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A professional employer organization (PEO) is a firm that provides a service under which an employer can outsource employee management tasks, such as employee benefits, payroll and workers' compensation, recruiting, risk/safety management, and training and development. The PEO does this by hiring a client company's employees, thus becoming their employer of record for tax purposes and insurance purposes. This practice is known as joint employment or co-employment.
As of 2010, there were more than 700 PEOs operating in the United States, covering 2-3 million workers. PEOs operate in all fifty U.S. states. Similar services are described in Sweden and Germany.
In co-employment, the PEO becomes the employer of record for tax purposes, filing paperwork under its own tax 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 gross payroll. This fee is in addition to the normal employee overhead costs, such as the employer's share of FICA, Medicare, and unemployment insurance withholding.
One key service usually provided by a PEO is to secure workers' compensation insurance coverage at a lower cost than client companies can obtain on an individual basis. Essentially, a PEO obtains workers' compensation coverage for its clients by negotiating insurance coverage that covers not just the PEO, but also the client companies. This is allowed because legally the PEO is the co-employer of the workers at the client companies. There have been instances of PEOs using improper means to lower their workers' compensation insurance costs and some principals of PEOs have been found criminally liable for fraud. PEOs can also offer basic levels of background & drug screening.
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.
Several variations on the PEO model exist, differing in the nature of the relationship formed between PEO and client company.
PEOs can benefit companies differently. For example, a blue collar organization may see more value in workers' compensation insurance and vice versa. A variation of a PEO model without co-employment is an administrative services organization.
Employee leasing in the United States began in the late 1960s by three businessmen, Eugene Boffa, Louis Calmare, and Joseph Martinez. The concept was popularized by Marvin R. Selter, who leased the employees of a doctor's office in Southern California. 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.
A new business has also developed recently, in which a marketing or brokering company serves to connect businesses with professional employer organizations. Many of these sites receive a commission if they arrange a contract between a PEO and a new business client. These sites earn their money by "brokering" for various PEOs and receiving compensation for contracting PEO relationship.
State Unemployment Tax (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. However in any PEO relationship the client company would take the Professional Employer Organization's SUTA rate by law, in effect many times lowering their SUTA through SUTA Arbitrage, however the only time this wouldn't apply is in client reporting states.
Owners of professional employer organizations are in a position to commit fraud by keeping the funds deducted from employee paychecks instead of paying the insurance and government entities for whom the deductions were made. In a case in San Antonio, Texas  four executives were convicted of siphoning $133 million from the three PEOs they owned and operated.
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.
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. Most states have now done so; however, federal law does not prohibit companies from using a PEO to obtain more favorable SUTA rates.
The staff leasing industry itself has also taken steps to address abuses. It formed its first trade association, the National Staff Leasing Association, in 1985. The association changed its name to the National Association of Professional Employer Organizations in 1994 to reflect the term in current usage.
As part of the industry's efforts to self regulate, an independent accreditation body, Employer Services Assurance Corporation (ESAC), was formed in 1995. ESAC's purpose is to verify PEO compliance with important ethical, financial, and operational standards and to provide financial assurance backing the performance of its accredited PEOs.
PEOs may also undergo a certification process conducted by the independent Certification Institute (CI) formed in 2002. This certification verifies that a PEO's workers' compensation (WC) program is meeting proven insurance industry risk management best practices to reduce work-related accidents and health exposures and control WC insurance losses.
In 1985 there were approximately 275 staff leasing companies in operation. In 2012, according to NAPEO, there are now approximately 700 PEO's operating in all 50 states. They were responsible for approximately $81 billion in gross revenue in 2010.
A recent change in 2013 regarding the way companies Experience Modifier is calculated has caused companies with previously good modifiers to get better, while companies whose modifiers had struggled previously have gotten worse. The Experience Rating Plan, as NCCI refers to it, will be undergoing a change that NCCI believes will more accurately reflect individual employers’ claims experience. NCCI, the National Council on Compensation Insurance, sees this as a "Mod Neutral" action since the median average does not change. While some companies get better, some get worse. Overall, however, the "center" stays in essentially the same spot. While this will assist the good companies to improve their position, this will cause the companies in dire straights to get worse. Many of these companies may be forced out of the "standard" market and into secondary markets such as PEO's and other "options of last resort" such as state pools. This may lead to a further increase in the number of PEO's, or it may lead to an increase in state pools, or possibly both.
NCCI views this action as having two primary benefits. The first is that it "tailors the cost prediction and final net premium cost to the individual insured" making the calculation more accurate. The second benefit is that "it provides added incentives for loss reduction."