Flood insurance is a challenge for both consumers as well as financial institutions. The rules are complex, cumbersome, and flood insurance can be extremely expensive - so expensive, in fact, that some consumers have found it more affordable to pay for forced placed flood insurance than to get a separate flood insurance policy. While this this current trend can help to save the customer some money in the short run, it could cause some compliance challenges down the road.
For example, if a customer who currently has forced placed flood insurance wants to refinance their loan at a later time, is the financial institution permitted to close the new loan with forced place insurance, or is a new individual flood insurance policy needed?
Flood Insurance Rules for Originating a Loan with Forced Placed Insurance
Prior to the Biggert-Watters Flood Insurance Reform Act of 2012, FEMA had implemented guidance for financial institutions to follow called Mandatory Purchase of Flood Insurance Guidelines (last version September 2007). Though FEMA rescinded this guidance after Biggert-Waters, it is important to note that this guidance had specifically addressed situations where a lender wanted to originate a loan by using force-placed flood insurance:
“The force placement of coverage is designed for use at any time during the term of a loan in uninsured and underinsured situations; it is not intended for use at loan origination. If a borrower refuses to obtain flood insurance coverage as a condition of obtaining a loan, the loan is deficient and is not to be made.”
As FEMA’s flood insurance guidance was rescinded, interagency guidance has been issued over the last several years, much of which has reiterated the prior guidance by FEMA. Unfortunately, however, there is not currently any interagency guidance that clearly addresses whether a financial institution is prohibited from originating a loan with force placed flood insurance.
FDIC Internal Memo Regarding Forced Placed Insurance
I have heard several sources state that the FDIC permits a loan to close if the prior loan had forced placed flood insurance. Unfortunately, the FDIC hasn’t provided any public guidance regarding this interpretation of the rules, but rather has provided an “internal memo” that outlines this stance. Apparently, this internal memo states that an existing loan that is going through a MIRE event can proceed even if there is only a forced placed flood insurance policy on the loan. The memo, however, apparently makes it clear that new loans are not permitted to originate with forced placed flood insurance.
Based on the informality of the FDIC guidance referenced above, it would appear that the best practice approach is to follow FEMA’s rescinded guidance and require a separate flood insurance policy before any MIRE event (Make, Increase, Renew Extend) even on new or existing loans. Alternatively, a financial institution (such as those regulated by the FDIC) may consider reaching out to their primary regulator regarding instances in which the regulator deems it appropriate to have a MIRE event when an existing loan has a forced placed flood insurance policy.