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FLOOD INSURANCE AUTHORITY LAPSE
December 20, 2002
TO: CHIEF EXECUTIVE OFFICER
SUBJECT: Lapse of FEMA Authority to Issue Flood Insurance Contracts
This letter provides guidance to assist state member banks in dealing with the period
following January 1, 2003 during which the authority of the Federal Emergency
Management Agency ("FEMA") to issue flood insurance contracts under the National
Flood Insurance Program (the "NFIP") will lapse.
Background: The Flood Disaster Protection Act of 1973, as amended, prohibits lenders
from making, increasing, extending, or renewing loans secured by improved real property
or a mobile home located in a special flood hazard area where federal flood insurance is
available unless the building or mobile home is covered by flood insurance. See 42
U.S.C. § 4012a. This requirement is generally satisfied with coverage obtained through
the NFIP.
The 107th Congress adjourned at the end of November 2002 without extending the
statutory authority in the National Flood Insurance Act of 1968 to issue flood insurance
policies under the NFIP. As a result, the authority of FEMA to issue new flood insurance
policies, issue increased coverage on existing policies, and issue renewal policies will
expire on December 31, 2002.
Borrowers, therefore, will not be able to obtain NFIP insurance for loans secured by
property located in a special flood hazard area ("SFHA") that close after December 31,
2002 (or renew or increase existing policies after December 31, 2002) until the NFIP is
reauthorized, except under the circumstances described below.
FEMA has indicated that it expects the new Congress to reauthorize the NFIP shortly
after it convenes on January 7, 2003, and that the reauthorization will likely be made
retroactive to January 1, 2003.
Nevertheless, there are no guarantees that Congress will reauthorize the NFIP, or that
reauthorization will be given retroactive effect. This letter contains informal guidance on
issues that may arise during this period of lapsed authorization for lenders and borrowers
concerning loans that are or will be secured by property located in a SFHA.
Summary: State member banks may continue to make loans subject to the flood
provisions of Regulation H, 12 C.F.R. § 208.25, without flood insurance during the
period the NFIP is not available. Such lending does not violate 12 C.F.R. § 208.25.
However, these institutions must continue to make flood determinations, provide timely,
complete, and accurate notices to borrowers, comply with other parts of the flood
insurance regulations, and evaluate safety and soundness risks and prudently manage
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those risks during the lapse period. Further, regulated institutions should have a system
in place to ensure that policies are obtained as soon as available following reauthorization
for properties that are subject to mandatory flood insurance coverage.
The following discussion provides guidance to assist state member banks (hereinafter,
“lenders”) in dealing with the period during which the authority to issue flood insurance
contracts under the NFIP has lapsed.
Discussion:
Ability to Make Loans Unaffected by Lack of Authority
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Does the lapse in FEMA flood insurance authority mean that loans secured by
improved real property located in flood hazard areas may not be made by lenders
once the FEMA authority expires at year end 2002?
No, it does not. Lenders are not precluded during the lapse in flood insurance authority
from making loans due to a lack of NFIP flood insurance.
FEMA has taken the position in a letter to the federal financial institution regulatory
agencies dated December 12, 2002 that during the lapse in FEMA flood insurance
authority, flood insurance will not be available under the NFIP. A copy of the FEMA
document is attached to this letter. 1 During such time that flood insurance is unavailable
under the NFIP, a lender may legally make a loan to a borrower secured by improved real
property in a flood hazard area without requiring the borrower to obtain flood insurance
coverage.
This does not mean, however, that a lender is relieved of other obligations under federal
flood insurance law nor does it mean that safety and soundness considerations can be
disregarded. (Both of these matters are dealt with in more detail below.)
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How long will this situation last?
FEMA is actively working with Congress to provide flood insurance reauthorization
retroactively to January 1, 2003. FEMA has submitted model legislation that would
accomplish this. We do not know whether or how long it will take for Congress to act
after it convenes in January; nor can we affirmatively state that any renewal will be made
retroactive.
Retroactivity of Reauthorized Flood Insurance Policies
1
The December 12, 2002 letter from FEMA contains a “Notice 3” regarding “New Business or Coverage
Increase Endorsements” to be provided by NFIP servicing agents to flood insurance applicants. Previously,
on November 25, 2002, FEMA issued Notices 1 and 2 regarding renewals which are available through
FEMA http://bsa.nfipstat.com/wyobull/w-02082.pdf. In addition, FEMA has issued Frequently Asked
Questions (FAQs) on the lapsed insurance authority, which is available through FEMA
http://www.fema.gov/nfip/custfaq.htm.
