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, 1996

                                       OR

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

                       For the transition period from to

                         Commission file number: 1-8865

                          SIERRA HEALTH SERVICES, INC.
             (Exact name of Registrant as specified in its charter)

                                     NEVADA
                         (State or other jurisdiction of
                         incorporation or organization)
                                   88-0200415
                     (I.R.S. Employer Identification Number)
                              2724 NORTH TENAYA WAY
                             LAS VEGAS, NEVADA 89128
               (Address of principal executive offices) (Zip Code)

         Registrant's telephone number, including area code:  (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 ]

         The aggregate  market value of the voting stock held by  non-affiliates
of the registrant on March 14, 1997 was $405,166,000.

The number of shares of the registrant's  common stock  outstanding on March 14,
1997 was 17,865,000.

                       DOCUMENTS INCORPORATED BY REFERENCE
       DOCUMENT                                          WHERE INCORPORATED

Registrant's Current Report on Form 8-K dated                  Part I
  March 28,1997.                                           Part II, Item 7

Portions of the registrant's definitive proxy statement for     Part III
its 1997 annual meeting to be filed with the SEC not later
    than 120 days after the end of the fiscal year.




<PAGE>



                          SIERRA HEALTH SERVICES, INC.

                          1996 FORM 10-K ANNUAL REPORT

                                TABLE OF CONTENTS

                                                                          Page
                                     PART I

Item  1.      Business ...................................................  1

Item  2.      Properties..................................................  14

Item  3.      Legal Proceedings...........................................  14

Item  4.      Submission of Matters to a Vote of Security Holders.........  14


                                     PART II

Item  5.      Market for Registrant's Common Stock and
                 Related Stockholder Matters..............................  15

Item  6.      Selected Financial Data.....................................  16

Item  7.      Management's Discussion and Analysis of Financial Condition
                 and Results of Operation.................................  17

Item  8.      Financial Statements and Supplementary Data.................  26

Item  9.      Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure......................  54


                                    PART III

Item 10.      Directors and Executive Officers of the Registrant..........  54

Item 11.      Executive Compensation......................................  54

Item 12.      Security Ownership of Certain Beneficial Owners
                and Management............................................  54

Item 13.      Certain Relationships and Related Transactions..............  54


                                     PART IV

Item 14.      Exhibits, Financial Statement Schedules
                and Reports on Form 8-K...................................  55

                                        i

<PAGE>



                                     PART I


ITEM 1.           BUSINESS
                                     GENERAL

     Sierra Health Services, Inc. ("Sierra") and its subsidiaries  (collectively
referred  to as the  "Company"),  is a managed  health  care  organization  that
provides and administers the delivery of comprehensive  health care and workers'
compensation programs with an emphasis on quality care and cost management.  The
Company's  strategy has been to develop and offer a portfolio of managed  health
care and workers' compensation products to employer groups and individuals.  The
Company's  broad range of managed  health care services is provided  through its
federally qualified and non-qualified health maintenance organizations ("HMOs"),
insurance  companies,  managed  indemnity  plans,  a third-party  administrative
services  program  for   employer-funded   health  benefit  plans  and  workers'
compensation medical management  programs.  Ancillary products and services that
complement the Company's managed health care and workers'  compensation  product
lines are also offered.

     In June 1996,  the  Civilian  Health and Medical  Program of the  Uniformed
Services  ("CHAMPUS")  granted a 5-year  contract to provide health  services to
Regions 7 and 8, which includes a total of 17 states, to a consortium consisting
of Sierra and 13 other health care  companies.  In April 1997,  this  consortium
will begin providing health care to approximately 700,000 individuals,  of which
Sierra  will  be  responsible  for  providing  care  to   approximately   93,000
individuals in Nevada and Missouri.

     In November 1996, the Company acquired the remaining ownership interests of
HMO Texas  for $5.0  million.  The  Company  had  previously  held a 50  percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996.

     Effective  December 31, 1996, the Company  purchased Prime  Holdings,  Inc.
("Prime") for  approximately  $31.2 million in cash. At December 31, 1996, Prime
operated MedOne Health Plan,  Inc., a 12,800 member HMO, and also served 215,000
people through preferred provider organizations ("PPOs"),  workers' compensation
programs and  administrative  services  products for self-insured  employers and
union welfare funds primarily in the state of Nevada.

     The  principal  executive  offices of the Company are located at 2724 North
Tenaya Way, Las Vegas, Nevada 89128, and its telephone number is (702) 242-7000.

Managed Care Products and Services

     The  Company's  primary  types of health care  coverage are HMO plans,  HMO
Point of Service ("POS") plans, and managed indemnity plans, which include a PPO
option.  As  of  December  31,  1996,  the  Company  provided  HMO  products  to
approximately 177,000 members. Of these HMO members, approximately 92% reside in
Nevada.  The POS products  allow  members to choose one of the various  coverage
options  when medical  services are required  instead of one plan for the entire
year.  The Company also provides  managed  indemnity  products to  approximately
46,000 members,  Medicare supplement  products to approximately  23,000 members,
and  administrative  services  to  approximately  501,000  members,  of  whom  a
significant   portion  are  employees  covered  through  workers'   compensation
products.  Medical premiums account for approximately 67% of total revenues, 87%
of which are derived from southern Nevada.



                                        1

<PAGE>



     Health  Maintenance  Organizations.  The  Company  operates  a mixed  group
network  model  HMO in  Nevada,  and a network  model  HMO in Texas,  as well as
managed  indemnity PPO plans. Most of its managed health care services in Nevada
are provided  through its  networks of over 1,800  providers  and 17  hospitals.
These  networks  include the  Company's  multi-specialty  medical  group,  which
provides  medical  services to  approximately  74% of the  Company's  Nevada HMO
members and employs over 134 primary care and other providers in various medical
specialties.  The Company directly  provides home health care,  hospice care and
behavioral health care services.  In addition,  the Company operates two 24-hour
urgent  care  centers,  a  radiology   department,   a  vision  department,   an
occupational  medicine  department  and two  free-standing,  state-licensed  and
Medicare-approved  ambulatory  surgery  centers.  The Company believes that this
vertical  integration of its health care delivery  system provides a competitive
advantage  as it has helped it to manage  health  care costs  effectively  while
delivering  quality  care.  As of December 31, 1996,  the Texas HMO members were
served by approximately 1,600 contracted providers and 33 hospitals.  Contracted
primary  care  physicians  and  specialists  for the HMOs are  compensated  on a
capitation  or modified  fee-for-service  basis.  Contracts  with their  primary
hospitals are on a capitation or discounted  per diem basis.  Members  receive a
wide range of coverage  after paying a nominal  co-payment  and are eligible for
preventive care coverage.  The HMOs do not require deductibles,  co-insurance or
claim forms.

     In addition to its commercial  HMO plan,  which  involves  traditional  HMO
benefits and Point of Service  benefits,  the Company offers prepaid health care
programs for Medicare-eligible  beneficiaries called Senior Dimensions in Nevada
and Golden Choice in Texas.  Senior Dimensions is marketed directly to Medicare-
eligible beneficiaries in the Company's Nevada service area. Federal legislation
has been enacted which allows delivery of health care to Medicare  beneficiaries
through  HMOs.  Such  legislation  provides  that the  federal  government  will
reimburse HMOs for health care services to Medicare  beneficiaries  in an amount
equal to 95% of the Medicare payments to fee-for-service  providers in a defined
service  area.  As of December 31, 1996,  approximately  29,000,  or 17%, of the
Company's  total  Nevada HMO members  were  enrolled in Senior  Dimensions.  The
Senior   Dimensions  plan  enables   Medicare   beneficiaries  to  reduce  their
out-of-pocket  expenses and receive additional benefits not covered by Medicare.
In July 1996 the Company's Texas HMO received  approval to offer a Medicare risk
product and by the end of the year 11% of the  Company's  HMO Texas members were
enrolled in Golden Choice.

     Social Health  Maintenance  Organization.  Effective  November 1, 1996, the
Company entered into a three year Social HMO contract  pursuant to which a large
portion of the Company's  Medicare risk enrollees will receive certain  expanded
benefits. The Company expects to receive additional revenues for providing these
expanded  benefits.  The additional  revenues will be determined based on health
care assessments that will be performed on the Company's  eligible Medicare risk
members.  The additional  benefits  include,  among other things,  assisting the
eligible  Medicare  risk  members with typical  daily living  functions  such as
bathing,  dressing,  walking and shopping.  These members,  as identified in the
health care assessments,  are ones who currently have difficulty performing such
daily living functions because of a health or physical  problem.  The additional
reimbursement will be subject to adjustment based on the number of beneficiaries
who need assistance  with the social  problems noted above and their  individual
health care  assessments.  The ultimate  payment  received  from the Health Care
Financing  Administration  ("HCFA") will be based on these and other factors and
is expected to exceed the current  reimbursement  rate from HCFA.  At this time,
however, there can be no assurance as to what the final per member reimbursement
will be.

     Preferred Provider Organizations.  The Company also offers health insurance
through its PPO. The Company's  managed indemnity plans generally offer insureds
the  option of  receiving  their  medical  care from  either  non-contracted  or
contracted  providers.  Insureds  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  providers  who  are  part of the
Company's Nevada PPO network, consisting of approximately 3,000 providers and 32
hospitals.  As of December 31, 1996,  approximately 46,000 persons were enrolled
in Sierra's managed indemnity plans.


                                        2

<PAGE>



     The Company currently  provides managed  indemnity and Medicare  supplement
services to individuals in Nevada, Arizona,  Colorado,  Texas,  California,  New
Mexico,  Missouri,  and  Mississippi.  The  Company  is also  exploring  further
expansion in certain  other  states.  During 1996 the Company  adopted a plan to
restructure  certain insurance  operations to allow the Company to focus on more
favorable  operating  markets.  This plan  significantly  reduced the  Company's
presence in Arizona and Colorado for certain managed indemnity products.

