A PEO’s Field of Dreams – Insurance Program Structure

by Frank Huang | February 15, 2019

Every time I attend a professional sporting event, I am always in awe of how pristine the playing surface is. The professional athletes who play on these surfaces are probably used to these conditions which allow them to compete at the highest level. But what if you told two NFL teams that instead of competing in one of their home stadiums, they would be competing at a local high school field instead? Do you think there would be any impact on their level of play, or the competitiveness of each team?

The insurance program structure of a PEO is the platform on which PEO departments compete and perform. The selection of the insurance program structure has arguably the greatest impact to each department, and thus the PEO’s success. Through the course of this article, I hope to explain why that is, as well as help readers who may be contemplating similar decisions to discern the right choice for their PEO. Finally, I hope to touch a bit on what captive insurance is and why it may make sense for PEOs.

What is an “Insurance Program Structure”?

Though a bit unwieldy, the terminology I am using is meant to describe the PEO’s philosophy and approach to managing risk – whether workers compensation, health benefits, employer practices, or credit. Each of these traditional PEO risks impact the PEO differently, and are in varying degrees incorporated into the value proposition. Due to these and other considerations, the PEO may take different approaches to each risk, as it sees fit. But what are the different approaches and how can leadership understand at a basic level which approach is optimal for its corporate goals?

Simply put, a PEO is in the business of business risk. One perspective of a PEO’s value proposition is to help manage business risk for their clients so that their clients can manage the business. Because the PEO is actively seeking clients, and thus continuously aggregating risk , leadership must have a way to economically address it.

At a high level, there are two approaches to risk: transfer or retain. To transfer risk completely is to have ground-up insurance coverage for a particular risk, thereby transferring the risk in exchange for a set premium. To retain risk is to forgo paying a premium to an insurance company, and instead utilize all or part of the original premium to pay for the risks that were retained. This approach is often termed “self-insurance”. While full self-insurance is rarely reached and reserved for very large companies, smaller companies can benefit from transferring even some of their risk. In fact, there are three main reasons to move away from being fully insured and towards self-insurance: premium savings, risk appetite, and a stronger value proposition.

Premium Savings. To be fully insured is to enjoy the simplicity of selling and running the business with knowing exactly what your insurance costs will be and without having to deal with administrative hassles or employ insurance industry specialists. However, the cost is in the premium charged, as smaller PEOs have less leverage to negotiate favorable terms. And with worsening or unmanaged claims, premium rates could increase significantly over time. If a PEO retained even some of their risk, the savings generated could be considerable.

Risk Appetite . The second benefit to retaining more risk is that the PEO can theoretically have more control over their program and what types of risks to write. When a PEO is fully insured, they are more subject to the insurer’s risk appetite and cannot write business as freely as they might prefer. (Or they can but they will be charged rates that are unworkable.) Taking on more risk allows the PEO to move towards having greater control over its own risk profile which allows greater freedom and flexibility to achieve growth and market goals.

Stronger Value Proposition. The final benefit is that the premium savings and greater control of a PEO’s risk profile both strengthen the PEO’s value proposition.

When a PEO presents to a prospect, a fully insured program does not contribute much to making a PEO’s value proposition distinct from another PEO. But with premium savings as proof, the PEO can show the prospect that it has a track record of helping employers in the same particular space. The lower price alone may sway some prospects, but the cohesiveness of the story strengthens the value proposition.

Before wrapping up, I would be remiss if I did not touch a bit on captive insurance.

A Captivating Arrangement

A captive is a common vehicle for those somewhere on the fully self-insured side of the spectrum. Though captives can take on a variety of forms, they all essentially serve as the PEO’s own insurance company. So rather than pay premium to insurer XYZ you can pay that premium to the captive which will not only cover claims, but also remain to provide additional cover for subsequent policy years. Many of the same benefits noted above with greater retention of risk applies to captives as well – for example, the ability for a PEO to write risks that an insurer would not. There are also benefits unique to captives, such as tax advantages on premiums and claims paid. A full discussion of captives and their benefits to the PEO is outside the scope of this article, but may be a topic of a future article.

Wrap Up

Even if you aren’t ready to move towards taking more control over your risk profile and risk program, hopefully you can see the benefits available to PEOs through such an approach, and especially through the use of a captive. The right decisions here can truly improve the playing field for all PEO departments.

Take-Away Questions

1. What rationale(s) led to your current insurance program structure?
2. Which of the benefits of retaining more risk is most appealing to you: Premium savings? More control over risk appetite? Stronger value proposition?


Frank Huang has more than 15 years of actuarial consulting experience serving a wide range of clients, including serving as ADP’s Chief Actuary.  Learn more about our PEO consulting practice here.