Ways to avoid flood insurance compliance violations

April may bring showers and flowers, but it can also bring snow and ice thaws with torrents of runoff and flooding. The threat of flooding ranks high on the risk meter for bank loans secured by improved real property. One critical difference between flood and other regulatory requirements is that it is not limited to consumer-purpose transactions, and may expose banks to greater risk for larger, commercial-purpose loans.

Flood insurance requirements are overseen by the Federal Emergency Management Agency (FEMA), and comprise the National Flood Insurance Act of 1968 (NFIA) and many significant amendments. Flood compliance requirements for federally regulated financial institutions became effective when Congress enacted the Flood Disaster Protection Act of 1973. Federal bank regulatory agencies issued regulations to financial institutions under their supervision to not “make, increase, extend, or renew any loan secured by improved real estate or mobile homes located, or to be located, in a special flood hazard area (SFHA) where flood insurance is available under the [National Flood Insurance Program] (NFIP) unless … covered by flood insurance for the term of the loan.”

Know your loan

Remember those magic words: “Make, increase, extend, or renew.” Lenders must initially determine whether a prospective loan will be secured—including security interests taken as an abundance of caution—by residential or nonresidential buildings or mobile homes that are or will be in a SFHA covered by flood insurance under the NFIP.

Whether the structures are in a covered SFHA or not, the lender is required to document the results of the flood hazard determination on FEMA’s Standard Flood Hazard Determination Form (SFHDF). You must also retain a hard copy or electronic record throughout the term of the loan.

A lender may rely on its prior determination of the property’s flood status, but only under certain circumstances. A flood hazard determination must be conducted before loan closing, and flood insurance, if required, must generally be purchased prior to loan closing.

Notice to borrowers

If the property securing the loan is or will be in an SFHA, the lender must notify the borrower, even if insurance is not available under the NFIP. A record of the borrower’s receipt of the notice must be maintained for the life of the loan. No notice provided is a common violation.

Flood insurance coverage and force placement

Flood insurance coverage is generally required to be the lesser of 1) the loan’s outstanding principal balance or 2) the maximum amount of coverage available under the NFIP for the property serving as collateral.

The maximum coverage available under the NFIP is the lesser of 1) the maximum amount of coverage available under the NFIP for the property type securing the loan (i.e. residential or nonresidential) or 2) the overall property value securing the loan, minus the value of the land on which it is located: the property’s “insurable value.”

The maximum coverage caps in an NFIP-participating community are $250,000 for a residential building and $500,000 for a nonresidential building. The Biggert-Waters Flood Insurance Reform Act of 2012 (BWA) increased the maximum amount of coverage for a non-condominium residential building designed for use for five or more families from $250,000 to $500,000, effective for new policies, renewals or change endorsements made on or after June 1, 2014.

If a lender or servicer determines at any time during the term of the loan that the collateral has less flood coverage than required, it must take steps to force place flood insurance. Interagency Flood Q&A 61 states that if a borrower fails to obtain insurance within 45 days after notification, the lender or servicer is required to purchase the insurance on behalf of the borrower on the 46th day.

Common compliance violations include inadequate or no insurance coverage, lapsed insurance, and failure to force place insurance or comply with force placement rules.
Flood compliance rules include condominium coverage, flood insurance premium and fee escrows, coverage for home equity loans and home equity lines of credit (HELOC), and services provided by a third party.

Sound compliance practices, including strong internal controls to conduct and document flood hazard checks, monitor flood insurance coverage on covered loans and implement force placement, stem the tide of flood compliance issues.