Proposed Rulemaking
Comments Due Dec. 10, 2013 
The compliance world has been deluged with 166 new pages of proposed rulemaking to amend flood insurance rules. Issued by the five federal regulators on October 11, the proposal amends regulations varying from escrow of premiums and fees to the seven rules for private flood insurance. In addition, the paperwork is changing: a number of forms have proposed revisions. Get ready to dive in!
While the comment period for the proposal closes Dec. 10, 2013, and further changes may be forthcoming, it is worthwhile for any and all residential insurance providers to keep abreast of this subject in order to avoid being blindsided by new regulations and a potential $2000 fine for each violation. If you don’t have time to read the novel-length proposal itself, we present this article.
This document reviews the proposal and what it would mean to financial institutions (FI). In connection with this, we’ve updated our Biggert-Waters tracking document for your consideration. Here’s our breakdown of what you need to know.

Elements in the Deeper Waters

While the proposal addresses a number of elements, there remains this statement:
The Agencies’ proposal would implement only certain provisions of the Act over which the Agencies have jurisdiction. Accordingly, the Agencies encourage lenders to consult the Act for further information about the revisions to the flood insurance statutes that will not be implemented through the rulemaking.
This undercurrent runs throughout this regulation. It remains speculative to pinpoint who has oversight on certain elements of flood insurance. What should institutions do about those elements not under the jurisdiction of the regulatory agencies? Who does the FI go to on those points, and what if there is no guidance on those points? In such cases, it falls upon those responsible for compliance at their institutions to do their best to “feel” their way through the process.

Key Proposal Items

Maximum Penalties

This one is clear: up to $2,000 per violation.

Escrow of Premiums and Fees for Flood Insurance

The proposal is along the lines of what was previously noted in various statements on the matter. The proposal seeks to require regulated lending institutions, or servicers acting on their behalf, to escrow premiums and fees for flood insurance for any loans secured by residential improved real estate or a mobile home, unless the institutions qualify for the statutory exception.
The statutory exception focuses on asset size, using the $1 billion threshold as of July 6, 2012 (the Act’s enactment date). Institutions under that threshold were not required by Federal or State law to escrow taxes and insurance.
This is essentially what we understood six months ago, so it should not be of any surprise to FIs.
The focus of the proposal reiterates the statement that the intent of the regulation’s escrow provisions was for residential real estate, but notes that it was also for those loans subject to RESPA/TILA. As such, business/commercial and/or agricultural purpose loans are excluded, even if secured by residential real estate. Subsequently, documentation on the purpose of a loan takes on even more importance.
The proposal emphasizes that only one escrow account is required (i.e., subordinate lien) and if additional insurance is required that the subordinate lien holder will work through the primary borrowing/escrow account. You may be wondering what happens if the first lien holder doesn’t have to escrow due to exceptions? Here, if thesecond lien holder isn’t exempt, the escrow requirement will come into play, which could make it interesting to see how such situations are handled. Other inevitable issues that arise involve condominiums, including the handling of exclusions for escrow, sufficiency analysis on blanket condominium policies, and others. If a deficiency is observed, the FI must require a separate policy and, if not exempted, the FI would then be subject to escrow requirements.
The implementation date would be 7/6/14, and it applies to all covered loans where a renewal occurs after that date.
The proposal also added requirements on loans secured by properties that were not originally subject to flood insurance, but subsequently become subject to flood insurance requirements (e.g., remapping) and thereby potentially subject to escrow requirements. In this case, the lender proceeds through the notification requirements and then either the borrower pays for the flood insurance policy or the lender would force-place a policy and charge the borrower for the cost of coverage. The lender also would commence escrowing payments to cover premiums and fees, which would be applied to the next annual policy renewal, upon the borrower’s next loan payment. The proposal further notes that, if the covered loan and lender are subject to escrow requirements, that the FI must escrow those payments even if the insurance is force-placed.
For this element and others, a transition rule for growing institutions applies. The rule focuses on asset size of the FI. For those institutions not over the $1 billion mark on July 6, 2012, the focus shifts to asset size over the prior to calendar years similar to CRA. If the FI is over the $1 billion mark at the end of  the prior two calendar years, it would become subject to the escrow requirement. The proposal gives those FIs six months to develop the capacity to manage escrow and notification requirements. Thus, an FI over $1 billion on December 31, 2013 and December 31, 2014 would be subject to escrow requirements for covered loans beginning on July 1, 2015.
If a loan is sold to a covered FI, that FI must adhere to the escrow requirements at the time of flood insurance renewal or six months after the acquisition with proper notification of 90 days as required under the proposal. The reverse scenario is not presented, but presumably escrow requirements would not hit.

