Does Zenefits need to join a PEO?

A December 3, 2015 article in the Wall Street Journal discussed HR troubles at the high flying VC darling, Zenefits. From the article it appears that fast growing Zenefits has run afoul of California Department of Industrial Relations regarding unpaid wages. Claims have been made that Zenefits failed to pay employees for unused paid time off and for overtime. Some California employees were offered up to $5,000 to sign a waiver releasing Zenefits from all future claims. WSJ article link (subsciption required).


Exempt vs Non-Exempt Workers Reclassification
One of the claims made was that certain employees had been classified as “exempt” and later had their status changed to “non-exempt”. While classified as “exempt” those certain employees were not paid overtime and were prevented from taking vacations. Part of the dispute involves going back and calculating the compensation what should have been paid had the employees been classified correctly in the first place. The Zenefits case demonstrates that declaring workers as “exempt” to avoid overtime payment requirements can be a costly mistake.

Paid Time Off Troubles
In addition there were claims that Zenefits failed to pay employees for unused paid time off (comp time) as required under California law. According to the WSJ:

“A copy of the company’s employee handbook dated May 2014 that was reviewed by the Journal states clearly that employees would accrue vacation at a rate of three days a month up to 10 days a year. It also stated that “on termination of your employment you will be paid for all accrued but unused [paid-time off]. New employees were required to sign the handbook, says a person familiar with the matter.In March 2015 the handbook was updated to reflect a new, unlimited vacation policy, but under California law Zenefits still would have owed employees for vacation previously accrued. Startups often run afoul of labor and other rules early on. Zenefits stands out because its employee base has expanded far faster than most other startups. By the fall of 2014, less than two years after it started, Zenefits had 400 employees. A year later, it has quadrupled that number to around 1,600.”

Comparing the Zenefits Business Model to Professional Employer Organizations

Zenefits has gained attention by essentially being an insurance broker (for workers’ comp, health insurance, supplemental insurance, etc) and earning revenue from the insurance commissions. Their niche is that in return for naming them the insurance agent (and getting the commission revenue), they offer businesses customers free access to HR information systems and payroll services. This model has been around for years and is known as an Administrative Services Organization or ASO. ADP and Paychex have been two of the more well-known payroll service bureaus that have recognized the revenue potential from business insurance products and have been working to bundle those products to their payroll services. Because Zenefits is selling insurance products as bundled part of its product suite there have been challenges with meeting each states requirements for Zenefits sales staff to also be licensed as insurance agents/brokers in the state. An article at Buzzfeed reviewed some of the challenges they are facing with insurance licensing. PEOs do not typically “sell” insurance, rather they allow their members companies (and their workers) to join their workers comp, health insurance or other policies.

The Big PEO Difference – Risk Shifting
Compared to an ASO like Zenefits, PEOs offer an important additional service suite… ensuring regulatory compliance and reducing regulatory risk.

What is Regulatory Risk?
Regulatory risk is the financial risk to a company for being non-compliant with employment related rules and regulations. The employee mis-classification problem is just one risk in a sea of employment related icebergs. PEO have significant in-house expertise regarding legally compliant HR practices and they apply that expertise for their member/client companies in a way that an ASO usually does not.

Companies that join a PEO are implementing HR practices that are legally compliant and defensible in the event of claims by employees or regulators like the Department of Labor or any other federal or state agency regarding their employment practices.Companies that join a PEO (rather than hire an ASO) implement a co-employment model between their company and the PEO. This arrangement not only reduces regulatory risk but also shifts that risk to a third party, the PEO. Shifting risk always has a cost and PEOs will necessarily charge fees to cover those potential costs. Like any insurance… it’s a bet. A regular monthly insurance premium cost reduces the financial impact when something bad happens. Think of PEOs as employment practices business partners and insurance against employment related regulatory risk.

image courtesy of Axlon23 at Flickr