<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                                     _____

                                   FORM 10-K

            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                       SECURITIES EXCHANGE ACT OF 1934

                  For the fiscal year ended December 31, 1996

                                       OR

          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

                For the transition period from ______ to ______

                        COMMISSION FILE NUMBER  0-21098
                                               ---------

                        PHYSICIANS HEALTH SERVICES, INC.
                (Exact name of Company as specified in charter)

             Delaware                                          06-1116976
   (State or other jurisdiction of                           (IRS employer
   incorporation or organization)                       identification number)

        One Far Mill Crossing                                      06484
         Shelton, Connecticut                                   (ZIP Code)
(Address of principal executive offices)

         Company's telephone number, including area code (203) 381-6400

Securities registered pursuant to Section 12(b) of the Act:  NONE

Securities registered pursuant to Section 12(g) of the Act:

                Class A Common Stock, par value $.01 per share
                               (Title of Class)

Indicate by check mark whether the Company: (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                    Yes   X                   No
                        -----                    -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]

Aggregate market value of the voting stock held by non-affiliates at March 25,
1997 amounted to $114,394,815 (assuming for purposes of this calculation only,
that all directors and executive officers are affiliates).
(Class B Common Stock is assumed to have a market value of $19.875 per share)

Indicate the number of shares of each of the Company's classes of Common Stock,
as of the latest practicable date.

            Shares of Common Stock outstanding as of March 25, 1997:

                      5,763,905 shares of Class A Common Stock
                      3,546,212 shares of Class B Common Stock

                     DOCUMENTS INCORPORATED BY REFERENCE:
                        1997 Proxy Statement (Part III)
<PAGE>

                                 PART I

ITEM 1.  BUSINESS

GENERAL

          Physicians Health Services, Inc., a Delaware corporation ("PHS" or the
"Company"), is the parent of three health maintenance organizations ("HMOs"):
(1) Physicians Health Services of Connecticut, Inc., a Connecticut corporation
("PHS/CT"), operating in Connecticut; (2) Physicians Health Services of New
York, Inc., a New York corporation ("PHS/NY"), operating in New York's
Westchester, Dutchess, Orange, Putnam, Rockland, Nassau and Suffolk Counties,
and the five boroughs of New York City; and (3) Physicians Health Services of
New Jersey, Inc., a New Jersey corporation ("PHS/NJ"), operating in New
Jersey. In addition, the Company is the parent of Physicians Health Insurance
Services, Inc. ("PHIS"), which is licensed in Connecticut as an insurance broker
to offer various insurance products, PHS Investments, Inc. ("PHSI"), the
Company's investment subsidiary, PHS Insurance of Connecticut, Inc.
("Insurance/CT"), which holds a health insurance license in the State of
Connecticut, Physicians Health Services Insurance of New York, Inc.
("Insurance/New York"), which holds a health insurance license in the State of
New York, Physicians Health Services (Bermuda), Ltd. ("Bermuda"), an insurance
company licensed as a reinsurer in Bermuda, and PHS Real Estate, Inc. ("PHSRE"),
a Delaware corporation which owns all of the outstanding stock of the Company's
one indirect subsidiary, PHS Real Estate II, Inc. ("PHSREII"), a Delaware
corporation which owns the Company's corporate headquarters in Shelton,
Connecticut. All of the aforementioned subsidiaries are wholly-owned, either
directly or indirectly, by the Company, except for PHS/NJ, in which MasterCare
Companies, Inc. ("MasterCare") holds a 20% minority interest. The Company is
federally qualified as an HMO throughout its Connecticut and New York service
areas.

          The Company conducts substantially all of its operations through its
subsidiaries. Unless the context otherwise requires, the terms "Company and PHS"
refer to Physicians Health Services, Inc. and its subsidiaries. Its principal
offices are located at One Far Mill Crossing, Shelton, Connecticut 06484 , and
its telephone number is (203) 381-6400.

          The Company's managed care products include traditional HMO products,
in both open access and gatekeeper models, point of service ("POS") products,
administrative services only ("ASO") plans and Medicare and Medicaid plans.  The
Company's HMO subsidiaries contract for medical and related services with
individual practice associations ("IPAs"), physician hospital organizations
("PHOs"), physicians, physician groups, hospitals and other health care
providers.  The Company arranges for health care coverage for its members for a
fixed monthly payment, generally without regard to the frequency or extent of
health care services actually furnished, although small copayments may apply and
members pay a deductible and coinsurance in connection with the out-of-network
benefits in POS plans.

          As of January 1997, the Company had contracted with 23,298 providers
and 183 hospitals throughout its tri-state service area.  It had enrolled
400,021 members as of December 31, 1996 (424,940 as of January 1, 1997).


PRODUCTS

          The Company offers a broad assortment of managed care products. Its
POS products enable members to choose health care providers from the Company's
network of 23,298 providers and 183 hospitals or to obtain covered services
outside its network. The POS products combine the features of an HMO with the
features of an indemnity-type benefit for out-of-network utilization. Under the
POS plans, a member who obtains benefits outside of the PHS network pays a
deductible and coinsurance. As used herein, a plan with a POS out-of-network
benefit is referred to as a POS plan. The Company's traditional HMO plans
include a gatekeeper model HMO plan, which requires prior approval by a member's
primary care physician before the member may obtain the services of specialists
(the "Passport" plan), and an open access HMO plan in which members can obtain
services from all PHS participating physicians without the need for a referral
(the "Charter" plan). The Charter and Passport plans can be obtained as
traditional HMO plans or as the underlying HMO product for a POS plan. Under the
Company's traditional HMO plans, a member who selects a hospital or physician
from outside the network bears the entire cost of such services, unless the care
is related to an emergency or the member has received prior approval from the
Company.
<PAGE>

          The Company sells its products both on a proprietary basis and through
a joint marketing arrangement with The Guardian Life Insurance Company of
America ("The Guardian"). See "Business - Joint Marketing Arrangement with The
Guardian." Proprietary products are sold to medium and large size groups,
typically as one of several health care plans made available by the employer to
its employees ("alternative products"). Under the agreements with The Guardian,
jointly developed managed care products are marketed to existing customers of
The Guardian, as well as to new customers, under the tradename "Healthcare
Solutions". The Healthcare Solutions products are offered principally in the
small employer group market on a total replacement basis. Under this
arrangement, employees are offered the choice of traditional HMO products, POS
products, and, in certain cases, The Guardian indemnity products. Through the
first nine months of 1996, PHS and The Guardian shared profits and losses on the
Healthcare Solutions products through a combination of reinsurance and profit
sharing arrangements. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations". Effective October 1, 1996, the Company and
The Guardian converted all of the Healthcare Solutions products to a reinsurance
basis. As of October 1, 1996, the Company no longer shared profits and losses
with The Guardian with respect to indemnity products sold under the joint
marketing arrangement. The joint marketing arrangement covers PHS's New York,
New Jersey and Connecticut service areas.

          The Company offers third party administrator ("TPA") services for
administrative services only ("ASO") plans, Medicare risk and cost plans,
Medicaid plans, and individual plans in the New York service area. The Company
has a contract with the Mashantucket Pequot Tribe Employee Benefit Plan to
provide access to the Company's network of health care providers and utilization
management programs. In 1995, the Company began marketing plans to the small
group market through the Connecticut Business and Industry Association ("CBIA").
The Company is one of only four participants in the CBIA program. The Company
has a three-year contract with the Electric Boat Division of General Dynamics to
provide managed health care services to all of its salaried employees in
Connecticut. This contract was effective January 1, 1995 and has been recently
expanded to include the members of the Metal Trades Council Union. The Company
has a three-year contract to provide services to General Electric Company for
its employees in Connecticut. The General Electric plan, which was effective
January 1, 1996, combines elements of a fully insured HMO plan and an ASO plan.
Effective December, 1996, the Company initiated coverage for the New York State
Nurses Association Benefits Fund and its almost 29,000 members under a Charter
POS Plan.


HMO PLANS

          The Company's traditional HMO plans provide comprehensive health care
services to enrollees for a fixed monthly premium per enrollee, typically
charged to the enrollee's employer group, that does not vary with the nature,
frequency, or cost of services provided, although, where allowed by regulation,
premiums are age/sex adjusted according to the demographic characteristics of
the employer group.  Adjusted community rating, which includes factors related
to a specific employer's claims experience, is used with some of the Company's
larger accounts in certain of its service areas.  The Company is also able to
experience rate certain groups insured under its Healthcare Solutions products.
See "Business - Enrollment, Employer Groups and Marketing."  Under the
traditional HMO plans, the Company does not cover health care services provided
by non-participating physicians or other health care providers unless pre-
approval for an out-of-plan referral has been obtained or such services are the
result of a medical emergency.  Members are required to receive hospital care at
participating hospitals except for preauthorized out-of-plan referrals or
emergency admissions.  The traditional HMO benefit plans range from a plan with
limited copayments to a plan combining lower monthly premiums with higher
copayments paid by the member.  The plans provide coverage for physicians'
services, surgery, hospital care, x-ray and laboratory services, emergency care,
maternity services, well baby and other preventive health services and, to a
limited extent, skilled nursing, home health care, alcohol and drug
rehabilitation and mental health services.  The traditional HMO plans are
marketed to employer groups of all sizes, generally as alternative products.  As
of December 31, 1996, 33% of total membership was enrolled in traditional HMO
products (23.2% commercial enrollees, 1.6% ASO enrollees and 8.2% government
enrollees).

                                       2
<PAGE>

          The Company's traditional HMO plans are the Charter and Passport
plans. The Charter plan is an open access model which permits members to use PHS
participating physicians generally without a referral or pre-authorization. The
Passport plan is a gatekeeper plan that the Company developed in response to
employer interest in such plans. Under the Passport plan, each member selects or
is assigned to a primary care provider, typically a family practice physician,
who is responsible for seeing that the member's medical needs are met. Use by
the Passport member of specialists for treatment typically requires a referral
by the primary care provider in order for the services to be covered.


POS PLANS

          POS Plans are marketed to all size employer groups as either a total
replacement or alternative product. Under a POS Plan, an enrollee chooses, at
the time of services, whether to use participating providers and hospitals, or
non-participating providers and hospitals.  If the enrollee chooses to use out-
of-network services, the enrollee is subject to deductibles, coinsurance and
claim forms.  The POS products have become increasingly popular because of the
freedom of choice afforded enrollees under such plans. The POS plans are wrapped
around the Company's traditional HMO plans so that an enrollee has the in-
network benefits of the Charter or Passport HMO plan. An enrollee who has a POS
Passport plan can elect to see participating or non-participating providers
without the customary prior referrals required in the Passport plan, in which
event such non-referred services are treated as out-of-network services.

          A significant portion of the Company's recent growth in membership has
occurred in its POS plans. As of December 31, 1996, 60.7% of total membership
was enrolled in POS products (51.1% commercial enrollees, 9.6% ASO enrollees).
Only 36% of total membership was enrolled in such plans at December 31, 1995.
The Company expects this trend to continue for the foreseeable future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Cautionary Statement".


ASO PRODUCTS

          Under self-funded medical plans, the employer self-insures its health
care expenses and pays for health claims only as they are incurred, rather than
paying monthly premiums for insurance which covers the cost of medical services
as well as administrative expenses.  The Company, as a TPA, typically provides
claims processing and health care cost containment services through its provider
network and utilization management programs, and is paid a fee only in
conjunction with these administrative services.  The Company's ASO products
enable employers to access the Company's provider network and to realize savings
through certain of the Company's discounted fee arrangements and medical cost
containment capabilities, while allowing employers to design custom health
benefit plans in accordance with their own requirements and objectives.  Certain
of the Company's ASO products include performance guarantees.  See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Cautionary Statement."  As of December 31, 1996, 16.9% of total membership was
enrolled in ASO products (9.6% in POS plans, 1.6% in HMO plans and 5.7% in the
Mashantucket Peqout plan).

                                       3
<PAGE>

MEDICARE/MEDICAID PRODUCTS

          The Company offers PHS/SmartChoice, a federal Medicare program, to
Medicare eligible individuals under the terms of risk contracts with the Health
Care Financing Administration ("HCFA"). PHS/SmartChoice is typically
marketed directly to individuals. The Company also offers PHS/SmartChoice as a
POS product in the group market. It is currently offered in New York and
Connecticut. Enrollees in PHS/SmartChoice have limited copayments as long as
they use health care providers within the Company's network. PHS/SmartChoice
replaces both Medicare Part A and Part B coverage for enrollees and extends
coverage for preventive care, acute hospitalization and skilled nursing care. In
the PHS/SmartChoice gatekeeper product, in the event an enrollee chooses to
receive health care from a non-participating physician, neither PHS/SmartChoice
nor Medicare will cover the costs of such care absent an emergency or urgent
situation.

          Under its risk contracts with HCFA, the Company is paid a fixed per
member per month capitation amount by HCFA based upon a formula established by
HCFA establishing the projected cost to provide the covered services to each
Medicare member. The Company bears the risk that the actual costs of health care
services may exceed the per member per month capitation amount.

          Medicare risk contracts provide revenues that are generally higher per
member than those for non-Medicare members, and thus provide an opportunity for
increased profits and cash flow.  Such risk contracts, however, also carry
certain risks such as higher comparative medical costs, government regulatory
and reporting requirements, the possibility of reduced or insufficient
government reimbursement in the future, and higher marketing and advertising
costs per member as the result of marketing to individuals rather than to
groups.

          In Connecticut the PHS/SmartChoice product is intended to replace
another Medicare product (PHS/Carefree) formerly offered by the Company
pursuant to a cost contract with HCFA. As of December 31, 1996, the Company had
9,638 members enrolled in PHS/Carefree. The Company anticipates that almost all
of these members will convert to the PHS/SmartChoice product by the end of 1997.

          The Company participates in Connecticut's Medicaid managed care
program pursuant to a contract with the Connecticut Department of Social
Services.  PHS had enrolled 20,781 members in this program as of December 31,
1996.  The Company receives fixed monthly premiums per member under the contract
with the Connecticut Department of Social Services and bears the risk that the
actual costs of health care may exceed the per member per month capitation
amounts received by the Company.  Medicaid plans also involve the risk of
reduced or insufficient government reimbursement and higher marketing and
advertising costs per member as a result of marketing to individuals rather than
to groups.  PHS has participated in the New York Medicaid managed care program
in Westchester County since February, 1994.  It contracts with Westchester
Prepaid Health Service Plans, Inc. for the provision of services under this
program.

          As of December 31, 1996, 9% of total membership was enrolled in a
government program, almost all in HMO plans.

                                       4
<PAGE>

OTHER PRODUCTS

          The Company has entered into marketing arrangements with three
prominent HMO networks, UltraLink/SM/, HMO National Network/SM/ and National
Managed Care, Inc., to facilitate cooperative marketing efforts focusing on
national employer groups with employees in the Company's service area.  The
Company's affiliations with national networks allow it to compete with national
managed care companies for employers desiring a national managed care network.
In 1996, the Company generated almost $7 million in premium revenues from
employer groups accessing these national networks.  The Company has a multi-year
contract with Dental Benefit Providers, Inc. to market managed dental products
in New York and Connecticut.  These managed dental products offer different
levels of dental benefits through a selected panel of dentists at a cost that is
below average indemnity plan prices.  These products are designed to increase
the Company's managed care product market penetration and to promote retention
of its enrollee base.  The Company also offers prescription drug riders to its
HMO and POS plans.  The prescription drug riders are offered through PCS, Inc.,
an unaffiliated company that has established contracts with most of the local
pharmacies in the Company's service area.  The prescription drug rider pays the
cost of all covered prescriptions, less, in some instances, a deductible or
copayment. The Company also offers a Connecticut small employer plan to groups
of fewer than 50 employees.  The Company also offers an individual HMO and an
individual POS plan throughout its New York State service area. The Company's
insurance brokerage subsidiary,

                                       5
<PAGE>

PHIS, markets various insurance products of unaffiliated companies such as
dental and life insurance, short-term disability and stop-loss coverage
available from other insurers. PHIS's insurance activities are solely as an
agent and represented less than 0.1% of the Company's total revenues in 1996 .
The Company contracts with Davis Vision of Plainview, New York for provision of
certain routine and non-routine vision services to both commercial and
government product members.


OTHER INVESTMENTS

          In 1995, the Company invested $2.3 million in MasterCare Companies,
Inc. ("MasterCare"), a company offering workers compensation managed care
services in New Jersey and Connecticut. See "Business - Arrangement with
MasterCare."


PROVIDER ARRANGEMENTS

PHYSICIANS AND OTHER HEALTH CARE PROVIDERS

          The Company contracts with physician groups, such as IPAs, PHOs, and
multi-specialty groups (collectively, "Physician Groups"), individual physicians
and other health care providers for a defined range of health services,
including primary and specialty care. As of January 1, 1997, the Company had
agreements with 23,298 providers and 183 hospitals in its tri-state service
area. The Company's contracts with providers include discounted fee for service
arrangements as well as capitated group arrangements in which the contracting
Physician Group assumes a significant amount of the risk of overutilization. The
Company currently has contracts with four IPAs, three PHOs and one large
physician group ("Group") that provide for most of its physician services in its
Connecticut service area. In New York and New Jersey, the Company generally
contracts directly with physicians and other health care providers. Under the
typical Physician Group arrangements, the Physician Group receives a fixed
monthly capitation payment for each member selecting a primary care physician
from that Physician Group. Capitation payments may be for all members selecting
a primary care physician in the Physician Group or only as to members in certain
commercial HMO and POS plans, depending upon the negotiated arrangement with the
Physician Group. Capitation rates and any increases thereto are negotiated for
the term of the contract. The capitation payment is designed to cover not only
the professional medical services (including ancillary tests and services)
rendered by the physicians and other providers associated with that Physician
Group but also includes payments for certain other services rendered to the
enrollee by providers who are not members of the Physician Group. Services
covered by the capitation payment include, among other things, virtually all
physician claims (whether inpatient or outpatient, including authorized out-of-
plan care) and care rendered by other professionals such as physical therapists
and psychologists. In certain of the contracts, the Physician Groups also are at
risk for hospital, pharmacy and other facility expenses. The Company does not
capitate physicians directly.

          Three of the Company's four Connecticut IPA contracts expire on
December 31, 1997; the Company has reached an agreement in principle with the
fourth IPA to extend its present arrangements through December 31, 1997 on
slightly different terms. In the event that the Company was unable or chose not
to renew any Physician Group contract, it would seek alternative arrangements to
ensure the continuation of health care services to its enrollees. However, if
the Company failed to renew any Physician Group contract covering a significant
number of its enrollees and the Company was unable to obtain satisfactory
alternative arrangements, there could be a significant disruption in the
Company's business.

