We own approximately 27,000 square feet of space in Las Vegas, Nevada, which houses our in-house print shop operations and information systems data center. We lease office and clinical space in Nevada totaling approximately 408,000 and 322,000 square feet, respectively. HPN and SHL own a 134,000 square foot administrative building as their Las Vegas headquarters, which serves as the home office and a regional home office for our Nevada HMO and health insurance subsidiaries, respectively.

In conjunction with the Kaiser-Texas acquisition, we purchased eight medical and office facilities with approximately 323,000 square feet of clinical facilities and approximately 175,000 square feet of administrative facilities. These buildings are subject to a deed of trust note with an original balance of $35.2 million and a remaining principal balance of $12.7 million at December 31, 2002. Four of the original eight buildings were sold during 2002. The remaining four buildings total approximately 254,000 square feet of clinical space and of this total approximately 113,000 is leased to outside parties. The Texas assets have been written down to their estimated market value and are included in the assets of the discontinued operations. We are actively seeking a buyer for the assets.

The workers' compensation subsidiary is headquartered in Nevada and subleases space from us as well as an additional approximately 63,000 square feet of leased office space in California, Colorado and Texas.

We lease approximately 169,000 square feet of office space in other various states as needed for the SMHS administrative headquarters, TRICARE service centers and other regional operations.

We believe that current and planned clinical space will be adequate for our present needs. However, additional clinical space may be required if membership expands in southern Nevada.

We are subject to various claims and other litigation in the ordinary course of business. Such litigation includes, but is not limited to, claims of medical malpractice, claims for coverage or payment for medical services rendered to HMO members and claims by providers for payment for medical services rendered to HMO and other members. Some litigation may also include claims for punitive damages that are not covered by insurance. Also included in such litigation are claims for workers' compensation and claims by providers for payment for medical services rendered to injured workers. These actions are in various stages of litigation and some may ultimately be brought to trial. With respect to certain pending actions, we maintain commercial insurance coverage with varying deductibles for which we maintain estimated reserves for our self- insured portion based upon our current assessment of such litigation. Due to recent unfavorable changes in the commercial insurance market, we have, for certain risks, purchased coverage with higher deductibles and lower limits of coverage. In the opinion of management, based on information presently available, the ultimate resolution of these pending legal proceedings should not have a material adverse effect on our financial condition.

None

PART II

Our common stock, par value $.005 per share (the "Common Stock"), is listed on the New York Stock Exchange under the symbol SIE since April 26, 1994 and, prior to that, had been listed on the American Stock Exchange since our initial public offering on April 11, 1985. The following table sets forth the high and low closing prices for the Common Stock for each quarter of 2002 and 2001.

On March 17, 2003, the closing sale price of Common Stock was $12.29 per share.

The number of record holders of Common Stock at March 10, 2003 was 691. Based upon information available to us, we believe there are approximately 6,200 beneficial holders of the Common Stock.

The following table provides information as of December 31, 2002, regarding outstanding awards and shares remaining available for future issuance under the Company's compensation plans under which equity securities are authorized for issuance (excluding 401(k) plans and similar tax-qualified plans):

                                         (a)                   (b)                    (c)
                                 Number of securities                         Number of securities
                                  to be issued upon     Weighted-average    remaining available for
                                     exercise of        exercise price of  future issuance under equity
         Plan Category          outstanding options(1) outstanding options     compensation plans (2)
-------------------------------- --------------------  ------------------- -------------------------- 
                                             (In thousands, except exercise price)
Equity compensation plans
     approved by security
     holders....................               2,643          $      8.45                      1,331 (3)

Equity compensation plans
     not approved by security
     holders (4)................               3,380                 6.18                        892
                                 --------------------                      --------------------------
Total...........................               6,023          $      7.21                      2,223
                                 ====================                      ==========================

See Note 13 of the Notes to the Consolidated Financial Statements for additional information on our stock based compensation plans.

No cash dividends have been paid on the Common Stock since our inception. We currently do not anticipate paying any cash dividends in the foreseeable future. As a holding company, our ability to service our debt and to declare and pay dividends is dependent upon cash distributions from our operating subsidiaries. The ability of our HMO and our insurance subsidiaries to declare and pay dividends is limited by state regulations applicable to the maintenance of minimum deposits, reserves and net worth. The declaration of any future dividends will be at the discretion of our Board of Directors and will depend on, among other things, future earnings, debt covenants, operations, capital requirements, the tax treatment of dividends, our financial condition and general business conditions. Our new credit agreement restricts our ability to pay dividends.

The table below presents our selected consolidated financial information for the years indicated. The table should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information which appears elsewhere in this 2002 Form 10-K. The selected consolidated financial data below has been derived from our audited Consolidated Financial Statements. Due to the classification of the workers' compensation operations as discontinued, the amounts presented below were reclassified to conform with the current year presentation.

_________________

The following discussion and analysis provides information which management believes is relevant for an assessment and understanding of our consolidated financial condition and results of operations. The discussion should be read in conjunction with the Consolidated Financial Statements and related Notes thereto. The information contained below may be subject to risk factors. We urge you to review carefully the section "Risk Factors" in this 2002 Form 10-K for a more complete discussion of the risks associated with an investment in our securities. See "Note on Forward-Looking Statements and Risk Factors" under Item 1.

Our continuing operations derive revenues from our health maintenance organization, managed indemnity plans and military health care services. To a lesser extent, we also derive revenues from non-HMO and insurance products (consisting of fees for workers' compensation third party administration, utilization management services and ancillary products), professional fees (consisting primarily of fees for providing health care services to non-members and co-payment fees received from members), and investment and other revenue.

Our principal expenses consist of medical expenses, military contract expenses, and general and administrative expenses. Medical expenses represent capitation fees and other fee-for-service payments paid to independently contracted physicians, hospitals and other health care providers to cover members, pharmacy costs, as well as the aggregate expenses to operate and manage our wholly owned multi-specialty medical group and other provider subsidiaries. As a provider of health care management services, we seek to positively affect quality of care and expenses by contracting with physicians, hospitals and other health care providers at negotiated price levels, by adopting quality assurance programs, monitoring and managing utilization of physicians and hospital services and providing incentives to use cost-effective providers. Military contract expenses represent payments to providers for health care services rendered under the TRICARE program, as well as administrative costs to operate the military health care subsidiary. General and administrative expenses generally represent operational costs other than those directly associated with the delivery of health care services and military contract services.

Discontinued Operations. During the third quarter of 2001, we announced our plan to exit the Texas HMO health care market and received formal approval from the Texas Department of Insurance to withdraw our HMO operations in mid-October. We ceased providing HMO health care coverage in Texas on April 17, 2002. As part of our plan to exit Texas, in the third quarter of 2001, we recorded a charge of $17.1 million for premium deficiency costs, the write down of certain assets, legal and restitution costs, and various other exit related costs.

We elected to early adopt Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" or SFAS No. 144, effective January 1, 2001. In accordance with SFAS No. 144, beginning January 1, 2001, our Texas HMO health care operations were reclassified and presented as discontinued operations.

On January 15, 2003, we announced that we were exploring strategic alternatives for our workers' compensation insurance company, CII Financial, Inc., or CII. The alternatives may include a sale, spin-off or management buyout. The disposal of the operations was approved by our Board of Directors on December 31, 2002. Accordingly, beginning in the fourth quarter of 2002, we reclassified our workers' compensation insurance business as discontinued operations. We will continue to operate the business until a disposal occurs.

In conjunction with the decision to dispose of the workers' compensation operations, CII recorded valuation adjustments of $17.3 million, $11.3 million after tax, to reduce this business to its estimated net realizable value upon disposition. The valuation adjustments included the write down of accounts receivable, fixed assets and certain other assets of $4.0 million and additional loss reserves of $8.3 million for the 2002 accident year and $5.0 million for prior accident years.

Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing these financial statements, we are required to make judgments, assumptions and estimates, which we believe are reasonable and prudent based on the available facts and circumstances. These judgments, assumptions and estimates affect certain of our revenues and expenses and their related balance sheet accounts and in disclosing our contingent assets and liabilities. We base our assumptions and estimates primarily on historical experience and trends and factor in known and projected trends. On an on-going basis, we re-evaluate our selection of assumptions and the method of calculating our estimates. Actual results, however, may differ from our calculated estimates and this difference would be reported in our current operations. The following discusses our most critical accounting policies and estimates, which have been reviewed by the Audit Committee of our Board of Directors.

Medical Premiums and Expenses. Medical premium revenues are recorded in the month when we are obligated to provide services to our enrolled members. Premiums received in advance of the coverage period are recorded as unearned premiums. Our premium revenues are net of an estimate for an allowance for retroactive adjustments. At December 31, 2002, our allowance for retroactive adjustments for health care premium revenues was $3.3 million. Retroactive adjustments result from changes in enrollments that relate to prior periods due to delays in processing or reporting by employers. We use historical trends and known activities to estimate our premium allowances. Any subsequent difference between actual premium adjustments and previously estimated premium adjustments would be reflected in that subsequent year's operating results.

Health care medical expenses are recorded in the period when services are provided to enrolled members, including estimates for provider costs which have been incurred as of the balance sheet date but not yet reported to us. We use a variety of standard actuarial projection methods to make these estimates and we must use our judgment in selecting development factors and assumed trends. In making our projections, we consider medical cost utilization and trends, changes in internal processes, the average interval between the date services are rendered and the date claims are received and/or paid, denied claims activity, disputed claims activity, utilization, seasonality patterns and changes in membership. Our assumptions could be affected by the timing of the receipt of claims, the timing of processing claims and unanticipated changes, such as adverse legal outcomes, legislative or regulatory changes, new interpretations of existing laws or regulations or disputed contract provisions that result in our having to provide new or extended benefits and changes in our health care delivery system or costs. Any subsequent changes in an estimate for a prior year would be reflected in that subsequent year's operating results.

Management believes, based on information presently available, that the recorded liability for medical claims payable, which at December 31, 2002, represented 10.8% of our total consolidated liabilities or $98.0 million, are reasonable and adequate to cover future health care claim payments. However, a difference between the recorded liability and actual developed claim payments could have a material impact to our financial results. For example, a 1% increase in medical claims payable as of December 31, 2002, would reduce reported net income for the year 2002 by $637,000 or 1.75% and diluted earnings per share would be reduced by $0.02.

Military Contract Revenues and Expenses. Military contract revenue is recorded based on the contract price as agreed to by the federal government. The contract was based on prior years' data provided by the government along with assumptions of future trends. The contract contains provisions that adjust the contract price based on actual experience, which we call the bid price adjustment, or BPA, and for government-directed change orders. For the year ended December 31, 2002, we estimate that approximately $149 million or 40% of the total military contract revenues were for BPA and change orders. At December 31, 2002, military accounts receivable due from the federal government was $47.1 million of which approximately $19.6 million was for accrued BPA and change order revenues. As the data becomes available from the government, we compare the actual results to the contract assumptions and the estimated effects of these adjustments are recognized on a monthly basis. In addition, we record revenue based on estimates of the earned portion of any contract change orders not originally specified in the contract. The BPA and government-directed change orders are subject to negotiation and we must use our judgment in making our estimates. The actual negotiated price could be substantially different from what we had originally estimated. Any subsequent difference would be reported in that subsequent year's operations.

Military contract health care costs are recorded in the period when services are provided to eligible beneficiaries, including estimates for provider costs which have been incurred as of the balance sheet date but not reported to us. We use a variety of actuarial projection methods to make these estimates and we must use our judgment in selecting development factors and assumed trends. Our assumptions, which are in large part related to the same assumptions we use in estimating military contract revenues, could be affected by unanticipated changes, such as new interpretations of contract provisions that result in our having to provide new or extended benefits and changes in our health care delivery system or costs. We must also factor into our assumptions the limited risk sharing that we have with the government in providing health care services. Any substantial change in our estimates may to a large degree be mitigated by the risk-sharing contract provision. At December 31, 2002, our military health care payable was $65.2 million. Any subsequent changes in an estimate for a prior year would be reflected in that subsequent year's operating results.

Investment Securities. At December 31, 2002, we had total investments for continuing operations of $200.0 million. All of these investments are classified as available-for-sale and are presented at fair value. Except for restricted cash and investments, which totaled $17.6 million at December 31, 2002, and are reported as non-current assets, the remainder of these investments of $182.4 million are available to support current operations and are therefore reported as current assets.

Our discontinued operations had total investments of $291.5 million of which $286.4 million was classified as available-for-sale and the balance of $5.1 million was classified as held-to-maturity. Held-to-maturity investments are reported at amortized cost because we have the intent and ability to hold these investments until they mature.

Unrealized investment gains and losses, net of related income taxes, on the available-for-sale investments are included as a separate component of stockholders' equity until realized. Realized gains and losses are calculated using the specific identification method and are included in investment and other revenues.

We periodically review our investment portfolio to determine if there is an impairment that is other than temporary. We must use our judgment in testing for impairment and we consider, among other factors, the length of time and the extent of a security's unrealized loss, the financial condition and near term prospects of the issuer, economic forecasts and market or industry trends. If the impairment is determined to be other than temporary, a realized loss is recognized at the date of determination. To date, we have not experienced any significant impairments that were other than temporary in our investments. However, due to the current economic environment and the volatility of the securities market, testing for impairment has become more difficult and there is no assurance that future impairments may not be sustained, which could adversely impact our business and results of operations. For example, if an other than temporary impairment occurred that reduced our investments by 1% at December 31, 2002, our reported net income for the year 2002 would be reduced by $3.2 million or 8.8% and fully diluted earnings per share would be reduced by $0.10.

Litigation and Legal Accruals. We are subject to various claims and other litigation in the ordinary course of business. Such litigation includes, but is not limited to, claims of medical malpractice, claims for coverage or payment for medical services rendered to HMO members and claims by providers for payment for medical services rendered to HMO and other members. We may also face claims for punitive damages that are not covered by insurance. We are also subject to claims for workers' compensation and claims by providers for payment for medical services rendered to injured workers. With respect to certain pending actions, we maintain commercial insurance coverage with varying deductibles for which we maintain estimated reserves for our self- insured portion based upon our current assessment of such litigation. In addition, we accrue estimated legal defense and other settlement costs based on our assessment of the available information, including our outside legal counsel's assessment of the case. We also assess potential legal exposure, based on the available information, to determine if a precautionary notice of potential claim should be reported to our insurers and if an accrual should be established.

Workers' Compensation Loss and Loss Adjustment Expenses. Discontinued operations' workers' compensation insurance losses and loss adjustment expenses, or LAE, are based upon the accumulation of cost estimates for reported claims occurring during the period as well as an estimate for losses that have occurred but have not yet been reported. Similar to the health care medical expenses, we use a variety of standard actuarial projection methods to make these estimates and we must use our judgment in selecting development factors and assumed trends. Unlike health care medical expenses, where the cost to provide health care services is substantially completed within one year, workers' compensation claims can be paid out over a substantial number of years due to certain lifetime benefits. In addition, the period between when a claim is reported to us and when the injury occurred could be longer than one year and when we are no longer insuring the account. Loss and LAE reserves have a significant degree of uncertainty when related to their subsequent payments. Although our reserves are established on the basis of a reasonable estimate, it is not only possible but probable that our reserves will differ from their related subsequent developments. Underlying causes for this uncertainty include, but are not limited to, uncertainty in development patterns, unanticipated inflationary trends affecting the cost of services covered by the insurance contract, adverse legal outcomes and new interpretations of laws or regulations or of disputed contract provisions that result in our having to provide new or extended benefits. This uncertainty can result in both adverse as well as favorable development of actual subsequent activity when compared to the reserve established. During the past four years (1999-2002), we have had adverse development in our previously recorded loss and LAE reserves that has ranged from a low of $8.7 million to a high of $24.0 million. Any subsequent change in loss and LAE reserves established in a prior year would be reflected in that subsequent year's operating results.

Management believes, based on information presently available, that the recorded liability for loss and LAE reserves is reasonable and adequate to cover future workers' compensation claim payments. At December 31, 2002, loss and LAE reserves represented 85.3% of the liabilities of discontinued operations and 47.0% of our total consolidated liabilities. A change between the recorded liability and actual developed claim payments could have a material impact to our business and results of operations. For example, a 1% increase in loss and LAE reserves, not covered by reinsurance, as of December 31, 2002, would reduce reported net income for the year 2002 by $2.8 million or 7.6% and diluted earnings per share would be reduced by $0.09.

Reinsurance Recoverable. Included in the assets of discontinued operations is reinsurance recoverable, which represents the estimated amount of unpaid workers' compensation loss and LAE reserves that would be recovered from our reinsurers and, to a lesser extent, amounts billed to the reinsurers for their portion of paid losses and LAE. Reinsurance receivable for ceded paid claims is recorded in accordance with the terms of the agreements and reinsurance recoverable for unpaid losses and LAE is estimated in a manner consistent with the claim liability associated with the reinsurance policy. Any significant changes in the underlying claim liability could directly affect the amount of reinsurance recoverable. Reinsurance recoverable, including amounts related to paid and unpaid losses, are reported as assets rather than a reduction of the related liabilities. Reinsurance contracts do not relieve us from our obligations to enrollees, injured workers or policyholders. If our reinsurers were to fail to honor their obligations because of insolvency, disputed contract provisions or for other reasons, we could incur significant losses. Prior to entering into reinsurance contracts, we evaluate the financial condition of our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. In addition, we periodically monitor the financial strength of our reinsurers to determine if an allowance for uncollectible reinsurance recoverables is warranted. To date, we have never had to write-off a workers' compensation reinsurance recoverable balance and no allowance for uncollectible amounts has been established. At December 31, 2002, reinsurance recoverable for workers' compensation was $189.4 million. Any subsequent change in reinsurance recoverable established in a prior year would be reflected in that subsequent year's operating results.

