Regulation Silence…Finding Answers to Ensure Flood Compliance

Author: Becky Breland, Esq., Principal Consultant, Regulatory Advisory Services

The cost of non-compliance with Regulation H can be staggering to a financial institution.  Maintaining flood compliance can be complex and a challenge for financial institutions as ways to comply are not readily apparent within the regulation itself. For instance, under Regulation H, financial institutions are prohibited from making, increasing, extending, or renewing a designated loan unless the building or mobile home and any personal property securing the loan is covered by flood insurance for the duration of the loan.  Insurance coverage must be at least equal to the lesser of (1) the outstanding principal balance of the loan, (2) the maximum limit available for the type of structure, or (3) the insurable value of the structure.   If you look at FRB Regulation H, you will not find the term “insurable value.”  For information on insurable value, you must look to the Loans in Areas Having Special Flood Hazards; Interagency Questions and Answers Regarding Flood Insurance; which has recently been republished.

Insurable value is discussed in the Interagency Questions and Answers Regarding Flood Insurance, Section X:  Determining the Appropriate Amount of Flood Insurance Required (Amount).  

Question 1 under the heading of Amount tells us, “the Regulation also provides that ‘‘flood insurance coverage under the Act is limited to the building or mobile home and any personal property that secures a loan and not the land itself,’’ which is commonly referred to as the ‘‘insurable value’’ of a structure.”…“the insurable value of improved real estate for flood insurance purposes also includes the repair or replacement cost of the foundation and supporting structures. It is very important to calculate the correct insurable value of the property; otherwise, the lender might inadvertently require the borrower to purchase too much or too little flood insurance coverage. For example, if the lender fails to exclude the value of the land when determining the insurable value of the improved real estate, the borrower will be asked to purchase coverage that exceeds the amount the NFIP will pay in the event of a loss.”

Furthermore, Question Amount 2 provides, “The insurable value of the building may generally be the same as 100 percent Replacement Cost Value (RCV), which is the cost to replace the building with the same kind of material and construction without deduction for depreciation. In calculating the amount of insurance to require, the lender and borrower (either by themselves or in consultation with the flood insurance provider or other appropriate professional) may choose from a variety of approaches or methods to establish the insurable value. They may use an appraisal based on a cost-value (not market-value) approach, a construction cost calculation, the insurable value used on a hazard insurance policy (recognizing that the insurable value for flood insurance purposes may differ from the coverage provided by the hazard insurance and that adjustments may be necessary), the replacement cost value listed on the flood insurance policy declarations page, or any other reasonable approach, so long as it can be supported.”

The takeaway from this discussion is that compliance officers and auditors should not solely depend on an Act or its implementing regulation for all answers.  Compliance officers and auditors should broaden their research to include: (1) any Interagency Questions and Answers, (2) Official Staff Commentary, (3) Supplementary Information to new or revised rules published in a Federal Register notice; (4) case law; and (5) guidance issued by Regulatory Agencies.  Also, consider “Google”.  When I was a newbie compliance officer, google was in its infancy.  Today, you can google Flood Q&As and receive an outrageously large result to muddle thru.  I caution if you rely on googling for your answer, make sure you use a reliable source.

Maintaining flood compliance can be complex and a challenge for financial institutions.  Consider partnering with trusted third-parties to assist in your compliance and audit efforts.  Capco RISC Services can review a sample size or entire loan portfolio to ensure flood compliance.  Additionally, Capco Regulatory Advisory Services (RAS) has a team of subject matter experts that can assist with day-to-day regulatory questions as well as provide compliance and audit tools in the form of calculators and quick reference guides.  We are here to assist you to ensure regulatory compliance.  For additional information, please email Regulatory.Services@capco.com.