Navigating the Complexities of Flood Insurance Compliance

Flooding is the most common natural disaster that occurs in the United States. In historically flood-prone regions, this can lead to increased risks for both buyer and lender. To help protect property owners against losses, the National Flood Insurance Program was founded in 1968 through the National Flood Insurance Act as an alternative insurance option for communities located in federally designated flood plains. For lenders, the Flood Disaster Protection Act of 1973, later reinforced by the 1994 Reform Act, required federally-regulated and federally-insured lenders to monitor and mandate flood coverage on properties throughout the entire term of the loan.

As a result, compliance does not end at loan closing – it’s an ongoing process for as long as the loan exists. This impacts any and all loans (including second mortgages and equity lines) secured by a property determined to be in a Special Flood Hazard Area. That means a lender must determine if a property is in a SFHA at the time of loan closing, while also periodically checking for changes to the property’s flood zone designation.

Most recently, the passage of the Biggert-Waters Act of 2012 introduced a new provision that requires lenders to accept private flood insurance policies that exist outside of the NFIP as long as they continue to match federal requirements.

These regulations can be complicated, and, as demonstrated by the recent federal joint ruling on private flood insurance, continues to change. It is important for lenders to understand what areas of loan origination and servicing are impacted by changing legislation, so they can effectively navigate and refine their processes. There are three elements of flood insurance compliance that a lender should focus its regulatory efforts on:

1. Develop a process for performing flood determinations throughout the life of the loan.

FEMA is currently in the middle of a Multi-Year Flood Map Modernization effort with flood hazard data being updated for 100% of the nation’s populated coastal areas, so it’s important to stay up to date on those designation changes.

This includes at the time of loan closing, anytime a flood zone is remapped by FEMA, or when the existing map is reevaluated. This can be labor-intensive and inefficient for lenders to monitor internally, so contracting with a life-of-loan flood determination service is an effective way to meet this requirement. These vendors monitor and interpret flood zone maps in real-time to make the necessary changes to any impacted properties. Financial institutions should have internal procedures for updating flood zones in their servicing platform both at origination and as properties are remapped. This information will be necessary to successfully monitor ongoing flood insurance coverage on SFHA properties.

2. Obtain evidence of flood insurance at origination.

At loan origination (or modification), if the property is determined to be in a SFHA, flood insurance coverage is required by law as a condition of closing. While this requirement may seem straightforward at first glance, regulations have introduced procedural challenges for financial institutions. For example, per the Biggert-Waters Flood Insurance Reform Act, unless financial institutions meet small lender exception criteria, flood insurance must be escrowed for all improved real estate in an SFHA, even if the loan in question is, for example, a home equity line of credit.

Additionally, while NFIP policies are acceptable evidence of flood insurance, the existence of Write Your Own policies and the re-emergence of private flood insurance in the marketplace (see Section 100239 of the Biggert-Waters Flood Insurance Reform Act of 2012) has introduced additional regulatory guidelines for mortgage loan processors and originators to understand and navigate. With the joint ruling by the federal agencies that goes into effect on July 1, 2019, Biggert-Waters’ requirement to accept private flood insurance will now make it even more necessary for loan origination teams to be able to identify NFIP policies vs. private flood policies and determine if it’s equivalent to the NFIP standard policy.

Flood insurance tip: NFIP (including WYO) evidence of insurance can be identified by the existence of an “HFIAA Surcharge” and/or “Community Name” and “Community Number.”

3. Monitor and maintain flood insurance for the duration of the loan.

Not only are the above requirements applicable at origination, they also apply for the duration of the loan or for as long as the property is in an SFHA. This means that as a consumer changes their coverage, financial institutions will need to proactively identify that new policy and implement a review to determine whether the new policy meets all federal flood regulations.

In the event that a property in a SFHA is lacking adequate flood insurance, the financial institution will need to begin the process of “lender-placing” coverage. This presents another set of specific regulatory requirements (including a 45-day notification period). The resulting processes necessary to manage and monitor flood insurance quickly become technical and complex. Partnering with a vendor can ease this burden by tracking flood properties and making sure adequate flood insurance is maintained throughout the life of the loan – at minimal interruption or cost to your business.

As our Federal Government and private insurance market continue their efforts to develop a more sustainable flood coverage solution for homeowners, the already complex regulations that exist today are likely to develop even more complicated layers. In order to effectively manage the regulatory and financial risks associated with flood insurance, all areas involved in originating and servicing loans secured by improved real estate should regularly assess whether they have the necessary systems, processes and procedures in place.

Phil Reinking is a Second Vice President in the Loan Servicing Product Division for Allied Solutions. He can be reached at philip.reinking@alliedsolutions.net.