Retention bonus as an incentive in the Armed Forces: applying personnel economics in a military context

Many military organizations offer retention bonuses to reduce quit rates among personnel with specific skills and work experience. In the Norwegian Armed Forces (NAF), a retention bonus has since 2004 been part of the scheme of monetary incentives to recruit and retain personnel in short-career contracts (T35 – retirement at age 35). The T35 contracts are offered to Other Ranks (OR), and ensure a relatively young personnel structure when combined with T60 contracts to Officers (OF) and OR. In the context of a labor market with strong unions, government regulation, and high job security, the T35 contract offers 1,1 million NOK (approx. 125 000 USD) if the personnel continue in NAF until forced retirement. The bonus is in place primarily to compensate for early retirement and ease the transfer to a civil work life, and secondarily to improve retention rates. NAF perceive the quit rates to be too high, in particular among the youngest cohorts, and decided therefore in 2020 to revise the retention bonus scheme. In this report, we study the application of retention bonuses in NAF generally in light of the bonus scheme for T35 personnel. By reviewing the economics literature on bonuses, we derive theoretical principles for when and how bonuses should be applied to secure cost-efficient spending. The analysis shows that the criteria are more or less satisfied, but that the presence of personnel who would remain employees in NAF regardless of the existence of a retention bonus challenges the cost-efficiency of the scheme. By linking two datasets – wage data and service data – we can study personnel on T35 contracts over time. We find that the quit rates during the introduction of the new employment policy (towards a NATO-based distinction between OF and OR) in 2016 have been ten percent (fourteen percent for OR 2–4 and eight percent for OR 5–9), while it was seven percent for the personnel on T35 contracts prior to the introduction. Around 50 percent of the long-serving personnel (>six years) that end their contracts before turning 35 years old, continue in other contracts in NAF. The revised retention bonus scheme allows for an earlier payment of the bonus. The personnel can now receive 1/3 already when turning 25 years old. Another revision is that the personnel can choose between a cash payment or a one-year study leave while receiving a salary. Ceteris paribus, we expect the quit rates to go down after the revision. We show however that the expenditure on bonus will increase substantially. The main cost driver is bonus payments to personnel who do not change behavior. Under optimistic assumptions, the calculations shows that only 10 percent of the bonus spending are allocated to personnel who actually stay longer in NAF. Although we do not attempt to estimate the benefits for NAF of lower quit rates, the cost finding suggests that the revision struggles to meet the cost-efficiency criteria. We propose instead to separate the compensation part from the retention bonus by keeping a cash bonus for personnel that stays till 35 years old and introduce a pure retention bonus that are applied with surgical precision to keep personnel with critical skills, education, and work experience.