The devastating storms of the last two hurricane seasons have raised many questions regarding the adequacy of the National Flood Insurance Program (NFIP), which serves a key function in commercial/multifamily real estate finance. The program reduces the cost of financing a property located in a flood-prone area by providing affordable and reliable baseline flood insurance.
Even before the mandatory purchase requirement was enacted in 1968, lenders often required flood insurance to protect their collateral interests. Without a reliable and uninterrupted source of flood insurance, the Mortgage Bankers Association (MBA) believes mortgage credit would, at best, be more expensive. At worst, it would become unavailable in many markets.
Reform to the nation's flood insurance program is clearly on the horizon, but it's important that radical changes not be made and implemented as a knee-jerk reaction to the Katrina disaster. The implications of any changes also must be communicated to borrowers and lenders.
The commercial/multifamily mortgage industry wants to ensure the continued viability of NFIP. At the same time, overly expansive extension of the flood insurance requirements could have unintended consequences, increasing the costs of affordable rental housing and occupancy costs for businesses. It could also increase delinquencies and foreclosures, as well as reduce property values.
Mandates on coverage
All federally regulated financial institutions must determine if a property or building is located in a designated Special Flood Hazard Area (SFHA). If so, they must require the purchase of NFIP insurance for the duration of the loan. Failure to enforce this coverage results in fines to the financial institution.
The special flood designation specifies zones in the 100-year flood plain. “This does not mean that a flood will occur in these zones every 100 years, but that there is a 1 percent chance that the water level will reach or exceed elevation on an annual basis,” says Kathleen Dufraine, a member of the MBA Insurance Task Force and vice president of insurance and operations at Wachovia Securities.
The National Flood Insurance Reform Act of 1994 expanded the mandatory purchase requirement to loans purchased by Fannie Mae or Freddie Mac. The two government-sponsored enterprises, however, already required the purchase of flood insurance. The reform act also re-affirmed the lender's obligation to keep the policy obtained at origination in force for the life of the loan through the use of lender-placed insurance, if necessary.
Commercial and multifamily mortgage firms execute the flood insurance obligations consistently and with few errors. MBA members, especially servicers, have instituted procedures to ensure compliance with statutory obligations. After all, it is in the best interest of the lender to protect the property at hand.
In March, the House Financial Services Committee passed H.R. 4973, the Flood Insurance Reform and Modernization Act of 2006. The legislation would increase the borrowing limit for NFIP from $18.5 billion to $25 billion and would make changes that would limit future taxpayer liability for claims. Key factors include:
an increase in the amount of money NFIP can borrow in the future;
an increase to the limits of coverage to $335,000 for residential and $670,000 for commercial;
an increase in deductibles;
an increase in the penalties for financial institutions that do not comply; and
inclusion of business interruption coverage for commercial companies.
The bill would have eliminated penalty caps, and increased the penalty from $350 to $2,000 per violation. The legislation was amended to cap penalties for lenders and create a safe harbor that covers good-faith efforts to comply and non-material violations. The Senate Banking, Housing and Urban Affairs Committee will now mark up its flood insurance bill, which has yet to be officially introduced.
Plea for prudence
The federal flood insurance program was solvent until the 2005 hurricane season. There is no easy recipe to ensure the program brings in sufficient premiums to cover the federal outlay of funds used to pay claims. But there are incremental changes that can and should be made to improve the program.
Lenders take seriously their responsibility to assist in efforts to maintain a viable national flood insurance program. MBA is working with Congress to identify measures that can be taken to assure the continuation of NFIP that do not impose adverse, unintended consequences on property owners and communities.
Deborah McKinnon serves as vice president of MBA's commercial/multifamily division. She is based in Washington, D.C.