Section-by-Section Analysis of the Private Flood Rule
Big News: One of the great things about SCA is the range of issues we get to see, and the wealth of knowledge we get to tap into while working with dozens of clients on a monthly basis. Today, we'll share some important news about the new private flood rule.
By: Gregg Oberg
Effective July 1, 2019, regulated lending institutions must accept Private Flood Insurance (PFI) policies which meet statutory requirements confirming the PFI policy meets the Biggert-Waters definition of PFI by virtue of being “at least as broad as” the Standard Flood Insurance Policy (SFIP) offered at the time through the National Flood Insurance Program (NFIP).
A. Definitions (as applicable to Credit Unions under NCUA Regulation, in final form)
Mutual Aid Society: an organization:
(1) Whose members share a common religious, charitable, educational, or fraternal bond;
(2) That covers losses caused by damages to members’ property pursuant to an agreement, including damage caused by flooding, in accordance with this common bond; and
(3) That has a demonstrated history of fulfilling the terms of agreements to cover losses to members’ property caused by flooding.
Private Flood Insurance (PFI): as defined in Section 102(b)(7) of the FDPA, means an insurance policy that:
(1) Is issued by an insurance company that is:
- (i) licensed, admitted, or otherwise approved to engage in the business of insurance by the insurance regulator of the State or jurisdiction in which the property to be insured is located; or
- (ii) Recognized, or not disapproved, as a surplus lines insurer by the insurance regulator of the State or jurisdiction in which the property to be insured is located in the case of a policy of difference in conditions, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property,
(2) provides flood insurance coverage that is at least as broad as the coverage provided under an SFIP for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer. To be at least as broad as the coverage provided under an SFIP, the policy must, at a minimum:
- (i) Define the term “flood” to include the events defined as a “flood” in an SFIP;
- (ii) Contain the coverage specified in an SFIP, including that relating to building property coverage; personal property coverage, if purchased by the insured mortgagor(s); other coverages; and increased cost of compliance coverage;
- (iii) Contain deductibles no higher than the specified maximum, and include similar non-applicability provisions, as under an SFIP, for any total policy coverage amount up to the maximum available under the NFIP at the time the policy is provided to the lender;
- (iv) Provide coverage for direct physical loss caused by a flood and may only exclude other causes of loss that are excluded in an SFIP. Any exclusions other than those in an SFIP may pertain only to coverage that is in addition to the amount and type of coverage that could be provided by an SFIP or have the effect of providing broader coverage to the policyholder; and
- (v) Not contain conditions that narrow the coverage provided in an SFIP;
(3) Includes all of the following:
- (i) A requirement for the insurer to give written notice 45 days before cancellation or non-renewal of flood insurance coverage to:
· (A) The insured; and
· (B) The credit union that made the designated loan secured by the property covered by the flood insurance, or the servicer acting on its behalf;
- (ii) Information about the availability of flood insurance coverage under the NFIP;
- (iii) A mortgage interest clause similar to the clause contained in an SFIP; and
- (iv) A provision requiring an insured to file suit not later than one year after the date of a written denial of all or part of a claim under the policy; and
(4) Contains cancellation provisions that are as restrictive as the provisions contained in an SFIP.
If a PFI meets all above criteria, the regulated lending instruction is required to accept the coverage. Alternatively, as discussed in the Compliance Aid section, regulated lending institutions may rely on statements by the insurer, or may perform its own diligence to reach a conclusion as to eligibility of the PFI.
Standard Flood Insurance Policy (SFIP): means a flood insurance policy issued under the NFIP in effect as of the date the private flood insurance is provided to a credit union.
For purposes of the Final Rule, these definitions combine to require a comparison of the SFIP available through NFIP as of the date the insurance binder for the private coverage is delivered to the lender.
B. Requirement to Purchase Flood Insurance
The Final Rule does not substantively modify the triggers which previously would require purchase of SFIP under NFIP. NFIP coverage is limited—and continues to be limited—to the building or mobile home and any personal property securing the loan.
The Final Rule acknowledges that a declarations page may not be sufficient to determine qualification of a PFI, and instructs lenders to work directly with the insurer to obtain sufficient information to make a determination of coverage eligibility.
Finally, the Final Rule notes that in the event of conflict with state law, institutions are not required to accept a policy that complies with State law and conflicts with the definition of PFI under Biggert-Waters Act. However, lenders are free to exercise their discretionary power to accept PFI outside of the Biggert-Waters definition.
C. Compliance Aid for Mandatory Acceptance
Where the 2016 Proposed Rule included a tripart test for whether PFI meets the statutory definition—and thus must be accepted as a substitute to SFIP—the Final Rule simplified the compliance aid and shifted burden (at least in theory) to the insurers themselves.
