Professional Employer Organizations (PEOs) can offer significant benefits and cost savings to businesses, but there can also be hidden pitfalls that business owners and managers need to understand. The benefits and savings possible by using a PEO are heavily promoted in the marketing efforts of PEOs, but lax regulation and oversight of the industry mean that it can be difficult to distinguish well-run PEOs from those that may pose problems.
A PEO enters into contractual agreements with client businesses to provide behind-the-scenes services such as Workers Compensation coverage, payroll, employee benefits, and handling taxes. The contractual agreements makes the PEO a “co-employer” with the client so that the PEO can legally handle these services that are normally the responsibility of the client company. So if ABC Manufacturing enters into a PEO arrangement with ACME Staffing, ABC can turn over responsibility for Workers Compensation, unemployment compensation, health insurance, and payroll over to ACME.
Workers’ Compensation coverage, in particular, is a service that is often heavily marketed by PEOs. The theory is that a large PEO can obtain Workers’ Compensation coverage more cheaply than individual client companies can obtain on their own. And it is true that economies of scale can operate to make it possible for a PEO to indeed obtain Workers’ Compensation insurance at lower rates.
But obtaining Workers’ Compensation insurance at these lower rates can be a serious challenge for PEOs, and sometimes even some large PEOs have found that shifts in the insurance marketplace leave them unable to get coverage at the lower rates they need to make their business model work. And it can be difficult if not impossible for clients of the PEO to know when the PEO is encountering such problems.
Some years ago, one of the largest PEO operations in the U.S. ran into such difficulties. TTC, a PEO based in Illinois (but working with clients across the U.S) had its Workers’ Compensation insurance policy abruptly canceled when the insurance market shifted. TTC scrambled desperately to obtain replacement coverage over a period of months, but ultimately was unable to obtain valid Workers’ Compensation insurance. Yet while behind the scenes the operators of TTC were frantically seeking new coverage, the company continued to represent to clients that Workers’ Compensation coverage was in place. Ultimately, the PEO collapsed, and eventually several executives of the company were convicted of criminal offenses in connection with the operation of TTC. But for the client companies who had accepted TTC’s assurances of valid coverage, it was a painful and expensive lesson. When it was discovered that TTC did not have valid Workers’ Comp coverage in place, all the claims that client companies thought were being handled by TTC (and for which the client companies had been paying significant fees to TTC) became the responsibility of the client companies.
Illinois is one of many states that license and “regulate” the PEO industry, but in truth the regulation in Illinois is minimal. Responsibility for licensing and regulating PEOs in Illinois rests with the Illinois Department of Insurance, which at current staffing and budget levels is unable to properly carry out its primary duties. The regulation of the PEO industry consists essentially of collecting registration fees. So TTC was allowed to operate for months without actually having valid Workers’ Compensation insurance for its clients.
The insurance industry generally tends to view PEO companies with some suspicion, as there have been a number of PEOs over the years that were found to be providing misleading or fraudulent information to their insurer, in order to obtain Workers’ Compensation insurance at lower rates. This can complicate the ability of legitimate PEO operations to obtain Workers’ Compensation insurance, particularly in hard insurance markets.
And yet, a well run and professional PEO can indeed provide valuable benefits to clients. Many larger PEOs have considerable in-house expertise in Workers’ Compensation insurance, and have been able to obtain innovative insurance coverage that enables them to genuinely offer cost savings to clients. But because of the limited oversight and regulation of the PEO industry, it can be difficult for clients and prospective clients to easily evaluate the safety and stability of a particular PEO. The PEO industry has worked to establish voluntary self-regulation to address this issue, and to help differentiate legitimate PEO operations from those that are questionable. ESAC, the Employer Services Assurance Corporation, was established to provide accreditation of legitimate PEOs and to help clients evaluate the stability and reliability of PEOs.
And some states have moved to increase oversight of the PEO industry–although such oversight tends to still be minimal in many jurisdictions. So currently, it remains incumbent on business owners and managers to evaluate carefully the stability and professionalism of any PEO that proposes to provide vital back office services.
