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Part II: Keeping Your Head Above the Water: New Private Policy Flood Rules

Welcome to part II of our analysis of the new private flood insurance rule.

Now that you’ve had a week to process the meaning of “private flood insurance” and how that definition affects your institution, welcome to part II of our analysis of the new private flood insurance rule. In this article, we will discuss optional acceptance of private policies as well as those issued by mutual aid societies, and then wrap up by looking at some practical aspects of the new rule.

While every lender must accept a policy that meets the definition of “private flood insurance,” a lender has the option to accept a private policy that falls short of that definition. Even so, the policy must meet all of the following requirements:

• The policy must be issued by an insurance company that is licensed, admitted or otherwise approved in the state where the property to be insured is located, including surplus lines insurers that are recognized or not disapproved by the applicable insurance regulator.
• The policy must provide coverage in an amount required by the flood insurance purchase requirements.
• The policy must cover both the mortgagor and the mortgagee as loss payees, unless it is a policy provided and paid for by a condominium association, homeowners association or other applicable group.
• The lender must document that the policy provides sufficient protection for the loan, consistent with general safety and soundness principles.

Factors to consider when determining whether the policy sufficiently protects the loan:

• Does the insurer provide adequate cancellation notice to the mortgagor and mortgagee to ensure timely force-placement, if necessary?
• Are the loss payment terms and aggregate limits adequate to protect the lender’s interest in the collateral?.
• Does the policy comply with state insurance laws?
• Does the provider have the financial strength, solvency and ability to satisfy claims?

Additionally, lenders have the option to accept policies issued by mutual aid societies that do not meet the definition of “private flood insurance.” A mutual aid society is an organization:

• Whose members share a common religious, charitable, educational or fraternal bond
• That covers the losses caused by damage to members’ properties pursuant to an agreement, including damage caused by flooding, in accordance with this common bond
• That has demonstrated a history of fulfilling the terms of the agreement to cover the losses to members’ property caused by flooding

Assuming a mutual aid society that meets the definition above provides the policy, a lender may optionally accept the policy if it meets all of the following criteria:

• The institution’s primary supervisory agency has determined that such plan qualifies as flood insurance for purposes of the Federal flood insurance statutes.
• The policy meets the amount of coverage for losses specified in the flood insurance purchase requirement.
• The policy covers both the mortgagor and the mortgagee as loss payees.
• The regulated lending institution has documented that the policy provides sufficient protection for the loan.

The flood escrow requirement only applies if the borrower is paying for the private flood policy. If the mutual aid society pays for the policy, then the flood escrow requirement does not apply.

So, how does this new rule really affect individual lenders in a practical setting? The reality is that most existing private flood policies will not meet the definition of “private flood insurance,” leaving lenders with the option of accepting policies under the less stringent discretionary provisions. Interestingly, several agencies have already indicated that they rarely expect to make determinations that policies provided by “mutual aid societies” qualify as flood insurance. So, the opportunity to allow this type of policy will likely be somewhat limited.

Lenders already accepting private flood policies are currently doing so under guidance that is very similar to the provisions found in the final rule, so the compliance burden on these lenders is expected to be minimal.

The real burden will come for those lenders that are not currently accepting private flood policies. These lenders will need to update policies, develop procedures and implement training to bring staff up to speed on the discretionary acceptance criteria.

Lastly, all lenders will need to be certain they have the tools in place to recognize those policies that meet the definition of “private flood insurance” in the event they encounter a policy that does not contain the compliance aid. If your ears just perked up, and you are not sure what “compliance aid” means, please see part I of this article from last week’s newsletter. In the end, the rule is straightforward and less restrictive than originally proposed. Keep in mind, the Temenos Advisory Team is always here to support you as we move towards the July 1 effective date.