Management believes, based on information presently available, that the recorded balance for reinsurance recoverables is reasonable and collectible. A change between the recorded balance and the actual developed recoverable could have a material impact to our business and results of operations. For example, a 1% decrease in reinsurance recoverables as of December 31, 2002, would reduce reported net income for the year 2002 by $1.2 million or 3.4% and diluted earnings per share would be reduced by $0.04.

Deferred Tax Assets and Liabilities. Deferred income tax assets and liabilities result from temporary differences between the tax basis of assets and liabilities and the reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. Our temporary differences arise principally from certain net operating losses, accrued expenses, reserves that are discounted for tax return purposes, depreciation and impairment charges. We regularly review our deferred tax assets for recoverability based on historical taxable income, projected future taxable income and the expected timing of the reversals of the existing temporary differences. A valuation allowance is established for those portions of the deferred tax assets that we consider to be more likely than not unrealizable. At December 31, 2002, our total deferred tax assets, including discontinued operations, was $83.3 million and our total deferred tax liabilities were $1.0 million.

Management believes, based on information presently available, that the recorded deferred tax assets are reasonable and recoverable. A change between the recorded asset and the subsequently used deferred tax asset could have a material impact to our business and results of operations. For example, a 1% decrease in the deferred tax asset as of December 31, 2002 would reduce reported net income for the year 2002 by $833,000 or 2.3% and diluted earnings per share would be reduced by $0.03.

Other. In addition to the most critical accounting policies and estimates discussed above, other areas requiring us to use judgment, assumptions and estimates include, but are not limited to, workers' compensation earned but unbilled premiums, contractual discounts on professional fee revenue, allowances for doubtful receivables, other accrued liabilities, accrued payroll and taxes, post-employment benefit liabilities, accrued policyholders' dividends, unearned premium revenue and contingent assets and liabilities. For a more extensive discussion of our accounting policies, see Note 2 in the Notes to the Consolidated Financial Statements.

The following table sets forth selected operating data as a percentage of revenues for the periods indicated:

                                                            Years Ended December 31,
                                                      ----------------------------------
                                                         2002        2001        2000
                                                      ----------  ----------  ----------
OPERATING REVENUES:
     Medical Premiums...............................       67.1 %      65.2 %      62.5 %
     Military Contract Revenues.....................       29.2        30.7        32.4
     Professional Fees..............................        2.4         2.6         3.2
     Investment and Other Revenues .................        1.3         1.5         1.9
                                                      ----------  ----------  ----------
        Total.......................................      100.0       100.0       100.0
                                                      ----------  ----------  ----------
OPERATING EXPENSES:
     Medical Expenses...............................       55.7        55.2        56.6
     Military Contract Expenses ....................       28.2        30.0        31.7
     General and Administrative Expenses............       10.5        11.1        11.0
     Asset Impairment, Restructuring,
        Reorganization and Other Costs..............         --          --         3.0
                                                      ----------  ----------  ----------
     Total..........................................       94.4        96.3       102.3
                                                      ----------  ----------  ----------
OPERATING INCOME (LOSS) FROM CONTINUING
     OPERATIONS.....................................        5.6         3.7        (2.3)
INTEREST EXPENSE....................................       (0.6)       (1.4)       (1.7)
OTHER INCOME (EXPENSE), NET.........................         --        (0.2)        0.1
                                                      ----------  ----------  ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES ...........................        5.0         2.1        (3.9)
(PROVISION) BENEFIT  FOR INCOME TAXES...............       (1.7)       (0.7)        0.9
                                                      ----------  ----------  ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS............        3.3         1.4        (3.0)
LOSS FROM DISCONTINUED OPERATIONS...................       (0.5)       (1.1)      (16.6)
                                                      ----------  ----------  ----------
NET INCOME (LOSS)...................................        2.8 %       0.3 %     (19.6)%
                                                      ==========  ==========  ==========

Total Operating Revenues increased approximately 15.9% to $1.28 billion from $1.10 billion for 2001.

The change in operating revenues was comprised of the following:

• An increase in medical premiums of $138.7 million
• An increase in military contract revenues of $34.7 million
• An increase in professional fees of $1.9 million
• A decrease in investment and other revenues of approximately $200,000

Medical Premiums from our HMO and managed indemnity insurance subsidiaries increased $138.7 million or 19.3%. The $138.7 million increase in premium revenue reflects a 5.1% increase in Medicare member months (the number of months individuals are enrolled in a plan), a 52.2% increase in Medicaid member months and a 20.4% increase in commercial member months. The growth in Medicare member months contributes significantly to the increase in premium revenues as the Medicare per member premium rates are more than three times higher than the average commercial premium rate.

HMO and POS premium rates for renewing commercial groups increased on average 9% to 12% while the overall rate increase, including continuing business and new members, resulted in an approximate 9.6% increase. Managed indemnity rates increased approximately 10.6%. We did not receive a Medicaid rate increase in 2002 and we do not anticipate one in 2003. The basic Medicare rate increase received in 2002 for the Las Vegas area was approximately 2%. Our overall Medicare rate increase was approximately 6.4% due primarily to the following:

• An increase in the Social HMO membership as a percentage of our total Medicare membership. The Social HMO members have a higher average rate than our other Medicare members. Over 97% of our Las Vegas, Nevada Medicare members are enrolled in the Social HMO Medicare program.
• We experienced increased risk factors in our Social HMO membership which contributes to higher rates and corresponding medical expenses.
• We received rate increases in excess of 2% for membership outside of the Las Vegas area.

The Centers for Medicare and Medicaid Services, or CMS, formerly known as the Health Care Financing Administration, or HCFA, may consider adjusting the reimbursement factor or changing the program for the Social HMO members in the future. At this time, however, the final reimbursement per member for 2004 has not been determined and there is no guaranty that the Social HMO contract will be renewed beyond 2003. It should be noted that Congress has in the past agreed to extend the contract. If the reimbursement for these members decreases significantly and related benefit changes are not made timely, there could be a materially adverse effect on our business. Continued medical premium revenue growth is principally dependent upon continued enrollment in our products and upon competitive and regulatory factors.

Military Contract Revenues increased $34.7 million or 10.2%. The increase in revenue is primarily the result of additive change order work and is significantly offset by increased military contract expenses associated with those change orders. The Congressionally approved Department of Defense, or DoD, fiscal year 2001 budget included several sweeping changes to the TRICARE program. In April 2001, SMHS began implementation of a prescription drug program for beneficiaries over age 65. Likewise, in October 2001, SMHS implemented TRICARE for Life which is a comprehensive health care benefit to those retired military beneficiaries over age 65. Both of these modifications resulted from Congressional changes to the program. SMHS administers the expanded benefits only to the over age 65 retiree military population. SMHS does not directly fund claims payment or bear any health care underwriting risk on these program modifications for the actual level of health care service utilization and does not record any claim payments or related revenue on these program modifications.

SMHS will complete the last year of a five-year contract in May 2003, but it has successfully completed negotiations with the DoD to extend the contract for up to four years at the government's sole option on a year-to- year basis. The DoD is also currently procuring managed care services under the Next Generation TRICARE contract, or the T-Nex contract, in a combined and larger North Region (covering Michigan, Ohio, Kentucky, Indiana, Illinois, Wisconsin, Virginia and North Carolina in addition to the areas that make up Region 1 which we currently serve). SMHS submitted its bid to the DoD for the T-Nex contract for the North Region on January 29, 2003, with Sierra as a proposed guarantor. The award decision for this contract is initially expected to be made in mid-2003. Once awarded, the new contractor is scheduled to be fully operational in Region 1 by the third quarter of 2004, based on the current timetable set by the DoD, and the new contract would supersede the remainder of the contract extension we have negotiated with the DoD under our current TRICARE Region 1 contract. In March 2003, we contributed $35.0 million of the proceeds of the Sierra Debentures to SMHS in furtherance of its bid for the T-Nex contract.

Professional Fees increased $1.9 million or 6.7% as a result of higher average co-pays and increased visits at our provider subsidiaries.

Investment and Other Revenues decreased approximately $200,000 or 1.3% due primarily to a decrease in the average investment yield during the period offset by an increase in the average invested balance. Investment and other revenues now include the revenue associated with administrative services, which were previously reported as part of specialty product revenues.

Medical Expenses increased $103.5 million or 17.0% due primarily to our increased membership. Medical expenses as a percentage of medical premiums and professional fees decreased to 80.2% from 81.4%. The decrease is primarily due to premium yields in excess of cost and utilization increases which were partially offset by higher bed days in 2002. Our medical claims payable liability requires us to make significant estimates. See the discussion of our medical claims payable liability under critical accounting policies and estimates for a further explanation.

During the third quarter of 2002, the Company entered into a new hospital contract. With this new contract, which began October 1, 2002, the Company holds some form of contracted provider relationship with every hospital in the Las Vegas area.

Military Contract Expenses increased $28.8 million or 8.7%. The increase is consistent with the increase in revenues discussed previously. Health care delivery expense consists primarily of costs to provide managed health care services to eligible beneficiaries in accordance with Sierra's TRICARE contract. Under the contract, SMHS provides health care services to approximately 678,000 eligible individuals of active duty military personnel, military retirees under the age of 65 and dependents of military retirees through a network of approximately 55,000 health care providers and certain other subcontractor partnerships. Also included in military contract expenses are costs incurred to perform specific administrative services, such as health care appointment scheduling, enrollment, medical and network management services as well as health care advice line services, and other administrative functions of the military health care subsidiary. These administrative services are performed for active duty personnel and family members as well as retired military families.

General and Administrative Expenses, or G&A, increased approximately $11.4 million or 9.3%. The primary increases in G&A expenses were payroll and benefits, brokers fees, which were primarily due to increased premium revenues, and facility lease expense. The increase in facility lease expense is due to the rent payments associated with the sale- leaseback transaction for our administrative buildings now being recorded as an operating expense. Previously the rent payments were recorded as interest and a reduction of principal and the assets were being depreciated. Our administrative office buildings associated with the sale-leaseback transaction qualified as a sale at the end of the first quarter of 2002. This resulted in a quarterly increase in G&A expenses of approximately $1.1 million and a corresponding decrease in interest expense. See Note 4 of the Notes to the Consolidated Financial Statements for a further explanation of the sale- leaseback transaction. As a percentage of revenues, G&A expenses were 10.5% for 2002, compared to 11.1% in 2001. As a percentage of medical premium revenue, G&A expenses were 15.6% for 2002, compared to 17.1% for 2001. G&A expenses now include the expenses associated with administrative services which were previously reported as part of specialty product expenses.

Interest Expense decreased $8.3 million or 52.6%. Interest expense related to the revolving credit facility decreased $3.7 million due to a decrease in the average balance of outstanding debt during the period and a decrease in the weighted average cost of borrowing. Our average interest rate on the revolving credit facility, excluding the amortization of deferred financing fees, our interest rate swap agreement and fees on the unused portion of the credit facility was 4.6% in 2002, compared to 8.1% in 2001. We incur a fee of 0.5% on the unused portion of the revolving credit facility. In addition, we are amortizing approximately $300,000 per quarter of deferred financing fees.

Interest expense related to the sale-leaseback transaction decreased by $4.9 million as the remaining buildings qualified as a sale during 2002. See Note 4 of the Notes to the Consolidated Financial Statements for a further explanation of the sale-leaseback transaction. We had various increases in interest expense of approximately $300,000.

Other Income (Expense), Net increased $2.0 million. We had a net loss on sale of assets of $2.3 million in 2001. In addition, we had an increase between 2002 and 2001 for various other expense items totaling approximately $300,000.

Provision for Income Taxes was recorded at $22.1 million for 2002 compared to $7.2 million for 2001. The effective tax rate for 2002 was 34.3% compared to 31.6% for 2001. Our ongoing effective tax rate is less than the statutory rate due primarily to tax preferred investments.

Discontinued Operations consist of our Texas HMO health care operations and the CII workers' compensation operations. The loss from discontinued operations for 2002 was $5.9 million compared to $12.0 million for 2001. The Texas HMO health care operations had a gain of $8.5 million for 2002 which was offset by a loss on the CII workers' compensation operations of $14.3 million.

Discontinued Texas HMO health care operations. The gain from the Texas HMO health care operations for 2002 included gains, net of tax, related to reserves and accrued liabilities of $5.9 million and to real estate of $2.6 million. During 2002, we had favorable development in both medical claims and legal, restitution and other exit related costs. As a result, we reduced our estimate for medical claims payable by $4.8 million and our legal, restitution and other exit related costs by $4.2 million. The adjustments resulted in income, net of tax, from the discontinued Texas HMO health care operations of $5.9 million.

During 2002, TXHC sold four real estate properties and a piece of land which resulted in a gain, net of tax, on the sale of approximately $700,000. In conjunction with the sales we were required, under the terms of the mortgage loan agreement, to pay pre-determined minimum amounts of the mortgage note. Since the principal payments resulted in a reduction of future interest, future accrued interest was reduced and a gain, net of tax, of $1.9 million was recorded.

Discontinued CII workers' compensation operations. The discontinued workers' compensation operations for 2002 had a loss of $14.3 million, which included valuation adjustments of $17.3 million, or $11.3 million after tax, to reduce this business to its estimated net realizable value upon disposition. We will continue to operate the business until a disposal occurs.

Net earned premiums increased by $3.0 million or 1.7% due primarily to a decrease in ceded reinsurance premiums of $12.9 million that was partially offset by a $9.9 million decrease in gross earned premiums. Gross written premiums decreased by $10.7 million due primarily to reduced California premium writings. We have been attempting to increase our premium rates, especially in California, where we have experienced significant adverse loss development. In addition, we are becoming more selective in the types of accounts we insure. In 2002, our average premium rate increase on renewing California policies was approximately 37%, which is on top of a 38% average rate increase in 2001. Due to lost business and lower amounts of new business, gross premiums written in California were reduced by $14.1 million. In other states, our average premium rate increase on renewing policies was approximately 8% in 2002 compared to 12% in 2001 and gross premiums written have increased by $3.4 million, primarily in Nevada.

Due to the impact of new legislation in California (see below) and the continuing higher amounts of average incurred claims we have been experiencing, our rate increase in the first two months of 2003 on renewing California policies is approximately 30 - 50%. In addition, we continue to implement stricter underwriting guidelines. This has resulted in a continuation of lost business and lower amounts of new business and our premiums written for the first two months of 2003 in California are down approximately 22% over the comparable 2002 period. Premiums written in our other states are also down by approximately 11%, primarily in Colorado. Premium production results for the first two months of 2003 may not be indicative of the full year's premium production.

Premiums in force are an indicator of future written premium trends and represent the total estimated annual premiums of all policies in force at a point in time. Total inforce premiums decreased by 1% from $168.4 million at December 31, 2001 to $166.9 million at December 31, 2002. As noted above, our premiums written in the first two months of 2003 are significantly reduced from the first two months of 2002. Total inforce premiums at February 28, 2003 are $145.0 million, which represents a reduction of 13.1% from December 31, 2002. At February 28, 2003, premiums in force for California business was reduced by 17.2% to $94.8 million and non-California business was reduced by 4.1% to $50.2 million.

Investment and other revenue decreased by $2.2 million due to a $500,000 investment valuation adjustment and a decrease in the average investment yield during the period offset by an increase in the average invested balance.

Expenses increased in the CII workers' compensation operations by approximately $26.3 million or 14.3%. The increase in expenses is primarily due to the following:

• In conjunction with the decision to dispose of the workers' compensation operations, CII recorded valuation adjustments, which included the write down of accounts receivable, fixed assets and certain other assets of $3.5 million and an increase in loss and LAE reserves of $13.3 million.
• Approximately $2.3 million in additional loss and LAE is related to the increase in net earned premiums in 2002 compared to 2001.
• In 2002, we recorded $24.0 million of net adverse loss development for prior accident years compared to net adverse loss development of $8.7 million recorded in 2001. Of the $24.0 million recorded, $1.4 million is related to our mandatory participation in assumed reinsurance pools and $5.0 million was recorded in conjunction with the valuation adjustments described above. The net adverse loss development recorded was largely attributable to higher costs per claim, or claim severity, in California, primarily on accident years 1996, 1997, 2000 and 2001. Higher claim severity has had a negative impact on the entire California workers' compensation industry in the past few periods and this trend may continue.
• The loss and LAE ratio for the 2002 accident year was higher by 3.0% which resulted in an increase of approximately $5.3 million in additional losses including the $8.3 million recorded as part of the valuation adjustments. Excluding the valuation adjustment, which represents 4.7% of net earned premiums, the 2002 accident year loss and LAE ratio would have been 1.7% less than the 2001 accident year loss ratio. The decrease is due to the higher premium rates we have been obtaining which were substantially offset by higher estimated average incurred claims.
• The net decrease in underwriting expenses, policyholders' dividends and other operating expenses, excluding the valuation adjustments, was approximately $100,000.

The net adverse loss development on prior accident years included those years that were covered by our low level reinsurance agreement. This resulted in an increase in the reinsurance recoverable balance which is then reduced by amounts collected from reinsurers. During the year ended December 31, 2002, we increased our ceded reserves by $45.9 million and received payments from our reinsurers totaling $74.6 million.

The loss and LAE reserves recorded as of December 31, 2002 reflect our best estimate of the ultimate loss costs for reported and unreported claims occurring in accident year 2002 as well as those occurring in accident years prior to 2002 and are slightly in excess of our independent actuary's point estimate. Workers' compensation claim payments are made over several years from the date of the claim. Until the final payments for reported claims are made, reserves are invested to generate investment income.

The combined ratio is a measurement of the workers' compensation underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio, net of valuation adjustments which represent 9.6%, was 110.0% compared to 106.1% for 2001. The increase was primarily due to increased net adverse loss development for prior accident years. Excluding valuation adjustments and prior accident years' adverse loss development, the combined ratio would have been 99.3% for 2002 and 101.1% for 2001.

