HUD audit reveals $4.5 billion risk to lenders from flood insurance gaps
In 2020, loan servicers were exposed to $4.5 billion in risk due to lack of proper flood insurance. This, according to a HUD’s Office of Inspector General’s (OIG’s) audit of FHA-insured loans, which determined more than 30,000 loans serviced in designated special hazard areas lacked proper flood insurance.
HUD’s OIG called for lenders to provide evidence of sufficient flood insurance coverage for the loans in question and develop a better way to detect loans that do not maintain the required flood insurance “to avoid potential future costs to the FHA insurance fund from inadequately insured properties.”
For servicers, the fallout is costly: $2,000 per violation. Keep in mind, the audit covered only FHA-insured loans, though other loans in a servicer’s portfolio may be at risk.
FHA Uncovers Lender Violations
How did this happen? First, the FHA has failed to enforce lenders’ responsibilities to ensure homeowners maintain the required flood insurance policies. The glaring – and costly – lender violations uncovered by HUD’s audit are a harbinger of things to come. Lenders now must comply with FEMA’s new Risk Rating 2.0 plan, which went into effect of October 1, 2021. This plan completely overhauls how the National Flood Insurance Program (NFIP) calculates flood insurance premiums and redraws the flood insurance rate map (FIRM).
HUD’s OIG found three violations:
- Failure to meet the minimum flood insurance requirement
- Lack of flood insurance coverage
- Private flood insurance policies instead of the required NFIP coverage
*Note: As of 2019, federal regulators now allow lenders to accept private flood insurance. Private insurers now have sophisticated risk mapping and modeling that makes for more accurate risk-pricing.
Servicers Pay the Price
The loans in question are for borrowers in federally designated special hazard flood areas. When such a loan is originated, servicers point borrowers in the direction of NFIP, which offers flood insurance policies. But that’s where the process goes off the rails. The FHA does not require servicers to report or follow up with borrowers on whether they take out or maintain a policy. All of this has left servicers at risk for civil penalties for failure to comply.
Where do I start?
Get a compliance assessment. The best first step is an assessment of your current flood insurance program for compliance with NFIP, FDPA and the Biggert-Waters Insurance Reform Act.