Don't Get Caught in the Regulatory Flood

Don’t Get Caught in the Regulatory Flood 

Internal auditors can help ensure their institutions are compliant with flood insurance regulations and avoid hefty fines for violations.
Bruce B. Zaret, CPA 
Partner, Advisory Services 
Weaver LLP
Scott Opdahl 
Director, Advisory Services 
Weaver LLP
Sarah Johnson
Senior Associate,Advisory Services 
Weaver LLP


Anyone from the Upper Midwest who recalls the spring of 1997 understands the potential for widespread flooding this year. Record snowfall from the Upper Midwest to the East Coast has significantly increased the risk for flooding, particularly if an early and extended warm spell occurs. As a result, financial institutions with loans collateralized by real estate in geographically vulnerable flood areas face elevated compliance and operating risk. For those responsible for compliance and internal audit activities, understanding flood insurance regulations and related documentation requirements is critical to effective risk management.  

Flood regulations are addressed in the Flood Disaster Protection Act of 1973 and apply to structures lying within special flood hazard areas as designated by the Federal Emergency Management Agency (FEMA). Flood insurance is required by the lender when: 

  • The financial institution makes, increases, extends, or renews a loan (commercial or consumer) secured by improved real estate or a mobile home that is affixed to a permanent foundation and located in a special flood hazard area.
  • The community participates in the National Flood Insurance Program (NFIP), created by the United States Congress in 1968 to make federal flood insurance available in communities that enact and enforce satisfactory floodplain management regulations.

By regulation, insurance coverage must be in place for whichever is less: a) the outstanding principal balance of the loan; b) the maximum limit available under the NFIP for the type of structure; or c) the “insurable value” of the structure. The maximum insurable limit for residential structures is US $250,000 and US $500,000 for commercial structures.

To calculate insurable value of improved real property located in a special flood hazard area, the land value is deducted from the total appraised value of the property. The minimum insurance coverage required by lenders typically does not cover furniture, fixtures, and equipment. 

In an effort to update property information on flood prone areas and with the increase of adverse events occurring, Congress passed the five-year Flood Map Modernization Program (FMMP) in 2003. FMMP was designed to identify, assess, communicate, and eventually mitigate the risk to life and property from natural disasters. The program has identified many new areas as “high-risk flood zones” since its inception, resulting in a heavier financial burden for borrowers whose property did not previously require additional flood insurance. Many property owners that had lower-cost Preferred Risk Policies (PRP) through the NFIP now face considerably higher insurance rates. 


In response to the additional hardship placed on many citizens impacted by FMMP during an era of high unemployment, FEMA extended the eligibility of writing a lower-cost PRP to two years after a revised flood map’s effective date. With over 20,000 communities participating in the NFIP, updating flood hazard maps is an ongoing effort. A community’s flood hazard map can be updated through: 1) a FEMA initiated study or restudy; 2) a community-initiated revision under NFIP regulations; or 3) through the Cooperating Technical Partners initiative — a program that encourages cooperation between FEMA, NFIP communities, and state agencies.

The new rules specify that for any policy effective on or after Jan. 1, 2011, FEMA will apply the two-year PRP eligibility extension for: 1) buildings affected by map changes from Oct. 1, 2008, to Jan. 1, 2011, and 2) buildings affected by map changes on or after Jan. 1, 2011.  

Structures newly mapped into high-risk flood zones (designated with “A” or “V” on flood maps) on or after Oct. 1, 2008, and before Jan. 1, 2011, are eligible for a PRP for two policy years, effective Jan. 1, 2011, through Dec. 31, 2012.  Therefore, policies issued as standard-rated policies or converted to standard-rated policies following map changes on or after Oct. 1, 2008, may be converted to a lower-cost PRP for two years beginning on the first renewal, effective on or after Jan. 1, 2011. Structures meeting those same conditions that were not previously insured may be issued a new business PRP on or after Jan. 1, 2011, with the same eligibility period.  


Compliance with flood regulations is mandatory under the law. As such, this area should be high on a financial institution’s risk radar and an integral part of a robust compliance program. Evaluating the effectiveness of internal controls over flood compliance should include at a minimum:

  • Understanding prior regulatory and internal audit findings and actions taken by management to remediate deficiencies.
  • Adequately assessing flood compliance and operating risk by:
    • Evaluating internal procedures and controls to ensure consistent compliance with regulatory requirements, and ensuring the borrower was notified the improved property was or will be located in a Standard Flood Hazard Area (SFHA).
    • Monitoring flood insurance to ascertain the loan has not been uninsured longer than 45 calendar days after the bank notified the borrower, at which time the financial institution will force place flood insurance at the expense of the borrower. If flood insurance lapses for more than 45 days and insurance is not force placed, it is considered a violation of law and the institution may be cited, which may include civil money penalties.
    • Making certain flood insurance premiums are included in the escrow, if escrow is required for the loan.
    • Evaluating whether the loan is covered by an adequate amount of flood insurance.
    • Validating that flood insurance is in accordance with the financial institution’s lending policy (i.e., if the policy requires a new determination upon renewal, ensure a new determination is included).
    • Ensuring that loan officers and lending personnel understand flood regulations.
  • Ensuring internal audit staff members performing the reviews are fully trained on flood regulatory requirements.
  • Verifying the following documentation exists to demonstrate compliance with the FDPA:
    • A Standard Flood Hazard Determination form showing the prepared date was prior to origination of the loan.
    • Signed notification by the borrower stating the property is or will be located in a SFHA.
    • A current insurance policy listing the amount of flood insurance and the correct address of the property.
    • All previous insurance policies of the loan to validate that the property has not been uninsured longer than the allowable 45-day period.
    • If force placement of flood insurance has occurred, documentation should include notifications to the borrower of the force placed policy, along with related expenses.

Flood regulations are a critical component of regulatory compliance reviews. Understanding and appropriately monitoring these requirements will help avoid regulatory violations and will strengthen internal controls over the lending function. Financial institutions can certainly expect flood compliance to be a high-risk area during regulatory examinations. 

Additional information on flood regulations can be found at:

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