Q: What action must a lender take if the RCBAP coverage is insufficient to meet the Regulation’s mandatory purchase requirements for a loan secured by an individual residential condominium unit?
A: If the lender determines that flood insurance coverage purchased under the RCBAP is insufficient to meet the Regulation’s mandatory purchase requirements, then the lender should request that the individual unit owner/borrower ask the condominium association to obtain additional coverage that would be sufficient to meet the Regulation’s requirements (see question and answer 28). If the condominium association does not obtain sufficient coverage, then the lender must require the individual unit owner/borrower to purchase a dwelling policy in an amount sufficient to meet the Regulation’s flood insurance requirements. The amount of coverage under the dwelling policy required to be purchased by the individual unit owner would be the difference between the RCBAP’s coverage allocated to that unit and the Regulation’s mandatory flood insurance requirements (see question and answer 29). Example: Lender makes a loan in the principal amount of $300,000 secured by a condominium unit in a 50-unit condominium building, which is located in an SFHA within a participating community, with a replacement cost value of $10 million; however, the RCBAP is at 80 percent of replacement cost value ($8 million or$160,000 per unit).
• Outstanding principal balance of loan is $300,000
• Maximum amount of coverage available under the NFIP, which is the lesser of:
o Maximum limit available for the residential condominium unit is $250,000; or
o Insurable value of the unit based on 100 percent of the building’s replacement value
($10 million ÷ 50 = $200,000).
The lender must require the individual unit owner/borrower to purchase a flood insurance dwelling policy in the amount of $40,000 to satisfy the Regulation’s mandatory flood insurance requirement of $200,000. (This is the lesser of the outstanding principal balance ($300,000), the maximum coverage available under the NFIP ($250,000), or the insurable value ($200,000).) The RCBAP fulfills only $160,000 of the Regulation’s flood insurance requirement.
While the individual unit owner’s purchase of a separate dwelling policy that provides for adequate flood insurance coverage under the Regulation will satisfy the Regulation’s mandatory flood insurance requirements, the lender, and the individual unit owner/borrower may still be exposed to additional risk of loss. Lenders are encouraged to apprise borrowers of this risk. The dwelling policy provides individual unit owners with supplemental building coverage to the RCBAP. The policies are coordinated such that the dwelling policy purchased by the unit owner responds to shortfalls on building coverage pertaining either to improvements owned by the insured unit owner or to assessments. However, the dwelling policy does not extend the RCBAP limits, nor does it enable the condominium association to fill in gaps in coverage.
The risk arises because the individual unit owner’s dwelling policy may contain claim limitations that prevent the dwelling policy from covering the individual unit owner’s share of the co-insurance penalty, which is triggered when the amount of insurance under the RCBAP is less than 80 percent of the building’s replacement cost value at the time of loss. In addition, following a major flood loss, the insured unit owner may have to rely upon the condominium association’s and other unit owners’ financial ability to make the necessary repairs to common elements in the building, such as electricity, heating, plumbing, and elevators. It is incumbent on the lender to understand these limitations.
– This Q&A was included in the “Interagency Questions and Answers Regarding Flood Insurance.” For ease of collection, this has been obtained from the FDIC’s Compliance Examination Manual – April 2016, which may be found here: https://fdic.gov/regulations/compliance/manual/5/V-6.1.pdf