In February 2002, California enacted Assembly Bill 749. This new legislation increased benefits paid to injured workers starting January 1, 2003. Increased loss costs, such as benefit increases, are normally built into the rate making process so that premiums are increased to cover the increase in costs. On October 18, 2002, the California Insurance Commissioner approved an increase of 10.5% in pure premium rates for new and renewal policies effective in 2003. In addition, the Commissioner approved a 4.9% increase in pure premium rates for the unexpired terms of policies in force at January 1, 2003. Although we have increased our premiums, there is no assurance that our increase will be sufficient enough to cover the ultimate cost increases or that the estimate of cost increases provided by the Workers' Compensation Insurance Rating Bureau (the organization that accumulates premium and loss data for the State of California for rate making purposes) is accurate. Assembly Bill 749 is effective for claims occurring on and after January 1, 2003. However, due to other statutes, certain temporary total disability claims with dates of injury prior to 2003 will automatically increase to the new benefit levels effective January 1, 2003.

Under our low level reinsurance agreement, we reinsured 30% of the first $10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000. The maximum net loss retained on any one claim ceded under this agreement was $17,000. This agreement covered all policies in force at July 1, 1998 and continued until June 30, 2000, when we exercised an option to extend coverage to all policies in force as of June 30, 2000. The termination of the low level agreement resulted in our keeping more retained losses and LAE. However, our California premium rates have been increasing, which we believe will largely mitigate the loss of this favorable reinsurance protection. The premium rate increases on policies renewed in California during 2002 and 2001 were approximately 37% and 38%, respectively. For policies effective from July 1, 2000, we obtained excess of loss reinsurance for 100% of the losses above $250,000 and less than $500,000. This agreement terminated on June 30, 2001 and only covered claims with dates of injury occurring by that date. We already had an existing excess of loss reinsurance agreement that covered 100% of the losses above $500,000. The latter reinsurance agreement is a fixed rate multi-year contract that expired December 31, 2002. We executed an option to extend the coverage for all policies in force as of December 31, 2002 until they expire in 2003.

In the wake of the events of September 11, 2001 and the ensuing hardening of the reinsurance market, our new reinsurance agreements, which cover new and renewal policies effective on and after January 1, 2003, will cost more and has reduced coverage limits, including exclusions for terrorist acts. We continue to retain the first $500,000 per occurrence but the maximum coverage has been reduced from statutory (i.e., unlimited) limits to $20.0 million per occurrence. We also must meet certain annual aggregate deductibles before we can begin to recover from some of our reinsurers. This new coverage will result in our retaining more of the losses and LAE. We have factored these higher costs into our premium rates but there is no assurance that our rates will be adequate to cover these additional costs. The reinsurers on the new agreement consist of domestic as well as foreign reinsurers, and all are rated at least A- or better by A.M. Best Company as of December 31, 2002.

Reinsurance contracts do not relieve us from our obligations to injured workers or policyholders. At December 31, 2002, we had $189.4 million in reinsurance recoverable. We evaluate the financial condition of our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. We also periodically review the financial strength ratings of our reinsurers to determine if an allowance for uncollectible reinsurance is warranted. As of December 31, 2002 and 2001, no allowance was established. At December 31, 2002, all of our reinsurers were rated AA- and A+ or better by Fitch Ratings and the A.M. Best Company, respectively. Should these companies be unable to perform their obligations to reimburse us for ceded losses, we would experience significant losses.

Total Operating Revenues for 2001 increased approximately 8.2% to $1.10 billion from $1.02 billion for 2000.

The change in operating revenues was comprised of the following:

• An increase in medical premiums of $81.2 million
• An increase in military contract revenues of $8.6 million
• A decrease in professional fees of $4.1 million
• A decrease in investment and other revenues of $1.8 million

Medical Premiums from our HMO and managed indemnity insurance subsidiaries increased $81.2 million or 12.7%. The $81.2 million increase in premium revenue reflects a 7.9% increase in Medicare member months (the number of months individuals are enrolled in a plan) and a 10.9% increase in commercial member months. The growth in Medicare member months contributes significantly to the increase in premium revenues as the Medicare per member premium rates are over three times higher than the average commercial premium rate. HMO premium rates for commercial groups increased approximately 6.6%, managed indemnity rates increased approximately 14.6% and Medicare rates increased approximately 4.0%.

Military Contract Revenues increased $8.6 million or 2.6%. The increase in revenue is primarily the result of additive change order work and is significantly offset by increased military contract expenses associated with those change orders. The Congressionally approved DoD fiscal year 2001 budget included several sweeping changes to the TRICARE program. In April 2001, SMHS began implementation of a prescription drug program for beneficiaries over age 65 and the implementation of a waiver of co- payments for active duty family members. Both of these program modifications resulted from Congressional changes to the program. Likewise, in October 2001, SMHS implemented TRICARE for Life which is a comprehensive health care benefit to those retired military beneficiaries over age 65. SMHS only administers the expanded benefits to the over age 65 retiree military population.

Professional Fees decreased $4.1 million or 12.4% due primarily to the closing of our affiliated medical group in Arizona during 2000.

Investment and Other Revenues decreased $1.8 million or 9.7% due primarily to a decrease in the average investment yield during the period offset by an increase in the average invested balance. Investment and other revenues now include the revenue associated with administrative services which were previously reported as part of specialty product revenues.

Medical Expenses increased $32.0 million or 5.6%. Excluding the effects of changes in estimate charges for 2000, medical expenses increased approximately $58.0 million or 10.5%. Medical expenses as a percentage of medical premiums and professional fees decreased from 82.1% to 81.4%, excluding changes in estimate charges as described below. The improvement is primarily due to the closing of our rural Nevada clinical operation with a higher medical care ratio and premium yields in excess of cost increases.

Medical expenses reported in 2000 included change in estimate charges of $16.5 million for reserve strengthening primarily due to adverse development on prior years' medical claims and $9.5 million of other non- recurring medical costs primarily relating to the write-down of certain medical subsidiary assets.

Military Contract Expenses increased $8.4 million or 2.6%. The increase is consistent with the increase in revenues discussed previously. Also included in military contract expenses are costs incurred to perform specific administrative services, such as health care appointment scheduling, enrollment, network management and health care advice line services, and other administrative functions of the military health care subsidiary.

General and Administrative Expenses, or G&A, increased $10.4 million or 9.3%. As a percentage of revenues, G&A expenses were 11.1% in 2001 compared to 11.0% in 2000. As a percentage of medical premium revenue, G&A expenses were 17.1% for 2001 compared to 17.6% for 2000. G&A expenses now include the expenses associated with administrative services which were previously reported as part of specialty product expenses.

Asset Impairment, Restructuring, Reorganization and Other Costs for 2000 are discussed below.

Asset Impairments. Management adopted a plan in the second quarter of 2000 to discontinue medical delivery operations in Mohave County, Arizona and to sell the real estate assets located there, as well as an underperforming medical clinic in Las Vegas. In connection with the restructuring plans adopted and announced by us in the second quarter of 2000, we re-evaluated the recoverability of certain long-lived assets, in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", or SFAS No. 121, and Accounting Principles Board Opinion No. 17, "Intangible Assets", or APB No. 17, and determined that the carrying values of certain goodwill and other long-lived assets were impaired.

In assessing the asset impairment of the long-lived assets, we first allocated a portion of related goodwill to the fixed assets to be disposed of, in accordance with SFAS No. 121. The fixed assets were then written down to estimated fair value less costs to sell, which was determined from independent valuations. The remainder of the related goodwill was then assessed for recoverability in accordance with APB No. 17 based on projected discounted cash flows.

The charges recorded for the write-off of goodwill totaled $15.1 million related primarily to the Prime Holdings, Inc. acquisition. The charges recorded for fixed asset impairment totaled $9.5 million for the Arizona and Nevada operations.

Restructuring and Reorganization. In the second quarter of 2000, we adopted a plan and announced additional restructuring of the Arizona managed health care operations. As a result of this restructuring, we recorded charges in accordance with Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" of approximately $2.0 million. Of the costs recorded, $1.2 million was for severance, $400,000 was related to clinic closures and lease termination and $400,000 was for other costs.

Other:

The $4.3 million of costs recorded in the second quarter of 2000 relate primarily to an accrual for certain legal settlements as wells as the write-down of certain receivables.

The table below presents a summary of asset impairment, restructuring, reorganization and other costs for the years indicated.

                                                   Restructuring
                                         Asset         and
                                      Impairment   Reorganization  Other      Total
                                      -----------  ------------  ---------  ---------
                                                      (In thousands)
  Balance, January 1, 2000.......... $        --  $         --  $   3,449  $   3,449
  Charges recorded..................      24,553         1,983      4,300     30,836
  Cash used.........................          --        (1,389)      (302)    (1,691)
  Noncash activity..................     (24,553)           --     (3,000)   (27,553)
  Changes in estimate...............          --            --         --         --
                                      -----------  ------------  ---------  ---------
  Balance, December 31, 2000........          --           594      4,447      5,041
  Charges recorded..................          --            --         --         --
  Cash used.........................          --          (594)        --       (594)
  Noncash activity..................          --            --         --         --
  Changes in estimate...............          --            --         --         --
                                      -----------  ------------  ---------  ---------
  Balance, December 31, 2001........          --            --      4,447      4,447
  Charges recorded..................          --            --         --         --
  Cash used.........................          --            --         --         --
  Noncash activity..................          --            --       (500)      (500)
  Changes in estimate...............          --            --         --         --
                                      -----------  ------------  ---------  ---------
  Balance, December 31, 2002........ $        --  $         --  $   3,947  $   3,947
                                      ===========  ============  =========  =========

The remaining other costs of $3.9 million are primarily related to legal claims. Management believes that the remaining reserves as of December 31, 2002 are adequate and that no revisions to the estimates are necessary at this time.

Interest Expense decreased $2.1 million or 11.6%. Interest expense related to the revolving credit facility decreased $13.3 million due to a decrease in the average balance of outstanding debt during the period and a decrease in the weighted average cost of borrowing. Our average revolving credit facility balance was $61 million in 2001 compared to $183 million in 2000. Our average interest rate on the revolving credit facility, excluding the amortization of deferred financing fees and our interest rate swap agreement was 8.1% in 2001 compared to 9.8% in 2000. The decreases were offset by an increase in interest expense of $9.2 million related to the net financing obligations associated with the sale-leaseback transaction and $2.0 million in other interest expense.

Other Income (Expense), Net decreased $3.2 million. We had a net loss on sale of assets in 2001 of $2.3 million compared to a gain of $1.2 million in 2000. In addition, we had an increase between 2001 and 2000 for various other income items totaling approximately $300,000.

Provision for Income Taxes was recorded at $7.2 million for 2001 compared to a tax benefit of $9.2 million for 2000. The effective tax rate for 2001 was 31.6% compared to 22.9% for 2000. The effective tax rate for 2000 reflects the non-deductibility of certain portions of goodwill impairment expense recorded during the period.

Discontinued Operations consist of our Texas HMO health care operations and the CII workers' compensation operations. The loss from discontinued operations for 2001 was $12.0 million compared to $168.9 million for 2000. The Texas HMO health care operations had a loss of $14.0 million for 2001 compared to a gain of $2.0 million for the CII workers' compensation operations.

Discontinued Texas HMO health care operations. The 2001 loss includes costs to exit the Texas HMO health care market of $17.1 million offset by various other income from operations. Included in the 2000 loss were the following: (a) asset impairment charges of $126.4 million for impaired goodwill; (b) $36.5 million for impaired real estate and other fixed assets; (c) medical expenses of $14.7 million, primarily for adverse development on prior periods' medical claims; (d) $15.5 million for premium deficiency medical costs; (e) $10.4 million for premium deficiency maintenance costs; and (f) other restructuring, reorganization and other costs of $13.3 million.

Discontinued CII workers' compensation operations. The discontinued workers' compensation operations for 2001 had a profit of $2.0 million compared to a loss of $7.8 million in 2000. Net earned premiums increased by $47.7 million or 38.0% due primarily to a decrease in ceded reinsurance premiums. Ceded reinsurance premiums decreased as our low level reinsurance agreement expired on June 30, 2000 and was replaced by a new reinsurance agreement with lower ceded premiums.

Expenses increased in the CII workers' compensation operations by approximately $33.0 million or 21.8%. The increase in expenses is primarily due to the following:

• Approximately $32.9 million in additional loss and LAE is related to the increase in net earned premiums in 2001 compared to 2000.
• In 2001, we recorded $8.7 million of net adverse loss development for prior accident years compared to net adverse loss development of $23.3 million recorded in 2000. The net adverse loss development recorded was largely attributable to higher costs per claim, or claim severity, in California. Higher claim severity has had a negative impact on the entire California workers' compensation industry and this trend may continue.
• We established a higher loss and LAE ratio for the 2001 accident year, which has resulted in an increase of approximately $12.5 million. The majority of the increase is due to the termination of the low level reinsurance agreement on June 30, 2000, which results in a higher risk exposure on policies effective after that date and a higher amount of net incurred loss and LAE.
• During the second quarter of 2000, we wrote-off capitalized costs of $3.0 million related to the application development of an information system software project, which was canceled because the vendor was unable to fulfill its contractual obligations. The amounts written off included software and consulting costs of $1.6 million and capitalized internal personnel costs of $1.4 million.
• A net increase in underwriting expenses, policyholders' dividends and other operating expenses of $5.2 million related primarily to the increase in net earned premiums.

The combined ratio is a measurement of the workers' compensation underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio was 106.1% in 2001 compared to 115.8% for 2000. The decrease was primarily due to significantly higher prior year adverse loss development recorded during 2000. Excluding adverse loss development, the combined ratio would have been 101.1% for 2001 and 97.3% for 2000. The increase in the accident year loss and LAE ratio was primarily due to the run off of the low level reinsurance, which resulted in our retaining more of the incurred losses. The underwriting expense ratio decreased primarily due to higher retained net earned premiums.

We had cash flows from operating activities for continuing operations of $136.6 million for the year ended December 31, 2002 compared to $98.2 million in 2001. We used the majority of the cash flow for the purchase of investments and for reductions of debt. Overall, discontinued operations used cash of $47.9 million in 2002 compared to $46.0 million in 2001. Excluding cash used to purchase investments, discontinued operations used cash of $700,000 in 2002 compared to $14.1 million in 2001. The improvement in continuing operations over 2001 is primarily attributable to cash from earnings and the change in assets and liabilities.

The cash flow resulting from the change in assets and liabilities of $72.6 million was primarily due to the following:

• a source of cash due to the decrease in the deferred tax asset balance of $37.9 million
• a source of cash due to the increase in medical claims payable of $16.4 million
• a source of cash due to the increase in other liabilities of $15.0 million
• a source of cash due to the increase in other current liabilities of $14.7 million
• a source of cash due to the decrease in other current assets of $6.5 million
• a use of cash due to the decrease in military health care payable balance of $12.0 million
• a use of cash due to the increase in the military accounts receivable balance of $7.0 million
• various other changes in assets and liabilities accounting for the remaining source of cash of $1.1 million

SMHS receives monthly cash payments equivalent to one-twelfth of its annual contractual price with the Department of Defense, or DoD. SMHS accrues health care revenue on a monthly basis for any monies owed above its monthly cash receipt based on the number of at-risk eligible beneficiaries and the level of military direct care system utilization. The contractual bid price adjustment, or BPA, process serves to adjust the DoD's monthly payments to SMHS, because the payments are based in part on 1996 DoD estimates for beneficiary population and beneficiary population baseline health care cost, inflation and military direct care system utilization. As actual information becomes available for the above items, quarterly adjustments are made to SMHS' monthly health care payment in addition to lump sum adjustments for past months. In addition, SMHS accrues change order revenue for DoD directed contract changes. As a result of preliminary data accumulated from the BPA process in the last quarter of 2002, SMHS will receive an upward adjustment in 2003 of approximately $3.3 million to its monthly DoD payments starting January 2003. Our business and cash flows could be adversely affected if the timing or amount of the BPA and change order reimbursements vary significantly from our expectations.

On November 16, 2001, SMHS entered into a securitization arrangement with General Electric Capital Corporation. The arrangement provides for the assignment of SMHS' Federal Government accounts receivable to SMHS Funding. SMHS Funding is a special purpose limited liability company owned by SMHS and was formed for the purpose of purchasing all receivables of SMHS. This entity is fully consolidated into SMHS. SMHS Funding may assign an undivided interest in certain of the receivables to a subsidiary of General Electric Capital Corporation in the event that additional financing by SMHS is warranted. This securitization arrangement was not utilized in 2002 and we do not anticipate utilizing it in 2003. See Note 2 of the Notes to the Consolidated Financial Statements.

In the event SMHS wins the competitive procurement for the North Region T-Nex contract, SMHS has received a commitment from General Electric Capital Corporation to provide a $200.0 million senior secured revolving credit facility to support SMHS' additional working capital needs and to refinance its existing securitization agreement.

Net cash used from continuing operations for investing activities during 2002 included $12.4 million in capital expenditures associated with the continued implementation of new computer systems, leasehold improvements on facilities and furniture, equipment and other capital purchases to support our growth. This was offset by net proceeds of $680,000 from property and equipment dispositions. The net cash change in investments for the year was an increase in investments of $135.0 million as investments were purchased with available funds.

Cash used in financing activities during 2002 included payments of $30.4 million on debt related items offset by $16.9 million in proceeds received from the sale-leaseback notes and $10.2 million in cash received related to the sale of stock through our employee stock purchase plan and stock option plans. The year 2001 included net proceeds from long-term borrowings (proceeds less payments) of $53.2 million and proceeds of $2.1 million related to the sale of stock through our employee stock purchase plan.

