Professional Employer Organization (PEO) Trends

Professional Employer Organization (PEO) Trends

Revenue Drivers

The current revenue drivers in the Professional Employer Organization (PEO) space are increased number of employees, increased number of businesses, and increased demand for PEO services. While the drivers are sustainable in the near future, some are unsustainable in the long-term. The requested information about the drivers is presented below.

Increased Number of Employees

  • One of the key revenue drivers in the PEO industry is the rising number of worksite employees. Although COVID-19 greatly disrupted business activities across the globe, the number of employees has been increasing as the economy starts to recover.
  • In 2019, PEOs reported a first quarter revenue rise of 13.7%. The rise was attributed to a 15% rise in the average number of worksite employees engaged with the PEOs per month. According to the industry reports, the growth in the number of employees was spurred by enrollment of new clients.
  • In the PEO industry, a rise in the number of employees leads to a high demand for PEO services. Moreover, growth in employment prompts small businesses to grow, thus giving them the capacity to outsource human resource functions.
  • Increased revenue growth is sustainable in the near future as the economy recovers from the COVID-19 pandemic. With economy opening, more opportunities for employment will emerge for the many people laid down during the pandemic.
  • However, the driver many not be sustainable in the long-term because it is more dependent on the prevailing economic conditions. Thus, unfavorable economic conditions may reduce the number of employees through unemployment.

Increased Number of Businesses

  • The United States is home to over 907 PEOs providing services to 175,000 small and mid-sized firms. The country has experienced a rise in the number of domestic companies in the recent past, with the 2019 statistics showing a 0.7% gain.
  • Although the growth has been reversed in 2020 due to COVID-19 that forced many businesses to close down, the number is expected to pick up as the economy opens. For the PEOs, the growing number of businesses will provide a lucrative opportunity to grow their revenue.
  • Although the number of businesses resuming is a sustainable revenue driver in the near future, emergence of ‘new normal’ trends such as remote working may make this driver unsustainable in the long-term. Although PEOs will still create and maintain business relationships, the new dynamics will have an impact on the industry.

Increased Demand for PEO Services

  • With many businesses in the United States focusing on cost saving, the demand for PEO services has been on the rise. Many small businesses find outsourcing services to PEOs as a cheap alternative to providing the services in-house. The move enables them to boost their margins and transfer the saved costs to consumers.
  • The many advantages of using PEOs such as lower overhead cost, low turnover rates, reduced inabilities and risks, among others have created a huge demand for PEOs. The growing demand is demonstrated by the market size of PEOs that has also been on an upward trend as shown by the graph below. PEO Market Size
  • Although the growth may decline in 2020 due to the current pandemic, businesses will still find PEOs useful to their operations.
  • Demand for PEOs as a revenue driver is sustainable, both in the near future and in the long-term because every business is looking to be more efficient in its operations. The many advantages of using PEOs focus on improving efficiency.

Growth Trajectory

At the end of 2017, Professional Employer Organizations (PEOs) in the United States generated $176 billion in wage revenue from worksite employees up from between $136 and $156 billion in 2015. Industry participants in the PEO sector project that this figure will rise to approximately $241 billion by 2023. Since its inception, the industry has expanded to accommodate approximately 907 service providers and 175,000 new clients.

A Historical 0utlook

  • The market size of the PEO industry in the United States experienced an annual steady growth of 4.1% between 2015 and 2020.
  • From 2015 to 2017, the CAGR of worksite (WSE) employees in the PEO industry was growing at a steady rate of 8.3%.
  • In 2018, the PEO industry grossed $176.3 billion in revenue, of which $155.4 billion represented WSE wages.
  • The projected profit for the PEO industry was $1.3 billion in 2019 down from $1.8 billion in 2018.

