Contents Coverage for Purposes of Flood Insurance
By Scott Birrenkott
While there are no new requirements regarding flood insurance, examiners have been looking closely at portfolios for flood compliance lately. Specifically, WBA has become aware of some questions arising regarding contents coverage. This article will discuss what the flood rules require for purposes of insuring contents, as well as some important concepts to be aware of.
The requirement of “contents coverage” starts with the general requirement to purchase flood insurance for designated loans. That requirement being that a bank shall not make, increase, extend, or renew any designated loan unless the building or mobile home and any personal property securing the loan are covered by flood insurance for the term of the loan. “Personal property” in this context will be referred to as “contents” for the rest of this article. Meaning, a bank making a designated loan in a special flood hazard area (SFHA) must also ensure that any contents securing that loan are covered by flood insurance. The rule, in this context, leaves some unanswered questions. Fortunately, the agencies have provided clarification in the form of questions and answers.
In 2022, the agencies issued the revised Interagency Questions and Answers Regarding Flood Insurance (Q&As). The Q&As clarify that when a building and its contents both secure a loan, and the building is located in a SFHA in which flood insurance is available, flood insurance is required for the building and any contents securing the loan. They also clarify that if contents securing the loan are stored in a building which does not secure the loan, then flood insurance is not required on those contents, regardless of whether the building is in a SFHA. The agencies also clarify that both contents and the building will be considered to have a sufficient amount of flood insurance coverage for regulatory purposes so long as some reasonable amount of insurance is allocated to each category. The Q&As provide an example which is helpful in this regard:
Lender A makes a loan for $200,000 that is secured by a warehouse with an insurable value of $150,000 and inventory in the warehouse worth $100,000. The Act and Regulation require that flood insurance coverage be obtained for the lesser of the outstanding principal balance of the loan or the maximum amount of flood insurance that is available. The maximum amount of insurance that is available for both building and contents is $500,000 for each category. In this situation, Federal flood insurance requirements could be satisfied by placing $150,000 worth of flood insurance coverage on the warehouse, thus insuring it to its insurable value, and $50,000 worth of contents flood insurance coverage on the inventory, thus providing total coverage in the amount of the outstanding principal balance of the loan. Note that this holds true even though the inventory is worth $100,000.
It is important to note that when contents coverage is required, a bank must always assign a “reasonable amount” to the contents. This is true even if the building’s value meets or exceeds the minimum flood insurance required. For example, if the facts of the above example were changed so that the insurable value of the warehouse was $200,000, the bank couldn’t assign $200,000 to the warehouse alone and leave the contents uninsured. It would need to be divided in a reasonable amount among both the warehouse and the contents.
In the commercial and agricultural setting, it is common within the industry for banks to take a security interest in property which includes contents. Because of this, it’s important to be aware of the language within a bank’s security agreements, and what it covers, so that the bank is able to meet flood insurance requirements. If a bank does not wish to take contents as collateral to avoid flood insurance implications, it could consider disclaiming the collateral. In this case, the bank should also consider the implications of disclaiming collateral from a loan policy standpoint, understanding that such decisions have broader implications on the security of the loan beyond just flood insurance rules. The Q&As can be found here: https://www.fdic.gov/sites/default/files/2024-03/fil22020a.pdf
Birrenkott is the WBA director – legal
