PEO Pricing: Strategic Pricing for Long-Term Profitability

by Frank Huang | February 15, 2019

One of the most common things a new client asks us to help with is to revamp their underwriting and pricing models. Obviously, the two go hand-in-hand, as underwriting and pricing decisions both utilize overlapping data sets like claims experience, experience mods, underlying exposures, etc. I originally wanted to write about pricing in the underwriting section, but I waited until now so that the reader (who hopefully read the articles sequentially) can first understand all the different risk program functions, and then see how pricing – like underwriting – can be so much more than what is usually done.

Different Strokes

A PEO may think of pricing like many of us think of filing tax returns – as a burden to be completed as soon as possible instead of as an opportunity to maximize return. The typical approach is to find the highest acceptable price the client is willing to pay and close on the deal rather than charge an optimal amount based on a variety of factors. Not only is this not optimal, it is not sustainable long-term.

Most PEOs can and will do better. They will look at the prospect’s experience and exposures, try to conceptually forecast what the prospect’s experience would be, and then determine a price. The goal is to improve top line growth but not at the detriment of bottom line growth or the risk program. This is a much better approach.

Some PEOs take it one step further. They price based on the prospect’s experience, but also compare against other indications. They may utilize home-grown or third-party analytics to expedite processes and decisions. The goal is to improve top line growth and maximize margins. But even then, there is much room for improvement.

Quantum Leap

To take a Scott Bakula-sized leap forward, PEOs need to look not just at present concerns – like what price to charge to close this deal – but also at future concerns. While there are many variables to ensure proper pricing, there are two big-picture concepts PEOs could benefit greatly from if considered.

The first is to consider the lifetime value of a client rather than the profit from the first year. From this perspective, a PEO can see a client as a series of cash flows over time, and the longer the series the more value that client has to the PEO. This speaks to the insurance adage that renewing existing business is always less expensive than acquiring new business.

The second concept appends nicely to the first. While a client’s value to the PEO can be viewed as a series of cash flows, the actual amounts of those cash flows may change over time, especially if just viewing margins. This concept is arguably the most complex, as there are a variety of reasons why revenue and cost may change over time. While fully discussing this is outside the scope of this article, it is imperative that PEOs price in consideration of all such factors so as to maximize both the number and magnitude of those cash flows. I anticipate that PEOs who implement these ideas into their pricing will derive a sizeable competitive advantage against their peers, much like what early adopters within the personal lines insurance market achieved through using predictive analytics to improve their pricing.

The Wonder Years (Wrap Up)

Pricing properly is scary, as most PEOs probably see their growth and are satisfied with it. Why fix it if it ain’t broke? But with strategic pricing, the best years of a PEO are all ahead.

Take-Away Questions

1. Which one of the hypothetical PEO pricing strategies most closely resembles your company?
2. When was the last time your firm made significant improvements to its pricing model?
3. What was your favorite 1980s TV series?

 

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