New Private Flood Rule Offers Hope And Raises Concern

In late 2020, the Department of Housing and Urban Development (HUD) released its proposed rule to accept private flood insurance for Federal Housing Administration (FHA) insured loans.  Currently, FHA is one of the few lending programs that does not accept private flood insurance on properties in high risk flood zones.  FHA currently only accepts flood insurance through the National Flood Insurance Program (NFIP).  Lenders, real estate agents, insurers, first-time homebuyers and others who use FHA for a mortgage have been waiting for FHA to begin to accept private flood policies.  While the announcement of the FHA proposed rule made headlines and brought hope to many, the proposed rule as written is also causing concerns.  Among the concerns are issues around the “compliance aid” and whether an FHA lender “may” or “must” accept a private flood insurance policy.   Industry has responded to HUD in a strong way.  The way that HUD responds in its final rule later this year will impact the effectiveness of the FHA private flood acceptance rule.

By way of background, Federal Regulatory Lending Agencies (excluding FHA) implemented new federal flood regulations in July 2019.  These regulations provided the framework for lending institutions to accept private flood insurance policies for loans.  This change in regulation has been effective in providing lenders a path to accept private flood insurance policies.  While challenges remain, both the lending and insurance industry have worked to streamline the process.  A key part of the 2019 regulation is the inclusion of a “compliance aid”, which is a specific statement that, if in the policy, allows a lender to accept the private flood insurance policy without further review.  Specifically, the compliance aid statement is as follows: “This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation”.  This statement has been adopted by many insurance carriers. Unfortunately, in the proposed FHA rule, HUD includes its own version of a “compliance aid” which is “This policy meets the definition of private flood insurance contained in paragraph (e) of this section for FHA-insured mortgage”.  While HUD’s goal may have been to also streamline the FHA lending process, the variation in compliance aids creates challenges and issues.  First, this difference in compliance aids would require lenders to adopt separate and specific processes for FHA loans which could cause lending delays.  Second, this will delay the industry’s ability to accept private flood insurance policies for FHA-insured loans because it will take time for insurance companies to add the FHA compliance aid language to its policy forms. There is also no guarantee that insurance companies will adopt this second compliance aid statement or that lenders will be willing to accept it. HUD is adding a layer of complexity and introducing unnecessary delays.  

Another important aspect that is not addressed in the FHA proposed rule is the ability for lenders to accept a private flood policy even if the policy does not meet the definition of private flood insurance. This is referred to in the federal flood regulations as “discretionary review”.  While this “discretionary review” is important, some small and medium size lenders are choosing to not accept a private flood insurance policy if it doesn’t meet the strict definition of private flood insurance. This means that currently some private policies that provide sufficient protection are being rejected.  While not ideal, HUD may exacerbate this issue.  This is due to the question HUD asks, “whether FHA regulations should state that a Mortgagee may accept a qualifying private flood insurance policy in lieu of an NFIP policy or that a Mortgagee must accept a qualifying private flood insurance policy in lieu of an NFIP policy”.  If HUD decides to adopt “may accept” in its final regulation, FHA lenders would essentially be able to reject private flood insurance policies for all FHA loans.  These two issues have raised concerns for many in the industry.

While these concerns are serious, there remains hope.  Various trade associations submitted a joint letter urging HUD to make changes in order to simplify compliance, facilitate the ability for lenders to accept private flood insurance policies, and provide FHA borrowers with more choice. It is expected that HUD’s response in the form of a final rule will be published sometime later in 2021.  When published, industry hopes that those applying for FHA loans—including those first-time homebuyers–may finally be able to compare policies, prices, and coverages both from the NFIP as well as the private flood insurance market.