On December 28, 2000, we sold the majority of our Las Vegas, Nevada administrative and medical clinic real estate holdings in a sale-leaseback transaction. As part of the transaction, we financed a portion of the sales price with mortgage notes receivable of $22.2 million and provided deposits of $4.3 million. In accordance with Statement of Financial Accounting Standards No. 98, "Accounting for Leases", or SFAS No. 98, we recorded the transaction as a financing obligation of $113.7 million offset by the mortgage notes receivable of $22.2 million. As of September 30, 2002, we had received the deposits back and full payment of the outstanding mortgage obligations. The payments cured the continuing involvement criteria from SFAS No. 98 and the transaction then qualified as a sale. See Note 4 of the Notes to the Consolidated Financial Statements for a further explanation.

In March 2003, we issued $115.0 million aggregate principal amount of 2¼% senior convertible debentures due March 15, 2023. We used the net proceeds of the offering to repay the $39.0 million outstanding under our existing credit facility and to contribute $35.0 million to SMHS in furtherance of its bid for the TRICARE Next Generation contract. We also used $19.9 million of the proceeds to purchase 1.6 million shares of our common stock under our repurchase program. The remainder of the net proceeds will be used for working capital and general corporate purposes, including, subject to board approval, additional share repurchases.

The debentures are convertible, at the option of the holders, into shares of Sierra Health Services, Inc. common stock at a conversion price of $18.29, upon certain conditions including the sale price of Sierra's common stock exceeding 120% of the conversion price at specified times. The debentures are puttable to us for cash or Sierra common stock, at our election, on March 15 in 2008, 2013 and 2018 and upon certain corporate events including a change in control. The debentures can be called for cash beginning on March 20, 2008.

On March 3, 2003, we entered into a new $65.0 million revolving credit facility which replaces the amended and restated credit facility. The new facility may be increased up to an aggregate amount of $125.0 million upon receipt of new commitments from existing or additional lenders. Interest on the facility is initially LIBOR plus 2.25%. The facility will expire on April 30, 2006 but can be extended, at the sole discretion of each of the lenders, until March 3, 2008. The new facility is available for general corporate purposes.

The new credit facility is secured by guarantees by certain of our subsidiaries and a first priority perfected security interest in (i) all the capital stock of each of our unregulated, material domestic subsidiaries (direct or indirect) as well as all of the capital stock of certain regulated, material domestic subsidiaries and (ii) all other present and future assets and properties of ours and those of our subsidiaries that guarantee our credit agreement obligations (including, without limitation, accounts receivable, inventory, real property, equipment, contracts, trademarks, copyrights, patents, license rights and general intangibles) subject, in each case, to the exclusion of the capital stock of CII Financial, Inc. or any of its subsidiaries and certain other exclusions.

The new revolving credit facility has covenants that restrict our ability and the ability of our subsidiaries to dispose of assets, incur indebtedness, incur other liens, make investments, loans or advances, make acquisitions, engage in mergers or consolidations, or make capital expenditures and otherwise restricts certain corporate activities. In addition, we will be required to comply with specified financial ratios as set forth in the new credit agreement.

At September 30, 2000, CII Financial, Inc., currently part of our discontinued operations, had approximately $47.1 million of subordinated debentures that were due on September 15, 2001. These subordinated debentures were neither assumed nor guaranteed by Sierra and were subordinated to Sierra's credit facility debt. In December 2000, CII Financial commenced an offer to exchange the subordinated debentures for cash and/or new debentures. On May 7, 2001, CII Financial closed its exchange offer on $42.1 million of its outstanding subordinated debentures. CII Financial purchased $27.1 million in principal amount of subordinated debentures for $20.0 million in cash and issued $15.0 million in new 9½% senior debentures, due September 15, 2004, in exchange for $15.0 million in subordinated debentures. The transaction was accounted for as a restructuring of debt; therefore all future cash payments, including interest, related to the debentures will be reductions of the carrying amount of the debentures and no future interest expense will be recognized. Accordingly, the new 9½% senior debentures have a carrying amount of $16.8 million consisting of principal of $14.0 million and $2.8 million in future accrued interest. Since the time of the exchange and as of December 31, 2002, Sierra has purchased $1.0 million in outstanding 9½% senior debentures which are eliminated upon consolidation.

To facilitate the exchange offer, Sierra lent CII Financial $17.0 million, of which $7.5 million was borrowed from California Indemnity Insurance Company, a wholly-owned subsidiary of CII Financial. In addition, California Indemnity received approval from the California Department of Insurance to pay a dividend of $15.0 million to CII Financial. In September 2001, California Indemnity received approval from the California Department of Insurance to pay an additional $5.0 million dividend to CII Financial, which was used to pay the remaining subordinated debentures that matured on September 15, 2001.

The new 9½% senior debentures pay interest, which is due semi-annually on March 15 and September 15 of each year, commencing on September 15, 2001. The new 9½% senior debentures rank senior to outstanding notes payable from CII Financial to Sierra and CII Financial's guarantee of Sierra's revolving credit facility. The new 9½% senior debentures may be redeemed by CII Financial at any time at premiums starting at 110% and declining to 100% for redemptions after April 1, 2004. In the event of a change in control of CII Financial, the holders of the new 9½% senior debentures may require that CII Financial repurchase them at the then applicable redemption price, plus accrued and unpaid interest.

CII is a holding company and its only significant asset is its' investment in California Indemnity. Of the $23.1 million in cash and cash equivalents it held at December 31, 2002, approximately $21.5 million was designated for use only by the regulated insurance companies. CII has limited sources of cash and is dependent upon dividends paid by California Indemnity. California Indemnity may only pay a dividend without the prior approval of the state insurance commissioner to the extent the cumulative amount of dividends or distributions paid or proposed to be paid in any year does not exceed the amount shown as unassigned funds (reduced by any unrealized gains or losses included in any such amount) on its statutory statement as of the previous December 31. In 2003, California Indemnity cannot pay dividends without the prior approval of the state insurance commissioner. In 2002 California Indemnity paid a total of $1.5 million in dividends. We are not in a position to assess the likelihood of obtaining future approval for the payment of dividends other than those specifically allowed by law in each of our subsidiaries' state of domicile.

On January 7, 2003, we announced that our Board of Directors authorized a program for the repurchase of up to 2.0 million shares of our common stock. On February 25, 2003, we announced that we had repurchased approximately 600,000 shares of our common stock and that our Board of Directors had authorized us to purchase up to an additional 600,000 shares under our share repurchase program. Such purchases have been made from time to time at prevailing prices in the open market, by block purchase or in private transactions. As of March 6, 2003, we had purchased a total of 2.2 million shares for $27.6 million.

Our HMO and insurance subsidiaries are required by state regulatory agencies to maintain certain deposits and must also meet certain net worth and reserve requirements. The HMO and insurance subsidiaries, including the discontinued operations, had restricted assets on deposit in various states totaling $33.2 million at December 31, 2002. The HMO and insurance subsidiaries must also meet requirements to maintain minimum stockholders' equity, on a statutory basis, as well as minimum risk-based capital requirements, which are determined annually. Additionally, in conjunction with the Kaiser-Texas acquisition, TXHC entered into a letter agreement with the Texas Department of Insurance whereby TXHC agreed to maintain a net worth of $20.0 million, on a statutory basis, until certain income levels were achieved. In conjunction with the exit from the Texas HMO health care market, the Texas Department of Insurance approved a plan of withdrawal and TXHC is now required to maintain deposits and net worth of at least $3.5 million. We believe we are in material compliance with our regulatory requirements.

Of the $68.8 million in cash and cash equivalents held at December 31, 2002, including discontinued operations, $23.0 million was held by discontinued operations and of the remainder, $11.7 million, was designated for use only by the regulated subsidiaries. Amounts are available for transfer to the holding company from the HMO and insurance subsidiaries only to the extent that they can be remitted in accordance with the terms of existing management agreements and by dividends. The holding company will not receive dividends from its regulated subsidiaries if such dividend payment would cause violation of statutory net worth and reserve requirements.

The following schedule represents our obligations and commitments for long-term debt, capital leases and operating leases at December 31, 2002. With the exception of our amended and restated revolving credit facility, the amounts below represent the entire payment, principal and interest, on our outstanding obligations. The outstanding balance of the amended and restated revolving credit facility is $60 million as of December 31, 2002. The amount has been reflected as due in 2006 as the credit facility was refinanced and terminated in conjunction with the issuance of the Sierra Debentures and the new $65 million credit facility on March 3, 2003.

                                         Long-
                                         Term        Capital     Operating
                                         Debt         Leases      Leases      Total
                                      -----------  ------------  ---------  ---------
                                                               (In thousands)
Continuing Operations
Payments due in less than 1 year.... $        98  $        121  $  18,428  $  18,647
Payments due in 1 to 3 years........          71           114     34,980     35,165
Payments due in 4 to 5 years........      60,071            62     32,805     92,938
Payments due after 5 years..........         362           153    123,420    123,935
                                      -----------  ------------  ---------  ---------
     Total Continuing Operations.... $    60,602  $        450  $ 209,633  $ 270,685
                                      ===========  ============  =========  =========
Discontinued Operations
Payments due in less than 1 year.... $     3,954  $        235  $     422  $   4,611
Payments due in 1 to 3 years........      20,408            --         69     20,477
Payments due in 4 to 5 years........       7,364            --         --      7,364
Payments due after 5 years..........          --            --         --         --
                                      -----------  ------------  ---------  ---------
     Total Discontinued Operations.. $    31,726  $        235  $     491  $  32,452
                                      ===========  ============  =========  =========

Included in long-term debt payments for discontinued operations is a mortgage loan secured by certain underlying real estate assets of the discontinued operations of $15.0 million and the CII Senior Debentures of $16.8 million. We are actively seeking a buyer for the real estate assets and anticipate selling them by the end of 2003. As the assets are sold, we are required to make reductions on the mortgage note and completely satisfy the obligation once all of the assets have been sold.

We have a 2003 capital budget of $30.9 million and are also limited in the amount of capital expenditures we can make by our new revolving credit facility. The 2003 planned expenditures are primarily for a new medical clinic, the purchase of computer hardware and software, furniture and equipment and other normal capital requirements. Our liquidity needs over the next 12 months will primarily be for the capital items noted above, debt service and funds required to exit the Texas HMO health care market. We believe that our existing working capital, operating cash flow and, if necessary, equipment leasing, divestitures of certain non-core assets and amounts available under our credit facility should be sufficient to fund our capital expenditures and debt service. Additionally, subject to unanticipated cash requirements, we believe that our existing working capital and operating cash flow should enable us to meet our liquidity needs on a long-term basis.

We have a $25.0 million interest-rate swap agreement that allows us to mitigate the risk of interest rate fluctuation on our credit facility. The original intent of the agreement was to keep our interest rate on $25.0 million of the credit facility relatively fixed. In accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," we recorded the interest- rate swap agreement at its fair value as of December 31, 2002. The fair value indicated that we would need to pay $645,000 to terminate the swap agreement. If the prime rate were to decrease by 1%, we estimate our maximum increase in annual expense associated with the swap to be approximately $250,000.

In the second quarter of 1997, our Board of Directors authorized a $3.0 million loan from us to our Chief Executive Officer, or CEO. In April 2000, our Board of Directors authorized an additional $2.5 million loan from us to our CEO. In the second quarter of 2001, our Board of Directors approved a loan amendment which extended the maturity of the principal balance along with accrued interest to December 31, 2003. During 2002 and 2001, our CEO made payments of $1.0 million and $898,000, respectively. As of December 31, 2002, the aggregate principal balance outstanding and accrued interest for both instruments was $4.2 million. All amounts borrowed bear interest at a rate equal to the rate at which we could have borrowed funds under our revolving credit facility at the time of the borrowing plus 10 basis points. The amounts outstanding are collateralized by certain of the CEO's assets and rights to compensation from us.

Health care costs continue to rise at a rate faster than the Consumer Price Index. We use various strategies to mitigate the negative effects of health care cost inflation, including setting commercial premiums based on our anticipated health care costs, risk-sharing arrangements with our various health care providers and other health care cost containment measures including member co-payments. There can be no assurance, however, that in the future, our ability to manage medical costs will not be negatively impacted by items such as technological advances, competitive pressures, applicable regulations, increases in pharmacy costs, utilization changes and catastrophic items, which could, in turn, result in medical cost increases equaling or exceeding premium increases.

Our business, offering health care coverage, health care management services, workers' compensation programs and, to a lesser extent, the delivery of medical services, is heavily regulated at both the federal and state levels.

Government regulation of health care coverage products and services is a dynamic area of law that varies from jurisdiction to jurisdiction. Amendments to existing laws and regulations are continually being considered and interpretation of the existing laws and rules changes from time to time. Regulatory agencies generally exercise broad discretion in interpreting laws and promulgating regulations to enforce their interpretations.

While we are unable to predict what legislative or regulatory changes may occur or the impact of any particular change, our operations and financial results could be negatively affected by any legislative or regulatory requirements. For example, any proposals to eliminate or reduce the Employee Retirement Income Security Act, or ERISA, which regulates insured and self-insured health care coverage plans offered by employers, pre-emption of state laws that would increase litigation exposure, affect underwriting practices, limit rate increases, require new or additional benefits or affect contracting arrangements (including proposals to require HMOs and PPOs to accept any health care provider willing to abide by an HMO's or PPO's contract terms) may have a material adverse effect on our business. The continued consideration and enactment of "anti-managed care" laws and regulations by federal and state bodies may make it more difficult for us to manage medical costs and may adversely affect financial results.

In addition to changes in existing laws and regulations, we are subject to audits, investigations and enforcement actions. These include possible government actions relating to ERISA, the Federal Employees Health Benefit Plan, or FEHBP, federal and state fraud and abuse laws and laws relating to utilization management and the delivery and payment of health care. In addition, our Medicare business is subject to Medicare regulations promulgated by CMS. Violation of government laws and regulations may result in an assessment of damages, civil or criminal fines or penalties, or other sanctions, including exclusion from participation in government programs. In addition, disclosure of any adverse investigation or audit results or sanctions could negatively affect our reputation in various markets and make it more difficult for us to sell our products and services.

In addition to the items described above, we urge you to review carefully the section "Risk Factors" in this 2002 Form 10-K for a more complete discussion of the risks associated with an investment in our securities. See "Note on Forward-Looking Statements and Risk Factors" under Item 1.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees", or FIN 45. FIN 45 requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation it has undertaken in issuing the guarantee. We will apply FIN 45 to guarantees, if any, issued after December 31, 2002. We do not expect the adoption of FIN 45 to have a material effect on our consolidated financial position or results of operations.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities", or FIN 46. FIN 46 requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity's activities without receiving additional subordinated financial support from the other parties. We do not expect the adoption of FIN 46 to have a material effect on our consolidated financial position or results of operations.

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections", or SFAS No. 145. SFAS No. 145 requires that gains and losses from extinguishment of debt be classified as extraordinary items only if they meet the criteria in Accounting Principles Board Opinion No. 30 ("Opinion No. 30"). Applying the provisions of Opinion No. 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual and infrequent that meet the criteria for classification as an extraordinary item. SFAS No. 145 is effective for us beginning January 1, 2003. We do not expect the adoption of SFAS No. 145 to have a material effect on our consolidated financial position or results of operations.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", or SFAS No. 146. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. A fundamental conclusion reached by the FASB in this statement is that an entity's commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. We did not elect to early adopt SFAS No. 146 nor do we expect the adoption to have a material effect on our consolidated financial position or results of operations.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", or SFAS No. 148. SFAS No. 148 is an amendment of Statement of Financial Accounting Standards No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 requires prominent disclosures in interim as well as annual financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported net income. The disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. We have not yet determined if we will implement the voluntary change to the fair value based method of accounting as allowed under SFAS No. 148 for 2003.

We are exposed to market risk for the impact of interest rate changes and changes in the market value of our investments. We have not utilized derivative financial instruments in our investment portfolio.

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and our long-term debt. As of December 31, 2002, including discontinued operations, we have approximately $560.3 million in cash and cash equivalents and current, long-term and restricted investments. Of the investments, approximately $486.4 million are classified as available-for-sale and $5.1 million are classified as held-to-maturity. These investments are primarily in fixed income, investment grade securities. Our investment policy emphasizes return of principal and liquidity and is focused on fixed returns that limit volatility and risk of principal. Because of our investment policies, the primary market risk associated with our portfolio is interest rate risk.

Assuming interest rates were to increase by a factor of 1.1, the net hypothetical loss in fair value of stockholders' equity related to financial instruments is estimated to be approximately $5.1 million after tax (3.2% of total stockholders' equity). Of the $5.1 million decrease, $4.1 million is related to our discontinued operations. We believe that such an increase in interest rates would not have a material impact on future earnings or cash flows, as it is unlikely that we would need or choose to substantially liquidate our investment portfolio.

The effect of interest rate risk on potential near-term net income, cash flow and fair value was determined based on commonly used interest rate sensitivity analyses. The models project the impact of interest rate changes on a wide range of factors, including duration and prepayment. Fair value was estimated based on the net present value of cash flows or duration estimates, assuming an immediate 10% increase in interest rates. Because duration is estimated, rather than a known quantity, for certain securities, other market factors may impact security valuations and there can be no assurance that our portfolio would perform in line with the estimated values.

As of December 31, 2002, we had $60 million in borrowings outstanding under a revolving credit facility. The average cost of borrowing on the revolving credit facility for 2002, including the amortization of deferred financing fees and the impact of the swap agreement, was 7.4%. If the average cost of borrowing on the amount outstanding as of December 31, 2002 were to increase by a factor of 1.1, our annual income before tax would decrease by approximately $400,000.

