Mastering the Challenges of Flood Insurance Compliance Management

Some banks have faced challenges complying with flood insurance-related rules. In 2016, the federal regulatory agencies assessed $85,785 in civil money penalties (CMP) for violations of the flood insurance rules at three financial institutions in the Ninth District. In addition, examiners continue to see flood insurance-related violations during state member bank (SMB) examinations. However, banks can overcome these challenges by establishing consistent procedures and internal controls to manage the process. This article will discuss the strong practices examiners see in effective flood insurance compliance management programs at our SMBs, including at smaller banks that have been able to make these operational improvements with minimal cost.

Some important challenges

• The flood insurance rules cover a number of business lines at a bank, such as residential real estate loans, commercial loans, agricultural loans and home equity lines of credit. Regulation H, which implements the Federal Reserve System’s flood insurance rules, requires banks to complete a standard flood hazard determination form for all loans secured by improved real property. The loans secured by properties in special flood hazard areas have additional requirements; the bank must provide the borrower with a flood insurance availability notice, and the borrower must obtain the appropriate amount of flood insurance coverage prior to closing the loan.¹


• Compliance with flood insurance requirements covers the life cycle of a loan, from application to origination to servicing. As discussed, banks must comply with several requirements when originating loans secured by improved real property. Banks must also ensure that the borrower maintains an adequate amount of flood insurance during the loan’s term. This requirement includes force-placing insurance if the insurance lapses or coverage falls short and the borrower does not obtain adequate insurance after receiving notice of the insurance lapse or shortfall. Some of the force-placement requirements changed with the enactment of the Biggert-Waters Flood Insurance Reform Act of 2012 (BWA).², ³   


• Assessing the adequacy of insurance coverage levels is complicated. The flood insurance rules describe what constitutes adequate insurance coverage, but determining the appropriate amount of insurance is challenging, particularly for more complicated loans.⁴


• New rules have added to the complexity of understanding regulatory requirements. For example, the BWA added certain escrow requirements for lenders servicing residential real estate loans. Exceptions apply to small lenders that meet certain requirements (see endnote 3).

Overcoming challenges

Financial institutions that effectively manage flood insurance compliance risks use some or all of the following internal controls:

• Consolidate expertise and oversight when and where applicable.
  - A centralized procedure or process for all business lines can help decrease the risk of noncompliance related to having a number of lenders and/or loan processors with flood-related responsibilities. For small banks, having another loan officer or loan processor review the loan checklist is an effective control. In addition, a uniform procedure or centralized process helps ensure that borrowers receive the flood insurance notice with sufficient time to purchase flood insurance before the loan closing. This process also helps minimize the risk that loans could close without adequate flood insurance in place.


• Conduct second reviews of loans with flood insurance before origination.
  - Establishing a second review of loans before origination will ensure that lenders do not close loans with insufficient flood insurance coverage and that borrowers have acknowledged receiving the flood insurance notice. As noted, completing a document processing checklist prior to loan closing is one way to conduct second reviews.


• Clearly articulate to staff that covered loans cannot close without sufficient flood insurance coverage.
  - Some institutions have made this a performance-related job objective.


• Provide tools that help staff members calculate sufficient flood insurance coverage amounts, especially for more complex transactions such as loans with multiple structures and condominium loans. Several compliance websites have flood insurance coverage worksheets and worksheets for calculating coverage for condominiums.


• Establish escrow accounts when needed for serviced loans according to the new rules adopted in January 2016


• Track covered loans and adopt a centralized tickler system for ongoing monitoring of insurance coverage.
  - Centralizing a tickler system for monitoring the expiration of flood insurance policies helps ensure that borrowers maintain adequate insurance coverage during the loan’s term.


• Ensure timely responses, including force-placement when required, if flood insurance lapses.
  - Overall, establishing clear policies and procedures as well as strong internal controls helps minimize the likelihood of noncompliance with the flood insurance requirements of Regulation H. Financial institutions should also consider providing periodic training to all lending staff on the flood insurance requirements. As discussed, violations of the flood insurance provisions of Regulation H can be costly.⁵

Compliance resources

Several agency resources provide guidance on complying with flood insurance regulations, including the following:

• The 2011 Interagency Questions and Answers: https://www.federalreserve.gov/newsevents/press/bcreg/20111014a.htm


• Consumer Compliance Outlook Newsletter Articles
  - Flood Insurance Compliance Issue: https://consumercomplianceoutlook.org/2015/third-fourth-quarter/note-from-editors
  - Interagency Flood Insurance Regulation Update Webinar Questions and Answers: https://consumercomplianceoutlook.org/2016/first-issue/interagency-flood-insurance-regulation-update-webinar-questions-answers/


• Consumer Compliance Outlook Live Webinar
  - October 2015 Interagency Flood Insurance Regulation Update: https://consumercomplianceoutlook.org/outlook-live/2015/interagency-flood-insurance-regulation-update/

Endnotes

1 Regulation H, sections 208.25 (f) and 208.25(i).

2 Regulation H, section 208.25(g).

3 “Agencies Issue Flood Insurance Rule,” June 22, 2015, available at www.federalreserve.gov/newsevents/press/bcreg/20150622a.htm.

4 Consumer Compliance Outlook Newsletter, Third/Fourth Quarter 2015, pp. 7-8.

5 The maximum civil money penalty for flood insurance violations is $2,000 per violation, with no statutory cap.