Future Growth Projections

  • As more areas of HR like employee retention become more challenging, the PEO industry is expected to maintain an upward trajectory over the next 5-year period.
  • “The outlook for continued growth and vibrancy is extremely bright for PEOs given the significant value proposition we offer to small and mid-size businesses: Faster growth, higher profitability, and happier employees,” said NAPEO President & CEO Pat Cleary in a study examining the industry’s economic footprint.
  • Industry participants in the PEO sector project that the gross revenue will rise to approximately $241 billion by 2023.
  • Prior to the COVID-19 outbreak, the industry gross revenue was expected to grow by an annualized rate of 1.1% between 2019 and 2024.

COVID 19 Impact on the PEO Industry

  • Since COVID-19 was declared a pandemic by the World Health Organization, major economies and financial markets have been disrupted, including the PEO industry.
  • Restrictions to help address the pandemic have disrupted employment patterns globally, negatively affecting industry participants.
  • IBIS anticipates that the unemployment rate in the United States, fueled by the outbreak, will increase by up to 178% in 2020 alone.
  • Due to declining demand in PEOs, the industry market size is expected to decline by up to 9.4% in 2020.
  • Being in uncharted waters due to the ongoing pandemic, the PEO industry is expected to under perform for the foreseeable future.

Business Risks

Some of the business risks that are challenging the Professional Employer Organization (PEO) industry who are serving small-to-medium-sized companies include the liability that will be imposed by the IRS if there are mistakes in the filing of employee taxes. Their clients can also choose to avail of the IRS’ “voluntary certification program for PEOs,” thereby placing the tax liabilities squarely on the shoulders of PEOs. The rest of the business risks of PEOs who serve small-to-medium-sized businesses were indicated below.

  • Based on an article that revolves around the use of PEO payroll services by small companies, one of the business risks that are challenging the Professional Employer Organization (PEO) industry is the existence of inexperienced payroll services providers as there is a high risk of these vendors committing costly payroll errors.
  • Another business risk that is challenging the Professional Employer Organization (PEO) industry is the liability that will be imposed by the IRS if there are mistakes in the filing of employee taxes. Companies can also choose to avail of the IRS’ “voluntary certification program for PEOs.” If this happens, the tax liabilities will be shouldered completely by the PEOs.
  • As per ADP and TriNet, PEOs that serves SMEs, some of the business risks that the company encounter came from being a co-employer.
  • PEOs have to deal with the outcome of current and future legal and tax mandates.
  • They also have to deal with sudden changes in employees’ compensation and “health insurance claims and costs.”
  • PEOs also have to face the impact of uncertainties in the financial and economic landscape of their clients’ industries.
  • Another business risk could include unfavorable modifications in insurance terms or their relationships with insurance providers.
  • Another risk factor that they might have to face includes the cancellation of contracts by the clients.
  • They might also have to deal with movements in their business KPIs as a result of uncontrollable events such as sudden surges in the number of “compensation and health insurance claims, the amount and timing of insurance costs, operating expenses, and capital expenditure
  • requirements.”
  • PEOs also have to face the risks associated with their means to find ways to work around the limitations of their credit facilities to meet loan obligations.
  • Small to medium-sized firms are also highly impacted by the prevailing economic condition where PEOs also operate. As a result, they are more likely to reduce headcount and compensation levels due to credit and cash liquidity problems. This situation can potentially impact PEO’s earnings and profits if they will not be able to decrease their operating costs quickly.
  • PEOs also have to face the risks associated with the liabilities associated with their worksite employees. This can include “client deposits, accrued wages, payroll tax liabilities, and other payroll withholdings, accrued health benefit costs, accrued workers’ compensation costs, insurance premiums and other payables, and other current liabilities.”
  • Another business risk involves the need to strictly comply with the federal and state payroll tax and unemployment tax demands that are applicable for their clients. Tax reform initiatives, and other payroll tax amendments at the federal, state, and local level can affect the PEO’s payroll tax reporting responsibilities for its clients and the solutions that are being provided.

