A PEO is an organization in which multiple companies are pooled together under a single Federal Employer Identification Number (FEIN) to receive the same benefits and leverage the volume as a larger employer. This is also commonly referred to as a co-employment agreement.
While the concept of pooling together with other companies to gain buying power on benefits, workers’ compensation, taxes and administrative services may have benefits to some employers, it also has an inherent shared risk with other companies of varying risks. Many myths exist on where the blurred lines of risk and liabilities rest in a co-employment environment. There are a number of things a business owner should consider before entering into a PEO relationship since these agreements can be more difficult to get out of than to enter.
- Mid-year starts or conversions to a PEO reset employer and employee tax liabilities
- State unemployment tax rate charged could be higher or lower than client’s existing rate.
- PEOs may not honor or stop charging at the wage base limits (State unemployment, Federal Unemployment & Social Security)
- PEOs may choose to keep any credits earned under the FEIN such as Work Opportunity Tax Credits (WOTC) or FICA Tip Tax Credits.
- PEOs often keep the employer portion of the 7.65% FICA savings generated under the Section 125 Plan benefits where all eligible premiums are pre-tax.
- If the PEO offers benefits under a POP plan (health, dental, life, vision, etc.) where they are the plan sponsor and employer of record for benefits, the rates offered to the client are often not the same rates the insurance carrier is charging the PEO.
- Poor underwriting guidelines used by a PEO for new business has proven to adversely affect plan rates by virtue of adverse selection and compounding poor claim history. This practice may create a very challenging environment and future rate increases.
- Poor claim history in a benefit plan offered by a PEO can increase the employer and employee premium costs, as well as out of pocket expenses even if you didn’t contribute to the claim history from your company or your employees.
- If the PEO offers a master Workers’ Compensation plan, employers are joined together in one risk pool. As previously mentioned this can sometimes be beneficial and other times be inherently risky.
- Like the benefits above, the rates charged to the client for Workers’ Compensation are often not the same rates the insurance carrier is charging the PEO.
- If underwriting guidelines are not thorough and consistent, the same adverse selection and poor claim history can result prompting rate increases to employers; some that may not have contributed to the loss ratio of the plan.
- Under a PEO master plan, the PEO is typically unable to let the owner exempt themselves and their wages from the calculation required for premium to be charged.
- Under a PEO master plan, the PEO may calculate and charge premium on all gross wages vs. only calculating on the subject wages.
- Generally PEO’s do not offer any type of earned or performance based dividend or reimbursement program to clients for favorable claim history.
- This fee and the method by which it’s charged are at the discretion of the PEO and may require annual negotiations.
- There are 2 primary methods used for billing Administrative Fees; 1) a fixed percentage (%) of gross payroll wages or 2) a flat per employee per month fee (PEPM).
Human Resources Services
- Many PEOs provide some level of HR services as part of the offering. The depth of their participation on any given event various between PEOs.
- Many PEO’s offer on-site support from a dedicated and certified HR professional. Typically they act as a consultant and provide support limited to the terms and conditions set forth in the Service Agreement.
Service Agreement (Contract)
- Some PEO service agreements or contracts have provisions that charge a penalty or fee for early or mid term termination from the agreement.
Most agreements spell out the actual liability responsibilities between the client and the PEO which generally have numerous indemnification provisions protecting the PEO.
When a company joins a PEO, they assume the PEOs rates for state and federal taxes. This can be beneficial to companies that have high tax rates for Unemployment due to high turnover. However, newer companies and those that have few unemployment claims could end up paying a higher tax rate.
Additionally, if a company considers a transition to a PEO in the middle of the year; all tax liabilities reset for the client and their employees. This means that employers would start over and re-pay the following taxes on their employee’s wages for that calendar year:
|Social Security||6.2% up to the Federal wage limit (changes annually)/td>|
|Federal Unemployment||.60% on first $7,000 in wages*|
|PA State Unemployment||Rate TBD on wages up to the state limit**|
*Generally, you can take a credit against your FUTA tax for amounts you paid into state unemployment funds. Employers are entitled to a credit of up to 5.4% off the 6.0% rate (net of .60% above) if they paid their state unemployment taxes in full and on time. It is important to confirm if the PEO takes this tax credit and if they pass it on to their clients.
**Some PEOs use the clients state unemployment rate vs. their own. It is important to confirm the method and responsibilities for both the PEO and the client if this method is used.
Most PEOs include a master benefits plan/package with their offering. The PEO negotiates the plan design and rates. Typically these appear to be flexible and cost effective options for smaller companies but for others, these plan designs can be very limited compared to the plan design options available in the open market. A limited number of plans and plan designs can prevent the employer from customizing the plan to better direct and control expenses (co-pay, deductible, etc.) to help reduce or stabilize long term premiums.
The master plan business practice has caused concern for many PEO consumers over the years, because the rates offered to the client are often not the same rates the insurance carrier is charging the PEO. Therefore, some PEO agreements or contracts may be negotiated to allow the client to utilize their own benefit plans and maintain existing broker relationships. It is advisable that an employer discuss this option before making a transition into a PEO relationship. Be mindful of the administration of the Section 125 plan and the affect the selected method may have on eligibility of pre-tax options.
