Case Study: Creating a national health portal for employees.
An outsourcing partnership delivers e-health portal to Northrop Grumman employees in all 50 states.
Following 16 major acquisitions since 1994, Northrop Grumman, the second-largest defense contractor in the United States, had grown from roughly 40,000 employees to 120,000. Along the way, we also inherited nearly 350 different health and welfare plans and 16 different pension plans. And, although we have been outsourcing a significant portion of our administration for the past 10 years, we did not bring all of our acquisitions together onto one common administrative and design platform until recently.
The catalyst for this consolidation was our 2001 acquisition of Litton Industries. We used this acquisition as an opportunity to redesign all of our benefit programs for several reasons. First, we hadnt redesigned most of our programs for several years and were facing pension issues. And, as we realigned newly acquired employees into different areas within Northrop Grumman, the benefit programs needed to make more sense across the entire company.
Integrating our acquisitions gave us the opportunity to redefine health care at Northrop Grumman. This was a huge undertaking that required a threepronged approach: plan redesign, health care resources, and engaging our leadership and employees from the beginning. Because of the magnitude of the task, we couldnt do it alone. We needed the help of our main outsourcing vendor, Towers Perrin, an HR consulting and administration services firm, to actually make it all happen.
Integral to the changes we were making, and a key piece that we outsourced to Towers Perrin, was the creation of a Web portal to promote health care consumerism (which has the potential to help stem rising health care costs.) We looked at consumerdirected health plans but realized they would only touch those employees who selected them. We wanted to provide health care tools and resources for all of our employees. One of our key messages was that health care was changing dramatically. For employees, the message was that, whether or not we took all of these 350 different health and welfare programs and merged them into one, we were still going to have to address health care cost increases.
In making the decision to outsource the e-health portal, we recognized both the complexity of the task as well as the fact that we were still in the process of implementing our redesigned flexible benefit, recordkeeping, and defined benefit programs. We chose Towers Perrin, in partnership with WebMD, a leading provider of Web-based consumer-focused health care information, because we believed that they would be able to provide us with a solution that would meet our needs.
With our input, Towers Perrin developed an entire health online strategy for Northrop Grumman. They delivered an e-health portal that contains all of the critical health care information needed to help our employees become better health care consumers. Those resources include Health Online, a medical plan comparison tool, online open enrollment, and care management.
In early 2003, we introduced our new Web site NG Benefits Online to our employees, following an intensive communication effort. Through NG Benefits Online, employees can now access a wealth of information and enroll in their benefits with just one click of a mouse. A customized consumerism guide highlights all of the new resources now available.
At Health Online, employees can take a health risk assessment, visit a condition center, maintain their family health records, and use tools to compare drug costs or determine the quality of different hospitals. Care management provides a nurse advice line, a disease and case management option, and a list of centers of excellence. We also use the information employees provide in their health risk assessment to match them with appropriate disease management programs.
We have had very good results to date and view our new e-health portal as an ongoing endeavor to get employees to pay attention to health care costs and their part in managing them. Towers Perrin has provided user statistics that underscore the success of our portal, including the fact that 90 percent of our employees enrolled in their 2004 health care benefits online, 40 percent used the medical plan evaluation tool, and 17 percent registered at Health Online. Based on these encouraging results, we will continue to work with Towers Perrin and WebMD to provide our employees with the best tools to help them become even better health care consumers and managers of their health program costs.
Corporate training and e-learning are poised for a rebound.
Corporate training budgets are notorious for being the first ones to be slashed by organizations in difficult economic times. The last two years proved no exception to the rule, and providers of corporate training services have had to learn new survival skills during dismal years for their industry. For the survivors, though, there is finally some indication that the corporate training market is recovering and is expected to grow robustly over the next several years.
According to research firm IDCs U.S. Corporate and Government eLearning Forecast2004-2007, all three segments of the corporate training market covered in the survey (e-learning, business skills training, and IT education services) should see substantial growth during the next five years. In particular, strong increases in e-learning spending should continue to outpace the already robust growth expected for the broader training market.
