Professional employer organization

A professional employer organization (PEO) provides outsourcing of payroll, workers' compensation, human resources and employee benefits administration. It does this by hiring a client company’s employees, thus becoming their employer of record. It then leases them back under contract to the original employer. This practice is known as co-employment, employee leasing, or staff leasing.

As of 2007, there were more than 700 PEOs operating in the United States, covering 2-3 million workers.^[1] PEOs operate in all fifty U.S. states, Sweden, ^[2] Germany,^[3] the UK,^[4] and Russia.^[5]

Business model

In a co-employment contract, the PEO becomes the employer of record for tax and insurance purposes, filing paperwork under its own identification numbers. The client company continues to direct the employees’ day-to-day activities. PEOs charge a service fee for taking over the human resources and payroll functions of the client company: typically, this is from 3 to 15% of total payroll.^[6] This fee is in addition to the normal employee overhead costs, such as the employer's share of Medicare and unemployment insurance withholding. In addition, PEOs benefit from aggregation of employee headcount: by combining the employees from multiple clients, they qualify for lower premiums on health insurance plans.

A PEO generally generates some of its income through various methods of insurance, wage and tax arbitrage. In insurance products, a PEO will purchase workers' compensation, employment practices liability and employee benefits insurance at a given price. The PEO then adds a markup to the premium costs and bills that rate to the client company, which is still less than the company would pay on its own. A PEO is often able to negotiate volume discount deals with payroll service providers, allowing client companies to reduce payroll processing costs.

The value proposition to client companies is that the use of a PEO saves time and staff that would be used to prepare payroll and administer benefits plans, and may reduce legal liabilities or obligations to employees that it would otherwise have. The client company may also be able to offer a better overall package of benefits, and thus attract more skilled employees. The PEO model is therefore attractive to small and mid-sized businesses and associations, and PEO marketing is typically directed toward this segment.^[6]

In the United States, many small to medium size professional services firms utilize PEOs to allow them to provide the kinds of benefit plans which otherwise could only be made available at a prohibitively high cost to both the employer and the employee.

Several variations on the PEO model exist, differing in the nature of the relationship formed between PEO and client company.

• Administrative services organizations (ASO) are PEOs that provide outsourcing of human resources tasks but do not create a co-employment relationship. Employees remain solely under the control of the client company. Tax and insurance filings are done by the PEO, but under the client company’s Employer Identification Number.^[7]
• Umbrella companies, found primarily in the UK, act as employer of record for independent contractors instead of permanent employees. The contractors become employees of the umbrella company, but do not also become employees of the client. The growth in umbrella companies in the UK is attributed to legislation targeting "disguised income" by contractors performing the same duties as employees but hired via intermediaries.^[8] The press release announcing the legislation, IR35, is often used to refer to the legislation itself.
• Pass-through agencies are staffing firms that act as the employer of record for independent contractors, but do not obtain work for them. Like umbrella companies in the UK, the contractors do not become employees of the client.^[9]
• Financial intermediaries, also called fiscal intermediaries, act as an employer of record for home healthcare workers who serve disabled persons. This streamlines the process of hiring such workers, because neither the household hiring them nor government units that provide funding need to take on the duties of an employer.^[10] They are part of the self-determination movement in disability care.

Early History

Employee leasing in the United States began as early as the 1940's. In the early 1970's, the concept was popularized by a consultant named Martin Selter, who leased the employees of a doctor's office in Southern California.^[11] The Employee Retirement Income Security Act of 1974 (ERISA) contained an exemption for multiple employer welfare arrangements (MEWA), which provided a loophole for employers with leased employees to claim they were exempt from the ERISA requirements. Passage of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) further encouraged employee leasing by providing a tax shelter for employers who contributed a minimum amount to employee plans. More stringent guidelines in the Tax Reform Act of 1986 later eliminated most of the TEFRA incentive, however.

By 1985, there were approximately 275 staff leasing companies in the United States.^[12]

Abuses

PEOs have been associated with various types of fraud and evasion of laws designed to protect workers. In 1991 the Texas State Board of Insurance estimated that only 40 of the over 200 staff leasing firms operating in the state were legitimate.^[12]

• Fraudulent staff leasing firms are set up by con artists who charge client companies for employee taxes and insurance payments, but divert the money instead of remitting it to the taxing authorities.

• Labor Law evasion is a frequent goal of client companies who seek PEO services. An employer who leases employees, particularly when facing unionization, may be able to avoid many liabilities and legal obligations an employer may otherwise face.

• Workers compensation fraud occurs when high-risk companies with many prior claims transfer staff to new PEOs with no claims history. When rising claims raise rates for the PEO as well, the PEO shuts down and the cycle repeats.(ref)

• PEOs have also been used to evade minimum participation rules for pension and health care plans, which state that a minimum percent of employees must participate for the plan to be offered. Employers that do not want to offer such plans to its lower-paid employees outsource those employees to a PEO so they are not counted. This leaves the remaining highly-paid employees with a qualifying level of participation.

• SUTA arbitrage, commonly referred to as "SUTA dumping," occurs when an employer with a high unemployment insurance rate transfers or "dumps" employees to purchased subsidiaries with lower unemployment insurance rates.

At least 15 PEO companies were the subject of criminal prosecution during 2006, despite regulation attempts.^[13]

Regulation

Each state in the U.S. has differing regulations for workers’ compensation insurance and state unemployment insurance, so PEOs are typically regulated at the state level.^[14]

In 2004, President George W. Bush signed into law the SUTA Dumping Protection Act of 2004, which requires that all 50 states enact anti-SUTA-dumping legislation by 2007.^[15] Most states have now done so;^[16] however, federal law does not prohibit companies from using a PEO to obtain more favorable SUTA rates.^[17]

The staff leasing industry itself has also taken steps to address abuses. It formed its first trade association, the National Staff Leasing Association (NSLA), in 1985. The association changed its name to the National Association of Professional Employer Organizations (NAPEO) in 1994 to reflect the term in current usage.

An independent accreditation body, Employer Services Assurance Corporation, was formed in 1995. Its purpose is to assure clients of PEO solvency via surety bonds, and to certify PEO compliance with "ethical, financial, and operational standards". ^[18] Currently there are 43 ESAC-accredited PEOs.

References