Q: Sometimes the replacement cost value (RCV) is lower on an appraisal than the RCV on the hazard insurance policy or flood insurance policy. It was brought to our attention that once we receive the flood insurance policy we should rely on the RCV used by the flood insurance provider, even if the appraisal RCV is lower.
Which RCV is appropriate to use? The bank receives the RCV from the appraisal before closing, the hazard insurance policy at the time of closing, and the flood insurance policy after closing. If a bank should rely on the RCV from the flood insurance policy after closing, does it need to send a 45 day letter to increase coverage from the amount the bank originally told the borrower based on the appraisal? Also, is it a best practice to review the RCV annually? What determines or defines awareness about the amount of coverage?
A: Question and Answer #9 provides guidance on determining the “insurable value” of a building. For properties in a SFHA, the maximum amount of insurance available under the NFIP is the lesser of the maximum limit of coverage available for the particular type of property or the insurable value of the property. The answer includes the following:
“In calculating the amount of insurance to require, the lender and borrower (either by themselves or in consultation with the flood insurance provider or other appropriate professional) may choose from a variety of approaches or methods to establish the insurable value. They may use an appraisal based on a cost-value (not market-value) approach, a construction cost calculation, the insurable value used in a hazard insurance policy (recognizing that the insurable value for flood insurance purposes may differ from the coverage provided by the hazard insurance and that adjustments may be necessary; for example, most hazard policies do not cover foundations), or any other reasonable approach, so long as it can be supported.”
Based on the above guidance, a bank has flexibility in establishing insurable value.
There are no requirements under the law or regulation to perform a regular review of insurable value. A bank may choose to perform such a review based on risk management principles. This type of review could make the institution aware of inadequate flood insurance even though the bank did not make, increase, extend, or renew the loan. This awareness would require the lender to comply with the regulation, including force placing insurance, if necessary.
– This Q&A was included in the materials from the FDIC New York Region Regulatory Teleconference: “Flood Insurance – Flood Insurance Compliance and an Examiner’s Perspective” which took place on December 3, 2012. These materials may be found here: https://www.fdic.gov/news/conferences/NY/2012-12-03.html