SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

(Mark One)

[x]      ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
         SECURITIES EXCHANGE ACT OF 1934
         For the fiscal year ended December 31, 1997
                                       OR

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

COMMISSION FILE NO. 0-25944
----------------------------

                                   FOHP, INC.
                     ----------------------------------------
                    (Exact name of registrant as specified in
                                  its charter)

                  NEW JERSEY                            22-3314813
    ---------------------------------------       -------------------------
        (State or other jurisdiction                 (I.R.S. Employer
       of incorporation or organization)             Identification No.)

           3501 State Highway 66
            Neptune, New Jersey                            07753
    ---------------------------------------       -------------------------
          (Address of principal                           Zip Code
            executive offices)

                         Registrant's telephone number,
                       including area code: (732) 918-6700

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

                                                     Name of each exchange
Title of each class                                  on which registered
------------------                                   ---------------------
      None                                               Not Applicable

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

                                  Common Stock

        -----------------------------------------------------------------
                                (Title of class)

        -----------------------------------------------------------------
                                (Title of class)


<PAGE>




         Indicate by check mark whether the Registrant (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
Registrant 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  Registrant'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. [ ]

         The  aggregate  market value of the shares of the  Registrant's  Common
Stock, par value $.01 per share ("Common Stock"),  held by non-affiliates of the
Registrant,  as of March 15, 1998, was $1,483,504.  The Common Stock is the only
class of the  Registrant's  capital  stock  with  shares  currently  issued  and
outstanding.  Inasmuch as shares of Common  Stock are not listed on any exchange
or quoted on any  quotation  system,  nor has there been any regular  trading in
shares of Common Stock since the inception of the  Registrant,  the  aforestated
aggregate market value of outstanding Common Stock held by non-affiliates of the
Registrant was computed by multiplying the number of shares of Common Stock held
by  non-affiliates  of the Registrant as of March 15, 1998, by $.72, the average
per share purchase price paid by Foundation  Health Systems,  Inc. in connection
with the  conversion  of  Debentures  (as defined  herein) into shares of Common
Stock in 1997.

         As of March  15,  1998,  the  number  of  outstanding  shares of Common
Stock-NJ was 100,000,000.

      Documents incorporated by                   Part of Form 10-K into which
     reference into this report                     document is incorporated
     --------------------------                     ------------------------
               None                                           None

         Certain  information  included in this report and other  filings of the
Registrant  under the  Securities  Act of 1933, as amended,  and the  Securities
Exchange Act of 1934, as amended (the  "Exchange  Act"),  as well as information
communicated orally or in writing between the dates of such filings, contains or
may contain forward looking information that is subject to certain risks, trends
and  uncertainties  that could cause actual  results to differ  materially  from
expected  results.  Among  these  risks,  trends and  uncertainties  are matters
related to national and local economic  conditions,  the effect of  governmental
regulation on the Registrant and its subsidiaries,  the competitive  environment
in which the Registrant and its subsidiaries  operate,  the relationship between
the Registrant and Foundation Health Systems,  Inc., the holder of approximately
98% of the Registrant's  Common Stock, and the ability of the Registrant and its
subsidiaries  to generate or raise  sufficient  capital to remain in  compliance
with any  applicable  statutory net worth or other capital  requirements  and to
continue to operate their businesses as currently operated.  See "Description of
Business,"  "Management's  Discussion  and Analysis of Financial  Condition  and
Results of Operation" and "Certain Relationships and Related Transactions."

                                       -2-


<PAGE>


                                     PART I

ITEM 1.  BUSINESS.

(A)      GENERAL DEVELOPMENT OF BUSINESS

         FOHP, Inc., a New Jersey  corporation (the "Company" or  "Registrant"),
was formed in May 1994 to effect the reorganization  (the  "Reorganization")  of
First Option  Health Plan of New Jersey,  Inc., a New Jersey  corporation  which
operates as a health maintenance organization ("HMO") in the State of New Jersey
("FOHP-NJ"),   into  a  holding  company   structure.   The  Reorganization  was
consummated on June 8, 1995.  Pursuant to the  Reorganization,  FOHP-NJ became a
wholly-owned  subsidiary of the Company and the former holders of FOHP-NJ common
stock received shares of the Company's Common Stock-NJ ("Common Stock-NJ").  All
the outstanding  shares of Common Stock-NJ were later converted on a one for one
basis into shares of Common  Stock in  connection  with  amendments  made to the
Company's  Certificate  of  Incorporation  in April 1997.  See  "Description  of
Business."

         During 1997,  Foundation Health Systems,  Inc., a Delaware  corporation
formerly  known  as  Health  Systems  International,   Inc.  ("FHS"),  purchased
convertible  debentures  from the Company in the aggregate  principal  amount of
$80,701,120.38  (each a "Debenture" and  collectively,  the  "Debentures").  FHS
converted  approximately  $70,654,050  principal  amount of the Debentures  into
97,913,161  shares of Common Stock,  which represents  approximately  98% of the
outstanding   Common  Stock  of  the  Company.   See  "Description  of  Business
Transaction with FHS; Description of FHS" and "Certain Relationships and Related
Transactions."

         The  principal  executive  offices of the  Company  are located at 3501
State Highway 66,  Neptune,  New Jersey 07753 and its  telephone  number at such
location is (732) 918-6700.

(B)      FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

         Since  its  inception,  substantially  all of the  Company's  revenues,
operating results and assets have been attributable to the operation of FOHP-NJ,
an HMO which operates in the State of New Jersey.

(C)      DESCRIPTION OF BUSINESS

         In response to  exclusively  profit driven  managed care  organizations
generally  operated  by  large  insurance  companies,  FOHP-NJ,  a  wholly-owned
subsidiary  of the  Company,  was  formed  in May  1993 by  certain  New  Jersey
hospitals  and  physicians  to operate as a  provider  owned HMO in New  Jersey.
FOHP-NJ received a Certificate of Authority  ("COA") to operate as an HMO in New
Jersey  in June  1994,  and  commenced  operations  on July 1,  1994.  FOHP-NJ's
objective  was  to  have  quality  medical  care  delivered  by its  network  of
providers, in a cost effective manner, to as many persons as possible. To ensure
that the health care

                                       -3-


<PAGE>


providers associated with FOHP-NJ would maintain control over and participate in
the  management of the HMO, only health care providers  associated  with FOHP-NJ
were  permitted to purchase  shares of FOHP-NJ  common  stock.  In addition,  to
ensure that the hospitals and physicians  participating  in the FOHP-NJ provider
network  were able to  contribute  equally to the  governance  of  FOHP-NJ,  the
Certificate of  Incorporation of FOHP-NJ required that the Board of Directors of
FOHP-NJ  initially  be  comprised  of an equal  number  of  physician-designated
directors and hospital-designated directors.

         In early 1995, it became  apparent to the Board of Directors of FOHP-NJ
that the health  plans  offered by  FOHP-NJ  would  become  more  attractive  to
prospective  employer groups with employees in New Jersey and neighboring states
if the employees had access to the  hospitals,  physicians and other health care
providers  located or  practicing  in the states  neighboring  New Jersey.  As a
result,  FOHP-NJ was reorganized into a holding company  structure to facilitate
the  formation  of HMOs  in  states  other  than  New  Jersey.  Pursuant  to the
Reorganization,  the Company,  which was formed solely for purposes of effecting
the  Reorganization,  acquired  all of the  outstanding  shares of each class of
FOHP-NJ common stock and, as a result, FOHP-NJ became a wholly-owned  subsidiary
of the Company and the former holders of FOHP-NJ common stock received shares of
Common  Stock-NJ,  which were later converted on a one for one basis into Common
Stock.

         During the first quarter of 1996,  the Company  learned that  FOHP-NJ's
statutory  net worth as of  December  31,  1995 may have been  below 125% of the
minimum  requirement.  FOHP-NJ's  COA  provides  that if its net worth is, or is
expected to be, less than 125% of the minimum  requirement,  FOHP-NJ is required
to submit to the New Jersey  Department of Banking and Insurance (the "DOI") and
the New Jersey Department of Health and Senior Services (the "DOH", and together
with the DOI, the  "Departments")  a plan of action to address the deficiency or
expected  deficiency.  FOHP-NJ addressed this potential deficiency by submitting
in April 1996 a plan of action to the  Departments  which  outlined  the actions
which had been taken and measures to be used by FOHP-NJ to correct the potential
deficiency.

         Although the operational changes implemented by the Company to increase
capital in 1996 enabled the Company to reduce  operating  losses,  the Company's
Board of Directors  (the "Board" or "Board of Directors")  recognized  that such
changes would not allow the Company to adequately  address  FOHP-NJ's  statutory
net worth deficiency.  In order to adequately  address  FOHP-NJ's  statutory net
worth  deficiency,  the  Board  believed  that the  Company  needed  to infuse a
significant amount of capital into FOHP-NJ.  To raise the required capital,  the
Company considered offering,  in a public offering,  securities to the providers
in the FOHP-NJ provider network.  A public offering of securities was ultimately
rejected by the Board  because the Board did not believe that the Company  could
raise the capital needed in a public offering, given the Company's deteriorating
financial condition.

         To raise the capital necessary for FOHP-NJ to remain in compliance with
its  statutory net worth  requirements,  the Board  determined  that the Company
needed to effect a private

                                       -4-


<PAGE>



placement of capital to an investor interested in acquiring a significant equity
position in the Company.

TRANSACTION WITH FHS
--------------------

         After  considering  proposals  submitted  by several  large health care
corporations,  an insurer with affiliations to a provider-owned HMO, and several
private  investor  groups,  on October  24,  1996,  the Company  entered  into a
Securities Purchase Agreement with FHS (the "Securities Purchase Agreement"). As
a result of a significant  increase in medical  claims expense during the fourth
quarter of 1996, due to more complete payment data that was not available to the
Company  or its  actuaries  prior  to such  quarter,  FHS was not  obligated  to
consummate the transactions  contemplated by the Securities  Purchase  Agreement
and  therefore  elected  in late  January  1997 to  renegotiate  the  terms  and
conditions of the Securities Purchase Agreement. Shortly thereafter, on February
10, 1997,  the Securities  Purchase  Agreement was terminated and replaced by an
amended Securities Purchase Agreement. On March 13, 1997, the amended Securities
Purchase  Agreement was amended to clarify certain provisions therein and in the
proposed  Certificate  of  Incorporation  of the Company  attached as an exhibit
thereto  (as so amended,  the  "Amended  Securities  Purchase  Agreement").  The
Amended Securities Purchase Agreement was declared effective on March 14, 1997.

         The  Amended  Securities  Purchase  Agreement,   and  the  transactions
contemplated  thereby, were approved by the shareholders of the Company on April
16, 1997.  To effect the  transactions  contemplated  by the Amended  Securities
Purchase Agreement, including the sale of Debentures to FHS, the shareholders of
the  Company  also  approved  (i)  certain  amendments  to  the  Certificate  of
Incorporation  of the Company  relating to changes in the classes of  securities
authorized  for  issuance  by  the  Company,  (ii)  certain  amendments  to  the
Certificate of Incorporation of the Company relating to changes in the rights of
shareholders of the Company, and (iii) certain amendments to the Certificates of
Incorporation  and By-laws of the Company and FOHP-NJ  relating to the Boards of
Directors of the Company and FOHP-NJ and changes in the composition thereof.

         On  April  30,  1997,  pursuant  to  the  Amended  Securities  Purchase
Agreement, FHS purchased from the Company a Debenture in the aggregate principal
amount of $51,701,120.38 (the "Initial Debenture").  The principal amount of the
Initial  Debenture was convertible,  at the option of FHS, into up to 71% of the
Company's capital stock on a fully-diluted basis. At the closing of the purchase
of the Initial Debenture, FHS converted $1,701,120.38 of principal amount of the
Initial  Debenture  into  168,109  shares of  Common  Stock,  which  represented
approximately 7.5% of the Company's then outstanding Common Stock.

         Effective  December 1, 1997, FHS converted the remaining $50 million of
the principal  amount of the Initial  Debenture into 4,941,049  shares of Common
Stock. After the conversion,  FHS owned 5,109,158 shares of the 7,195,997 shares
of Common Stock then  outstanding,  which  represented 71% of the  fully-diluted
equity of the Company.

                                       -5-


<PAGE>


         In connection with FHS' purchase of the Initial Debenture,  FHS and the
Company entered into a General Administrative Services Management Agreement (the
"Administrative  Management  Agreement"),  pursuant  to which FHS  oversees  the
management  of the  Company and assists  the  Company's  management  in provider
contracting, utilization review and quality assurance, employee relations, sales
and marketing,  and strategic planning,  among other services.  The Company pays
FHS 2% of its  premium  revenue  for the  services  provided  by FHS  under  the
Administrative  Management  Agreement.  See "Certain  Relationships  and Related
Transactions."

         In  addition,  FHS and  the  Company  have  entered  into a  Management
Information  Systems and Claims Processing  Services  Management  Agreement (the
"MIS Agreement," and together with the Administration  Management Agreement, the
"Management Agreements"), pursuant to which FHS would provide claims processing,
record keeping and data processing  services to all the health plans offered, or
to be offered,  by the Company's  subsidiaries.  The MIS  Agreement  will become
effective at FHS's option. See "Certain Relationships and Related Transactions."

         In  connection  with the  sale of the  Initial  Debenture,  FHS and the
Company entered into a letter agreement (the "Letter Agreement") which clarifies
FHS's right under the Amended Securities Purchase Agreement to infuse additional
capital into the Company in the event that it is  determined  that FOHP-NJ needs
capital to meet applicable statutory net worth requirements  (referred to herein
as a "Net Capital Shortfall").  Pursuant to the Letter Agreement,  FHS could, at
any time prior to December 31, 1997,  at its own  discretion,  contribute  up to
$5,000,000  in additional  capital to the Company to be used in connection  with
certain  anticipated  liabilities and contribute up to such  additional  amounts
that may be  projected to be required  from time to time (based upon  reasonable
projections  prepared  by FHS taking  into  account  anticipated  full year 1997
operating  results) in order for  FOHP-NJ to meet 100% of the minimum  statutory
net worth  requirements  (or such higher  percentage that may be required by the
appropriate  regulators)  as of  December  31,  1997.  In  the  event  that  FHS
contributes additional capital to the Company to meet a Net Capital Shortfall or
projected  Net  Capital  Shortfall,  FHS will be issued  additional  convertible
debentures in substantially  the same form as the Debentures.  See "Management's
Discussion and Analysis of Financial Condition and Results of Operation."

         In order to satisfy certain statutory net worth requirements applicable
to FOHP-NJ,  and in accordance with the Amended Securities Purchase Agreement as
amended by the Letter  Agreement,  FHS elected on December 8, 1997 to infuse $29
million  into the Company in  exchange  for a  Debenture  (the "New  Convertible
Debenture") in form and substance substantially similar to the Initial Debenture
issued to FHS on April 30, 1997. Immediately upon receipt of the New Convertible
Debenture,  FHS converted  approximately  $18,952,930  of the  principal  amount
thereof into 92,804,003 shares of Common Stock.  After the partial conversion of
the New Convertible  Debenture,  FHS owned 97,913,161  shares of the 100,000,000
shares of Common Stock  outstanding,  which represents  approximately 98% of the
fully-diluted equity of the Company.  See "Management's  Discussion and Analysis
of Financial Condition and Results of Operation."

                                       -6-


<PAGE>


         As of year end 1997, FHS also  contributed an additional $24 million to
the Company to satisfy certain  statutory net worth  requirements  applicable to
FOHP-NJ in return for  additional  subordinated  debentures.  See  "Management's
Discussion and Analysis of Financial Condition and Results of Operation."

DESCRIPTION OF FHS
------------------

         FHS is an integrated  managed care  organization  which administers the
delivery of managed health care services.  Through its subsidiaries,  FHS offers
group,  individual,  Medicaid,  Medicare  and  preferred  provider  organization
("PPO")  plans;  government  sponsored  managed  care plans;  and  managed  care
products related to  administration  and  cost-containment,  behavioral  health,
dental, vision and pharmaceutical  products and services.  Over the past several
years, FHS has developed a diversified  product line and has achieved geographic
expansion  throughout the United  States.  FHS operates and conducts its HMO and
other businesses through its wholly and majority owned subsidiaries, such as the
Company.

         FHS currently operates in the managed health care industry segment, and
in 1997 FHS operated in six different  divisions (the  "Divisions")  within such
segment,  including  three  regional  operational  divisions  (the  "Operational
Divisions")   and  three   additional   specialty   divisions  (the   "Specialty
Divisions").  Such  Divisions  encompass  the  following  three primary lines of
business in which FHS continues to operate:  (i) health plan operations (through
the three regional  Operational  Divisions  described  below);  (ii)  government
contracts  (through the Government  Operations  Division);  and (iii)  specialty
services  (through the Specialty  Services  Division).  FHS has discontinued its
operations in the Workers'  Compensation  Division (the sixth  Division in which
FHS operated in 1997).

         FHS is one of the largest  managed  health care companies in the United
States,  with more than 4.3 million full-risk and  administrative  services only
("ASO") members through its Operational Divisions.  FHS provides a comprehensive
range of health  care  services  through  HMOs  organized  in three  Operational
Divisions located in the following geographical regions: the California Division
(encompassing  only  the  State  of  California),  the  Eastern  Division  (West
Virginia, Ohio, Connecticut, Pennsylvania, New York, New Jersey and Florida) and
the Western Division  (Washington,  Oregon, Idaho,  Colorado,  New Mexico, Utah,
Arizona,  Texas,  Oklahoma  and  Louisiana).  FHS  also  operates  PPO  networks
providing  access to health care services in over 45 states and owns four health
and life  insurance  companies  licensed to sell  insurance in 35 states and the
District of Columbia.

         FHS's HMOs market  traditional  HMO  products  to  employer  groups and
Medicare  and Medicaid  products  directly to employer  groups and  individuals.
Health care  services  that are  provided  to FHS's  commercial  and  individual
members include primary and specialty physician care, hospital care,  laboratory
and radiology  services,  prescription  drugs,  dental and vision care,  skilled
nursing care, physical therapy and mental health.

                                       -7-


<PAGE>



         The Eastern  Division  currently  includes FHS operations in Ohio, West
Virginia,  Connecticut,  Pennsylvania, New York, New Jersey, and Florida. During
1997,  FHS  acquired  Advantage  Health,  the trade  name for a group of managed
health care  companies  headquartered  in  Pittsburgh,  with  operations in West
Virginia,  Ohio and Pennsylvania;  Physicians Health Services,  Inc. ("PHS"),  a
group of  managed  health  care  companies  headquartered  in  Connecticut  with
operations in Connecticut, New Jersey and New York; and the Company.

         FHS's  Northeast  region,  a subset  of  FHS's  Eastern  Division,  was
recently formed in January 1998.  FHS's  Northeast  region includes the Company,
PHS and M.D. Health Plan, a Connecticut based HMO.

DESCRIPTION OF FOHP-NJ
----------------------

         FOHP-NJ is the Company's principal subsidiary and only subsidiary which
has obtained a COA to operate as an HMO. FOHP-NJ operates an HMO in the State of
New Jersey pursuant to a COA issued by the Departments.  FOHP-NJ has established
a  provider   network  and  has  entered  into  provider   agreements   with  NJ
Practitioners,  NJ Acute Care Institutions and NJ Other Providers (as such terms
are defined below).  FOHP-NJ has entered into provider agreements with (i) 62 NJ
Acute Care  Institutions  located  throughout  New  Jersey's 21  counties,  (ii)
approximately 11,000 NJ Practitioners, practicing in primary care and 30 medical
specialities  throughout  New  Jersey,  and  (iii)  approximately  75  NJ  Other
Providers.   Providers   contracting   with  FOHP-NJ  are  not  required  to  be
shareholders of the Company.  Currently,  of the approximately  11,137 providers
who have contracted with FOHP-NJ, 2,629 are shareholders of the Company.

         As used herein, a "NJ Acute Care Institution"  shall mean a hospital or
acute care  institution,  licensed by the DOH, which has entered into a provider
agreement  with  FOHP-NJ to  provide  health  care  services  to the  members of
FOHP-NJ's health plans; a "NJ  Practitioner"  shall mean a member of the medical
staff of a NJ Acute Care  Institution,  or a physician  designated by a NJ Acute
Care  Institution,  who is licensed to practice  medicine or  osteopathy  in the
State of New Jersey and who has entered into a provider  agreement  with FOHP-NJ
to provide  health care services to the members of FOHP-NJ's  health plans;  and
"NJ Other  Provider"  shall mean a health care provider or  professional,  other
than a NJ Practitioner or NJ Acute Care Institution,  licensed,  certificated or
authorized  to operate or practice  in the State of New Jersey,  who has entered
into a provider agreement with FOHP-NJ.

         Each member of FOHP-NJ's  provider  network has entered into a provider
agreement  with  FOHP-NJ.  Each  provider  agreement  has a one-year term and is
renewable annually. Such agreements with NJ Acute Care Institutions and NJ Other
Providers  may be terminated  by mutual  consent or, after the initial  one-year
term, by either party upon 90 days notice;  agreements with NJ Practitioners may
be terminated by either party upon 60 days notice.  The  agreements  also may be
terminated for breaches specified therein.  The terms and conditions of provider
agreements are not affected by whether the provider is, or is not, a shareholder
of the  Company.  However,  some  agreements  with  NJ  Acute  Care  Institution
shareholders as

                                       -8-


<PAGE>


subscribers in FOHP-NJ health plans are different from the subscriber agreements
of non-  shareholders in that premium rates for those NJ Acute Care Institutions
that are  shareholders  are capped to be within a certain corridor (+/- 4%) from
their prior year premium  rates.  There are 24 NJ Acute Care  Institutions  with
such subscriber  agreements.  Preferred  Providers  (i.e.,  members of FOHP-NJ's
provider network) are permitted to contract with other entities, including other
health plans.

         FOHP-NJ  markets its  services to  employers,  including  NJ Acute Care
Institutions  which are  providers  of  health  care  services  to  FOHP-NJ  and
shareholders  of  the  Company.   Pursuant  to  the  Company's   Certificate  of
Incorporation,  NJ Acute Care  Institutions  which own  shares of Common  Stock,
directly or through  affiliates,  are required to offer a FOHP-NJ health plan to
their employees under certain  circumstances.  In the event that a NJ Acute Care
Institution  fails to comply  with such  requirements,  the Company may elect to
repurchase the shares of Common Stock held by the NJ Acute Care Institution. See
"Marketing."

BENEFITS PROVIDED BY FOHP-NJ

         FOHP-NJ  currently offers two principal types of coverage plans,  point
of service  ("POS") and Non-POS,  each having  multiple  variations.  Under both
types of product,  each new FOHP-NJ  member will be required to select a primary
care  physician  from a list  supplied by FOHP-NJ.  All medical care  thereafter
received by the member under a Non-POS plan,  including  specialist and hospital
care,  will be supervised by the primary care physician who is familiar with the
member's  medical history.  A POS plan will permit members to utilize  providers
who are not under contract with FOHP-NJ. In such circumstances,  members will be
subject to higher  co-payments  and be responsible for payment of any difference
between  what  FOHP-NJ  pays for covered  services and the amount of the charges
incurred for such services. Generally, FOHP-NJ will pay no more than 80% and the
member will pay no less than 20% of the charges for covered  services  when care
is provided by non-Preferred Providers.

         FOHP-NJ's health plans require precertification for hospital admissions
and diagnostic and outpatient procedures. Except for co-payments, FOHP-NJ covers
all other charges for treatment at non-Preferred Provider emergency rooms in the
event of a medical  emergency or urgently  needed  services,  as  determined  by
FOHP-NJ.

         Generally,  rates for each employer  group are fixed for a twelve-month
period and may be increased for each renewal term; provided,  however,  that the
new rate  methodology must be submitted to the DOI and there can be no assurance
that any new rate  methodology  will be accepted by the DOI.  Renewal dates vary
among employer  groups.  FOHP-NJ utilizes a system of community rating by class,
adjusted  (with respect to employer  groups of more than 100  employees) by age,
sex and industry classification,  in determining its rates for various employers
in the proposed  service  area.  Accordingly,  rates can vary  between  employer
groups  for  coverage  under the same  FOHP-NJ  health  plan.  FOHP-NJ  has also
established  rates for the health  benefits  plans  required by the State of New
Jersey to be offered by all HMOs that choose to market to small employer  groups
(50 employees or less), which are based on overall

                                       -9-


<PAGE>



community rates for New Jersey calculated by independent  consulting  actuaries,
as  statutorily  required.  Proposed  rates for the basic  health care  coverage
required by the State of New Jersey is submitted to the DOI.  Rates will also be
affected by federal regulations which generally limit experience rating of group
accounts.

         FOHP-NJ health plans require  members to make  co-payments  directly to
the treating  health care  provider for office  visits to  physicians  and other
health care providers, physician house calls and certain hospital emergency room
visits. All FOHP-NJ plans allow subscribers to enroll their spouses and eligible
dependents.

         FOHP-NJ offers multiple  coverage plans to employer groups of more than
50  employees.  Some  coverages  in each  product are subject to annual  maximum
benefits.  Generally,  the  products  within  each  POS  and  Non-POS  plan  are
distinguished by the amount of the applicable  co-payments and the obligation of
the POS member to pay to the provider the  difference  between what FOHP-NJ pays
and the total charges.