As of December 31, 2002, CII had $14.0 million principal amount of senior debentures outstanding, which is net of $1.0 million in debentures purchased by Sierra and eliminated upon consolidation. The market value of the outstanding debentures was estimated to be approximately $13.1 million at December 31, 2002, based on the last trade in 2002 before the debentures were no longer listed by the New York Stock Exchange. If interest rates were to fluctuate by a factor of 1.1, we do not anticipate a material change in the fair value of the debentures based on the current market for them.

INDEX TO FINANCIAL STATEMENTS

The management of Sierra Health Services, Inc. is responsible for the integrity and objectivity of the accompanying consolidated financial statements. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America applied on a consistent basis and are not misstated due to fraud or material error. The statements include some amounts that are based upon the Company's best estimates and judgment.

The accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against losses from unauthorized use or disposition. Management believes that for the year ended December 31, 2002, such systems and controls were adequate to meet the objectives discussed herein.

The accompanying consolidated financial statements have been audited by independent certified public accountants, whose audits thereof were made in accordance with auditing standards generally accepted in the United States of America and included a review of internal accounting controls to the extent necessary to design audit procedures aimed at gathering sufficient evidence to provide a reasonable basis for their opinion on the fairness of presentation of the consolidated financial statements taken as a whole.

The Audit Committee of the Board of Directors, comprised solely of directors from outside the Company, meets regularly with management and the independent auditors to review the work procedures of each. The independent auditors have free access to the Audit Committee, without management being present, to discuss the results of their opinions on the adequacy of the Company's accounting controls and the quality of the Company's financial reporting. The Board of Directors, upon the recommendation of the Audit Committee, appoints the independent auditors, subject to stockholder ratification.

Anthony M. Marlon, M.D.
Chairman and Chief Executive Officer

Paul H. Palmer
Senior Vice President, Finance
    Chief Financial Officer and Treasurer

To the Board of Directors and Stockholders of
Sierra Health Services, Inc.:

We have audited the accompanying consolidated balance sheets of Sierra Health Services, Inc. and its subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedules listed in the Index at Item 15 (a)(2). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sierra Health Services, Inc. and its subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

As described in Note 18 to the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" as of January 1, 2002.

DELOITTE & TOUCHE LLP

Las Vegas, Nevada
January 29, 2003, (March 14, 2003 as to Notes 6 and 19.)

                                                                                                 
                                                                           2002          2001
                                                                       ------------  ------------
                               ASSETS                                                            
CURRENT ASSETS:
    Cash and Cash Equivalents........................................ $     45,778  $    107,114
    Investments......................................................      182,452        52,498
    Accounts Receivable (Less Allowance for Doubtful
         Accounts: 2002 - $10,626; 2001 - $11,251)...................       11,232        15,334
    Military Accounts Receivable (Less Allowance for Doubtful
         Accounts: 2002 - $0; 2001 - $0).............................       47,126        40,166
    Current Portion of Deferred Tax Asset............................       50,402        82,277
    Prepaid Expenses and Other Current Assets........................       18,380        26,028
    Assets of Discontinued Operations................................      565,058       533,673
                                                                       ------------  ------------
         Total Current Assets........................................      920,428       857,090

PROPERTY AND EQUIPMENT, NET..........................................       64,868       136,496
RESTRICTED CASH AND INVESTMENTS......................................       17,557         9,721
GOODWILL (Less:  Accumulated Amortization $6,972)....................       14,782        14,782
DEFERRED TAX ASSET (Less Current Portion)............................       14,947        14,549
OTHER ASSETS.........................................................       33,384        32,208
                                                                       ------------  ------------
TOTAL ASSETS......................................................... $  1,065,966  $  1,064,846
                                                                       ============  ============
                                                                                                 
                LIABILITIES AND STOCKHOLDERS' EQUITY                                             
CURRENT LIABILITIES:
    Accrued Liabilities.............................................. $     50,349  $     40,691
    Trade Accounts Payable...........................................       29,249        22,500
    Accrued Payroll and Taxes........................................       13,660        13,465
    Medical Claims Payable...........................................       98,031        81,662
    Unearned Premium Revenue.........................................       40,758        38,592
    Military Health Care Payable.....................................       65,223        77,261
    Current Portion of Long-term Debt................................          186           191
    Liabilities of Discontinued Operations...........................      500,720       516,742
                                                                       ------------  ------------
         Total Current Liabilities...................................      798,176       791,104

LONG-TERM DEBT (Less Current Portion)................................       60,710       163,993
OTHER LIABILITIES....................................................       50,515        13,230
                                                                       ------------  ------------
TOTAL LIABILITIES....................................................      909,401       968,327
                                                                       ------------  ------------
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
    Preferred Stock, $.01 Par Value, 1,000
         Shares Authorized; None Issued or Outstanding
    Common Stock, $.005 Par Value, 60,000 Shares Authorized;
         Shares Issued: 2002 - 30,953; 2001 - 29,648.................          155           148
    Treasury Stock: 2002  - 1,163; 2001 - 1,523 Common Stock Shares..      (17,148)      (22,789)
    Additional Paid-In Capital.......................................      196,711       181,076
    Deferred Compensation............................................         (473)       (1,058)
    Accumulated Other Comprehensive Gain (Loss)......................          381        (5,636)
    Accumulated Deficit..............................................      (23,061)      (55,222)
                                                                       ------------  ------------
TOTAL STOCKHOLDERS' EQUITY...........................................      156,565        96,519
                                                                       ------------  ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................... $  1,065,966  $  1,064,846
                                                                       ============  ============

See the accompanying notes to consolidated financial statements.

                                                                 2002         2001         2000
                                                              -----------  -----------  -----------
OPERATING REVENUES:
Medical Premiums............................................ $   857,741  $   718,994  $   637,769
Military Contract Revenues..................................     373,589      338,918      330,352
Professional Fees...........................................      30,923       28,985       33,102
Investment and Other Revenues...............................      16,382       16,603       18,393
                                                              -----------  -----------  -----------
   Total....................................................   1,278,635    1,103,500    1,019,616
                                                              -----------  -----------  -----------
OPERATING EXPENSES:
Medical Expenses............................................     712,290      608,757      576,738
Military Contract Expenses..................................     360,375      331,621      323,265
General and Administrative Expenses.........................     133,979      122,623      112,220
Asset Impairment, Restructuring,
     Reorganization and Other Costs.........................          --           --       30,836
                                                              -----------  -----------  -----------
   Total....................................................   1,206,644    1,063,001    1,043,059
                                                              -----------  -----------  -----------
OPERATING INCOME (LOSS) FROM CONTINUING
     OPERATIONS.............................................      71,991       40,499      (23,443)
Interest Expense............................................      (7,487)     (15,786)     (17,865)
Other Income (Expense), Net.................................        (108)      (2,071)       1,084
                                                              -----------  -----------  -----------
INCOME (LOSS) FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES....................................      64,396       22,642      (40,224)
(PROVISION) BENEFIT FOR INCOME TAXES........................     (22,088)      (7,161)       9,205
                                                              -----------  -----------  -----------
INCOME (LOSS) FROM CONTINUING OPERATIONS....................      42,308       15,481      (31,019)
LOSS FROM DISCONTINUED OPERATIONS (net of income tax
      benefit of $2,945, $5,403 and $65,020)................      (5,860)     (11,995)    (168,896)
                                                              -----------  -----------  -----------
NET INCOME (LOSS)........................................... $    36,448  $     3,486  $  (199,915)
                                                              ===========  ===========  ===========
EARNINGS PER COMMON SHARE:
    Income (Loss) From Continuing Operations................ $      1.47  $      0.56  $     (1.15)
    Loss from Discontinued Operations.......................       (0.20)       (0.43)       (6.22)
                                                              -----------  -----------  -----------
    Net Income (Loss)....................................... $      1.27  $      0.13  $     (7.37)
                                                              ===========  ===========  ===========
EARNINGS PER COMMON SHARE ASSUMING DILUTION:
    Income (Loss) From Continuing Operations................ $      1.36  $      0.54  $     (1.15)
    Loss from Discontinued Operations.......................       (0.19)       (0.42)       (6.22)
                                                              -----------  -----------  -----------
    Net Income (Loss)....................................... $      1.17  $      0.12  $     (7.37)
                                                              ===========  ===========  ===========

See the accompanying notes to consolidated financial statements.

                                                                                                                   Accumulated   Retained       Total
                                                         Common Stock        In Treasury Additional    Deferred       Other      Earnings      Stock-
                                              --------------------- -------------------    Paid-In    Compensa-    Comprehensive(Accumulated  holders'
                                                Shares     Amount    Shares     Amount     Capital       tion      Gain (Loss)   Deficit)      Equity
                                              ----------  --------- ---------  --------  -----------  ----------   -----------  -----------  -----------
BALANCE, JANUARY 1, 2000.....................    28,400  $     142     1,523  $(22,789) $   175,915  $       --   $   (16,063) $   141,207  $   278,412
Common Stock Issued in Connection
     with Stock Plans........................       415          2        --        --        1,578          --            --           --        1,580
Comprehensive Income:
   Net Loss..................................        --         --        --        --           --          --            --     (199,915)    (199,915)
   Other Comprehensive Loss:
    Unrealized Holding Gain on Available-
       for-Sale Investments ($17,065 pretax).        --         --        --        --           --          --        11,092           --       11,092
    Reclassification Adjustment for Gains
       Included in Net Income ($1,071 pretax)        --         --        --        --           --          --          (696)          --         (696)
                                                                                                                   -----------  -----------  -----------
Total Comprehensive Income (Loss)............        --         --        --        --           --          --        10,396     (199,915)    (189,519)
                                              ----------  --------- ---------  --------  -----------  ----------   -----------  -----------  -----------
BALANCE, DECEMBER 31, 2000...................    28,815        144     1,523   (22,789)     177,493          --        (5,667)     (58,708)      90,473

Common Stock Issued in Connection
     with Stock Plans........................       589          3        --        --        2,087          --            --           --        2,090
Income Tax Benefit Realized Upon
     Exercise of Stock Options...............        --         --        --        --           97          --            --           --           97
Issuance of Restricted Stock.................       244          1        --        --        1,399      (1,400)           --           --           --
Amortization of Deferred Compensation........        --         --        --        --           --         342            --           --          342
Comprehensive Income:
   Net Income................................        --         --        --        --           --          --            --        3,486        3,486
   Other Comprehensive Income:
    Unrealized Holding Gain on Available-
       for-Sale Investments ($374 pretax)....        --         --        --        --           --          --           243           --          243
    Reclassification Adjustment for Gains
       Included in Net Income ($326 pretax)..        --         --        --        --           --          --          (212)          --         (212)
                                                                                                                   -----------  -----------  -----------
Total Comprehensive Income...................        --         --        --        --           --          --            31        3,486        3,517
                                              ----------  --------- ---------  --------  -----------  ----------   -----------  -----------  -----------
BALANCE, DECEMBER 31, 2001...................    29,648        148     1,523   (22,789)     181,076      (1,058)       (5,636)     (55,222)      96,519

Common Stock Issued in Connection
     with Stock Plans........................     1,305          7      (360)    5,641        8,798          --            --       (4,287)      10,159
Income Tax Benefit Realized Upon
     Exercise of Stock Options...............        --         --        --        --        6,837          --            --           --        6,837
Amortization of Deferred Compensation........        --         --        --        --           --         585            --           --          585
Comprehensive Income:
   Net Income................................        --         --        --        --           --          --            --       36,448       36,448
   Other Comprehensive Income:
    Unrealized Holding Gain on Available-
       for-Sale Investments ($10,671 pretax).        --         --        --        --           --          --         6,936           --        6,936
    Reclassification Adjustment for Losses
       Included in Net Income ($217 pretax)..        --         --        --        --           --          --           141           --          141
    Minimum Pension Liability
       Adjustment ($1,630 pretax)............        --         --        --        --           --          --        (1,060)          --       (1,060)
                                                                                                                   -----------  -----------  -----------
Total Comprehensive Income...................        --         --        --        --           --          --         6,017       36,448       42,465
                                              ----------  --------- ---------  --------  -----------  ----------   -----------  -----------  -----------
BALANCE, DECEMBER 31, 2002...................    30,953  $     155     1,163  $(17,148) $   196,711  $     (473)  $       381  $   (23,061) $   156,565
                                              ==========  ========= =========  ========  ===========  ==========   ===========  ===========  ===========

See the accompanying notes to consolidated financial statements.

                                                                                                     
                                                                         Years Ended December 31,
                                                                   ----------------------------------
                                                                      2002        2001        2000
                                                                   ----------  ----------  ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net Income (Loss).......................................... $   36,448  $    3,486  $ (199,915)
      Adjustments to Reconcile Net Income (Loss) to Net Cash
         Provided by Operating Activities:
          Loss from Discontinued Operations......................      5,860      11,995     168,896
          Depreciation and Amortization..........................     18,245      24,184      24,145
          Deferred Compensation Expense..........................        585         342          --
          Provision for Doubtful Accounts........................      2,835       1,251       1,278
          Provision for Asset Impairment.........................         --          --      36,079
          Loss (Gain) on Property and Equipment Dispositions.....         17       2,311      (1,114)
      Change in Assets and Liabilities:
          Other Assets...........................................        (16)      2,839      (7,499)
          Deferred Tax Asset.....................................     37,931       2,107     (51,464)
          Other Current Liabilities..............................     14,660       3,853     (19,427)
          Accounts Receivable....................................      1,267      (2,921)      3,988
          Other Current Assets...................................      6,454      (2,153)      2,411
          Military Accounts Receivable...........................     (6,960)     32,436     (11,462)
          Military Health Care Payable...........................    (12,038)     (7,598)     34,028
          Medical Claims Payable.................................     16,369       7,258       9,146
          Other Liabilities......................................     14,980      18,774       8,399
                                                                   ----------  ----------  ----------
         Net Cash Provided by Operating Activities of
            Continuing Operations................................    136,637      98,164      (2,511)
                                                                   ----------  ----------  ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures.......................................    (12,392)     (7,136)    (14,674)
      Property and Equipment Dispositions........................        680       7,265      10,942
      Purchase of Available-for-Sale Investments.................   (847,437)   (130,625)    (37,865)
      Proceeds from Sales/Maturities of
          Available-for-Sale Investments.........................    712,483     107,540      57,638
                                                                   ----------  ----------  ----------
         Net Cash (Used for) Provided by Investing Activities of
            Continuing Operations................................   (146,666)    (22,956)     16,041
                                                                   ----------  ----------  ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing..........................         --          --      91,459
      Proceeds on Sale-Leaseback Deposit.........................     16,862          --          --
      Payments on Debt and Capital Leases........................    (30,399)    (53,187)    (39,225)
      Exercise of Stock in Connection with Stock Plans...........     10,159       2,090       1,580
                                                                   ----------  ----------  ----------
         Net Cash (Used for) Provided by Financing Activities of
            Continuing Operations................................     (3,378)    (51,097)     53,814
                                                                   ----------  ----------  ----------
NET CASH (USED FOR) PROVIDED
       BY DISCONTINUED OPERATIONS................................    (47,929)    (45,954)     24,566
                                                                   ----------  ----------  ----------
NET (DECREASE) INCREASE IN CASH AND
       CASH EQUIVALENTS..........................................    (61,336)    (21,843)     91,910
CASH AND CASH EQUIVALENTS AT BEGINNING
       OF YEAR...................................................    107,114     128,957      37,047
                                                                   ----------  ----------  ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR......................... $   45,778  $  107,114  $  128,957
                                                                   ==========  ==========  ==========

See the accompanying notes to consolidated financial statements.