          Each Physician Group reimburses its member physicians and other
providers out of the capitation payment paid to it by the Company according to a
maximum fee-for-service schedule for claims submitted by those physicians and
providers affiliated with the Physician Group.  A portion of each physician's
and provider's payment is withheld and is




                                       6
<PAGE>

contributed to the Physician Group's risk pool to cover those expenses that
exceed the Physician Group's budget for health care expenses. The withheld
portion is returned to providers if the Physician Group operates within its
prescribed budget for services. Because in most instances the capitation
payments received by the Physician Group are fixed amounts unrelated to the
services provided, the provision of excessive services would obligate the
Physician Group to pay more to its physicians than the Physician Group receives
from the Company. The principal exception is the Greater Bridgeport IPA, where
overruns are shared equally between the Company and IPA. The Company's
capitation system is designed to place upon the Physician Group and its member
physicians the responsibility for managing the use of hospital and other medical
services. In the event that the Physician Group is required to pay more to its
physicians than it receives from the Company, the Physician Group must continue
to cover ongoing expenses and will be required to take corrective action to
restore its financial position. Corrective action may include, among other
things, lowering its fee-for-service schedule or increasing its withhold
percentage. The Company believes that the member physicians of its Physician
Groups have an interest in supporting the financial condition of their Physician
Group through temporary reductions in fee schedules and increases in withhold.
In 1996, each Physician Group received a return of all or a portion of its
withhold account. Physician Groups may incur an operating loss which would
result in the Physician Group having a retained earnings deficit. If such
deficit were not eliminated through corrective action, the Company might find it
necessary to advance funds to cover such deficit, although it would not be
obligated to do so. Certain of the Company's IPA stockholders, through their
ownership of Company stock or through members who serve on the Company's Board
of Directors, may seek to have the Company fund such deficits in the future and
failure by the IPAs to eliminate such future deficits, if any, could result in
unrecovered cash advances. Any such funding is subject to approval by the
Board's Audit Committee, a majority of which is composed of independent
directors. If any Physician Group with which the Company contracts for services
became insolvent, such insolvency could have a material adverse effect on the
business of the Company.

         The capitation payments to Physician Groups other than the PHOs
typically do not cover hospital and other facility expenses, although the
Physician Groups are partially at risk for non-Medicare and non-Medicaid
hospital utilization. The Company establishes an annual per member, per month
target for hospital expenses. The amount varies by benefit plan and Physician
Group, and encompasses both inpatient and outpatient costs. If total hospital
expenses generated by the Physician Group exceed the applicable hospital expense
target, the Company withholds from amounts owed by it to the Physician Group all
or a portion of the excess over budget, in most cases one-half of the excess
over budget. If actual costs are less than budgeted targets, the Physician Group
receives from the Company an incentive credit typically equal to forty to fifty
percent of the amount by which actual costs are less than budgeted targets.

          In its New York and New Jersey expansion areas and in areas in
Connecticut not served through Physician Group contracts, the Company contracts
for services principally through direct contracts with individual physicians and
other health care providers. In addition, the Company contracts with two IPAs in
the northern counties of its New York service area. The Company withholds a
percentage of reimbursement for services rendered pursuant to its direct
physician contracts against budgeted amounts to manage excessive utilization.

          The Company provides services to enrollees in PHS/SmartChoice pursuant
to a combination of direct physician agreements, and, in New York, risk sharing
agreements with the aforementioned IPAs. In Connecticut, the Company has
contracted with and is in negotiations with PHOs and other risk entities for its
Medicare risk product to shift the risk of all medical costs to the risk
entity in return for a fixed percentage of the Medicare premium received by the
Company. The Company's agreements in connection with its Medicare risk products
are subject to compliance with new risk sharing regulations adopted by HCFA,
which require disclosure and reinsurance for specified levels of risk sharing,
and proposed state regulations that could affect physician risk sharing.

                                       7
<PAGE>

HOSPITALS

          The Company maintains contracts with 30 acute care hospitals in its
Connecticut service area. In New York, the Company contracts with 83 hospitals
in its service area. The Company has direct and indirect (through MasterCare)
arrangements with 70 hospitals in New Jersey. The Company generally negotiates
contracts with hospitals that include compensation on a per diem basis (at a
daily rate, without regard to the scope of services actually provided). Other
compensation arrangements with hospitals include charged-based discounts
(negotiated discounts from the hospital's billed charges) and all inclusive case
rates. In the case of non-participating hospitals, the Company pays either
hospital billed charges or negotiated discounted charges. Additionally, some
hospital contracts include per case, all-inclusive, payment arrangements for
select procedures such as maternity care.

OTHER HEALTH CARE PROVIDERS

          PHS maintains contracts with outside vendors to provide certain
ancillary services. Laboratory services are provided in Connecticut through an
exclusive arrangement with Diagnostic Medical Laboratory, Inc. Laboratory
services in New York and New Jersey are provided through arrangements with
Quest Diagnostics. Both are capitated arrangements that are effective through
December 31, 1999 and December 31, 1997, respectively. Mental health, substance
abuse and detoxification services are provided in New York City and Long Island
through a capitated arrangement with CMG Health, Inc. ("CMG"). This agreement is
now in a renewal period and may be terminated by either party with at least 120
days notice. CMG also provides these services for the Company's Medicaid members
in Connecticut under a fully capitated arrangement, which began on August 1,
1995 for a period of 27 months and is automatically renewable thereafter for one
year periods unless terminated by either party on 120 days notice. In
Westchester, Dutchess, Orange, Putnam, and Rockland Counties, New York, CMG
provides case management services only. This agreement is in a renewal period
and may be terminated by either party on at least 120 days notice.


MEDICAL COST CONTROLS

          Control of health care expenses is critical to the profitability of a
managed care company. Expansion into new areas, introduction of new products,
changes in health care practices, medical cost inflation, new technologies,
government regulation, major epidemics, natural disasters and numerous other
factors affecting the delivery and costs of health care may adversely affect the
Company's operating results and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Cautionary Statement."

          PHYSICIAN COSTS. The Company has developed several integrated
mechanisms and procedures for the control of health care costs. The Company's
health care programs are designed around primary care physicians who assume
overall responsibility for the care of enrollees and determine or recommend the
nature and extent of services provided to enrollees. In the case of enrollees
enrolled in Passport products, primary care physicians are also responsible for
making referrals to contracted specialist physicians and hospitals. Although the
primary care physician's prior approval for most specialist services is not
required in the Company's Charter products, it is recommended. Prior approval is
required in the Company's Charter products for the enrollee's use of certain
services such as home health care, hospice care, cardiac rehabilitation, private
duty nurses, skilled nursing care, drug and alcohol rehabilitation and, except
for enrollees in a POS plan, elective services rendered out-of-network. In
addition to the prior approval process for certain services, the Company
monitors services rendered to enrollees and provides utilization review
information to its Physician Groups. In cases of possible excessive utilization,
the Company counsels the enrollee with respect to the possible duplication of
services or medications.

          With respect to physicians who contract with PHS through Physician
Groups, costs are also controlled through contracts that provide for payment to
the Physician Group on a capitation basis. The capitation method of payment,
together with the withhold provisions in its contracts, transfers much of the
Company's risk of excessive physician utilization to the Physician Group.
Physicians who contract with PHS directly are not capitated, although withholds
apply in order to mitigate the risk to PHS of excessive utilization.


                                      8
<PAGE>

          The Company also endeavors to monitor the practice patterns of all
participating physicians and providers in order to identify inappropriate or
excessive utilization. Each physician's utilization pattern is reviewed against
other physicians within the relevant specialty area in the physician's Physician
Group or relevant geographic area to determine whether average costs per patient
are consistent with utilization generally. In the event there are insufficient
aggregate data in a particular area, the Company's Medical Directors review
utilization data on a specific case basis. If inappropriate utilization is
determined, PHS will typically institute corrective measures including, if
necessary, financial sanctions or, in rare instances, termination of the
physician's membership as a participating physician.

          The Company has developed a measurement tool called the "practice
profile" to evaluate and promote the quality of care being provided to the
Company's members.  The practice profile compares providers to their peers in
relation to specific quality indicators that measure quality across a broad
spectrum of areas.  The practice profile also provides feedback to providers to
assist them in assessing and enhancing their performance.

          HOSPITAL COSTS; UTILIZATION REVIEW. The control of the use of hospital
and other medical services by a member is primarily the responsibility of the
member's primary care physician. The Company requires preadmission notification
of non-emergency hospital admissions and stays, pre-certification of selected
inpatient and outpatient procedures, and retrospective review of ambulatory
health services. The Company also maintains nurse coordinators who are assigned
to certain participating hospitals to conduct concurrent reviews of hospital
admissions. In the event that the nurse coordinator believes that utilization is
inappropriate, the nurse coordinator first addresses his/her concerns with the
attending physician, then consults with a physician advisor, who reviews
admission information and patient records. Physician advisors as well as PHS
Medical Directors are available to assist the attending physician in determining
whether it is appropriate for a patient to remain hospitalized. The physician
advisor, Medical Director and/or nurse coordinator works with the responsible
physician to arrange alternative health care where appropriate, thereby reducing
the length of hospital stays. The Company performs telephonic reviews at certain
hospitals where it is not practical to perform on-site concurrent reviews.

          The Company has implemented special review procedures for
pharmaceutical usage and the treatment of mental health and substance abuse
conditions. In addition to the foregoing controls, the Company has adopted
certain policies relating to the timing of admissions and the use of ambulatory
facilities for certain surgical procedures, among other services, in order to
reduce costs associated with hospital utilization.

          For catastrophic cases, the Company uses case management techniques to
work with the attending physician, facility, patient and his/her family, to
provide care in a cost-efficient manner consistent with the medical needs of the
patient.

          The Company has a pre-certification program for selected elective
inpatient and outpatient procedures to determine the medical necessity of those
services.  The pre-certification program requires the physicians performing the
designated procedures to obtain advance authorization, and permits appeal if the
procedure is initially denied. Procedures that are denied through this program
are ineligible for coverage by the Company.  As a pre-certification tool, the
Company utilizes the Value Health Sciences Medical Review System.  Since
implementation of this program in March 1993, the program has achieved an
overall 21% decrease in the utilization of procedures subject to the program.

          Hospital inpatient costs are also controlled through several
contractual mechanisms. The Company's contracts with Physician Groups contain
risk sharing mechanisms designed to provide incentives to control utilization of
hospital services and its contracts with PHOs include both
professional/physician and hospital/facility services within the capitation
payment to the PHO. In addition, the Company maintains insurance coverage that
reimburses the Company for hospital expenses incurred above certain levels,
limiting the risk to the Company of an individual enrollee's inpatient hospital
expense exceeding specified amounts. See "Business - Stop Loss and Other
Insurance."

                                       9

<PAGE>

MANAGEMENT INFORMATION SYSTEMS

          The Company believes that timely and relevant information is critical
to the success of its managed health care business.  The Company utilizes its
management information systems to process claims on an accurate and timely
basis; to analyze health care utilization; to support provider, member and
employer requirements; and to control administrative costs.  The Company's
claims operation is supported by staff and manager training, adherence to
performance standards (for both productivity and accuracy), auditing of claims
for claims processing accuracy, and adequate staffing and system programming to
ensure adherence to all benefit provisions of the Company's provider policies.
Currently, approximately 30% of physician/provider (non-facility) claims and
approximately 20%  of institutional claims are received electronically from the
Company's providers.  The Company intends to increase the amount of claims that
it processes electronically.  The Company's imaging system enables further
automation of the claims process.  The Company believes that its electronic
claims capabilities combined with the Company's imaging system have enabled the
Company to establish highly efficient claims processing and information
retrieval systems.  The Company has in place a disaster recovery plan that
provides for a back-up of its management information system in case of an
emergency.

          The Company is in the process of completing a significant upgrade of
its management information systems. The new systems are expected to begin to
come on line during the second quarter of 1997. At December 31, 1996, the costs
associated with this project included capital expenditures of approximately
$18.6 million, including enhancements beyond the original scope of the project.
The capital expenditures are expected to be amortized over five years commencing
with fiscal year 1997. When completed, the conversion to the new system is
expected to yield significant gains in productivity, accuracy and speed as well
as permit more significant information evaluation. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Cautionary
Statement. "


QUALITY ASSURANCE AND CUSTOMER SERVICE

          Prior to a physician's acceptance for participation in the Company's
network of providers, the Company reviews the physician's credentials and
background. Each physician must be board certified in his/her specialty, or
become board certified within five years of becoming credentialled. PHS has a
rigorous credentialling process that consists of primary verification of all
credentials; query of the National Practitioner Data Base, state medical boards
and admitting hospitals for malpractice history, disciplinary actions and/or
restrictions of hospital privileges; and on-site office evaluations including a
review of medical records to determine compliance with PHS's standards. The
Company biennially recredentials all its providers. Recredentialing includes
repeating the initial credentialling process as well as a reviewing the
provider's practice history with PHS. After acceptance, the Company monitors
various aspects of the physician's performance on an ongoing basis, including
the quality and appropriateness of care delivered. The Company evaluates the
quality and appropriateness of medical care provided to its enrollees by
performing medical care evaluation and member satisfaction studies, by reviewing
utilization of certain services and by responding to enrollee and physician
questions and concerns.

          In August 1995, the Company was awarded full three-year accreditation
in its then current service areas from the National Committee for Quality
Assurance ("NCQA"), an independent organization that reviews HMOs for compliance
with their quality standards.  This accreditation is effective from May, 1994
through May, 1997.  In connection with the re-accreditation process, the NCQA
staff made an on-site visit in late March, 1997.

          The Company has also established a formal system for documenting and
responding to customer grievances. The Company had no grievances upheld against
it during 1993, 1994 and 1995 by the New York Insurance Department. The Company
also had no complaints upheld against it during 1994 and only one complaint
upheld against it in 1995 by the Connecticut Department of Insurance. The
Company anticipates similarly good results for 1996. The Company believes that
it has established a reputation for high standards of service.

                                       10
<PAGE>

ENROLLMENT, EMPLOYER GROUPS AND MARKETING

          As of December 31, 1996, the Company provided managed health care
coverage to 400,021 enrollees. The Company offers its products to small groups,
generally on a total replacement basis, and to medium and large groups on both a
total replacement as well as alternative bases. The small group market segment
is currently marketed throughout the Company's tri-state service area through
its alliance with The Guardian and, in Connecticut, also through CBIA. In the
large group market, the Company sells both its proprietary HMO and POS products,
as well as ASO products. The Company's enrollee base is diverse and includes
federal and state employees and employees of banks, hospitals and major
industries. The Company's five largest fully insured employer groups represent
approximately 17% of its 332,363 fully insured enrollees and 14% of its total
enrollees. The New York State Nurses Association Benefits Fund, which
constitutes the largest fully insured employer group, represents 7.2% of the
Company's total enrollees and 8.6% of its fully insured enrollees.

          Employer groups of 50 or less are subject to community rating
restrictions throughout the Company's service area.  In these areas, the Company
uses underwriting guidelines and rating practices that comply with state
mandated community rating regulations.  In Connecticut and New Jersey, groups of
over 50 members are not subject to community rating regulation.  For these
groups, the Company employs rating techniques and underwriting guidelines
designed to price its products according to expected health care utilization
based on group experience.

          In New York, all groups written on the Company's HMO license are
subject to community rating regulations.  The Company uses underwriting
guidelines and rating practices that comply with New York mandated community
rating regulations.  See "Business - Competition."  The Company expects to begin
marketing an experience rated POS product in the over 50 employee group market
in mid-1997. In addition, the Company currently experience rates certain of its
Healthcare Solutions products offered in the over 50 employee group market in
New York.

          Subject to underwriting guidelines, the Company solicits new employer
groups for its proprietary products through its marketing staff and employee
benefits consultants. Most larger employer groups are represented by brokers and
consultants, who are typically paid by the employers, and work with the employer
to recommend or design employee benefit packages. The Company utilizes an
internal staff of sales and account service representatives and managers to
market its benefit plans to employers.  Healthcare Solutions products are sold
through the Company's and The Guardian's respective marketing staffs, as well as
through independent brokers.

          Marketing the Company's benefit plans in the alternative carrier
market is typically a two-step process in which presentations are first made to
employers and, after the employer selects the Company as one of its health care
providers, to its employees.  In the total replacement market, sales are made
solely at the employer levels and employees then can select from a number of PHS
products, or in the case of Healthcare Solutions, PHS or The Guardian products.

          The marketing process is continuous because contracts with employers
are typically renewed annually, employees are permitted to change plans annually
and employer groups experience regular employee turnover.


JOINT MARKETING ARRANGEMENT WITH THE GUARDIAN

          The Company has a joint marketing arrangement with The Guardian
throughout its tri-state service area.  The products that are subject to the
joint marketing arrangement are distributed through the brokerage community in
an integrated marketing effort.  The products are generally sold on a total
replacement basis, which eliminates the need for marketing to employees once the
products are sold to the employer group.  Products are marketed under the trade
name "Healthcare  Solutions" and employees are able to choose among PHS's
traditional HMO and POS products as well as, in certain instances, The
Guardian's indemnity products.  The Company and The Guardian target groups that
are currently enrolled in The Guardian's indemnity products.  Because of the
higher premiums associated with indemnity insurance generally, such groups are
often receptive to conversion to the Healthcare Solutions products.  The Company
and The Guardian also market to new groups.

                                       11
<PAGE>

          The joint marketing arrangements with The Guardian are for an
unlimited term but can be terminated by either party either with or without
cause, subject to potentially significant payments upon termination in the event
of a termination without cause, by the party electing to terminate, and in the
event of certain for cause terminations, by the party breaching the agreement.
The agreements can also be terminated by either party with respect to new
business following a change in control of the other party, in which event the
parties would continue to share profits and losses on business in effect on the
date of the change in control for a period of up to ten years. For a description
of the Company's financial arrangements with The Guardian in connection with the
Healthcare Solutions business, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Note 10 to the Consolidated
Financial Statements.

          As of December 31, 1996, there were 112,566  members enrolled in
Healthcare Solutions products (43,773 in Connecticut, 53,153 in New York and
15,640 in New Jersey).


STOP-LOSS AND OTHER INSURANCE

          The Company maintains reinsurance coverage for its existing business
to limit the risk of an individual member's inpatient hospital expense exceeding
specified amounts. The Company believes that its reinsurance coverage
substantially limits its risk of incurring catastrophic costs at a reasonable
premium cost. Beginning January 1, 1996 and continuing throughout 1997, the
reinsurance arrangement for the Company's HMO products throughout its entire
service area covers 80% of the next $400,000 of any member's inpatient hospital
expense and emergency out-of-area services (up to a stated daily maximum) in
excess of a $600,000 deductible. The reinsurance agreement provides a limit of
$1,000,000 per member, per contract period (12 months) and $2,000,000 per
member, per lifetime. The Company also maintains general liability, property,
fidelity and contingent malpractice insurance coverage in amounts it believes to
be adequate. Such insurance may become increasingly important if plaintiffs
prove successful in recent efforts to expand the liability of a managed health
care company for the negligence of providers with whom the Company directly or
indirectly contracts. The Company also requires contracting Physician Groups and
hospitals to maintain malpractice insurance coverage.