     Workers' Compensation Subsidiary. On October 31, 1995, the Company acquired
CII Financial, Inc. ("CII") for approximately $76.3 million of common stock in a
transaction  accounted  for as a  pooling  of  interests.  CII  writes  workers'
compensation insurance in the states of California,  Colorado, Kansas, Nebraska,
New Mexico,  Texas,  and Utah. CII has licenses in 24 states and the District of
Columbia.   California  and  Colorado  represent   approximately  87%  and  10%,
respectively, of CII's fully insured workers' compensation insurance premiums in
1996. Workers' compensation  insurance premiums account for approximately 21% of
the Company's total revenue.  In conjunction with the acquisition a supplemental
indenture was filed modifying CII's 7 1/2% convertible  subordinated  debentures
(the "Debentures"). As a result each $1,000 in principal is now convertible into
16.921  shares of Sierra's  common  stock at a  conversion  price of $59.097 per
share.

     Administrative  Services.  The Company's  administrative  services products
provide,  among  other  things,  utilization  review and PPO  services  to large
employer  groups  that  are  usually  self-insured.  As of  December  31,  1996,
approximately  289,000  persons were  enrolled in the  Company's  administrative
services  plans.  The  Company  also  provides  workers'   compensation  medical
management services to employers in Nevada. As of December 31, 1996,  enrollment
in this program was approximately 212,000.

     Ancillary Medical Services. Among the ancillary medical services offered by
the Company are outpatient surgical care, diagnostic tests, medical and surgical
procedures,  inpatient and outpatient  laboratory  tests,  x-ray,  CAT scans and
nuclear medicine services.  The Company also provides home health care services,
a hospice program and mental health and substance abuse services. These services
are  provided  to  members  of  the  Company's   HMO,   managed   indemnity  and
administrative  services plans as well as to approximately  99,000  participants
from non-affiliated employer groups and an insurance company.

     Ongoing  Initiatives.  During 1995, the Company entered the bidding process
to provide health services for military  dependents and retirees in Nevada and a
portion of Missouri. In June 1996, the Office of the Civilian Health and Medical
Program of the  Uniformed  Services  ("OCHAMPUS")  granted a 5-year  contract to
provide these  services to Regions 7 and 8, which includes a total of 17 states,
to a consortium  consisting of Sierra and 13 other health care  companies.  This
consortium will begin providing health care to approximately 700,000 individuals
in April  1997 of which the  Company  will be  providing  care to  approximately
93,000.  In  addition,  the  Company  has  submitted  a  proposal  as the  prime
contractor  to  CHAMPUS to  provide  managed  health  care  coverage  to CHAMPUS
eligible  beneficiaries in Region 1. This region includes  approximately 665,000
individuals  in  Connecticut,  Delaware,  Maine,  Maryland,  Massachusetts,  New
Hampshire, New Jersey, New York, Pennsylvania,  Rhode Island, Vermont,  northern
Virginia  and  Washington,  D.C.  The  Company  expects  to  incur  expenses  of
approximately  $8.0 to $10.0  million  during  the  Region 1  contract  proposal
process. The Company anticipates learning of the status of its bid in the second
quarter of 1997.



                                        3

<PAGE>



Marketing

     The Company's  marketing  efforts for its commercial  managed care products
involve a two-step process.  The Company first makes  presentations to employers
and then  provides  information  directly to  employees  once the  employer  has
decided to offer the Company's  products.  Once a  relationship  with a group is
established  and a group  agreement  is  negotiated  and signed,  the  Company's
marketing  efforts  focus 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 of their employment.  Although  contracts with employers are
generally  terminable on 60 days notice,  changes in membership  occur primarily
during open enrollment periods. Medicare risk products are primarily marketed by
the HMO's sales employees. Retention of employer groups and membership growth is
accomplished  through  print  advertising  directed  to  employers  and  through
consumer media campaigns.  Media communications convey the Company's emphasis on
preventive  care,  ready access to health care  providers  and quality  service.
Other  communications  to customers  include  employer  and member  newsletters,
member  education  brochures,  prenatal  information  packets,   employer/broker
seminars and direct mail  advertising  to clients.  Members'  satisfaction  with
Company  benefits and services is  monitored by customer  surveys.  Results from
these  surveys and other  primary  and  secondary  research  guide the sales and
advertising efforts throughout the year.

     The Company's workers'  compensation  insurance policies are sold primarily
through independent  insurance agents and brokers,  who may also represent other
insurance companies.  The Company believes that independent insurance agents and
brokers choose to market the Company's  insurance  policies primarily because of
the price the Company charges.  Additional considerations include the quality of
service that the Company  provides and the  commissions  the Company  pays.  The
Company  employs  full-time  employees  as  marketing  representatives  to  make
personal  contacts with agents and brokers,  to maintain  regular  communication
with them, to advise them of the Company's services and products, and to recruit
additional  agents and  brokers.  As of  December  31,  1996,  the  Company  had
relationships  with  approximately 420 agents and 30 brokers and paid its agents
and brokers  commissions  based on a  percentage  of the gross  written  premium
produced  by such agents and  brokers.  The  Company  also  utilizes a number of
promotional media,  including advertising in publications and at trade fairs, to
support the efforts of its independent agents.

Membership

Period End Membership:
<TABLE>


                                                                     Years Ended December 31,
<CAPTION>
                                                    1996          1995         1994         1993         1992
HMO:
<S>                                                  <C>          <C>          <C>           <C>          <C>
    Commercial..............................         147,000      116,000      107,000       89,000       82,000
    Medicare................................          30,000       25,000       20,000       15,000       14,000
Managed Indemnity...........................          46,000       31,000       24,000       30,000       30,000
Medicare Supplement.........................          23,000       15,000        9,000        4,000        2,000
Administrative Services.....................         501,000      211,000      144,000       59,000       59,000
    Total Membership........................         747,000      398,000      304,000      197,000      187,000
</TABLE>

     For the years  ended  December  31,  1996 and 1995,  the  Company  received
approximately 24.2% and 23.9%,  respectively,  of its total revenues pursuant to
its  contract  with  the  HCFA to  provide  health  care  services  to  Medicare
enrollees.  The Company's contract with HCFA is subject to annual renewal at the
election  of HCFA and  requires  the  Company  to comply  with  federal  HMO and
Medicare laws and

                                        4

<PAGE>



regulations  and may be  terminated  if the  Company  fails  to so  comply.  The
termination  of the Company's  contract with HCFA would have a material  adverse
effect on the Company's business. In addition,  there have been, and the Company
expects  that there will  continue to be, a number of  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.

     The  Company's  ability  to obtain and  maintain  favorable  group  benefit
agreements  with  employer  groups  affects  the  Company's  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,
1996,  the  Company's ten largest HMO employer  groups were,  in the  aggregate,
responsible for approximately 11% of the Company's total revenues. Although none
of such employer groups accounted for more than 3% of total revenues during that
period,  the loss of one or more of the larger  employer  groups  would,  if not
replaced  with  similar  membership,  have a material  adverse  effect  upon the
Company's business. The Company has generally been successful in retaining these
employer  groups.  However,  there can be no assurance  that the Company will be
able to renew its agreements  with such employer groups in the future or that it
will not  experience  a  decline  in  enrollment  within  its  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 the
Company's  health  care  delivery  system  and that of many other  managed  care
providers is the fact that approximately 74% of the Company's Nevada HMO members
receive  primary health care through the Company's own  multi-specialty  medical
group. The Company makes health care available through providers employed by the
multi-specialty  medical  group  and  an  independently  contracted  network  of
physicians, hospitals and other providers.

     Under the Company's  HMOs,  the member selects a primary care physician who
provides or  authorizes  any  non-emergency  medical  care given to that member.
These primary care physicians and some  specialists are compensated to a limited
extent on the basis of how well they  coordinate  appropriate  medical care. The
Company has a system of incentive risk  arrangements and utilization  management
with  respect to its  independently  contracted  primary  care  physicians.  The
Company  compensates its  independently  contracted  primary care physicians and
specialists  by using  both  capitation  and  modified  fee-for-service  payment
methods.  Under both the capitation  and modified  fee-for-service  methods,  an
incentive risk arrangement is established for institutional services. Additional
amounts may be made available to certain capitated  physicians if hospital costs
are less than anticipated for the Company's HMO members.  For those primary care
physicians receiving payments on a modified  fee-for-service  basis, portions of
the payments otherwise due the physicians are withheld. The amounts withheld are
available for payment to the physicians if, at year-end,  the  expenditures  for
both   institutional   and   non-institutional   medical   services  are  within
predetermined, contractually agreed upon ranges. It is believed that this method
of incentive risk payment is advantageous to the physician,  the Company and the
members  because all share in the  benefits of managing  health care costs.  The
Company has, however,  negotiated capitation agreements with certain specialists
who do not participate in the incentive risk arrangements.  The Company monitors
health care utilization,  including  evaluation of elective surgical procedures,
quality of care and financial stability of its capitated providers to facilitate
access to service and to ensure member satisfaction.

     The Company also believes that it has negotiated  favorable  rates with its
contracted  hospitals.   The  Company's  contracts  with  its  primary  hospital
providers  typically renew  automatically with both parties granted the right to
terminate  after a notice period  varying from between three and twelve  months.
Reimbursement  arrangements  with  hospitals  and other  health care  providers,
including pharmacies, are generally negotiated annually and are based on several
different  payment methods,  including per diems (where the  reimbursement  rate
varies and is based on a per day of service charge for specified types of care),
capitation or modified  fee-for-service  arrangements.  To the extent  possible,
when  negotiating  non-physician  provider  arrangements,  the Company  solicits
competitive bids.


