Professional Employer Organizations... 

What is a PEO?

Professional employer organizations are companies that contract with small- to mid-sized businesses to manage their human resource and personnel functions.

While the responsibilities of the PEO will vary by contract, typical duties include paying wages; reporting, collecting, and depositing employment taxes with state and federal authorities; handling claim management for workers compensation and unemployment insurance; ensuring safety and nondiscriminatory regulatory compliance; and supplying employee handbooks and other policies. And, importantly, it also provides benefit packages, including group health insurance.

In contrast, a small-business purchasing alliance, which is another means for small businesses to find affordable health insurance, offers access only to health care insurance.

The National Federation of Independent Businesses (NFIB), whose member companies average 10 employees, looks at PEOs as a possible way to avoid government-mandated health coverage by making affordable insurance more readily available. Fifty-six percent of employees in its member companies currently lack health insurance. "We're always looking for solutions for the working uninsured," says Jamie Amaral, the group's national director of health care. "PEOs are a way to do that."

The big trade-off

When small businesses contract with a professional employer organization, the PEO becomes a co-employer of that company's employees. And the owner of the business becomes an employee of the PEO, while retaining ownership of their company. Sound complicated? Consider the case of Grobleski Construction. It contracted with Bradenton, Fla.-based Staff Leasing Inc., which bills itself as the country's largest PEO. Staff Leasing is now a co-employer of the company's employees. It also is the employer of the Grobleskis themselves, who remain owners of their construction business.

It's all perfectly legitimate under U.S. tax code, which allows a business to have two "masters," says Milan P. Yager, executive vice president of the National Association of Professional Employer Organizations (NAPEO), an industry trade group based in Alexandria, Va., that represents about 350 PEOs. Yet the dual role of small-business people as both employees of the PEO and owners of their company can be threatening, Yager concedes. "At first, they don't like having to tell the PEO how much they get paid," he says. "But you get paid the same; you still control that. The PEO has responsibility over salaries, but it doesn't set them."

Increase your buying power

The PEO industry is rather new, emerging just in the last 20 years, Yager says. But it's grown exponentially in the past several years as the health care crisis has worsened and as nearly every state has eased up on a key regulation affecting PEOs. Today, every state but Maryland — "They're regressive," Yager insists — allows PEOs to be recognized as a large group employer, which means they can lump together all their client companies in order to buy health insurance, giving them enormous potential buying power.

In the past, a PEO could purchase benefits only for each of its client companies individually — which, effectively, meant it had no more buying power than the small business itself. Now, no longer is it four-person Grobleski Construction seeking an HMO for affordable coverage; it's 126,000-employee Staff Leasing.

Because of their economy of scale, PEOs can offer a variety of health plans. For its Florida clients, Staff Leasing, for instance, is able to offer an HMO and a point of service plan (POS) through Blue Cross and Blue Shield, and it will add a preferred provider plan (PPO) next year. It also offers separate dental and vision plans.

The benefits of benefits

Craig P. Coy, CEO of HR Logic Inc., based in Newton, Mass., one of the Northeast's largest privately held PEOs, says high-tech start-ups often think they can put aside human resource functions and forgo health care benefits. But Coy warns that if start-ups hope to gain a foothold in today's competitive marketplace, they have a compelling reason to seek out a professional employer organization.

"A lot of people work for the big companies because of the benefits package offered, although professionally they would have more enjoyment and more enrichment working for a small company," he says. "If you're going to lure someone away from Microsoft or Intel, you better have a pretty good benefits package, and one way to do that is with a PEO."

Who joins a PEO?

According to a 1996 report called "Professional Employer Organizations: Changing the Face of Business," conducted by Raymond James & Associates Inc., an investment firm based in St. Petersburg, Fla., most PEOs cater to the blue-collar industry.

HR Logic, however, attracts many Internet start-ups. The PEO, which was founded two years ago, has about 200 client companies, representing some 6,000 employees, mainly along the East Coast from Boston to Washington, D.C. Its client companies range in size from three employees to more than 200, but most have 15 to 20.

Staff Leasing takes on clients that range in size from five to 99 employees. As of March 1999, it had 10,375 clients, mainly in Florida, Texas, Georgia, Arizona, Minnesota, North Carolina, and Tennessee. It has the largely blue-collar clientele that is more typical of the average PEO: 30 percent of its revenues come from clients in the construction business; 24 percent from the service industry; 11 percent from manufacturing; and 8 percent from both retail and restaurants.

