What is a PEO - Human Resources Hero

What is a PEO

If you’re an HR Manager or small business owner, then you may have heard the term PEO when discussing human resources or insurance for your business. So what is a PEO exactly, how does it work, and is it worth the investment?

How PEO’s Work

PEO is an acronym for Professional Employer Organization which means something very specific in the HR world. It’s a unique model of delivering HR, payroll, insurance, and benefits products and services to your business that relies on something called co-employment.

Co-employment is what makes a PEO tick and it can have some very big pro’s when it comes to everything related to human capital management in your business. If you are
considering a PEO, you need to understand exactly what co-employment is and is not before making a decision on which PEO provider to use or whether a PEO is even a good fit for your company in the first place.

Co-employment essentially means that all of your employees also become employees of the company that runs the PEO. Co-employment is different from staffing or employee leasing (although some staffing or leasing companies call themselves PEO’s) in the sense that your employees are still your employees. They are just also employees of the PEO, hence the term co-employment.

Co-employment has some pretty big implications when it comes to things like:

  • Taxes
  • Business insurances
  • Employee benefits
  • Liability
  • Payroll
  • Workers compensation
  • And more…

Because entering into a PEO service agreement impacts all of these things, you need to be comfortable with the company you are choosing for your PEO service and you need to be confident that the benefits of a co-employment arrangement far outweigh any unwanted side effects.

Not All PEO’s Are Created Equal

Professional Employer Organizations are made possible by IRS code section 3511 which allows a PEO to withhold and remit federal income and unemployment taxes for worksite employees who are shared with another company, however there is really no federal oversight or regulation of the PEO industry as a whole. Different states have different PEO registration and licensing requirements but in some cases, virtually anyone can start a PEO and there is no standardized way that PEO’s report on how they bill clients or how they pay taxes on behalf of their clients. This lack of oversight has led to the potential for fraud and abuse in the industry.

Because of the overall lack of regulation, it’s important that you choose a reputable provider that can produce audited financial statements and is licensed to operate in your state (if state licensing exists).

PEO’s can join The National Association of Professional Employer Organizations (NAPEO) which vets its members, or they can go through the rigorous (and new) IRS PEO certification process. Very few companies have gone through this process to date however, so a lack of IRS certification should not disqualify a PEO from being considered as a service provider by any means. Regardless of a company’s membership or certification, do your due diligence on every prospective service provider including asking for financial statements and references.

Featured Resource:

2020 HR Services Pricing Guide

This guide is full of straightforward independent information to help you get the right service and price for your company.

Using a PEO for Benefits and Insurance

The benefits of working with a high quality PEO can be significant. PEO’s can often use their significant buying power to negotiate with health insurance and other employee benefits companies and pass the savings on to you. This leverage can allow your company to offer far better employee benefits at a far lower cost to your employees. It’s not uncommon for a company with less than 100 employees to save 10%-15% on their health insurance premiums by moving to a PEO. Along with significant savings on vision, dental, life and other insurances, the cost reduction on employee benefits can add up to tens of thousands of dollars or more a year.

In addition, many PEO’s can offer reduced workers compensation rates by leveraging the same principals and spreading risk out among tens of thousands of worksite employees. You may also get lower rates on things like state unemployment insurance. However, the ability of a PEO to offer unemployment and workers compensation insurance varies by state so make sure that you discuss this with your prospective service provider, especially if you operate In multiple states.

The downside to this cost savings arrangement is that PEO service providers have a vested interest in keeping their insurance groups “clean”. After all, the healthier or safer all of the employees are in their large combined employee group, the lower the rates they can negotiate. Many times I have seen PEO service providers increase costs or flat out deny service to companies with unhealthy employees recent accidents because they did not want to risk a rate increase with their insurance providers. Most legitimate PEO’s have an underwriting department that will determine if your company is a good fit for the PEO, and PEO’s vary in their risk tolerance. Just because one PEO thinks your not a good fit doesn’t mean that another can’t work with you and give you substantial savings.

A High Level of HR Support

Because the PEO has a vested interest in keeping your employees healthy and safe and keeping your employee turnover rate low, Many PEO’s will also provide you with excellent and proactive HR and safety support as part of their service. Typically, reputable Professional Employer Organizations will offer you a comprehensive human capital management solution including payroll service, HR software for onboarding employees and storing documents, proactive HR and safety services to help you comply with OSHA regulations, write your Injury and Illness Prevention Program (IIPP) , craft policies and your employee handbook, train employees and managers, and provide support to handle day to day HR issues that come up. You can better understand the potential HR issues in your business by using our free HR Problem Finder.

