“PROFESSIONAL EMPLOYER
ORGANIZATIONS”
R. Burke McLemore, Jr., Esquire
Thomas & Thomas & Hafer, LLP
IMAGINE….
• You own a small business, 18-20
employees
• “Killer” workers’ compensation premiums
• High unemployment compensation rates
• Several different types of employees:
office employees, production employees,
and delivery drivers
• Next year, workers’ compensation
premiums will increase dramatically
The Genie
“In today’s competitive market, only the smart
leader sees profit margins climbing. You realize
that one of the largest problems facing your
business is balancing cost against having an
effective staff. Using concepts tried and proven
by some of today’s leaders and most profitable
companies, I can help to stabilize your costs and
insulate you from unexpected increases, which
can send your profit margins tumbling.”
The First Year
• Everything is great!
• Costs have dropped
• Everything the genie said would happen is
coming true….....
• But then………
• PEO fails to make payments of
unemployment compensation and health
insurance premiums for “its employees”
• PEO gets dropped by “its” workers’ comp
carrier
• One of your drivers suffers a catastrophic
injury in a truck accident
• PEO gets into litigation with its prior carrier
over cancellation of the policy
• PEO disappears or goes into bankruptcy
• The owners – just like the genie of the
bottle – are untraceable
Now…….
• You have no coverage
• Entire loss falls on you
• Petition filed against you for benefits owed
AND for penalties for failing to maintain
proper workers’ compensation insurance
• Criminal prosecution for failing to comply with
workers’ compensation laws
• Audit and fine for unemployment compensation
premiums
• Suit in tort by the injured Claimant, but no
coverage
• Employees end up with no workers’
compensation coverage and no health insurance
benefits
• You lose your entire business and go bankrupt
How is this relevant to you, self-insureds?
• Some of you are already contracting with PEOs
• Some are dealing with PEOs and don’t even know it
• When PEO defaults and loss falls upon the uninsured
employer, who do you think is the next in line to pay?
• Potentially, it is you as a statutory employer
• You may be statutorily bound to provide coverage for
persons that you have no contractual relationship with
whatsoever
WHAT IS A “PEO” AND HOW
DOES IT OPERATE?
• Entity that provides employers with
administrative services such as payroll,
employee benefits, tax management and
workers’ compensation coverage
• PEO considered the “administrative”
employer
• “Actual” employer continues to exercise all
control
• Establishes a contractual relationship for:
- payroll administration, including payment of
wages and employment taxes
- tax reporting, including preparing and filing
records, collecting taxes due
- creating a co-employment situation by
establishing and maintaining and
employment relationship with the
actual
employer’s employees
• PEOs are not “labor brokers”
• Rarely, if ever, do PEOs assume any responsibility or
control over an employee’s work, workplace, or safety
• PEO model is based on the concept of cost
consolidation
• Quality of PEOs varies widely
• Often focus their marketing on employers with high
workers’ compensation costs.
• Often create a “pool” of clients based upon adverse
selection
• Not a “cream skimmer” situation!
• Some engage in “Unemployment Compensation
dumping”
HOW PREVALENT ARE PEOs
AND WHY ARE THEY POPULAR?
• Popularity of employee leasing and
explosive growth in the industry results
from two factors:
– benefits costs and
– complexity of administration and regulatory
compliance.
• National Association of Professional Employer
Organizations (NAPEO) indicates there are now
at least 700 PEOs operating in the United
States. In 2010, revenues increased by $10
billing to $81 billing
• Huge segment of the labor market
• “Contingent workforce” has grown approximately
75% faster than overall workforce
• Businesses are not equipped to handle
onslaught of regulations and regulators
– burden particularly onerous on small
business
• FMLA Act
• National Labor Relations Act
• Cheaper workers’ compensation coverage
• PEOs may actually try to make additional
profit by establishing a “retro plan”
– which may have beneficent effect of
encouraging PEOs to police their clients’
risks, encourage safety and eschew
partnering with risky businesses
• By pooling risks, employee leasing
company or PEO may have thousands of
employees working at several hundred
client companies
HOW DO PEOs DEFINE AND
MARKET THEMSELVES?
• NAPEO alone lists well over 350 members
• “With employee paperwork headaches out
of the way, businesses can concentrate
their efforts on doing the things they do
best and on growing their business”
• NAPEO touts “co-employer relationship”
with PEO clients: contractual allocation
and sharing of employer responsibilities
between the PEO and the client.
• “Value” provided by PEOs:
– Relief from the burden of employment administration
– Wide range of personnel management solutions
through a team of professionals
– Improved employment practices, compliance and risk
management to reduce liabilities
– Access to a comprehensive employee benefits
packages, allowing clients to be competitive in the
labor market;
– Assistance to improve productivity and profitability
• Favorable spinoff to the government as
well:
– Aggregates dozens of small clients and takes
care of tax payments
– Potential for increased compliance with
employment law requirements
– Group purchasing power for health insurance
and other benefits
– Improved worker safety
– Some large enough to provide 401K plans
HOW DOES THE PEO OPERATE?
