THE TRUTHABOUT PEOs9 critical components you must consider before choosing the right one for your business

CLINT KONZMAN

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TABLE OF CONTENTS

Why PEO? .......................................................................................................................................................................................... 5

Managing Compliance ........................................................................................................................................................................................7

Retirement Benefits ........................................................................................................................................................................................... 8

Maximizing HR............................................................... ........................................................................................................................................... 9

Should Your Company Be Using a PEO? .................................................................................................................................................. 11

Critical Considerations ..................................................................................................................................................................................... 12

Employee Confusion........................................................................................................................................................................................... 13

Who is Hiring/Firing Staff? ............................................................................................................................................................................14

Insurance Premiums and Renewal Increases ........................................................................................................................................... 15

Technology ........................................................................................................................................................................................................... 17

Fee Structure .......................................................................................................................................................................................................18

The Fine Print .....................................................................................................................................................................................................20

Be Specific When Asking for References .................................................................................................................................................21

Tax Restarts .........................................................................................................................................................................................................22

Transitioning to a PEO ....................................................................................................................................................................................23

Summary ........................................................................................................................................................................................................... . .24

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The professional employer organization (PEO) industry becomes more relevant for small businesses with each new employment law that is passed and every annual increase to health insurance premiums. Because of this, PEOs can be a valuable partner for many businesses, but they are not a fit for everyone.

Whether or not a PEO is the right choice for your business depends on many factors. You’ve got to consider if the economic, cultural, and technological effects are advantageous to your organization. As with any service provider, it is vitally important to understand the impact of the relationship and more importantly, which hard questions you should be asking to determine if it’s a fit for your company.

The main focus for those running a small business is developing a product, putting together the financial and human capital needed, and gaining a share of the increasingly competitive global market. All of their energy and effort is focused on success. A bi-product of this success, however, is a myriad of requirements that may not have been fully considered at the onset. Daunting non-revenue producing administrative functions such as payroll, unemployment claims management, employment law compliance, and benefits and COBRA administration, can bog you down.

According to Entrepreneur1, small business owners can spend up to 40% of their work day on human resources issues, and this means taking precious time and energy away from growing their business.

1 Is It Time to Outsource Human Resources? Entrepreneur.com https://www.entrepreneur.com/article/217866

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At one point or another you’ve probably asked yourself how you will:

Manage your

back office systems more

efficiently?

Maintain compliance

with the ever increasing amount

of employment laws?

Contain the

staggering increasing cost

of employee benefits?

Recruit and retain

the type of top talent needed to grow your

business?

How are you addressing these increasingly complex questions?

Should you:

• Manage HR with existing staff or hire ahuman resources professional?

• Utilize a human resource informationsystem (HRIS) such as Namely?

• Continue with an insurance broker or usean integrated benefits administration andpayroll platform like Zenefits?

• Partner with a professional employerorganization (PEO)?

Now more than ever businesses are deciding to outsource key components of their HR function, and therefore the market for these solutions has grown to meet the demand. The availability of so many choices can make it difficult to determine which is your best option.

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WHY PEO?

Similar to other outsourced HR models, a PEO manages most aspects of the human resources function including:

A PEO operates under a co-employment model. This means that you and the professional employer organization will share in the employment responsibilities with the PEO becoming the administrative employer of record. The PEO will now be responsible and liable for payroll processing, employment tax remittance, employment law compliance, workers’ compensation coverage, and benefits administration.

Due to the nature of this relationship, the PEO is able to impact your business in a

way that the other HR outsourcing options cannot; it allows you to access large group benefit offerings that can reduce costs in the short term and create predictability around potential increases down the road.

Another unique advantage to co-employment is that a PEO shares your company's interest in maintaining compliance. Unlike a typical service provider, a PEO has a vested interest in this because they too are now liable for violations that may occur at your company.

PAYROL

PAID TIME-OFF TRACKING

TAXATIONEMPLOYEE BENEFITS

ADMINISTRATIONRETIREMENT

PLANS

UNEMPLOYMENT CLAIMS

EMPLOYMENT LAW

COMPLIANCE

WORKERS' COMPENSATION

AND SAFETYRECRUITMENT

EMPLOYEE TRAINING

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Therefore, PEOs offer services and guidance to protect you, including:

• Sexual harassment training

• Hiring and termination best practices

• Employee handbook creation andmaintenance

• Fair Labor Standards Act (FLSA) &Family Medical Leave Act (FMLA)guidance

As a result of allowing you to access their large group purchasing power, a PEO must share in your employment liabilities. It’s not just a slick interface, it’s a complete and comprehensive shield for your business, protecting you from insurance carriers and their premium increases, the government and its ever changing regulations, and even your own employees.

