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PEOs and Employee Leasing

What exactly is an employee leasing arrangement? Generally speaking, an employee leasing arrangement is one in which a professional employer organization (PEO), also known as a labor contractor or an employee leasing firm, takes over various personnel and related administrative responsibilities of an employer’s existing workforce. The employees are leased back (services provided) to the original employer’s business. (A more specific definition will be discussed at [“The Hidden Uninsured Piggyback Leasing Firm”).  For the remainder of this discussion, the original employer will be referred to as the client (of the leasing firm). Legally speaking, under the special employer doctrine, the leasing firm becomes the general employer whereas the client remains the special employer.

Insurance Code 11663 apportions liability when both general and special employers main- tain workers compensation coverage. The insurer covering the liability of the general employer (leasing firm) is liable for the entire cost of compensation payable on account of injury occurring in the course of and arising out of general and special employments unless the special employer (client) had the employee on his or her payroll at the time of injury, in which case the insurer of the special employer is solely liable.
Usually, the client assumes that he or she (or it if a corporation) has no further obligation to provide workers compensation insurance to the employees, especially since the leasing firm’s fee includes charges for that cost. This is only partially correct. Labor Code 3602(d) permits an employer to:

"secure the payment of compensation on employees provided to it by agreement by another employer by entering into a valid and enforceable agreement with that other employer under which the other employer agrees to obtain, and has, in fact, obtained workers compensation coverage for those employees. In those cases, both employers shall be considered to have secured the payment of compensation … and the coverage remains in effect for the duration of the employment …"

Hence, an employee leasing arrangement to obtain workers compensation insurance is perfectly legal—with the caveat noted in the next paragraph—but potentially highly risky. Any employer entering into a leasing arrangement remains potentially liable, not just for workers compensation benefits if the leasing firm does not provide coverage, whether through failure to purchase insurance or should its insurer become insolvent, but for the severe legal penalties of having no workers compensation insurance. As discussed in ]“Claims under the Employer’s Nonleasing Policy”[, if the staffing company’s insurer becomes insolvent and the employer-client has no independent coverage, it will be illegally uninsured. If it does have other coverage, its insurer—not the state guarantee fund (CIGA)—will be responsible for the claims.

Accordingly, it is essential that employers in leasing arrangements ensure that the leasing firm actually does maintain workers compensation insurance through sound insurers licensed to provide such insurance in California. ]See “‘Sovereign Nation’ Occupational Injury Insurance.”[

Labor Code 3602(d) prohibits this arrangement if the agreement is made for the purpose of avoiding an employer’s appropriate experience rating. ]See “Experience Rating Subter- fuge” in section 6.I.[ Experience rating rules require that an employer’s experience mod- ification continue to be applied under a separate policy in an employee leasing arrange- ment. ]See “Premium Discount.”[ Separate policy requirements, amended effective July 1, 2005, are discussed under “Rule Four,” below.

May a PEO self-insure for workers compensation in California? Yes; as of February 2006, at least two such firms were listed on the Department of Industrial Relations’ roster of private firms licensed for individual self-insurance ( PrivateRoster.pdf).

Labor Code 3602(d) permits an employer to “secure compensation” by arrangement with another firm that “obtained workers compensation coverage.” “Coverage” usually refers

to insurance coverage. Arguably, a licensed self-insurer has not obtained “coverage” but rather alternatively “secured compensation” through self-insurance. This argument would further point to the statute’s uses of the broader “secure compensation” language when it intends to include self-insurance, and therefore that “coverage” does not do so. The logical conclusion of this argument would be that an employer has not satisfied its obligation by contracting with a legally self-insured employer.

Given the existence of the self-insurer’s insolvency fund, the better argument is that con- tracting with a permissibly self-insured PEO constitutes “coverage” and satisfies the em- ployer’s obligation to “secure compensation.” However, an employer contracting with a self-insured PEO may wish to obtain a legal opinion confirming this and/or an advisory opinion from the Department of Industrial Relations.


Published: Friday, March 7, 2008
Last updated: Sunday, February 26, 2012
By: Arthur J. Levine, Ph.D.

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