Private flood rule revised

The long-awaited final private flood rule was jointly released Feb. 20 by the OCC, FRB, FDIC, FCA and NCUA, six long years after the first proposed rule. The first proposed rule that was released in October 2013 introduced the requirements for accepting private flood insurance that meets the definition under the Biggert-Waters Act. Three years later, in November 2016, the agencies revised and reintroduced the private flood rule.

There are some key differences between the final private flood rule and the 2016 proposal. The final rule requires the bank to accept private flood insurance that meets the definition under the rule, without exception. However, it also allows the bank a safe harbor if the policy contains the Compliance Aid sentence.

The bank is permitted to rely on the Compliance Aid sentence, which states that the policy meets the definition of private flood insurance under the law and regulation. Specifically, it states: “This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.”

If the Compliance Aid sentence is not included in the policy, the bank is required to look through the policy to determine if it meets the definition of private flood insurance. In order for the policy to meet the definition of private flood insurance it must:

• Be issued by an insurer or surplus insurer that is licensed by the state regulatory agency in which the property is located,
• Be at least as broad as NFIP, including deductibles, exclusions and conditions,
• Require a 45-day written notice for non-renewal or cancellation,
• Include information regarding insurance available under NFIP,
• Have a clause similar to SFIP regarding mortgage interest,
• Include a one-year statute of limitations provision and
• Include cancellation provisions that are as restrictive as those in SFIP.

Unfortunately, the final rule does not specifically address what happens if the Compliance Aid sentence is not 100% correct or if it varies from the sentence in the rule. However, it would be most conservative to not rely on the sentence if it is not 100% correct or varies from the sentence in the regulation.

The final rule also does not address situations in which the Compliance Aid sentence appears in the policy exactly as it is written in the rule but the policy is contradictory and clearly does not meet the definition of private flood insurance.

Again, it would be most conservative to not rely on the sentence if it is not 100% correct and to go through the policy and document exactly why the policy does not meet the definition of private flood insurance as it is defined in the rule.

What happens if the bank reviews the policy to determine if it meets the definition of private flood insurance and it does not contain the Compliance Aid sentence? There is not a prohibition in doing that. However, there is a possibility that the sentence could be there, the bank goes through the policy and then finds that the policy in fact does not meet the definition of private flood insurance, in which case the bank can deny it.

The bank should thoroughly document this practice in its internal policies and procedures as well as in the loan file explaining why it found that the policy did not meet the definition of private flood insurance even though the policy included the Compliance Aid sentence.

Even if the policy does not meet the definition of private flood insurance under the definition in the rule, the bank may still accept the policy, subject to certain restrictions. In order for the bank to accept the policy under discretionary acceptance, the policy must (1) meet the minimum coverage amounts, (2) be issued by a license insurer, (3) include both the mortgagor and the mortgagee as loss payees and (4) provide sufficient protection, considering safety and soundness, and the bank can document this in writing.

The rule also includes specific requirements related to when a bank may accept a mutual aid society policy under discretionary acceptance. In order for the society to be considered a mutual aid society such that the rule would allow the bank to accept the policy, (1) the members of the group must share a religious, charitable, educational or fraternal bond; (2) the group must have an agreement to cover losses due to property damage, including for flooding; and (3) the group must have a demonstrated history of fulfilling the terms of the agreements for flooding. Unfortunately, the final rule does not expand on mutual aid societies, and new guidance related to the new final rule has not yet been released by the agencies. The bank will need to thoroughly document its analysis and determination regarding any mutual aid society policies.

The bank will need to begin looking at these issues and making policy decisions soon, as the final rule took effect July 1. It applies when a building is used to secure the loan and it is in a Special Flood Hazard Area (often referred to a SFHA, Flood Zone, High Risk Flood Zone or 100-year floodplain), even if it is only taken in an abundance of caution during a MIRE event (making, increasing, renewing or extending).

If the building is not used to secure the loan, it is specifically carved out of the collateral or the loan is secured by something else, like a CD, then the flood rule does not apply. If the building is not in a SFHA, then flood insurance is not required, but may be a safety or soundness consideration.