One of the largest draws to utilizing a PEO is the ability to gain coverage for hard to insure classification codes or to lower the company’s workers’ compensation rates. This can be a big benefit for high risk industries or companies that have a high experience modification rate. This can also be beneficial to companies that may have had a large claim against their account resulting in a large rate increase. This practice and the resulting clients associated with it can mean the pool of companies collectively has a higher overall claim to premium ratio (loss ratio) and may limit a clean company (risk) with favorable claim history from further potential discounts.
If your company does not fall into one of these categories, you could be paying a higher rate than what would be available to you on an individual policy due to the PEOs risk pool. This means you could be paying a higher than average workers’ compensation rate because of higher claim activity from another company.
PEOs have historically billed clients on a percentage based billing model. However, to stay competitive with payroll companies and other Administrative Service Organizations, many PEOs will now price their services on a per-employee-per-month (PEPM) pricing model. It is important to understand how you are being billed for services, especially if you are on percentage based billing. Below is an example of what percentage based billing would look like.
|PEO Services||Percentage of Payroll|
If you have an annual payroll of $300,000 for this example, you would be paying approximately $54,750 to your PEO for the items listed above. This total does not include benefit costs which are typically billed directly. While most of this cost consists of statutory taxes and workers’ compensation, an Administrative Fee of 4.0% alone would be $12,000. This fee could be more or less cost effective than a per employee per month fee especially if the employer provides annual wage increases. So make sure you understand how your taxes, workers’ compensation, and fees are calculated and know exactly what your costs will be before signing an agreement.
Human Resources Services (HR)
As a result of rising costs and overhead in most of the hard cost areas that the PEO is responsible for negotiating and managing, PEOs have positioned HR support as an important and critical feature in their product suite to establish value. Experience shows it is the most widely underutilized service PEOs provide and that very similar HR support services are available in the market at a fraction of the cost compared to the rates PEOs charge.
Service Agreement (Contract)
PEO Service Agreements and the terms and conditions within them vary greatly. Most will spell out the responsibilities of both parties (PEO and client) to be used if/when a problem arises. It is strongly recommended you and your legal counsel thoroughly review each and every provision and clause of the agreement.
Upon review, many agreements will clearly indemnify the PEO from a number of responsibilities. It is important to know how this agreement might limit you from changes in the future. For example, many will have events such as annual enrollment for benefits at an off cycle time on the calendar (other than calendar year end) so it automatically makes it expensive to leave later given the start over of payroll taxes required when a move is made.
It is important to confirm how far the PEO will go to support you as a client if a problem arises during the relationship. Many agreements limit the PEOs engagement in certain environments leaving the client to their own devices. It’s critical to know where these might be embedded in the agreement.
Most agreements have a 30 day notice provision if either party wishes to terminate the agreement. Again, it is strongly recommended to confirm whether there is a termination fee (sometimes per employee) for ending the agreement.
20 Questions to Consider Asking your PEO
- Do you honor all wage bases on federal unemployment, state unemployment and social security consistent with the current guidelines?
- Do you pass through any credits earned such as Work Opportunity Tax Credits (WOTC) or FICA Tip Tax Credits back to the client in full?
- Do you pass through the credit to my company of the earned savings on the employer portion of FICA (7.65%) for all eligible premiums under the Section 125 plan?
- Do you mark up the benefit premiums charged to my company to earn additional profit? If so, how much is the mark-up?
- What are your underwriting guidelines for new business regarding benefits and how do you manage the type of risk coming into the plan to prevent poor claim history later?
- What are your guidelines and how do you manage poor claim activity from current clients within any of the benefit plans provided?
- Do you mark up the workers’ compensation premiums charged to my company and earn additional profit? If so, how much is the mark-up?
- What are your underwriting guidelines for new business regarding workers’ compensation and how do you manage the type of risk coming into the plan to prevent poor claim history later?
- What are your guidelines and how do you manage poor claim activity from current clients within the workers’ compensation plan?
- As an owner of my business, can I continue to exempt myself from workers’ compensation coverage and premium?
- Do you calculate and charge workers’ compensation premium on all gross wages or do you charge premium on only the subject wages?
- Do you provide my company any dividend or premium reimbursement program for favorable workers’ compensation claim history?
- Are your Administration Fees charged as a percentage (%) of gross wages or is it charged using a per employee per month (PEPM) method? If percentage, can you change the billing method to PEPM so I don’t incur additional fees each time my gross wages go up?
- Do you come in and participate directly in face to face employee communication if we have a problem involving HR? If not, do you leave that up to us to handle direct employee communication?
- Do you actively participate and support the client onsite in any legal case that might arise under the HR support services? If not, what is your role?
- What are the termination guidelines in your service agreement? Does your service agreement have any termination fees if I decide to leave your service?
- Exactly which employer responsibilities or liabilities that I’m currently responsible for shift to you with this service agreement?
- Do you offer EPLI (employment practices liability insurance) coverage as part of your proposal? If so, does the coverage and policy limit aggregate across all clients or per client? If the coverage limits are tapped by a series of claims during a policy year by a few clients, does the coverage run out for other clients to use if needed?
- How often and when have you increased rates in the past? Are rate increases limited to the Administration Fees you charge or do rate increases include unemployment and workers’ compensation rates? What type of notice do you provide prior to effective date of any rate increase?
- If my claim history is good, and I have good controls in place, and I’ve done a good job containing my costs, what is the benefit of me using a PEO?