Uncovering the Pitfalls of PEOs: Part II

One of the more questionable benefits of using a PEO is mod-washing. How can employers watch for this workers' comp pratice and the other PEO pitfalls?

By Mark Noonan

According to the National Association for Professional Employer Organizations, the industry's gross revenue for 2008 was $68 billion. For a relatively young industry, the revenue proves it is an industry on the move, but one issue, mod-washing, may be its next hurdle to conquer.

As we discussed in the first part of this column last month, professional employer organizations (PEO) are service providers for companies that want to outsource their human resources, employee benefits, payroll and workers' compensation programs.

Washington: DLI looks to establish medical provider network (09/10/12)
New York: Temporary insurance rule in effect (11/07/11)
Washington: Safety and health grants program rules allow for funding (03/05/12)
Oregon: Division sets claims processing administrative cost factor (01/30/12)
Virginia: Commission seeks comments before hearing (09/27/11)

PEO workers' comp policies are generally written as a multiple coordinated policy (MCP), where each client of the PEO has its own policy covering the leased workers, or through one master policy issued in the name of the PEO that provides coverage for all of the PEO's leased and non-leased workers.

Like other workers' compensation policies, those covering leased workers are also subject to experience rating. Varying by state, some workers' comp laws require the use of the experience modifier, or x-mod, of the company purchasing the coverage. Other states allow the client to assume the x-mod of the PEO. Many rules apply when the client's modifier is larger than the PEO's. Some states require that the client's x-mod be applied for a specified time period before the PEO modifier can be used.

The PEO industry has come under scrutiny by regulators for a practice called mod-washing, when unsafe employers with high experience modifiers are able to hide behind their PEO's experience. When employers leave a private carrier and go to a PEO, some do not have to be placed with the x-mod they have created in the past.

Over the years, the National Council of Insurance Legislators (NCOIL) has rejected motions by PEOs to let employers without experience ratings use their PEO's x-mod. NCOIL has also been working to set national standards to put an end to mod-washing.

The National Association of Insurance Commissioners (NAIC) has also gotten involved with its PEO Model Law Working Group, which was established to update existing regulations to address concerns regarding the coverage and ratings of employers within PEOs. Whether or not the these guidelines affect federal and state laws remains to be seen, but they are expected to be the starting point for state insurance departments when considering regulations and rules for PEOs. NAIC reports that the number of states with any kind of statutory regulations on the PEO industry has increased from 4 in 1991 to 32 in 2007.

WHAT EMPLOYERS CAN DO

A company that leases employees must comply with the laws of each state it operates within. Realizing the ambiguities created by PEO arrangements, many states have enacted statues that specifically address these issues. Other states rely on case law to resolve the issue of who is the "official" employer for the purpose of workers' compensation.

To take full advantage of a PEO arrangement, and to avoid all possible risks, the company must understand the legal obligations and risks involved. PEOs manage critical human resource responsibilities and employer risks, but the fact that a company hires a PEO does not release them from liability. Structuring the PEO relationship in a way that addresses those obligations will help minimize legal risks.

First, as simple as it sounds, hire an experienced, reputable and legally insured PEO. Check the PEO's client and professional references. Remember, a court may determine that the company and the PEO are joint employers. In that case, the company is also jointly responsible for the PEO's mistakes and noncompliance.

Make sure the PEO is paying payroll taxes. Check whether the PEO's financial statements are audited by a CPA and ask to see a copy. The company has a responsibility to ensure their workers are covered by a valid workers' compensation policy, so make sure the PEO meets all state requirements and that proper licenses and registrations are in place.

Find out what services the PEO will offer. Determine and define who is responsible for such things as tracking hours worked, paying wages, and withholding and remitting applicable employment related taxes. If possible, meet the people who will provide the services. Do they have professional training? Are they located within driving distance to the company's office?

Next, carefully review the service agreement. The term "employee" should be clearly defined. The responsibilities of each party should also be described and guarantees should be delineated. What provisions allow the contact to be cancelled? Written agreements between the company and the PEO should state each party's responsibilities, including all aspects of the workers' employment and compliance with all federal and state laws.

A PEO will also be doing due diligence on the company. In particular, it will look at a company's workplace safety record. If the PEO is signing on companies with high workers' compensation claims, the PEO's financial strength may be jeopardized in the future.

(Editor's note: Read Part 1 of "Uncovering the Pitfalls of PEOs" here.)

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.

February 3, 2011

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