Simply put, a PEO will provide a vital safety net for your business.

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MANAGING COMPLIANCE

While you’re busy trying to perfect your product or service, a PEO partner is making sure payroll taxes are paid. While you’re developing staff, PEOs are concerned with EEO regulations. You’re focused on market share; they’re focused on negotiating affordable insurance plans.

As an employer, you must be in compliance with a host of laws, many of which you may not understand or even be aware of. Most likely you don’t have the time, or the inclination, to find out what they mean or how to deal with them. But that nagging feeling in the back of your mind won’t go away…knowing that these laws could jeopardize you and your company’s success.

A PEO will share in your burden in managing compliance. They are responsible for your compliance in every state in which you do business, providing guidance and recommendations on an ongoing basis.

Like a security system for your home, a PEO acts deterrent to inquiries from the Department of Labor, because they know that when a business is partnered with a PEO, compliance is taken seriously.

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RETIREMENT BENEFITS

Retirement benefits are fast becoming a key asset in attracting and retaining top talent. Four in ten employees point to having a defined benefit plan as a reason for joining or staying with a company.

Do you:

• Know how to source a 401(k) and what to look for?

• Understand the tax benefits available to yourcompany when employees participate?

• Understand the fiduciary liability that you and someof your staff assume in offering a 401(k) plan?

ERISA law governs this type of retirement plan and those managing it are taking on a fiduciary responsibility that includes:

• Acting solely in the interest of plan participants andtheir beneficiaries and with the exclusive purpose ofproviding benefits to them;

• Carrying out their duties prudently;

• Following the plan documents (unless inconsistentwith ERISA);

• Diversifying plan investments; and

• Paying only reasonable plan expenses

Fiduciaries that do not follow the basic standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions.

Because of the nature of the co-employment relationship, clients that offer their PEO’s 401k program to its employees are shielding themselves from virtually all personal fiduciary liability. The PEO is now responsible for providing documentation to the employees, handling fund contributions, reviewing investment performance, monitoring fund and plan fees to ensure they are reasonable, and record-keeping of all changes to the plan offering. It’s shown that a plan through a PEO increases participation and thus enhances the tax benefits a small business can enjoy. In fact, only 23% of non-PEO employees participate in a retirement plan compared to 52% participation of PEO worksite employees (for companies with 10 to 49 workers).1

So long as its potential liability to the business and fiduciaries is kept in check, a strong retirement program is crucial in recruiting and retaining a talented workforce.

1 Professional Employer Organizations: Fueling Small Business Growth McBassi & Company http://www.napeo.org/docs/default-source/white-papers/whitepaper1.pdf?sfvrsn=2

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MAXIMIZING HR

Bersin & Associates groups organizations into four categories with the lowest level being “compliance-driven HR”, which is where most small companies are operating. Led by an operations or finance executive, companies at this level are often concerned with payroll and benefits only, and little else.1

Bersin & Associates describes the highest level of an organization’s human resources maturity as “business-integrated”, with HR playing a much more strategic role in the development of its people. Compared to compliance-driven HR organizations, companies with business-integrated HR realize a 40%

1 Maximizing your HR Spend Human Resource Executive Online http://www.hreonline.com/HRE/view/story.jhtml?id=533338466

reduction in turnover and more than double their revenue per employee. They also show 38% higher employee engagement, which translates to higher productivity.

While the per employee cost for compliance-driven HR is considerably less than business-integrated HR ($1,061 versus $1,759), the payoff can be worthwhile for organizations that strive to achieve this level.

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If your dedicated HR person could outsource transactional HR tasks, they could work strategically with management to develop and grow human capital. That shift from compliance-driven to business-integrated HR could translate into better employee retention, engagement, productivity, and overall profit.

Many companies are realizing the benefits of outsourcing some or all aspects of the human resource function. Reasons for this trend are detailed in a Society for Human Resources (SHRM) survey:

When surveyed, 58% of companies achieved an average savings of 24% or at least realized no increase in costs when they went to a PEO.2

2 Human Resource Outsourcing Society for Human Resource Management (SHRM) https://www.shrm.org/publications/hrmagazine/editorialcontent/documents/human%20resources%20outsourcing%20survey%20report.pdf

56%

55%

47%

42%

42%

save money/reduce operating costs

control legal risk/improve compliance

gain access to vendor talent/expertise

offer services the organization could not otherwise provide

allow the company to focus on its core business

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SHOULD YOUR COMPANY BE USING A PEO?

