considered one of the “leased employees” you can’t even participate in it. You may have to set up your own IRA or SEP – at additional expense.

You will still be responsible for proper enrollment and participation, testing, employer matching, and you may be held liable for unpaid fees.

There is no validity to better investment potential since each employee is individually controlling their investment choices. There may be an economy of scale to administrative fees if they are not based on a per participant basis. However, there would not be any savings from investment manager fees which are generally not reduced based on volume.

Questionable practices: The IRS rules (backed by the court) say that it is the responsibility of the plan sponsor (you) to provide investment advice as part of your fiduciary responsibility. We have had reports from prior PEO users that they (and their employees) received no assistance or advice on investment choices or deferrals – and they report that this was one of their reasons for leaving the PEO or ASO.

Taxes and Finance.  The claim is that the PEO is going to take responsibility and liability for assuring proper payroll tax deposits and filing and any other financial issues associated with being an employer.

The truth is that even though the PEO will be paying taxes under their tax ID, you will still be responsible for the correct and timely deposits of payroll taxes since the IRS and State will look at you as the ultimate employer. You may also be held responsible for loans, liens, violations, and fraud by the PEO when pertaining to taxes and finance.

Questionable practices: Most PEOs do not cap FUTA, SUTA, or Social Security. They continue to charge you for these. FUTA and SUTA both currently have a $7,000 earnings cap. SUTA for California averages 4.2% and FUTA averages 0.8%. Combined they average about 5% of the first $7,000 in compensation for each employer every year (which is attained rather quickly). For most of the year, you will continue to be charged for this. Social Security has a much higher cap – for 2008 it is $102,000 at 6.2% – so for the higher compensated individuals you and your employee will continue to contribute this beyond the cap. This is usually spelled out in the PEO contract which makes it legal. When you think about it … this averages out to at least 5% of payroll – a significant impact to your overall cost.

Conflict of Interest.  Some would agree that there appears to be a conflict of interest when the PEO is providing insurance, benefits, and financial products to its co-employer. If the PEO’s insurance and benefits policies are self-funded there can be manipulation of the claims and costs data so it adds to their profits. Unfortunately, by going to a PEO you have abdicated your local broker/advocate as your primary watchdog and no one is looking out for you. The PEO (or their operatives) are acting as the insurance agents and brokers and are negotiating the various rates and coverage under which your employees will be covered. At the same time, they are acting as their payroll processor and third party administrator with no oversight system or policy in place. The situation resembles the old fox and the hen house scenario.

If you have additional questions about any of these myths vs truths, contact one of our Employee Benefit Consultants.

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