                                                             Years ended December 31
                                                         -------------------------------
                                                           2002          2001          2000
                                                         ---------     ---------     ---------
                                                          (In thousands, except per share data)
Net income (loss), as reported......................... $  36,448     $   3,486     $(199,915)
Less: total stock-based employee compensation
   expense determined under fair value based
   methods for all awards, net of tax..................    (4,598)       (3,506)       (3,378)
                                                        ----------     ----------    ----------
Pro forma net income (loss)............................ $   31,850    $     (20)    $(203,293)
                                                         ==========    ==========    ==========

Net income (loss) per share, as reported............... $    1.27     $    0.13     $   (7.37)
Pro forma net income (loss)............................      1.11            --         (7.49)

Net income (loss) per share
    assuming dilution, as reported..................... $    1.17     $    0.12     $   (7.37)
Pro forma net income (loss)............................      1.02            --         (7.49)

                                                     Years ended December 31,
                                               ----------------------------------
                                                  2002        2001        2000
                                               ----------  ----------  ----------
                                             (In thousands, except per share data)

Income (loss) from continuing operations..... $   42,308  $   15,481  $  (31,019)
Loss from discontinued operations............     (5,860)    (11,995)   (168,896)
                                               ----------  ----------  ----------
Net income (loss)............................ $   36,448  $    3,486  $ (199,915)
                                               ==========  ==========  ==========
Earnings per common share:
Income (loss) from continuing operations..... $     1.47  $     0.56  $    (1.15)
Loss from discontinued operations............      (0.20)      (0.43)      (6.22)
                                               ----------  ----------  ----------
Net income (loss)............................ $     1.27  $     0.13  $    (7.37)
                                               ==========  ==========  ==========
Earnings per common share assuming dilution:
Income (loss) from continuing operations..... $     1.36  $     0.54  $    (1.15)
Loss from discontinued operations............      (0.19)      (0.42)      (6.22)
                                               ----------  ----------  ----------
Net income (loss)............................ $     1.17  $     0.12  $    (7.37)
                                               ==========  ==========  ==========

Weighted average common shares outstanding...     28,756      27,685      27,142
Dilutive options outstanding.................      2,141         787          --
Restricted Shares outstanding................        244          37          --
Weighted average common shares outstanding     ----------  ----------  ----------
         assuming dilution...................     31,141      28,509      27,142
                                               ==========  ==========  ==========

                                                  2002        2001
                                               ----------  ----------            
                                                    (In thousands)
Land......................................... $    2,984  $   11,147
Buildings and Improvements...................     22,415      99,472
Furniture, Fixtures and Equipment............     39,286      36,945
Data Processing Equipment and Software.......     98,216      91,060
Software in Development and Construction
   in Progress...............................        697       2,331
Less:  Accumulated Depreciation .............    (98,730)   (104,459)
                                               ----------  ----------
    Property and Equipment, Net.............. $   64,868  $  136,496
                                               ==========  ==========

                                                  2002        2001
                                               ----------  ----------            
                                                 ( In thousands)
Buildings and Improvements................... $      245  $      245
Data Processing Equipment and Software.......        333         333
Less: Accumulated Depreciation...............       (413)       (316)
                                               ----------  ----------
   Property and Equipment, Net............... $      165  $      262
                                               ==========  ==========

                                                                 Amortized   Unrealized  Unrealized     Fair
                                                                    Cost       Gains       Losses      Value
                                                                 ----------  ----------  ----------  ----------
                                                                                    (In thousands)
Available-for-Sale Investments:
Classified as Current:
    U.S. Government and its Agencies........................... $   35,338  $      747  $       19  $   36,066
    Municipal Obligations......................................     87,701          21          83      87,639
    Corporate Bonds............................................     54,845           4          --      54,849
    Other Debt Securities......................................      1,161           4          --       1,165
                                                                 ----------  ----------  ----------  ----------
       Total Debt Securities...................................    179,045         776         102     179,719
    Preferred Stock............................................      2,754          20          41       2,733
                                                                 ----------  ----------  ----------  ----------
 Total Current.................................................    181,799         796         143     182,452
                                                                 ----------  ----------  ----------  ----------
Classified as Restricted:
    U.S. Government and its Agencies...........................      8,785         208          --       8,993
    Municipal Obligations......................................      1,397          43          10       1,430
    Other Debt Securities......................................      7,134          --          --       7,134
                                                                 ----------  ----------  ----------  ----------
 Total Restricted..............................................     17,316         251          10      17,557
                                                                 ----------  ----------  ----------  ----------
          Total Available-for-Sale............................. $  199,115  $    1,047  $      153  $  200,009
                                                                 ==========  ==========  ==========  ==========

                                                                               Gross       Gross
                                                                 Amortized   Unrealized  Unrealized     Fair
                                                                    Cost       Gains       Losses      Value
                                                                 ----------  ----------  ----------  ----------
                                                                                    (In thousands)
Available-for-Sale Investments:
Classified as Current:
    U.S. Government and its Agencies........................... $   36,093  $       --  $    1,277  $   34,816
    Municipal Obligations......................................     14,188          --         341      13,847
    Other Debt Securities......................................        851          --          --         851
                                                                 ----------  ----------  ----------  ----------
       Total Debt Securities...................................     51,132          --       1,618      49,514
    Preferred Stock............................................      3,013          --          29       2,984
                                                                 ----------  ----------  ----------  ----------
 Total Current.................................................     54,145          --       1,647      52,498
                                                                 ----------  ----------  ----------  ----------
Classified as Restricted:
    U.S. Government and its Agencies...........................      6,532          90         317       6,305
    Municipal Obligations......................................      1,348          39          --       1,387
    Other......................................................      2,029          --          --       2,029
                                                                 ----------  ----------  ----------  ----------
 Total Restricted..............................................      9,909         129         317       9,721
                                                                 ----------  ----------  ----------  ----------
          Total Available-for-Sale............................. $   64,054  $      129  $    1,964  $   62,219
                                                                 ==========  ==========  ==========  ==========

                                                                Amortized      Fair
                                                                    Cost       Value
                                                                 ----------  ----------            
                                                                     (In thousands)
Due in one year of less........................................ $   88,842  $   88,877
Due after one year through five years..........................     55,212      55,719
Due after five years through ten years.........................     16,736      16,688
Due after ten years through fifteen years......................      6,700       6,702
Due after fifteen years........................................     28,871      29,290
                                                                 ----------  ----------
    Total...................................................... $  196,361  $  197,276
                                                                 ==========  ==========

                                                                    2002        2001
                                                                 ----------  ----------            
                                                                      (In thousands)
Revolving Credit Facility...................................... $   60,000  $   89,000
Net Financing Obligations......................................         --      73,948
Other..........................................................        896       1,236
                                                                 ----------  ----------
  Total........................................................     60,896     164,184
Less Current Portion...........................................       (186)       (191)
                                                                 ----------  ----------
Long-term Debt................................................. $   60,710  $  163,993
                                                                 ==========  ==========

                                                                             Obligations
                                                                   Notes     Under Capital
                                                                  Payable      Leases
                                                                 ----------  ----------            
                                                                     (In thousands)                
Years ending December 31,                                                                          
    2003....................................................... $       93  $      121
    2004.......................................................         31          83
    2005 ......................................................         32          31
    2006.......................................................     60,033          31
    2007.......................................................         34          31
    Thereafter.................................................        362         153
                                                                 ----------  ----------
       Total................................................... $   60,585         450
                                                                 ==========
    Less:  Amounts Representing Interest.......................                   (139)
                                                                             ----------
    Present Value of Minimum Lease Payments....................             $      311
                                                                             ==========

                                                                    2002        2001        2000               
                                                                 ----------  ----------  ----------
                                                                             (In thousands)
Provision (Benefit) for Income Taxes:
   Current..................................................... $  (11,498) $   (2,763) $   (1,656)
   Deferred....................................................     33,586       9,924      (7,549)
                                                                 ----------  ----------  ----------
     Total..................................................... $   22,088  $    7,161  $   (9,205)
                                                                 ==========  ==========  ==========

                                                                    2002        2001        2000               
                                                                 ----------  ----------  ----------
Statutory Rate.................................................         35 %        35 %       (35)%
State Income Taxes.............................................         --          (1)          1
Tax Preferred Investments......................................         (1)         (1)         (1)
Change in Valuation Allowance..................................         (3)         (2)         (3)
Intangible Amortization........................................         --           1          14
Compensation and Benefit Plans.................................          3           1          --
Other..........................................................         --          (1)          1
                                                                 ----------  ----------  ----------
Provision (Benefit) for Income Taxes...........................         34 %        32 %       (23)%
                                                                 ==========  ==========  ==========

                                                                    2002        2001               
                                                                 ----------  ----------
                                                                    (In thousands)
Deferred Tax Assets:
    Medical Claims Payable and
      Losses and Loss Adjustment Expense Reserves..............     $15,611     $10,502
    Accruals Not Currently Deductible..........................      16,125      16,542
    Compensation Accruals......................................      11,259       9,974
    Bad Debt Allowances........................................       3,140       4,091
    Loss Carryforwards and Credits.............................      28,696      59,756
    Depreciation and Amortization..............................       3,642       5,038
    Unearned Premiums..........................................       2,976       1,757
    Deferred Reinsurance Gains.................................       1,806       2,022
    Unrealized Investment (Gains) Losses.......................        (777)      3,033
    Other......................................................         844         190
                                                                  ----------  ----------
     Total....................................................       83,322     112,905
                                                                  ----------  ----------

Deferred Tax Liabilities:
    Deferred Policy Acquisition Costs..........................         758         741
    Other......................................................         242         947
                                                                  ----------  ----------
    Total....................................................         1,000       1,688
                                                                  ----------  ----------
    Net Deferred Tax Asset....................................     $ 82,322    $111,217
                                                                  ==========  ==========

                                                                    2002        2001
                                                                 ----------  ----------   
Deferred Tax Assets:                                                 (In thousands)
    Medical Claims Payable..................................... $    4,587  $    5,099
    Accruals Not Currently Deductible..........................     15,162      14,592
    Compensation Accruals......................................     10,772       9,190
    Bad Debt Allowances........................................      2,769       3,600
    Loss Carryforwards and Credits.............................     28,544      58,163

    Unrealized Investment (Gains) Losses.......................       (353)        645
    Depreciation and Amortization..............................      3,650       5,294
    Other......................................................        218         243
                                                                 ----------  ----------
      Total....................................................     65,349      96,826
                                                                 ----------  ----------
Deferred Tax Liabilities:
    Other......................................................        849         554
                                                                 ----------  ----------
      Total....................................................        849         554
                                                                 ----------  ----------
    Net Deferred Tax Asset..................................... $   64,500  $   96,272
                                                                 ==========  ==========

                                                                        Years ended December 31,
                                                                 ----------------------------------
                                                                    2002        2001        2000
                                                                 ----------  ----------  ----------
                                                                             (In thousands)
  Operating Revenues........................................... $    4,791  $  181,132  $  233,398
                                                                 ----------  ----------  ----------

  Medical Expenses.............................................     (8,933)    175,333     233,652
  General and  Administrative Expenses.........................      1,906      29,607      31,346
  Asset Impairment, Restructuring,
     Reorganization and Other Costs............................      5,000      (1,250)    186,604
  Interest Expense and Other, Net..............................     (6,216)     (1,532)      4,268
                                                                 ----------  ----------  ----------
  Income (Loss) from Discontinued Operations Before Income Tax.     13,034     (21,026)   (222,472)
  Income Tax (Provision) Benefit...............................     (4,562)      7,046      61,350
                                                                 ----------  ----------  ----------
  Income (Loss) from Discontinued Operations................... $    8,472  $  (13,980) $ (161,122)
                                                                 ==========  ==========  ==========

                                              Restructuring
                                   Asset           and            Premium
                                  Impair-        Reorgan-       Deficiency
                                   ment          ization        Maintenance     Other      Total
                                -----------  ----------------  -------------  ---------  ---------
                                                               (In thousands)
Balance, January 1, 2000...... $        --  $             --  $      11,000  $      --  $  11,000
Charges recorded..............     162,937            11,509         10,358      1,800    186,604
Cash used.....................                        (7,754)       (12,080)      (200)   (20,034)
Noncash activity..............    (162,937)               --             --       (800)  (163,737)
Changes in estimate...........          --                --             --         --         --
                                -----------  ----------------  -------------  ---------  ---------
Balance, December 31, 2000....          --             3,755          9,278        800     13,833
Charges recorded..............       1,600             4,380            570         --      6,550
Cash used.....................          --            (3,716)        (1,478)      (800)    (5,994)
Noncash activity..............      (1,600)             (125)            --         --     (1,725)
Changes in estimate...........          --                --         (7,800)        --     (7,800)
                                -----------  ----------------  -------------  ---------  ---------
Balance, December 31, 2001....          --             4,294            570         --      4,864
Charges recorded..............          --                --             --         --         --
Cash used.....................          --            (2,490)          (570)        --     (3,060)
Noncash activity..............          --            (4,222)            --         --     (4,222)
Changes in estimate...........          --             5,000             --         --      5,000
                                -----------  ----------------  -------------  ---------  ---------
Balance, December 31, 2002.... $        --  $          2,582  $          --  $      --  $   2,582
                                ===========  ================  =============  =========  =========

                                                                  December 31,
                                                             -------------------------
                                                                2002          2001
                                                             -----------  ------------             
                                                                  (In thousands)
ASSETS
Cash and Cash Equivalents.................................. $        --  $         --
Investments................................................       4,263         4,274
Other Assets...............................................         916         4,023
Property and Equipment, Net................................      11,967        20,107
                                                             -----------  ------------
TOTAL ASSETS...............................................      17,146        28,404
                                                             -----------  ------------
LIABILITIES
Accounts Payable and Other Liabilities.....................       9,059        16,475
Medical Claims Payable.....................................       1,754        36,567
Premium Deficiency Reserve.................................          --         1,700
Mortgage Loan..............................................      14,961        29,189
                                                             -----------  ------------
TOTAL LIABLIITIES..........................................      25,774        83,931
                                                             -----------  ------------
NET LIABILITIES OF DISCONTINUED OPERATIONS................. $    (8,628) $    (55,527)
                                                             ===========  ============

                                                                    December 31,
                                                             -------------------------
                                                                2002          2001
                                                             -----------  ------------             
                                                                  (In thousands)
ASSETS
Cash and Cash Equivalents.................................. $    23,060  $      8,641
Investments................................................     287,242       231,987
Reinsurance Recoverable....................................     189,409       218,079
Property and Equipment, Net................................       2,167         4,955
Other Assets...............................................      46,034        41,607
                                                             -----------  ------------
TOTAL ASSETS...............................................     547,912       505,269
                                                             ----------  ------------

LIABILITIES
Accounts Payable and Other Accrued Expenses................      30,989        28,919
Senior Debentures..........................................      16,765        18,187
Reserve for Loss and Loss Adjustment Expenses..............     427,192       385,705
                                                             -----------  ------------
TOTAL LIABILITIES..........................................     474,946       432,811
                                                             -----------  ------------
NET ASSETS OF DISCONTINUED OPERATIONS...................... $    72,966  $     72,458
                                                             ===========  ============

                                                             Years ended December 31,
                                                         -------------------------------
                                                           2002       2001       2000
                                                         ---------  ---------  ---------
OPERATING REVENUES:                                                 (In thousands)
Specialty Product Revenues............................. $ 176,189  $ 173,215  $ 125,555
Investment and Other Revenues..........................    12,633     14,786     14,409
                                                         ---------  ---------  ---------
    Total Revenues.....................................   188,822    188,001    139,964
                                                         ---------  ---------  ---------

OPERATING EXPENSES:
Specialty Product Expenses.............................   209,601    183,666    145,827
Asset Impairment.......................................        --         --      3,000
Interest Expense and Other, Net........................     1,059        707      2,581
                                                         ---------  ---------  ---------
    Total Operating Expenses...........................   210,660    184,373    151,408
                                                         ---------  ---------  ---------

(Loss) Income from Discontinued Operations
   Before Income Tax ..................................   (21,838)     3,628    (11,444)

Income Tax Benefit (Provision).........................     7,506     (1,643)     3,670
                                                         ---------  ---------  ---------
Net (Loss) Income from Discontinued Operations......... $ (14,332) $   1,985  $  (7,774)
                                                         =========  =========  =========

                                                  2002        2001
                                               ----------  ----------            
                                                   (In thousands)
Land......................................... $      116  $      116
Buildings and Improvements...................      1,522       2,350
Furniture, Fixtures and Equipment............         70       2,620
Data Processing Equipment and Software.......      3,534       5,345
Software in Development and Construction
   in Progress...............................         45          93
Less: Accumulated Depreciation...............     (3,120)     (5,569)
                                               ----------  ----------
    Property and Equipment, Net.............. $    2,167  $    4,955
                                               ==========  ==========

                                                                 Amortized   Unrealized  Unrealized     Fair
                                                                    Cost       Gains       Losses      Value
                                                                 ----------  ----------  ----------  ----------
Available-for-Sale Investments:                                                    (In thousands)
Classified as Current:
    U.S. Government and its Agencies........................... $  164,404  $    2,729  $      423  $  166,710
    Municipal Obligations......................................     65,454         338         501      65,291
    Corporate Bonds............................................     19,830          49       1,919      17,960
    Other......................................................     10,987          46          25      11,008
                                                                 ----------  ----------  ----------  ----------
       Total Debt Securities...................................    260,675       3,162       2,868     260,969
    Preferred Stock............................................      5,939         210          22       6,127
                                                                 ----------  ----------  ----------  ----------
 Total Current.................................................    266,614       3,372       2,890     267,096
                                                                 ----------  ----------  ----------  ----------
Classified as Restricted:
    U.S. Government and its Agencies...........................     12,489         711                  13,200
    Municipal Obligations......................................        974          62                   1,036
    Corporate Bonds............................................        756           5                     761
                                                                 ----------  ----------  ----------  ----------
 Total Restricted..............................................     14,219         778          --      14,997
                                                                 ----------  ----------  ----------  ----------
          Total Available-for-Sale............................. $  280,833  $    4,150  $    2,890  $  282,093
                                                                 ==========  ==========  ==========  ==========

Held-to-Maturity Investments:
Classified as Current:
   Corporate Bonds............................................. $      799  $        3  $           $      802
                                                                 ----------  ----------  ----------  ----------
Classified as Long-term:
    U.S. Government and its Agencies...........................        662          10                     672
    Municipal Obligations......................................        328          25                     353
    Corporate Bonds............................................      1,749         113                   1,862
                                                                 ----------  ----------  ----------  ----------
Total Long-term................................................      2,739         148          --       2,887
                                                                 ----------  ----------  ----------  ----------
Classified as Restricted:
    Municipal Obligations......................................        637          49                     686
    Corporate Bonds............................................        974          39                   1,013
                                                                 ----------  ----------  ----------  ----------
Total Restricted...............................................      1,611          88          --       1,699
                                                                 ----------  ----------  ----------  ----------
          Total Held-to-Maturity............................... $    5,149  $      239  $       --  $    5,388
                                                                 ==========  ==========  ==========  ==========

                                                                               Gross       Gross
                                                                 Amortized   Unrealized  Unrealized     Fair
                                                                    Cost       Gains       Losses      Value
                                                                 ----------  ----------  ----------  ----------
                                                                                   (In thousands)
Available-for-Sale Investments:
Classified as Current:
    U.S. Government and its Agencies........................... $  174,856  $    1,129  $    6,214  $  169,771
    Municipal Obligations......................................      2,087          30          53       2,064
    Corporate Bonds............................................     28,572          81       2,051      26,602
                                                                 ----------  ----------  ----------  ----------
       Total Debt Securities...................................    205,515       1,240       8,318     198,437
    Preferred Stock............................................      5,871          34          21       5,884
                                                                 ----------  ----------  ----------  ----------
 Total Current.................................................    211,386       1,274       8,339     204,321
                                                                 ----------  ----------  ----------  ----------
Classified as Restricted:
    U.S. Government and its Agencies...........................     11,145         262          57      11,350
    Municipal Obligations......................................        977          12          12         977
    Corporate Bonds............................................      1,495          35                   1,530
                                                                 ----------  ----------  ----------  ----------
 Total Restricted..............................................     13,617         309          69      13,857
                                                                 ----------  ----------  ----------  ----------
          Total Available-for-Sale............................. $  225,003  $    1,583  $    8,408  $  218,178
                                                                 ==========  ==========  ==========  ==========