ARRANGEMENT WITH MASTERCARE

          The Company has entered into a marketing relationship with MasterCare
and its affiliates. In addition, the parties have network access agreements with
each other stemming from their respective expansion activities. In connection
with the formation of PHS/NJ, the Company used the MasterCare network of
providers to help it develop a network in New Jersey. As consideration, the
Company issued a 20% interest in PHS/NJ to MasterCare. In addition, at December
31, 1996 PHS owned an interst in MasterCare Companies, Inc. and its subsidiary,
MasterCare of Connecticut, formerly Total Employee Care, a workers compensation
company formerly wholly-owned by the Company. See Note 11 to the Condolidated
Financial Statements.


GOVERNMENT REGULATION

FEDERAL REGULATION

          The Company is subject to the Health Maintenance Organization Act of
1973, as amended, and the rules and regulations promulgated thereunder ("HMO
Act"), which prescribe the manner in which an HMO must be organized and operated
in order to meet and maintain federal qualification and to be eligible to enter
into Medicare contracts with the federal government.  PHS/CT and PHS/NY are
federally qualified under the HMO Act.  In order to maintain this status the
Company must file periodic reports with, and is subject to periodic review by,
the Department of Health and Human Services through HCFA and the Office of
Prepaid Health Care.  In addition, HCFA has the

                                       12
<PAGE>

right to audit the Company to determine compliance with HCFA's regulations and
to monitor the quality of care rendered to PHS/CT's and PHS/NY's Medicare
enrollees. Reimbursements payable to PHS/CT and PHS/NY under the Medicare risk
contracts are subject to periodic unilateral revision by the federal government.
Future levels of such payments may be affected by federal government efforts to
contain health care costs and cannot be predicted with certainty. Each of the
Company's Medicare contracts are renewable on an annual basis. Health plans
which offer a Medicare risk product must also comply with requirements
established by peer review organizations, which are organizations which contract
with HCFA to monitor the quality of health care received by Medicare
beneficiaries. These requirements relate to quality assurance and utilization
review procedures. Recent requirements of HCFA impose requirements relating to
physician incentive plans, which place physicians participating in Medicaid and
Medicare HMO plans at substantial financial risk.  Enrollment under
the Medicare risk program cannot exceed 50% of a health plan's total enrollment.
Termination of the Company's Medicare program could have a material adverse
effect on its business.

          As a result of its Medicaid contract,  PHS/CT is subject to both
federal and state regulation regarding services provided to Medicaid enrollees,
payment for those services and other aspects of the Medicaid program.  Medicaid
regulations require that enrollment of Medicaid and other federal government
program beneficiaries cannot exceed 25% of a health plan's total enrollment.

          The Company is also required by federal and state regulatory agencies
to maintain restricted cash reserves and/or a minimum net worth.  To remain
licensed, it may be necessary for the Company to make changes from time to time
in its services, procedures, structure and marketing methods.  Such changes may
be required as a result of amendment to, or other significant modification of,
federal and state laws and regulations controlling the Company's operations.
Any changes in federal or state government regulation could affect the Company's
operations, profitability and business prospects.


STATE REGULATION

          The Company's HMO and insurance subsidiaries are subject to
substantial state government regulation. PHS/CT is licensed by the Insurance
Commissioner of Connecticut to be a health maintenance organization and is
subject to regulation by the Connecticut Department of Insurance.  PHS/NY is
also licensed as a health maintenance organization by the Commissioner of Health
of the State of New York and is subject to regulation by the Department of
Health of the State of New York and the Department of Insurance of the State of
New York. PHS/NJ is licensed as a health maintenance organization by the
Commissioner of Health and Senior Services and Commissioner of Banking and
Insurance of the State of New Jersey and is subject to regulation by the
Department of Health and Senior Services of the State of New Jersey and the
Department of Banking and Insurance of the State of New Jersey. State regulatory
authorities exercise oversight regarding the Company's provider networks,
medical care delivery and quality assurance programs, contract forms and their
provisions, and financial condition, including reserve and cash flow
requirements. Applicable state law requires periodic financial reports, imposes
minimum standards for investments, capital, deposits and reserves, and regulates
marketing, rates, medical benefits, payment of dividends and affiliate
transactions. In addition, the premiums charged by the Company are subject to
review and changes in rates must be approved in advance by state regulatory
authorities. The Company's HMOs are also subject to periodic examination by the
relevant state regulatory authorities.

          Insurance/CT is an accident and health company licensed by the
Connecticut Department of Insurance, Insurance/NY is a property and casualty
company licensed by the New York Department of Insurance and Bermuda is an
insurance company licensed as a reinsurer in Bermuda. Applicable laws contain
requirements relating to Insurance/CT's, Insurance/NY's and Bermuda's financial
condition, reserve requirements, premium rates and contracts and require
periodic filings and examinations.

          Applicable Connecticut, New York and New Jersey statutes and
regulations require the prior approval of the Connecticut Commissioner of
Insurance, New York Commissioner of Health and New Jersey Commissioner of
Health, respectively, for any acquisition of control of the Company or its
subsidiaries.  For purposes of these statutes and regulations, "control" means
the direct or indirect possession of the power to direct or cause the direction
of the

                                       13
<PAGE>

management and policies of an entity. Control is presumed to exist when a
person, group of persons or entity acquires the power to vote 10% or more of the
voting securities of another entity.

          New York law requires health insurers to accept all individuals and
small groups (between three and fifty employees or group members) without regard
to their age, sex, occupation or medical condition at a "community rated"
premium based on the experience of the entire pool of risks covered by the
insurer. The New York community rating law establishes a pooling mechanism
providing for payments to insurers writing such policies for a disproportionate
share of individuals with certain demographic characteristics and catastrophic
medical expenses. Depending on the age and sex characteristics of an insurer's
members and the incidence of certain high-cost medical conditions among members,
an insurer will either make payments to or receive payments from the state
pooled fund. To date, the Company has incurred expenses related to this fund
amounting to $1,152,000 in 1994, $1,483,000 in 1995 and $3,180,000 in 1996. The
New York community rating law also provides, among other things, for portability
of health insurance, thereby facilitating continued coverage for those wishing
to seek new employment or insurers, and allows members of a small group to
continue their coverage after their membership is terminated. New York law
requires all HMOs to offer an individual HMO plan and an individual POS plan.
The benefits available under these plans are mandated by law and do not differ
between health plans.

          Connecticut law also regulates health insurance for employer groups of
fifty and fewer employees.  The Connecticut small employer insurance law
includes guaranteed issue, pre-existing condition restrictions and guaranteed
renewability provisions.  Connecticut applies adjusted community rating
restrictions to all small employer medical plans.  Under adjusted community
rating, the only factors that may be used are age, gender, geographic area,
industry, group size and family composition.  Such factors are further limited
by applicable Connecticut law.

          New Jersey regulates health insurance for employer groups of two to
forty-nine employees through the New Jersey Small Employer Health Benefits
Program.  The law sets out six standard plans, only one of which is an HMO plan
(the others are all indemnity plans).  The law also mandates the benefits to be
offered under such plans and sets out the participation and contribution
requirements, applies a preexisting condition restriction, guaranteed
renewability and rating restrictions.

          The Company's HMO subsidiaries are subject to statutory regulations
that restrict the payment of dividends. Connecticut law imposes a 1.75% premium
tax on the Company's fully insured business written in Connecticut. All HMOs in
Connecticut are now assessed for the costs of the HRA (Health Reinsurance
Association), which offers individual coverage to any person residing in
Connecticut and special health care plans to low income groups of ten or less.
The assessments are used to cover the losses incurred by the program. In
addition, all Connecticut HMOs are now assessed a portion of the cost of funding
the Connecticut Department of Insurance, which until recently had been funded
entirely by assessments only on insurers operating in the state.

          If the Company acquires or establishes HMOs in states where it does
not presently operate, it will have to comply with the applicable state statutes
which vary from state to state.

RECENT REGULATORY DEVELOPMENTS AND INITIATIVES

Federal
          The recently enacted Federal Health Insurance Portability and
Accountability Act of 1996 (i) insures portability of health insurance to
individuals changing jobs or moving to individual coverage by limiting
application of pre-exiting condition exclusions, (ii) guarantees availability of
health insurance to employees in the small group market and (iii) prevents
exclusion of individuals from coverage under group plans based on health status.
The Act also permits offering Medical Savings Account plans on a pilot basis and
includes programs targeting fraud and abuse.  The provisions are effective
beginning July 1, 1997.  The Company is currently subject to similar state law
provisions in New York limiting pre-existing conditions for new group and
individual enrollees who had continuous prior coverage and requiring issuance of
group coverage to small group employers.  Recently enacted federal legislation
mandates coverage for minimum hospital stays after childbirth (consistent with
many new state law requirements) and parity between any lifetime limits imposed
on mental health benefits and those for other medical

                                       14
<PAGE>

benefits. In addition, HCFA adopted rules in 1996 imposing reinsurance,
disclosure and other reporting requirements relating to physician incentive
plans which place physicians participating in Medicare and Medicaid HMO plans at
substantial financial risk.

          Congress is also considering significant changes to both Medicare and
Medicaid programs, including changes that would significantly reduce
reimbursement to HMOs. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Cautionary Statement". In addition,
proposed Medicare reform bills contain provisions that would facilitate entry of
competing HMOs in the Company's service area by repealing the rule that Medicare
risk contractors have one commercial enrollee for each Medicare or other
government program enrollee and creating permissive licensure for HMOs sponsored
by provider networks. In Connecticut, the Department of Social Services is
expected to request HMOs participating in its Medicaid program to resubmit bids
in 1997. It is expected that Connecticut will mandate additional reporting
requirements and other changes that will reduce the number of companies willing
to participate.

State
          There is a national trend among state governments to enact legislation
which increases regulation of HMOs and managed care companies and to mandate
certain policies and procedures.  Each state that the Company does business in
is considering or has implemented wide-ranging "Patient Protection" and
"Consumer Disclosure" bills and regulations.

          The New York State legislature enacted the Health Care Reform Act of
1996 ("HCRA"), effective January 1, 1997, that eliminated regulation of hospital
rates and adopted surcharges and covered lives assessments to fund various
public programs. This deregulation allows all private health care payors to
negotiate payment rates for inpatient hospital services. Previously, only HMOs
could negotiate rates for these services. As a result of the enactment of HCRA,
non-HMOs who compete with the Company may be able to negotiate better rates with
hospitals in New York because of the volume of patients they represent, which
would have an adverse effect on the Company's ability to compete effectively in
New York. Also, effective January 1, 1997, the Company is required to make
payments to state funding pools to finance hospital bad debt and charity care,
graduate medical education, and other state programs under HCRA. Previously,
hospital bad debt and charity care and graduate medical education were financed
by surcharges on payments to hospitals for inpatient services. The Company has
renegotiated many of its hospital contracts in New York to reflect the
surcharges. These adjustments are generally effective as of January 1, 1997, but
they are not expected to result in savings equal to the cost of the surcharges.
The New York legislature also recently passed legislation related to operation
of managed care plans, which contains provisions relating to, among other
things, utilization review, consumer disclosure and the right of a physician to
a hearing on termination from a health plan network.

          In addition, the New Jersey Department of Health and Senior Services
recently issued a comprehensive revision to its existing HMO regulations, which
encompasses many of the same features as the aforementioned New York law, but
also includes a non-binding external appeals process. Connecticut is considering
increased regulation which, like New York and New Jersey, includes extensive new
reporting and data collection requirements. These regulatory developments are
likely to increase the Company's medical and administrative costs.

COMPETITION

          The health care industry in the Company's market area is highly
competitive. The Company has numerous competitors, including for-profit and not-
for-profit HMOs , preferred provider organizations ("PPOs") and indemnity
insurance carriers, and certain of the Company's competitors have substantially
greater enrollment and financial
                                       15
<PAGE>

resources than the Company. The Company's major competitors include independent
HMOs, such as Oxford Health Plans, Inc., and United Health Care, which have
significant enrollment in the New York metropolitan area, and HMOs and managed
care plans sponsored by large health insurance companies, such as Aetna/U.S.
Healthcare, Inc., Blue Cross/Blue Shield, The New York Life Insurance Company
and CIGNA. Additional competitors may enter the Company's market in the future.
In addition, the managed care industry has experienced significant consolidation
recently, and such consolidation is expected to continue, possibly resulting in
fewer but larger competitors in the Company's service area. The Company competes
on the basis of price, quality and scope of services provided, including the
extent of its provider network. The Company believes the quality of its service
and physicians, as well as its reputation, are important competitive factors.
However, the cost of providing benefits is in many instances the controlling
factor in obtaining and retaining employer groups and certain of PHS's
competitors have set premium rates at levels below PHS's rates for comparable
products. The Company anticipates that premium pricing will continue to be
highly competitive.


TRADEMARKS AND TRADENAMES

          The Company has a number of registered trademarks.  The Company
believes that its trademarks and tradenames are important to its marketing
efforts.  Any challenge to the use of a material tradename, trademark or service
mark could have an adverse effect upon the Company's business.


EMPLOYEES

          As of December 31, 1996, the Company had 971 full-time employees.  The
Company is not a party to any collective bargaining agreement and has not
experienced any work stoppage since its organization.  The Company believes its
relations with its employees to be good.


ITEM 2.  PROPERTIES

          The Company's corporate headquarters offices were relocated to
Shelton, Connecticut in early 1997 and comprise 327,195 square feet, located in
three adjacent building, which the Company purchased in June, 1996 for $16.6
million. The Company presently occupies approximately 65% of the available space
in this facility. The Company expects that the remainder of the available space
will require renovation before it can be occupied by the Company's employees.
The Company continues to own and occupy its former headquarters in Trumbull,
Connecticut which comprises 74,350 square feet. PHS/CT leases properties at
three locations, for an aggregate of 97,488 square feet. PHS/NY leases 11,752
square feet of property in White Plains, New York, 18,415 square feet in New
York City and 3,415 square feet in Lake Success, New York. PHS/NJ leases 12,895
square feet of space in Paramus, New Jersey.


ITEM 3.  LEGAL PROCEEDINGS

          The Company is involved in litigation arising in the ordinary course
of its business, a significant portion of which involves claims for coverage or
payment of medical services rendered to enrollees. In the opinion of the
Company's management, based upon discussions with legal counsel, existing
litigation will not have a material adverse effect on the Company's financial
position.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matters were submitted to a vote of security holders during the
fourth quarter.

                                       16
<PAGE>

                                PART II

ITEM 5.  MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

          The Company completed its initial public offering of 2,975,000 shares
of Class A Common Stock in January, 1993.  The Company's Class A Common Stock is
traded in the over-the-counter market on the National Association of Securities
Dealers Automated Quotation ("NASDAQ") National Market System under the symbol
"PHSV."  There is no market for the Company's Class B Common Stock.  The
following table sets forth the range of high and low sale prices for the Class A
Common Stock for each of the periods indicated as reported on the NASDAQ
National Market System.  Quotations represent prices between dealers and do not
reflect retail mark-ups, mark-downs or commissions.  There was no market for the
Company's Class A Common Stock prior to its initial public offering in January,
1993.

                                                       High    Low
                                                       ------  ------
          January 1, 1995 through March 31, 1995       $33.75  $26.75
          April 1, 1995 through June 30, 1995          $34.25  $24.50
          July 1, 1995 through September 30, 1995      $28.75  $22.00
          October 1, 1995 through December 31, 1995    $43.25  $27.25

          January 1, 1996 through March 31, 1996       $40.75  $29.50
          April 1, 1996 through June 30, 1996          $34.50  $19.75
          July 1, 1996 through September 30, 1996      $25.50  $14.50
          October 1, 1996 through December 31, 1996    $20.00  $14.00


          There were an aggregate of 390 holders of record of the Company's
Class A and Class B Common Stock (the "Common Stock") as of March 25, 1997.  The
Company has not paid any dividends on its Common Stock since its issuance.  The
Company does not intend to pay any cash dividends in the foreseeable future.
Rather, the Company intends to retain its earnings to provide for the operation
and expansion of its business.  The Company's ability to declare and pay
dividends to its stockholders may be dependent upon its ability to obtain cash
distributions from its operating subsidiaries.  The ability to pay dividends is
also restricted by insurance and health regulations applicable to its
subsidiaries.  See "Business - Government Regulation."

                                       17
<PAGE>

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA

    The income statement data and balance sheet data set forth below have been
derived from the audited consolidated financial statements of the Company.  The
information below is qualified by reference to and should be read in conjunction
with the consolidated financial statements and related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included herein.

<TABLE>
<CAPTION>
                                                                        Year Ended December 31
                                                  1996            1995            1994           1993          1992
                                               ----------      ----------      ----------     ----------    ----------
                                                   (in thousands, except per share amounts and operating statistics)
<S>                                             <C>              <C>             <C>            <C>           <C>
INCOME STATEMENT DATA:
REVENUES:
 Premiums                                       $ 481,534        $342,975        $289,784       $274,795      $265,436
 Investment and other income                        6,574           6,968           4,160          5,435         3,459
                                               ----------      ----------      ----------     ----------    ----------
  Total revenues                                  488,108         349,943         293,944        280,230       268,895
                                               ----------      ----------      ----------     ----------    ----------

Health care expenses:
 Hospital services                                178,059         111,947          94,934        105,592       107,638
 Physicians and related health care services      198,591         131,019         117,393        110,599       106,617
 Other health care services                        42,382          18,707          12,943          9,741         9,724
 Indemnity costs                                    7,008           2,157              --             --            --
                                               ----------      ----------      ----------     ----------    ----------
  Total health care expenses                      426,040         263,830         225,270        225,932       223,979
                                               ----------      ----------      ----------     ----------    ----------

Selling, general and administrative                86,728          58,504          44,089         33,730        28,590
Guardian joint marketing (income)
 expense, net                                        (809)          2,298              --             --            --
Proxy defense costs                                                   892
Interest                                              388              --              --            378           875
                                               ----------      ----------      ----------     ----------    ----------
     Total expenses                               512,347         325,524         269,359        260,040       253,444
                                               ----------      ----------      ----------     ----------    ----------
Income (loss) before income taxes                 (24,239)         24,419          24,585         20,190        15,451
Income tax expense (benefit)                      (11,275)          8,449          10,451          8,299         6,890
                                               ----------      ----------      ----------     ----------    ----------
Net income (loss)                                ($12,964)       $ 15,970        $ 14,134       $ 11,891      $  8,561
                                               ==========      ==========      ==========     ==========    ==========
Net income (loss) per
 Common Share                                      ($1.39)          $1.70           $1.52       $   1.31      $   1.36
Weighted average shares outstanding                 9,301           9,403           9,307          9,101         6,283

BALANCE SHEET DATA:
  Working capital                               $  16,744        $ 62,585        $ 64,037       $ 58,714      $ 13,091
  Total assets                                    238,310         211,068         207,148        171,456       120,031
  Total long term debt                                 --             --            --                --         5,000
  Stockholders' equity                             96,286         108,881          91,206         77,968        25,586

OPERATING STATISTICS:
  Enrollment (1)                                  400,021         267,116         179,550        158,984       136,832
  Enrollment (monthly average)                    342,576         219,475         173,523        153,251       135,506
  Hospital days per thousand (2)                      272             281             327            360           403
  Medical loss ratio (3)                             89.8%           78.2%           79.0%          82.9%         84.4%
</TABLE>

----------
(1)  At end of period.
(2)  On an annualized basis for commercial products only.
(3)  Health care expenses as a percentage of premium revenues excluding
     self-funded product revenues.


