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Small businesses offer big benefits through PEOs, part II

The pitfalls of PEOs: Benefits might be too rich

Despite all the apparent advantages of professional employer organizations (PEOs), there are thorns among the roses.

Potential advantages of a PEO

For the business
For the employee
Controls costs
Access to benefits
Saves time and paperwork hassles
Accurate, on-time payroll
Provides professional compliance
Professional assistance with employment-related problems
Attracts better employees
Efficient claims processing
Provides professional human resource services
Portable benefits that go with you if you change job sites

Potential disadvantages of a PEO

For the business
For the employee
Loss of independence
Fears about nonlocal control
Benefit packages unnecessarily rich
Would rather not pay health care premiums
Risk that claims won't be paid
Risk that claims won't be paid
Risk of nonpayment of payroll
Risk of not being paid
May be told by the PEO to buy new equipment or revise procedures
Can be fired or re-assigned by the PEO
Potential liability for discrimination or safety violations
Perception of less loyalty from the PEO
Small companies may become subject to laws covering large employers
May find themselves subject to new policies, such as drug tests

For one thing, buying health insurance through a PEO is not intended to be a money-saving venture; rather, it's meant to provide convenient access to benefits, contends Milan P. Yager, executive vice president of the National Association of Professional Employer Organizations (NAPEO). "The price is about equal to what it's costing you now, but you get a much richer benefits package," Yager says. Other industry representatives disagree and say it can cut costs, if you do the right shopping.

Regardless of any potential cost savings, the health care benefits offered by PEOs might simply be too rich for some small companies. The National Federation of Independent Businesses (NFIB) suggests many of the group's small-business owners don't even want Fortune 500-level benefits, stating these small business employees would rather have more money in their paychecks, especially if they're young and healthy. Also, many small businesses have employees who are part-time and seasonal, and PEOs don't work well with an unstable workforce as far as benefits go.

Whose company is it, anyway?

Another significant concern of some small businesses is the potential loss of independence when they contract with a PEO and thus become its employee and merely co-employers of their own workers.

As co-employers with their client companies, PEOs contractually assume substantial employer rights, responsibilities, and risk through the establishment and maintenance of an employer relationship with the workers assigned to its clients. More specifically, a PEO establishes a contractual relationship with its clients whereby the PEO retains a right to hire, reassign and fire the employees and resolve employee disputes.

The client retains ownership of the company and control over its operations, NAPEO states. As co-employers, the PEO and client will contractually share or allocate employer responsibilities and liabilities. The PEO will generally only assume responsibilities and liabilities associated with a "general" employer for purposes of administration, payroll, taxes and benefits. The client will continue to have responsibility for worksite safety and compliance. The PEO will be responsible for payroll and employment taxes, will maintain employee records and reserves a right to hire and fire. Because the PEO also may be responsible for workers' compensation, many PEOs also focus on and improve safety and compliance. In general terms, the PEO will focus on employment-related issues and the client will be responsible for the actual business operations, NAPEO states.

Do your homework first

States that require PEOs to be licensed
  • Arkansas
  • Florida
  • Illinois
  • Kentucky
  • Louisiana
  • Maine
  • Minnesota
  • Montana
  • Nevada
  • New Hampshire
  • New Jersey
  • New Mexico
  • Oregon
  • South Carolina
  • Tennessee
  • Texas
  • Utah
  • Vermont
  • Virginia
  • Washington

Another major concern is the credibility of the PEO with which you contract. A 1996 report called "Professional Employer Organizations: Changing the Face of Business," produced by Raymond James & Associates Inc., an investment firm based in St. Petersburg, Fla., says early PEOs sometimes operated unscrupulously by failing to provide workers compensation and health care benefits for its enrolled employees.

"PEO subscribers do risk operating without workers compensation coverage, unpaid health care claims, and other potential liabilities (either legal or even nonpayment of payroll) if they are in a relationship with an unscrupulous, inept, or undercapitalized PEO," the report warns. "Consequently, a potential subscriber should conduct thorough due diligence of a PEO before engaging in any business arrangement."

NAPEO offers these guidelines when choosing a PEO:

  • Don't rely on the PEO's fancy proposals and brochures; meet the people who will be serving you.
  • Check the PEO's financial background through public filings or from annual reports and other information supplied by the company, and get banking and credit references. Ask the PEO to demonstrate that payroll taxes and insurance premiums have been paid.
  • Ask for client and professional references.
  • Find out if the management staff are "certified professional employer specialists," a designation bestowed by NAPEO.
  • Ask how the employee benefits are funded, whether they are fully insured or partially self-funded. Find out who the third-party administrator or carrier is and if it's licensed by the state in which it operates, if necessary.
  • Review the contract carefully to make sure the responsibilities and liabilities are clearly spelled out, what guarantees are provided, and what provisions there are for either side to cancel the contract.
  • If your state requires the PEO to be licensed, make sure it meets all requirements.

Get it in writing

Yager also advises hiring a lawyer to review a PEO contract before you sign. "If you don't understand it," he says, "don't sign it." He also suggests picking several different PEOs from your market area and having each present a proposal and contract for comparison.

It shouldn't be difficult finding PEOs in your area: hundreds are listed on Web sites of NAPEO and IAPEO, on their own Web sites, and in phone books. In addition, 20 states license PEOs, some of them requiring PEOs to maintain minimum net worth and some conducting background checks of the firm's principals.

The contracts should stipulate as many details as possible about the PEO-client relationship. Most, for instance, include opt-out clauses that allow either side to terminate a contract, usually with 30-days notice. Some specify how much you must have in liability insurance, stock option plans, management practices, and optional benefits. Yager's contract even addresses intellectual property: he is prohibited from using his PEO's trademarks, and it is prohibited from using his.

Accrediting agency puts PEOs through their paces

The Institute for the Accreditation of Professional Employer Organizations, based in Little Rock, Ark., began accrediting PEOs in 1996, based on stringent financial, ethical, and operational standards. Accredited PEOs, for example, must have a net worth of at least $50,000 or 5 percent of their total liabilities (whichever is greater).

Other features of IAPEO's accreditation process:

  • Annual background checks of the firm and the people who control it
  • Annual verification of financial statements
  • Quarterly confirmation of tax and benefit payments
  • Quarterly confirmation of minimum equity standards
  • Strict compliance with detailed operating procedures
  • Continuing professional education of management.

Due diligence is vital. If a PEO goes broke, your business is liable for back taxes, unemployment insurance, workers comp premiums, and so on.

Can your small business pass muster, too?

A professional employer organization will check out your record, too. It will review your financial and safety history, workers comp claims, risk-management plans, status of employment taxes, employee turnover, and even whether you tend to change benefits packages frequently.

That's because the PEO wants to make sure your company is a sound "investment," since, as a co-employer of your business, it will assume some of your legal liability.

If there is a work-site accident, for instance, your business will be responsible. But if you skip town, the PEO has a legal obligation to pay your employees for one pay period and meet the requirements of the federal Fair Labor Standards Act. Beyond that, though, the PEO has no obligation to keep the employees on and can lay them off.

Back to: Part 1, Small businesses offer big benefits through PEOs

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