         FOHP-NJ  offers  seven  small  employer  group (50  employees  or less)
products. Five of them are identical to the small business plans designed by the
Board of Directors of the Small Employer Health Benefits Program, the regulatory
agency  responsible  for the  regulation  of  small  business  health  insurance
products in New Jersey.  The other two small employer group products are offered
as riders to one of the four other small employer  products.  Either rider makes
that  product  virtually  identical  to one of FOHP-NJ's  large  employer  group
products.

         FOHP-NJ  also offers a dental plan and has expanded the coverage of the
benefits plans offered by FOHP-NJ to include vision care.  Moreover,  commencing
in December  1995,  FOHP-NJ began  offering  Non-POS  products to individuals as
required  by the State of New  Jersey.  The Non-POS  products  being  offered by
FOHP-NJ to individuals  pursuant to the state requirement  contain all the state
mandated benefits,  including coverage for preventive care,  in-patient hospital
care, substance abuse and mental health. All the products offered to individuals
by  FOHP-NJ as  required  by the State of New Jersey  require  co-payments.  See
"Government Regulation."

         FOHP-NJ currently offers coverage for Medicaid beneficiaries in the New
Jersey counties of Essex, Cumberland,  Gloucester,  Hudson, Middlesex,  Passaic,
Union,  Mercer and Camden. In December 1995,  FOHP-NJ qualified  federally as an
HMO, and, as a result,  currently offers coverage for Medicare  beneficiaries in
New Jersey.

         FOHP-NJ also provides utilization management and its PPO product to the
members of self-funded plans. In addition, FOHP-NJ provides its PPO product to a
number of other self-funded plans.  FOHP-NJ also offers pharmacy,  mental health
and chemical  dependency  management services through third parties who or which
have entered into sub-contract arrangements with FOHP-NJ.

                                      -10-


<PAGE>


         In   addition  to  offering   services  as  an  HMO,   FOHP-NJ   offers
administrative  services,  including access to FOHP-NJ's  provider  network,  to
health plans governed by the Employee Retirement Income Security Act of 1974, as
amended,  such as employer  groups  which are  self-insured,  as well as to such
groups as ASOs,  Third  Party  Administrators  and Managed or  Coordinated  Care
Organizations ("MCOs").

ARRANGEMENTS WITH NJ PRACTITIONERS

         FOHP-NJ  may  contract   with   Individual  or   Independent   Practice
Associations  (individually,  an "IPA"),  Physician Hospital Organizations or NJ
Practitioners.  Under the terms of FOHP-NJ's practitioner provider agreement, NJ
Practitioners  will  provide  primary  and  specialty  care to FOHP-NJ  members.
FOHP-NJ has entered into provider  agreements with physicians and others who are
not  shareholders to provide services to its members.  NJ Practitioners  will be
paid  pursuant  to a fee  schedule  established  by  FOHP-NJ  and will only bill
members of a FOHP-NJ plan for co-payments and non-covered  services, if any. The
fees paid to NJ  Practitioners  are based on a  percentage  of the fees  payable
under the fee schedule developed for Medicare.  Co-payments, in amounts approved
by FOHP-NJ, are collected directly by the NJ Practitioner from the member.

         In  addition  to  specifying  the  types  of  services  required,  each
practitioner provider agreement imposes various requirements and standards (many
of  which  are  also  mandated  by  applicable  federal  and  state  law)  on NJ
Practitioners.

         Each member  selects a primary  care  physician  from a list of primary
care  physicians  who are under  contract with FOHP-NJ.  Under the Non-POS plans
offered by  FOHP-NJ,  primary  care  physicians  are  required,  when  medically
necessary and appropriate, to refer members to specialist physicians,  hospitals
and other health care providers who are under contract with FOHP-NJ.

         FOHP-NJ is a named insured under the  Company's  comprehensive  general
liability  insurance,  with coverage of at least  $1,000,000  per occurrence and
$10,000,000  in the  aggregate  per year.  In addition,  FOHP-NJ  maintains  HMO
reinsurance for those situations where the acute care of a commercial,  Medicaid
or Medicare member exceeds $150,000 in a calendar year, with a per member annual
maximum of $1,000,000 and lifetime maximum of $2,000,000. Individual physicians,
including  any  physician  practicing  in an IPA or other group,  must  maintain
professional  liability insurance coverage of at least $1,000,000 per occurrence
and $3,000,000 in the aggregate per year.

ARRANGEMENTS WITH NJ ACUTE CARE INSTITUTIONS

         FOHP-NJ's  agreements with NJ Acute Care  Institutions  provide,  among
other things, for a reimbursement schedule setting the amounts to be paid to the
NJ Acute Care  Institutions  by FOHP-NJ for  services  provided to members.  The
reimbursement  schedule  of  a  provider  agreement  between  a  NJ  Acute  Care
Institution and FOHP-NJ is individually negotiated. Rates

                                      -11-


<PAGE>


paid to NJ Acute Care Institutions for services provided to members of FOHP-NJ's
health plans vary from  institution to institution and are based on, among other
things, the type of services provided by, and the location of, the NJ Acute Care
Institution.  The  agreements are site  specific.  Therefore,  in the event of a
merger or acquisition or similar transaction between a NJ Acute Care Institution
and another  institution,  services  provided to members of FOHP-NJ health plans
pursuant to an agreement  between it and the affected NJ Acute Care  Institution
are  required to be provided  only at the  location of such  institution.  Also,
under the terms of such agreements,  NJ Acute Care  Institutions are required to
use their best efforts to notify  FOHP-NJ within 48 hours or one business day of
a member's  emergency  admission.  NJ  Practitioners  are required to notify and
receive  prior  approval  from  FOHP-NJ for all  elective  hospital  admissions.
Agreements with  participating NJ Acute Care Institutions  prohibit the NJ Acute
Care  Institutions  from  billing  a member  of a  FOHP-NJ  health  plan for any
services paid for under such plan except for any applicable co-payment.

         In  addition  to  specifying  the  types  of  services  required,  each
agreement with a NJ Acute Care  Institution  imposes  various  requirements  and
standards  (some of which are also mandated  under state and federal law) on the
NJ Acute Care Institution.

         Each NJ Acute  Care  Institution  must  maintain  a policy  of  general
liability  insurance  in  amounts  of at least  $1,000,000  per  occurrence  and
$3,000,000  in  the  aggregate  per  year.  In  addition,  each  NJ  Acute  Care
Institution must maintain  professional  liability insurance coverage in amounts
required by the State of New Jersey.  Each NJ Acute Care  Institution has agreed
to indemnify  FOHP-NJ,  and FOHP-NJ has agreed to  indemnify  each such NJ Acute
Care  Institution,  against  liability  arising from its actions,  except to the
extent that injury results from the negligence of the other party.

ARRANGEMENTS WITH NJ OTHER PROVIDERS

         FOHP-NJ  contracts  with NJ Other  Providers  such as  skilled  nursing
facilities and home health care agencies to provide  services to members.  These
providers are paid pursuant to a program rate which is  individually  negotiated
with  FOHP-NJ.   Payment   procedures,   service   authorization   requirements,
obligations   imposed  on  the  provider,   and  insurance  and  indemnification
obligations are similar to those outlined above for NJ Acute Care Institutions.

OTHER ARRANGEMENTS INVOLVING FOHP-NJ

         FOHP-NJ  arranges  for the  provision  of certain  services  to members
including mental health/chemical dependency,  pharmacy, laboratory and radiology
through risk sharing  arrangements  with other entities,  where feasible and not
prohibited by applicable law.

COMPETITION

         The competition  for prospective  enrollees in prepaid health plans has
increased over the past few years as a result of the significant increase in the
number of companies offering HMO

                                      -12-


<PAGE>


and other  managed care  products.  For  example,  FOHP-NJ  competes  with other
prepaid  health  plans  and with  traditional  health  insurers  as well as with
self-insured  programs,  PPOs and other MCOs.  Other programs or entities may be
substantially better capitalized than FOHP-NJ. Moreover, a number of traditional
health  insurers  have begun to  aggressively  market HMO and other managed care
products of their own. In addition,  competition  may be affected if any federal
legislation or regulation  with respect to health plans or health care providers
is adopted. See "Government Regulation."

         Competition  among HMOs and  traditional  and other health  insurers is
based principally on benefits offered and premium cost. FOHP-NJ,  which operates
an HMO, may find itself at a competitive disadvantage if its premiums are higher
than those of other HMOs or traditional  health  insurers.  Premiums  negotiated
with employers,  fee schedules  negotiated with hospitals,  physicians and other
providers,  the scope of benefits offered,  unique benefit designs and access to
physicians and hospitals constitute the principal methods of competition.

 MARKETING

         FOHP-NJ  markets  its health care  benefits  products  and  services to
prospective  members  through  full-time  marketing  representatives,   selected
brokers and consultants and other sales  professionals  under the direction of a
Director of Sales.  Marketing efforts are concentrated on employer groups of all
sizes  with  particular  emphasis  placed on  employers  with  fewer  than 1,000
employees.

         FOHP-NJ  markets its  services to  employers,  including  NJ Acute Care
Institutions  which are providers to FOHP-NJ and are either  shareholders of the
Company  or  affiliated  with  shareholders  of  the  Company.  Pursuant  to the
Company's  Certificate of  Incorporation,  if the existing health plan of any NJ
Acute Care  Institution  shareholder is a self-insured  plan, such NJ Acute Care
Institution  is obliged to offer a FOHP-NJ health plan to its employees as their
exclusive  plan in  accordance  with a  timetable  determined  by  FOHP-NJ to be
feasible. The Company's Certificate of Incorporation also provides that NJ Acute
Care  Institutions  which are  shareholders or affiliated with  shareholders and
offer one or more health plans,  including any self-insured plan, are obliged to
offer a FOHP-NJ health plan and have at least 50% of its employees enrolled in a
FOHP-NJ  health  plan by  January  1,  1996,  and at least  75%of its  employees
enrolled  in a  FOHP-NJ  health  plan by  January  1,  1997,  and NJ Acute  Care
Institutions  which are  shareholders  or affiliated with  shareholders  and are
subject to  collective  bargaining  agreements  are  required  to use their best
efforts  to offer a  FOHP-NJ  health  plan to  their  non-union  employees  on a
"non-exclusive"  basis.  In  addition,  NJ Acute  Care  Institutions  which  are
shareholders  or  affiliated  with  shareholders  and are subject to  collective
bargaining  agreements  are  required  to use their  best  efforts  to qualify a
FOHP-NJ  health  plan  as the  union-  designated  plan  and  to pay  reasonable
deductibles or other costs to so qualify a FOHP-NJ health plan.

         The provisions in the Certificate of  Incorporation of the Company with
respect to the above described covenants of the NJ Acute Care Institutions which
own shares of Common

                                      -13-


<PAGE>


Stock or of the  affiliates  of NJ Acute Care  Institutions  which own shares of
Common   Stock   (collectively   referred   to  herein   as  "NJ   Institutional
Shareholders,"  and  individually  referred  to  herein  as a "NJ  Institutional
Shareholder") shall continue until December 31, 1999. The Company's  Certificate
of  Incorporation  also provides that, if, upon the termination of the covenants
contained therein as they relate to a specific NJ Institutional Shareholder, the
NJ  Institutional  Shareholder  or its  affiliated  NJ  Acute  Care  Institution
proposes  to offer to its  employees  any health  plan  similar to a health plan
offered by  FOHP-NJ,  such NJ  Institutional  Shareholder  shall  provide  prior
written  notice to  FOHP-NJ  of the  material  terms of the Bona Fide  Offer (as
hereinafter  defined) by such other health  benefits plans. In the event FOHP-NJ
offers to provide an FOHP-NJ health plan containing  terms at least as favorable
in all material respects to the employees of the NJ Institutional Shareholder or
its  affiliated NJ Acute Care  Institution  as those  contained in the Bona Fide
Offer,  such NJ  Institutional  Shareholder  or its  affiliated  NJ  Acute  Care
Institution  shall offer such FOHP-NJ  health plan to its  employees on the same
basis as it would have been obligated  under the covenants if such covenants had
not terminated.

         In the event a NJ Institutional  Shareholder or its affiliated NJ Acute
Care  Institution (i) breaches any of the covenants in the proposed  Certificate
of  Incorporation  of the  Company  applicable  to it, or (ii)  fails to provide
reimbursement  rates (a) for  in-patient  visits at the lower of (I) the  lowest
rate of reimbursement  received by such provider from nongovernmental payors for
each line of business, or (II) the rate of reimbursement  reflecting a reduction
(compared to calendar 1996 rates) of 5% in in-patient costs,  provided that such
reduction is solely as a result of rate  reductions and not through  utilization
or medical  management  efforts,  and (b) for out-patient visits at the lower of
(I)  the  lowest  rate  of   reimbursement   received  by  such  providers  from
nongovernmental  payors  for  each  line  of  business,  or  (II)  the  rate  of
reimbursement reflecting a reduction (compared to calendar 1996 rates) of 10% in
out-patient  costs,  provided that such  reduction is solely as a result of rate
reductions and not through utilization or medical management  efforts,  then the
Company  shall have the option to purchase  all or a portion of the Common Stock
held by the NJ Institutional Shareholder at a purchase price equal to the lowest
of (i) the Book Value (as such term is defined in the Company's  Certificate  of
Incorporation),  (ii) the lowest  shareholder  equity reflected on the Company's
quarter-end balance sheets during the period of noncompliance giving rise to the
repurchase right, excluding any Debentures issued to FHS, prepared in accordance
with  generally  accepted  accounting  principles,  divided  by  the  number  of
outstanding  shares  of  Common  Stock on a fully  diluted  basis,  or (iii) the
original  purchase  price  paid by such NJ  Institutional  Shareholder  for such
shares of Common Stock.  The Company shall have full  discretion with respect to
its election to exercise or not to exercise the  foregoing  rights of repurchase
with  respect to any given  shareholder,  taking  into  account  any factors the
Company deems appropriate relating to such shareholder's  relationships with the
Company or the Company's  business or otherwise,  and the Company's  election to
make or not to make a repurchase  from one  shareholder  shall have no effect on
the  Company's  election  to make or not to make a  repurchase  from  any  other
shareholder.

         On March 3, 1997, the Company  redeemed the shares of one NJ Acute Care
Institution which had not complied with its enrollment obligations.  The Company
is currently reviewing

                                      -14-


<PAGE>


whether to redeem the Company Common Stock held by other  non-compliant NJ Acute
Care Institutions.

         A "Bona Fide Offer" shall mean an offer of a health benefits plan which
is prepared  with the  objective of covering the offeror's (i) health care costs
and  administrative  expenses  in the case of risk  products,  and (ii) costs of
performing  administrative services and any risk assumed (e.g.,  reinsurance) in
the case of self funded products. An offer by any health benefits plan below the
offeror's  costs for the purpose of achieving  market share  increases shall not
constitute a Bona Fide Offer.

GOVERNMENT REGULATION

         For a tax exempt  hospital or other  entity to maintain  its tax exempt
status under section  501(c)(3) of the Internal Revenue Code of 1986, as amended
(the  "Code"),  its income or assets may not be utilized to inure to the benefit
of (i)  an  individual  considered  to be an  insider  by  virtue  of his or her
relationship  with the  exempt  organization  (generally,  any  person  having a
personal or private  interest in the activities of an organization  exempt under
section  501(c)(3)  of the Code,  including  any  physician  employed by or with
admitting  privileges  at a tax  exempt  hospital,  is often  referred  to as an
"insider"),  or (ii) any other  person.  Any  conduct  in  contravention  of the
furtherance of the entity's  exempt  purposes may result in the loss of a health
care  provider's  tax exempt status.  In the case of an insider,  a compensation
arrangement in excess of fair market value, a below market loan, or a no rent or
below market rent arrangement may constitute private inurement,  or, in the case
of any other person or entity  (including,  among  others,  vendors or key staff
personnel),  an excessive benefit which is not incidental to the  accomplishment
of the entity's exempt purposes may constitute private inurement.

         Federal law prohibits the payment or receipt of  remuneration  directly
or indirectly  for referring or furnishing  any service for which payment may be
made under the Medicare or Medicaid programs.  The applicable statute,  known as
the Medicare/Medicaid  Anti-Kickback Statute,  prohibits, among other things, an
entity from  selecting a physician or other  investor based upon his, her or its
ability  to make  referrals  or from  offering  such an  investor  (i) a greater
investment  opportunity,   or  (ii)  a  disproportionately  large  return  on  a
disproportionately  small  investment.  The statute imposes  criminal as well as
other penalties for engaging in prohibited practices.

         Federal law also prohibits physician referrals to clinical laboratories
in which  they or members  of their  families  have a  financial  interest  and,
effective  January 1, 1995,  prohibits  referrals by physicians  for  additional
designated health services to other entities in which physicians or their family
members have a financial interest. The Stark II Amendments  specifically exclude
from the prohibition,  in-network  referrals by physicians who have ownership or
investment  interests in, or compensation  arrangements  with,  certain Medicare
health organizations, federally qualified HMOs, or other prepaid plans operating
under a demonstration project.

                                      -15-


<PAGE>


         Management does not believe that any  arrangements  between the Company
or any of its subsidiaries and its shareholders or directors is violative of the
Medicare/Medicaid  Anti-Kickback Statute or the Stark II Amendments.  No Company
shareholder  nor any  provider  of services  to a  subsidiary  of the Company is
required to make referrals as a condition of making or maintaining an investment
interest in the Company or otherwise.  If any arrangement between the Company or
a  subsidiary  of the Company and its  shareholders  or  directors  was found to
contravene  current law or in the event any change in the law prohibits any such
arrangement, the Company would seek to restructure such arrangement.

         New Jersey has also adopted legislation which prohibits physicians from
referring  patients  to health care  services  in which they or their  immediate
families  have a  significant  beneficial  interest  unless such  interests  are
disclosed  in  advance  to such  patients.  The  restriction  does not  apply to
services  provided in a physician's  medical  office or to certain  therapies or
protocols.

         Federal   antitrust  laws   generally   prohibit   agreements   between
competitors that unreasonably  restrict  competition and, as such laws relate to
the Company, may prohibit,  among other things, the disclosure of information by
a provider to FOHP-NJ relating to (i) the providers' rates, costs,  salaries and
benefits,  and (ii) the terms, prices and conditions of any managed care plan in
which the provider  participates,  unless such information is a matter of public
record.  Such laws also may prohibit the disclosure by FOHP-NJ of the prices and
terms of any  arrangement  between  FOHP-NJ  and one of its  providers  to other
providers  in  FOHP-NJ's  provider  network.  In an effort to  prevent  any such
conduct,  the Company has distributed an Antitrust  Compliance  Manual to its NJ
Institutional  Shareholders and requires that each NJ Institutional  Shareholder
acknowledge  the receipt of such  manual.  In  addition,  the  Company  includes
information regarding  prohibitions under federal antitrust laws in the provider
agreements  entered  into  by  FOHP-NJ  and  NJ  Practitioners.  Any  prohibited
disclosure or other  violations of the federal  antitrust laws could subject the
Company or FOHP-NJ or any of their directors or shareholders to monetary damages
and other penalties under such antitrust laws.

         HMOs are subject to extensive governmental regulation.  Among the areas
regulated  are the scope of benefits  required to be made  available to members,
reserves required to be maintained, the manner in which members' co-payments are
structured, procedures for review of quality assurance, enrollment requirements,
the relationship between the HMO and its health care providers and the financial
condition  of the  HMO.  Any  HMO  formed  in New  Jersey  is  regulated  by two
governmental  departments,  the DOI and the DOH. The DOI monitors the  financial
condition  of an HMO formed in New Jersey  whereas the DOH  reviews  quality and
access issues.

         In June 1994,  FOHP-NJ,  the Company's only  subsidiary  licensed as an
HMO, received its COA from the Departments.  In December 1995,  FOHP-NJ received
approval  from  the  U.S.  Health  Care  Financing  Administration  of the  U.S.
Department of Health and Human Services (commonly known as "HCFA") to operate as
a  federally  qualified  HMO and,  as a result,  is now  providing  services  to
Medicare beneficiaries. In February 1995, FOHP-NJ entered into an agreement with
the New Jersey Department of Human Services to provide services to Medicaid

                                      -16-


<PAGE>


recipients,  and it has received  approval to provide such  services in nine New
Jersey counties.

         If a New Jersey HMO fails to meet the statutory net worth  requirements
applicable  to it,  the DOI has the power to  suspend  or revoke  the HMO's COA.
Without a COA, an entity cannot conduct business as an HMO in New Jersey.

         Federal law requires a federally  qualified  HMO to have a positive net
worth  (however,  no amount is specified)  and to provide  evidence of financing
until revenues are sufficient to support  operations.  The financial reserves of
federally  qualified HMOs are required to provide adequately against the risk of
insolvency,  but the amount of such  reserves are not  specified  in  applicable
regulations  and is subject to the  discretion  of the  Secretary  of the United
States Department of Health and Human Services.

         Provisions affecting HMOs were enacted as part of the federal "Balanced
Budget  Act of  1997."  The  Balanced  Budget  Act  of  1997  provides  Medicare
beneficiaries with the option to enroll in a new Medicare + Choice Program which
allows  provider-sponsored  networks  and other  non-HMO  entities  to  contract
directly  with  Medicare  to  provide  services  to  Medicare  + Choice  Program
beneficiaries.  The  Balanced  Budget  Act  of  1997  also  includes  provisions
impacting on state  administered  Medicaid managed care plans.  These provisions
include,  among others,  provisions relating to increased beneficiary protection
and quality assurance.

         As a result of  legislation  enacted by the State of New Jersey in 1991
and 1993,  New Jersey HMOs must offer health care benefits  plans to individuals
including  hospital  expense  coverage and annual  physical  examinations  for a
defined  period.  HMOs which do not offer coverage to individuals are subject to
an assessment.  Additionally,  legislation  adopted in New Jersey,  which became
effective  on July 1,  1994,  requires  health  insurers,  including  HMOs which
provide pharmacy  services,  to permit enrollees to select their own pharmacists
and pharmacies.  In 1995, New Jersey enacted  legislation  which requires that a
mother  delivering a baby be permitted to remain at the facility  where the baby
was born for a minimum  of 48 or 96 hours,  depending  upon the method of birth.
Legislation  also was  enacted  in New  Jersey  in 1995  which  requires  health
insurers, including HMOs, to provide certain mandated diabetes benefits.

         In 1997,  the New Jersey  legislature  enacted the "Health Care Quality
Act."  Among other  things,  the Health Care  Quality Act  provides  that health
insurers,  including  HMOs,  must disclose  information  regarding the terms and
conditions of their health benefit plans, as well as other related  information,
to  subscribers at the time of enrollment  and annually  thereafter.  The Health
Care  Quality  Act also  imposes  on an HMO  requirements  with  respect  to the
responsibilities of the HMO's medical director, the HMO's utilization management
program and the HMO's relationship with participating providers. The legislation
also  requires  an HMO to  offer a POS  plan to every  contract  holder  (either
directly or through a  selective  contracting  arrangement)  which would allow a
covered  person to receive  covered  services from out-of-  network  health care
providers.  Also in 1997, the DOH adopted extensive amendments to the New Jersey
regulations  applicable to HMOs for purposes of providing additional protections
to consumers of HMO products and promote consumer confidence in HMOs. Generally,
the

                                      -17-


<PAGE>


amended  regulations  provide,  among other things, that a member of an HMO plan
shall be entitled to appeal service denials to an independent  medical panel and
require health plans to disclose operational information,  including information
regarding  financial   incentives  provided  to  physicians  by  HMOs  in  their
reimbursement procedures.

         Prior to the  adopting  of the Health  Care  Quality  Act,  the DOH, in
consultation  with the DOI,  adopted  new  regulations  (the "POS  Regulations")
intended  generally to apply to HMOs offering POS products.  The POS Regulations
clarify the circumstances under which an HMO may contract with a health insurer,
health service  corporation or medical service  corporation to provide indemnity
benefits or services.  Under the POS  Regulations,  it is  necessary  for an HMO
offering POS products to enter into a  contractual  arrangement  with a licensed
indemnity carrier. In response to these regulations,  FOHP-NJ has entered into a
contractual arrangement with an indemnity carrier.

         Generally,  rates and proposed  coverage  benefits must be submitted to
the DOI  prior  to  their  imposition.  There  can be no  assurance  that  rates
submitted by FOHP-NJ will be accepted without objection or approved.

         Finally,  it is impossible to predict  whether  federal  legislation or
regulations  with  respect  to health  plans or health  care  providers  will be
adopted or the impact that any such federal  legislation or regulations may have
on the health care delivery system.

 EMPLOYEES

         At March 15,  1998,  the  Company,  through  its  principal  subsidiary
FOHP-NJ,  employed 361 full-time and 18 part-time active employees. In addition,
the Company  currently  utilizes the  services of  approximately  150  temporary
employees. The Company currently has four executive officers who are employed by
FHS  pursuant  to  the  Administrative   Management   Agreement.   See  "Certain
Relationships  and Related  Transactions."  None of the  Company's  employees is
represented by a union.  The Company  believes that the  relationships  with its
employees are satisfactory.

ITEM 2.  PROPERTIES.

         The Company,  through FOHP-NJ,  subleases  approximately  59,706 square
feet of office space at 3501 State Highway 66,  Neptune,  New Jersey 07754.  The
lease  has a term of  approximately  3 years  ending  on  January  30,  1999 and
contains  a 5 year  renewal  option.  The  monthly  rental of the lease  term is
$77,120.25 plus certain additional charges and expenses,  including maintenance,
utilities  and taxes.  The  monthly  rental of the 5 year option of the lease is
$84,504.16 plus certain additional charges and expenses,  including maintenance,
utilities and taxes.

