Pitfalls of PEOs

PEO stands for Professional Employer Organization. The idea behind it is that companies can use a PEO provider (think Justworks, Rippling) to outsource the administration and responsibilities like human resources, benefits, and payroll. A lot of smaller companies choose to use a PEO because its easy to sign up for and they believe that it will save them time and money.

A PEO functions by pooling together headcount from their corporate customers to try to negotiate rates down with health insurers. They also try to create economies of scale with HR services by having one representative spread between a number of companies.

Legally, companies that register with PEOs are still co-employers. The PEO becomes the employer of record (EoR) for taxes and employees are employed by the PEO itself. Lots of companies are eased into a false sense of security about how much a PEO offers or the level of responsibility they still have over their staff. The reality is that while many standard recurring processes are outsourced to the PEO, the liability and risk still remains with the company and they then have much less control over it.

While health insurance rates have been steadily increasing for years in the U.S., the post COVID renewal rates have been astronomical. The costs of years of government sponsored vaccines and testing are now coming to roost. Pharmaceutical companies and health insurers are now passing expenses down to employers. The days of 2% or 3% renewals are over. At Franklin, we have seen customers switch away from PEOs because of insurance renewal rates of 11%-35% increases. The pooled strategy that PEOs employ for applying for health insurance has turned to an extremely costly situation for its customers.

Since PEOs are also using their banks to facilitate payroll payments, money moves more slowly and move expensively than if it were going directly between employer and employee. Some PEOs require pre-funding of payroll up to two weeks in advance. Others will run an ACH pull up to 11 business days in advance of payday. This is a problem for companies that have tight cash flows. For reference, Franklin which is a payroll processor and not a PEO can settle USD payroll in 2 business days, allowing our customers to hold onto their funds for longer.

The human resources side of PEOs is also questionable. Many PEOs will pass having built in some notifications or advice about unique state requirements about hiring and terminating staff as “HR services.” HR management has a much wider spectrum of responsibilities that will always live with the company no matter what — recruiting, evaluating, supporting and enriching staff is not an outsource-able service, but many PEO customers pay for the idea of it.

Companies that chose to directly employ their workers rather than go through a PEO can expect to save money and maintain more control. Although it may take a little more time to set up directly employing your workers, the longer terms costs and administrative burden are much less.

Payroll management has historically been a headache for businesses that only had outdated, complicated, and expensive tools to use. PEOs have capitalized on this by offering a service that is extremely costly and complicated with a nicer UI than other payroll processors. Companies that are just getting started or are looking for a new solution should strongly consider directly employing their teams rather than using an expensive intermediary.

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