Force Placed Flood Insurance on Commercial Condominium Unit and Contents

Issue/Inquiry

A commercial loan is secured by a commercial condominium unit which has been remapped into a flood zone. The loan amount is $87,000, with a $300,000 Replacement Cost Value (“RCV”) for the condominium unit. A security interest has been taken in business assets. In the event the condominium is not already covered, would the borrower need to obtain both building and contents coverage?

Response Summary

The Bank must follow its forced placement procedures, since it has determined during the term of the loan that the property must be insured against flood hazard and is not. It has the option of immediately force placing flood insurance, with the obligation of refunding to the borrower the cost of such insurance that overlaps coverage obtained by the borrower. Regardless, it must immediately notify the borrower that the borrower is obligated to obtain flood insurance at the borrower’s expense within 45 days of notice. If the borrower does not provide proof of flood insurance coverage within that time, the Bank must force place flood insurance coverage.

Response Detail

Forced Placement

The Bank must first follow its forced placement procedures. Under the Flood Rules, if at any time during the term of a designated loan the lender determines that the property securing the loan is not covered by flood insurance or is covered by flood insurance in an amount less than the amount required, the lender must do the following:

• Notify the borrower that the borrower should purchase flood insurance in the appropriate amount, at the borrower’s expense, for the remaining term of the loan.
• If the borrower does not obtain flood insurance 45 days after the institution has provided notice to the borrower, the lender must purchase insurance on the borrower’s behalf.

Federal flood insurance regulations permit no discretion in notifying a borrower or force placing insurance once the 45-day period has ended. 12 CFR §339.7.

Under the Biggert-Waters Flood Insurance Reform Act of 2012, the premiums and fees a lender may charge the borrower include those incurred for coverage beginning on the date on which flood insurance lapsed or did not provide a sufficient coverage amount. Within 30 days of receiving confirmation of a borrower’s existing coverage, the lender must terminate any force-placed insurance and refund to the borrower all force-placed insurance premiums and any related fees paid for by the borrower during any period of overlap between the borrower’s policy and the force placed policy. Interagency Statement on the Impact of the Biggert-Waters Act, FIL-14-2013.

Since the Bank now knows that the property securing the loan is in a Special Flood Hazard Area (“SFHA”) and that there is no flood insurance coverage on file, it must immediately notify the borrower of the borrower’s responsibility for insuring the property against flood hazard and be prepared to force place coverage, if proof of flood coverage is not provided by the borrower within 45 days of the notice. As noted, the Bank may also obtain flood insurance from the time it determined that the property was in a SFHA and not covered by flood insurance. If it does so, the notice to the borrower should, as a matter of best practice, indicate that the Bank has already obtained flood insurance coverage.

Flood Insurance Coverage

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 SFHA 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).

Commercial condominiums are insured through the NFIP Condominium Association Program under a General Policy Form. The “nonresidential” limits for such a policy apply to the building, which means that the maximum amount for which the building can be insured is $500,000, regardless of the number of units. 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, but is allowed to purchase separate commercial contents coverage for up to $500,000. NFIP Flood Insurance Manual, GR 7, 8.

In this case, the loan is secured by a commercial condominium unit with a purported RCV of $300,000. Under the “Mandatory Purchase of Flood Insurance Guidelines” of the Federal Emergency Management Agency, the insured value of nonresidential properties is normally based on the Actual Cash Value (“ACV”) of the building, which is the RCV less depreciation. This means that insurable value of the condominium unit may be less than $300,000.

In calculating the amount of insurance required, the Bank and the borrower, either by themselves or in consultation with the flood insurance provider or other appropriate professional, could choose from several approaches to establish the insurable value. They may use an appraisal based on a cost-value approach (not market-value), a construction-cost calculation, the insurable value used in a hazard insurance policy (with the understanding that insurable value for hazard insurance purposes may be different than that for flood insurance purposes, since most hazard insurance policies do not cover foundations), or any other reasonable approach, as long as it can be supported. Loans in Areas Having Special Flood Hazards: Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q. 9.

If the Bank is taking a security interest in business assets, and the business assets are the contents of the building securing the loan which is in a SFHA, the Flood Rules require the contents as well as the building to be insured against flood damage. As with evaluating improved real property, the Bank can use any reasonable method for assigning a value to the personal property securing a loan, but the value should be based on the ACV of the personal property rather than the market value. This is true whether the contents are in a residential or commercial building. The ACV is the cost to replace an insured item of property at the time of the loss, less the value of its physical depreciation. FEMA, National Flood Insurance Program, Summary of Coverage for Commercial Property, F-778.

If the insurable value of the commercial condominium unit is $300,000 and the outstanding loan balance is $87,000, it appears that the value of the unit greatly exceeds the amount of the loan. Does this mean that the loan would be sufficiently covered by flood insurance for regulatory purposes, if only the unit is insured, although the Bank is also taking a security interest in business assets? The answer is that when a loan is insured by improved real property and its contents, both the real property and the contents must be covered by flood insurance in a reasonable amount, even when the value of the real property exceeds the loan balance being secured by it and the contents.

The Interagency Questions and Answers on Flood Insurance 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 the minimum amount required. Interagency Q&A, Q. 39.

Furthermore, the Interagency Questions and Answers on Flood Insurance addresses the situation in which a loan is secured by several properties located in a SFHA. 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, since 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 Q&A, Q. 14.

When the revised Interagency Questions and Answers on Flood Insurance was published, 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 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.

 

This entry was posted on Monday, July 31st, 2017 at 1:34 pm.