Three recent transactions, all taking place within weeks of each other earlier this year, illustrate the different ways in which investors and strategic buyers are placing new bets on the corporate training market.
In January, Chrysalis Ventures led a B-round investment in TechSkills, the Austin-based national provider of IT certification, medical education, and general businessskills training. Chrysalis was joined in this round by OCA Ventures and Tobat Capital, both current investors in TechSkills.
TechSkills is extremely well-positioned to take advantage of the rebound in corporate training spending with an offering specializing in blended-learning solutions that combine instructor-led training with elearning solutions. With 30 learning centers across the country and more than 100 courses focused on skillsbased training or certification, TechSkills clearly hopes to bridge the gap many businesses are expected to face during the next five years as the U.S. educational system comes about 6 million graduates short of the anticipated demand for skilled labor.
INTREPID LEARNING SOLUTIONS
A few weeks later, Seattle-based Intrepid Learning Solutions announced an additional round of investment led by new investor Rustic Canyon Partners. Existing investors Madrona Venture Group, Buerk Dale Victor, and Staenberg Venture Partners also participated in the new round of financing.
Unlike TechSkills, with its proprietary training centers, Intrepid Learning is a provider of outsourced training services who takes over the management of existing corporate training departments for large clients (like Boeing) and applies a proprietary learning delivery system aimed at improving employee performance in a cost-effective manner. This model should appeal to larger organizations that have invested heavily in corporate university models and are now seeking to run these cost centers more effectively.
Finally, in February, publicly-held Phoenixbased Prosoft Training and Berkeley-based Trinity Learning announced that they had agreed to merge their businesses.
The merged company combines Prosofts line of certification products and services for IT and communications professionals with Trinity Learnings current training and certification offerings. Prosofts Certified Internet Webmaster certification program, in particular, is a very well-recognized professional certificate covering IT job-role skills (in Web-site design, e-commerce, network administration, security, application development, and programming) and has been earned by individuals in more than 100 countries.
According to Harvard professor David A. Garvin, an expert on learning organizations, At the core of active learning is a deceptively simple requirement: Students must be personally invested in the learning process. Trinity Learning, Prosoft, and the roster of fund managers who invested in TechSkills and Intrepid Learning are in fact betting that investing with their wallets will bring rewards well beyond sheer learning for their investors and shareholders.
An occasional review of its moving parts is usually a good idea.
Recent scandals — ranging from questionable timing of stock trades to questionable communications to employees about the stability of their 401(k) plan investments — have brought to light a truism that benefits consultants have been gently sharing with plan sponsors for a very long time. Once in a while, just like you and your car, even the most uncontroversial of DC plans needs a check-up.
In technical terms, this check-up would ask, “Are you adhering to your fiduciary responsibilities to plan participants?” In plain English, it asks “Have you or anyone else looked lately to see how your plan’s administrators — i.e., your payroll system, recordkeeper, trustee, and anyone else with their hands on your plan’s data and/or its assets — are doing their jobs?”
Although plan sponsors typically think first of reviewing investment products, the operational review these questions suggest, sometimes called an “audit” (though not at all an accounting function), warrants attention and explanation. Such a review is often inspired by one of three general circumstances:
- preparation for an impending merger or acquisition, where the acquiring or controlling entity wants to confirm the operational stability of what it’s taking on;
- response to one or more major, visible breakdowns in, for example, recordkeeping accuracy, communications, payment timing, etc.; or
- responsibility of management (recognized, documented, and legally required) to monitor the benefits and related services provided to employees, even if nothing in particular has apparently gone wrong.
In other words: this exercise can be defensive, reactive or proactive, any of which is better than it being nonexistent.
There are many behind-the-scenes administrative aspects to DC plans. Some are very technical and some, rather mundane. The failure of any one of them can escalate into costly customer service problems, potentially with legal implications. The fundamental objectives of any operational review are almost always to confirm that:
- the day-to-day operation of the plan is in keeping with its rules (i.e., what is written in the plan document, any formal administrative documentation, SPDs, and any other formal employee communications); and
- no aspect of the plan’s operation is out of compliance with federal law (e.g., IRS contribution and pay limits, permissible hardship withdrawal circumstances, etc.).
