Making, Increasing, Renewing, or Extending a Loan with Force-Placed Flood Insurance Coverage

Issue/Inquiry

The Bank asks, “Can a loan be made, increased, modified or extended with force placed flood insurance in effect?”

Response Summary

The Flood Rules do not address whether the flood insurance coverage required when a loan is made, increased, modified or extended must be purchased by the borrower or can be obtained by the lender through its forced placement authority. Federal regulators will probably expect that flood insurance will be purchased by the borrower in such situations, since forced placement is intended for when the lender determines that the coverage in place for an existing loan is inadequate. Apparently, some banks have been told by NFIP and FDIC regional offices that force placed flood insurance would be adequate when a loan is renewed. Nevertheless, the Bank would potentially be at risk for being found in violation of the Flood Rules if it makes, increases, modifies, or extends a loan in reliance on a force placed flood insurance policy.

Response Detail

The Food Rules provide that “a bank shall not make, increase, extend, or renew any designated loan unless the building or mobile home or any personal property securing the loan is covered by flood insurance for the term of the loan.” 12 CFR 339.3.  

While this requirement seems clear enough, it does not address whether the flood insurance coverage must be purchased by the borrower or whether it can be a force-placed policy obtained by the lender. There is also no official guidance on the question.

The expectations of the Federal regulators, however, are indicated by this passage from the FDIC Compliance Examination Manual:

Forced placement should not be necessary at the time an institution makes, increases, extends, or renews a loan, when it is obligated to require that flood insurance must be in place prior to closing. Rather, forced placement authority is designed to be used if, over the term of the loan, the institution or its servicer determines that flood insurance coverage on the security property is deficient; that is, whenever the amount of coverage in place is not equal to the lesser of the outstanding principal balance of the loan or the maximum stipulated by statue for the particular category of collateral securing the loan. FDIC Compliance Examination Manual, V – 6.6.

Some bank compliance officers have reported receiving direction from NFIP and FDIC regional offices that an existing lender-placed flood insurance policy would be adequate when a loan is renewed. The rationale seems to be that the credit has already been extended and that the borrower has, in effect, purchased the policy that is in place, since the lender has been billing the borrower or adding the cost of the force-placed coverage to the loan balance.

Nevertheless, given the apparent expectations of Federal regulators to the contrary and the lack of official guidance, the Bank would be at risk for being found in violation of the requirements of the Flood Rules if it makes, increases, renews, or extends a loan in reliance upon a force-placed flood insurance policy. The risk would be greater when a loan is being made or increased, since the force placed rule was not intended as a substitute for requiring the borrower to provide proof of coverage before new money is extended, but to allow a lender to obtain flood insurance coverage in the event the coverage for an existing loan was found to be inadequate.

The risk would be less when an existing loan is renewed or extended, since the loan is already in existence and no new money is being extended. In such case, the force-placed coverage is more likely to be seen as being used in the manner intended by the Flood Rules.

Even so, a potential for risk remains. The Bank, therefore, will have to make a business decision as to whether it will rely upon a force-insurance policy in particular situations.

This entry was posted on Tuesday, September 8th, 2015 at 2:00 pm.