UNITED STATES
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, 2004OR[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934For the transition period from ___________ to _____________Commission file number:    1-8865



Sierra Health Services,  Inc.



|NEVADA                                                         | 88-0200415                             
|-------------------------------------------------------------- | ---------------------------------------
|(State or other jurisdiction of
incorporation or organization) | (I.R.S. Employer Identification Number)

2724 North Tenaya Way
Las Vegas, Nevada    89128

(702) 242-7000

Securities Registered Pursuant to Section 12(b) of the Act:



|Title of each class           | Name of each exchange on which registered
|----------------------------- | -----------------------------------------
|Common Stock, par value $.005 | New York Stock Exchange                  

Securities Registered Pursuant to Section 12(g) of the Act:  None

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.     [X]

Indicate by check mark if the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
    Yes  
[X]       No  [     ]

The aggregate  market value of the voting stock held by  non-affiliates  of
the registrant on June 30, 2004 was $1,065,576,000.

The number of shares of the registrant's  common stock  outstanding on March 7, 2005 was 26,707,000.

DOCUMENTS INCORPORATED BY REFERENCE



|DOCUMENT
  Portions of the registrant's definitive proxy
statement for its 2005 Annual meeting
to be filed with the SEC not later than 120 days
after the end of the fiscal year. | WHERE INCORPORATED
Part III
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------

---



|           |                                                                                                |  |  |  |      |  |     | 
|---------- | ---------------------------------------------------------------------------------------------- |  |  |  | ---- |  | --- | 
|           | SIERRA HEALTH SERVICES, INC. 2004 Annual Report on Form 10-K 
TABLE OF CONTENTS                |  |  |  |      | 
|           |                                                                                                |  |  |  | Page | 
|           | PART I                                                                                         |  |  |  |      |  |     | 
|Item 1.    | Business                                                                                       |  |  |  |      |  | 1   | 
|Item 2.    | Properties                                                                                     |  |  |  |      |  | 23  | 
|Item 3.    | Legal Proceedings                                                                              |  |  |  |      |  | 23  | 
|Item 4.    | Submission of Matters to a Vote of Security Holders                                            |  |  |  |      |  | 24  | 
|           | PART II                                                                                        |  |  |  |      |  |     | 
|Item 5.    | Market for Registrant's Common Equity and Related Stockholder Matters                          |  |  |  |      |  | 25  | 
|Item 6.    | Selected Financial Data                                                                        |  |  |  |      |  | 27  | 
|Item 7.    | Management's Discussion and Analysis of Financial Condition
and Results of Operations          |  |  |  |      |  | 29  | 
|Item 7a.   | Quantitative and Qualitative Disclosures about Market Risk                                     |  |  |  |      |  | 53  | 
|Item 8.    | Financial Statements and Supplementary Data                                                    |  |  |  |      |  | 54  | 
|Item 9.    | Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure           |  |  |  |      |  | 94  | 
|Item 9a.   | Controls andProcedures                                                                         |  |  |  |      |  | 94  | 
|           | PART III                                                                                       |  |  |  |      |  |     | 
|Item 10.   | Directors and Executive Officers of the Registrant                                             |  |  |  |      |  | 95  | 
|Item 11.   | Executive Compensation                                                                         |  |  |  |      |  | 95  | 
|Item 12.   | Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters |  |  |  |      |  | 95  | 
|Item 13.   | Certain Relationships and Related Transactions                                                 |  |  |  |      |  | 96  | 
|Item 14.   | Principal Accounting Fees and Services                                                         |  |  |  |      |  | 96  | 
|           | PART IV                                                                                        |  |  |  |      |  |     | 
|Item 15.   | Exhibits and Financial Statement Schedules                                                     |  |  |  |      |  | 97  | 
|Signatures |                                                                                                |  |  |  |      |  | 102 | 

i

---

Table of Contents

PART I

ITEM 1. BUSINESS
General

Unless specifically indicated or the context clearly
indicates otherwise, "Sierra," "we," "us," and
"our" refer to Sierra Health Services, Inc. and its subsidiaries.
Overview

We are a managed health care organization that provides and
administers the delivery of comprehensive health care programs with an emphasis
on quality care and cost management.  Our strategy has been to develop and offer
a portfolio of managed health care products to employer groups and individuals.
Our broad range of managed health care services is provided through the
following:


a federally qualified health maintenance organization or
HMO;







In addition, we have a subsidiary that administered a managed
care federal contract for the Department of Defense's TRICARE program in Region
1.  Health care services under our TRICARE contract for Region 1 ended on August
31, 2004.  On September 1, 2004, we entered an eight-month phase-out period at
substantially reduced revenues.



Required financial information by business segment is set
forth in Note 18 of the Notes to the Consolidated Financial Statements.  Unless
otherwise indicated, information presented in this 2004 Form 10-K is for
continuing operations and excludes the discontinued Texas HMO health care
operations and workers' compensation insurance operations.

Subsidiary Summary



The following briefly describes our significant subsidiaries:



Managed Care Operations:

Health Insurers:

- Health Plan of Nevada, Inc. (HPN), a Nevada corporation,
is a federally qualified health maintenance organization or HMO.
- Sierra Health and Life Insurance Company, Inc. (SHL), a
California corporation, provides managed indemnity plans, as well as Medicare
Select products in five states.



Multi-specialty medical group and other ancillary services to
support our managed health care operations:

- Southwest Medical Associates, Inc. (SMA) is Nevada's
largest multi-specialty medical group serving as the primary care provider for
almost 75% of our southern Nevada HMO members.
- Behavioral Healthcare Options, Inc. provides mental
health and substance abuse services.
- Family Health Care Services is a Medicare certified full
service home health agency licensed by the State of Nevada, providing in-home
care and case management.

---

Table of Contents



Other managed care operations:

- Sierra Health-Care Options, Inc. operates third-party
network access and utilization review services for employer-funded health
benefit plans.
- Sierra Nevada Administrators, Inc. operates as a third-party administrator of
workers' compensation claims for self-insured Nevada
employers.



Military Health Services Operations:

- Sierra Military Health Services, LLC administered a
managed care federal contract for the Department of Defense's TRICARE program in
Region 1 and is currently in a phase-out of its operations.



Discontinued Texas HMO Health Care Operations:

- Sierra Health Holdings, Inc. a Nevada corporation, is the
parent company for Texas Health Choice, L.C., and is a part of our discontinued
Texas HMO health care operations.



Discontinued Workers' Compensation Insurance Operations:

- CII Financial, Inc. a California corporation, was the
parent company of our four workers' compensation insurance companies that were
sold in March 2004.



Managed Care Products and Services



The primary types of health care coverage offered by our
subsidiaries are HMO plans (including Medicare and Medicaid), HMO Point of
Service (POS) plans, managed indemnity plans, which include a managed indemnity
PPO option and Medicare supplement products.  As of December 31, 2004, we
provided HMO products to approximately 330,000 members.  We also provided
managed indemnity products to approximately 26,000 members, Medicare supplement
products to approximately 16,000 members, and administrative services to
approximately 188,000 members.  Medical premiums accounted for approximately 72%
of total revenues from continuing operations in 2004.

Health Maintenance Organizations.  We operate a mixed
model HMO in Las Vegas, Nevada, in which we use our own multi-specialty medical
group as well as a network of independent contracted providers.  We also operate
a network model HMO in Reno, Nevada.  Independent contracted primary care
physicians and specialists for our HMO are compensated on a capitated or
modified discounted fee-for-service basis. Contracts with our primary hospitals
are on a per diem or diagnosis related group (DRG) basis. Members receive a wide
range of coverage after paying a co-payment and are eligible for preventive care
coverage.



Our commercial HMO plans offer traditional HMO benefits and
POS benefits.  At December 31, 2004, we had approximately 226,000 commercial
members.  Based on data provided by the Nevada State Health Division, as of
September 30, 2004, we maintain approximately 65% of the Nevada, and
approximately 78% of the southern Nevada, commercial HMO market share.  In
southern Nevada, HMOs have a market penetration of under 22%.



We also offer a Medicare risk product that we market directly
to Medicare-eligible beneficiaries.  The monthly payment we receive for Medicare
members is determined by a formula established by federal law.  As of December
31, 2004, we had approximately 53,000 Medicare members.  Approximately 52,000 of
those were enrolled in the Social HMO, which is discussed below.



In addition, as of December 31, 2004, we had approximately
40,000 members enrolled in our HMO Medicaid risk program.  To enroll in this
program, an individual must be eligible for the Temporary Assistance for

2

---

Table of Contents

Needy
Families or the Children's Health Assurance Program categories of the State of
Nevada's Medicaid program.  We also have 11,000 Nevada Check Up members.  Nevada
Check Up is the State Children's Health Insurance Program, which covers
uninsured children who do not qualify for Medicaid.  We receive a monthly fee
for each Medicaid and Nevada Check Up member enrolled by the state's managed
care division and we also receive a per case fee for each Medicaid and Nevada
Check Up eligible newborn delivery.



Social Health Maintenance Organization.  In 1996, we
entered into a Social HMO contract with the Centers for Medicare and Medicaid
Services (CMS) pursuant to which a large portion of our Medicare risk members
receive certain expanded benefits for which we receive additional revenues.  The
additional revenues are determined based on health risk assessments that have
been, and will continue to be, performed on our eligible Medicare members.  The
additional benefits include, among other things, assisting eligible Medicare
members with activities of daily living such as bathing, dressing and walking.
Members are eligible for the additional benefits based on need, as identified by
the health risk assessments.

Effective January 2004, CMS adopted a new risk adjustment
payment methodology for Medicare beneficiaries who are enrolled in managed care
programs, including the Social HMO.  For Social HMO members, the new methodology
includes a frailty adjuster that uses measures of functional impairment to
predict expenditures.  CMS is transitioning to the new payment methodology on a
graduated basis from 2004 through 2007.  In 2004, we were paid 90% based on the
previous payment approach and 10% based on the new approach.  Excluding the
effects of the Medicare Prescription Drug, Improvement, and Modernization Act of
2003 (MMA) the new payment methodology reduced our rate increase by 60 basis
points.  The Social HMO program has been administratively extended by CMS but
will phase-out at the end of 2007.  For 2005, 2006 and 2007, we will be paid
70%, 50% and 25%, based on the previous payment approach and 30%, 50% and 75%,
based on the new approach, respectively.  The extension of the Social HMO
program through 2007 will serve as a transition period so that we can convert to
a Medicare Advantage plan in 2008.



Preferred Provider Organizations.  Our managed
indemnity plans generally offer members a PPO option of receiving their medical
care from either contracted or non-contracted providers.  Members pay higher
deductibles and co-insurance or co-payments when they receive care from non-contracted
providers.  Out-of-pocket costs are lowered by utilizing contracted
independent providers who are part of our PPO network.



During 2004, we provided managed indemnity and/or Medicare
supplement services to members in Colorado, Iowa, Louisiana, Nevada and Texas.
As of December 31, 2004, our managed indemnity subsidiary was licensed in a
total of 43 states and the District of Columbia.



Ancillary Medical Services.  Most of our managed
health care services in Clark County, Washoe County, and surrounding rural areas
are provided through our independent contracted network of approximately 2,700
providers and 36 hospitals.  These Nevada networks include our affiliated multi-specialty
medical group, which provides primary care medical services for almost
75% of our southern Nevada HMO members and employs approximately 210 primary
care and other providers in various medical specialties. Through our affiliates,
the following services are offered: urgent care; home health care; hospice care;
behavioral health care; home infusion; oxygen and durable medical equipment;
ambulatory surgery; and radiology.  As of December 31, 2004, mental health and
substance abuse services were provided to approximately 294,000
participants.



We believe that this vertical integration of our health care
delivery system in southern Nevada provides a competitive advantage as it helps
us to effectively manage health care costs while delivering quality care.



Administrative Services.  Our administrative services
products provide, among other things, PPO network access and utilization review
services to large employer groups that are self-insured.  As of December 31,
2004, approximately 188,000 members were enrolled in our health administrative
services plans. In addition, we provide administration services for self-insured
workers' compensation plans.  The revenues and

3

---

Table of Contents

expenses for these services are
included in investment and other revenues and in general and administrative
expenses, respectively, in the Consolidated Statements of Operations.



Military Contract Services



Sierra Military Health Services, LLC (SMHS).  Pursuant
to a triple-option health benefits contract, known as TRICARE, with the
Department of Defense (DoD), SMHS provided managed health care coverage to
dependents of active duty military personnel, military retirees and dependents
of military retirees through subcontractor partnerships and individual providers
in Region 1.  SMHS also performed specific administrative services, including
health care appointment scheduling, enrollment, network management and health
care management services.  SMHS performed these services using primarily DoD
information systems.



We submitted a proposal in January 2003 for the Next
Generation TRICARE (T-Nex) North Region contract, which includes Region 1.  We
were not awarded the T-Nex North Region contract and our appeal to the United
States General Accounting Office was denied in December 2003.  SMHS completed
the fifth year of a five-year contract in May 2003.  SMHS then operated under a
negotiated contract extension period, which ended August 31, 2004.  The new
contractor became operational in Region 1 on September 1, 2004 and the new
contract superseded the remainder of our TRICARE Region 1 contract.  On
September 1, 2004, SMHS commenced an eight-month phase-out of operations at
prices previously negotiated with the DoD.  SMHS does not meet the definition of
discontinued operations since we do not have plans to dispose of the operations
before the phase-out is complete.



In March 2004, SMHS entered into a definitive agreement with
the new T-Nex North Region Contractor to provide certain transition services and
to sell certain portions of its TRICARE business, including its provider network
and certain other assets.  The value of the transaction was $4.0 million and was
contingent on SMHS' operational performance through October 2004.  SMHS recorded
the full revenue of $4.0 million pursuant to this agreement based on its
operational performance.



Discontinued Workers' Compensation Insurance Operations



Workers' Compensation Subsidiary.  On October 31, 1995,
we acquired CII Financial, Inc. (CII) for approximately $76.3 million of common
stock in a transaction accounted for as a pooling of interests.  On January 15,
2003, we announced that we were exploring strategic alternatives to dispose of
CII.  Sierra's Board of Directors authorized the sale of the operations on
December 31, 2002.  Accordingly, beginning in the fourth quarter of 2002, we
reclassified our workers' compensation insurance business as discontinued
operations.



On November 25, 2003, we announced that we had reached an
agreement to sell California Indemnity Insurance Company (Cal Indemnity) and its
subsidiaries.  Cal Indemnity was CII's only significant asset.  In the fourth
quarter of 2003, we recorded a charge of $15.6 million, gross and net of tax, to
write down the investment in Cal Indemnity to its estimated net sales proceeds.



On March 31, 2004, we completed the sale of Cal Indemnity.
Cal Indemnity's subsidiaries, which were included in the sale, are Commercial
Casualty Insurance Company, Sierra Insurance Company of Texas, and CII Insurance
Company.

We received $14.2 million in cash at the closing, which was
subsequently reduced by $2.7 million based on the final closing date balance
sheet.  The $2.7 million adjustment is a timing difference and is expected to be
repaid to us over the next few years.  The transaction also included a note
receivable of $62.0 million, plus accrued interest, payable to us in January
2010. The note receivable can be increased or decreased depending on favorable
or adverse claim and expense development from the date of closing through
December 31, 2009, and other offsets and additions based on certain agreements
between the parties.  The note receivable can be increased on a dollar for
dollar basis for the first $15 million in positive loss reserve

4

---

Table of Contents

development and
$.50 per dollar on any positive development in excess of $15 million.  The note
receivable can also be decreased on a dollar for dollar basis for the first $58
million in adverse loss development.  At December 31, 2004, based on actuarially
determined loss development projections, we recorded a valuation allowance on
the note receivable of $15.0 million.



Certain other contractual assets and liabilities were
recorded in conjunction with the sale including a current asset of $15.8 million
and a non-current asset of $7.1 million that represent Cal Indemnity's
unallocated loss adjustment expense (ULAE) reserves to be paid to Sierra.
Offsetting these assets was a current liability of $15.8 million and a non-current
liability of $7.1 million, which represent the contractual services to
be performed by Sierra.  Including the cash proceeds, net assets of $68.3
million were initially recorded in conjunction with the sale of Cal Indemnity.



Marketing

The marketing and sales of our commercial managed care
products typically include a multi-step process involving our sales
representatives, a consultant/broker appointed by the client and the client.
Once a relationship with a group has been established and a group agreement is
negotiated and signed, we focus our marketing efforts on individual employees.
During a designated "open enrollment" period each year, usually the
month preceding the annual renewal of the agreement with the group, employees
choose whether to remain with, join or terminate their membership with a
specific health plan offered by the employer.  New employees decide whether to
join one of the employers' health insurance options at the time they begin their
employment.  Although contracts with employers are generally terminable on 60
days notice, changes in membership occur primarily during annual open enrollment
periods.



We use media communications to convey our emphasis on access
to our broad health care provider network and services at a reasonable price.
Other communications to customers include employer and member newsletters,
member education brochures, prenatal information packets, employer/broker
seminars, certain Internet information and direct mail advertising to clients.
Members' satisfaction with our benefits and services is monitored by customer
surveys.  Results from these surveys and other primary and secondary research
guide our sales and advertising efforts throughout the year.



Medicare risk products are primarily marketed by the HMO's
sales employees.  Retention of employer groups and membership growth is
accomplished through competitive pricing and products, customer service and
print advertising directed to employers and through consumer media campaigns.

5

---

Table of Contents

Membership



Period End Membership:



|                                          |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|----------------------------------------- |  | --------------- | ------- |  | ---- |  | --------- | ---- |  | ---- | --------- | ---- |  | --------- |  |  | --------- | 
|                                          |  | At December 31, |        
|                                          |  | 2004            |         |  | 2003 |  |           | 2002 |  | 2001 |           | 2000 | 
|Continuing Operations:                    |  |                 |        
|HMO:                                      |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|Commercial                                |  |                 | 226,000 |  |      |  | 202,000   |      |  |      | 187,000   |      |  | 175,000   |  |  | 140,000   | 
|Medicare                                  |  |                 | 53,000  |  |      |  | 51,000    |      |  |      | 48,000    |      |  | 45,000    |  |  | 42,000    | 
|Medicaid                                  |  |                 | 51,000  |  |      |  | 39,000    |      |  |      | 37,000    |      |  | 27,000    |  |  | 15,000    | 
|Managed indemnity                         |  |                 | 26,000  |  |      |  | 25,000    |      |  |      | 27,000    |      |  | 29,000    |  |  | 31,000    | 
|Medicare supplement                       |  |                 | 16,000  |  |      |  | 18,000    |      |  |      | 19,000    |      |  | 23,000    |  |  | 28,000    | 
|Administrative services                   |  |                 | 188,000 |  |      |  | 193,000   |      |  |      | 221,000   |      |  | 196,000   |  |  | 197,000   | 
|                                          |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|Subtotal                                  |  |                 | 560,000 |  |      |  | 528,000   |      |  |      | 539,000   |      |  | 495,000   |  |  | 453,000   | 
|TRICARE eligibles                         |  |                 |        |  |      |  | 707,000   |      |  |      | 678,000   |      |  | 639,000   |  |  | 621,000   | 
|                                          |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|Total Membership, Continuing Operations   |  |                 | 560,000 |  |      |  | 1,235,000 |      |  |      | 1,217,000 |      |  | 1,134,000 |  |  | 1,074,000 | 
|                                          |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|Discontinued Operations:                  |  |                 |        
|HMO:                                      |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|Commercial                                |  |                 |        |  |      |  |          |      |  |      |          |      |  | 43,000    |  |  | 73,000    | 
|Medicare                                  |  |                 |        |  |      |  |          |      |  |      |          |      |  | 12,000    |  |  | 8,000     | 
|                                          |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 
|Total Membership, Discontinued Operations |  |                 |        |  |      |  |          |      |  |      |          |      |  | 55,000    |  |  | 81,000    | 
|                                          |  |                 |         |  |      |  |           |      |  |      |           |      |  |           |  |  |           | 

We categorize groups by size
into small, mid-size and large.  At December 31, 2004, the breakdown of our
commercial membership by size and type are as follows:

|Membership By Commercial Employer Group Size |        | Membership By Commercial Employer Group Type
|-------------------------------------------- | ------ | --------------------------------------------
|                                             |        |                                             
|1 - 50 employees
  (small)                   | 7.8%   |                                             
|51 - 500 employees (mid size)                | 29.4%  |                                             
|501 +
  employees (large)                    | 62.8%  |                                             
|                                             |        |                                             
|Total                                        | 100.0% |                                             
|                                             |        |                                             
|                                             |        |                                             
|                                             |        |                                             
|                                             |        |                                             



During 2004, 2003 and 2002, we received approximately 28.9%,
25.3% and 26.6%, respectively, of our total revenues from our contract with CMS
to provide health care services to Medicare beneficiaries. Our contract with CMS
is subject to annual renewal at the election of CMS and requires us to comply
with federal HMO and Medicare laws and regulations and may be terminated if we
fail to comply.  The termination of our contract with CMS and the loss of our
Medicare revenue would have a material adverse effect on our business. In
addition, there may be legislative proposals to limit Medicare reimbursements
and to require additional benefits.  Future levels of funding of the Medicare
program by the federal government cannot be predicted with certainty, see
Government Regulation and Recent Legislation.



Our ability to obtain and maintain favorable group benefit
agreements with employer groups affects our profitability.  The agreements are
generally renewable on an annual basis but are subject to termination on
generally 60 days prior notice.  For the fiscal year ended
December 31, 2004, our six largest HMO employer groups were, in the
aggregate, responsible for less than 10% of our total revenues.  Although none
of our employer groups accounted for more than 3% of total revenues during that
period, the loss of one or more of the larger employer groups could, if not
replaced with similar membership, have a material adverse effect

6

---

Table of Contents

upon our
business.  We have generally been successful in retaining these employer groups.
However, there can be no assurance that we will be able to renew our agreements
with our employer groups in the future or that we will not experience a decline
in enrollment within our employer groups.  Additionally, revenues received under
certain government contracts are subject to audit and retroactive adjustment.

Provider Arrangements and Cost Management

HMO and Managed Indemnity Products.  A significant
distinction between our health care delivery system and that of many other
managed care providers is the fact that almost 75% of our southern Nevada HMO
members receive primary health care through our own multi-specialty medical
group.  We also make health care available through independent contracted groups
of physicians, hospitals and other providers.



Under our HMO, the member selects a primary care physician
who provides or authorizes certain non-emergency medical care given to that
member.  We compensate our independent contracted primary care physicians by
using both capitation and/or modified fee-for-service payment methods.  We have
negotiated capitated and/or reduced fee-for-service agreements with our
specialty network as well.  We monitor certain health care utilization,
including evaluation of elective surgical procedures, quality of care and the
financial stability of our capitated providers to facilitate access to services
and member satisfaction.



We negotiate discounted contracts with hospitals for
inpatient and outpatient hospital care, including room and board, diagnostic
tests and medical and surgical procedures. We believe that we currently have a
favorable contract with our primary southern Nevada contracted hospital
organization, comprised of Sunrise Hospital and Medical Center, Mountain View
Hospital and Southern Hills Hospital and Medical Center. These facilities are
owned by HCA Inc..  Subject to certain limitations, the contract provides, among
other things, guaranteed contracted per diem rate increases on an annual basis.
Our contract with HCA Inc. contains a clause, which, based on our meeting
certain utilization requirements, requires HCA Inc. to provide us with their
best rates in the market place. Since the majority of our southern Nevada
hospital days are at these facilities, this contract assists us in managing a
significant portion of our medical costs. We can be, and at times have been,
affected by these hospitals' limited capacity and have had to place our members
in other facilities, some with a higher cost to us, due to a shortage of
available beds at these hospitals.  In general, our other hospital contracts in
Las Vegas are based on a fixed per diem rate structure.



For hospitals other than HCA Inc., our contracts typically
renew automatically with both parties granted the right to terminate after a
notice period ranging from three to twelve months.  Our current contract with
HCA Inc. expires December 31, 2006.  Reimbursement arrangements with other
health care providers, including pharmacies, generally renew automatically or
are negotiated annually and are based on several different payment methods,
including per diems (where the reimbursement rate is based on a per day of
service charge for specified types of care), capitation, discounted per diem,
DRG and modified fee-for-service arrangements.  To the extent feasible, when
negotiating non-physician provider arrangements, we solicit competitive
bids.



For services to members utilizing a PPO plan, we reimburse
participating physicians on a modified fee-for-service basis and we reimburse
participating hospitals on a per diem basis.  For services rendered under a
standard indemnity plan, pursuant to which a member may select a non-plan
provider, we reimburse non-contracted physicians at a pre-established rate based
on a usual and customary reimbursement methodology.



We manage health care costs through our large case management
program, utilization review, monitoring of care in the appropriate setting and
by member education on how and when to use the services of our plans and how to
manage chronic disease conditions.  We audit some hospital bills and review some
hospital and high volume providers' claims to ensure appropriate billing and
utilization patterns. We also perform some monitoring of the appropriateness of
the referral process from the primary care physician to the specialty network.
Further, we utilize our home health care agency and our hospice, which help to
minimize hospital

7

---

Table of Contents

admissions and the length of stay.



Military Contract Services.  Under our former TRICARE
contract, dependents of active duty military personnel, military retirees and
dependents of military retirees chose one of three option plans available to
them for health care services:  (i) TRICARE Prime (an HMO style option with a
self-selected primary care manager and no deductibles); (ii) TRICARE Extra (a
PPO style option with deductibles and cost shares); or (iii) TRICARE Standard
(an indemnity style option with deductibles and cost shares).  In the most
recent year, approximately 37% of eligible beneficiaries received their primary
care through existing military treatment facilities.  SMHS negotiated discounted
contracts with approximately 37,000 individual providers, 2,700 institutions and
10,000 pharmacies to provide supplemental network access for TRICARE Prime and
Extra beneficiaries.  SMHS' contracts with providers were primarily on a
discounted basis from the TRICARE established fee schedule with renewal and
termination terms similar to our commercial practice. SMHS was at-risk for and
managed the health care service cost of all TRICARE Extra and Standard
beneficiaries, as well as a small percentage of TRICARE Prime beneficiaries.



SMHS implemented the TRICARE Senior Pharmacy Program (Senior
Rx) on April 1, 2001.  The Senior Rx program enabled Military Health Services
Medicare eligible beneficiaries, age 65 and over, to obtain prescription drugs,
and the supplies necessary for the administration of pharmaceuticals, from a
network of retail pharmacies, non-network retail pharmacies or through the
National Mail Order Pharmacy.  SMHS did not assume any health care underwriting
risk under that program, which expired on June 1, 2004.



On October 1, 2001, SMHS implemented the TRICARE for Life
program.  The additional DoD program provided continued TRICARE coverage to
military family retirees age 65 and over, as a supplement to Medicare.  SMHS did
not assume any health care underwriting risk under the additional program.  On
August 31, 2004, SMHS ceased arranging for the provision of health care services
to TRICARE beneficiaries.

Risk Management

We maintain general and professional liability, property and
fidelity insurance coverage in amounts that we believe, based upon historical
experience, are adequate for our operations.  Due to recent unfavorable changes
in the commercial insurance market, we have, for certain risks, purchased
coverage with higher deductibles and lower limits of coverage.  Our current
primary medical professional liability policy provides coverage in the amount of
$1 million per loss event with an annual aggregate limit of coverage per
provider of $3 million.   We have purchased excess medical professional
liability and managed care coverage that requires us to be responsible for a
self-insured retention of $3 million per loss event.  In the case of a medical
professional liability loss event, the $1 million primary policy limit will
apply toward the $3 million self insured retention. The primary and excess
medical professional liability policies apply retroactively to June 15, 2001.
In addition, we require all of our independent contracted provider physician
groups, individual practice physicians, specialists, dentists, podiatrists and
other health care providers (with the exception of certain hospitals) to
maintain professional liability coverage.  Certain of the hospitals with which
we contract are, however, self-insured.  We also maintain stop-loss insurance
that reimburses us between 50% and 90% of hospital charges for each individual
member of our HMO and managed indemnity plans whose hospital expenses exceed
$350,000 and $150,000, respectively, during the contract year and up to $2
million per member per lifetime. In the ordinary course of business, we are
subject to claims that are not insured, principally claims for punitive damages
and claims that fall within the applicable self-insured retention.



Information Systems



We use information systems to support, among other things,
pricing our services, monitoring utilization and other cost factors, providing
bills on a timely basis, identifying accounts for collection, managing the
scheduling and delivery of health care services, processing claims for
reimbursement, delivering customer service and handling various accounting and
reporting functions.

8

---

Table of Contents

In 2004, we updated our data center disaster recovery plan
and we completed a business continuity plan. We completed the rollout of an
electronic medical record system and the expansion of an automated care
management system to support the coordination of care for seniors enrolled in
our Social HMO program. We believe we are in compliance with the Federal Health
Insurance Portability and Accountability Act of 1996 (HIPAA) as required by the
Privacy Rule and the Standards for Code Sets and Electronic Transactions.  Other
security and controls work was completed to comply with Section 404 of the
Sarbanes-Oxley Act of 2002.



There can be no assurance that we will be able to maintain
and enhance our information systems including ongoing HIPAA and Sarbanes-Oxley
compliance.  Our failure to maintain and enhance our information systems could
have a material adverse impact on our business and results of operations.



We view our information systems capability as critical to the
performance of ongoing administrative functions and integral to quality
assurance and the coordination of patient care.  We are continually modifying or
improving our information systems capabilities in an effort to improve operating
efficiencies and service levels.



Quality Assurance and Improvement

We promote continuous improvement in the quality of
member care and service through our quality programs. Our quality programs are a
combination of quality assurance activities and include the retrospective
monitoring and problem solving associated with the quality of care delivered.
Continuous quality improvement activities include the trending and analysis of
ongoing aggregate data for purposes of prospective planning.



Our quality assurance methodology is based on: (i) collection
and analysis of data; (ii) reviews of adverse health outcomes as well as
appropriateness and quality of care; (iii) focused reviews of high volume/high
risk diagnoses or procedures; (iv) monitoring for trends; (v) peer review of the
clinical process of care; (vi) development and implementation of corrective
action plans, as appropriate; (vii) monitoring compliance/adherence to
corrective action plans; and (viii) assessment of the effectiveness of the
corrective action plans.



Our quality improvement methodology is based on: (i)
collection and analysis of data; (ii) analysis of barriers to achieving goals
and/or benchmarks; (iii) development and implementation of interventions to
address barriers; (iv) remeasurement of data to assess effectiveness of
interventions; (v) development and implementation of new or additional
interventions, as appropriate; and (vi) follow-up remeasurement of data to
assess effectiveness or sustained impact.



Several independent organizations have been formed for the
purpose of responding to external demands for accountability in the health care
industry.  The National Committee for Quality Assurance (NCQA) and the
Utilization Review Accreditation Commission (URAC) currently evaluate certain of
our subsidiaries.



The NCQA is an independent, not-for-profit organization that
evaluates managed care organizations and assesses and reports on the quality of
managed care plans by evaluating over 60 standards that fall into four
categories: (i) quality management and improvement; (ii) utilization management;
(iii) members' rights and responsibilities; and (iv) credentialing and
recredentialing.  The NCQA's accreditation levels include excellent,
commendable, accredited, provisional and denied.  In 2003, we earned a
"Commendable" status from the NCQA for our commercial HMO, commercial
POS, and Medicare HMO product lines.  "Commendable" status is awarded
to plans that demonstrate levels of service and clinical quality that meet or
exceed NCQA's rigorous requirements for consumer protection and quality
improvement.



URAC's Health Utilization Management Standards (UM standards)
program is the largest and most recognized program of its type in the United
States.  The UM standards are meant to ensure organizations follow a process
that is clinically sound, promotes quality care and respects members' rights.
URAC

9

---

Table of Contents

performs reviews of standards in the following categories:
confidentiality, staff qualifications, program qualifications, information upon
which organizations conduct utilization management, procedures for review
determination and procedures for appeals of determinations not to certify
(expedited and standard appeals). The URAC accreditation levels include full,
conditional, corrective action, denied, or withdrawn.  Applicants who
successfully meet all requirements are awarded a full two-year accreditation.
In 2003, our HPN, SHL, Sierra Health-Care Options, Inc., and Behavioral
Healthcare Options, Inc., utilization management operations were all "fully
accredited" by URAC, under URAC's UM standards program.



There can be no assurance, however, that we will maintain
NCQA, URAC or other accreditations in the future and there is no basis to
predict what effect, if any, the lack of accreditations could have on our
competitive position.



Underwriting

HMO.  We develop premium rates for our various health
plans primarily through a "community rating by class" (CRC)
methodology.  Under the CRC method, all costs of basic benefit plans for our
entire membership population are aggregated, projected forward to future periods
and expressed on a "per member per month" basis.  Subject to certain
legal constraints, actuarial adjustments are made to the base premium rates for
demographic variations specific to each employer group.  Such variations may
include, but are not limited to, the average age and gender of their employees,
group size, area, health status, and industry.  For most employer groups, the
adjusted rates are then converted to tiered premium rates for various coverage
types, such as single or family coverage.  For some small employer groups, the
final premium rates are expressed in a table format using age range bands and
gender of each employee and dependent.



In addition to premiums paid by employers, members also pay
co-payments at the time most services are provided.  We believe that co-payments
encourage appropriate utilization of health care services while allowing us to
offer competitive premium rates.  We also believe that the capitation method of
provider compensation encourages physicians to provide only medically necessary
and appropriate care.



Managed Indemnity.



Competition



HMO and Managed
Indemnity.

10

---

Table of Contents

Ratings



Financial strength ratings
are the opinion of the rating agencies and the significance of individual
ratings varies from agency to agency.  Companies with higher ratings generally,
in the opinion of the rating agency, have the strongest capacity for repayment
of debt or payment of claims, while companies at the bottom end of the range
have the weakest capacity.  Rating agencies continually review the financial
performance and condition of insurers. The current financial strength ratings of
Sierra's HMO and health and life insurance subsidiaries and senior convertible
debt are as follows:

|                                                 |  | A.M. Best Company, Inc. |  | Fitch Ratings |  | Standard
    & Poor's Corp.
|------------------------------------------------ |  | ----------------------- |  | ------------- |  | ---------------------------
|                                                 |  |                         |  |               |  |                            
|                                                 |  | Rating                  |  | Ranking       |  | Rating                     
|                                                 |  |                         |  |               |  |                            
|Financial Strength Rating:                       |  |                         |  |               |  |                            
|HMO and
  health and life insurance subsidiaries |  | B++ Very Good           |  | 5th of 16     |  | BBB Good                   
|                                                 |  |                         |  |               |  |                            
|Debt Rating:                                     |  |                         |  |               |  |                            
|Senior
  convertible debentures                  |  | BB Speculative          |  | 12th of 22    |  | BB Speculative             

The financial strength ratings reflect the opinion of each
rating agency on our operating performance and ability to meet obligations to
policyholders and debenture holders, and are not evaluations directed toward the
protection of investors in our common stock or senior convertible
debentures.



Government Regulation and Recent Legislation

HMOs and Managed Indemnity.  Federal and state
governments have enacted statutes that extensively regulate the activities of
HMOs. Among the areas regulated by federal and state law are the scope of
benefits available to members, grievances, appeals, external review of adverse
benefit determinations, prompt payment of claims, premium structure, enrollment
requirements, the relationships between an HMO and its health care providers and
members, licensing and financial condition.  Government concerns regarding
increasing health care costs and quality of care could result in new or
additional state or federal legislation that could impact health care companies,
including HMOs, PPOs and other health insurers.



Government regulation of health care coverage products and
services is a dynamic area of law that varies from jurisdiction to jurisdiction.
Amendments to existing laws and regulations are continually being considered and
interpretation of the existing laws and rules changes from time to time.
Regulatory agencies generally exercise broad discretion in interpreting laws and
promulgating regulations to enforce their interpretations.  Federal MMA
legislation enacted in December 2003, while generally favorable to our business,
may result in increased competition for Medicare beneficiaries and may have a
material adverse effect on our business and results of operations.



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

11

---

Table of Contents

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



In December 2003, President Bush signed into law the MMA,
which, among other changes to Medicare, alters the Medicare+Choice program.
Under the MMA, Medicare+Choice plans, renamed Medicare Advantage plans, received
increased funding from CMS beginning March 2004.  Because of the way in which
the increased funding is calculated, both our non-Social HMO Medicare Advantage
benefit plans and our Social HMO benefit plans received increased funding
beginning March 1, 2004.  The MMA increased our Medicare payment rates by more
than 15%.  The increased funding was used to reduce beneficiary cost sharing,
enhance benefits, and stabilize the provider network.  In addition, some of the
funds were placed into a benefit stabilization fund.



The MMA expands the options that will be available to
Medicare beneficiaries for their health care coverage, including regional PPOs.
Beginning with the 2006 contract year, the payment methodology will change from
the current government price-setting to market-place competition, whereby
private health plans will compete for beneficiaries through a competitive
bidding process.  Nevada has been designated a discrete region and we will be
evaluating the opportunities available to us for 2006 as a result of this
designation.



The MMA establishes a Medicare Part D program which, when it
becomes effective January 1, 2006, will provide beneficiaries under the
traditional fee-for-service Medicare program with coverage for outpatient
prescription drugs, a benefit the beneficiaries don't currently have.   Although
varying in structure, we have to date, included coverage for prescription drugs
in our benefit plans.



Prior to the implementation of Medicare Part D in 2006, the
MMA provides for an interim prescription drug discount card program.  This
program became operational in Spring 2004.  Known as the Medicare Prescription
Drug Discount Card and Transitional Assistance Program, this program is designed
to provide savings for beneficiaries through discounts at retail or through mail
order pharmacies, depending upon the benefit design, until the Medicare Part D
program goes into effect on January 1, 2006.  Medicare beneficiaries who meet
income thresholds are eligible for federal subsidies to help pay for their
prescription drugs under this interim program.  We participate in this program
as an exclusive sponsor for our Medicare members and as a general sponsor for
Medicare fee-for-service members.  Pending the final issuance of the Medicare
Part D rules, we are evaluating the opportunity associated with applying to CMS
to participate as a stand-alone Prescription Drug Program participant.



The MMA also allowed for the implementation of Health Savings
Accounts (HSAs) beginning January 1, 2004.  Not generally available to Medicare
beneficiaries, HSAs are designed for individuals with high-deductible health
plans.  Contributions to the HSAs are permitted up to the applicable plan
deductible, with caps at specific amounts, and are used to pay for qualified
medical expenses.  In addition to allowing for HSA balances to accumulate from
year-to-year, HSAs have tax advantages to employers who contribute on their
employees' behalf and to individuals who contribute themselves.



The MMA also further delayed the "lock-in"
requirement until 2006.  Once fully implemented, "lock-in" will
restrict a Medicare beneficiary's ability to change his or her health care
coverage on a monthly basis as is currently allowed; e.g., from traditional fee-for-service
Medicare to a Medicare Advantage program and back again on a monthly
basis.  The "lock-in" requirement could slow the growth rate of our
Medicare Advantage membership as potential members would have fewer
opportunities to select our plan.

