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Agencies Issue Final Rule for New Flood Insurance Requirements
by Blessing Chimwanda, Senior Associate Examiner, Federal Reserve Bank of Boston, and Danielle Martinage, Senior Associate Examiner, Federal Reserve Bank of Boston

On July 21, 2015, the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (Federal Reserve Board), the Office of the Comptroller of the Currency (OCC), the Farm Credit Administration (FCA), and the National Credit Union Administration (NCUA) jointly published a final rule to implement new flood insurance requirements enacted by the Biggert–Waters Flood Insurance Reform Act (BWA) of 2012 and the Homeowner Flood Insurance Affordability Act (HFIAA) of 2014.¹ The final rule makes four changes to the federal flood insurance requirements:

• Lenders are required to escrow all premiums and fees for flood insurance for loans secured by residential real estate or mobile homes in a special flood hazard area that are made, increased, extended, or renewed on or after January 1, 2016, subject to certain exceptions, including an exception for small lenders. For loans made, increased, renewed, or extended before that date that are still outstanding and not subject to one of the exceptions, lenders must notify borrowers by June 30, 2016, of the option to escrow flood insurance premiums and costs.
• To help reduce the cost of premiums, the rule exempts structures that are part of a residential property but detached from it and do not serve as a residence (such as a tool shed or pool house) from the mandatory flood insurance purchase requirement, although lenders still have the option to require it to protect the collateral underlying the loan.
• Lenders may charge the borrower for the costs of force-placed coverage beginning on the date the borrower’s previous coverage lapsed or did not provide sufficient coverage.
• If a lender charges a borrower for force-placed flood insurance but later learns that the borrower actually had sufficient coverage, the lender or its servicer must terminate the force-placed insurance and refund any premiums or fees paid during the period of duplicate coverage.

This article summarizes the final rule.²

Escrow of Flood Insurance Payments for Loans with Triggering Events

A regulated lending institution, or a servicer acting on its behalf, must escrow all flood insurance premiums and fees for loans secured by residential improved real estate or a mobile home in a special hazard area unless the loan or the lending institution qualifies for one of several exceptions. The escrow requirement applies to any nonexcepted loan secured by residential improved real estate or a mobile home that is made, increased, extended, or renewed on or after January 1, 2016.

The rule also states that the escrow provisions of the Real Estate Settlement Procedures Act (RESPA) apply to flood insurance escrows if the loan is subject to RESPA, which applies to “federally related mortgage loans.”³ The escrow provisions of RESPA generally limit the amount that may be maintained in escrow accounts and require escrow account statements.⁴ The rule also requires lenders to provide the escrow notice for any excepted loan that could lose its exemption during the term of the loan.

Escrow Notice to Affected Borrowers

For loans subject to the escrow requirement or loans that could be subject to it if one of the escrow exceptions discussed in the following section no longer applies, lenders must notify borrowers of the escrow requirement in the Notice of Special Flood Hazards. To facilitate compliance, the agencies updated the model notice form in Appendix A of their regulations to include this information.

Small Lender Exception

The final rule excepts from the flood insurance escrow requirement any financial institution with total assets of less than $1 billion (as of December 31 of either of the two prior calendar years) that, as of July 6, 2012:

• was not required under federal or state law to deposit taxes, insurance premiums, fees, or any other charges in an escrow account for the entire term of any loan secured by residential improved real estate or a mobile home, and
• did not have a policy of consistently and uniformly requiring the deposit of taxes, insurance premiums, fees, or any other charges in an escrow account for loans secured by residential improved real estate or a mobile home.

Financial institutions are not required to count the assets of other institutions under common ownership with the regulated lending institution when calculating asset size. The final rule also reaffirms that a regulated lending institution that may initially qualify for the exception, but later exceeds the $1 billion asset-size threshold, must begin escrowing for any loans made, increased, extended, or renewed on or after July 1 of the first calendar year of changed status.

Loan-Related Exceptions

The rule also excepts several categories of loans from the flood insurance escrow requirement:

• Loans with a subordinate position to a senior lien secured by the same property for which flood insurance is being provided
• Loans secured by residential improved real estate or a mobile home that is part of a condominium, cooperative, or other project development when covered by a flood insurance policy that (a) meets the mandatory flood insurance purchase requirement; (b) is provided by the condominium association, cooperative, homeowners association, or other applicable group; and (c) the premium for which is paid by the condominium association, cooperative, homeowners association, or other applicable group as a common expense
• Loans secured by residential improved real estate or a mobile home that is used as collateral for a business, commercial, or agricultural purpose
• Home equity lines of credit
• Nonperforming loans, which the regulation defines as a loan that is 90 or more days past due and remains nonperforming until it is permanently modified or until the entire amount past due, including principal, accrued interest, and penalty interest incurred as the result of past due status, is collected or otherwise discharged in full
• Loans with terms of 12 months or less

As a general rule, if a lender or its servicer determines during the term of a loan covered by this rule that an exception does not apply, the lender or its servicer shall require the escrow of all flood insurance premiums and fees as soon as reasonably practicable.