         The Company  also  leases  approximately  11,000  square feet of office
space at 2 Bridge Avenue, Building 6, Red Bank, New Jersey 07701-1106. The lease
has a term of 5 years

                                      -18-


<PAGE>


ending August 31, 1999, and a 5 year renewal  option.  The monthly rental ranges
from $10.00 to $12.50 per square foot over the initial  term of the lease,  plus
certain additional  charges and expenses  including common maintenance  charges,
utilities and taxes.  The monthly  rental of the 5 year option term of the lease
ranges from approximately $14.00 to $16.00 per square foot.

         The Company also leases office space in several other  locations in New
Jersey, including Mt. Laurel and Roseland.

ITEM 3.  LEGAL PROCEEDINGS.

         There are no  material  legal,  governmental,  administrative  or other
proceedings  pending  against  the  Company  or its  properties  or to which the
Company  is a  party,  and to the  knowledge  of  management  no  such  material
proceedings are threatened or contemplated except as provided below:

         The Company  recently  received a letter from the DOH dated January 23,
1998 (the  "DOH  Letter"),  in which the DOH  states  that it is in  receipt  of
information  that  indicates  that the  Company is in  violation  of a number of
provisions of the statutes and rules  governing  HMOs in New Jersey.  In the DOH
Letter, the DOH alleges that the Company constructively  terminated its provider
contracts with certain NJ Acute Care  Institutions  by  unilaterally  adding new
terms to the  existing  contracts  between  the  Company  and such NJ Acute Care
Institutions.  More  specifically,  the DOH alleges  that the Company had stated
that it would not honor its  existing  agreements  with  certain  NJ Acute  Care
Institutions for the provision of surgical services unless all anesthesiologists
at the hospitals became  providers in the Company's  provider  network.  The DOH
also states in the DOH Letter its  intention  to levy fines  against the Company
based on the  information  that it has  already  received  with  respect  to the
Company  and on any  additional  information  obtained  by the  DOH  during  its
investigation of the Company.

         In the DOH Letter,  the DOH  specifically  alleges that (i) the Company
violated  N.J.A.C.  8:38-2.7  for  failure  to notify the DOH of a change in and
reduction of its provider network, which could result in a fine up to $1,000 per
day for the period  commencing  December 15, 1997 and  continuing to the date of
the DOH Letter,  (ii) the Company violated  N.J.A.C.  8:38-3.5(a) for failure to
provide members currently  undergoing a course of treatment with at least thirty
(30) days prior notice of  termination  from the network of the provider who was
treating  the member,  which could result in a fine of up to $1,000 per affected
member per day for the period  commencing  December  15,  1997 until the day the
Company  reversed its denial of the treatment of the member (the DOH  identified
only two incidents  involving members in the DOH Letter),  and (iii) the Company
violated  N.J.A.C.  8:38-3.5(b)  for failure to provide notice to all its health
care  providers  with whom it has  contracted  and its members who reside in the
counties where the alleged  terminated NJ Acute Care Institutions are located or
in the counties adjacent to such counties, which could result in a fine of up to
$1,000 per  affected  member per day and up to $1,000 per  affected  health care
provider per day for the period  commencing  December 15, 1997 and continuing to
the date of the DOH Letter.

                                      -19-


<PAGE>


         The Company has complied with all requests  from the DOH and,  based on
the  information  provided to the DOH, the Company  does not believe  there is a
basis  for the DOH to levy  any  fines  against  the  Company.  The  Company  is
currently  attempting  to resolve this matter with the DOH without the need of a
formal  hearing.  In  addition,  because  the  January  23,  1998  letter  was a
constructive  notice of  fines,  and not an  actual  notice of fines,  it is not
possible to predict at this time what fines or other  actions,  if any,  the DOH
will levy or take  against the Company or the amount or extent of any such fines
or actions.

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

         During  the fourth  quarter  ended  December  31,  1997,  no matter was
submitted to a vote of security  holders of the Company through the solicitation
of proxies or otherwise.

                                      -20-


<PAGE>


                                     PART II

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

         There is no public  market  for the  Company's  Common  Stock,  and the
Company has no current  intention of listing or  including  any shares of Common
Stock on a stock  exchange or quotation  system since shares of Common Stock can
be held by or transferred only to providers to the Company's  subsidiaries which
operates as HMOs,  FHS and the Company.  Accordingly,  it is  improbable  that a
market will develop for the Company's securities.

         In addition, pursuant to the Amended Securities Purchase Agreement, FHS
may effect, in 1999, a transaction which would result in each shareholder of the
Company,  other than FHS, being required,  through a merger, to exchange or sell
his, her or its shares of Common Stock for cash or securities of an issuer other
than the  Company.  FHS has  informed the Company  that,  at such time,  it will
comply with applicable disclosure  obligations under the Exchange Act, including
without  limitation  applicable  requirements  under Rule  13e-3.  See  "Certain
Relationships and Related Transactions."

         Since its  inception,  the  Company  has not sold any  shares of Common
Stock for any  price  other  than  $15,  other  than  shares  issued to FHS upon
conversion of Debentures.  In addition,  the Company is not aware of any sale of
Common Stock by one provider to another for any price other than $15.

         As  of  March  15,  1998,  100,000,000  shares  of  Common  Stock  were
outstanding  and  were  held by 2,630  shareholders  of the  Company,  including
97,913,161  shares  held by FHS,  1,006,717  shares  held  by 41 NJ  Acute  Care
Institutions, 1,036,786 shares held by 2585 NJ Practitioners, 40,002 shares held
by 2 NJ Other Providers and 3,334 shares held by an IPA.

         The Company has not paid any cash  dividends on Company  Common  Stock.
The Board of Directors of the Company will review the Company's  dividend policy
from time to time to determine the  desirability  and feasibility of paying cash
dividends  after  giving  consideration  to the  Company's  earnings,  financial
condition, capital requirements and such other factors as the Board of Directors
of the Company deems relevant.

                                      -21-


<PAGE>


ITEM 6.  SELECTED FINANCIAL DATA.

         Prior to the  Reorganization,  the Company did not conduct any business
nor did it have any significant assets or liabilities. Accordingly, the selected
financial  information  as of December  31, 1994 and 1993 and for the year ended
December  31, 1994 and for the period from May 19,  1993 (date of  inception  of
FOHP-NJ)  to December  31,  1993 is derived  from the  financial  statements  of
FOHP-NJ,  the  Company's  principal  subsidiary.  The  data  should  be  read in
conjunction  with the consolidated  financial  statements of the Company and the
related notes thereto and management's discussion and analysis thereof appearing
elsewhere in this report.

         The selected  financial  information as of December 31, 1997,  1996 and
1995, and for the years ended December 31, 1997,  1996 and 1995, is derived from
the  consolidated  financial  statements  of the  Company  and should be read in
conjunction  with the consolidated  financial  statements of the Company and the
related notes thereto and management's discussion and analysis thereof appearing
elsewhere in this report.

                                      -22-


<PAGE>


                      SUMMARIZED BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>

                                                                                                            FINANCIAL DATA OF
                                                                                                                 FOHP-NJ
                                                                                                             PREDECESSOR TO
                                                                                                               THE COMPANY
                                                                                                     ----------------------------
                                                               DECEMBER 31,                                    DECEMBER 31,
                                          ----------------------------------------------------       ----------------------------
                                               1997               1996               1995                1994             1993
                                               ----               ----               ----                ----             ----
<S>                                        <C>                 <C>                 <C>                <C>              <C>

Assets:
Cash and cash equivalentS                  $ 79,266,721        $36,664,911         $23,882,286        $13,030,295      $10,503,225
Goodwill                                    107,730,254                 --                  --                 --               --
Other                                        31,614,256         17,587,306          13,479,547          7,050,765          390,965
                                           ------------        -----------         -----------        -----------      -----------
Total Assets                               $218,611,231        $54,252,217         $37,361,833        $20,081,060      $10,894,190
                                           ============        ===========         ===========        ===========      ===========
Liabilities and Shareholders'
  (Deficiency) Equity:
Liabilities:
Medical claims payable,
  accounts payble,
  accrued expenses and
  other current liabilities                 110,883,608         80,118,284          32,482,794          8,101,405          576,125
Convertible debentures                       11,294,406                 --                  --                 --               --
Subordinated debentures                      24,000,000                 --                  --                 --               --
                                           ------------        -----------       -------------       ------------       ----------
Total Liabilities                          $146,178,014        $80,118,284         $32,482,794         $8,101,405         $576,125

FOHP-NJ Practitioner
  Provider Common
  STOCK, $.01 par value,
  511,800 shares issued and
  outstanding (at December
  31, 1994, redeemable at
  $3,900,000)                                       --                  --                  --          7,677,000               --

Common stock subscribed                             --                  --                  --                 --       12,400,000

Shareholders' (Deficiency)
  Equity:

Preferred Stock, $1.00 par value,
  10,000,000 shares authorized,
  none issued and outstanding                       --                  --                 --                  --               --

FOHP, Inc. Common Stock
  $.01 par value, 100,000,000
  shares authorized, 100,000,000
  issued and outstanding                      1,000,000             21,002              21,002                 --               --

</TABLE>

                                      -23-


<PAGE>




                  SUMMARIZED BALANCE SHEET INFORMATION (CONT.)
<TABLE>
<CAPTION>

                                                                                                FINANCIAL DATA OF
                                                                                                     FOHP-NJ
                                                                                                  PREDECESSOR TO
                                                                                                   THE COMPANY
                                                         DECEMBER 31,                              DECEMBER 31,
                                         ----------------------------------------          --------------------------
                                             1997             1996            1995           1994           1993   
                                             ----             ----            ----           ----           ----   
<S>                                      <C>              <C>              <C>            <C>            <C>       

FOHP-NJ Other Provider Common
  Stock, $.01 par value,
  40,002 Shares issued and
  outstanding                                      --              --              --            400             --

Additional paid-in capital                208,053,796      30,648,489      30,648,489     15,341,561             --

Deficit                                  (136,620,579)    (56,535,558)    (25,790,452)   (11,049,507)    (2,081,935)
                                         ------------     -----------     -----------    -----------    -----------
Total Shareholders'
  (Deficiency) Equity                      72,433,217    (25,866,067)      4,879,039      4,302,655     10,318,065
                                         ------------     -----------     -----------      ---------    -----------
Total Liabilities and Shareholders'
 (Deficiency) Equity                     $218,611,231     $54,252,217     $37,361,833    $20,081,060    $10,894,190
                                         ============     ===========     ===========    ===========    ===========
</TABLE>



                                      -24-


<PAGE>


                 Summarized Statement of Operations Information

<TABLE>
<CAPTION>
                                                                                                FINANCIAL DATA OF FOHP-NJ
                                                                                                PREDECESSOR TO THE COMPANY
                                                                                              -------------------------------
                                                                                                               FOR THE PERIOD
                                                                                                                FROM MAY 18,
                                                                                              FOR THE YEAR      1993 (DATE OF
                                                 FOR THE YEAR ENDED                              ENDED          INCEPTION) TO
                                                    DECEMBER 31,                              DECEMBER 31,      DECEMBER 31,
                                          -----------------------------                       ------------      ------------
REVENUE:                                      1997             1996             1995              1994             1993
                                              ----             ----             ----              ----             ----
<S>                                       <C>              <C>              <C>                <C>                 <C>    
Premium revenue from owners/providers     $132,575,894     $135,544,112     $ 63,630,797       $5,639,724               --

Other premium revenue                      239,132,416      112,125,670       38,819,206        1,803,624               --

Interest and other income                    5,697,921        9,706,526        8,844,036        1,177,171          $22,151
                                          ------------     ------------     ------------       ----------       ----------
Total Revenue                             $377,406,231     $257,376,308     $111,294,039       $8,620,519          $22,151
                                          ------------     ------------     ------------       ----------       ----------
Expenses:

Medical services to owners/providers        63,882,103       37,026,903       17,319,035        1,405,175               --

Hospital services to owners/providers       64,553,166       30,156,890       11,068,909          808,920               --

Other medical services                     148,812,233      105,551,393       38,548,819        2,727,694               --

Other hospital services                    101,521,355       63,760,554       24,637,249        1,710,020               --

Selling, general and administrative         55,106,022       50,734,197       32,638,106       10,624,261        2,063,239
                                                            
Management Fee - Qualmed, Inc.               7,502,899               --               --               --               --

Interest - Foundation Health
  Systems, Inc.                              1,790,410               --               --               --               --

Restructuring Costs                         12,825,570               --               --               --               --

Other                                        1,495,355          890,553        1,751,263          240,021           40,847
                                         -------------     ------------      -----------      -----------       ----------
Total Expenses                            $457,489,113     $288,120,490     $125,963,381      $17,588,091       $2,104,086
                                          ------------     ------------     ------------      -----------       ----------
Provision for state income taxes                 2,139              924           71,603               --               --
                                       ---------------    --------------    ------------      -----------       ----------
Net loss                                  ($80,085,021)    ($30,745,106)    ($14,740,945)     ($8,967,572)     ($2,081,935)
                                       --------------     ------------     ------------       ----------      -----------
Net loss per common share                       ($9.18)         ($14.64)          ($8.65)          ($8.40)          ($2.52)
                                       ===============    =============    =============      ===========      ===========

</TABLE>


                                      -25-


<PAGE>


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

OVERVIEW

         The Company, a New Jersey corporation, was formed in May 1994 to effect
the   Reorganization   of  FOHP-NJ  into  a  holding  company   structure.   The
Reorganization was consummated on June 8, 1995.  Pursuant to the Reorganization,
FOHP-NJ  became  a  wholly-owned   subsidiary  of  the  Company.  Prior  to  the
Reorganization,  the Company did not  conduct any  business  nor did it have any
significant  assets or  liabilities.  The  Company  does not  conduct,  nor does
management believe that it will conduct,  any business.  All health care benefit
products and services are, and will be, provided by the Company's subsidiaries.

         FOHP-NJ, a New Jersey corporation, was formed in May 1993 to operate as
an HMO in the  State of New  Jersey.  FOHP-NJ  received  its COA in June 1994 to
operate as an HMO in the  service  area  encompassing  the  entire  State of New
Jersey and commenced operations on July 1, 1994. Pursuant to the Reorganization,
FOHP-NJ  became  a  wholly-owned  subsidiary  of the  Company  on June 8,  1995.
Currently, it is the Company's principal subsidiary.

         FOHP-NJ  markets a  comprehensive  range of health  care  benefit  plan
products  pursuant to contractual  arrangements  with physicians,  hospitals and
other  health care  providers.  As of March 15,  1998,  FOHP-NJ had entered into
provider agreements with 62 NJ Acute Care Institutions,  approximately 11,000 NJ
Practitioners and approximately 75 NJ Other Providers.  The provider  agreements
have an initial term of one-year and are  renewable  annually.  Such  agreements
with NJ Acute Care  Institutions  and NJ Other  Providers  may be  terminated by
mutual consent or, after the initial one-year term, by either party upon 90 days
notice;  agreements with NJ Practitioners may be terminated by either party upon
60 days notice.  The agreements  also may be terminated  for breaches  specified
therein.  The terms and  conditions of provider  agreements  are not affected by
whether the provider is, or is not, a shareholder of the Company.  However, some
agreements with NJ  Institutional  Shareholders as subscribers in FOHP-NJ health
plans are different from the subscriber  agreements of  non-shareholders in that
premium rates for those NJ Institutional  Shareholders are capped to be within a
certain  corridor  (+/-4%) from their prior year premium rates.  There are 24 NJ
Acute Care Institutions with such subscriber agreements.

         FOHP-NJ's agreements with NJ Acute Care Institutions provide for, among
other things, a reimbursement  schedule setting the amounts to be paid to the NJ
Acute Care  Institutions  by FOHP-NJ  for  services  provided  to  members.  The
reimbursement  schedule  of  a  provider  agreement  between  a  NJ  Acute  Care
Institution and FOHP-NJ is individually negotiated.  Rates paid to NJ Acute Care
Institutions  for services  provided to members of  FOHP-NJ's  health plans vary
from  institution to institution and are based on, among other things,  the type
of services  provided by, and the  location  of, the NJ Acute Care  Institution.
Agreements with  participating NJ Acute Care Institutions  prohibit the NJ Acute
Care Institutions from billing a member of a

                                      -26-


<PAGE>


FOHP-NJ  health  plan for any  services  paid for under such plan except for any
applicable co-payment, co-insurance, deductibles and non-covered services.

         NJ  Practitioners  are paid pursuant to a fee schedule  established  by
FOHP-NJ and are prohibited  from billing members of a FOHP-NJ health plan except
for  co-payments  and  non-covered  services,  if  any.  The  fees  paid  to  NJ
Practitioners  are  based on a  percentage  of the fees  payable  under  the fee
schedule  developed for Medicare.  Co-payments,  co-insurance and deductibles in
amounts approved by FOHP-NJ,  are collected directly by the NJ Practitioner from
the member.

         Subscriber  contracts are entered into with large employer groups (more
than 50  employees)  and small  employer  groups (50  employees  or less).  Such
contracts  are  generally  for a term of one year,  but may be  cancelled by the
employer group upon 30 days written notice.  Under these contracts,  FOHP-NJ has
agreed to provide  the  employer  groups  with  health  coverage in return for a
monthly  premium.  FOHP-NJ  utilizes  a system  of  community  rating  by class,
adjusted (with respect to employer  groups of 100 or more employees) by age, sex
and industry  classification,  in determining its rates for various employers in
the proposed service area.  Premium revenue generated from subscriber  contracts
is  recorded  as  revenue  in the month in which  subscribers  are  entitled  to
service. Premiums collected in advance are reported as unearned premium revenue.

RESULTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996

         PREMIUM REVENUE.  For the year ended December 31, 1997, medical premium
revenue  totalled  $371.7 million or $124.0 million more than the $247.7 million
of  medical  premium  revenue  generated  during the same  period in 1996.  This
increase was due to the significant  subscriber growth  experienced during 1997.
Approximately 35% of medical premium revenue generated in 1997 and approximately
55% of medical  premium revenue  generated in 1996 was  attributable to NJ Acute
Care  Institutions  which are  obligated  to enroll  their  employees in FOHP-NJ
health  plans.  The Company  believes  that the  percentage  of medical  premium
revenue  attributable to NJ Acute Care Institutions will continue to decrease as
FOHP-NJ's  operations  grow and as FOHP-NJ's  current sales efforts  continue to
focus on products  which are not sold  directly to  employees  of  providers  of
FOHP-NJ.  The Company also believes that it will benefit by its inclusion in the
formation of FHS's  Northeast  region,  which is comprised of three health plans
with a total of more than one million members in the New York tri-state area.

         OTHER REVENUE. Other revenue,  principally administrative fees, for the
year ended December 31, 1997 was $2.0 million  compared to $7.9 million of other
revenue for 1996.  This decrease is attributed to the sale of First Managed Care
Option, Inc. ("FMCO"), formally a wholly owned subsidiary of the Company, in the
last quarter of 1996.  Interest income for 1997 was $3.7 million, a $1.9 million
increase from the $1.8 million generated in 1996. The increase

                                      -27-


<PAGE>


in  interest  income  was  due  to  the  larger  cash  reserves  related  to the
investments by FHS in April 1997 and December 1997.

         MEDICAL AND HOSPITAL SERVICE EXPENSES.  Total expenses  attributable to
medical and  hospital  service for the year ended  December 31, 1997 were $378.8
million or $142.4 million higher than expenses incurred in 1996. The increase in
medical  and  hospital   service  expenses  from  1996  to  1997  was  primarily
attributable to a significant  increase in enrollees in FOHP-NJ health plans. In
addition,  the medical loss ratio (i.e.,  the  percentage of each premium dollar
used to pay medical  expenses)  for the year ended  December 31, 1997 was 101.9%
compared to 95.5% for the same  period in 1996.  This  increase  was a result of
increased  utilization in FOHP-NJ  health  benefit plans,  changes in the mix of
products  offered by FOHP-NJ,  the inability of FOHP-NJ to  effectively  control
utilization  and  referrals  due to the  significant  growth of FOHP-NJ,  and an
increase  in claims  reserves  to an  amount  at the high end of an  actuarially
determined range to reflect the Company's  recent  fluctuation of claims payment
patterns. The Company believes that recent operational changes, specifically the
implementation  of  a  modified  provider  reimbursement  schedule,  along  with
enhanced  utilization  management efforts,  will lower the percentage of medical
expenses to premium dollars in the future.

         SELLING,  GENERAL AND  ADMINISTRATIVE  EXPENSES.  Selling,  general and
administrative  expenses  totalled $64.4 million for the year ended December 31,
1997, including a $7.5 million administrative  management fee charged by FHS and
$1.8 million interest expense associated with the Debentures,  compared to $50.8
million incurred for the same period in 1996. This increase in selling,  general
and administrative expenses was the result of the significant growth of FOHP-NJ.

         OTHER EXPENSES.  Depreciation  and  amortization  expenses for the year
ended  December  31, 1997  increased  by $525  thousand  from the $879  thousand
incurred  during 1996.  This  increase was mostly the result of the costs of the
Debentures being amortized in 1997 (approximately $309,000).

         RESTRUCTURING  COSTS. During 1997, the Company estimated and recorded a
restructuring charge of $12.8 million in connection with the FHS investment. The
plan of  restructuring  primarily  includes  costs  associated  with work  force
reductions,  terminations  of  existing  contracts,  asset  impairment  and  the
write-off of unamortized merger costs.

FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995

         PREMIUM REVENUE.  For the year ended December 31, 1996, medical premium
revenue  totalled  $247.7 million or $145.2 million more than the $102.5 million
of medical premium revenue generated in 1995.  Medical premium revenue generated
by the Company during the year ended December 31, 1996 was substantially greater
than the medical premium revenue  generated by the Company during the year ended
December 31, 1995, due to the significant  subscriber growth  experienced during
1996.  Approximately  55% of  medical  premium  revenue  generated  in 1996  and
approximately 62% of medical premium revenue generated in 1995 was

                                      -28-


<PAGE>


attributable to NJ Acute Care  Institutions  which are obligated to enroll their
employees in FOHP-NJ health plans.  The Company  believes that the percentage of
medical premium revenue attributable to NJ Acute Care Institutions will continue
to decrease as FOHP-NJ's  operations  grow and FOHP-NJ  begins to fully  benefit
from current  marketing  efforts  focused on  individuals  and businesses who or
which are not providers to FOHP-NJ.

         OTHER REVENUE. Other revenue,  principally administrative fees, for the
year ended December 31, 1996 was $7.9 million  compared to $7.6 million of other
revenue for the prior year. This increase is attributed to the subscriber growth
in  self-insured  products.  Interest  income for 1996 was $1.8 million,  a $600
thousand  increase  from the $1.2  million  generated  in 1995.  The increase in
interest income was due to the larger cash reserves maintained by the Company in
1996.

         MEDICAL AND HOSPITAL SERVICE EXPENSES.  Total expenses  attributable to
medical and  hospital  service for the year ended  December 31, 1996 were $236.4
million or $144.8 million higher than expenses incurred in 1995. The increase in
medical  and  hospital   service  expenses  from  1995  to  1996  was  primarily
attributable to a significant  increase in enrollees in FOHP-NJ health plans. In
addition,  the medical loss ratio (i.e.,  the  percentage of each premium dollar
used to pay medical expenses) increased in 1996 to 95.5% from 89.3% in 1995 as a
result of increased  enrollment in the FOHP-NJ health plans,  changes in the mix
of products  offered by FOHP-NJ,  and the  inability  of FOHP-NJ to  effectively
control utilization and referrals due to the significant growth of FOHP-NJ.  The
Company   believes   that   recent   operational   changes,   specifically   the
implementation of a modified  provider  reimbursement  schedule,  will lower the
percentage of medical expenses to premium dollars in the future.

         Medical and  hospital  services  expenses are accrued in the period the
services are provided to enrollees in the FOHP-NJ health plans, based in part on
estimates for hospital and other health care  services  which have been incurred
but not yet reported.  Such  estimates are monitored and reviewed by the Company
and its outside  actuaries on a monthly  basis and, as  settlements  are made or
estimates  adjusted,  the  resulting  differences  are  reflected in the current
period  of  operations.  Since  FOHP-NJ  recently  began  operations  and  lacks
significant  historical  experience,  the  estimate  for  incurred  but  not yet
reported  medical  claims is based on  currently  available  industry  ratios of
claims expense to premiums earned as well as the limited  historical  experience
of FOHP-NJ.

         In the spring of 1996,  the number of medial  claims  that had not been
processed by the Company's outside claims administrator increased as a result of
the significant  increase in the number of enrollees in the FOHP-NJ health plans
and the systems limitations of the outside claims  administrator  engaged by the
Company to provide claims  processing  services.  During the summer of 1996, the
Company,  in an effort to decrease the medical claims  backlog,  began using its
own personnel to process  claims and notified its outside  claims  administrator
that if it did not begin to perform its claims processing  functions in a manner
consistent  with the  contract  between  FOHP-NJ  and the claims  administrator,
FOHP-NJ would withhold  payments as permitted in such  contract.  As a result of
these efforts, the medical claims backlog was reduced

                                      -29-


<PAGE>


significantly  by the end of the third quarter of 1996. In the fourth quarter of
1996,  the Company and its outside  actuaries,  using the same  methodology  for
estimating  incurred but not yet reported  medical claims as had been used since
FOHP-NJ  first  received  its COA to operate as an HMO,  but having  more claims
payment  data  available  as a result of the  reduction  in the claims  backlog,
realized that they had previously  underestimated the amount of the incurred but
not yet reported  medical claims and that, as a result,  FOHP-NJ's  incurred but
not yet reported reserve needed to be increased in the fourth quarter of 1996 by
approximately $13 million. The Company believes that the underestimation was due
to FOHP-NJ's limited historical experience and the high medical costs related to
new products offered by FOHP-NJ,  such as Medicare  products,  Medicaid products
and small business products.

