Flood Insurance for Contents of Commercial Condominium

Issue/Inquiry

The Bank’s loan is secured by a first mortgage on one commercial unit in a mixed use building insured against flood hazard under a General Policy Form with a $500,000 limit.  The loan is also secured by a security interest in five new soft serve ice cream individual freezers with an invoiced value of $81,000.00. What would the appropriate amount of flood insurance coverage be for the contents?

Response Summary

When a building and its contents secure a loan, and the amount of the loan is the lesser of the value of the collateral and the amount of available flood insurance coverage, the minimum amount of flood insurance required will be equal to the outstanding loan balance. The amount of that coverage can be allocated between the building and contents, as long as each is given a reasonable coverage.

With regards to commercial condominiums, the NFIP rules provide that the building may be insured in the name of the condominium association up to the limit of $500,000, as it has been in this case. This is in excess of the minimum amount of flood insurance required. The Flood Rules and their guidance, however, do not address a situation when the flood insurance already in place is above the minimum amount required, but does not cover each category of collateral.

It appears that additional flood insurance should be purchased for the personal property securing the loan, in order for each category of collateral to be covered, but there is no clear guidance as to the amount.

Given the ambiguity of the Flood Rules in this matter, we offer further comments which the Bank may consider in requiring proof of further flood insurance coverage.

Response Detail

Flood Rules and Guidance

Under the Flood Rules, an FDIC-supervised institution shall not make, increase, extend, or renew any designated loan unless the building or mobile home and any personal property securing the loan is covered by flood insurance for the term of the loan. A designated loan is a loan secured by a building or mobile home located in a special flood hazard area for which flood insurance is available. The amount of insurance must be at least equal to the lesser of the outstanding principal balance of the designated loan or the maximum limit of coverage available for the particular type of property under the NFIP. Insurance coverage is limited by the insurable value of the property, which is the value of the improvements less the value of the land.12 CFR §339.2(d), 3(a).

In this case, the loan is to be secured by a commercial condominium unit in a building located in a special flood hazard area. The unit has an insurable value of $225,000. The building is insured through the NFIP Condominium Association Program under a General Policy Form for $500,000. Under the NFIP rules, the building and commonly owned contents are insured in the name of the condominium association. The individual unit owner cannot purchase building coverage.

Individual unit owners or tenants, however, are allowed to purchase separate commercial contents coverage under the NFIP for up to $500,000. Since the Bank is taking a security interest in personal property located in the unit, it would follow that the personal property should also be insured against flood hazard.

Based on the invoice price of the freezers, $81,000 would be a reasonable value for them. The amount of insurance coverage required for this personal property, however, may be affected by other factors.

Under the Flood Rules, the coverage for the collateral securing the loan would be the lesser of:

• The loan amount: $140,000
• The value of the building and personal property securing the loan: $306,000 ($225,000 for the condominium unit and $81,000 for the ice cream freezers)
• The available coverage under the NFIP: $500,000 for the building and $500,000 for the contents

The minimum amount of flood insurance required would thus be equal to the loan amount of $140,000, as this is the lesser of the value of the collateral and the amount of available insurance.

Since the condominium unit is located in a building already insured for $500,000, which exceeds the minimum amount of flood insurance required of $140,000, does this mean that the loan is sufficiently covered by flood insurance for regulatory purposes, even though the freezers in which the Bank is taking a security interest are not insured?

The Interagency Questions and Answers on Flood Insurance (“Interagency Q&A”) offers the example of a $200,000 commercial loan secured by a warehouse with a value of $150,000 and inventory stored in the warehouse with a value of $100,000. Flood insurance coverage of up to $500,000 is available for both the building and its contents. Since the amount of the loan is the lesser of the available insurance and the value of the collateral, the minimum amount of insurance coverage required would be $200,000, which is the amount of the loan. The example suggests that the building could be insured for up to its value of $150,000 and the contents insured for $50,000, so that the total amount of insurance coverage would equal to the minimum amount required. Interagency Questions and Answers on Flood Insurance, Q. 39.

The Interagency Q&A also addresses the situation where a loan is secured by several properties located in a special flood hazard area. If three non-residential buildings were each worth $100,000 and secured a loan in the amount of $150,000, the minimum amount of flood insurance required would be $150,000, as this is the lesser amount of the outstanding balance of the loan, the insurable value of the collateral, and the flood insurance available. The flood insurance could be allocated among the three buildings, as long as each building received some coverage. Interagency Questions and Answers on Flood Insurance, Q. 14.

When the revised Interagency Q&A was issued, the official commentary stated that the rule pertaining to coverage for multiple buildings would also apply to a building and its contents. That is, both the building and contents would be considered to have a sufficient amount of flood insurance coverage for regulatory purposes as long as some reasonable amount of coverage was allocated to each category. Federal Register, Vol. 74, No. 138, July 21, 2009, page 35924.

The Interagency Q&A assumes, however, that the amount of flood insurance would be purchased in the minimum amount required and allocated between the building and the contents.  It does not address a situation where the building is already insured in an amount in excess of the minimum required amount.

In addressing situations where a loan is secured by multiple buildings or a building and its contents, the Interagency Q&A indicates that all categories of collateral must receive some coverage or “a reasonable amount” of coverage. The factual context of its examples is where the minimum amount of insurance required is less than the insurable value of the collateral and not where the insurance already in place exceeds the minimum amount required.

Comments

In view of this ambiguity, we offer the following comments regarding this situation:

• An argument can be made that the General Policy Form covering the condominium fulfills the flood insurance requirements, as the amount of its coverage exceeds the minimum amount of flood insurance required.
• The Federal examiners may nevertheless expect the personal property securing the loan (i.e., the ice cream freezers) to also be insured against flood hazard, despite the amount of flood coverage already in place, given the emphases of the Interagency Q&A on all categories of collateral being insured to some extent.
• The Bank must consider that the personal property securing the loan will not be insured against flood hazard unless separate contents coverage is purchased for it by the borrower.
• The Bank must also consider that the condominium unit securing the loan may not be fully insured, even though the condominium is insured up to the $500,000 limit, as this would depend on the insurable value of all of the units.
• An NFIP policy will not cover more than the “insurable amount” of a structure, which in the case of a commercial property is the Replacement Cost Value less physical depreciation (i.e. the “actual cash value”) of the improvements.  Interagency Questions and Answers on Flood Insurance, Qs 8 & 9.
• The Bank is permitted to require flood insurance in excess of the minimum required under the Flood Rules, though the borrower may have to seek such coverage outside the NFIP.  Interagency Questions and Answers on Flood Insurance, Q. 16.

 

This entry was posted on Monday, August 17th, 2015 at 2:00 pm.