Professional employer organizations (PEOs) began their rise after the adoption of the Tax Equity and Fiscal Responsibility Act of 1982 cleared a path for the creation and expansion of such entities. Between 780 and 980 professional employer organizations operate across all 50 states. According to the National Association of Professional Employer Organizations, approximately three million employees work under a PEO arrangement and the PEOs industry earned, on the top end of the estimate, $156 billion in gross revenues in 2014 (gross revenues are the total payrolls plus the fees charged by the PEO).
PEO contracts are co-employment arrangements whereby the professional employer organization and the client with whom it contracts both retain some right of control over the individual worker or workers collectively. Such relationship is wholly different than a leased employee or the use of a borrowed servant. Leased employees and borrowed servants are under the absolute control of the special employer. Co-employment vests responsibility and control with both parties to the contract.
The National Association of Professional Employer Organizations (NAPEO) website explains these responsibilities as follows:
The PEO relationship involves a contractual allocation and sharing of employer responsibilities between the PEO and the client. This shared employment relationship is called co-employment.
As co-employers with their client companies, PEOs contractually assume substantial employer rights, responsibilities, and risk through the establishment and maintenance of an employer relationship with the workers assigned to its clients. More specifically, a PEO establishes a contractual relationship with its clients whereby the PEO:
- Co-employs workers at client locations, and thereby assumes responsibility as an employer for specified purposes of the workers assigned to the client locations.
- Reserves a right of direction and control of the employees.
- Shares or allocates with the client employer responsibilities in a manner consistent with maintaining the client’s responsibility for its product or service.
- Pays wages and employment taxes of the employee out of its own accounts.
- Reports, collects and deposits employment taxes with state and federal authorities.
- Establishes and maintains an employment relationship with its employees that is intended to be long term and not temporary.
- Retains a right to hire, reassign and fire the employees.
When evaluating the employer role of either the PEO or the client, the facts and circumstances of each employer obligation should be examined separately, because neither party alone is responsible for performing all of the obligations of employment. Each party will be solely responsible for certain obligations of employment, while both parties will share responsibility for other obligations. When the facts and circumstances of a PEO arrangement are examined appropriately, both the PEO and the client will be found to be an employer for some purposes, but neither party will be found to be “the” employer for all purposes.
NCCI and PEO Arrangements
NCCI monitors the workers’ compensation issues and problems created when employers choose to join a PEO. A 2005 report printed in NCCI’s Workers’ Compensation Issues Report delineates and briefly discusses many of the continuing issues. A few of the problems/issues discussed in the NCCI article include:
- Experience Modification Calculations: Most states require the PEO to individually monitor and report the claims experience of each individual client. The purpose is to thwart the efforts of employers with bad experience to escape their problems by joining a PEO for a couple of years then coming back out and starting over. Since individual experience must be monitored and reported, the employer’s experience mod will be correct based on its experience; it will not get a 1.0 when it leaves the PEO unless that is what it has earned;
- The ability of executive officers to exclude themselves (if allowed by law); and/or the ability of sole proprietors or partners to include themselves (if allowed by law); and the ability to include or exclude members of an LLC (based on the applicable state law);
- Problems that might arise if the employer/client hires an uninsured subcontractor. Is the PEO’s workers’ compensation carrier required to pay as the statutory (de jure) employer?
- Problems that arise out of PEOs being insured in state assigned risk pools; and
- Are the proper endorsements in place? For example, NCCI states in this article that the Alternate Employer Endorsement is not intended for use in co-employment situations. However, without using this endorsement there is a problem when trying to effectuate and confirm the proper dovetailing of coverage between the employer/client and the PEO (detailed below).
NCCI’s report specifically lists and highlights more problems than those listed here.
Four endorsements are available for use in most co-employment situations, and depending on the jurisdiction a fifth endorsement may be necessary. Two are client-specific and two are intended to be attached to the PEO’s policy. Contractual agreement between the PEO and the employer regarding which entity is responsible for providing workers’ compensation benefits govern which endorsements are used.
Employer/Client Responsible for Providing Workers’ Compensation
When the direct employer/PEO client is contractually responsible for providing benefits, two endorsements dovetail to provide the necessary or required workers’ compensation benefits:
- Labor Contractor Endorsement (WC 00 03 20 A). This endorsement is attached to the client’s (the leasee’s) policy. Attachment of this endorsement extends benefits to the leased employees from the direct employer’s policy and essentially provides additional insured status to the scheduled PEO. The use of this endorsement is coupled with the …
- Labor Contractor Exclusion Endorsement (WC 00 03 21). Attached to the PEO’s workers’ compensation policy, this exclusionary endorsement excludes coverage for employees leased to the client(s) scheduled in the form. This endorsement is used when the client leases employees on an “other-than-short term” basis and such client is contractually charged with providing the workers’ compensation benefits.
PEO is Responsible for Providing Workers’ Compensation Protection
As above, two endorsements, one attached to the direct employer’s/client’s policy and the second to the PEO’s, work in tandem to assure that coverages mesh as per the contractual agreement requiring the PEO to extend workers’ compensation benefits to the leased workers.
- Employee Leasing Client Exclusion Endorsement (WC 00 03 22). This endorsement is attached to the direct employer’s/client’s workers’ compensation policy to exclude the extension of workers’ compensation benefits to employees leased on a long-term basis from the scheduled labor contractor (PEO). Only use this endorsement when the PEO is responsible for providing coverage. The direct employer/client must confirm that the PEO attaches the …
- Professional Employer Organization (PEO) Extension Endorsement (WC 00 03 20 B). Workers’ compensation and employers’ liability benefits extend exclusively from the PEO when this endorsement is attached to the PEO’s This extension only applies to employees leased to the client(s) listed on the schedule.
- Alternate Employer Endorsement (WC 00 03 01 A). Although NCCI states this endorsement is not properly used in co-employment situations and even the form itself does not contemplate its use in these relationships, if the insured is located in a state that has not approved the PEO Extension Endorsement discussed above, the Alternate Employer Endorsement may be the only way to extend coverage from the PEO’s form to protect the direct employer/client. This endorsement is attached to the PEO’s policy naming the employer/client as the alternate employer. The use of this form in co-employment contracts is not recommended and should be avoided if possible.
Separate Workers’ Compensation Policies for Employers Using PEOs
As evidenced above, it is absolutely essential that the employer/client have in place a workers’ compensation policy even when the PEO is contractually providing coverage. Since both entities are legally employers and, in fact, are the “employers of record,” such contractual arrangement does not preclude the necessity of coverage.
Exposure to a workers’ compensation claim still exists if an uninsured subcontractor is hired, if there are employees hired outside of the leasing contract (temporary workers, etc.) and other potential gaps in protection as studied and monitored by NCCI. Further, while it may seem like a weak argument, without a workers’ compensation policy in force, the employer/client has nothing to which the required endorsements can attach attesting that coverage is extended from another party.
Lastly, if the PEO’s coverage is compromised or the PEO suddenly goes out of business, the employer is in violation of the law until coverage can be placed. Many employers have received notice that the PEO with which they were contracted is no longer in business.
Employers should carry the workers’ compensation policy even if it must be set up using “If Any” payrolls. The cost is very low for the protection it provides. A central theme of risk management is “don’t risk a lot for a little.” The small premium may avoid big problems.
A Place for PEOs
PEOs offer many services to and advantages for employers using their services. But the use of a PEO does not relieve the direct employer of its responsibility to assure workers’ compensation protection is properly constructed – before the injury occurs.
Information for this article is taken from, The Insurance Professional’s Practical Guide to Workers’ Compensation: From History through Audit. Click here for more information on this useful guide.
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