New Flood Insurance Coverage and Escrow Requirements
By: Kerri M. Smith, Christopher G. Smith
Last week, federal regulators issued long-awaited flood regulations implementing the Biggert-Waters Flood Insurance Reform Act of 2012 (“Biggert-Waters”) and Homeowner Flood Insurance Affordability Act of 2014 (“HFIAA”). To those following the legislative and regulatory developments for federally mandated flood insurance, there won’t be any big surprises in the final rule. Indeed, in both Biggert-Waters and HFIAA, Congress prescribed relatively clear and specific requirements; thus, in responding to comments, the agencies were largely able to rely on statutory language to shape the new obligations. In a few instances, the agencies added clarity through new definitions or additional explanations, but largely the agencies followed the statutes’ road map.
Notable changes established in the rule include:
- For all loans secured by residential improved real estate or a mobile home that experience a “triggering event” (making, increasing, renewing or extending the loan) after January 1, 2016, a lender must escrow all premiums and fees for flood insurance, subject to certain exceptions. This is a major change from the prior flood insurance regulations, which required escrowing those amounts only if the lender also required the escrow of other amounts (usually for taxes or insurance).
- “Small lenders” are exempt from this requirement, so lenders that have total assets of less than $1 billion on December 31 of either of the two prior years, as measured each year, subject to certain exceptions. For example, if a lender, as of July 6, 2012, had a policy of consistently and uniformly requiring the escrow of taxes, insurance premiums, fees or other charges, the lender is not eligible for the small lender exception.
- Certain loans are also exempt from this requirement, including: (i) loans extended primarily for business, commercial or agricultural purposes; (ii) loans in a subordinate position to a lien on the same property that is adequately covered; (iii) loans secured by properties that are already covered by a blanket condo, co-op, HOA or similar group policy; (iv) HELOCs; (v) nonperforming loans (90 days or more past due and remaining nonperforming until they are permanently modified, or the entire amount past due is collected or discharged); and (vi) loans with terms less than 12 months.
- The regulators reiterate that receipt of a loan application is not a “triggering event.” So, for example, if a regulated lender accepts a loan application in December 2015 but expects the loan to close in January, the escrow requirements will apply.
- Relatedly, for loans secured by residential improved real estate or a mobile home that are outstanding on January 1, 2016, a lender must give the borrower the option to escrow flood insurance premiums, subject to the same exceptions outlined above.
- The option to escrow also does not apply to the extent the requirement to escrow above is in effect. Therefore, this option only applies to those outstanding loans where there has been no “triggering event.”
- Regulated lending institutions must mail or deliver information to borrowers about the option to escrow by June 30, 2016.
- A lender may charge the borrower for the costs of forced-placed coverage beginning on the date on which the borrower’s previous coverage lapsed or did not provide sufficient coverage. A lender must terminate any force-placed insurance within 30 days of receipt of confirmation of sufficient existing coverage, and must refund to the borrower any premium and related fees charged during overlapping coverage. This may require lenders to bear the costs of some force-placed insurance related to periods when the borrower has sufficient insurance but force-placed coverage is also in effect.
- A borrower can demonstrate sufficient coverage by providing a declarations page that includes the existing flood insurance policy number and the identity of and contact information for the insurance company or its agent.
- Unlike in the context of escrows accounts established for hazard insurance under Regulation X, a regulated lender has no obligation under federal flood law to advance funds to pay for mandatory flood insurance premiums in lieu of force-placing insurance.
- Exempt from the mandatory flood insurance purchase requirements is any structure on a residential property that is detached from the primary residential structure and that does not serve as a residence. This exemption applies to multifamily properties as well, so detached maintenance sheds on multifamily residential properties, for example, are not required to be covered by flood insurance.
- The agencies have included in each “Appendix A” a revised Notice of Special Flood Hazards form designed to comply with new notice requirements, effective October 1, 2015.
The final rule’s escrow and option-to-escrow provisions become effective January 1, 2016, while the force-placed insurance provisions and certain notice requirements become effective October 1, 2015. Although Biggert-Waters requires rulemaking that will direct lending institutions to accept private flood insurance, the agencies opted to address this topic in a separate, forthcoming rulemaking.
Many of the rules discussed above are subject to exceptions, limitations or clarifications, and our summary does not reflect all of the regulation’s changes. If you have any questions about how the upcoming changes may affect your business specifically, please do not hesitate to reach out to us.