                                       18
<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following table shows certain income statement data expressed as a
percentage of total revenues for the years indicated:

<TABLE>
<CAPTION>
                                                         Year Ended December 31
                                                   ----------------------------------
                                                     1996         1995         1994
                                                   --------     --------     --------
<S>                                                <C>          <C>          <C>
Revenues:
     Premiums                                        98.7 %       98.0 %       98.6%
     Investment and other income                      1.3          2.0          1.4
                                                   --------     --------     --------
       Total revenues                               100.0        100.0        100.0
                                                   --------     --------     --------

Health care expenses:
     Hospital services                               36.5         32.0         32.3
     Physicians and related health care services     40.7         37.5         39.9
     Other health care services                       8.7          5.3          4.4
     Indemnity costs                                  1.4          0.6
                                                   --------     --------     --------
       Total health care expenses                    87.3         75.4         76.6
                                                   --------     --------     --------

Selling, general and administrative expenses         17.8         16.7         15.0
Guardian joint marketing (income) expense, net       (0.2)         0.7          0.0
Proxy defense costs                                    --          0.2           --
Interest                                              0.1          0.0          0.0
                                                   --------     --------     --------
  Total expenses                                    105.0         93.0         91.6
                                                   --------     --------     --------
Income (loss) before taxes                           (5.0)         7.0          8.4
Income tax expense (benefit)                         (2.3)         2.4          3.6
                                                   --------     --------     --------
Net income (loss)                                    (2.7)%        4.6 %        4.8 %
                                                   ========     ========     ========
</TABLE>


    The Company's subsidiaries, PHS/CT, PHS/NY, PHS/NJ and Bermuda, have entered
into several marketing and reinsurance agreements with The Guardian. Under these
agreements, jointly developed managed care and indemnity products are offered to
existing Guardian insureds as well as to new prospects. The Company and The
Guardian have implemented different ways to share profits and losses under these
agreements which vary among the particular states and time periods as described
below.

    In Connecticut, PHS/CT wrote 100% of the managed care business and The
Guardian wrote 100% of the indemnity business. The parties shared profits and
losses through September 30, 1996 pursuant to a "selection adjustment payment"
mechanism. Under this arrangement, each party calculated its quarterly profit or
loss (net premiums earned, minus claims payments, capitation payments and
withholds paid with respect to managed care plans, reserve increases or
decreases, administrative charges, commissions and premium taxes, plus
investment income). The selection adjustment payment, which was designed to
mitigate the effect of potential adverse selection in groups which selected
Healthcare Solutions products and enable the parties to share in any long-term
profits or loses, then provided that if both parties had losses, no adjustment
would be made from one to the other, and each would retain its respective loss.
If both parties had profits, the amounts were combined, and the party with the
greater profit would make a selection adjustment payment to the other, in an
amount equal to half of the profit differential. If only one party had a profit,
the
                                       19
<PAGE>

profitable party made a selection adjustment payment equal to that party's
reported profit, thereby partially or fully reimbursing the other party's loss.
If the result was a combined profit, the profitable party would make a selection
adjustment payment equal to the other party's loss, increased by half of the
combined profit. Selection adjustment calculations were done on a cumulative
basis, and accordingly, losses are carried forward to offset against future
profits. Because both PHS and The Guardian incurred losses in Connecticut in
1996, no selection adjustment payment was made, and the Company reported 100% of
the cumulative losses on the managed care products sold under the Healthcare
Solutions product line.

    The parties entered into new agreements with respect to the Connecticut
Healthcare Solutions business that were effective as of October 1, 1996. The
selection adjustment methodology was replaced with a reinsurance agreement
pursuant to which the Company cedes 50% of the risk on the managed care portion
of the Healthcare Solutions products to The Guardian. In connection with the
conversion to reinsurance, the parties agreed that 50% of the cumulative losses
in Connecticut would be offset from amounts otherwise due to The Guardian under
the reinsurance agreement when profits, if any, are generated.

In New York, The Guardian cedes 50% of its risk for the out-of-network portion
of the POS Healthcare Solutions products to Bermuda and the Company cedes 50% of
its risk for HMO products and the in-network portion of the POS Healthcare
Solutions products to The Guardian. In New Jersey, the Company cedes 100% of the
risk of the out-of-network portion of the POS Healthcare Solutions products and
50% of the risk on the other HMO Healthcare Solutions products to The Guardian
and The Guardian retrocedes 50% of the risk for the out-of-network portion of
the POS Healthcare Solutions products back to Bermuda. The reinsurance
agreements were amended in 1996 to reduce the Company's risk for indemnity
Healthcare Solutions products. In New York, the Company was responsible for 10%
of the associated losses on the indemnity business between January 1 and June
30, 1996 and did not share risk with respect to the indemnity portion of the
Healthcare Solutions business after June 30, 1996. In Connecticut, the
agreements were amended effective October 1, 1996 so that the Company will not
share risk with respect to the indemnity business in those states following
September 30, 1996.

As a result of its arrangements with the Guardian, the Company's percentage
growth in its aggregate premium revenue has lagged its percentage growth in
enrollment, since a portion of the Healthcare Solutions revenues and expenses
that were ceded to The Guardian are omitted from the Company's Statement of
Operations. The Company expects that this trend will continue if its Healthcare
Solutions products continue to be successful and the enrollment mix between its
proprietory products and the Healthcare Solutions products shifts to a greater
percentage in Healthcare Solutions. The aggregate revenue is impacted by this
mix due to the fact that for its proprietary products the Company retains 100%
of the revenue and related healthcare expenses while under the Healthcare
Solutions product, 50% of the revenue and related health care expenses are ceded
to The Guardian, therefore impacting the aggregate revenue growth compared to
aggregate membership growth. Per member, per month ("PMPM") amounts are
similarly impacted by this mix due to the fact Healthcare Solutions membership
is reflected at 100% and revenue and related health care expenses are reflected
at 50%.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

    Premium revenue increased 40.4% to $481.5 million in 1996 from $343.0
million in 1995, while enrollment at December 31, 1996 increased 49.8% over 1995
to 400,021. As of December 31, 1996, fully-insured enrollees increased 59.9% to
332,363 members up from 207,856 as of December 31, 1995, while self-funded
enrollees increased 14.2% to 67,658 members as of December 31, 1996, up from
59,260 at December 31, 1995. The aggregate premium revenue increase lagged the
membership growth due primarily to the growth of membership in the Healthcare
Solutions product where 50% of the premium revenue and related healthcare costs
are ceded to The Guardian pursuant to the agreement and a membership shift in
the fully insured product mix to lower benefit, lower PMPM revenue products.
Also, enrollee statistics include 100% of the approximately 112,000 members
enrolled in Healthcare Solution products at December 31, 1996, while premium
revenue includes only the Company's 50% share of the Healthcare Solutions
revenues derived from the New York arrangements which became effective July 1,
1995, the New Jersey arrangements effective January 1, 1996, and the Connecticut
arrangements effective October 1, 1996.


                                       20
<PAGE>

    Investment and other income declined 5.6% in 1996 from $7.0 million for the
year ended December 31, 1995 to $6.6 million for the year ended December 31,
1996.  The decline in investment income is due primarily to a decline in
invested assets and lower investment yields due to lower interest rates.

    Health care expenses as a percentage of premium revenue (medical loss ratio)
increased to 89.8% for 1996 from 78.2% for 1995. The increase in the medical
loss ratio resulted from a 7.4% increase in medical costs on a PMPM basis
(primarily hospital and prescription drug costs as discussed below) and a
decline of 6.5% in the PMPM premium revenue.

    Hospital services expenses increased 59.1% to $178.1 million in 1996 from
$111.9 million in 1995. The increase is due primarily to an increase in fully-
insured membership. On a PMPM basis, however, hospital services increased 5.7%
from 1995 to 1996. This increase is attributable primarily to the recent trend
to perform certain lower cost services, which historically had been performed in
an in-patient setting, in an out-patient setting. This results in a higher
average cost for those services which are still performed in an in-patient
setting. Inpatient hospital utilization for fully-insured commercial enrollees
decreased 3.2% to 272 days per thousand members, per year for the year ending
December 31, 1996 from 281 days per thousand members, per year for the same 1995
period. This decrease was primarily due to the continued trend towards less
expensive treatment being provided in the out-patient setting and more effective
medical management techniques.

    Physician and related health care expenses increased 51.6% in 1996 from
1995.  The increase is primarily due to the 59.9% increase in fully insured
membership as well as increases in non-capitated expenses, including costs for
out-of-network physicians' services.

    Other health care expenses increased by $23.7 million from 1995 to 1996 due
primarily to higher prescription drug costs resulting from an increase in the
number of members covered by prescription drug riders.  Additionally, there was
a shift in membership to drug riders which offered greater benefits.  At the
same time, fewer generic drugs were prescribed resulting in increased pharmacy
costs.

    Indemnity costs reflect the medical costs associated with the indemnity
revenue assumed in connection with The Guardian reinsurance arrangement in New
York which began in 1995. The Company's net indemnity costs for 1996 were $7.0
million, up from $2.2 million for 1995. As a result of continuing adverse
experience related to this business, the Company amended the New York
reinsurance agreement to reduce the Company's share of the indemnity business
assumed from 50% to 10%, for the period from January 1, 1996 to June 30, 1996.
The impact of this adjustment reduced the after tax loss associated with the
indemnity business by approximately $900 thousand, which was recorded in the
second quarter of 1996. The amendment also provided that the Company will assume
no further indemnity risk in the New York market for claims incurred after June
30, 1996. As noted above, after September 30, 1996 the Company did not share
risk in connection with the Healthcare Solutions indemnity business in the
Connecticut market. Selling, general and administrative expenses increased 48.2%
to $86.7 million in 1996 from $58.5 million in 1995. The increase was
principally due to additional staffing, outside services and other costs needed
to support geographic expansion, product diversification and enrollment growth.

    The Company's effective tax benefit rate was 46.5% for the year ended
December 31, 1996, as compared to an effective tax provision rate of 34.6% for
the comparable 1995 period.  The 1996 effective tax rate resulted primarily from
the favorable effect of the income from tax exempt securities which increases
the tax benefit when there are losses.

    The Company has undertaken a number of actions intended to restore
profitability in 1997. It increased its premiums an average of 4.4% at the end
of 1996 for groups renewing in 1997 and may make further adjustments subject to
competitive conditions. It has moved to introduce enhanced medical management,
which is intended to result in reduced health care expenses on a PMPM basis in
1997. In addition, its contracts with risk entities shift a greater amount of
the risk of overutilization to the risk entities, which will provide further
protection against rising health care costs. Moreover, the Company has shifted a
portion of the Healthcare Solutions membership to capitation arrangements with
the Physician Groups. Although there can be no assurance that these changes,
among others, will enable the

                                       21
<PAGE>

Company to be profitable in 1997, the Company expects to see significant
improvement in its financial results in 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Cautionary
Statement."


YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

    Premium revenue increased 18.4% to $343.0 million in 1995 from $289.8
million in 1994 while enrollment at December 31, 1995 increased 48.8% over 1994
to 267,116.  As of December 31, 1995, fully-insured enrollees increased 55.5% to
207,856 members from 133,676 as of December 31, 1994, while self-funded
enrollees increased 29.2% to 59,260 members as of December 31, 1995, up from
45,874 as of December 31, 1994.  The premium revenue increase lagged the
membership growth due to more aggressive pricing and a shift in fully insured
product mix to lower revenue yielding products.  Also, enrollee statistics
include 100% of the enrollees in New York, while premium revenue includes only
the Company's 50% share of revenues derived from the New York Guardian
arrangements which become effective July 1, 1995.

    Investment and other income was up 67.5% in 1995 from $4.2 million for the
year ended December 31, 1994 to $7.0 million for the year ended December 31,
1995.  The increase in investment income was due to improved portfolio yields
and a reduction in realized losses.

    Health care expenses as a percentage of premium revenue (medical loss ratio)
decreased to 78.2% for 1995 from 79.0% for 1994.  The decrease in the medical
loss ratio resulted from a 7.0% decline in medical costs on a per member per
month basis which was partially offset by a 6.4% decline in the per member per
month premium revenue.  Total health care expenses increased 17.1% to $263.8
million in 1995 from $225.3 million for 1994.

    Hospital services expenses increased 17.9% to $111.9 million in 1995 from
$94.9 million in 1994.  On a PMPM basis, hospital services declined 6.8% from
1994 to 1995.  The decline was due primarily to a reduction in in-patient
hospital utilization which was partially offset by higher out-patient
utilization.  In-patient hospital utilization for fully-insured enrollees,
excluding Medicare cost contract enrollees, decreased 14.1% to 281 days per
thousand members per year for the year ending December 31, 1995 from 327 days
per thousand members for the same 1994 period.

    Physician and related health care expenses increased 11.6% in 1995 from 1994
despite a 55.5% increase in fully insured enrollees.  As a result, physician
expense declined 11.8% on a per member per month basis for the year ended
December 31, 1995 as compared to the same 1994 period.  The decrease is largely
due to more favorable capitation arrangements with providers and a shift in
membership to lower cost capitated products.

    Other health care expenses increased by $5.8 million from 1994 to 1995 due
primarily to higher prescription drug expense resulting from an increase in
prescription drug benefit coverage and increased utilization.  Additionally, in
1995, other health care expenses includes the Healthcare Solutions profit
sharing expense which resulted from The Guardian reinsurance arrangement in
Connecticut.

    Indemnity costs reflect the medical costs associated with the indemnity
revenue assumed in connection with The Guardian reinsurance arrangement in New
York which began in 1995.

    Selling, general and administrative expenses increased 32.7% to $58.5
million in 1995 from $44.1 million in 1994.  The increase was principally due to
continuing resource commitments to support enrollment growth and the expansion
into the Connecticut, New York and New Jersey tri-state region.  Additionally,
the related administrative infrastructure was also expanded to accommodate the
increased growth.

    The Company's effective tax rate declined to 34.6% for the year ended
December 31, 1995 from 42.5% for the comparable 1994 period. The decline in the
effective tax rate resulted primarily from the shift of much of the Company's
investment portfolio into tax exempt municipal bonds and to a slight decline in
the statutory state income tax rates. Additionally, the effective tax rate for
1995 was favorably affected by the reconciliation of prior provisions.

                                       22
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

    PHS has historically financed its operations primarily through internally
generated funds. The Company's primary capital requirements are for working
capital, principally to fund geographic and product expansion, and to maintain
necessary regulatory capital. In addition, the Company's HMO subsidiaries,
PHS/CT, PHS/NY and PHS/NJ, and its insurance subsidiaries, are subject to
statutory regulations that restrict the payment of dividends.

    Net cash flows for the year ended December 31, 1996 resulted in an increase
in cash and cash equivalents of $31.7 million. Although operating cash flows
were unfavorably affected by the Company's 1996 loss of $13.0 million, net cash
was provided by operating activities of $24.6 million for the year ended
December 31, 1996. The difference between the net loss and the net cash provided
from operating activities resulted primarily from a $22.3 million increase in
hospital incurred but not reported ("IBNR") claims, which was generated from the
increase in the volume of claims activity due to the rise in membership and
the timing of the related claims payments and from the collection of outstanding
advances to hospitals which totalled $5.5 million. Additionally, the amounts due
to IPAs, physicians and other providers increased $15.3 million in 1996,
reflecting an increase in the amounts payable to non-capitated providers, such
as out of network providers, and the timing of those related payments. These
items were offset in part by the net increase in receivables of approximately
$10.0 million which occurred due to the growth in enrollment from both the
Company's proprietary business and from its arrangements with The Guardian.
Approximately $44.0 million of net cash was provided by the sales and maturities
of marketable securities, of which $34.6 million was used to fund the
enhancement of the Company's computer infrastructure and to purchase the
Company's new corporate headquarters .

   PHS's net cash used in operations amounted to $9.5 million in 1995. Since The
Guardian holds the funds generated by Healthcare Solutions, on which the Company
earns interest, and since the funds were not released by year end, operating
cash flows in 1995 were unfavorably affected by the arrangements with The
Guardian. In addition, IPA withhold percentages were generally decreased in
1995, and as a result, the amounts owed to the IPAs tended to be paid over on a
more rapid schedule. Further, accelerated payments related to income taxes and
the Medicare cost contract decreased operating cash flows. These items were
partially offset by the net income of $16.0 million generated during the year.
Cash used for investing activities was $11.7 million for the year ended December
31, 1995, primarily due to capital expenditures of $15.2 million which
represented investments in optical imaging technology and other improvements in
the computer infrastructure needed to support the Company's expansion.

    Net cash flow during 1994 resulted in an increase in cash and investments to
$139.8 million at December 31, 1994 from $112.2 million at December 31, 1993.
Cash provided by operating activities totaled $39.3 million, resulting primarily
from net income of $14.1 million generated during the period, the timing of the
receipt of medical claims and the timing of payments related to other
liabilities.

    At December 31, 1994, PHS was no longer required to maintain a restricted
cash reserve to comply with the requirement of the Office of Prepaid Healthcare
in connection with the Medicare cost contract.  In New York, the Company is
required to maintain an escrow reserve equal to 5% of estimated health care
expenses for the current year, for the protection of enrollees, which, as of
December 31, 1996 was $9.0 million.  In Connecticut, the Company is required to
maintain a statutory minimum unimpaired capital surplus of $1.0 million.  The
Company is currently in compliance with all applicable statutory capital
requirements. The Company is subject to various laws and regulations which, at
December 31, 1996, caused the aggregate amount of its restricted net assets to
be approximately $38.8 million.

    The Company's expenditures for capital equipment, primarily for computers
and related equipment, and in 1996 for the purchase of the Company's new
headquarters, totaled $34.6 million, $15.2 million and $9.7 million for the
years ended December 31, 1996, 1995 and 1994, respectively. The Company expects
to spend additional capital, principally in computer and technology systems
enhancements, over the next several years. The Company expects to require
additional capital over the next several years and, although it can provide no
assurances in this regard, believes that in addition to its current capital
resources and internally generated funds, it will be able to obtain financing,
if necessary, sufficient for its continued operations.


EFFECT OF INFLATION

    Health care industry costs have been rising annually at rates higher than
the Consumer Price Index. To offset this trend, PHS has been able to achieve
premium rate increases for its 1997 business which should help mitigate the
effect of medical cost inflation on its operations. The Company's premiums are
higher than many of its competitors, however, and there can be no assurance that
the Company will be able to increase premiums sufficiently to offset the rise in
health care costs without jeopardizing the Company's competitive position. In
addition, PHS contracts with several major hospitals on a multi-year basis with
fixed annual increases. The

                                       23
<PAGE>

Company's risk sharing arrangements with its Physician Groups and other cost
control measures, such as its utilization review program, also help to mitigate
the effects of price increases on operations. There can be no assurance that the
Company's efforts to reduce the impact of inflation will be successful.