Regulations

Several regulations may impact Professional Employer Organizations (PEOs) directly or indirectly. As PEOs share a co-employment relationship with multiple business types, there is a possibility of PEOs experiencing additional risks emerging from these partnerships. The recent regulations that have impacted PEOs include changes in rules governing workers’ compensation and the tax relief offered through the recently signed Coronavirus Aid, Relief and Economic Security (CARES) Act. In the section below, we outline some recent changes:

The Coronavirus Aid, Relief and Economic Security Act

Covid-19 has led to an increase in the unemployment rate as businesses have shut down or scaled back. To contain unemployment and prevent employers from laying-off employees, the President recently signed the CARES Act. The Act allows firms to choose from a combination of benefits. This move is targeted toward small and medium businesses and is likely to impact their cash-flow positively. A firm’s capacity to avail these benefits is not affected in any way if it hires a PEO. Some provisions include:

  • Paycheck Protection Program: Available to employers with 500 or fewer employees, the PPP loan offers businesses funds to meet costs such as salaries, employee benefits, taxes, mortgage interest or rent.
  • Employee Retention Tax Credit: Under this, any business that faced a 50% reduction in its gross receipts or has had to suspend business operations due to a government order relating to Covid-19 becomes eligible to receive a tax credit. Businesses of all sizes can avail of this benefit.
    • An employer can claim a refundable tax credit against select employment taxes amounting to 50% of qualified wages (up to $10,000 per employee) paid after March 12, 2020, and before January 1, 2021.
  • Social Security Tax Deferral: All firms can defer the submission of the employer’s share of social security deposits due from March 27, 2020, through year-end. The business will have to pay half of the deferred social security tax by December 31, 2021, and the other half by December 31, 2022.

An employer cannot choose all of these benefits. Availing one impacts eligibility for another benefit. Businesses and PEOs will have to choose to match their unique needs.

Workers’ Compensation

Across the United States, the regulatory framework governing worker compensation is evolving to adjust to the challenges posed by Covid-19. As PEOs offer workers’ compensation insurance and health insurance to businesses, these changes might affect them.

  • Most states have created a rebuttable presumption that “frontline workers” operating out of their place of employment must have contracted the disease at the workplace. In some states, the presumption extends to all employees.
  • For example, in California, the Governor issued an order on May 6, 2020, that presumes that all employees diagnosed with Covid-19 after 14 days of working at their place of employment must have contracted the disease at work. The order was recently codified when Governor Newsom signed two bills in September 2020, expanding workers’ access to compensation.
  • In Illinois, the Governor signed a law that establishes a rebuttable presumption that any frontline worker, healthcare worker, or an employee of an essential business who gets infected with Covid-19 contracted the disease at work.
  • While there may be an increase in workers’ compensation due to claims relating to Covid-19, businesses expect a reduction in overall claims as many workers are operating from home, some our furloughed and others are let go off.

Other Regulatory Reforms

Besides these recent reforms, in 2019, the Department of Labor identified PEOs as employers under the Employee Retirement Income Security Act of 1974. The Department also permitted Multiple Employer Plans (MEPs), allowing different private players to use a single retirement plan. These changes allowed for MEPs to be sponsored by PEOs leading to a substantial increase in plans offered by them.

Pricing Advantages/Disadvantages

According to NAPEO, businesses having a team size of 10 to 100 employees could benefit from using PEO services. The average administration fees charged by PEOs can range from 2%-6% of an employee’s salary and can fluctuate with workforce changes. Additionally, PEOs can diminish the control of business owners on their workforce. However, PEOs can offer greater savings to small business owners with better compensation rates, insurance benefits, and statutory-legal protection.

