What Is a PEO?
Economies of Scale
Other Advantages
Choosing a PEO

When his firm started doing accounting work for a Professional Employer Organization (PEO), Dan Klecka realized that a PEO could be a CEO’s best friend. So his certified public accounting firm, Klecka, Wilkins & Klecka of Phoenix, hired a PEO of its own to handle employment-related administrative chores.

“It allows us, as partners and senior staff, to devote our time to income-producing activities instead of administrative activities,” Klecka says. “We have the PEO there to take care of personnel headaches – the medical benefits and the payroll taxes and all those kinds of things – which frees us up to do more productive things.” Now his firm encourages many of its clients to turn over personnel administration to a PEO “mainly because of the payroll issues,” Klecka says.

“Payroll is an area that is labor-intensive. You need a person that stays up on all of the withholding rules and all of the deposit requirements and all of the reports that are due. We found that, for most of our clients, it’s less expensive, instead of hiring that extra person, to go with a PEO.”

What Is a PEO?

Professional employer organizations handle payroll and more, selling a full range of personnel administration services to small- and medium-size companies. Unlike vendors specializing in one type of personnel administration, such as issuing paychecks, PEOs sell services that include processing payroll, acquiring and administering group health insurance plans, running 401(k) investment plans and monitoring changes in workplace laws.

It’s a concept catching on fast as CPA firms and other types of businesses try to exert more control over the cost of employee benefits. Studies show that the national PEO market is expanding by more than 25 percent a year. When a company hires a PEO, it farms out the day-to-day administrative functions of personnel management to the organization and makes it a “co-employer.” The PEO contractually assumes certain employer responsibilities and employment-related liabilities, and establishes a fully accessible, off-site human resources department.

Economies of Scale

Economies of scale are a major incentive for employers to become PEO members. Participating employers are grouped into a single organization with greater negotiating leverage than any of them individually, allowing the PEO to obtain preferred rates for health insurance and other employee benefits.

Large corporations enjoy greater purchasing power than smaller companies. Small companies can be especially hard hit in the areas of employee health benefits and workers’ compensation insurance. By teaming with a PEO, small- and medium-sized companies are able to benefit from the PEO’s negotiating power and volume discounts.

After his CPA firm allied with a professional employer organization, “our health insurance cost went down somewhere between 15 percent and 20 percent, which made the whole plan cost almost nothing,” says Eli Mendlowitz, partner in the firm of Louis J. Septimus & Co. of New York.

Other Advantages

“Since then, we’ve recommended PEOs to several of our clients,” Mendlowitz says. Convenience alone is a major advantage. “Some of these companies are dealing with three or four companies – one company for the payroll, a second company for health insurance, and a third for workers’ compensation,” he says. “With a PEO, it’s all in one package, and much more cost-efficient.”

Liability mitigation is a major plus. Some PEOs sell insurance to cover employment-practices liability. Some also provide training to reduce the risk of lawsuits. The need is clear. The number of employment-discrimination suits filed by the Equal Employment Opportunity Commission jumped 140 percent from 1996 to 1999.

If anything, employer liability seems to be expanding. In the last decade, the federal government has enacted landmark, employment-related laws, including the Americans with Disabilities Act and the Family and Medical Leave Act. State and local employment laws can be a legal minefield for employers, too, especially for smaller employers trying to keep up with constant changes in workplace regulation.

“Often times, there’s a lot of clerical work that clients do not have the capability of doing,” says B. Terry Aidman, managing director of Aidman, Piser Company, a CPA firm in Tampa, Florida, that farms out its personnel administration to a PEO. “Clients may have employees in multiple states around the country, and have to know the rules and forms for every one of the states, and it becomes a nightmare.”

Employee turnover contributes to employer liability by creating a big pool of potential wrongful-termination cases. According to the U.S. Department of Labor, half of all new hires leave their jobs within the six months. Studies show that a company’s legal costs in a wrongful termination lawsuit can run up to $85,000 and that winning plaintiffs receive judgments averaging about $500,000.

The cost of compliance with workplace regulation is often a bigger burden for small companies than for large ones, largely because the associated overhead expense is spread over a smaller work force. Small companies spend up to 80 percent more per employee on federal regulatory compliance than big companies, according to a study by the U.S. Small Business Administration. Poor management of personnel-related tasks can make compliance even more costly. Companies end up paying extra, for example, when they report workplace injuries in weeks, rather than days, and fail to make timely payroll-tax payments.

“We have some clients that aren’t good about making payroll tax deposits, and using the PEO avoids penalties,” Aidman says. “We recommend it highly in many cases. Our theory is, the smaller the employer, the more we tend to suggest a PEO. When they get up over 100 employees, they probably can do the job inside. But the smaller employers with under 100 do not have all the skills inside.”

Choosing a PEO

Before choosing a PEO to work with, employers should conduct a background check to determine how long the PEO has been in business and whether it provides references. Another important consideration is the stability of the PEO’s financial history and whether its benefit plans are properly funded and backed by a reputable insurance company.

It’s also wise to determine if the PEO is licensed to operate in states where such licensing is required, and whether it’s accredited by the Employer Service Assurance Corporation, an independent body nationally recognized for establishing professional responsibility standards in the PEO industry.

The PEO trend may be in its infancy. By one estimate, PEOs have penetrated only 5 percent of the U.S. market for their services. By contracting with a PEO, small companies usually are able to offer improved employee benefits previously unavailable to them because of their size, making them more viable in the competition for the best-qualified workers.

Indeed, if the growth of the PEO industry continues at double-digit rates, its acronym may one of the most familiar in corporate America. With an estimated 95 percent of the PEO market still untapped, some financial analysts have forecast that the PEO industry will become the country’s largest employer over the next 20 years.

About the Author
Tom Shehan is general manager of the Midwest region of ADP TotalSource, a Professional Employer Organization.

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