While collecting and assessing an adequate variety of tell-tale participant test cases and plan-wide data and documentation to meet those two primary objectives, you might also want to confirm, for example, that:
- participants’ accounts are accurately updated with appropriate investment results;
- deposits into plan assets are correctly timed in relation to corresponding payroll deductions or participants’ instructions;
- the timing and amount of payments to plan participants properly relate to their submitted requests;
- generic and personalized communications regarding any particular transaction — whether on paper, a Web site, or an automated telephone voice response system — are accessible (and helpful) to current and former employees and beneficiaries as soon as they are first eligible to make the transaction or state an interest in doing so; and
- statistical reports provided to benefits management on plan utilization and customer service activity are accurate and informative.
Even if you didn’t have contracts or service level agreements with your administrative service providers, wouldn’t you want an objective appraisal of at least how these aspects of your plan’s operations are working, if not a more in-depth review of data management and customer service? It’s true that technological advancements and growing industry-wide expertise have rightfully led the DC plan administrative function to be taken for granted by many (think “commodity”). However, imperfections in any of the functions listed above can and still do spawn from payroll data problems, complex plan design, and customer service overload.
If identified, these imperfections would not necessarily lead to plan qualification or compliance issues (although they could). But any of them could be signs of potential or actual administrative breakdown and, possibly, someone’s failure to meet their fiduciary obligations to plan participants. If that is happening, or if significant required documentation (or charters or policy statements) turns out not to exist, wouldn’t you prefer to know that sooner rather than later?
Look for the biggest and most effective PEOs to get bigger and more effective.
I have to apologize for leaving you hanging. In the last edition, after a brief history of the PEO and a discussion about their recent success in the public markets, I abruptly ended on a quite cynical (okay, dire) note about the future of the industry. Let me clarify.
I believe the co-employment (i.e., PEO) model will continue to work, and for some, thrive. Administaff, GevityHR, and TotalSource all generate (or are on target to generate) operating profit of $100-200 per serviced employee annually-that is real money to which investors and analysts will attach real value. However, I do not expect the sector to swing back into favor in the eyes of investors, and therefore, I do not expect the area to re-emerge as a booming area within business services. What I do expect is the perception of the co-employment model and possibly the PEO business model to change over the next few years.
The staff leasing (predecessor to the PEO) sector was created as a vehicle for small businesses to obtain cost-effective insurance. The idea was that scale, effective claims management, and the ability (sometimes unwarranted) to assume risk enabled the provider to maintain a lower cost of insurance. When PEOs emerged in the public markets in the late-nineties, the value proposition changed to one of fee-based HRO-much like you would find with ADP in payroll or TALX in automated employment verification. The trend has clearly been to de-emphasize insurance as part of the value. Administaff has always maintained a “white collar” focus within its client base; GevityHR has dramatically lowered its workers’ comp exposure; and ADP-TotalSource spent two years cleansing its worksite employee base. I believe the co-employment models-even the ones just mentioned-remain heavily reliant on the value of delivering cost-effective health and workers’ compensation insurance to small businesses. In other words, a substantial portion of the $100-200 per serviced employee per year comes from insurance-related profits, in my view.
Big problem? It depends. Insurance-related profits can be okay, at least for a while. Clearly, there is value to aggregating employees for distribution efficiencies. Insurance underwriters often struggle with cost-effectively serving the small business market, due to high cost of sales and service, and sometimes adverse selection. As a result, it is not uncommon for the premiums for comparable coverage to be substantially higher for small businesses on a per-employee basis, or for underwriters to actually pull out of some small business markets altogether. If PEOs can deliver small business employees to underwriters at a reasonable cost, value is created. How much value depends on many factors, but a good starting point is the sales commission typically paid to insurance agents. A 10 percent commission rate on health and workers’ compensation combined could produce “value” of more than $500 per employee per year or more-interestingly, this turns out to be the difference in gross profit per employee between a co-employment contract and ASO contract.