Under the Final Rule, “[a] credit union may determine that a policy meets the definition of private flood insurance in § 760.2, without further review of the policy, if the following statement is included within the policy or as an endorsement to the policy: ‘This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.’”
As a practical matter, the Compliance Aid is only useful to the extent that insurers have adopted the above referenced language. First, there may well be an extended lag time in implementation by insurers due to liability for erroneous determinations by the insurer. Second, the Final Rule explicitly rejected safe harbor protection in analyzing this section. Third, while a lender is permitted to accept the Compliance Aid for purposes of verifying PFI coverage eligibility, a lender may not reject a PFI policy merely because it lacks the Compliance Aid statement. Fourth, the Final Rule permits additional due diligence beyond the Compliance Aid statement, leaving open a possibility of legal liability for negligently approving an inappropriate policy.
For the foreseeable future, lenders need to be prepared to analyze whether a PFI meets the SFIP minimum criteria through due diligence rather than mere reliance on third party representations.
D. Discretionary Acceptance
The Final Rule modified the 2016 Proposed Rule criteria around discretionary acceptance of PFI that does not meet the definition of PFI under Biggert-Waters; simplifying the application for community lenders.
Discretionary acceptance is not without risk—and is a relatively subjective standard. Under NCUA rules:
“A credit union may accept a flood insurance policy issued by a private insurer that is not issued under the NFIP and that does not meet the definition of private flood insurance in § 760.2 in satisfaction of the flood insurance purchase requirement … if the policy:
(i) Provides coverage in the amount required by [NFIP];
(ii) Is issued by an insurer that is licensed … in the business of insurance by the insurance regulator of the State or jurisdiction in which the property is located …;
(iii) Covers both he mortgagor(s) and the mortgagee(s) as loss payees, except in the case of a policy that is provided by a condominium, association, cooperative, homeowners association, … or other applicable group as a common expense; and
(iv) Provides sufficient protection of the designated loan, consistent with general safety and soundness principles, and the credit union documents its conclusion regarding sufficiency of the protection of the loan in writing.
(v) Specifically, subsection (iv) places risk on the lending institution when making a subjective determination of whether the protection on a specific loan is “consistent with general safety and soundness principles.” The Agencies note factors that lenders may consider for this prong, including reasonableness of deductibles in light of the borrower’s financial condition, adequacy of cancellation notices to ensure timely force placement, per loss or per occurrence and aggregate limits on coverage, compliance by the insurer with state laws, and general solvency, strength, and ability to satisfy claims.
E. Mutual Aid Societies
In permitting lending institutions to accept certain flood coverages provided by Mutual Aid Societies, the Final Rule creates a second permissive category through which lenders may meet the flood insurance purchase requirements via PFI issuers. As defined above, Mutual Aid Societies include groups with common religious, educational, or fraternal bonds.
Institutions should evaluate Mutual Aid Society coverage only after determining if the PFI must be accepted under the Final Rule or whether the institution is free to allow discretionary acceptance based on the terms of the PFI in comparison to the SFIP. This in effect creates a waterfall within policy where any PFI presented to the institution should be evaluated for Mandatory Acceptance, Discretionary Acceptance, and then Mutual Aid Society qualification. The later two may be completely disregarded by the institution if they so choose.
In order for Mutual Aid Society coverage to satisfy the statutory requirement to purchase flood insurance, lenders must evaluate if:
(i) The NCUA [or other Agency] has determined that such plans qualify as flood insurance for purposes of the Act;
(ii) The plan provides coverage in the amount required by [the Act];
(iii) The plan covers both the mortgagor(s) and the mortgagee(s) as loss payees; and
(iv) The plan provides sufficient protection of the designated loan, consistent with general safety and soundness principles, and the credit union documents its conclusions regarding sufficiency of the protection of the loan in writing.
DISCLAIMER: This document summarizes the Final Rule issued jointly by the Agencies with regard to mandatory acceptance by lenders of Private Flood Insurance policies. This is NOT legal advice or a substitute for legal advice, and language is heavily paraphrased for purposes of conveying a succinct understanding of the Final Rule. It is assumed that readers already have a functioning understanding of Pre-2019 Flood Insurance rules and regulations. The opinions express herein are my own, and not necessarily representative of my employer or any client(s). Trust but verify.
Spillane Consulting Associates has served the residential mortgage lending business since 1991. We have specialized in mortgage banking consulting services and provided quality control reviews, risk management and process consulting and employee training to credit unions, community banks and non-depository institutions. We are a thought leader on the strategic growth of residential mortgage lending. You can learn more by visiting our website, or scheduling a meeting with me or one of my colleagues.
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