Professional employer organizations

In a tight labor market, employers pay closer attention to any mechanism that may provide a competitive advantage in employee recruitment and retention. Small

More and more, small businesses in Texas and around the country lease employees from professional employer organizations (PEOs, or, in legal parlance, license holders). A typical staff leasing arrangement involves three discrete entities: the PEO company, a client company, and employees. By definition, staff leasing is an "arrangement by which employees of a license holder are assigned to work at a client company and in which employment responsibilities are in fact shared by the license holder and the client company"1

Neither temporary help firms nor independent contractors, PEOs lease employees over the long term, and these employees comprise a majority of all employees at the client companies. The PEO and client company allocate some and share other employment responsibilities under the contractual arrangement, with the client company retaining essential management control over the end product of the work performed by the employees. Essentially, the client company provides day-to-day supervision and management of employees. The PEO assumes responsibility for a wide range of employer responsibilities and risks and is the legal employer of record for purposes of payroll tax, benefits, and administration.

The Evolution of the PEO Industry

The growth of the PEO industry gained momentum about 25 years ago when provisions in tax and pension laws made employee leasing very attractive to the owners of small businesses and professional practices.2 Employers could offer tax-advantaged pension benefits to their owners, while segregating non-owning employees into a separate pool, which provided fewer benefits. Subsequent changes in federal legislation basically eliminated those loophole provisions.

A second growth spurt in the mid-1980s was based on economies of scale in buying health and workers' compensation insurance. Coverage was expanded to larger numbers ofemployees, and client companies reduced their costs through the bulk purchasing process. This phase eventually fell prey to imprudent self insurance and risk management practices on the part of several large leasing companies, leading to the failure of several staff leasing companies and blemishing the entire industry.

The current growth surge began in the early 1990s. Characterized by increased professionalism and less risky business practices, the industry has also seen increased regulation by federal and state governments. PEOs now use economies of scale in human resource management and employee benefits. Several other advantages include improved fringe benefits, expertise in benefits administration, and assumption of an administrative function that has become increasingly complex because of employment regulation. PEOs offer a compelling option forthe increasing number of small and medium-sized enterprises.

PEOs in Texas

Although still in its infancy, the PEO industry in Texas continues to grow at a healthy rate. Key findings from a recently completed baseline study of the industry within the state included:

* From 1994-1998, the number of client companies increased by an average of 21 percent annually. Although rather uneven, employee growth in that period averaged about 9 percent annually. (See fig. 1.) PEO employees represent approximately 1 percent of the total workforce in Texas.

* About 70 percent of all PEO employees work in the largest six counties in Texas, with Houston (Harris County) and Dallas claiming more than 40 percent. Growth by county from 1994-1998 has been the greatest in El Paso, followed by Dallas. (See fig. 2.)

* PEO employees cluster by industry: in 1998 the top three Standard Industrial Classification (SIC) categories--business services, construction trades, and health-- composed nearly half (45 percent) of all employees. Recently, however, significant growth has occurred in wholesale trade, real estate, and, the most rapidly growing industry, eating and drinking establishments, indicating that the trend is veering away from concentration.

* According to a survey of Texas-based companies completed in late 1999, nearly all PEOs provide their client companies with assistance in the development of personnel policies and procedures. Also, nearly all PEOs provide coverage for workers' compensation, health insurance, and life insurance. A slightly smaller proportion, but still a large majority, provide vision insurance, disability insurance, and direct payroll deposit. About half of the PEOs offer employee assistance programs, access to a credit union, recruitment, and placement. Other services and activities, provided by some PEOs, include pre-employment testing and assessment, affirmative action plans, and training and staff development.

Current Outlook

While the number of covered employees and the range of services have increased over the past five years, the number of PEOs in Texas has decreased and will likely continue to decline as the relatively fragmented industry undergoes consolidation. Several of the larger organizations may purchase niche PEOs. Smaller PEOs will exit after determining they cannot achieve the requisite size to provide services in an industry that exists on thin margins. The remaining PEOs appear poised for at least continuing, if not accelerated, growth. Electronic transactions will enable the industry to become more dispersed geographically, and PEOs are penetrating further into new industries within the state, thereby opening up new opportunities.

Growth will be driven both by the productivity increases derived from economies of scale and by the expertise of PEOs in human resource administrative practices. Providing a tail wind for the industry will be continued outsourcing, a tight labor market, new fringe benefits, and a general trend toward more complex human relations statutes. With reasonable state regulatory policies and increased professionalism by the PEOs, this industry should continue to benefit employers and employees alike in coming years.

Acknowledgements: The author wishes to thank Carl Kleimann, former president of the Texas Chapter of National Association of Professional Employer Organizations, for his insights and assistance with all aspects of this research. Assistance also was provided by Ben Campbell, consultant Mike Marks of the Texas Chapter; and Dede McEachern of the Texas Department of Licensing and Regulation.

For more information:

Texas Chapter of the National Association of Professional Employer Organizations, 823 Congress Avenue, Suite 1300, Austin, TX 78701. http:// www. texaspeo.org

Texas Department of Licensing and Regulation, P.O. Box 12157, Austin, TX 78711. http://www napeo.org/ (National Association of Professional Employer Organizations)