12

---

Table of Contents

We have HMO licenses in Nevada, Texas and Arizona.  Our HMO
operations are subject to regulation by the Nevada Division of Insurance, the
Nevada State Board of Health, the Texas Department of Insurance and the Arizona
Department of Insurance.  In May 2001, we terminated our HMO operations in
Arizona, and in September 2001, we filed a withdrawal plan with the Department
of Insurance in Texas to terminate our Texas HMO operations, effective on April
17, 2002.  As part of the withdrawal plan, we terminated our Texas CMS
Medicare+Choice and Federal Employees Health Benefits Program contracts at the
end of 2001.



Our Nevada HMO is federally qualified under the Federal HMO
Act and is subject to this Act and its regulations.  In order to obtain federal
qualification, an HMO must, among other things, provide its members certain
services on a fixed, prepaid fee basis and set its premium rates in accordance
with certain rating principles established by federal law and regulation.  The
HMO must also have quality assurance programs in place with respect to health
care providers.  Furthermore, an HMO may not refuse to enroll an employee, in
most circumstances, because of a person's health, and may not expel or refuse to
re-enroll individual members because of their health or their need for health
services.



Our managed indemnity health insurance subsidiary is
domiciled and incorporated in California and is licensed in 43 states and the
District of Columbia.  It is subject to licensing and other regulations of the
California Department of Insurance as well as the insurance departments of the
other states in which it operates or holds licenses.



Our HMO and health insurance subsidiary insurance premium
rate increases are subject to various state insurance department approvals or
reviews.



Our Nevada HMO and managed indemnity health insurance
subsidiaries currently maintain a home office and a regional home office,
respectively, in Las Vegas and, accordingly, are eligible for certain premium
tax credits in Nevada.   We intend to take all necessary steps to continue to
comply with eligibility requirements for these credits. The elimination or
reduction of the premium tax credit would have a material adverse effect on our
business and results of operations.



Under the "corporate practice of medicine"
doctrine, in most states, business organizations, other than those authorized to
do so, are prohibited from providing or holding themselves out as providers of
medical care.  Some states, including Nevada, exempt HMOs from this doctrine.
The laws relating to this doctrine are subject to numerous conflicting
interpretations.  Although we seek to structure our operations to comply with
corporate practice of medicine laws in all states in which we operate, there can
be no assurance that, given the varying and uncertain interpretations of these
laws, we would be found to be in compliance with these laws in all states.  A
determination that we are not in compliance with applicable corporate practice
of medicine laws in any state in which we operate could have a material adverse
effect on our business and results of operations if we were unable to
restructure our operations to comply with the laws of that state.



Certain Medicare and Medicaid antifraud and abuse provisions
are codified at 42 U.S.C. Section 1320a-7b(b) (the Anti-kickback Statute) and
Section 1395nn (the Stark Amendments).  Many states have similar anti-kickback
and anti-referral laws.  These statutes prohibit certain business practices and
relationships involving the referral of patients for the provision of health
care items or services under certain circumstances. Violations of the Anti-kickback
Statute and the Stark Amendments may result in criminal penalties,
civil sanctions, fines and possible exclusion from the Medicare, Medicaid and
other federal health care programs.  Similar penalties are provided for
violation of state anti-kickback and anti-referral laws. The U.S. Department of
Health and Human Services (HHS) has issued regulations establishing and defining
"safe harbors" with respect to the Anti-kickback Statute and the Stark
Amendments.  We believe that our business arrangements and operations are in
compliance with the Anti-kickback Statute and the Stark Amendments as defined by
the relevant safe harbors.  However, there can be no assurance that (i)
government officials charged with responsibility for enforcing the prohibitions
of the Anti-kickback Statute and the Stark Amendments or Qui Tam relators
purporting to act on behalf of the Government will not assert that we, or
certain actions we take, are in violation of those statutes; and (ii) such
statutes will ultimately be interpreted by the courts in a manner consistent
with our interpretation.

13

---

Table of Contents

HIPAA contains provisions that impact us and have required
operational changes as various federal departmental regulations required by the
Act have been promulgated.  During 2004, we substantially established the
policies and ongoing procedures to comply with the health information security
rule and we will complete the requirements in advance of the compliance date of
April 20, 2005.  Complying with the HIPAA privacy and security rules requires
ongoing diligence to ensure that appropriate measures are being taken to
maintain the privacy of protected health information.  We believe we have
management processes in place to ensure our ongoing compliance with the HIPAA
privacy and security rules, once effective. Relative to the HIPAA requirements
for standard EDI transactions, to date, we have implemented claims and
enrollment standard transactions with a number of trading partners (e.g.,
providers, clearinghouses and employers).  Relative to the other HIPAA defined
transactions; our trading partners have not pursued the development of these
transactions with us, although we are prepared to implement these transactions
if requested by a covered entity with which we do business.  Ongoing compliance
with the HIPAA privacy and security rules and the transaction standards will be
managed by HHS through a complaint process.  There can be no assurance that a
complaint will not be filed against us or whether there would be any material
impact on our business to resolve the complaint.



In 2003, Congress passed Do Not Call List legislation and the
Federal Trade Commission and the Federal Communications Commission adopted
implementing regulations in 2003 and 2004.  We believe we are in compliance with
the current legislation and regulations and the cost of compliance has been
minimal.



General.  Besides state insurance laws, we are subject
to general business and corporation laws, federal and state securities laws,
consumer protection laws, fair credit reporting acts and other laws regulating
the conduct and operation of our subsidiaries.



In the normal course of business, we may disagree with
various government agencies that regulate our activities on interpretations of
laws and regulations, policy wording and disclosures or other related issues.
These disagreements, if left unresolved, could result in administrative hearings
and/or litigation.  We attempt to resolve all issues with the regulatory
agencies, but are willing to litigate issues where we believe we have a strong
position.  The ultimate outcome of these disagreements could result in sanctions
and/or penalties and fines assessed against us.  Currently, there are no
litigation matters pending with any government agencies.



Deposits. Our HMO and insurance subsidiaries are required
by state regulatory agencies to maintain certain deposits and must also meet
certain net worth and reserve requirements.  The HMO and insurance subsidiaries,
including the discontinued operations, had restricted assets on deposit in
various states totaling $16.8 million at December 31, 2004. The HMO and
insurance subsidiaries must also meet requirements to maintain minimum
stockholders' equity, on a statutory basis, as well as minimum risk-based
capital requirements, which are determined annually.  Additionally, in
conjunction with the exit from the Texas HMO health care market, the Texas
Department of Insurance approved a plan of withdrawal and Texas Health Choice,
L.C. (TXHC) is now required to maintain deposits of $1.5 million and net worth
of at least $3.5 million. We believe we are in material compliance with our
regulatory requirements.



Dividends. Our HMO and insurance company subsidiaries
are restricted by state law as to the amount of dividends or distributions that
can be declared and paid.  Moreover, insurers and HMOs domiciled in Texas,
Nevada and California generally may not pay extraordinary dividends or
distributions without providing the state insurance commissioner with 30 days
prior notice, during which period the commissioner may disapprove the payment.
An "extraordinary dividend or distribution" is generally defined as a
dividend or distribution whose fair market value together with that of the other
dividends or distributions made within the preceding 12 months exceeds the
greater of (i) ten percent of the insurer's surplus as of the preceding December
31; or (ii) net gain from operations of a life insurer, or net income if not a
life insurer, for the 12-month period ending on the preceding December 31.



In addition, our California domiciled insurer may not pay a
dividend without the prior approval of the state insurance commissioner to the
extent the cumulative amount of dividends or distributions paid or proposed

14

---

Table of Contents

to be paid in any year exceeds the amount shown as unassigned funds (reduced by any
unrealized gains included in any such amount) on the insurer's statutory
statement as of the previous December 31.



No prediction can be made as to whether any legislative
proposals relating to dividend rules in the domiciliary states of our
subsidiaries will be made or adopted in the future, whether the insurance
departments of such states will impose either additional restrictions in the
future or a prohibition on the ability of our regulated subsidiaries to declare
and pay dividends or what will be the effect of any such proposals or
restrictions on them.



Employees

We had approximately 2,900
employees as of March 1, 2005.  None of our employees are covered by a
collective bargaining agreement.  We believe that relations with our employees
are good.

Other

Our principal executive offices are located at 2724 North
Tenaya Way, Las Vegas, Nevada 89128, and our telephone number is (702) 242-7000.
Our website is www.sierrahealth.com.  We make available free of charge,
through our website, by phone request or via mail request, our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act as soon as reasonably practicable after we
electronically file such material with or furnish it to the Securities and
Exchange Commission (SEC).



We also make available on our website our Corporate
Governance Guidelines, Code of Ethics for Directors, Code of Ethics, Code of
Conduct for the Chief Executive Officer and Senior Financial Officers,
Nominating and Governance Committee Charter, Compensation Committee Charter and
Audit Committee Charter.  Such information is also available in print free of
charge to stockholders upon request.

Forward-Looking Statements

This annual report on Form 10-K contains "forward-looking
statements" within the meaning of Section 27A of the Securities Act
of 1933 and Section 21E of the Securities Exchange Act of 1934, both as
amended.

The forward-looking statements regarding our business and
results of operations should be considered by our stockholders or any reader of
our business or financial information along with the risk factors discussed
below.  All statements other than statements of historical fact are forward-looking
statements for purposes of federal and state securities laws. The
cautionary statements are made pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, as amended,
and identify important factors that could cause our actual results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to us.  These forward-looking statements are identified by
their use of terms and phrases such as "anticipate,"
"believe," "could,"  "estimate,"
"expect,"  "hope,"  "intend,"  "may,"
"plan,"  "predict,"  "project,"
"seeks," "will," "continue," and other similar
terms and phrases, including references to assumptions.  Such forward-looking
statements may be contained in the sections "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and
"Business" among other places.



Some of the potential issues that could cause our actual
results to differ substantially from our expectations are as follows:

- loss of health care premium revenues due to heightened pricing competition
or other factors;
- inadequate premium revenues due to heightened
competition, miscalculations of underlying health care cost inflation,
utilization and other factors in our rate filings and in underwriting
accounts;

15

---

Table of Contents

- significant reductions in account and member retention;
- inability or delays in making timely changes to health
care benefits to offset the impact of inadequate premium rates;
- loss of Medicare, Medicaid, or large commercial
contracts;
- a reduction in the actual proceeds to be realized from
the note receivable related to the sale of our workers' compensation insurance
business;
- loss of or significant changes in our health care
provider contracts;
- inability or unwillingness of our contracted providers to
provide health care services to our members;
- higher than expected medical costs including utilization
of services;
- the introduction of new medical technologies and
pharmaceuticals;
- higher costs of medical malpractice and other insurance,
increased claims, reduced coverage that increases our risk exposure or the
unavailability of coverage that either affects us or our contracted providers;
- unpaid health care claims and health care costs resulting
from insolvencies of providers with whom we have capitated contracts;
- terrorist acts that directly affect the operation of our
business and/or our providers, customers, policyholders and members;
- a sustained economic recession, especially in
Nevada;
- adverse loss development on health care payables
resulting from unanticipated increases or changes in our claims costs;
- adverse legal judgments that are not covered by insurance
or that indirectly impact our ability to obtain insurance in the future at
reasonable costs;
- significant declines in investment rates;
- inability to implement material regulatory requirements
on a timely, accurate and cost effective basis;
- a ratings downgrade from insurance rating agencies, such
as A.M. Best Company and Fitch Ratings, and from health care quality rating
organizations, such as the NCQA or URAC;
- changes in federal or state regulations and laws or
programs, including but not limited to, health care reform, other initiatives
and taxes;
- inability to maintain or enhance, as required, our
management information systems to ensure, among other things, the timely and
accurate billing of premiums and the timely and accurate payment of claims, in
compliance with applicable governmental and contractual requirements;
- inability to expand our e-business initiatives on a
timely basis and in compliance with government regulations; and
- other factors referenced in this annual report on Form
10-K, including those set forth under the caption "Risk
Factors."

16

---

Table of Contents

Although we believe that the expectations reflected in any of
our forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements.

In making these statements, we disclaim any intention or
obligation to address or update each factor in future filings or communications
regarding our business or results, and we do not undertake to address how any of
these factors may have caused changes to discussions or information contained in
previous filings or communications.  In addition, any of the matters discussed
below may have affected our past results and may affect future results, so that
our actual results may differ materially from those expressed here and in prior
or subsequent communications.



We urge you to review carefully the section below, "Risk
Factors," in Part 1, Item 1 of this 2004 annual report on Form 10-K for a
more complete discussion of the risks associated with an investment in our
securities.

Risk Factors

You should carefully consider the following risks, as well
as the other information contained in this annual report on Form 10-K.  If any
of the following risks actually occur, our business could be adversely affected.
You should refer to the other information set forth in this annual report on
Form 10-K, including the information set forth in "Forward-Looking
Statements," and our consolidated financial statements herein.  The
information specifically set forth under "Forward-Looking Statements"
constitutes additional risks, which, if they actually occur, could adversely
affect our business as well.

The termination of the TRICARE Region 1 contract effective
September 1, 2004, will materially adversely affect our revenues and operating
income for future years.

Starting September 1, 2004, we began the phase-out of our
TRICARE Region 1 contract, which is expected to occur through the second quarter
of 2005.  We negotiated with the Department of Defense phase-out revenues to
perform certain services and processes.  These phase-out revenues will be
significantly less than the revenues SMHS earned under the TRICARE Region 1
contract.  For the year ended December 31, 2004, our Military Health Services
Operations segment accounted for $374.1 million, or 23.7%, of total consolidated
revenues.  For the year ended December 31, 2004, our Military Health Services
Operations segment had operating income of $56.4 million, or 28.5%, of total
consolidated operating income, which included favorable contractual settlements
and other adjustments of approximately $25 million.  Phase-out revenues for the
year 2005 are expected to be approximately $8 million.  In addition, there can
be no assurance that the phase-out revenues will cover all of our costs incurred
during this period.  As a result, our failure to win the competitive procurement
for the T-Nex contract will have a material adverse effect on our revenues and
operating income for future years.



The payment methodology for our Social HMO Medicare program
is resulting in a lower premium rate increase.  In addition, the Social HMO
program is expected to be terminated on December 31, 2007.  If we are unable to
compensate by reducing costs, our financial results would be materially
affected.



Our Medicare program accounted for approximately 29% of
our 2004 consolidated revenues from continuing operations.



Effective January 2004, CMS adopted a new risk adjustment
payment methodology for Medicare beneficiaries who are enrolled in managed care
programs, including the Social HMO.  For Social HMO members, the new methodology
includes a frailty adjuster that uses measures of functional impairment to
predict expenditures.  CMS is transitioning to the new payment methodology on a
graduated basis from 2004 through 2007.  In 2004, we were paid 90% based on the
previous payment approach and 10% based on the new approach.  Excluding the
effects of MMA, the new payment methodology reduced our rate increase by 60
basis points.  The Social HMO program has been administratively extended by CMS
but will

17

---

Table of Contents

phase-out at the end of 2007.  For 2005, 2006 and 2007, we will be paid
70%, 50% and 25%, based on the previous payment approach and 30%, 50% and 75%,
based on the new approach, respectively.  The extension of the Social HMO
program through 2007 will serve as a transition period so that we can convert to
a Medicare Advantage plan in 2008.  Based on the most recent information
available to us, our 2005 annual Medicare increase, before the effect of the new
payment approach and the MMA, would have been 7.9%. The new payment approach
reduced this to approximately 4% although the actual increase we will receive
over the fourth quarter of 2004 will be approximately 2% as the increased MMA
funds were received over the last 10 months of the year and included a
proportionate share for January and February 2004.



Every year, we receive adjustments to the amount CMS pays us
for the services we provide to our Medicare enrollees and we adjust the benefits
we provide to Medicare enrollees to reflect the changing CMS payments so that we
can maintain our operating margin.  If we are unable to adjust benefits we
provide to Medicare enrollees to reflect changes in CMS payments and the
associated cost of providing benefits so that we can attempt to maintain our
operating margin, or if our contract with CMS were to be terminated, our
financial results would be materially adversely impacted.



As a health care company, we and our health care providers
may be subject to increased malpractice costs and claims, which could adversely
affect our business.



We and our health care providers are subject to
malpractice claims.  We require our health care providers to maintain
malpractice insurance and we set up reserves with respect to potential
malpractice claims.  While we do not believe that our uninsured exposure to
liabilities resulting from malpractice claims is material, there may in the
future be significant malpractice liabilities for which we do not have adequate
reserves or insurance coverage, and this insurance may not continue to be
available at all or on commercially reasonable terms.  In addition, punitive
damage awards are generally not covered by insurance.



If we fail to qualify for the Nevada home office tax credit, our premium
tax costs will increase.

Under existing Nevada law, a 50% premium tax credit is
generally available to HMOs and insurers that own and substantially occupy home
offices or regional home offices within Nevada. In connection with the
settlement of a prior dispute concerning the premium tax credit, the Nevada
Department of Insurance acknowledged in November 1993 that our HMO and insurance
subsidiaries met the statutory requirements to qualify for this tax credit.  We
intend to take all necessary steps to continue to comply with these
requirements.  However, the elimination or reduction of the premium tax credit,
or our failure to qualify for the premium tax credit, would substantially
increase our premium tax burden and, and our financial results would be
materially adversely impacted.



Our ability to obtain and maintain favorable group benefit
agreements with employer groups affects our profitability.



Our ability to obtain and maintain favorable group
benefit agreements with employer groups affects our profitability.  The
agreements are generally renewable on an annual basis but are subject to
termination on 60 days prior notice.  For the fiscal year ended December 31,
2004, our six largest HMO employer groups were, in the aggregate, responsible
for less than 10% of our total revenues.  Although none of our employer groups
accounted for more than 3% of our total revenues during that period, the loss of
one or more of the larger employer groups could, if not replaced with similar
membership, have a material adverse effect upon our business.  We have generally
been successful in retaining these employer groups in Nevada.  However, there
can be no assurance that we will be able to renew our agreements with our
employer groups in the future or that we will not experience a decline in
enrollment within our employer groups.

18

---

Table of Contents

There can be no assurance that we will be able to maintain and enhance our
information systems.



Our information systems are a vital and integral part of our
operations.  We depend on our information systems to enable us to bill and
collect premium revenues, process and pay claims and other operating expenses,
and provide effective and efficient services to our customers.  We also depend
on our information systems to provide us with accurate and complete data to
enable us to adequately price our products and services and report our financial
results.  We are required to commit significant ongoing resources to maintain
and enhance our existing information systems as well as develop new systems to
keep pace with continuing changes in technologies, industry practices,
regulatory standards and changing customer preferences.

In 2004, we updated our data center disaster recovery plan
and we completed a business continuity plan. We completed the rollout of an
electronic medical record system and the expansion of an automated care
management system to support the coordination of care for seniors enrolled in
our Social HMO program. We believe we are in compliance with HIPAA as required
by the Privacy Rule and the Standards for Code Sets and Electronic Transactions.
Other security and controls work was completed to comply with Section 404 of the
Sarbanes-Oxley Act of 2002.

If the information we rely upon to run our businesses was
found to be inaccurate or unreliable or if we fail to maintain effectively our
information systems and data integrity, we could lose existing customers, have
difficulty in attracting new customers, have problems in determining medical
cost estimates and establishing appropriate pricing, have customer and physician
and other health care provider disputes, have regulatory problems, have
increases in operating expenses or suffer other adverse consequences.

We operate in a highly competitive environment.

We operate in a highly competitive environment.  Our
major competition is from self-funded employer plans, PPO products, other HMOs
and traditional indemnity carriers, such as Aetna and PacifiCare.  Many of our
competitors have substantially larger total enrollments, greater financial
resources and offer a broader range of products.  Additional competitors with
greater financial resources may enter our markets in the future. We believe that
the most important competitive factors are the delivery of reasonably priced,
quality medical benefits to members and the adequacy and availability of health
care delivery services and facilities.  We depend on a large PPO network and
flexible benefit plans to attract new members.  Competitive pressures and other
factors may result in reduced membership levels.  It is impractical to attempt
to quantify the financial impact of an unspecified reduction in membership.
However, we believe any reductions in our membership levels that are not
compensated by reductions in operating expenses could materially affect our
business and results of operations.

Our results of operations could be adversely affected by
understatements in our actual liabilities caused by understatements in our
actuarial estimates of incurred but not reported health care claims.



We estimate the amount of our reserves for incurred but not
reported (IBNR) claims primarily using standard actuarial methodologies based
upon historical data.  These methodologies include, among other factors, the
average interval between the date services are rendered and the date claims are
received and/or paid, denied claims activity, disputed claims activity,
utilization, seasonality patterns and changes in membership.  The estimates for
submitted claims and IBNR claims liabilities are made on an accrual basis and
adjusted in future periods as required.  These estimates could understate or
overstate our actual liability for claims and benefits payable.  For example,
during 2004, our actuarial best estimate of the liability recorded at December
31, 2003 decreased approximately $11.4 million.  This is compared to a decrease
of approximately $14.0 million in the liability recorded at December 31, 2002
during 2003.  Any increases to prior estimates could adversely affect results of
operations in future periods.  In addition, the premium pricing of our health
care plans take into consideration past historical cost trends.  If our actual
liability for claims and benefits are higher than our prior recorded estimates,
our business and results of operations in future

19

---

Table of Contents

periods could be adversely
impacted.

Our failure to comply with "corporate practice of
medicine" laws in states in which we operate could result in our being
unable to practice medicine in that state and possibly lead to penalties and/or
higher medical expenses.

Under the "corporate practice of medicine"
doctrine, in most states, business organizations, other than those authorized to
do so, are prohibited from providing, or holding themselves out as providers of,
medical care.  Some states, including Nevada, exempt HMOs from this doctrine.
The laws relating to this doctrine are subject to numerous conflicting
interpretations.  Although we seek to structure our operations to comply with
corporate practice of medicine laws in all states in which we operate, there can
be no assurance that, given the varying and uncertain interpretations of these
laws, we would be found in compliance with these laws in all states.  A
determination that our medical provider subsidiary, SMA, is not exempt and is
not in compliance with applicable corporate practice of medicine laws in Nevada
could result in SMA being unable to practice medicine in Nevada and possibly
lead to penalties and/or higher medical expenses.

At December 31, 2004, almost 75% of our southern Nevada HMO
health care members chose one of our SMA physicians as their primary care
provider. A determination that SMA is not in compliance with applicable
corporate practice of medicine laws in Nevada could require that we divest our
ownership interest in or dissolve SMA.  Alternatively, we may be required to
expand our network of independent contracted providers, all of which could lead
to a disruption in our provider network, member dissatisfaction and ultimately
higher medical expenses for our HMO and health care insurance subsidiaries.

We issued $115.0 million of senior convertible debentures,
which we may not be able to repay in cash.

In March 2003, we issued $115.0 million aggregate
principal amount of 21⁄4% senior convertible debentures due March 15, 2023.  The
debentures pay interest, which is due semi-annually on March 15 and September 15
of each year.  Each $1,000 principal amount of debentures is convertible, at the
option of the holders, into 54.6747 shares of Sierra Health Services, Inc.,
common stock prior to March 15, 2023 if: (i) the market price of our common
stock for at least 20 trading days in a period of 30 consecutive trading days
ending on the last trading day of the preceding fiscal quarter exceeds 120% of
the conversion price per share of our common stock; (ii) the debentures are
called for redemption; (iii) there is an event of default with respect to the
debentures; or (iv) specified corporate transactions have occurred.  Beginning
December 2003 and for each subsequent period, the market price of our common
stock has exceeded 120% of the conversion price for at least 20 trading days in
a period of 30 consecutive trading days.  The conversion rate is subject to
certain adjustments.  This conversion rate initially represents a conversion
price of $18.29 per share. Holders of the debentures may require us to
repurchase all or a portion of their debentures on March 15 in 2008, 2013 and
2018 or upon certain corporate events including a change in control.  In either
case, we may choose to pay the purchase price of such debentures in cash or
common stock or a combination of cash and common stock.  We may not have enough
cash on hand or have the ability to access cash to pay the debentures if
presented or at maturity. We may redeem all or some of the debentures on or
after March 20, 2008 for cash.



Our debt levels may limit our flexibility in obtaining
additional financing and in pursuing other business opportunities.



At December 31, 2004, we had $125.5 million of
indebtedness on a consolidated basis.  This level of indebtedness will have
several important effects on our future operations, including our ability to
obtain additional financing for working capital, capital expenditures,
acquisitions, general corporate and other purposes.

Our ability to meet our debt service obligations and to
reduce our total indebtedness depends upon our future performance, which will be
subject to general economic conditions, industry cycles and financial,

20

---

Table of Contents

business
and other factors affecting our operations, many of which are beyond our
control.

Our senior secured credit facility imposes significant
operating and financial restrictions on us.



We entered into a revolving credit facility on March 3, 2003
and at December 31, 2004, we had $10.0 million in outstanding borrowings on it.
The amended credit agreement provides us with a revolving credit facility of
$100.0 million and is secured by guarantees by certain of our subsidiaries and a
first priority perfected security interest in (i) all the capital stock of each
of our unregulated, material domestic subsidiaries (direct or indirect) as well
as all of the capital stock of certain regulated, material domestic
subsidiaries; and (ii) all other present and future assets and properties of
ours and those of our subsidiaries that guarantee our credit agreement
obligations (including, without limitation, accounts receivable, inventory, real
property, equipment, contracts, trademarks, copyrights, patents, license rights
and general intangibles) other than cash and cash equivalents, subject, in each
case, to the exclusion of the capital stock of CII and certain  other
exclusions.



The revolving credit facility restricts our ability and the
ability of our subsidiaries to dispose of assets, incur indebtedness, incur
other liens, make investments, loans or advances, make acquisitions, engage in
mergers or consolidations, or make capital expenditures and otherwise restrict
certain corporate activities. These covenants may prevent us from pursuing
certain business opportunities and taking certain actions. In addition, we are
required to comply with specified financial ratios as set forth in the credit
agreement.  A failure to comply with these covenants would be an event of
default under the credit agreement.  The amended revolving credit facility
matures on December 31, 2009.  There is no assurance that we will be able to
successfully refinance or pay any outstanding indebtedness when it matures.

We depend on our management for our success and the loss
of our founder, Chairman of the Board and Chief Executive Officer, or other key
executives, could have a material adverse effect on our business.

Our success has been dependent to a large extent upon the
efforts of Anthony M. Marlon, M.D., our founder, Chairman of the Board and Chief
Executive Officer, who has an employment agreement with us. Although we believe
that the development of our management staff has made us less dependent on
Dr. Marlon, the loss of Dr. Marlon or other key executives could still
have a material adverse effect on our business.

Terrorist attacks, such as the attacks that occurred in
New York and Washington, D.C. on September 11, 2001, and other attacks, acts of
war or military actions, such as military actions in Iraq or elsewhere, may
adversely affect our operating results and financial condition.

The attacks of September 11, 2001 have contributed to major
instability in the U.S. and other financial markets.  These terrorist attacks,
the military response and future developments, or other military actions such as
the military actions in Iraq or elsewhere, may adversely affect prevailing
economic conditions and the insurance and reinsurance markets.  These
developments, depending on their magnitude, could have a material adverse effect
on our operating results and financial condition.

Our business is subject to substantial government
regulation and the impact of this regulation may increase our exposure to
lawsuits and/or penalties or other regulatory actions for non-compliance or may
otherwise adversely affect our business.

The health care industry in general, and HMOs and health
insurance companies in particular, are subject to substantial federal and state
government regulation.  These regulations, which may increase our exposure to
lawsuits and/or penalties or other regulatory actions for non-compliance,
include, but are not limited to cash reserves; minimum net worth; solvency
standards; licensing requirements; approval of policy language and benefits;
claims payment practices; mandatory products and benefits; provider compensation
arrangements; patient confidentiality; premium rates; changes of control and
related party transaction approval requirements; medical management tools;
dividend payments; investment and risk restrictions; and periodic

21

---

Table of Contents

examinations
by state and federal agencies.

As a result, a portion of our HMOs' and insurance companies'
cash is essentially restricted by various state regulatory or other requirements
limiting certain of our subsidiaries' cash to use within their current
operations.  State and federal government authorities are continually
considering changes to laws and regulations that may affect us.  Additionally,
legislators in the states in which we operate continue to face pressure to cut
back services and programs in ways that could adversely affect us.  Many states
in which we operate are currently considering regulations relating to mandatory
benefits, provider compensation, disclosure and composition of physician
networks.  If such regulations were adopted by any of the states in which we
operate, our business could be materially adversely affected.

As a result of the continued escalation of health care costs
and the inability of many individuals to obtain health care insurance, numerous
proposals relating to health care reform have been or may be introduced in the
United States Congress and state legislatures.  Any proposals affecting
underwriting practices, limiting rate increases, requiring new or additional
benefits or affecting contracting arrangements (including proposals to require
HMOs and PPOs to accept any health care providers willing to abide by an HMO's
or PPO's contract terms), may make it more difficult for us to control medical
costs and could have a material adverse effect on our business.

In addition to applicable laws and regulations, we are
subject to various audits, investigations and enforcement actions.  These
include possible government actions relating to ERISA, which regulates insured
and self-insured health coverage plans offered by employers; FEHBP, CMS, which
regulates Medicare and Medicaid programs; federal and state fraud and abuse
laws; and laws relating to utilization management and the delivery of health
care and the timeliness of payment or reimbursement.  Any such government action
could result in assessment of damages, civil or criminal fines or penalties, or
other sanctions, including exclusion from participation in government programs.
In addition, disclosure of any adverse investigation, audit results or sanctions
could negatively affect our reputation in various markets and make it more
difficult for us to sell our products and services.

We may not realize the total amount of the net sales proceeds
from our sale of the workers' compensation insurance operations.



Effective March 31, 2004, we sold our workers' compensation
insurance subsidiaries, consisting of California Indemnity and its wholly-owned
insurance subsidiaries. The sales proceeds included a note receivable, which is
payable in 2010 and is subject to adjustment based upon the loss and allocated
loss adjustment expense development from the closing date through December 31,
2009.  Any adjustments due to adverse loss and allocated loss adjustment expense
development would be included in continuing operations.  Factors such as
reinsurers failing to honor their obligations to the workers' compensation
subsidiaries, economic recessions and the resulting higher unemployment rates,
over utilization of medical treatments, and the effect of new legislation or
regulations could affect the subsidiaries' loss and allocated loss adjustment
expense development. Our sold workers' compensation insurance subsidiaries have
had net adverse loss development occur in each of the past years 1999 to 2004.
For the years ended December 31, 2002 and 2003, we recorded net adverse loss
development of $24.0 million and $16.9 million related to prior periods,
respectively. At December 31, 2004, based on actuarially determined reserve
analyses, we established a valuation allowance of $15.0 million on the note
receivable.  In addition, effective with the close of the sale, the workers'
compensation claims were out-sourced to an independent third party claims
administrator (TPA).  Part of the TPA's compensation is subject to satisfactory
adherence to certain agreed upon claims administration processes and procedures.
While we will audit the claims handling performance of the TPA, we cannot be
certain that all of the claims will be administered in the most cost effective
manner, which could result in adverse loss development.  There is no assurance
that we will actually realize or be able to collect the note receivable, as
adjusted.

22

---

Table of Contents

We are obligated to perform certain services in connection
with the sale of the workers' compensation insurance operations and the accrual
for the estimated contractual funding shortfall may be insufficient, which could
result in a material adverse effect to our financial results.

The sale of the workers' compensation insurance operations
require us to perform, or be responsible for the performance of, certain
transition services through December 31, 2009.  This includes claims
administration, processing policy transactions, premium collections and other
services related to insurance operations.  We receive a limited amount of funds
to perform these services from Cal Indemnity and we accrued additional
liabilities for the projected shortfall in funding. If the amount we accrued for
the contractual funding shortfall is understated, our financial results could be
materially adversely affected.

ITEM 2. PROPERTIES

We own approximately 27,000
square feet of space in Las Vegas, Nevada, which houses our in-house print shop
operations and information systems data center.  We lease office and clinical
space in Nevada totaling approximately 335,000 and 412,000 square feet,
respectively, with the majority of the lease agreements running through January
2016. HPN and SHL own a 134,000 square foot administrative building as their Las
Vegas headquarters, which serves as the home office and regional home office for
our Nevada HMO and health insurance subsidiaries, respectively.  We also own
several parcels of land in Las Vegas which we plan to use to build three new
medical facilities over the next few years.



Cal Indemnity subleases space from Sierra as well as
approximately 31,000 square feet of additional leased office space in California
with some lease agreements running through 2008.  Sierra was required to assume
all outstanding lease agreements upon the sale of Cal Indemnity.



We lease approximately 48,000 square feet of office space in
Baltimore, Maryland for the SMHS administrative headquarters.  Of the current
48,000 square feet of leased space, 35,000 is scheduled for termination on March
31, 2005, with the remaining space leased through 2008.  SMHS is attempting to
sublease the remaining 13,000 square feet which will be vacant at the completion
of the phase-out period.



On March 15, 2004, SMHS entered into a lease assignment
agreement relative to 18,700 square feet of one of its administrative locations.
The agreement assigns the remainder of the lease term, which expires September
30, 2012.  Under the assignment, SMHS remains contingently liable should the new
tenant not perform under its obligation.  At December 31, 2004, the future lease
payments due under the lease agreement total $5.2 million.  SMHS did not record
a liability for its obligation under this agreement as the likelihood of non-performance
is considered remote at this time and SMHS would have the ability to
sublease or enter into another assignment arrangement if required to perform on
this obligation.



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



ITEM 3. LEGAL PROCEEDINGS



Although Sierra has not been sued, we were identified in discovery submissions in pending class
action litigation against major managed care companies, as having allegedly participated in an
unlawful conspiracy to improperly deny, diminish or delay payments to physicians.  In Re:
Managed Care Litigation, MDL No. 1334 (S.D.Fl.).

Beginning in 1999, a series of class action lawsuits were filed against many major firms in the
health benefits business. A multi-district litigation panel has consolidated for pre-trial discovery
some of these cases in the United States District Court for the Southern District of Florida, Miami
Division. In the lead case, known as Shane, the amended complaint alleges multiple violations
under the Racketeer Influenced and Corrupt Organizations Act (RICO). The suit seeks injunctive,
compensatory and equitable relief as well as restitution, costs, fees and interest payments.
Discovery remains ongoing.  On April 7, 2003, the United

23

---

Table of Contents

States Supreme Court determined that
certain claims against certain defendants should be arbitrated.  Subsequent lower court rulings
have further resolved which of the plaintiffs' claims are subject to arbitration.  In 2004, the Court
of Appeals for the Eleventh Circuit upheld a district court ruling certifying a plaintiff class in the
Shane case.  The district court has recently determined to bifurcate the case, holding a trial
phase limited to liability issues, and a second, if necessary, regarding damages.  A trial date has
been set for September 2005. Plaintiffs in the Shane proceeding have stated their intention to
introduce evidence at trial concerning Sierra and other parties not named as defendants in the
litigation.  Two of the defendants, Aetna Inc. and Cigna Corporation, have entered into settlement
agreements, which have been approved by the district court.



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



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



None

24

---

Table of Contents

PART II

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



Market Information



Our common stock, par value $.005 per share (the "Common
Stock"), has been listed on the New York Stock Exchange under the symbol
SIE since April 26, 1994 and, prior to that, had been listed on the American
Stock Exchange since our initial public offering on April 11, 1985.  The
following table sets forth the high and low closing prices for the Common Stock
for each quarter of 2004 and 2003.

|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|Period         |  | High |       | Low
|2004           |  |      |       |     |   |      
|First quarter  |  | $    | 36.40 |     | $ | 25.10
|Second quarter |  |      | 47.15 |     |   | 35.21
|Third quarter  |  |      | 47.93 |     |   | 39.81
|Fourth quarter |  |      | 57.85 |     |   | 41.30
|               |  |     
|2003           |  |      |       |     |   |      
|First quarter  |  | $    | 14.75 |     | $ | 11.75
|Second quarter |  |      | 21.67 |     |   | 12.24
|Third quarter  |  |      | 27.09 |     |   | 19.15
|Fourth quarter |  |      | 29.42 |     |   | 21.25

On March 9, 2005, the closing market price of Common Stock
was $62.48 per share.



Share Repurchases

|                                             |  |                                      |  |                             |  |                                                                                  |  |                                                                               |       |                                                                                         |        
|-------------------------------------------- |  | ------------------------------------ |  | --------------------------- |  | -------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------- | ----- | --------------------------------------------------------------------------------------- | -------
|(In thousands, except per share data) Period |  | Total NumberOf SharesRepurchased (1) |  | Average PricePaid Per Share |  | Total Number OfShares Purchased AsPart
      Of PubliclyAnnounced Plan OrProgram |  | MaximumNumber OfShares That
      May Yet BePurchased UnderThe Plan
      (2) |       | ApproximateDollar Value OfShares That
      May Yet BePurchased UnderThe Plan
      (3)
|Beginning shares available to be purchased   |  |                                      |  |                             |  |                                                                                  |  |                                                                               | 2,270 |                                                                                         |       
|January 1, 2004 - January 31, 2004           |  |                                     |  |                            |  |                                                                                 |  |                                                                               | 2,270 |                                                                                         |       
|February 1, 2004 - February 29, 2004 (4)     |  | 663                                  |  | $31.86                      |  | 663                                                                              |  |                                                                               | 1,607 |                                                                                         |       
|March 1, 2004 - March 31, 2004               |  | 317                                  |  | 34.19                       |  | 317                                                                              |  |                                                                               | 1,290 |                                                                                         |       
|April 1, 2004 - April 30, 2004               |  | 16                                   |  | 34.91                       |  | 16                                                                               |  |                                                                               | 1,274 |                                                                                         |       
|May 1, 2004 - May 31, 2004                   |  | 590                                  |  | 39.20                       |  | 590                                                                              |  |                                                                               | 684   |                                                                                         | $70,000
|June 1, 2004 - June 30, 2004 (5)             |  | 628                                  |  | 43.20                       |  | 628                                                                              |  |                                                                               | 56    |                                                                                         | 70,000 
|July 1, 2004 - July 31, 2004                 |  | 95                                   |  | 43.46                       |  | 95                                                                               |  |                                                                               |      |                                                                                         | 68,334 
|August 1, 2004 - August 31, 2004             |  | 610                                  |  | 41.62                       |  | 610                                                                              |  |                                                                               |      |                                                                                         | 42,963 
|September 1, 2004 - September 30, 2004       |  |                                     |  |                            |  |                                                                                 |  |                                                                               |      |                                                                                         | 42,963 
|October 1, 2004 - October 31, 2004           |  | 330                                  |  | 45.14                       |  | 330                                                                              |  |                                                                               |      |                                                                                         | 28,076 
|November 1, 2004 - November 30, 2004         |  | 128                                  |  | 47.74                       |  | 128                                                                              |  |                                                                               |      |                                                                                         | 21,964 
|December 1, 2004 - December 31, 2004         |  | 9                                    |  | 54.79                       |  | 9                                                                                |  |                                                                               |      |                                                                                         | 71,444 

|(1) | Certain repurchases were made pursuant to a 10b-5
plan.
|--- | -------------------------------------------------------

|(2) | On
      October 28, 2003, the Company announced that its Board of Directors had
      authorized the Company to purchase an additional 3.0 million shares of its
      common stock in addition to the 4.6 million shares that had previously
      been authorized. The repurchase program had no stated expiration date.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

25

---

Table of Contents

|(3) | On
      May 20, 2004, the Company's Board of Directors authorized the Company to
      purchase $70.0 million of its common stock.  On December 7, 2004, the Company's Board of Directors authorized
      the Company to purchase an additional $50.0 million of its common stock.
      The repurchase program has no stated expiration date, and commenced after
      the previously authorized share repurchase was completed.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes 500,000 shares the Company purchased from its
CEO at $32.00 per share.
|--- | -------------------------------------------------------------------------------

|(5) | Includes 500,000 shares the Company purchased from its
CEO at $43.20 per share.
|--- | -------------------------------------------------------------------------------

Holders



The number of record holders of Common Stock at March 1,
2005 was 515.  Based upon information available to us, we believe there are
approximately 22,000 beneficial holders of the Common Stock.



