How Banks Should Prepare for a Flood Insurance Lapse

By Diana Banks

Flood insurance is required on loans secured by properties located or to be located within Special Flood Hazard Areas, which encompass many coastal and waterfront communities. The National Flood Insurance Program, administered by the Federal Emergency Management Agency, is the most commonly available flood insurance coverage in most parts of the nation.

As a federal program, the NFIP operates under congressional authority and relies on congressional authorization. When the NFIP lapses, either due to a shutdown of the federal government or because Congress does not reauthorize it, many loan closings in these areas can be delayed or otherwise complicated, resulting in additional costs and borrower frustrations. Unfortunately, the potential for lapse has become increasingly common, with 11 short-term extensions of the program and two brief lapses since 2016. The current authorization for the NFIP will expire at midnight on Thursday, Nov. 21, 2019.

The American Bankers Association continues to advocate for a long-term reauthorization of the NFIP, along with appropriate and necessary reforms to address the program’s sustainability, affordability and availability. However, given the program’s volatility in recent years, it is good practice to prepare for potential lapses.

What to do before a lapse

Lenders should be prepared and have a plan to avoid the potential disruption to loans scheduled to close during a lapse. Loans that require flood insurance can still close during a lapse in the NFIP, either by following certain NFIP and regulatory guidelines and ensuring that a system is in place to obtain NFIP policies as soon as the program is reauthorized, or by obtaining private flood insurance.

The prudential regulators—the FDICOCC and Federal Reserve—have each released guidance on what to do if the NFIP lapses. This guidance was originally issued in 2010, but remains applicable in the event of any lapse, even with the availability of private flood coverage. It is well worth the time to review the appropriate guidance and consult with counsel to apply it to the bank’s specific business operations. Additionally, FEMA usually releases guidance after a lapse, which can be found here.

Remember: flood determinations, disclosures and notices to borrowers and other regulatory requirements must continue during a lapse. It’s also important to evaluate safety and soundness risk and adequately document the bank’s management of those risks during a lapse. Remember to consider the overall portfolio risk created by a lapse in coverage, particularly if the bank has a significant amount of loans secured by property located in a special flood hazard area.

Borrowers with existing NFIP policies should be advised to consider renewing their policies early if their renewal date falls within a potential lapse. For example, if the current NFIP authorization expires on Nov. 21, and a policy is scheduled to renew on Nov. 30, it may be prudent for the borrower to pay the renewal premium prior to Nov. 21. That would ensure continued coverage for the property even in the event of a lapse, and FEMA would still have authority to ensure the payment of valid claims with available funds.

What to do after a lapse

Once the program has been reauthorized, remember to check whether the reauthorization is retroactive. Retroactivity determines the effective date of coverage for any NFIP policies applied for during the lapse. If the reauthorization is retroactive to the date of the program lapse, then NFIP policies are effective as of the date of application and payment. If the reauthorization is not retroactive, then NFIP policies are not effective until the actual date of reauthorization, at the earliest. This means that any losses sustained during the lapse are not recoverable under the NFIP. Bankers and borrowers would benefit from reviewing and understanding this risk.

Diana Banks is senior counsel for fair and responsible banking at ABA.