         As a result of a significant increase in medical claims expenses during
the fourth quarter of 1996,  including an increase in FOHP-NJ's incurred but not
yet reported reserve by  approximately  $13 million due to more complete payment
data that were not available to the Company and its outside  actuaries  prior to
such quarter, and the deterioration of the financial condition of the Company as
a result of continuing  losses generated from operations due to over utilization
and high medical costs related to FOHP-NJ's Medicare products, Medicaid products
and small business  products,  the Company's  losses for the year ended December
31, 1996  increased  by  approximately  $17 million from the  approximately  $14
million reported by the Company as of September 30, 1996.

         SELLING,  GENERAL AND  ADMINISTRATIVE  EXPENSES.  Selling,  general and
administrative  expenses  totalled $50.8 million for the year ended December 31,
1996 compared to $32.6 million incurred in 1995. This increase was the result of
the significant growth of the Company and FOHP-NJ.

         OTHER EXPENSES.  Depreciation  and  amortization  expenses for the year
ended  December  31, 1996  increased  by $205  thousand  from the $674  thousand
incurred in 1995.  This increase was a result of the  significant  investment in
capital equipment in the end of 1995 and the beginning of 1996. Interest expense
decreased in 1996 to $11,200 from the $90,000  incurred in 1995.  This  decrease
was primarily the result of the  repayment of the  short-term  financing for the
acquisition of FMCO.

LIQUIDITY AND CAPITAL RESOURCES

         Gross proceeds of approximately  $12,400,000,  received by FOHP-NJ from
the private  offering and sale of 826,708  shares of common stock in 1993,  were
sufficient  to cover the  expenses  incurred by FOHP-NJ in  connection  with the
formation  and  development  of its  business.  In order to fund its  continuing
development activities,  FOHP-NJ sold 744,445 shares of common stock in a public
offering which closed on October 31, 1994. Gross proceeds received by FOHP-NJ as
a result of the sale of stock in the public  offering  amounted to  $11,166,675.
Further,  in order  to fund  its  continuing  development  of HMOs in New  York,
Pennsylvania and several other states, the Company sold 529,120 shares of Common
Stock-NJ

                                      -30-


<PAGE>


to NJ  Practitioners  in an offering  which ended on  September  1, 1995.  Gross
proceeds  received by the Company as a result of the sale of Common  Stock-NJ in
the offering to NJ Practitioners amounted to $7,937,000.

         FOHP-NJ is required by the Departments to maintain a minimum  statutory
net worth.  In addition,  FOHP-NJ's  COA  originally  provided that if FOHP-NJ's
statutory  net worth is, or is  expected  to be,  less than 125% of the  minimum
requirement,  FOHP-NJ is required to submit to the  Departments a plan of action
to address the  deficiency or expected  deficiency.  During the first quarter of
1996, the Company learned that FOHP-NJ's  statutory net worth as of December 31,
1995 may have been below 125% of the minimum requirement. FOHP-NJ addressed this
potential  deficiency  by  submitting  in  April  1996 a plan of  action  to the
Departments  which  outlined the actions which had been taken and measures to be
used by FOHP-NJ to correct the potential deficiency.

         As part of the plan of action,  on April 30, 1997,  the Company sold to
FHS the Initial Debenture in the aggregate  principal amount of  $51,701,120.38,
pursuant to the Amended Securities Purchase  Agreement.  The principal amount of
the Initial  Debenture  was  convertible,  at the option of FHS, into 71% of the
Company's  capital stock on a fully diluted  basis.  See "Notes to  Consolidated
Financial  Statements  - Note 2." At the closing of the  purchase of the Initial
Debenture,  FHS  converted  $1,701,120.38  of  principal  amount of the  Initial
Debenture into 168,109 shares of Common Stock.

         To facilitate the sale of the Initial Debenture to FHS, the Departments
agreed to rescind  their  conditions  attached to their  approval of the plan of
action submitted by FOHP-NJ in April 1996,  subject to the Department's right to
require  FOHP-NJ to submit a new plan of action if FOHP-NJ fails to increase its
net worth to 100% of the minimum statutory net worth requirement by December 31,
1997. In addition,  the Departments agreed that subsequent to December 31, 1997,
FOHP-NJ  will only be  required  to  maintain  net worth at 100% of the  minimum
statutory  net worth  requirement  applicable to it, and not 125% of the minimum
statutory  net worth  requirement  as required  prior to the sale of the Initial
Debenture,   provided  that  FHS  guarantees,   in  form   satisfactory  to  the
Commissioner  of the DOI, that FOHP-NJ's net worth will be maintained at a level
equal to or in excess of 100% of the  minimum  statutory  net worth  requirement
applicable to FOHP-NJ.  In December  1997,  the  Departments  further  agreed to
permit  FOHP-NJ's  net worth to remain  below  100%  until  December  31,  1998,
provided that it attain 25% increments each quarter during 1998.

         In  connection  with the  sale of the  Initial  Debenture,  FHS and the
Company entered into the Letter  Agreement which clarifies FHS's right under the
Amended  Securities  Purchase  Agreement to infuse  additional  capital into the
Company in the event that it is  determined  that FOHP-NJ  needs capital to meet
applicable  statutory net worth requirements.  Pursuant to the Letter Agreement,
FHS had the right to, at any time prior to December 31, 1997,  contribute  up to
$5,000,000  in additional  capital to the Company to be used in connection  with
certain anticipated  liabilities and contribute such additional amounts that may
be projected to be required from time to time (based upon reasonable projections
prepared by FHS taking into account

                                      -31-


<PAGE>


anticipated full year 1997 operating  results) in order for FOHP-NJ to meet 100%
of the minimum statutory net worth  requirements as of December 31, 1997. In the
event  that FHS  contributed  additional  capital  to the  Company to meet a Net
Capital  Shortfall or projected  Net Capital  Shortfall in  accordance  with the
terms of the  Letter  Agreement,  FHS  would be  issued  additional  convertible
debentures in substantially the same form as the Debentures.

         The Amended  Securities  Purchase  Agreement  also provides that if the
Company  projects a Net Capital  Shortfall and FHS does not advance funds to the
Company to satisfy  such Net Capital  Shortfall,  the Company may initiate a pro
rata offering of its Common Stock to all the  then-current  shareholders  of the
Company to raise capital to satisfy the Net Capital Shortfall.

         Effective  December 1, 1997, FHS converted the remaining $50 million of
the principal amount of the Initial Debenture,  dated as of April 30, 1997, into
4,941,049  shares of Common  Stock.  After the full  conversion  of the  Initial
Debenture,  FHS owned 5,109,158  shares of the 7,195,997  shares of Common Stock
outstanding, which represented 71% of the fully diluted equity of the Company.

         In order to  satisfy  certain  net  worth  requirements  applicable  to
FOHP-NJ and in accordance with the Amended Securities  Purchase  Agreement,  FHS
elected on December  8, 1997 to infuse $29 million  into the Company in exchange
for the New  Convertible  Debenture.  Immediately  upon the  receipt  of the New
Convertible Debenture, FHS converted approximately  $18,952,930 of the principal
amount  thereof  into  92,804,003  shares of  Common  Stock.  After the  partial
conversion of the New Convertible Debenture,  FHS owned 97,913,161 shares of the
100,000,000 shares of Common Stock outstanding,  which represents  approximately
98% of the fully-diluted equity of the Company.

         As of December 31, 1997, FHS also contributed an additional $24 million
to the Company to satisfy certain statutory net worth requirements applicable to
FOHP-NJ in return for additional subordinated debentures.

         Pursuant  to new HMO  regulations  adopted in the State of New  Jersey,
FOHP-NJ is required to  maintain a "Minimum  Insolvency  Deposit for Health Care
Expenditures." It is estimated that this deposit covering two months of incurred
health  expenditures will be approximately $50 million. A final determination of
the deposit will be made in 1998.  One- fourth of the deposit,  or $12.5 million
(including interest earned), was made prior to September 30, 1997. The remainder
of the deposit must be in quarterly installments during 1998, recalculated as of
year-end 1997.

IMPACT OF YEAR 2000

The Year 2000 issue is the result of computer  programs  being written using two
digits  rather than four to define the  applicable  year.  Any of the  Company's
computer programs that have  time-sensitive  software may recognize a date using
"00" as the year 1900 rather than the year 2000.  This could  result in a system
failure or miscalculations causing disruptions of operations,

                                      -32-


<PAGE>


including,  among other things, a temporary  inability to process  transactions,
send invoices, or engage in similar normal business activities.

Based on a recent assessment, the Company determined that it will be required to
modify or replace  significant  portions of its  software  so that its  computer
systems  will  function  properly  with  respect  to dates in the Year  2000 and
thereafter.  The Company presently  believes that with modifications to existing
software  and  conversions  to new  software  the Year 2000  issue will not pose
significant  operational  problems for its computer  systems.  However,  if such
modifications  and  conversions are not made, or are not completed  timely,  the
Year 2000 issue could have a material impact on the operations of the Company.

The Company has  initiated  formal  communications  with all of its  significant
suppliers  and large  customers to determine  the extent to which the  Company's
interface  systems are vulnerable to those third  parties'  failure to remediate
their own Year 2000 issues.

The Company  has  developed a plan to modify its  information  technology  to be
ready  for the Year  2000 and has  begun  converting  critical  data  processing
systems. The Company currently expects the project to be substantially  complete
by early 1999 and as yet is unable to estimate  the cost.  The Company  does not
expect this project to have a  significant  effect on  operations.  Expenditures
through December 31, 1997 have not been material. The Company will implement its
plan by placing a higher  priority on the systems with  significant  operational
implications.  The Company  will  continue to implement  systems with  strategic
value through some projects may be delayed due to resource constraints.

                                      -33-


<PAGE>


ITEM 8.  FINANCIAL STATEMENT AND SUPPLEMENTARY DATA.

         The consolidated  financial  statements and  supplementary  data of the
Company  called for by this item are  submitted  as a  separate  section of this
report.

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

         Not applicable.

                                      -34-


<PAGE>


                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

EXECUTIVE OFFICERS OF THE REGISTRANT

         The name,  age and  position  of each  person  serving as an  executive
officer of the Company are set forth below and brief summaries of their business
experience  and certain  other  information  with respect to each of them is set
forth in the information which follows the table:

    NAME                   AGE     POSITION
    ----                   ---     --------
    Roger W. Birnbaum       61     President and Chief Executive
                                   Officer

    Dr. Joseph Singer       40     Executive Vice President and Chief
                                   Medical Officer

    Donald Parisi           42     Senior Vice President, Secretary and General
                                   Counsel
 
    Marc M. Stein           46     Chief Financial Officer

----------
         Roger W. Birnbaum has served as President and Chief  Executive  Officer
of the  Company  since  June 1,  1997,  and  served  on the  Company's  Board of
Directors from April 16, 1997 to March 25, 1998. Prior to becoming President and
Chief  Executive  Officer  of the  Company,  he served as the  President  of the
Princeton  HealthCare Group from October 1991. From July 1972 to September 1991,
Mr. Birnbaum served as the President and Chief Executive  Officer of HIP/Rutgers
Health Plan,  Inc.  Mr.  Birnbaum has been a Professor of Health Care at Rutgers
State University of New Jersey since July 1972 and Adjunct  Associate  Professor
at the  University  of Medicine and  Dentistry of New Jersey since January 1974.
Mr.  Birnbaum is on the Board of Directors of Caldwell B.  Esselstyn  Foundation
and the Board of Trustees of Rutgers Community Health Foundation.

         Dr.  Joseph  Singer has served as Executive  Vice  President  and Chief
Medical Officer of the Company since June 8, 1995. Dr. Singer also has served as
Executive Vice President,  Medical Affairs and Medical Director of FOHP-NJ since
February 1995. Prior to joining FOHP-NJ,  Dr. Singer was a practicing  physician
in Moorestown and Medford,  New Jersey,  with a family practice and specialty in
geriatrics.

                                      -35-


<PAGE>


         Donald  Parisi  has  served as Senior  Vice  President,  Secretary  and
General  Counsel  of the  Company  since  June 1,  1997 and from June 8, 1995 to
December 1996. Mr. Parisi served as acting President and Chief Executive Officer
of the Company from  December  1996 to May 31, 1997.  Mr.  Parisi served as Vice
President, Legal Affairs and General Counsel of FOHP-NJ from August 1994 to June
8,  1995.  From  1992 to 1994 he was a  partner  in the law  firm of  Donington,
Karcher,  Leroe,  Salmond,  Ronan & Rainone and from 1988 to 1992 he served as a
Deputy Attorney General for the State of New Jersey.

         Marc M. Stein has  served as Chief  Financial  Officer  of the  Company
since February 18, 1997.  Prior to becoming the Chief  Financial  Officer of the
Company,  he served as  Treasurer  of HIP  Insurance  Company  of New Jersey and
financial  officer of HIP Health Plan of  Pennsylvania  from February 1995. From
November 1992 to February 1995, Mr. Stein served as Senior Vice President of HIP
of Greater New York.

         Pursuant  to  the  Administrative  Management  Agreement,  each  of Mr.
Birnbaum, Dr. Singer, Mr. Parisi, and Mr. Stein is employed by FHS. The salaries
and  benefits  of the  aforementioned  executive  officers  is either paid by or
charged to the Company. See "Executive  Compensation-Employment  Agreements" and
"Certain Relationships and Related Transactions."

                                      -36-


<PAGE>


CURRENT DIRECTORS OF THE REGISTRANT

         The name, address,  age and principal  occupation or employment of each
director currently serving on the Board of Directors of the Company is set forth
below:

                                              PRINCIPAL OCCUPATION
    NAME AND ADDRESS            AGE               OR EMPLOYMENT
    ----------------            ---          ----------------------
Dr. John F. Bonamo               47   Obstetrician and Gynecologist
95 Northfield Avenue
West Orange, NJ  07052

Sister Jane Frances Brady        62   President of St. Joseph's Hospital and
St. Joseph's Hospital and             Medical Center
 Medical Center
703 Main Street
Paterson, NJ  07503

Mr. Bruce G. Coe                 67   President Emeritus of New Jersey Business
41 Lambert Lane                       and Industry Association
Lambertville, NJ  08530

Mr. Christopher M. Dadlez        44   Executive Vice President of Saint Barnabas
Saint Barnabas Health Care            Health Care System
 System
Old Short Hills Road
Livingston, NJ  07039

Dr. Mark L. Engel                51   Ophthalmologist
733 North Beers Street
Holmdel, NJ  07733

Dr. Thomas J. Feneran            49   Urologist
102 East Bay Avenue, Suite C
Manahawkin, NJ  08050


                                      -37-


<PAGE>


                                                PRINCIPAL OCCUPATION
      NAME AND ADDRESS             AGE             OR EMPLOYMENT
      ----------------             ---       ---------------------------
Mr. John J. Gantner                 45    Senior Vice President of Finance and
Robert Wood Johnson                       Treasurer of the Robert Wood Johnson
 University Hospital                      University Hospital
One Robert Wood Johnson Place
New Brunswick, NJ  08903

Mr. Jay M. Gellert                  44    President and Chief Operating Officer
Foundation Health Systems, Inc.           of Foundation Health Systems, Inc.
21600 Oxnard Street
Woodland Hills, CA  91367

Mr. Laurence M. Merlis              43    Executive Vice President of the
Meridian Health System                    Meridian Health System
Monmouth Shores Corporate Park
1350 Campus Parkway
Wall, NJ  07753

Mr. Robert L. Natt                  49    President and Chief Executive Officer
Physician Health Services, Inc.           of FHS Northeast Region
One Far Mill Crossing
Shelton, CT  06484

Dr. Om P. Sawhney                   60    Plastic Surgeon
1550 Park Avenue
South Plainfield, NJ  07080

Mr. Thomas W. Wilfong               42    President of New Jersey Operations of
FOHP, Inc.                                Foundation Health Systems, Inc.
3501 State Highway 66
Neptune, NJ  07754

-------------
         There  are no  family  relationships  among the  current  directors  or
executive  officers of the Company.  None of the executive officers or directors
of the Company are directors of any company registered pursuant to Section 12 of
the Exchange Act or subject to the requirements of Section 15(d) of the Exchange
Act or any company  registered  as an investment  company  under the  Investment
Company Act of 1940. Pursuant to the By-laws of FOHP-NJ,  each person serving on
the Board of the Company automatically serves on the Board of Directors of FOHP-
NJ.

                                      -38-


<PAGE>


         Dr. John F. Bonamo has been an obstetrician and gynecologist in private
practice  since  1981.  He is  Secretary  of the  Department  of OB/GYN of Saint
Barnabas Medical Center. Dr. Bonamo serves as Chairman of the Board of MetroWest
I.P.A. He has served as a director of the Company since April 16, 1997.

         Sister Jane Frances Brady has served as the  President of St.  Joseph's
Hospital and Medical Center since November 1972. She also serves as Treasurer of
St. Joseph's Hospital and Medical Center and the Paterson  Economic  Development
Corporation.  Sister  Jane  Frances  Brady  serves as a trustee of St.  Joseph's
Hospital and Medical  Center  Foundation  and as Chairperson of the Board of the
Via Caritas Health System. In addition,  she serves as the President of Hospital
Alliance of New Jersey.  She has served as a director of the Company since April
16, 1997 and as a director of FOHP-NJ since January 1994.

         Mr. Bruce G. Coe is currently serving as President  Emeritus of the New
Jersey  Business  and  Industry  Association.  From  1982 to 1996 he  served  as
President of the New Jersey Business and Industry Association. Mr. Coe serves on
the Boards of Directors of New Jersey Resources  Corporation.  He also serves on
the Boards of Trustees of New Jersey Future and New Jersey  Historical  Society.
He has served as a director of the Company since April 16, 1997.

         Mr. Christopher M. Dadlez,  FACHE, has been Executive Vice President of
the Saint Barnabas  Health Care System since June 1996.  From March 1992 to June
1996, Mr. Dadlez served as the President and Chief Executive Officer of Monmouth
Medical  Center.  From  January  1995 to May  1996,  Mr.  Dadlez  served  as the
President of  Mid-Atlantic  Health  Group.  From June 1984 to March 1992, he was
Executive  Vice  President  and  Chief  Operating  Officer  of  Sinai  Hospital,
Baltimore,  Maryland.  Mr.  Dadlez  serves on the Board of  Trustees  of the New
Jersey Hospital  Association and Ronald McDonald House. He serves as Chairman of
Long Branch  Tomorrow and is on the Board of Trustees of the Greater Long Branch
Chamber of  Commerce.  He has served as a director of the Company  since June 7,
1995 and as a director of FOHP-NJ since January 1994.

         Dr. Mark L.  Engel,  an  ophthalmologist,  has served as  President  of
Ophthalmic  Physicians of Monmouth since August 1975.  From January 1989 through
December 1990 he served as President of the Bayshore Hospital Medical Staff. Dr.
Engel is a trustee of  Ophthalmic  Physicians  of  Monmouth.  He has served as a
director of the  Company  since June 7, 1995 and as Chairman of the Board of the
Company  since April 16,  1997.  Dr.  Engel also served as a director of FOHP-NJ
since January 1994 and as Chairman of the Board of FOHP-NJ since June 1995.

         Dr.  Thomas J. Feneran has been a physician in private  practice  since
June 1983. He is an urologist,  associated in Drs. Feneran & Fernicola, P.C. Dr.
Feneran  serves  as a  physician  representative  to the  Board of  Trustees  of
Southern Ocean County Hospital. He has served as a director of the Company since
June 7, 1995 and as a director of FOHP-NJ since January 1994.

                                      -39-


<PAGE>


         Mr. John J.  Gantner has served as Treasurer of the Robert Wood Johnson
University  Hospital  since May 1995.  In 1993,  he joined  Robert Wood  Johnson
University  as Senior Vice  President of Finance.  From October 1988 to December
1992,  Mr.  Gantner was a partner in the New York/New  Jersey  office of Ernst &
Young. Mr. Gantner is a Certified Public  Accountant and a Certified  Managerial
Accountant. He has served as a director of the Company since April 16, 1997.

         Mr. Jay M. Gellert became President and Chief Operating  Officer of FHS
on May 7, 1997.  From April 1, 1997 until May 7,  1997,  Mr.  Gellert  served as
Executive Vice President and Chief Operating  Officer of FHS. Mr. Gellert served
as a director  and  President  and Chief  Operating  Officer  of Health  Systems
International,  Inc., a predecessor  of FHS, from June 1996 until April 1, 1997.
Prior to joining FHS, Mr. Gellert  directed  Shattuck  Hammond  Partners  Inc.'s
strategic  advisory  engagements  in the  area of  integrated  delivery  systems
development,  managed  care  network  formation  and  physician  group  practice
integration. Prior to joining Shattuck Hammond Partners, Inc. Mr. Gellert was an
independent consultant,  and from 1988 to 1991, he served as President and Chief
Executive  Officer  of Bay  Pacific  Health  Corporation.  From 1985 to 1988 Mr.
Gellert was Senior Vice  President and Chief  Operating  Officer for  California
Healthcare  System.  He has served as a director of the Company  since March 25,
1998.

         Mr. Laurence M. Merlis has served as an Executive Vice President of the
Meridian Health System since January 1, 1997.  Prior thereto,  Mr. Merlis served
as President and Chief  Executive  Officer of Riverview  Medical  Center for the
period May 1993 to January 1997. From January 1986 through May 1993 he served as
President of East Orange  General  Hospital.  Mr.  Merlis serves on the Board of
Directors of  Monmouth-Ocean  Hospital  Corporation.  He also is a member of the
Board of  Trustees  of the New  Jersey  Hospital  Association.  He has  served a
director of the Company  since April 16, 1997 and as a director of FOHP-NJ since
January 1994.

         Mr. Robert L. Natt became  President of the Northeast  region of FHS in
January 1998. Previously,  he served as President and Co-Chief Executive Officer
of PHS, now a subsidiary of FHS, from August 1996 until December 1997,  when FHS
acquired PHS. From 1985 through August 1996, Mr. Natt served as Chief  Operating
Officer of PHS. He has served as a director of the Company since March 25, 1998.

         Dr. Om P. Sawhney has been a practicing  physician in Plastic Surgery &
Rehabilitation  Medicine  Associates  since  January  1974.  Dr.  Sawhney  is  a
consultant  to the Audit  Committee - Medical Inter  Insurance  Exchange and the
Board of Managers of Associates in Medical  Service at Muhlenberg,  L.L.C. He is
on the Board of Directors of the  Muhlenberg  Foundation  and the Central Jersey
I.P.A. Dr. Sawhney is also President of Associates in Medicine and Surgery, P.A.
He has served as a director of the Company  since June 7, 1995 and as a director
of FOHP-NJ since January 1994.

         Mr.  Thomas W.  Wilfong  has  served as  President  of FHS' New  Jersey
operations  since February  1998.  Mr.  Wilfong served as Executive  Director of
PHS's New Jersey operations

                                      -40-


<PAGE>


from August 1996 to February  1998.  From July 1986 to August 1996,  Mr. Wilfong
served as Vice  President of Medical  Management  of Central New Jersey  Medical
Group. He has served as a director of the Company since March 25, 1998.

DIRECTOR COMPENSATION; COMMITTEE SERVICE

         The  members of the  Company's  Board of  Directors  and any  committee
thereof may be paid their  expenses,  if any,  relating to their  attendance  at
Board or committee  meetings,  and directors who are not full-time  employees of
the  Company  may be paid a fixed  sum for  attendance  at  Board  or  committee
meetings or paid a stated  salary as a director.  Currently,  the members of the
Company's  Board of  Directors  are  entitled  to receive an annual  retainer of
$10,000 and $500 for each Board meeting attended, $300 for each telephonic Board
meeting in which the  director  participates,  $300 for each  committee  meeting
attended,  and $200 for each  telephonic  committee  meeting in which a director
participates.  The  Chairman of the Board is  entitled to receive an  additional
$5,000 annual  retainer and the  chairpersons  of the following  committees  are
entitled  to  receive  a  $2,000  annual  retainer:  Audit  Committee;   Finance
Committee; Medical Affairs Committee; and Grievance Committee.

         The Company paid  approximately  $107,150 during the fiscal  year-ended
December  31, 1997 to members of the Board of  Directors  for their  services as
directors and committee members.

COMMITTEES

         Pursuant to the Company's  By-laws,  the Company has an Audit Committee
which  is  responsible  for  evaluating  and  recommending  the  appointment  of
independent auditors for the Company and its subsidiaries, and for reviewing, in
consultation  with  such  auditors,   the  annual  financial  statements  (on  a
consolidated  and  separate  company  basis),  systems of internal  controls and
accounting principles of the Company and its subsidiaries.

