In a world of changing regulations, employers are increasingly looking to service providers to help ensure they meet all applicable mandates. Expect more contracts, especially mid-market ones, to tack on compliance as part of the service delivery.
New market research indicates that compliance and the regulatory reporting associated with HR transactions and processes have fast become one of the most heavily outsourced areas of the back office. According to new data released by Everest Research, more than half of all HRO transactions involve regulatory and compliance services.
As organizations face increasing complexity in regulations and a constantly changing legislative environment, executives realize that outsourcing the compliance aspects of HR functions can relieve a lot of the internal pressure to stay on top of rules and allow them to focus more on core business functions. As a result, their willingness to outsource parts of the compliance function is reaching an all-time high.
Staying abreast of confusing and extremely complex regulations is an enormous task for any internal HR department. From a tax standpoint, some regulations are open to interpretation, and their applicability can also change if an organization alters its business model, requiring HR to diligently track any such alterations. Many HR departments simply find it easier to outsource their compliance chores rather than take them on internally.
However, while outsourced solutions are available, buyers must be careful not to shirk their responsibility for ensuring obligations are met. Bill Bierce, a principal with law firm Bierce and Kenerson, advises companies to keep that in mind when going into any HRO contract.
“The HRO contract does not remove the final responsibility from the client. A company should develop and implement a strong partnership with the provider involving a robust process of liaison, internal auditing, risk management, and performance and compliance reporting,” he cautioned.
What’s Driving the Change?
Increasing complexity in regulations is absolutely leading to an increased dependency on compliance outsourcing. With more overlapping legislation, gaps in compliance are possible anywhere. Changes in one law may have repercussions on how an HR organization complies with another. For instance, one of the greatest HR challenges an employer faces is the integration of the Family and Medical Leave Act, Americans with Disabilities Act, and local workers’ compensation. A company that employs workers in 50 states would need to keep up with workers’ comp in all of those states and any changes to each regulation at all times.
The complexity of tax regulations is also a given. Fritz Hewelt, vice president of the National Tax and ERISA (the Employee Retirement Income Security Act) practice of HRO provider Aon, pointed out that growing areas of overlap are causing more firms to outsource their compliance needs.
“We have fundamental concepts within ERISA that aren’t always 100 percent consistent with parallel concepts in the IRS code. For instance, what is an employee? To most people it is a very simple definition. Yet if you look at the definition of an employee within ERISA, it doesn’t exactly parallel the IRS code in a particular situation.”
According to Hewelt, there are overlaps in pieces of legislation that were enacted at different points in time or in legislation that has evolved. For instance, the FMLA mandated certain requirements be met, but offered no solutions on how to comply in context with IRS regulations or cafeteria documents. In an effort to address these concerns, new changes were recently proposed to the FMLA that spanned 128 pages. HR needs to learn those changes and implement them immediately—and it must do so without making mistakes.
As a result, the growing inclusion of compliance services in HRO contracts can be tied to several factors. Aside from the increasing complexity of meeting state and local regulations, the scope of functions these regulations affect is spreading and reaching smaller firms. Brad Everett, senior vice president of human capital management solutions at Affiliated Computer Services (ACS), noted that while many regulatory mandates once affected only organizations of a certain size, that threshold is steadily heading south.
“In the past, a particular regulation may have applied to a company with 100 employees and above. Now, we see it may apply to a company of 50 or even 20 employees. So we’re seeing that the application of some of these complex regulations is now penetrating even the smallest of organizations,” Everett stated.
Compliance is not a core competency, or even something that helps a company achieve its business goals; it is just a necessary evil that all organizations must address. However, compliance is a fairly standardized function with deliverables that are predictable, making it a great candidate for outsourcing.
“Compliance can take a lot of time and expense that mid-market firms do not have. It’s something that the providers can develop expertise and capabilities for and scale it across a number of clients. The more scaled the provider gets with its solution, the more affordable outsourcing becomes, contributing further to the growth,” said Monica Barron, vice president of research at Everest Research Institute.
Providers say they see a real desire for this service and have developed highly specialized technology and invested in professional staff to keep clients on top of potential changes to applicable regulations. They are also hiring in-house lawyers and regulatory experts, trained in specific areas of compliance such as benefits administration, payroll, and data privacy. This comes as a welcome investment for many clients concerned about whether they can keep up with compliance requirements internally.
Jodi Hayes-Roth, vice president of HRO service and implementation at Ceridian, pointed out that since the passage of the Sarbanes-Oxley Act (SOX), HR organizations in public companies have been particularly concerned about compliance.