CAUTIONARY STATEMENT

    In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby making cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements made by or on behalf of the Company.

    The Company wishes to caution readers that the following important factors,
among others, could cause the Company's actual financial or enrollment results
to differ materially from those expressed in any projected, estimated or
forward-looking statements relating to the Company.

PREMIUM STRUCTURE; UNPREDICTABILITY OF MEDICAL COSTS. A substantial amount of
the Company's revenues are generated by premiums which represent fixed monthly
payments for each person enrolled in the Company's plans. If the Company is
unable to obtain adequate premiums because of competitive or regulatory
considerations, the Company could incur decreased margins or significant losses.
The Company believes that commercial premium pricing will continue to be highly
competitive. The Company's revenues from its Medicare and Medicaid programs
could be adversely affected if reimbursement rates do not keep pace with rising
medical costs. Historically, these rates have been subject to wide variations
from year to year. In the event reimbursement were to decline from projected
amounts, the Company would attempt to renegotiate its contracts with its health
care providers. There can be no assurance that it could successfully renegotiate
these financial arrangements and failure to reduce the health care costs
associated with such programs could have a material adverse effect upon the
Company's business.

    The Company's profitability is also dependent, in large part, upon its
ability to accurately project and manage health care costs, including without
limitation, appropriate benefit design, utilization review and case management
programs, and its risk sharing arrangements with providers, while providing
members with quality health care.  Health care costs are affected by a variety
of factors that are difficult to predict and are not entirely within the
Company's control, including the severity and frequency of claims.  Medical cost
inflation, mandated benefits and other regulatory changes, new technologies,
natural disasters, epidemics and other external factors relating to the delivery
of health care services, inability to establish acceptable risk sharing
arrangements with providers and other factors may adversely affect the Company's
ability to manage the costs of providing health care services.  In addition, the
Company experienced high out-of-network utilization in connection with its POS
products in 1996 in New York, which resulted in medical costs for the POS
products exceeding budgeted amounts.  The Company is seeking to expand its
network in New York and institute other measures to limit the risk of high out-
of-network utilization.  The Company is implementing a variety of measures to
help it manage health care costs better.  However, there can be no assurance
that the Company will be able to continue to reduce its medical costs
sufficiently to restore profitability in all its product lines.  In light of the
expected continuing growth of the POS products, failure to reduce out-of-network
utilization could adversely affect the Company's profitability.

    Accrued health care expenses payable in the Company's financial statements
include reserves for incurred but not reported claims ("IBNR"), the amount of
which is estimated by the Company.  The Company estimates the amount of such
reserves using standard actuarial methodologies based upon historical data
including the average interval between the date services are rendered and the
date claims are paid, expected medical cost inflation, seasonality patterns and
increases in membership.  The Company believes that its reserves for IBNR are
adequate in order to satisfy its ultimate claims liability.  However, there can
be no assurances as to the ultimate accuracy or completeness of such estimates
or that adjustments to reserves will not cause volatility in the Company's
results of operations.

DEPENDENCE UPON KEY EMPLOYER AGREEMENTS.  The Company's ability to obtain and
maintain favorable group benefit agreements with employer groups affects the
Company's profitability.  Currently, 17% of its total

                                       24
<PAGE>

commercial enrollment (those groups which are fully insured, which includes
332,363 enrollees) is derived from its largest five fully insured accounts.
Fully insured groups produce the highest PMPM revenues for the Company. Although
during the Company's most recent fiscal year, no employer group accounted for
more than 7.5% of total revenues, the loss of one or more of the larger employer
group accounts could have a material adverse effect upon the Company's business.
Although only 8% of the Company's total membership in 1996 was enrolled in
Medicare and Medicaid programs, that percentage is expected to increase in the
future. Loss of one or more of the contracts the Company currently has or
expects to have to serve Medicaid or Medicare participants could have a material
adverse effect upon the Company's business. Finally, the Company has agreed to
certain performance guarantees for certain of the large employer groups with
which it contracts. Failure to satisfy such guarantees could result in financial
penalties.

KEY PARTNERSHIP.  The Company's contracts with The Guardian are expected to
represent a significant percentage of the Company's revenue and enrollment in
future years.  See "Business-Joint Marketing Arrangement with The Guardian."
The loss of this relationship could have a material adverse effect on the
Company's business.


COMPETITION. Managed care companies and HMOs operate in a highly competitive
environment. The Company has numerous types of competitors, both local and
national, including, among others, HMOs, PPOs, self-insured employer plans and
traditional indemnity carriers, many of which have substantially larger total
enrollments, greater financial resources and other characteristics that give
them an advantage in competing with the Company. Additional competitors with
needs or desires for immediate market share or those with greater financial
resources than the Company have entered or may enter the Company's market. The
Company also believes that the addition of new competitors can occur relatively
easily. In addition, certain of the Company's customers may decide to perform
for themselves certain administrative services currently provided by the
Company, which could adversely affect the Company's revenues. Significant merger
and acquisition activity has occurred in the managed care industry as well as in
industries which are suppliers to the Company. This activity may result in
stronger competitors or increase health care costs. Increased competitive
pressures may limit the Company's ability to increase, or in some instances,
maintain premiums, reduce membership levels or decrease profit margins, and
there can be no assurance that the Company will not incur increased pricing and
enrollment pressure from local and national competitors. Any such pressures
could materially affect the Company's results of operations.

GOVERNMENT REGULATION.  The Company's business is subject to extensive federal
and state laws and regulations, including, but not limited to, financial
requirements, licensing requirements, enrollment requirements and periodic
examinations by governmental agencies.  The laws and regulations governing the
Company's business and the interpretation of those laws and regulations are
subject to frequent change.  Existing or future laws or regulations could force
the Company to change the way it does business and may restrict the Company's
revenue or enrollment growth or increase its health care and/or administrative
costs.  In particular, the Company's HMO and insurance subsidiaries are subject
to regulations relating to cash reserves, minimum net worth, premium rates and
approval of policy language and benefits.  Although such regulations have not
significantly impeded the growth of the Company's business to date, there can be
no assurance that the Company will be able to continue to obtain or maintain
required governmental approvals or licenses or that regulatory changes will not
have a material adverse effect on the Company's business.  In addition, delays
in obtaining regulatory approvals or moratoriums imposed by regulatory
authorities could adversely effect the Company's ability to bring new products
to market as forecasted.  The Company is also subject to various governmental
audits and investigations.  Such activities could result in the loss of required
licenses or the right to participate in certain programs, or the imposition of
penalties and/or other sanctions .  In addition, disclosure of any adverse
investigation or audit results or sanctions could negatively affect the
Company's reputation in various markets and make it more difficult for the
Company to sell its products and services.

MANAGEMENT INFORMATION SYSTEM.  The Company's management information system is
critical to its current and future operations.  The information gathered and
processed by the Company's management information system assists the Company in,
among other things, pricing its services, monitoring utilization and other cost
factors, processing provider claims, providing bills on a timely basis and
identifying accounts for collection.  Any difficulty associated with or failure
to successfully implement the current conversion of its management information
system, or any inability to expand processing capability in the future in
accordance with its business needs, could result in a loss of

                                       25
<PAGE>

existing customers and difficulty in attracting new customers, customer and
provider disputes, regulatory problems, increases in administrative expenses or
other adverse consequences.

NEW SERVICE AREAS AND PRODUCTS.  The Company recently undertook a significant
expansion of its geographic market area.  In addition, it recently introduced
several new products, including Medicare risk and Medicaid products. The success
of its geographic and product expansion efforts depends in large part on its
ability to develop market share in a highly competitive market and to develop
the infrastructure necessary to support the forecasted enrollment growth.  The
Company believes that it has budgeted sufficient amounts to meet its growth
expectations; however, there can be no assurance that it will not require
greater resources than expected or that it will be successful in its marketing
efforts.  Furthermore, although it believes it has introduced programs to
effectively manage its new products, there can be no assurance that the health
care and other costs associated with such programs will not be greater than
revenues.  Medicare risk contracts provide revenues which are generally higher
per member than those for non-Medicare members, and thus provide an opportunity
for increased profits and cash flow.  Such risk contracts, however, also carry
certain risks such as higher comparative medical costs, government regulatory
and reporting requirements, the possibility of reduced or insufficient
government reimbursement in the future, and higher marketing and advertising
costs per member as the result of marketing to individuals as opposed to
groups.

POSSIBLE VOLATILITY OF COMMON STOCK PRICE. Recently, there has been significant
volatility in the market prices of securities of companies in the health care
industry, including the price of the Company's Common Stock. Many factors,
including medical cost increases, analysts' comments, speculation about a
possible merger or acquisition, announcements of new legislative proposals or
laws relating to health care reform, the performance of, and investor
expectations for, the Company, the trading volume of the Company's Common Stock
and general economic and market conditions, may influence the trading price of
the Company's Common Stock. Accordingly, there can be no assurance as to the
price at which the Company's Common Stock will trade in the future.

NEGATIVE PUBLICITY. The managed care industry has recently received a
significant amount of negative publicity. Such general publicity, or any
negative publicity regarding the Company in particular, could adversely affect
the Company's ability to sell its products or services or could create
regulatory problems for the Company. Recently, the managed care industry has
experienced significant merger and acquisition activity. Speculation or
uncertainty about the Company's future could adversely affect the ability of the
Company to market its products.

ACCREDITATION. Certain of the Company's customers or potential customers
consider rating, accreditation or certification of the Company by various
private or governmental bodies or rating agencies as necessary and/or important.
The Company currently has three year accreditation from the National Committee
on Quality Assurance ("NCQA") which will expire in May, 1997. NCQA visited the
Company's offices in connection with its reaccrediation in late March 1997.
Should the Company fail to maintain three-year NCQA accreditation, or obtain any
other certification or accreditation as may be deemed to be necessary and/or
important by customers, it may adversely affect the Company's ability to obtain
or retain the business of such customers.

ADMINISTRATIVE EXPENSE.  The level of administrative expense is a partial
determinant of the Company's profitability.  While the Company attempts to
effectively manage such expenses, increases in staff-related and other
administrative expenses may occur as a result of business or product expansion,
changes in business, acquisitions, regulatory requirements or other reasons.
Such expense increases are not clearly predictable and increases in
administrative expenses may adversely affect financial results.

The Company currently believes that it has a relatively experienced, capable
management staff.  Loss of certain managers or a number of such managers could
adversely affect the Company's ability to administer and manage its business.

LITIGATION AND INSURANCE.  The Company is subject to a variety of legal actions
to which any corporation may be subject.  In addition, because of the nature of
its business, the Company incurs and likely will continue to incur potential
liability for claims related to its business, such as failure to pay for or
provide health care, poor outcomes for care delivered or arranged, provider
disputes and claims related to self-funded business.  It is possible that
punitive or substantial non-economic damages may be sought in cases of this
nature.  While the Company currently has insurance coverage for some of
these potential liabilities, others may not be covered by insurance, the
insurers may dispute coverage or the amount of insurance may not be enough to
cover the damages awarded.  In

                                       26
<PAGE>

addition, certain types of damages, such as punitive damages, may not be covered
by insurance and insurance coverage for all or certain forms of liability may
become unavailable or prohibitively expensive in the future.

PROVIDER RELATIONS.  One of the significant techniques that the Company uses to
manage health care costs and utilization is contracting with physicians,
hospitals and other providers.  Because of the large number of providers with
which the Company contracts, the Company currently believes that it has a
limited exposure to provider relations issues.  In any particular market,
however, providers could refuse to contract with the Company, demand higher
payments or take other actions which could result in higher health care costs,
less desirable products for customers and members or difficulty in meeting
regulatory or accreditation requirements.  In some markets,  certain providers,
particularly hospitals, physician/hospital organization or multi-speciality
physician groups, may have significant market positions.  Such groups may also
compete directly with the Company.  If such providers refuse to contract with
the Company or utilize their market position to negotiate favorable contacts or
place the Company at a competitive disadvantage, the Company's ability to market
products or to be profitable in those areas could be adversely affected.

In addition, the Company has recently entered into a number of contracts with
physician/hospital organizations and other physician groups that place a
significant percentage of the risk of overutilization on those groups.  Although
this technique is believed to be advantageous to the Company insofar as it
limits the Company's risk, failure of one or more of the physician/hospital or
other physician groups to successfully manage the risk could have a material
adverse effect on the Company's business and results of operations.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

    The response to this Item is submitted in Item 14 of this Report.


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

    None.

                                       27
<PAGE>

                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

    The information required by this Item is incorporated herein by reference to
the Company's 1997 Proxy Statement.


ITEM 11.  EXECUTIVE COMPENSATION

    The information required by this Item is incorporated herein by reference to
the Company's 1997 Proxy Statement.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The information required by this Item is incorporated herein by reference to
the Company's 1997 Proxy Statement.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   The information required by this Item is incorporated herein by reference to
the Company's 1997 Proxy Statement.



                                       28
<PAGE>

                                PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a)  1.   All financial statements - see Index to Consolidated Financial
          Statements and Schedules on page 33.

     2.   Financial statement schedules - see Index to Consolidated Financial
          Statements and Schedules on page 33.

     3.   Exhibits - see Exhibit Index on page 55.

(b)  Reports on Form 8-K

          None



                                       29
<PAGE>

                                SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the Town of Shelton and State
of Connecticut on the 27th day of March, 1997.


                                    PHYSICIANS HEALTH SERVICES, INC.



                                    By:  /S/Robert L. Natt
                                         -----------------
                                    President and Co-Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed by the following persons on behalf of the Company and in the
capacities indicated on March 27th, 1996.

     Signature                    Title
     ---------                    -----



/S/Robert L. Natt                 Principal Executive Officer
-----------------
Robert L. Natt


/S/James L. Elrod, Jr.            Principal Financial Officer
----------------------------
James L. Elrod, Jr.



/S/Craig Dupont                   Principal Accounting Officer
--------------------
Craig Dupont



/S/Lewis Bader, M.D.              Director
--------------------
Lewis Bader, M.D.



/S/Larry Coletti, M.D.            Director
----------------------
Larry Coletti, M.D.

                                       30
<PAGE>

/S/Melvin P. Coolidge, M.D.       Director
---------------------------
Melvin P. Coolidge, M.D.



/S/Arnold DoRosario, M.D.         Director
-------------------------
Arnold DoRosario, M.D.



/S/Santiago Escobar, M.D.         Director
-------------------------
Santiago Escobar, M.D.



/S/Richard Freeman                Director
------------------
Richard Freeman



/S/David Grayer, M.D.             Director
---------------------
David Grayer, M.D.



/S/Michael E. Herbert             Director
---------------------
Michael E. Herbert



/S/A. Thomas Licciardello, M.D.   Director
-------------------------------
A. Thomas Licciardello, M.D.



/S/Andrew Lozyniak                Director
------------------
Andrew Lozyniak



/S/Murray A. Morrison, M.D.       Director
---------------------------
Murray A. Morrison, M.D.



/S/Joseph E. Nechasek, Ph.D.      Director
----------------------------
Joseph E. Nechasek, Ph.D.


                                       31
<PAGE>

/S/Noel R. Newman, Esq.           Director
-----------------------
Noel R. Newman, Esq.



/S/Kenneth Sacks, M.D.            Director
----------------------
Kenneth Sacks, M.D.



/S/Edward Sawicki, M.D.           Director
-----------------------
Edward Sawicki, M.D.



/S/Arthur H. Sheer                Director
------------------
Arthur H. Sheer



/S/Bernard Sherlip, M.D.          Director
------------------------
Bernard Sherlip, M.D.



/S/John C. Washburn               Director
-------------------
John C. Washburn



                                       32
<PAGE>

               PHYSICIANS HEALTH SERVICES, INC. AND SUBSIDIARIES
           INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

<TABLE>
<CAPTION>
                                                                                Page
                                                                                ----
<S>                                                                             <C>
Report of Independent Auditors. . . . . . . . . . . . . . . . . . . . . . . . .  34
Consolidated Balance Sheets as of December 31, 1996 and 1995. . . . . . . . . .  35
Consolidated Statements of Operations for the years ended December 31, 1996,
1995 and 1994  . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .  36
Consolidated Statements of Shareholders' Equity for the years ended December 31,
1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  37
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . 39
Schedule I - Condensed Financial Information of Registrant .  . .  . . . . . . . 51
Schedule II - Valuation and Qualifying Accounts. . . . . . . . . . . . . . . . . 54
</TABLE>


                                       33
<PAGE>

                         Report of Independent Auditors



Board of Directors
Physicians Health Services, Inc.

We have audited the consolidated balance sheets of Physicians Health Services,
Inc. and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the three years in the period ended December 31, 1996. Our audits also included
the financial statement schedules listed in the Index at Item 14(a). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Physicians Health
Services, Inc. and subsidiaries at December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.

As discussed in Note 2 to the consolidated financial statements, in 1994 the
Company changed its method of accounting for certain investments in debt and
equity securities.



Stamford, Connecticut
March 14, 1997

                                                               ERNST & YOUNG LLP

                                      34
<PAGE>

                        Physicians Health Services, Inc.

                          Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                               DECEMBER 31
                                             1996        1995
                                          ----------------------
<S>                                       <C>         <C>

                                          (DOLLARS IN THOUSANDS)
ASSETS
Current assets:
 Cash and cash equivalents                  $ 39,213    $  7,536
 Investments available for sale, at
  fair value:
  Fixed maturity securities                   59,115     102,130
  Equity securities                               --       1,355
 Accounts receivable, less allowances         38,028      31,548
   (1996-$1,781 and 1995-$1,050)
  Other receivables                           19,696      14,815
  Advances to participating hospitals            400       5,903
 Prepaid expenses and other                    1,154         204
                                          ----------------------

                TOTAL CURRENT ASSETS         157,606     163,491

Property, plant and equipment:
 Land                                          8,822       3,322
 Building and improvements                    26,938      14,645
 Furniture and equipment                      46,559      29,817
                                          ----------------------

                                              82,319      47,784

Less accumulated depreciation and
 amortization                                 15,273      11,028
                                          ----------------------
                                              67,046      36,756
Other assets (including restricted
 investments)                                 13,658      10,821
                                          ----------------------
                TOTAL ASSETS                $238,310    $211,068
                                          ======================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Accrued hospital and other health care
  expenses                                  $ 46,153    $ 23,878
 Unearned premiums                            27,757      25,022
 Amounts due to IPAs, physicians and
  other providers                             53,103      37,806
 Accounts payable and accrued expenses        13,849      14,199
                                          ----------------------
                TOTAL CURRENT LIABILITIES    140,862     100,905

Excess of net assets over cost of
 company acquired                              1,162       1,282
                                          ----------------------
                        TOTAL LIABILITIES    142,024     102,187

Stockholders' equity:
 Preferred Stock, par value $0.01 per
  share - authorized 500 shares,
       none issued                                --          --
 Class A Common Stock, par value $0.01
  per share - authorized 13,000,000
  shares; issued and outstanding 1996 -
  5,566,023 shares; 1995 - 5,310,347
  shares; voting rights - 1 per share             56          53

 Class B Common Stock, par value $0.01
  per share; non-transferable;
  authorized and issued 1996 -
  3,829,880 shares; 1995 - 4,052,974
  shares; voting rights - 10 per share            38          41


Additional paid-in capital                    41,360      40,760
Net unrealized gains on marketable
  securities, net of tax                         279         510
Retained earnings                             54,554      67,518
                                          ----------------------
                                              96,287     108,882
Less cost of Class B Common Stock
 (86,400 shares) in Treasury                       1           1
                                          ----------------------
                TOTAL STOCKHOLDERS' EQUITY    96,286     108,881
                                          ----------------------

        TOTAL LIABILITIES AND STOCKHOLDERS'
         EQUITY                             $238,310    $211,068
                                          ======================
</TABLE>
See notes to consolidated financial statements.

