By Meg Eynon, Vice President, The Payroll Factory®
Published: 30 AUG 06

You keep hearing the phrase PEO, but what does it mean and it is a viable option for your company to use?

PEO stands for a professional employer organization. This is a company that puts your workers on their books and leases those employees back to you.

Why would you do this?

The theory behind using a PEO is that it would eliminate the hassles employers face for workers compensation plans, withholding payroll taxes and having to cut paychecks for their employees.

There are benefits to using a PEO.

These include the fact that if you are in an industry with a high employer rate for worker’s compensation you may get a better rate with a PEO as they have the ability to offer high deductibles and multiple workers’ compensation categories to choose from. Most PEOs also handle worker’s claims efficiently and put a lot of effort into verifying those claims so that fraudulent claims are not paid out.

Another benefit to using a PEO is that they do extensive background checks. Most of the time consuming issues that employers face when hiring an employee are handled through the PEO, eliminating the time, expense and aggravation of the hiring process.

PEOs also offer all of your employee benefits and can do so from health and dental insurance to retirement plans and employee deferrals.

Once you have started using a PEO you would no longer need to process payroll, produce tax payments and file payroll tax returns. The PEO would take care of this on your company’s behalf.

Sounds great so far, so why isn’t everyone converting their employees through a PEO?

There are distinct disadvantages to using a PEO. In some cases a PEO can drop your worker’s compensation category due to the risk involved in your industry. This leaves you in the same position you started in prior to using a PEO, unobtainable or highly priced worker’s compensation policies. Most companies choose to use a PEO due to the high risk nature of their business only to find out that their PEO is not required to renew their worker’s compensation policies on an annual basis.

The other fall back to using a PEO is that your company does not have its own history of worker’s compensation claims.

Why is this an issue?

Worker’s compensation rates are complied in part by your company’s claim record. The modified rates are based on a three year claim history. Maintain a safe working environment, educate your employees on safety issues, keep claims to a minimum and you can expect to pay less. If you use a PEO and then decide to go back to your original employee structure you will be forced to apply for worker’s compensation on your own. Since your company has no current history of worker’s compensation claims you can expect to pay the base rate and not have access to a modified rate for three years.

Another reason some company’s do not use a PEO is because they lose control of their hiring practices. You may find a job candidate that you would like to hire, only to have that person turned down by the PEO. If the PEO is not comfortable with the candidate’s background they can refuse to hire that individual. This is a two sided issue. On the one hand you may have to pass up the perfect candidate, on the other you may have missed something in your screening processes that your PEO has caught on your behalf. Either way, the days of using your best judgment are over. You must now rely on the judgment of a third party to figure out who would be the best employee for your company.

The final thing to consider is whether or not the PEO you choose is in a strong financial position. Get back ground on their other clients. Find out their cash flow. Ask about how your money is handled? Is it reconciled back to you? You need to be 100% sure that the employees you leased from the PEO are getting paid and paid timely.

A PEO is not the perfect solution for every company. If your company is considered a high risk category for worker’s compensation insurance and you are having a hard time finding insurance coverage at a reasonable cost a PEO might be the right answer for you.