Closing a Loan with Force Placed Flood Insurance

Adam uses this Compliance Clip (video) to answer the question: Can you close a loan with force placed flood insurance? This question often comes up when an applicant has an existing loan with force placed flood insurance coverage and wants to refinance. Adam explains the conservative approach that will ensure compliance with flood insurance rules.

The following is a transcript of this Compliance Clip:

This Compliance Clip is going to talk about closing a loan with force placed flood insurance so let’s dive in and make a splash on this compliance topic.

The challenge here with force placed insurance is that over the last decade or so we have seen significant changes to the existing flood insurance rules. In 2012 specifically, we saw the Biggert-Waters Flood Insurance Reform Act come out and make a number of significant changes. One of the significant changes that affected your customers had to do with the cost of individual flood insurance policies. So what ultimately happened was that the flood insurance program was operating in the negative deficit in Congress decided that they had to bring the program back into the black because they were currently in the red and they needed to make this program work.

One of the ways they did that was to start increasing rates. At least that’s the long story short. What happened was that consumers saw the rates literally double and triple overnight, when the flood insurance policies would come due for renewal. This caused a number of problems. Again, long story short, what ultimately happened was that consumers had found that forced placed coverage through their financial institution was actually significantly less than what it cost and to get their own private policy.

I talked to one banker recently who said that they’re forced placed policy coverage was about 1/3 of the cost of the private policy for a customer who wanted to deal with the bank’s forced placed coverage.  

Now, it’s OK for a financial institutions to have force placed coverage, but it has been a general consensus that you cannot make, increase, renew, or extend a loan with force placed coverage. The consumer must have their own private policy. A voluntary policy, per se, in order for a financial institution to do the loan. This is been the rules for a very long time.

So what ultimately has happened is that we have consumers who have an existing force placed policy because they had a policy that they let it lapse in the bank force placed it, and now they want to maybe refinance the loan so what ultimately has happened is that we have consumers who have an existing force placed policy because they had a policy that they let lapse, and now they want to maybe refinance the loan and they don’t want to have their own private policy because of the cost.  So what happens?

The question becomes this: can a bank close a loan with a forced placed Flood insurance policy in place?

It is a little bit difficult because the rules for flood insurance have been a moving target for a while now. It used to be that we had clear guidance on this. The guidance was the mandatory purchase of one insurance guidelines from FEMA. In the guidance, it specifically stated that “forced placement of coverage is designed for use at any time during the term of the loan in uninsured and underinsured situations. It is not intended for you sitting on origination. If a bar refuses to obtain flight insurance coverage as a condition of obtaining a loan the loan is deficient and is not to be made.“

The bottom line here is that FEMA has always said that you should not be making loans with force placed coverage. The consumer must have their own voluntary policy. Now if it lapses later, you can force place, but to make a loan you would have to have their own voluntary policy.

So the question becomes, does this apply to make increased renew or extend, or does this just applied to making a loan, or when does the supply? The general consensus over the years was pretty much you should not do any loans with force placed coverage. But we saw that the FDIC has given informal guidance to examiners, and we even heard this on a webinar a couple years back, that it is OK to allow force placed flood insurance coverage to renew a loan, basically refinance a loan that is already with your bank.  Basically, if you already have a loan that has force placed coverage on your books, some examiners have said that it is OK to go ahead and renew the loan. The problem is, that guidance is not written down anywhere. I have not been able to find it and if you have let me know.

So what is the conservative approach?

Of course, the conservative approach is going to be to just require a voluntary, individual flood insurance policy for every loan into not close any loans with force placed what insurance coverage.

So that is the key. You probably want to require this every time, or you could consider getting something in writing from your regulator and cross your fingers that all future orders in examiners agree with that approach.