                                      35
<PAGE>

                        PHYSICIANS HEALTH SERVICES, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                              YEAR ENDED DECEMBER 31
                                             1996       1995      1994
                                        --------------------------------
<S>                                       <C>         <C>       <C>
                                          (DOLLARS IN THOUSANDS, EXCEPT
                                                 PER SHARE DATA)
REVENUES:
 Premiums                                  $481,534   $342,975  $289,784
 Investment and other income                  6,574      6,968     4,160
                                        --------------------------------
                                            488,108    349,943   293,944
Costs and expenses:
 Hospital services                          178,059    111,947    94,934
 Physicians and related health care
  services                                  198,591    131,019   117,393
 Other health care services                  42,382     18,707    12,943
 Indemnity costs                              7,008      2,157        --
 Selling, general and administrative
  expenses                                   86,728     58,504    44,089
 Guardian joint marketing expense
  (income), net                                (809)     2,298        --
 Proxy defense costs                             --        892        --
 Interest expense                               388         --        --
                                        --------------------------------
                                            512,347    325,524   269,359

Income (loss) before income taxes           (24,239)    24,419    24,585
Income tax expense (benefit)                (11,275)     8,449    10,451
                                        --------------------------------
Net income (loss)                          $(12,964)  $ 15,970  $ 14,134
                                        ================================

Net income (loss) per common share           $(1.39)     $1.70     $1.52
                                        ================================

Weighted average number of common and
 common equivalent shares outstanding         9,301      9,403     9,307
                                        ================================
</TABLE>

See notes to consolidated financial statements.

                                      36
<PAGE>

                        PHYSICIANS HEALTH SERVICES, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>

                                              YEAR ENDED DECEMBER 31
                                            1996       1995       1994
                                        -------------------------------
                                             (DOLLARS IN THOUSANDS)
<S>                                       <C>        <C>        <C>
CLASS A COMMON STOCK
Balance at beginning of period            $     53   $     49   $    45
Conversion of Class B Common Stock into
 Class A Common Stock:
 1996 - 223,094 shares, 1995 - 437,537
  shares, 1994 - 435,228 shares                  3          4         4
Options exercised:
 1996 - 32,582 shares, 1995 - 14,974
  shares, 1994 - 3,558 shares
                                        -------------------------------
Balance at end of period                  $     56   $     53   $    49
                                        ===============================

CLASS B COMMON STOCK
Balance at beginning of period            $     41   $     45   $    49
Conversion of Class B Common Stock into
 Class A Common Stock:
 1996 - 223,094 shares, 1995 - 437,537
  shares, 1994 - 435,228 shares                 (3)        (4)       (4)
                                        -------------------------------
Balance at end of period                  $     38   $     41   $    45
                                        ===============================

ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period            $ 40,760   $ 40,514   $40,461
Exercise of stock options                      600        246        53
                                        -------------------------------
Balance at end of period                  $ 41,360   $ 40,760   $40,514
                                        ===============================

NET UNREALIZED GAINS (LOSSES) ON
 MARKETABLE SECURITIES, NET OF TAX
Balance at beginning of period            $    510   $   (949)  $   --
Net unrealized gain at date of adoption
 of SFAS 115, net of tax                        --         --       184
Net unrealized gain (loss)                    (231)     1,459    (1,133)
                                        -------------------------------
Balance at end of period                  $    279   $    510   $  (949)
                                        ===============================

RETAINED EARNINGS
Balance at beginning of period            $ 67,518   $ 51,548   $37,414
Net income (loss)                          (12,964)    15,970    14,134
                                        -------------------------------
Balance at end of period                  $ 54,554   $ 67,518   $51,548
                                        ===============================

TREASURY STOCK
Balance at beginning and end of period    $     (1)  $     (1)  $    (1)

TOTAL STOCKHOLDERS' EQUITY
Balance at beginning of period            $108,881   $ 91,206   $77,968
Exercise of stock options                      600        246        53
Net income (loss)                          (12,964)    15,970    14,134
Net unrealized gain (loss) on
 marketable securities, net of tax            (231)     1,459      (949)
                                        -------------------------------
Balance at end of period                  $ 96,286   $108,881   $91,206
                                        ===============================
</TABLE>

See notes to consolidated financial statements.

                                      37
<PAGE>

                        PHYSICIANS HEALTH SERVICES, INC.

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31
                                             1996        1995        1994
                                        -----------------------------------
<S>                                       <C>         <C>         <C>
                                               (DOLLARS IN THOUSANDS)
OPERATING ACTIVITIES
Net income (loss)                         $ (12,964)  $  15,970   $  14,134
Adjustments to reconcile net income
 (loss) to net cash provided by (used
 for) operating activities:
  Depreciation and amortization               4,302       3,064       2,364
  Provision for doubtful accounts             1,485         103       1,423
  Amortization of excess of net assets
   over cost of company acquired               (120)       (120)       (120)

  Deferred income tax expense (benefit)         690       1,421        (233)
  Changes in assets and liabilities:
   Accounts receivable                       (7,965)     (4,453)     (3,273)
   Other receivables                         (4,881)    (13,043)     (1,217)
   Advances to participating hospitals        5,503       1,619       3,794
   Prepaid expenses and other                  (950)        708        (114)
   Accrued health care expenses              22,275      (1,232)     (4,028)
   Unearned premiums                          2,735         631       2,233
   Due to IPAS, Physicians and other
    providers                                15,297      (5,793)      8,076
   Accounts payable and accrued expenses       (856)     (8,367)     16,292
                                          ---------------------------------
Net cash provided by (used for)
 operating activities                        24,551      (9,492)     39,331

INVESTING ACTIVITIES
Purchases of property, plant and
 equipment                                  (34,633)    (15,168)     (9,711)
Disposals of property, plant and
 equipment                                       41          14         226
Net increase in other assets                 (2,837)     (6,916)       (674)
Purchases of marketable securities         (242,451)   (324,877)   (340,176)
Proceeds from sales of marketable
 securities                                 286,406     335,262     332,629
                                          ---------------------------------
Net cash provided from (used for)
 investing activities                         6,526     (11,685)    (17,706)

FINANCING ACTIVITIES
Proceeds from revolving credit line          18,000          --          --
Repayment of revolving credit line          (18,000)         --          --
Exercise of stock options                       600         246          53
                                          ---------------------------------
Net cash provided by financing
 activities                                     600         246          53
                                          ---------------------------------

Increase (decrease) in cash and cash
 equivalents                                 31,677     (20,931)     21,678
Cash and cash equivalents at beginning
 of year                                      7,536      28,467       6,789
                                          ---------------------------------
Cash and cash equivalents at end of year  $  39,213   $   7,536   $  28,467
                                          =================================
</TABLE>
See notes to consolidated financial statements.

                                      38
<PAGE>

                       Physicians Health Services, Inc.

                  Notes to Consolidated Financial Statements

                               December 31, 1996



1. ORGANIZATION AND BUSINESS

Physicians Health Services, Inc. (the "Company" or "PHS") is a holding company
which owns nine subsidiary corporations: Physicians Health Services of
Connecticut, Inc. (PHS/CT), Physicians Health Services of New York, Inc.
(PHS/NY), Physicians Health Insurance Services, Inc. (PHIS), PHS Investments,
Inc., Physicians Health Services (Bermuda), Ltd. (PHS/Bermuda), Physicians
Health Services of New Jersey, Inc. (PHS/NJ), (which was licensed in January
1996), PHS Insurance of Connecticut, Inc. (PHS Insurance CT), Physicians Health
Services Insurance of New York, Inc. (PHS Insurance NY), and PHS Real Estate,
Inc. (PHS RE). PHS/CT and PHS/NY have been designated by the Department of
Health and Human Services (DHHS) as federally qualified Health Maintenance
Organizations (HMOs).

PHS/CT, PHS/NY and PHS/NJ operate as health maintenance organizations in
Connecticut, New York and New Jersey, respectively, and are regulated by their
respective state insurance departments. PHS/NY and PHS/NJ are also regulated by
the Department of Health and Human Services and New Jersey Department of Health
and Senior Services, respectively. State regulations include reserve and cash
flow requirements and restrictions on the ability to pay dividends. Subscribers
pay monthly premiums which entitle them to comprehensive health services as
needed, according to the terms of their contracts.

PHIS, which is licensed as an insurance broker, was formed to market insurance
products to enrollees. The operations of PHIS for all years presented were not
significant.

PHS Insurance CT and PHS Insurance NY operate in and are regulated by the
Insurance Departments of Connecticut and New York, respectively. These companies
are licensed to write accident and health indemnity insurance although no
business has yet been written.

PHS/Bermuda is an offshore property and casualty reinsurer that was formed to
support the business needs of the Company. This includes an agreement to
reinsure certain business with The Guardian Life Insurance Company of America
(see Note 10).

PHS/CT operates throughout most of Connecticut with a significant portion of its
enrollees currently located in Fairfield County. PHS/NY operates only in New
York's Westchester, Putnam, Dutchess, Rockland and Orange Counties, and the
metropolitan New York City and Long Island regions. PHS/NJ operates throughout
New Jersey. The Company's membership consists of commercial, government and
self-funded members.

PHS RE has a wholly owned subsidiary, PHS Real Estate II, Inc. (PHS RE II),
which owns the Company's new corporate headquarters. The operations of PHS RE
and PHS RE II were not significant.

The Company's managed care products include traditional HMO products, in both
open access and gatekeeper models, point of service ("POS") products,
administrative services only ("ASO") plans and Medicare and Medicaid plans.

The Company contracts with physician groups, such as IPAs, PHOs, and
multi-specialty groups (collectively, "Physician Groups"), individual physicians
and other health care providers for a defined range of health services,
including primary and specialty care. The Company's contracts with providers
include discounted fee for service arrangements as well as capitated group
arrangements in which the contracting Physician Group assumes a significant
amount of the risk of overutilization. The Company currently has contracts with
four IPAs, three PHOs and one large physician group ("Group") that provide for
most of its physician services in its Connecticut service area.  In New York and
New Jersey, the Company generally contracts directly with physicians and
other health care providers. Under the typical Physician Group arrangements, the
Physician Group receives a fixed monthly capitation payment for each member
selecting a primary care physician from that Physician Group. Capitation rates
and any increases thereto are negotiated for the term of the contract. The
capitation payment is designed to cover not only the professional medical
services (including ancillary tests and services) rendered by the physicians and
other providers associated with that Physician Group but also includes payments
for certain other services rendered to the enrollee by providers who are not
members of the Physician Group. Services covered by the capitation payment
include, among other things, virtually all physician claims (whether inpatient
or outpatient, including authorized out-of-plan care) and care rendered by other
professionals such as physical therapists and psychologists. In certain of the
contracts, the Physician Groups also are at risk for hospital, pharmacy and
other facility expenses. The Company does not capitate physicians directly.

The capitation payments to Physician Groups other than the PHOs typically do not
cover hospital and other facility expenses, although the Physician Groups are
partially at risk for non-Medicare and non-Medicaid hospital utilization. The
Company establishes an annual per member, per month target for hospital
expenses. The amount varies by benefit plan and Physician Group, and encompasses
both inpatient and outpatient costs. If total hospital expenses generated by the
Physician Group exceed the applicable hospital expense target, the Company
withholds from amounts owed by it to the Physician Group all or a portion of
the excess over budget, in most cases one-half of the excess over budget. If
actual costs are less than budgeted targets, the Physician Group receives from
the Company an incentive credit typically equal to forty to fifty percent of the
amount by which actual costs are less than budgeted targets.

In its New York and New Jersey expansion areas and in areas in Connecticut not
served through Physician Group contracts, the Company contracts for services
principally through direct contracts with individual physicians and other health
care providers. In addition, the Company contracts with two IPAs in the northern
counties of its New York service area. The Company withholds a percentage of
reimbursement for services rendered pursuant to its direct physician contracts
against budgeted amounts to manage excessive utilization.

The Company generally negotiates contracts with hospitals that include
compensation on a per diem basis (at a daily rate, without regard to the scope
of services actually provided). Other compensation arrangements with hospitals
include charged-based discounts (negotiated discounts from the hospital's billed
charges) and all inclusive case rates. In the case of non-participating
hospitals, the Company pays either hospital billed charges or negotiated
discounted charges. Additionally, some hospital contracts include per case,
all-inclusive payment arrangements for select procedures such as maternity
care.
                                      39
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



1. ORGANIZATION AND BUSINESS (CONTINUED)

At December 31, 1996, three of the IPA's own common stock of the Company
aggregating approximately 32% (which entitle them to 68% of the vote on matters
submitted to the Stockholders), with one IPA (Greater Bridgeport Individual
Practice Association) owning approximately 27% (58% of the vote). Capitation
expenses incurred relating to these three IPA's which are included in physician
and related healthcare expenses in the accompanying statements of operations
amounted to $55,019,000, $68,523,000 and $65,091,000 for the years ended
December 31, 1996, 1995 and 1994 respectively. At December 31, 1996 and 1995
amounts payable to these IPA's were $21,622,000 and $10,388,000, respectively.

2. SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly-owned except for PHS/NJ which is 80%
owned by the Company with a 20% minority interest owned by Mastercare
Companies, Inc.  (See Note 11).  Such minority interest was not material to the
accompanying consolidated financial statements.  Significant intercompany
accounts and transactions have been eliminated in consolidation.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.

REVENUE RECOGNITION

Premiums from subscribers and assumed or ceded under reinsurance agreements are
reflected in operations as earned on a pro-rata basis over the period of
coverage. Premiums for periods extending beyond year-end are classified as
unearned premiums. The Company maintains an allowance for doubtful accounts at
a level management believes is sufficient to cover potentially uncollectible
amounts.

PHYSICIANS AND RELATED HEALTH CARE SERVICES

The costs of physicians and related health care services are accrued for in the
period they are provided to enrollees. For the services provided for by
individually contracted physicians, the accrual for the incurred but not
reported claims represent the estimated liability on outstanding claims, based
upon an evaluation of reported claims. Such estimates are continually monitored
and, as estimates are adjusted, they are reflected in current operations. The
amounts accrued under capitation arrangements with IPA's are increased or
decreased based on a comparison of the HMO's hospitalization costs to
contractual targets.

                                      40
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

HOSPITAL AND OTHER HEALTH CARE SERVICES

The cost of health care services is accrued in the period they are provided to
enrollees. The amounts accrued for hospital and other health care expenses
represent the estimated liabilities for reported and unreported claims.  The
reserves for incurred but not reported claims represent the estimated liability
on outstanding claims, based on an evaluation of reported claims. The estimates
are continually monitored and reviewed and, as settlements are made or estimates
adjusted, the resulting differences are reflected in current operations.
Although considerable variability is inherent in such estimates, management
believes that reported reserves are adequate in the aggregate to cover the
ultimate resolution of incurred claims.

CONTRACTS WITH HEALTH CARE FINANCING ADMINISTRATION

Prior to 1996, the Company had entered into a "cost based" contract with the
Health Care Financing Administration ("HCFA"). Under this contract, HCFA pays
the Company a fixed per member per month amount for physician services, while
HCFA pays the costs for inpatient and outpatient services. During 1996, the
Company entered into a "risk based" contract with HCFA. Under the risk-based
contract the Company is paid a fixed per member, per month amount by HCFA for
all services provided. The Company bears the risk that the actual costs of
health care services may exceed the per member, per month amount. The risk based
contract is intended to replace the cost based contract for new enrollees.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost, less accumulated depreciation
and amortization. Provisions for depreciation and amortization are computed
using the straight-line method over the estimated useful lives of the assets or
the terms of the leases, if shorter. Included in property, plant and equipment
are the costs related to the development of a new managed care information
system, approximately $18,600,000 at December 31, 1996. This new system is
expected to be implemented in late 1997. Amortization of the cost of the new
system will begin upon its implementation and continue on a straight-line basis
over its estimated useful life.

EXCESS OF NET ASSETS OVER COST OF COMPANY ACQUIRED

The excess of net assets over the cost of company acquired is being amortized
by the straight-line method over a 20 year period ending August 31, 2006.
Accumulated amortization was $1,240,000 and $1,120,000 at December 31, 1996 and
1995, respectively.

PER SHARE DATA

Per share data are based on the weighted average number of common and common
equivalent shares outstanding during the period. Common stock equivalents
consist of stock options. Fully diluted per share data are not presented as
they are not materially different from primary earnings per share data.

                                      41
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STOCK BASED COMPENSATION

In 1996, the Company implemented the supplemental pro forma provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). SFAS 123, if adopted, requires companies
to recognize compensation expense for grants of restricted stock, stock options
and similar equity instruments to employees and directors based on their
respective fair values at the date of grant. However, the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25") may still be utilized with supplemental pro forma
disclosures of net income and earnings per share being made in the footnotes as
if the accounting provisions of SFAS 123 had been adopted. SFAS 123 is effective
for fiscal years beginning after December 15, 1995. The Company continues to
apply the requirements of APB 25 in the accompanying financial statements with
supplemental pro forma disclosures provided in the notes to the consolidated
financial statements (See note 8).

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of highly liquid investments with a maturity
of three months or less at the time of purchase.

FAIR VALUE OF FINANCIAL INSTRUMENTS

Cash and cash equivalents, accounts receivable, other receivables, advances to
participating hospitals and all current liabilities have fair values that
approximate their carrying amounts.

INVESTMENTS

In May 1993, the Financial Accounting Standards Board issued SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." The Company
adopted the provisions of the new standard as of January 1, 1994, and
categorizes its investments in fixed maturity and equity securities as
"available for sale." Accordingly, such investments are reported at fair value
with changes in unrealized gains and losses disclosed separately, net of taxes,
in stockholders' equity. Fair values are based primarily on quoted market
prices.

Investment income includes realized investment gains and losses on the sale or
maturity of investments, determined by the specific identification method, and
dividends and interest, which are recognized when earned. The amortization of
premium and accretion of discount for fixed maturities is computed utilizing
the interest method.

INCOME TAXES

Income taxes have been provided using the liability method in accordance with
SFAS 109, "Accounting for Income Taxes."

RECLASSIFICATIONS

Certain reclassifications were made to conform prior year amounts to current
year presentation.