Dividends



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

26

---

Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

The table below presents our selected consolidated financial
information for the years indicated.  The table should be read in conjunction
with the Consolidated Financial Statements and the related Notes thereto,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other information which appears elsewhere in this 2004 Form
10-K.  The selected consolidated financial data below has been derived from our
audited Consolidated Financial Statements.

|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|---------------------------------------------------------------------------- |  | ------------------------ | ------------------------------------- | - | ---- | - | --------- | ---- |  | -------- | --------- | -------- | - | --------- | - | - | --------- | -
|                                                                             |  | Years Ended December 31, |                                      
|                                                                             |  | 2004                     |                                       |   | 2003 |   |           | 2002 |  | 2001 (3) |           | 2000 (3) |  
|                                                                             |  |                          | (In thousands, except per share data) |  
|Statement
  Of Operations Data:                                              |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Operating Revenues:                                                          |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Medical premiums                                                             |  | $                        | 1,131,147                             |   |      | $ | 962,176   |      |  | $        | 857,741   |          | $ | 718,994   |   | $ | 637,769   |  
|Military contract revenues                                                   |  |                          | 372,608                               |   |      |   | 465,313   |      |  |          | 373,589   |          |   | 338,918   |   |   | 330,352   |  
|Professional fees                                                            |  |                          | 35,115                                |   |      |   | 37,367    |      |  |          | 30,923    |          |   | 28,985    |   |   | 33,102    |  
|Investment and other revenues                                                |  |                          | 36,565                                |   |      |   | 20,223    |      |  |          | 16,382    |          |   | 16,603    |   |   | 18,393    |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Total                                                                        |  |                          | 1,575,435                             |   |      |   | 1,485,079 |      |  |          | 1,278,635 |          |   | 1,103,500 |   |   | 1,019,616 |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Operating Expenses:                                                          |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Medical expenses                                                             |  |                          | 878,500                               |   |      |   | 762,865   |      |  |          | 712,290   |          |   | 608,757   |   |   | 576,738   |  
|Military contract expenses                                                   |  |                          | 317,699                               |   |      |   | 452,554   |      |  |          | 360,375   |          |   | 331,621   |   |   | 323,265   |  
|General and administrative expenses                                          |  |                          | 181,434                               |   |      |   | 137,263   |      |  |          | 133,979   |          |   | 122,623   |   |   | 112,220   |  
|Asset impairment, restructuring, reorganization and other costs (1)          |  |                          |                                      |   |      |   |          |      |  |          |          |          |   |          |   |   | 30,836    |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Total                                                                        |  |                          | 1,377,633                             |   |      |   | 1,352,682 |      |  |          | 1,206,644 |          |   | 1,063,001 |   |   | 1,043,059 |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Operating Income (Loss) From Continuing Operations                           |  |                          | 197,802                               |   |      |   | 132,397   |      |  |          | 71,991    |          |   | 40,499    |   |   | (23,443   | )
|Interest expense                                                             |  |                          | (4,684                                | ) |      |   | (5,491    | )    |  |          | (7,650    | )        |   | (15,738   | ) |   | (17,865   | )
|Other income (expense), net                                                  |  |                          | 104                                   |   |      |   | (223      | )    |  |          | 55        |          |   | (2,119    | ) |   | 1,084     |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Income (Loss) From Continuing Operations Before Income Taxes                 |  |                          | 193,222                               |   |      |   | 126,683   |      |  |          | 64,396    |          |   | 22,642    |   |   | (40,224   | )
|(Provision) benefit for income taxes                                         |  |                          | (70,096                               | ) |      |   | (44,565   | )    |  |          | (22,088   | )        |   | (7,161    | ) |   | 9,205     |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Income (Loss) From Continuing Operations                                     |  |                          | 123,126                               |   |      |   | 82,118    |      |  |          | 42,308    |          |   | 15,481    |   |   | (31,019   | )
|Loss from discontinued operations                                            |  |                          | (389                                  | ) |      |   | (19,792   | )    |  |          | (5,860    | )        |   | (11,995   | ) |   | (168,896  | )
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Net Income (Loss)                                                            |  | $                        | 122,737                               |   |      | $ | 62,326    |      |  | $        | 36,448    |          | $ | 3,486     |   | $ | (199,915  | )
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Earnings Per Common Share:                                                   |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Income
  (loss) from continuing operations                                   |  | $                        | 4.62                                  |   |      | $ | 2.93      |      |  | $        | 1.47      |          | $ | 0.56      |   | $ | (1.15     | )
|Loss from discontinued operations                                            |  |                          | (0.01                                 | ) |      |   | (0.71     | )    |  |          | (0.20     | )        |   | (0.43     | ) |   | (6.22     | )
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Net Income (Loss)                                                            |  | $                        | 4.61                                  |   |      | $ | 2.22      |      |  | $        | 1.27      |          | $ | 0.13      |   | $ | (7.37     | )
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Weighted average number of common shares outstanding                         |  |                          | 26,631                                |   |      |   | 28,053    |      |  |          | 28,756    |          |   | 27,685    |   |   | 27,142    |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Earnings Per Common Share Assuming Dilution:
  (2)                           |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Income
  (loss) from continuing operations                                   |  | $                        | 3.58                                  |   |      | $ | 2.34      |      |  | $        | 1.36      |          | $ | 0.54      |   | $ | (1.15     | )
|Loss from discontinued operations                                            |  |                          | (0.01                                 | ) |      |   | (0.55     | )    |  |          | (0.19     | )        |   | (0.42     | ) |   | (6.22     | )
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Net Income (Loss)                                                            |  | $                        | 3.57                                  |   |      | $ | 1.79      |      |  | $        | 1.17      |          | $ | 0.12      |   | $ | (7.37     | )
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  
|Weighted average number of common shares outstanding assuming dilution
  (2) |  |                          | 34,822                                |   |      |   | 35,633    |      |  |          | 31,141    |          |   | 28,509    |   |   | 27,142    |  
|                                                                             |  |                          |                                       |   |      |   |           |      |  |          |           |          |   |           |   |   |           |  

27

---

Table of Contents



|                                          |  |              |                |  |      |   |           |      |  |      |           |      |   |           |  |   |           | 
|----------------------------------------- |  | ------------ | -------------- |  | ---- | - | --------- | ---- |  | ---- | --------- | ---- | - | --------- |  | - | --------- | 
|                                          |  | December 31, |               
|                                          |  | 2004         |                |  | 2003 |   |           | 2002 |  | 2001 |           | 2000 |  
|                                          |  |              | (In thousands)
|Balance Sheet Data:                       |  |              |               
|Working
  capital                         |  | $            | 152,666        |  |      | $ | 171,652   |      |  | $    | 122,252   |      | $ | 65,986    |  | $ | 46,201    | 
|Total
  assets                            |  |              | 689,780        |  |      |   | 1,134,121 |      |  |      | 1,065,966 |      |   | 1,064,846 |  |   | 1,162,773 | 
|Long-term
  debt (net of current portion) |  |              | 125,395        |  |      |   | 116,645   |      |  |      | 60,710    |      |   | 163,993   |  |   | 224,970   | 
|Cash
  dividends
  per common share       |  |              | none           |  |      |   | none      |      |  |      | none      |      |   | none      |  |   | none      | 
|Stockholders'
  equity                    |  |              | 201,697        |  |      |   | 150,764   |      |  |      | 156,565   |      |   | 96,519    |  |   | 90,473    | 

|
|
|
|
|

---

Ratio of Earnings to Fixed Charges



The ratio of earnings to fixed charges for the periods shown
has been computed by dividing earnings available for fixed charges (income from
continuing operations before income taxes plus fixed charges including
capitalized interest) by fixed charges (interest expense including capitalized
interest).  Interest expense includes the portion of operating rental expense,
which we believe is representative of the interest component of rental
expense.

|                                                               |  |                          |                                   |  |      |   |         |      |  |      |        |      |   |        |  |   |         |  
|-------------------------------------------------------------- |  | ------------------------ | --------------------------------- |  | ---- | - | ------- | ---- |  | ---- | ------ | ---- | - | ------ |  | - | ------- | -
|                                                               |  | Years Ended December 31, |                                  
|                                                               |  | 2004                     |                                   |  | 2003 |   |         | 2002 |  | 2001 |        | 2000 |  
|                                                               |  |                          | (In thousands, except ratio data)
|Income
  (loss) from continuing operations before income taxes |  | $                        | 193,222                           |  |      | $ | 126,683 |      |  | $    | 64,396 |      | $ | 22,642 |  | $ | (40,224 | )
|                                                               |  |                          |                                   |  |      |   |         |      |  |      |        |      |   |        |  |   |         |  
|Fixed Charges:                                                 |  |                          |                                   | 
|Interest
  expense (including capitalized interest)            |  |                          | 4,698                             |  |      |   | 5,506   |      |  |      | 7,700  |      |   | 15,767 |  |   | 17,932  |  
|Interest
  relating to rental expense (1)                      |  |                          | 7,747                             |  |      |   | 6,795   |      |  |      | 5,205  |      |   | 2,609  |  |   | 2,387   |  
|                                                               |  |                          |                                   |  |      |   |         |      |  |      |        |      |   |        |  |   |         |  
|Total Fixed Charges                                            |  |                          | 12,445                            |  |      |   | 12,301  |      |  |      | 12,905 |      |   | 18,376 |  |   | 20,319  |  
|                                                               |  |                          |                                   |  |      |   |         |      |  |      |        |      |   |        |  |   |         |  
|Earnings Available
  For Fixed Charges                         |  | $                        | 205,667                           |  |      | $ | 138,984 |      |  | $    | 77,301 |      | $ | 41,018 |  | $ | (19,905 | )
|                                                               |  |                          |                                   |  |      |   |         |      |  |      |        |      |   |        |  |   |         |  
|Ratio
  Of Earnings To Fixed Charges (2)                       |  |                          | 16.53                             |  |      |   | 11.30   |      |  |      | 5.99   |      |   | 2.23   |  |   |        |  

|
|
|
|

---

28

---

Table of Contents

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

ITEM 7.



The following discussion and analysis provides information
which management believes is relevant for an assessment and understanding of our
consolidated financial condition and results of operations.  The discussion
should be read in conjunction with the Consolidated Financial Statements and
related Notes thereto.  The information contained below may be subject to risk
factors. We urge you to review carefully the section "Risk Factors" in
Part 1, Item 1 of this 2004 Form 10-K for a more complete discussion of the
risks associated with an investment in our securities. See note on
"Forward-Looking Statements" and "Risk Factors" under Item
1.

|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|------------------------------------------------------- |  | ---------------------------------- | --------- | - | ------------------------------------------ | - | --------- | ------------------ |  | - | --------- | - |  | ----- | - |  | ----- | - |  | ----------------- | - |  | ----------------- | -------- | - | ------ | - |  | - | ------- | - |  | ------ | -
|                                                        |  | Years Ended December 31,           |           |   | Percent Of RevenueYears Ended
December 31, |   |           | Increase(Decrease)
|                                                        |  | 2004                               |           |   | 2003                                       |   |           | 2002               |  |   | 2004      |   |  | 2003  |   |  | 2002  |   |  | 2004
    vs. 2003 |   |  | 2003
    vs. 2002 |         
|                                                        |  | (In thousands, except percentages)
|Operating
  Revenues:                                   |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Medical
  premiums                                      |  | $                                  | 1,131,147 |   |                                            | $ | 962,176   |                    |  | $ | 857,741   |   |  | 71.8  | % |  | 64.8  | % |  | 67.1              | % |  | $                 | 168,971  |   | 17.6   | % |  | $ | 104,435 |   |  | 12.2   | %
|Military
  contract revenues                            |  |                                    | 372,608   |   |                                            |   | 465,313   |                    |  |   | 373,589   |   |  | 23.7  |   |  | 31.3  |   |  | 29.2              |   |  |                   | (92,705  | ) | (19.9  | ) |  |   | 91,724  |   |  | 24.6   |  
|Professional
  fees                                     |  |                                    | 35,115    |   |                                            |   | 37,367    |                    |  |   | 30,923    |   |  | 2.2   |   |  | 2.5   |   |  | 2.4               |   |  |                   | (2,252   | ) | (6.0   | ) |  |   | 6,444   |   |  | 20.8   |  
|Investment and
  other revenues                         |  |                                    | 36,565    |   |                                            |   | 20,223    |                    |  |   | 16,382    |   |  | 2.3   |   |  | 1.4   |   |  | 1.3               |   |  |                   | 16,342   |   | 80.8   |   |  |   | 3,841   |   |  | 23.4   |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Total                                                   |  |                                    | 1,575,435 |   |                                            |   | 1,485,079 |                    |  |   | 1,278,635 |   |  | 100.0 |   |  | 100.0 |   |  | 100.0             |   |  |                   | 90,356   |   | 6.1    |   |  |   | 206,444 |   |  | 16.1   |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Operating
    Expenses:                                 |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Medical
  expenses                                      |  |                                    | 878,500   |   |                                            |   | 762,865   |                    |  |   | 712,290   |   |  | 55.7  |   |  | 51.4  |   |  | 55.7              |   |  |                   | 115,635  |   | 15.2   |   |  |   | 50,575  |   |  | 7.1    |  
|Medical
  Care Ratio                                    |  |                                    | 75.3      | % |                                            |   | 76.3      | %                  |  |   | 80.2      | % |  |       |   |  |       |   |  |                   |   |  |                   |          |   | (1.0   | ) |  |   |         |   |  | (3.9   | )
|Military
  contract expenses                            |  |                                    | 317,699   |   |                                            |   | 452,554   |                    |  |   | 360,375   |   |  | 20.2  |   |  | 30.5  |   |  | 28.2              |   |  |                   | (134,855 | ) | (29.8  | ) |  |   | 92,179  |   |  | 25.6   |  
|General and
  administrative expenses                   |  |                                    | 181,434   |   |                                            |   | 137,263   |                    |  |   | 133,979   |   |  | 11.5  |   |  | 9.2   |   |  | 10.5              |   |  |                   | 44,171   |   | 32.2   |   |  |   | 3,284   |   |  | 2.5    |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Total                                                   |  |                                    | 1,377,633 |   |                                            |   | 1,352,682 |                    |  |   | 1,206,644 |   |  | 87.4  |   |  | 91.1  |   |  | 94.4              |   |  |                   | 24,951   |   | 1.8    |   |  |   | 146,038 |   |  | 12.1   |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Operating
  Income From Continuing Operations           |  |                                    | 197,802   |   |                                            |   | 132,397   |                    |  |   | 71,991    |   |  | 12.6  |   |  | 8.9   |   |  | 5.6               |   |  |                   | 65,405   |   | 49.4   |   |  |   | 60,406  |   |  | 83.9   |  
|Interest
    expense                                    |  |                                    | (4,684    | ) |                                            |   | (5,491    | )                  |  |   | (7,650    | ) |  | (0.3  | ) |  | (0.4  | ) |  | (0.6              | ) |  |                   | 807      |   | (14.7  | ) |  |   | 2,159   |   |  | (28.2  | )
|Other
  income (expense), net                           |  |                                    | 104       |   |                                            |   | (223      | )                  |  |   | 55        |   |  |      |   |  |      |   |  |                  |   |  |                   | 327      |   | (146.6 | ) |  |   | (278    | ) |  | (505.5 | )
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Income
  From Continuing Operations Before Income Taxes |  |                                    | 193,222   |   |                                            |   | 126,683   |                    |  |   | 64,396    |   |  | 12.3  |   |  | 8.5   |   |  | 5.0               |   |  |                   | 66,539   |   | 52.5   |   |  |   | 62,287  |   |  | 96.7   |  
|Provision
  for income taxes                            |  |                                    | (70,096   | ) |                                            |   | (44,565   | )                  |  |   | (22,088   | ) |  | (4.5  | ) |  | (3.0  | ) |  | (1.7              | ) |  |                   | (25,531) |   | 57.3   |   |  |   | (22,477 | ) |  | 101.8  |  
|Tax Rate                                                |  |                                    | 36.3      | % |                                            |   | 35.2      | %                  |  |   | 34.3      | % |  |       |   |  |       |   |  |                   |   |  |                   |          |   | 1.1    |   |  |   |         |   |  | 0.9    |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Income
  From Continuing Operations                     |  |                                    | 123,126   |   |                                            |   | 82,118    |                    |  |   | 42,308    |   |  | 7.8   |   |  | 5.5   |   |  | 3.3               |   |  |                   | 41,008   |   | 49.9   |   |  |   | 39,810  |   |  | 94.1   |  
|Loss
  from discontinued operations                     |  |                                    | (389      | ) |                                            |   | (19,792   | )                  |  |   | (5,860    | ) |  |      |   |  | (1.3  | ) |  | (0.5              | ) |  |                   | 19,403   |   | (98.0  | ) |  |   | (13,932 | ) |  | 237.7  |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Net
  Income                                            |  | $                                  | 122,737   |   |                                            | $ | 62,326    |                    |  | $ | 36,448    |   |  | 7.8   | % |  | 4.2   | % |  | 2.8               | % |  | $                 | 60,411   |   | 96.9   | % |  | $ | 25,878  |   |  | 71.0   | %
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Earnings
  Per Common Share Assuming Dilution: (1)      |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Income
  from continuing operations                     |  | $                                  | 3.58      |   |                                            | $ | 2.34      |                    |  | $ | 1.36      |   |  |       |   |  |       |   |  |                   |   |  | $                 | 1.24     |   | 53.0   | % |  | $ | 0.98    |   |  | 72.1   | %
|Loss
  from discontinued operations                     |  |                                    | (0.01     | ) |                                            |   | (0.55     | )                  |  |   | (0.19     | ) |  |       |   |  |       |   |  |                   |   |  |                   | 0.54     |   | (98.2  | ) |  |   | (0.36   | ) |  | 189.5  |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Net
  Income                                            |  | $                                  | 3.57      |   |                                            | $ | 1.79      |                    |  | $ | 1.17      |   |  |       |   |  |       |   |  |                   |   |  | $                 | 1.78     |   | 99.4   | % |  | $ | 0.62    |   |  | 53.0   | %
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|HMO
  Membership:                                       |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Commercial                                              |  |                                    | 226,000   |   |                                            |   | 202,000   |                    |  |   | 187,000   |   |  |       |   |  |       |   |  |                   |   |  |                   | 24,000   |   | 11.9   | % |  |   | 15,000  |   |  | 8.0    | %
|Medicare                                                |  |                                    | 53,000    |   |                                            |   | 51,000    |                    |  |   | 48,000    |   |  |       |   |  |       |   |  |                   |   |  |                   | 2,000    |   | 3.9    |   |  |   | 3,000   |   |  | 6.3    |  
|Medicaid                                                |  |                                    | 51,000    |   |                                            |   | 39,000    |                    |  |   | 37,000    |   |  |       |   |  |       |   |  |                   |   |  |                   | 12,000   |   | 30.8   |   |  |   | 2,000   |   |  | 5.4    |  
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  
|Total                                                   |  |                                    | 330,000   |   |                                            |   | 292,000   |                    |  |   | 272,000   |   |  |       |   |  |       |   |  |                   |   |  |                   | 38,000   |   | 13.0   | % |  |   | 20,000  |   |  | 7.4    | %
|                                                        |  |                                    |           |   |                                            |   |           |                    |  |   |           |   |  |       |   |  |       |   |  |                   |   |  |                   |          |   |        |   |  |   |         |   |  |        |  

|
|
|

29

---

Table of Contents

Overview



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



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



Executive Summary

Continuing Operations.  Our 2004 operating results
were significantly improved over 2003.  Our income from continuing operations
increased by 49.9% to $123.1 million.  The improvement in the 2004 operating
results was primarily driven by medical premium revenue growth from new members,
premium rate increases, an expansion of our operating margin and contractual
settlements and other adjustments at our military operation.  Our HMO membership
increased by 13.0% from 292,000 at December 31, 2003, to 330,000 at December 31,
2004 as a result of new accounts and in-case growth.  Our aggregate 2004 premium rates increased by approximately 6.7% over
2003.  The combination of these factors resulted in a 17.6% increase in our
medical premium revenues to $1,131.1 million, which was primarily offset by an
increase in medical expenses, which increased by 15.2% to $878.5 million.
Medical expenses, as a percentage of medical premiums and professional fees,
decreased from 76.3% to 75.3%, or 100 basis points for the year.  Our operating
margin, which is operating income from continuing operations divided by total
revenues, improved by 370 basis points to 12.6%.



Our military health services operations segment represented
23.7% of our operating revenues and 28.5% of our operating income from
continuing operations for the year.  This segment had operating income of $56.4
million for the year compared to $14.8 million for the same period in 2003.  For
2003, excluding TRICARE Next Generation (T-Nex) bid related expenses, the
military health services operations segment would have had operating income of
$24.2 million.   The improvement over 2003 is primarily due to change orders and
final bid price adjustments on option periods three, four and five of the
TRICARE Region 1 contract.  The impact on income before taxes of the change
orders, final bid price adjustments for option periods three, four and five and
other contractual settlements was an increase in income of approximately $25
million.



We were not awarded the T-Nex North Region contract and our
appeal to the United States General

30

---

Table of Contents

Accounting Office was denied in December
2003.  Health care services under our TRICARE contract for Region 1 ended on
August 31, 2004.  On September 1, 2004, we entered an eight-month phase-out
period at substantially reduced revenues and earnings.



For the year ended December 31, 2004, compared to 2003,
investment and other revenues increased from $20.2 million to $36.6 million, an
increase of $16.3 million or 80.8%.  Of the increase, $12.1 million is related
to the services we are providing relative to our sales agreement for the
workers' compensation insurance operations, beginning April 1, 2004.  For a
further description of this agreement, see below in the discussion of investment
and other revenues.



For the year ended December 31, 2004, compared to 2003, our
general and administrative (G&A) expenses increased from $137.3 million to
$181.4 million, an increase of $44.2 million or 32.2%.  Of the increase, $21.6
million is for the cost to provide services and other adjustments related to the
sale of the workers' compensation insurance operations referred to above.



We had cash flows from operating activities of continuing
operations for the year ended December 31, 2004 of $166.2 million compared to
$151.9 million for 2003.  The improvement in cash flows from continuing
operations over 2003 is primarily attributable to cash from earnings offset by a
decrease in cash provided by the military health services operations segment for
2004 when compared to 2003.



Discontinued Operations.  On January 15, 2003, we
announced that we were exploring strategic alternatives to dispose of CII
Financial, Inc. (CII).  Sierra's Board of Directors authorized the sale of the
operations on December 31, 2002.  Accordingly, beginning in the fourth quarter
of 2002, we reclassified our workers' compensation insurance business as
discontinued operations.



On November 25, 2003, we announced that we had reached an
agreement to sell California Indemnity Insurance Company (Cal Indemnity), and
its subsidiaries.  Cal Indemnity was CII's only significant asset.  In the
fourth quarter of 2003, we recorded a charge of $15.6 million, gross and net of
tax, to write down the investment in Cal Indemnity to its estimated net sales
proceeds.



On March 31, 2004, we completed the sale of Cal Indemnity.
Cal Indemnity's subsidiaries, which were included in the sale, are Commercial
Casualty Insurance Company, Sierra Insurance Company of Texas, and CII Insurance
Company.



Year Ended December 31, 2004 Compared to 2003

Medical Premiums. The increase in premium revenue
for the year reflects an 11.9% increase in commercial member months (the number
of months individuals are enrolled in a plan), a 29.4% increase in Medicaid
member months and a 5.4% increase in Medicare member months.  The growth in
Medicare member months contributes significantly to the increase in premium
revenues as the Medicare per member premium rates are more than three times
higher than the average commercial premium rate.  Of the 29.4% increase in
Medicaid member months, 17.7% is due to the expansion of our Medicaid service
area to Reno, Nevada beginning February 2004.



HMO and POS premium rates for renewing commercial groups
increased approximately 7% while the overall recorded per member per month
revenue increase, including new and continuing business, was approximately 4%,
net of changes in benefits.  We did not receive a Medicaid rate increase in 2004
or 2003.

31

---

Table of Contents

The basic Medicare rate increase received for 2004 was approximately
2.2%.  In addition, we received a Medicare rate increase on March 1, 2004 of
over 15% due to the Medicare Prescription Drug, Improvement, and Modernization
Act of 2003 (MMA), as described below.



In December 2003, President Bush signed MMA into law, which,
among other changes to Medicare, alters the Medicare+Choice program. Under the
MMA, Medicare+Choice plans, renamed Medicare Advantage plans, received increased
funding from CMS starting March 2004.  Because of the way in which the increased
funding was calculated, both our non-Social HMO Medicare Advantage benefit plans
and our Social HMO benefit plans received the increased funding.  MMA increased
our Medicare premium rates by over 15% starting March 1, 2004.  The increased
funding was used to reduce beneficiary cost sharing, enhance benefits, and
stabilize the provider network.  In addition, some of the funds were placed into
a benefit stabilization fund.



Effective January 2004, CMS adopted a new risk adjustment
payment methodology for Medicare beneficiaries who are enrolled in managed care
programs, including the Social HMO.  For Social HMO members, the new methodology
includes a frailty adjuster that uses measures of functional impairment to
predict expenditures.  CMS is transitioning to the new payment methodology on a
graduated basis from 2004 through 2007.  In 2004, we were paid 90% based on the
previous payment approach and 10% based on the new approach.  Excluding the
effects of MMA, the new payment methodology reduced our rate increase by 60
basis points.  The Social HMO program has been administratively extended by CMS
through 2007.  For 2005, 2006 and 2007, we will be paid 70%, 50% and 25%, based
on the previous payment approach and 30%, 50% and 75%, based on the new
approach, respectively.  The extension of the Social HMO program will serve as a
transition plan so that we can convert to a Medicare Advantage plan in 2008.
Based on the most recent information available to us, our 2005 annual Medicare
increase, before the effect of the new payment approach and the MMA, would have
been 7.9%. The new payment approach reduced this to approximately 4% although
the actual increase we will receive over the fourth quarter of 2004 will be
approximately 2% as the increased MMA funds were received over the last 10
months of the year and included a proportionate share for January and February
2004.



Continued medical premium revenue growth is principally
dependent upon continued enrollment in our products and upon competitive and
regulatory factors.



Our commercial membership increased from 202,000 at December
31, 2003 to 226,000 at December 31, 2004. The increase in commercial membership during 2004
is attributed to in-case growth, movement from self-insured plans to
our commercial products and new accounts.  For January 2005, our commercial
membership is up over 9,000 members from December 31, 2004 and our commercial
member retention was over 90%.  Approximately 35% of our total commercial
membership renews in January.



Military Contract Revenues.  The decrease in military
contract revenue for the year is the result of Sierra Military Health Services
LLC (SMHS) completing its health care operations under the TRICARE contract on
August 31, 2004.  As a result, SMHS had eight months of health care delivery in
2004 compared to twelve months in 2003.



Incremental change order revenues and final bid price
adjustments on option periods three, four and five also decreased during 2004
compared to 2003.  Included in the total military contract revenues are
incremental change order and bid price adjustments for 2004 and 2003 of
approximately $96 million and $148 million, respectively.  The final bid price
adjustments in 2004 resulted in revenue increases of approximately $6.1

32

---

Table of Contents

million
for option period three (June 1, 2000 to May 31, 2001), which is 3.4% of the
final revenue settlement amount for that period.  Option period four (June 1,
2001 to May 31, 2002), had revenue increases of approximately $4.3 million,
which is 2.3% of the final revenue settlement amount for that period.  Option
period five (June 1, 2002 to May 31, 2003), had revenue increases of
approximately $3.8 million, which is 1.4% of the final revenue settlement amount
for that period.  The impact on income before taxes of the final bid price
adjustments for option periods three, four and five was an increase of $10.6
million.  The total impact on income before taxes of the change orders, bid
price adjustments and other contractual settlements was an increase of
approximately $25 million.



SMHS completed the fifth year of a five-year contract in May
2003.  SMHS then operated under a negotiated contract extension period, which
ended August 31, 2004.  The new contractor became operational in Region 1 on
September 1, 2004 and the new contract superseded the remainder of our  TRICARE
Region 1 contract.  On September 1, 2004, SMHS commenced an eight-month phase-out
of operations at prices previously negotiated with the DoD.  SMHS does not
meet the definition of discontinued operations since we do not have plans to
dispose of the operations before the phase-out is complete.



SMHS anticipates negotiating the final bid price adjustment
settlement with the DoD for option period six (June 1, 2003 to August 31, 2004),
during the second quarter of 2005.  This settlement will include the final
revenue adjustments and a final adjustment for updated health care expense
estimates for this option period.  At the conclusion of the settlement, SMHS
will pay the DoD the estimated portion of the remaining military health care
payable.  As with previous settlements, this final settlement may have a
material impact on our results of operations.



SMHS phase-out revenues for the year 2005 are expected to be
approximately $8 million.  As a result, our failure to win the competitive
procurement for the T-Nex contract will have a material adverse effect on our
revenues and operating income for future years.  In addition, there can be no
assurance that the phase-out revenues will cover all of our costs incurred
during this period.



In March 2004, SMHS entered into a definitive agreement with
the new T-Nex North Region Contractor to provide certain transition services and
to sell certain portions of its TRICARE business, including its provider network
and certain other assets.  The value of the transaction was $4.0 million based
on SMHS' operational performance through October 2004.



For more detail on SMHS' results of operations, see Note 18,
Segment Reporting, in the Notes to the Consolidated Financial Statements.



Professional Fees.  The decrease in professional fees
is primarily a result of the outsourcing of our eye care unit in late 2003.  The
outsourcing of these services reduced both our revenue and corresponding
expenses.



Investment and Other Revenues.  The primary increase
in investment and other revenues is in administrative services revenue due to
the services we are providing relative to our sales agreement for the workers'
compensation insurance operations beginning April 1, 2004.  On March 31, 2004,
we completed the sale of the workers' compensation insurance operations and we
have been engaged to administer claims through a third party claims
administrator for a period of fifteen years as well as perform certain
transition and managed care services.  Total revenue associated with these
services for the year ended December 31, 2004 was $12.1 million.  The cost to
provide these services is reflected in our general and administrative expenses.
In addition, we recorded accrued interest of $1.4 million on the note
receivable.

33

---

Table of Contents

Medical Expenses.  The increase in medical
expenses is due primarily to our increased membership, which is in part offset
by a lower medical care ratio.  This ratio, which is medical expenses as a
percentage of medical premiums and professional fees, decreased from 76.3% to
75.3%.  The favorable decrease in our medical care ratio is due primarily to
premium increases and benefit reductions in excess of cost increases.  The
number of days in claims payable, which is the medical claims payable balance
divided by the average medical expense per day for the year, at December 31,
2004, was 49.7 compared to 49.6 at December 31, 2003.  In an effort to further
improve service and customer relations with our medical providers, we have
enhanced several claims processes, including electronic data interchange and
optical character recognition, to reduce the time required to make claim
payments.  The impact of these enhancements has resulted in a slight decrease in
days in claims payable and the absence of these enhancements would have likely
resulted in a larger increase in days in claims payable.



Our medical claims payable liability requires us to make
significant estimates.  Any changes to the estimates would be reflected in the
year the adjustments are made.  Included in medical expenses is favorable
development on prior years' estimates of $11.4 million and $14.0 million for the
years ended December 31, 2004 and 2003, respectively.  The favorable development
is a result of claims being settled for amounts less than originally estimated.
For a further description of the estimate for our medical claims payable
liability, see below in our discussion of critical accounting policies.



We contract with hospitals, physicians and other independent
contracted providers of health care under capitated or discounted fee-for-service
arrangements, including hospital per diems, to provide medical care
services to members.  Capitated providers are at risk for a portion of the cost
of medical care services provided to our members in the relevant geographic
areas; however, we are ultimately responsible for the provision of services to
our members should the capitated provider be unable to provide the contracted
services.  We incurred capitation expenses with non-affiliated providers of
$114.1 million and $101.8 million, or 13.0% and 13.3%, of our total medical
expenses for 2004 and 2003, respectively.



Military Contract Expenses.  The decrease in military
contract expenses is primarily the result of SMHS completing its final month of
health care operations under the TRICARE contract in August 2004.  Partially
offsetting the decrease in contract expenses are final bid price adjustments on
option periods three, four and five of the TRICARE Region 1 contract.  The final
adjustments resulted in a contract expense increase of approximately $1.9
million for option period three, which is 0.9% of the final contract expense
settlement amount for that period.  Option period four had an increase of $1.9
million, which is 0.8% of the final contract expense settlement amount for that
period.  Option period five had an expense decrease of $200,000, which is 0.1 %
of the final contract expense settlement amount for that period. There were no
final settlements of bid price adjustments in 2003, however, 2003 included T-Nex
related costs of $9.4 million.  Included in our military contract expenses for
both periods is an allocation of corporate overhead of $1.0 million per quarter
for direct and indirect services provided to SMHS.



Included in military contract expenses is favorable
development of prior years' estimates of military health care payable having an
earnings impact of $14.1 million and $3.2 million for the years ended December
31, 2004 and 2003, respectively.  In addition, favorable development of prior
years estimates of military health care payable having a non-earnings impact
were $6.5 million and $10.8 million for 2004 and 2003, respectively.  The non-earnings
impact was offset by a reduction in military contract revenues pursuant
to the gain/loss risk-sharing with the government.  The favorable development
was a result of claims being settled for amounts less than originally estimated.
For a further description of the estimate for our military health care payable
liability, see below in our discussion of critical accounting policies.

34

---

Table of Contents

Health care delivery expenses consist primarily of costs to
provide managed health care services to eligible beneficiaries in accordance
with Sierra's TRICARE contract through August 31, 2004.  Under the contract,
SMHS provided health care services to 710,000 eligible individuals of active
duty military personnel, military retirees under the age of 65 and dependents of
military retirees through a network of approximately 50,000 health care
providers and certain other subcontractor partnerships.  Also included in
military contract expenses are costs incurred to perform specific administrative
services, such as health care appointment scheduling, enrollment, medical and
network management services as well as health care advice line services, and
other administrative functions of the military health care subsidiary. These
administrative services were performed for active duty personnel and family
members as well as retired military families.



General and Administrative Expenses.  The
primary increase in G&A expenses is the $21.6 million to provide services
and other adjustments relative to our sales agreement for the workers'
compensation insurance operations as discussed above.  Included in the $21.6
million are $15.0 million of G&A expenses related to a valuation allowance
recorded for the $62.0 million note receivable from the sale of the workers'
compensation insurance business.  The note is subject to adjustment based on
loss development that occurs from the sale date through December 31, 2009.
During the fourth quarter of 2004, we engaged a new independent actuary to
evaluate the loss development.  Based on their actuarial projections, we
recorded a $15.0 million valuation allowance.  Partially offsetting the
valuation allowance are adjustments in accrued liabilities associated with the
sale of Cal Indemnity of $5.5 million as a result of actual revenues exceeding
estimates and actual expenses being less than projected expenses.  The remaining
increase in G&A is due to increases in employee compensation related
expenses, premium taxes and brokers' fees.  As a percentage of total operating
revenues, G&A expenses were 11.5% for 2004, compared to 9.2% in 2003.  As a
percentage of medical premium revenue, G&A expenses were 16.0% for 2004,
compared to 14.3% for 2003.  Excluding the services relative to our sales
agreement for the workers' compensation insurance operations and the adjustments
described above, our 2004 G&A expenses, as a percentage of total operating
revenues and medical premium revenue, were 10.2% and 14.1%, respectively.



Interest Expense.  The decrease in interest
expense is primarily due to the write off of the remaining deferred financing
fees on our amended and restated credit facility of approximately $800,000 in
2003.



Other Income (Expense), Net.  The expense in 2003 was
primarily related to the loss on sale of various assets in the normal course of
operations.



Provision for Income Taxes. The effective tax rate
for 2004 was 36.3% compared to 35.2% for 2003. Our effective tax rate is greater
than the statutory rate due to state income taxes, valuation allowances and
other non-deductible expenses, offset by tax-preferred investments.



Our effective tax rate is based on actual or expected income,
statutory tax rates and tax planning opportunities available to us.  We may use
significant estimates and judgments in determining our effective tax rate.  We
are occasionally audited by federal, state or local jurisdictions regarding
compliance with federal, state and local tax laws and the recognition of income
and deductibility of expenses.  Tax assessments may not arise until several
years after tax returns are filed.  While there is an element of uncertainty in
predicting the outcome of tax audits, we believe that the recorded tax assets
and liabilities are appropriately stated based on our analyses of probable
outcomes, including interest and other potential adjustments.  Our tax assets
and liabilities are adjusted based on the most current facts and circumstances,
including the progress of audits, case law and emerging legislation and any
adjustments are included in the effective tax rate in the period of
adjustment.

35

---

Table of Contents

Discontinued Operations consist of our Texas HMO
health care operations and the CII workers' compensation operations up to March
31, 2004, the date of the sale of the insurance operations. The Texas HMO health
care operations had net income of $293,000 for 2004, which was offset by a net
loss on the CII workers' compensation operations of $682,000.



Discontinued Texas HMO health care operations. There is
minimal activity remaining relative to our discontinued Texas operations.  We
have discontinued paying most Texas claims, as our evidence of coverage requires
that all claims must be settled within 18 months of the time of service.



Discontinued CII workers' compensation operations.  On
March 31, 2004, we completed the sale of CII's subsidiary, Cal Indemnity.  The
ongoing activity related to this transaction, subsequent to the March 31, 2004
closing date, has been discussed above.



Year Ended December 31, 2003 Compared to 2002



Medical Premiums.  The increase in premium revenue
reflects a 7.2% increase in Medicare member months, a 19.9% increase in Medicaid
member months and a 4.8% increase in commercial member months.  HMO and POS
premium rates for renewing commercial groups increased approximately 13% while
the overall recorded per member per month revenue increase, including new and
continuing business, was approximately 11%.  Managed indemnity rates on renewing
groups increased approximately 9%.  We did not receive a Medicaid rate increase
in 2002 or 2003.  The basic Medicare rate increase received in 2003 was
approximately 2.0%.  Our overall Medicare rate increase was approximately 2.8%
due primarily to an increase in the Social HMO membership as a percentage of our
total Medicare membership.



