Flood Insurance

Federal banking agencies issued a revised proposal on November 7th to implement requirements for regulated institutions to accept private flood insurance. The Biggert-Waters Flood Insurance Reform Act (the “Act”) required those agencies to issue a rule directing their respective regulated lending institutions to accept such insurance. The purpose of the requirement is reportedly to stimulate the private flood insurance market, which in turn supports the financial solvency of the National Flood Insurance Program (“NFIP”).

The first issue the agencies tackle in requiring their regulated institutions to accept private flood insurance is what constitutes “private flood insurance.” The agencies proposed to rely largely on the Act’s definition, with only clarifying edits. Specifically, the rule would provide that “private flood insurance” is a policy that:

  1. Is issued by a duly licensed or approved insurance company;
  2. Provides coverage that is at least as broad as the coverage provided under a standard flood insurance policy (an “SFIP”);
  3. Includes a requirement for the insurer to give 45 days advance written notice to the borrower and lender (or a servicer acting on its behalf) of cancellation or non-renewal;
  4. Includes information about the availability of coverage under the NFIP;
  5. Includes a mortgage interest clause similar to the clause contained in an SFIP;
  6. Includes a provision requiring an insured to file suit not later than one year after the date of a written denial for all or part of a claim under the policy; and
  7. Contains cancellation provisions that are as restrictive as the provisions contained in an SFIP.

In determining whether the private policy’s coverage is as broad as an SFIP, the proposed rule would require institutions to determine that, among other criteria, the policy: (1) covers both the mortgagor and mortgagee as loss payees; (2) contains comparable deductibles; (3) provides coverage for direct physical loss caused by a flood; and (4) does not contain conditions that otherwise limit the coverage as compared to an SFIP.

The rule also addresses how institutions may determine whether a particular policy meets those criteria, particularly with regard to the scope of coverage. Comparison between policies is not always easy, not all lenders are insurance experts, and there is no safe side on which to err. Should the rule allow lenders to rely on a certification by a state insurance regulator, as the agencies previously considered? Or a certification by the insurance company? The rule proposes that insurers could help lenders make the determination of whether a policy meets the seven criteria above. A policy would be deemed to meet the definition of “private flood insurance” if: (1) the policy includes a written summary identifying the policy provisions meeting each criterion and confirming the insurer’s licensing/approval status; (2) the regulated institution verifies in writing the provisions identified in the summary, and that those provisions in fact satisfy the criteria; and (3) the policy includes the following assurance clause: “This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.”

The agencies assert that the assurance clause quoted above “could” provide the borrower and the lender with recourse against the insurance company if it or the policy fails to meet all the criteria. However, it is not clear exactly how much protection the clause would provide if the policy is, for some reason, subsequently deemed inadequate. On the other hand, the agencies admit that a regulated institution would be required to accept a policy that lacks the summary and/or the assurance clause if the policy nonetheless meets the seven criteria. The agencies are requesting comments on ways those three factors, intended as a compliance aid, could be improved.

While regulated institutions will be required to accept private flood insurance that meets the criteria described above, the institutions continue to have the discretion to accept other private policies.  The rule proposes that a regulated institution may accept (or decline) a policy that: (1) is issued by an insurer appropriately licensed or otherwise approved by the applicable state regulator; (2) covers both the mortgagor and mortgagee as loss payees; (3) provides for limited cancellation options and only upon reasonable notice to the borrower; and (4) is either “at least as broad” as coverage under an SFIP, or provides coverage that is “similar” to that under an SFIP with a lender’s documented determination that the policy provides sufficient protection. If a policy does not meet the strict seven-point definition of private flood insurance outlined above, but nonetheless meets these four criteria, the regulated institution may, at its discretion, accept the policy. The agencies have requested comment as to whether these four criteria are appropriate.

The proposed rule also would allow regulated lending institutions to accept flood insurance policies issued by “mutual aid societies,” defined as organizations (1) made up of members sharing a common religious, charitable, educational, or fraternal bond; (2) which cover losses caused by damage caused by flooding pursuant to agreement; and (3) which have a demonstrated history of fulfilling the terms of agreements to cover losses to members caused by flooding.  The rule proposes criteria for acceptable policies and organizations.

The Agencies are accepting comments until January 6, 2017. If you would like to provide a comment to the Agencies related to any of the above, Mayer Brown has experience in drafting and submitting such comments, and would be happy to aid in such submission.