On February 12, 2019, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, the Farm Credit Administration, and the National Credit Union Administration (collectively, the “Agencies”) issued final regulations that require regulated lending institutions to accept private flood insurance in lieu of flood insurance issued under the National Flood Insurance Program (“NFIP”) when flood insurance is required provided that the private policy meets certain qualifications. The final rule provides that a lending institution must accept a private policy in lieu of a policy issued under the NFIP as long as the policy satisfies the statutory definition for private flood insurance under the Biggert-Waters Flood Insurance Act of 2012 (the “Biggert-Waters Act”). To assist lenders in determining whether this condition has been met, the Agencies have established a compliance aid provision that will allow institutions to conclude the definition has been satisfied without further review of the policy if the policy or an endorsement to the policy affirmatively states that the policy meets the definition. The final rule also permits, although does not require, a lender to accept private flood insurance even if the policy does not meet the statutory definition if the lender concludes that the policy provides sufficient protection given general safety and soundness considerations and documents this determination. Last, the final rule also permits lending institutions to accept certain coverage by “mutual aid societies” under certain circumstances.

The final rule becomes effective on July 1, 2019, although early adoption is permitted. Lending institutions that make loans secured by property in special flood hazard areas should begin to review their loan closing procedures to ensure that they take into account the obligation to accept private flood insurance.

Background

The NFIP was created in 1968 by the passage of the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973, as amended, as a means for property owners located in certain flood-prone areas to purchase flood insurance, a peril not typically covered by the standard homeowner’s insurance policy. The NFIP requires the purchase of flood insurance in connection with loans made by a regulated lending institution that are secured by real estate located in a special flood hazard area. Each of the Agencies has regulations enforcing this mandatory purchase requirement. Lending institutions that fail to ensure that the requisite flood insurance has been purchased will face supervisory consequences, including civil money penalties. 

In 2012, the Biggert-Waters Act was passed mandating the acceptance of private flood insurance and requiring the Agencies to issue a rule to direct their supervised institutions to accept private flood insurance provided it satisfied the definition of “private flood insurance” set forth in the Biggert-Waters Act. The initial regulatory proposal that would implement all the requirements of the Biggert-Waters Act was issued in 2013, with eighty-one written comments received. The Agencies opted to finalize only certain portions of the proposal, but not the private insurance provisions. In November 2016, the Agencies reproposed regulations that would implement the private flood insurance requirement. The action taken on February 12, 2019, finalized these rules.

Definition of Private Flood Insurance Under the Final Rule

The final rule requires that lending institutions accept private flood insurance in lieu of insurance issued under the NFIP provided the private insurance meets the definition of “private flood insurance” under the Biggert-Waters Act. To do so, the policy must:

1. Be issued by an insurer that is approved to engage in the insurance business in the state in which the property is located, or recognized or not disapproved as a surplus lines insurer by the state insurance regulator;

2. Provide coverage that is at least as broad as that provided under the NFIP for the same type of property, including deductibles, exclusions, and other items; and

3. Include certain specified provisions such as a mortgage interest clause similar to a federal policy, information about the availability of federal flood insurance, and a requirement that 45 days’ written notice be given to both the insured and the lending institution before the policy is canceled.

Many commenters on both the first and second proposed rulemakings raised concerns as to the ability of the lending institution to make this determination. Practically speaking, in most instances the full policy may not be available for review at the time of closing. The Agencies sought to provide some assistance by establishing a compliance aid rule that allows the lender to determine that a private policy meets the definition if the following statement is included within the policy or as an endorsement to the policy: “This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.” While this compliance aid will simplify the determination process when the statement is provided in the policy or an endorsement to the policy, the Agencies warned that the absence of the statement does not relieve the institution of the obligation to accept the private flood insurance policy provided it meets the statutory definition.

Discretion to Accept Policies Not Meeting the Statutory Definition

The final rule also permits (but does not require) a lending institution to accept private flood insurance even though it may not meet the statutory definition described above provided that it:

1. Provides coverage in an amount at least equal to the lesser of the outstanding principal balance of the loan or the maximum amount of insurance coverage available for the particular type of property;

2. Is issued by an insurer that is approved to engage in the insurance business in the state in which the property is located, or recognized or not disapproved as a surplus lines insurer by the state insurance regulator;

3. Covers both the mortgagor and mortgagee, except in the case of a condominium or similar group, and for which the premium is paid as a common expense; and

4. Provides sufficient protection of the loan, consistent with general safety and soundness considerations, and the lending institution documents this determination.

The Agencies noted that factors the institution could take into account in making the determination that the policy provides sufficient protection of the loan include the policy’s deductibles, whether the policy provides adequate notice of cancellation, whether the policy’s limits of amounts to be paid per loss as well as the aggregate limits are adequate, whether the policy complies with state law, and whether the insurer has the financial solvency and strength to satisfy claims.

Mutual Aid Societies

Under the discretionary authority to accept policies not meeting the statutory definition of private flood insurance, the final rule also permits lending institutions to accept policies from mutual aid societies that do not satisfy all the requirements for even the discretionary authority described above. A mutual aid society is defined as an organization: (i) whose members share a common religious, charitable, educational, or fraternal bond; (ii) that covers losses caused by damage to members’ properties in accordance with this common bond; and (iii) that has a demonstrated history of fulfilling the terms of agreements to cover losses to members’ properties. Lenders may, but are not required to, accept flood insurance policies from mutual aid societies meeting the above-described definition provided the policy satisfies the same general requirements as for other private policies not meeting the statutory definition, with the added requirement that the lender’s primary supervisory agency must have determined that such policies qualify as flood insurance for purposes of the federal flood insurance statutes.