         In addition,  pursuant to the Company's By-laws, the Board of Directors
may, by one or more  resolutions  passed by a majority of the directors  then in
office,  establish such other committees as it shall determine necessary for the
operations  of the Company.  The Board of Directors has empowered the members of
the Audit Committee to act as the Company's  Compensation  Committee which shall
make  decisions  relating to the  compensation  of the  officers,  directors and
employees of the Company.  The Compensation  Committee is currently comprised of
the following directors:  Mr. Bruce G. Coe, Mr. John J. Gantner, Mr. Laurence M.
Merlis and Dr. Om P. Sawhney.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS

         During the fiscal  year  ended  December  31,  1997,  the  Compensation
Committee consisted of Mr. Coe, Mr. Gantner, Mr. Merlis and Dr. Sawhney.

                                      -41-


<PAGE>


         During the fiscal year ended December 31, 1997, no executive officer of
the Company,  served as a member of the compensation  committee or as a director
of another entity, except for any subsidiary or affiliate of the Company.

 COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

         Section  16(a) of the Exchange Act  requires  the  Company's  executive
officers and directors,  and persons who own more than 10% of a registered class
of the Company's equity securities,  to file reports of ownership and changes in
ownership on Forms 3, 4 and 5 with the Securities and Exchange  Commission  (the
"Commission").  Executive  officers,  directors  and  greater  than 10%  percent
shareholders are required by the Commission's regulations to furnish the Company
with copies of all Forms 3, 4 and 5 that they file.

         Based solely on the Company's review of the copies of such forms it has
received,  the Company believes that all its executive  officers,  directors and
greater  than  10%  beneficial  owners  complied  with all  filing  requirements
applicable  to them with respect to events or  transactions  during  fiscal 1997
except that the Form 4 required to be filed by FHS in January 1998 in connection
with the conversion of Debentures was filed in February 1998.

                                      -42-


<PAGE>


ITEM 11.  EXECUTIVE COMPENSATION.

         The following  table sets forth  information  concerning the annual and
long-term  compensation  for services in all  capacities  to the Company and its
subsidiaries,  for the fiscal years ended  December 31, 1997,  1996 and 1995, of
the persons  serving as the Chief  Executive  Officer of the Company  during the
fiscal year ended  December 31, 1997,  and the next three highest paid executive
officers of the Company in fiscal 1997 (collectively, the "Named Officers"):

                           SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>

                                         ANNUAL COMPENSATION                        LONG-TERM COMPENSATION
                                  ---------------------------------   -------------------------------------------------
                                                                                AWARDS             PAYOUTS
                                                                      -------------------------    -------
                                                           Other                      Securities              All
                                                           Annual     Restricted      Underlying              Other
Name and                                                   Compen-    Stock           Options/     LTIP       Compensa-
Principal Position        Year     Salary($)   Bonus($)    sation($)  Award(s)($)     SARS(#)      Payouts    tion($)(1)(2)
------------------        ----     --------    --------    ---------  -----------     -------      -------    ------------
<S>                       <C>      <C>         <C>            <C>        <C>           <C>           <C>      <C>       
Roger W. Birnbaum         1997     $140,615(3) $25,000(4)     --         --            --            --       $85,722(5)
 President and
 Chief Executive Officer

Joseph Singer             1997      240,000     28,000        --         --            --            --         5,035
 Executive Vice President 1996      239,354         --        --         --            --            --         4,905
 and Chief Medical        1995      177,217         --        --         --            --            --            --
 Officer

Donald Parisi(6)          1997      151,346     40,000        --         --            --            --         5,056
 Senior Vice President,   1996      144,231         --        --         --            --            --         4,981
 Secretary and General    1995      120,019         --        --         --            --            --         2,361
 Counsel

Marc M. Stein             1997      144,038(7)  35,000(8)     --         --            --            --         5,132
 Chief Financial Officer

</TABLE>

------------
(1)     Includes  amounts  contributed by the Company under its 401(k) Plan. All
        full-time  employees  who have  completed  30 days of  service  with the
        Company or any of its  subsidiaries  are eligible to  participate in the
        401(k) Plan which allows  eligible  employees to save up to 15% of their
        pre-tax  compensation  (subject to a maximum amount per year established
        annually pursuant to the Code) through a payroll  deduction.  Subject to
        the discretion of the Board of Directors,  the Company may make matching
        contributions to the 401(k) Plan. Amounts  contributed by the Company to
        the accounts of the Named  Officers for fiscal 1997 are as follows:  Mr.
        Birnbaum - $4,750;  Dr. Singer - $4,750;  Mr.  Parisi - $4,750;  and Mr.
        Stein - $4,750.
(2)     Includes  amounts of insurance  premiums paid by  the Company in  fiscal
        1997 with respect to term life  insurance  for the  benefit of the Named
        Officers.  Amounts  paid by  the  Company  for  the benefit of the Named
        Officers are  as  follows:  Mr.  Birnbaum - $972; Dr. Singer - $285; Mr.
        Parisi - $306; and Mr. Stein - $382.
(3)     Represents the period June 1, 1997 to December 31, 1997.
(4)     Such  bonus was earned in fiscal year 1997 but was not paid until  March
        1998.
(5)     Mr. Birnbaum served as a consultant to FHS from February to May 1997 for
        which he was paid a consultant fee by FHS of $80,000.
(6)     Mr. Parisi served as acting  President and  Chief Executive Officer from
        December, 1996 to May 31, 1997.

                                      -43-


<PAGE>


(7)    Represents the period February 18, 1997 to December 31, 1997.
(8)    Such bonus was earned in fiscal year 1997 but was not paid until February
       1998

EMPLOYMENT AGREEMENTS

        Effective June 1, 1997, Roger W. Birnbaum became the President and Chief
Executive  Officer of the Company  pursuant to an  employment  letter  agreement
entered into by Mr. Birnbaum and FHS dated May 6, 1997 (the "Birnbaum Employment
Agreement").  In accordance with the terms of the Birnbaum Employment Agreement,
Mr. Birnbaum (i) earns a monthly base salary of approximately  $20,833,  (ii) is
eligible  to  receive  a  monthly  automobile  allowance  of  $1,000,  (iii)  is
guaranteed a management bonus of at least $25,000 for 1997 and 1998, (iv) may be
granted  stock  options to  acquire  FHS stock in an amount  comparable  to peer
managers  of FHS upon the  approval  of the FHS  Compensation  and Stock  Option
Committee,  and (v) is entitled to other customary  benefits  provided by FHS to
its  employees.  Mr.  Birnbaum  recently  was paid his  1997  bonus of  $25,000.
Pursuant  to the terms of the  Birnbaum  Employment  Agreement,  Mr.  Birnbaum's
employment  with FHS is on an  "employee-at-will"  basis and FHS may at any time
terminate Mr. Birnbaum's employment for any reason other than cause by giving 60
days' prior written notice;  provided,  however,  that upon such termination Mr.
Birnbaum  will be entitled  to receive his base salary for six (6) months  after
the date of such termination (the "Birnbaum Severance  Payments"),  and, if such
termination is within the first twelve (12) months of Mr. Birnbaum's employment,
Mr.  Birnbaum  will be paid as an employed  consultant at his base salary at the
time of termination  for an additional  six (6) months.  As a consequence of the
formation of FHS's Northeast region, Mr. Birnbaum's  employment as President and
Chief  Executive  Officer of the Company will  terminate as of April 1, 1998. In
connection  with such  termination,  Mr.  Birnbaum  will  receive  the  Birnbaum
Severance Payments provided under the Birnbaum Employment  Agreement  commencing
October 1, 1998.  From April 1, 1998 to September  30, 1998,  Mr.  Birnbaum will
provide  consulting  services  to the  Company  as  set  forth  in the  Birnbaum
Employment Agreement.

        Effective July 1, 1997, FHS entered into an employment  letter agreement
(the "Singer Employment Agreement") with Dr. Joseph Singer pursuant to which Dr.
Singer  will  remain  as  Chief  Medical  Officer  of the  Company.  The  Singer
Employment Agreement supercedes all prior employment  agreements relating to Dr.
Singer's  employment by the Company.  In accordance with the terms of the Singer
Employment Agreement,  Dr. Singer (i) earns a monthly salary of $20,000, (ii) is
eligible to receive a monthly automobile  allowance of $1,000,  (iii) received a
$28,000  signing  bonus in 1997,  (iv) is  eligible  to  participate  in the FHS
Management Bonus Plan under which he may earn a percentage of his base salary as
a bonus  subject to the  discretion  of the FHS  Compensation  and Stock  Option
Committee,  and (v) is eligible to receive  and/or  participate  in the benefits
customarily  provided  by FHS to its  employees.  Pursuant  to the  terms of the
Singer Employment Agreement, Dr. Singer is an "employee-at-will" and is eligible
to receive four (4) months of severance  pay upon his leaving the employ of FHS,
provided that such  termination  is not by reason of "just cause," as defined in
the Singer Employment Agreement.

                                      -44-


<PAGE>


         Pursuant  to an  employment  letter  agreement  dated  February 6, 1997
between FHS and Marc M. Stein,  Mr. Stein became Chief Financial  Officer of the
Company on February 18, 1997.  Pursuant to such letter agreement,  Mr. Stein was
recently  paid a bonus of $35,000 or 20% of his annual base salary.  On February
9, 1998, FHS and Mr. Stein entered into another employment letter agreement (the
"Stein  Employment   Agreement"),   which  agreement   supersedes  the  previous
employment  letter  agreement  dated  February  6,  1997.  The Stein  Employment
Agreement  terminates  on March 31, 1999,  provided  that such  agreement may be
terminated  prior thereto at the discretion of FHS. In accordance with the terms
of the Stein  Employment  Agreement,  Mr.  Stein  (i) earns an annual  salary of
$175,000,  (ii) is eligible to participate in the 1998 FHS Management Bonus Plan
and in the 1999 FHS Management Bonus Plan on a prorated basis, (iii) is entitled
to  receive  a  monthly  automobile  allowance  of  $500,  (iv) is  eligible  to
participate  in the FHS  Management  Stock Option Plan,  and (v) receives  other
customary  benefits  provided by FHS to its  employees.  Provided that Mr. Stein
remains employed by FHS until March 31, 1999, or if his employment is terminated
prior to March 31,  1999 for any reason  other than "just  cause," as defined in
the Stein Employment Agreement,  Mr. Stein will receive as retention bonus equal
to three  months  salary on March 31,  1999.  Pursuant to the terms of the Stein
Employment  Agreement,  if Mr.  Stein's  employment is terminated for any reason
other than "just cause" prior to March 31,  1999,  FHS will  continue to pay Mr.
Stein his salary  through  September  30,  1999,  which  includes six (6) months
severance. If, on January 31, 1999, FHS offers continued employment to Mr. Stein
and Mr. Stein  rejects such offer,  Mr. Stein will be entitled to six (6) months
severance  commencing  April 1, 1999 and his retention bonus as described in the
Stein Employment Agreement.

                                      -45-


<PAGE>


 ITEM 12.  PRINCIPAL SHAREHOLDERS AND SECURITY OWNERSHIP MANAGEMENT.

        The following  table sets forth  information as of March 15, 1998,  with
respect to the  beneficial  ownership  (as defined in Rule 13d-3 of the Exchange
Act) of the  Company's  Common  Stock,  which is the only class of the Company's
capital  stock with  shares  issued and  outstanding,  by each  director  of the
Company,  each of the Named Officers (as defined in the section herein captioned
"Executive Compensation"),  each person or group of persons known by the Company
to be the beneficial  owner of more than 5% of Common Stock,  and all directors,
nominees for director and executive officers of the Company as a group:


                                                        BENEFICIAL OWNERSHIP OF
                                                             COMMON STOCK
                                                      --------------------------
                                                                      PERCENT OF
NAME OF BENEFICIAL OWNER                             NO. OF SHARES (1)  CLASS
-------------------------                            ----------------- ---------

Foundation Health Systems, Inc.(2)...................   97,913,161       97.9%

Dr. John F. Bonamo (3)...............................        1,500         (4)

Sister Jane Frances Brady (3)........................          --

Bruce G. Coe (3).....................................          --

Christopher M. Dadlez (3)............................          --

Dr. Mark L. Engel (3)................................       7,017 (5)      (4)

Dr. Thomas J. Feneran (3)............................       4,100          (4)

John J. Gantner (3)..................................          --

Jay M. Gellert (3)...................................          --

Laurence M. Merlis (3)...............................          --

Robert L. Natt (3)...................................          --

Dr. Om P. Sawhney (3) (6)............................       5,800 (6)      (4)

Thomas W. Wilfong (3) ...............................          --

Roger W. Birnbaum (7)................................          --


                                      -46-


<PAGE>


Dr. Joseph Singer (7)................................       8,000          (4)

Donald Parisi (7)....................................          --

Marc M. Stein (7)....................................          --

All Directors and Executive Officers

as a Group (16 persons)..............................      26,417 (5)(6)   (4)
---------------

(1)   Except as otherwise indicated,  all of the shares of Common Stock are held
      beneficially and of record.

(2)   FHS's  principal  offices  are  located  at  21600 Oxnard Street, Woodland
      Hills, CA 91367.
(3)   Such person currently serves as a director of the Company.
(4)   Shares beneficially  owned do  not exceed 1% of the Company's  outstanding
      Common Stock.
(5)   Includes an aggregate of 417 shares  of Common  Stock held  by Dr. Barbara
      Engel,  Dr.  Mark L. Engel's wife, as  to  which  shares he  disclaims any
      beneficial interest.
(6)   Includes an  aggregate of 500 shares  of  Common  Stock held  by Dr. Veena
      Sawhney,  Dr. Om P. Sawhney's wife, as to  which shares he  disclaims  any
      beneficial interest.
(7)   Such person is an executive officer of the Company.

                                      -47-


<PAGE>


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

      MANAGEMENT AGREEMENTS WITH FHS

      Each of the  Management  Agreements  provides  that  FHS will  employ  the
business  executives in charge of the Company and each of its subsidiaries,  and
each  executive  in charge of a principal  business  division,  unit or function
(including, but not limited to finance, legal, operations,  sales and marketing,
information systems, medical management, and provider contracting and relations)
(collectively,  the  "Executives").  Each of the Executives will report to FHS's
senior management.  All the Executives shall be appointed by the Company's Board
of Directors to the offices requested by FHS: PROVIDED,  HOWEVER, that the Board
may reject any proposed  appointee  it  reasonably  finds to be of  insufficient
ethical  character for such office;  and provided  further,  that the Board may,
after  due  consultation  with  FHS  based  on  a  reasonable  determination  of
intentional  and  material  unethical  behavior  or  insubordination  or willful
misconduct or gross negligence, remove any such Executive.  Currently, Mr. Roger
W. Birnbaum,  President and Chief Executive Officer of the Company,  Dr. Singer,
Executive Vice President and Medical Director of the Company, Mr. Donald Parisi,
Senior Vice  President,  General  Counsel and Secretary of the Company;  and Mr.
Marc M. Stein, Chief Financial Officer of the Company, are employed by FHS.

      Each of the Management Agreements provides that the Company will employ an
internal auditor who will report directly to the Board of Directors.

      Each of the  Management  Agreements  has an  initial  term of five  years,
subject to automatic one year renewal terms unless either party provides written
notice of  non-renewal  to the other  party at least two years prior to the then
current term of the  agreement.  A party may terminate  either of the Management
Agreements  if (i) the  other  party  is in  material  breach  of the  agreement
(subject to certain  rights to cure any such  breach);  (ii) the other party (a)
becomes  insolvent,  (b)  voluntarily  seeks,  consents to or  acquiesces in the
benefit or  benefits  of any Debtor  Relief  Law (as  defined in the  Management
Agreements) or (c) becomes a party to (or be made the subject of) any proceeding
provided by any Debtor Relief Law, other than as a creditor or claimant (unless,
in the event the proceeding is voluntary, the petition instituting the voluntary
proceeding is dismissed within 45 days of the date it was filed).

      Under the Administrative  Management Agreement, FHS is entitled to receive
a monthly  management fee (the  "Management  Fee") equal to the sum of (a) 2% of
the total  revenue of the health plans  offered by the Company (the "FOHP Health
Plans") for such month plus (b)  reimbursement  for (i) direct expenses incurred
by third  parties and (ii)  salaries and benefits of the  Executives;  PROVIDED,
HOWEVER, that the aggregate amount of payments to be made to FHS with respect to
clause  (a) for  each  calendar  year  during  the  term  of the  Administrative
Management Agreement shall in no event be less than $5,000,000.

                                      -48-


<PAGE>


      In connection with the sale of the Initial Debenture, the Company paid FHS
a phase-in period  management fee of  $1,701,120.38,  which was based on certain
administrative  services  provided by FHS to the Company from January 1, 1997 to
April 30, 1997.

      At the end of each month during the term of the Administrative  Management
Agreement,  FHS shall  provide the Company  with  statements  setting  forth the
Management  Fee for such month.  The  Management  Fee for any month shall become
payable  within ten days after receipt by the Company from FHS of the statements
for such month.

      In the event that FHS  establishes a regional or  centralized  multi-entry
system  relating to functions  ordinarily  and  customarily  handled at the plan
level and not  described  in the MIS  Management  Agreement  (such as plan level
accounting and membership  services),  FHS shall have the right to transfer such
functions  performed by the FOHP Health Plans to such regional system,  in which
case the Company  shall be  obligated  to pay to FHS the share of such  regional
systems costs  incurred by FHS with respect to such function  which is allocable
to  the  FOHP  Health  Plans;   provided,   however,   the   regionalization  or
centralization  of  functions  by FHS must  result,  in the  aggregate,  in cost
savings to the FOHP Health  Plans and any data  processing  functions  performed
under such  regionalization  or centralization  shall not cost more than what is
contemplated  under  the  Company's  current  Management   Information  Services
Agreement (the "HSII Agreement") with Health Systems Integration, Inc. ("HSII").

      In the event any of the  Management  Fees due and payable to FHS under the
Administrative  Management  Agreement are not paid, such Management Fees may, at
FHS's option,  be added to the principal  amount of the  Debentures  except that
Management  Fees due and payable during  calendar year 1998 may only be added to
such principal  amount to the extent  permitted by the  Debentures.  Any due and
payable  but unpaid  Management  Fees not added to the  principal  amount of the
Debentures  shall bear interest at the rate of the Initial  Debenture until paid
in their entirety or added to the principal amount of the Debentures.

      As compensation under the MIS Management  Agreement,  the Company will (i)
pay FHS fees and charges to be  specified by FHS upon the  effectiveness  of the
agreement, which fees and charges shall be no greater than the compensation paid
to HSII pursuant to the HSII Agreement and (ii) reimburse FHS for such costs and
expenses as to which HSII is entitled to reimbursement  under the HSII Agreement
and documents related thereto.

      FHS is required to provide and perform the  following  services  under the
Administrative Management Agreement, subject to the direction of the FOHP Health
Plans and consistent  with the manner in which FHS provides such services to its
other  subsidiaries,  without  disadvantage  to the  Company or the FOHP  Health
Plans;  (i) manage the  diagnosis and  assessment  of the  information/operating
systems  of the  FOHP  Health  Plans  and  provide  support  for  all  necessary
conversions,  supplements and enhancements to such systems; (ii) manage the FOHP
Health  Plans in their  provider  contracting  efforts  and  provider  relations
matters,  including the  establishment  of  appropriate  provider  reimbursement
structures;  (iii)  provide  human  resources  and  employee  benefit  corporate
management services to the FOHP Health Plans in recruiting employees and

                                      -49-


<PAGE>


in implementing personnel policies and procedures and employee benefit programs;
(iv) provide  consultation and assistance to the FOHP Health Plans in connection
with governmental  relations and legislative  activities  (including  regulatory
compliance  matters)  affecting the FOHP Health Plans; (v) provide  consultation
and  assistance  to  the  FOHP  Health  Plans  in  conducting  analyses  of  the
marketplace  in which they operate and in  developing an  appropriate  strategic
plan;  (vi)  provide  consultation  and  assistance  to the FOHP Health Plans in
connection with the development and  dissemination  of enrollment and disclosure
materials for enrollees thereof, employers and other groups contracting with any
of the FOHP Health Plans and other third parties;  (vii) provide  administrative
support to the FOHP Health Plans in the formulation review and implementation of
the utilization  review and quality assurance  programs thereof;  (viii) provide
consultation  and  assistance  to the  FOHP  Health  Plans  in  connection  with
protecting the  confidentiality  of the records thereof and ensuring  compliance
with all applicable  federal,  state and local laws and regulations  relating to
the records  thereof;  (ix)  consult  with and assist the FOHP  Health  Plans in
support of the medical management  policies and procedures thereof, in preparing
and  negotiating  contracts with  participating  providers,  subscriber  groups,
vendors and other third parties;  (x) provide consultation and assistance to the
FOHP Health Plans in the  preparation of the annual budget  thereof,  which will
set forth their major operating objectives, anticipated revenues, expenses, cash
flow and capital  expenditures;  (xi) provide  oversight  management to the FOHP
Health  Plans in  recording  and  analyzing  the  financial  condition  thereof,
including  financial  review and analysis of health care costs incurred  thereby
and  assist  in the  preparation  of  appropriate  federal,  state and local tax
returns  and provide the FOHP  Health  Plans with advice as to  appropriate  tax
accruals;  (xii) provide consultation and assistance to the FOHP Health Plans in
the establishment,  review and modification of collection  policies and programs
designed to minimize the number and amount of  outstanding  accounts  receivable
thereof;  (xiii) provide  consultation  and assistance in implementing  the FOHP
Health  Plans'  premium  structures,  which premium  structures  shall take into
account the financial  obligations  of the FOHP Health Plans,  the importance of
providing  quality health care at a reasonable  cost and competition of the FOHP
Health Plans and the service  areas;  (xiv) give advice to the FOHP Health Plans
concerning  various business insurance  programs,  including but not limited to,
professional  liability  insurance,  directors and officers liability insurance,
reinsurance and workers' compensation  insurance;  (xv) provide consultation and
assistance to the FOHP Health Plans in  connection  with the sales and marketing
efforts  of the FOHP  Health  Plans,  including  assistance  with  regard to the
selection  of  advertising  agencies,  the  conduct  of surveys  respecting  the
satisfaction of subscriber groups and enrollees of the FOHP Health Plans and the
FOHP Health  Plans' sales  programs and  techniques;  (xvi)  provide to the FOHP
Health  Plans  actuarial  and data  analysis  services,  and  assistance  in the
development of underwriting standards;  (xvii) assist the Boards of Directors of
the Company and its  subsidiaries in reviewing the short,  medium and long range
objectives  of the FOHP Health  Plans and in  formulating  recommendations  with
respect  thereto;  and (xviii)  provide such other  services,  not  specifically
mentioned herein, that are mutually agreed upon between the parties.

      FHS  shall  provide  and  perform  the  following  services  under the MIS
Management Agreement: (i) provide all claims processing, record keeping and data
processing services to the

                                      -50-


<PAGE>


FOHP  Health  Plans that are  currently  provided  by HSII  pursuant to the HSII
Agreement;  and (ii) provide such other related  services as are mutually agreed
upon between the parties.

      Under each of the Management  Agreements,  FHS will defend,  indemnify and
hold the FOHP  Health  Plans  and,  among  others,  their  respective  officers,
directors,  shareholders,  employees  and  agents,  from and against any and all
claims, actions, damages, obligations,  losses, liabilities, costs and expenses,
including  attorneys'  fees,  other  professional  fees, costs of collection and
other costs of defense ("Management  Agreement  Damages"),  resulting from FHS's
gross negligence or willful misconduct.  In addition,  the Company has agreed to
defend,  indemnify  and hold FHS and,  among others,  its  officers,  directors,
shareholders,  employees  and agents,  from and  against any and all  Management
Agreement Damages resulting from FHS's execution of the Management Agreements or
performance of services thereunder,  provided that no such indemnification shall
be provided to the extent that such  Management  Agreement  Damages  result from
FHS's gross negligence or willful misconduct.

      EXCHANGE/CASH OFFER FOR SHARES

      FHS may at any time during  1999,  at its option,  either make an offer to
shareholders  of the Company to exchange shares of FHS Common Stock (referred to
herein as the "Exchange Offer") or make an offer to pay cash (referred to herein
as the "Cash  Offer") for the shares of Common  Stock of the Company held by the
Company's  shareholders,  other than FHS. FHS is required to furnish the Company
with ten days written  notice of its  intention to promptly  make such  Exchange
Offer or Cash  Offer,  as the case may be (the date of such  notification  to be
referred to herein as the "Offer Notice Date"). In the Exchange Offer, FHS would
agree to exchange,  for each  outstanding  share of Common Stock,  the number of
shares of FHS Common  Stock as shall have a  Purchaser  Stock  Market  Value (as
hereinafter  defined) equal to the Company Stock Value (as hereinafter  defined)
of the share of Common  Stock that is being  exchanged.  In the Cash Offer,  FHS
would  agree to pay in cash,  for each  outstanding  share of  Common  Stock,  a
purchase  price  equal to the Company  Stock Value of the share of Common  Stock
being purchased.

      The term  "Purchaser  Stock Market Value" means the average  closing sales
price of the FHS Common Stock on the New York Stock Exchange,  Inc. (or, if such
FHS  Common  Stock is not at such time  listed on the New York  Stock  Exchange,
Inc., on such other national  securities  exchange as the FHS Common Stock shall
at such  time be  listed  or  quoted)  for the  five  consecutive  trading  days
immediately  preceding the date on which the Exchange Offer is commenced by FHS;
PROVIDED, HOWEVER, that, in the event FHS Common Stock shall at such time not be
listed or quoted on any national  securities  exchange,  "Purchaser Stock Market
Value"  shall  be  determined  in  accordance   with  the   procedures  for  the
determination of the Company Stock Value as described below.