                                        5

<PAGE>



     The Company provides, or negotiates discounted contracts with hospitals for
the provision of,  inpatient and outpatient  hospital  care,  including room and
board,  diagnostic  tests and  medical  and  surgical  procedures.  The  Company
believes  that it currently has a favorable  contract with its primary  southern
Nevada  contracted  hospital,  Columbia  Sunrise  Hospital.  Subject  to certain
limitations,  the contract provides,  among other things,  guaranteed contracted
per diem rate  increases  on an annual basis after  December  31, 1997.  Since a
majority of the Company's  southern Nevada hospital days are at Columbia Sunrise
Hospital, this contract assists the Company in managing a significant portion of
its  medical  costs.  The  contract  expires in the year 2012.  The  Company has
negotiated a capitation  arrangement with Columbia  Hospital,  Inc. for hospital
services provided in Houston to members of the Company's Texas HMO.

     The Company  utilizes two  reimbursement  methods for health care providers
rendering services under the Company's  indemnity plans. For services to members
utilizing  a PPO plan,  the Company  reimburses  participating  physicians  on a
modified  fee-for-service  basis which  incorporates  a limited fee schedule and
reimburses  hospitals on a per diem or  discounted  fee-for-service  basis.  For
services  rendered under a standard  indemnity plan,  pursuant to which a member
may select a non-plan provider, the Company reimburses non-contracted physicians
and  hospitals at  pre-established  rates,  less  deductibles  and  co-insurance
amounts.

     The  Company  also  manages  health  care  costs  through  its  large  case
management program, home health care agency, 24-hour urgent care centers and its
hospice  which helps to minimize  hospital  admissions  and lengths of stay.  In
addition,  the Company  educates its members on how and when to use the services
of its plans and how to manage chronic disease  conditions,  and audits hospital
bills to identify inappropriate charges.

Risk Management

     The Company  maintains  general and  professional  liability,  property and
fidelity  insurance  coverage in amounts  that it believes  are adequate for its
operations.   The  Company's  multi-specialty  medical  group  maintains  excess
malpractice  insurance for the providers  presently  employed by the group.  The
Company has,  however,  assumed the risk for the first $250,000 per  malpractice
case,  not to exceed $1.5 million in the  aggregate  per contract year up to its
limits of coverage.  In addition,  the Company requires all of its independently
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 the Company contracts are self-insured.  The
Company also maintains  stop-loss  insurance that reimburses the Company between
50% and 90% of hospital charges for each individual member of its HMO or managed
indemnity plans whose hospital  expenses exceed $75,000 during the contract year
and up to $2.0 million per member per lifetime. Workers' compensation claims are
reinsured  between  $350,000 and $60.0 million per  occurrence.  In the ordinary
course of its business,  however,  the Company is subject to claims that are not
insured, principally claims for punitive damages.

Information System

     The Company has in place  certain data systems which assist the Company in,
among other things, pricing its services,  monitoring utilization and other cost
factors,  providing bills on a timely basis, identifying accounts for collection
and  handling  various  accounting  and  reporting  functions.  Its  imaging and
workflow  systems are used to process and track claims and  coordinate  customer
service. Where it is cost efficient,  the Company's system is connected to large
provider  groups,  doctors'  offices,  payors and  brokers  to enable  efficient
transfer of information  and  communication.  The Company views its  information
systems  capability  as critical to the  performance  of ongoing  administrative
functions and integral to quality  assurance and to the  coordination of patient
care across care sites.  The Company is  continually  modifying or improving its
information systems capabilities in an effort to improve operating efficiencies.



                                        6

<PAGE>



Quality Assurance and Improvement

     The  Company  has  developed  programs  to help ensure that the health care
services  provided by its HMO and managed  indemnity plans meet the professional
standards of care  established by the medical  community.  The Company  believes
that its emphasis on quality  allows it to increase and retain its members.  The
Company  monitors and evaluates the availability and quality of the medical care
rendered by the providers in its HMO and insurance plans and periodically audits
selected diagnoses, problems and referrals to determine adherence to appropriate
standards of medical care. In addition,  the Company has medical  directors who,
supported   by  a   professional   medical   staff,   monitor  the  quality  and
appropriateness  of  health  care by  analyzing  a  physician's  utilization  of
diagnostic  tests,  laboratory and radiology  procedures,  specialty  referrals,
prescriptions  and  hospitals.  Physicians  and  hospitals  selected  to provide
services to the Company's members are subject to the Company's quality assurance
programs including a formal credentialing process of all physicians.

     The Company also has internal  quality  assurance  and  improvement  review
committees that meet on a regular basis to review specialist referrals,  monitor
the performance of physicians and review practice patterns, complaints and other
patient  issues.  Staff  members  regularly  visit  hospitals to review  medical
records,  meet with patients and review  treatment  programs and discharge plans
with attending  physicians.  In addition,  the Company solicits information from
both  existing  and  former  members  as to  their  satisfaction  with  the care
delivered.  Complaints  and  grievances are responded to on both an informal and
formal basis, depending on the nature of the complaint.

     With  the  increasing  significance  of  managed  care in the  health  care
industry,  several independent organizations have been formed for the purpose of
responding  to  external  demands  for  accountability  over  the  managed  care
industry.  The organizations  utilized by the Company are the National Committee
on Quality  Assurance (the "NCQA") and the Joint  Commission on Accreditation of
Healthcare  Organizations ("JCAHO"). The NCQA performs site reviews of standards
established  for  quality  assurance,  credentialing,   utilization  management,
medical records, preventive services and member rights and responsibilities. The
JCAHO reviews rights,  responsibilities and ethics, continuum of care, education
and communication, leadership, management of information and human resources and
network   performance.   In  1995,  the  Nevada  HMO  voluntarily   applied  for
accreditation  from the NCQA with respect to its operations in southern  Nevada,
which was denied.  The Company has  addressed  most of the NCQA's  findings  for
Nevada and has recently  gone through an NCQA site visit.  The results are still
pending.  The  Company's  Nevada  multi-specialty  clinic  has  received  a full
three-year  accreditation  from the American  Association for Ambulatory  Health
Care -- the highest  accreditation  issued to ambulatory  care  facilities.  The
clinic  is  the  only   multi-specialty  site  in  Nevada  to  be  awarded  this
accreditation.  Also, the Nevada HMO, along with the Company's managed indemnity
subsidiary,  have received  "excellent"  ratings from the A.M. Best Company,  an
independent  insurance  industry  rating  organization.  The Company's  workers'
compensation  subsidiaries  have received "very good" ratings from the A.M. Best
Company.  There can be no assurance,  however,  that the Company will receive or
maintain  NCQA or other  accreditations  in the  future and there is no basis to
predict what effect, if any, the lack of NCQA or other  accreditations will have
on the Nevada HMO's competitive position in southern Nevada.



                                        7

<PAGE>



Underwriting

     HMO.  The Company  structures  premium  rates for its various  health plans
primarily through  community rating and community rating by class method.  Under
the community rating method,  all costs of basic benefit plans for the Company's
entire  membership  population  are  aggregated.   These  aggregated  costs  are
calculated  on a "per member per month" basis and converted to premium rates for
coverage types, such as single or family coverage. The community rating by class
method  is  based  on the same  principles  as  community  rating,  except  that
actuarial  adjustments  to premium  rates are made for various  employer  groups
based  on the  average  age and sex of  their  employees.  All  employees  of an
employer  group  are  charged  the same  premium  rate if the same  coverage  is
selected.

     In addition to those premium  charges paid by the  employers  with whom the
Company's  HMOs  contract,  members  also pay  co-payments  at the time  certain
services are  provided.  The Company  believes that such  co-payments  encourage
appropriate  utilization  of health care services  while allowing the Company to
offer  competitive  premium rates. The Company also believes that the capitation
method of provider compensation  encourages physicians to provide only medically
necessary and appropriate care.

     Managed  Indemnity.  Premium  charges for the Company's  managed  indemnity
products  are set in a manner  similar to the  community  rating by class method
described above. This rate calculation utilizes age, sex and industry factors to
develop group-specific adjustments from a given base rate by plan. Actual health
claims  experience is used to develop premium rates for larger  insurance member
groups. This process includes the use of utilization experience, adjustments for
incurred but not reported claims, inflationary factors, credibility and specific
reinsurance pooling levels for large claims.

     Workers'  Compensation.  Prior to insuring a particular  risk,  the Company
reviews,  among other factors,  the employer's prior loss experience and premium
payment history.  Additionally,  the Company  determines  whether the employer's
employment  classifications are among the  classifications  that the Company has
elected  to  insure  generally  and  if the  amounts  of the  premiums  for  the
classifications are within the Company's  guidelines.  The Company reviews these
classifications  periodically to evaluate whether they are profitable.  A member
of  the  Company's  loss  control  department  may  conduct  an  on-site  safety
inspection  before the Company  insures  the  employer.  The  Company  generally
initiates this inspection for  enterprises  with  manufacturing  or construction
classifications.  The Company may also initiate  inspections  if the  enterprise
previously  has  had a high  loss  ratio  or  frequent  losses.  If the  on-site
inspection  reveals  hazards  that can be  corrected,  and an  agreement  can be
reached with the employer  that these  hazards will be corrected in a time frame
established by the Company's  underwriting  department,  the Company may issue a
policy  subject to  correction  of those  hazards.  In the event the Company has
issued  a  policy  where  no  previous   inspection  has  been  conducted,   and
subsequently  learns through an inspection the employer has hazards that must be
corrected, the Company will request that the employer correct the hazards within
a specified period of time. If these hazards are not corrected,  the Company may
cancel the policy for  non-compliance of the hazard  correction.  With regard to
new business,  the agent or broker will usually submit the claims history on the
prospective  account.  In those  situations  where  the  claims  history  is not
supplied by the agent or broker,  other sources (such as the prior  insurer) are
used to obtain the appropriate claims history if possible.

