Flood Insurance: What Causes Civil Money Penalties

2003 was a banner year for Civil Money Penalty (CMP) assessments relating to flood hazard insurance at banks across the nation. While the assessment of the civil money penalty is public knowledge, what led up to the penalties is not published in the orders. Those published by the FDIC give us a glimpse about what was found in the files to determine a "pattern or practice" of Violations of the Flood Act, but even with this information it is difficult to assess what was going on - or not going on - at the bank. Compliance Action has taken a look at the penalties for 2003 and compiled a chart to help show the relative significance of these penalties and we offer some advice on how to make sure you avoid your bank getting into Flood Insurance "deep water".

In an effort to establish what the regulators consider significantly egregious to impose a civil money penalty we spoke with several spokespersons at the various regulatory agencies.

A senior public affairs representative at the Federal Reserve Board offered the following nine things that banks should do to avoid Flood Act penalties:

Ensure that flood hazard determinations are made on all types of loans including construction loans that are secured by a building or mobile home. Flood insurance must be purchased before the loan is made, even though it doesn't take effect until improvements are underway. For the lender, the loan closing is always the trigger; not the construction date.
Ensure that when required, flood insurance is in place at closing for all types of loans including construction loans.
Make sure flood insurance is calculated and carried at:
- Maximum amount of flood insurance available from the National Flood Insurance Program;
- Outstanding Principal balance; or
- Value of the Property less the value of the land.
Resolve any disagreements about whether the property is in a Special Flood Hazard Area before originating the loan. Only FEMA may resolve disputes. Unless and until the dispute is resolved, the borrower must obtain insurance - or you don't make the loan.
Maintain an adequate tickler system to be aware of expiration dates of flood insurance policies.
Monitor renewal of policies by borrowers.
Force place insurance when borrowers do not renew or obtain adequate insurance within 45 days.
Send written notices of special flood hazard areas within a reasonable time before closing even if the bank elects to give oral notice to borrowers.
Monitor the compliance with any third party providers that the bank may us.

Additionally, the Federal Reserve representative emphasized the need for the following basic compliance program elements for flood hazard insurance:

Written Policies and procedures for flood hazard determination and maintenance.
Adequate training of all affected personnel
Follow up with prompt corrective action to any violations noted in a regulatory examination.

While these steps may not alter the finding of a "pattern or practice" of violations of the flood act when violations are identified, they may mitigate the amount of any required civil money penalty.

A spokesperson for the OCC noted that banks should remember that there are only four violations of the Flood Act for which a pattern or practice will result in a CMP.

Purchase of insurance when required
Escrow of premiums when there is an escrow account in connection with the loan
Force Placement of flood insurance when the borrower allows the insurance to lapse
Notice of required insurance

The grid on the next page summarizes the penalties assessed by the three major regulatory agencies in 2003. (As of November 30, 2003)

ACTION STEPS

Review commercial and construction loans to find out when flood hazard determinations were made. Also confirm that insurance was required by the lender and obtained by the borrower before settlement.
Review the system for tracking and renewing flood insurance and evaluate its effectiveness.
Pull a sample of flood insurance policies and compare the insurance amount to the loan balance and property value. Be sure that there is enough insurance attached to each property.
Pull a sample of loans that are subordinate liens and review flood insurance practices. Review the steps lenders take to assess whether additional insurance should be required.
Review your policies and procedures for flood hazard insurance. Give special attention to handling of disputes and force placement procedures.