Flood Insurance- What you don’t Know may Cause a UDAAP Violation- Part Two

In 2011, the newly published questions and answers pertaining to flood insurance brought significant, but unheralded change to the management of flood insurance at banks and financial institutions.   In the last blog we discussed the changes to the manner in which insurable value is calculated for purposes of commercial buildings and the possibility of over-insuring. 

Another area of change addressing in the questions and answers is one that has vexed compliance officers for some time-the 45 day rule.  The three questions that are addressed are:

                                                               i.      When does the 45 day notice period begin?

                                                             ii.      Can a borrower be charged for the cost of insurance purchased during the 45 day notice period?

                                                            iii.      How soon after the 45 days have expired should the bank purchase and force place insure? 

The answers to the first two questions have not been adopted as final.  However, both proposed questions and answers provide significant guidance.  The answer to the third question should serve as something of a warning to the unit at your bank that handles the flood insurance portfolio.  

Force Placing Should be Immediate

Force Placed Insurance must be in effect in a very short time after the 45 day period has expired. 

“The Regulation provides that the lender or its servicer shall purchase insurance on the borrower’s behalf if the borrower fails to obtain flood insurance within 45 days after notification. However, where there is a brief delay in force placing required insurance, the Agencies will expect the lender to provide a reasonable explanation for the delay,”

There is no further discussion of a “brief “delay.  However, the discussion in the question details the rationale that the bank has had knowledge of the expiration of the policy or under insured condition for some time and should anticipate that the borrower will need the policy.  It is clear that the examiners will look to the Bank to provide insurance IMMEDIATELY at the end of the 45 day notice period.  Failure to do so will need an explanation.   

When does the 45 Day Notice Period Begin?

The questions and answers here discuss the idea that the banks may accelerate the date for notice of force placement using the guidance form the NFIP flood insurance manual which discusses a notice being sent 45 days before the expiration of a policy.  However, the comments note that this direction is for the insurance companies and not the financial institutions.  Your bank must wait until it has actual knowledge that the policy has expired or the insurance amount is inadequate. [1]

Can a Borrower be charged for forced Placed Insurance in the 45 day Period?

Probably one of the most interesting questions in the whole force-placed insurance area is about the time period between the expiration of a policy and the force-placed new policy.  Is there a gap that is being created by the regulation?  The answer to the question indicates that a bank can in fact; charge the customer for force-placing insurance retroactive to the date that the coverage actually ends.  In most cases, this would be for a 15 day period insurance coverage ends 30 days after the policy expires.   The caveat here is that the bank must have written into its original loan agreement the right to charge the customer for insurance. 

 UDAAP 

The comments in proposed question 62 offer some further information that is critical. 

“the Agencies also encourage institutions to explain their force-placement policies to borrowers (including their policy on charging for force-placement coverage for the 45-day period and the timing of that charge) and encourage lenders and servicers to escrow flood insurance” 

While the language here may seem casual and merely suggestive, the wise compliance officer will see this information as the potential for a UDAPP violation if not followed.   If your bank intends to charge borrowers for forced placed flood policies for the time period retroactive to the date the coverage expires, it is best to clearly document the force-placed policies at the time the loan is made and again with the 45 day notice. 

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[1] Notice is also required at the moment that the Bank becomes aware of a change in the flood map that requires insurance for a property or collateral that was previously not in a flood zone.

 

Flood Insurance- What You May not Know can Cause a UDAAP Violation!  Part One.

For every compliance officer who has had to deal the vagaries of trying to get flood insurance right, the “terror”  associated with wretling with compliance and customer satisfaction is well know.  On the one hand, you have a customer who is livid about being charged for flood insurance at all for properties that they see as essentially worthless.  On the other hand, you have the regulators who are more than ready and willing to assess civil money penalties for what they see as a pattern and practice of violations!    

Well take heart!  Some positives have taken place in the recent future!    Especially in the area of insurable value!

One of the biggest questions that dog compliance people when it comes to flood insurance is; “what is the insurable value of a property?”  Since 2009 when the first set of interagency questions were published, the conventional wisdom has been that the proper valuation for all properties is the Replacement Cost Value (“RCV”).  The RCV is defined in the Interagency Questions and Answers Regarding Flood Insurance as:

RCV is the cost to replace property with the same kind of material and construction without deduction for depreciation.  

This definition has been rigidly applied to many of the institutions with whom we come into contact.  In fact, many an institution has been heavily criticized for inadequate insurance based upon this standard.  Of course the problem with this standard when it is applied to commercial buildings is that depreciation is in fact taken into account by insurance companies.  

However, in 2011, a light shone through!  The problem with using RCV as the insurable value of commercial property became evident.  In the event of damage or loss on these properties, the borrower would only receive the value to replace the building less accumulated depreciation (“ACV”).  As a result, using RCV means that in many cases, the borrower is OVER INSURED!  