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Why does retroactivity matter?
If authorization is not retroactive, new or renewal policies cannot be obtained for the
period when the program was not authorized, UNLESS they are obtained prior to January
1, 2003. Thus, if authorization is not provided retroactively, the earliest date that new
policies or renewals after the lapse would be effective would be the date of
reauthorization. In this situation, flood loss sustained would not be covered by the NFIP
if the loss occurred in the period subsequent to the lapse and prior to the date of
Congressional reauthorization.
If the authorization IS retroactive, according to FEMA, a flood insurance policy applied
and paid for during the lapse period prior to reauthorization will be deemed effective as
of the date of application and payment. In other words, retroactive application of FEMA
flood insurance authority to cover the lapse period will provide coverage in the event of a
flood between January 1 and the date of reauthorization for those borrowers who apply
and pay for NFIP flood insurance during the lapse.
Premium Payments Received Prior to January 1, 2003
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What about flood insurance payment premiums that are received before the expiration
of FEMA's flood insurance issuance authority?
FEMA has stated in its letter of December 12, 2002, that if a completed application
(including payment) or a renewal payment is received by NFIP Servicing Agents ON OR
BEFORE December 31, 2002, the covered property will be protected in the event of a
flood after that date. FEMA further states that claims under existing policies and policies
issued based on premiums received prior to the lapse will be processed without delay.
Therefore, according to FEMA, a borrower who makes an application for flood insurance
and pays the premium on or before December 31, 2002, will receive coverage even if the
effective date of the policy is after January 1, 2003.
This also applies to borrowers that renew policies on or before December 31, 2002, that
would otherwise expire during the lapse period. Accordingly, to the extent possible,
lenders are urged to encourage borrowers to complete applications for NFIP insurance
and pay premiums before December 31, 2002.
Duty of Lenders to Make Flood Hazard Determinations and Provide Notice to
Consumers Unaffected
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Do I still have to make flood hazard determinations?
Yes, you must continue to make standard flood hazard determinations and you must also
give borrowers the notice of special flood hazards and availability of Federal disaster
relief, if applicable, as required by 12 C.F.R. § 208.25.
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Flood Insurance Coverage During the Lapse
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What are my options regarding new loans that will be affected by this problem?
If you know that you will be making a covered loan that will close after December 31,
2002, you should encourage the borrower to complete the application and pay the
premium before that time. If the borrower does so, and the NFIP Servicing Agent
receives it on or before December 31, 2002, the policy can be effective after December
31, regardless of the NFIP reauthorization status.
The following describes options for you to consider to address this situation after
December 31, 2002:
•
FEMA has stated that you can have the borrower complete the application and pay
the premium, which will be held for processing pending Congressional
reauthorization by the insurance company (see attached FEMA guidance). FEMA
indicates that these applications will be processed as soon as the program is
reauthorized and will be made effective to the fullest extent of that authority. FEMA
has further stated that, if authorization is not granted within a reasonable period of
time after Congress convenes, the premiums will be refunded and the new and
renewal policies held in abeyance will not be issued. Banks should advise their
borrowers that remittance of the application and payment will not result in
immediate NFIP coverage and cannot legally be required until reauthorization, as
well as the consequences of non-retroactive reauthorization. FEMA has provided
standard language in the form of a notice for flood insurance agents to provide to
borrowers regarding availability of insurance during this period. A copy of the
notice is attached. You should ensure that borrowers with property in flood hazard
areas are similarly informed of the implications of closing on a mortgage loan during
this period.
•
You may determine that the risk of loss is sufficient to justify postponing closing the
loan until such time as the NFIP has been reauthorized.
•
You may still require that the borrower obtain private flood insurance where
available; however, the cost of such insurance may be a factor that would influence
you or the borrower to postpone closing rather than incur a long-term obligation to
address a short-term lapse.
