Flood Compliance Pitfall

Just when you think you had flood compliance under control at your institution, new flood “hot buttons” pop up during compliance exams!  The most recent flood compliance “hot button” is  related to content flood insurance requirements.

Under the flood rules, if the lender takes a collateral interest in “contents” located in a structure in a special flood hazard area that is insured under the National Flood Insurance Program (NFIP), the lender must also require flood insurance on those “contents.” Contents located in a structure that is in a special flood hazard area, but which is not insured under the NFIP, are not eligible for contents insurance coverage under the NFIP.

Insurable “contents” include items such as inventory, parts and equipment as part of open stock, self-propelled vehicles or machines (provided they are not licensed for use on public roads and are used mainly to service the described location; or designed and used to assist handicapped persons while the vehicles or machines are inside a building at the described location), as well as contents located in silos, grain storage buildings and cisterns. Items not eligible for content coverage include contents located in a structure not eligible for building coverage, contents located in a building not fully walled and/or not secured against flotation, and automobiles, motorcycles and motorized equipment – including dealer’s stock, assembled or not.

The flood rules require lenders to insure the contents, and structure in which they are located, in an amount equal to the lesser of:

  • The combined maximum amount of insurance available under the NFIP for the structure and contents;
  • The combined insurable value of the contents and structure; (Under the NFIP, the maximum amount of content coverage available for a non-residential structure under the regular program is $500,000.); or
  • The total loan amount secured by the insurable collateral in a special flood hazard area.

When a lender takes both contents and an insurable structure as collateral, the lender is required to insure both.  The Interagency FAQ (located at:  http://www.gpo.gov/fdsys/pkg/FR-2009-07-21/pdf/E9-17129.pdf) provides the following illustrative example of insurance coverage requirements:  Example: Lender A makes a loan for $200,000 that is secured by a warehouse with an insurable value of $150,000 and inventory in the warehouse worth $100,000. The Act and Regulation require that flood insurance coverage be obtained for the lesser of the outstanding principal balance of the loan or the maximum amount of flood insurance that is available under the NFIP. The maximum amount of insurance that is available for both building and contents is $500,000 for each category. In this situation, Federal flood insurance requirements could be satisfied by placing $150,000 worth of flood insurance coverage on the warehouse, thus insuring it to its insurable value, and $50,000 worth of contents flood insurance coverage on the inventory, thus providing total coverage in the amount of the outstanding principal balance of the loan. Note that this holds true even though the inventory is worth $200,000. 

Recent exam findings include failure to:

  • Insure contents when the lender takes a collateral interest in both the structure and the contents located in the insurable structure via a UCC filing on equipment and/or inventory.
  • Increase the amount of insurance when a lender makes a new extension of credit and refers to an existing security agreement on insurable contents (often referred to as “cross collateralizing”).
  • Insure (or increase insurance coverage) when referring to a collateral interest in contents as “an abundance of caution.” For flood insurance purposes, it does not matter if the collateral interest is taken as the primary source of collateral or as an abundance of caution, the insurance rules are applied in the same manner.

This and other common compliance pitfalls will be covered in detail on August 1, with the IBA Compliance Webinar, Common Compliance Pitfalls. Offered August, 1 and available OnDemand after, the webinar will focus on regulations that will NOT be changing as a result of the Dodd-Frank Act and are commonly cited as violations during compliance exams.  Our goal is to assist you in correcting these violations now, so when the Dodd-Frank Act changes become effective, your compliance efforts can be focused on new requirements, not existing, recurring compliance errors.  See the IBA website for complete details.

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