Flood Hazard Insurance Strengthening Compliance

In the wake of privacy implementation, terrorist attacks, and stock market crises, it is too tempting to ignore some compliance regulations. But we do so at our peril. FEMA reminds us that Mother Nature is unimpressed by the doings of humans and follows her own agenda. Just ask people living in Culpepper, VA or College Park, MD who were affected by tornados during a heavy rainstorm. Some FEMA staff were deployed from assignments related to terrorism to evaluate damage from that storm.

FEMA and the financial institution regulatory agencies are still watching compliance with flood hazard insurance requirements. The FDIC recently issued FIL-81-2001 to remind institutions of their flood hazard compliance responsibilities. Attached to this FIL are two documents to help with compliance. One is a flood insurance compliance monitoring checklist which institutions can use to routinely review compliance within the institution.

Why
FEMA has disturbing information related to flooding and resulting damage. The agency responds to all sorts of disasters, not simply floods. However, flood damage accounts for more than half of the disasters that resulted in Presidential disaster declarations. Flooding results in a steady loss in the United States, typically more than $1 billion per year. While earthquake damage can be more extensive, floods are much more frequent.

FEMA reports that less than half of the structures that should be are actually covered by flood insurance. Most of these properties have fire insurance. This discrepancy is not in the owner's interest because, over a 30-year period, the property has a 26% chance of being flooded but only a 1% chance of being damaged by fire.

What to do
An attachment to FIL-81-2001 contains a briefing document that you may find useful for training purposes. Embedded in this memo is advice about the most common violations that examiners find concerning flood insurance.

The very first sentence explains that flood hazard determinations must be performed before loans are closed. The regulation itself does not contain this kind of timing requirement. Instead, the timing must be deduced from the notice provisions. Lenders, indulging in what we like to call "unlicensed regulatory reading" claim that because there is no explicit timing requirement in the regulation, they may do the flood hazard determination after closing. However, the authors of the regulation point out that you can't very well provide notice and ensure that required insurance is in place before closing unless you do the determination before closing. This summary of requirements makes the timing requirement clear.

The only exception to this timing rule is when the loan will be secured by a mobile home and the permanent location is not known. In this case, the lender should perform the determination "as soon as a permanent location for the mobile home is obtained." The paper also reminds lenders that the Standard Flood Hazard Determination Form should be properly completed with all the required information. Often missing is the bank's identification number or information about the property location. This information is needed to help FEMA track insurance policies.

Lenders should keep a copy of the determination form "for the life of the loan." If the property is located in a flood hazard zone, the lender should also keep a record that the borrower received the notice.

No Exceptions
The flood insurance requirement may not be ignored. No lender has any authority whatsoever to "waive" the requirement for a borrower. Some lenders are reluctant to impose what they see as a financial imposition on the borrower - especially when the borrower objects. The same lenders don't hesitate to require fire insurance, even though the risk of a fire is much lower than the risk of a flood.

The summary points out that flood hazard determinations and insurance are quite simply a risk management tool for both lenders and borrowers. The cost of premiums are small relative to the cost of flood damage. The summary states that lenders may even, at their discretion, require flood insurance for properties not located in a flood hazard zone.

Only FEMA can make corrections if the map indicates that the property improvements are located in a flood hazard zone.

Compliance Program
Lenders must take active steps to ensure that compliance with flood hazard insurance is maintained. This includes several steps. First, there should be a procedure to check that borrowers maintain at least the minimum required coverage. Procedures should include checking the policies for key details, including whether they were written for the correct risk zone. If the risk zone is incorrect, the policy may not cover the actual risk and no claims will be paid unless and until the customer pays the correct amount.

Also check for policy renewals as they become due. The flood insurance requirement runs for the life of the loan. Lapses in insurance coverage are not uncommon. You should have a tracking system to ensure that required insurance is renewed.

Also check your relationship with the flood determination company. Make sure you know and provide what information they use to track loans during the life of the loan. Also check your contracts with the determination company and make sure that your treatment of extensions, renewals, and refinancing is consistent with the contract.

Price Tag
As a final incentive, the FDIC reminds institutions that there will be civil money penalties imposed if examiners find a pattern or practice of flood hazard insurance violations. Penalties include up to $350 per violation with a maximum penalty of $115,000 in any one calendar year.

The cost burden doesn't always end with civil money penalties. Institutions and loan officers should realize that if the institution fails to comply with flood insurance requirements, the institution may be the "insurer" if flood damage occurs on property that should have had insurance. Those costs could well exceed $115,000 in a given year.

Some Flood Facts*:

Nearly nine of every 10 presidential disaster declarations result from natural phenomena in which flooding was a major component.
Property damage from flooding now totals over $1 billion each year in the U.S.
The force of six inches of swiftly moving water can knock people off their feet.
Cars can easily be swept away in just two feet of moving water.

* Information from FEMA

ACTION STEPS

Review your lending procedures to be sure that there are adequate procedures for flood hazard determinations and insurance. This includes commercial as well as mortgage lending.
Review your ongoing compliance procedures to be sure that they include all the steps discussed in this article.
Send a memo to all lending staff to remind them of the flood hazard insurance requirements. In capital letters, tell staff they may not waive the requirement.
Review your procedures for resolving disputes or conflicting information regarding whether an improved real property is located in a flood hazard zone.
Discuss whether loan officers who fail to comply should be penalized. Just having the discussion should make the point.
Share some information about flood damage with lending staff so that they understand the reason for the requirements and can better explain any need for insurance to customers.
Remind loan officers about the limitations of federal disaster assistance.