On November 21, 2022, the Federal Housing Administration (“FHA”) announced a final rule to provide for the acceptance of private flood insurance in connection with FHA-insured loans.
FHA to Permit Private Flood Insurance Policies
Effective December 21, 2022, the FHA has adopted a long-awaited final rule (the “FHA Rule”) permitting the acceptance of private flood insurance policies in connection with FHA-insured loans. Proposed nearly two years ago, the regulations align requirements for the acceptance of private flood insurance for FHA-insured loans with those that apply to loans made by federally regulated financial institutions (“federally regulated lenders”).
In 2012, Congress enacted the Biggert-Waters Act Flood Insurance Reform Act, amending the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973 (collectively, the “Flood Act”) to clarify the obligations of federally regulated lenders to accept private flood insurance – among other provisions. Specifically, Biggert-Waters included a provision requiring the federal banking regulatory agencies – the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the National Credit Union Administration (the “Agencies”) – to adopt a rule directing regulated lenders to accept private flood insurance policies meeting statutory criteria, and to notify borrowers of the availability of private flood insurance coverage as an alternative to that available through the National Flood Insurance Program (“NFIP”). The Agencies first proposed such a rule in October 2013, and finalized it in February 2019 – with the provisions taking effect on July 1 of that year.
The FHA Rule
Neither the Biggert-Waters provision addressing private flood insurance nor the Agencies’ rule on the same topic, however, applies to FHA-insured loans. As a result, as of July 2019, there existed a significant disparity between most loans made by federally regulated lenders and those insured by the FHA: Private flood insurance was an option for the former, but prohibited for the latter because it did not comport with the requirements of FHA regulations. To address the differences, in November 2020, the FHA proposed to amend its regulations (24 CFR Parts 201, 203, and 206) to permit the acceptance of private flood insurance policies and provide other clarification on mortgagees’ obligation to ensure that appropriate flood insurance coverage is in place for FHA-insured loans.
Definition of Private Flood Insurance
Amending 24 C.F.R. 203.16a, the FHA Rule mirrors the definition of “private flood insurance” found in the Agencies’ rule, which includes four prongs. First, such a policy must be issued by an insurance company that is:
- Licensed, admitted, or otherwise approved to engage in the business of insurance by the insurance regulator of the State or jurisdiction in which the property to be insured is located; or
- Recognized, or not disapproved, as a surplus lines insurer by the insurance regulator of the State or jurisdiction in which the property to be insured is located in the case of a policy of difference in conditions, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property.
Second, the policy must provide flood insurance coverage that is at least as broad as the coverage provided under an NFIP Standard Flood Insurance Policy (“SFIP”) for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer (and as further specified in the definition).
Third, the policy must include:
- A requirement for the insurer to give written notice 45 days before cancellation or non-renewal of flood insurance coverage to the insured and the federally regulated lender that made the designated loan secured by the property covered by the flood insurance, or the servicer acting on its behalf;
- Information about the availability of flood insurance coverage under the NFIP;
- A mortgage interest clause similar to the clause contained in an SFIP; and
- A provision requiring an insured to file suit not later than one year after the date of a written denial of all or part of a claim under the policy.
Finally, the policy must contain cancellation provisions that are as restrictive as the provisions contained in an SFIP. The Agencies’ rule also gives a federally regulated lender discretion to accept a policy offered by a private insurer that does not meet all of the above criteria – such as a policy offered by a mutual aid society.
Like the Agencies’ rule, the FHA Rule includes a compliance aid intended to help mortgagees identify whether a private flood insurance policy meets the regulatory standard. The FHA Rule makes clear, however, that regardless of the presence of the compliance aid statement, a mortgagee may make its own determination of whether a private flood insurance policy meets the definition above. Unlike the Agencies’ counterpart, the FHA Rule does not provide discretion for a lender to accept a policy that does not meet the definition of (or other criteria for) private flood insurance as set forth in the rule. As a result, in its Federal Register notice of the rule adoption, the FHA emphasized that a policy acceptable under the Agencies’ rule may not satisfy the FHA standard.
The FHA Rule includes other important clarifications regarding the maintenance of flood insurance on FHA-insured loans.
First, under the Flood Act and the Agencies regulations, the minimum amount of coverage that must remain in place on property securing a loan throughout the life of the loan is the lesser of: (1) the outstanding principal balance of the loan; (2) the maximum limit of coverage available for the particular type of property under the Flood Act; or (3) the insurable value of the property. The FHA Rule states that for an FHA loan, the insurable value should be calculated as “100 percent replacement cost of the insurable value of the improvements, which consists of the development of project cost less estimated land cost.”
Second, the FHA Rule clarifies the application of flood insurance obligations to Home Equity Conversion Mortgages (HECMs), adding language to mirror the loss payee and compliance aid provisions of the rule applicable to forward mortgages.
The FHA Rule provides long-awaited clarity for lenders, brings FHA requirements relating to the acceptance of private flood insurance policies more into line with those applicable to federally regulated lenders, and expands the options that FHA borrowers have when their properties are located in special flood hazard areas.