More On PEOs and Workers Comp

I've written in the past about PEOs and Workers Compensation, but there are a few more points I thought might be useful to post about. To recap, a PEO (Professional Employer Organization) is currently the most common term for a business service that used to be known as Employee Leasing. It has some similarities to other kinds of staffing companies, but also very important differences. A PEO becomes, via contractual agreement, a "co-employer" along with the client companies of the PEO.

So, for example, if ABC Widget Remanufacturers, Inc. signs up with Supergreat PEOxperts, LLC, Supergreat becomes, for legal purposes, the co-employer of the people who work at ABC. That's an important and fundamental difference between a PEO and say, a staffing company that might provide temp workers to ABC who weren't already employees of ABC.

As co-employer, Supergreat can now legally do things like purchase Workers Compensation insurance that covers the workforce at ABC. Supergreat can also do things like handle withholding, get health insurance, and handle various other back office functions for ABC. But my focus is on the Workers Compensation coverage.

As I have said before, a well run PEO can indeed offer significant benefits to client companies in the area of Workers Compensation insurance. That's because there are economies of scale that can enable a PEO to obtain Workers Compensation insurance for less than the smaller individual client companies could get. So even with the fees charged by Supergreat, ABC likely can pay less for Workers Comp through the PEO than the best deal ABC could find on its own.

The problems I have observed with PEOs and Workers Comp have to do with some of the complexities of the Workers Compensation insurance system.  And when things go bad in a PEO Workers Compensation arrangement, they can go very bad indeed, and leave client companies like ABC with significant problems.

One problem is that PEOs are, in most states, loosely regulated at best. In my home state of Illinois, for example, a PEO must be registered and licensed by the Illinois Department of Insurance. But there is no actual oversight exercised by the department, save to confirm that the PEO has in place valid Workers Compensation insurance.

The big potential problem in regards PEO-provided Workers Compensation is if the PEO encounters difficulties in obtaining coverage at a cost that is low enough to make the PEO business model work. Sure, coverage is always available through Assigned Risk programs, but these insurers-of-last-resort pose real problems for PEOs--the cost is almost much higher than voluntary market coverage, and Assigned Risk coverage must often be cobbled together with a number of separate policies for different states.

As I've written about before, I once served as an expert witness in a legal case that involved, tangentially, the collapse of TTC, which had been, until it's demise, the largest PEO in the country. But the loss of affordable Workers Compensation insurance (which the PEO concealed from clients and regulators for as long as possible) ultimately doomed the company--and left client companies responsible for WC claims that they had thought were covered by the PEO  to which they had paid substantial sums for WC coverage).

TTC was hardly the only PEO to encounter Workers Comp related difficulties. In another case in which I served as an expert, a PEO had obtained WC coverage through the Assigned Risk plan. Now, it really should be impossible for a PEO to obtain WC insurance through an Assigned Risk program and still offer any cost savings to clients. But this PEO misrepresented classification codes and payroll amounts to the insurer, so that, until it all blew up, the premiums paid by the PEO were much, much lower than the clients could have obtained on their own (because of that aforementioned part about misrepresenting proper classifications and payroll amounts.)

The insurance industry has been, for many years, somewhat leery of the PEO industry, having been burned by shady operators who played games with classifications, payrolls, and experience modifiers, to obtain WC insurance at improperly-low rates. But then along came the advent of Large Deductible Workers Compensation insurance, and some insurers decided this could be a way to turn PEOs into profitable accounts and minimize the chances for improper premium avoidance.

With Large Deductible policies, the policyholder agrees to be responsible for all WC claims up some large amount (say, the first $100,000 of each claim--or the first $500,000, or even the first $1,000,000). Technically, the policyholder is responsible for funding upfront a pot of money to pay those claims, and then to replenish the pot as it gets used up. And the actual insurance premium charges under such policies gets heavily discounted, so that most of what the policyholder has to pay is really reimbursement for claims and associated handling fees and charges.

The problem with such a Large Deductible set up is that it's difficult to estimate what the actual exposure may be for claims under the deductible limit. Plus, insurers often make the details of these plans so complicated that it's very difficult for the policyholder to understand what the ultimate costs of the insurance really will be. A recipe, often, for policyholders running up tabs with insurers that they have difficulty understanding, or paying.

Now, the important aspect of Large Deductible insurance is that the insurance company is ultimately legally liable to pay claims under the policy, regardless of whether or not the policyholder reimburses for claims under the deductible. But this can introduce additional stresses on some insurers--and thus increase the odds of an insurer failing under those financial stresses.

The clients of a PEO usually don't have information about whether or not the PEO is insured via a Large Deductible policy or whether or not there are behind the scenes problems between the PEO and its insurer that could cause WC coverage to disappear on short notice. Clients of PEOs often assume that the insurance regulatory system is making sure there aren't abuses that will create unexpected and nasty surprises. But such assumptions, in many states, are probably not well warranted. Insurance regulators in many states have had a murky understanding, at best, of what is going on in the marketplace with PEOs and Large Deductible policies, and many state insurance regulators have had their staffs and budgets reduced significantly in recent years.  So oversight, never robust in many jurisdictions, is now further reduced. Caveat emptor, indeed.

If I were a business contemplating getting Workers Compensation insurance through a PEO, I think I would want to insist on getting a copy of the PEO's current WC policy, and then having an insurance professional take a look at said policy. I would want to know if the policy were a Large Deductible policy, or Assigned Risk policy, and who the insurer was. I would want to check into the financial size and stability of the insurer, and if it is a Large Deductible policy I would want to check carefully into the financial strength and stability of the PEO.  If it turned out to be an Assigned Risk policy, I would look to see if the correct classification code for my business was on that policy. If not, I would want to see evidence that the correct classification code for my kind of work was added to the policy once I signed up.  Because if it is not, the PEO might be misrepresenting classifications to its insurer, which is a big red flag that all is not well behind the scenes in regards Workers Comp coverage.

The insurance industry has taken significant steps, in recent years, to address some of the problems inherent in the PEO model. And as I said at the outset, a well run PEO can truly offer significant cost savings to clients. The trick is, I believe, to truly qualify which PEOs are indeed well run, at least in regards their Workers Compensation insurance. The current system does not always catch problems until something serious has gone wrong, and that can leave the clients of those problem PEOs holding an expensive bag.