Conflict Between Flood Zone on SHDF and Policy

Issue/Question

The Bank’s flood hazard search for a loan it will be making shows the property as being in flood zone A. The flood insurance policy provided by the borrower shows the flood zone as being X. What should the Bank do?

Response Summary

When there is a discrepancy between the flood zone shown on the Standard Flood Hazard Determination Form (“SFHDF”), and the flood insurance policy shows a lower risk zone than the SFHDF, the Bank has several courses of action available before closing:

• Close the loan, provided that the flood insurance policy has been revised to show the same flood zone as the SFHDF
• Do not close the loan until the discrepancy is resolved
• Close the loan and seek to resolve the discrepancy after the fact, with the option of force placing flood insurance if it determined that the flood insurance on file was inadequate

Of these three options, the third is the least desirable and the one most likely to result in a finding of a violation by a Federal regulator or subject the Bank to the risk that its collateral will not be insured against flood hazard.

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Response Detail

When there is a discrepancy between the flood zone shown on the Standard Flood Hazard Determination Form (“SFHDF”), and the flood insurance policy shows a zone with a lower risk than does the SFHDF, the Bank has several courses of action available before closing:

 

• Close the loan, provided that the flood insurance policy has been revised to show the same flood zone as the SFHDF
• Do not close the loan until the discrepancy is resolved
• Close the loan and seek to resolve the discrepancy after the fact, with the option of force placing flood insurance if it determined that the flood insurance on file was inadequate

Of these three options, the third is the least desirable and the one most likely to result in a finding of a violation by a Federal regulator or subject the Bank to the risk that its collateral will not be insured against flood hazard.

Under the Federal flood rules, a bank may not make, increase, renew, or extend a loan secured by improved real property located in a special flood hazard area unless the property is covered by flood insurance for the term of the loan. The ultimate responsibility is with the Bank to ensure that the property is covered by adequate flood insurance before the loan is closed. [12 CFR §339.3].

Generally, if flood insurance is written on the incorrect zone, the National Flood Insurance Program (“NFIP”) will not pay any claims until the correct premium for the correct zone is paid. Retroactive payments may be required going back as far as two years to make up the difference between the incorrect and the correct premium. While this may mitigate the coverage error, however, it does not relieve the bank of the responsibility to ensure that an appropriate amount of insurance is in place when the loan is made.

The Interagency Flood Questions and Answers provide that if there is a discrepancy between the flood zone shown on the SFHDF, and the flood insurance policy shows a lower risk zone than the SFHDF, the bank must investigate. If the investigation does not resolve the discrepancy, or if in the course of attempting to resolve the discrepancy, a borrower or insurance company or its agent is uncooperative, the bank should notify the insurance agent about the insurer’s duty to write a flood insurance policy that covers the most hazardous flood zone, as per FEMA’s letter of April 16, 2008 (W-08021). This notification should include the flood zone information developed by the bank. A copy should also be sent to the insurance company [Interagency Questions and Answers, Q. 72].

There may be legitimate reasons for the discrepancy. For example, the flood map covering the property may have been changed. If the borrower had flood insurance continuously in effect, the policy might be “grandfathered” under certain circumstances. The determination may also be in error. In that case, it will be possible to ask FEMA to review the determination or to have the flood map itself reviewed.

As to whether a bank can be found in violation of the flood rules, if there is a discrepancy between the flood zone designation on the flood determination form and the flood insurance policy, the Interagency Flood Questions and Answers state that if the bank is able to substantiate in its loan file a bona fide effort to resolve the discrepancy, either by finding a legitimate reason for it or by attempting to resolve the discrepancy, such as by contacting FEMA to review the determination, no violation will be found. However, if a pattern or practice of unresolved discrepancies is found in the bank’s portfolio due to a lack of effort on the bank’s part to resolve these discrepancies, the bank might be cited by its Federal regulator for a violation of the mandatory purchase requirements [Interagency Flood Questions and Answers, Q. 72].

The Interagency Flood Questions and Answers suggest that a bona fide investigative process is all that is required of the bank in order to comply with the Federal flood rules. The problem in the present case, however, is that they do not directly address what should be done when a discrepancy had been revealed prior to closing. If a pattern or practice of unresolved discrepancies may subject the bank to risk for failing to obtain proof of flood insurance coverage before making a loan, a pattern or practice of making loans in the face of such discrepancies would seem to subject it to even greater risk.

This entry was posted on Friday, January 9th, 2015 at 10:53 pm.