“SOX has been a driver, as far as compliance outsourcing is concerned, because it impacts the entire company. There is a heightened sense of awareness recently. From a controllership standpoint and from a finance standpoint, they’re driving that down into HR,” she said.
Where Growth Is Occurring
The need to outsource compliance support will always be there. Even if an organization needs to fill out just one tax form, it may prefer to rely on external expertise. While some regulations such as the ADA and FMLA extend to all employers, others are specific to certain industries. And more recently, the cry for outsourced compliance support is loudest from sectors that are—to no one’s surprise—the most heavily regulated. Among these are the automotive, pharmaceutical, financial services, and insurance industries, which have embraced external compliance outsourcing and appear ready to shift an ever-increasing number of compliance functions to their providers.
Mike Rogalski, division vice president and general manager of ADP National Accounts, noted, “We play everywhere now. Different industries face varying degrees of complexity or layers of compliance needs. Manufacturing is highly unionized and needs to comply with union organizations, so we offer that service. The insurance industry has clear requirements relative to the training and education of employees in those industries. Hospitals have the complexity of multi-shift differentials in terms of wage. Clients that deal with the public sector deal with EEO requirements, and so we help administer that.
“In any business, you’re going to have the tax side of things, and when you get into the BPO arena, it extends beyond in many instances the local taxing authorities to handling expats and how you deal with all of the additional complications that come with that. There is just no limit to the growth potential of this form of outsourcing, as many companies are taking advantage of the services that an outsourcer can provide.”
Everest’s Barron pointed out that the need for compliance support varies according to market segment. “Our analysis shows that the mid-market includes compliance in more deals than the larger markets. I would agree with that because the mid-market lacks the expertise, capability, or desire to keep up with changes in law or regulations, and they are relying on the outsourcer to do that for them. I think it’s something that mid-market companies see as even more critical to their outsourcing engagement in terms of deliverables.”
Even though outsourcing of compliance is growing rapidly and is involved in more HRO contracts, there are some areas that companies prefer to administer internally. Privacy and control, for instance, remain sensitive areas for some companies. When it comes to privacy issues, some are concerned about their associate data, social security information, and bank information. Control becomes an issue when an external client is involved—for instance, the information that an auditing firm might have on its customers. Some specific regulations involving HIPPA and COBRA rules and even specialized tax filings may require the internal domain expertise that only the employers possess. These are important functions that, if not performed accurately to government standards, can cause a company great pain.
Because the concern around these issues is so great, some providers have taken great pains to ensure that they have the regulatory knowledge to address clients’ needs. Arthur Mazor, senior vice president of Fidelity Investments’ HRO business, explained how the firm approaches compliance issues that arise.
“Whether you are managing government controls or government regulations, the only way to have good comfort in knowing that all areas are being properly managed in compliance is through very strong transparency of process and transparency of audits,” he said. “You must have really clear and well-documented processes and policies around how data are handled, how controls need to be embedded within day-to-day administrative processes, and then how audits and quality assurance efforts are folded into those processes. That allows for great transparency but also for good success in achieving the kind of compliance adherence essential in this environment.”
While worries about data security, internal control, and government regulations may be addressed with the right processes, some concerns remain about the offshoring of services. Some companies stay resistant to offshoring their compliance needs. Initially, they might view it as overly complicated, especially when it involves markets in the EU, where employers must deal with different countries and their individual regulations. Some HR departments are wary of exactly where their data are going and how they can be protected over such a wide geographic spread.
But with provider solutions growing more sophisticated, customers are becoming more comfortable with HRO as a whole, resulting in service scope creep that includes compliance. John Stacey, chairman and CEO of the Global Sourcing Advisory Group, noted, “We’re seeing much more HR outsourcing this year than the prior years because companies realize that the HR process within an organization is very costly and very time consuming, and providers have gotten really good at it for a fraction of the cost.”
If the state of the regulatory environment in recent years is any indicator of the future, addressing compliance will continue to be a complicated task. Regulations will reach into more and more HR areas that employers might not have been concerned with in the past. While it’s unlikely we would see another significant regulatory game-changer such as Sabanes-Oxley anytime soon, employers can never totally discount the possibility. Companies need to be able to handle the extraordinary demands that would be placed on them if sweeping regulations do come their way.
“The true leverage an organization receives by outsourcing is not dealing with the routine, but rather dealing with the unusual,” Hewelt pointed out.
As long as employers are unwilling or unable to invest internally in their compliance programs, providers will continue to advance their processes and technologies to support clients’ needs. Outsourcing will allow buyers to focus on their core needs rather than transactional and peripheral services such as tax filings, employment verification, or other compliance-related work. And as the regulatory landscape grows more complex, you can expect demand for this type of support to only increase in the future.