Military Contract Revenues.  Included in the total
military contract revenues are incremental change order and bid adjustments for
2002 and 2003 of approximately $149 million and $148 million, respectively. The
increase in revenue is the result of higher base contract revenue primarily due
to the increased eligible beneficiaries from the call up of reservists in Region
1 and their family members who are eligible for the TRICARE program after 30
days and the positive impact of the first year of our contract extension, which
began June 2003.  The base monthly revenue under the contract extension is
higher than it was under the previous contract. There were no final settlements
of bid price adjustments in 2002 or 2003.



Professional Fees.   The increase in
professional fees is a result of increased visits due to membership growth, a
higher percentage of members selecting our owned medical group and an increase
in related services performed by our other provider subsidiaries.



Investment and Other Revenues.  Investment and other
revenues increased due to higher average invested balances, an increase in net
gains on the sale of investments of $600,000 and an increase in revenues
associated with administrative services of $1.1 million.



Medical Expenses.  The increase in medical
expenses is due primarily to our increased membership, which is in part offset
by a lower medical care ratio.  This ratio, which is medical expenses as a
percentage of medical premiums and professional fees, decreased to 76.3% from
80.2%.  The favorable decrease in our medical care ratio is due primarily to
premium increases in excess of cost increases, lower average cost per hospital
bed day as a result of a new hospital contract we entered into in the third
quarter of 2002, favorable pharmacy costs and favorable claims development from
prior periods.  The favorable decrease was partially offset by malpractice cost
increases at our medical provider subsidiary.  The number of days in claims

36

---

Table of Contents

payable, which is the medical claims payable balance divided by the average
medical expense per day for the year, at December 31, 2003, was 49.6 compared to
50.3 at December 31, 2002.



Our medical claims payable liability requires us to make
significant estimates.  Any changes to the estimates would be reflected in the
year the adjustments are made.  Included in medical expenses is favorable
development on prior years' estimates of $14.0 million and $10.9 million for the
years ended December 31, 2003 and 2002, respectively.  The favorable development
is a result of claims being settled for amounts less than originally estimated.
For a further description of the estimate for our medical claims payable
liability, see below in our discussion of critical accounting policies.



We contract with hospitals, physicians and other independent
contracted providers of health care under capitated or discounted fee-for-service
arrangements, including hospital per diems, to provide medical care
services to members.  Capitated providers are at risk for a portion of the cost
of medical care services provided to our members in the relevant geographic
areas; however, we are ultimately responsible for the provision of services to
our members should the capitated provider be unable to provide the contracted
services.  We incurred capitation expenses of $101.8 million and $88.8 million,
or 13.3% and 12.5%, of our total medical expenses for 2003 and 2002,
respectively.



Military Contract Expenses.  The increase in
military contract expenses is consistent with the increase in revenues discussed
previously and includes $9.4 million in T-Nex related costs for 2003 compared to
$5.1 million in 2002.  Included in military contract expenses is favorable
development of prior years' estimates of military health care payable having an
earnings impact of $3.2 million and $4.6 million for the years ended December
31, 2003 and 2002, respectively.  In addition, favorable development of prior
years estimates of military health care payable having a non-earnings impact
were $10.8 million and $16.5 million for 2003 and 2002, respectively.  The non-earnings
impact was offset by a reduction in military contract revenues pursuant
to the gain/loss risk-sharing with the government.  The favorable development
was a result of claims being settled for amounts less than originally estimated.
For a further description of the estimate for our military health care payable
liability, see below in our discussion of critical accounting policies.



General and Administrative Expenses.  G&A
expenses increased due to increases in payroll and benefits and facility lease
expense partially offset by a decrease in legal expenses.  The increase in
facility lease expense is due to the rent payments associated with the sale-leaseback
transaction for our administrative buildings now being recorded as an
operating expense.  Previously, the rent payments were recorded as interest and
a reduction of principal and the assets were being depreciated.  As a percentage
of revenues, G&A expenses were 9.2% for 2003, compared to 10.5% in 2002 as a
result of the items described above and the overall increase in revenues.  As a
percentage of medical premium revenue, G&A expenses were 14.3% for 2003,
compared to 15.6% for 2002 due to the overall increase in medical premium
revenue.

Interest Expense.  The Company's sale-leaseback
transaction accounted for a decrease of approximately $2.8 million for 2003 as
the remaining buildings qualified as a sale during 2002.  The decrease in the
interest expense related to our revolving credit facility was primarily offset
by an increase in interest related to the new senior convertible debentures.



Other Income (Expense), Net resulted in expense
of approximately $200,000 for 2003 compared to income of approximately $55,000
for 2002.

37

---

Table of Contents

Provision for Income Taxes. The effective tax
rate for 2003 was 35.2% compared to 34.3% for 2002. Our effective tax rate was
greater than the statutory rate due primarily to an increase in state income
taxes.



Our effective tax rate is based on actual or expected income,
statutory tax rates and tax planning opportunities available to us.  We may use
significant estimates and judgments in determining our effective tax rate.  We
are occasionally audited by federal, state or local jurisdictions regarding
compliance with federal, state and local tax laws and the recognition of income
and deductibility of expenses.  Tax assessments may not arise until several
years after tax returns are filed.  While there is an element of uncertainty in
predicting the outcome of tax audits, we believe that the recorded tax assets
and liabilities are appropriately stated based on our analyses of probable
outcomes, including interest and other potential adjustments.  Our tax assets
and liabilities are adjusted based on the most current facts and circumstances,
including the progress of audits, case law and emerging legislation and any
adjustments are included in the effective tax rate in the period of
adjustment.



Discontinued Operations.   Discontinued
Texas HMO health care operations. The income from the Texas HMO health care
operations for 2003 included a pre-tax gain on the early payoff of the remaining
Kaiser-Texas mortgage loan of $2.1 million, a net decrease in litigation
accruals of $3.0 million and, favorable development in medical claim liabilities
of $1.8 million partially offset by a loss on the sale/write down of real estate
of approximately $400,000 and other operating expense and adjustments of $1.7
million. The combined adjustments resulted in pre-tax income from the
discontinued Texas HMO health care operations of $4.8 million, or $3.1 million
net of tax.

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



Discontinued CII workers' compensation operations. The
discontinued workers' compensation operations for 2003 had a net loss of $22.9
million.  Net earned premiums decreased by $53.2 million or 30.2% due primarily
to a decrease in direct earned premiums of $48.4 million and an increase in
ceded reinsurance premiums of $5.7 million partially offset by an increase in
assumed premiums of approximately $900,000.



Investment and other revenue decreased by $3.3 million or
26.4% due to a decrease in the average investment yields during the period.



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

In the second quarter of 2003, we recorded $4.0 million, $2.6
million after tax, in additional valuation adjustments.  On November 25, 2003,
we announced that we had reached an agreement to sell Cal Indemnity and its
subsidiaries.  In the fourth quarter of 2003, we recorded a charge of $15.6
million, gross and net of tax, to write down the investment in Cal Indemnity to
its estimated net sales proceeds.  Due to the nature of the loss on the write
down of the investment in Cal Indemnity no current tax benefit was

38

---

Table of Contents

realized.

Excluding the $15.6 million charge, expenses decreased in the
CII workers' compensation operations by approximately $65.8 million or 31.2%.
The decrease is primarily due to the following:

- In 2003, we recorded $16.9 million of net adverse loss
development for prior accident years compared to net adverse loss development of
$24.0 million recorded in 2002. The net adverse loss development recorded in
2003 was largely attributable to higher costs per claim, or claim severity, in
California, primarily on accident years 1997-2002 except 2000.  Higher claim
severity has had a negative impact on the entire California workers'
compensation industry in the past few periods and this trend may
continue.
- The loss and loss adjustment expense (LAE) ratio for the
2003 accident year compared to the 2002 accident year was lower by 7.0%, which
resulted in a decrease in loss and LAE of approximately $8.6 million.   The
reduction is primarily related to our premium rate increases.
- A $42.1 million reduction in loss and LAE is related to
the decrease in net earned premiums in 2003 compared to 2002.
- The net decrease in underwriting expenses, policyholders'
dividends and other operating expenses was approximately $8.0 million and is
attributable to the lower premium revenue for the period.

The net adverse loss development on prior accident years
included those years that were covered by our reinsurance agreements.  This
resulted in an increase in the reinsurance recoverable balance, which was then
reduced by amounts collected from reinsurers. For the year ended December 31,
2003, we increased our ceded reserves by $40.9 million and received payments
from our reinsurers totaling $53.0 million.

The combined ratio is a measurement of the workers'
compensation underwriting profit or loss and is the sum of the loss and LAE
ratio, underwriting expense ratio and policyholders' dividend ratio.  A combined
ratio of less than 100% indicates an underwriting profit.  Our combined ratio
was 118.9% compared to 119.6% for 2002.  The decrease was primarily due to a
decrease in the loss and LAE ratio. Excluding prior accident years' adverse loss
development, the combined ratio would have been 105.2% for 2003 and 106.0% for
2002.



LIQUIDITY AND CAPITAL RESOURCES

We had cash flows from operating activities for continuing
operations of $166.2 million for the year ended December 31, 2004 compared to
$151.9 million in 2003. We used the majority of the cash flow for the repurchase
of the Company's common stock and for capital expenditures. The improvement in
cash flows from continuing operations over 2003 is primarily attributable to
cash from earnings offset by a decrease in cash provided by the military health
services operations segment.



We expect that the loss of the T-Nex contract will adversely
affect our cash flow from operations in the first half of 2005.  During the
phase-out period, we expect that SMHS will use $15 million to $20 million of its
cash, as the payout of the remaining liabilities will exceed SMHS' accounts
receivable and other non-cash asset balances.



Net cash used for investing activities of continuing
operations during 2004 included $26.2 million in capital expenditures associated
with clinical expansion and associated medical equipment, continued
implementation of new computer systems, leasehold improvements on facilities,
furniture and equipment

39

---

Table of Contents

and other capital purchases to support our growth.  This
was offset by net proceeds of $3.1 million from property and equipment
dispositions.



Net cash used for financing activities of continuing
operations during 2004 included borrowing on our revolving credit facility of
$10.0 million offset by payments of $1.6 million on other debt.  Proceeds from
the issuance of stock in connection with stock plans were $26.8 million and cash
of $133.8 million was used to repurchase our common stock.



Discontinued operations provided cash of $1.8 million in
2004, compared to a use of cash of $17.8 million in 2003. Cash provided in 2004
was primarily the result of the sale of Cal Indemnity.  Cash used in 2003 was
primarily for the payoff of the remaining Kaiser-Texas mortgage loan for $12.9
million and the redemption of the outstanding 91⁄2% senior debentures for $15.3
million.

Sierra Debentures

In March 2003, we issued $115.0 million aggregate principal
amount of 21⁄4% senior convertible debentures due March 15, 2023.  The debentures
pay interest, which is due semi-annually on March 15 and September 15 of each
year.  Each $1,000 principal amount of debentures is convertible, at the option
of the holders, into 54.6747 shares of Sierra Health Services, Inc., common
stock prior to March 15, 2023 if (i) the market price of our common stock for at
least 20 trading days in a period of 30 consecutive trading days ending on the
last trading day of the preceding fiscal quarter exceeds 120% of the conversion
price per share of our common stock; (ii) the debentures are called for
redemption; (iii) there is an event of default with respect to the debentures;
or (iv) specified corporate transactions have occurred.  Beginning December 2003
and for each subsequent period, the market price of our common stock has
exceeded 120% of the conversion price for at least 20 trading days in a period
of 30 consecutive trading days.  The conversion rate is subject to certain
adjustments.  This conversion rate initially represents a conversion price of
$18.29 per share.  Holders of the debentures may require us to repurchase all or
a portion of their debentures on March 15 in 2008, 2013 and 2018 or upon certain
corporate events including a change in control.  In either case, we may choose
to pay the purchase price of such debentures in cash or common stock or a
combination of cash and common stock.  The debentures can be redeemed by us for
cash beginning on or after March 20, 2008.



We used the net proceeds of the offering to repay the $39.0
million outstanding under the then existing credit facility and to contribute
$35.0 million to SMHS.  The $35.0 million contribution to SMHS was subsequently
repaid to us in February 2004.  We also used $19.9 million of the proceeds to
purchase 1.6 million shares of our common stock under our repurchase program.
The remainder of the net proceeds were used for working capital and general
corporate purposes including additional share repurchases.

Revolving Credit Facility

On March 3, 2003, we entered into a $65.0 million revolving
credit facility, which replaced our amended and restated credit facility.
Interest on the facility was initially LIBOR plus 2.25% and had been LIBOR plus
2.00% since the third quarter of 2003.  The facility was set to expire on April
30, 2006.  Effective October 19, 2004, the facility was amended to extend the
maturity of the facility to December 31, 2009, increase the availability to
$100.0 million and reduce the interest rate which is currently LIBOR plus 1.20%
based on current covenant ratios.  The facility is available for general
corporate purposes.  At December 31, 2004, we have drawn $10.0 million on this
facility.

40

---

Table of Contents

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



The revolving credit facility has covenants that limit our
ability and the ability of our subsidiaries to dispose of assets, incur
indebtedness, incur other liens, make investments, loans or advances, make
acquisitions, engage in mergers or consolidations, make capital expenditures and
otherwise restrict certain corporate activities.  Per the most recent amendment,
based on us exceeding a certain covenant ratio requirement, our ability to pay
dividends, repurchase our common stock and prepay other debt is unlimited
provided that we can still maintain the required ratios after such transaction
or any borrowing incurred as a result of such transaction.  In addition, we are
required to comply with specified financial ratios as set forth in the credit
agreement.  We believe that we are in compliance with all covenants of the
credit agreement.



Sierra Share Repurchase Program

From January 1, 2004 through December 31, 2004, we purchased
3.4 million shares of our common stock, in the open market or negotiated
transactions, for $133.8 million at an average cost per share of $39.51. Since
the repurchase program began in early 2003 and through December 31, 2004, we
have purchased, in the open market or through negotiated transactions, 8.7
million shares for $233.3 million at an average cost per share of $26.76.  On
May 20, 2004, and December 7, 2004 our Board of Directors authorized us to
purchase an additional $50.0 million and $70.0 million worth of our common
stock, respectively.  At December 31, 2004, $71.4 million was still available
under the Board of Directors authorized plan.

Included in the repurchases for the first quarter of 2004 are
500,000 shares we purchased from our CEO, at $32.00 per share, for a total of
$16.0 million.  The closing price of our common stock on the date of the
transaction, February 11, 2004, was $32.35.  Included in the repurchases for the
second quarter of 2004 are 500,000 shares we purchased from our CEO, at $43.20
per share, for a total of $21.6 million.  The closing price of our common stock
on the date of the transaction, May 27, 2004, was $43.25. The independent
directors of our Board of Directors approved the purchases.



Our revolving credit facility, as amended, currently allows
for unlimited stock repurchases based on meeting a certain covenant ratio.  We
have repurchased 141,000 shares for $8.0 million at an average cost of $57.12
subsequent to December 31, 2004 through March 9, 2005.

Statutory Capital and Deposit Requirements



Our HMO and insurance subsidiaries are required by state
regulatory agencies to maintain certain deposits and must also meet certain net
worth and reserve requirements.  The HMO and insurance subsidiaries, including
the discontinued operations, had restricted assets on deposit in various states
totaling $16.8 million at December 31, 2004. The HMO and insurance subsidiaries
must also meet requirements to maintain minimum stockholders' equity, on a
statutory basis, as well as minimum risk-based capital requirements, which are
determined annually.  In conjunction with the exit from the Texas HMO health
care market, the Texas Department of Insurance approved a plan of withdrawal and
Texas Health Choice, L.C., is

41

---

Table of Contents

now required to maintain deposits of $1.5 million
and net worth of at least $3.5 million. We believe we are in material compliance
with our regulatory requirements.



Of the $207.6 million in cash and cash equivalents held at
December 31, 2004, including discontinued operations, $2.3 million was held by
discontinued operations and $129.7 million was designated for use only by the
regulated subsidiaries.  Amounts are available for transfer to the holding
company from the HMO and insurance subsidiaries only to the extent that they can
be remitted in accordance with the terms of existing management agreements and
by dividends. The holding company will not receive dividends from its regulated
subsidiaries if such dividend payment would cause violation of statutory net
worth and reserve requirements.



Obligations and Commitments

The following schedule
represents our obligations and commitments for long-term debt, capital leases
and operating leases at December 31, 2004.  The amounts presented below include
all future payments associated with each obligation including interest expense.

|                                     |  |                |                |                |   |     |                  |  |   |         |  |  |   |         | 
|------------------------------------ |  | -------------- | -------------- | -------------- | - | --- | ---------------- |  | - | ------- |  |  | - | ------- | 
|                                     |  | Long-Term Debt |                | Capital Leases |   |     | Operating Leases |  |   | Total   | 
|                                     |  |                | (In thousands) |               
|Payments
  due
  in less than 1 year |  | $              | 2,588          |                | $ | 135 |                  |  | $ | 19,370  |  |  | $ | 22,093  | 
|Payments
  due in
  1 to 3 years     |  |                | 5,175          |                |   | 264 |                  |  |   | 36,367  |  |  |   | 41,806  | 
|Payments
  due in
  4 to 5 years     |  |                | 15,175         |                |   | 136 |                  |  |   | 33,830  |  |  |   | 49,141  | 
|Payments
  due after 5 years         |  |                | 149,931        |                |   | 92  |                  |  |   | 97,366  |  |  |   | 247,389 | 
|                                     |  |                |                |                |   |     |                  |  |   |         |  |  |   |         | 
|Total                                |  | $              | 172,869        |                | $ | 627 |                  |  | $ | 186,933 |  |  | $ | 360,429 | 
|                                     |  |                |                |                |   |     |                  |  |   |         |  |  |   |         | 

Other

We have a 2005 capital budget of approximately $30
million and are also limited in the amount of capital expenditures we can make
by our revolving credit facility.  The 2005 planned expenditures are primarily
for the construction of a new medical clinic, the purchase of computer hardware
and software, furniture and equipment and other normal capital requirements.
Our liquidity needs over the next 12 months will primarily be for the capital
items noted above.  We believe that our existing working capital, operating cash
flow and amounts available under our credit facility should be sufficient to
fund our capital expenditures and liquidity needs.  Additionally, subject to
unanticipated cash requirements, we believe that our existing working capital
and operating cash flow should enable us to meet our liquidity needs on a long-term basis.



Inflation



Health care costs continue to rise at a rate faster than the
Consumer Price Index.  We use various strategies to mitigate the negative
effects of health care cost inflation, including setting commercial premiums
based on our anticipated health care costs, risk-sharing arrangements with our
various health care providers and other health care cost containment measures
including member co-payments.  There can be no assurance, however, that in the
future, our ability to manage medical costs will not be negatively

42

---

Table of Contents

impacted by
items such as technological advances, competitive pressures, applicable
regulations, increases in pharmacy costs, utilization changes and catastrophic
items, which could, in turn, result in medical cost increases equaling or
exceeding premium increases.



Government Regulation

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



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



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



In addition to changes in existing laws and regulations, we
are subject to audits, investigations and enforcement actions.  These include,
but are not limited to, possible government actions relating to ERISA, the
Federal Employees Health Benefit Plan, federal and state fraud and abuse laws
and laws relating to utilization management and the delivery and payment of
health care.  In addition, our Medicare business is subject to Medicare
regulations promulgated by CMS.  Violation of government laws and regulations
may result in an assessment of damages, civil or criminal fines or penalties, or
other sanctions, including exclusion from participation in government programs.
In addition, disclosure of any adverse investigation or audit results or
sanctions could negatively affect our reputation in various markets and make it
more difficult for us to sell our products and services.



In addition to the items described above, we urge you to
review carefully the section "Risk Factors" in Part 1, Item 1 of this
2004 Form 10-K for a more complete discussion of the risks associated with an
investment in our securities.  See "Note on Forward-Looking Statements and
Risk Factors" under Item 1.



Recently Issued Accounting Standards



In December 2004, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards No. 123 (revised
2004), "Share-Based Payment" (SFAS 123R), which replaces SFAS No. 123 and
supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS
123R requires all share-based payments to employees, including grants of
employee stock options, to be

43

---

Table of Contents

recognized in the financial statements based on
their fair values beginning with the first interim or annual period after June
15, 2005, with early adoption encouraged. The pro forma disclosures previously
permitted under SFAS 123 no longer will be an alternative to financial statement
recognition. We are required to adopt SFAS 123R beginning July 1, 2005. Under
SFAS 123R, we must determine the appropriate fair value model to be used for
valuing share-based payments, the amortization method for compensation cost and
the transition method to be used at date of adoption. The transition methods
include prospective and retroactive adoption options. The prospective method
requires that compensation expense be recorded for all unvested stock options
and restricted stock at the beginning of the first quarter of adoption of SFAS
123R.  The retroactive methods would record compensation expense for all
unvested stock options and restricted stock beginning with the first period
restated.  Prior periods may be restated either as of the beginning of the year
of adoption or for all periods presented.  We are currently evaluating the
requirements of SFAS 123R.  We anticipate adopting the prospective method of
SFAS 123R and expect that the adoption will have an after tax earnings impact of
approximately $1.5 to $2.0 million for 2005.



Emerging Issues Task Force Issue 04-8, "Accounting
Issues Related to Certain Features of Contingently Convertible Debt and the
Effect on Diluted Earnings per Share" (EITF 04-8) became effective
beginning in the fourth quarter of 2004.  EITF 04-8 addresses when the dilutive
effect of contingently convertible debt with a market price trigger should be
included in diluted earnings per share calculations. The EITF's conclusion is
that the market price trigger should be ignored and that these securities should
be treated as convertible securities and included in diluted earnings per share
regardless of whether the conversion contingencies have been met.  EITF 04-8
also requires restatement of all prior periods for which the convertible
debentures were outstanding.  Since the market price condition has been
satisfied in every quarter since the fourth quarter of 2003, the debentures have
already been considered common stock equivalents and were included in the
calculation of weighted average common shares outstanding assuming dilution for
each quarter of 2004.  The amounts previously reported for earnings per share
assuming dilution and weighted average common shares assuming dilution for 2003
of $2.05 and 30,421,000, respectively, have been restated in accordance with
EITF 04-8.



In March 2004, the FASB approved the consensus reached on the
Emerging Issues Task Force Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments" (EITF 03-1).
The Issue's objective is to provide guidance for identifying other-than-temporarily
impaired investments.  EITF 03-1 also provides new disclosure
requirements for investments that are deemed to be temporarily impaired.  In
September 2004, the FASB issued a FASB Staff Position EITF 03-1-1 that delays
the effective date of the measurement and recognition guidance in EITF 03-1
until further notice.  The disclosure requirements of EITF 03-1 are effective
with this annual report for 2004. Once the FASB reaches a final decision on the
measurement and recognition provisions, the company will evaluate the impact of
the adoption of the accounting provisions of EITF 03-1.



In December 2003, the FASB, issued Statement of Financial
Accounting Standards No. 132 (Revised 2003), "Employers' Disclosures about
Pensions and Other Postretirement Benefits, an amendment of FASB Statements No.
87, 88 and 106" (SFAS No. 132R).  SFAS No. 132R retains the disclosure
requirement contained in the original FASB Statement No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits", which it
replaces.  The statement also requires additional disclosures to those in the
original FASB Statement No. 132 about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other
postretirement plans.  See Note 15 of the Notes to the Consolidated Financial
Statements for disclosure on our defined benefit plan.

44

---

Table of Contents

Critical Accounting Policies and Estimates



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



Medical Claims Payable.  Our medical claims payable
includes claims in process, a provision for the estimate of incurred but not
reported (IBNR) claims and a provision for disputed claims obligations including
provider disputes.  Our most significant accounting estimate is for our reserves
for IBNR claims. We make this estimate primarily using standard actuarial
methodologies based upon historical data. These standard actuarial methodologies
recognize, among other factors, contractual requirements, historical utilization
trends, the interval between the date services are rendered and the date claims
are paid, denied claims activity, disputed claims activity, benefit changes,
expected health care cost inflation, seasonality patterns and changes in
membership. In developing the IBNR claims estimate, we apply different
estimation methods depending on the month for which incurred claims are being
estimated. For example, we actuarially calculate completion factors using our
analysis of claims payment patterns over the most recent six-to-twelve month
period. The completion factor is an actuarial estimate, based upon historical
experience, of the percentage of claims incurred during a given period that have
been paid by us as of the date of estimation. We then apply the completion
factors to the actual claims paid to date for each incurral month, except for
the most recent months, to estimate the expected amount of ultimate incurred
claims for each of these months.  For the most recent incurred months, generally
three months or less, the percentage of claims paid for claims incurred in those
months is usually low. This makes the completion factor methodology less
reliable for such months.  For these recent months, we estimate our claims
incurred by applying estimated per member per month (PMPM) costs to the current
membership. The estimated PMPM costs are derived from historical paid claims
(with completion factors as described above), trend assumptions and current
utilization reports.  This approach is consistently applied from period to
period.

45

---

Table of Contents

The completion factors and estimated PMPM costs are the most
significant factors we use in estimating our IBNR claims. The following table
illustrates the sensitivity of these factors and the estimated potential impact
on our medical claims payable balance as a result of these factors:

|                               |    |  |                                                |        |   |                                |    |    |                                                |   |        |  
|------------------------------ | -- |  | ---------------------------------------------- | ------ | - | ------------------------------ | -- | -- | ---------------------------------------------- | - | ------ | -
|Completion
  Factor (a)        |    |  | PMPM Factor (b)                                |       
|Increase(Decrease) In
  Factor |    |  | Increase (Decrease)In
  Medical Claims Payable |        |   | Increase(Decrease) In
  Factor |    |    | Increase (Decrease)In
  Medical Claims Payable |  
|                               |    |  | (In
  thousands, except percentages)           |        |   |                                |   
|(3                             | )% |  | $                                              | 21,705 |   |                                | (3 | )% |                                                | $ | (3,264 | )
|(2                             | )% |  |                                                | 14,321 |   |                                | (2 | )% |                                                |   | (2,176 | )
|(1                             | )% |  |                                                | 7,087  |   |                                | (1 | )% |                                                |   | (1,088 | )
|1                              | %  |  |                                                | (4,063 | ) |                                | 1  | %  |                                                |   | 1,088  |  
|2                              | %  |  |                                                | (5,640 | ) |                                | 2  | %  |                                                |   | 2,176  |  
|3                              | %  |  |                                                | (6,625 | ) |                                | 3  | %  |                                                |   | 3,264  |  

|(a) |  | Reflects estimated potential changes in medical claims payable caused by changes in the completion factors for claims incurred in months four through twenty-four.
Completion factors are not increased beyond 100%.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) |  | Reflects estimated potential changes in medical claims payable caused by changes in PMPM factors for claims incurred in the most recent three months.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------

Management believes, based on information presently
available, that the recorded liability for medical claims payable, which at
December 31, 2004, represented 24.5% of our total consolidated liabilities or
$119.3 million, is reasonable and adequate to cover the related future health
care claim payments.  However, a difference between the recorded liability and
actual developed claim payments could have a material impact to our financial
results.  For example, a 1% increase in medical claims payable as of December
31, 2004, would reduce reported net income for the year 2004 by $776,000 or .6%
and diluted earnings per share would be reduced by $0.02.



The table below provides historical information regarding the
accrual and payment of our medical claims payable. Components of the total
incurred claims for each year include amounts accrued for current year estimated
claims expense as well as adjustments to prior year estimated accruals.  The
impact of any "changes in prior periods' estimates" may be offset as
we establish the estimate for the current year. Our accounting practice is to
consistently recognize the actuarial best estimate of our ultimate liability for
our claims within a reasonable level of confidence required by actuarial
standards. Thus, only when the release of a prior year reserve is not offset
with the same level of conservatism in estimating the current year reserve will
the redundancy create a net reduction in current period medical expenses. The evaluation of
medical claims payable at December 31, 2004 is comparable to prior years
and that we have applied our methodology in a consistent manner in determining
our best estimate for medical claims payable at each reporting date.

46

---

Table of Contents

The following table reconciles the beginning and ending
balances of medical claims payable:

|                                                  |  |                          |         |      |   |         |      |  |   |        
|------------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- | ---- |  | - | -------
|                                                  |  | Years Ended December 31, |         |      |  
|                                                  |  | 2004                     |         | 2003 |   |         | 2002
|                                                  |  | (In thousands)           |        
|Medical
  claims payable, beginning of the period |  | $                        | 103,749 |      | $ | 98,031  |      |  | $ | 81,662 
|Add:
  Components Of Incurred Medical Expenses    |  |                          |         |      |   |         |      |  |   |        
|Current
  period medical claims                   |  |                          | 889,921 |      |   | 776,857 |      |  |   | 723,167
|Changes in
  prior periods' estimates             |  |                          | (11,421 | )    |   | (13,992 | )    |  |   | (10,877
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Total Incurred Medical Expenses                   |  |                          | 878,500 |      |   | 762,865 |      |  |   | 712,290
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Less:
  Medical Claims Paid                       |  |                          |         |      |   |         |      |  |   |        
|Current
  period                                  |  |                          | 780,934 |      |   | 683,597 |      |  |   | 630,411
|Prior
  period                                    |  |                          | 81,978  |      |   | 73,550  |      |  |   | 65,510 
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Total Claims Paid                                 |  |                          | 862,912 |      |   | 757,147 |      |  |   | 695,921
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Medical Claims Payable, End
  Of Period           |  | $                        | 119,337 |      | $ | 103,749 |      |  | $ | 98,031 
|                                                  |  |                          |         |      |   |         |      |  |   |        

The "changes in prior periods' estimates" of $11.4
million represents an estimate based on paid claim activity from January 1, 2004
to December 31, 2004. Medical claim liabilities are usually described as having
a "short tail", which means that they are generally paid within
several months of the member receiving service from the provider. Accordingly,
approximately 92% of the "changes in prior periods' estimates"
incurred in 2004 relates to claims incurred in 2003, with the remaining 8%
related to claims incurred in 2002 and prior.



We have not changed our methods and assumptions as we have
re-estimated reserves, but rather, the availability of additional paid claims
information drives our changes in the estimate of the medical claims payable.
Other than reflecting this additional historical activity in our estimates, the
method or assumptions have not materially changed since the last reporting
date.



Amounts incurred related to prior years vary from previously
estimated liabilities as the claims are ultimately settled. Liabilities at any
period-end are continually reviewed and re-estimated as information regarding
actual claims payments, or run-out, becomes known. This information is compared
to the originally established liability.  Favorable development related to prior
years, which is shown as a negative amount in the "changes in prior
periods' estimates", results from claims being settled for amounts less
than originally estimated.



Medical cost trends are potentially more volatile than other
segments of the economy.  The drivers of medical cost trends include increases
in the utilization of hospital and physician services, prescription drugs, and
new medical technologies, as well as the inflationary effect on the cost per
unit of each of these expense components.  Other external factors such as
government-mandated benefits or other regulatory changes, catastrophes, and
epidemics also may impact medical cost trends.  Other internal factors such as
system conversions and claims processing interruptions also may impact our
ability to accurately estimate historical completion factors or medical cost
trends.



The increase in the medical claims payable balance from
December 31, 2003 to December 31, 2004 is

47

---

Table of Contents

primarily due to activities in the
ordinary course of business.  These activities include, but are not limited to,
increases in membership, utilization and unit costs.  The ratio of medical
claims payable at the end of the period to the incurred medical expense for
current period medical claims is 13.6% for both 2003 and 2004.



Our provision for provider
disputes is based on a separate evaluation of each dispute.  We recognize a
liability for such loss contingencies when we believe it is both probable that a
loss will be incurred and that the amount of the loss can be reasonably
estimated.  Our loss estimates are primarily based on an analysis of potential
results, the stage of the dispute, our applicable insurance coverage,
consultation with outside legal counsel and any other relevant information
presently available.  The ultimate outcome of these loss contingencies cannot be
predicted with certainty and it is difficult to measure the actual loss that may
be incurred.  Actual results may materially differ from our estimates and this
difference would be reported in our current operations.



Military Health Care
Payable.



Our military health care
payable is typically more difficult to estimate than our medical claims payable
primarily as a result of having more variables which impact the estimate. The
variables include changes in the number of eligible beneficiaries, changes in
the utilization of military treatment facilities and changes in levels of
benefits versus the original contract provisions, resulting from government
issued contract change orders.



Our TRICARE contracts contain risk-sharing provisions with
the Department of Defense, which can limit the earnings impact when actual claim
experience varies from the estimated amounts. As a result, certain adjustments
to the military health care payable have a reduced impact on earnings due to the
offsetting revenue adjustments.



At December 31, 2004, the
completion factors are the most significant factor we use in estimating our
IBNR.  The following table illustrates the sensitivity of the completion factors
and the estimated potential impact on our military health care payable balance
as a result of changes in this factor:

|                                         |    |                                    |  |   |        |  
|---------------------------------------- | -- | ---------------------------------- |  | - | ------ | -
|Completion Factor (a)                   
|                                        
|                                         |    | Increase (Decrease)
      In      
|Increase (Decrease)
      In Factor      |    | Military
      Health Care Payable
|                                         |    |                                   
|(In thousands,
      except percentages)
|                                         | (3 | )%                                 |  | $ | 16,309 |  
|                                         | (2 | )%                                 |  |   | 10,758 |  
|                                         | (1 | )%                                 |  |   | 5,323  |  
|                                         | 1  | %                                  |  |   | (2,888 | )
|                                         | 2  | %                                  |  |   | (4,750 | )
|                                         | 3  | %                                  |  |   | (6,148 | )



|(a) |  | Reflects estimated potential changes in
  military health care payable caused by changes in the completion factors for claims incurred in months four through thirty-six.
Completion factors are not increased beyond 100%.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

48

---

Table of Contents

Management believes, based on information presently
available, that the recorded liability for military health care payable, which
at December 31, 2004 represented 3.5% of our total consolidated liabilities or
$17.1 million, is reasonable and adequate to cover future liabilities.



The following table reconciles the beginning and ending
balances of military health care payable:

|                                                        |  |                          |         |      |   |         |      |  |   |        
|------------------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- | ---- |  | - | -------
|                                                        |  | Years Ended December 31, |         |      |  
|                                                        |  | 2004                     |         | 2003 |   |         | 2002
|                                                        |  | (In thousands)           |        
|Military
  health care payable, beginning of the period |  | $                        | 76,605  |      | $ | 65,223  |      |  | $ | 77,261 
|Add:  Components
  Of Incurred Medical Expenses         |  |                          |         |      |   |         |      |  |   |        
|Current
  period medical claims                         |  |                          | 220,710 |      |   | 318,833 |      |  |   | 251,632
|Changes
  In Prior Periods' Estimates:                  |  |                          |         |      |   |         |      |  |   |        
|Earnings
  related changes                              |  |                          | (14,118 | )    |   | (3,235  | )    |  |   | (4,601 
|Non-earnings
  related changes                          |  |                          | (6,462  | )    |   | (10,777 | )    |  |   | (16,509
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Total Incurred Medical Expenses                         |  |                          | 200,130 |      |   | 304,821 |      |  |   | 230,522
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Less:  Military Contract Claims Paid                    |  |                          |         |      |   |         |      |  |   |        
|Current
  period                                        |  |                          | 201,950 |      |   | 244,644 |      |  |   | 194,659
|Prior
  period                                          |  |                          | 57,724  |      |   | 48,795  |      |  |   | 47,901 
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Total Military Contract Claims Paid                     |  |                          | 259,674 |      |   | 293,439 |      |  |   | 242,560
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Military Health Care Payable, End
  Of Period           |  | $                        | 17,061  |      | $ | 76,605  |      |  | $ | 65,223 
|                                                        |  |                          |         |      |   |         |      |  |   |        

The military contract expenses presented in our Consolidated
Statements of Operations include the total incurred medical expenses presented
above and the general and administrative expenses for SMHS. SMHS' general and
administrative expenses under the military contract totaled $117.6 million,
$147.7 million and $129.9 million for the years ended December 31, 2004, 2003,
and 2002, respectively.  Total incurred medical expenses include the current
year expenses plus adjustments to prior periods' estimates. Any subsequent
change in an estimate for a prior period is reflected in the current year.  Due
to the risk sharing described above, certain adjustments to prior periods have a
current year earnings impact while other adjustments do not have a current year
earnings impact.  For example in 2004, SMHS had total adjustments to prior
period estimates of $20.6 million.  These adjustments resulted in a reduction of
current period expense of $20.6 million and current period revenue of $6.5
million for a pre-tax increase of $14.1 million to current period earnings.



The "changes in prior periods' estimates" of $20.6
million represents an estimate based on paid claim activity from January 1, 2004
to December 31, 2004. Medical claim liabilities are usually described as having
a "short tail", which means that they are generally paid within
several months of the member receiving service from the provider. However, the
military contract claims have a somewhat longer tail because the providers tend
to lag in the submission of claims for the military population.  The TRICARE
program allows providers to submit claims up to one year from the date of
service.  Accordingly, approximately 83%, of the "changes in prior periods'
estimates" incurred in 2004 relates to claims incurred in 2003, with the
remaining 17% related to claims incurred in 2002 and prior.



We have not changed our methods and assumptions as we have
re-estimated reserves, but rather the availability of additional paid claims
information drives our changes in the estimate of the military health care

49

---

Table of Contents

payable.  Other than reflecting this additional historical activity in our
estimates and adjusting for the termination or our contract on August 31, 2004,
the method or assumptions have not materially changed since the last reporting
date.



Amounts incurred related to prior years vary from previously
estimated liabilities as the claims are ultimately settled. Liabilities at any
period-end are continually reviewed and re-estimated as information regarding
actual claims payments, or run-out, becomes known. This information is compared
to the originally established liability. Favorable development related to prior
years, which is shown as a negative amount in the "changes in prior
periods' estimates", results from claims being settled for amounts less
than originally estimated.



Military Contract Revenues and Expenses.  Military
contract revenue is recorded based on the contract price as agreed to by the
federal government.  The contract was based on prior years' data provided by the
government along with assumptions of future trends.  The contract contains
provisions that adjust the contract price based on actual experience, which we
call the bid price adjustment (BPA), and for government-directed change orders.
For the year ended December 31, 2004, we estimate that approximately $95.5
million or 25.6% of the total military contract revenues were for BPA and change
orders. At December 31, 2004, military accounts receivable due from the federal
government was $25.5 million of which approximately $5.4 million was for accrued
BPA and change order revenues.  As the data becomes available from the
government, we compare the actual results to the contract assumptions and the
estimated effects of these adjustments are recognized on a monthly basis.  In
addition, we record revenue based on estimates of the earned portion of any
contract change orders not originally specified in the contract.  The BPA and
government-directed change orders are subject to negotiation and we must use our
judgment in making our estimates.  The actual negotiated price could be
substantially different from what we had originally estimated.  Any subsequent
difference would be reported in that subsequent year's operations.



