The Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Farm Credit Administration and National Credit Union Administration (collectively, the “Agencies”) have released new guidance supplementing the Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&As”). 76 Fed. Reg. 64175 (Oct. 17, 2011). The guidance adds two new final questions and answers (“Q&As”) to the Interagency Q&As to address the options for determining the insurable value of properties and the timing requirements for the force placement of flood insurance.
The Agencies have withdrawn Q&A 10 as proposed on July 21, 2009. 74 Fed. Reg. 35914 (July 21, 2009). The Agencies have also proposed revisions to two Q&As originally proposed in 2009 and to a final Q&A. The guidance provided under the two new final Q&As and the withdrawal of proposed Q&A 10 was effective October 17, 2011. Comments on the three proposed revisions must be submitted to the Agencies on or before December 1, 2011.
New Final Questions and Answers
Insurable Value of Improvements
The Agencies have adopted a new Q&A 9 to address issues that may arise in calculating the insurable value of property for purposes of determining the amount of flood insurance coverage required under the National Flood Insurance Program (“NFIP”). The flood insurance regulations provide a two-part formula for determining the amount of insurance required for a particular property. The amount of required coverage is based on the lesser of the outstanding principal balance of the loan or the maximum limit of coverage available for the property under the NFIP. Since flood insurance coverage is limited to the value of the property securing the loan less the value of the land on which the building or mobile home is located, lenders must also determine the insurable value of the improvements on the property.
The new guidance tracks the guidelines from the Federal Emergency Management Agency (“FEMA”) and reaffirms that the insurable value for certain residential or condominium properties under the NFIP is the same as the replacement cost value (“RCV”) of the insured building. The RCV reflects the cost to replace the building with the same kind of materials and construction without deduction for depreciation. The Agencies recognize that a variety of methods may be used to establish the insurable value of a property, including the following:
Appraisal based on cost-value (not market-value) approach,
Construction cost calculation, or
Insurable value used in any hazard insurance policy (with any adjustment required to reflect that most hazard insurance policies do not cover foundations).
Other approaches for determining insurable value may also be used but the basis for the approach must be adequately documented by the lender. The new guidance also recognizes that insurance policies written for RCV may, in certain cases, require the insured to pay for coverage that significantly exceeds the amount the NFIP would pay in a loss. This problem may arise with nonresidential properties and certain residential properties where the insurance loss payout may be based on actual cash value (calculated as RCV less physical depreciation). If a property is insured for less than RCV, lenders should take care to verify that this amount is still sufficient to adequately insure the property for flood losses.
Force Placement of Flood Insurance
The Agencies have adopted a new Q&A 61 to provide guidance on when a lender should force place flood insurance coverage. The flood insurance regulations require a lender to purchase flood insurance on the borrower’s behalf if the borrower fails to obtain such insurance within 45 days of receiving notice of his obligation to obtain coverage. The new guidance notes that a lender should have policies and procedures in place to facilitate the force placement of coverage when the 45-day notice period has expired. The Agencies stopped short of providing a grace period for completion of the force placement process. If a force placed policy is not in place on the 46th day, a lender must be able to provide a reasonable explanation for any brief delay in coverage, such as the use of batch processing to purchase force placed policies.
The Agencies have withdrawn proposed Q&A 10, which had addressed alternative approaches for determining the insurable value of buildings. The Agencies reasoned that this issue was now adequately addressed in the new final Q&A 9.
Proposed Questions and Answers
Timing of Notice to Borrower
The Agencies have proposed to replace a Q&A originally proposed in 2009. Proposed Q&A 60 addressed whether a lender could accelerate the 45-day notice period by sending notice to the borrower prior to the actual date of expiration of flood insurance coverage. Since the 45-day notice period is required by statute, the Agencies have replaced the Q&A proposed in 2009 with a new proposed Q&A clarifying the events that trigger a lender’s obligation to send a force placement notice to a borrower. The Agencies noted that this proposed Q&A may need to be revised to reflect any future rulemaking regarding mandatory escrow accounts under Section 1461 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which amended Section 6 of the Real Estate Settlement Procedures Act (“RESPA”).
The proposed guidance notes that a lender must send a notice to the borrower when the lender (1) determines that the flood insurance coverage in place is inadequate or has expired, or (2) learns that new coverage is required as a result of a flood map change. To avoid the expiration of coverage, the Q&A also recommends that a lender advise the borrower when flood insurance coverage on the property is about to expire. This notice would likely provide the borrower with multiple pre-lapse notices, one from the lender and one or more from the insurer.
Borrower Charges for Coverage During Notice Period
The Agencies have proposed revisions to Q&A 62, which was originally proposed in 2009. The Agencies had noted in Q&A 62 that the federal flood insurance laws and regulations do not expressly authorize a lender to charge a borrower for force placed flood insurance coverage during the 45-day notice period. As such, the Agencies reasoned that a lender could not charge a borrower for force placed coverage until the expiration of the notice period, even if the insurance was obtained through the NFIP or a private provider. The majority of the 19 comments received on this proposed Q&A were in opposition to this position with many noting that the goal of the NFIP was to ensure continuous coverage of properties for the full term of a mortgage loan.
To address this and other concerns, the Agencies have revised this proposed Q&A to permit a lender or its servicers to charge a borrower for insurance coverage during any part or all of the 45-day notice period in which no adequate borrower-purchased flood insurance coverage is in place, if the borrower has given the lender or its servicer the express authority to charge the borrower for such coverage under the terms of the note, mortgage or other contract. The proposed Q&A notes, however, that if such a premium will be charged to a borrower pursuant to contract, any policy obtained by a lender or servicer should provide equivalent coverage and exclusions to those under an NFIP policy and cover the interests of both the borrower and lender.
Requirements for Force Placement of Insurance
The Agencies have proposed revisions to Q&A 57, addressing the requirements for force placement of flood insurance. Although the proposed revisions do not change the substantive guidance under this Q&A, the revisions may require lenders and their servicers to modify their notices and practices. The revised Q&A would require the 45-day notice to the borrower to clearly state that the borrower must obtain, at the borrower’s expense, flood insurance in an amount at least equal to the amount required under the NFIP for the remainder of the loan term. If the borrower fails to obtain such coverage, the notice must state that any premiums or fees charged by the lender for force placed coverage will likely be higher than the premiums and fees for coverage purchased by the borrower.
The Agencies noted in the proposed revisions that institutions are encouraged to explain their force placement policies to borrowers, including, where applicable, that they charge for force placed coverage during the 45-day notice period and the timing of this charge. If a borrower has not previously been required to have flood insurance coverage on the property, the proposed Q&A provides that it would be a “best practice” for the lender to send the borrower a copy of the “Notice of Special Hazards and Availability of Federal Disaster Assistance” with the force placement notice.
Section 1463 of the Dodd-Frank Act amended Section 6 of RESPA to provide for notification requirements in connection with the force placement of hazard insurance. The Agencies noted that Section 1463 specifically permits a servicer to provide a simultaneous or concurrent notice of the lack of flood insurance coverage with any notice regarding the force placement of hazard insurance required under the section. There has been no rulemaking to date to implement this section of the Dodd-Frank Act.
The Agencies intend to publish an updated final version of the Interagency Q&As to include all of these changes after the three proposed changes above are finalized. A copy of the notice and request for comment is available at here.
If you have any questions regarding this new flood insurance guidance, please contact Elena A. Lovoy or one of the other attorneys in the Banking and Financial Services Practice Group at Bradley Arant Boult Cummings LLP.