Flood Insurance Regulations Proposed

On October 18, 1995, the financial regulatory agencies proposed new flood insurance regulations to carry out the provisions in the Riegle Community Development and Regulatory Improvement Act of 1994 (CDRIA). The explanatory document published with the proposal (FR Vol. 60, No. 201, p. 53962) contains a valuable summary of the provisions of the new law.

The agencies have issued a joint proposal to minimize burden on institutions that would otherwise have to comply with differing and possibly conflicting regulations. Also from concerns about burden, they have published a minimalist regulation which contains only provisions and changes necessary to implement the provisions in the act.

The comment period closed on December 18, 1995. Because the joint agency drafting process involved detailed discussion and debate about the proposed regulation, it is not likely that the final regulation will be significantly different unless the comments submitted raise serious concerns. If the comment analysis process goes smoothly, final regulations should be out in several months.

Several provisions are worth noting, even before the regulation becomes final. In this article, we give you a quick overview of key issues in the proposal.

Escrow accounts
The CDRIA requires that whenever a lender requires an escrow account on a consumer loan for the payment of any fees or taxes related to the loan, the lender must also escrow flood insurance premiums if the loan is subject to flood insurance requirements. (Commercial loans are not subject to this escrow requirement.)

If an escrow account is maintained for a loan which is subject to mandatory flood insurance, the escrow account rules of the Real Estate Settlement Procedures Act apply to all payments into and from the account, including those for flood insurance. The escrow requirement for the flood insurance regulations will take effect when the new regulations are final.

Standard form
Certification of flood hazard determinations must now be done using the standard form issued by FEMA. The proposed regulations clarify that the bank may use a printed, computerized, or electronic version of the form. Similarly, the bank may retain the form as hard copy or electronically. The form must be retained for the period of time the bank owns the loan.

Notice
Banks must provide notice to borrowers that the property they will use to secure a loan is located in a flood hazard area. In order to accommodate lending practices, the proposed regulation does not contain a specific time requirement. It does provide a guideline that customers should be notified at least 10 days before closing. This provides the customer with time to obtain insurance.

New to this proposed regulation is the requirement that the bank notify FEMA of the identity of the loan servicer. The bank must also notify FEMA if there is a change in servicers. This notification is intended to support the goal of strengthening oversight of flood insurance compliance. Although this notice to FEMA could be burdensome, it is probable that FEMA will designate the insurance agent to receive the servicer notice. This will be less burdensome to the industry and more effective in getting information where it needs to be.

Forced-place Insurance
Under the new law, banks have authority to force place flood insurance if the borrower does not purchase it. The explanatory materials published with the proposed regulation point out that this authority is self-implementing. The proposed regulations explain that the bank should notify the customer of the flood insurance requirement, and provide a 45 day opportunity for the customer to obtain the insurance. If the customer does not purchase insurance during the 45 day period, the bank must purchase the insurance for the customer and may pass on the cost of insurance and fees to the customer.

Portfolio Review
The proposed regulations do not impose a requirement for portfolio review, either retroactive or prospective. The agencies have concluded that imposing a review requirement would be costly and unnecessary. However, the agencies believe that banks should have policies and procedures to ensure compliance with the flood insurance requirements, and have not ruled out the possibility of "providing guidance" on how banks should accomplish this.

An area of continuing controversy deals with whether the purchase of a loan constitutes the making of a loan. In this proposed regulation, the three bank regulatory agencies take the position that a purchase is not a making of a loan. Therefore, the purchaser does not have the obligation to make a flood zone determination.

One consequence of this position is that the loan purchase would not be a situation giving rise to purchasing insurance which could take effect immediately. Purchasers of loans on which the insurance policy has lapsed would therefore be at risk. The agencies advise banks to include provisions in their purchase contracts that require the seller of the loan to make the determination. The agencies are also considering whether to provide additional guidance on the applicability of the law and regulation to loan purchases.

ACTION STEPS

Review escrowing practices and procedures. Advise your lending staff and loan operations staff that flood insurance premiums must be escrowed whenever a consumer escrow account is required.
Review the existing consumer loan portfolio to identify any loans secured by improved real estate located in a flood hazard zone.
Determine whether insurance policies are being maintained.
Implement forced placement procedures on any flood insurance that has lapsed.
Review the procedures for determining flood hazard zones to be sure that the new form is being used.
Check every loan product - including commercial loans - that may take security in improved real property.
Review your policies and procedures for flood insurance compliance.
If your bank purchases loans, make sure that any pre-purchase review or due diligence procedures includes determining whether the loan is subject to flood insurance and that insurance is current.
If your bank purchases loans, review your contracts to determine how responsibilities and liabilities for compliance with flood hazard determinations and insurance requirements are provided for.