QUESTION
We are a
community bank financing the construction of a mixed use property consisting of
retail/business use on the first floor and four residential units on the second
floor. The property, which will be the collateral for the loan, is located in a
flood zone. The loan amount is $550,000, with a replacement cost value of
$980,000 (as is)/$1,110,000 (completed). The borrower is asking that we accept
a private flood insurance policy that contains an 80% coinsurance clause which
also has a 20% coinsurance deductible. Do we have any obligation to accept such
a policy? And, if not, are we permitted to accept such a policy? Lastly, given that this is a mixed use
property, how do we determine the maximum amount of coverage available under
the NFIP?
ANSWER
Let’s take
the last question first. Nonresidential buildings include mixed use buildings
with less than 75% residential square footage. If you are stating the first
floor is commercial space and the second floor is residential space, I am
assuming the square footage is 50-50, which would make it a nonresidential
building for the purpose of flood insurance under the NFIP. The maximum
coverage available for Other Non-Residential is $500,000.
Now onto
the private flood insurance policy issue! In light of the current regulations
as well as those effective July 1, 2019, the bank is under no obligation to
accept a private flood insurance policy containing a coinsurance clause. However,
the bank may use its discretion and accept same, provided the policy meets certain
criteria which include the provision of sufficient protection of the loan,
consistent with general safety and soundness considerations.
Under
current law, with respect to properties located in a flood zone, the bank must
require flood insurance in an amount at least equal to the lesser of the
outstanding principal balance of the loan or the maximum coverage available for
the particular type of property under the Act.
[12 CFR §339.3 (effective 10/01/15)] Under the National Flood Insurance
Program (NFIP) policy, insurance will cover up to whatever the stated amount is
(less any deductible).
The current
regulation is silent as to whether the bank must accept private flood insurance
in lieu of that provided under the NFIP.
Effective
July 1, 2019 (although earlier adoption is permissible), the regulations have
been revised such that the bank must accept private flood insurance in
satisfaction of the requirement for flood insurance if the policy meets certain
requirements.
The bank is
mandated to accept a private flood insurance policy that, among other items
“provides flood insurance coverage that is at least as broad as the coverage provided under an SFIP for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer. To be at least as broad as the coverage provided under an SFIP, the policy must, at a minimum: . . . (ii) Contain the coverage specified in an SFIP, including that relating to building property coverage; personal property coverage, if purchased by the insured mortgagor(s); other coverages; and increased cost of compliance coverage; (iii) Contain deductibles no higher than the specified maximum, and include similar non-applicability provisions, as under an SFIP, for any total policy coverage amount up to the maximum available under the NFIP at the time the policy is provided to the lender; . . . and (v) Not contain conditions that narrow the coverage provided in an SFIP.” [12 CFR §339.2 (effective 7/01/19)]
A private
flood insurance policy which contains a coinsurance clause does not equate to a
policy issued under the NFIP. The coinsurance clause narrows the coverage
otherwise provided under an SFIP, and effectively is a clause not applicable in
an SFIP policy. Under an NFIP General Property – Standard Flood Insurance
Policy, which is what issues with respect to Other Non-Residential Building
such as the property you describe, the insurance covers up to whatever the
stated amount is (in this case $500,000) less any deductible. However, the
amount covered under a private policy with a coinsurance clause vastly differs.
Under a
policy with a coinsurance clause, the insured must carry insurance equal to at
least a certain percentage of the property’s actual cash value. This is done to
ensure that the property is not underinsured when the replacement cost loss
settlement option is purchased.
Your
scenario is as follows:
- Loan amount: $550,000
- RCV: $980,000 (as is)/$1,110,000 (as complete)
- Insurance: $500,000
- Coinsurance Clause: 80%
Let’s
assume the loss to the property is $600,000 and the actual cash value at time
of loss is $980,000.
- Required coinsurance = $784,000 (ACV x .80 coinsurance)
- 63.75% = $500,000 (amount of insurance carried) / $784,000 (amount of insurance should have carried)
- 63.75% x $600,000 (amount of loss) = $382,500 (amount covered by insurance less any deductible)
For the
purpose of this analysis, I will assume that the deductible under both the NFIP
and private policy is $0. So, at the end of the day, under the NFIP policy,
$500,000 will be covered by insurance whereas under the private policy, only
$382,000 will be covered by insurance. Thus, as the coverage provided under the
private policy is not meeting the maximum coverage available under the Act, the
bank is under no obligation to accept it.