During 2004, we finalized option periods three (June 1, 2000
to May 31, 2001), four (June 1, 2001 to May 31, 2002) and five (June 1, 2002 to
May 31, 2003) with the DoD.  The final bid price adjustments resulted in an
increase in net income of approximately $2.5 million, $1.4 million and $2.4
million for option periods three, four and five, respectively.  During 2005, we
expect to finalize our remaining option period six (June 1, 2003 to August 31,
2004) along with our phase-out contract.



SMHS anticipates negotiating the final bid price adjustment
settlement with the DoD for option period six during the second quarter of 2005.
This settlement will include the final revenue adjustments and a final
adjustment for updated health care expense estimates for this option period.  At
the conclusion of the settlement, SMHS will pay the DoD the estimated portion of
the remaining military health care payable.  As with previous settlements, this
final settlement may have a significant impact on our results of operations.



Litigation and Legal Accruals.  We are subject to
various claims and other litigation in the ordinary course of business.  Such
litigation includes, but is not limited to, claims of medical malpractice,
claims for coverage or payment for medical services rendered to HMO members and
claims by providers for payment for medical services rendered to HMO and other
members.  We may also face claims for punitive damages that are not covered by
insurance.  In addition, under the terms of the note receivable due from the
sale of Cal Indemnity, which is subject to adjustment for loss development, we
can be indirectly affected by claims for workers' compensation and claims by
providers for payment of medical services rendered to injured workers.  With
respect to certain pending actions, we maintain commercial insurance coverage
with varying deductibles for

50

---

Table of Contents

which we maintain estimated reserves for our self-insured
portion based upon our current assessment of such litigation.  In
addition, we accrue estimated legal defense and other settlement costs based on
our assessment of the available information, including our outside legal
counsel's assessment of the case.  We also assess potential legal exposure,
based on currently available information, to determine if a precautionary notice
of potential claim should be reported to our insurers and if an accrual should
be established.



Note Receivable From the Sale of Cal Indemnity.  On
March 31, 2004, we completed the sale of Cal Indemnity and its insurance
subsidiaries.  We received a note for $62.0 million, which is subject to
adjustments based on the development that occurs on the loss and allocated loss
adjustment expense (ALAE) reserves from the closing date through December 31,
2009. Included in the development is, if applicable, any uncollectible reinsured
losses.  We are also obligated to perform, or be responsible for the performance
of, certain transition services through December 31, 2009 for which we will
receive a limited amount of funds for these services.



In the fourth quarter of 2003, we recorded a charge of $15.6
million, gross and net of tax, to write-down the investment in Cal Indemnity to
its estimated net sales proceeds of approximately $73 million.  We used
estimates and assumptions to project Cal Indemnity's future operating results,
the costs to perform transition services, the funds to be received for
transition services, the expected value of certain assets, the development of
loss and ALAE reserves, and the sales transaction costs.



The determination of loss development requires an actuarial
evaluation of Cal Indemnity's loss reserves.  Projecting loss and ALAE reserves
have a significant degree of inherent uncertainty when related to their
subsequent payments.  It is not only possible but also probable that the
projected reserves will differ from their related subsequent developments.
Underlying causes for this uncertainty include, but are not limited to,
uncertainty in development patterns, unanticipated inflationary trends affecting
the cost of services covered by the insurance contract, adverse legal outcomes
and new interpretations of laws or regulations or of disputed contract
provisions that result in having to provide new or extended benefits.  This
uncertainty can result in both adverse as well as favorable development of
actual subsequent activity when compared to the reserve established.  During the
years 1999 to 2003, Cal Indemnity had adverse development in its previously
recorded loss and loss adjustment expense reserves ranging from a low of $8.7
million to a high of $24.0 million.



In making actuarial loss projections, there is no single
"right" way or method.  An actuary must exercise a significant amount
of his or her judgment in selecting loss development factors and even a small
change in one loss development factor can have a large impact when it is applied
over several accident years.  This can result in significant differences between
one actuary's best estimate of the projected loss reserves and another actuary's
best estimate of those same loss reserves.  In addition, actuarial projections
will change with the passage of time as new or additional information is
obtained or experienced.



The actuarial projections for the second and third quarters
of 2004 had only indicated a small amount of loss development.  In the fourth
quarter of 2004, we engaged a new independent actuary to perform an analysis of
the loss and ALAE reserves.  The analysis was used to help us determine if a
valuation allowance should be established on the note receivable.  We were
required to engage a new actuary to avoid a potential conflict of interest with
our former actuary, who is still engaged by Cal Indemnity, and the resulting
impact to internal controls.  Our new actuary used standard casualty insurance
projection methods including paid and incurred development methods and paid and
incurred Bornhuetter-Ferguson methods.  The development methods

51

---

Table of Contents

utilize
historical patterns of paid and incurred development over time to estimate
future development.  The Bornhuetter-Ferguson methods determine the expected
unreported and expected unpaid losses by estimating the expected loss ratio and
subtracting the actual reported incurred and paid losses.  The actuary then
selects a projected ultimate cost using the four methods as a guide as well as
considering industry trends and other factors.



Based on our new actuary's analyses as well as considering
the historical adverse loss development trend, we recorded a valuation allowance
of $15.0 million in December 2004.  Partially offsetting this was a reduction in
accrued liabilities related to the sale.  As noted above, we are contractually
obligated for the performance of certain transition services through December
31, 2009.  We previously accrued net liabilities for the then projected
deficiency in the revenues to be received to perform the services.  Due to
actual revenues exceeding estimates and actual expenses being less than
projected expenses, we re-evaluated the remaining liabilities which resulted in
a $5.5 million reduction.



Any future adverse loss development could have a material
effect on our financial results.  For example, a 1% increase in the projected
loss and ALAE ratios for all of the 2000 through 2004 accident years would
increase the adverse development by approximately $6.4 million.  If the loss and
ALAE ratios for all accident years since Cal Indemnity's inception (1988)
increased by 1%, the adverse development would increase by approximately $17.5
million.



Other.  In addition to the critical accounting
policies and estimates discussed above, other areas requiring us to use
judgment, assumptions and estimates include, but are not limited to, allowance
for retroactive premium adjustments, potential investments impairment, deferred
tax assets and liabilities, contractual discounts on professional fee revenue,
allowances for doubtful receivables, other accrued liabilities, accrued payroll
and taxes, post-employment benefit liabilities, unearned premium revenue and
contingent assets and liabilities. For a more extensive discussion of our
accounting policies, see Note 2 in the Notes to the Consolidated Financial
Statements.

52

---

Table of Contents

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK



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



Our exposure to market risk for changes in interest rates
relates primarily to our investment portfolio. At December 31, 2004, including
discontinued operations, we had approximately $382.5 million in cash and cash
equivalents and current, long-term and restricted investments.  Of the total
investments of $174.9 million, approximately $146.8 million are classified as
available-for-sale and $28.1 million are classified as held-to-maturity. These
investments are primarily in fixed income investment grade securities.  Our
investment policy emphasizes return of principal and liquidity and is focused on
fixed returns that limit volatility and risk of principal.  Because of our
investment policies, the primary market risk associated with our portfolio is
interest rate risk.



Assuming interest rates were to increase by a factor of 1.1,
the net hypothetical loss in fair value of stockholders' equity related to
financial instruments is estimated to be approximately $500,000 after tax (0.3%
of total stockholders' equity).  We believe that such an increase in interest
rates would not have a material impact on future earnings or cash flows, as it
is unlikely that we would need or choose to substantially liquidate our
investment portfolio.



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

53

---

Table of Contents

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS



|                                                                                                      | Page
|----------------------------------------------------------------------------------------------------- | ----
|Management's Report on Internal Control Over Financial Reporting                                      | 55  
|Report of Independent
Registered Public Accounting Firm on Internal Controls Over Financial Reporting | 56  
|Report of Independent
Registered Public Accounting Firm on Consolidated Financial Statements          | 58  
|Consolidated Balance Sheets at December 31, 2004 and 2003                                             | 59  
|Consolidated Statements of Operations for the Years Ended December 31, 2004,
2003 and 2002            | 60  
|Consolidated Statements of Stockholders' Equity for the Years Ended December 31,
2004, 2003 and 2002  | 61  
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2004,
2003 and 2002            | 62  
|Notes to Consolidated Financial Statements                                                            | 63  

54

---

Table of Contents

MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Sierra Health Services, Inc. (the
"Company") is responsible for establishing and maintaining adequate
internal control over financial reporting and for the assessment of the
effectiveness of internal control over financial reporting. As defined in Rules
13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, internal control over financial reporting
is a process designed by, or supervised by, the Company's principal executive and principal financial
officers, and effected by the Company's board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements in accordance
with generally accepted accounting principles.



The Company's internal control over financial reporting is
supported by written policies and procedures, that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the Company's assets; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of the Company's management
and directors; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
Company's assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.



In connection with the preparation of the Company's annual
financial statements, management of the Company has undertaken an assessment of
the effectiveness of the Company's internal control over financial reporting as
of December 31, 2004 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Management's assessment included an evaluation of the
design of the Company's internal control over financial reporting and testing of
the operational effectiveness of the Company's internal control over financial
reporting.

Based on this assessment, management did not identify any
material weakness in the Company's internal control, and management has
concluded that the Company's internal control over financial reporting was
effective as of December 31, 2004.



Deloitte & Touche LLP, the independent registered public accounting
firm that audited the Company's financial statements included in this report,
have issued an attestation report on management's assessment of internal control
over financial reporting, a copy of which is included in this Annual Report on
Form 10-K.





/s/ Anthony M. Marlon, M.D.
Chairman and Chief Executive Officer
March 14, 2005





/s/ Paul H. Palmer
Senior Vice President, Finance
   Chief Financial Officer and Treasurer
March 14, 2005

55

---

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROLS OVER FINANCIAL REPORTING



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

We have audited management's assessment, included in the
accompanying Management's Report on Internal Controls Over Financial Reporting,
that Sierra Health Services, Inc. and subsidiaries (the "Company")
maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
The Company's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting.  Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of
the Public Company Accounting Oversight Board (United States).  Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in
all material respects.  Our audit included obtaining an understanding of
internal control over financial reporting, evaluating management's assessment,
testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.

A company's internal control over financial reporting is a
process designed by, or under the supervision of, the company's principal
executive and principal financial officers, or persons performing similar
functions, and effected by the company's board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.  A
company's internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.

Because of the inherent limitations of internal control over
financial reporting, including the possibility of collusion or improper
management override of controls, material misstatements due to error or fraud
may not be prevented or detected on a timely basis.  Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting
to future periods are subject to the risk that the controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.

In our opinion, management's assessment that Sierra Health Services, Inc.
and subsidiaries maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on the criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.  Also in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on the criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.

56

---

Table of Contents

We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the consolidated
financial statements and financial statement schedules as of and for the year
ended December 31, 2004 of the Company and our report dated March 14, 2005
expressed an unqualified opinion on those financial statements and financial
statement schedules.



/s/ DELOITTE & TOUCHE
LLP
Las Vegas, Nevada
March 14, 2005

57

---

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON CONSOLIDATED
FINANCIAL STATEMENTS

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



We have audited the accompanying consolidated balance sheets
of Sierra Health Services, Inc. and subsidiaries (the "Company") as of
December 31, 2004 and 2003, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 2004.  Our audits also included the financial
statement schedules listed in the Index at Item 15 (a)(2).  These financial
statements and financial statement schedules are the responsibility of the
Company's management.  Our responsibility is to express an opinion on the
financial statements and financial statement schedules based on our audits.



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



In our opinion, such consolidated financial statements
present fairly, in all material respects, the financial position of Sierra
Health Services, Inc. and subsidiaries as of December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America.  Also, in our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.

We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the effectiveness of
the Company's internal control over financial reporting as of December 31, 2004,
based on the criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 14, 2005 expressed an unqualified opinion on
management's assessment of the effectiveness of the Company's internal control
over financial reporting and an unqualified opinion on the effectiveness of the
Company's internal control over financial reporting.





/s/ DELOITTE & TOUCHE LLP
Las Vegas, Nevada
March 14, 2005

58

---

Table of Contents

SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31,
2004 and 2003

(In thousands, except per share data)



|                                                                                                        |  |      |          |   |      |   |           |  
|------------------------------------------------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | --------- | -
|                                                                                                        |  | 2004 |          |   | 2003 |  
|ASSETS                                                                                                  |  |      |          |   |      |   |           |  
|Current
  Assets:                                                                                       |  |      |          |   |      |   |           |  
|Cash and
  cash equivalents                                                                             |  | $    | 205,290  |   |      | $ | 118,473   |  
|Investments                                                                                             |  |      | 147,264  |   |      |   | 197,573   |  
|Accounts
  receivable (less allowance for doubtful accounts:
  2004 - $5,380; 2003 - $7,342)            |  |      | 15,150   |   |      |   | 12,080    |  
|Military
  accounts receivable (less allowance for doubtful accounts:
  2004 and 2003 - $100)           |  |      | 25,452   |   |      |   | 47,389    |  
|Current
  portion of deferred tax asset                                                                 |  |      | 17,560   |   |      |   | 33,708    |  
|Prepaid
  expenses and other current assets                                                             |  |      | 36,106   |   |      |   | 37,478    |  
|Assets of
  discontinued operations                                                                     |  |      | 4,152    |   |      |   | 533,756   |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Total Current Assets                                                                                    |  |      | 450,974  |   |      |   | 980,457   |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Property
  and equipment, net                                                                           |  |      | 71,152   |   |      |   | 63,109    |  
|Restricted
  cash and investments                                                                       |  |      | 20,353   |   |      |   | 17,646    |  
|Goodwill
  (less accumulated amortization: 2004 and 2003 - $6,972)                                      |  |      | 14,782   |   |      |   | 14,782    |  
|Deferred
  tax asset (less current portion)                                                             |  |      | 13,275   |   |      |   | 11,501    |  
|Note receivable (less valuation
  allowance: 2004 - $15,000)                                            |  |      | 47,000   |   |      |   |          |  
|Other
  assets                                                                                          |  |      | 72,244   |   |      |   | 46,626    |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Total
  Assets                                                                                          |  | $    | 689,780  |   |      | $ | 1,134,121 |  
|                                                                                                        |  |      |          |   |      |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                    |  |      |          |   |      |   |           |  
|Current
  Liabilities:                                                                                  |  |      |          |   |      |   |           |  
|Accrued
  liabilities                                                                                   |  | $    | 75,646   |   |      | $ | 55,633    |  
|Trade
  accounts payable                                                                                |  |      | 7,123    |   |      |   | 37,787    |  
|Accrued
  payroll and taxes                                                                             |  |      | 27,668   |   |      |   | 16,573    |  
|Medical
  claims payable                                                                                |  |      | 119,337  |   |      |   | 103,749   |  
|Unearned
  premium revenue                                                                              |  |      | 50,763   |   |      |   | 45,888    |  
|Military
  health care payable                                                                          |  |      | 17,061   |   |      |   | 76,605    |  
|Current
  portion of long-term debt                                                                     |  |      | 100      |   |      |   | 163       |  
|Liabilities of
  discontinued operations                                                                |  |      | 610      |   |      |   | 472,407   |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Total Current Liabilities                                                                               |  |      | 298,308  |   |      |   | 808,805   |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Long-term
  debt (less current portion)                                                                 |  |      | 125,395  |   |      |   | 116,645   |  
|Other
  liabilities                                                                                     |  |      | 64,380   |   |      |   | 57,907    |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Total
  Liabilities                                                                                     |  |      | 488,083  |   |      |   | 983,357   |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Commitments and contingencies                                                                           |  |      |          |   |      |   |           |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Stockholders'
  Equity:                                                                                 |  |      |          |   |      |   |           |  
|Preferred
  stock, $.01 par value, 1,000 shares authorized; none issued or outstanding                  |  |      |          |   |      |   |           |  
|Common
  stock, $.005 par value, 60,000 shares authorized; 2004 - 35,573; 2003 - 33,173
  shares issued |  |      | 178      |   |      |   | 166       |  
|Treasury
  stock: 2004 - 9,192; 2003 - 6,221 common stock shares                                        |  |      | (237,876 | ) |      |   | (112,737  | )
|Additional
  paid-in capital                                                                            |  |      | 286,571  |   |      |   | 227,417   |  
|Deferred
  compensation                                                                                 |  |      | (288     | ) |      |   | (22       | )
|Accumulated
  other comprehensive loss                                                                  |  |      | (245     | ) |      |   | (479      | )
|Retained
  earnings                                                                                     |  |      | 153,357  |   |      |   | 36,419    |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Total
  Stockholders' Equity                                                                            |  |      | 201,697  |   |      |   | 150,764   |  
|                                                                                                        |  |      |          |   |      |   |           |  
|Total Liabilities And Stockholders' Equity                                                              |  | $    | 689,780  |   |      | $ | 1,134,121 |  
|                                                                                                        |  |      |          |   |      |   |           |  



See the accompanying notes
to consolidated financial statements.



59

---

Table of Contents



SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Years Ended December 31,
2004, 2003 and 2002

(In thousands, except per share data)



|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|-------------------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | ---------
|                                                                                             |  | 2004 |           |   | 2003 |   |           | 2002
|Operating
  Revenues:                                                                        |  |      |           |   |      |   |           |      |  |   |          
|Medical
  premiums                                                                           |  | $    | 1,131,147 |   |      | $ | 962,176   |      |  | $ | 857,741  
|Military
  contract revenues                                                                 |  |      | 372,608   |   |      |   | 465,313   |      |  |   | 373,589  
|Professional
  fees                                                                          |  |      | 35,115    |   |      |   | 37,367    |      |  |   | 30,923   
|Investment and
  other revenues                                                              |  |      | 36,565    |   |      |   | 20,223    |      |  |   | 16,382   
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Total                                                                                        |  |      | 1,575,435 |   |      |   | 1,485,079 |      |  |   | 1,278,635
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Operating
  Expenses:                                                                        |  |      |           |   |      |   |           |      |  |   |          
|Medical
  expenses                                                                           |  |      | 878,500   |   |      |   | 762,865   |      |  |   | 712,290  
|Military
  contract expenses                                                                 |  |      | 317,699   |   |      |   | 452,554   |      |  |   | 360,375  
|General and
  administrative expenses                                                        |  |      | 181,434   |   |      |   | 137,263   |      |  |   | 133,979  
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Total                                                                                        |  |      | 1,377,633 |   |      |   | 1,352,682 |      |  |   | 1,206,644
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Operating
  Income From Continuing Operations                                                |  |      | 197,802   |   |      |   | 132,397   |      |  |   | 71,991   
|Interest
  expense                                                                           |  |      | (4,684    | ) |      |   | (5,491    | )    |  |   | (7,650   
|Other
  income (expense), net                                                                |  |      | 104       |   |      |   | (223      | )    |  |   | 55       
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Income
  From Continuing Operations Before Income Taxes                                      |  |      | 193,222   |   |      |   | 126,683   |      |  |   | 64,396   
|Provision
  for income taxes                                                                 |  |      | (70,096   | ) |      |   | (44,565   | )    |  |   | (22,088  
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Income
  From Continuing Operations                                                          |  |      | 123,126   |   |      |   | 82,118    |      |  |   | 42,308   
|Loss
  from discontinued operations (net of income tax benefit of $690, $3,578 and
  $2,945) |  |      | (389      | ) |      |   | (19,792   | )    |  |   | (5,860   
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Net
  Income                                                                                 |  | $    | 122,737   |   |      | $ | 62,326    |      |  | $ | 36,448   
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Earnings
  Per Common Share:                                                                 |  |      |           |   |      |   |           |      |  |   |          
|Income from
  continuing operations                                                          |  | $    | 4.62      |   |      | $ | 2.93      |      |  | $ | 1.47     
|Loss from
  discontinued operations                                                          |  |      | (0.01     | ) |      |   | (0.71     | )    |  |   | (0.20    
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Net Income                                                                                   |  | $    | 4.61      |   |      | $ | 2.22      |      |  | $ | 1.27     
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Earnings
  Per Common Share Assuming Dilution:                                               |  |      |           |   |      |   |           |      |  |   |          
|Income from
  continuing operations                                                          |  | $    | 3.58      |   |      | $ | 2.34      |      |  | $ | 1.36     
|Loss from
  discontinued operations                                                          |  |      | (0.01     | ) |      |   | (0.55     | )    |  |   | (0.19    
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          
|Net Income                                                                                   |  | $    | 3.57      |   |      | $ | 1.79      |      |  | $ | 1.17     
|                                                                                             |  |      |           |   |      |   |           |      |  |   |          



See the accompanying notes
to consolidated financial statements.





60

---

Table of Contents



SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

For the Years Ended December 31,
2004, 2003 and 2002

(In thousands)



|                                                                               |  |        |   | Common Stock |  | In Treasury |   |        | AdditionalPaid-In Capital |   |        | DeferredCompensa-tion |  |   | AccumulatedOtherComprehensiveGain (Loss) |   |   | RetainedEarnings(AccumulatedDeficit) |   |   | TotalStock-holders'Equity
|------------------------------------------------------------------------------ |  | ------ | - | ------------ |  | ----------- | - | ------ | ------------------------- | - | ------ | --------------------- |  | - | ---------------------------------------- | - | - | ------------------------------------ | - | - | -------------------------
|                                                                               |  |        |   | Shares       |  | Amount      |   | Shares |                           |   | Amount |                       |  |   |                                          |   |   |                                      |   |   |                          
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Balance, January 1, 2002                                                       |  | 29,648 | $ | 148          |  | 1,523       |   | $      | (22,789                   | ) | $      | 181,076               |  | $ | (1,058                                   | ) | $ | (5,636                               | ) | $ | (55,222                  
|Common
  stock issued in connection with stock plans                           |  | 1,305  |   | 7            |  | (360        | ) |        | 5,641                     |   |        | 8,798                 |  |   |                                         |   |   |                                     |   |   | (4,287                   
|Income
  tax benefit realized
  upon exercise of stock options                 |  |       |   |             |  |            |   |        |                          |   |        | 6,837                 |  |   |                                         |   |   |                                     |   |   |                         
|Amortization of deferred compensation                                          |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   | 585                                      |   |   |                                     |   |   |                         
|Comprehensive Income:                                                          |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Net
  income                                                                   |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   |                                     |   |   | 36,448                   
|Other
  Comprehensive Income:                                                  |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Unrealized
  holding gain on available-for-sale investments ($10,671 pretax)   |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 6,936                                |   |   |                         
|Reclassification
  adjustment for losses included in net income ($217 pretax)  |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 141                                  |   |   |                         
|Minimum
  pension liability adjustment ($1,630 pretax)                         |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | (1,060                               | ) |   |                         
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Total Comprehensive Income                                                     |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 6,017                                |   |   | 36,448                   
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Balance, December 31, 2002                                                     |  | 30,953 |   | 155          |  | 1,163       |   |        | (17,148                   | ) |        | 196,711               |  |   | (473                                     | ) |   | 381                                  |   |   | (23,061                  
|Common
  stock issued in connection with stock plans                           |  | 2,220  |   | 11           |  | (272        | ) |        | 3,896                     |   |        | 18,110                |  |   |                                         |   |   |                                     |   |   | (2,846                   
|Income
  tax benefit realized upon exercise of stock options                   |  |       |   |             |  |            |   |        |                          |   |        | 12,596                |  |   |                                         |   |   |                                     |   |   |                         
|Amortization of deferred compensation                                          |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   | 451                                      |   |   |                                     |   |   |                         
|Repurchase of common stock shares                                              |  |       |   |             |  | 5,330       |   |        | (99,485                   | ) |        |                      |  |   |                                         |   |   |                                     |   |   |                         
|Comprehensive Income:                                                          |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Net
  income                                                                   |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   |                                     |   |   | 62,326                   
|Other
  Comprehensive Income:                                                  |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Unrealized
  holding loss on available-for-sale investments ($4,446 pretax)    |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | (2,890                               | ) |   |                         
|Reclassification
  adjustment for gains included in net income ($1,493 pretax) |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 970                                  |   |   |                         
|Minimum
  pension liability adjustment ($1,630 pretax)                         |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 1,060                                |   |   |                         
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Total Comprehensive Income                                                     |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | (860                                 | ) |   | 62,326                   
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Balance, December 31, 2003                                                     |  | 33,173 |   | 166          |  | 6,221       |   |        | (112,737                  | ) |        | 227,417               |  |   | (22                                      | ) |   | (479                                 | ) |   | 36,419                   
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Common
  stock issued in connection with stock plans                           |  | 2,400  |   | 12           |  | (415        | ) |        | 8,670                     |   |        | 31,867                |  |   | (6,313                                   | ) |   |                                     |   |   | (5,799                   
|Income
  tax benefit realized upon exercise of stock options                   |  |       |   |             |  |            |   |        |                          |   |        | 27,287                |  |   |                                         |   |   |                                     |   |   |                         
|Amortization of deferred compensation                                          |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   | 6,047                                    |   |   |                                     |   |   |                         
|Repurchase of commonstockshares                                                |  |       |   |             |  | 3,386       |   |        | (133,809                  | ) |        |                      |  |   |                                         |   |   |                                     |   |   |                         
|Comprehensive Income:                                                          |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Net
  income                                                                   |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   |                                     |   |   | 122,737                  
|Other
  Comprehensive Income:                                                  |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Unrealized
  holding gain on available-for-sale investments ($58pretax)        |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 38                                   |   |   |                         
|Reclassification
  adjustment for losses included in net income ($301 pretax)  |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 196                                  |   |   |                         
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Total Comprehensive Income                                                     |  |       |   |             |  |            |   |        |                          |   |        |                      |  |   |                                         |   |   | 234                                  |   |   | 122,737                  
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          
|Balance, December 31, 2004                                                     |  | 35,573 | $ | 178          |  | 9,192       |   | $      | (237,876                  | ) | $      | 286,571               |  | $ | (288                                     | ) | $ | (245                                 | ) | $ | 153,357                  
|                                                                               |  |        |   |              |  |             |   |        |                           |   |        |                       |  |   |                                          |   |   |                                      |   |   |                          



See the accompanying notes
to consolidated financial statements.



61

---

Table of ContentsSIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31,
2004, 2003 and 2002 (In thousands) 
2004


2003


2002Cash
  Flows From Operating Activities:Net
  income

$
122,737


$
62,326



$
36,448Adjustments
  To Reconcile Net Income To Net Cash Provided By Operating Activities:Loss from
  discontinued operations


389



19,792




5,860Depreciation


17,084



15,929




18,245Stock
  based compensation expense


7,332



451




585Provision for
  doubtful accounts


1,667



3,071




2,835(Gain)
  loss on property and equipment dispositions


(136
)


825




17Valuation
  allowance on note receivable


15,000








Change
  In Operating Assets And Liabilities:Other
  assets


(7,758
)


(7,408

)


(16

)Deferred
  tax asset


41,589



32,688




37,931Other
  current liabilities


(18,321
)


24,623




15,242Accounts
  receivable


(5,407
)


(3,919

)


1,267Other
  current assets


16,660



(19,097

)


6,454Military
  accounts receivable


21,937



(263

)


(6,960

)Military
  health care payable


(59,544
)


11,382




(12,038

)Medical
  claims payable


15,588



5,718




16,369Other
  liabilities


(2,636
)


5,745




14,398Net Cash Provided
  By Operating Activities Of Continuing Operations


166,181



151,863



136,637Cash
  Flows From Investing Activities:Capital
  expenditures


(26,237
)


(21,774

)


(12,392

)Property and
  equipment dispositions


3,135



3,256




680Purchase of
  available-for-sale investments


(557,572
)


(540,206

)


(847,437

)Proceeds from
  sales/maturities of available-for-sale investments


626,109



527,696




712,483Purchase of
  held-to-maturity investments


(30,825
)







Proceeds from
  sales/maturities of held-to-maturity investments


2,750








Net Cash
  Provided By (Used For) Investing Activities Of Continuing Operations


17,360



(31,028
)


(146,666
)Cash
  Flows From Financing Activities:Payments on
  debt and capital leases


(1,566
)


(60,721

)


(30,399
)Proceeds
  from other long-term debt


10,000



1,480




Purchase of
  treasury stock


(133,809
)


(99,485
)


Exercise of
  stock in connection with stock plans


26,834



19,171




10,159Proceeds
  from senior convertible debentures






115,000




Debt
  issue costs






(5,834

)


Proceeds on sale-leaseback deposit











16,862Net Cash Used
  For Financing Activities Of Continuing Operations


(98,541
)


(30,389
)


(3,378
)Net
  cash provided by (used for) discontinued operations


1,817



(17,751
)


(47,929
)Net
  Increase (Decrease) In Cash And Cash Equivalents


86,817



72,695




(61,336

)Cash
  And Cash Equivalents At Beginning Of Year


118,473



45,778




107,114Cash
  And Cash Equivalents At End Of Year

$
205,290


$
118,473


$
45,778 See the accompanying notes
to consolidated financial statements. 


62

Table of ContentsSIERRA HEALTH SERVICES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSFor the Years Ended December 31, 2004, 2003 and 2002

1. BUSINESS
Business.  The consolidated financial statements
include the accounts of Sierra Health Services, Inc. and its subsidiaries
(collectively referred to as "Sierra" or the "Company").
Sierra is a managed health care organization that provides and administers the
delivery of comprehensive health care programs with an emphasis on quality care
and cost management.  Sierra's broad range of managed health care services are
provided through its health maintenance organization ("HMO"), managed
indemnity plans, military health services programs, third-party administrative
services programs for employer-funded health benefit plans and medical
management programs.  Ancillary products and services that complement the
Company's managed health care product lines are also offered.

The Company's continuing operations currently operate in two
reportable segments:  managed care and corporate operations and military health
services operations.  The Company's prior third reportable segment, workers'
compensation operations, was classified as a discontinued operation and was sold
on March 31, 2004.

Discontinued Operations.  During the third quarter of
2001, the Company announced its plan to exit the Texas HMO health care market
and received formal approval from the Texas Department of Insurance to withdraw
its HMO operations in mid-October 2001.  The Company ceased providing HMO health
care coverage in Texas on April 17, 2002.

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

In accordance with SFAS No. 144, during the fourth quarter of
2002, the Company reclassified its workers' compensation insurance operations as
discontinued operations.  During the fourth quarter of 2003, the Company
announced that it and its wholly-owned subsidiary, CII Financial Inc.
("CII"), entered into a Stock Purchase Agreement, which provides for
the sale of all of the capital stock of California Indemnity Insurance Company
("Cal Indemnity"), a wholly-owned subsidiary of CII.

On March 31, 2004, the Company completed the sale of Cal
Indemnity which was CII's only significant asset.  Cal Indemnity's subsidiaries,
which were included in the sale, are Commercial Casualty Insurance Company,
Sierra Insurance Company of Texas, and CII Insurance Company.

The individual line items on the consolidated balance sheets
have been presented net of the discontinued operations with the total assets and
liabilities of the discontinued operations presented on one line within current
assets and current liabilities, respectively. The results of operations from the
discontinued operations have been reported net of tax as a separate component of
income on the consolidated statements of operations. The cash flows from the
discontinued operations have been reported as a separate component on the
consolidated statements of cash flows. See Notes 9 and 10 for disclosure on and
a description of the discontinued operations.

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation.  All significant
intercompany transactions and balances have been eliminated in consolidation.
Sierra's consolidated subsidiaries include:  Health Plan of Nevada, Inc.
("HPN") and Texas Health Choice, L.C. ("TXHC"), which are
licensed HMOs; Sierra Health and Life Insurance Company, Inc. ("SHL"),
a health and life insurance company; Southwest Medical Associates, Inc.
("SMA"), a multi-specialty medical provider group; Sierra Military
Health Services, LLC, and its subsidiary, ("SMHS"), a company that
provided and administered managed care services to certain TRICARE eligible
beneficiaries;
63

Table of ContentsCII; administrative services companies; a home health care
agency; an in-home hospice agency; a home medical products subsidiary; and a
company that provides and manages mental health and substance abuse services.

Medical Premiums.  Membership contracts are generally
established on an annual basis subject to cancellation by the employer group or
Sierra generally upon 60 days written notice.  Premiums, including premiums from
both commercial and governmental programs, are due monthly and are recognized as
revenue during the period in which members are entitled to receive services and
are net of estimated retroactive adjustments of members and groups.  Non-Medicare
member enrollment is represented principally by employer groups. HPN
offers a prepaid health care program to Medicare recipients.  Revenues
associated with Medicare recipients were approximately $455.0 million, $375.2
million and $340.1 million in 2004, 2003 and 2002, respectively. Premiums
collected in advance are recorded as unearned premium revenue and can include
payments under prepaid Medicare contracts with the Centers for Medicare and
Medicaid Services ("CMS") and prepaid HPN commercial and SHL PPO
premiums.

Military Contract Revenues.  Revenue under the Department
of Defense TRICARE contract is recorded based on the contract price as agreed to
by the federal government.  The health care component of the TRICARE contract
has a fixed bid price component (established when the contract was awarded based
on the government's assumptions regarding enrollment and utilization), as well
as a Bid Price Adjustment ("BPA") component.  The BPA is used to
adjust the fixed bid price health care component up or down over the course of
the contract for changes in health care cost trends due to changes in enrollment
and utilization patterns from the government's original assumed enrollment and
utilization patterns.  On a monthly basis, SMHS records the base bid health care
revenue component as stated in the original bid and SMHS also records an
estimate for the BPA using the latest government provided data.  SMHS adjusts
each BPA accrual as it is provided with new government data.  After each BPA
negotiation with the government is completed, SMHS records a final BPA
adjustment for the ultimate negotiated amount.

While the BPA relates to the original contract and was an
ongoing part of the contract, modifications to the original contract are
referred to by the Company as change orders.  The government negotiates both the
cost and profit to be paid on each contract modification.  As SMHS incurs costs
under the government's direction to proceed with a modification to the contract,
the government is contractually obligated to reimburse SMHS for all of its
incremental, allowable costs incurred through the final negotiation date.  The
allowable costs are those costs determined in accordance with Federal
Acquisition Regulation Part 31.  Revenue is realizable and earned when SMHS
starts performing as contractually required, even though the change order profit
has not been fully negotiated.  As costs are incurred, SMHS records an estimate
of its revenue earned under the modification.  The estimate recorded does not
include profit until the profit is determined when it is negotiated and
finalized with the government.  Enrollment fees collected in advance of the
service period are recorded as unearned premium revenue and are earned over the
service period.

On September 1, 2004, SMHS commenced an eight-month phase-out
of operations at prices previously negotiated with the Department of Defense
("DoD").  Based on meeting certain criteria as defined in the phase-out
contract, SMHS will receive $23.0 million during the phase-out period.  SMHS
is recording phase-out revenue equal to the phase-out expenses it is incurring.
If SMHS is able to perform the phase-out contract for less than the negotiated
price, a gain will be recognized at the completion of the phase-out period.

Professional Fees.  Revenue for professional medical
services is recorded on the accrual basis in the period in which the services
are provided.  Such revenue is recorded at established rates, net of provisions
for estimated contractual allowances and allowances for doubtful accounts.

Investment and Other Revenues.  Investment income is
recognized in the period earned.  Realized gains and losses are recognized as
incurred and are calculated using the specific identification method.  Other
64

Table of Contentsrevenues include administrative services fees and certain ancillary product
revenues.  Such revenues are recognized in the period in which the service is
performed or the period that coverage for services is provided.

Medical Expenses.  Health care expenses are recorded
in the period when services are provided to enrolled members, including
estimates for provider costs, which have been incurred at the balance sheet date
but not yet reported to the Company.  The Company uses a variety of standard
actuarial projection methods to make these estimates and must use judgment in
selecting development factors and assumed trends.  In making projections, the
Company considers medical cost utilization and trends, changes in internal
processes, the average interval between the date services are rendered and the
date claims are received and/or paid, denied claims activity, disputed claims
activity, seasonality patterns and changes in membership.  Assumptions could be
affected by the timing of the receipt of claims, the timing of processing claims
and unanticipated changes, such as adverse legal outcomes, legislative or
regulatory changes, new interpretations of existing laws or regulations or
disputed contract provisions that result in the Company having to provide new or
extended benefits and changes in the Company's health care delivery system or
costs.  The Company believes that the recorded liability for medical claims
payable at December 31, 2004 is reasonable and adequate to cover future health
care claim payments.  Any subsequent changes in an estimate for a prior year
would be reflected in that subsequent year's operating results.

The Company contracts with hospitals, physicians and other
independent contracted providers of health care under capitated or discounted
fee-for-service arrangements, including hospital per diems, to provide medical
care services to enrollees.  Capitated providers are at risk for a portion of
the cost of medical care services provided to the Company's enrollees in the
relevant geographic areas; however, the Company is ultimately responsible for
the provision of services to its enrollees should the capitated provider be
unable to provide the contracted services.   Also included in medical expenses
are the operating expenses of the Company's medical provider subsidiaries and
certain claims-related administrative expenses.

Military Contract Expenses.  This expense consists
primarily of costs to provide managed health care services to eligible
beneficiaries in accordance with the Company's TRICARE contract.  Under the
contract, SMHS provided health care services to approximately 710,000 dependents
of active duty military personnel, military retirees under the age of 65 and
dependents of military retirees through a network of approximately 50,000 health
care providers and certain other subcontractor partnerships.  Health care costs
are recorded in the period when services are provided to eligible beneficiaries
including estimates for provider costs, which have been incurred at the balance
sheet date but not reported to the Company. Also included in military contract
expenses are costs incurred to perform specific administrative services, such as
health care appointment scheduling, enrollment, network management and health
care advice line services and other administrative functions of the military
health care subsidiary.  These administrative services were performed for active
duty personnel and dependants as well as retired military families.

Cash and Cash Equivalents.  The Company considers cash
and cash equivalents as all highly liquid instruments with a maturity of three
months or less at time of purchase.  The carrying amount of cash and cash
equivalents approximates fair value because of the short maturity of these
instruments.

Investments.  Investments consist primarily of U.S.
Government and its agencies' securities, municipal bonds, corporate bonds,
securities and first trust deed mortgage notes.  All investments that have not
been designated as held-to-maturity are designated as available-for-sale and are
stated at fair value.  Fair value is estimated primarily from published market
values at the balance sheet date.  All non-restricted available-for-sale
investments are classified as current assets.    These investments are available
for use in the current operations regardless of contractual maturity dates.
Restricted investments are classified as non-current assets. Realized gains and
losses are calculated using the specific identification method and are included
in investment and other revenues.  Unrealized holding gains and losses on
available-for-sale securities are included as a separate component of
stockholders' equity, net of income tax effects, until realized.
65

Table of ContentsInvestments that the Company has the intention and ability to
hold to maturity are stated at amortized cost and categorized as held-to-maturity.
All non-restricted investments designated as held-to-maturity are
classified as current assets if expected maturity is within one year of the
balance sheet date.  Otherwise, they are classified as long-term investments.
The Company's held-to-maturity investments consist of first trust deed mortgage
notes.  The Company does not believe any of its investments are other than temporarily impaired at
December 31, 2004.

Restricted Cash and Investments.  Certain subsidiaries
are required by state regulatory agencies to maintain deposits and must also
meet net worth and reserve requirements.  The Company believes its subsidiaries
are in compliance with the applicable minimum regulatory and capital
requirements.

