Determining Insurable Value for Flood Insurance Coverage

Issue/Inquiry

How does a bank calculate total replacement cost for the purpose of determining the correct amount of flood insurance required?

Response Summary

The insurable value of a building is the same as the overall value of a property minus the land on which the property is located. The replacement cost value (“RCV”) is appropriate for some residential properties, while the actual cost value (i.e., RCV less physical depreciation) is generally used for non-residential properties. In determining the insurable value, a lender can use a variety of approaches, as long as they are reasonable and can be supported. In determining RCV, an appraisal based on a cost approach might be appropriate, as would a construction calculation. A hazard insurance policy might provide an RCV, provided that adjustments are made, as hazard insurance policies typically do not cover the foundation, while National Flood Insurance Program (“NFIP”) flood insurance policies do.

Response Detail

The amount of flood insurance required for a loan secured by improved real property located in a special flood hazard area is the lesser of:

• The loan’s outstanding principal balance
• The maximum amount of coverage available under NFIP

The maximum amount of flood insurance available under the NFIP is the lesser of:

• The maximum amount of coverage available under the NFIP for the type of property securing the loan
• The insurable value of the property. 12 CFR §339.3.

The insurable value of a building is the same as the overall value of a property minus the land on which the building is located. The RCV is appropriate for some properties, generally single-family houses, while the actual cost value (i.e., RCV less physical depreciation) is generally used for non-residential properties. As RCV is not always appropriate, requiring a borrower to purchase flood insurance coverage based on RCV may result in the borrower paying for coverage that exceeds what the NFIP would pay in the event of a loss. A lender may, therefore, consider the extent of recovery allowed under the NFIP in determining the amount of recovery allowed under the NFIP. Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q. 9; FRB, Consumer Compliance Outlook, Third Quarter 2015, Flood Insurance Compliance Requirements.

Under the “Mandatory Purchase of Flood Insurance Guidelines” of the Federal Emergency Management Agency (“FEMA”), the insurable value of a building is the same as 100 percent RCV of the insured building, which is defined as:

The cost to replace property with the same kind of material and construction without deduction for depreciation. Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q. 9.

A single-family dwelling, including a single-family unit in a building under a condominium form of ownership, used as the insured’s primary residence, is covered under the NFIP’s Dwelling Policy and, upon loss, payment is settled at RCV if the dwelling is insured for at least the lesser of 80 percent of the dwelling’s full RCV or the maximum limit of coverage under the NFIP. Losses on other residential properties and on non-residential properties are settled at actual cash value. Interagency Q&A, Q. 9, footnote 4; FEMA, National Flood Insurance Program: Summary of Coverage, FEMA F-679.

In calculating the amount of insurance to require, the lender or borrower, either by themselves or in consultation with the flood insurance provider or other appropriate professional, may use a variety of approaches to establish the insurable value.  An appraisal based on a cost-value approach, rather than market value, or which provides the cost value as well as the market value, may be the basis for a determination of RCV. A construction cost calculation might also be suitable.

The RCV given by the hazard insurance policy could also be used, though adjustments would have to be made, since a hazard insurance policy typically does not cover the foundation, which would be covered by a NFIP flood insurance policy.

Other reasonable valuation methods can be used, as long as they can be supported. Interagency Q&A, Q. 9.

This entry was posted on Monday, April 9th, 2018 at 6:00 am.