How do I evaluate a PEO?

By Penny Morey

Opinions expressed by Entrepreneur contributors are their own.

We are looking to outsource our HR functions. Do you have any recommendations for PEOs? Do you know any PEOs that will work with 1099 consultants? Or any PEOs that will offer benefits to part-time employees? What criteria would you use to determine effectiveness?
This can be very challenging! Hence, this very long response: Originally, when Professional Employer Organizations (employee leasing) became fashionable, the advantages of PEOs--for smaller companies generally--were the leverage of a larger group negotiating for reduced costs for benefits (e.g., group medical, dental, etc.) most often sold by salespeople not licensed as insurance agents. Over time, these advantages diminished. Many benefits brokers can find very competitive rates for their small company clients, especially when all carriers can be accessed versus the usual only one (or at most two) carrier option offered by PEOs. There are a variety of retirement options from which smaller companies can choose (a much better choice because the employer can choose a plan that fits the company’s individual needs versus a “plan in a box”) and the advantage of the bundled workers compensation rates evaporated as well. While most PEOs also touted their payroll and human resources support, most often the payroll services were no better or worse than those of free-standing payroll services-only providers (typically lacking any type of customization as the software was written for PEOs) and the human resource support routinely consisted of a very generic employee manual, varying levels of employment expertise and advice most often provided by service staff, not human resource experts.

With the emergence of full-service Administrative Services Offering (ASO) vendors, PEOs have now become the expensive alternative to accessing bundled benefits, payroll, workers compensation and human resources services. However, be aware that if the ASO vendor with which you talk offers a PEO option, the vendor may try to convince you to buy PEO services instead of the ASO model due to the higher profit margins that the PEO generates for the vendor. These higher PEO profit margins are generated by many hidden costs which can be almost impossible to decipher on the automatic fees report that the employer receives when the fees are being automatically taken out of the employer’s account along with the payroll and payroll taxes.

Also, PEOs use the annual contract to try to hold onto customers and they can also make it very difficult and painful to exit the PEO. The contract can always be broken but a PEO will try to use scare tactics to keep the client. I have seen PEOs retain employee records and ignore former customers’ requests for data. Employees may have to complete a variety of “new hire” paperwork. And if the employer is in the PEO for more than a year or so, the employer’s workers compensation mod will be reset with no regard to the employer’s good safety record. An employer will also lose a good unemployment rate once they’ve been with a PEO for 3 years. They will also charge a “not for profit” FUTA taxes, which “not for profits” are actually exempt from paying.

Unless there is a truly compelling reason not to seek the better option, I recommend that before you make any decision you look for an ASO that does not require an annual contract such as Tricore ( If you are determined to go the PEO route, set up a spreadsheet and see if you can extract applicable accurate information from each PEO vendor with whom you talk to fill in the columns. Expect it to be almost impossible to get the same kinds of cost breakdowns from each vendor. They make it difficult to do in my experience. Also, ask for at least six references (happy users with similar size and types of companies to yours) and call each one with a standard list of questions about costs and services. What would be ideal, of course, would be to talk to the unhappy former PEO users and see what their experiences were.

Hope this is helpful.

Penny is a seasoned human resources executive and consultant with over 25 years of diverse business experience in advising enterprise leaders on employment-related matters.

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