Flood Insurance - So What’s the Big Deal?

 One of the “hot topics in compliance that will always be a “hot topic is Flood Insurance.  One of the largest areas of civil money penalties continues to be flood insurance violations.  No matter what else the compliance examination may cover, the examiners will be looking to see if the Board has established complete and sound policies and procedures for flood insurance. The standard here is that a novice should be able to read the policies and have a general idea about flood insurance, while the procedures should give clear direction on what to do.   

A Brief History of the Flood Program
In 1968, the regulations that established a federal flood insurance program were first passed. However, the program was voluntary and relatively ineffective. In 1973, Congress passed legislation that prohibited financial aid for all communities that were in a flood zone that refused to participate in the flood insurance program. The same legislation made it a matter of law for federally regulated or insured lenders to require flood insurance on loans. In 1994, the amount of insurance coverage required was increased. In addition, the Federal Emergency Management Agency (FEMA) was required to review its database of information on floodplains every five years. Today FEMA has three main roles when it comes to the flood insurance program; a) identifying and mapping flood prone areas, b) providing flood insurance and c) ensuring that communities in flood prone are required to join the flood insurance program.  

Flood Insurance and Bank Regulation
Though the flood insurance requirement is not technically a banking regulation, it has the potential for dramatic impact on a bank’s operation. The federal flood insurance program requires participation of all communities that are in flood zones (failure to do so would result in no federal assistance for the non-participating community). In addition, all institutions that have federal insurance or are federally regulated are required to participate in the program. As a practical matter, then, the federal flood insurance program is a banking regulation.       

Since 1996 federal and state banking regulatory agencies have made compliance with the requirements of the federal flood insurance program part of the examination process. In the aftermath of the flood disaster caused by Hurricane Katrina, flood insurance is an issue that is paramount in the public consciousness. Though a satisfactory flood insurance program will not necessarily improve a banks operating position, an unsatisfactory review can have dramatic impact! 

Flood Insurance Examination Process
The bank regulators’ review for compliance in the flood insurance area will generally consist of a review of four components;

·         Policies and procedures;

·         Training;

·         Management information systems;

·         Internal controls

Each of these will all be reviewed and analyzed. After this analysis is completed, it is standard practice to conduct transaction testing which in this case would mean a review of a sample of real estate loan files.   

The examiners will review the training that is required of loan and operations staff and the method by which training is documented. In some cases, the examiners will interview bank staff to determine their level of knowledge and expertise on the flood program A standard examination will also test the management information systems in place to determine that information is both complete, up to date and correct. Another important component of the examination will be the analysis of the internal controls in place. The idea here is that there is either some form of internal audit or independent audit that is conducted on a regular basis to make sure that the system is working.

Finally, the examiners will take a sample of real estate secured loans and review for compliance. This review will include a check for actual documentation that the property securing the loan is not in a flood zone. In other words, for all loans secured by real estate, there should be evidence of a “flood certification”, which is a search of FEMA’s flood hazard records. The lack of evidence of this certification can lead to a finding or a violation of law. 

The list of violations or findings that can result from an examination include the following:

• Failure to determine flood status
• Failure to provide Insurance
• Inadequate insurance
• Lapsed insurance or failure to renew insurance on a timely basis

So What’s the Big Deal? 
If at the end of an examination, the regulators determine that the bank has more than one of the above violations or is lacking in one of the fundamental compliance program areas and unsatisfactory rating might result. Such a rating brings with it additional regulatory actions that range from memorandums of understanding to cease and desist orders. Moreover, if the regulators determine that there is a “pattern and practice” of violations if the regulation, civil money penalties (CMP’s) could be ordered. While CMP’s are generally not large financial fines, the fact that the fines have been levied are reported in all reports and present significant reputation risk to the bank.