The best way for your company to leverage a PEO is to take advantage of the full array of services a PEO can offer. PEO’s are usually the best fit for companies that are looking for a comprehensive HR infrastructure they can tap into. They want support with Payroll, human resources, technology, and employee benefits all in one place. The best PEO’s offer robust support in each of these areas, allowing your business to focus on driving growth while spending far less time on things that fall under the human resources umbrella.

How A PEO Charges You Matters

PEO’s are often the top tier HR service available and are priced accordingly. Typically Professional Employer Organizations bill their clients in one of two ways:

  • A flat rate per employee per month
  • A percentage of your gross payroll

Some service providers are far more transparent in their billing than others. Many will itemize the cost of the service and break out costs like insurance premiums and taxes and some will not – bundling all related costs into one percentage of payroll or flat rate. Some service providers will apply for and receive tax credits that your company is eligible for and pass those credits on to your company and some PEO’s will keep the credits and never tell you that they were applied for in the first place.

Because there is no standardized way that PEO companies bill their clients, it can be difficult to pinpoint the actual cost of the service or to know if you’re getting a fair price. It’s a good idea to ask to see a sample invoice from any prospective service provider and to ask that each cost be broken down for you. You want to know what your insurance premiums will be, apart from your tax liability apart from the actual cost of service. You also want to ask who keeps tax credits that your company is eligible to receive. Requiring this breakdown can potentially save your business thousands of dollars and help you understand if the service provider you’re talking to is someone you really want to have a close relationship with. Any company that can’t clearly articulate the cost of their service is not a company you want to enter into a co-employment relationship with. For more information on PEO pricing, download our free HR Services Pricing Guide.

What Does a PEO Provider Do for You?

Now that you’ve read what a PEO is, perhaps you’re wondering what a PEO company could do for you. One thing it could do is allow you to focus on running the business you know and love while keeping an eye on future growth opportunities. These probably describe some of the reasons you started your business to begin with.

As a small-business owner, you naturally feel pride in building your own company and knowing what’s best for it. According to a December 2020 article in the National Bureau of Economic Research’s The Reporter, only “ten percent of the workforce, or 12 million people, own a business rather than holding a wage or salaried job. These owners hold a disproportionate amount of total wealth and create jobs for others.” Although many Americans dream of owning their own businesses, not very many achieve this dream.

When thinking about your business’s HR needs, however, consider carefully whether your entrepreneurial impulse to go things on your own might be interfering this time. HR management requires a complex, ever evolving, and specialized knowledge base. The learning curve for a non-HR specialist is steep, and the stakes are high given the potential tax and regulatory implications involved.

The benefits of a PEO relationship include receiving comprehensive HR services like these:

  • Payroll
  • Employee health insurance/benefits
  • Employee retirement programs
  • Legal compliance
  • Unemployment matters
  • Workers’ compensation cases
  • Recruitment
  • New hire services
  • Training policies and manuals
  • Document storage
  • Software and technology solutions
  • Support

The HR services your business needs—and doesn’t need—are important to keep in mind when researching and choosing a PEO company. For a thoroughly researched white paper discussing the benefits of working with a PEO, see this page on the NAPEO website.

Who Uses a PEO Provider?

PEO clients are often smaller businesses that want the expertise a PEO offers. They might not have an internal HR department, or they might assign HR responsibilities to staff members whose learn-as-they-go approach is no longer adequate. They might do business in a heavily regulated industry and find themselves overwhelmed by all the legal requirements, or they might suffer from the inefficiencies that high employee turnover is causing.

Business owners looking to cut costs also become PEO clients to help their companies save money. In addition, they learn that their employees are likely to save money as well, because the co-employment model helps employees pay less for benefits such as health insurance.

Medium-sized businesses too find that working with a PEO can benefit their companies and employees, often in the same ways just described for smaller companies. But even businesses that have internal HR departments can improve their use of web-based HR technologies and software solutions, for example, by working with a PEO.

PEO clients range from accounting and legal firms, to construction companies, to high-tech businesses and startups. PEO clients come from many different industries, but they are likely to share one thing: an open-minded approach to meeting challenges. And managing human resources certainly qualifies as a challenge for most small- to medium-sized businesses. 

Summing It All Up

Overall, professional employer organization services can represent a tremendous value for your company, especially if you want to provide your employees with a great benefits package and excellent human capital management resources. However, because PEO offerings vary tremendously, you need to do your due diligence on any prospective service provider and fully understand their pricing model to make sure that you are getting the best value for your company.

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