The county we do the majority of our lending has remapped. During the process of notifying customers of their change in status, we have first mortgages that will require the flood insurance premium to be escrowed. If they customer does not respond and force placement of flood insurance is necessary, how is that handled since an escrow would be required?

In the January 2016 edition o]f our newsletter, I covered the "Force Placing Insurance / MIRE Event" issue. Here's the article (although the formatting is messed up when I paste it). Be sure to read the "Recommendations" section for specifics on your question.


In our January newsletter, we addressed whether adding force placed flood insurance premiums to the loan balance is a MIRE event. [Just in case, “MIRE” stands for “Make, Increase, Renew, Extend”, and these events trigger the flood insurance requirements]. If you recall, we had written the FDIC and challenged their position on this issue. Since then, we’ve had several discussions with field examiners on this topic and we received a “final” answer just a few weeks ago. We don’t think you will like the answer.

Apparently, the FDIC is standing on an Interagency Policy Group’s opinion – issued through an internal memo (not for public view) – that indicates adding force placed flood insurance premiums to the existing loan balance is a triggering event for the flood requirements. This interpretation literally opens the compliance floodgates (pun intended) and could possibly include the need for a new Standard Flood Hazard Determination Form (SFHDF), a new flood notice, higher amount of flood insurance and escrowing for flood premiums. We’ll discuss each of these and more in this article.

As far as we know, the FDIC is the only agency making this claim even though it’s based on an Interagency opinion (which should include all regulatory agencies). While at a state banking conference a few months ago, this was brought up during a regulatory panel. The OCC and FRB examiners on the panel didn’t say much and inferred they were not in agreement, but didn’t want to contradict the FDIC examiner. If the FDIC is not your regulator, your examiners may or may not be enforcing this interpretation. We recommend you check with them.

The FDIC examiner we spoke with indicated this would not be issued as formal guidance since the FDIC didn’t see a need for it to be announced. We strongly disagree as this is a new interpretation and creates many concerns. We strongly encourage everyone to contact your trade associations (state and federal) about this issue. Our hope would be that the trade associations would put pressure on the regulators to rethink their position or issue formal guidance, at a minimum.

What is triggered?
When a bank adds force placed flood insurance premiums (or makes any type of increase) to the loan balance, this is a “MIRE” event. Thus, all flood insurance requirements are triggered. This includes:
1. SFHDF: You may be able to rely upon a previous determination, but if the SFHDF is older than 7 years or references an old map that has since been updated, you must complete a new determination form. Your bank’s procedures may also require a new SFHDF.
2. Notice: Every time you MIRE a loan, you must give a new Notice a reasonable period of time prior to closing. If you force place insurance by adding it to the loan balance, you need to deliver a new notice PRIOR to the increase.
3. Higher Insurance: If the loan balance increases and it is the lowest dollar amount in determining the necessary insurance amount (compared to the insurable value and maximum available), you’ll need to increase the amount of flood insurance to achieve adequate coverage. This alone is a complicated issue that we will discuss further below.
4. Escrow: If you MIRE a loan secured by residential real estate after January 1, 2016, you must escrow for the flood insurance premiums (unless your institution or the loan qualifies for an exemption).

Adequate Coverage
Lenders use the “lesser of 3” (loan amount, insurable value and maximum available) to determine the proper amount of flood insurance. If the loan amount is the least of the three and you add the force placed insurance premium to the loan balance, this increases the loan balance, which in turn creates a need for a higher amount of insurance.

Let’s assume you inform a borrower on April 1st that they need to purchase flood insurance by sending them a letter. The letter states they need $100,000 of flood insurance since that’s the borrower’s current loan balance. Let’s also assume the borrower does not purchase the insurance. If you’re going to add insurance to the loan balance, you will need to get more insurance than just the current loan balance so you have enough to cover the loan balance and the added premium. But how much? If you get a quote from the insurance agent for the premium on $100,000 in insurance (for example, $2,000) and add it to the loan balance, then you’re still “short”. The loan balance increased by $2,000, so now you need $102,000 in flood insurance. But if you purchase a higher amount, the loan balance increases again, driving up the need for yet more insurance. You can see how this is a “circular” issue, so examiners suggest you get a little more to make sure you have enough insurance to cover the loan balance once the insurance premium is added.

The new insurance amount needed is the current loan balance plus the new insurance premium, not to exceed the insurable value or maximum available from the NFIP.

Escrow
Beginning January 1, 2016, if you MIRE a loan secured by residential real estate, you must begin escrowing for future flood insurance premiums (if the loan or your institution is not exempt). This is a regulatory requirement and not an option for the bank or the borrower. As any lender knows, there’s
a correlation between non-cooperative borrowers and those for whom you must force place insurance. So, now you get to tell these non-cooperative borrowers that they also have to begin escrowing.
Good luck! The escrow must be established once the insurance premium is added to the loan balance. This means RESPA’s escrow requirements (if applicable) will need to be followed and an Initial Escrow Account Disclosure Statement will need to be delivered to the borrower.

Recommendations
Go back to the letter you sent the borrower on April 1st (in our previous example). You told them they needed $100,000 in insurance, but now they really need a higher amount. You never informed the borrower they needed this new higher amount and you didn’t tell them they would now be required to escrow. We recommend stating these potential consequences in the initial force placement letter.
You may not be able to quote the exact amount of insurance (loan balance plus new/higher premium), but you can let them know it will be a higher amount. This clearly communicates the two options the borrower has: 1) purchase their own insurance, or, 2) allow the bank to force place a higher amount of insurance, increase the borrower’s loan balance and begin to escrow for future flood insurance premiums.

You should also send the borrower a new Notice at this time. If you end up force placing insurance, you trigger a new notice prior to adding it to the loan balance. By sending the Notice with the force placement letter, you’ve met this requirement.
Furthermore, if you charge a fee for force placement, you should inform the borrower of this in the initial notification letter. Last, you should inform the borrower that their failure to purchase adequate insurance would also result in a requirement to escrow for future flood insurance premiums (if applicable).

Alternative Approach
There is another way to get around all this. Instead of adding the premium for the force placed insurance to the loan balance, you could put it in a suspense account. This is not a MIRE event and the issues discussed in this article would be avoided. Seems like the easy answer, right? Not necessarily. There are operational issues as well as legal risks that could be triggered by using suspense accounts. For example, collection during foreclosure, quoting appropriate loan payoffs, etc. This is a management decision and should be discussed thoroughly.

In Closing
We have a new flood insurance interpretation and unfortunately it's not published in ANY regulatory guidance to the banking industry. You need to sit down and put your heads together to think through how you will comply with this requirement and adjust your procedures accordingly. Don’t hesitate to contact us if you need further clarification or training on these or other issues.

David, I appreciate this information. What I am looking for is regarding force placed insurance and escrows.

Example -
1st mortgage currently not escrowing
Due to County remap, the property is in the flood zone
Customer does not respond to requirement to obtain flood insurance.
The Bank will be required to force place, however with the escrow requirement, an escrow will need to be established.
How would we handle that?

You are going to have to refer to your loan and security agreements to determine your options.