     In California,  under open rating as it became effective for  policyholders
in 1995, the Company has subdivided many of the standard classifications.  These
subclassifications   have  been  determined  on  the  Company's   perception  of
differences in risk exposure.  As a result,  different rates have been filed for
each of these subclassifications.  The use of these subclassifications  requires
more detailed  information  than was required prior to open rating.  The Company
ascertains   characteristics   of   various   employers   through   the  use  of
questionnaires  and telephone  inquiries by underwriters to determine the proper
subclassification.  Subclassifications  are  subject  to  verification  by  loss
control and premium audits.


                                        8

<PAGE>



Competition

     HMO and Managed  Indemnity.  Managed care  companies  and HMOs operate in a
highly competitive environment.  The Company's major competition in Las Vegas is
from self-funded  employer plans, PPO networks,  other HMOs, such as Humana Care
Plus and Pacificare,  Inc., and  traditional  indemnity  carriers,  such as Blue
Cross/Blue Shield. Many of the Company's  competitors have substantially  larger
total enrollments, have greater financial resources and offer a broader range of
products  than  the  Company.  Additional  competitors  with  greater  financial
resources  than the Company may enter the  Company's  market in the future.  The
Company believes 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.  The Company
depends  on a large PPO  network  and  flexible  benefit  plans to  attract  new
members.  Competitive  pressures are expected to limit the Company's  ability to
increase premium rates and, to a lesser extent,  to result in declining  premium
rates.  Accordingly,  the  profitability of the Company will, to a large extent,
depend on the  Company's  ability to manage the costs of  providing  health care
benefits to its  members.  The  inability  of the Company to manage  these costs
would have an adverse  impact on the Company's  future  results of operations by
reducing margins. In addition,  competitive pressures may also result in reduced
membership  levels.  Any such reductions could  materially  affect the Company's
results of operations.

     Workers'  Compensation.  The Company's  workers'  compensation  business is
concentrated in California,  a state where the workers'  compensation  insurance
industry is  extremely  competitive.  Based upon data  provided by the  Workers'
Compensation Insurance Rating Bureau ("WCIRB"),  for the year ended December 31,
1995, which is the latest data available, there were approximately 225 insurance
companies  writing workers'  compensation  insurance in California.  Many of the
Company's  competitors  have been in business  longer,  have a larger  volume of
business,  offer a more  diversified  line of insurance  coverage,  have greater
financial resources and have greater  distribution  capability than the Company.
The largest writer of workers' compensation insurance in California is the State
Compensation Insurance Fund. Prior to 1995, the Company concentrated on insuring
workers'  compensation  accounts in the small- to medium-size  range.  Under the
current open rating  environment,  the Company is actively  pursuing accounts of
all sizes.

     In  all  states  in  which  the  Company  is  currently  writing  business,
competition for workers' compensation insurance is primarily driven by price and
secondarily  by services  provided to insureds and agents.  In states other than
California, commissions are normally not a dominant competitive factor. In those
other states, the National Council on Compensation Insurance ("NCCI") is usually
the  designated  rating  organization.  Like the WCIRB in  California,  the NCCI
accumulates  statistical  information  and  recommends  pure  loss  costs to the
state's  Department  of  Insurance.  As in  California  under  the  open  rating
environment,  the Company then adds loss cost  multipliers  or expense  loads to
derive premium rates.  Rating plans in those states are more  "standardized" and
are usually based on plans developed by the NCCI. Unlike  California,  where the
Company has developed  subclasses,  the Company will use standard classes in the
other states.

Losses and Loss Adjustment Expenses

     Often, in workers' compensation insurance, several years may elapse between
the  occurrence  of a loss and the final  settlement  of the loss.  To recognize
liabilities  for unpaid  losses,  the Company  establishes  reserves,  which are
balance sheet liabilities representing estimates of future amounts needed to pay
claims and related  expenses for insured events,  including  reserves for events
that have occurred but have not yet been reported to the Company ("IBNR").



                                        9

<PAGE>



     When  a  claim  is  reported,  the  Company's  claims  personnel  initially
establish  reserves  on a  case-by-case  basis for the  estimated  amount of the
ultimate  payment.  These estimates reflect the judgment of the claims personnel
based on their  experience and knowledge of the nature and value of the specific
type of claim and the available facts at the time of reporting as to severity of
injury and initial medical  prognosis.  Included in these reserves are estimates
of the  expenses of settling  claims,  including  legal and other fees,  and the
general  expenses  of  administering  the  claims  adjustment  process.   Claims
personnel  adjust the amount of the case  reserves as the claim  develops and as
the facts warrant.

     IBNR reserves are  established for unreported  claims and loss  development
relating to current  and prior  accident  years.  In the event that a claim that
occurred  during  a prior  accident  year was not  reported  until  the  current
accident year, the case reserve for such claim typically will be established out
of previously established IBNR reserves for that prior accident year.

     The Company  reviews the  adequacy of its  reserves on a monthly  basis and
considers  external  forces  such  as  changes  in the  rate of  inflation,  the
regulatory environment, the judicial administration of claims, medical costs and
other  factors  that could  cause  actual  losses and loss  adjustment  expenses
("LAE") to change.  Reserves are reviewed with the Company's independent actuary
at least  annually.  The  actuarial  projections  include  a range of  estimates
reflecting the uncertainty of projections.  Management evaluates the reserves in
the aggregate,  based upon the actuarial indications and makes adjustments where
appropriate.  The consolidated  financial  statements of the Company provide for
reserves based on the anticipated ultimate cost of losses.

     Once an employer is insured by the  Company,  the  Company's  loss  control
department may assist the insured in developing and maintaining  safety programs
and procedures to minimize  on-the-job  injuries and industrial  health hazards.
The safety programs and procedures  vary from insured to insured.  The Company's
loss control  department  may recommend to the employer that a safety  committee
consisting of members of the employer's  management  staff and its general labor
force be established.  The Company's loss control department may then assist the
committee members in isolating safety hazards,  advising the committee on how to
correct the hazards and  assisting  the employer in  establishing  procedures to
enforce the corrections.  The Company's loss control department may also revisit
the employer to determine  whether the  recommended  corrections  and procedures
have  been  implemented.  Depending  upon the  size,  classifications,  and loss
experience  of  the  employer,   the  Company's  loss  control  department  will
periodically inspect the employer's places of business and may recommend changes
that could  prevent  industrial  accidents.  In  addition,  severe or  recurring
injuries may also warrant on-site inspections. In certain instances,  members of
the Company's loss control department may conduct special  educational  training
sessions  for  insured  employees  to assist  in the  prevention  of  on-the-job
injuries.  For  example,  employers  engaged in  manufacturing  may be offered a
training  session  on how to  prevent  back  injuries  or  employers  engaged in
contracting  may be  offered  a  training  session  on  general  first  aid  and
prevention of injuries that may result from specific work exposures.

Government Regulation and Recent Legislation

     HMOs and Managed  Indemnity.  Federal and state  governments  have  enacted
statutes  extensively  regulating the  activities of HMOs. In addition,  growing
government  concerns  over  increasing  health care costs could result in new or
additional state or federal legislation that could affect health care providers,
including  HMOs,  PPOs and other health  insurers.  Among the areas regulated by
federal and state law are the scope of benefits  available  to members,  premium
structure,  procedures for review of quality assurance, enrollment requirements,
the  relationship  between an HMO and its health care  providers,  licensing and
financial condition.



                                       10

<PAGE>



     The Company must file  periodic  reports  with,  and is subject to periodic
review and audit by, federal and state  licensing  authorities.  The Company has
HMO  licenses  in Nevada and Texas and is subject  to  regulation  by the Nevada
Division of Insurance, the Nevada Division of Health and the Texas Department of
Insurance.   The  Company's  health   insurance   subsidiary  is  domiciled  and
incorporated in California and is licensed in 26 states, with current operations
in Nevada,  Arizona,  Colorado,  Texas,  California,  New Mexico,  Missouri  and
Mississippi.  It is  subject  to  licensing  by  and  other  regulations  of the
California Department of Insurance as well as the insurance departments of other
states in which it  operates  or holds  licenses.  The  Company's  premium  rate
increases  are subject to various  state  insurance  department  approvals.  The
Company's HMO and insurance  subsidiaries  are also required by state regulatory
agencies to maintain  certain  deposits and must also meet certain net worth and
reserve  requirements.  The Company also has certain other deposit requirements.
The Company has  restricted  assets on deposit in various  states  ranging  from
$20,000 to $2.2 million and totalling  $13.6  million at December 31, 1996.  The
Company's HMO and insurance  subsidiaries  meet requirements to maintain minimum
stockholder's equity ranging from $200,000 to $5.2 million. The Company's Nevada
HMO and health  insurance  subsidiaries  currently  maintain  home offices and a
regional home office, respectively,  in Las Vegas and, accordingly, are eligible
for certain premium tax credits in Nevada.

     The Company's HMO  subsidiaries  are also restricted by state law as to the
amount of dividends that can be declared and paid. Moreover, insurance companies
and HMOs  domiciled  in  Texas,  Nevada  and  California  generally  may not pay
extraordinary  dividends without providing the state insurance commissioner with
30 days prior notice,  during which period the  commissioner  may disapprove the
payment.  An  "extraordinary  dividend" is generally defined as a dividend whose
fair market value together with that of other  dividends or  distributions  made
within the  preceding  12 months  exceeds  the lesser of (i) ten  percent of the
insurer's  surplus  as of the  preceding  December  31 or (ii) the net gain from
operations  of such insurer,  not  including  realized  capital  gains,  for the
12-month  period  ending on the  preceding  December 31. The Company is not in a
position to assess the likelihood of obtaining  future  approval for the payment
of "extraordinary  dividends" or dividends other than those specifically allowed
by law in each of its  subsidiaries'  states of domicile.  No prediction  can be
made as to whether any legislative  proposals  relating to dividend rules in the
domiciliary states of the Company's  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 the
Company's  regulated  subsidiaries  to declare  and pay  dividends  or as to the
effect  of  any  such  proposals  or  restrictions  on the  Company's  regulated
subsidiaries.