Pros of PEO services

  • According to a recent report by NAPEO, the annual cost savings for small businesses using PEO is about 27.2%, i.e., businesses would benefit $272 for every $1,000 spent on PEO services.
  • The co-employment model used by PEOs enables small businesses to have benefits similar to large enterprises, like compensation coverage, dental and health insurance, commuter benefits, 401(k) plans, liability coverage, and risk management support.
  • According to NAPEO, the average size of small businesses using a PEO is about 22 employees. Hence, businesses having a team size of 10 to 100 employees could benefit more from PEO services.
  • Hiring a PEO can lower the overhead costs for small businesses by eliminating the need to hire payroll management. Also, PEOs can offer lower insurance costs and unemployment insurance rates due to better buying power.
  • In a flat fee per paycheck model, the PEO fee does not increase with employee wage hikes, commissions, or bonuses.
  • The statutory and legal expenses are calculated, collected, and remitted to the governing body by PEOs. Hence, business owners do not need to submit the Federal Insurance Contributions Act (FICA), Medicare, and Federal Unemployment Taxes (FUTA) for their employees.
  • PEOs offer legal protection for civil defense and employment liability insurance to businesses if an employee sues the company for wrongful termination.

Cons of PEO services

  • PEO administrative fees are generally pegged at around 2%-6% of an employee’s salary and can fluctuate with workforce changes.
  • PEOs can switch insurance providers for better margins, leading to price fluctuations and employee discontent.
  • The PEO agreements may include additional charges for technology upgrades, adjunct services, and other liability coverage.
  • The business owners control over its human capital is diminished, as the employees become the PEO fixes W2 members of the PEO staff and benefits offered. Additionally, small business owners may lose tax savings for health insurance provided by the government.
  • Invoices and monthly fees can be difficult to understand as most of the components like payroll, workers’ compensation, taxes, ELPI, and administrative fee are clubbed together as a bundled package.
  • If the PEO reports the company under its own SUTA account, then a repayment of taxes is to be done by the employer, resulting in a loss of control on the rate charged by the PEO.
  • PEOs generally charge workers’ compensation insurance on a base of “dollar per hundred,” i.e., if the compensation rate is $5, then for every $100 of payroll, about $5 will be charged in that classification.

Pricing

  • There are two pricing structures used by PEOs, i.e., charging on a per-employee basis and charging on a percentage of total monthly payroll.
  • The average per-employee fees can cost around $40 to $160 per employee, per month (PEPM), whereas the flat percentage rate can range from 3% to 12% of a company’s total monthly payroll expenses.
  • It is noted that for salaried employees about 2% of salary is charged by PEOs, while for wage workers about 6% of payout can be charged as fees by a PEO.
  • PEO services can start at $39 per employee PEPM (Justworks) and can cross more than $125 per month (TriNet) for each worker depending on the average compensation and other variables, like add-on service offerings.
  • Factors affecting the pricing for PEOs include:

Examples of Percentage vs. Per-Check (flat rate) ​Calculatio

  • The Percentage Method
  • If 5 employees are paid biweekly than the gross wages for a biweekly cycle would be $5769.
  • Now, if the PEO’s fees is charged at 2% per payroll cycle, than the business owner would need to pay about $115.38 biweekly for their services.
  • The Per-Check Method
  • If 5 employees are paid biweekly than the gross wages for a biweekly cycle would be $5769.
  • Now, if the PEO’s fees is charged at $24 per-check per payroll cycle, than the business owner would need to pay about $120 biweekly for their services.

Distribution/Go-To-Market Partnerships

The current trends in distribution and/or go-to-market partnerships in the professional employer organization (PEO) space include more PEOs partnering with insurance brokers, technology providers collaborating with PEOs to enhance their platform offerings, and PEOs joining associations such as NAPEO. PEOs enter into these partnerships to enhance the solutions that they are bringing into the market.

