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PEO Background

PEOs, also know as Professional Employer Organizations, Employee Leasing, and Human Resource Outsoaring, were first conceived by a group of professionals from the legal, accounting, insurance, and HR fields.  The strategy was to create a mechanism for increasing employer efficiencies and reducing costs by pooling larger numbers to create economies of scale. PEOs initially gained popularity in the 1980's due to escalating insurance rates in the workers compensation market.  Additionally, PEO master health plans also help improve the popularity of PEO in the 90's as small group health rates increased.

Like most industries, PEOs have continuously changed over the past 30 years and there are tremendous differences in PEO operating models today.  State and federal regulatory laws and market forces continue to create change within the PEO industry.

PEO Concept

The PEO concept is relatively simple and makes good practical sense in theory.  The basic premise centers around an agreement between the PEO and an employer group or client.  The client company enters into a co-employment contract (employee leasing agreement) with the PEO and designates them the "employer of record" for IRS purposes.  The client (managers/owners) basically act as the onsite supervisors for the PEO, controlling and directing the PEO worksite employees on the jobsite which basically means they retain control of the leased workforce.

Once executed, the co-employment agreement allows the PEO to assume certain liabilities for employer taxes, insurance, benefits, and human resources.  This transfer of employment status is designed to pool multiple employers into one larger employer group.  As a larger employer, the PEO should now be able to most of the following:  1) Hire expert staff in the areas of payroll, HR, benefits, risk management, etc. and spread that cost out over all the employer group creating economy of scale.  2) Negotiate better insurance rates such as workers compensation and health insurance.  3) Increase efficiencies and reduce costs for things like unemployment tax (SUTA), HR, and insurance by utilizing best practices implemented by the experts within the PEO.

PEO Advantages

When done properly, PEOs can be a great alternative for all types of employers.  But it is difficult, if not impossible, for a PEO to be all things to all employers.  In other words, a PEO needs to specialize their services for certain types of employer groups who have specific needs in order to create real value for the clients.

Many PEOs have the ability to:

  • Simplify the process of employing people
  • Reduce the employer startup costs and deposits for insurance
  • Lower the overall costs associated with workers compensation insurance
  • Reduce the costs associated with health insurance for some employer groups
  • Provide better HR services and risk management practices for employers
  • Improve employee benefit options available for employees
  • Reduce the cost of unemployment taxes in some states due to state experience rating

Unfortunately it is unlikely a PEO will be able to do all of these things at the same time for all types of employers. 

Take health insurance for example:  Fewer and fewer PEOs operate master health plans due to carrier resistance and claims history.  The PEOs who do offer master health plans operate them under greater scrutiny than ever before in order to maintain acceptable claims ratios.  This means that PEOs today must individually underwrite each employer group and then properly price the group under certain rate tiers to protect the overall policy.  Some employer groups will not even qualify.  Furthermore, PEOs often must require certain participation requirements for each group.

Now consider workers compensation:  While the majority of PEO still operate master policies, many now "carve out" this service and provide client owned policies that are administered by the PEO.  Carved out policies are good for clients with good experience modifiers, but provide less value to clients who have had some claims.  PEOs who excel in workers compensation are unlikely to excel in health insurance for most industries.

PEO Disadvantages

While there are some great PEOs around the county, there are some less than desirable PEOs as well.  Some PEOs have been associated with various types of fraud with regard to workers compensation, tax reporting, and SUTA dumping.  According to Wikipedia on PEOs, at least 15 PEO Companies were the subject of criminal prosecution during 2006.

Here is a list of the potential general disadvantages:

  • Dependence on PEO to negotiate insurance rates and control claims history
  • High administration fees and/or hidden fees on SUTA or work comp
  • Legal ambiguity associated with state and federal co-employment laws affecting PEOs
  • Potential for fraudulent tax reporting or workers compensation premium reporting

PEO Shopping and Alternatives

The best method for measuring the viability of outsourcing to a PEO is to compare your current employer program and needs to multiple PEO options as well as other solutions such as payroll and administrative outsourcing or direct insurance products and programs to address any problems or needs identified.

PEOshop was created to help employers take a much broader approach in identifying current problems and implementing solutions.  We work with employers and create multiple opportunities and advise them on costs and benefits of each opportunity including PEOs.

 

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