• Written agreement with their clients
• Worker is considered an employee of the
PEO
• “Actual employer” oftentimes treated like a
borrowing or special employer
– Entitled to traditional workers’ compensation
immunity from suit by the “employee”
• “Actual employer” is not really seeking
temporary labor services but is seeking to
shift the risk of loss for its permanent
workforce
• Client is “outsourcing” all of its personnel
and then leasing them back
THE TYPICAL PEO AGREEMENT
• Initial term of 30 days, automatically renewing for 30 day
term
• Client is obligated to furnish to the PEO a list of
employees
• No employee shall be employed by the PEO or entitled
to any benefits or workers’ compensation coverage
unless the “employee” has completed an I-9 form, an
Employment Application, withholding forms and until the
client receives confirmation from the PEO that the
employee has been “hired”
• Actual employer is obligated to provide accurate wage
information
• Barring full compliance, the Agreement
normally places all liability for any benefits
or damages back on the client
• The Agreement normally provides
that the actual employer shall
maintain all right of control for the
day to day work activities of the
employee, and that the PEO
retains no right of control
• “Client shall have sole and exclusive control over the day
to day job duties of all leased employees and PEO shall
have no responsibilities with regard to the leased
employee’s performance of day to day job duties.
Furthermore, PEO shall have no control over the job site
at which, or from which, leased employees perform their
services. Control over the day to day job duties of
leased employees and over the job site at which or from
which leased employees perform their services is solely
and exclusively assigned to client. Client expressly
absolves PEO of control over the day to day job duties of
the leased employees and over the job site at which, or
from which, leased employees perform their services.”
• Standard Agreement requires PEO to secure
workers’ compensation coverage “in such
amounts as is required by applicable law”
• Claim management may be done in house, or
through a TPA
• PEO “shall” provide proof of insurance coverage
to client
• If policy is cancelled, notice must be given within
so many days prior to termination date
• Cross-indemnification provisions
• Personal guaranty of the client or its officers
PROBLEMS WITH THE RATING
PROCESS/RATING AND COVERAGE
CHALLENGES
• Major challenges in the insurance realm for regulators
anxious to promote proper risk classification and
experience ratings
• Non-capitalized entity nominally employing a whole
variety of employees
• Clients of PEO laboring in varying unrelated enterprises
in multitude of jurisdictions
• When “client” joins or leaves a PEO, how is its and/or the
PEOs experience rating appropriately calculated?
• Public construction contracts require that the contractors
provide proof of insurance
• Demonstrating proper comp coverage is
normally straightforward…..
• But when business has outsourced not
only its insurance responsibility but also its
employees, how can this task reasonable
be accomplished?
• Several Factors of Concern:
– Distorted experience ratings
– When a PEO contracts with another PEO, carrier may
not know who they are underwriting
– Can the PEO self insure?
– How do you rate a master policy?
– What happens to the employees if the actual
employer fails to notify the PEO about the hiring?
– Does the client really know who the “carrier” is?
– Is the carrier even licensed to write in the state?
• When all goes well, these issues never arise….
• But…..Injured workers with bona fide or
undisputed claims – but no employer or carrier
willing to voluntarily accept liability or even
acknowledge employee status – cause genuine
problems
• Employers who thought (incorrectly) that they
had coverage through a PEO appear at
compensation hearings, often unrepresented,
and admit they have no independent means of
paying their workers’ compensation claims
• Employees sue their employer in tort
cases and personal injury actions,
resulting in essentially, “no fault”
judgments against the employer
• Declaratory judgment actions arise over
coverage and cancellation of policies
• Courts are presented with increasing
number of insurance coverage disputes
arise out of employee leasing
• Are carriers of employee leasing firms are
responsible under Part 2 of the standard policy
to defend and potentially indemnity an employer
when the employee has collected under Part 1
of the policy?
• Does the standard Comprehensive General
Liability (CGL) policy legitimately exclude
coverage for claims made by leased
employees?
• In states that have procedures like
supersedeas funds or which finance their
workers’ compensation programs through
a percentage of premium dollars, those
who have proper coverage – whether
through self insurance or otherwise – end
up “taking the hit”
DEALING WITH FRADULENT
CLIENTS AND PEOs
• Problems can occur with the client of the
PEO:
• Example – Claimant lost four fingers on the first day of
work with the client before he was recorded on the
payroll and before his employment application had been
received by the PEO. PEO and carrier denied the claim
as “not an employee”
– PEO relied on contract provision: “must be on the payroll” to be
employee
• Court upholds contract: “Employee leasing enterprises
can be the target of workers’ compensation fraud by
client companies who might conceal workers from the
leasing company to avoid a leasing charge for that
person”
• PEO standard contract with client contained a
provision that no one would be considered an
“employee” until:
(1) the person completed and signed all pages
of the hiring packet
(2) the PEO gave written approval for that
person to be hired
As such, the client, not the PEO, was
responsible for the injured employee.
