Professional employer organizations (PEO) may lead workers compensation to InsurTech

The history of professional employer organizations’ (PEO) involvement in workers compensation has been fraught with bad actor scams1 and insurance company insolvencies2. Now, through the rise of technology and the prevalence of PEOs in the workers compensation market, companies may see truly useful transformation within traditional workers compensation models.

PEOs and workers compensation insurance regulation

Ever since the creation of workers compensation insurance more than 100 years ago, nearly every employee in the United States has been insured for workers compensation through a policy issued to the employer by a regulated insurance company; the amount charged for that coverage has also been regulated. Due to the perceived randomness and long-tail nature of workers compensation claims, as well as the small sample size of any individual employer, state mandated rates for each employer were based solely on the employer’s industry classification. The rigid assumption that the amount of claims incurred by an individual employer does not impact rates has become relaxed throughout the years due to the regulatory approval of experience rating, retrospective rating and large deductibles. Currently, there is much variation in regulated rates within employer classification codes, but the regulated rates still do not reflect all differences in expected losses. Through increased use of self-insurance (e.g., large deductibles), many employers are now able to retain more workers compensation risk than what was possible in the early years of workers compensation.

History of PEOs

PEOs are organizations that assist their clients with human resources and employee benefits, including workers compensation insurance. These institutions assist with workers compensation by taking responsibility for their clients’ obligations to provide this type of insurance, essentially becoming the statutory employer (see chart below). The term PEO, however, did not always exist. Initially, staffing agencies realized they could buy workers compensation insurance based on the staffing agency employer classification code, even if their employees were staffed in an industry with higher risks. These so-called temporary staffing, or employee leasing agencies, sold their services on the basis of being able to pass through a much reduced workers compensation cost to their clients. Despite the lower rates the staffing agencies were continuing to pay, their policies were covering the operations of their new higher risk clients. As a result, the mandatory rates were inadequate and a regulated workers compensation insurer was footing the bill.

As these early PEOs flourished and grew, insurer insolvencies resulted. There were many loopholes in the rate regulation system, bad actors in the PEO industry and an overall resistance to being classified as something other than a standard temporary employment agency. All of these factors allowed this behavior to continue for many years before insurance regulation caught up.