Flood Insurance and Multiple Properties

Issue/Inquiry

The Bank has a commercial loan with a $5 million balance secured by a campground with 19 structures on it, some of which are sheds and outdoor privies. The flood determinations on file indicate that a portion of the property is located in flood zone “X,” which is not a special flood hazard area (“SFHA”), and partially located in flood zone “A,” which is a special flood hazard area. The Bank has received a flood insurance policy that insures two buildings (buildings “A” and “B”) for $500,000. The agent for the flood insurance issuer has indicated that these buildings are the only ones located in the special flood hazard area. The buildings may be residential in nature. What should the Bank be aware of in determining whether it has proof of adequate flood insurance coverage? How is the amount of such coverage determined?

Response Summary

Flood insurance coverage of $500,000 may meet the minimum requirements of the Flood Rules, in that it would be the aggregate amount of coverage appropriate for a one-to-four family residential property. However, the Bank must determine what buildings securing the loan are located in the SFHA, what type of buildings they are, and what their insurable value is. To the extent that some buildings are residential in nature, other buildings detached from such buildings would not qualify for the Biggert-Waters exemption, since they do not have a personal, family, or household use.

Response Detail

NFIP Policy

FEMA generally does not insure more than one building per policy. For the Standard Flood Insurance Policy issued by the National Flood Insurance Program (“NFIP”), a separate policy is required for each qualifying building, according to the NFIP Flood Insurance Manual. Therefore, if there is more than one building securing a loan, each building will have its own policy.

Building

A “building” is defined as a “walled and roofed structure, other than a gas or liquid storage tank, that is principally above ground and affixed to a permanent site, and a walled and roofed structure while in the course of construction, alteration, or repair”. 12 CFR 339.2.

This means that, to the extent that the structures on the property securing the loan are considered buildings, they must be insured against flood hazard, unless exempted from coverage under the Flood Rules.

Multiple Properties

If the real estate security contains more than one building located in a SFHA in a participating community, the Bank must determine the amount of insurance required on each building and add these individual amounts together. The total amount of required flood insurance is the lesser of:

• The outstanding principal balance of the loan; or
• The maximum amount of insurance available under the NFIP, which is the lesser of:

• • The maximum amount available for the type of structures; or
  • The “insurable value” of the structures. Interagency Questions and Answers Regarding Flood Insurance (“Interagency Q&A”), Q.14.

The interagency guidance provides the example of a lender making a loan in the principal amount of $150,000 secured by five nonresidential buildings, three of which are located in SFHAs within participating communities. It breaks the problem down as follows:

• Outstanding loan principal is $150,000
• Maximum amount of insurance under the NFIP:

• • Maximum limit available for the type of structure is $500,000 per building; or
  • Insurable value (for each nonresidential building for which insurance is required, which is $100,000 or $300,000 total).

The amount of insurance required for the three buildings is $150,000, which is the lesser of the outstanding loan balance or maximum amount of insurance available under the NFIP. The amount of required flood insurance can be allocated between the buildings in varying amounts, so long as each is covered by flood insurance. Interagency Q&A, Q.14.

In applying this example in the present matter, the amount of the loan would be one factor in determining the amount of flood insurance coverage required. The Bank would also use the aggregate insurable value and aggregate of the maximum NFIP available for each of the buildings securing the loan as the other factors in the determination.

Therefore, the Bank must determine which buildings securing the loan are located in a SFHA. It must also determine the types of buildings that are located in the SFHA, as to whether they are one-to-four family residential, multi-family, or commercial, since the maximum amount of insurance coverage available under the NFIP varies by property type.

Assuming that two buildings securing the loan are located in a SFHA, and that both of them are residential in nature, the Bank knows that the amount of the loan is $5 million and that the flood insurance coverage is an aggregate of $500,000. Regardless of the insurable value of the buildings, the maximum amount of insurance coverage that would be required would be an aggregate of $500,000, since a one-to-four family residence can be insured up to a maximum of $250,000.

If one of the properties was residential in nature and the other commercial, then, depending on the insurable value of the properties, the aggregate of flood insurance coverage could be as much as $750,000. Therefore, a determination must be made as to the nature of the properties and their insurable value.

Insurable Value

While the amount of required flood insurance coverage may not be more than $500,000, assuming that only two residential buildings securing the loan are located in a SFHA, it would still be necessary to determine what the insurable values of the buildings are. Flood insurance coverage can only be enforced to the extent of the value of the property, if the insurable value of the property is less than the amount of the flood insurance.

The “insurable value” is the overall value of the property, including foundation and supporting structures, minus the value of the land. The replacement cost value (“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 noted, a lender may consider the extent of recovery allowed under the NFIP in determining the amount of recovery allowed under the NFIP. 12 CFR 339.3; Interagency Q&A, Qs. 8 & 9; FRB, Consumer Compliance Outlook, Third Quarter 2015, Flood Insurance Compliance Requirements.

Assessing Insurable Value

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 a number of 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 the 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, so long as it can be supported. Interagency Q&A, Q.9.

Given the size of the loan and the value of the collateral, the best approach is to have the properties assessed by an appraiser on a cost-value or insurable basis.

Exemption for Detached Structures

The Biggert-Waters Flood Insurance Reform Act of 2012 provides an exemption for detached structures associated with residential real estate. To qualify for such, each of the following conditions must be met:

• There must be more than one building on the property
• One building must serve as a residence (i.e., it must have sleeping, bathroom, or kitchen facilities)
• The detached structure must be used primarily for personal, family, or household purposes, but not as a residence. 12 CFR 339.4(c).

Assuming that the two buildings securing the loan are residential in nature, any detached outbuildings also located in the SFHA would have to be insured against flood hazards, since the nature of the property as a campground means that the detached buildings could not satisfy the “personal, family, or household purposes” requirement of the Biggert-Waters exemption.

This entry was posted on Monday, August 19th, 2019 at 6:00 am.