Other methods clients defraud PEOs:
• By using the easy trick of under-reporting
the number of employees.
• Using fake or substitute job titles of actual
workers
• Paying wages directly to the employee,
thereby avoiding fees to the PEO
• Underreporting of payroll can also be a
device used by the PEO to make a profit
• The Clancy case:
– Employees received two checks: one for what Clancy
called W-2 wages, another referred to as “dividend”
– Clancy failed to disclose the amount of the so-called
“dividend” paid to each employee to the state fund
– Dividend usually amounted to more than ½ of the
employee’s income
– Clancy claimed to clients and prospects that he could
reduce their premiums by 50% and provide complete
workers’ compensation coverage through the
California State Fund
– …..it cost him $14.6 million…..
• Potential fraud can occur when a group of
similar companies with an intent to
defraud, establish a proprietary leasing
firm and transfer all of their existing
employees to that firm in an effort to use it
as a “front” to disguise their own
operations:
– Used to avoid experience modification
surcharges
– To hide misclassification of job duties
HOW HAVE PEOs BEEN
STATUTORILY REGULATED?
• Several states have established PEO
licensing divisions.
• In order to become licensed, the
“controlling person” must meet certain
criteria
• Leasing agreement must show that the PEO is
responsible for:
– Maintaining accounting and employment records
– Reserving some right of direction and control over
leased employees
– Assuming responsibility for payment of wages to the
leased employees without regard to payment by the
client of the leasing company
– Assuming full responsibility for payroll taxes and
collection of taxes
– Retaining authority to hire, terminate, discipline and
reassign the leased employees
– Performing (or having performed) safety inspections
– Promulgating and administering employment and
safety policies
– Managing workers’ compensation claims
– Giving written notice of the relationship between the
employee leasing company and the client company to
each leased employee
– Retaining a right of direction and control over
management of safety, risk and hazard control at the
work site
• PEO shall be responsible for providing
workers’ compensation coverage “as
required by law”
• Bond or irrevocable letter of credit typically
required
IMMUNITY FROM SUIT AND
RECOVERY FROM THE
CORRECT “POCKET”
• The employer who has right to control the
employee enjoys statutory immunity from
suit
• PEO typically eschews any right to control
the employee’s activities
• Problems can clearly arise, however,
when neither client nor PEO secures the
coverage necessary to protect against
workers’ compensation claims.
• Employee can attempt to sue the PEO for
failing to police the workplace, etc.
• Statutory employer provisions of the typical
Workers’ Compensation Act
– Injured employee simply works his way “up the chain”
to the statutory employer
• Crucial to know whether your contractors
and their subcontractors have in fact
secured coverage for workers’ compensation
and whether they are utilizing the services of
PEO employees
• Uninsured client who has not contracted
with an insurer or a legitimately selfinsured PEO may be sued by the
employee in tort.
– Typically “strict liability”
• Insurance coverage outside the realm of
workers’ compensation is an important
part of the concern.
– Occidental Fire and Casualty – Employer
sought coverage under its CGL policy; actual
employer’s liability insurance specifically
excluded coverage for erstwhile workers’
compensation claims.
– Employer/client had no coverage at all
• When PEO defaults, remedy in suit against the PEO:
• John T. Gallaher Timber Transfer v. Robert Hamilton –
primary employer was responsible to reimburse the
statutory employer
• Tri-Union Express v. WCAB – Estoppel theory to require
that the leasing company be bound to provide coverage:
Bound by promises to provide coverage irrespective of
their statutory obligation to do so
• American Insurance Company v. WCAB – “[b]ecause
Truck Services obtained and paid for a workers’
compensation policy and led the Claimant to believe that
the policy coverage was in effect, Truck Services cannot
contend that an employer/employee relationship does
not exist between it and the Claimant”.
STAYING PROTECTED
• Some of the potential problems receive
statutory treatment or statutory protection.
• In most cases, however, the answer is that
there is no statutory remedy.
• “Best Practices”:
– Verify the requirements of state law
– Document the terms of the relationship
carefully
– Verify the rate classifications for your
employees
– Know your PEO
– Get references and check them out
thoroughly
– Get to know the principals of the PEO
– Know the PEO’s corporate structure
– Make sure that if any licenses are required by
the PEO, the licensing has been obtained and
is current
– Verify the insurance, particularly the workers’
compensation coverage
• Have your company named as an additional
named insured
• Insist that notification of any policy cancellation be
given to you no later than 30 days prior to
cancellation
• Verify that the workers’ compensation
carrier for the PEO is licensed to do
business in the states in which you
operate
• Verify that the PEO is making payments
on payroll related taxes, unemployment
compensation and the like
• Make sure that a bond or irrevocable letter
of credit is in place
• Avoid signing a “standard” boilerplate
contract agreement
WRAP UP
• Protect yourself in advance and avoid the “after
market” risks of leased employees
• Risk shifting and similar schemes have a cost
• “There is no such thing as a free lunch”
• And remember: There is no magic genie, either!