Since Congress did not authorize an extension of the National Flood Insurance Program (NFIP) prior to the deadline, the Program has lapsed.
Now, lenders are questioning how they should treat the loan originations in their pipeline that require flood insurance. The immediate question is, should the lender delay settlement of these loans until Congress reauthorizes the NFIP? Additionally, how should lenders treat their existing portfolio loans where the flood insurance policy will expire prior to the renewal of NFIP?
We will walk through the different scenarios and considerations to answer these questions.
What the NFIP Lapse Means for Lenders
The National Flood Insurance Program is funded through the Congressional appropriations process. Consequently, Congress must periodically reauthorize the NFIP. Failing to receive the applicable reauthorization prior to September 30, 2025, the NFIP lapsed. Consequently, NFIP will cease selling new policies and renewing existing policies.
In the Interagency Questions and Answers Regarding Flood Insurance (Interagency Q&As), federal regulators provide guidance on what is required if coverage under the NFIP is unavailable; for example, if the program lapses.
First and foremost, a lapse in the NFIP does not relieve lenders of obligations under the flood insurance regulations that do not relate to the mandatory purchase requirements. For example, lenders must continue to use the Standard Flood Hazard Determination Form to determine whether the building or mobile home securing the loan is or will be located in a Special Flood Hazard Area, for which coverage is available under the National Flood Insurance Act. In addition, when making, increasing, extending, or renewing a loan secured by a building or mobile home located in (or, to be built in) a Special Flood Hazard area, the lender is still required to furnish the Notice of Special Flood Hazards and Availability of Federal Disaster Relief to the borrower and retain record of the borrower’s receipt of the Notice.
While lenders must still comply with the above requirements in the event of a lapse, the question is: how lenders can comply with the mandatory purchase requirement when coverage is not available under the NFIP?
Fortunately, the Interagency Q&As provide lenders with options when a lapse occurs. It’s important to note that while adhering to the mandatory purchase requirements is a compliance function, there are also safety and soundness considerations. A lack of adequate flood insurance coverage on collateral properties can result in increased risk of loss for the lender. Before deciding how to proceed during an NFIP lapse, the lender should work with borrowers to mitigate the risk of loss.
Some possible courses of action for lenders in the event of an NFIP lapse are:
- The lender may assess the safety and soundness risk and determine that settlement should be postponed until coverage under the NFIP is once again available.
- The lender may require that the borrower obtain a private flood insurance policy as a condition of closing the loan. In this case, after considering the cost of a private flood insurance policy in relation to that of an NFIP policy, the borrower or the lender may decide to postpone the closing until coverage under the NFIP is available. If the lender accepts a private flood insurance policy, it should ensure that it has adequate processes and controls in place to review the private flood insurance policy for compliance with the mandatory or discretionary criteria. Institution policies and procedures should be specific as to whether the lender accepts private policies that meet only the discretionary criteria.
- The Interagency Q&As provide that lenders may make the loan without requiring the borrower to apply for flood insurance or pay the premium while NFIP coverage is not available. Before choosing this option, lenders should carefully consider the associated risk – this option carries the most risk for the lender. Ultimately, having an uninsured collateral property located in a Special Flood Hazard area poses a risk of loss to the lender.
How Lenders Can Respond
Once coverage is available from the NFIP, the lender must have sufficient processes and controls to ensure that adequate flood insurance coverage is promptly obtained. Coverage options will include voluntary borrower purchase or even force placement, if necessary.
However, the lender should have a documented process to make borrowers aware of the flood insurance purchase requirements that will be imposed if/when the NFIP is reinstated. They should also inform borrowers that force-placed insurance is typically more expensive than coverage obtained by the borrower.
Before deciding on a course of action due to an NFIP lapse, lenders should carefully evaluate the safety and soundness risks of originating loans without flood insurance and retain documentation of this analysis. The lender may very well determine that originating loans without flood insurance is a practice that creates risk in excess of the lender’s tolerance and risk appetite. In this case, it may be more prudent to either postpone settlement or require that borrowers obtain a private flood insurance policy.
If the lender sells loans on the secondary market, the lender should also ascertain the requirements of its investors with respect to lapses in the NFIP. This includes its obligations related to the loan if/when NFIP is reinstated, and any recourse should a natural disaster arise without adequate flood insurance coverage.
Ultimately, the institution may take a blanket approach or a case-by-case approach to this decision. With proper documentation demonstrating that such decision conforms with safety and soundness considerations, as well as fair lending requirements.
