PEO Valuation: Liability Legality and Loss Ratios

PEO Valuation: Liability, legality and loss ratios. Determining risk factors in the valuation of a PEO.


  1. How do you define Loss Ratio?

    I have seen it most commonly expressed as Incurred Losses / Premiums Earned but have also seen it as Incurred Losses / Payroll. Does it make sense to look at this ratio as Incurred Losses / Payroll?

    Also, what would you say is a strong Loss Ratio for a PEO?

    1. Hi Dan, good questions. A loss ratio on a guaranteed cost plan can be defined as incurred losses / premiums earned. However, on a high deductible program, I would define it as incurred losses / manual premium since a PEO only remits a portion of the premium collected to the carrier since the PEO itself is taking on claims risk with a deductible in place. I personally don’t think it makes sense to look at loss ratios as a percentage of payroll. However, it is all relative considering that premium is charged on a percentage of payroll.

      For example:

      $50K in payroll X 5% WC rate = $2,500 in premium.
      If the client had $500 in losses, the loss ratios would equate to:

      Loss ratio (incurred / premium): 20%
      Loss ratio (incurred / payroll): 1%

      If the losses remained at $500 and the payroll doubled to $100K, the following would be true:

      Loss ratio (incurred / premium): 10%
      Loss ratio (incurred / payroll): 0.5%

      So regardless of what you use, your ratio will fluctuate commensurately. From my experience, the majority of the market uses incurred / premium.

      An acceptable range in the PEO industry would be a raw loss ratio between 30% and 45% with a total developed loss ratio between 55% and 70%. Keep in mind that when reviewing loss ratios for a PEO on a high deductible program, deductible payments must be factored in to view the true loss ratio.

      Also, when reviewing high deductible workers’ compensation programs within the PEO industry, be sure to be cognizant of the following variables:

      – Deductible amount
      – Deductible payment structure
      – LDF
      – Collateral Requirements
      – PEO WC pricing to clients
      – Workers’ comp tail
      – Average timeline for claims closures (how long due claims remain open?)
      – Percentage of lost time claims
      – Litigation percentage
      – Average number of days off work for lost time claims
      – There is more, but this will get you started.

      I also like to look at claims concentrations. This could take form in geography, clients, business units, industry, class code, repetitive claimants, etc. Miliman has a great predictive analytics tool that can help with some of the information in this area.

      Hope this helps answer your questions Dan. While my firm does WC analysis and risk mitigation strategy as part of our consulting and due diligence offering, I’m happy to refer your PE to some experts who solely focus on workers’ compensation within the PEO industry at your request.

      Take care,

      Rob Comeau

Leave a Reply

Your email address will not be published. Required fields are marked *