Flood Insurance in the Absence of a RCBAP

Issue/Inquiry

The Bank has a loan secured by multiple properties, one of which is a condominium unit located in a flood zone. The borrower has obtained private flood insurance for the individual unit, but the condominium association has not obtained flood insurance. The association claims that the building is not in a flood zone. The flood determination obtained by the Bank indicates that it is in flood zone AE, a Special Flood Hazard Area.

What does the Bank need to do in order to be in compliance with the Flood Rules?

Response Summary

The Bank will be in compliance with the Flood Rules if the private flood insurance policy obtained by the borrower is a dwelling policy that provides coverage for the condominium unit in an amount equal to what would have been provided by an RCBAP, and if such policy adequately protects the collateral.

Response Detail

Ordinarily, a residential condominium unit would be covered by a Residential Condominium Building Association Policy (“RCBAP”) obtained by the condominium association, which provides coverage for the unit that is, at least, equal to the lesser of:

• The outstanding principal balance of the loan
• The maximum amount of flood insurance available under the National Flood Insurance Program (“NFIP”), which is the lesser of:
  • The maximum limit available for the individual condominium unit
  • The “insurable value” allocated to the individual condominium unit, which is the replacement cost value of the condominium building divided by the number of units. Interagency Questions and Answers (“Interagency Q&A”), Q.28.

If there is no RCBAP, either because the condominium association will not obtain it or because individual unit owners are responsible for obtaining their own insurance, the lender must require the individual unit owner/borrower to obtain a dwelling policy in an amount equal to what the individual unit coverage would have been under the RCBAP. Interagency Q&A, Q.29.

The Interagency Q&A provides the following example:

The lender makes a $175,000 loan secured by a condominium unit in a 50-unit residential condominium building, which is located in a Special Flood Hazard Area in a community participating in the NFIP, with a replacement cost value of $10 million; however, there is no RCBAP.

The minimum coverage required for the condominium unit will be the lesser of:

• The outstanding principal balance of the loan of $175,000
• The maximum amount of coverage available under the NFIP, which is the less of:
  • The maximum limit available for residential condominium units of $250,000; or
  • The insurable value of the unit, based on 100 percent of the replacement cost value of the building ($10,000,000 ÷ 50 units = $200,000).

The lender must require the individual unit owner/borrower to purchase a flood insurance dwelling policy with at least $175,000, since there is no RCBAP, in order to satisfy the mandatory purchase requirement of the Flood Rules. Interagency Q&A, Q.29.

In the Bank’s case, the Bank would have to determine whether the flood coverage obtained by its borrower is adequate under the formula of the lesser of the outstanding principal balance, the maximum amount of coverage available under the NFIP, or the insurable value of the condominium unit.

The Bank has also indicated that the flood insurance coverage obtained by its borrower is through a private policy. The Biggert-Waters Flood Insurance Reform Act of 2012 requires lenders to accept private flood insurance in satisfaction of the mandatory purchase requirement, if such insurance meet certain criteria. FEMA’s mandatory purchase guidelines listed the following six elements by which private flood 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 both 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 a minimum, as broad as under the SFIP.
5. Strength of Mortgage Interest Clause: The mortgage interest clause must be, at least, equal to that in the SFIP.
6. Legal Recourse: The policy must contain a provision that the insured must file suit within one year after the date of written denial for 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 if a lender is satisfied that a private policy adequately protects its security, despite not containing some of the above elements or differing from them, it is within the authority of the lender to accept the private policy.

From a safety and soundness standpoint, RSK recommends that the coverage be as broad as that provided by a policy issued by the NFIP. FEMA has provided lenders with discretion in determining the adequacy of a private flood insurance policy; however, the more such a policy deviates from the criteria, the greater the justification for the policy that will be expected of the lender from its federal regulator.

In this case, the Bank will have to review the policy itself, and determine whether the coverage amounts and other conditions are adequate. If the Bank ultimately determines that the policy adequately protects its security, it could accept such in satisfaction of the mandatory flood insurance requirement.

This entry was posted on Monday, March 12th, 2018 at 6:00 am.