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.