     The  Company  is  subject  to the  Federal  HMO  Act  and  the  regulations
promulgated  thereunder.  Of the Company's  three  subsidiary  HMOs, only MedOne
Health Plan, acquired at the end of 1996, is not federally- qualified under this
Act. 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 its health care  providers.  Furthermore,  an HMO may not
refuse to enroll an employee,  in most  circumstances,  because of such person's
health,  and may not expel or refuse to re-enroll  individual members because of
their health or their need for health services.

     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 the
Company seeks to structure its operations to comply with  corporate  practice of
medicine  laws in all  states in which it  operates,  there can be no  assurance
that, given the varying and uncertain interpretations of those laws, the Company
would  be  found  to  be  in  compliance  with  those  laws  in  all  states.  A
determination  that the Company is not in compliance with  applicable  corporate
practice  of  medicine  laws in any  state  in which it  operates  could  have a
material  adverse  effect on the  Company if it were unable to  restructure  its
operations to comply with the laws of that state.

                                       11

<PAGE>




     Medicare and Medicaid  antifraud  and abuse  provisions  are codified at 42
U.S.C. Sections 1320a-7(b) (the "Anti-kickback  Statute") and 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.  Sanctions for  violations  of the  Anti-kickback
Statute and the Stark Amendments include criminal penalties and civil sanctions,
including fines and possible  exclusion from the Medicare and Medicaid programs.
Similar  penalties  are  provided  for  violation  of  state  anti-kickback  and
anti-referral  laws.  The  Department of Health and Human  Services  ("HHS") has
issued  regulations  establishing  "safe  harbors"  with  respect  to the  Anti-
kickback  Statute.  The Office of the Inspector  General  recently  proposed new
rules to clarify those safe harbors.  HHS has also proposed to establish certain
safe harbors under the Stark Amendments.  The Company believes that its business
arrangements and operations are in compliance with the Anti-kickback Statute and
the Stark  Amendments and the  exceptions  set forth therein,  regardless of the
availability  of  regulatory  safe  harbor  protection  with  respect  to  those
statutes.  There can,  however,  be no assurance that (i)  government  officials
charged with  responsibility for enforcing the prohibitions of the Anti-kickback
Statute  and the Stark  Amendments  will not assert  that the Company or certain
transactions in which it is involved are in violation of those statutes and (ii)
such  statutes  will  ultimately  be  interpreted  by  the  courts  in a  manner
consistent with the Company's interpretation.

     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 have a material  adverse  effect on the Company's
business.

     For example, recent news reports indicate that President Clinton may submit
a budget proposal to Congress that will reduce Medicare spending by $100 billion
and impose certain  limits on Medicaid  spending.  Although  neither the present
administration's health care reform proposals nor alternative health care reform
proposals introduced by certain members of Congress were previously adopted, the
Health Insurance Portability and Accountability Act of 1996 (the "Accountability
Act") was passed by Congress and signed into law by President  Clinton on August
21,  1996 and will  generally  take  effect  beginning  July 1, 1997.  While the
Accountability  Act contains  provisions  regarding  health  insurance or health
plans, such as portability and limitations on pre-existing condition exclusions,
guaranteed  availability and renewability,  it also contains several  anti-fraud
measures that significantly change health care fraud and abuse provisions.  Some
of the provisions include (i) creation of an anti-fraud and abuse trust fund and
coordination of fraud and abuse efforts by federal, state and local authorities,
(ii)  extension  of the  criminal  anti-kickback  statues to all federal  health
programs,  (iii)  expansion  of and  increase  in the  amount of civil  monetary
penalties and establishment of a knowledge  standard for individuals or entities
potentially subject to civil monetary  penalties,  and (iv) revisions to current
sanctions for fraud and abuse, including mandatory and permissive exclusion from
participation in the Medicare or Medicaid programs. The Company does not believe
that the  Accountability  Act  should  have a  material  adverse  effect  on the
Company's  operations,  but is  unable to  predict  the  ultimate  impact of any
federal or state restructuring of the health care financing and delivery system,
which  ultimately  could  have a  material  adverse  impact  on the  operations,
financial condition and prospects of the Company.

     Workers'  Compensation.  The Company is subject to  extensive  governmental
regulation  and  supervision  in  each  state  in  which  it  conducts  workers'
compensation business. The primary purpose of such regulation and supervision is
to provide  safeguards for policyholders and injured workers rather than protect
the interests of  shareholders.  The extent and form of the regulation may vary,
but generally has its source in statutes that establish  regulatory agencies and
delegate  to  the  regulatory   agencies  broad   regulatory,   supervisory  and
administrative authority. Typically, state regulations extend to such matters as
licensing companies; restricting the types or quality of investments;  requiring
triennial financial examinations

                                       12

<PAGE>



and market conduct surveys of insurance companies;  licensing agents; regulating
aspects of a company's  relationship  with its agents;  restricting  use of some
underwriting  criteria;  regulating rates,  forms and advertising;  limiting the
grounds for cancellation or nonrenewal of policies, solicitation and replacement
practices; and specifying what might constitute unfair practices.  Moreover, the
payment of dividends and the making of other distributions to the Company by its
workers'  compensation  insurance  company  subsidiaries are contingent upon the
earnings   of  those   subsidiaries   and  are   subject  to  various   business
considerations,  applicable state corporate laws and  regulations,  the terms of
agreements to which they may become a party and  government  regulations,  which
restrict in certain circumstances the payment of dividends and distributions and
the transfer of assets to the Company.

     In the  normal  course of  business,  the  Company  and the  various  state
agencies  that   regulate  the   activities  of  the  Company  may  disagree  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.  The Company attempts to resolve all
issues with the regulatory agencies,  but is willing to litigate issues where it
believes it has a strong position.  The ultimate outcome of these  disagreements
could  result in  sanctions  and/or  penalties  and fines  assessed  against the
Company.  Currently, there are no litigation matters pending with any department
of insurance.

     Typically, states mandate participation in insurance guaranty associations,
which  assess   solvent   insurance   companies  in  order  to  fund  claims  of
policyholders of insolvent insurance companies. Under this arrangement, insurers
can be  assessed  up to 1% (or 2% in certain  states) of  premiums  written  for
workers' compensation insurance in that state each year to pay losses and LAE on
covered  claims of insolvent  insurers.  In California and certain other states,
insurance  companies are allowed to recoup such assessments  from  policyholders
while several states allow an offset against premium taxes. Potential assessment
expenses,  net of  recoupment,  if any, for  insolvencies  are not accrued until
after an  insolvency  has occurred  since the  likelihood  and the amount of the
assessment expense cannot be reasonably determined or estimated.  In California,
there have been no new assessments for insolvent workers' compensation insurance
companies since 1990.

     California's  Insurance  Holding  Company  Act  regulates  the  payment  of
shareholder dividends by insurance companies. To date, the workers' compensation
insurance subsidiaries have not paid dividends to the Company.

     General.  Besides state  insurance  laws, the Company is 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 its subsidiaries.

Employees

     The Company had approximately 2,600 employees on December 31, 1996. None of
these employees are covered by a collective  bargaining  agreement.  The Company
believes that its relations with its employees are good.



                                       13

<PAGE>



ITEM 2.           PROPERTIES

     The Company  owns  several  administrative  facilities  in southern  Nevada
totalling   approximately  221,000  square  feet.  Such  facilities  include  an
approximate   134,000  square  foot  six-story  home  office   building  and  an
approximate 43,000 square foot two-story corporate administrative  headquarters.
These  buildings are subject to liens  securing a $7.8 million loan balance from
Bank of America.  The  Company  also owns  several  clinical  facilities  in the
southern Nevada area totalling  approximately 319,000 square feet and consisting
primarily of six medical clinics and two surgery centers. Certain clinical space
is subject to a $3.2 million  mortgage in favor of GE Capital  Asset  Management
Corporation.  The Company leases  additional office and clinical space in Nevada
totalling  approximately  137,000  and 59,000  square  feet,  respectively.  The
Company owns real estate and a building in Park City,  Utah purchased in 1996 to
provide  entertainment  and a meeting  environment for  significant  current and
prospective  clients,  brokers and others who assist in the Company's  marketing
efforts. In connection with its workers' compensation insurance subsidiary,  the
Company leases approximately  141,000 square feet of office space in California.
The Company  also leases  approximately  42,000  square feet of office  space in
various states as needed for other regional operations, including the Texas HMO.

     The Company has begun  construction of an approximately  59,000 square foot
medical  facility  in Las Vegas with an  estimated  total cost of $7.3  million.
Completion is expected in the fourth quarter of 1997. The Company  believes that
current  and planned  clinical  space will be  adequate  for its present  needs.
Additional clinical space may be required,  however, if membership  continues to
expand in  southern  Nevada.  The  Company  has also  begun  construction  of an
additional  administrative  building of approximately 180,000 square feet. Costs
are expected to be approximately $35.0 million,  and completion is scheduled for
the fourth  quarter  of 1997.  The land was  purchased  for  approximately  $2.0
million in December 1995.