Military Accounts Receivable.  Amounts receivable
under government contracts are comprised primarily of amounts due from military
treatment facilities, estimates of adjustments under the contract based on
actual experience, estimates of the earned portion of any change orders not
originally specified in the contract and amounts due under the phase-out
contract.

Reinsurance Recoverable.  In the normal course of
business, the Company seeks to reduce the effects of catastrophic and other
events that may cause unfavorable underwriting results by reinsuring certain
levels of risk with other reinsurers.  Reinsurance receivable for ceded paid
claims is recorded in accordance with the terms of the agreements and
reinsurance recoverable for unpaid losses and loss adjustment expense and
medical claims payable is estimated in a manner consistent with the claim
liability associated with the reinsurance policy. Reinsurance receivables,
including amounts related to paid and unpaid losses, are reported as assets
rather than a reduction of the related liabilities.

The Company is covered under medical reinsurance agreements
that provide coverage for 50% - 90% of hospital and other costs in excess of
$350,000 per case, up to a maximum of $2.0 million per member per lifetime for
both the managed indemnity and HMO subsidiaries.

Certain of the Company's HMO members are covered by an excess
catastrophe reinsurance contract and SHL maintains reinsurance on certain of its
insurance products.  Reinsurance premiums of $1.9 million, $2.2 million and $2.3
million, net of reinsurance recoveries of $3.1 million, $2.3 million and $1.3
million, are included in medical expenses for 2004, 2003 and 2002, respectively.

Property and Equipment.  Property and equipment is
stated at cost less accumulated depreciation. Maintenance and repairs that do
not significantly improve or extend the life of the respective assets are
charged to operations.  The Company capitalizes interest expense as part of the
cost of construction of facilities and the implementation of computer systems.
Depreciation is computed using the straight-line method over the estimated
service lives of the assets or terms of leases if shorter.  Estimated useful
lives are as follows:



|Buildings and
Improvements
Leasehold Improvements
Data Processing Hardware and Software
Furniture, Fixtures and Equipment | 10
3
3
3 | 


 | 30
10
10
5 | years
years
years
years
|------------------------------------------------------------------------------------------------------------------------- | -------- | ------- | ---------- | -----------------------



Goodwill.  The goodwill balance at December 31, 2004,
was $14.8 million, all of which is part of the managed care and corporate
operations segment.  During 2004, 2003 and 2002, the Company's assessment of
goodwill resulted in no impairment of goodwill.



Treasury Stock.  Shares purchased and placed in
treasury are valued at cost.  Subsequent sales of treasury stock at amounts in
excess of their cost are credited to additional paid-in capital.  Sale of
treasury stock at amounts below their cost are charged to additional paid-in
capital to the extent it includes gains

66

---

Table of Contents

from previous sales and the remainder to
retained earnings.  Sales of treasury shares in 2004 and 2003, at amounts below
their cost of $5.8 million and $2.8 million, respectively were charged to
retained earnings, as the Company did not previously have gains in additional
paid-in capital.  All sales of treasury shares in 2004 and 2003 were in
connection with the exercise of stock options.



Stock Option Plans.  The Company has several plans,
which are described more fully in Note 16.  The Company accounts for its stock-based
compensation using the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," as amended.  Accordingly, no compensation cost has been
recognized for the Company's employee stock plans except for those expenses
associated with the restricted stock units.



The following table represents the effect on net income and
earnings per share if the Company had applied the fair value based method and
recognition provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"),
to stock-based  compensation:



|                                                                                                                               |  |                                       |         |      |   |        |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------- | ------- | ---- | - | ------ | ---- | - | ------ | -
|                                                                                                                               |  | Years Ended December 31,              |         |      |  
|                                                                                                                               |  | 2004                                  |         | 2003 |   |        | 2002
|                                                                                                                               |  | (In thousands, except per share data) |        
|Net
  income, as reported                                                                                                      |  | $                                     | 122,737 |      | $ | 62,326 |      | $ | 36,448 |  
|Less:
  total stock-based employee compensation expense determined under fair value
  based methods for all awards, net of tax |  |                                       | (9,750  | )    |   | (7,173 | )    |   | (4,598 | )
|                                                                                                                               |  |                                       |         |      |   |        |      |   |        |  
|Pro Forma Net Income                                                                                                           |  | $                                     | 112,987 |      | $ | 55,153 |      | $ | 31,850 |  
|                                                                                                                               |  |                                       |         |      |   |        |      |   |        |  
|Net
  income per share, as reported                                                                                            |  | $                                     | 4.61    |      | $ | 2.22   |      | $ | 1.27   |  
|Pro
  forma net income, per share                                                                                              |  |                                       | 4.24    |      |   | 1.97   |      |   | 1.11   |  
|                                                                                                                               |  |                                       |         |      |   |        |      |   |        |  
|Net
  income per share assuming dilution, as reported                                                                          |  | $                                     | 3.57    |      | $ | 1.79   |      | $ | 1.17   |  
|Pro
  forma net income, per share                                                                                              |  |                                       | 3.29    |      |   | 1.59   |      |   | 1.02   |  

Due to the fact that the Company's stock option programs vest
over many years and additional awards are made each year, the above pro forma
numbers are not indicative of the financial impact had the disclosure provisions
of SFAS 123 been applied to all the years of previous option grants.  The above
numbers do not include the effect of options granted prior to 1995.  See Note 16
for a discussion of the assumptions used in the option pricing model and
estimated fair value of employee stock options.



Premium Deficiency Reserves.  Premium deficiency
expenses are recognized when it is probable that the future costs associated
with a group of existing contracts will exceed the anticipated future premiums
on those contracts.  The Company calculates expected premium deficiency expense
based on budgeted revenues and expenses.  Once established, premium deficiency
reserves are evaluated quarterly for adequacy.  The Company has not recorded any
premium deficiency reserves during the past three years.



Income Taxes.  The Company accounts for income taxes
using the liability method.  Deferred income tax assets and liabilities result
from temporary differences between the tax basis of assets and liabilities and
the reported amounts in the consolidated financial statements that will result
in taxable or deductible amounts in future years.  The Company's temporary
differences arise principally from loss carryforwards and credits, medical
claims payable, compensation accruals, valuation allowance and depreciation.



Concentration of Credit Risk.  The Company's financial
instruments that are exposed to credit risk consist

67

---

Table of Contents

primarily of cash equivalents, investments and accounts receivable.  The Company maintains cash
and cash equivalents and investments with various financial institutions.  These
financial institutions are located in many different regions and Company policy
is designed to limit exposure with any one institution.   The Company's first
trust deed investments are with numerous independent borrowers and are secured
by real estate in several states.



Credit risk with respect to accounts receivable is generally
diversified due to the large number of entities comprising the Company's
customer base and their dispersion across many different industries.  The
Company's customers are primarily located in the various states in which the
Company is licensed and operates although they are principally located in
Nevada. In addition, at December 31, 2004, the Company had receivables
outstanding from the federal government related to its TRICARE contract in the
amount of $25.5 million.  The Company also has receivables from its reinsurers.
Reinsurance contracts do not relieve the Company from its obligations to
enrollees or policyholders.  Failure of reinsurers to honor their obligations
could result in losses to the Company.  The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies. All reinsurers with whom the Company has reinsurance
contracts are rated A- or better by Fitch Ratings (7th of 23) and the
A.M. Best Company (4th of 16).



Recently Issued Accounting Standards.  In December
2004, the FASB, issued Statement of Financial Accounting Standards No. 123
(revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123
and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees."  SFAS 123R
requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values beginning with the first interim or annual period after June
15, 2005, with early adoption encouraged. The pro forma disclosures previously
permitted under SFAS 123 no longer will be an alternative to financial statement
recognition. Sierra is required to adopt SFAS 123R beginning July 1, 2005. Under
SFAS 123R, Sierra must determine the appropriate fair value model to be used for
valuing share-based payments, the amortization method for compensation cost and
the transition method to be used at the date of adoption. The transition methods
include prospective and retroactive adoption options. The prospective method
requires that compensation expense be recorded for all unvested stock options
and restricted stock at the beginning of the first quarter of adoption of SFAS
123R.  The retroactive methods would record compensation expense for all
unvested stock options and restricted stock beginning with the first period
restated.  Prior periods may be restated either as of the beginning of the year
of adoption or for all periods presented.  The Company is currently evaluating
the requirements of SFAS 123R.  The Company anticipates adopting the prospective
method of SFAS 123R and expects that the adoption will have an after tax
earnings impact of approximately $1.5 to $2.0 million for 2005.



Emerging Issues Task Force Issue 04-8, "Accounting
Issues Related to Certain Features of Contingently Convertible Debt and the
Effect on Diluted Earnings per Share" ("EITF 04-8") became
effective beginning in the Company's fourth quarter of 2004. EITF 04-8 addresses
when the dilutive effect of contingently convertible debt with a market price
trigger should be included in diluted earnings per share calculations. The
EITF's conclusion is that the market price trigger should be ignored and that
these securities should be treated as convertible securities and included in
diluted earnings per share regardless of whether the conversion contingencies
have been met.  EITF 04-8 also requires restatement of all prior periods for
which the convertible debentures were outstanding.  Since the market price
condition has been satisfied in every quarter since the fourth quarter of 2003,
the debentures have already been considered common stock equivalents and were
included in the calculation of weighted average common shares outstanding
assuming dilution for each quarter of 2004.  The amounts previously reported for
earnings per share assuming dilution and weighted average common shares assuming
dilution for 2003 of $2.05 and 30,421,000, respectively, have been restated in
accordance with EITF 04-8.



In March 2004, the FASB approved the consensus reached on the
Emerging Issues Task Force Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments"
("EITF

68

---

Table of Contents

03-1").  The Issue's objective is to provide guidance for
identifying other-than-temporarily impaired investments.  EITF 03-1 also
provides new disclosure requirements for investments that are deemed to be
temporarily impaired.  In September 2004, the FASB issued a FASB Staff Position
EITF 03-1-1 that delays the effective date of the measurement and recognition
guidance in EITF 03-1 until further notice.  The disclosure requirements of EITF
03-1 are effective with this annual report for 2004. Once the FASB reaches a
final decision on the measurement and recognition provisions, the company will
evaluate the impact of the adoption of the accounting provisions of EITF 03-1.



In December 2003, the FASB, issued Statement of Financial
Accounting Standards No. 132 (Revised 2003), "Employers' Disclosures about
Pensions and Other Postretirement Benefits, an amendment of FASB Statements No.
87, 88 and 106" ("SFAS No. 132R").  SFAS No. 132R retains the
disclosure requirement contained in the original FASB Statement No. 132,
"Employers' Disclosures about Pensions and Other Postretirement
Benefits", which it replaces.  The statement also requires additional
disclosures to those in the original FASB Statement No. 132 about the assets,
obligations, cash flows, and net periodic benefit cost of defined benefit
pension plans and other postretirement plans.  See Note 15 for disclosure on the
Company's defined benefit plan.



Use of Estimates and Assumptions in the Preparation of
Financial Statements.  The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period.  Management must exercise its
judgment taking into consideration the facts and circumstances in selecting
assumptions and other factors in calculating its estimates.  On an on-going
basis, management re-evaluates its assumptions and the methods of calculating
its estimates.  Estimates and assumptions include, but are not limited to,
medical expenses and reserves, military revenue and expenses, reinsurance
recoverables, legal reserves, fair values of investments, amounts receivable or
payable under government contracts, deferred income taxes, goodwill, asset
allowances, accrued liabilities, malpractice reserves and amounts collectable
from notes receivable.  Actual results may materially differ from estimates.



Reclassifications.  Certain amounts in the
Consolidated Financial Statements as of and for the years ended
December 31, 2003 and 2002 have been reclassified to conform with the
current year presentation.  The reclassifications have no effect on net income
or stockholders' equity as previously reported.

69

---

Table of Contents

3.	EARNINGS PER SHARE



The following table provides a reconciliation of basic and
diluted earnings per share ("EPS"):



|                                                                |  |                                       |         |      |   |         |      |  |   |       
|--------------------------------------------------------------- |  | ------------------------------------- | ------- | ---- | - | ------- | ---- |  | - | ------
|                                                                |  | Years Ended December 31,              |         |      |  
|                                                                |  | 2004                                  |         | 2003 |   |         | 2002
|                                                                |  | (In thousands, except per share data) |        
|Basic
  Income (Loss) Per Share:                                |  |                                       |         |      |   |         |      |  |   |       
|Income from
  continuing operations                             |  | $                                     | 123,126 |      | $ | 82,118  |      |  | $ | 42,308
|Loss from
  discontinued operations                             |  |                                       | (389    | )    |   | (19,792 | )    |  |   | (5,860
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Net Income                                                      |  | $                                     | 122,737 |      | $ | 62,326  |      |  | $ | 36,448
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Weighted
  average common shares outstanding                    |  |                                       | 26,631  |      |   | 28,053  |      |  |   | 28,756
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Earnings
  Per Common Share:                                    |  |                                       |         |      |   |         |      |  |   |       
|Income from
  continuing operations                             |  | $                                     | 4.62    |      | $ | 2.93    |      |  | $ | 1.47  
|Loss from
  discontinued operations                             |  |                                       | (0.01   | )    |   | (0.71   | )    |  |   | (0.20 
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Net Income                                                      |  | $                                     | 4.61    |      | $ | 2.22    |      |  | $ | 1.27  
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Diluted
  Income (Loss) Per Share:                              |  |                                       |         |      |   |         |      |  |   |       
|Income from
  continuing operations                             |  | $                                     | 123,126 |      | $ | 82,118  |      |  | $ | 42,308
|Loss from
  discontinued operations                             |  |                                       | (389    | )    |   | (19,792 | )    |  |   | (5,860
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Net Income                                                      |  |                                       | 122,737 |      |   | 62,326  |      |  |   | 36,448
|Interest
  expense on Sierra debentures, net of tax             |  |                                       | 1,682   |      |   | 1,390   |      |  |   |      
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Income
  For Purposes Of Computing Diluted Net Income Per Share |  | $                                     | 124,419 |      | $ | 63,716  |      |  | $ | 36,448
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Weighted
  average common shares outstanding                    |  |                                       | 26,631  |      |   | 28,053  |      |  |   | 28,756
|Dilutive
  impact of conversion of Sierra debentures            |  |                                       | 6,288   |      |   | 5,212   |      |  |   |      
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Weighted
  Average Common Shares Outstanding Assuming Dilution  |  |                                       | 34,822  |      |   | 35,633  |      |  |   | 31,141
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Earnings
  Per Common Share Assuming Dilution:                  |  |                                       |         |      |   |         |      |  |   |       
|Income from
  continuing operations                             |  | $                                     | 3.58    |      | $ | 2.34    |      |  | $ | 1.36  
|Loss from
  discontinued operations                             |  |                                       | (0.01   | )    |   | (0.55   | )    |  |   | (0.19 
|                                                                |  |                                       |         |      |   |         |      |  |   |       
|Net Income                                                      |  | $                                     | 3.57    |      | $ | 1.79    |      |  | $ | 1.17  
|                                                                |  |                                       |         |      |   |         |      |  |   |       





Stock options to purchase 319,000 and 325,000 shares in 2003
and 2002, respectively, were not dilutive and, therefore, were not included in
the computations of diluted earnings per share.

70

---

Table of Contents

4. PROPERTY AND EQUIPMENT



Property and equipment at December 31, consists of the
following:



|                                                       |  |                |          |   |      |   |          |  
|------------------------------------------------------ |  | -------------- | -------- | - | ---- | - | -------- | -
|                                                       |  | 2004           |          |   | 2003 |  
|                                                       |  | (In thousands) |         
|Land                                                   |  | $              | 14,893   |   |      | $ | 2,991    |  
|Buildings and
  improvements                           |  |                | 26,833   |   |      |   | 25,269   |  
|Furniture,
  fixtures and equipment                    |  |                | 44,216   |   |      |   | 42,058   |  
|Data
  processing equipment and software               |  |                | 98,162   |   |      |   | 98,489   |  
|Software in
  development and construction in progress |  |                | 368      |   |      |   | 202      |  
|Less:
  accumulated depreciation                       |  |                | (113,320 | ) |      |   | (105,900 | )
|                                                       |  |                |          |   |      |   |          |  
|Property
  And Equipment, Net                          |  | $              | 71,152   |   |      | $ | 63,109   |  
|                                                       |  |                |          |   |      |   |          |  

The following is an analysis of property and equipment under
capital lease by classification at December 31:



|                                         |  |                |      |   |      |   |      |  
|---------------------------------------- |  | -------------- | ---- | - | ---- | - | ---- | -
|                                         |  | 2004           |      |   | 2003 |  
|                                         |  | (In thousands) |     
|Buildings and
  improvements             |  | $              | 278  |   |      | $ | 245  |  
|Data
  processing equipment and software |  |                |     |   |      |   | 333  |  
|Vehicles                                 |  |                | 391  |   |      |   | 153  |  
|Less:
  accumulated depreciation         |  |                | (257 | ) |      |   | (506 | )
|                                         |  |                |      |   |      |   |      |  
|Property
  And Equipment, Net            |  | $              | 412  |   |      | $ | 225  |  
|                                         |  |                |      |   |      |   |      |  

Depreciation expense including capital leases from continuing operations in 2004, 2003
and 2002 was $17.1 million, $15.9 million and $18.2 million, respectively.



5. CASH AND INVESTMENTS



Investments that the Company has the intention and ability to
hold to maturity are stated at amortized cost and categorized as held-to-maturity.
The remaining investments have been categorized as available-for-sale
and are stated at their fair value.  Fair value is estimated primarily from
published market values at the balance sheet date.  Gross realized gains on
investments, from continuing operations, for 2004, 2003 and 2002 were $585,000,
$905,000 and $82,000, respectively.  Gross realized losses on investments, from
continuing operations, for 2004, 2003 and 2002 were $535,000, $313,000 and
$84,000, respectively.

71

---

Table of Contents

The following table summarizes the Company's current, long-term
and restricted investments from continuing operations at December 31,
2004:

|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|------------------------------------ |  | ------------- | ------- | -------------------- | - | -------------- | --------------------- |  | - | --------- |  |  | - | ------- | 
|                                     |  | AmortizedCost |         | GrossUnrealizedGains |   |                | GrossUnrealizedLosses |  |   | FairValue | 
|                                     |  |               |         |                      |   | (In thousands) |                       |  |   |           | 
|Available-For-Sale Investments:      |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Classified
  As Current:             |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|U.S.
  government and its agencies   |  | $             | 33,949  |                      | $ | 144            |                       |  | $ | 189       |  |  | $ | 33,904  | 
|Municipal
  obligations              |  |               | 81,730  |                      |   | 223            |                       |  |   | 269       |  |  |   | 81,684  | 
|Mortgage
  backed securities         |  |               | 545     |                      |   | 8              |                       |  |   | 2         |  |  |   | 551     | 
|Corporate
  bonds                    |  |               | 7,007   |                      |   | 49             |                       |  |   | 13        |  |  |   | 7,043   | 
|Other
  debt securities              |  |               | 60      |                      |   |               |                       |  |   |          |  |  |   | 60      | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total
  Debt Securities              |  |               | 123,291 |                      |   | 424            |                       |  |   | 473       |  |  |   | 123,242 | 
|Preferred
  stock                    |  |               | 1,593   |                      |   | 25             |                       |  |   | 171       |  |  |   | 1,447   | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total Current                        |  |               | 124,884 |                      |   | 449            |                       |  |   | 644       |  |  |   | 124,689 | 
|Classified
  As Restricted:          |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|U.S.
  government and its
  agencies |  |               | 10,153  |                      |   | 4              |                       |  |   | 178       |  |  |   | 9,979   | 
|Municipal
  obligations              |  |               | 2,160   |                      |   | 21             |                       |  |   |          |  |  |   | 2,181   | 
|Other
  debt securities              |  |               | 8,193   |                      |   |               |                       |  |   |          |  |  |   | 8,193   | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total Restricted                     |  |               | 20,506  |                      |   | 25             |                       |  |   | 178       |  |  |   | 20,353  | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total
  Available-For-Sale           |  | $             | 145,390 |                      | $ | 474            |                       |  | $ | 822       |  |  | $ | 145,042 | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Held-To-Maturity Investments:        |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Classified
  As Current:             |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|First
  trust deed mortgage notes    |  | $             | 22,575  |                      | $ |               |                       |  | $ |          |  |  | $ | 22,575  | 
|Classified
  As Long-Term:           |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|First
  trust deed mortgage notes    |  |               | 5,500   |                      |   |               |                       |  |   |          |  |  |   | 5,500   | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total Held-To-Maturity               |  | $             | 28,075  |                      | $ |               |                       |  | $ |          |  |  | $ | 28,075  | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 







72

---

Table of Contents

The following table summarizes the Company's current and
restricted investments, from continuing operations, at December 31, 2003:

|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|------------------------------------ |  | ------------- | ------- | -------------------- | - | -------------- | --------------------- |  | - | --------- |  |  | - | ------- | 
|                                     |  | AmortizedCost |         | GrossUnrealizedGains |   |                | GrossUnrealizedLosses |  |   | FairValue | 
|                                     |  |               |         |                      |   | (In thousands) |                       |  |   |           | 
|Available-For-Sale Investments:      |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Classified
  As Current:             |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|U.S.
  government and its
  agencies |  | $             | 73,461  |                      | $ | 168            |                       |  | $ | 925       |  |  | $ | 72,704  | 
|Municipal
  obligations              |  |               | 102,469 |                      |   | 283            |                       |  |   | 194       |  |  |   | 102,558 | 
|Mortgage
  backed securities         |  |               | 961     |                      |   | 4              |                       |  |   |          |  |  |   | 965     | 
|Corporate
  bonds                    |  |               | 178     |                      |   | 8              |                       |  |   |          |  |  |   | 186     | 
|Other
  debt securities              |  |               | 18,559  |                      |   |               |                       |  |   |          |  |  |   | 18,559  | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total Debt Securities                |  |               | 195,628 |                      |   | 463            |                       |  |   | 1,119     |  |  |   | 194,972 | 
|Preferred
  stock                    |  |               | 2,663   |                      |   |               |                       |  |   | 62        |  |  |   | 2,601   | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total Current                        |  |               | 198,291 |                      |   | 463            |                       |  |   | 1,181     |  |  |   | 197,573 | 
|Classified
  As Restricted:          |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|U.S.
  government and its
  agencies |  |               | 7,764   |                      |   | 99             |                       |  |   |          |  |  |   | 7,863   | 
|Municipal
  obligations              |  |               | 2,260   |                      |   | 39             |                       |  |   | 21        |  |  |   | 2,278   | 
|Other
  debt securities              |  |               | 7,505   |                      |   |               |                       |  |   |          |  |  |   | 7,505   | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total Restricted                     |  |               | 17,529  |                      |   | 138            |                       |  |   | 21        |  |  |   | 17,646  | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 
|Total
  Available-For-Sale           |  | $             | 215,820 |                      | $ | 601            |                       |  | $ | 1,202     |  |  | $ | 215,219 | 
|                                     |  |               |         |                      |   |                |                       |  |   |           |  |  |   |         | 

The following table shows our investments' fair value and
unrealized losses, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position, at
December 31, 2004:

|                                        |  |                     |                |                  |                     |      |           |       |                  |        |  |           |      |                  |  |   |        |  |   |      |  
|--------------------------------------- |  | ------------------- | -------------- | ---------------- | ------------------- | ---- | --------- | ----- | ---------------- | ------ |  | --------- | ---- | ---------------- |  | - | ------ |  | - | ---- | -
|                                        |  | Less Than 12 Months |                |                  | 12 Months
  Or More |      |           | Total |                 
|Description
  Of Securities:            |  | FairValue           |                | UnrealizedLosses |                     |      | FairValue |       | UnrealizedLosses |        |  | FairValue |      | UnrealizedLosses | 
|                                        |  |                     | (In thousands) |                  |                    
|U.S.
  government and its agencies      |  | $                   | 19,201         |                  | $                   | (123 | )         |       | $                | 7,237  |  | $         | (244 | )                |  | $ | 26,438 |  | $ | (367 | )
|Municipal
  obligations                 |  |                     | 50,084         |                  |                     | (122 | )         |       |                  | 9,095  |  |           | (147 | )                |  |   | 59,179 |  |   | (269 | )
|Mortgage
  backed securities            |  |                     | 363            |                  |                     | (2   | )         |       |                  |       |  |           |     |                  |  |   | 363    |  |   | (2   | )
|Corporate
  bonds                       |  |                     | 543            |                  |                     | (13  | )         |       |                  |       |  |           |     |                  |  |   | 543    |  |   | (13  | )
|                                        |  |                     |                |                  |                     |      |           |       |                  |        |  |           |      |                  |  |   |        |  |   |      |  
|Total
  Debt Securities                 |  |                     | 70,191         |                  |                     | (260 | )         |       |                  | 16,332 |  |           | (391 | )                |  |   | 86,523 |  |   | (651 | )
|Preferred
  stock                       |  |                     | 1,354          |                  |                     | (82  | )         |       |                  | 26     |  |           | (89  | )                |  |   | 1,380  |  |   | (171 | )
|                                        |  |                     |                |                  |                     |      |           |       |                  |        |  |           |      |                  |  |   |        |  |   |      |  
|Total
  Temporarily Impaired Securities |  | $                   | 71,545         |                  | $                   | (342 | )         |       | $                | 16,358 |  | $         | (480 | )                |  | $ | 87,903 |  | $ | (822 | )
|                                        |  |                     |                |                  |                     |      |           |       |                  |        |  |           |      |                  |  |   |        |  |   |      |  



The unrealized losses in the Company's investments in U.S.
government and its agencies, municipal obligations, mortgage backed securities
and corporate bonds is due to interest rate increases. It is expected that the
securities would not be realized at a price less than the amortized cost of the
Company's investment. Based on the immaterial severity of the impairments and
the ability and intent of the Company to hold these investments until recovery
of fair value, which may be maturity, the investments were not considered to be
other than temporarily impaired at December 31, 2004.

73

---

Table of Contents

The unrealized losses in the Company's investments in
preferred stock of $171,000 is not considered to be other than temporary at
December 31, 2004 due to the duration of the impairment, overall market
volatility and the Company's ability and intent to hold these securities for a
reasonable period of time sufficient for a recovery of fair value.

The contractual maturities of available-for-sale debt
securities at December 31, 2004 are shown below:



|                                            |  |                |         |  |           |   |         | 
|------------------------------------------- |  | -------------- | ------- |  | --------- | - | ------- | 
|                                            |  | AmortizedCost  |         |  | FairValue |  
|                                            |  | (In thousands) |        
|Due in
  one year or less                   |  | $              | 56,601  |  |           | $ | 56,563  | 
|Due after
  one year through five years     |  |                | 50,985  |  |           |   | 50,810  | 
|Due after
  five years through ten years    |  |                | 20,076  |  |           |   | 19,951  | 
|Due after
  ten years through fifteen years |  |                | 7,458   |  |           |   | 7,527   | 
|Due after
  fifteen years                   |  |                | 8,677   |  |           |   | 8,744   | 
|                                            |  |                |         |  |           |   |         | 
|Total                                       |  | $              | 143,797 |  |           | $ | 143,595 | 
|                                            |  |                |         |  |           |   |         | 

Expected maturities may differ from contractual maturities
because certain borrowers have the right to call or prepay obligations.



The contractual maturities of held-to-maturity debt
securities at December 31, 2004 are shown below:

|                                            |  |                |        |  |           |   |        | 
|------------------------------------------- |  | -------------- | ------ |  | --------- | - | ------ | 
|                                            |  | AmortizedCost  |        |  | FairValue |  
|                                            |  | (In thousands) |       
|Due in
  one year or less                   |  | $              | 22,575 |  |           | $ | 22,575 | 
|Due after
  one year through five years     |  |                | 5,500  |  |           |   | 5,500  | 
|Due after
  five years through ten years    |  |                |       |  |           |   |       | 
|Due after
  ten years through fifteen years |  |                |       |  |           |   |       | 
|Due after
  fifteen years                   |  |                |       |  |           |   |       | 
|                                            |  |                |        |  |           |   |        | 
|Total                                       |  | $              | 28,075 |  |           | $ | 28,075 | 
|                                            |  |                |        |  |           |   |        | 

Expected maturities may differ from contractual maturities
because certain borrowers have the right to call or prepay obligations.

Of the cash and cash equivalents and current investments that
total $352.6 million in the accompanying Consolidated Balance Sheet at December
31, 2004, $246.0 million is limited for use only by the Company's regulated
subsidiaries.  Such amounts are available for transfer to Sierra from the
regulated subsidiaries only to the extent that they can be remitted in
accordance with terms of existing management agreements or by dividends, which
customarily must be approved by regulating state insurance departments.  The
remainder is available to Sierra on an unrestricted basis.

74

---

Table of Contents

6.	LONG-TERM DEBT

Debt at December 31,
consists of the following:

|                                    |  |                |         |   |      |   |         |  
|----------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                    |  | 2004           |         |   | 2003 |  
|                                    |  | (In thousands) |        
|21⁄4% Senior
  convertible debentures |  | $              | 115,000 |   |      | $ | 115,000 |  
|Revolving
  credit facility         |  |                | 10,000  |   |      |   |        |  
|Capital
  leases and other          |  |                | 495     |   |      |   | 1,808   |  
|                                    |  |                |         |   |      |   |         |  
|Total                               |  |                | 125,495 |   |      |   | 116,808 |  
|Less
  current portion              |  |                | (100    | ) |      |   | (163    | )
|                                    |  |                |         |   |      |   |         |  
|Long-Term Debt                      |  | $              | 125,395 |   |      | $ | 116,645 |  
|                                    |  |                |         |   |      |   |         |  

Sierra Debentures - In March 2003, the Company issued
$115.0 million aggregate principal amount of its 21⁄4% senior convertible
debentures due March 15, 2023.  The debentures are not guaranteed by any of
Sierra's subsidiaries. The debentures pay interest, which is due semi-annually
on March 15 and September 15 of each year.  Each $1,000 principal
amount of debentures is convertible, at the option of the holders, into 54.6747
shares of Sierra Health Services, Inc., common stock prior to March 15, 2023 if:
(i) the market price of the Company's common stock for at least 20 trading days
in a period of 30 consecutive trading days ending on the last trading day of the
preceding fiscal quarter exceeds 120% of the conversion price per share of the
Company's common stock; (ii) the debentures are called for redemption; (iii)
there is an event of default with respect to the debentures; or (iv) specified
corporate transactions have occurred.  Beginning December 2003 and for each
subsequent period, the market price of the Company's common stock has exceeded
120% of the conversion price for at least 20 trading days in a period of 30
consecutive trading days.  The conversion rate is subject to certain
adjustments. This conversion rate initially represents a conversion price of
$18.29 per share.  Holders of the debentures may require the Company to
repurchase all or a portion of their debentures on March 15 in 2008, 2013 and
2018 or upon certain corporate events including a change in control.  In either
case, the Company may choose to pay the purchase price of such debentures in
cash or common stock or a combination of cash and common stock.  The debentures
can be redeemed by the Company for cash beginning on or after March 20,
2008.

Revolving Credit Facility - On March 3, 2003, the
Company entered into a $65.0 million revolving credit facility, which replaced
its amended and restated credit facility.  The facility was set to expire on
April 30, 2006.  Effective October 19, 2004, the facility has been amended to
extend the maturity of the facility to December 31, 2009, increase the
availability to $100.0 million and reduce the interest rate.  The current
interest rate on the facility is LIBOR plus 1.2%.  The facility is available for
general corporate purposes.  At December 31, 2004, the Company has drawn $10.0
million on this facility.



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

The revolving credit facility has covenants that limit the
Company's ability and the ability of the Company's subsidiaries to dispose of
assets, incur indebtedness, incur other liens, make investments, loans or
advances, make acquisitions, engage in mergers or consolidations, make capital
expenditures and

75

---

Table of Contents

otherwise restrict certain corporate activities.  Per the most
recent amendment dated October 19, 2004, based on the Company exceeding a
certain leverage ratio requirement, the Company's ability to pay dividends,
repurchase its common stock and prepay other debt is unlimited provided that the
Company can still maintain the required ratios after such transaction or any
borrowing incurred as a result of such transaction.  In addition, the Company is
required to comply with specified financial ratios as set forth in the credit
agreement.  The Company believes it is in compliance with all covenants of the
credit agreement.



Other.  The Company has obligations under capital
leases with effective interest rates from 3.2% to 12.2%.



Scheduled maturities of the Company's long-term debt and
future minimum payments under capital leases, together with the present value of
the net minimum lease payments at December 31, 2004, are as follows:

|                                          |  |                |         |  |                                |   |      |  
|----------------------------------------- |  | -------------- | ------- |  | ------------------------------ | - | ---- | -
|                                          |  | Long-TermDebt  |         |  | ObligationsUnder CapitalLeases |  
|                                          |  | (In thousands) |        
|Years Ending December 31,                 |  |                |         |  |                                |   |      |  
|2005                                      |  | $              |        |  |                                | $ | 135  |  
|2006                                      |  |                |        |  |                                |   | 135  |  
|2007                                      |  |                |        |  |                                |   | 129  |  
|2008                                      |  |                |        |  |                                |   | 83   |  
|2009                                      |  |                | 10,000  |  |                                |   | 53   |  
|Thereafter                                |  |                | 115,000 |  |                                |   | 92   |  
|                                          |  |                |         |  |                                |   |      |  
|Total                                     |  | $              | 125,000 |  |                                |   | 627  |  
|                                          |  |                |         |  |                                |   |      |  
|Less:
  amounts representing interest     |  |                |         |  |                                |   | (132 | )
|                                          |  |                |         |  |                                |   |      |  
|Present Value
  Of Minimum Lease Payments |  |                |         |  |                                | $ | 495  |  
|                                          |  |                |         |  |                                |   |      |  

The fair value of long-term debt, including the current
portion, is estimated to be approximately $125.6 million based on the borrowing
rates currently available to the Company.



7. SHARE REPURCHASE PROGRAM



From January 1, 2004 through December 31, 2004, the
Company purchased 3.4 million shares of its common stock, in the open market or
negotiated transactions, for $133.8 million at an average cost per share of
$39.51. Since the repurchase program began in early 2003 and through December
31, 2004, the Company had purchased, in the open market or through negotiated
transactions, 8.7 million shares for $233.3 million at an average cost per share
of $26.76.  On May 20, 2004, and December 7, 2004, the Company's Board of
Directors authorized the Company to purchase an additional $50.0 million and
$70.0 million worth of its common stock, respectively.  At December 31,
2004, $71.4 million was still available under the Board of Directors' authorized
plan.

Included in the repurchases for the first quarter of 2004 are
500,000 shares the Company purchased from its CEO, at $32.00 per share, for a
total of $16.0 million.  The closing price of the Company's common stock on the
date of the transaction, February 11, 2004, was $32.35.  Included in the
repurchases for the second quarter of 2004 are 500,000 shares the Company
purchased from its CEO, at $43.20 per share, for a total of $21.6 million.  The
closing price of the Company's common stock on the date of the transaction, May
27, 2004, was $43.25. The independent directors of the Company's Board of
Directors approved both of the purchases.

The Company's revolving credit facility, as amended,
currently allows for unlimited stock repurchases based

76

---

Table of Contents

on meeting a certain
covenant ratio.  The Company has repurchased 141,000 shares for $8.0 million at
an average cost of $57.12 subsequent to December 31, 2004 through March 9,
2005.



8. INCOME TAXES

A summary of the provision for income taxes for continuing
operations for the years ended December 31, is as follows:

|                                        |  |                |        |      |   |        |      |   |         |  
|--------------------------------------- |  | -------------- | ------ | ---- | - | ------ | ---- | - | ------- | -
|                                        |  | 2004           |        | 2003 |   |        | 2002
|                                        |  | (In thousands) |       
|Provision (Benefit)
  For Income Taxes: |  |                |        |      |   |        |      |   |         |  
|Current                                 |  | $              | 49,589 |      | $ | 2,909  |      | $ | (11,498 | )
|Deferred                                |  |                | 20,507 |      |   | 41,656 |      |   | 33,586  |  
|                                        |  |                |        |      |   |        |      |   |         |  
|Total                                   |  | $              | 70,096 |      | $ | 44,565 |      | $ | 22,088  |  
|                                        |  |                |        |      |   |        |      |   |         |  

The following reconciles the difference between the reported
and statutory provision for income taxes, from continuing operations, for the
years ended December 31:

|                                             |  |      |    |      |  |      |   |  |    |  
|-------------------------------------------- |  | ---- | -- | ---- |  | ---- | - |  | -- | -
|                                             |  | 2004 |    | 2003 |  | 2002
|Statutory
  rate                             |  |      | 35 | %    |  | 35   | % |  | 35 | %
|State
  income taxes, net of federal benefit |  |      | 1  |      |  |     |   |  |   |  
|Tax
  preferred investments                  |  |      | (1 | )    |  | (1   | ) |  | (1 | )
|Change in
  valuation allowance              |  |      | 1  |      |  |     |   |  | (3 | )
|Compensation and
  benefit plans             |  |      |   |      |  |     |   |  | 3  |  
|Other                                        |  |      |   |      |  | 1    |   |  |   |  
|                                             |  |      |    |      |  |      |  
|Effective
  Rate                             |  |      | 36 | %    |  | 35   | % |  | 34 | %
|                                             |  |      |    |      |  |      |  

The Company's effective tax rate is based on actual or
expected income, statutory tax rates and available tax planning opportunities.
The Company may use significant estimates and judgments in determining its
effective tax rate.  The Company is occasionally audited by federal, state or
local jurisdictions regarding compliance with federal, state and local tax laws
and the recognition of income and deductibility of expenses.  Tax assessments
may not arise until several years after tax returns are filed.  While there is
an element of uncertainty in predicting the outcome of tax audits, the Company
believes that the recorded tax assets and liabilities are appropriately stated
based on its analyses of probable outcomes, including interest and other
potential adjustments.  The tax assets and liabilities are adjusted based on the
most current facts and circumstances, including the progress of audits, case law
and emerging legislation and any adjustments are included in the effective tax
rate in the period of adjustment.