      The  "Company  Stock Value" shall be  determined  as follows:  FHS and the
Company  (through the  directors of the Company  with no  affiliation  with FHS)
shall,  within ten days after the Offer Notice Date,  each select an independent
qualified appraiser to appraise the Company

                                      -51-


<PAGE>


Stock Value.  The two  independent  qualified  appraisers  shall  exchange their
respective appraisals within ten business days and submit such appraisals to the
Company  and  FHS.  If the two  independent  qualified  appraisers  agree  on an
appraisal  for the Company  Stock  Value,  the Company  Stock Value shall be the
agreed-upon  amount.  If only one of such  appraisers  so submits  an  appraisal
within the ten business day period,  the Company Stock Value shall be the amount
set forth in such appraisal.  If the two independent qualified appraisers submit
their  appraisals  within the ten  business  day period but cannot  agree upon a
Company Stock Value,  the two independent  qualified  appraisers  shall select a
third independent  qualified  appraiser to appraise the Company Stock Value. The
third  independent  qualified  appraiser  shall  submit its  appraisal  with ten
business  days to FHS  and  the  Company.  The  Company  Stock  Value  shall  be
determined by taking the average of the two appraisals which are closest to each
other;  PROVIDED,  HOWEVER,  that if the appraisal amount which is less than the
highest  appraisal and greater than the lowest appraisal is greater or less than
the average  amount of the other  appraisals by an amount  representing  no more
than 7.5%,  then the average of all three  appraisals  will be the Company Stock
Value.  The following is an example for the valuation  method  described  above.
Assuming that FHS's independent qualified appraiser valued the aggregate Company
Stock Value at $50,000,000, the Company's independent qualified appraiser valued
the aggregate  Company  Stock Value at  $150,000,000  and the third  independent
qualified  appraiser  valued the aggregate  Company Stock Value at $125,000,000,
the aggregate  Company Stock Value would be $137,500,000 (the average of the two
closest  appraisals);  if,  however the third  independent  qualified  appraiser
appraised the Company Stock Value at $105,000,000  (greater than $100,000,000 by
an amount less than 7.5% of  $100,000,000),  the  aggregate  Company Stock Value
would  be  approximately   $101,700,000  (the  average  of  all  three).   After
determining the aggregate Company Stock Value, the value of each share of Common
Stock will be  determined  by dividing the Company  Stock Value by the number of
then outstanding shares of Common Stock.

      MERGER

      At any time  during  the 1999  calendar  year,  FHS may  effect a  merger,
business combination or consolidation  transaction involving the Company for the
purpose of  obtaining  100% of the then  outstanding  equity of the Company (the
"Merger"),  which  Merger has been  approved  by the Board of  Directors  of the
Company  and  therefore  is  not  prohibited  by  the  New  Jersey  Shareholders
Protection Act, subject to the following terms and conditions:

           (a) the  amount of  consideration  to be paid or  distributed  to the
shareholders  of the  Company  in  respect  of each  share  of  Common  Stock in
connection  with the Merger  will  either be (i) cash in an amount  equal to the
Company  Stock Value of such share of Common Stock or (ii) such number of shares
of FHS Common  Stock as shall have a Purchaser  Stock  Market Value equal to the
Company Stock Value of such share of Common Stock;

           (b) the  shareholders  of the  Company,  other  than  FHS,  shall  be
afforded  dissenters'  rights in the same  manner  and under the same  terms and
conditions as is provided under Chapter

                                      -52-


<PAGE>


11 of the New Jersey  Business  Corporation  Act,  regardless  of  whether  such
shareholders  would  otherwise  have been  entitled to such rights under the New
Jersey Business Corporation Act.

           (c) the  Company,  or any  successor  thereto,  shall  provide in its
By-laws  indemnification  provisions  substantially  similar to those  currently
contained in the Company's By-laws for the period ending six years from the date
of the Merger,  or, if earlier,  for the period  ending on the date on which the
statute of  limitations  has  expired  with  respect to the  Company's  Board of
Directors'  approval of the Amended Securities Purchase Agreement and the Merger
contemplated thereby; and

           (d) the Company, or any successor thereto, shall maintain officer and
director  insurance  with terms and  conditions  substantially  similar to those
contained  in the officer and director  insurance  currently  maintained  by the
Company  for the period  ending six years  from the date of the  Merger,  or, if
earlier,  for the period ending the date on which the statute of limitations has
expired  with  respect to the  Company's  Board of  Directors'  approval  of the
Amended Securities Purchase Agreement and the Merger contemplated thereby, which
insurance shall provide coverage for former directors of the Company.

         ALTERNATE PROPOSAL

         Recognizing  that the additional  infusions of capital into the Company
to satisfy certain statutory net worth requirements  applicable to FOHP-NJ,  and
the  subsequent  conversion  of  Debentures  issued  by  the  Company  to FHS in
connection  with such infusions,  has resulted in a significant  dilution of the
provider shareholders'  interest in the Company, FHS is contemplating  providing
the  provider  shareholders  with  alternate  consideration  in the  event of an
Exchange  Offer,  Cash  Offer  or  Merger  (the  "Alternate  Proposal").  FHS is
proposing that in the event of an Exchange Offer, Cash Offer or Merger, provider
shareholders  will be offered a choice  between (i) the per share  consideration
determined in accordance  with the  appraisal  formula  described in the section
hereof  captioned  "Exchange/Cash  Offer for Shares," or (ii) the  alternate per
share consideration calculated in accordance with the Alternate Proposal. FHS is
currently  discussing  with the Board the terms and  conditions of the Alternate
Proposal.  FHS has  expressed an  intention of offering to each NJ  Practitioner
$15.00 for each share of Common  Stock held by him or her which would be payable
on July 1, 2001,  provided  that the NJ  Practitioner  remains in the  Company's
provider  network until December 31, 2001 and certain other  conditions are met.
FHS and the Company  anticipate  finalizing the Alternate Proposal over the next
several weeks,  including the type and amount of  consideration to be offered to
the NJ Acute Care  Institutions  or their  affiliates  holding  shares of Common
Stock.

         EXECUTIVE OFFICERS OF NJ ACUTE CARE INSTITUTIONS SERVING ON BOARD OF
         DIRECTORS

         The  following  directors of the Company are  executive  officers of NJ
Acute Care  Institutions  which have  purchased,  either  directly or through an
affiliate,  shares of Common  Stock;  Sister Jane Frances  Brady,  President and
Chief  Executive  Officer of St.  Joseph's  Hospital  and  Medical  Center;  Mr.
Christopher Dadlez, Executive Vice President of Saint Barnabas Health Care

                                      -53-


<PAGE>


System,  which includes Clara Maass Medical Center,  Irvington General Hospital,
Monmouth  Medical  Center,  Newark Beth Israel  Medical  Center,  Saint Barnabas
Medical Center, Union Hospital, Wayne General Hospital and West Hudson Hospital;
Mr. John J.  Gantner,  Senior Vice  President  of Finance and  Treasurer  of the
Robert Wood Johnson University Hospital;  and Mr. Laurence M. Merlis,  Executive
Vice President of the Meridian Health System,  which includes  Riverview Medical
Center,  Jersey Shore Medical Center and the Medical Center of Ocean County. See
"Current  Directors of the  Registrant." In addition,  a large percentage of the
revenues  of  FOHP-NJ is  generated  from NJ Acute  Care  Institutions  who have
enrolled   employees  in  FOHP-NJ  plans  as  required  by  the  Certificate  of
Incorporation of the Company.

      GUARANTIES AND LETTERS OF CREDIT

      In March 1996, Mr. William  Roberts,  former  Chairman of the Board of the
Company, secured from Chase Manhattan Bank (formerly Chemical Bank) a $3,000,000
letter of credit (the "Chase  Manhattan  Letter of Credit") which could be drawn
upon by the Company in the event the Company was required to contribute  capital
to FOHP-NJ so that FOHP-NJ  remained in compliance  with the statutory net worth
and other  capital  requirements  applicable  to it. The Company paid $48,500 in
bank  fees  in   connection   with  the  Chase   Manhattan   Letter  of  Credit.
Contemporaneously with the issuance of the Chase Manhattan Letter of Credit, the
Company and Mr. Roberts entered into a reimbursement agreement pursuant to which
Mr.  Roberts  would be reimbursed by the Company for any amounts he was required
to pay  Chase  Manhattan  Bank in  connection  with any draw  against  the Chase
Manhattan Letter of Credit by the Company.  Under the terms of the reimbursement
agreement between Mr. Roberts and the Company, the Company paid to Mr. Roberts a
fee of $10,000 per month  through  May,  1996 and  $20,000 per month  thereafter
until April 1997.

      The Chase  Manhattan  Letter of Credit  was to expire on  January 2, 1997.
However,  in December  1996, the Chase  Manhattan  Letter of Credit was extended
until March 31, 1997.  In connection  with the extension of the Chase  Manhattan
Letter of Credit,  the  Company  paid $8,550 in bank fees.  The Chase  Manhattan
Letter of Credit was later  extended until April 30, 1997, for which the Company
paid Chase  Manhattan  Bank $4,000 in bank fees. The Chase  Manhattan  Letter of
Credit expired on April 30, 1997 without being drawn upon by the Company.

      On March 29, 1996,  certain NJ  Practitioners,  each a shareholder  of the
Company, secured from Carnegie Bank a $3,475,000 letter of credit (the "Carnegie
Letter of  Credit")  which  could be drawn upon by the  Company in the event the
Company was required to contribute  capital to FOHP-NJ so that FOHP-NJ  remained
in  compliance  with the  statutory  net worth and  other  capital  requirements
applicable to it. The NJ Practitioners who secured the Carnegie Letter of Credit
are: Dr. Chris Anayiotos,  Dr. Tun Chu, Dr. Miguel Damien,  Dr. Shirley Hoh, Dr.
Renny Lin, Dr. Carl Raso, Dr. Donato  Santangelo,  III, Dr.  Mohammad A. Sarraf,
Dr. Mohammed Shafi, Dr. Kishori P. Shah, Dr. Gary Siemons,  Dr. John Sutherland,
Dr. Kock-Yen Tsang, Dr. Lewis Wetstein, Dr. Renato Ynaya and Dr. Henry Yu.

                                      -54-


<PAGE>


         The Company paid $52,125 in bank fees in  connection  with the Carnegie
Letter of Credit.  Contemporaneously with the issuance of the Carnegie Letter of
Credit, the Company entered into a separate reimbursement agreement with each NJ
Practitioner who secured the Carnegie Letter of Credit, pursuant to which the NJ
Practitioner  would be  reimbursed  by the Company for any amounts he or she was
required to pay Carnegie Bank in  connection  with any draw against the Carnegie
Letter  of  Credit  by  the  Company.  Under  the  terms  of  the  reimbursement
agreements,  the Company paid to the NJ  Practitioners  who secured the Carnegie
Letter of Credit an aggregate fee of $173,750 or 2.5% of the aggregate amount of
the guaranties  furnished by the NJ  Practitioners to secure the Carnegie Letter
of Credit.

         The  Carnegie  Letter of  Credit  was to expire  on  January  1,  1997.
However,  in December  1996,  the Carnegie  Letter of Credit was extended  until
March 31, 1997.  In  connection  with the  extension  of the Carnegie  Letter of
Credit,  the  Company  paid  $14,681  in  bank  fees  and  an  aggregate  fee of
approximately $43,000 to the NJ Practitioners who secured the Carnegie Letter of
Credit.  The Carnegie Letter of Credit was later extended to April 30, 1997, for
which  the  Company  paid  $20,000  in  bank  fees  and  an  aggregate   fee  of
approximately $43,438 to the NJ Practitioners who secured the Carnegie Letter of
Credit.  The Carnegie  Letter of Credit  expired on April 30, 1997 without being
drawn upon by the Company.

         In March and April 1996, Dr. Randall  Krakauer,  a former member of the
Board of  Directors  of FOHP-NJ  and  shareholder  of the  Company,  and John L.
Adessa,  a former  President and Chief  Executive  Officer of the Company,  each
secured  from  CoreStates  Bank a  separate  letter of credit  (the  "CoreStates
Letters of  Credit")  which  could be drawn upon by the Company in the event the
Company was required to contribute  capital to FOHP-NJ so that FOHP-NJ  remained
in  compliance  with the  statutory  net worth and  other  capital  requirements
applicable  to it.  Dr.  Krakauer  secured a  $300,000  letter of credit and Mr.
Adessa secured a $323,000 letter of credit. The Company paid $7,199 in bank fees
in  connection  with the  CoreStates  Letters of Credit.  As  consideration  for
securing a letter of credit, the Company paid Dr. Krakauer $7,500 and Mr. Adessa
$8,075,  or  2.5%  of the  amount  of the  letter  of  credit  secured  by  each
individual.

         In September  1996,  the amount of the letter of credit  secured by Mr.
Adessa from  CoreStates  Bank was reduced  from  $323,000  to  $100,000,  and on
January 1, 1997, the remaining amount of the letter of credit expired.

         The letter of credit  secured by Dr.  Krakauer was to expire on January
1, 1997. However, in December 1996, the letter of credit secured by Dr. Krakauer
was  extended  until March 31, 1997.  In  connection  with the  extension of the
letter of credit,  the Company paid approximately $800 in bank fees and a fee of
$1,875 to Dr.  Krakauer.  The letter of credit secured by Dr. Krakauer was later
extended until April 30, 1997, for which Dr. Krakauer was paid a fee of $650 and
CoreStates Bank was paid bank fees of approximately $1,000. The letter of credit
expired on April 30, 1997 without being drawn upon by the Company.

                                      -55-


<PAGE>


         In March and April 1996, certain NJ Acute Care Institutions and certain
affiliates of NJ Acute Care  Institutions  executed  guaranties on behalf of the
Company and in favor of FOHP-NJ  which  guaranteed  the payment of the Company's
capital  obligation to FOHP-NJ.  The name of each NJ Acute Care  Institution and
affiliate of a NJ Acute Care Institution  which guaranteed the Company's capital
obligation  to  FOHP-NJ  and the  amount  guaranteed  by each such  entity is as
follows:  Community-Kimball  Health Care Systems,  Inc. (an affiliate of Kimball
Medical  Center  and  Community  Medical  Center)  -  $250,000;  Saint  Barnabas
Corporation (an affiliate of Saint Barnabas Medical Center) - $250,000; Monmouth
Medical  Center -  $250,000;  Barnert  Hospital - $100,000;  Bayshore  Community
Hospital - $100,000;  Burdette  Tomlin  Memorial  Hospital -  $100,000;  Chilton
Memorial  Hospital - $100,000;  C.H.  Management  Corp.  (an affiliate of Christ
Hospital) - $250,000;  Comprehensive  Health & Education  Corp. (an affiliate of
Muhlenberg  Regional Medical Center) - $250,000;  JFK Medical Center - $250,000;
Memorial  Health  Alliance  (an  affiliate  of Memorial  Hospital of  Burlington
County) - $250,000; Mercer Medical Center - $100,000; Newton Memorial Hospital -
$100,000;  Our Lady of Lourdes Health Care  Services,  Inc. (an affiliate of Our
Lady of Lourdes Hospital) - $100,000; Beth Israel Hospital (Passaic) - $100,000;
The Valley  Hospital - $250,000;  Riverview  Health  Affiliates (an affiliate of
Riverview  Medical  Center) -  $250,000;  West Hudson  Hospital - $100,000;  St.
Joseph's Hospital and Medical Center - $250,000;  Morristown Memorial Hospital -
$250,000;  Elizabeth  General  Health  Services Corp. (an affiliate of Elizabeth
General Medical Center) - $100,000;  Englewood  Healthcare Ent. (an affiliate of
Englewood Hospital and Medical Center) - $250,000;  MidJersey Health Corporation
(an affiliate of Hunterdon  Medical Center) - $100,000;  and Robert Wood Johnson
University Hospital - $250,000.

         In addition,  in July and August,  1996, Holy Name Hospital  guaranteed
$150,000 of the Company's capital obligation to FOHP-NJ, and The Valley Hospital
and West Hudson  Hospital  guaranteed an additional  $50,000 and $25,000 of such
obligation, respectively.

         Each  guarantor's  liability  under its  institutional  guaranty was to
expire on  January  1, 1997.  However,  in  December  1996,  each  institutional
guaranty was extended until March 31, 1997. In connection  with the extension of
the institutional  guaranties,  the Company paid $100 to each guarantor. Most of
the institutional guaranties were extended to April 30, 1997. By April 30, 1997,
all the  institutional  guaranties had expired without liability to any NJ Acute
Care Institution.

                                      -56-


<PAGE>


                                     PART IV

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

(a)      1. and 2.         FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
                           SCHEDULES.

         Reference is made to the Index of Financial
         Statements hereinafter contained.........................F-1

         Other than the  Financial  Data  Schedule  included  as Exhibit  27, no
         Financial  Statement  Schedules are required to, nor will any, be filed
         with this Annual Report on Form 10-K.

         3.  EXHIBITS

         Reference is made to the Index of Exhibits
         hereinafter contained....................................E-1

(b)      REPORTS ON FORM 8-K

         During the fourth quarter ended  December 31, 1997, no Current  Reports
         on Form 8-K were filed by the Company with the Commission.



                                      -57-


<PAGE>



                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                         FOHP, INC.
                                                         ----------
                                                         (Registrant)

Date: March 30, 1998                                 By: /S/ Roger W. Birnbaum
                                                        ----------------------
                                                   Roger W. Birnbaum, President
                                                    and Chief Executive Officer

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities and on the date indicated.

      SIGNATURE                         TITLE                     DATE
      ---------                         -----                     -----
/s/ Roger W. Birnbaum             President and Chief          March 30, 1998
---------------------             Executive Officer
Roger W. Birnbaum                 (Principal Executive
                                  Officer)

/s/ Marc M. Stein                 Chief Financial Officer      March 30, 1998
---------------------             (Principal Financial and
Marc M. Stein                     Accounting Officer)

/s/ Mark L. Engel                 Chairman of the Board        March 30, 1998
---------------------
Dr. Mark L. Engel

/s/ John F. Bonamo
---------------------             Director                     March 30, 1998
Dr. John F. Bonamo

/s/ Sister Jane Frances Brady     Director                     March 30, 1998
-----------------------------
Sister Jane Frances Brady




                                      -58-


<PAGE>




      SIGNATURE                   TITLE                DATE
      --------                    -----                ----
/s/ Bruce G. Coe                 Director         March 30, 1998
--------------------
Bruce G. Coe

/s/ Christopher M. Dadlez        Director         March 30, 1998
-------------------------
Christopher M. Dadlez

/s/ Thomas J. Feneran            Director         March 30, 1998
-------------------------
Dr. Thomas J. Feneran


/s/ John J. Gantner              Director         March 30, 1998
---------------------
John J. Gantner

/s/ Jay M. Gellert               Director         March 30, 1998
---------------------
Jay M. Gellert

/s/ Laurence M. Merlis           Director         March 30, 1998
----------------------
Laurence M. Merlis

/s/ Robert L. Natt               Director         March 30, 1998
---------------------
Robert L. Natt

/s/ Om P. Sawhney                Director         March 30, 1998
---------------------
Dr. Om P. Sawhney

/s/ Thomas W. Wilfong            Director         March 30, 1998
---------------------
Thomas W. Wilfong

                                      -59-


<PAGE>

                        Consolidated Financial Statements


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

                                December 31, 1997



                                    CONTENTS



Report of Independent Auditors..............................................F-2
Consolidated Balance Sheets.................................................F-3
Consolidated Statements of Operations.......................................F-4
Consolidated Statements of Shareholders' (Deficiency) Equity................F-5
Consolidated Statements of Cash Flows.......................................F-6
Notes to Consolidated Financial Statements..................................F-7




                                      F-1
<PAGE>


                         Report of Independent Auditors


The Board of Directors
FOHP, Inc.

We have audited the accompanying  consolidated balance sheets of FOHP, Inc. (the
"Company")  and  subsidiaries  as of December 31, 1997 and 1996, and the related
consolidated  statements of operations,  shareholders'  (deficiency)  equity and
cash flows for the years ended December 31, 1997, 1996 and 1995. 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 FOHP, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the  consolidated  results of
their  operations  and their cash flows for the years ended  December  31, 1997,
1996 and 1995, in conformity with generally accepted accounting principles.




Iselin, New Jersey                                            Ernst & Young LLP
February 13, 1998




                                      F-2

<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

                           Consolidated Balance Sheets


<TABLE>
<CAPTION>

                                                                                        DECEMBER 31
                                                                                   1997              1996
                                                                            -------------------------------------
<S>                                                                         <C>              <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                 $ 79,266,721     $ 36,664,911
  Accounts receivable from owners/providers, net of allowance
   for doubtful accounts and retroactive terminations of
   $922,354 in 1997 and $1,600,000 in 1996 (NOTE 3)                           11,096,487        8,206,471
  Other accounts receivable, net of allowances for doubtful
   accounts and retroactive terminations of $2,507,619 in 1997
   and $100,000 in 1996 (NOTE 3)                                               3,131,333        3,666,887
  Prepaids and other current assets                                              635,548        1,904,360
                                                                            -----------------------------
Total current assets                                                          94,130,089       50,442,629

Restricted cash (NOTE 2)                                                      13,846,682        1,265,449
Furniture and equipment, net (NOTE 4)                                          2,480,042        1,884,558
Goodwill (NOTE 2)                                                            107,730,254               --
Other assets                                                                     424,164          659,581
                                                                            -----------------------------
                                                                            $218,611,231     $ 54,252,217
                                                                            =============================

LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) EQUITY
Current liabilities:
 Medical claims payable to owners/providers                                 $ 20,308,241     $ 13,775,534
 Other medical claims payable                                                 62,614,704       55,370,457
 Accounts payable and accrued expenses                                        18,251,160        5,163,115
 Due to Foundation Health Systems, Inc. (NOTE 11)                                543,075
 Due to QualMed, Inc. (NOTE 11)                                                1,192,716
 Unearned premium                                                              7,965,658        4,598,662
 Other                                                                             8,054        1,210,516
                                                                            -----------------------------
Total current liabilities                                                    110,883,608       80,118,284

Convertible debentures (NOTE 2)                                               11,294,406
Subordinated debentures (NOTE 5)                                              24,000,000
                                                                            ------------------------------
Total liabilities                                                            146,178,014       80,118,284

Commitments and contingencies (NOTE 10)

Shareholders' (deficiency) equity:
 Preferred Stock, $1.00 par value, 10,000,000 shares authorized,
   none issued or outstanding
 FOHP,  Inc.  Common  Stock,  $.01 par  value,  100,000,000
   shares  authorized, 100,000,000 in 1997 and 2,100,173 in 1996
   issued and outstanding (NOTE 6)                                             1,000,000           21,002
 Additional paid-in capital                                                  208,053,796       30,648,489
 Accumulated deficit                                                        (136,620,579)     (56,535,558)
                                                                            -----------------------------
Total shareholders' (deficiency) equity                                     $ 72,433,217      (25,866,067)
                                                                            =============================
                                                                            $218,611,231       54,252,217
                                                                            =============================
</TABLE>



SEE ACCOMPANYING NOTES.


                                      F-3


<PAGE>




                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

                      Consolidated Statements of Operations



<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31
                                                                  1997              1996               1995
                                                              ---------------------------------------------------
<S>                                                           <C>               <C>          <C>              
Revenue:
   Premiums from owners/providers                             $132,575,894      $135,544,112      $ 63,630,797
   Other premium revenue                                       239,132,416       112,125,670        38,819,206
   Other, principally administrative service fees                2,045,011         7,863,006         7,621,790
   Interest income                                               3,652,910         1,843,520         1,222,246
                                                              ---------------------------------------------------
Total revenue                                                  377,406,231       257,376,308       111,294,039

Expenses:
   Medical services to owners/providers                         63,882,103        37,026,903        17,319,035
   Hospital services to owners/providers                        64,553,166        30,156,890        11,068,909
   Other medical services                                      148,812,233       105,551,393        38,548,819
   Other hospital services                                     101,521,355        63,760,554        24,637,249
   Selling, general and administrative                          55,106,022        50,734,197        32,638,106
   Management fee - QualMed, Inc. (NOTE 11)                      7,502,899
   Depreciation and amortization                                 1,404,192           879,306           674,433
   Interest - Foundation Health Systems, Inc.                    1,790,410
   Other interest                                                   91,163            11,247            90,048
   Restructuring costs (NOTE 12)                                12,825,570
   Write-off of intangible asset (NOTE 7)                                                               986,782
                                                              ---------------------------------------------------
Total expenses                                                 457,489,113       288,120,490        125,963,381
                                                              ---------------------------------------------------
Net loss before provision for state income taxes               (80,082,882)      (30,744,182)       (14,669,342)

Provision for state income taxes (NOTE 8)                            2,139               924             71,603
                                                              ---------------------------------------------------
Net loss                                                      $(80,085,021)     $(30,745,106)      $(14,740,945)
                                                              ===================================================

Net loss per common share                                     $      (9.18)     $     (14.64)     $       (8.65)
                                                              ===================================================

</TABLE>


SEE ACCOMPANYING NOTES.



