We hold a first lien on a commercial property in a flood zone, but we failed to require flood insurance because we did not know the property was in a flood zone. As far as we know, the second lien holder (the Small Business Administration) also did not require flood insurance for its loan. Now that we are making a third loan on the property, do we have to cover the second lien lender’s portion of the insurance, too? In other words, what are our responsibilities regarding flood insurance on the second lien loan? How do we calculate the amount of coverage required, and what is the highest deductible permitted under the flood insurance rules?

You are required to ensure that the property has the minimum amount of required flood insurance, regardless of whether a previous lender failed to require or obtain such a policy. The Interagency Guidance on flood insurance states that when a lender makes a second (or third) mortgage secured by a building in a flood zone, the lender must ensure that adequate flood insurance already is in place or require that additional flood insurance coverage be added to the flood insurance policy.

The guidance encourages junior lienholders to work with senior lienholders to determine how much flood insurance is needed. To that end, a junior lienholder should obtain the borrower’s consent to get information from the senior lienholder regarding the balance of the existing loan and the coverage of any existing flood insurance policies. Consequently, we recommend that you reach out to the second lien lender (after obtaining the borrower’s consent) to discuss your joint obligations regarding the flood insurance. If the second lien lender is uncooperative or otherwise falls short of its flood insurance obligations, that does not relieve your institution of its responsibility to require or obtain the minimum coverage.

The minimum insurance amount is calculated by using the lesser of three options: (1) the combined total outstanding principal balance of all the loans, (2) the maximum amount available under the National Flood Insurance Act (currently $500,000 for a non-residential building), or (3) the “insurable value” (i.e., the replacement cost of the building) of the property. For example, if a non-residential building has an insurable value of $250,000 and three different loans with a combined principal balance of $200,000, the minimum required insurance would be $200,000.

Regarding deductibles, the amounts vary based on the policy rating and the amount of coverage purchased, as described more thoroughly in Table 8B in the National Flood Insurance Program Manual. For non-residential buildings, the maximum deductible is $50,000. Lenders are permitted to use the maximum deductible in order to reduce the cost of flood insurance. However, Interagency Guidance warns that “it is not a sound business practice to use the maximum deductible amount in every situation.” A lender should “determine the reasonableness of the deductible on a case-by-case basis, taking into account the risk that such a deductible would pose to the borrower and lender.” In addition, “a lender may not allow the borrower to use a deductible amount equal to the insurable value of the property to avoid the mandatory purchase requirement for flood insurance.”

For resources related to our guidance, please see:

Interagency Questions and Answers Regarding Flood Insurance, Question 36 (“When a lender makes, increases, extends or renews a second mortgage secured by a building or mobile home located in an SFHA, how much flood insurance must the lender require? Answer: The lender must ensure that adequate flood insurance is in place or require that additional flood insurance coverage be added to the flood insurance policy in the amount of the lesser of either the combined total outstanding principal balance of the first and second loan, the maximum amount available under the Act (currently $250,000 for a residential building and $500,000 for a nonresidential building), or the insurable value of the building or mobile home. The junior lienholder should also ensure that the borrower adds the junior lienholder's name as mortgagee/loss payee to the existing flood insurance policy. Given the provisions of NFIP policies, a lender cannot comply with the Act and Regulation by requiring the purchase of an NFIP flood insurance policy only in the amount of the outstanding principal balance of the second mortgage without regard to the amount of flood insurance coverage on a first mortgage.”)

Interagency Questions and Answers Regarding Flood Insurance, Question 36 (“A junior lienholder should work with the senior lienholder, the borrower, or with both of these parties, to determine how much flood insurance is needed to cover improved real estate collateral. A junior lienholder should obtain the borrower's consent in the loan agreement or otherwise for the junior lienholder to obtain information on balance and existing flood insurance coverage on senior lien loans from the senior lienholder.”)

FDIC Compliance Examination Manual, Lending – Flood Disaster Protection, V-6.3 (April 2016) (“The minimum amount of flood insurance required must be at least equal to the lesser of the outstanding principal balance of the loan, the maximum amount available under the NFIP for the type of structure, or the insurable value of the property.”)

FDIC Compliance Examination Manual, Lending – Flood Disaster Protection, V-6.3 (April 2016) (“Flood insurance coverage under the NFIP is limited to the building or mobile home and any personal property that secures the loan and not the land itself. The limits of coverage for flood policies are: . . . $500,000 for non-residential structures and $500,000 for contents [and] $500,000 for non-condominium residential buildings of five units or greater and $100,000 for personal contents.”)

NFIP Flood Insurance Manual, Rate 17, (April 1, 2016) (“[T]he NFIP minimum deductibles vary based on the policy rating and the amount of coverage purchased. An optional deductible amount may be applied to most policies. Please note that building and contents deductibles can be different. Effective April 1, 2015, a $10,000 deductible is available for residential properties, and this option must be clearly disclosed to the applicant. See Table 8B for deductible options.”)

NFIP Flood Insurance Manual, Table 8B, Footnote 7, Rate 18, (November 2015) (“Deductibles of $15,000 to $50,000 are available only for Non-Residential Business or Other Non-Residential Policies.”)

Interagency Questions and Answers Regarding Flood Insurance, Question 17 (“Can a lender allow the borrower to use the maximum deductible to reduce the cost of flood insurance? Answer: Yes. However, it is not a sound business practice for a lender to allow the borrower to use the maximum deductible amount in every situation. A lender should determine the reasonableness of the deductible on a case-by-case basis, taking into account the risk that such a deductible would pose to the borrower and lender. A lender may not allow the borrower to use a deductible amount equal to the insurable value of the property to avoid the mandatory purchase requirement for flood insurance.”)