To PEO or Not to PEO, That is the Question…

To many small businesses, the term “PEO” has become synonymous with health insurance, payroll administration and HR. There is good reason for this as Professional Employer Organizations do a very good job of providing all of these services and sometimes more, with the convenience of one stop shopping. The question for business owners is whether this ease of access represents a good deal in terms of cost and in terms of maximizing buying power as a business grows. I am regularly asked if PEOs make sense and they do, in two specific circumstances.

First, starting a small business and getting over the hump from survival to prosperity is not for the faint of heart. It takes hard work, guile, good management and a little luck. In the early stages of a business when there are but a handful of employees, the convenience of PEOs enables a small business owner to outsource payroll and HR, and provide generous benefits in one fell swoop. By eliminating the distraction of setting up all of these pieces separately and then staffing for them a business owner is free to concentrate on customers and survival. There may be cost savings from needing fewer employees as well.

The second situation in which I recommend a PEO is when a small business has poor claims history and has difficulty finding competitively priced health insurance. PEOs often operate large, self-insured plans and are able to absorb the expense of catastrophic claims better than a small employer would on their own.

When is a PEO not a good deal? As we learned in school, “there is no such thing as a free lunch”. Convenience comes with a price as the cost of bundled PEO services often greatly exceeds what a business could purchase independently. Insurance purchased independently is easier to customize and as there are more employees to cover, bargaining power increases as well. Payroll services are also much less expensive when purchased separately and HR support is available through numerous sources.

Another problem with PEOs relates to one of the things I mentioned they actually do well. While PEOs are able to spread catastrophic health insurance claims over a larger population, over time they tend to attract many employers facing the challenge of getting affordable coverage. In insurance this is known as “adverse selection”, the tendency to attract higher risk. Inevitably PEOs need to increase their health insurance rates and when combined with higher costs for other services, things can head south quickly.

The last thing to consider is that PEOs create golden handcuffs. In other words, an individual business is generally unable to get financial data such as premiums versus claims pertaining to their own plan. This makes health insurers and workers compensation insurers very leery.

In summary, if your company is very small or if you have several employees with large, ongoing health insurance claims, PEOs offer good value. As a business grows to ten or more employees, the risks and price points generally begin to outweigh the advantages.


1 Response to “To PEO or Not to PEO, That is the Question…”

  1. August 10, 2010 at 7:58 pm

    Good article!! SuperiorHR looks forward to being a resource!

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