                                      F-4


<PAGE>




                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

          Consolidated Statements of Shareholders' (Deficiency) Equity

<TABLE>
<CAPTION>
                                                           COMMON STOCK                                                TOTAL
                                                  -------------------------------   ADDITIONAL                     SHAREHOLDERS'
                                                                        PAR          PAID-IN       ACCUMULATED     (DEFICIENCY)
                                                        SHARES          VALUE         CAPITAL         DEFICIT         EQUITY
                                                  ------------------------------------------------------------------------------
<S>                                                    <C>              <C>       <C>              <C>            <C>
Balance at January 1, 1995                             1,060,053    $   10,601     $ 15,341,561    $(11,049,507)   $ 4,302,655
  Reclassification of FOHP-NJ Practitioner
   Provider Common Stock from temporary equity           511,800         5,118        7,671,882                      7,677,000
  Redemption of FOHP-NJ Practitioner Provider
   Common Stock                                             (100)           (1)          (1,499)                        (1,500)
  Conversion of outstanding shares of FOHP-NJ
   Common Stock to FOHP, Inc. Common Stock-NJ:
    FOHP-NJ Institutional Provider                    (1,020,051)      (10,201)                                        (10,201)
    FOHP-NJ Other Provider                               (40,002)         (400)                                           (400)
    FOHP-NJ Practitioner Provider                       (511,700)       (5,117)                                         (5,117)
  FOHP, Inc. Common Stock-NJ issued (at $15 per
   share)                                              2,100,173        21,002        7,931,516                      7,952,518
  Payment of issue costs                                                               (294,971)                      (294,971)
  Net loss                                                                                          (14,740,945)   (14,740,945)
                                                  -------------------------------------------------------------------------------
Balance at December 31, 1995                           2,100,173        21,002       30,648,489     (25,790,452)     4,879,039
  Net loss                                                                                          (30,745,106)   (30,745,106)
                                                  ------------------------------------------------------------------------------
Balance at December 31, 1996                           2,100,173        21,002       30,648,489     (56,535,558)   (25,866,067)
  Redemption of FOHP, Inc. Common Stock-NJ               (13,334)         (133)             133                              -
  Conversion of outstanding shares of FOHP, Inc.
   Common Stock-NJ to Common Stock:
   FOHP, Inc. Common Stock-NJ                         (2,086,839)      (20,869)                                        (20,869)
   Issued Common Stock (at $.01 per share)             2,086,839        20,869                                          20,869
  Issued Common Stock (April 30, 1997 at $10.12
   per share)                                            168,109         1,681        1,699,440                      1,701,121
  Issued Common Stock (December 1, 1997
   at $10.12 per share)                                4,941,049        49,410       49,950,590                     50,000,000
  Issued Common Stock (December 8, 1997
   at $.20 per share)                                 92,804,003       928,040       18,024,890                     18,952,930
  Goodwill (NOTE 2)                                                                $107,730,254                    107,730,254
  Net loss                                                                                          (80,085,021)   (80,085,021)
                                                  ------------------------------------------------------------------------------
Balance at December 31, 1997                         100,000,000    $1,000,000     $208,053,796   $(136,620,579)   $72,433,217
                                                  ==============================================================================

</TABLE>

SEE ACCOMPANYING NOTES.


                                      F-5



<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

                      Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
                                                                                   YEAR ENDED DECEMBER 31
                                                                           1997              1996              1995
                                                                        -------------------------------------------------

<S>                                                                     <C>              <C>               <C>          
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss                                                                $(80,085,021)    $(30,745,106)     $(14,740,945)
Adjustments to reconcile net loss to net cash (used in)
 provided by operating activities:
   Depreciation and amortization                                           1,404,192          879,306           674,433
   Loss from sale of assets                                                   80,966
   Write-off of deferred issuance costs                                    1,132,656
   Write-off of intangible asset                                                                                986,782
   Interest cost converted to debt                                         1,247,337
   Changes in operating assets and liabilities:
     Accounts receivable from owners/providers                            (2,890,016)      (1,865,379)       (4,539,229)
     Other accounts receivable                                               535,554         (414,248)       (2,075,825)
     Prepaid expenses and other current assets                             1,268,812       (1,369,609)          232,524
     Restricted cash                                                     (12,581,233)         (64,648)         (893,610)
     Other assets                                                            235,417         (368,448)          207,136
     Medical claims payable to owners/providers                            6,532,707        5,417,849         6,496,873
     Other medical claims payable                                          7,244,247       36,767,869        14,990,425
     Accounts payable and accrued expenses                                13,088,045          872,013         1,787,571
     Due to Foundation Health Systems, Inc.                                  543,075
     Due to QualMed, Inc.                                                  1,192,716
     Unearned premium revenue                                              3,366,996        4,257,570           216,193
     Other liabilities                                                    (1,202,462)         320,189           890,327
                                                                       --------------------------------------------------
Net cash (used in) provided by operating activities                      (58,886,012)      13,687,358         4,232,655

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of furniture and equipment                                      (1,799,093)        (904,733)       (1,020,993)
Proceeds from sale of equipment                                               27,260
                                                                       --------------------------------------------------
Net cash used in investing activities                                     (1,771,833)        (904,733)       (1,020,993)

CASH FLOWS FROM FINANCING ACTIVITIES
Deferred issuance costs                                                   (1,441,465)
Issuance of convertible debentures                                        80,701,120
Issuance of subordinate debentures                                        24,000,000
Issuance of common stock                                                                                      7,640,329
                                                                        -------------------------------------------------
Net cash provided by financing activities                                103,259,655                -         7,640,329
                                                                        -------------------------------------------------
Increase in cash and cash equivalents                                     42,601,810       12,782,625        10,851,991
Cash and cash equivalents at beginning of year                            36,664,911       23,882,286        13,030,295
                                                                        -------------------------------------------------
Cash and cash equivalents at end of year                                $ 79,266,721     $ 36,664,911       $23,882,286
                                                                        =================================================

SUPPLEMENTAL INFORMATION
Interest paid for the year                                              $     48,319     $      7,488       $   725,123
                                                                        =================================================

Conversion of debentures into common stock                              $ 70,654,051     $          -       $         -
                                                                        =================================================

</TABLE>



SEE ACCOMPANYING NOTES.


                                      F-6


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

                   Notes to Consolidated Financial Statements

                                December 31, 1997


1.  GENERAL

FOHP,  Inc. (the "Company")  serves as the holding company for its  wholly-owned
subsidiaries.  The  Company's  principal  operating  subsidiary  is First Option
Health Plan of New Jersey,  Inc.  (FOHP-NJ).  FOHP-NJ,  a New Jersey corporation
formed in May 1993,  received its Certificate of Authority ("COA") to operate as
a health  maintenance  organization  ("HMO") in New  Jersey in June 1994.  Other
wholly-owned subsidiaries of the Company include First Option Health Plan of New
York,  Inc.  ("FOHP-NY"),  a New York  corporation,  First Option Health Plan of
Pennsylvania,  Inc. ("FOHP-PA"), a Pennsylvania corporation, First Option Health
Plan of Maryland,  Inc.("FOHP-MD"),  a Maryland corporation, First Option Health
Plan of  Delaware,  Inc.("FOHP-DE"),  a Delaware  corporation,  and FOHP Agency,
Inc., a New Jersey  corporation,  each formed in 1995,  and First Option Dental,
Inc.("First  Dental"),  a New Jersey  corporation,  formed in 1996.  These other
subsidiaries  have not  commenced  operations.  The  Board of  Directors  of the
Company recently approved the dissolution of FOHP-NY, FOHP-MD, FOHP-DE and First
Dental.

The  Company  is a New  Jersey  corporation  which was  formed in May 1994.  The
Company was formed to effect the  reorganization  of First Option Health Plan of
New  Jersey,   Inc.   ("FOHP-NJ")   into  a  holding   company   structure  (the
"Reorganization"), which was consummated on June 8, 1995. The Reorganization was
completed through an exchange of FOHP-NJ's  outstanding  common stock for shares
of the Company's Common Stock-NJ. In connection with the Reorganization, FOHP-NJ
distributed, as a dividend, all of the outstanding common stock of First Managed
Care  Option,  Inc.  ("FMCO") to the  Company.  Pursuant to the  Reorganization,
FOHP-NJ and FMCO became wholly-owned  subsidiaries of the Company.  Prior to the
Reorganization,  the Company did not  conduct any  business  nor did it have any
significant assets or liabilities. The primary purpose of the Reorganization was
to facilitate the formation of additional  health  maintenance  organizations in
states other than New Jersey.

Effective   December  8,  1997,   through  the  conversion  of  debentures  (the
"Convertible  Debentures")  to  common  stock,  the  Company  became a 98% owned
subsidiary of Foundation Health Systems, Inc. (Note 2). The Company is dependent
upon the availability of funds, as needed, from Foundation Health Systems,  Inc.
("FHS")  to  provide  sufficient  capital to meet its  operating  and  statutory
financial  requirements.  It is the  intention of FHS to provide such funds,  as
needed.

During  the  summer  of 1996,  as a result  of  FOHP-NJ's  statutory  net  worth
deficiency  discussed  in Note 2 and the  conditions  imposed  by the New Jersey
Departments  of Banking  and  Insurance  and Health  and  Senior  Services  (the
"Departments"), the Board of Directors of the Company discontinued the Company's
expansion efforts in states other


                                      F-7


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)




1.  GENERAL (CONTINUED)

than New  Jersey,  including  expansion  efforts in New York,  Pennsylvania  and
Maryland. The Company currently has no plans to expand into any other state.

The  statement of  operations  and  statement of cash flows for 1996 include the
results of the  wholly-owned  subsidiary,  FMCO,  which was sold on December 31,
1996. On a consolidated  basis,  the revenue and operating  results of FMCO were
not a significant part of the Company's revenue and operating results (Note 7).

Health  care  providers  investing  in the  Company  are  required to enter into
provider agreements (the "Provider  Agreements") with the Company.  The Provider
Agreements  have an initial term of one year and are  renewable  annually.  Such
agreements with acute care  institutions and certain other health care providers
may be terminated either by mutual consent of both parties or, after the initial
one year term,  by either party upon 90 days  written  notice;  agreements  with
physicians  may be  terminated  by either  party  upon 60 days  written  notice.
Provider  agreements also may be terminated for breaches specified therein.  The
Provider Agreements, among other things, establish covered services, billing and
payment procedures, and reimbursement methods.

2.  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The Company has incurred a 1997  consolidated net loss of $80,085,021 and has an
accumulated  deficit of  $136,620,579  at December  31,  1997.  In order for the
Company's principal operating  subsidiary FOHP-NJ to meet its 1997 statutory net
worth requirements  pursuant to its COA granted by the Departments,  the Company
must generate  sufficient  operating  profits  and/or obtain one or more capital
infusions.

In an effort to increase capital,  FOHP-NJ effected several  operational changes
in 1996. The operational changes made by FOHP-NJ included (a) the implementation
of a modified provider reimbursement schedule which became effective on April 1,
1996, for purposes of reducing medical costs, (b) the implementation of a hiring
freeze and  suspension of bonus  payments and the use of consultants in order to
control FOHP-NJ's  administrative  costs, (c) the implementation of a program to
generate   increased   operating   profits  by  requiring   certain  acute  care
shareholders  which  had not  met  their  enrollment  commitments  to meet  such
commitments in order to remain  shareholders of the Company and providers in the
FOHP-NJ  network,  and (d) the  discontinuation  of expansion  efforts in states
other than New Jersey. In connection with FOHP-NJ's plan to remedy the statutory
net worth  deficiency,  in October  1996 the Board of  Directors  of the Company
initially approved a $30 million investment by FHS, a Delaware corporation


                                      F-8


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)



2.  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

formerly  known as Health  Systems  International,  Inc.,  into the Company.  At
closing,  FHS was to purchase $30 million of debentures  convertible into 40% of
the  Company's  outstanding  equity  and FHS would  have  received  an option to
acquire another 11% ownership.  After closing,  FHS would have been obligated to
either acquire up to an additional 20% of the outstanding equity of the Company,
or require the  Company to have  repurchased  that  amount  with FHS  financing.
However,  due to a significant  increase in medical claims  expenses  during the
fourth  quarter of 1996 as a result of more  complete  claim  payment  data,  in
January  1997 FHS  exercised  its  right to  re-negotiate  certain  terms of the
original Securities Purchase Agreement among FHS, the Company and FOHP-NJ. Under
the  terms of the  renegotiated  Securities  Purchase  Agreement  (the  "Amended
Securities  Purchase  Agreement"),  FHS  invested  $51,701,121  into the Company
through the  purchase  of a  Convertible  Debenture  (the  "Initial  Convertible
Debenture") convertible into 71% of the Company's outstanding equity, on a fully
diluted  basis.  At the  closing  of the  purchase  of the  Initial  Convertible
Debenture,  which  occurred on April 30, 1997,  FHS converted  $1,701,121 of the
principal amount of the Initial Convertible Debenture into 168,109 shares of the
Company's  Common  Stock.  On  December 1, 1997,  FHS  converted  the  remaining
$50,000,000  of the principal  into  4,941,049  shares of the  Company's  Common
Stock.  On December 8, 1997, due to the continued  operating  losses of FOHP-NJ,
FHS  invested an  additional  $29,000,000  into the  Company in  exchange  for a
Convertible  Debenture (the "New  Convertible  Debenture") in form and substance
substantially  similar to the  Initial  Convertible  Debenture  issued to FHS on
April 30, 1997. Immediately upon receipt of the New Convertible  Debenture,  FHS
converted  $18,952,930 of the principal amount thereof into 92,804,003 shares of
the Company's  Common Stock.  The price per share paid by FHS upon conversion of
the  Convertible  Debentures  is  calculated  in  accordance  with  the  Amended
Securities Purchase Agreement.  The Convertible  Debentures accrue interest at a
variable rate adjusted on a calendar  quarterly basis.  Such interest is due and
payable  within  ten  days  after  the end of each  calendar  quarter.  Any such
interest  not paid when due and payable is  considered  defaulted  interest  and
shall  be  added to the  principal  amount  of the  Convertible  Debentures.  At
December 31, 1997, $1,247,337 of defaulted interest is included in the principal
amount of the Convertible Debentures.


In connection with the purchase by FHS of the Company's Common Stock through the
conversion of Convertible  Debentures,  goodwill totalling $107,730,254 has been
recorded to reflect the excess of FHS's purchase price over the approximate fair
value of the net assets acquired.  The acquisition was treated as a purchase for
accounting  purposes.  Allocation of purchase price is subject to valuations and
other  studies which are not yet  complete.  However,  management of the Company
does not believe such  differences will have a material impact on the results of
operations  and  shareholders'  equity.  The  goodwill  will be  amortized  on a
straight line basis not exceeding  forty years.  Amortization  for the one month
period ended  December  31,  1997,  which  approximated  $368,000,  has not been
reflected in the Statement of Operations as it has been deemed immaterial to the
Company's operations.

As of December 31, 1997, FHS also  contributed an additional  $24,000,000 to the
Company  to satisfy  certain  statutory  net worth  requirements  applicable  to
FOHP-NJ in return for  additional  subordinated  debentures  (the  "Subordinated
Debentures")  which are not  convertible  into the Company's  Common Stock,  but
otherwise have substantially the same terms as the Convertible Debentures.


                                      F-9


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)


2.  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The following are significant accounting policies of the Company:

   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.

   PRINCIPLES OF CONSOLIDATION

   The consolidated financial statements include the accounts of the Company and
   its  wholly-owned  subsidiaries.  All significant  intercompany  balances and
   transactions have been eliminated in consolidation.

   CASH AND CASH EQUIVALENTS

   Cash and cash equivalents  include money market funds and U.S. Treasury Bills
   with original maturities of three months or less when purchased.  Fair market
   values,  as determined  through quoted market prices, of the cash equivalents
   approximate  carrying value.  Cash and cash  equivalents at December 31, 1997
   were on deposit with two commercial banks.

   ACCOUNTS RECEIVABLE

   Accounts  receivable  are  reported  at  estimated  net  realizable  value by
   including provisions for retroactive terminations and uncollectible amounts.

   RESTRICTED CASH

   At December 31, 1997, FOHP-NJ was required to maintain $49,384,483 on deposit
   with the New Jersey  Department of Banking and Insurance  (the "DOI") to meet
   its "Minimum Insolvency Deposit for Healthcare Expenditures" (the "Insolvency
   Deposit")  under current  insurance  regulation.  The  Insolvency  Deposit is
   calculated  based on the current  financial  statements and is required to be
   funded by June 30, 1998. As of December 31, 1997,  FOHP-NJ had $12,510,878 on
   deposit with the DOI. FOHP-NJ has obtained  approval from the DOI to fund the
   remaining   Insolvency  Deposit  quarterly  through  December  31,  1998.  In
   addition,  FOHP-NJ is required to maintain  $1,200,000  cash reserve with the
   Health Care Financing Administration  ("HCFA")for its federal programs. As of
   December  31,  1997,  FOHP-NJ  had  $1,335,804  on  deposit  for its  federal
   programs.

                                      F-10
      
<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)



2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FURNITURE AND EQUIPMENT
  
Furniture and equipment are recorded at cost.  Depreciation is calculated on the
straight-line  method over the useful  lives of the  depreciable  assets (3 to 5
years).

PREMIUM REVENUE

Subscriber  contracts for commercial managed care products are on a yearly basis
subject to  cancellation  by the  employer  group upon 30 days  written  notice.
Premium  revenue is  recorded as revenue in the month in which  subscribers  are
entitled  to service.  Premiums  collected  in advance are  reported as unearned
premium revenue.

Certain premium revenue is earned under a contract between FOHP-NJ and the State
of New Jersey Department of Human Services,  Division of Medical  Assistance and
Health Services  ("NJDHS-DMAHS").  The contract with  NJDHS-DMAHS had an initial
term of 18 months and may be renewed for successive one year terms. The contract
can be suspended  (by  NJDHS-DMAHS)  or  terminated  (by either  party) upon the
occurrence of certain events. Premiums are earned monthly on a per capita basis,
based on the  number of  eligible  members  enrolled  in  FOHP-NJ.  Members  may
disenroll  at  any  time  other  than  months  2  through  6 of  membership  and
eligibility is determined by NJDHS-DMAHS.

Certain premium revenue is earned under a contract  between FOHP-NJ and HCFA for
services provided to Medicare eligible recipients. The contract with HCFA had an
initial  term of 12 months and may be renewed  for  successive  one year  terms.
Premiums  are  earned  monthly  on a per  capita  basis,  based on the number of
eligible members enrolled in FOHP-NJ health plans.

OTHER REVENUE

Other  revenue  consists  principally  of fees for  administrative  service only
contracts which are recognized as income as services are rendered.

MEDICAL AND HOSPITAL SERVICE EXPENSES

Medical and hospital service expenses are accrued in the period the services are
provided to enrollees,  based in part on estimates for hospital and other health
care services which have been incurred but not reported ("IBNR"). Such estimates
are

                                      F-11

<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)




2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

continually  monitored  and reviewed and, as  settlements  are made or estimates
adjusted,  the  resulting  differences  are  reflected in the current  period of
operations.
 
FOHP-NJ's arrangements for commercial products with hospitals are primarily on a
per diem reimbursement basis and with physicians on a discounted fee for service
basis.

Under the contract  with the  NJDHS-DMAHS  for  Medicaid and HCFA for  Medicare,
providers  are  reimbursed  for health care  services  provided to Medicaid  and
Medicare  eligible  members  on a per  member,  per month  capitation  basis for
primary care services, fee for service basis for specialty services and per diem
arrangement for inpatient services.  For 1996, payments to providers are subject
to a withhold of up to 15% of the reimbursement rate for Medicaid claims and 10%
for Medicare claims. The Medicaid  withholds are segregated into  geographically
designated  risk pools.  Payments from the risk pools are settled  annually with
the  participating  providers based on annual incurred costs. At settlement,  if
there is a surplus in any of the risk pools,  such surplus is first used to fund
deficits  in other  risk  pools,  after  which  any  remaining  surplus  will be
distributed  among all providers.  The Medicare  withhold program is a statewide
program with one risk pool which covers  anticipated  health care  expenses.  At
settlement,  if there is a  surplus  of funds,  FOHP-NJ  will  retain  10% for a
contingency  reserve  pool that will be  available  to offset  any  future  year
losses,  with the remaining surplus funds being distributed among the providers.
If a deficit  fund  exists,  the  withholds  will be applied to the deficit with
FOHP-NJ  assuming  the  responsibility  for  the  remaining  deficit.  Estimated
surpluses  associated  with these  contracts  are  included  in  medical  claims
payable. During 1997, Medicare and Medicaid withhold programs were terminated.

FOHP-NJ also contracts  with another party for the  arrangement of mental health
services  provided  to  enrollees  in its health  plans.  FOHP-NJ  pays for such
services on a capitated  basis.  If the costs of such services are less than the
capitation payments,  the amount of any savings is shared equally by FOHP-NJ and
the servicer.  If costs are greater than the capitation payments,  any shortfall
must be funded equally by FOHP-NJ and the servicer.

Also included in medical claims payable is a premium  deficiency accrual related
to FOHP-NJ's Medicare product.


                                      F-12


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)





2.  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

ADVERTISING COSTS

Advertising  costs are charged to operations  when the  advertising  first takes
place and approximated $1,131,000, $2,154,000 and $1,692,000 for the years 1997,
1996 and 1995, respectively.

INCOME TAXES

The Company  provides for income taxes based on income  recognized for financial
statement purposes. The Company recognizes a deferred tax asset or liability for
the  expected  future tax  effects  attributable  to the  temporary  differences
between  the tax and  financial  statement  bases  of  assets  and  liabilities.
Deferred tax assets and liabilities are adjusted to reflect changes in tax rates
or other  provisions of  applicable  federal and state tax laws in the period in
which such changes are enacted.  Deferred tax assets are recognized unless it is
more likely than not that some  portion or all of the  deferred  tax assets will
not be recovered.

PER SHARE DATA

Per share data are based on the weighted average number of shares of all classes
of common stock outstanding  during the period (8,724,799 in 1997,  2,100,173 in
1996 and 1,703,908 in 1995).

In December 1997, FHS converted Convertible Debentures into the Company's Common
Stock.  If the conversion  had been effective  January 1, 1997, the net loss per
common share would have been $0.80.

RECLASSIFICATION

Certain  reclassifications  have  been  made  to the  1996  and  1995  financial
statements to conform with the current year presentation.



                                      F-13

<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)





3.  ACCOUNTS RECEIVABLE

The  following  is the  activity of the  allowances  for  doubtful  accounts and
retroactive terminations:

                                                    ACCOUNTS
                                                RECEIVABLE FROM
                                                    OWNERS/       OTHER ACCOUNTS
                                                   PROVIDERS        RECEIVABLE
                                                --------------------------------

Balance, January 1, 1995                                            $   100,300
   Provision for bad debts                                              232,604
   Provision for retroactive terminations                               442,256
   Write-offs                                                           (98,945)
                                                                ----------------
Balance, December 31, 1995                                              676,215
   Provision for bad debts                                              431,849
   Provision for retroactive terminations            $1,600,000         349,579
   Write-offs                                                        (1,357,643)
                                                --------------------------------
Balance, December 31, 1996                            1,600,000         100,000
   Provision for bad debts                               32,316         475,775
   Provision for retroactive terminations                             2,283,905
   Write-offs                                          (709,962)       (352,061)
                                                --------------------------------
Balance, December 31,1997                            $  922,354     $ 2,507,619
                                                ================================

4.  FURNITURE AND EQUIPMENT

Furniture and equipment consists of
 the following:

                                                      1997             1996
                                              ----------------------------------

Leasehold improvements                             $  247,640      $   258,381
Furniture and fixtures                                767,401          806,518
Equipment                                           3,740,779        2,090,020
Automobiles                                            74,096           68,113
                                              ----------------------------------
                                                    4,829,916        3,223,032
Less accumulated depreciation                      (2,349,874)      (1,338,474)
                                              ----------------------------------
                                                   $2,480,042      $ 1,884,558
                                              ==================================

Depreciation  expense was  $1,095,383,  $879,306 and $563,769 for 1997, 1996 and
1995, respectively.



                                      F-14


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)





5.  SUBORDINATED DEBT

In accordance  with the terms of the  Convertible  Debentures  and  Subordinated
Debentures,  repayment of principal  and interest  will occur only from free and
divisible  surplus as  reflected  in the  audited  financial  statements  of the
Company and with written  approval of the  Commissioner of the DOI. In the event
of dissolution or liquidation of the Company, no repayment on these notes can be
made unless and until all other liabilities of the Company have been satisfied.

The Convertible Debentures and Subordinated Debentures are due December 31, 2002
and accrue interest at a rate determined  quarterly based on the rate charged to
FHS under its credit facility  (5.85% as of December 31, 1997).  Interest is due
and payable within ten days after the end of each quarter,  subject to the terms
noted above.

6.  COMMON STOCK

In March 1997, the Company  redeemed 13,334 shares of Common Stock-NJ at no cost
from a New  Jersey  acute  care  institution  which  had not  complied  with the
enrollment provisions of the Company's  Certificate of Incorporation  applicable
to it.

In  connection  with the April 30, 1997  investment by FHS, the  Certificate  of
Incorporation of the Company was amended to, among other things,  reclassify the
Company's  capital stock.  As a result,  the Company  currently has  110,000,000
shares of authorized  capital stock, which is comprised of 100,000,000 shares of
Common  Stock,  par value $.01 per share,  and  10,000,000  shares of  Preferred
Stock, par value $1.00 per share. In connection with the reclassification of the
Company's capital stock, each outstanding share of Common Stock-NJ was converted
into one share of Common  Stock.  As a result,  all  2,086,839  shares of Common
Stock-NJ  outstanding at the time of the Company's  Certificate of Incorporation
was  amended,  were  converted  into Common  Stock.  Prior to the April 30, 1997
investment  by FHS,  the  authorized  capital  stock of the Company  totaled 100
million shares and was comprised of the following  classes of Common Stock, $.01
par value: Common Stock-NJ,  Common Stock-NY,  Common Stock-PA,  Common Stock-DE
and Unclassified  Common Stock. During 1995, the Company issued 2,100,173 shares
of Common  Stock-NJ.  There were no additional  shares of Common Stock-NJ issued
during 1996.