77

---

Table of Contents

The tax effects of significant items comprising the net
deferred tax assets of the Company's continuing operations are as follows at
December 31:

|                                                    |  |                |        |  |      |   |        | 
|--------------------------------------------------- |  | -------------- | ------ |  | ---- | - | ------ | 
|                                                    |  | 2004           |        |  | 2003 |  
|                                                    |  | (In thousands) |       
|Deferred Tax Assets:                                |  |                |        |  |      |   |        | 
|Medical
  claims payable                            |  | $              | 7,588  |  |      | $ | 7,236  | 
|Accruals
  not currently deductible                 |  |                | 1,292  |  |      |   | 4,688  | 
|Compensation
  accruals                             |  |                | 15,997 |  |      |   | 12,217 | 
|Bad
  debt allowances                               |  |                | 1,007  |  |      |   | 2,428  | 
|Loss
  carryforwards and credits                    |  |                | 19,681 |  |      |   | 18,249 | 
|Other                                               |  |                | 352    |  |      |   | 391    | 
|                                                    |  |                |        |  |      |   |        | 
|Total                                               |  |                | 45,917 |  |      |   | 45,209 | 
|                                                    |  |                |        |  |      |   |        | 
|Deferred Tax Liabilities:                           |  |                |        |  |      |   |        | 
|Depreciation and
  amortization                     |  |                | 4,688  |  |      |   | 3,099  | 
|Other                                               |  |                | 517    |  |      |   | 995    | 
|                                                    |  |                |        |  |      |   |        | 
|Total                                               |  |                | 5,205  |  |      |   | 4,094  | 
|                                                    |  |                |        |  |      |   |        | 
|Net
  Deferred Tax Asset Before Valuation Allowance |  |                | 40,712 |  |      |   | 41,115 | 
|Less: 
  Valuation Allowance                        |  |                | 15,082 |  |      |   |       | 
|                                                    |  |                |        |  |      |   |        | 
|Net Deferred Tax Asset                              |  | $              | 25,630 |  |      | $ | 41,115 | 
|                                                    |  |                |        |  |      |   |        | 

At December 31, the Company had alternative minimum tax
credits of approximately $4.1 million, which can be used to reduce regular tax
liabilities in future years.  There is no expiration date for the alternative
minimum tax credits.  Also included in loss carryforwards and credits is the
unrealized capital loss on the sale of Cal Indemnity of $43.1 million.  There is
no tax benefit for the capital loss due to the nature of the contingent note
receivable associated with the sale of Cal Indemnity.  This loss will not be
realized for tax purposes until December 31, 2009.  The Company cannot be
assured that it can generate sufficient capital gains during the applicable
carry-over periods to recognize the tax benefit of this capital loss.
Accordingly, the Company has a valuation allowance at December 31, 2004.



The Company, at a consolidated level including discontinued
operations, did not have a valuation allowance at December 31, 2003.  Under the
Company's tax sharing agreements, the discontinued operations did have a
valuation allowance at December 31, 2003, which was eliminated in the Company's
consolidated financial statements.



Current income tax receivables, including discontinued
operations, total $2.3 million at December 31, 2004, and $10.0 million at
December 31, 2003.  Current income tax payables total $4.1 million at December
31, 2004.



9.	TEXAS DISCONTINUED OPERATIONS

During the third quarter of 2001, the Company announced its
plan to exit the Texas HMO health care market and received formal approval from
the Texas Department of Insurance to withdraw its HMO operations in mid-October
2001.  The Company ceased providing HMO health care coverage in Texas on April
17, 2002.

The Company elected to early adopt SFAS No. 144 effective
January 1, 2001. In accordance with SFAS No. 144, the Company's Texas HMO
subsidiaries' health care operations were reclassified as discontinued
operations.

78

---

Table of Contents

The following are the assets and liabilities of the Company's
discontinued Texas HMO subsidiaries'  health care operations:

|                                         |  |                |       |  |      |   |       | 
|---------------------------------------- |  | -------------- | ----- |  | ---- | - | ----- | 
|                                         |  | December 31,   |       |  |      |  
|                                         |  | 2004           |       |  | 2003 |  
|                                         |  | (In thousands) |      
|ASSETS                                   |  |                |       |  |      |   |       | 
|Cash and
  cash equivalents              |  | $              | 2,329 |  |      | $ | 47    | 
|Investments                              |  |                | 1,811 |  |      |   | 4,048 | 
|Other
  assets                           |  |                | 12    |  |      |   | 115   | 
|                                         |  |                |       |  |      |   |       | 
|Total
  Assets                           |  |                | 4,152 |  |      |   | 4,210 | 
|                                         |  |                |       |  |      |   |       | 
|LIABILITIES                              |  |                |       |  |      |   |       | 
|Accounts
  payable and other liabilities |  |                | 610   |  |      |   | 2,658 | 
|Medical
  claims payable                 |  |                |      |  |      |   | 202   | 
|                                         |  |                |       |  |      |   |       | 
|Total
  Liabilities                      |  |                | 610   |  |      |   | 2,860 | 
|                                         |  |                |       |  |      |   |       | 
|Net
  Assets Of Discontinued Operations  |  | $              | 3,542 |  |      | $ | 1,350 | 
|                                         |  |                |       |  |      |   |       | 

The assets and liabilities above do not include an
intercompany liability of $1.9 million and $6.9 million from the Company's Texas
HMO subsidiaries to Sierra at December 31, 2004 and 2003, respectively.  The
liability has been eliminated upon consolidation.



Management believes that the remaining liabilities, at
December 31, 2004, are appropriate and that no further revisions to the
estimates are necessary at this time.  Based on the current estimated Texas HMO
health care remaining liabilities, the Company believes the Texas HMO
subsidiaries have adequate funds available and the ability to fund the
anticipated obligations.



The following are condensed statements of operations of the
Company's discontinued Texas HMO subsidiaries' health care operations:

|                                                                  |  |                          |      |      |   |        |      |  |   |       
|----------------------------------------------------------------- |  | ------------------------ | ---- | ---- | - | ------ | ---- |  | - | ------
|                                                                  |  | Years Ended December 31, |      |      |  
|                                                                  |  | 2004                     |      | 2003 |   |        | 2002
|                                                                  |  | (In thousands)           |     
|Operating
  revenues                                              |  | $                        | 119  |      | $ | 217    |      |  | $ | 4,791 
|                                                                  |  |                          |      |      |   |        |      |  |   |       
|Medical
  expenses                                                |  |                          | (726 | )    |   | (1,802 | )    |  |   | (8,933
|General and
  administrative expenses                             |  |                          | 330  |      |   | 624    |      |  |   | 1,906 
|Asset
  impairment, restructuring, reorganization and other costs |  |                          |     |      |   |       |      |  |   | 5,000 
|Interest
  expense and other, net                                 |  |                          | 73   |      |   | (3,399 | )    |  |   | (6,216
|                                                                  |  |                          |      |      |   |        |      |  |   |       
|Income
  From Discontinued Operations Before Income Tax           |  |                          | 442  |      |   | 4,794  |      |  |   | 13,034
|Income
  tax provision                                            |  |                          | (149 | )    |   | (1,703 | )    |  |   | (4,562
|                                                                  |  |                          |      |      |   |        |      |  |   |       
|Net
  Income
  From Discontinued Operations                       |  | $                        | 293  |      | $ | 3,091  |      |  | $ | 8,472 
|                                                                  |  |                          |      |      |   |        |      |  |   |       

Operating revenues of $81,000, $217,000 and $153,000 for the
years ended December 31, 2004, 2003 and 2002, respectively, are related to
investment income.  All of the discontinued Texas HMO health care operations had
previously been a component of the "managed care and corporate
operations" segment.

79

---

Table of Contents

During 2002, the Company had favorable development related to
its medical claims and reduced its medical claims payable and medical expenses
by $9.8 million.  The favorable development was partially offset by an increase
in the estimate of legal, restitution and other exit related costs of $800,000.
The adjustments resulted in income, net of tax, of $5.9 million.

10.	CII FINANCIAL, INC. DISCONTINUED OPERATIONS

On January 15, 2003, the Company announced that it was
exploring strategic alternatives for its workers' compensation company, CII.
Sierra's Board of Directors approved the sale of the operations on December 31,
2002.  Accordingly, beginning in the fourth quarter of 2002, the Company
reclassified its workers' compensation insurance business as discontinued
operations.

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

In the second quarter of 2003, CII recorded $4.0 million,
$2.6 million after tax, in additional valuation adjustments.  On November 25,
2003, the Company announced that it had reached an agreement to sell Cal
Indemnity and its subsidiaries.  Cal Indemnity was CII's only significant asset.
In the fourth quarter of 2003, the Company recorded a charge of $15.6 million,
gross and net of tax, to write down the investment in Cal Indemnity to its
estimated net sales proceeds.

On March 31, 2004, the Company completed the sale of
California Indemnity.  Cal Indemnity's subsidiaries, which were included in the
sale, are Commercial Casualty Insurance Company, Sierra Insurance Company of
Texas, and CII Insurance Company.

The Company received $14.2 million in cash at the closing,
which was subsequently reduced by $2.7 million based on the final closing date
balance sheet. The $2.7 million adjustment is a timing difference and is
expected to be repaid to the Company over the next few years.  The transaction
also includes a note receivable of $62.0 million, plus accrued interest, payable
to the Company in January 2010. The note receivable can be increased or
decreased depending on favorable or adverse claim and expense development from
the date of closing through December 31, 2009, and other offsets and additions
based on certain agreements between the parties.  The note receivable can be
increased on a dollar for dollar basis for the first $15 million in positive
loss reserve development and $.50 per dollar on any positive development in
excess of $15 million.  The note receivable can also be decreased on a dollar
for dollar basis for the first $58 million in adverse loss development.

During the fourth quarter, the Company engaged a new
independent actuary to evaluate the loss development. Based on the independent
actuarial projections, the Company recorded a $15.0 million valuation allowance
as of December 31, 2004.  The Company was required to engage a new actuary to
avoid a potential conflict of interest with its former actuary, who is still
engaged by Cal Indemnity, and the resulting impact to internal controls.

Certain other contractual assets and liabilities were
recorded in conjunction with the sale including a current asset of $15.8 million
and a non-current asset of $7.1 million that represent Cal Indemnity's
unallocated loss adjustment expense ("ULAE") reserves to be paid to
Sierra.  Offsetting these assets was a current liability of $15.8 million and a
non-current liability of $7.1 million, which represent the contractual services
to be performed by Sierra.  Including the cash proceeds, net assets of $68.3
million were recorded in conjunction with the sale of Cal Indemnity.
Previously, CII had recorded valuation adjustments to reduce the business to

80

---

Table of Contents

its
estimated net realizable value upon disposition.  No further adjustments were
required upon final disposition; therefore, no gain or loss on the sale was
recorded.

A third-party claims administrator was engaged to administer
claims for a period of 15 years. Under the terms of this agreement, the
administrator will provide certain claims services for Cal Indemnity and its
subsidiaries. Sierra will be responsible for this administrator's costs and for
providing certain transition services for varying terms to Cal Indemnity.  The
purchaser of Cal Indemnity will pay Sierra for these costs from an account
consisting of the ULAE reserves and accrued liabilities as of the closing, a
percentage of premiums earned after the closing, plus accrued interest on the
ULAE reserves.  In addition, Sierra is providing workers' compensation managed
care services at market rates to Cal Indemnity.  For the year ended December 31,
2004, the Company recorded $12.1 million in administrative services revenue and
$12.1 million in operating expenses to provide the contractual administrative
services.



The Company had previously estimated that the revenues and
funds the Company expected to receive would not cover the expected cost to
provide the contractual administrative services so the Company accrued
additional liabilities at March 31, 2004 to cover the expected deficiency.  Due
to actual revenues exceeding estimates and actual expenses being less than
projected expenses, the Company reduced the accrued liabilities by $5.5 million
during the year ended December 31, 2004.



The Company's December 31, 2004 Consolidated Balance Sheet
does not include the assets and liabilities of Cal Indemnity due to the disposal
of those assets and liabilities at March 31, 2004.  The Company's Consolidated
Statement of Income for the year ended December 31, 2004 reflects the activity
of the discontinued operations through the disposal date, March 31, 2004.  Any
subsequent activity related to this disposal has been reflected in continuing
operations.



The following were the assets and liabilities of the
discontinued operations of CII:

|                                                |  |  |  |  |                  |                |         | 
|----------------------------------------------- |  |  |  |  | ---------------- | -------------- | ------- | 
|                                                |  |  |  |  | December 31,2003 |               
|                                                |  |  |  |  |                  | (In thousands)
|ASSETS                                          |  |  |  |  |                  |                |         | 
|Cash and
  cash equivalents                     |  |  |  |  |                  | $              | 58,634  | 
|Investments                                     |  |  |  |  |                  |                | 243,647 | 
|Reinsurance
  recoverable                       |  |  |  |  |                  |                | 177,333 | 
|Property and
  equipment, net                   |  |  |  |  |                  |                | 1,612   | 
|Other
  assets                                  |  |  |  |  |                  |                | 48,320  | 
|                                                |  |  |  |  |                  |                |         | 
|Total
  Assets                                  |  |  |  |  |                  |                | 529,546 | 
|                                                |  |  |  |  |                  |                |         | 
|LIABILITIES                                     |  |  |  |  |                  |                |         | 
|Accounts
  payable and other accrued expenses   |  |  |  |  |                  |                | 54,208  | 
|Reserve for
  loss and loss adjustment expenses |  |  |  |  |                  |                | 415,339 | 
|                                                |  |  |  |  |                  |                |         | 
|Total
  Liabilities                             |  |  |  |  |                  |                | 469,547 | 
|                                                |  |  |  |  |                  |                |         | 
|Net
  Assets Of Discontinued Operations         |  |  |  |  |                  | $              | 59,999  | 
|                                                |  |  |  |  |                  |                |         | 

81

---

Table of Contents

The following are condensed statements of operations of the
discontinued operations of CII:

|                                                      |  |                          |        |      |   |         |      |  |   |        
|----------------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------- | ---- |  | - | -------
|                                                      |  | Years Ended December 31, |        |      |  
|                                                      |  | 2004                     |        | 2003 |   |         | 2002
|                                                      |  | (In thousands)           |       
|Operating Revenues:                                   |  |                          |        |      |   |         |      |  |   |        
|Specialty
  product revenues                          |  | $                        | 19,015 |      | $ | 123,001 |      |  | $ | 176,189
|Investment and
  other revenues                       |  |                          | 1,290  |      |   | 9,301   |      |  |   | 12,633 
|                                                      |  |                          |        |      |   |         |      |  |   |        
|To
  Total Revenues                                   |  |                          | 20,305 |      |   | 132,302 |      |  |   | 188,822
|                                                      |  |                          |        |      |   |         |      |  |   |        
|Operating Expenses:                                   |  |                          |        |      |   |         |      |  |   |        
|Specialty
  product expenses                          |  |                          | 21,917 |      |   | 145,824 |      |  |   | 209,601
|Asset
  impairment                                    |  |                          |       |      |   | 15,610  |      |  |   |       
|Interest
  expense and other, net                     |  |                          | (91    | )    |   | (968    | )    |  |   | 1,059  
|                                                      |  |                          |        |      |   |         |      |  |   |        
|Total Expenses                                        |  |                          | 21,826 |      |   | 160,466 |      |  |   | 210,660
|                                                      |  |                          |        |      |   |         |      |  |   |        
|Loss
  From Discontinued Operations Before Income Tax |  |                          | (1,521 | )    |   | (28,164 | )    |  |   | (21,838
|Income
  tax benefit                                  |  |                          | 839    |      |   | 5,281   |      |  |   | 7,506  
|                                                      |  |                          |        |      |   |         |      |  |   |        
|Net
  Loss
  From Discontinued Operations             |  | $                        | (682   | )    | $ | (22,883 | )    |  | $ | (14,332
|                                                      |  |                          |        |      |   |         |      |  |   |        

The activity for 2004 is through the disposal date, March 31,
2004.  All activity subsequent to March 31, 2004 is reflected in continuing
operations.  Specialty product revenues consisted of workers' compensation
insurance net earned premiums.  Specialty product expenses consisted of loss and
loss adjustment expenses incurred and general and administrative expenses.



11.	COMMITMENTS AND CONTINGENCIES



Leases.  The Company is the lessee under several
operating leases, most of which relate to office facilities and equipment.  The
rentals on these leases are charged to expense over the lease term as the
Company becomes obligated for payment and, where applicable, provide for rent
escalations based on certain costs and price index factors.  The following is a
schedule, by year, of the future minimum lease payments under existing operating
leases:

|                         |  |  |  |  |  |   |                | 
|------------------------ |  |  |  |  |  | - | -------------- | 
|Years Ended December 31, |  |  |  |  |  |   | (In thousands) | 
|2005                     |  |  |  |  |  | $ | 19,370         | 
|2006                     |  |  |  |  |  |   | 18,472         | 
|2007                     |  |  |  |  |  |   | 17,895         | 
|2008                     |  |  |  |  |  |   | 17,218         | 
|2009                     |  |  |  |  |  |   | 16,612         | 
|Thereafter               |  |  |  |  |  |   | 97,366         | 
|                         |  |  |  |  |  |   |                | 
|Total                    |  |  |  |  |  | $ | 186,933        | 
|                         |  |  |  |  |  |   |                | 

Rent expense totaled $23.5 million, $20.6 million and $15.8
million for the years ended December 31, 2004, 2003 and 2002, respectively.



On March 15, 2004, SMHS entered into a lease assignment
agreement relative to one of its administrative locations.  The agreement
assigns the remainder of the lease term, which expires September 30, 2012.

82

---

Table of Contents

Under the assignment, SMHS remains contingently liable should the new tenant not
perform under its obligation.  At December 31, 2004, the future lease payments
due under the lease agreement total $5.2 million.  SMHS did not record a
liability for its obligation under this agreement as the likelihood of non-performance
is considered remote at this time and SMHS would have the ability to
sublease or enter into another assignment arrangement if required to perform on
this obligation. The fair value of this obligation is considered immaterial.

Litigation and Legal Matters.  Although the Company has not been sued,
it was identified in discovery submissions in pending class action litigation against major
managed care companies, as having allegedly participated in an unlawful conspiracy to improperly deny, diminish or delay
payments to physicians.  In Re: Managed Care Litigation, MDL No. 1334 (S.D.Fl.).

Beginning in 1999, a series of class action lawsuits were filed against
many major firms in the health benefits business. A multi-district litigation panel has
consolidated for pre-trial discovery some of these cases in the United States District
Court for the Southern District of Florida, Miami Division. In the lead case, known as Shane,
the amended complaint alleges multiple violations under the Racketeer Influenced and Corrupt
Organizations Act (RICO). The suit seeks injunctive, compensatory and equitable relief as well
as restitution, costs, fees and interest payments. Discovery remains ongoing.  On April 7, 2003, the United States
Supreme Court determined that certain claims against certain defendants should be arbitrated.  Subsequent
lower court rulings have further resolved which of the plaintiffs' claims are subject to arbitration.  In 2004,
the Court of Appeals for the Eleventh Circuit upheld a district court ruling certifying a plaintiff class in the Shane
case.  The district court has recently determined to bifurcate the case, holding a trial phase limited to liability
issues, and a second, if necessary, regarding damages.  A trial date has been set for September 2005. Plaintiffs
in the Shane proceeding have stated their intention to introduce evidence at trial concerning Sierra and other
parties not named as defendants in the litigation.  Two of the defendants, Aetna Inc. and Cigna Corporation, have
entered into settlement agreements, which have been approved by the district court.



The Company is subject to other various claims and litigation
in the ordinary course of business.  Such litigation includes, but is not
limited to, claims of medical malpractice, claims for coverage or payment for
medical services rendered to HMO and other members and claims by providers for
payment for medical services rendered to HMO and other members.  Some litigation
may also include claims for punitive damages that are not covered by insurance.
In addition, under the terms of the note receivable due from the sale of Cal
Indemnity, which is subject to adjustment based on loss development, the Company
can be indirectly affected by claims for workers' compensation and claims by
providers for payment of medical services rendered to injured workers.  These
actions are in various stages of litigation and some may ultimately be brought
to trial.  With respect to certain pending actions, the Company maintains
commercial insurance coverage with varying deductibles for which the Company
maintains estimated reserves for its self-insured portion based upon its current
assessment of such litigation.  Due to recent unfavorable changes in the
commercial insurance market, the Company has, for certain risks, purchased
coverage with higher deductibles and lower limits of coverage.  In the opinion
of management, based on information presently available, the amount or range of
any potential loss for certain claims and litigation cannot be reasonably
estimated or is not considered probable but the ultimate resolution of these pending legal proceedings should
not have a material adverse effect on our financial condition.



12.	RELATED PARTY TRANSACTIONS



At December 31, 2002, the Company's Chief Executive Officer
("CEO") had loans outstanding to the Company in the amount of $4.2
million with a maturity date of December 31, 2003.  During 2003, the Company's
CEO paid the entire outstanding balance including accrued interest.

83

---

Table of Contents



The Company has a minority interest in a health care facility
in Las Vegas, which is accounted for under the equity method.  The Company made
an initial capital contribution of $1.1 million and has subsequently increased
the carrying amount of its investment by $2.9 million to reflect its share of
the undistributed income of the health care facility.  The Company made
capitated payments of $28.4 million, $26.7 million and $24.3 million to the
health care facility for services performed in the ordinary course of business
during 2004, 2003 and 2002, respectively.

On February 11, 2004, the Company purchased 500,000 shares at
$32.00 per share from its CEO for a total of $16.0 million.  The closing price
of the Company's common stock on February 11, 2004, was $32.35.  On May 27,
2004, the Company purchased an additional 500,000 shares at $43.20 per share
from its CEO for a total of $21.6 million.  The closing price of the Company's
common stock on May 27, 2004, was $43.25.  The shares are included in the total
repurchases through December 31, 2004, of 3.4 million. The independent directors
of the Company's Board of Directors approved both of the purchases.



The Company incurred legal fees of $7,000, $25,000 and
$24,000 in the years ended December 31, 2004, 2003 and 2002 respectively, with a
Nevada law firm of which a non-employee Board of Director member is a
shareholder.



13.	MEDICAL CLAIMS PAYABLE



The following table reconciles the beginning and ending balances of
medical claims payable:

|                                                  |  |                          |         |      |   |         |      |  |   |        
|------------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- | ---- |  | - | -------
|                                                  |  | Years Ended December 31, |         |      |  
|                                                  |  | 2004                     |         | 2003 |   |         | 2002
|                                                  |  | (In thousands)           |        
|Medical
  claims payable, beginning of the period |  | $                        | 103,749 |      | $ | 98,031  |      |  | $ | 81,662 
|Add:
  Components Of Incurred Medical Expenses    |  |                          |         |      |   |         |      |  |   |        
|Current
  period medical claims                   |  |                          | 889,921 |      |   | 776,857 |      |  |   | 723,167
|Changes in
  prior periods' estimates             |  |                          | (11,421 | )    |   | (13,992 | )    |  |   | (10,877
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Total Incurred Medical Expenses                   |  |                          | 878,500 |      |   | 762,865 |      |  |   | 712,290
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Less:
  Medical Claims Paid                       |  |                          |         |      |   |         |      |  |   |        
|Current
  period                                  |  |                          | 780,934 |      |   | 683,597 |      |  |   | 630,411
|Prior
  period                                    |  |                          | 81,978  |      |   | 73,550  |      |  |   | 65,510 
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Total Claims Paid                                 |  |                          | 862,912 |      |   | 757,147 |      |  |   | 695,921
|                                                  |  |                          |         |      |   |         |      |  |   |        
|Medical Claims Payable, End
  Of Period           |  | $                        | 119,337 |      | $ | 103,749 |      |  | $ | 98,031 
|                                                  |  |                          |         |      |   |         |      |  |   |        

Amounts incurred related to prior years show that the
liability at the beginning of each year was ultimately greater than the amount
subsequently incurred.  This favorable development has primarily been a result
of claims being settled for amounts less than originally estimated.

84

---

Table of Contents

14.	MILITARY HEALTH
CARE PAYABLE



The following table reconciles the
beginning and ending balances of military health care payable:

|                                                        |  |                          |         |      |   |         |      |  |   |        
|------------------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- | ---- |  | - | -------
|                                                        |  | Years Ended December 31, |         |      |  
|                                                        |  | 2004                     |         | 2003 |   |         | 2002
|                                                        |  | (In thousands)           |        
|Military
  health care payable, beginning of the period |  | $                        | 76,605  |      | $ | 65,223  |      |  | $ | 77,261 
|Add:  Components
  Of Incurred Medical Expenses         |  |                          |         |      |   |         |      |  |   |        
|Current
  period medical claims                         |  |                          | 220,710 |      |   | 318,833 |      |  |   | 251,632
|Changes
  In Prior Periods' Estimates:                  |  |                          |         |      |   |         |      |  |   |        
|Earnings
  related changes                              |  |                          | (14,118 | )    |   | (3,235  | )    |  |   | (4,601 
|Non-earnings
  related changes                          |  |                          | (6,462  | )    |   | (10,777 | )    |  |   | (16,509
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Total Incurred Medical Expenses                         |  |                          | 200,130 |      |   | 304,821 |      |  |   | 230,522
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Less:  Military Contract Claims Paid                    |  |                          |         |      |   |         |      |  |   |        
|Current
  period                                        |  |                          | 201,950 |      |   | 244,644 |      |  |   | 194,659
|Prior
  period                                          |  |                          | 57,724  |      |   | 48,795  |      |  |   | 47,901 
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Total Military Contract Claims Paid                     |  |                          | 259,674 |      |   | 293,439 |      |  |   | 242,560
|                                                        |  |                          |         |      |   |         |      |  |   |        
|Military Health Care Payable, End
  Of Period           |  | $                        | 17,061  |      | $ | 76,605  |      |  | $ | 65,223 
|                                                        |  |                          |         |      |   |         |      |  |   |        

The military contract expenses presented in the Consolidated
Statements of Operations include the total incurred medical expenses presented
above and the general and administrative expenses for SMHS. SMHS' general and
administrative expenses under the military contract totaled $117.6 million,
$147.7 million and $129.9 million for the years ended December 31, 2004, 2003,
and 2002, respectively.  Total incurred medical contract expenses include the
current year expenses plus adjustments to prior periods' estimates. Any
subsequent change in an estimate for a prior period is reflected in the current
year.  Certain adjustments to prior periods have a current year earnings impact
while other adjustments do not have a current year earnings impact.  The
adjustments that do not have a current year earnings impact are the result of an
offsetting revenue adjustment in accordance with the risk-sharing terms under
SMHS' contract with the Department of Defense ("DoD").  For example in
2004, SMHS had total adjustments to prior period estimates of $20.6 million.
These adjustments resulted in a reduction of current period expense of $20.6
million and current period revenue of $6.5 million for a pre-tax increase of
$14.1 million to current period earnings.  The favorable development in the
earnings related changes for the years ended December 31, 2004 and 2003 have
primarily been a result of claims being settled for amounts less than originally
estimated.



15.	EMPLOYEE BENEFIT PLANS

Defined Contribution Plan.  The Company has a defined
contribution pension and 401(k) plan (the "Plan") for its employees.
The Plan covers all employees who meet certain age and length of service
requirements.  The Company matches 50%-100% of an employee's elective deferral
up to a maximum of 6% of a participant's annual compensation, subject to IRS
limits. The Plan does not require additional Company contributions.  Expense
under the plan totaled $5.1 million, $5.3 million and $4.4 million for the years
ended December 31, 2004, 2003 and 2002, respectively.



Supplemental Retirement Plans.  The Company has
Supplemental Retirement Plans (the "SRPs") for certain officers,
directors and highly compensated employees.  The SRPs are non-qualified deferred
compensation plans through which participants may elect to postpone the receipt
and taxation of all or a portion of their salary and bonuses received from the
Company.  As contracted with the Company, the participants or their designated
beneficiaries may begin to receive benefits under the SRPs upon a participant's
death, disability,

85

---

Table of Contents

retirement, termination of employment or certain other
circumstances including financial hardship.  The Company had a liability of
$16.5 million and $12.9 million for the SRPs at December 31, 2004 and 2003,
respectively.  While the SRPs are unfunded plans, the Company is informally
funding the plans through life insurance contracts on certain Company employees.
The life insurance contracts had cash surrender values of $15.3 million and $9.8
million at December 31, 2004 and 2003, respectively.



Executive Split Dollar Life Insurance Plan.  The
Company has split dollar life insurance agreements with certain officers and key
executives (selected and approved by the Sierra Board of Directors).  The
premiums paid by the Company will be reimbursed upon the occurrence of certain
events as specified in the contract.  No premiums have been paid under these
policies since July 2002.



Supplemental Executive Retirement Plan
("SERP").  The Company has a defined benefit retirement plan
covering certain key employees.  The Company is informally funding the benefits
through the purchase of life insurance policies.  Benefits are based on, among
other things, the employee's average earnings of the three highest years over
the five-year period prior to retirement or termination, and length of service.
Benefits attributable to service prior to the adoption of the plan are amortized
over the estimated remaining service period for those employees participating in
the plan.  The Company expects to contribute $784,000 to the plan in 2005 to
fund expected benefit payments.  The annual plan measurement date is December
31.

86

---

Table of Contents

A reconciliation of ending year SERP balances is as follows:

|                                                 |  |                          |         |      |   |         |   |   |         |  
|------------------------------------------------ |  | ------------------------ | ------- | ---- | - | ------- | - | - | ------- | -
|                                                 |  | Years Ended December 31,
|                                                 |  | 2004                     |         | 2003 |   | 2002   
|                                                 |  | (In thousands)          
|Change
  In
  Benefit Obligation                 |  |                          |         |      |   |         |   |   |         |  
|Benefit
  obligation at beginning of year        |  | $                        | 29,896  |      | $ | 23,461  |   | $ | 19,143  |  
|Service
  cost                                   |  |                          | 425     |      |   | 374     |   |   | 292     |  
|Interest
  cost                                  |  |                          | 1,674   |      |   | 1,547   |   |   | 1,375   |  
|Actuarial
  (gain) loss                          |  |                          | (8,114  | )    |   | 5,298   |   |   | 3,435   |  
|Benefits paid                                    |  |                          | (784    | )    |   | (784    | ) |   | (784    | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Benefit
  Obligation At End Of Year              |  | $                        | 23,097  |      | $ | 29,896  |   | $ | 23,461  |  
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Change
  In
  Plan Assets                        |  |                          |         |      |   |         |   |   |         |  
|Fair
  value of plan assets at beginning of year |  | $                        |        |      | $ |        |   | $ |        |  
|Employer
  contributions                         |  |                          | 784     |      |   | 784     |   |   | 784     |  
|Benefits paid                                    |  |                          | (784    | )    |   | (784    | ) |   | (784    | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Fair
  Values Of Plan Assets At End Of Year      |  | $                        |        |      | $ |        |   | $ |        |  
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Funded
  status                                  |  | $                        | (23,097 | )    | $ | (29,896 | ) | $ | (23,461 | )
|Unrecognized
  prior service cost                |  |                          | 6,936   |      |   | 8,145   |   |   | 6,761   |  
|Unrecognized
  net actuarial loss                |  |                          | (338    | )    |   | 8,212   |   |   | 5,640   |  
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Accrued
  Net Benefit Cost                       |  |                          | (16,499 | )    |   | (13,539 | ) |   | (11,060 | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Unfunded
  accumulated benefit obligation        |  |                          | (17,581 | )    |   | (21,146 | ) |   | (18,330 | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Additional
  Minimum Liability                   |  |                          | (1,082  | )    |   | (7,607  | ) |   | (7,270  | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Intangible
  asset                               |  |                          | 1,082   |      |   | 7,607   |   |   | 5,640   |  
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Accumulated
  Other Comprehensive Loss           |  |                          |        |      |   |        |   |   | (1,630  | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Benefit
  Liability                              |  | $                        | (17,581 | )    | $ | (21,146 | ) | $ | (18,330 | )
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Discount
  rate                                  |  |                          | 5.8     | %    |   | 5.8     | % |   | 6.5     | %
|Rate of
  compensation increase                  |  |                          | 3.0     | %    |   | 3.0     | % |   | 3.0     | %
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Components
  Of Net Periodic Benefit Cost:       |  |                          |         |      |   |         |   |   |         |  
|Service
  cost                                   |  | $                        | 425     |      | $ | 374     |   | $ | 292     |  
|Interest
  cost                                  |  |                          | 1,674   |      |   | 1,547   |   |   | 1,375   |  
|Amortization of
  prior service credits          |  |                          | 1,211   |      |   | 1,210   |   |   | 925     |  
|Recognized
  actuarial loss                      |  |                          | 435     |      |   | 131     |   |   | 575     |  
|                                                 |  |                          |         |      |   |         |   |   |         |  
|Net Periodic Benefit Cost                        |  | $                        | 3,745   |      | $ | 3,262   |   | $ | 3,167   |  
|                                                 |  |                          |         |      |   |         |   |   |         |  

While the SERP is an unfunded plan, the Company is informally
funding the plan through life insurance contracts on certain Company employees.
The life insurance contracts had cash surrender values of $19.7 million, $14.7
million and $11.7 million at December 31, 2004, 2003 and 2002, respectively.

87

---

Table of Contents

At December 31, 2004, expected future benefit payments related to the
Company's defined  benefit plans were as follows:

|                    |  |  |  |  |  |   |                | 
|------------------- |  |  |  |  |  | - | -------------- | 
|                    |  |  |  |  |  |   | (In thousands) | 
|2005                |  |  |  |  |  | $ | 784            | 
|2006                |  |  |  |  |  |   | 946            | 
|2007                |  |  |  |  |  |   | 946            | 
|2008                |  |  |  |  |  |   | 1,699          | 
|2009                |  |  |  |  |  |   | 1,803          | 
|2010
  through 2040 |  |  |  |  |  |   | 51,191         | 
|                    |  |  |  |  |  |   |                | 
|Total               |  |  |  |  |  | $ | 57,369         | 
|                    |  |  |  |  |  |   |                | 

16. CAPITAL STOCK PLANS



Stockholders' Rights Plan.  The Company had a
Stockholders' Rights Plan, which expired on June 14, 2004.  Under the Rights
Plan, each share of Sierra common stock, par value $.005 per share, contained
one right (a "Right"), which entitled the registered holder to
purchase from Sierra a unit consisting of one one-hundredth (.01) of a share of
the Sierra Series A Junior Participating Preferred Shares (a "Unit"),
par value $.01 per share, or a combination of securities and assets of
equivalent value, at a purchase price of $100.00 per Unit, subject to
adjustment.  The Rights had certain anti-takeover effects.  The Rights could
have caused substantial dilution to a person or group that attempted to acquire
Sierra on terms not approved by Sierra's Board of Directors, except pursuant to
an offer conditioned on a substantial number of Rights being acquired.  The
Rights would not have interfered with any merger or other business combination
approved by the Board of Directors since Sierra could redeem the Rights at the
price of $.02 per Right prior to or within ten days of the time that a person or
group had acquired, or obtained the right to acquire, beneficial ownership of
20% or more of Sierra's common stock.



Stock Option Plans.  The Company has several plans
that provide common stock-based awards to employees and to non-employee
directors.  The plans provide for the granting of options, stock and other
stock-based awards.  A committee appointed by the Board of Directors grants
awards. Options become exercisable at such times and in such installments as set
by the committee.  The exercise price of each option equals the market price of
the Company's stock on the date of grant. Stock options generally vest at a rate
of 20% - 33% per year.  Options expire from one to eight years after the end of
the vesting period.

88

---

Table of Contents

The following table reflects the activity of the stock option
plans:

|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|------------------------------------------ |  | -------------- | ------ | ------------------ | ------------------------------- | ----- | ----------- |  | -------------------- | ----- | - | ----- |  | - | -----
|                                           |  | NumberOfShares |        | OptionsExercisable |                                 |       | OptionPrice |  | WeightedAveragePrice
|                                           |  |                |        |                    | (Number of shares in thousands) |       |            
|Outstanding January 1,
  2002              |  |                | 6,003  |                    |                                 | 1,391 |             |  | $                    | 3.13  |  | 24.69 |  | $ | 6.81 
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Granted                                    |  |                | 944    |                    |                                 |       |             |  |                      | 8.13  |  | 13.17 |  |   | 10.88
|Exercised                                  |  |                | (995   | )                  |                                 |       |             |  |                      | 3.25  |  | 22.38 |  |   | 5.73 
|Canceled                                   |  |                | (100   | )                  |                                 |       |             |  |                      | 3.25  |  | 24.69 |  |   | 11.32
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Outstanding December 31,
  2002            |  |                | 5,852  |                    |                                 | 1,866 |             |  |                      | 3.13  |  | 24.69 |  |   | 7.56 
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Granted                                    |  |                | 1,603  |                    |                                 |       |             |  |                      | 12.21 |  | 23.96 |  |   | 14.48
|Exercised                                  |  |                | (1,918 | )                  |                                 |       |             |  |                      | 3.25  |  | 24.50 |  |   | 6.92 
|Canceled                                   |  |                | (178   | )                  |                                 |       |             |  |                      | 3.75  |  | 24.69 |  |   | 13.65
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Outstanding December 31,
  2003            |  |                | 5,359  |                    |                                 | 1,384 |             |  |                      | 3.13  |  | 23.96 |  |   | 9.65 
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Granted                                    |  |                | 135    |                    |                                 |       |             |  |                      | 27.73 |  | 40.71 |  |   | 34.93
|Exercised                                  |  |                | (2,334 | )                  |                                 |       |             |  |                      | 3.13  |  | 40.71 |  |   | 8.27 
|Canceled                                   |  |                | (555   | )                  |                                 |       |             |  |                      | 3.25  |  | 40.71 |  |   | 13.35
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Outstanding December 31,
  2004            |  |                | 2,605  |                    |                                 | 692   |             |  |                      | 3.13  |  | 40.71 |  |   | 11.42
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|Available
  For Grant At December 31, 2004 |  |                | 2,314  |                    |                                 |       |             |  |                      |       |   |       |  |   |      
|                                           |  |                |        |                    |                                 |       |             |  |                      |       |   |       |  |   |      

The following table summarizes information about stock
options outstanding at December 31, 2004:

|  |                      |  |                      |  |                            |  |                     |  |                      |  |                |  |                 |  |          |  |       |  |  |  |     |  |   |  |      
|- | -------------------- |  | -------------------- |  | -------------------------- |  | ------------------- |  | -------------------- |  | -------------- |  | --------------- |  | -------- |  | ----- |  |  |  | --- |  | - |  | -----
|  |                      |  |                      |  |                            |  | Options Outstanding |  | Options Exercisable 
|  |                      |  |                      |  |                            |  |                     |  |                     
|  |                      |  |                      |  |                            |  | Number
      Of     |  | Weighted Average     |  | Weighted       |  | Number
      Of |  | Weighted
|  | Range
      Of       |  | Options              |  | Contractual
      Life     |  | Average             |  | Options              |  | Average       
|  | Exercise
      Price |  | (In
      Thousands) |  | Remaining
      (In Years) |  | Exercise Price      |  | (In
      Thousands) |  | Exercise Price
|  |                      |  |                      |  |                            |  |                     |  |                      | 
|$ | 3.13                 |  |                     |  | 4.80                       |  |                     |  | 639                  |  |                |  | 5               |  | $        |  | 3.81  |  |  |  | 176 |  | $ |  | 3.76 
|  | 5.73                 |  |                     |  | 11.65                      |  |                     |  | 899                  |  |                |  | 7               |  |          |  | 9.87  |  |  |  | 368 |  |   |  | 9.81 
|  | 11.71                |  |                     |  | 12.61                      |  |                     |  | 406                  |  |                |  | 8               |  |          |  | 12.50 |  |  |  | 29  |  |   |  | 12.48
|  | 13.17                |  |                     |  | 40.71                      |  |                     |  | 661                  |  |                |  | 8               |  |          |  | 20.23 |  |  |  | 119 |  |   |  | 30.94
|  |                      |  |                      |  |                            |  |                     |  |                      |  |                |  |                 |  |          |  |       |  |  |  |     | 
|  | 3.13                 |  |                     |  | 40.71                      |  |                     |  | 2,605                |  |                |  | 7               |  |          |  | 11.42 |  |  |  | 692 |  |   |  | 12.00
|  |                      |  |                      |  |                            |  |                     |  |                      |  |                |  |                 |  |          |  |       |  |  |  |     | 



Employee Stock Purchase Plans.  The Company has an
employee stock purchase plan (the "Purchase Plan") whereby employees
may purchase newly issued shares of common stock through payroll deductions at
85% of the fair market value of such shares on the lower of the first trading day of the plan period
or the last trading day of the plan period as defined in the
Purchase Plan. During 2004, a total of 357,000 shares were purchased at prices
of $16.28 and $23.33 per share.  At December 31, 2004, the Company had 734,000
shares reserved for purchase under the Purchase Plan of which 136,000 shares
were purchased by employees at $37.05 per share in January 2005.