ITEM 3.           LEGAL PROCEEDINGS

     On March 18,  1997,  the Company  announced  it had  terminated  its merger
agreement with Physician  Corporation of America ("PCA"). The original agreement
had been entered into in November 1996. On March 18, 1997,  prior to termination
of the merger  agreement,  PCA filed a lawsuit against the Company in the United
States  District  Court for the  Southern  District  of Florida  (the  "District
Court"),  seeking,  among  other  things,  specific  performance  of the  merger
agreement and monetary  damages.  While the Company  believes the PCA lawsuit is
without  merit,  there can be no assurance as to the outcome of the PCA lawsuit.
The Company has filed a motion in the District  Court seeking a dismissal of the
PCA lawsuit for lack of diversity jurisdiction. The Company has also initiated a
lawsuit in the Court of Chancery of the State of Delaware  seeking a declaratory
judgment as well as other remedies. The Company intends to vigorously pursue all
remedies  available to it,  however,  there can be no assurance that the Company
will prevail in such  litigation or that PCA will have  sufficient  funds to pay
any damages that the Company may be awarded.

     The  Company  is subject to  various  claims  and other  litigation  in the
ordinary  course  of  business.  Such  litigation  includes  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
members.  Also included in such litigation are claims for workers'  compensation
and claims by  providers  for payment for medical  services  rendered to injured
workers. In the opinion of the Company's management,  the ultimate resolution of
pending  legal  proceedings  should  not have a material  adverse  effect on the
Company's financial condition.

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

     None


                                       14

<PAGE>



                                     PART II

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

Market Information

     The Company's 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, was listed on the American Stock Exchange since the
Company's  initial public  offering on April 11, 1985. The following  table sets
forth the high and low  sales  prices  for the  Common  Stock on the  respective
exchanges for each quarter of 1996 and 1995. <TABLE>

<CAPTION>
         Period                                                                     High               Low

         1996
<S>                                                                                <C>                 <C> <C>
             First Quarter........................................                 $36                 $29 7/8
             Second Quarter.......................................                   35 7/8              29
             Third Quarter........................................                   34 7/8              25 1/4
             Fourth Quarter.......................................                   34 3/8              22 3/8
</TABLE>
<TABLE>

<CAPTION>
         1995
<S>                                                                                <C> <C>             <C> <C>
             First Quarter........................................                 $32 7/8             $27 3/8
             Second Quarter.......................................                   33 5/8              22 1/8
             Third Quarter........................................                   29                  23
             Fourth Quarter.......................................                   33 1/8              24 1/8
</TABLE>

On March 14,  1997,  the closing  sale price of the common stock was $26 1/2 per
share.

Holders

     The  number of record  holders of Common  Stock at March 14,  1997 was 318.
Based upon  information  available to it, the Company believes there are several
thousand beneficial holders of the Common Stock.

Dividends

     No cash  dividends  have been paid on the Common Stock since the  Company's
inception.  The Company  currently intends to retain its earnings for use in its
business and does not anticipate  paying any cash  dividends in the  foreseeable
future.  As a holding  company,  the  Company's  ability to  declare  and to pay
dividends is dependent upon cash distributions from its operating  subsidiaries.
The ability of the Company's HMO and  insurance  subsidiaries  to declare and to
pay dividends is limited by state  regulations  applicable to the maintenance of
minimum  deposits,  reserves and net worth.  (See  Management's  Discussion  and
Analysis of Financial  Condition  and Results of  Operations  --  Liquidity  and
Capital  Resources.)  The  declaration  of any future  dividends  will be at the
discretion of the  Company's  Board of Directors and will depend on, among other
things, future earnings,  debt covenants,  operations,  capital requirements and
the financial condition of the Company and upon general business conditions.

                                       15

<PAGE>



ITEM 6.           SELECTED FINANCIAL DATA

       The  following  selected  consolidated  financial  data of Sierra  Health
Services,  Inc., and subsidiaries (the "Company"),  for each of the fiscal years
in the five-year  period ended  December 31, 1996 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 Annual Report
on Form 10-K.  The selected  consolidated  financial data below has been derived
from the audited Consolidated Financial Statements of the Company.

<TABLE>
                            Years Ended December 31,
<CAPTION>
                                                                      1996            1995         1994           1993         1992
                                                                                  (Amounts in thousands, except per share data)
Statement of Operations Data (1):
OPERATING REVENUES:
<S>                                                                  <C>            <C>           <C>           <C>        <C>
   Medical Premiums.............................................     $386,968       $319,475      $269,382      $240,691   $217,624
   Specialty Product Revenue....................................      133,324        102,807       101,287       113,714    107,229
   Professional Fees............................................       28,836         19,417        12,331        11,254     10,206
   Investment and Other Revenue.................................       26,283         25,310        19,081        17,771     15,397
     Total......................................................      575,411        467,009       402,081       383,430    350,456
OPERATING EXPENSES:
   Medical Expenses.............................................      315,915        245,135       200,229       178,526    166,495
   Specialty Product Expenses...................................      130,758        102,859        96,600       118,868    156,042
   General, Administrative and Marketing Expenses...............       72,237         63,562        53,671        50,715     44,176
   Acquisition, Restructuring and Other Expenses (2) ...........       12,064         11,614
     Total......................................................      530,974        423,170       350,500       348,109    366,713
OPERATING INCOME (LOSS) ........................................       44,437         43,839        51,581        35,321    (16,257)
OTHER INCOME (EXPENSE):
   Minority Interests ..........................................        2,065          2,471          (113)         (179)      (249)
   Interest Expense and Other, Net..............................       (4,888)        (6,208)       (6,288)       (4,258)    (4,641)
   Litigation Settlement........................................                                                               (784)
     Total......................................................       (2,823)        (3,737)       (6,401)       (4,437)    (5,674)
Income (Loss) from Continuing Operations
     Before Income Taxes .......................................       41,614         40,102        45,180        30,884    (21,931)
Provision for Income Taxes......................................       10,471         12,198         8,236         8,435      7,045
Income (Loss) from Continuing Operations........................       31,143         27,904        36,944        22,449    (28,976)
Loss from Discontinued Operations ..............................                      (6,600)       (2,501)         (404)
Extraordinary Gain .............................................                                                                457
Cumulative Effect of Adopting FAS 109...........................                                                   5,250

NET INCOME (LOSS)...............................................     $ 31,143       $ 21,304     $  34,443     $  27,295   $(28,519)

EARNINGS PER COMMON SHARE (3)
   Income (Loss) from Continuing Operations
     Per Share .................................................        $1.76          $1.60         $2.36         $1.50    $ (1.98)
   Loss Per Share from Discontinued Operations .................                        (.38)         (.16)         (.02)
   Extraordinary Gain Per Share ................................                                                                .03
   Cumulative Effect of Adopting FAS 109. ......................                                                     .35
   Net Income (Loss) Per Share .................................        $1.76          $1.22         $2.20         $1.83    $ (1.95)

   Weighted Average Number of Common
     Shares Outstanding ........................................       17,726         17,414        15,678        14,939     14,601
</TABLE>



                                       16

<PAGE>


<TABLE>

                            Years Ended December 31,
<CAPTION>
                                                                      1996            1995         1994           1993          1992
                                                                                                  (Amounts in thousands)

Balance Sheet Data:
<S>                                                                  <C>            <C>           <C>           <C>        <C>
   Working Capital .............................................     $ 76,530       $ 18,157      $ 71,337      $ 21,323   $ 10,578
   Total Assets.................................................      629,462        575,146       535,487       445,510    373,848
   Long-term Debt (Net of Current Maturities)...................       66,189         71,257        75,209        72,802     64,461
   Cash Dividends Per Common Share..............................         NONE           NONE          NONE          NONE       NONE
   Stockholders' Equity.........................................      234,482        207,715       168,157        84,708     54,380
</TABLE>

(1)  The  Company's  consolidated  financial  statements  have been  restated to
     reflect  the  results of  acquisitions  accounted  for in  accordance  with
     pooling  of  interests  method  of  accounting.  See Note 1 of Notes to the
     Consolidated Financial Statements.

(2)  In connection with certain  acquisitions  and  restructurings,  the Company
     recorded certain  non-recurring  incremental costs. See Note 13 of Notes to
     the  Consolidated  Financial  Statements.

(3)  Adjusted to account for a two-for-one  stock split of the Company's  common
     stock in 1992.


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

     The following discussion and analysis provides information which management
believes  is  relevant  for  assessment  and   understanding  of  the  Company's
consolidated  financial  condition  and results of  operations.  The  discussion
should  be  read  in  conjunction  with  the  Condensed  Consolidated  Financial
Statements and Related Notes thereto. Any forward-looking  information contained
in this Management's  Discussion and Analysis of Financial Condition and Results
of  Operations  and any other  sections of this 1996 Annual  Report on Form 10-K
should be considered in connection with certain cautionary  statements contained
in the Company's  Current  Report on Form 8-K filing dated March 28, 1997.  Such
cautionary  statements are made pursuant to the "safe harbor"  provisions of the
Private  Securities  Litigation  Reform Act of 1995 and identify  important risk
factors  that could  cause the  Company's  actual  results to differ  from those
expressed in any projected,  estimated or forward-looking statements relating to
the Company.

Acquisitions

     Effective  December 31, 1996, the Company purchased Prime for approximately
$32.2 million in cash. At December 31, 1996,  Prime operated MedOne Health Plan,
Inc., a 12,800  member HMO, and also served  215,000  people  through  preferred
provider  organizations,  workers'  compensation  programs,  and  administrative
services products for self-insured  employers and union welfare funds, primarily
in the state of Nevada.  The  acquisition  of Prime has been  accounted for as a
purchase and, therefore,  none of Prime's prior operations have been included in
the information  contained in this discussion and analysis;  however, all of the
acquired  assets and  liabilities  have been  reflected in the Company's  ending
consolidated balance sheet, along with the associated goodwill.