The Certificate of Incorporation and By-Laws of the Company include  significant
restrictions  on the  issuance  and  transfer  of shares of  Common  Stock.  The
Certificate of  Incorporation  of the Company  provides that only FHS and health
care


                                      F-15


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)






6.  COMMON STOCK (CONTINUED)

providers who enter into and maintain a provider  agreement with a subsidiary of
the Company may purchase Common Stock.  Acute care institutions which enter into
a provider  agreement  with a subsidiary  of the Company may purchase  shares of
Common Stock directly or through an affiliate.

The Company may, but is not obligated to, repurchase shares of Common Stock from
any shareholder whose provider  agreement  terminates for any reason or upon the
occurrence  of certain  events,  as described in the  Company's  Certificate  of
Incorporation.  The  determination of the repurchase price of the shares is also
described in the Company's Certificate of Incorporation.

7.  FMCO

In August  1995,  FOHP-NJ  and the  sellers  of FMCO (the  "Sellers")  agreed to
terminate their existing  relationships and entered into a Settlement  Agreement
and General Release (the  "Settlement  Agreement").  Pursuant to this Settlement
Agreement,   the  consulting  agreements  between  the  Sellers  and  FMCO  were
terminated  and,  in  connection  therewith,  the  Sellers  were  paid,  in  the
aggregate,  $218,000  which is included in the Holding  Company's  1995 selling,
general and administrative expenses.

In December 1995,  management determined that due to the recent loss of business
volume  from  certain  FMCO  customers  and  because  of current  and  projected
operating losses of FMCO, the  recoverability of this intangible asset could not
be assured.  Accordingly,  the net carrying value of $986,782 was written-off in
1995.

In December 1996, the Company sold all of the  outstanding  common stock of FMCO
to an unrelated third party for $250,000,  plus, subject to certain limitations,
a percentage of  collections  on accounts  receivable  that were greater than 90
days old as of September 30, 1996 collected  after November 1, 1996. As a result
of the  transaction,  the  Company  recorded a loss of  approximately  $145,000.
Revenues and operating results of FMCO were not significant in 1996.

8.  INCOME TAXES

The Company and its subsidiaries file a consolidated  federal income tax return.
No federal income taxes have been provided for or paid since the Company and its
subsidiaries have incurred  operating losses and income tax reporting  purposes.
For state  purposes,  each entity files  separately.  At December 31, 1997,  net
operating loss ("NOL")

                                      F-16


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)


8.  INCOME TAXES (CONTINUED)

carryforwards  for federal and state income tax reporting  purposes  approximate
$105,200,000  subject to the limitation  discussed  below.  These losses will be
available to offset future  taxable  income.  Such NOL's expire through 2012 for
federal purposes and between 2000 and 2012 for state tax purposes.

Internal  Revenue  Code  Section  382 limits the  potential  utilization  of net
operating  loss  carryforwards  in  periods  following  a  corporate  "ownership
change".  In general,  for federal income tax purposes,  an ownership  change is
deemed to occur if the percentage of stock of a loss corporation owned by one or
more "5%  shareholders" has increased by more than 50 percentage points over the
lowest  percentage of such stock owned during a three year testing period.  As a
result of FHS's investment in the Company during 1997, a change in ownership has
occurred  and the  Company's  ability to utilize its NOL  carryforwards  will be
significantly limited.

The tax effects of temporary  differences  that give rise to deferred tax assets
are as follows:

                                                 DECEMBER 31
                                             1997             1996
                                          -------------------------------

Capitalization of start-up costs and 
  organization costs                      $     603,000    $   2,987,000
Net operating loss carryforwards             42,990,000       15,039,000
Reserve discounting                             877,000          738,000
Allowances for doubtful accounts and 
  retroactive terminations                    1,200,000          595,000
Other                                         2,287,000          726,000
Restructuring costs                           3,832,000
                                          -------------------------------
Total deferred tax assets                    51,789,000       20,085,000

Valuation allowance for deferred
   tax assets                               (51,789,000)     (20,085,000)
                                          -------------------------------
Net deferred tax assets                   $           -    $           -
                                          ===============================

The  valuation  allowance  has  been  recorded  due  to the  uncertainty  of the
realization  of the  deferred tax asset since the  realization  of such asset is
dependent on future operating profits of the Company.



                                      F-17

<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)






8.  INCOME TAXES (CONTINUED)

The effective  income tax rate for 1997, 1996 and 1995 varied from the statutory
federal income tax rate as follows:

                                             1997     1996      1995
                                           -----------------------------

Statutory federal income tax rate              35%     35%       35%
State income taxes                              6       6         6
                                           -----------------------------
Subtotal                                       41      41        41

Valuation allowance                           (41)    (41)      (41)
                                           -----------------------------
Effective income tax rate                       -%      -%        -%
                                           =============================

9.  DEFINED CONTRIBUTION PLAN

The  Company   maintains  a  defined   contribution   (401[k])   plan   covering
substantially all of its employees.  Employees may contribute to the plans after
completing  certain  service  requirements.  The Company matches 50% of employee
contributions  not to exceed (i) limits  established  under  Section  415 of the
Internal  Revenue  Code or (ii) the lesser of 25% of  compensation  or  $30,000.
Total plan expense for 1997,  1996 and 1995  amounted to $403,000,  $406,000 and
$197,000, respectively.

10.  COMMITMENTS AND CONTINGENCIES

LEASES

The Company  leases office space under  noncancelable  lease  arrangements.  The
leases are for terms of 5 years and generally  provide for renewal options of up
to 5  additional  years.  Total  rent  expense  for  1997,  1996  and  1995  was
approximately $1,403,000, $1,796,000 and $927,000, respectively.

The following is a schedule of minimum  future  payments on long-term  operating
leases at December 31, 1997:

               1998                            $1,868,334
               1999                               702,844
               2000                               298,742
               2001                               167,978
               2002                                44,602
                                               ----------
                                               $3,082,500
                                               ==========




                                      F-18

<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)






10.  COMMITMENTS AND CONTINGENCIES (CONTINUED)

SERVICE AGREEMENT

FOHP-NJ  entered into an agreement with a claims  processing  company to provide
recordkeeping  and data  processing  functions  to FOHP-NJ on a fee for services
basis. The agreement expires March 31, 1998.  FOHP-NJ has the right to terminate
this  agreement  without cause upon not less than 180 days prior written  notice
provided  that FOHP-NJ does so by acquiring a license for the system used by the
service  bureau  processor.  The cost for the system  license  is  approximately
$800,000  and is subject  to  reduction  as long as the  Company  continues  the
agreement.

MEDICARE CONSULTING AGREEMENT

In January  1995,  FOHP-NJ  entered  into an agreement  with another  company to
assist FOHP-NJ in obtaining  approval from HCFA to offer health care products to
Medicare  beneficiaries  in New Jersey.  Such  approval was obtained in December
1995.  Fees paid by  FOHP-NJ,  including  specified  bonus  payments,  under the
agreement  totaled  $1,012,604,  $1,621,186 and $392,000 in 1997, 1996 and 1995,
respectively.  In addition,  a variable  percentage  (.5% to 1%) of any Medicare
revenue  generated by FOHP-NJ for a total of eight years after  FOHP-NJ  entered
into a Medicare Risk  Contract  with HCFA will be payable to the other  company.
The minimum  payment for each year,  pursuant to such  variable  percentage,  is
$1,000,000  and the maximum for any such payment is  $3,500,000.  In  connection
with the sale of  Convertible  Debentures  (see Note 2), the  Company has agreed
under  the  terms  of the  Amended  Securities  Purchase  Agreement  with FHS to
negotiate a termination of its agreement with the other company.  The Company is
currently  involved  in  litigation  with  respect  to this  matter.  Management
believes that such  litigation  will not result in a material  adverse effect on
the Company's consolidated financial statements.

REINSURANCE ARRANGEMENTS

The  Company  has  entered  into a  reinsurance  contract to limit its losses on
individual claims. The reinsurance  contract for 1997 provides for reimbursement
of eligible hospital claims per enrollee which exceed $150,000 for all enrollees
within a calendar year up to a maximum  reimbursement per enrollee of $1,000,000
per calendar year and $2,000,000  per lifetime.  The  reinsurance  contracts for
1996 and 1995 were  consistent  with the 1997  contract,  except  the  contracts
provided for  reimbursement of eligible hospital claims which exceed $75,000 for
commercial and Medicaid enrollees and $100,000 for Medicare enrollees.  Per diem
arrangements  with hospitals are also subject to maximum  limits  dependent upon
length of stay,  and claims per enrollee which exceed  certain  deductibles  are
subject to coinsurance provisions.


                                      F-19


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)







10.  COMMITMENTS AND CONTINGENCIES (CONTINUED)

Reinsurance expense, net of recoveries,  was approximately  $4,294,000,  $55,000
and  $695,000  for the years ended  1997,  1996 and 1995,  respectively,  and is
included in medical and hospital services expense.

STATUTORY NET WORTH

Financial  statements issued in accordance with statutory  accounting  practices
differ from financial  statements  issued in accordance with generally  accepted
accounting  principles (GAAP).  Statutory  financial  statements exclude certain
items included in GAAP financial statements.  These "non-admitted" items include
certain assets such as prepaid  expenses,  equipment other than certain computer
equipment,  organizational  costs,  certain loans and receivables,  supplies and
other items.

FOHP-NJ,  pursuant  to its COA to operate an HMO in New  Jersey,  is required to
maintain  a  minimum  statutory  net  worth.  The  minimum  statutory  net worth
requirement  at  December  31,  1997  and  1996  amounted  to  $23,694,000   and
$15,054,000, respectively. In addition, under the terms of its COA, if net worth
is less than 125% of the required minimum,  FOHP-NJ is required to submit a plan
of action to the DOI. FOHP-NJ has obtained  approval of its Plan of Action which
states  FOHP-NJ  will have a  positive  statutory  net worth for the year  ended
December  31,  1997 and that  FOHP-NJ  statutory  net worth  will be 100% of the
required   minimum  by  December  31,  1998.   FOHP-NJ's   statutory  net  worth
requirements are shown below:


<TABLE>
<CAPTION>
                                     1997                                         1996
                 --------------------------------------------  -------------------------------------------
                      GAAP       ELIMINATIONS    STATUTORY       GAAP      ELIMINATIONS      STATUTORY
                 --------------------------------------------  -------------------------------------------
<S>              <C>             <C>          <C>            <C>            <C>              <C>        
Assets           $108,142,744    $3,463,563   $104,679,181   $ 62,225,369   $12,009,871      $50,215,498
Liabilities       104,252,789                  104,252,789     76,705,815                     76,705,815
                 -----------------------------------------------------------------------------------------
Net equity
  (deficiency)   $  3,889,955    $3,463,563   $    426,392   $(14,480,446)  $12,009,871     $(26,490,317)
                 =========================================================================================
</TABLE>

In addition to the minimum statutory net worth requirements, FOHP-NJ may not pay
dividends to its parent without prior approval of the Commissioner of the DOI.




                                      F-20


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)








11.  RELATED PARTY TRANSACTION

Pursuant to the Amended  Securities  Purchase Agreement with FHS, the Company is
required  to pay FHS, or a  designated  subsidiary  of FHS  (QualMed,  Inc.),  a
management fee based on 2% of total revenue of the Company's  health plans.  For
the year ended  December 31, 1997,  the Company  charged  $7,502,899  to expense
related to these management fees.

The amount due to FHS at December 31, 1997,  represents interest payable related
to the Convertible  Debentures.  The amount due to QualMed, Inc. at December 31,
1997 primarily represents management fees payable.

12.  RESTRUCTURING COSTS

Pursuant to the Amended  Securities  Purchase  Agreement  with FHS,  the Company
recorded  the  impact of a  restructuring  plan  designed  to  increase  overall
profitability of FOHP-NJ by scaling back certain product lines that have not met
profitability  expectations.  Restructuring costs of approximately $12.8 million
represent provision for lease termination costs,  employee  termination benefits
and write-down of the related assets.  Included in the total restructuring costs
is  approximately  $2.6  million  related to employee  termination  benefits for
approximately  140  employees  from various  departments  of the Company.  As of
December 31, 1997, approximately $116,000 of termination benefits have been paid
and six employees have been actually terminated.


13.  FAIR VALUES OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:

   RESTRICTED  CASH:  The fair value of restricted  cash is  determined  through
   quoted market prices.

   CONVERTIBLE AND SUBORDINATED DEBENTURES: The Company's Convertible Debentures
   and Subordinated  Debentures carry variable interest rates,  therefore,  fair
   values approximate carrying values.

                                      F-21


<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)


13. FAIR VALUES OF FINANCIAL INSTRUMENTS (continued)

The carrying amounts and fair values of the Company's financial  instruments are
as follows:


<TABLE>
<CAPTION>

                                          1997                               1996
                            -------------------------------  ------------------------------------
                                CARRYING          FAIR            CARRYING           FAIR
                                 AMOUNT           VALUE            AMOUNT            VALUE
                            -------------------------------  ------------------------------------
<S>                              <C>             <C>              <C>              <C>        

Cash and cash equivalents        $79,266,721     $79,266,721      $36,664,911      $36,664,911
Restricted cash                   13,846,682      13,846,682        1,265,449        1,265,449
Convertible debentures            11,294,406      11,294,406
Subordinated debentures           24,000,000      24,000,000

</TABLE>

The  carrying  amount  of  all  other  financial  instruments  reported  in  the
consolidated balance sheets approximate their fair value.

14.  IMPACT OF YEAR 2000 (UNAUDITED)

The Year 2000 issue is the result of computer  programs  being written using two
digits  rather than four to define the  applicable  year.  Any of the  Company's
computer programs that have  time-sensitive  software may recognize a date using
"00" as the year 1900 rather than the year 2000.  This could  result in a system
failure or miscalculations causing disruptions of operations,  including,  among
other things, a temporary inability to process  transactions,  send invoices, or
engage in similar normal business activities.

Based on a recent assessment, the Company determined that it will be required to
modify or replace  significant  portions of its  software  so that its  computer
systems  will  function  properly  with  respect  to dates in the Year  2000 and
thereafter.  The Company presently  believes that with modifications to existing
software  and  conversions  to new  software,  the Year 2000 issue will not pose
significant operational problems for its computer systems.

However,  if  such  modifications  and  conversions  are  not  made,  or are not
completed  timely,  the Year 2000  issue  could  have a  material  impact on the
operations of the Company.

The Company has  initiated  formal  communications  with all of its  significant
suppliers  and large  customers to determine  the extent to which the  Company's
interface  systems are vulnerable to those third  parties'  failure to remediate
their own Year 2000 issues.


                                      F-22

<PAGE>


                           FOHP, Inc. and Subsidiaries
           (Successor to First Option Health Plan of New Jersey, Inc.)

             Notes to Consolidated Financial Statements (continued)




14.  IMPACT OF YEAR 2000 (UNAUDITED) (CONTINUED)

The Company  has  developed a plan to modify its  information  technology  to be
ready  for the Year  2000 and has  begun  converting  critical  data  processing
systems. The Company currently expects the project to be substantially  complete
by early 1999 and as yet is unable to estimate  the cost.  The Company  does not
expect this project to have a  significant  effect on  operations.  Expenditures
through December 31, 1997 have not been material. The Company will implement its
plan by placing a higher  priority on the systems with  significant  operational
implications.  The Company  will  continue to implement  systems with  strategic
value though some projects may be delayed due to resource constraints.

                                      F-23

<PAGE>




================================================================================

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D. C. 20549


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



                                    EXHIBITS
                                       to
                                    FORM 10-K

                                  ANNUAL REPORT

                       Pursuant to Section 13 or 15(d) of

                       THE SECURITIES EXCHANGE ACT OF 1934

                   For the Fiscal Year ended December 31, 1997
                           --------------------------



                                   FOHP, INC.
                          (Exact name of registrant as
                            specified in its charter)





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


================================================================================


<PAGE>


                                   FOHP, INC.

                                  EXHIBIT INDEX


EXHIBIT NO.
-----------

     b    2.1       Agreement of Merger and Plan of  Reorganization  dated April
                    12, 1995 among FOHP-NJ,  the Registrant and FOHP  Transition
                    Company, a wholly-owned subsidiary of the Registrant.


     f    3.1       Amended and Restated  Certificate  of  Incorporation  of the
                    Registrant,  as  filed  with the  Secretary  of State of the
                    State of New Jersey on April 17, 1997.

     ff   3.2       By-laws of Registrant, as amended.

     fff  4.1       Specimen certificate representing Registrant's Common Stock.

          4.2       Convertible Subordinated Surplus Debentures in the aggregate
                    principal amount of $29,000,000  issued by the Registrant to
                    Foundation Health Systems, Inc. ("FHS") on December 8, 1997.

          4.3       Subordinated  Surplus Debentures in the aggregate  principal
                    amount of  $24,000,000  issued by the  Registrant  to FHS on
                    December 31, 1997.

(*)      10.1       Employment Agreement dated May 6, 1997 between FHS and Roger
                    W. Birnbaum.

(*)      10.2       Employment   Agreement   dated   July  1,  1997   among  the
                    Registrant, FHS and Joseph Singer, M.D.

(*)      10.3       Employment  Agreement dated February 8, 1998 between FHS and
                    Marc M. Stein.

     a   10.7       Lease Agreement dated September 1, 1994 between  Theodore G.
                    Sourlis  and Elaine  Sourlis,  husband  and wife,  and First
                    Option  Health  Plan  of New  Jersey,  Inc.  ("FOHP-NJ"),  a
                    wholly-owned  subsidiary of the Registrant,  and the undated
                    Addendum thereto.


                                       E-1

<PAGE>


     a 10.10        Form of Hospital Participation (provider) Agreement required
                    to  be   executed   by  each  NJ  Acute   Care   Institution
                    participating in the FOHP-NJ network and by FOHP-NJ.

     a 10.11        Form of Individual Practice Association (provider) agreement
                    required   to  be   executed   by   FOHP-NJ   and  the  IPAs
                    participating in the FOHP-NJ network.

     a 10.12        Form of  Individual  Practitioner  Participation  (provider)
                    Agreement  required  to be  executed  by FOHP-NJ and each NJ
                    Practitioner participating in the FOHP-NJ network.

     a 10.13        Form of Provider  Agreement  (Non-Acute Care) required to be
                    executed by FOHP-NJ and each NJ Other Provider participating
                    in the FOHP-NJ network.

     c 10.14.1      Form  of  First  Option  Master  Group  Contract  (point  of
                    service) for large employer groups.

     c 10.14.2      Form  of  First  Option   Master  Group   Contract   (health
                    maintenance organization) for large employer groups.

     c 10.14.3      Form  of  First  Option  Master  Group  Contract  for  small
                    employer groups.

     c 10.14.4      Form of First Option Individual Contract for individuals.

     b 10.21        Agreement  to provide HMO  services  to Medicaid  recipients
                    dated February 8, 1995 between  FOHP-NJ and the State of New
                    Jersey  Department  of Human  Services,  Division of Medical
                    Assistance and Health Services.

     d 10.22        Sublease  dated as of December 15, 1995 between  FOHP-NJ and
                    The Continental Insurance Company.

     d 10.28        Mental  Health  Management  Agreement  dated  July  1,  1994
                    between  FOHP-NJ  and  Mental  Health  Network,   Inc.,  and
                    amendment thereto entered into in January 1996.

     d 10.33        Contract between FOHP-NJ and the Secretary of the Department
                    of Health and Human Services, who has delegated authority to
                    the    Administrator    of   the   Health   Care   Financing
                    Administration,  with respect to health  insurance  benefits
                    for the aged and disabled (Contract No. H3155).


                                       E-2

<PAGE>


     d 10.43        Capital Contribution Agreement dated as of December 31, 1995
                    between the Registrant and FOHP-NJ.

     e 10.45.1      Amended and Restated  Securities  Purchase  Agreement  dated
                    February 10, 1997 among the  Registrant,  FOHP-NJ and Health
                    Systems International, Inc. (the predecessor to FHS) and the
                    following exhibits thereto:  Exhibit A - Form of Debentures;
                    Exhibit B-1 - Form of Amended and  Restated  Certificate  of
                    Incorporation  of the  Registrant;  Exhibit  B-2 -  Form  of
                    By-laws of the Registrant; Exhibit B-3 - Form of Amended and
                    Restated  Certificate of Incorporation  of FOHP-NJ;  Exhibit
                    B-4 - Form of  By-laws  of  FOHP-NJ;  Exhibit  D-1 - Form of
                    General  Administrative  Services Management Agreement;  and
                    Exhibit  D-2 - Form of  Management  Information  Systems and
                    Claims Processing  Services  Agreement.  Upon the request of
                    the  Securities  and  Exchange  Commission,  the  Registrant
                    agrees to furnish a copy of Exhibit C-1 - Form of  Exclusive
                    Plan  Hospital  Provider  Agreement,  Exhibit C-2 - Forms of
                    Non-Exclusive Plan Hospital Provider Agreements, Exhibit E -
                    Form of Investors Agreement,  Exhibit F - Form of Opinion of
                    Outside Counsel of Registrant and FOHP-NJ,  Exhibit G - Form
                    of Officer's  Certificate and Exhibit H - Form of Opinion of
                    Outside Counsel of Health Systems  International,  Inc., and
                    Schedules  2.1A  through  2.25 as follows:  Schedule  2.1A -
                    Subsidiaries;  Schedule 2.1B - Good Standing; Schedule 2.3 -
                    Rights  of First  Refusal;  Schedule  2.4(a) - SEC  Reports;
                    Schedule 2.4(b) - Unreported  Liabilities  and  Obligations;
                    Schedule   2.5  -   Company's   Reports;   Schedule   2.6  -
                    Noncontravention;  Schedule 2.7 - Litigation; Schedule 2.9 -
                    Compliance  with  Law;  Schedule  2.10  -  Certain  Material
                    Contracts and Defaults;  Schedule 2.11 - Consents;  Schedule
                    2.12  -  Licenses,   Permits  and  Governmental   Approvals;
                    Schedule  2.14  -  Environmental  Matters;  Schedule  2.15 -
                    Properties and Assets;  Schedule 2.16 - Taxes; Schedule 2.20
                    - Insurance;  Schedule 2.22 - Employment/Severance  Matters;
                    and Schedule 2.25 - Employee Benefit Plans.

     e 10.45.2      Amendment  dated March 13, 1997 to the Amended and  Restated
                    Securities Purchase Agreement referenced in Exhibit 10.45.1.

     g 10.46        Form of General Administrative Services Management Agreement
                    dated April 30, 1997 between FHS and the Registrant.


                                       E-3

<PAGE>


     h   10.47      Form of Management Information Systems and Claims Processing
                    Services  Agreement dated April 30, 1997 between FHS and the
                    Registrant.

         21.        Subsidiaries of the Registrant.

     i   27.        Financial Data Schedule for year ended December 31, 1997.
----------------

     (*)            Constitutes a management contract required to be filed as an
                    exhibit pursuant to Item 14(c) of Form 10-K.

     a              Incorporated  by  reference  to  the  identically   numbered
                    exhibit to the Registrant's  Registration  Statement on Form
                    S-4 (Registration No. 33-89356).

     b              Incorporated  by  reference  to  the  identically   numbered
                    exhibit to Amendment No. 1 to the Registrant's  Registration
                    Statement on Form S-4 (Registration No. 33-89356).

     c              Incorporated  by  reference  to  the  identically   numbered
                    exhibit to the Registrant's  Registration  Statement on Form
                    S-1 (Registration No. 33-80817).

     d              Incorporated  by  reference  to  the  identically   numbered
                    exhibit to the  Registrant's  Annual Report on Form 10-K for
                    the year ended December 31, 1995.

     e              Incorporated   by  reference  to   Appendices   A-H  of  the
                    Registrant's  definitive  Proxy  Statement  filed  with  the
                    Commission  on  March  19,  1997  in  connection   with  the
                    Registrant's 1996 Annual Meeting of Shareholders.

     f              Incorporated by reference to Exhibit 2.1 of the Registrant's
                    Registration Statement on Form 8-A, effective July 8, 1997.

     ff             Incorporated by reference to Exhibit 2.2 of the Registrant's
                    Registration Statement on Form 8-A, effective July 8, 1997.

     fff            Incorporated  by reference to Exhibit 4 of the  Registrant's
                    Registration Statement on Form 8-A, effective July 8, 1997.



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<PAGE>


     g              Incorporated by reference to Appendix C of the  Registrant's
                    definitive  Proxy  Statement  filed with the  Commission  on
                    March 19,  1997 in  connection  with the  Registrant's  1996
                    Annual Meeting of Shareholders.

     h              Incorporated by reference to Appendix D of the  Registrant's
                    definitive  Proxy  Statement  filed with the  Commission  on
                    March 19,  1997 in  connection  with the  Registrant's  1996
                    Annual Meeting of Shareholders.

     i              The  Financial  Data  Schedule is  submitted  in  electronic
                    format only.



                                       E-5