Private Flood Insurance

This aspect of the proposed rule is more interesting. Here the proposal focuses on whether FIs must accept private flood insurance that meets statutory definitions to satisfy the mandatory purchase requirements. But what does it mean to meet the definition of private flood insurance under the Act, and what if the insurance policy issued by the private insurer doesn’t meet that definition?
A private flood insurance definition includes seven requirements:

  1. Policy is issued by an insurance company that is licensed, admitted, or otherwise approved to engage in the business of insurance in the state or jurisdiction in which the insured building is located by the insurance regulator of the state or jurisdiction or, in the case of a policy of difference in condition, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property, is recognized, or not disapproved, as a surplus lines insurer by the insurance regulator of the state or jurisdiction;
  2. Provides flood coverage at least as broad as the coverage provided by a standard flood insurance policy (SFIP) under the NFIP, including when considering deductibles, exclusions, and conditions offered by the insurer;
  3. Includes a requirement for the insurer to give 45 days’ written notice of cancellation or non-renewal of flood insurance coverage to the insured and the regulated lending institution;
  4. Includes information about the availability of flood insurance coverage under the NFIP;
  5. Includes a mortgage interest clause similar to the clause contained in an SFIP;
  6. Includes a provision requiring an insured to file suit no later than one year after the date of a written denial for all or part of a claim under a policy; and
  7. Contains cancellation provisions that are as restrictive as the provisions contained in an SFIP.

It is clear that having to complete an analysis of item #1 would be exceptionally burdensome especially for smaller FIs. As such, the regulators are proposing a safe harbor for policies issued by private insurance companies when the state insurance regulator makes a written determination that the company’s policies are sanctioned. This could prove interesting, especially since the proposal includes solicitation for required acceptance of insurance when the insurance entity does not meet the definition of private flood insurance company. So much for standards. It’s interesting that FEMA itself punted on the regulatory acceptance of private insurance policy and stated that FIs must look to their regulator. Seems like no one wants to take a lead position on this one. We’ll see how the comments flow from those most affected by the issue.

Sample Forms

This is a big one. The proposal includes a number of new and revised sample notice forms and clauses including an amended Form of Notice of Special Flood Hazards and Availability of Federal Disaster Relief Assistance. The form will need to be amended no matter how the private insurance issue is resolved. The notice is a required disclosure whether the loan is located in a SFHA and flood insurance is required or available. Other changes to the escrow requirements and force-placement notice are presented.
The proposed rule would mandate that a regulated lending institution, or a servicer acting on its behalf, mails or delivers a written notice informing a borrower that it is required to escrow all premiums and fees for required flood insurance on residential improved real estate. The notice has specific language that will be added to the existing Notice of Special Flood Hazards and Availability of Federal Disaster Relief Assistance (“Notice”). The new language requirement will apply to loans on or after July 6, 2014 with those loans subject to future escrow requirements receiving a similar notice at least 90 days prior to the anticipated escrow requirement (i.e., 90 days prior to renewal) if subject to the escrow requirements.
The new disclosures, as noted, include allowances for private insurance company–issued policies.

Force-Placement Requirements

This is one area where many have been awaiting guidance. We know that a lender will be able to charge a borrower for the cost of flood insurance coverage commencing on the date on which the borrower’s coverage lapsed or became insufficient. But, as we have noted in the past, the question on handling duplicate coverage issues and other related issues merits attention, such as what documentation is acceptable.
The section presents the historical language for notification of lack of coverage and/or insufficient coverage and then the statement on failure of the borrower to obtain required coverage. The proposed amendment would “provide that the regulated lending institution or its servicer may charge the borrower for the cost of premiums and fees incurred for coverage beginning on the date on which flood insurance coverage lapsed or did not provide a sufficient coverage amount.”
The regulators are asking for clarification on what is defined by “lapsed” since that varies by responder. Hence, we should be getting a clear definition of whether there is a grace period under the definition.
However, the regulators then note that overlaps may occur and that the advantage remains with the borrower and the potential cost falls on the shoulders of the FI. The proposal further clarifies that a lender or its servicer must accept from the borrower an insurance policy declarations page that includes the existing flood insurance policy number and the identity of and contact information for the insurance company or its agent, as confirmation of the existence of coverage. Coverage adequacy rests on the lender.

Turf Wars Abated?

The FDIC and OCC propose to integrate their flood insurance regulations, which makes sense and is obviously happening with everything else under CFPB.

Conclusion to Flood Proposal

As with anything as complex as flood insurance rules, the regulators’ proposal will undoubtedly generate a heavy amount of question and comments. However, they can only go on so long before issuing a final rule, so our guess is that this is going to be the framework on key elements under Biggert-Waters, with additional clarification on matters that are deemed to be of some importance during the comment review period, such as what happens if the state refuses to certify private insurance companies, how long the borrower has to notify the FI that they obtained flood insurance during a dual-coverage period, or what happens if an exempted FI purchases a loan that was subject to escrow requirements.
By noting these changes for your financial institution, the new wave of flood insurance rules begin to feel less like uncharted territory and more like manageable waters.