•
You may make the loan without requiring the borrower to apply for flood insurance
and pay the premium pending reauthorization. However, this option poses a number
of risks that should be carefully evaluated. Moreover, if Congress reauthorizes the
NFIP, the agencies expect that flood insurance will be obtained for these loans,
including, if necessary, by force-placement as provided in 12 C.F.R. § 208.25(g),
"Forced placement of flood insurance." Before making such loans, you should
ensure that borrowers are aware of the flood insurance requirements and that
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force-placed insurance is typically more costly than borrower-obtained insurance.
You should also have a system to identify these loans so that you can ensure that
insurance is purchased if the NFIP is made available subsequent to closing.
Each lender remains responsible for protecting its collateral from risk in a manner
appropriate to the circumstances and for ensuring the overall safety and soundness of its
loan portfolio. You should consider the options above in the context of the overall credit
quality of your loan portfolio, safe and sound banking practices, and effective risk
management principles. Among the factors to consider are your volume and
concentration of lending in special flood hazard areas, including loans already in your
portfolio that may be subject to renewal and those to be made during the lapse period.
Lenders with an elevated level of risk of flood hazard should conduct their operations by
taking advantage of the available options in a manner that minimizes undue risk.
Renewals of Flood Insurance Policies
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What happens to renewals?
The situation is similar to that of making new loans. If possible, lenders and servicers
should try to accelerate the payment of renewal premiums due in the period immediately
following January 1, 2003. If the NFIP servicing agents and Write Your Own ("WYO")
companies that act on behalf of FEMA receive such payments prior to January 1, 2003,
FEMA has stated that there will be no lapse in coverage. For applications and premiums
received on or after January 1, 2003, FEMA has committed to process all renewals as
soon as the program is reauthorized. FEMA has provided standard notices for NFIP
servicing agents and WYO companies to provide to policyholders, and suggests that
these companies continue to collect premiums and hold them for processing until the time
that NFIP flood insurance policies are reauthorized. Lenders are encouraged to notify
their servicers that flood insurance payment premiums may continue to be processed
during the lapse. Lenders who act as their own servicers may also continue to process
such payments during the period of lapsed authority.
Alternatively, depending on the terms of the mortgage, you may be able to require
borrowers to obtain coverage outside the NFIP, as a risk management measure.
Securitization of Mortgage Loans and the Secondary Market
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Will I be able to sell loans on the secondary market that do not have flood insurance
coverage?
That will depend on the decisions of your purchaser. You should consult them about,
among other things, eligibility requirements and post closing obligations before closing a
loan affected by this problem.
The Federal Home Loan Mortgage Corporation ("Freddie Mac"), a principal purchaser of
securitized mortgages on the secondary market, issued an announcement on December
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16, 2002 that set forth its policies on flood insurance for loans during the lapse period. A
copy of the announcement is attached to this letter.
Federal Housing Authority (FHA)/Veterans Administration (VA) Loans
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Will I be able to make FHA and VA loans, and other federally guaranteed or insured
loans?
You should consult with FHA, VA or other federal guarantee agency, as appropriate.
Agency Flood Insurance Enforcement
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Will my financial institution violate 12 C.F.R. § 208.25 by not obtaining flood
insurance coverage of loans made while the NFIP statutory authority has lapsed?
No. The flood insurance rule defines a "designated loan" as a loan secured by a building
or a mobile home that is located or to be located in a special flood hazard area in which
flood insurance is available under the NFIP. Because no flood insurance will be
available under the NFIP during the lapse, lenders will not be in violation of the
prohibition against making loans without flood insurance coverage during that period.
Lenders, however, must still make flood determinations, provide timely, complete, and
accurate notices to borrowers, and comply with other parts of the flood insurance
regulations that have not lapsed. Moreover, lenders must carefully evaluate safety and
soundness risks and prudently manage those risks during the lapse period. The federal
financial institution regulatory agencies will notify financial institutions of any
Congressional action to reauthorize the NFIP. Upon such reauthorization, flood
insurance coverage must be obtained for any loan where it would have been required but
for the lapse in FEMA authority. If necessary, this must be accomplished through forced
placement of flood insurance by the lender. Failure to require insurance once the NFIP is
reauthorized would constitute a violation of the flood rule.
Attachments:
FEMA Letter of December 12, 2002 (328 KB PDF) to the Federal Financial Institution
Regulatory Agencies Concerning the Lapse in Flood Insurance Authority
Freddie Mac Announcement of December 16, 2002
http://www.freddiemac.com/sell/selnews/fyam2.html (Electronic version)