The 2011 interagency statement added question 9 which details the way insurance may be calculated for commercial buildings.  The guidance says in relevant part:
 

“in calculating the required amount of insurance, the lender and borrower (either by themselves or in consultation with the flood insurance provider or other appropriate professional) may choose from a variety of approaches or methods to establish a reasonable valuation. They may use an appraisal based on a cost-value (not market-value) approach, a construction-cost calculation, the insurable value used in a hazard insurance policy (recognizing that the insurable value for flood insurance purposes may differ from the coverage provided by the hazard insurance and that adjustments may be necessary; for example, most hazard policies do not cover foundations), or any other reasonable approach, so long as it can be supported.”

This approach means that for commercial buildings, your bank cannot insist on an insurance amount that exceeds what the borrower can actually receive in the event of a loss. 

While there is no anecdotal evidence to date; it is only a matter of time before a borrower or even a regulator raises the specter of a UDAAP action based upon the Bank demanding excessive insurance. This is just a friendly heads up!  Beware! 

In Part two we will discuss the updates on the 45 day rule.     

Training is not a Luxury Item!

It happens every time economic downturns come to the fore. Businesses look at their operating expenses in search of areas to cut. Expense items that are seen as superfluous or non-essential are significantly reduced or cut entirely from the operating budget. Unfortunately, training of staff is often at the top of the list of items that are viewed as easy to cut. The arguments for cutting training are easily recognizable. “The cost of traveling doesn’t justify the result.” Or, “We can put that off for a year or two without much trouble.” In addition, to cost concerns, training is often seen as a luxury that is nothing more than a boondoggle for employees.

Nowhere is this truer than in the banking industry. Today, with profits in question throughout the industry as the economy continues to shrink, banks are looking for ways to cut costs. However, as the budget axe continues to look for potential places to cut, please do not consider your training program to be non-essential! The regulators will not like it and you may ultimately do more harm than good!

Training as an Essential Part of a Compliance Program
Since regulators first embraced the risk-based approach to supervision of banks, training of staff was recognized as one of the pillars of a strong compliance program. In its 2002 article entitled A Banker's Guide to Establishing and Maintaining an Effective Compliance Management Program, the Kansas City Federal Reserve Bank discussed the importance of training to a compliance program:

“The importance of having a staff that is knowledgeable of regulatory requirements cannot be overstated. Regardless of an institution's philosophy and policies, ultimately it is line staff who process transactions and interact with customers. If employees are not adequately trained in compliance matters, errors are certain to occur” [1]

Mark W Olson, Member of the Board of Governors of the US Federal Reserve System, also emphasized this point in his remarks at the American Bankers Association's Regulatory Compliance Conference, Orlando , June 12, 2006. He stated in part that:

“Training on policies, procedures, and associated controls is a component of compliance-risk management that should not be overlooked. Examiners will determine whether the banking organization's training program ensures that compliance policies, procedures, and controls are well understood and appropriately communicated throughout the organization. [2]

These two ideas make it clear that training of staff is not only important, but that is an essential component of compliance. There must be a mechanism in place to make sure that everyone associated with your bank is kept abreast of changes to regulations that directly impact the operations of the bank. In addition, when management and staff have a clear understanding of the requirements of regulations, they are more effective and efficient in compliance. While good training will not make up for unsafe and unsound practices, a well trained staff can cover a multitude of “ sins”.

Training Can be a Cost Saver
In the area of compliance, the most frequent violations of regulations are a direct result of either misunderstanding the requirements of regulations or ignorance of changes to regulations. [3] Training courses that cover the requirements of consumer regulations are extremely effective in reducing these kinds of violations. While compliance violations rarely result in the closure of a bank, the fines, penalties and reimbursements that result can have a drastic impact on the profitability of a bank.

In many cases, when regulatory changes occur, changing the bank’s policies and procedures to reflect the changes can take time. In the meantime, a well-trained staff and management can immediately effect the changes that are required by new regulations , and can be mindful of forms, documents, disclosures or other materials that are out of date or are not in compliance.

Various Forms of Training Classes
Today there are many options available to the cost-conscious bank that wants to provide training. On-line courses, classes delivered by vendors, and even regulatory agencies all have developed various training courses at affordable prices. With a minimum of research, it is possible to find various forms of training that can be tailored to the educational and economic needs of your individual bank.

Do not Give Training the AxeEven in the toughest of economic times, training of staff and management is a necessity. Through training courses that are specifically designed to meet the needs of individual organizations, banks can be prepared to meet the challenges of a changing regulatory environment. As one of the most important pillars of a strong compliance program, training should never be considered a luxury!

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[1] A Banker's Guide to Establishing and Maintaining an Effective Compliance Management Program (the Guide). Federal Reserve Bank of Kansas City , 2002

[2] Remarks by Mark W Olson, Member of the Board of Governors of the US Federal Reserve System, at the American Bankers Association's Regulatory Compliance Conference, Orlando, 12 June 2006.

[3] For a list of the most frequent consumer violations, see A Banker's Guide to Establishing and Maintaining an Effective Compliance Management Program Kansas City Federal Reserve Bank 2002