Held-to-Maturity Investments:
Classified as Current:
    Corporate Bonds............................................ $    2,999  $       22  $           $    3,021
                                                                 ----------  ----------  ----------  ----------
 Total Current.................................................      2,999          22          --       3,021
                                                                 ----------  ----------  ----------  ----------

Classified as Long-term:
    U.S. Government and its Agencies...........................      5,608                     258       5,350
    Municipal Obligations......................................        328                      15         313
    Corporate Bonds............................................      2,498         175                   2,673
                                                                 ----------  ----------  ----------  ----------
Total Long-term  ..............................................      8,434         175         273       8,336
                                                                 ----------  ----------  ----------  ----------
Classified as Restricted:
    U.S. Government and its Agencies...........................        626          24                     650
    Municipal Obligations......................................        636                      29         607
    Corporate Bonds............................................      1,114          42                   1,156
                                                                 ----------  ----------  ----------  ----------
Total Restricted ..............................................      2,376          66          29       2,413
                                                                 ----------  ----------  ----------  ----------
          Total Held-to-Maturity............................... $   13,809  $      263  $      302  $   13,770
                                                                 ==========  ==========  ==========  ==========

                                                                 Amortized      Fair
                                                                    Cost       Value
                                                                 ----------  ----------            
                                                                    (In thousands)
Due in one year or less........................................ $   56,532  $   56,835
Due after one year through five years..........................     56,321      57,103
Due after five years through ten years.........................     32,216      32,682
Due after ten years through fifteen years......................     15,061      15,595
Due after fifteen years........................................    114,764     113,751
                                                                 ----------  ----------
     Total..................................................... $  274,894  $  275,966
                                                                 ==========  ==========

                                                                 Amortized      Fair
                                                                    Cost       Value
                                                                 ----------  ----------            
                                                                      (In thousands)
Due in one year or less........................................ $    1,274  $    1,277
Due after one year through five years..........................      2,248       2,400
Due after five years through ten years.........................
Due after ten years through fifteen years......................
Due after fifteen years........................................      1,627       1,711
                                                                 ----------  ----------
     Total..................................................... $    5,149  $    5,388
                                                                 ==========  ==========

                                                                             Change in
                                                                 Recoveries  Recoverable
                                                                  on Paid    on Unpaid    Premiums
                                                                 Losses/LAE  Losses/LAE    Ceded
                                                                 ----------  ----------  ----------
                                                                             (In thousands)
Year Ended December 31, 2002:
 Low level reinsurance carrier................................. $   60,314  $  (37,854) $   (2,184)
 Excess of loss reinsurance carriers...........................      2,308      19,403       2,617
                                                                 ----------  ----------  ----------
 Total ........................................................ $   62,622  $  (18,451) $      433
                                                                 ==========  ==========  ==========
Year Ended December 31, 2001:
 Low level reinsurance carrier................................. $   80,932  $  (40,430) $    9,136
 Excess of loss reinsurance carriers...........................      4,407       9,125       4,244
                                                                 ----------  ----------  ----------
 Total ........................................................ $   85,339  $  (31,305) $   13,380
                                                                 ==========  ==========  ==========
Year Ended December 31, 2000:
 Low level reinsurance carrier................................. $   53,408  $  100,240  $   74,071
 Excess of loss reinsurance carriers...........................      2,324       8,428       3,449
                                                                 ----------  ----------  ----------
 Total ........................................................ $   55,732  $  108,668  $   77,520
                                                                 ==========  ==========  ==========

                                                                    2002        2001        2000
                                                                 ----------  ----------  ----------
                                                                             (In thousands)
Net Beginning Losses and LAE Reserve .......................... $  198,252  $  155,797  $  134,305
                                                                 ----------  ----------  ----------
Net Provision for Insured Events Incurred in:
   Current Year ...............................................    139,513     131,923      86,587
   Prior Years.................................................     23,998       8,691      23,293
                                                                 ----------  ----------  ----------
     Total Net Provision.......................................    163,511     140,614     109,880
                                                                 ----------  ----------  ----------
Net Payments for Losses and LAE
   Attributable to Insured Events Incurred in:
   Current Year ...............................................     29,448      28,560      26,867
   Prior Years.................................................     74,125      69,599      61,521
                                                                 ----------  ----------  ----------
     Total Net Payments .......................................    103,573      98,159      88,388
                                                                 ----------  ----------  ----------
Net Ending Losses and LAE Reserve .............................    258,190     198,252     155,797
Reinsurance Recoverable .......................................    169,002     187,453     218,757
                                                                 ----------  ----------  ----------
Gross Ending Losses and LAE Reserve ........................... $  427,192  $  385,705  $  374,554
                                                                 ==========  ==========  ==========

                                                                                                   
Years Ended December 31,                                     (In thousands)                        

   2003.................................................... $    18,428
   2004....................................................      17,819
   2005....................................................      17,161
   2006....................................................      16,603
   2007....................................................      16,202
   Thereafter..............................................     123,420
                                                             -----------
         Total............................................. $   209,633
                                                             ===========

                                                                      Years ended December 31,
                                                             --------------------------------------
                                                                2002          2001         2000
                                                             -----------  ------------  -----------
                                                                          (In thousands)
Changes in Projected Benefit Obligation:
Projected Benefit Obligation at Beginning of Period........ $    19,143  $     13,698  $    12,813
Service Cost ..............................................         292           322          365
Interest Cost .............................................       1,375         1,162          887
Actuarial Losses (Gains)...................................       3,435         4,745         (174)
Benefits Paid .............................................        (784)         (784)        (193)
                                                             -----------  ------------  -----------
Projected Benefit Obligation at End of Period.............. $    23,461  $     19,143  $    13,698
                                                             ===========  ============  ===========

Fair Value of Plan Assets at End of Period (1)............. $        --  $         --  $        --
                                                             ===========  ============  ===========

Funded Status of the Plan ................................. $   (23,461) $    (19,143) $   (13,698)
Unrecognized Net Actuarial (Gain)/Loss.....................       6,761         3,900         (685)
Unrecognized Prior Service Credit .........................       5,640         6,566        7,491
                                                             -----------  ------------  -----------
Accrued Net Benefit Costs ................................. $   (11,060) $     (8,677) $    (6,892)
                                                             ===========  ============  ===========
Amounts Recognized in the Consolidated Balance Sheets:
Accrued Net Benefit Costs ................................. $   (11,060) $     (8,677) $    (6,892)
Additional Minimum Liability ..............................      (7,270)       (7,773)      (3,459)
Intangible Asset ..........................................       5,640         7,773        3,459
Accumulated Other Comprehensive Loss.......................       1,630            --           --
                                                             -----------  ------------  -----------
Net Liability Reflected in the Consolidated Balance Sheets: $   (11,060) $     (8,677) $    (6,892)
                                                             ===========  ============  ===========

Assumptions:
Discount Rate .............................................         6.5%          7.0%         7.0%
Rate of Compensation Increase .............................         3.0%          3.0%         3.0%

Components of Net Periodic Benefit Cost:
Service Cost............................................... $       292  $        322  $       365
Interest Cost .............................................       1,375         1,162          887
Amortization of Prior Service Credits......................         925           925          925
Recognized Actuarial Loss (Gain)...........................         575           159          (20)
                                                             -----------  ------------  -----------
Net Periodic Benefit Cost.................................. $     3,167  $      2,568  $     2,157
                                                             ===========  ============  ===========

                                                               Number                    Weighted
                                                                 of          Option       Average
                                                               Shares        Price         Price
                                                             -----------  ------------  -----------
                                                                (Number of shares in thousands)

Outstanding January 1, 2000................................       3,904  $6.31 - 24.69 $     15.37
   Granted.................................................       2,458   3.13 -  7.19        3.87
   Canceled................................................      (2,112)  3.75 - 24.69       18.17
                                                             -----------
Outstanding December 31, 2000..............................       4,250   3.13 - 24.69        7.31
   Granted.................................................       2,218   4.24 -  8.93        6.57
   Exercised...............................................         (72)  3.75 -  8.00        5.25
   Canceled................................................        (393)  3.19 - 24.69       10.98
                                                             -----------
Outstanding December 31, 2001..............................       6,003   3.13 - 24.69        6.81
   Granted.................................................         944   8.13 -  13.17      10.88
   Exercised...............................................        (995)  3.25 -  22.38       5.73
   Canceled................................................        (100)  3.25 - 24.69       11.32
                                                             -----------
Outstanding December 31, 2002..............................       5,852   3.13 - 24.69        7.56
                                                             ===========

Exercisable at December 31, 2002...........................       1,866   3.13 - 24.69        8.55
                                                             ===========

Available for Grant at December 31, 2002...................       1,462
                                                             ===========

                                                                          Weighted Average
                     Weighted Average            Options                  Exercise Price
 Range of Exercise   Contractual Life -----------------------  ------------------------
       Price         Remaining in DaysOutstanding Exercisable  Outstanding  Exercisable
-------------------- ---------------- ----------- -----------  -----------  -----------
  $3.13   -  3.75         2,709            1,515         297  $      3.71  $      3.68
   4.24   -  5.73         3,031            1,409         581         5.55         5.68
   6.19   -  8.93         2,186            1,837         672         8.21         8.08
    9.91 -  24.69         2,801            1,091         316        14.40        19.37

                                                             Years ended December 31,
                                                         -------------------------------
                                                           2002       2001       2000
                                                         ---------  ---------  ---------
                                                                 (In thousands)
Cash Paid During the Year for Interest
     (Net of Amount Capitalized)....................... $   7,205  $  17,164  $  23,704
Cash Received During the Year
     for Income Taxes..................................   (12,796)      (221)   (10,615)
Non-cash Investing and Financing Activities:
     Retired Sale-Leaseback Assets, Liabilities
       and Financing Obligations.......................    89,751     14,552         --
     Note Received for Sale of Investment..............        --         --      3,700
     Stock Issued for Exercise of Options
       and Related Tax Benefits........................     6,837         97         --
     Additions to Capital Leases.......................        --         --      1,835
     Debentures Exchanged..............................        --     19,692         --

                                                   Restructuring
                                         Asset         and
                                      Impairment   Reorganization  Other      Total
                                      -----------  ------------  ---------  ---------
                                                     (In thousands)
  Balance, January 1, 2000.......... $        --  $         --  $   3,449  $   3,449
  Charges recorded..................      24,553         1,983      4,300     30,836
  Cash used.........................          --        (1,389)      (302)    (1,691)
  Noncash activity..................     (24,553)           --     (3,000)   (27,553)
  Changes in estimate...............          --            --         --         --
                                      -----------  ------------  ---------  ---------
  Balance, December 31, 2000........          --           594      4,447      5,041
  Charges recorded..................          --            --         --         --
  Cash used.........................          --          (594)        --       (594)
  Noncash activity..................          --            --         --         --
  Changes in estimate...............          --            --         --         --
                                      -----------  ------------  ---------  ---------
  Balance, December 31, 2001........          --            --      4,447      4,447
  Charges recorded..................          --            --         --         --
  Cash used.........................          --            --         --         --
  Noncash activity..................          --            --       (500)      (500)
  Changes in estimate...............          --            --         --         --
                                      -----------  ------------  ---------  ---------
  Balance, December 31, 2002........ $        --  $         --  $   3,947  $   3,947
                                      ===========  ============  =========  =========

                                                            Managed    Military
                                                            Care and     Health
                                                           Corporate    Services
                                                           Operations  Operations    Total
                                                           ----------  ----------  ----------            
                                                                       (In thousands)                    
Year Ended December 31, 2002                                                                             
Medical Premiums......................................... $  857,741  $       --  $  857,741
Military Contract Revenues...............................         --     373,589     373,589
Professional Fees........................................     30,923          --      30,923
Investment and Other Revenues............................     14,305       2,077      16,382
                                                           ----------  ----------  ----------
   Total Revenue......................................... $  902,969  $  375,666  $1,278,635
                                                           ==========  ==========  ==========

Segment Operating Profit ................................ $   56,700  $   15,291  $   71,991
Interest Expense Other...................................     (7,455)        (32)     (7,487)
Other Income (Expense), Net..............................       (309)        201        (108)
                                                           ----------  ----------  ----------
Income from Continuing Operations
     Before Income Taxes................................. $   48,936  $   15,460  $   64,396
                                                           ==========  ==========  ==========

Segment Assets........................................... $  387,097  $  113,811  $  500,908
Capital Expenditures.....................................    (10,829)     (1,563)    (12,392)
Depreciation and Amortization............................     15,730       2,515      18,245
                                                                                                         
Year Ended December 31, 2001                                                                             
Medical Premiums......................................... $  718,994  $       --  $  718,994
Military Contract Revenues...............................         --     338,918     338,918
Professional Fees........................................     28,985          --      28,985
Investment and Other Revenues............................     14,199       2,404      16,603
                                                           ----------  ----------  ----------
   Total Revenue......................................... $  762,178  $  341,322  $1,103,500
                                                           ==========  ==========  ==========

Segment Operating Profit ................................ $   30,798  $    9,701  $   40,499
Interest Expense Other...................................    (15,693)        (93)    (15,786)
Other Income (Expense), Net..............................     (2,175)        104      (2,071)
                                                           ----------  ----------  ----------
Income from Continuing Operations
     Before Income Taxes................................. $   12,930  $    9,712  $   22,642
                                                           ==========  ==========  ==========

Segment Assets........................................... $  413,871  $  117,302  $  531,173
Capital Expenditures.....................................      5,759       1,377       7,136
Depreciation and Amortization (1)........................     20,159       4,025      24,184
                                                                                                         
Year Ended December 31, 2000                                                                             
Medical Premiums......................................... $  637,769  $       --  $  637,769
Military Contract Revenues...............................         --     330,352     330,352
Professional Fees........................................     33,102          --      33,102
Investment and Other Revenues............................     17,488         905      18,393
                                                           ----------  ----------  ----------
   Total Revenue......................................... $  688,359  $  331,257  $1,019,616
                                                           ==========  ==========  ==========

Segment Operating Profit (2)............................. $   25,412  $    7,992  $   33,404
Interest Expense Other...................................    (17,511)       (354)    (17,865)
Other Income (Expense), Net..............................      1,341        (257)      1,084
Changes in Estimate Charges (3)..........................    (26,011)         --     (26,011)
Asset Impairment, Restructuring,
     Reorganization and Other Costs......................    (30,836)         --     (30,836)
                                                           ----------  ----------  ----------
(Loss) Income from Continuing Operations
     Before Income Taxes................................. $  (47,605) $    7,381  $  (40,224)
                                                           ==========  ==========  ==========

Segment Assets........................................... $  485,208  $  115,520  $  600,728
Capital Expenditures.....................................     13,957         717      14,674
Depreciation and Amortization (1)........................     21,219       2,926      24,145

Year Ended December 31, 2001
                                                             Adjustments
                                                             for Amortization
                                               As Reported   of Goodwill  As Adjusted
                                               ------------  -----------  ------------
                                                (In thousands, except per share data)

Income from Continuing Operations............ $     15,481  $       523  $     16,004
Loss from Discontinued Operations............      (11,995)          --       (11,995)
                                               ------------  -----------  ------------
   Net Income................................ $      3,486  $       523  $      4,009
                                               ============  ===========  ============

Earnings per Common Share:
----------------------------
Income from Continuing Operations............ $       0.56  $      0.02  $       0.58
Loss from Discontinued Operations............        (0.43)          --         (0.43)
                                               ------------  -----------  ------------
   Net Income................................ $       0.13  $      0.02  $       0.15
                                               ============  ===========  ============

Earnings per Common Share Assuming Dilution:
---------------------------------------------
Income from Continuing Operations............ $       0.54  $      0.02  $       0.56
Loss from Discontinued Operations............        (0.42)          --         (0.42)
                                               ------------  -----------  ------------
   Net Income................................ $       0.12  $      0.02  $       0.14
                                               ============  ===========  ============

Year Ended December 31, 2000
                                                             Adjustments
                                                             for Amortization
                                               As Reported   of Goodwill  As Adjusted
                                               ------------  -----------  ------------
                                                (In thousands, except per share data)

(Loss) Income from Continuing Operations..... $    (31,019) $       735  $    (30,284)
(Loss) Income from Discontinued Operations...     (168,896)       1,100      (167,796)
                                               ------------  -----------  ------------
   Net (Loss) Income......................... $   (199,915) $     1,835  $   (198,080)
                                               ============  ===========  ============

Earnings per Common Share:
----------------------------
(Loss) Income from Continuing Operations..... $      (1.15) $      0.03  $      (1.12)
(Loss) Income from Discontinued Operations...        (6.22)        0.04         (6.18)
                                               ------------  -----------  ------------
   Net (Loss) Income......................... $      (7.37) $      0.07  $      (7.30)
                                               ============  ===========  ============

Earnings per Common Share Assuming Dilution:
---------------------------------------------
(Loss) Income from Continuing Operations..... $      (1.15) $      0.03  $      (1.12)
(Loss) Income from Discontinued Operations...        (6.22)        0.04         (6.18)
                                               ------------  -----------  ------------
   Net (Loss) Income......................... $      (7.37) $      0.07  $      (7.30)
                                               ============  ===========  ============