Insurance-related profits are bad (unsustainable) when the difference between what the PEO pays for coverage and what clients pay for coverage is simply the result of the PEO absorbing a higher level of risk. This is called insurance arbitrage, and is predicated on the notion that PEOs either do a better job than the insurance company in assessing risk (doubtful!), or believe that they can actually reduce risk (a possibility). Over periods where claims experience is relatively light and abnormally few adverse events occur, profitability may appear extremely high. However, the tables can turn quickly, and PEOs often do not have a strong enough balance sheet to handle a worst-case scenario.
The co-employment model will likely survive, but the perception will undoubtedly change over time. If the value proposition of co-employment is largely rooted in efficient insurance distribution, then the sustainable business models must include size, consistent client selection, and effective management and operations. Due to the complexities of employment and insurance, the PEO business is one of the most difficult to manage. Do not expect to see a line-up of new publicly traded PEO prospects coming out of the woodwork. Rather, look for the biggest and most effective to get bigger and more effective.
Employee incentive programs are increasingly regarded as strategic business tools.
Once treated as little more than freebies with no measurable impact on a companys bottom line, employee incentives are now increasingly regarded as must-have programs, strategic business tools with the power to improve productivity and profits, and especially effective in dealing with a soft economy. The big difference is that now the roi power of incentives can be measured, and it is superb.
The PEO rollercoaster.
Surviving PEOs are bouncing back, but does it mean the industry will do the same?
When I began my career as an analyst in the mid-90s, my first major project was to understand an emerging area that promised to transform small business HR-the PEO. My goal was to figure out whether this would be an investible area. My conclusion? I am still working on it.
For those not familiar with the PEO concept, it is most easily understood from the client perspective. A company outsources their entire HR function and their employees become employees of the PEO for administrative purposes-a co-employment relationship. This offers small companies “big company” benefits. The value proposition is straightforward. The challenge is in managing the risks and the costs- PEOs act as underwriters and distributors of workers’ comp, healthcare, and state unemployment insurance. If the price charged to clients does not cover the losses, the PEO will have problems.
For the first few years, PEOs were a hit in the market. Employee Solutions, Vincam, Administaff, OutSource International, and Staff Leasing took turns in the IPO spotlight. Investor favorites ADP and Paychex paid large sums to buy their way into the business, legitimizing the model. However, investors discovered (the hard way) the difficulty PEOs have in managing risks. Employee Solutions and Outsource International became insolvent-largely due to inadequate workers’ comp reserves and acquisition-related issues. Vincam hit a wall following several acquisitions, before selling to ADP. Staff Leasing imploded more than once after discovering inadequate health and workers’ comp insurance reserves. And Administaff’s stock fell more than 90 percent during the nine months following the announcement of a dispute with its health insurance carrier. By mid-2002, investors had seen enough of the PEO.
But 2003 has been a different story. The two pure PEOs in the public markets, Administaff and Gevity HR (formerly Staff Leasing), have increased 81 percent and almost 300 percent, respectively (see charts below). Administaff is now trading at more than 5 times its low and Gevity at more than 18 times. TotalSource (ADP’s PEO) has arguably become one of ADP’s best performing business units, growing 37 percent in the recent fiscal year. Why the sudden turn? First, each of the Big-3 companies has undergone significant change resulting in stronger business-Gevity has refocused sales and retention on the less risky white collar clients; Administaff has changed health carriers and overhauled its billing system. Second, the extraordinarily tight insurance market has forced many smaller competitors out of business. Finally, rising insurance costs have become a big problem for small businesses, increasing the value proposition of the PEOs.
Is the PEO coming back? I don’t think so, and I would be cautious when considering investing. While the Big-3 should continue to show improving results, the industry faces three key obstacles: (1) Legislation is working against PEOs (more on that next month); (2) Insurance markets change-a less penalizing market for small businesses could take away from the PEO value proposition; and (3) The ASO concept is gaining traction, particularly among the payroll processors. Next month, I will elaborate on these challenges.
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