To PEO or Not | Professional Employer Organizations

March 27, 2023

5 minute read: A Professional Employer Organization (PEO) is a co-employer relationship with your employees. Offering payroll services, and related tax filing. Employee benefits,  Work Comp., Compliance services, and benefits coaching, and more. 2% of the industry is a certified PEO. 

Business leaders faced historic challenges in the pandemic, but now they’re gaining in confidence and growth, according to the latest Principal Business Owner Insights December ’22 Survey of 1,018 small and midsize businesses (those with fewer than 500 employees).

A record 36% of these businesses classify themselves as “growing.” The year-end 2022 survey shows that employee turnover has hit record levels, with more than one-fourth of businesses reporting increased turnover—up from 20% in 2021 or as little as 11% in 2015. As a solution, more than 70% of owners now see employee benefits as critical to help improve retention. When asked business owners ranked their top 5 priorities this way: 1) Business Protection. 2) Health & Wellness Solutions. 3) Business Succession Planning. 4) Income Protection. 5) Non-Medical Benefits.

The reliance is with most employees regardless of employer size, never the less reasons for the drop off are varied. Some of the most challenging examples include a combination of a lack of resources (whether financial or personnel-related) and a tendency to overestimate the cost to provide employee benefits.

A PEO is a company that provides a co-employer service under which an employer can outsource employee management and administrative tasks such as employee benefits, payroll and workers’ compensation, recruiting, risk and safety management and training and development. Employers with less than 500 employees are becoming more aware of this. Employers are attracted to the idea of hiring a client company’s employees, becoming their employer of record for tax purposes and insurance purposes, known as co-employment or shared employment.

“Why haven’t I heard about this?” There’s a large education gap that must be filled within the business community in order for this employer segment in the U.S. to become greater enablers of  this financial inclusion.

Better professional training and support is a key solution to the problem. Presently in small to medium enterprises (less than 500 employees), often management teams are acting as employers for the first time, due to existing HR personnel. Coupled with higher than ever demand for 24-7-365 employee services.

What is a certified PEO? Pursuant to section 7705(a) of the Internal Revenue Code, the term “certified professional employer organization” (CPEO) means a person that applies to be certified as a CPEO and that the Internal Revenue Service (IRS) has certified as meeting the applicable requirements. The Tax Increase Prevention Act of 2014, enacted December 19, 2014, requires the IRS to establish a voluntary certification program for PEOs which is the CPEO Program. Some liken this to the banking industry’s FDIC stamp.

So, the PEO’s first focus is payroll and then usually health insurance. As they consider additional benefits, they often significantly overestimate the cost per employee and may shy away from providing more benefits as a result. Perceptions around cost, coupled with the daunting task of narrowing which benefits to offer and a provider to work with, can deter many of these businesses from pursuing more comprehensive support.

Then we have to add this in, focus on key employees is on the rise. The number of businesses with four or more key employees has grown to 40%, compared to 35% in past years. More than half of business owners (55%) would like to reward these key employees with additional benefits. (That rises to 66% among owners of businesses with 50 or more employees).

The facts: In the U.S., there are between 708 and 980 PEO’s currently operating and providing services. PEO’s are providing services to roughly 180,000 small and midsize businesses. According to the National Association of PEOs (NAPEO), the estimated overall PEO industry penetration rate is 11% across all businesses with 10-99 employees. The number of employers using PEOs has grown about 40% since 2008, when only about 7.85% of employers with 10-99 workers used a PEO.

The number of employers joining PEOs may be poised to grow even more in the coming years. Through an increase in remote work and businesses being more open to hiring remote employees, the pandemic increased many firms’ geographic footprint. The more states employers have workers in, the likelier they are to use a PEO. Twenty-five percent of employers with workers in 10 or more states use a PEO compared to 11% of employers with workers in five to nine states.

The industry pulse shows an estimated PEO penetration rate is highest (16%) among firms with 20-49 employees.

Employers that are members of PEOs are predominately in manufacturing, construction, and professional, scientific, and technical service industries. Across industries, the main reason businesses that use a PEO cited for doing so is to access more employer-sponsored benefits to offer their employees.

Overall, employers using a PEO are more successful across several measures than employers that don’t. While there are several factors contributing to this, nearly a third of business owners using a PEO cite the fact that PEOs help remove distractions relating to HR administration, enabling them to focus on business and revenue generation.

Employers that use PEOs are far likelier (70%) than those that don’t (61%) to prioritize doing a better job of helping workers make better benefits decisions. One way they do this is by providing a more digital enrollment process.

They also prioritize finding HR and benefits administration technology that includes the ability to integrate with decision support tools to help employees make better enrollment decisions. Nearly three-quarters of businesses that use a PEO (72%) say it’s very important to integrate with decision support tools compared to only 57% of businesses that don’t use a PEO.

Is working with a cPEO right for your business?

Depending on your business’ unique needs, working with a PEO may be a helpful strategy. Here are some takeaways based on the business and attitudinal characteristics of firms that use PEOs to keep in mind:

  1. For small (under 500) and relatively young (roughly 5-10 years old) companies, PEOs can help compete with larger firms when it comes to offering competitive benefits.
  2. Businesses that manage complex workforces (for example, employees in multiple states or that employ a significant number of part-time and/or consultant workers) may find PEOs helpful as they help streamline benefits administration.
  3. Most businesses using PEOs are in the financial, IT, and professional/administrative services industries. Firms in industries such as construction or manufacturing can help differentiate themselves by joining a PEO to offer their workforces a greater range of benefits.
  4. PEO membership is correlated with more progressive paid leave and flexible work policies, suggesting the convenience and simplification of benefits management that comes with using a PEO enables the businesses that do to focus on more strategic HR initiatives.

APPENDIX:  See Guardian’s 11th Annual Workplace Benefits Study – looking at the PEO industry today and the advantages that employers are experiencing from working with them for additional details. file:///Users/josephsimon/Downloads/Guardian_Life_The_PEO_Advantage_Report_2022.pdf

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