     In November 1996, the Company acquired the remaining ownership interests of
HMO Texas  for $5.0  million.  The  Company  had  previously  held a 50  percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996.

     On October 31, 1995, the Company  acquired CII Financial,  Inc., a workers'
compensation  insurance  holding  company,  for  approximately  $76.3 million of
common  stock,  in a transaction  accounted  for as a pooling of interests.  The
information  contained in this  discussion  and  analysis  has been  restated to
include the results of CII for all periods presented.


                                       17

<PAGE>



Overview

     The Company  derives  revenues from its health  maintenance  organizations,
managed indemnity and workers' compensation insurance subsidiaries.  To a lesser
extent,  the Company also derives  additional  specialty  product  revenues from
non-HMO and insurance  products  (consisting  of fees for workers'  compensation
administration,   utilization   management  services  and  ancillary  products),
professional  fees  (consisting  primarily  of fees for  providing  health  care
services  to  non-members  and  co-payment  fees  received  from  members),  and
investment  and  other  revenue.   Medical   premium   revenues   accounted  for
approximately  67.3%, 68.4%, and 67.0% of the Company's total revenues for 1996,
1995 and  1994,  respectively.  Continued  medical  premium  revenue  growth  is
principally  dependent upon continued  enrollment in the Company's  products and
upon  competitive  and  regulatory  factors  which  are  expected  to limit  the
Company's ability to implement annual premium rate increases.

     The Company's  principal  expenses consist of medical  expenses,  specialty
product expenses,  and general,  administrative and marketing expenses.  Medical
expenses   represent   the   aggregate   expenses  of  operating  the  Company's
multi-specialty  medical  group  and  other  provider  subsidiaries  as  well as
capitation  fees  and  other  fee-for-service  payments  paid  to  independently
contracted physicians,  hospitals and other health care providers. As a provider
of managed  care  services,  the  Company  seeks to manage  medical  expenses by
employing  or  contracting  with  physicians,  hospitals  and other  health care
providers at negotiated price levels, by adopting quality assurance programs, by
monitoring and managing  utilization of physicians and hospital  services and by
providing incentives to use cost-effective providers. Specialty product expenses
primarily  consist  of losses and loss  adjustment  expenses,  and  underwriting
expenses   associated  with  the  Company's  workers'   compensation   insurance
subsidiaries. General, administrative and marketing expenses generally represent
operational  costs other than those  associated with the delivery of health care
services and specialty product services.

     Acquisition,  restructuring and other expenses  represent the non-recurring
incremental  costs the Company has incurred in connection with various  mergers,
acquisitions and planned dispositions.

                                       18

<PAGE>



Results of Operations

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

<CAPTION>
                                                                            Years Ended December 31,
                                                                     1996              1995             1994
OPERATING REVENUES:
<S>                                                                   <C>              <C>              <C>
     Medical Premiums........................................         67.3%            68.4%            67.0%
     Specialty Product Revenue...............................         23.2             22.0             25.2
     Professional Fees.......................................          5.0              4.2              3.1
     Investment and Other Revenue............................          4.5              5.4              4.7
        Total................................................        100.0            100.0            100.0

OPERATING EXPENSES:
     Medical Expense.........................................         54.9             52.5             49.8
     Specialty Product Expense...............................         22.7             22.0             24.0
     General, Administrative and Marketing Expenses..........         12.6             13.6             13.4
     Acquisition, Restructuring and Other Expenses ..........          2.1              2.5
        Total................................................         92.3             90.6             87.2

OPERATING INCOME ............................................          7.7              9.4             12.8

OTHER INCOME (EXPENSE):
     Minority Interests .....................................          0.4              0.5
     Interest Expense and Other, Net.........................       (0.9)            (1.3)            (1.6)
        Total................................................       (0.5)            (0.8)            (1.6)

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES ....................................          7.2              8.6             11.2

PROVISION FOR INCOME TAXES...................................          1.8              2.6              2.0

INCOME FROM CONTINUING OPERATIONS ...........................          5.4              6.0              9.2

NET OPERATING LOSS ON DISCONTINUED
   OPERATIONS  ..............................................                         (.4)             (.6)

NET LOSS ON DISPOSAL OF
   DISCONTINUED OPERATIONS ..................................                        (1.0)

NET INCOME...................................................          5.4%             4.6%              8.6%
</TABLE>


                                       19

<PAGE>



1996 Compared to 1995

     Revenues.  The Company's total operating  revenues for 1996 increased 23.2%
to $575.4  million from $467.0  million for 1995. The increase was primarily due
to medical premium revenue increases of approximately  $67.5 million,  or 21.1%,
from the  Company's  HMO and  managed  indemnity  insurance  subsidiaries.  Such
premium growth resulted  principally from a 19.6% increase in member months. The
Company  experienced an overall rate increase for its Medicare members due to an
approximate   2.9%  increase  in  its  capitation  rate   established  by  HCFA.
Additionally, the Company realized minimal rate changes for the HMO subsidiary's
commercial  groups and managed  indemnity  insurance  subsidiary.  The Company's
specialty product revenue  increased $30.5 million,  or 29.7%, to $133.3 million
in 1996 from $102.8 million in 1995. Such increases were primarily from workers'
compensation  premiums in California.  Professional fees increased $9.4 million,
or 48.5%,  over 1995 to $28.8  million.  This  increase is due  primarily to the
acquisition  of a medical  facility  in the  fourth  quarter  of 1995 as well as
expanded services at the Company's existing medical  facilities.  Investment and
other  revenue  increased  $1.0  million,  or 3.8%,  over the prior  year due to
changes in the investment balances and market yield fluctuations.

     Medical and Specialty Product Expenses. Total medical expenses increased by
$70.8 million in 1996 compared to 1995.  This 28.9%  increase  resulted from the
consolidated  member  month  growth  discussed  above,  as well as the  clinical
expansions and increases associated with professional fee growth. These factors,
as well as an increase in Medicare  members as a  percentage  of total  members,
increased the Company's  medical loss ratio to 76.0% for the twelve months ended
December 31, 1996, from 72.3% for the comparable twelve months in 1995. The cost
of  providing  medical  care to Medicare  members  generally  requires a greater
percentage of the premium revenue received. Specialty product expenses increased
$27.9  million,  or 27.1%,  over 1995.  This  increase is due  primarily  to the
increase in workers'  compensation  premiums noted above,  offset in part by the
Company's  ability to overlay  managed care  techniques  on the  management  and
payment of certain workers' compensation claims. In addition,  specialty product
expenses  for 1996 and  1995  were  impacted  by the loss  development  on prior
accident years.  During the year, the Company had net favorable loss development
on prior  accident  years of  $15.3  million,  compared  to net  favorable  loss
development of $20.1 million for the comparable prior year period.  The majority
of the  favorable  loss  development  occurred on the 1992 through 1994 accident
years.  The  favorable  development  on the 1992  accident  year  appears  to be
primarily  due to the  Company's  aggressive  actions  to  resolve  claims.  The
favorable  development  on the 1993 and 1994 accident years appears to have been
aided by the  workers'  compensation  reforms  that were enacted in July 1993 to
combat the abuses in the California workers'  compensation  system. There can be
no assurances that favorable  development,  or the magnitude of the development,
will  continue  in the  future.  See Note 6 of Notes to  Consolidated  Financial
Statements.

     General, Administrative and Marketing Expenses. General, administrative and
marketing ("G&A") costs increased $8.7 million,  or 13.6%, for the twelve months
ended  December 31, 1996 compared to the twelve months ended  December 31, 1995.
As a percentage  of  revenues,  however,  G&A costs for the twelve  months ended
December 31, 1996 decreased to 12.6% from 13.6% during the comparable  period in
1995. Of the $8.7 million increase in G&A, $3.3 million is in compensation costs
primarily resulting from additional employees supporting expanded services, $3.8
million is from percent of premium costs such as broker  commissions and premium
taxes,  and the  remaining  $1.6  million  is made up of various  changes  which
individually are insignificant.

     Acquisition,  Restructuring and Other Expenses. During 1995, as part of the
Company's clinical expansion and growth efforts,  the Company acquired a medical
facility in Mohave County,  Arizona,  across the border from  Laughlin,  Nevada.
This medical facility included a small 12 bed hospital.  During 1996 the Company
implemented a plan to exit the hospital business and has actively pursued buyers
for this  business.  As a result of this plan, the Company took a charge of $3.8
million  ($2.8 million  after tax) in the fourth  quarter of 1996,  primarily to
recognize the estimated costs to dispose of the hospital.

                                       20

<PAGE>




     As a result of higher than expected claim and administrative costs relative
to premium rates that can be obtained in certain regional  insurance  operations
and the Company's  inability to negotiate adequate provider contracts due to its
limited  presence  in some of  these  markets,  the  Company  adopted  a plan to
restructure  certain  insurance  operations during the third quarter of 1996 and
recorded  a charge of $8.3  million.  The plan  included  the sale or closure of
certain regional operations in California,  Arizona, and Colorado. The plan will
allow the  Company to focus on more  favorable  operating  markets  and  improve
operating efficiencies. The Company believes that this restructuring, over time,
will result in improved  cash flow and  operating  cost savings in excess of the
amount of the charge.

     As a result of these restructurings, the Company recorded expenses of $12.1
million. These costs included cancellation of certain contractual obligations of
$6.0 million, lease termination costs of $1.5 million, and $4.6 million of other
costs including the estimated  costs to dispose of the hospital.  As of December
31, 1996,  approximately  $4.1 million of these costs had been paid or otherwise
charged against the accrual and the Company estimates that most of the remaining
cash expenditures will be paid over the next twelve months.