Not all businesses will be welcomed with open arms by PEOs. Some, like off-shore drilling enterprises, professional athletic teams, and dog groomers, are hard to regulate for safety issues and thus make less appealing clients, says Doug Hall, Staff Leasing's vice president of marketing and investor relations.

The PEO benefits extend far beyond health care and human resources, especially for white-collar professional companies. Some offer retirement savings plans, credit unions, short-term and long-term disability insurance, life insurance, employee-assistance programs (for mental health issues), education benefits, and even adoption assistance. "That's a pretty awesome package of benefits, and now it's available to the rank and file," Yager says. "You can buy a Lexis PEO or a Chevy PEO. But either way, you're getting more benefits than if you were to walk."

What's in it for the PEO?

The PEO industry is estimated at $30 billion. Although that might sound like a lot already, the Raymond James report says that with 98 percent of the market untapped, the potential worth is an astounding $1 trillion.

To collect revenue, most PEOs tack an administrative fee onto the weekly payroll. Hall says the typical range is 2 percent to 5 percent of payroll. But some news reports have said PEOs charge as much as 20 percent of a company's gross monthly payroll.

PEOs that serve high-salary clients might charge per paycheck, such as $20 all the way up to $150 per employee per pay period, depending on the services provided. In calculating the wage base, a PEO might consider just wages, or wages and taxes, or wages, taxes, and benefits.

The pitfalls of PEOs: Benefits might be too rich

Despite all the apparent advantages of professional employer organizations (PEOs), there are thorns among the roses.

For one thing, buying health insurance through a PEO is not intended to be a money-saving venture; rather, it's meant to provide convenient access to benefits, contends Milan P. Yager, executive vice president of the National Association of Professional Employer Organizations (NAPEO). "The price is about equal to what it's costing you now, but you get a much richer benefits package," Yager says, although others disagree and say it can cut costs.

Craig P. Coy, CEO of HR Logic Inc., based in Newton, Mass., one of the Northeast's largest privately held PEOs, says his clients are able to save money on health care costs through his service. "There was a national increase in premiums of about 15 percent last year," he says. "We negotiated an increase of only 5 percent with our insurance companies." HR Logic offers a variety of benefit packages through several health insurers, including Blue Cross and Blue Shield and Harvard Pilgrim Health Care in Massachusetts.

Alyson and James Grobleski, owners of Grobleski Construction in Sarasota, Fla., which has a contract with the Bradenton, Fla.-based PEO Staff Leasing Inc., pay about $70 a week for an HMO plan that includes the couple and their young son. They have co-pays of $15 for doctor's office visits and $20 for specialists. And while their construction company doesn't contribute anything toward the costs of health benefits for its employees, the Grobleskis note that the PEO at least gives the workers access to an affordable group health plan that they otherwise wouldn't have.

Regardless of any potential cost savings, the health care benefits offered by PEOs might simply be too rich for some small companies. Jamie Amaral, national director of health care for the National Federation of Independent Businesses (NFIB), says many of the group's small-business owners don't even want Fortune 500-level benefits. "They'd rather have more money in their paychecks, especially if they're young and healthy," she says. "And a lot of our members have employees who are part-time and seasonal, and PEOs don't work well with an unstable workforce as far as benefits go."

Whose company is it, anyway?

Another significant concern of some small businesses is the potential loss of independence when they contract with a PEO and thus become its employee and merely co-employers of their own workers. "It's a tough issue," Amaral says. "Many of our members have a lot of family members employed in their business. For a lot of people, having a third party as a co-employer might be a negative."

Yager, whose own 17-employee PEO trade association has contracted with a professional employer organization, acknowledges that small-business owners are hesitant to enter a relationship for that very reason. But he insists that they actually gain independence for their companies because they can devote more time to handling day-to-day operations and less on human resource functions. "The owner probably spends 20 to 40 percent of their time each day on payroll, benefits, or HR administration," he says. "That's a huge chunk of time. I don't have 20 percent of my 12-hour day to spend on that. So I actually gain back 20 percent of my business when I turn those functions over to a PEO."

