May 2003

Outsourcing HR Paperwork

By Carlos Rodriguez

Professional employer organizations (PEO) handle payroll and much more, selling a full range of personnel administration services to small and medium-size companies. Unlike vendors specializing in one type of personnel administration, such as issuing paychecks, PEOs sell services that include processing payroll, acquiring and administering group health insurance plans, running 401(k) investment plans, and monitoring changes in workplace laws.

The concept is gaining popularity as businesses, including CPA firms, try to exert more control over the cost of employee benefits. Studies show the national PEO market expanding by more than 25% a year. When a company hires a PEO, it farms out the day-to-day administrative functions of personnel management and makes the organization a “co-employer” that contractually assumes certain employer responsibilities and employment-related liabilities, and establishes a fully accessible, off-site human resources department.

Economies of scale are a major incentive for employers to use a PEO. Participating employers are grouped into a single organization with greater negotiating leverage, allowing the PEO to obtain preferred rates for health insurance and other employee benefits. Large corporations enjoy greater purchasing power than smaller companies, which can be hit especially hard in the areas of employee health benefits and workers compensation insurance. Using a PEO enables small and medium-sized companies to benefit from the PEO’s negotiating power and volume discounts.

After a company allies with a PEO, it is not unusual for its health insurance costs to decrease by 15% to 20%. Also, because some businesses deal with three or four companies—one company for payroll, another for health insurance, and a third for workers compensation—the PEO provides both convenience and cost efficiency.

Mitigating Liability

Liability mitigation is another benefit. Some PEOs sell insurance to cover employment-practices liability or provide training to reduce the risk of lawsuits. In both cases the need is clear: The number of employment-discrimination suits filed by the Equal Employ-ment Opportunity Commission (EEOC) rose 140% from 1996 to 1999.

In recent history, the federal government has enacted landmark employment-related laws, including the Americans with Disabilities Act (ADA) and the Family and Medical Leave Act (FMLA). State and local employment laws can be a legal minefield for employers, too, especially for smaller employers. PEOs help businesses with employees in multiple states manage clerical and administrative functions, and PEOs are better equipped to know the rules and forms for every state.

Employee turnover contributes to employer liability by creating potential wrongful-termination cases. According to the U.S. Department of Labor, half of all new hires leave their jobs within the first six months. Studies show that a company’s legal costs in a wrongful termination lawsuit can run up to $85,000 and that winning plaintiffs receive judgments averaging $500,000.

Additionally, the cost of compliance with workplace regulation is often a bigger burden for small companies, primarily because the associated overhead expense is spread over a smaller workforce. According to a U.S. Small Business Administration survey, small companies spend up to 80% more per employee on federal regulatory compliance than do large companies. Poor management of personnel-related tasks can make compliance even more costly. For example, businesses pay extra when they fail to make timely payroll tax payments, or if they report workplace injuries weeks rather than days after the incident.

Evaluating a PEO

Before contracting with a PEO, employers should conduct a background check to determine how long the PEO has been in business. Another important consideration is the stability of the PEO’s financial history and whether its benefit plans are properly funded and backed by a reputable insurance company.

It’s also wise to determine whether the PEO is licensed to operate, in states where such licensing is required, and whether it is accredited by the Institute for the Accreditation of Professional Employer Organizations (, an independent body nationally recognized for establishing professional responsibility standards in the PEO industry.

If the growth of the PEO industry continues at double-digit rates, its abbreviation may become one of the most familiar in corporate America. With an estimated 95% of the PEO market still untapped, some financial analysts forecast that the PEO industry will become one of the country’s largest employers over the next 20 years.

Carlos Rodriguez is president of the professional employer organization ADP TotalSource (www.adptotal

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