Amount of Flood Insurance Required

Inquiry/Issue
The Bank is thinking of making a loan for over $1 million dollars that will be secured by a property with three commercial buildings on it. The flood determinations show that one of the three buildings is in a flood zone. The Bank intends to have the borrower obtain the maximum amount of flood insurance available on this one structure, which would be $500,000 since it is a commercial structure. Is the Bank correct in doing so?

Response Summary

The Bank is required to obtain flood insurance only for the building located in the special flood hazard area. The amount of flood insurance required will be the insurable value of the building, the amount of the loan, or the maximum amount of flood insurance available on the building (i.e., $500,000), whichever is less. Obtaining $500,000 in flood insurance would be required only if the maximum amount of insurance available is less than the loan amount or the insurable value of the property. If the Bank obtained a policy in the maximum amount because it was unsure as to the value of property, this would address the requirement for coverage, but such a policy could be enforced only to the actual insurable value of the property. This would require a valuation of the property to be obtained as soon as possible afterwards, both as the basis for recovery under the policy and for an adjustment in the premium, reflecting the correct amount of coverage.

Response Detail

The flood rules apply to loans secured by buildings or mobile homes located or to be located in areas determined by the Director of the Federal Emergency Management Agency to be in a Special Flood Hazard Area (“SFHA”).

Under these rules, a bank shall not make, increase, extend, or renew a loan unless the building or mobile home is covered by flood insurance for the term of the loan. The term “building” means “a walled and roofed structure, other than a gas or liquid storage tank, that is principally above ground and affixed to a permanent site.” 12 CFR §339.1(c), 2(c) & 3(a).

In this case, the Bank would be required to obtain proof of flood insurance coverage for the building in the special flood hazard area, but the two buildings not located in a special flood hazard area would not have to be covered by flood insurance. While the value of all three buildings would be considered for underwriting purposes, only the value of the building in the SFHA would be considered in determining the value of flood insurance required.

Since building in the special flood hazard area is a commercial building, the minimum amount of flood coverage required is the lesser of the following:

• The insurable value of the structure, including foundation and supporting structures (i.e., 100 percent Actual Cost Value (“ACV”)
• The outstanding principal balance of the loan (including senior liens)
• The maximum available under the National Flood Insurance Program (“NFIP”), which is $500,000 for a commercial structure and $500,000 for its contents

ACV is the Replacement Cost Value (“RCV”) less depreciation. RCV is used for principal residences and ACV for all other properties.

In this case, it will be necessary to determine the insurable value of the building in the SFHA in order to determine the amount of flood insurance required.

If the loan is for $1 million, the maximum amount of insurance available under the NFIP is $500,000, and the building has an ACV of $350,000, the insurance required will be $350,000, since the insurable value of the property is less than the amount of the loan or the maximum amount of flood insurance available.

On the other hand, if the amount of the loan remains $1 million, but the ACV of the building is $700,000, the insurance required will be $500,000, since the maximum amount of insurance available under the NFIP is $500,000, a sum less than the amount of the loan or the insurable value of the property.

The Bank would be required by the flood rules to obtain the $500,000 maximum for flood insurance, only if that amount is less than the loan amount or the insurable value of the property. There is nothing to prevent a flood insurance policy in the maximum amount available from being obtained, but it can only be enforced to the extent of the value of the property, if the value of the property is less than the amount of the flood insurance.

This entry was posted on Monday, April 27th, 2015 at 1:30 pm.