89

---

Table of Contents

Restricted Stock Units.  The Company has issued units
of restricted stock ("Units") to certain executives.  Each Unit
represents a nontransferable right to receive one share of Sierra common stock
and there is no cost by the recipient to exercise the Units.  The Units are
included in total outstanding common shares. In the calculation of earnings per
share, the unvested Units are not included in the common shares outstanding but
are included in the calculation of common shares outstanding assuming dilution.
The transactions are recorded by including the value of the Units as common
stock and additional paid-in capital offset by a contra-equity account, deferred
compensation.  Compensation expense is recognized over the vesting period.



The Company issued 244,000 non-performance based Units during
2001.  The first half of the Units vested in 2003 with the remainder vesting in
2004.  The value of the transaction was based on the number of Units issued and
the Company stock price on the date of issuance, which was $5.73.  Total expense
associated with the plan was $22,000, $451,000 and $585,000 for 2004, 2003 and
2002, respectively.



The Company issued 125,000 performance-based Units in 2004.
The first third of the Units vested in 2004 with the remainder vesting in 2005.
The value of the transaction is based on the number of Units issued and the
Company stock price on the date the performance criteria is met.  The stock
price on the date the first performance criteria was met was $41.30.  For the
Units vesting in 2005, the price at December 31, 2004, $55.11, was used to value
the Units at December 31, 2004.  The expense will subsequently be adjusted based
on the share price on the date second performance criteria is met.  Total
expense recognized during 2004 for the Units was $6.0 million.



Accounting for Stock-Based Compensation.  The Company
uses the intrinsic value method in accounting for its stock-based compensation
plans.  The fair value pro forma presentation in Note 2 was estimated at the
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 2004, 2003 and 2002,
respectively: dividend yield of 0% for all years; expected volatility of 74%,
73% and 74%; risk-free interest rates of 3.48%, 2.93% and 3.32%; and expected
lives of one to five years.  The weighted average fair value of options granted
in 2004, 2003 and 2002 was $24.04, $10.94 and $8.60, respectively.



The fair value of each offering of the Purchase Plans is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 2004, 2003 and 2002, respectively: dividend yield
of 0% for all years; expected volatility of 41%, 64% and 56%; risk-free interest
rates of 1.32%, 0.93% and 1.48%; and expected lives of six months for all
years.

90

---

Table of Contents

17. CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL
INFORMATION



Supplemental statements of cash flows information is
presented below:

|                                                                       |  |                          |         |      |   |         |      |  |   |       
|---------------------------------------------------------------------- |  | ------------------------ | ------- | ---- | - | ------- | ---- |  | - | ------
|                                                                       |  | Years Ended December 31, |         |      |  
|                                                                       |  | 2004                     |         | 2003 |   |         | 2002
|                                                                       |  | (In thousands)           |        
|Cash
  paid during the year for interest (net of amount capitalized)   |  | $                        | 3,025   |      | $ | 3,342   |      |  | $ | 7,205 
|Cash
  (paid) received during the year for income taxes                |  |                          | (12,900 | )    |   | (10,741 | )    |  |   | 12,796
|Non-Cash Investing
  And Financing Activities:                         |  |                          |         |      |   |         |      |  |   |       
|Assets
  and liabilities recorded in conjunction with the sale         |  |                          |         |      |   |         |      |  |   |       
|of the workers' compensation operations                                |  |                          | 54,060  |      |   |        |      |  |   |      
|Stock
  issued for exercise of options and related tax benefits        |  |                          | 27,287  |      |   | 12,596  |      |  |   | 6,837 
|Additions to
  capital leases                                          |  |                          | 253     |      |   | 153     |      |  |   |      
|Retired
  sale-leaseback assets, liabilities and financing obligations |  |                          |        |      |   |        |      |  |   | 89,751



18. SEGMENT REPORTING



The Company has two reportable segments based on the
products and services offered:  managed care and corporate operations, and
military health services operations. The managed care segment includes managed
health care services provided through HMO, managed indemnity plans, third-party
administrative services programs for employer-funded health benefit plans and
self-insured workers' compensation plans, multi-specialty medical groups, other
ancillary services and corporate operations.  The military health services
segment administered a managed care federal contract for the Department of
Defense's TRICARE program in Region 1.



SMHS completed the fifth year of a five-year contract in May
2003.  SMHS then operated under a negotiated contract extension period, which
ended August 31, 2004.  The new contractor became operational on September 1,
2004 and the new contract superseded the remainder of the Company's  TRICARE
Region 1 contract.  On September 1, 2004, SMHS commenced an eight-month phase-out
of operations at prices previously negotiated with the DoD.  SMHS does not
meet the definition of discontinued operations since the Company does not have
plans to dispose of the operations before the phase-out is complete.



SMHS anticipates negotiating the final bid price adjustment
settlement with the DoD for option period six (June 1, 2003 to August 31, 2004)
during the second quarter of 2005.  This settlement will include the final
revenue adjustments and a final adjustment for updated health care expense
estimates for this option period.  At the conclusion of the settlement, SMHS
will pay the DoD the estimated portion of the remaining military health care
payable.  As with previous settlements, this final settlement may have a
material impact on the Company's results of operations.

Through participation in Medicare, TRICARE and the Federal Employees Health Benefit Plan programs,
the Company generated approximately 53%, 57% and 57% of its total consoldiated revenues from agencies of the U.S. government
for the years ended December 31, 2004, 2003 and 2002, respectively.  The TRICARE revenue is presented below in the
military health services operations segment and the remainder of the revenue described above is included in the managed
care and corporate operations segment.

91

---

Table of Contents

The Company evaluates each segment's performance based on
segment operating profit.  The accounting policies of the operating segments are
the same as those described in the summary of significant accounting policies.

Information concerning the operations of the reportable segments is as
follows:

|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|------------------------------- |  | ----------------------------------- | --------- | - | --------------------------------- | - | ------- | ----- |  | - | --------- | -
|                                |  | ManagedCare And CorporateOperations |           |   | Military HealthServicesOperations |   |         | Total | 
|                                |  | (In thousands)                      |          
|Year Ended December 31,
  2004  |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Medical
  premiums              |  | $                                   | 1,131,147 |   |                                   | $ |        |       |  | $ | 1,131,147 |  
|Military
  contract revenues    |  |                                     |          |   |                                   |   | 372,608 |       |  |   | 372,608   |  
|Professional
  fees             |  |                                     | 35,115    |   |                                   |   |        |       |  |   | 35,115    |  
|Investment and
  other revenues |  |                                     | 35,063    |   |                                   |   | 1,502   |       |  |   | 36,565    |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Total Revenue                   |  | $                                   | 1,201,325 |   |                                   | $ | 374,110 |       |  | $ | 1,575,435 |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Segment
  operating profit      |  | $                                   | 141,391   |   |                                   | $ | 56,411  |       |  | $ | 197,802   |  
|Interest
  expense              |  |                                     | (4,624    | ) |                                   |   | (60     | )     |  |   | (4,684    | )
|Other
  income (expense), net   |  |                                     | 209       |   |                                   |   | (105    | )     |  |   | 104       |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Income
  Before Income Taxes    |  | $                                   | 136,976   |   |                                   | $ | 56,246  |       |  | $ | 193,222   |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Segment
  assets                |  | $                                   | 625,938   |   |                                   | $ | 59,690  |       |  | $ | 685,628   |  
|Capital
  expenditures          |  |                                     | (26,214   | ) |                                   |   | (23     | )     |  |   | (26,237   | )
|Depreciation                    |  |                                     | 15,904    |   |                                   |   | 1,180   |       |  |   | 17,084    |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Year Ended December 31,
  2003  |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Medical
  premiums              |  | $                                   | 962,176   |   |                                   | $ |        |       |  | $ | 962,176   |  
|Military
  contract revenues    |  |                                     |          |   |                                   |   | 465,313 |       |  |   | 465,313   |  
|Professional
  fees             |  |                                     | 37,367    |   |                                   |   |        |       |  |   | 37,367    |  
|Investment and
  other revenues |  |                                     | 18,192    |   |                                   |   | 2,031   |       |  |   | 20,223    |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Total Revenue                   |  | $                                   | 1,017,735 |   |                                   | $ | 467,344 |       |  | $ | 1,485,079 |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Segment
  operating profit      |  | $                                   | 117,607   |   |                                   | $ | 14,790  |       |  | $ | 132,397   |  
|Interest
  expense              |  |                                     | (5,217    | ) |                                   |   | (274    | )     |  |   | (5,491    | )
|Other
  income (expense), net   |  |                                     | (631      | ) |                                   |   | 408     |       |  |   | (223      | )
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Income Before Income Taxes      |  | $                                   | 111,759   |   |                                   | $ | 14,924  |       |  | $ | 126,683   |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Segment
  assets                |  | $                                   | 424,695   |   |                                   | $ | 175,670 |       |  | $ | 600,365   |  
|Capital
  expenditures          |  |                                     | (19,768   | ) |                                   |   | (2,006  | )     |  |   | (21,774   | )
|Depreciation                    |  |                                     | 14,234    |   |                                   |   | 1,695   |       |  |   | 15,929    |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Year Ended December 31,
  2002  |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Medical
  premiums              |  | $                                   | 857,741   |   |                                   | $ |        |       |  | $ | 857,741   |  
|Military
  contract revenues    |  |                                     |          |   |                                   |   | 373,589 |       |  |   | 373,589   |  
|Professional
  fees             |  |                                     | 30,923    |   |                                   |   |        |       |  |   | 30,923    |  
|Investment and
  other revenues |  |                                     | 14,305    |   |                                   |   | 2,077   |       |  |   | 16,382    |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Total Revenue                   |  | $                                   | 902,969   |   |                                   | $ | 375,666 |       |  | $ | 1,278,635 |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Segment
  operating profit      |  | $                                   | 56,700    |   |                                   | $ | 15,291  |       |  | $ | 71,991    |  
|Interest
  expense              |  |                                     | (7,455    | ) |                                   |   | (195    | )     |  |   | (7,650    | )
|Other
  income (expense), net   |  |                                     | (309      | ) |                                   |   | 364     |       |  |   | 55        |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Income Before Income Taxes      |  | $                                   | 48,936    |   |                                   | $ | 15,460  |       |  | $ | 64,396    |  
|                                |  |                                     |           |   |                                   |   |         |       |  |   |           |  
|Segment
  assets                |  | $                                   | 387,097   |   |                                   | $ | 113,811 |       |  | $ | 500,908   |  
|Capital
  expenditures          |  |                                     | (10,829   | ) |                                   |   | (1,563  | )     |  |   | (12,392   | )
|Depreciation                    |  |                                     | 15,730    |   |                                   |   | 2,515   |       |  |   | 18,245    |  

92

---



19. UNAUDITED QUARTERLY
INFORMATION

|                                              |  |         |         |        |   |                                       |  |   |            |  |  |   |        
|--------------------------------------------- |  | ------- | ------- | ------ | - | ------------------------------------- |  | - | ---------- |  |  | - | -------
|Quarter Ended 2004:                           |  | March31 |         | June30 |   | September30                           |  |   | December31
|                                              |  |         |         |        |   | (In thousands, except per share data) |  |   |           
|Operating
  revenues                          |  | $       | 408,190 |        | $ | 441,239                               |  | $ | 393,280    |  |  | $ | 332,726
|Operating
  income from continuing operations |  |         | 42,160  |        |   | 61,167                                |  |   | 48,735     |  |  |   | 45,740 
|Income from
  continuing operations           |  |         | 26,315  |        |   | 38,221                                |  |   | 30,727     |  |  |   | 27,863 
|Net
  income                                  |  |         | 25,829  |        |   | 38,221                                |  |   | 30,727     |  |  |   | 27,960 
|                                              |  |         |         |       
|Basic Earnings
  Per Share:                   |  |         |         |        |   |                                       |  |   |            |  |  |   |        
|Income from
  continuing operations           |  | $       | 0.97    |        | $ | 1.43                                  |  | $ | 1.16       |  |  | $ | 1.06   
|Net
  income                                  |  |         | 0.96    |        |   | 1.43                                  |  |   | 1.16       |  |  |   | 1.06   
|                                              |  |         |         |       
|Dilutive Earnings
  Per Share:                |  |         |         |        |   |                                       |  |   |            |  |  |   |        
|Income from
  continuing operations           |  | $       | 0.75    |        | $ | 1.10                                  |  | $ | 0.90       |  |  | $ | 0.83   
|Net
  income                                  |  |         | 0.74    |        |   | 1.10                                  |  |   | 0.90       |  |  |   | 0.83   
|                                              |  |         |         |       
|Quarter Ended 2003:                           |  |         |         |        |   |                                       |  |   |           
|                                              |  |         |         |       
|Operating
  revenues                          |  | $       | 352,270 |        | $ | 370,205                               |  | $ | 389,237    |  |  | $ | 373,367
|Operating
  income from continuing operations |  |         | 25,275  |        |   | 33,296                                |  |   | 35,178     |  |  |   | 38,648 
|Income from
  continuing operations           |  |         | 15,428  |        |   | 20,510                                |  |   | 22,177     |  |  |   | 24,003 
|Net
  income                                  |  |         | 15,022  |        |   | 20,265                                |  |   | 22,207     |  |  |   | 4,832  
|                                              |  |         |         |       
|Basic Earnings
  Per Share:                   |  |         |         |        |   |                                       |  |   |            |  |  |   |        
|Income from
  continuing operations           |  | $       | 0.53    |        | $ | 0.75                                  |  | $ | 0.78       |  |  | $ | 0.88   
|Net
  income                                  |  |         | 0.52    |        |   | 0.74                                  |  |   | 0.78       |  |  |   | 0.18   
|                                              |  |         |         |       
|Dilutive Earnings
  Per Share: (1)            |  |         |         |        |   |                                       |  |   |            |  |  |   |        
|Income from
  continuing operations           |  | $       | 0.47    |        | $ | 0.58                                  |  | $ | 0.61       |  |  | $ | 0.68   
|Net
  income                                  |  |         | 0.46    |        |   | 0.57                                  |  |   | 0.61       |  |  |   | 0.15   

|
|
|

93

---



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



None.

ITEM 9a. CONTROLS AND PROCEDURES

a.	Evaluation of Disclosure Controls and Procedures



The Company's management, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of the Company's disclosure controls and procedures as of the end
of the period covered by this report.  Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures as of the end of the period covered by this
report were designed and were functioning effectively to provide reasonable
assurance that the information required to be disclosed by the Company in
reports filed under the Securities Exchange Act of 1934 (i) is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms and (ii) accumulated and communicated to our management,
including our chief executive officer and chief financial officer, as
appropriate to allow timely decisions regarding disclosure.  The Company
believes that a system of controls, no matter how well designed and operated,
cannot provide absolute assurance that the objectives of the controls are met,
and no evaluation of controls can provide absolute assurance that all control
issues and instances of fraud, if any, within a company have been detected.



b.	Management's Report on Internal Control over
Financial Reporting



Our management's report on internal control over financial reporting is set forth in Item 8
of this Annual Report on Form 10-K and is incorporated by reference herein.



c.	Change in Internal Control over Financial
Reporting



No change in our internal control over financial reporting
occurred during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.





94

---

Table of Contents

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



The information set forth under the caption "Election of
Directors" in Sierra's Proxy Statement for its 2005 Annual Meeting of
Stockholders, is incorporated herein by reference.



ITEM 11. EXECUTIVE COMPENSATION



The information set forth under the caption
"Compensation of Executive Officers" in Sierra's Proxy Statement for
its 2005 Annual Meeting of Stockholders, is incorporated herein by
reference.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND



Equity Compensation Plan Information



The following table provides information as of December 31,
2004, regarding outstanding awards and shares remaining available for future
issuance under the Company's compensation plans under which equity securities
are authorized for issuance (excluding 401(k) plans and similar tax-qualified
plans):

|                                                                 |  |                                       |                                                                               |  |  |   |                                                             |  |  |  |                                                                                                   |    
|---------------------------------------------------------------- |  | ------------------------------------- | ----------------------------------------------------------------------------- |  |  | - | ----------------------------------------------------------- |  |  |  | ------------------------------------------------------------------------------------------------- | ---
|Plan Category                                                    |  |                                       | (a) Number
  Of SecuritiesTo Be Issued UponExercise OfOutstanding Options (1) |  |  |   | (b)  Weighted-AverageExercise Price
  OfOutstanding Options |  |  |  | (c)Number
  Of SecuritiesRemaining AvailableFor Future IssuanceUnder EquityCompensation Plans (2)
|                                                                 |  | (In thousands, except exercise price)
|Equity
  compensation plans approved by security holders         |  |                                       | 456                                                                           |  |  | $ | 8.31                                                        |  |  |  | 1,225                                                                                             | (3)
|Equity
  compensation plans not approved by security holders (4) |  |                                       | 2,271                                                                         |  |  |   | 11.42                                                       |  |  |  | 1,823                                                                                            
|                                                                 |  |                                       |                                                                               |  |  |   |                                                             |  |  |  |                                                                                                   |    
|Total                                                            |  |                                       | 2,727                                                                         |  |  |   | 10.90                                                       |  |  |  | 3,048                                                                                            
|                                                                 |  |                                       |                                                                               |  |  |   |                                                             |  |  |  |                                                                                                   |    

See Note 16 of the Notes to the Consolidated Financial
Statements for additional information on our stock based compensation plans.



(1)
    In addition, a total of 3,100 shares of common stock are subject
      to options assumed by the Company in connection with acquisitions, with a
      weighted average exercise price of $11.71.  (2)
    All of the shares available for future issuance include: (i)
      2,126,000 shares under the 1995 Long-Term Incentive Plan, as amended and
      restated, issuable as restricted stock or as a bonus; (ii) 188,000 shares
      under the 1995 Non-Employee Directors' Stock Plan, as amended and
      restated, issuable in lieu of directors fees; and (iii) 734,000 shares
      under the Amended and Restated 1985 Employee Stock Purchase Plan (Purchase
      Plan), which may be sold directly to employees at a discount.
      Shares other than those under the Purchase Plan may also be issued in
      connection with options, warrant and rights.  (3)
    Includes 734,000 shares remaining available for future issuance
      under the ESPP of which 136,000 were issued in January 2005. 95  Table of Contents (4)
    The 1995 Long-Term Incentive
      Plan (Plan) was approved by
      shareholders in 1995, with additional shares authorized by shareholders in
      1998. Subsequent amendments to the Plan by the Board of Directors reserved
      additional shares for the Plan, resulting in 2,073,000 shares in column
      (a) and 1,638,000 shares in column (c) at December 31, 2004. The
      Compensation Committee of the Board of Directors, which is permitted to
      delegate authority in limited circumstances, administers the Plan. The
      Plan authorizes grants of incentive and non-qualified stock options, stock
      appreciation rights, restricted stock, deferred stock, bonus stock
      (including in lieu of other payment obligations), dividend equivalents,
      and other stock-based awards. The Committee sets vesting and forfeiture
      terms of awards. To date, the Company has granted primarily options and
      deferred stock (designated as restricted stock units) under the Plan.
      Options must have an exercise price of at least 100% of the fair market
      value of the common stock on the grant date, and generally have a term not
      exceeding ten years. The exercise price may be paid in cash or by
      surrender of previously acquired shares. Restricted stock and restricted
      stock units granted under the Plan are generally to be settled only in
      shares, and are subject to a risk of forfeiture upon termination of
      employment for a specified period, except more favorable terms apply to
      termination due to death, disability and in other specified cases. The
      Plan provides that certain awards will become vested upon a change in
      control of the Company.The 1995 Non-Employee Directors'
Stock Plan, as amended and restated, was approved by shareholders in 1995.
Subsequent amendments to the Plan by the Board of Directors reserved additional
shares for the Plan, resulting in 198,000 shares in column (a) and 185,000
shares in column (c) at December 31, 2004. The Plan is administered by the Board
of Directors. It authorizes the automatic grant of an option to purchase 10,000
shares to each newly elected non-employee director and thereafter annually to
each eligible non-employee director. Options have an exercise price of 100% of
the fair market value of the common stock on the grant date, and expire at the
earlier of ten years after grant, one year after termination of service due to
death, disability, or retirement, or six months after other terminations
(subject to extension if death occurs during the post-termination exercise
period). Options become exercisable 20% per year beginning one year after grant,
subject to acceleration in the case of death or disability, at a specified date
near an optionee's 78th birthday, or in connection with certain change of
control transactions. Options may be exercised after termination only to the
extent vested at termination, unless otherwise determined by the Board. The Plan
also permits discretionary option grants by the Board, with vesting and
forfeiture terms set by the Board. The exercise price may be paid in cash or by
surrender of previously acquired shares. The Plan also permits directors to
elect to receive fees in the form of unrestricted shares of common stock or to
defer fees in the form of deferred shares, with the number of such shares or
deferred shares calculated by dividing the replaced or deferred fees by the
then-fair market value of a share of common stock. The information set forth under the caption "Security
Ownership of Certain Beneficial Owners and Management" in Sierra's Proxy
Statement for its 2005 Annual Meeting of Stockholders, is incorporated herein by
reference.   ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS  The information set forth under the caption "Certain
Relationships and Related Transactions" in Sierra's Proxy Statement for its
2005 Annual Meeting of Stockholders, is incorporated herein by reference.   ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES  The information set forth under the caption "Principal Accounting Fees
and Services" in Sierra's Proxy Statement for its 2005 Annual Meeting of
Stockholders, is incorporated herein by reference. 96  Table of Contents PART IV ITEM
15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)(1)
    Financial Statements.  See Index to Financial Statements and Schedule on page 54.(a)(2)
    Financial Statement Schedules: Schedule I
Condensed Financial Information of Registrant
S-1 All other schedules are omitted
because they are not applicable, not required, or because the required information
is in the consolidated financial statements or notes thereto. (a)(3)
    The following exhibits are filed
      as part of, or incorporated by reference into this Report as required by
      Item 601 of Regulation S-K: (3.1)
Articles of Incorporation, as
amended through September 10, 2003, incorporated by reference to Exhibit 3.1 to
the Registrant's Annual Report on Form 10-K for the fiscal year ended December
31, 2003.(3.2)
Articles of Incorporation, together
with amendments thereto to date, incorporated by reference to Exhibit 4 (b) to
the Registrant's Registration Statement on Form S-8 (No. 33-41543) effective
July 3, 1991.(3.3)
Certificate of Division of Shares
into Smaller Denominations of the Registrant, incorporated by reference to
Exhibit 3.2 to Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2001.(3.4)
Amended and Restated Bylaws of the
Registrant, as amended through March 21, 2002, incorporated by reference to
Exhibit 3.3 to Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2001.(3.5)
Certificate pursuant to NRS Section
78.207 increasing the number of authorized shares of common stock to 60,000,000
pursuant to the Company's stock split on May 18, 1998, incorporated by reference
to Exhibit 3.4 to Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2001.(4.1)
Specimen Common Stock Certificate,
incorporated by reference to Exhibit 4.3 to Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 2001.(10.1)
Form of Contract With Eligible
Medicare+Choice Organization and the Centers for Medicare and Medicaid Services
for the period January 1, 2001 to December 31, 2001, incorporated by reference
to Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2001.(10.2)
Credit Agreement dated as of March
3, 2003, among Sierra Health Services, Inc. as Borrower, Bank of America N.A. as
Administrative Agent and L/C Issuer, Credit Lyonnais New York Branch as
Syndication Agent, U.S. Bank National Association as Documentation Agent and
Banc of America as Sole Lead Arranger and Sole Book Manager, incorporated by
reference to Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2002.(10.3)
First Amendment to the Credit
Agreement dated as of March 3, 2003, among Sierra Health Services, Inc. as
Borrower, Bank of America N.A. as Administrative Agent and L/C Issuer, Credit
Lyonnais New York Branch as Syndication Agent, U.S. Bank National Association as 97  Table of Contents Documentation Agent and Banc of America as Sole Lead Arranger and Sole Book
Manager, incorporated by reference to Exhibit 10.3 to Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2003.(10.4)
Second Amendment to the Credit
Agreement dated as of March 3, 2003, among Sierra Health Services, Inc. as
Borrower, Bank of America N.A. as Administrative Agent and L/C Issuer, Credit
Lyonnais New York Branch as Syndication Agent, U.S. Bank National Association as
Documentation Agent and Banc of America as Sole Lead Arranger and Sole Book
Manager, incorporated by reference to Exhibit 10.4 to Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2003.(10.5)
Fourth Amendment to the Credit
Agreement dated as of March 3, 2003, among Sierra Health Services, Inc. as
Borrower, Bank of America N.A. as Administrative Agent and L/C Issuer, Calyon
New York Branch (formerly known as Credit Lyonnais New York Branch) and U.S.
Bank National Association as Syndication Agents, Banc of America Securities LLC,
Calyon New York Branch and U.S. Bank National Association as Joint Book Managers
and Banc of America Securities LLC as Sold Lead Arranger, incorporated by
reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K on October
19, 2004, File No. 001-08865.(10.6)
Compensatory Plans, Contracts and
Arrangements. (1)
Employment Agreement with Jonathon
W. Bunker dated February 1, 2003, incorporated by reference to Exhibit 10.6 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
2002, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.4 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(2)
Employment Agreement with Frank E.
Collins dated November 16, 2000, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
2000, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.3 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(3)
Employment Agreement with William
R. Godfrey dated December 10, 1999, incorporated by reference to Exhibit 10.8 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
1999, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.9 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(4)
Employment Agreement with Laurence
S. Howard dated December 10, 1999, incorporated by reference to Exhibit 10.8 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
1999, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.7 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(5)
Employment Agreement with Anthony
M. Marlon, M.D. dated November 16, 2000, incorporated by reference to Exhibit
10.5 to Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000, and as further amended on December 13, 2004, and incorporated
by reference to Exhibit 10.1 to Registrant's Report on Form 8-K filed on
December 16, 2004, File No. 001-08865.(6)
Employment Agreement with Erin E.
MacDonald dated February 12, 2001, incorporated by reference to Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
2001, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.2 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865. 98  Table of Contents (7)
Employment Agreement with Michael
A. Montalvo dated January 1, 2003, incorporated by reference to Exhibit 10.6 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
2002, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.6 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(8)
Employment Agreement with Marie H.
Soldo dated November 16, 2000, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
2000, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.8 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(9)
Employment Agreement with Paul H.
Palmer dated December 1, 2001, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
2001, and as further amended on December 13, 2004, and incorporated by reference
to Exhibit 10.5 to Registrant's Report on Form 8-K filed on December 16, 2004,
File No. 001-08865.(10)
Form of Split Dollar Life Insurance
Agreement effective as of August 25, 1998, by and between Sierra Health
Services, Inc., and Jonathon W. Bunker, Frank E. Collins, William R. Godfrey,
Laurence S. Howard, Erin E. MacDonald, Anthony M. Marlon, M.D., Kathleen M.
Marlon, Michael A. Montalvo, John A. Nanson, M.D., Paul H. Palmer and Marie H.
Soldo, incorporated by reference to Exhibit 10.5 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
2000.(11)
Sierra Health Services, Inc.
Deferred Compensation Plan effective May 1, 1996, as Amended and Restated
Effective January 1, 2001, incorporated by reference to Exhibit 10.6 to
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31,
2002.(12)
Sierra Health Services, Inc.
Supplemental Executive Retirement Plan effective July 1, 1997, as Amended and
Restated January 1, 2001, incorporated by reference to Exhibit 10.5 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2000.(13)
Sierra Health Services, Inc.
Supplemental Executive Retirement Plan effective as of March 1, 1998,
incorporated by reference to Exhibit 10 to the Registrant's Quarterly Report on
Form 10-Q for the fiscal quarter ended March 31, 1998.(14)
The Registrant's Second Amended and
Restated 1986 Stock Option Plan as amended to date, incorporated by reference to
Exhibit 4 (a) to the Registrant's Registration Statement on Form S-8 (No. 33-41543)
effective July 3, 1991.(15)
Amendment No. 1 to The Registrant's
Second Amended and Restated 1986 Stock Option Plan as amended to November 11,
1992, incorporated by reference to Exhibit 10.5 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.(16)
Amendment No. 2 to The Registrant's
Second Amended and Restated 1986 Stock Option Plan as amended to March 16, 1993,
incorporated by reference to Exhibit 10.5 to Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 2001.(17)
Sierra Health Services, Inc.
Management Incentive Compensation Plan for the year ended December 31, 2004. 99  Table of Contents (18)
Sierra Health Services, Inc. 1995
Long-Term Incentive Plan, as amended and restated through December 11, 2001,
incorporated by reference to Exhibit 10.5 to Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 2001.(19)
Sierra Health Services, Inc. 1995
Non-Employee Directors' Stock Plan, as amended and restated through August 10,
2000, incorporated by reference to Exhibit 10.7 to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended September 30, 2000.(20)
Form of Sierra Health Services, Inc. 1995 Long-Term
Incentive Plan Non-Qualified Stock Option Agreement.(21)
Form of Sierra Health Services, Inc. 1995 Non-Employee Directors'
Stock Plan Non-Qualified Stock Option Agreement.(22)
Form of Sierra Health Services, Inc. 1995 Long-Term
Incentive Plan Restricted Stock Units Agreement. (10.7)
Stock Purchase Agreement, dated as
of November 25, 2003, as amended on December 17, 2003, as further amended on
December 29, 2003 and as further amended on January 12, 2004, among Sierra
Health Services, Inc., CII Financial, Inc. and Folksamerica Holding Company,
Inc., incorporated by reference to Exhibit 10.6 to Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2003.(10.8)
Form of Contingent Purchase Price
Note Agreement among Folksamerica Holding Company, Inc., Sierra Health Services,
Inc., CII Financial, Inc., and, with respect to Article 5 only, Folksamerica
Reinsurance Company, incorporated by reference to Exhibit 10.7 to Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31,
2003.(12.1)
Statement re: Computation of
Ratios.(21)
Subsidiaries of the Registrant
(listed herein):There is no parent of the Registrant.  The following is a
listing of the active subsidiaries of the Registrant:Behavioral Healthcare Options, Inc. 
CII Financial, Inc. 
Family Health Care Services  
Family Home Hospice, Inc.  
Health Plan of Nevada, Inc.Sierra Nevada Administrators, Inc. 
Northern Nevada Health Network, Inc. 
Sierra Health and Life Insurance Company, Inc.  
Sierra Health Holdings, Inc.
      (Sierra Military Health Services, LLP, Texas Health Choice, L.C.) 
Sierra Health-Care Options, Inc. 
Sierra Home Medical Products, Inc. 
Sierra Medical Management, Inc. and Subsidiaries 
Southwest Medical Associates, Inc.  
Southwest Realty, Inc.

Jurisdiction ofIncorporationNevada
California
Nevada
Nevada
Nevada
Nevada
Nevada
California
Nevada
 
Nevada
Nevada
Nevada

Nevada
Nevada 100  Table of Contents (23.1)
Consent of Deloitte & Touche
LLP.(31.1)
Rule 13a - 14(a) Certification of
Chief Executive Officer.(31.2)
Rule 13a - 14(a) Certification of
Chief Financial Officer.(32.1)
Certification pursuant to 18 U.S.C.
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Principal Executive Officer dated March 14, 2005.(32.2)
Certification pursuant to 18 U.S.C.
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Principal Financial Officer dated March 14, 2005. All other Exhibits are omitted because they are not applicable.(d)
    Financial Statement Schedules
    The Exhibits set forth in Item 15 (a)(2) are filed herewith. 101 Table of Contents SIGNATURES  Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has caused this report to be
signed on its behalf by the undersigned thereto duly authorized.  SIERRA HEALTH SERVICES, INC.

                                       By:/s/ Anthony M. Marlon, M.D.

                                                  Anthony M. Marlon, M.D. Date: March 14, 2005 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 dates indicated.  Signature
Title
Date/s/ Anthony M. Marlon, M.D.
Anthony M. Marlon, M.D.
Chief Executive Officer and Chairman of the Board
(Chief Executive Officer)
March 14, 2005/s/ Paul H. Palmer
Paul H. Palmer
Senior Vice President of Finance,
Chief Financial Officer, and Treasurer
(Chief Accounting Officer)
March 14, 2005/s/ Erin E. MacDonald
Erin E. MacDonald
Director
March 14, 2005/s/ Charles L. Ruthe
Charles L. Ruthe
Director
March 14, 2005/s/ William J. Raggio
William J. Raggio
Director
March 14, 2005/s/ Thomas Y. Hartley
Thomas Y. Hartley
Director
March 14, 2005/s/ Albert L. Greene
Albert L. Greene
Director
March 14, 2005/s/ Michael E. Luce
Michael E. Luce
Director
March 14, 2005/s/ Anthony L. Watson
Anthony L. Watson
Director
March 14, 2005 102  Table of Contents SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT CONDENSED BALANCE SHEETS - Parent Company Only  December 31,2004


2003(In thousands)ASSETSCurrent
  Assets:Cash and
  cash equivalents

$
47,889


$
2,515Short-term
  investments


22,744



994Current
  portion of deferred tax asset


6,962



27,612Prepaid
  expenses and other current assets


27,748



40,823Total Current Assets


105,343



71,944Property
  and equipment, net


28,886



30,093Equity
  in net assets of subsidiaries


189,498



181,946Notes
  receivable from subsidiaries


9,014



9,135Goodwill


2,154



2,154Deferred
  tax asset


14,555



4,064Other


58,739



46,267Total
  Assets

$
408,189


$
345,603LIABILITIES AND STOCKHOLDERS' EQUITYCurrent
  Liabilities:Accounts
  payable and other accrued liabilities

$
26,092


$
23,336Current
  portion of long-term debt


26



47Total Current Liabilities


26,118



23,383Long-term
  debt (less current portion)


125,099



115,013Other
  liabilities


55,275



56,443Total
  Liabilities


206,492



194,839Stockholders'
  Equity:Common
  stock


178



166Treasury
  stock


(237,876
)


(112,737
)Additional
  paid-in capital


286,571



227,417Deferred
  compensation


(288
)


(22
)Accumulated
  other comprehensive loss


(245
)


(479
)Retained
  earnings


153,357



36,419Total
  Stockholders' Equity


201,697



150,764Total
  Liabilities And Stockholders Equity

$
408,189


$
345,603 S-1  Table of Contents


SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) CONDENSED STATEMENTS OF OPERATIONS - Parent Company Only 

Years Ended December 31,2004

2003


2002(In thousands)Revenues:Management
  fees

$

142,178

$
123,669



$
81,363Subsidiary
  dividends



52,250


11,000




20,000Investment and
  other income



6,934


3,179




698Total
  Revenues



201,362


137,848




102,061Expenses:Depreciation



9,161


9,052




10,699Other



53,113


37,923




36,186Interest
  expense and other, net



1,164


2,682




8,017Total
  Expenses



63,438


49,657




54,902Income
  Before Income Taxes



137,924


88,191




47,159Income
  tax provision



(22,363
)

(26,543

)


(8,615

)Income
  Of Parent Company



115,561


61,648




38,544Equity
  in undistributed income of subsidiaries from continuing operations



7,565


20,470




3,764Income
  From Continuing Operations



123,126


82,118




42,308Loss
  from discontinued operations



(389
)

(19,792

)


(5,860

)Net
  Income

$

122,737

$
62,326



$
36,448S-2


Table of Contents
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) CONDENSED STATEMENTS OF CASH FLOWS - Parent Company Only 




Years Ended December 31,2004

2003


2002(In thousands)Cash
  Flows From Operating Activities:Income
  from continuing operations

$

123,126

$
82,118



$
42,308Adjustments
  To Reconcile Net Income To Net Cash Provided By Operating Activities:Depreciation



9,161


9,052




10,699Deferred
  compensation



7,332


451




585(Gain)
  loss on
  property and equipment dispositions



(89
)

190




Equity in
  undistributed income of subsidiaries continuing operations



7,565


20,470




3,764Change in
  assets and liabilities



(16,695
)

(88,117

)


(51,053

)Net Cash Provided
  By Operating Activities



130,400


24,164




6,303Cash
  Flows From Investing Activities:Capital
  expenditures



(9,495
)

(6,486

)


(5,273

)Property and
  equipment dispositions



1,750


2,599




144(Increase)
  decrease in investments



(32,501
)

727




(117

)Dividends from
  subsidiaries



52,250


11,000




20,000Net Cash Provided
  By Investing Activities



12,004


7,840




14,754Cash
  Flows From Financing Activities:Payments on
  debt and capital leases



(55
)

(60,092

)


(38,927

)Proceeds from
  other long-term debt



10,000







Purchase of
  treasury stock



(133,809
)

(99,485

)


Exercise of
  stock in connection with stock plans



26,834


19,171




10,159Proceeds from
 senior convertible debentures






115,000




Debt
  issue costs






(5,834

)


Proceeds of
  sale-leaseback deposit











9,462Net Cash Used
  For Financing Activities



(97,030
)

(31,240

)


(19,306

)Net Increase
  In Cash And Cash Equivalents



45,374


764




1,751Cash
  and cash equivalents at beginning of year



2,515


1,751




Cash
  And Cash Equivalents At End Of Year

$

47,889

$
2,515



$
1,751Supplemental
  Condensed Statements Of Cash Flows Information:Cash
  paid during the year for interest (net of amount capitalized)

$

2,979

$
3,254



$
11,559Cash
  (paid) received during the year for income taxes



(12,620
)

(10,324

)


13,051Non-Cash Investing
  And Financing Activities:Stock
  issued for exercise of options and related tax benefits



27,287


12,596




6,837Additions to
  capital leases



120


17




Retired
  sale-leaseback assets, liabilities and financing obligations










89,751S-3

Table of ContentsSIERRA HEALTH SERVICES, INC. AND SUBSIDIARIESSCHEDULE I - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (Continued) NOTES
TO CONDENSED INFORMATION OF REGISTRANT For
the Years Ended December 31, 2004 and 2003  1.   
LONG-TERM DEBT  Scheduled
maturities of long-term debt, including the principal portion of obligations
under capital leases, are as follows: 



December 31,






(In thousands)2005





$

262006







272007







282008







282009







10,016Thereafter







115,000Total





$

125,1252.    OTHER
Management Fees.Sierra Health Services,
Inc., receives monthly management fees from certain wholly-owned subsidiaries
for services performed. The majority of the fees are from Health Plan of Nevada,
Inc. under an administrative services agreement that has been approved by the
Nevada Division of Insurance. The fees have been recorded as revenue in the
Condensed Financial Information of Registrant for the three years ended December
31, 2004.

S-4