                                      42
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



3. EXCESS OF LOSS REINSURANCE AGREEMENT

During 1996 the Company limited the amount of its risk on eligible hospital
claims for any one member in a contract year by acquiring reinsurance coverage
for claims in excess of $600,000 per member, per year for PHS/CT, PHS/NY and
PHS/NJ. The reinsurance contracts allow the Company to transfer to the reinsurer
80% of the next $400,000 of claims per member per year. The contract limits
covered claims to $2 million per member per lifetime (including the deductible).
During 1995 and 1994, the Company acquired reinsurance coverage for claims in
excess of $250,000 per member, per year for PHS/CT and $100,000 per member, per
year for PHS/NY. Those reinsurance policies allowed the Company to transfer to
the reinsurer 80% of the next $750,000 (PHS/CT) and $900,000 (PHS/NY) of the
amount of claims in excess of the aforementioned annual retentions. Reinsurance
expense and recoveries are included in other health care services.

Reinsurance expense was $910,000, $1,300,000, and $636,000, for 1996, 1995 and
1994, respectively. Recoveries were $311,000, $60,000, and $106,000 for 1996,
1995, and 1994, respectively.

4. INVESTMENTS AND OTHER INCOME

The amortized cost, gross unrealized gains and losses, and estimated fair values
of investments are as follows (in thousands):
<TABLE>
<CAPTION>

                                                   DECEMBER 31, 1996
                                     -----------------------------------------
                                                  GROSS       GROSS
                                     AMORTIZED  UNREALIZED  UNREALIZED  FAIR
                                       COST       GAINS      LOSSES     VALUE
                                     -----------------------------------------
<S>                                  <C>        <C>         <C>       <C>
U.S. Government and its agencies     $  5,598      $  -        $15    $  5,583
Corporate securities                   12,803         5         20      12,788
Municipals                             40,242       503          1      40,744
                                     -----------------------------------------
Total fixed securities               $ 58,643      $508        $36    $ 59,115
                                     =========================================
</TABLE>
<TABLE>
<CAPTION>

                                                   DECEMBER 31, 1995
                                     -----------------------------------------
                                                  GROSS       GROSS
                                     AMORTIZED  UNREALIZED  UNREALIZED  FAIR
                                       COST       GAINS      LOSSES     VALUE
                                     -----------------------------------------
<S>                                  <C>        <C>         <C>       <C>
U.S. Government and its agencies     $ 10,629      $ 22     $ -       $ 10,651
Corporate securities                    1,535        14       -          1,549
Municipals                             89,017       936      23         89,930
                                     -----------------------------------------
  Fixed securities                    101,181       972      23        102,130
Equity securities                       1,417         -      62          1,355
                                     -----------------------------------------
  Total                              $102,598      $972     $85       $103,485
                                     =========================================
</TABLE>

                                      43
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)


4. INVESTMENTS AND OTHER INCOME (CONTINUED)

At December 31, 1996, the contractual maturities of investments in fixed
maturities are as follows (in thousands):


                                                AMORTIZED      FAIR
                                                  COST         VALUE
                                             ---------------------------

Due in one year or less                        $  25,037       $25,131
Due after one year through five years             33,106        33,485
Due after ten years                                  500           499
                                             ---------------------------
                                               $  58,643       $59,115
                                             ===========================

Major sources of and related amounts of net investment and other income are as
follows (in thousands):



                                                 YEAR ENDED DECEMBER 31
                                               1996      1995        1994
                                           ----------------------------------

Dividends and interest income from
 investments                                  $5,444    $7,099     $ 5,091
Realized gains                                   139       385         290
Realized losses                                  (99)     (366)     (1,170)
Investment expenses                             (132)     (193)       (258)
                                           ----------------------------------
Net investment income                          5,352     6,925       3,953
Interest on Guardian Receivable                  866        --          --
Other income                                     356        43         207
                                           ----------------------------------
Net investment and other income               $6,574    $6,968     $ 4,160
                                           ==================================

5. INCOME TAXES

Significant components of income tax expense (benefit) were as follows (in
thousands):



                                                 YEAR ENDED DECEMBER 31
                                               1996      1995        1994
                                           ----------------------------------

Current income tax expense (benefit):

  Federal                                   $(10,004)   $5,428     $ 7,720
  State                                       (1,961)    1,600       2,964
                                           ----------------------------------
                                             (11,965)    7,028      10,684
Deferred income tax expense (benefit)            690     1,421        (233)
                                           ----------------------------------
Income tax expense (benefit)                $(11,275)   $8,449     $10,451
                                           ==================================

The following is a reconciliation of federal income tax expense computed at
statutory rates to the amount of income tax expense reflected in the
consolidated statements of operations (in thousands):



                                                 YEAR ENDED DECEMBER 31
                                               1996      1995        1994
                                           ----------------------------------

Federal income tax (benefit) at
 statutory rates                            $(8,484)    $ 8,547     $ 8,605
State income taxes (net of federal
 tax benefit)                                (1,750)      1,773       1,938
Tax exempt interest                          (1,239)     (1,790)          -
Other                                           198         (81)        (92)
                                           ----------------------------------
Income tax expense (benefit)               $(11,275)    $ 8,449     $10,451
                                           ==================================

                                      44
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



5. INCOME TAXES (CONTINUED)

Net deferred tax liabilities, which are included in accounts payable and
accrued expenses, reflect the tax effect of temporary differences between the
carrying amounts of assets and liabilities for financial reporting and income
tax purposes. Significant components of the Company's net deferred tax
liabilities as of December 31 are as follows (in thousands):



                                                           1996      1995
                                                     -----------------------

Deferred tax assets:
 Provision for bad debts                                 $  748    $  444
 Nondeductible hospitalization accruals                     968       643
 Accrued vacation                                           611       428
 State net operating loss carryforward                    1,864         -
 Other                                                      370         -
                                                     -----------------------
Total deferred tax assets                                 4,561     1,515

Deferred tax liabilities:
 Unrealized gains on investments                            193       377
 Depreciation                                             1,075     1,090
 Tax credit for research activities                       4,242       751
 Prepaid expenses                                           240         -
 Accrued market discount on bonds held                      443       423
                                                     -----------------------
Total deferred tax liabilities                            6,193     2,641
                                                     -----------------------
Net deferred tax liability                               $1,632    $1,126
                                                     =======================


As a result of current year losses, approximately $27.0 million of state tax
loss carryforwards will be available for use to offset future state taxable
income through 2001.

The Company paid income taxes of $904,000 in 1996, $10,754,000 in 1995, and
$7,059,000 in 1994.

6. LEASES

The Company leases office space for ten branch locations.

Future minimum lease payments under noncancelable operating leases with
remaining terms of one year or more consisted of the following at December 31,
1996 (in thousands):



                1997                        $ 2,530
                1998                          2,573
                1999                          2,465
                2000                          2,264
                2001                          1,779
                2002 and thereafter           5,094
                                          -----------
                                            $16,705
                                          ===========

Total rent expense was $2,784,000 in 1996, $1,423,000 in 1995,
and $420,000 in 1994.

                                      45
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



7. COMMITMENTS AND CONTINGENCIES

The Company is involved in various litigation and claims arising in the normal
course of business which management believes, based upon discussions with legal
counsel, will not have a material adverse effect on the accompanying financial
statements.

During 1996, the Company entered into a revolving credit agreement under which
it borrowed $18 million to provide short-term financing for the
purchase of the Company's new headquarters. In the fourth quarter the Company
repaid amounts due under the credit agreement and terminated the credit line.
Total interest expense paid in connection with this agreement was approximately
$388,000.

The Health Reinsurance Association ("HRA") provides for otherwise unavailable
health insurance coverage to uninsured or underinsured Connecticut residents.
All health insurers, including HMOs, licensed in Connecticut are subject to
assessment by the HRA to the extent the HRA incurs net losses.  Assessments are
based on premiums written and amounted to $1,018,000, $692,000, and $800,000 in
1996, 1995 and 1994, respectively.

PHS/NY is subject to a community rating law which establishes a pooling
mechanism providing for payments to insurers writing policies for a
disproportionate share of individuals with certain demographic characteristics
and catastrophic medical expenses. Depending on the age and sex characteristics
of an insurer's members, an insurer will either make payments to or receive
payments from the state pooled fund. Expenses related to the demographic pool
were $3,180,000 in 1996, $1,483,000 in 1995 and $1,152,000 in 1994.

For further commitments, refer to Note 11.

8. EMPLOYEE BENEFIT AND STOCK OPTION PLANS

The Company sponsors a defined contribution pension plan covering all full-time
eligible employees (as defined). Contributions are based on a percentage of
eligible salaries as determined by the Board of Directors. This plan also
allows for additional voluntary contributions by covered full-time employees.
Pension cost was approximately $1,061,000 in 1996, $853,000 in 1995 and
$696,000 in 1994. The Company also has a 401(k) plan which covers substantially
all eligible employees (as defined). This plan allows for voluntary employee
contributions and a corporate match of 75% up to 4% of each employee's
compensation. In addition, the Company contributes 1% of each eligible
employee's compensation (as defined) to the plan. Expense related to the 401(k)
plan was $858,000 in 1996, $654,000 in 1995, and $519,000 in 1994.

The Company's Board of Directors, on November 17, 1992, and subsequently on
November 21, 1995, adopted two Stock Option Plans (the "Plans") under
which the Company may grant to certain officers and key employees (and, under
the 1995 Plan, directors) incentive and nonqualified stock options for up to an
aggregate maximum of 1,400,000 shares of Class A Common Stock. Under the Plans,
the Board or Compensation Committee sets the exercise price for such options,
but for incentive stock options, the exercise price shall not be less than the
fair market value of the stock at the date of grant. Under the Plans, options
may be exercised only at such times and under such conditions as determined by
the Board or the Compensation Committee, but in no event more than ten years
after the date of grant. The options that have been granted to date become
exerciseable in equal installments over a period of three years and expire after
ten years except for ten percent shareholders for which such options expire five
years after the grant dates and certain performance based options granted in
1996, whose vesting may be accelerated based upon achievement of certain
earnings targets.

                                      46
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



8. EMPLOYEE BENEFIT AND STOCK OPTION PLANS (CONTINUED)


Information relating to stock options during 1996, 1995, and 1994 is as
follows:

<TABLE>
<CAPTION>
                                                1996                            1995                           1994
                                   -------------------------------------------------------------------------------------------
                                        NUMBER         WEIGHTED         NUMBER         WEIGHTED        NUMBER      WEIGHTED
                                       OF SHARES       AVERAGE         OF SHARES       AVERAGE        OF SHARES    AVERAGE
                                                       EXERCISE                        EXERCISE                    EXERCISE
                                                        PRICE                           PRICE                       PRICE
                                   -------------------------------------------------------------------------------------------

<S>                                   <C>              <C>             <C>             <C>            <C>          <C>
Outstanding at beginning of year        574,478         $24.78          187,514         $18.40          86,848      $15.00
Granted                                 565,040          22.09          413,098          27.45         111,950       20.86
Exercised                               (32,582)         18.43          (14,974)         16.73          (3,558)      15.00
Canceled                                (37,153)         29.29          (11,160)         27.05          (7,726)      17.36
                                   -------------------------------------------------------------------------------------------
Outstanding at end of year            1,069,783         $23.40          574,478         $24.78         187,514      $18.40
                                   ===========================================================================================
Exercisable at end of year              317,478         $22.90           73,364         $17.55          25,318      $15.00
Available for grant, at end of year     279,103           -             506,990           -            408,928        -
</TABLE>

Supplemental and Pro Forma Disclosure:

The following pro forma information regarding net income (loss) and net income
(loss) per share, required by SFAS 123, has been determined as if the Company
had accounted for its stock-based compensation plans under the fair value
methods described in that statement. The fair value of options granted under the
Company's stock-based compensation plans was estimated at the date of grant
using a Black-Scholes option pricing model. The Black-Scholes option pricing
model was developed for use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In addition, option
pricing models require the input of highly subjective assumptions including the
expected dividend yield, the expected life of the options, the expected price
volatility and the risk free interest rate. The weighted averages of the
assumptions used are set forth in the following paragraph.

The weighted average dividend yield for stock option grants during 1996 and
1995 was 0%. The weighted average expected life for 1996 and 1995 was 5 years.
The weighted average volatility for 1996 and 1995 was .46%. The weighted
average risk-free interest rate for 1996 and 1995 was 5.87% and 6.99%,
respectively.

For purposes of pro forma disclosure, the estimated fair values of the options
awarded are amortized to expense over the options' vesting period and do not
include grants prior to January 1, 1995. As such, the pro forma information is
not indicative of future years. The Company's pro forma information was as
follows (in thousands, except per share data):



                                           1996           1995
                                      ---------------------------
Net income (loss):
    As reported                         $(12,964)       $15,970
    Pro forma                            (14,379)        15,535

Net income (loss) per common share:
    As reported                           $(1.39)         $1.70
    Pro forma                              (1.54)          1.65

                                      47
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)


9. DIVIDEND AND INVESTMENT RESTRICTIONS OF SUBSIDIARIES

The Company's HMO and insurance subsidiaries are subject to statutory
regulations that restrict the payment of dividends. Based on laws currently in
effect, PHS/CT generally may not pay dividends in excess of the greater of (1)
the net gain from operations for the preceding calendar year, or (2) 10% of
capital and surplus as of the preceding year end, both as determined in
accordance with statutory accounting practices, without receiving approval of
the Connecticut Insurance Commissioner. The maximum amount of cash dividends
that PHS/CT could pay in 1997 without regulatory approval is approximately
$2,800,000.

The Company is required by the State of New York to maintain an escrow reserve,
currently held in U.S. government obligations, equal to 5% of PHS/NY's
estimated health care expenses for the upcoming year. The escrow reserve was
approximately $9,113,000 and $7,087,000 at December 31, 1996 and 1995,
respectively.

The Company is required by the New Jersey State Insurance Department to
maintain an escrow reserve of $300,000 in the event of insolvency. The escrow
reserve was approximately $322,000 at December 31, 1996.

Based on statutory rules and restrictions, the amount of restricted net assets
of consolidated subsidiaries at December 31, 1996 was approximately $38.8
million.

10. ARRANGEMENT WITH THE GUARDIAN LIFE INSURANCE COMPANY OF AMERICA

In 1995, the Company's subsidiaries, PHS/CT, PHS/NY and PHS/Bermuda, entered
into several marketing and reinsurance agreements with The Guardian Life
Insurance Company of America ("Guardian") and, together, the "companies".
Under these agreements, jointly developed managed care and indemnity products
are marketed to existing insureds of Guardian. In addition, the companies
distributed these products through the brokerage community and an integrated
marketing effort by the companies under the trade name "Healthcare Solutions."

In 1995 and for the first nine months of 1996, PHS/CT, under the terms of the
marketing agreement, wrote 100% of the HMO/POS business and Guardian wrote 100%
of the indemnity business in Connecticut. Under the terms of the profit sharing
agreement, a profit or loss was determined for each line of business. If both
lines were profitable, profits, after provisions for related expenses, as
defined, were shared equally. If neither line were profitable, each company
retained losses, after provisions for related expenses, for its line of business
written. If one line was profitable and the other unprofitable, payments, as
defined, were to be made by the company writing the profitable line to the
company with the unprofitable line, before net profits, if any, were shared. In
connection with this agreement, PHS/CT reported losses of $7.6 million for the
HMO/POS business.

As of October 1, 1996, PHS/CT writes 100% of the HMO/POS business and, under the
terms of a quota share reinsurance agreement, cedes 50% of it to Guardian.
Accordingly, profits and losses, after provisions for related expenses, as
defined, are shared equally. Additionally, 50% of losses previously reported
under the agreement discussed in the preceeding paragraph are recoverable from
future profits, if any, under the reinsurance agreement. After September 30,
1996, PHS/CT no longer participates in the indemnity business.

In 1995, PHS/NY wrote the HMO/POS In-Network business and, under the terms of a
quota share reinsurance agreement, ceded 50% of it to Guardian, while Guardian
wrote 100% of the Indemnity/POS Out-of-Network business and, under the terms of
a quota share reinsurance agreement with PHS/Bermuda, ceded 50% of it to PHS/
Bermuda. As such, profits and losses, after provisions for related expenses, as
defined, were shared equally.

From January 1, 1996 to June 30, 1996, PHS/NY's participation in the Indemnity
business was reduced from 50% to 10%. After June 30, 1996, PHS/NY no longer
participates in the Indemnity business.

                                      48
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



10. AGREEMENT WITH THE GUARDIAN LIFE INSURANCE COMPANY OF AMERICA (CONTINUED)

In 1996, PHS/NJ entered into marketing and reinsurance agreements with Guardian.
PHS/NJ writes the HMO/POS In-Network business and, under the terms of the quota
share reinsurance agreement, cedes 50% of it to Guardian PHS/NJ writes the
HMO/POS out-of-network business and under the terms of a quota share reinsurance
agreement, ceded 100% of it to Guardian, who retrocedes 50% of it back to PHS.
As such, profits and losses, after provisions for related expenses, as defined,
are shared equally.

In 1996, these jointly marketed products generated approximately $114.5 million
of revenue and $129.1 million of medical costs and other expenses for PHS.

In 1995, these jointly marketed products generated approximately $21.5 million
of revenue and $20.2 million of medical costs and other expenses for PHS.

Other receivables at December 31, 1996 and 1995 includes amounts due from
Guardian under profit sharing and reinsurance agreements of approximately $18.4
million and $11.8 million, respectively.

In October 1996, Guardian canceled its warrant that was issued by the
Company in 1995, which originally provided for the purchase of one million
shares of the Company's Class A common stock, once certain operating conditions
had been met. Based upon a subsequent agreement with Guardian, the number
of shares available for purchase under the warrant at the time it was canceled
had been substantially reduced as a result of the Guardian's purchase of shares
of the Company's Class A common stock on the open market. The Company had not
recognized any expense related to the warrant as the conditions to its
exercisability had not been met, nor was it deemed probable that they would be
met up to the date of cancellation.

11. SALE OF TEC AND INVESTMENT IN MASTERCARE COMPANIES, INC.

In September 1995, the Company sold 81% of its wholly-owned subsidiary Total
Employee Care, Inc. to Mastercare Companies, Inc. (Mastercare) for 625,000
voting shares of Mastercare common stock. In addition, the Company purchased
additional shares of Mastercare voting stock in the amount of 1,250,000 shares
at $1.20 per share. The Company owns less than 20% of the voting stock and does
not have the ability to exercise significant influence over the operating and
financial policies of Mastercare and, accordingly has reported this investment
at the lower of cost or market.

12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Selected unaudited data reflecting the Company's results of operations for each
of the last eight fiscal quarters are shown in the following table (dollars in
millions):



                                                        1996
                                          1ST      2ND        3RD        4TH
                                     -------------------------------------------

Premium revenues                        $111.8   $118.4     $123.2     $128.1
Total health care expenses                92.9    108.9      109.6      114.6
Selling general and administrative
 expenses                                 19.4     20.0       23.4       23.2
Net income (loss)                           .9     (5.0)      (4.5)      (4.4)
Net income (loss) per share               0.09    (0.54)     (0.49)     (0.46)

                                      49
<PAGE>

                       Physicians Health Services, Inc.

