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Lahaina, HI, and California wildfires. Katrina. Sandy. Harvey. Ian.
Financial institutions have real skin in the game when it comes to flood insurance. First and foremost, they need to know that their collateral is protected come rain or, well, rain. Flood risk and compliance is complicated and there’s a lot that lenders should keep in mind.
Simply put, a Flood Zone Determination explains what flood zone applies to a particular structure. This is determined using maps from the Federal Emergency Management Agency (FEMA). A lender must make a flood determination during the underwriting process and notify the borrower in writing prior to closing if the collateral is determined to be in a SFHA. Flood insurance, in this case, also must be purchased prior to closing. A lender should remember that if a loan is secured by land that will later be developed, flood insurance is not required until such development begins.
Regulators require the Notice to Borrower to be given within “a reasonable amount of time” prior to loan closing. Of course, what constitutes ‘reasonable’ will depend upon the circumstances of the transaction. The lender should provide notice to the borrower with enough time to ensure that they can purchase insurance before the completion of the loan transaction. At least ten days’ notice is still considered to be the best practice. That being said, some home equity loans close in less than 10 days from application. In cases where notice is not given at least 10 days prior to closing, the lender should note their loan file as to why a shorter time frame was reasonable.
With regards to construction loans, a lender should keep in mind that any coverage that comes through the National Flood Insurance Program (NFIP) does not come into effect until construction starts or materials are placed on or adjacent to the premises — even though a policy may be purchased beforehand.
Lenders should also understand that their obligations regarding flood determinations come about not only when a loan is made, increased, extended, or renewed, but also any time after closing should they become aware of collateral moves into a Special Flood Hazard Area (“SFHA” or 100-year floodplain). In these post-closing situations, they must send a notice to the borrower that details their Flood Zone Determination status and insurance requirements.
However, the NFIP is not a borrower’s only flood insurance option. There are also always private insurers (including AFR Services) that provide coverage — and often those policies extend broader coverage and higher coverage limits than the NFIP offers.
Another consideration revolves around structures that are determined to be in a SFHA but that are later removed from that SFHA through FEMA’s Letter of Map Amendment (LOMA) process. A LOMA typically is granted by FEMA if the lowest adjacent grade to the structure is at or above the Base Flood Elevation for the area. Many property owners and lenders assume that an elevation certificate by itself can be used to demonstrate a structure is not in a SFHA. However, the elevation certificate must be sent to FEMA, along with a completed LOMA application, for FEMA’s review and approval.
In addition to understanding standard flood insurance requirements prior to closing, lenders also need to be familiar with lender-placed insurance options for post-closing needs. While lender-placed insurance shouldn’t be the first option, sometimes it’s the only option. If, during the course of the loan, the lender learns that the required flood insurance is lacking or is insufficient, then it must provide notice to the borrower informing them of the need to purchase flood insurance. Ideally, the borrower then acquires the requisite coverage. However, if the borrower fails to do so within 45 days, then the lender must purchase coverage on their behalf.
That’s a lot to keep in mind as a lender when it comes to managing compliance and insurance risk. Why not work with AFR Services? Our 30+ years working in flood research, compliance and insurance provides us with the tools and knowledge needed to protect your interests while providing your clients with the best insurance solutions possible.
Want to learn more? Reach out to AFR Services today and let us discuss your needs and questions.