Option to Escrow on Outstanding Loans

The final rule requires regulated lending institutions to offer and make available to a borrower the option to escrow flood insurance premiums and fees for loans secured by residential improved real estate or a mobile home that are outstanding as of January 1, 2016, subject to the exceptions outlined previously. The final rule clarifies that the option to escrow does not apply to an outstanding loan that is already escrowing flood insurance premiums and fees or will be subject to the flood insurance escrow requirement. Furthermore, the rule requires regulated lending institutions that lose the small lender exception to offer the option to escrow to existing borrowers with outstanding loans secured by residential improved real estate or a mobile home. Regulated lending institutions have until June 30, 2016, to provide notice to affected borrowers about the option to escrow.

To facilitate compliance with the Option to Escrow notice requirement, the final rule includes a new model clause in Appendix B of the agencies’ flood regulations. Using the model clause provides a safe harbor for complying with the notice requirement.

Detached Structures

Under the final rule, flood insurance is no longer required on structures that are part of a residential property but are detached from the primary residential structure and do not serve as a residence, such as a tool shed or pool house. Previously, detached nonresidential structures had to be insured separately from dwellings (except for detached garages that were covered under dwelling policies up to 10 percent of the policy amount).

According to the final rule, “a structure that is part of a residential property” refers to a structure used primarily for personal, family, or household purposes, and not used primarily for agricultural, commercial, industrial, or other business purposes. In instances in which certain structures are used for both residential and business purposes, the exemption applies only to structures with a primary residential purpose. A structure is “detached” if it stands alone, meaning it is not joined by any structural connection to the residential structure. Furthermore, the detached structure may not “serve as a residence.” Since the lender is in the best position to consider all the facts and circumstances surrounding the detached structure, the final rule requires lenders to consider the actual and intended use of a structure and to determine in good faith if the structure serves as a residence. While the rule notes that structures can vary greatly in terms of size, value, purpose, and facilities, the rule explains that a structure could be considered a residence if it includes sleeping, bathroom, or kitchen facilities. The status of a detached structure must be re-examined upon a qualifying “triggering” event, such as making, increasing, renewing, or extending a loan.

Although detached structures are exempt from the mandatory purchase of flood insurance, lenders may nevertheless require flood insurance on a detached structure to protect the collateral securing the mortgage.

Force Placement of Flood Insurance

Under the new rule, financial institutions may charge a borrower for the cost of force-placed flood insurance and related fees starting on the date on which flood insurance coverage lapsed or did not provide the proper amount of coverage for the property securing the loan.

It is important to emphasize that a lender is not required to force place flood insurance on the date it learns insurance is required for a property securing an existing loan. A regulated lender must send a force-placed notice to the borrower on that date but is permitted to wait until 45 days after sending the notice before force placing insurance. When determining whether to force place on the date a lender learns flood insurance is required, a lender may consider in the case of a lapsed policy that the National Flood Insurance Program provides a grace period during which an expired policy remains in effect for 30 days after its expiration date as long as the overdue premium is paid within 30 days. Therefore, a lender’s greatest risk for a lapsed policy is the period after the grace period expires and before the lender is required to force place on the 46th day if the borrower does not comply.⁵

The final rule also requires a lender to refund any premiums and fees for the period during which a lender force placed flood insurance and the borrower already had coverage. The rule requires the lender to contact the insurer to terminate the force-placed insurance and refund any overlapping premiums and fees charged within 30 days of receiving proof of a borrower’s existing flood insurance coverage. For purposes of confirming existing flood insurance coverage, a financial institution or servicer must accept from the borrower an insurance policy declarations page that includes the existing flood insurance policy number, the identity of the insured, and contact information.

Effective Dates

The mandatory escrow of flood insurance premiums provisions and the escrow option provisions becomes effective on January 1, 2016. The force placement provisions became effective on July 6, 2012, when the BWA was enacted, and the detached structure exemption became effective on March 21, 2014, when the HFIAA was enacted.

Conclusion

It is important for financial institutions to become familiar with these new flood insurance regulatory requirements. Financial institutions should update their policies and procedures and provide training to their staff to ensure compliance with these new flood insurance rules by the applicable effective dates. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.