                                                             March        June     September    December
Quarter Ended 2002:                                            31          30          30          31
                                                           ----------  ----------  ----------  ----------
                                                                (In thousands, except per share data)


  Operating Revenues as Reported......................... $  348,580  $  363,968  $  381,324  $  326,902
  Reclassification for Discontinued Operations...........     44,832      47,000      50,307          --
                                                           ----------  ----------  ----------  ----------
  Operating Revenues.....................................    303,748     316,968     331,017     326,902
                                                           ----------  ----------  ----------  ----------

  Operating Income from Continuing Operations as Reported     13,976      17,777      19,561      19,645
  Reclassification for Discontinued Operations...........        463         (31)     (1,464)         --
                                                           ----------  ----------  ----------  ----------
  Operating Income from Continuing Operations............     13,513      17,808      21,025      19,645
                                                           ----------  ----------  ----------  ----------

  Income from Continuing Operations as Reported..........      7,381      10,523      12,135      12,229
  Reclassification for Discontinued Operations...........        239         (20)       (259)         --
                                                           ----------  ----------  ----------  ----------
  Income from Continuing Operations......................      7,142      10,543      12,394      12,229
                                                           ----------  ----------  ----------  ----------
  Net Income............................................. $    7,381  $   10,523  $   14,063  $    4,481
                                                           ==========  ==========  ==========  ==========

  Basic earnings per share:
     Income from Continuing Operations as Reported....... $     0.26  $     0.37  $     0.42  $     0.41
     Reclassification for Discontinued Operations........       0.01          --          --          --
                                                           ----------  ----------  ----------  ----------
     Income from Continuing Operations...................       0.25        0.37        0.42        0.41
                                                           ----------  ----------  ----------  ----------
     Net Income ......................................... $     0.26  $     0.37  $     0.48  $     0.15
                                                           ==========  ==========  ==========  ==========

  Diluted earnings per share:
     Income from Continuing Operations as Reported....... $     0.25  $     0.34  $     0.38  $     0.39
     Reclassification for Discontinued Operations........       0.01          --       (0.01)         --
                                                           ----------  ----------  ----------  ----------
     Income from Continuing Operations...................       0.24        0.34        0.39        0.39
                                                           ----------  ----------  ----------  ----------
     Net Income.......................................... $     0.25  $     0.34  $     0.44  $     0.14
                                                           ==========  ==========  ==========  ==========

                                                             March        June     September    December
Quarter Ended 2001:                                            31          30          30          31
                                                           ----------  ----------  ----------  ----------
                                                                (In thousands, except per share data)

  Operating Revenues as Reported......................... $  303,228  $  318,327  $  330,854  $  339,092
  Reclassification for Discontinued Operations...........     43,385      46,076      50,061      48,479
                                                           ----------  ----------  ----------  ----------
  Operating Revenues.....................................    259,843     272,251     280,793     290,613
                                                           ----------  ----------  ----------  ----------

  Operating Income from Continuing Operations as Reported     10,062      11,391      10,758      12,621
  Reclassification for Discontinued Operations...........      1,021       1,931         545         836
                                                           ----------  ----------  ----------  ----------
  Operating Income from Continuing Operations............      9,041       9,460      10,213      11,785
                                                           ----------  ----------  ----------  ----------

  Income from Continuing Operations as Reported..........      3,466       3,777       4,572       5,651
  Reclassification for Discontinued Operations...........        (84)      1,711         277          81
                                                           ----------  ----------  ----------  ----------
  Income from Continuing Operations......................      3,550       2,066       4,295       5,570
                                                           ----------  ----------  ----------  ----------
  Net Income (Loss)...................................... $    3,205  $    2,795  $   (7,554) $    5,040
                                                           ==========  ==========  ==========  ==========

  Basic earnings per share:
     Income from Continuing Operations as Reported....... $     0.13  $     0.14  $     0.16  $     0.20
     Reclassification for Discontinued Operations........         --        0.06        0.01          --
                                                           ----------  ----------  ----------  ----------
     Income from Continuing Operations...................       0.13        0.08        0.15        0.20
                                                           ----------  ----------  ----------  ----------
     Net Income (Loss)................................... $     0.12  $     0.10  $    (0.27) $     0.18
                                                           ==========  ==========  ==========  ==========

  Diluted earnings per share:
     Income from Continuing Operations as Reported....... $     0.13  $     0.13  $     0.16  $     0.19
     Reclassification for Discontinued Operations........         --        0.06        0.01          --
                                                           ----------  ----------  ----------  ----------
     Income from Continuing Operations...................       0.13        0.07        0.15        0.19
                                                           ----------  ----------  ----------  ----------
     Net Income (Loss)................................... $     0.12  $     0.10  $    (0.26) $     0.17
                                                           ==========  ==========  ==========  ==========

                                                                                                                       
                                                                                            December 31,
                                                                                        --------------------
                                                                                          2002       2001
                                                                                        ---------  ---------
                                        ASSETS                                            (In thousands)
CURRENT ASSETS:
     Cash and Cash Equivalents ....................................................... $   1,751  $      --
     Short-term Investments...........................................................     1,747      1,585
     Current Portion of Deferred Tax Asset............................................    40,444     15,301
     Prepaid Expenses and Other Current Assets........................................    23,433     31,966
                                                                                        ---------  ---------
           Total Current Assets.......................................................    67,375     48,852
PROPERTY AND EQUIPMENT - NET .........................................................    35,430    109,658
EQUITY IN NET ASSETS OF SUBSIDIARIES .................................................   134,989     50,582
NOTES RECEIVABLE FROM SUBSIDIARIES ...................................................     9,246      9,345
GOODWILL   ...........................................................................     2,154      2,154
DEFERRED TAX ASSET....................................................................    13,394     67,829
OTHER ................................................................................    29,469     23,416
                                                                                        ---------  ---------
TOTAL ASSETS ......................................................................... $ 292,057  $ 311,836
                                                                                        =========  =========
                                                                                                                       
                         LIABILITIES AND STOCKHOLDERS' EQUITY                                                          
CURRENT LIABILITIES:
     Accounts Payable and Other Accrued Liabilities .................................. $  21,105  $  22,836
     Current Portion of Long-term Debt ...............................................        83      3,728
                                                                                        ---------  ---------
           Total Current Liabilities .................................................    21,188     26,564

LONG-TERM DEBT (Less Current Portion).................................................    67,551    177,981
OTHER LIABILITIES ....................................................................    46,753     10,772
                                                                                        ---------  ---------
TOTAL LIABILITIES ....................................................................   135,492    215,317
                                                                                        ---------  ---------
STOCKHOLDERS' EQUITY:
     Capital Stock ...................................................................       155        148
     Treasury Stock ..................................................................   (17,148)   (22,789)
     Additional Paid-in Capital.......................................................   196,711    181,076
     Deferred Compensation............................................................      (473)    (1,058)
     Accumulated Other Comprehensive Gain (Loss)......................................       381     (5,636)
     Accumulated Deficit..............................................................   (23,061)   (55,222)
                                                                                        ---------  ---------
TOTAL STOCKHOLDERS' EQUITY ...........................................................   156,565     96,519
                                                                                        ---------  ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................................ $ 292,057  $ 311,836
                                                                                        =========  =========

                                                                                                                       
                                                                                             Years ended December 31,
                                                                                        -------------------------------
                                                                                          2002       2001       2000
                                                                                        ---------  ---------  ---------
REVENUES:                                                                                          (In thousands)
    Management Fees................................................................... $  81,363  $  69,603  $  61,101
    Subsidiary Dividends..............................................................    20,000     10,000      5,137
    Investment and Other Income.......................................................       698      5,250      7,320
                                                                                        ---------  ---------  ---------
    Total Revenues....................................................................   102,061     84,853     73,558
                                                                                        ---------  ---------  ---------
EXPENSES:
     Depreciation.....................................................................    10,699     14,125     10,650
     Other............................................................................    36,186     36,478     32,546
     Asset Impairment, Restructuring,
          Reorganization and Other Costs..............................................        --         --      8,454
     Interest Expense and Other, Net..................................................     8,017      9,065     15,945
                                                                                        ---------  ---------  ---------
     Total Expenses...................................................................    54,902     59,668     67,595
                                                                                        ---------  ---------  ---------
INCOME BEFORE INCOME TAXES............................................................    47,159     25,185      5,963
INCOME TAX (PROVISION) BENEFIT........................................................    (8,615)   (37,155)    61,877
                                                                                        ---------  ---------  ---------
INCOME (LOSS) OF PARENT COMPANY.......................................................    38,544    (11,970)    67,840
EQUITY IN UNDISTRIBUTED
      INCOME (LOSS) OF SUBSIDIARIES FROM CONTINUING OPERATIONS........................     3,764     27,451    (98,859)
                                                                                        ---------  ---------  ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS..............................................    42,308     15,481    (31,019)

INCOME (LOSS) FROM DISCONTINUED OPERATIONS............................................    (5,860)   (11,995)  (168,896)
                                                                                        ---------  ---------  ---------
NET INCOME (LOSS)..................................................................... $  36,448  $   3,486  $(199,915)
                                                                                        =========  =========  =========

                                                                                                                       
                                                                                            Years ended December 31,
                                                                                        -------------------------------
                                                                                          2002       2001       2000
                                                                                        ---------  ---------  ---------
CASH FLOWS FROM OPERATING ACTIVITIES:                                                              (In thousands)
      Net Income (Loss) From Continuing Operations.................................... $  42,308  $  15,481  $ (31,019)
      Adjustments to Reconcile Net Income (Loss) to Net Cash
          Provided by (Used for) Operating Activities:
          Depreciation and Amortization...............................................    10,699     14,231     10,755
          Deferred Compensation.......................................................       585        342         --
          Provision for Property Impairment ..........................................        --         --      3,604
          Equity in Undistributed Income (Loss) of Subsidiaries Continuing Operations.     3,764     27,451    (98,859)
          Change in Assets and Liabilities............................................   (51,053)   (25,683)    49,489
                                                                                        ---------  ---------  ---------
          Net Cash Provided by (Used for) Operating Activities........................     6,303     31,822    (66,030)
                                                                                        ---------  ---------  ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures ...........................................................    (5,273)    (3,915)    (5,527)
      Property and Equipment Dispositions.............................................       144      5,356      9,920
      (Increase) Decrease in Investments..............................................      (117)    (1,247)       836
      Dividends from Subsidiaries.....................................................    20,000     10,000      5,137
                                                                                        ---------  ---------  ---------
          Net Cash (Used for) Provided by Investing Activities .......................    14,754     10,194     10,366
                                                                                        ---------  ---------  ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing ..............................................        --      7,500     91,520
      Proceeds of Sale Leaseback Deposit .............................................     9,462         --         --
      Reductions in Long-term Obligations and
          Payments on Capital Leases..................................................   (38,927)   (49,926)   (22,400)
      Notes Receivable from Subsidiaries..............................................        --    (16,910)        --
      Exercise of Stock in Connection with Stock Plans................................    10,159      2,090      1,580
                                                                                        ---------  ---------  ---------
          Net Cash (Used for) Provided by Financing Activities........................   (19,306)   (57,246)    70,700
                                                                                        ---------  ---------  ---------
Net Increase (Decrease) in Cash and Cash Equivalents..................................     1,751    (15,230)    15,036
Cash and Cash Equivalents at Beginning of Year........................................        --     15,230        194
                                                                                        ---------  ---------  ---------
Cash and Cash Equivalents at End of Year.............................................. $   1,751  $      --  $  15,230
                                                                                        =========  =========  =========
Supplemental condensed statements of cash flows information:
Cash Paid During the Year for Interest
      (Net of Amount Capitalized)..................................................... $  11,559  $  22,075  $  21,734
Cash Received During the Year for Income Taxes........................................   (13,051)       (80)   (11,286)
Noncash Investing and Financing Activities:
      Stock Issued for Exercise of Options
          and Related Tax Benefits....................................................     6,837         97         --
      Retired Sale-Leaseback Assets, Liabilities
          and Financing Obligations...................................................    89,751     14,552         --
      Addition to capital leases......................................................        --         --      1,835

(In thousands)

December 31,
------------                                 
     2003............................................................................. $      83
     2004.............................................................................     7,551
     2005.............................................................................        --
     2006.............................................................................    60,000
     2007.............................................................................        --
     Thereafter.......................................................................        --
                                                                                        ---------
         Total........................................................................ $  67,634
                                                                                        =========

                                                                                                         Claims and Claim
                                               Gross                                                       Adjustment
                                             Reserves     Discount                                      Expenses Incurred   Amortization
                               Deferred     for Unpaid     if any                             Net          Related to       of Deferred   Paid Claims
                                Policy      Claims and    Deducted                Gross     Invest-   --------------------     Policy     and Claims    Direct
                              Acquisition   Adjustment       in      Unearned    Earned      ment        (1)        (2)     Acquisition   Adjustment   Premiums
Affiliation With Registrant      Costs       Expenses     Column C   Premiums   Premiums    Income     Current   Prior Year    Costs       Expenses     Written
          Column A             Column B      Column C     Column D   Column E   Column F   Column G     Year     Column H     Column I     Column J    Column K
----------------------------  -----------  -------------  ---------  ---------  ---------  ---------  ---------  ---------  ------------  -----------  ---------
Consolidated Property and
  Casualty Entities of CII
  Financial, Inc. for
Years Ended:
    December 31, 2002....... $     2,257  $     427,192  $      --  $  14,446  $ 174,930  $  14,485  $ 139,513  $  23,998  $     28,252  $   103,573  $ 174,651
    December 31, 2001.......       2,236        385,705         --     14,327    186,296     15,475    131,923      8,691        29,272       98,159    187,129
    December 31, 2000.......       2,015        374,554         --     13,493    203,075     15,074     86,587     23,293        21,386       88,388    203,268

                                                                Year ended December 31,
                       -------------------------------------------------------------------------------------------------------------
                          2002     2001      2000      1999       1998      1997      1996      1995      1994      1993      1992
                       --------  --------  --------  ---------  --------  --------  --------  --------  --------  --------  --------
Losses and LAE
    Reserve.......... $427,192  $385,705  $374,554  $ 244,394  $212,264  $202,699  $187,776  $182,318  $190,962  $200,356  $178,460
Less Reinsurance
    Recoverables (1).  169,001   187,453   218,757    110,089    37,797    21,056    15,676    25,871    29,342    25,841    20,207
                       --------  --------  --------  ---------  --------  --------  --------  --------  --------  --------  --------
Net Loss and LAE
    Reserves.........  258,191   198,252   155,797    134,305   174,467   181,643   172,100   156,447   161,620   174,515   158,253
Net Reserve
  Re-estimated as of:
    1 Year Later ....            222,250   164,488    157,598   184,386   172,000   163,130   141,163   139,741   160,562   154,388
    2 Years Later ...                      179,043    171,136   204,029   173,596   146,987   132,193   125,279   141,100   147,167
    3 Years Later ...                                 183,524   218,626   186,794   140,563   113,766   117,792   126,483   134,747
    4 Years Later ...                                           231,386   198,403   146,266   102,652   102,955   122,517   132,193
    5 Years Later ...                                                     210,763   153,423   104,249    95,997   114,443   131,112
    6 Years Later ...                                                               159,652   108,208    95,954   112,284   127,258
    7 Years Later ...                                                                         111,195    98,482   111,883   125,936
    8 Years Later ...                                                                                   100,367   113,929   125,907
    9 Years Later ...                                                                                             115,468   127,225
    10 Years Later...                                                                                                       128,381
Cumulative Redundancy
    (Deficiency).....            (23,998)  (23,246)   (49,219)  (56,919)  (29,120)   12,448    45,252    61,253    59,047    29,872
Cumulative Net Paid
    as of:
    1 Year Later.....             74,125    69,599     61,522    80,416    71,933    56,977    45,731    44,519    50,210    50,360
    2 Years Later....                      105,043    103,855   124,191   117,794    91,765    70,854    68,619    79,788    84,465
    3 Years Later....                                 127,505   159,335   143,369   113,054    83,674    80,645    94,865   104,569
    4 Years Later....                                           179,825   164,584   125,024    91,115    86,381   102,395   114,293
    5 Years Later....                                                     178,482   135,421    95,609    89,601   106,012   119,462
    6 Years Later....                                                               142,508   100,365    91,676   107,850   122,000
    7 Years Later....                                                                         103,168    93,789   109,201   123,291
    8 Years Later....                                                                                    95,534   110,743   124,220
    9 Years Later....                                                                                             111,948   125,147
    10 Years Later...                                                                                                       126,001
Net Reserve..........  258,190   198,252   155,797    134,305   174,467   181,643   172,100   156,447   161,620   174,515
Reins. Recoverables..  169,002   187,453   218,757    110,089    37,797    21,056    15,676    25,871    29,342    25,841
                       --------  --------  --------  ---------  --------  --------  --------  --------  --------  --------
Gross Reserve ....... $427,192   385,705   374,554    244,394   212,264   202,699   187,776   182,318   190,962   200,356
Net Re-estimated
  Reserve ...........            222,250   179,043    183,524   231,386   210,763   159,652   111,195   100,367   115,468
Re-estimated Reins
    Recoverables ....            216,060   279,973    179,794    75,589    32,849    24,877    20,009    16,674    14,004
                                 --------  --------  ---------  --------  --------  --------  --------  --------  --------
Gross Re-estimated
    Reserve .........            438,310   459,016    363,318   306,975   243,612   184,529   131,204   117,041   129,472
                                 --------  --------  ---------  --------  --------  --------  --------  --------  --------
Gross Cumulative
    Redundancy
      (Deficiency)...           $(52,605) $(84,462) $(118,924) $(94,711) $(40,913) $  3,247  $ 51,114  $ 73,921  $ 70,884
                                 ========  ========  =========  ========  ========  ========  ========  ========  ========