Not every company is a fit for the PEO model. Typically, businesses with a certain profile can benefit more than others. The following are important questions to answer before you begin the process of exploring a PEO.

• Do you contribute more than 50% towards youremployees’ medical insurance premiums?

• Do you offer a a robust, high-end benefits package?

• Do more than 75% of eligible employees participate inmedical insurance?

• Do you struggle each year to absorb the rising cost ofinsurance?

• Do your employees work in multiple states or is thereplanned expansion into other markets?

• Does your company have less than 100 employees?

• Are you concerned that compliance with federal, stateand local employment laws is not being maintained?

• Are most of your employees full-time?

• Are payroll and other HR functions currentlyoutsourced?

If you answered yes to most of these questions, then it’s likely that partnering with a PEO could benefit your business.

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CRITICAL CONSIDERATIONS

It’s true that a PEO can help your company to:

• Offload the burden of non-revenue producing administrative activities so you can be more focused on increasingrevenue

• Offer more and potentially better benefits to help recruit and retain top talent

• Ensure compliance with all applicable laws and regulations

• Lower the per employee cost of managing your HR function

As with any solution there can be drawbacks if important aspects are not considered.

The remaining topics will address these critical components to consider when deciding on whether or not a PEO is right for your business.

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EMPLOYEE CONFUSION

If you move to a PEO you will be partnering with them to administer (not run) your business. You make all of the day-to-day decisions (although they may advise on personnel matters) and they manage the “back-office” administrative functions. The core foundation of the PEO relationship with its clients and their employees centers around payroll. Your PEO will issue checks and sign them for each of your employees, although most have the capability of keeping your company’s name and address on the note.

One typical concern of the co-employment relationship pertains to the PEO’s name being on your employees’ W2. It is a concern that the name of their employer does not match the name on the W2 and could prohibit them from qualifying for loans. It must be noted that this has never been an issue for the more than 1.2 million employees currently working under this arrangement. If an employee applying for a mortgage incurs questions concerning their employment arrangement, the following approach is recommended:

• Provide an employment letter on company letterheadstating the employee’s salary and job title, alongwith an explanation of the relationship between yourcompany and the PEO

• Request a supporting letter from your PEO explainingthe relationship between your companies that alsostates the PEO is responsible for payroll processing,issuing paychecks and W2s

A competent PEO will provide a comprehensive explanation to your employees detailing the nature of the relationship and how your employees benefit from the partnership you’ve created.

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WHO IS HIRING/FIRING STAFF?

One of the most common misconceptions of partnering with a professional employer organization is the concern that you will lose control over your business. One glaring point that lends itself to perpetuating this notion is that a PEO’s client service agreement outlines their right to hire and terminate your employees.

The reality is, you would continue to retain control over your staff and all day-to-day activities. You conduct your own hiring, determine employee promotions and make decisions on necessary terminations. PEOs are simply there to provide best practice guidance and support around these functions.

However, a PEO must retain the right to hire and terminate your employees in order to ensure compliance. For example, if a client company attempts to hire an employee that cannot provide sufficient proof to satisfy I9 documentation requirements, the PEO must have the ability to deny their employment for risk of violating Department of Labor regulation. This is no small liability as non-compliance can bring both civil and criminal penalties.

So while this language may sound intrusive, in practice it is simply a mechanism to protect your business as well as their own.

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INSURANCE PREMIUMS AND RENEWAL INCREASES

As with any partnership, do your homework. Many companies explore using a PEO in order to gain access to their large group health benefits. Joining a PEO can bring your staff into a larger pool of insureds, bringing down costs and/or improving coverage. Be aware, however, that PEOs are no magic bullet. They are as susceptible to large rate increases just as any other business. Any increase in insurance premiums is in direct correlation to the underlying performance of your professional employer organization’s risk pool; i.e., you and your fellow PEO members. If a PEO is a publicly traded company it is much easier to research and understand how their health insurance program is performing. However, since all but four PEOs are privately held entities, it can be challenging to understand who you’re sharing the pool with. The best approach is to identify four key components of the PEO:

• What’s the profile of their typical client?The profile of the typical client is important so that you understand what other types of companies are in your risk pool. If you’re a technology company with good demographics and you join a PEO whose clients present more risk, you will be subsidizing these fellow members.

