Lions, Tigers and How to Grin and Bear a PEO Extraction

“Am I the only one who thinks it's an impossible task?”- The Wizard of Oz

I’m fascinated by the rationale of growing employers surrounding the decision to stay in a professional employer organization (“PEO”). PEOs have obvious benefits such as offloading HR responsibilities and allowing smaller companies to access group health insurance benefits as part of a larger group. It is a neat package that wraps up the administrative aspects of running a business: payroll and benefits administration, worker’s compensation and some HR. The bundle is extremely appealing, particularly in the M&A space where there are so many decisions to be made and terms to be negotiated. A PEO is one solution which solves many of them, so it makes sense, even if it is imperfect.

But as your company grows in the number of full-time employees, it is unwise not to consider the Law of Diminishing Marginal Returns. There is a tipping point in terms of number of employees where it makes sense to bring all (or most) of the PEO functions in-house, or outsource to a third party that is not the PEO, because sharing the burden of the overhead with the PEO favors the PEO instead of you, the employer.

If an employer understands all of the costs associated with staying in the PEO, and consciously decides those costs are worth avoiding the aggravation associated with the extraction and ongoing administration, then that is what works for them. However, like all misconceptions, I suspect that many employers don’t fully realize how high the cost of staying in the PEO actually may be and “No Decision” is still a decision.

When is it Time to Leave a PEO?

My colleague, Chris Baldwin, Business Development Leader – HR Technology Practice, shared the following signs for when it is time to consider exiting a PEO:

• Cost & Strategy. A broker can take your census to the market and find out what health insurance plans are available and at what cost. By stripping the overhead of the PEO, the overall rate may be less expensive. Alternatively, a company may need a more robust and competitive benefits offering to attract the quality of talent they need. Meaning that even if it costs significantly more, it is an investment the employer is willing to make to expand their offerings.

• Size/Staffing Considerations. The sweet spot for PEOs are usually companies under 50 full-time employees. Of course, there are exceptions to this rule, but once an employer reaches 100+ full-time U.S. employees, it’s generally time to consider whether the PEO is the most cost effective approach.

• Control/Data Access. As part of a PEO, an employer likely conformed to the PEO’s way of doing business with their rules and their benefit options. The employer may be ready to change this dynamic to have more control, including the ability to respond to employees’ needs/interests. Additionally, employers may want access to data and/or analytics that they are otherwise unable to obtain.

• No “best fit” options. PEOs generally work with a standard/limited set of service providers, which may or may not be a best fit for a specific employer need. For example, an employer may want to use a specific healthcare insurance carrier, type of coverage, or plan design that is not available through the PEO.

•Service. When service levels provided by the PEO do not meet expectations -- e.g., poor client management, slow response time, insufficient process automation, inflexible and/or hard to navigate technology --it is time for the employer to either consider a different PEO or move away from a PEO strategy altogether.

Lining Up Replacements before Exiting the PEO

Before you exit a PEO, consider the fact that all of the PEO functions need to be replaced by third parties or in-house staff. If you build your team well, the minutia of all of the things the PEO was doing can be delegated to the respective teams and done in a fashion that is more tailored to your business objectives. There are a multitude of vendors to select for each function of the PEO. When a new client asks us to help them leave a PEO, we engage the following consulting teams to navigate the selection of vendors or carriers, all related to employee benefits and Human Resources.:

“If you build your team well, the minutia of all of the things the PEO was doing can be delegated to the respective teams and done in a fashion that is more tailored to your business objectives.”

Two important points to note: (1) many PEOs allow you to stay on their payroll system and carve out the other functions, and (2) worker’s compensation and employment practices liability coverage needs to be obtained by a property and casualty broker.

Conclusion

Even when a review of the data supports an exit with compelling financial and strategic reasons, there is often still quite a bit of push back and resistance. Why? Because people are concerned by the extraction.

Coming off a PEO when you have reached a certain employee count is the equivalent of choosing to wake up early to exercise. Perhaps in the moment, it is not exactly how you want to spend your time or exercising is physically difficult, even mildly uncomfortable. Think of your broker partner as a personal trainer: your broker can encourage you, show you new approaches, and make it less likely you’ll injure yourself. Recognizing and taking this administrative heavy-lift head on may be undesirable in the short-term but incredibly beneficial in the longer term. If you are able to save on the administrative costs of the employee benefit offering, you can reallocate those funds in a manner which better serves your employees.

About the Author

Ally Lamson partners with fast-growing employers of various sizes, advising them on the best practices in employee benefits with an eye toward growth. Having been trained as a lawyer, Ally is conscious about pulling in Gallagher’s legal compliance team, as needed, to ensure companies are aware of their obligations as they grow. She works closely on PEO extractions with her colleague and friend, Molly Belmont.