Both Coy and Doug Hall, vice president of marketing and investor relations for Staff Leasing, also say the small businesses retain their independence. "People are worried about losing control, but they're not really losing control," Hall says. "They're just shifting the business risk from themselves to us."

In fact, however, small-business owners do lose some independence and control over their business. NAPEO's own Web site, for instance, says "PEOs . . . reserve the ultimate right to hire and fire, and have the authority to resolve employee disputes." And the Institute for the Accreditation of Professional Employer Organizations (IAPEO), which accredits PEOs, also says they assume hiring and firing responsibility — which might not go over well with either the small business or its employees, who could grow fearful of the power that a large, out-of-state company can wield over their employment status. The PEO can even have the right to transfer one small business' employees to another client's site.

Do your homework first

Another major concern is the credibility of the PEO with which you contract. A 1996 report called "Professional Employer Organizations: Changing the Face of Business," produced by Raymond James & Associates Inc., an investment firm based in St. Petersburg, Fla., says early PEOs sometimes operated unscrupulously by failing to provide workers compensation and health care benefits for its enrolled employees.

"PEO subscribers do risk operating without workers compensation coverage, unpaid health care claims, and other potential liabilities (either legal or even nonpayment of payroll) if they are in a relationship with an unscrupulous, inept, or undercapitalized PEO," the report warns. "Consequently, a potential subscriber should conduct thorough due diligence of a PEO before engaging in any business arrangement."

NAPEO offers these guidelines when choosing a PEO:

Don't rely on the PEO's fancy proposals and brochures; meet the people who will be serving you

Check the PEO's financial background through public filings or from annual reports and other information supplied by the company, and get banking and credit references. Ask the PEO to demonstrate that payroll taxes and insurance premiums have been paid

Ask for client and professional references

Find out if the management staff are "certified professional employer specialists," a designation bestowed by NAPEO

Ask how the employee benefits are funded, whether they are fully insured or partially self-funded. Find out who the third-party administrator or carrier is and if it's licensed by the state in which it operates, if necessary

Review the contract carefully to make sure the responsibilities and liabilities are clearly spelled out, what guarantees are provided, and what provisions there are for either side to cancel the contract.

If your state requires the PEO to be licensed, make sure it meets all requirements.

Get it in writing

Yager also advises hiring a lawyer to review a PEO contract before you sign. "If you don't understand it," he says, "don't sign it." He also suggests picking several different PEOs from your market area and having each present a proposal and contract for comparison.

The contracts should stipulate as many details as possible about the PEO-client relationship. Most, for instance, include opt-out clauses that allow either side to terminate a contract, usually with 30-days notice. Some specify how much you must have in liability insurance, stock option plans, management practices, and optional benefits. Yager's contract even addresses intellectual property: He is prohibited from using his PEO's trademarks and it is prohibited from using his.

Accrediting agency puts PEOs through their paces

The Institute for the Accreditation of Professional Employer Organizations, based in Little Rock, Ark., began accrediting PEOs in 1996, based on stringent financial, ethical, and operational standards. Accredited PEOs, for example, must have a net worth of at least $50,000 or 5 percent of their total liabilities, whichever is greater. Only a handful of PEOs have passed muster.

Other features of IAPEO's accreditation process:

Annual background checks of the firm and the people who control it

Annual verification of financial statements

Quarterly confirmation of tax and benefit payments

Quarterly confirmation of minimum equity standards

Strict compliance with detailed operating procedures

Continuing professional education of management.

Due diligence is vital. If a PEO goes broke, your business is liable for back taxes, unemployment insurance, workers comp premiums, and so on.

Can your small business pass muster, too?

A professional employer organization will check out your record, too. It will review your financial and safety history, workers comp claims, risk-management plans, status of employment taxes, employee turnover, and even whether you tend to change benefits packages frequently.

That's because the PEO wants to make sure your company is a sound "investment," since, as a co-employer of your business, it will assume some of your legal liability.

If there is a work-site accident, for instance, your business will be responsible. But if you skip town, the PEO has a legal obligation to pay your employees for one pay period and meet the requirements of the federal Fair Labor Standards Act, Hall says. Beyond that, though, the PEO has no obligation to keep the employees on and can lay them off. "We're a co-employer for administrative purposes only, not for anything to do with the job site," Hall notes. "We hold responsibility for payroll matters only." And, Yager notes, the PEO will go after your assets if you leave it in the lurch.