You say you are a small servicer, but there's a different exemption for Small Banks found in the Flood rules. Here's an excerpt from our Flood training manual on the Small Bank Exception:
2. Small Bank Exception [§339.5(c)(1)]:
Some banks will be exempt from the flood insurance escrow requirements (including optional escrows). Any bank that meets the following:
a. Asset Size Test:
The bank had assets of less than $1 billion either of the prior two calendar year ends; and
b. Escrow Account Test:
In relation to any loans secured by residential improved real estate or a mobile home on or before July 6, 2012:
i. Consistent Escrow Policy:
The bank did not have a policy of consistently and uniformly requiring an escrow account); and
ii. HPML Escrow Requirement:
The bank was not required to escrow under Federal (i.e., HPML) or State law for the entire term of any loan.
iii. Voluntary Escrow Account Note:
The small bank exception cannot be lost due to voluntary escrow accounts.
If you qualify as a Small Bank, then you don't need to worry about escrowing for flood insurance. If you don't qualify, then "yes", if you force place and add the premium to the loan amount, you are Increasing the loan amount (a MIRE event).
Please reply and let us know if you qualify for the exemption. If not, I can give you more about notifying applicable borrowers (it's a LONG story!).