Since the inception of co-employment or “staff-leasing” as it was referred to in the early 1980’s, many small to midsize employers have utilized a PEO (Professional Employers Organization) an affordable HR outsourcing solution. Traditionally, in this co-employment arrangement the “worksite” employer becomes a co-employer with the PEO and in turn reaps the benefits of shared risk for managing the liability associated with HR compliance requirements and gains access to its shared HR resources, specifically HR expertise and HRIS technology, which otherwise were not accessible, affordable, or necessary to add to the company staff. Additionally, and perhaps the greatest benefit employers saw in using a PEO was that the co-employment solution provided a vehicle for obtaining and controlling healthcare and worker’s compensation insurance expenses. Historically, the larger PEO providers were able to offer a multiple employer health plan that pooled several employers. Because the insurance carriers gave PEO’s the flexibility to manage their client’s health risk independently and the mere volume of participants enrolled in the plan created buying power which resulted in more affordable premiums.
These same benefits do still exist for employers who utilize a PEO, however the changes with healthcare reform, the spike in unemployment, revised tax legislation, and the overall impact the recession has had on the economy has diminished the cost/value that many employers once gained through a co-employment arrangement.
These factors have prompted many employers to re-think whether it makes sense to continue its current co-employment arrangement or to take pause and carefully consider whether co-employment is even a viable HR outsourcing option.
The manner in which regulatory authorities namely the Department of Labor, Department of Health and Human Services, and the Internal Revenue Service classify PEOs or co-employers has always been a gray area. In addition to the unknown future for PEOs, many employers are no longer benefiting from lower health insurance premiums like they once did. In years past, many PEOs were able to offer health plans that were less expensive than the national average and could guarantee renewals that were lower than the trend (10-13%). This past year proved that this no longer the case as many PEOs delivered renewals upwards of 35% to their clients.
Healthcare Reform and Co-Employment
Employers alike are struggling to fully understand the options and direct impact that healthcare reform changes will have on their business but an area of even greater uncertainty lies in how new healthcare reform will affect co-employment providers and their respective co-employed clients. Optimists state that because of the legislative volatility and shifts in employer regulations, the value of co-employment will increase from an administrative perspective as the PEO will be required to sustain compliance by updating the changes in legislation such as tax credits, HSA limits, 401(k) deductions, etc. Perhaps as healthcare reform changes continue, the PEO may even be required to support employee enrollment in the new health care exchange for its clients. There is future speculation that if PEOs continue to exist as they do today, the pooling of several employers operating as a single entity may begin to serve as a loophole or hedge for employers to avoid penalties for not offering employer healthcare coverage which are determined based on employee headcount.
Skeptics on the other hand question if “multiple employer group health plans” that pool several companies under a single plan with shared risk via the co-employment structure will become outlawed altogether. The concerns lie in how the IRS will further define co-employment and the responsibilities of the worksite employer vs. the employer of record as it pertains to applicable healthcare reform penalties, liability, and taxation. Will worksite employers dodge tax penalties or surrender tax credits?
Further speculation might suggest that the entire PEO industry will naturally dissolve based on how the legislative changes decrease a PEO’s ability to deliver services and maintain a viable profit margin. The revenue generated from commissions on healthcare premiums alone represent a significant portion of many PEOs profit margin which could potentially be eliminated. In addition, the PEOs will bear the burden and internal costs associated with updating its systems which are necessary to maintain compliance.
Understanding the Cost of Services
There are 4 key indicators an employer can use to gauge whether the co-employment relationship currently and more importantly will continue to sustain its value in the future as a positive solution for the business. The first challenge before considering the key indicators is to confirm the actual cost of the PEOs services. It may sound easy, however the task has proven to be quite daunting for several employers. The cost analysis may be not only confusing but also very time consuming wherein seeking outside from a consultant for assistance will save time and mitigate any confusion.
Because the PEO solution contains multiple products and services, it makes it easy for PEO providers to shift costs from one area to another to create the most favorable scenario for its client. For example, a PEO may present an affordable solution for its client by subsidizing health insurance premiums, however it recover this loss by increasing the cost of Workers Compensation premiums or admin fees. A PEO may bill fees as a percentage of gross payroll vs. a fee per each employee. Some might combine certain services, such as Workers Compensation premiums and Admin fees, and line item employee benefits separately. The other line item cost to examine is a fee that many PEOs call Administrative Costs or an Admin Fee. This fee as well might be shown separately and billed either as at flat per employee per month rate or it could be shown as a percentage of each employee’s earned wage for the pay period and combined with other cost components such as Benefits or Worker’s Compensation premiums. Because employer taxes are constantly fluctuating, this complicates the billing even more leading employers to question its accuracy. Lastly, Typically the Administrative fee is where the bulk of the profit margin lies for the PEO and when the services are bundled, it makes it easy for the PEO to shift costs so they remain profitable.
4 Keys Questions to Determine Value
1. Does the PEO provide high touch HR support to the extent that without this service, the company would have to hire someone internally to maintain the same level of operational continuity?
2. Would the company be in a position to obtain similar health coverage at a comparable rate as its own entity rather than under the co-employment multiple employer plan? How has the increase in healthcare renewals for the company under the PEO over the last 2-3 years compare to the national average ranging from in 2011-2012 at 12%-13%?
3. Would the company be in a position to obtain similar Workers Compensation and EPLI (Employers Practice Liability Insurance) coverage at a comparable rate as its own entity rather than under the co-employment multiple employer plan?
4. Would the company experience an increase or decrease to the tax rate associated with SUI (State Unemployment Income) as it own entity compared to the PEOs tax rate?
If the company has any uncertainty or concern around at least one of the 4 key questions above, a total cost analysis is definitely worth conducting. In many cases, an employer may not realize that what seems like a great deal in one area is only an offset in cost due to overpayment in another.
Comparing Apples to Apples
In order to get a full understanding of the financial impact of moving away, ask your PEO to break out each cost area separately: Benefits, Workers Compensation, EPLI, SUI, and Administrative fees. You then have a basis to compare costs as a stand-alone group outside of the PEO. The only sensible way to compare is to look at the total cost WITH the PEO versus the total cost OUTSIDE of the PEO. The only cost that will remain constant in or outside the PEO is employer-paid FICA and FUTA taxes.
5 Key Services to Shop
- Health Insurance and other related benefit products including STD/LTD, Life Insurance, Vision, Dental, COBRA, FSA, and HSA
- Workers Compensation/EPLI
- SUI – this rate will be the manual rate for a new business in each state
- Payroll/HRIS services
- Fractional HR or the cost of hiring an HR resource
If the company is also utilizing the PEO’s 401(K), add this to the list items to consider.
The Timing of Transition: A Key Financial Driver
The timing of the transition away from the PEO must be considered because of tax implications to both the employer and employees. Making a change later in the year will have a greater impact because more employees will have met their Social Security wage requirements and employers will have met their SUI and FUTA limits. Employees will have to adjust this when they do their tax return because they will have an overpayment. The tax duplication payments need to be deducted from any savings if you are looking to make a mid-year switch.
In addition, an employer’s unemployment experience rating adjusts as if the employer were a new business in each state that it has employees. This could have either a positive or negative impact on the employer and should be considered in the financial analysis as well.