What is longevity risk? ALDA

We plan our retirement. We generously estimate our life expectancy (it might sound rough, but in most cases it's necessary). We own some wealth and calculate that, taking inflation into account, we can use this wealth to live until we die. But what if... we live many more years than our life expectancy?

In general, we don't like insurances because they have negative mathematical expectations for the buyer (otherwise insurance companies don't make money). However, there are things or events that we, as individuals, cannot risk to lose or suffer (like a house because of a fire). And "overliving" can be one of them if we are short of money.

We all know what an annuity is. It's kind of an insurance. There is one which makes sense, though. It's called ALDA or Advanced Life Deferred Annuity. If applied correctly, it can be very beneficial. The idea is to pay a lump sum today and leave it in the insurance company producing some yield until we get close to our life expectancy, when we will start receiving our monthly payments usually guaranteed.

Why waiting until 85 years old to get some returns from our investment? Because the cost of an ALDA is cheap and it perfectly hedges the problem we had at the beginning: the longevity risk or the possibility of running out of money because we are living more years than calculated.