RSK.IQ Question of the Week 3/6/17

Flood Insurance Purchased by Tenant


The Bank wishes to make a commercial mortgage loan to the owner of a warehouse that is being rented to a tenant. As part of the lease agreement, the tenant has obtained a flood insurance policy in its name that covers the building and will be subordinated to Bank. Does this satisfy the requirement to have the collateral property insured against flood hazard?

Response Summary

The Flood Rules require the Bank to obtain proof of flood insurance coverage before making the loan. The rules do not specify who must appear on the policy as the insured; however, the NFIP rules require the owner of the building to appear on the property as the insured. If the policy was purchased by a tenant, as per the lease agreement, the tenant can be named as an additional insured. If the insurance policy purchased is a private flood insurance policy, the Bank will have to evaluate it to determine whether the coverage provided is adequate.

Response Detail

The Flood Rules provide that 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. 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 National Flood Insurance Act (“NFIP”). 12 CFR §339.3(a).

While the Flood Rules do not specify who must appear on the flood insurance policy as the insured, the NFIP rules do have such provisions. As stated in subsection IX.F of the General Rules of the NFIP Flood Insurance Manual, the building owner must be named on the flood insurance policy. If the building coverage is purchased by a tenant pursuant to a lease agreement, the tenant may be named as an additional insured on that policy.

In Bulletin W-14028, FEMA stated that the NFIP does not designate any of the name insureds as primary or secondary. The rule was intended to ensure that any claim payment would be made to all parties named as insureds on the policy. Furthermore, in Bulletin W-14059, FEMA reiterated that the Standard Flood Insurance Policy (“SFIP”) issued by the NFIP prohibits duplicate building coverage by the same insured, which means that “the NFIP will only pay for building coverage under one policy, and the owner must be a named insured.”

Therefore, if the landlord is the owner and the policy is issued by the NFIP, the policy must name the landlord as the insured. The tenant can be named as an additional insured, if it obtained the policy pursuant to the lease agreement, but the landlord must be on the policy as the owner of the property. Otherwise, the policy will not be valid and, thus, it will not be proof of the required flood insurance coverage.

The Biggert-Waters Flood Insurance Reform Act of 2012 requires lenders to accept private flood insurance policies in satisfaction of the mandatory purchase requirement to meet certain criteria. In providing assistance to lenders, FEMA’s mandatory purchase guidelines lists six elements by which such insurance should be evaluated:

  1. Licensure: The insurer is licensed or approved to do business in the jurisdiction where the building is located.
  2. Surplus Lines Recognition (Non-Residential Commercial): The insurer should be recognized or not disapproved as a surplus lines insurer in the jurisdiction where the building is located.
  3. Requirement of 45-Day Cancellation/Non-Renewal Notice: The policy would require 45-days written notice to the insured and the lender prior to cancellation or non-renewal.
  4. Breadth of Coverage: The policy must guarantee that the flood insurance coverage, considering deductibles, exclusions, and conditions offered by the insurer, is at least as broad as under the SFIP.
  5. Strength of Mortgage Interest Clause: Mortgage interest clause must be at least equal to that in the SFIP.
  6. Legal Recourse: Policy must contain a provision that the insured must file suit within one year after the date of written denial of all or part of the claim.

In Bulletin W-12022, FEMA clarified this guidance, indicating that the list of six elements was not meant to be exclusive, but that if a lender is satisfied that a private policy adequately protects its security, despite not containing some of these elements or differing from them, it was within the authority of the lender to accept the private policy.

If the policy obtained by tenant is issued by a private insurer, the Bank would have to review it and determine if the coverage amounts and other conditions are adequate. From a safety and soundness standpoint, we would recommend that the coverage be as broad as that provided by a policy issued by the NFIP.

This entry was posted on Monday, March 6th, 2017 at 1:34 pm.

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