• How strict is their underwriting process?The stricter the underwriting process, the more assurance you have that the PEO is selective in the

types of groups they accept into their pool, thus better protecting you.

• What is the ratio of health insurance participants to total worksite employees?PEOs generally tout the number of employees they have underneath their umbrella, but this number and how many are actually participating in their plan are two different things. The ratio of participants to overall worksite employees is important. The lower this ratio, the more likely the PEO has many clients who do not offer medical insurance. This indicates a high risk clientele which can lead to higher premiums increases for your company.

• What are their minimum contribution and participation requirements?Minimum requirements associated with a PEO’s medical plan give insight into the integrity of the program. The higher the requirements, the less likely a company will meet them, resulting in a more exclusive risk pool which can keep down costs.

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You may ask why size of the PEO is not mentioned here. Because it is not as important a predictor of health insurance increases as you may think. If a PEO collects $8,000,000 in health insurance premium and pays out $7,500,000 in claims, their increase on a percentage basis will be significantly higher than a PEO collecting $1,000,000 in premium and paying out $700,00 in claims. The larger PEO may be able to negotiate lower margins with the carrier, however cost of insurance is mainly driven by premium paid versus claims made.

Therefore, regardless of the premium volume, the lower the medical loss ratio (claims / premium), the lower the premium increase.

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TECHNOLOGY

Far too often companies decide to use a PEO without seeing a demo of their technology or ensuring the PEO is capable of producing the reports needed to run their business. Every PEO has their own unique technology and reporting capabilities, and it is vitally important to completely understand the platform of the one you’re contemplating. Far too often clients discover that the PEO’s platform is not capable of providing required reports or doesn’t fit their company culture until after implementation is complete, when it’s already too late to change course.

Bear in mind, this technology platform is one of the first interactions a new-hire will have with your company. It is the technological face of your business. Each time an employee wants to view their pay stub, review benefit plans summaries, or request paid-time-off, they will be logging onto this system.

Don’t make your decision until you demo the technology to ensure it meets your requirements, represents the company image you want to project and fits within the culture you’re building for your business.

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FEE STRUCTURE

There are two basic ways in which a PEO will charge its clients for administrative fees, benefits, workers’ compensation and employer taxes.

1. Flat rate methodThis is the most transparent and straightforwardway for a PEO to invoice its clientele. Simply put,the PEO charges a flat dollar amount per employeeper month for administrative fees. Workers’compensation and employer taxes are billed at apercentage of wages with the PEO honoring all taxcutoffs as wage limits are met. When billed in thisformat, the PEO will break out each of your costs asa separate line item so you can easily understandyour expenses as you reconcile them within yourgeneral ledger.

2. Percentage of payroll methodThis means that administrative fees, workers’

compensation, employer taxes, and in some

cases, benefits are billed at a percentage of each

employees’ gross wages. There are two main

subsets of this method; un-bundled and bundled.

a. PEOs that use the un-bundled method arebreaking out the actual dollar amount ina separate line item along with workers’

compensation premium and employer taxes so that the client will see the exact cost of each item. Many of these PEOs charge for benefit premiums as a flat dollar amount on the invoice.

b. The bundled method is the least transparent.

The PEO is not only charging its administrativefee as a percentage of the employees’ grosswages, but it’s bundling this percentage in withthe workers’ compensation premium and allemployer taxes. Therefore, when a clientreviews their invoice, all of those various costsare bundled together into one bill rate, which isthen levied on the wages.

For instance, if employee John Smith is paid$1,000 on January 15th and the bundledpercentage is 19.8%, the client will be invoiced$1,198 for John Smith. The PEO generally doesnot provide a breakout of the various costswhich causes the client to not fully understandwhat constitutes the $198. A PEO will defendthis model as a way to prevent you fromincorrectly accounting for labor costs. Butmake no mistake, PEOs that bill as a bundledpercentage of payroll are doing so for onereason. TO HIDE FEES.

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In fact, current research into actual invoices from clients being billed in the bundled method of some PEOs has yielded astonishing results: when their fees are compared to those of the flat rate method, they are being overcharged by an average of 82.8%. In hard dollars this translates into $29,808 in excessive fees for a 30 employee company!

In addition, a bundled bill rate allows the PEO to keep Section 125 pre-tax savings that would otherwise be realized by the client. Few clients realize that the FICA savings they would normally receive through their employees’ pre-tax deductions for medical, dental, vision and commuter benefits, is retained by the PEO. This can lead to many thousands of dollars in lost savings in just one year.

