When a customer doesn’t pay their flood insurance premiums and allows their flood insurance to lapse, financial institutions are required to force-place flood insurance for an appropriate amount. While customers who allow their flood insurance coverage to lapse often do so because they can’t or don’t want to pay for such coverage, it can be difficult for financial institutions to collect for the premiums (or cost) of the force-placed flood insurance.
Typically, there are three options for a financial institution to collect force-placed flood insurance premiums from borrowers:
To have the borrower pay the premium by check.
To add the cost of the force-place flood insurance premium to an escrow account.
To add the amount of the flood insurance premium to the loan amount which remains due.
As options 1 and 2 are often not available to financial institutions, many financial institutions end up adding the amount of the force-placed flood insurance premium to the outstanding loan balance. In recent years, however, this practices has been considered problematic.
Force-Placed Insurance to Loan Amount as Triggering Event
In recent years, some regulators (i.e. the FDIC) have cited financial institutions for violations of flood rules when they add a force-placed flood insurance premium to a loan amount. Their reasoning for this is they say that adding a flood insurance premium to a loan amount is technically an “increase” - which is a MIRE (Make, Increase, Renew or Extend) triggering event - and requires that all flood insurance rules be followed.
This stance would require a few things. First, the amount of flood insurance obtained in the force-placed policy would need to be enough to cover the new outstanding loan balance, which would include applicable premiums and fees. This means that if a borrower owed $30,000 and the bank was adding a force-placed policy premium of $2,500 to the outstanding balance of the loan, the amount of force-placed coverage would need to be at least $32,500 in order to sufficiently cover the new outstanding principal balance.
Secondly, the stance of saying that adding a force-placed flood insurance premium to an outstanding loan amount would also trigger a flood insurance notice. While it would be obvious to both the borrower (who let their insurance lapse and has been notified by the financial institution that they will be force-placing coverage) and the lender (who is doing the force-placement), a notice informing the borrower that they are located in a high-risk flood zone would still be required since this would technically be a MIRE triggering event.
Finally, if adding force-placed flood insurance premiums to the outstanding loan balance is considered to be a MIRE event triggering flood insurance rules, a financial institution would be required to escrow flood insurance premiums and fees unless the institution or loan qualifies for an exception. If the institution is required to escrow, it must also provide a notice to the borrower informing them of the escrow requirements along with the notice of special flood hazards.
Agency Letter to the ABA
On May 22, 2017, the FDIC, Federal Reserve, and OCC issued a joint letter to the American Bankers Association (ABA) regarding a letter the ABA had sent nearly a year before where the ABA requested clarification on whether the addition of a force-placed flood insurance premium to the outstanding loan balance would be a triggering event, requiring sufficient insurance, a new flood notice, and the establishment of an escrow account (as applicable). In this letter, the agencies explained that the treatment of force-placed flood insurance premiums and fees will depend on the method the financial institution uses for charging the borrower.
Premiums and Fees Billed Directly to Borrower
For instances where a financial institution bills a borrower directly for the cost of force-placed flood insurance premiums, the agencies have stated that this approach does not increase the loan balance and, therefore, is not a triggering event. This means that the flood notice and escrow requirements are not necessary when premiums and fees are billed directly to the borrower. While this approach often won’t apply for consumers who let their personal flood insurance policies lapse - because they can’t or won’t pay it - it could apply in instances where a borrower has chosen to obtain force-placed insurance instead of their private policy (such as in instances where force-placed insurance is significantly cheaper than a private policy).
Premiums and Fees Added to an Unsecured Account
Similar to when premiums and fees are billed directly to the borrower, financial institutions do not have a triggering event when they account for and track the amount owed for the force-placed flood insurance premiums and fees in a separate, unsecured account.
Premiums and Fees Added to Mortgage Loan Balance
The guidance provided by the Agencies in regards to instances when premiums and fees are added to a mortgage loan balance contains two distinct requirements - which depend on the institutions contract with the borrower.
The first instance includes times when a financial institution's loan contract with the borrower includes a provision which permits the lender/servicer to advance funds to pay for flood insurance premiums and fees as additional secured debt. This situation would be considered part of the loan and, therefore, the addition of the flood insurance premiums and fees to the loan balance would not be considered an “increase” in the loan amount - meaning that this is not a triggering event and the notice and escrow requirements would not apply. That said, the Agencies have made it clear that the amount of flood insurance required for the force-placed policy must include the full outstanding balance - after the premium and fees have been added to the outstanding balance.
In instances where a financial institution does not have a contract provision with the borrower which specifically permits an advance of funds to cover force-placed flood insurance premiums and fees, the Agencies have stated that this situation would be considered an “increase” in the loan amount. Therefore, this would become a triggering event and the notice and escrow requirements would apply. The amount of needed flood insurance for the force-placed policy would also include the full outstanding balance, which would be the full amount after the premium and fees have been added back in.
New Guidance for Adding Force-Placed Flood Insurance Premiums to Outstanding Loan Balance
While the ABA letter provides clear guidance for financial institutions who are adding a force-placed flood insurance premium to an outstanding loan balance, this letter is not formal guidance. In addition to this, the letter isn’t even public information - it is available only to applicable ABA members.
Therefore, this leaves many financial institutions (who are not members of the ABA) between a rock and a hard place. The good news is that the agencies stated in the ABA letter that “the Agencies plan to provide written guidance on the issue.” Until that guidance comes, the best thing that (OCC, Fed, and FDIC) financial institutions can do is to follow this guidance and reference the May 22, 2017 ABA letter.