No matter how or why lenders have required flood insurance on a property, if the flood insurance lapses during the term of the covered loan, it’s a problem. First, of course, there is the possibility that flood damage could occur during the lapse, and, second, most regulators will cite flood insurance lapses as violations.
It is imperative that lenders and servicers implement procedures to ensure comprehensive coverage of all flood compliance requirements, applicable regulatory guidance documents, and specific requirements of lending programs, such as those under the Federal Housing Administration (FHA) and others for the required period of coverage – including preventing or curing lapses in coverage.
Not all loans require a flood determination; however, it’s a pretty sure thing that most mortgage loan transactions, because they are or will be secured by residential real estate, will require a flood determination. The National Flood Insurance Program (NFIP) covers improved real property or mobile homes located or to be located in an area identified by the Federal Emergency Management Agency (FEMA) as having special flood hazards. Covered properties generally include:
- Residential, industrial, commercial, and agricultural buildings that are walled and roofed structures which are principally above ground.
- Buildings under construction where a development loan is made to construct insurable improvements on the land. Insurance can be purchased to keep pace with the new construction.
- Mobile homes that are affixed to a permanent site, including mobile homes that are part of a dealer’s inventory and affixed to permanent foundations.
- Condominiums and co-operative buildings.
Flood insurance is required, then, for the term of the loan on such properties when all three of the following factors are present:
- The institution makes, increases, extends, or renews any loan(s) (commercial or consumer) secured by improved real estate or a mobile home that is affixed to a permanent foundation (security property);
- The property securing the loan is located or will be located in an SFHA as identified by FEMA; and
- The community participates in the NFIP.
Lapses in coverage and forced placement requirements
If, at any time during the life of the loan, the institution or its servicer determines that required flood insurance is deficient or lapsed, the law requires initiation of forced placement procedures. The institution must provide specific notice to the borrower(s) and allow 45 days for the borrower(s) to obtain the flood insurance before force placing insurance and charging the borrower(s) a fee. Mortgage servicing rules made effective in January 2014 require, among other things, special notices to borrowers to allow fee charges, and they require a reminder notice at least 30 days after the first notice and another notice at least 15 days before charges are imposed. Effective systemic support is essential to monitor lapses in insurance coverage and policy expirations. For more detailed information about recent flood insurance compliance changes see Mortgage Compliance Magazine “Weekly NewsLINEs” January 7, 2016 and February 3, 2016.
With respect to LPI, the Final Flood Rule (1) clarifies that a lender may charge a borrower for LPI beginning on the date on which the borrower’s coverage lapsed or became insufficient; (2) requires a lender to cancel LPI and refund unearned premiums within 30 days of receipt of acceptable borrower-obtained flood insurance; and (3) requires a lender to accept as proof of insurance a declarations page that includes the flood policy number, insurance company or agent, and contact number.
Initiating and Charging for LPI
Under pre-existing requirements, when a lender learns that a borrower’s flood insurance coverage has either lapsed or become insufficient, the lender must send to the borrower a letter—commonly referred to as the “45-day letter”—informing the borrower that he or she has 45 days to purchase adequate flood insurance. If the borrower does not do so, the lender is required to purchase insurance on the borrower’s behalf, which is known as “lender-placing” or “force-placing” insurance.
The 45-day letter must be sent “upon making a determination” that the existing insurance coverage is inadequate or has expired—which includes, for example, receiving a notice of cancellation or expiration from the insurance provider, discovering a lapse as the result of an internal flood policy monitoring system, or learning that the property now requires flood insurance coverage because of a flood map change that placed it in an SFHA. Although a lender may send one or more notices prior to a policy’s expiration date as a courtesy to the borrower, such notices are not a substitute for the 45-day letter (which must be sent after determining that coverage is inadequate or has expired).
Through the Final Flood Rule, the Agencies clarified the following:
The date of lapse of the borrower’s policy is either the expiration date as provided by the policy or the date that the policy is cancelled; and
The borrower may be charged for LPI beginning as early as the date on which the borrower’s policy lapsed or did not provide sufficient coverage—that is, a lender need not wait until the end of the 45-day period to either begin LPI coverage or charge the borrower for such coverage. However, if the borrower obtains a flood insurance policy that overlaps with the LPI policy, the lender must refund any premiums paid by the borrower for this overlap period. This much-needed clarification resolves what has been a hotly contested issue.
Prior to Biggert-Waters, there were no express requirements regarding when a lender needed to cancel LPI, but Biggert-Waters changed that. Lenders are now required to cancel LPI and refund unearned or overlapping premiums and fees within 30 days of receipt of acceptable borrower-obtained flood insurance.
The 30-day clock to provide a refund does not begin until the borrower’s policy is actually “in effect.” If the borrower’s policy is subject to a 30-day waiting period, it is not “in effect” until the waiting period has expired. Furthermore, lenders must refund all premiums for periods of overlapping coverage regardless of when the borrower provides proof of insurance. This means that, even if a borrower delays providing evidence of coverage, lenders are still responsible for refunding any overlapping LPI coverage.
Determining Whether LPI Should Be Terminated
Under Biggert-Waters, a lender must accept a declarations page as proof of borrower-purchased coverage as long as the declarations page includes the policy number, insurance company or agent, and contact number. However, in the Preamble to the Final Flood Rule, the Agencies confirm that a lender can, subject to safe and sound banking practices, accept alternative evidence of insurance. Thus, as a practical matter, lenders still have some leeway to determine whether additional types of proof of insurance are acceptable.
The lender is also responsible for making all necessary inquiries into the adequacy of the borrower’s insurance policy, and must do so within 30 days of receiving the borrower’s confirmation of existing flood insurance. If the lender determines that the coverage amount—or any other terms and conditions of the policy—fail to meet any applicable requirements, the lender should notify the borrower and request that the borrower obtain an adequate flood insurance policy.
Although we’ve experienced recent technical changes to compliance with the National Flood Insurance Act (NFIA) and Flood Disaster Protection Act of 1973 (FDPA), the basic tenets remain solid. Your Compliance Management System (CMS) should include compliance requirements for evaluating flood insurance requirements, documenting the results of flood hazard checks, and maintaining the flood insurance coverage (or implementing it, if necessary) for the required period during the loan.
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