Understanding the Fine Print: How to Make Informed Decisions about PEOs

Major savings, less paperwork, and reduced administrative obligations. At first glance, professional employer organizations (PEOs) sound like an ideal antidote for busy business owners. PEOs boast that while partnering with them, business owners get to focus their time and energy on the things they do best while outsourcing the tedium of setting up employee benefits, managing human resources, keeping track of payroll, and managing their workers’ compensation program. Some even view PEOs as a potential growth strategy — rather than as competitors — for insurance agents and brokers. However, as the adage goes, things may not always be as they appear.

PEOs could expose employers to broad workers’ compensation risks and potential unpaid workers’ comp claims. Also, while the bundled costs PEOs offer appear to offer great savings, they could end up costing more if certain unnoticed nuances are left unaddressed. Most critically, standard PEO contract language could expose employers to unintended workforce and financial risks.

None of this bodes well for commercial insurance agents or brokers who recommend PEOs to clients without conducting proper due diligence. Of course, there are situations in which partnering with a PEO can be advantageous for certain clients — especially those with difficult or near impossible to place workers’ compensation risks. However, when companies transition to a PEO, new, unimagined risks could also emerge. So, before you recommend a client take the plunge and sign on with a PEO, here are a few key issues to consider.

Do PEOs Save Money?

One of the most attractive aspects of a PEO is its promise to save clients money by bundling services such as payroll, workers’ compensation benefits, health insurance and other benefits. In exchange, the PEO charges a fee, usually between 2% to 6%, to handle payroll, all the payments for payroll taxes, workers’ comp, group health insurance and other administrative costs.

The ease of use is great. Clients write just one check each pay period and everything is handled. However, those who lack a complete picture of their business’ detailed finances could end up spending more money than planned or anticipated based on their understanding of the PEO proposal. In some cases, the PEO might overestimate client expenses to come up with a desirable amount in savings.

For example: workers’ compensation costs start with a manual rate, which is modified by credits and other factors to determine the “net rate.” Frequently, PEOs fail to apply all of the credits and discounts to the workers’ compensation manual rates when comparing the clients’ costs to their costs. As a result, the client’s rates are overstated, which makes the PEOs’ costs look more favorable than they might actually be.

There are also additional deductions on the employers’ cost side that PEOs don’t automatically remove from their standard contract language.

For example, employers do not have to pay state and federal taxes for employees who have reached $7,000 per calendar year, usually by the first few months of the year. However, when a PEO is handling a company’s payroll, absent changes to standard contract language, most PEOs continue collecting those dollars for the rest of the year, even after the state and federal tax threshold has been met. One way this can be prevented is to make sure the contract specifically states that when each and every employee reaches $7,000, the PEO will lower the bundled rate. This is an often overlooked nuance in most PEO contracts. The same applies to Social Security and Medicare taxes. Asking the PEO to lower the bundle rate, once certain criteria and tax obligations are met, will ensure the employer isn’t paying beyond their actual obligation and can result in genuine cost savings to the employer.

What’s in the Contract?

A PEO provides an alternative arrangement between employees and their employer. As co-employers, a PEO will assume certain responsibilities as defined in the contract. It’s crucial to not only carefully review the contract language, but to understand any potential risk exposures created, unintentionally or otherwise, by the agreement. This can be a critical opportunity for agents and brokers to demonstrate their value to the client as part of the client’s attorney review process. While the attorney will focus on the legal obligations and responsibilities associated with the contract language, experienced agents and brokers will be best positioned to identify the risk exposures created or overlooked that impact their client in standard PEO contract language.

Clients also cannot assume every perk and benefit presented in a proposal by the PEO representative makes it into the final contract. In my experience, some PEOs might have as many as eight to 10 different contracts, all with varying terms. What isn’t stated in the contract is as important, or sometimes more important, compared to what is in the contract.

For example, a contract might specify that the PEO will cover work-related injuries for employees but not for independent contractors or any other “non-leased employees.” As such, if an uninsured independent contractor is injured on the client’s job site, the client — not the PEO — will have the statutory responsibility to compensate the injured worker. In other words, if your client does not have a named insured workers’ comp policy, the client assumes additional risks because the PEO is not going to cover what they contractually exclude. A traditional named insured workers’ comp policy would typically cover uninsured subcontractors.

I’ve also seen contracts that say PEOs are indemnified against their own negligence. In such an instance, the PEO contractually clarifies that if they are negligent and judgements, fines or penalties result from a lawsuit, the employer will hold the PEO harmless. This subsequently puts the employer on the hook for those judgements, fines and penalties, and in some cases any related costs to indemnify and defend the PEO, including legal fees.

Are PEOs Right for Your Clients?

In recent years, instead of competing with PEOs, some insurance agents and brokers have offered PEOs to their clients who are interested in a wider range of services. It’s important, as trusted advisors to clients, that agents and brokers understand the pros and cons of PEOs and advise their clients accordingly. As PEOs continue to gain market share, a preemptive conversation with clients may be warranted so clients know what questions to ask when, not if, they are approached by a PEO sales representative.

Should a PEO reach out to your client, it’s important you work closely with the client to ensure they understand not only the PEO contract language, but also the company’s true operating costs as noted above. This ensures you’ll be able to help clients make better, more informed decisions.

For agents and brokers looking to partner with PEOs, the key is to avoid misrepresenting any promised savings on quotes or coverage. Take your client through the contract, line by line, so they have a complete picture of the benefits and risks associated with working with PEOs. Most PEO sales representatives are not licensed insurance agents because PEOs are considered human resource consulting firms by state laws and enabling legislation. If a PEO sales representative makes a misrepresentation of their product or service, their greatest risk is the loss of their job. For agents and brokers, relying on information they have not themselves vetted can result in a misrepresentation that can cost us our licenses and our ability to work in the insurance industry.

Additionally, should a PEO working with your client become insolvent, your client could find themselves obligated for all unpaid payroll taxes or unpaid workers’ comp claims. In most states, the PEO has to pay the employees for two weeks, even if they don’t get reimbursed by the employer. However, there’s a clause in most of the standard contract language I’ve seen stating that if a PEO — for any reason — feels uncomfortable receiving payments from a client, they can immediately terminate the policy. In a worst-case scenario, a company could receive the termination notice at 5 p.m. on a Friday and not be able to resume business on a Monday. Without workers’ comp, group health or a functional payroll system, the company can essentially go out of business almost overnight. As agents and brokers, we are in the business of protecting our clients’ businesses.

The PEO value proposition is powerful: Your client has the potential to save a lot of money with fewer liabilities and responsibilities. No doubt, as businesses continue to look for opportunities to reduce costs, there will be agents and brokers willing to partner with PEOs as both a potential revenue stream as well as a way to keep some portion of their clients’ business. However, it is incumbent on insurance professionals to be methodical when advising clients on the potential risks and true cost of doing business with a PEO. Above all, insurance agents must be transparent when recommending a PEO to a client so the client can make the most informed decision possible. To do so, insurance agents and brokers need to understand the fine print of typical PEO contracts.