Flood Insurance Policy with High Deductible

Inquiry/Issue

The Bank has a commercial mortgage in the closing process in which the collateralized property is located within a SFHA.  The borrower is asking if the Bank will accept a policy with a $50,000 deductible.  This is the highest deductible allowed by FEMA for a commercial property, but are there any restrictions on deductibles for compliance with flood regulations?

Response Summary

Under the flood rules, a lender can allow a borrower to use the maximum deductible to reduce the cost of flood insurance. Whether it should do so, however, must be determined on a case-by-case basis, taking into account the risk that such a deductible would pose to the borrower and lender. While this is a business decision for the Bank to make, it must also consider whether its federal regulator would be critical of its accepting the higher risk which goes with a higher deductible.

Response Analysis

Under the National Flood Insurance Program, deductibles of $10,000 to $50,000 are available for non-residential policies. A higher deductible will lower the premium the borrower has to pay, but it will also reduce the borrower’s claim payment. As per the Interagency Flood Questions and Answers, a lender can allow a borrower to use the maximum deductible to reduce the cost of flood insurance. Whether it should do so, however, must be determined on a case-by-case basis, taking into account the risk that such a deductible would pose to the borrower and lender.

The deductible does not play into the coverage amount, but a lender may not allow the borrower to use a deductible amount equal to the insurable value of the property to avoid the mandatory purchase requirement for flood insurance. FEMA, National Flood Insurance Program Summary of Coverage for Commercial Property; NFIP Flood Insurance Manual, Rate 14, footnote 6; Interagency Flood Questions and Answers, Q. 17.

A flood insurance policy with a high deductible increases the risk of a loan not being repaid. In determining whether the Bank should accept a commercial flood policy with a $50,000 deductible, it should consider such questions as:

• Can the borrower cover a deductible in that size?
• If the borrower cannot cover such a deductible, to what extent will the collateral value be compromised, in the event of flood damage?
• If the borrower cannot cover such a deductible, how will the borrower’s ability to repay the loan be compromised, in the event of unrepaired damage to the property?
• How will the safety and soundness of the bank be affected if the collateral securing this loan is compromised?
• How will the safety and soundness of the bank be affected if it must cover the deductible?
• How will the safety and soundness of the bank be affected in the event of default?

Under the flood rules, whether the Bank accepts a commercial flood policy with a deductible as high as $50,000 is a business decision for it to make. It should document the basis for its decision, giving consideration to the above factors. Since a bank operates within a legal and regulatory environment, however, it must also consider whether its federal regulator would be critical of its accepting the higher risk that goes with a higher deductible.

This entry was posted on Thursday, August 14th, 2014 at 8:01 pm.