The storm-related flooding that occurred in the late summer and fall of 1999 in the Eastern United States was so severe that areas in the 100-year flood plain and even the 500-year flood plain were flooded. Damage from Hurricane Floyd has already been estimated at $1.3 billion. With this experience, flood hazard insurance is likely to remain a top compliance topic.
Compliance is - or should be - relatively straightforward. It just doesn't seem to work out that way. Failures in compliance are largely the result of lending staff taking a short cut because they don't really believe that compliance with flood insurance is all that urgent. Lending staff is also put under pressure to skip flood insurance requirements by their customers who are tying to reduce their settlement costs and don't think that floods can happen to them.
In fact, penalties are steep. First, if there is no flood insurance when there should have been, the practical result is that the bank is the insurer. It will be the bank paying out the losses to the customer. Second, regulators may impose civil money penalties on institutions that have a pattern or practice of violations. The penalties may be up to $350 per violation but not more than $105,000 in any calendar year.
Maintaining compliance is really not complicated. It is much easier than chasing finance charges. First, perform a flood hazard determination for any improved real property or mobile home offered as security for a loan. Don't get into complicated discussions of what constitutes an "improvement." Keep it simple: an improvement is anything man-made that can wash away or get damaged in a flood. That includes sheds.
This rule is not consumer-driven. It is driven by loss that can occur in floods. Therefore, commercial loans are included. In fact, commercial loans can involve greater losses.
Second, give notice to the borrower if the property is in a flood hazard area. Although there is no specific timing requirement for this notice, it should be sent to the customer in time for the customer to obtain insurance before closing. Waiting until the last day before closing to obtain a flood hazard determination will mean that, if the property is in a flood hazard area, you won't be able to give the customer time to purchase insurance. And that means that you can't close the loan on schedule.
Third, you may not close the loan until the customer has adequate flood insurance in place. You can't close the loan on the understanding that the customer will find and purchase insurance "right away." The rule is simple: no insurance, no loan.
Fourth, if there is an escrow account established or maintained in connection with the loan, the flood insurance premiums must be escrowed. The flood hazard insurance act does not require that an escrow account be established whenever insurance is purchased. However, whenever there is an escrow account for any other reason, you must include flood insurance in the account.
Finally, the lender must notify FEMA of the identity of the loan servicer so that FEMA can track the flood insurance and notify the service if the insurance is allowed to lapse.
Safety & Soundness
Flood hazard insurance is not simply a compliance issue. It is also - or perhaps fundamentally - a safety and soundness issue. The purpose of having flood insurance is to protect both the home-owner andthe lender.
The procedural requirements in the regulation - to conduct a flood hazard determination and to notify the customer if insurance is needed - is classic compliance. It involves taking specific steps and making specific disclosures at the time required.
But the underlying purpose for flood hazard insurance really goes to the safety and soundness of the loan. The security on a loan isn't much good if most of it has washed downstream or into the ocean. Think of the insurance as part of the security for the loan.
- Train your loan officers on flood insurance requirements at least once each year.
- Remind loan officers of the penalties for violations of flood insurance.
- Review your procedures for requesting flood hazard determinations.
- Designate an individual and a back-up to be responsible for tracking flood map changes and notifying all appropriate bank staff when that occurs.
- During a loan compliance audit, review loan files for compliance. Be sure to include commercial loans in this review.
- Check escrow accounts for inclusion of flood insurance premiums.
- If your bank sells servicing, be sure that the procedures for sale include notification to FEMA whenever flood insurance is required.
Copyright © 2000 Compliance Action. Originally appeared in Compliance Action, Vol. 4, No. 17 & 18, 1/00
First published on 01/01/2000