Q: We have a loan secured by property that is not in a flood zone, but a shed that is also part of our collateral is in a flood zone. The original appraisal gave no value to the shed. However, an updated appraisal valued the shed at $500. The shed is insured for $500 but the deductible is $1,000. Is this the appropriate way to insure the shed?
A: If the bank has taken the shed as collateral then flood insurance would be required. However, the shed appears to have no insurable value based on the original appraisal. A flood insurance policy for $500 with a deducible of $1,000 provides no benefit to the borrower or the bank. Even with a $500 deductible there is no benefit. In this case, the bank should document the lack of insurable value that was in the first appraisal. While the second appraisal shows $500, the deductible is larger than the policy and further supports the lack of value for the building.
The preamble to the October 17, 2011 Federal Register states that insuring non-residential buildings to 100 percent of replacement cost value may not be practical in all cases. The bank, either by itself or in conjunction with the flood insurance provider or other appropriate professional, is permitted to use different methods to determine insurable value for non-residential property such as an appraisal based on a cost-value approach, the insurable value used in the hazard insurance policy (recognizing that adjustments may be needed since hazard policies do not cover foundations), a construction-cost calculation, or any other reasonable approach provided it can be supported. It is important for lenders to recognize that, when calculating the minimum amount of insurance that is required to be purchased, the insurable value is only relevant to the extent that it is lower than either the outstanding principal balance of the loan or the maximum amount of insurance available under the NFIP.
Information regarding deductibles can be found in the FEMA Flood Insurance manual that is published primarily for insurance agents (http://www.fema.gov/business/nfip/manual.shtm).
– 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