A Deal From Uncle Sam: The Grandfather Rule

[u]REQUIRED READING:[/u][/i][/b] [b]We all like a good deal. The trick is to know a good deal when you see one and then take the appropriate action.[/b] Suze Orman, ‘The Antiques Roadshow,’ and even Jim Cramer's ‘Mad Money’ all stress the importance of wise investments that can yield future dividends or increases in value. One such good deal offered by the Federal Emergency Management Agency (FEMA) through the administration of the National Flood Insurance Program (NFIP) is a special allowance known as the "Grandfather Rule." By understanding this rule and taking appropriate action, homeowners can save thousands of dollars over the life of their loan in "future" discounted premiums, based on the previous flood map, for required flood insurance protection. Equally important, mortgage servicers need to recognize when this allowance applies, thereby helping their borrowers protect and maximize this indefinite savings vehicle. To understand this rule and how the applicable savings apply, one needs to recognize that historically, communities experience changes in flood-zone rating determinations. While some high-risk flood zones may be re-identified on new maps as low- to moderate-flood-risk zones, more often, it is the reverse. These changes can be based on changes to the typography due to community development or as a result of natural causes, such as erosion and subsidence. These changes may alter the base flood elevations (BFEs) and/or flood insurance risk zones. As flood zones or BFEs change, corresponding premiums rate to the flood risk change respectively. By some estimates, the average servicer had about 19% of its portfolio affected by flood-map updates in 2009. The "Grandfather Rule" recognizes the occurrence and impact of the above zone changes and rewards the following policyholders: [list]Those who built their homes in compliance with the Flood Insurance Rate Map in force at the time of construction (these structures adhered to existing BFE building requirements at the time of construction); and/or* Proactively purchased flood coverage through the NFIP on a voluntary basis before a flood-zone map change required the mandatory purchase of specified flood coverage. This voluntary coverage must be current and in force, without interruption, prior to the new zone's effective date.[/list] The good deal for homeowners who meet any of the above conditions is now having the option to use the previous map zone and BFE under standard rates for calculating the flood insurance premium. The grandfathered rates reflect zone conditions based on the zone ratings before their properties were classified as flood insurance "required" based on new higher-risk flood-zone mapping changes. Additionally, this rating option is made available to the homeowner's benefit in perpetuity, as long as they own the home and maintain their insurance coverage without lapse or interruption. [b][i]Grandfathering in action[/i][/b] Perhaps two examples will help to illustrate the value of the Grandfather Rule. In our first example, a homeowner had voluntarily purchased a "Preferred Risk Policy." He could do this because he resided in a low to moderate flood zone with a rating of "B," "C," or "X." Later, the homeowner, through his community's awareness program, is notified that the flood maps in his area are changing. Now, the changed flood zone reflects an "A" zone, whereby flood insurance becomes mandatory. In this situation, the coverage rate for a new flood-required insurance policy is nearly six times that of the homeowner's original Preferred Risk Policy rate. However, because this homeowner chose to take advantage of the NFIP Grandfathering Rule, his rate increase is three to four times his Preferred Risk Policy rate. While the increase is still significant – reflecting the increased risk – the difference between a 600% rate increase and a 300% to 400% rate increase is still impressive, especially when that savings remains in effect as long as the homeowner owns the home and maintains his or her flood insurance coverage without interruption. Both Orman and Cramer would consider this a deal. In a second scenario, the Grandfather Rule can also benefit homeowners who constructed their homes in compliance with all known building codes as required by the prevailing flood plain map rating at the time. These homeowners are rewarded for their prior compliance to known flood plain construction requirements, and they, too, are now eligible for a standard flood policy rate, based on the zone and BFE at the time of construction, rather than on the higher risk policy rate mandated on newly purchased/constructed properties. Loan servicing personnel must be diligent in their efforts to recognize and protect these savings available based on the Grandfather Rule. There was a change to the Standard Flood Insurance Policy application in the Oct. 1, 2009, Flood Insurance Manual, requiring the agent to provide proof of grandfathering to the Write Your Own (WYO) company and for the company to then indicate "Grandfathered Y" on the declarations page on new policies issued after that date. This should reduce confusion and highlight the acceptance of the applicable discounted rate. However, despite great effort on FEMA's part, a universal notation does not exist across all renewal policy declarations pages. Because loan servicing personnel may not see the same Grandfather Rule notation on renewal policy declaration pages, they should be prepared to contact the homeowner or agent who sold the policy for written confirmation of the Grandfather Rule's applicability if there is any doubt. Community officials or insurance agents of WYO companies will normally provide supporting documentation needed to confirm the accuracy of the discounted rate. Best practices suggest that loan files should then be sufficiently notated for future servicing renewals that the loan does indeed comply with the Grandfather Rule discounts. This can be accomplished by the NFIP participating company choosing to endorse an existing policy declarations page to show eligibility in order to avoid having to provide a current or future letter to lenders. [b][i]Customer experience[/i][/b] Sometimes, the grandfathered discounted rates lead to erroneous coverage deficiency notices being sent out to customers. This occurs when the originating or servicing personnel have not carefully examined both the flood rating and the coverage rates. What happens next can be at minimum a nuisance, and at worst, create lasting customer ill will. Upon receiving a flood deficiency notice, some homeowners may feel they need to purchase an additional flood policy from the NFIP. Later, FEMA gets involved with homeowner disputes and escalations. In an environment marked with ever-increasing defaults due to the inability to afford home loans, declining property values and the landmine of strategic defaults, the savvy servicer can ensure goodwill and continued savings to the homeowners they service through adherence to the Grandfather Rule. Traditionally, the issue of flood coverage for servicers has been one of adherence to regulatory flood requirements. The servicer usually has outsourced flood mapping and determination requirements to a flood vendor, thereby leaving the servicer with the obligation of enforcement only when map changes require coverage. Communication of pending changes to borrowers prior to mapping changes is usually left to the communities, which do so via town-hall meetings or other local communication vehicles. This arrangement has made sense, in light of the frequency of loan acquisitions and rapid updates to flood requirements. Servicers may do well to re-evaluate how they can use the Grandfather Rule to their advantage. More than ever, home affordability is becoming the charge of the servicer. The climbing default and strategic default rates certainly beg the question of whether servicers may have a more substantive role in ensuring homeowners can afford the total expenses of homeownership. The availability of certain technologies may make it a bit more practical for servicers to help point homeowners to discounted grandfathered rates. One possibility may lie with new Geographical Information System technology. With inputs from FEMA map update projections (available via the FEMA Web site six months prior to an anticipated change), servicers may be able to overlay a map of their portfolio properties with this data to help them issue proactive and targeted Grandfather Rule notices. Keep in mind that as long as homeowners purchase their coverage prior to the day it becomes required, the Grandfather Rule can be applied. Servicers who choose to deploy advanced technology or simply adopt diligent processes regarding Grandfather Rule verification, would go far in building goodwill with homeowners by saving them from significant flood insurance rate increases and in preventing the frustration that occurs when multiple flood policies are issued and are then followed by incorrect policy cancellations. [i]Robert Shekell is senior vice president of account management and industry relations for Atlanta-based Sterling National Corp. He can be reached at robert.shekell@sterlingnationalcorp.com. This article was facilitated by conversations and input from Tuula Young and Jana Critchfield, lender compliance officer and regional flood insurance specialist, respectively, with FEMA and the Department of Homeland Security.[/i] [i]This article originally appeared in the May 2010 edition of [b]Servicing Management[/


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