Methods for Determining Insurable Value (Forced)

This is a complicated topic. Most banks use the insurable value of the hazard insurance policy. However, make sure the hazard insurance includes the full value of the foundation and other improvements below ground. If not, you'll need to add these to their value.

We recently wrote an article about the newly revised Flood FAQs (October 2011) and Questions #9 - which addressed insurable value. Here in an excerpt from the article:

The Agencies finalized Question 9 with a revision to calculating the required amount of insurance for nonresidential properties (ranching, farming or industrial). This also applies to some residential properties that would not qualify for a NFIP dwelling policy such as rental homes, second homes or vacation homes. The regulators affirm in cases involving a single-family dwelling and single-family units in a condominium used as the insured’s primary residence, flood insurance policies should be written to Replacement Cost Value (RCV). As we are aware, the NFIP dwelling policy contains provisions regarding residency requirements and insurance levels relative to RCV but we believe for the most part this calculation should not pose a regulatory issue for a primary residence located in a SFHA.

For those nonresidential and “other” residential properties, the Agencies state in Question 9 “lender and borrower, by themselves or with appropriate professionals” may choose from a variety of approaches or methods to establish a reasonable valuation for insurable value. The first method is obtaining an appraisal based on a cost-value approach. It’s important to remember most appraisals provide market value only and requesting a cost-value approach would most likely require additional time and money. Also, what about a transaction where an appraisal isn’t obtained and other information to value collateral like a tax assessed value is used? The Regulator’s second method to consider is a construction-cost calculation. Again, it is easy to propose but for a lender and borrower to go through the process of seeking a professional to assist with this calculation will not only slow the loan process down but will also add additional costs to the transaction.

The third method the Agencies identify is the insurable value used in a hazard policy but also recognizes that the insurable value may require adjustments to include items such as foundations. In our mind, this will require yet more time and effort to calculate this value. Finally, the Agencies provide a fourth method of any other reasonable approach, so long as it can be supported.

The Regulators were so pleased with their response to Question 9 they decided Question 10 is no longer an issue and has withdrawn it. Question 10 introduced us to the concept of determining insurable value based on “functional building cost value” or “demolition/removal cost value”. With the adoption of Question 9, these terms are history, right? Maybe not. Question 9 provides that one method a lender and borrower could adopt to determine insurable value is “any reasonable approach, as long as it can be supported”. We believe these are still viable options, you just have to support the value you arrive at and like all of the methods to calculate insurable value, that means file documentation.

For many financial institutions calculating insurable value is the most difficult part of flood compliance. In the case of non-primary residences it’s is a no-win situation. Requiring RCV on these structures could often lead to “over-insuring” them; however, the Regulators warn lenders about being mindful of avoiding situations where they under-insured property. When dealing with properties in a flood zone, patience rules the day and documented due diligence is required to determine insurable value for the type of improvement. We wish there were a simpler approach.

First published on BankersOnline.com 2/6/12