PEOs Partnership with Insurance Brokers

  • In the past, PEOs have competed directly with insurance brokers as the former have also added insurance offerings to their product roster. This has threatened to eclipse the insurance options provided by the typical insurance brokers.
  • However, this trend has reversed in recent years as more PEOs are now partnering with insurance brokers to focus on bringing better solutions to the market.
  • Insurance brokers who have partnered with PEOs are starting to discover that the partnership has enabled them to provide improved solutions to their customers, establish their “book of business,” and enhance customer retention.
  • Insurance brokers who collaborated with PEOs found that they were able to provide more assortment into their HR offerings that enabled smaller businesses to have the same benefits as bigger firms.
  • These brokers can also differentiate their solutions more in a highly-competitive industry. Offering their PEO partner’s additional benefits to their prospects can help increase their chances of being selected by these clients.
  • Extensis is an example of a PEO who partners with brokers to enhance the solutions that they are bringing into the market.
  • Brokers who partner with PEOs can add more benefits in their offerings to small business clients. Some of these benefits include “401(k)s, voluntary benefits, complimentary benefits, access to HR and compliance experts, and traditional HR services.”

PEOs Collaboration with Innovative Technology Providers

Group Captive Partnership

HRIS/Ben Admin and Competitive Threat

The Professional Employer Organization (PEO) industry faces competitive threats from other business process outsourcing firms, providers of human resource outsourcing, human resource consultants, payroll and benefits brokers, HRM, and Ben Admin solutions.

COMPETITIVE THREATS

Threat from Other BPO Firms

  • Small and medium enterprises are increasingly adopting business process outsourcing (BPO) models. According to Technavio research, “nearly one-third of small businesses are outsourcing some of their business processes to focus on core competencies.”
  • BPOs offer broad ranges of services beyond the human resource field, including customer service, web design & development, transcription outsourcing, marketing, and more, which would otherwise not be possible under the PEO model.
  • Other business process outsourcing (BPO) companies are also putting pressure on the PEO space by selling PEO options. This is due to the attractive margins resulting from “hidden expenses in fees paid along with payroll and payroll taxes.”

Threat from Other Providers of HRO

  • PEOs also face competition from providers of human resource outsourcing. While a PEO acts as a co-employer of the SME, taking over the entire HR responsibilities, an HRO set-up offers flexibility, allowing the employer to choose the services to outsource “while retaining control of major HR management and admin decisions.”
  • The HRO market is forecast to grow between 2020 and 2025, fueled by small and medium-sized enterprises seeking HR services “to manage their administrative tasks in order to have economic and operational benefits.”

Threat from HR Consultants and Benefits Brokers

  • Small and medium enterprises would prefer to hire HR consultants and benefit brokers to assist with some administrative functions handled by PEOs.
  • An HR consultant will help set up the firm’s HR infrastructure, including “drafting a mission statement, employee handbook, policies, offer letter templates, and other considerations such as how to designate employees as exempt or non-exempt.”
  • A benefit and payroll broker will help with setting up “online enrollment and payroll services with minimal paperwork at a reasonable price.”
  • The PEO space will experience increasingly stiff competition from the HR consulting market. A study by Technavio predicts an annual growth rate of 6% into 2021, fueled by small businesses opting for HR consultants instead of complete PEO services.

Threat from Increasing Adoption of HRMS and Ben Admin Among SMEs

  • According to Research and Markets, there’s increasing adoption of HRMS among small and medium firms to effectively manage their core HR, talent management, recruitment, workforce planning, analytics, and reduce “the burden of carrying out administrative tasks.”
  • Grand View Research supports this notion, suggesting that the adoption of HRMS among SMEs will continue rising as a result of the availability of cloud technology, allowing these firms to adopt “HRM solutions at reasonable prices without the need for constant upgrades or replacements of systems.”
  • The Ben Admin space is also predicted to grow during the period 2019-2024, according to Planet Market Research. Some key industry players like Gusto are focusing on Ben Admin for SMEs with aggressive pricing to gain market share.
  • As a result of the growth in the HRMS and Ben Admin markets, fueled by increased adoption of SMEs, the Professional Employer Organization (PEO) space will increasingly experience stiff competition from these services into the future.

COVID-19 Impact

Following the COVID-19 crisis, the US Professional Employer Organizations (PEO) industry experienced a decline in industry revenue, corporate profits, and service programs/industry establishments. Individual companies such as Insperity and WageWorks suffered a decrease in earnings and disruption of service programs, respectively.