The vast majority of PEOs are upstanding when it comes to disclosure of fees and costs. There are a few, however, that lack transparency and can create uncertainty with their billing. The fact that most of the offending PEOs are the largest and most well-known, allows them to continue this misleading practice. It is strongly recommended to avoid the bundled method in favor of a flat rate model.

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THE FINE PRINT

Entering into a relationship with a PEO is no different than any other business endeavor and it’s advisable that you read and consider all the language of the client service agreement (CSA). Some common provisions to look for are:

Termination notice

COBRA continuation

fees

typical CSAs require a 30 day notice to terminate. Requirements beyond this are egregious.

many PEOs penalize clients who leave COBRA participants on their medical insurance plan after the relationship ends. Charges for this can be as high as $250 per participant per month for the duration of their stay on the PEO’s plan. These fees should be addressed before you sign the agreement.

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BE SPECIFIC WHEN ASKING FOR REFERENCES

References can be ineffective since the PEO may only provide you with names of satisfied customers. To combat this, ask for references of three clients that have been with the PEO for three years or more. Ask these references the following questions. Over the past three years how much have your:

• Insurance premiums increased?

• State unemployment rates increased?

• Workers’ compensation premiums increased?

• Administrative fees increased?

Anyone can give you a good reference and service questions are subjective, but factual questions garner a much more accurate picture.

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TAX RESTARTS

If you join a PEO at any time other than January 1st, your company will have to restart employee wages and repay employer taxes again. This reset impact can be significant depending on the time of year you join, how much your employees make and the states in which you do business.

For example, Acme, Inc. has 40 employees (5 who make $240,000/year, the remainder, less than $100,000/year) in New York State and on July 1st is considering joining a PEO that has a state unemployment rate (SUTA) of 4.1%. Since Acme, Inc. will assume the PEO’s SUTA rate, the tax restart impact for Acme, Inc. (based on its total payroll) will be $57,148.

• Federal Unemployment (FUTA): $1,680 [40 x $7,000(wage cap) x .06%]

• SUTA: $17,548 [40 x $10,700 (wage cap) x 4.1%]

• Social Security: $37,920 [5 x $118,500 (wage cap) x6.2%]

° Since there are only 5 employees making over theannual cap for Social Security tax, none of the other employees would be affected.

Be sure to address tax restarts with the PEO you’re considering, as many are able to offset some of these reset costs through credits to your administrative fees. Typically, these PEO will require a long-term commitment with payback of all the credits as a penalty for breaching this commitment.

There are a few PEOs who take a position that the federal (FUTA & Social Security) employer taxes should not be reset and honor the wages you’ve paid year-to-date, thus eliminating any impact. In fact, recent legislation passed by the federal government reinforces this position. Not all PEOs will have the ability to offer this, but through a voluntary certification process, many will take advantage of this law to drastically reduce the tax burden of starting after the 1st of the year.

If you’re deciding to start using a PEO at any point after January 1st, always make it a point to address tax resets so that there are no surprises or unanticipated costs.

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TRANSITIONING TO A PEO

When transitioning into a PEO, timing is important. Both the time of year and the amount of time you allow for implementation can greatly impact your transition experience.

Even though January 1st seems like the logical time to start it’s important to realize that most other companies are starting then as well. In fact, more than 40% of industry’s new business can come onboard in the month of January alone. This creates enormous pressure on resources, and the reality is many PEOs are not adequately staffed to accommodate this influx of new clients. Most of the on-boarding process takes place during the holiday season which further exacerbates the situation.

Irrespective of the time of year, and depending on the size of your company, it’s advisable to allow yourself as many as six weeks prior to the start-date to begin the on-boarding process. Giving yourself this window of time will positively impact your experience as it gives both the PEO’s staff, as well as your own, enough time to execute the implementation timeline. Employees take vacations, unexpected projects arise, and illnesses occur; so the more buffer you build into the timeline, the better the experience will be for all involved.

Ultimately, whether your on-boarding experience is that of relative ease or not, can typically be traced back to the commitment of time given to the process.

SUMMARY

A professional employer organization can help divert the time you spend on compliance and human resource matters, giving you more time to focus on revenue producing activities. They can reduce your risk and prevent unnecessary lawsuits, fines and other stressful situations. Through large group purchasing power they can give you the ability to offer a robust and affordable benefits package to attract and retain top talent.

Whether or not a PEO is right for your company depends on many factors. As with any large and complex purchase, it is recommended that you utilize an experienced PEO specialist to help you navigate the process.

To get started on finding out if a PEO is right for you, contact us.