Professional Employer Organizations can at times present some significant advantages for small to medium sized businesses in the areas of health insurance and workers’ compensation; however, I am increasingly seeing business owners who were sold on a package of services years ago that are not currently being delivered. A Professional Employer Organization (PEO) is a company that co-employs client company employees under the guise of offsetting employment related liability and the provision of large group advantages in the procurement of benefits and workers compensation. Oh, and they throw in the HR administration to boot. If you can save an employer hard dollars in today’s environment and throw in HR administration for free, co-employment may make good sense regardless of the quality of service involved. You know what they say, “If it sounds too good to be true, it probably is.”

My business partner and I came from the PEO industry, and I feel that there is a pretty good handle between us on what the true advantages and disadvantages of the industry are, but the bottom line today often comes down to three things—cost,cost, and cost. When the PEO industry got its legs 30 years ago, insurers were not yet privy to the true risks associated with engaging these companies. On the outside, a PEO looks a lot like a large corporation. A company that essentially co-employs the staff of 200 client companies averaging 20 employees or so each has the appearance of a corporation with 4,000 heads. In the insurance world, that is a home run. Ask any broker or benefits consultant if he would like to take a look at an employer that has 4,000 lives, and then stand back and watch him hyperventilate. A medium-sized PEO is a big fish by any measure, but the insurance industry has learned that this fish can come with the bite of a shark.

Here is the problem: A normal corporation that employees 4,000 people hires based on divisional or company needs. Some who are hired are young, some are older, some are healthy, and some not so much, but the gist of it is that a somewhat average demographic is turned over. A team of underwriters at an insurance company feels comfortable that providing one rate across the organization makes actuarial sense. Losses will generally be spread thin enough that profits are made, and employees are afforded sustainable coverage. Let’s face it, a recruiter for a large corporation does not hire based on health rates, but a PEO often does.

A PEO is not an average corporation. In our example, a PEO is a company with 4,000 employees on various client worksites and an internal service staff of roughly 35. Out of those 35 internal employees, 3-4 are salespeople whose job it is to close new business. Closing new business means adding heads to the PEO pool. And how does the average or sub-average PEO salesperson close business? Cheap health insurance or savings in workers’ compensation is the most common answer. At the beginning of the year, an insurer gives a PEO a renewal rate based on experience, and maybe the PEO buys that rate down a bit further through partial self-insurance. The salespeople subsequently go to the phones, networking events, church or out into their chosen trade organizations like sharks searching for wounded business owners, oftentimes those who are barely able to continue to sustain benefits or workers compensation. What would you say if I could save you 15% on your health and comp premiums? Would you let me hire your employees? Let me offload some of that employment related liability. These are all common phrases used to get in the door, but what is happening to the past employers who have been brought into the web?

If the PEO program is sold based on insurance premiums, the attractive employers in the pool will be subject to disproportionate increases, but they get so wound up in the co-employment model, that it is a nightmare to escape. As less attractive groups are brought into the company year after year and rates continue to be chased higher, good groups pour out the back door, and the model that was sold on price is no longer delivered; however, it is often all or nothing with a PEO. Once you are in, it is hard to leave, and the industry knows it. With all due respect, the insurance industry and the actuaries who keep these companies in the black are sharp folks. If they even still agree to write PEO business, there is a multiple tier platform for groups within the group so groups are essentially rated independently anyway. So out goes more of the advantage.

I met with a PEO client last week, and we went down the list of PEO services that are being provided contractually by this employer’s vendor. In going down the list we found that there were very few items being taken advantage of by this company. They were getting some support, but over the years had moved back onto their own insurance programs due to the above phenomenon. PEO rates had become unattractive, but this employer was wound up in the payroll and support functions being provided by their particular vendor. They are overpaying tens of thousands of dollars a year for payroll service and a few supporting functions, but they have never seriously considered unwinding the web. It is not an overnight transition, but it can be done.

If you are interested in unwinding your PEO relationship in favor of a more customized, affordable and comfortable platform, find a company with experience in the industry to help you escape the web.