Decline in Industry Revenue

  • An IBISWorld research states that “the COVID-19 (corona virus) pandemic has led to conditions that have had a negative effect on market conditions and demand for industry operators. Furthermore, restrictions resulting from efforts to address the pandemic disrupted employment globally, negatively affecting industry operators”.
  • According to the report, the US PEO industry will see a 9.4% decline in revenue as demand shrinks following the effects of COVID-19.
  • The decline in demand comes about even as unemployment rates are expected to increase to 176% this year.
  • An example of a PEO serving SMEs in the United States that has been affected by COVID-19 is Insperity. While announcing its second-quarter earnings for 2020, it noted that “the average number of worksite employees (“WSEEs”) paid per month decreased by 1.8%, due primarily to layoffs in the client base associated with the COVID-19 pandemic.”
  • The decline in paid worksite employees contributed to the 5% decline in revenue compared to the second quarter of 2019.

Decline in Corporate Profits

  • Operators in the PEO industry (including those dealing with small and medium enterprises) are expected to experience a 25.1% decline in corporate profit as the number of businesses in the United States shrink by 2.3% following the impact of COVID-19.
  • Following the effects of the COVID-19 pandemic, Insperity’s operating expenses increased by 9% in 2020 compared to the second quarter of 2019. This is expected to cause a decline in the company’s profit margin.
  • According to general insights on the business landscape across various industries (including the PEO industry), declining profits will be part of the new normal in the post-COVID-19 era.
  • Most, if not all, of the industry operators in the PEO industry, depend on staffing levels as they derive their fees on a per worksite employee per month basis. As small and medium enterprises continue to lay off their staff following COVID-19 effects, they are set to register even lower earnings in the immediate future.

Decline in Service Programs and Industry Establishments

  • Furthermore, IBISWorld reports that industry operators’ declines will further cause a drop of about 3.9% in industry establishments in 2020.
  • Some industry operators like WageWorks had to withdraw some of their services/programs following COVID-19. Specifically, the company withdrew its WageWorks Commuter Card when Uber and Lyft removed UberPool and Lyft Line options from their apps due to COVID 19 impact in the US. Following the action, several service users have been forced to seek alternative ways to meet their commuter needs.
  • With the restrictions and control measures that saw many companies have their employees work from home, many industry operators in the PEO industry had to put a hold on project establishments planned for 2020.

Additional Insights

  • Just like in the case of many other companies, operators in the PEO industry had to adjust quickly to the restrictions that came with the COVID-19. Insperity, for instance, transitioned to a work-from-home model to protect its employees and their families.
  • Some industry operators such as Insperity also had to effect policy changes to accommodate their clients amidst the changing face of operations and impending disruptions as the corona-virus continued to hit.
  • Insperity had to alter and modify its internal systems, especially with how they attended to clients and, most importantly, their reporting procedures to have a clear picture of how their clients were coping with the COVID-19 crisis.

Uptake Rates

Around 15% of all businesses with 10 to 99 employees enlisted the services of PEOs in 2018.However, only 0.58% of all SMEs in the United States used PEOs in 2018.

PEO Uptake Rate for SMEs

  • There were 907 PEOs in the United States in 2018, which served 175,000 small and mid-sized businesses.
  • Around 15% of all firms in the United States, with 10 to 99 employees, were served by the PEOs.
  • PEOs employed 3.7 million people across all industries in the United States. It is imperative to point out that the number of people used by PEOs grew at a compounded annual rate of 8.3%.
  • In 2019, there were 30.7 million SMEs in the United States, while in 2018, there were 30.2 million SMEs.
  • According to Genesis HR solutions, PEO clients come from all industries and businesses, including accounting firms, high-tech companies, small manufacturers, doctors, retailers, mechanics, engineers, plumbers, and NGOs.

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