Uncovering the Pitfalls of PEOs

Professional employer organizations provide significant value to small and midsize employers. They can also cause workers' comp headaches.

By Mark Noonan

Many claim that the leasing of security guards in the 19th century by the Pinkerton National Detective Agency was the original employee leasing operation, but the first professional employer organization (PEO) opened for business in California in 1972. Since then, the industry has grown to more than 700 PEOs that operate in all 50 states. As the use of PEOs becomes more common, we are also seeing new workers' compensation coverage issues arise.

PEO ADVANTAGES

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A professional employer organization is a service provider for companies that want to outsource their human resources, employee benefits, payroll and workers' compensation program. They are typically small to midsize companies that do not have or need a dedicated department to handle their human resources or workers' compensation administration.

Don't confuse a PEO (commonly referred to as employee leasing) with temporary help companies. They are quite different. While temporary help companies recruit employees and assign them to client businesses on an as-needed basis, the clients of PEOs turn over all their personnel functions for the PEO to administer and lease back the employees. The PEO assumes responsibility for all tax filings; payroll and benefits obligations; and workers' compensation coverage, claims reporting and injuries.

According to the federal Small Business Association, the number of regulations and labor laws grew by almost two-thirds between 1980 and 2000. The SBA estimates that owners of small to midsize businesses spend up to a quarter of their time on employment-related paperwork. By contracting with a PEO, these companies can transfer the burdensome responsibility of regulation compliance.

PEOs are able to provide employees with coverage under various employment laws and regulations that employees may not have had with their employer. According to the National Association of Professional Employer Organizations (NAPEO), the average PEO client has just 19 worksite employees. Due to such an employer's small size, many federal, state and local discrimination laws would not apply to the employee without the PEO relationship, such as:

-- Age Discrimination in Employment Act

-- Americans with Disabilities Act

-- Fair Labor Standards Act

-- Consolidated Omnibus Budget Reconciliation Act (COBRA)

-- Heath Insurance Portability and Accountability Act (HIPAA)

-- Employee Retirement Income Security Act (ERISA)

-- Unemployment compensation

Along with better coverage for their employees, companies contracting with a PEO also gain the advantage of lowering their costs. Because the PEO will have many clients, it can purchase a larger array of employee benefits at a lower cost than if the client employer obtained them individually.

This includes workers' compensation--especially if the PEO's experience modifier (or x-mod) is lower than the company's current x-mod rate.

WORKERS' COMP CONFLICTS

Arguments can flare up over which is responsible for providing workers' compensation coverage, the PEO or the individual client company. The cost of coverage and the type of coverage (guaranteed cost versus retained-risk programs) can trigger questions. If the PEO offers a retained risk workers' comp program, for instance, the financial viability of the PEO and its program need analysis. A guaranteed cost option may be more expensive than what the employer has now. Control of claims for aggressive management is an issue for discussion as well.

The answers depend on the statutory law where the employee works and the contract terms between the PEO and the company. Some states have laws specifying whether the PEO or the company is responsible for providing workers' compensation benefits. Other states permit either party to provide benefits and assume responsibility. In that case, responsibilities of each party should be clearly outlined in the leasing contract.

When arguments about workers' comp responsibility do arise, they are typically resolved in court based on state law and the leasing contract terms. When the issue is not defined by state law or outlined in a contract, "common law" typically applies. The "borrowing" employer may be responsible for providing workers' compensation benefits If the employer decides how the work is completed, if the employee is doing work mainly for the employer, and if there is an implied contract between the PEO and the employer. In some cases, a court may find both parties to be co-employers and jointly liable for providing benefits.

NEXT STEP FOR EMPLOYERS

Before entering into a relationship with a PEO, it is crucial for a company to review the workers' compensation insurance requirements of the jurisdictions where their soon-to-be leased employees are located. Then determine which party, by law, is the "official" employer.

Failure to obtain workers' compensation coverage by the official employer can result in fines and uninsured liabilities. The official employer will also be the party protected by the exclusive remedy provision.

In part two of this column, we'll discuss concerns when selecting a PEO and some additional issues surrounding the use of a PEO.

MARK NOONAN is a managing principal and the senior knowledge manager for workers' compensation for the Casualty Practice within Integro Insurance Brokers.

Read more at the WorkersComp Forum homepage.

January 6, 2011

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