            Notes to Consolidated Financial Statements (continued)



12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (CONTINUED)



                                                        1995
                                          1ST      2ND        3RD        4TH
                                     -------------------------------------------

Premium revenues                     $  79.6    $  78.7    $  85.7    $ 99.0
Total health care expenses              62.5       60.8       63.7      76.8
Selling general and administrative
 expenses                               12.6       14.0       15.4      18.8
Net income                               3.1        3.7        5.2       4.0
Net income per share                    0.33       0.39       0.55      0.42


Note: The sum of the quarters' net income (loss) per share does not equal the
full year per share amount due to rounding.

                                      50
<PAGE>


                                                                      Schedule I



                       Physicians Health Services, Inc.

                 Condensed Financial Information of Registrant
                            (Dollars in Thousands)

                                Balance Sheets

                               (Parent Company)




                                               DECEMBER 31
                                             1996        1995
                                        -----------------------
Assets
     Cash                                  $ 15,572    $    187
     Other receivables                          219         192
     Prepaid expenses and other               1,128          99
                                        -----------------------
          TOTAL CURRENT ASSETS               16,919         478
                                        -----------------------

     Property, plant and equipment              408         250
     Other assets                             2,319       2,306
     Investment in and advances to
     wholly-owned subsidiaries               86,603     106,206
                                        -----------------------
          TOTAL ASSETS                     $106,249    $109,240
                                        =======================

Liabilities and stockholders' equity
     Accounts payable and accrued
      expenses                             $  9,963    $    359
                                        -----------------------
          TOTAL CURRENT LIABILITIES           9,963         359
                                        -----------------------

Stockholders' equity
     Common Stock                                94          94
     Additional paid-in capital              41,360      40,760
     Net unrealized gains on
      marketable securities
      of subsidiaries, net of tax               279         510
     Retained earnings                       54,554      67,518
                                        -----------------------
                                             96,287     108,882
Less treasury stock                              (1)         (1)
                                        -----------------------
          TOTAL STOCKHOLDERS' EQUITY         96,286     108,881
                                        -----------------------

     TOTAL LIABILITIES AND                 $106,249    $109,240
      STOCKHOLDERS' EQUITY              =======================


The condensed financial information should be read in conjunction with the
consolidated financial information and the accompanying notes thereto.


                                      51
<PAGE>

                                                                      Schedule I



                       Physicians Health Services, Inc.

                 Condensed Financial Information of Registrant
                            (Dollars in Thousands)

                           Statements of Operations

                               (Parent Company)



                                                YEAR ENDED DECEMBER 31
                                             1996        1995       1994
                                        ----------------------------------
Revenue:
     Investment income                    $       92    $     8   $      -

                                        ----------------------------------

Costs and expenses:
     General and administrative expenses           -      2,188      1,243
     Interest expense                            381          -          -
                                        ----------------------------------
                                                 381      2,188      1,243
                                        ----------------------------------

LOSS BEFORE INCOME TAXES                        (289)    (2,180)    (1,243)

Income tax expense (benefit)                     249        505       (154)
                                        ----------------------------------
Loss before equity in net income (loss)
 of wholly-owned subsidiaries                   (538)    (2,685)    (1,089)
Equity in net income (loss) of
 wholly-owned subsidiaries, net of
 taxes                                       (12,426)    18,655     15,223
                                        ----------------------------------

NET INCOME (LOSS)                          ($ 12,964)   $15,970    $14,134
                                        ==================================


The condensed financial information should be read in conjunction with the
consolidated financial information and the accompanying notes thereto.


                                      52
<PAGE>

                                                                      Schedule I



                       Physicians Health Services, Inc.

                 Condensed Financial Information of Registrant
                            (Dollars in Thousands)

                           Statements of Cash Flows

                               (Parent Company)




                                                YEAR ENDED DECEMBER 31
                                               1996        1995       1994
                                          ----------------------------------
OPERATING ACTIVITIES
Net income (loss)                            ($12,964)    15,970   $ 14,134
Plus equity in net loss (income) of            12,426    (18,655)   (15,223)
 subsidiaries
Adjustments to reconcile net income
 (loss) to cash provided by
 (used for) operating activities               8,377      2,382      1,271
                                          ----------------------------------
Net cash provided by (used for)                 7,839       (303)       182
 operating activities

FINANCING ACTIVITIES
Advances to subsidiaries                      (40,198)    (9,000)   (10,000)
Dividends and return of capital
  from subsidiaries                            47,144      9,000     10,000
Exercise of stock options                         600        246         53
                                          ----------------------------------
Net cash provided by financing activities       7,546        246         53

Increase (decrease) in cash                   15,385         (57)       235
Cash at beginning of year                        187         244          9
                                          ----------------------------------
Cash at end of year                       $   15,572    $    187   $    244
                                          ==================================



The condensed financial information should be read in conjunction with the
consolidated financial information and the accompanying notes thereto.


                                      53

<PAGE>

                                                                     Schedule II



               Physicians Health Services, Inc. and Subsidiaries

                               December 31, 1996

                       Valuation and Qualifying Accounts
                            (Dollars in Thousands)



                                Balance at   Charge to                Balance at
                                Beginning     Cost and                   End of
                                of Period     Expenses    Deductions     Period
                               ------------------------------------------------

Year ended December 31, 1994
     Allowance for doubtful
     accounts                      $926       $1,423       ($549)      $1,800
                                   ====       ======       ======     ========

Year ended December 31, 1995
     Allowance for doubtful
     accounts                    $1,800         $103       ($853)      $1,050
                                 ======         ====       ======      ======

Year ended December 31, 1996
     Allowance for doubtful
     accounts                    $1,050       $1,485       ($754)      $1,781
                                 ======       ======       ======      ======



                                      54
<PAGE>

                                EXHIBIT INDEX

<TABLE>
<CAPTION>
                                                                                SEQUENTIAL
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                           PAGE NUMBER
<S>       <C>                                                                   <C>

     3    Amended and Restated Certificate of Incorporation of Company
          (Incorporated by reference to Exhibit 3 in Company's Registration
          Statement on Form S-1 (File No. 33-54918))

    3(a)  Bylaws of the Company (Incorporated by reference to Exhibit 3(a) in
          Company's Registration Statement on Form S-1 (File No. 33-54918))

     4    Form of Stock Certificate (Incorporated by reference to Exhibit 4 in
          Company's Registration Statement on Form 8-A (File No. 0-21098))

   4.1    Stock Warrant Purchase Agreement, dated November 28, 1995, between
          the Company and The Guardian Life Insurance Company of America
          (Incorporated by reference to Exhibit 4.1 in Company's Current Report
          on Form 8-K, dated November 28, 1995)

   4.2    Warrant Certificate No. AC-1, dated November 28, 1995, issued by the
          Company to The Guardian Life Insurance Company of America
          (Incorporated by reference to the Company's Current Report on Form 8-K,
          dated November 28, 1995)

   4.3    Agreement, dated October 21, 1996, between The Guardian Life Insurance
          Company of America and Physicians Health Services, Inc. relinquishing
          rights to purchase common stock pursuant to warrant dated November 28,
          1995. (Incorporated by reference to Exhibit 10(a) in Company's
          Quarterly Report on Form 10-Q for the quarter ended September 30,
          1996)

   4.4    Agreement, dated August 7, 1996, between Physicians Health Services,
          Inc. and The Guardian Life Insurance Company of America (Incorporated
          by reference to Exhibit 5.1 in the Company's Current Report on Form 8-K,
          dated August 26, 1996)

   10(a)  Employment Agreement, dated October 29, 1996, between the Company
          and Robert L. Natt (Incorporated by reference to Exhibit 10(b) in
          Company's Quarterly Report on Form 10-Q for the quarter ended
          September 30, 1996)

   10(b)  Amendment, dated August 28, 1996, to the Employment Agreement
          dated December 17, 1995 between Michael E. Herbert and Physicians
          Health Services, Inc. (Incorporated by reference to Exhibit 10(c) in
          Company's Quarterly Report on Form 10-Q for the quarter ended
          September 30, 1996)

   10(c)  Employment Agreement, dated February 27, 1990, between the
          Company and Michael E. Herbert, as amended by Amendment to
          Employment Agreement, dated November 19, 1992 (Incorporated by
          reference to Exhibit 10(b) in Company's Registration Statement on
          Form S-1 (File No. 33-54918))
</TABLE>


                                      55
<PAGE>

<TABLE>
<CAPTION>
                                                                                SEQUENTIAL
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                           PAGE NUMBER
<S>       <C>                                                                   <C>

   10(d)  Employment Agreement, dated December 19, 1995, between the Company
          and Michael E. Herbert (Incorporated by reference to Exhibit 10(d) in
          Company's Annual Report on Form 10-K for the year ended December 31,
          1995)

   10(e)  Employment Agreement, dated December 31, 1994, between the
          Company and Richard C. O'Connor, M.D. (Incorporated by
          reference to Exhibit 10(c) in Company's Annual Report on Form 10-K
          for the fiscal year ended December 31, 1994)

   10(f)  Employment Agreement, dated December 31, 1994, between the
          Company and Regina M. Campbell (Incorporated by reference to
          Exhibit 10(c) in Company's Annual Report on Form 10-K for the
          fiscal year ended December 31, 1994)

   10(g)  Employment Agreement, dated as of January 1, 1994, between the
          Company and Stanley M. Stier, M.D. (Incorporated by reference to
          Exhibit 10(g) in Company's Annual Report on Form 10-K for the
          fiscal year ended December 31, 1993)

   10(h)  Employment Agreement, dated December 1994, between the
          Company and James L. Elrod, Jr. (Incorporated by reference to
          Exhibit 10(g) in Company's Annual Report on Form 10-K for the
          fiscal year ended December 31, 1994)

    10(i) Employment Agreement, dated August 24, 1994, between the
          Company and Steven Black (Incorporated by reference to
          Exhibit 10(h) in Company's Annual Report on Form 10-K for the
          fiscal year ended December 31, 1994)

   10(j)  Employment Agreement, dated April 28, 1994, between the
          Company and Paul M. Philpott (Incorporated by reference to
          Exhibit 10(i) in Company's Annual Report on Form 10-K for the
          fiscal year ended December 31, 1994)

   10(k)  Employment Agreement, dated May 9, 1995, between the Company
          and Paul M. Philpott (Incorporated by reference to Exhibit 10(k) in
          Company's Annual Report on Form 10-K for the year ended
          December 31, 1995)

   10(l)  Agreement of Sale, dated March 12, 1996, between the Company and
          Richardson-Vicks Real Estate, Inc. (filed herewith)
</TABLE>


                                      56
<PAGE>

<TABLE>
<CAPTION>
                                                                                SEQUENTIAL
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                           PAGE NUMBER
<S>       <C>                                                                   <C>

   10(m)  Amended and Restated Marketing and Services Agreement,
          dated October 1, 1996,   By and Among Physicians Health
          Services, Inc., Physicians Health Services of Connecticut, Inc.,
          and The Guardian Life Insurance Company of America
          (filed herewith)

   10(n)  Amended and Restated Marketing and Services Agreement,
          dated October 1, 1996, By and Among Physicians Health Services, Inc.,
          Physicians Health Services of New York, Inc. and The Guardian
          Life Insurance Company of America (filed herewith)

   10(o)  Amended and Restated Marketing and Services Agreement,
          dated October 1, 1996,   By and Among Physicians Health Services,
          Inc., Physicians Health Services of New Jersey, Inc. and The
          Guardian Life Insurance Company of America (filed herewith)

   10(p)  Reinsurance Agreement, dated October 1, 1996, Between Physicians
          Health Services   of Connecticut, Inc. and The Guardian Life
          Insurance Company of America (filed herewith)

   10(q)  Amended and Restated Reinsurance Agreement, dated October 1, 1996,
          Between Physicians Health   Services of New York, Inc. and The
          Guardian Life Insurance Company of America (filed herewith)

   10(r)  Amended and Restated Reinsurance Agreement, dated October 1, 1996,
          Among Physicians   Health Services of New Jersey, Inc. Physicians
          Health Services   (Bermuda) Ltd. and The Guardian Life Insurance
          Company of America (filed herewith)

   10(s)  Amended and Restated Reinsurance Agreement, dated October 1, 1996,
          Between Physicians   Health Services (Bermuda) Ltd. and The Guardian
          Life Insurance Company of America (filed herewith)

   10(t)  GBIPA Service Agreement, dated as of January 1, 1997, between
          the Company and Greater Bridgeport Individual Practice Association,
          Inc. (filed herewith)

   10(u)  HMO-IPA Service Agreement, dated as of January 1, 1997,
          between the Company and Fairfield Individual Practice Association,
          Inc. (filed herewith)

   10(v)  HMO-IPA Service Agreement, dated as of January 1, 1997,
          between the Company and Heritage Individual Practice Association,
          Inc. (filed herewith)
</TABLE>


                                      57
<PAGE>

<TABLE>
<CAPTION>
                                                                                SEQUENTIAL
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                           PAGE NUMBER
<S>       <C>                                                                   <C>

   10(w)  HMO-IPA Service Agreement, dated as of April 26, 1984, between
          the Company and Colonial Individual Practice Association, Inc., as
          amended effective January 1, 1994 (Incorporated by reference to
          Exhibit 10(j) in Company's Annual Report on Form 10-K for the year
          ended December 31, 1993)

   10(x)  HMO-IPA Service Agreement, dated as of May 19, 1987, between the
          Company and White Plains IPA, Inc., as amended effective January
          1, 1992 (Incorporated by reference to Exhibit 10(m) in Company's
          Registration Statement on Form S-1 (File No. 33-54918))

   10(y)  Amendment to HMO-IPA Service Agreement, dated as of April 28,
          1993, between the Company and White Plains - Sound Shore IPA,
          Inc. (f/k/a White Plains IPA, Inc.) (Incorporated by reference to
          Exhibit 10(o) in Company's Annual Report on Form 10-K for the
          year ended December 31, 1993)

   10(z)  1994-1996 Amendment to HMO-IPA Service Agreement, dated
          September 20, 1993, between the Company and White Plains - Sound
          Shore IPA, Inc., effective January 1, 1994 (Incorporated by reference
          to Exhibit 10(p) in Company's Annual Report on Form 10-K for the
          year ended December 31, 1993)

   10(aa) HMO-IPA Service Agreement, dated as of May 19, 1987, between the
          Company and Hudson IPA, Inc., as amended, effective January 1,
          1992 (Incorporated by reference to Exhibit 10(n) in Company's
          Registration Statement on Form S-1 (File No. 33-54918))

   10(bb) Amendment to HMO-IPA Service Agreement, dated as of April 29,
          1993, between the Company and Hudson IPA, Inc. (Incorporated by
          reference to Exhibit 10(r) in Company's Annual Report on Form 10-K
          for the year ended December 31, 1993)

   10(cc) 1994-1996 Amendment to HMO-IPA Service Agreement, dated
          August 20, 1993, between the Company and Hudson IPA, Inc.
          effective January 1, 1994 (Incorporated by reference to Exhibit 10(s)
          in Company's Annual Report on Form 10-K for the year ended
          December 31, 1993)

   10(dd) Amended and Restated 1995 Stock Option Plan (filed herewith)

   10(ee) HMO-PHO Service Agreement, dated as of December 23, 1993,
          between the Company and Saint Francis/Mount Sinai Physicians
          Hospital Organization (Incorporated by reference to Exhibit 10(t) in
          Company's Annual Report on Form 10-K for the year ended December
          31, 1993)
</TABLE>


                                      58
<PAGE>

<TABLE>
<CAPTION>
                                                                                SEQUENTIAL
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                           PAGE NUMBER
<S>       <C>                                                                   <C>

   10(ff) Letter Amendment to HMO-PHO Service Agreement, dated
          September 28, 1995, between the Company and Saint
          Francis/Mount Sinai Physicians Hospital Organization (Incorporated
          by reference to Exhibit 10(y) in Company's Annual Report on Form
          10-K for the year ended December 31, 1995)

   10(gg) Service Agreement between the Company and Hartford Physician
          Hospital Corporation effective January 1, 1996 (Incorporated
          by reference to Exhibit 10(z) in Company's Annual Report on Form
          10-K for the year ended December 31, 1995)

   10(hh) Agreement between Company and Yale-New Haven Hospital-
          Physicians Corporation Agreement regarding covered services
          (Incorporated by reference to Exhibit 10(gg) in Company's Annual
          Report on Form 10-K for the year ended December 31, 1994)

   10(ii) Financial Letter, dated September 24, 1991, to Bridgeport Hospital
          summarizing the arrangements between the Company and Bridgeport
          Hospital (Incorporated by reference to Exhibit 10(o) in Company's
          Registration Statement on Form S-1 (File No. 33-54918))

   10(jj) 1992 Stock Option Plan, as amended (Incorporated by reference to
          Exhibit 10(x) in Company's Annual Report on Form 10-K for the
          year ended December 31, 1994)

   10(kk) Company's 401(k) Plan (Incorporated by reference to Exhibit 10(x) in
          Company's Registration Statement on Form S-1 (File No. 33-54918))

   10(ll) Amendment to Company's 401(k) Plan (Incorporated by reference to
          Exhibit 10(z) in Company's Annual Report on Form 10-K for the year
          ended December 31, 1994)

   10(mm) Agreement between the Company and Phoenix Mutual Life Insurance
          Company ("Phoenix") (Incorporated by reference to Exhibit 10(r) in
          Company's Registration Statement on Form S-1 (File No. 33-54918))

   10(nn) Letter Agreement, dated as of September 19, 1990 between the
          Company and Phoenix (Incorporated by reference to Exhibit 10(s) in
          Company's Registration Statement on Form S-1 (File No. 33-54918))
</TABLE>


                                      59
<PAGE>

<TABLE>
<CAPTION>
                                                                                SEQUENTIAL
EXHIBIT NO.                   DESCRIPTION OF DOCUMENT                           PAGE NUMBER
<S>       <C>                                                                   <C>

   10(oo) Form of Change in Control Agreement entered into between the
          Company and Messrs. Herbert and Natt, Drs. Stier and O'Connor
          and Ms. Campbell.  (Incorporated by reference to Exhibit 10(z) in
          Company's Annual Report on Form 10-K for the year ended
          December 31, 1993)

   10(pp) Form of Conditional Employment Agreement entered into between the
          Company and Messrs. Herbert, Natt, Elrod and Philpott, Drs.
          O'Connor and Stier and Ms. Campbell (Incorporated by reference to
          Exhibit 10(dd) in Company's Annual Report on Form 10-K for the
          year ended December 31, 1994)

   10(qq) Form of Change in Control Agreement entered into between the
          Company and certain other members of senior management
          (Incorporated by reference to Exhibit 10(aa) in Company's Annual
          Report on Form 10-K for the year ended December 31, 1993)


   21              Subsidiaries of the Company (filed herewith)

   23              Consent of Independent Auditors (filed herewith)
</TABLE>


                                      60