Insurance within the PEO model
How important is the insurance component of the PEO offering? Very important. The market share for PEO is drastically higher than ASO. The main driver behind the market share differential is insurance. There are numerous examples of how the insurance offering helps drive business growth within the PEO model. This article will cover a few of these examples to explore how insurance affects PEO growth and profitability.
Insurance plays a vital part in the sales cycle of PEO business. An insurance renewal date puts a finite timeline on an SMB’s decision-making process. If a prospect has a WC or Health Insurance renewal date of January 1st, a decision must be made prior to that date. Without insurance renewal dates, the PEO sales process would be longer. It would be an open-ended proposition without a forced date for decision making. Insurance is an integral part of the PEO offering. The PEO benefits by having a built-in decision deadline with each SMB to help shorten the sales cycle for procuring new business.
Many PEOs have achieved economies of scale. As a result, they typically have the buying power to procure goods (like insurance) at better rates than smaller organizations (i.e. SMBs) due to scale. Assuming the PEO has appropriate controls in place to mitigate certain liabilities with insurance, it creates favorable pricing elasticity for the PEO. In other words, the PEO may be able to increase its margin by running a clean insurance program. Let’s look at an example for additional color on the subject.
In this example, we’ll assume that through the standard market, the prospect has an average WC rate of 5% with a WSE payroll of $1M. This equates to a WC premium of $50K. If the PEO is operating on a high-deductible WC program, and managing the program efficiently, it may come in at a premium of $35K. Assuming the SMB has 25 WSEs and the PEO charges $1,200 per head annually in administrative fees, all in the client would pay $65,000 for the PEO program. Of course, the PEO may have ancillary profit pools beyond WC and admin but for the sake of focusing on insurance in this article, we’ll just focus on the insurance impact of profitability. In this scenario, the SMB would only need to pay $15K more for the full suite of PEO services, inclusive of insurance, than solely procuring just a WC policy. When other factors are considered, i.e. payroll service charges if the SMB didn’t go with the PEO, the costs between the two options narrows. If the PEO did not offer an insurance platform, i.e. an ASO model, their cost to the SMB would be $30K, which doesn’t include insurance. This is why, when we have reviewed ASOs, we typically see lower admin margins than with PEOs. The ASO does not posses the same insurance lever to off-set administrative fees with insurance savings and many opt to reduce admin fees to secure new business.
A PEO provides a greater ROI than a stand alone insurance policy. If a PEO has a solid value proposition, it doesn’t need to beat the standard market on price as the PEO offers more. However, when a PEO is completely out of the ballpark of private insurance carrier pricing, it will likely impede new business growth. Bottom-line, when an insurance program is effectively managed by a PEO, it has greater flexibility with client pricing, but the PEO should not discount the value of its service offering in its pricing.
Insurance vehicles can provide profitability levers for a PEO. Keep in mind however that the door swings both ways on these profit pools. Superior client selection, risk mitigation, and claims management will increase a PEO’s profitability. The opposite creates an adverse scenario that could ultimately bankrupt the PEO. If a PEO operates on a high-deductible program and remits 30% of manual premium to the carrier in fees, it has a 70% pool to pay out claims (assuming it is charging its clients the manual rate premium). This means that if the ultimate losses come in under 70%, the PEO creates profit in its loss fund. If the losses are higher than 70%, the PEO looses money. If the PEO charges its clients higher than manual rates for WC, it creates additional profit. The ultimate loss ratio (ULR) is the indicator on how the PEO is trending with its insurance platform. For health benefits the medical loss ratio (MLR) is the benchmark for performance. Favorable loss outcomes don’t solely help a PEOs profitability today. Favorable loss ratios lead to future favorable pricing with PEO carriers. This allows the PEO to be more competitive, when appropriate on future deals, which can help drive revenue growth.
2014 was a big growth year for the PEO industry as noted in Figure 1 of our recent industry statistics article. This spike of 17%+ was largely due to the ACA compliance requirements for SMBs pertaining to health insurance. PEOs whom were well positioned to assist SMBs with compliance captured higher market share than in previous years. With PEO client retention hovering between 88% and 90% on average, any spike in revenue growth typically remains with the PEO for years. Any regulator shift which requires SMB compliance typically bodes well for the PEO industry. In 2014, it was regulatory requirements surrounding health insurance that helped bolster growth for the industry.
Health insurance has been on a steady rate of inflation. Workers’ compensation insurance is more cyclical in nature. Each state will have cycles with workers’ compensation volatility (i.e. hard market and soft market). Certain states like California and New York are more prone to higher undulation in these waves whereas other less volatile states have ripples in lieu waves. PEOs with a well-managed WC book can capture increased market share during hard markets. A smart PEO will not chase the rabbit all the way down the hole during a soft market but rather emphasize its value differentiation to retain clients. Moreover, on a long enough timeline, the PEO creates an element of predictability with the SMB’s overhead by removing much of the undulation of cyclicality. If a client is performing well, from an insurance perspective, while at the PEO, it should experience less peaks and valleys than if the SMB was in the standard market.
A PEO of scale will almost always have claims management redundancy. What does this mean? The PEO will hire internal claims adjusters or liaisons to oversee and work with the claims adjusters at the carrier and/or TPA. These claims liaisons focus on helping the claims adjusters close claims out at a lesser cost and/or shorter timeline. As a result, the ULR for the PEO, when the book is managed appropriately, should be at healthy levels. Moreover, a material portion of the PEO’s profitability hinges on effective claims management and loss mitigation. Therefore, the PEO is incentivized to help its clients reduce claims exposure and cost, in order to maximize the PEO’s profitability. The byproduct of this model is that the client should experience favorable claims trending while with the PEO, assuming the PEO’s value proposition is appropriate and the client adheres to the PEO’s guidance for claims mitigation.
While there is certainly more that we could cover on this subject, this should be sufficient to illustrate why insurance is an important factor within the PEO model. Ultimately, insurance provides a finite decision-making date in the sales process, it creates pricing elasticity to be utilized when appropriate, it creates additional profit pools when the book is managed effectively, it can lessen cyclicality for SMB clientele, and it creates opportunity for PEOs to capture increased market share with insurance related compliance initiatives (i.e. ACA).
Insurance should not be the only element that a PEO sells on, but it is an important factor within the equation.
Rob Comeau is the CEO of Business Resource Center, Inc., a business consulting and M&A advisory firm to the PEO industry. Comeau has reviewed the impact of insurance on the PEO model through work experience, research, acquisition due diligence projects, consulting projects, and statistical analysis. To contact Rob, you may email him at firstname.lastname@example.org or visit BRC at www.biz-rc.com.