     Income Taxes. The Company's  effective tax rate for the year ended December
31,  1996 was 25.2%,  compared  to 30.4% in 1995,  or 25.4%  after  taking  into
account the non-deductible merger costs incurred in 1995. The difference between
the  Company's  effective  tax  rate  and the  current  federal  tax rate is due
primarily to a $2.7  million tax benefit  recorded as a result of a reduction of
the deferred tax valuation allowance and the Company's  significant portfolio of
tax  preferred  investments.  See  Note 8 of  Notes  to  Consolidated  Financial
Statements.

     Net Income.  Net income for 1996  increased  $9.8 million,  or 46.2%,  over
1995.  This  increase  was  impacted  in part  by  several  non-recurring  items
including the  restructurings  in 1996 and  discontinued  operations  and merger
costs in 1995. Excluding non-recurring items and the related tax effects, income
from ongoing operations for 1996 increased $2.6 million, or 6.9%.

1995 Compared to 1994

     Revenues.  The Company's total operating  revenues for 1995 increased 16.1%
to $467.0  million from $402.1  million for 1994. The increase was primarily due
to medical premium revenue  increases of approximately  $50.1 million,  or 18.6%
from the  Company's  HMO and  managed  indemnity  insurance  subsidiaries.  Such
premium growth resulted  principally from a 12.5% increase in member months. The
Company  experienced an overall rate increase for its Medicare members due to an
approximate   7.5%  increase  in  its  capitation  rate   established  by  HCFA.
Additionally, the Company realized minimal rate changes for the HMO subsidiary's
commercial  groups and managed  indemnity  insurance  subsidiary.  The Company's
specialty  product  revenue  increased  slightly to $102.8  million in 1995 from
$101.3 million in 1994.  Specialty  product revenue increased by $1.7 million in
Nevada and $2.0 million in all other states excluding California. Such increases
were  offset by a $2.2  million  decrease  in the  amount of  specialty  product
revenue  earned in  California.  The decrease in  California  specialty  product
revenues is primarily  due to the  abolishment  of minimum  premium rates in the
California  workers'  compensation  market and the  commencement  of open rating
effective  January 1, 1995,  as well as a 16% rate  decrease  which had occurred
October 1, 1994. Professional fees increased by $7.1 million, or 57.5% over 1994
due  principally to the opening of three new medical  clinics (one in the latter
part of 1994 and two in 1995), a new surgery  center,  and the  acquisition of a
medical facility. Investment and other revenue increased $6.2 million, or 32.6%,
primarily due to increased  investment  balances from the Company's common stock
offering completed in October 1994.



                                       21

<PAGE>



     Medical and Specialty Product Expense.  Total medical expenses increased by
approximately  $44.9  million in 1995  compared  to 1994.  This  22.4%  increase
resulted from the  consolidated  member month growth discussed above, as well as
the clinical  expansions and increases  associated with professional fee growth.
These  factors,  as well as an increase in Medicare  members as a percentage  of
total  members,  increased  the  Company's  medical  loss ratio to 72.3% for the
twelve  months ended  December 31, 1995,  from 71.1% for the  comparable  twelve
months in 1994. The cost of providing medical care to Medicare members generally
requires a greater percentage of the premium revenue received. Specialty product
expenses increased by 6.5% over 1994. This increase is primarily the result of a
higher loss ratio in 1995 due to the decrease in premium rates discussed  above,
offset  in part by  favorable  development  during  1995 in  reserves  for prior
accident years.  During the year, the Company had net favorable loss development
on prior  accident  years of  $20.1  million,  compared  to net  favorable  loss
development of $14.0 million for the comparable prior year period.  The majority
of the favorable loss development  occurred on the 1992 and 1993 accident years.
The favorable  development on the 1992 accident year appears to be primarily due
to the Company's aggressive actions to resolve claims. The favorable development
on  the  1993  accident  year  appears  to  have  been  aided  by  the  workers'
compensation  reforms that were enacted in July 1993 to combat the abuses in the
California  workers'  compensation  system.  There  can  be no  assurances  that
favorable development, or the magnitude of the development, will continue in the
future.
See Note 6 of Notes to Consolidated Financial Statements.

     General, Administrative and Marketing Expenses. General, administrative and
marketing  ("G&A") costs  increased 18.4% to $63.6 million for the twelve months
ended  December 31, 1995 compared to the twelve months ended  December 31, 1994.
As a percentage  of  revenues,  however,  G&A costs for the twelve  months ended
December 31, 1995 increased to 13.6% from 13.3% during the comparable  period in
1994.  Excluding the  operations of HMO Texas,  however,  G&A as a percentage of
revenue  for 1995  decreased  to 12.6%.  Of the $9.9  million  increase  in G&A,
approximately  $4.8  million  was due to the HMO  Texas  operations.  Additional
increases  include $3.2 million of compensation  costs primarily  resulting from
additional  employees   supporting  expanded  services,   and  $1.6  million  in
additional marketing and related fees.

     Income  Tax.  The  Company's  effective  income tax rate for the year ended
December 31,  1995,  was 30.4%  compared to 18.2% for the year ended 1994.  This
change is primarily due to the non-deductibility of a significant portion of the
merger costs incurred in 1995 and a $4.0 million tax benefit recorded as part of
the 1994  provision as a result of a reduction  of the  deferred  tax  valuation
allowance. See Note 8 of Notes to Consolidated Financial statements.

     Discontinued  Operations.   During  1995,  CII  sold  its  interest  in  an
unprofitable  subsidiary for approximately  $1.0 million in cash and securities.
This disposal resulted in a loss on discontinued operations, net of tax effects,
of $6.6 million in 1995 compared to losses of $2.5 million from the discontinued
operations in 1994.

     Net Income.  Net income for 1995  decreased  to $21.3  million,  from $34.4
million in 1994.  This  decrease is  primarily  due to the  non-recurring  items
previously discussed,  discontinued operations, merger and integration expenses,
and the change in the deferred tax valuation allowance.  Excluding non-recurring
items and the  related tax  effects,  income from  ongoing  operations  for 1995
increased 11.9% to $36.8 million from $32.9 million in 1994.



                                       22

<PAGE>



LIQUIDITY AND CAPITAL RESOURCES

     The  Company's  cash and cash  equivalents  increased  by $46.5  million to
$103.6 million at December 31, 1996, from $57.0 million at December 31, 1995. At
December 31, 1996, the Company had working capital of $76.5 million. The primary
source of cash received during the year ended December 31, 1996, was operations.

     The Company's cash flow from operating activities resulted in $52.4 million
of cash flow for the twelve months ended  December 31, 1996.  This cash flow was
primarily  generated  from  net  income  of  $31.1  million,  $10.5  million  in
depreciation  and  amortization,  and a  net  change  in  operating  assets  and
liabilities, excluding cash and cash equivalents, of $10.8 million. The increase
in  cash  from   fluctuations  in  such  operating  assets  and  liabilities  is
principally  due to  increases  in the  reserve  for losses and loss  adjustment
expense,  other liabilities and medical claims payable, as well as a decrease in
reinsurance  recoverable.  These  increases  in cash were offset by increases in
accounts receivable and other assets.

     In 1996 the Company  spent $36.3  million on the  acquisition,  net of cash
acquired, of Prime and the remaining interests of HMO Texas and $17.9 million in
capital expenditures.  Capital expenditures were primarily for new facilities as
well  as  the  expansion  of  existing   medical   facilities  and  include  the
construction  costs of a 59,000  square foot medical  facility in Las Vegas with
completion  expected in the fourth  quarter of 1997,  medical  equipment for the
Breast Care Center and 23 hour recovery  unit,  remodeling  of certain  existing
medical  space  and   construction   costs  on  an   additional   administrative
headquarters  building of  approximately  180,000 square feet.  Such  facilities
accounted  for $8.5 million of the total  capital  expenditures.  Other  capital
expenditures  were  primarily  for business  expansion of the HMO and  insurance
operations,  along with general corporate  expansion.  Such amounts include $3.2
million in computer hardware and software. In addition, the Company reduced debt
obligations by $9.6 million in 1996. Most of this debt reduction was a result of
the Company  paying off a mortgage on one of the  clinics.  These cash  outflows
were offset  through the net change of  marketable  securities,  as well as $3.6
million  received in connection with the purchase of stock through the Company's
employee stock plans.

     In April  1996,  the Company  obtained a $50.0  million  unsecured  line of
credit from Bank of America National Trust & Savings Association  ("BofA") for a
term of five years at an interest  rate equal to the London  InterBank  Offering
Rate  ("LIBOR")  plus 32 basis  points.  Such rate  would  have  been  5.875% at
December 31, 1996 if the line of credit had been drawn upon.

     In September  1991, CII issued  convertible  subordinated  debentures  (the
"Debentures")  due September 15, 2001.  The  Debentures  bear interest at 7 1/2%
which  is due  semi-annually  on March  15 and  September  15.  Each  $1,000  in
principal is convertible  into 16.921 shares of the Company's  common stock at a
conversion  price of  $59.097  per  share.  Unamortized  issuance  costs of $1.1
million  are  included  in other  assets  on the  balance  sheet  and are  being
amortized over the life of the Debentures.  The Debentures are general unsecured
obligations  of CII only and are not  guaranteed  by  Sierra.  During the twelve
months  ended  December  31,  1996,  the Company  purchased  $2.3 million of the
Debentures  on the open market.  At December  31, 1996,  CII had total assets of
$315.9 million,  consisting  primarily of investments,  and total liabilities of
$271.0 million,  consisting primarily of reserves for losses and loss adjustment
expense and the  debentures.  For the year ended  December 31, 1996, CII had net
premiums  earned of $121.0  million and  investment  and other  revenue of $18.7
million, and total operating expenses of $128.9 million.

     The Company  has a 1997  capital  budget of  approximately  $45.0  million,
primarily for the completion of the  construction on the new 59,000  square-foot
medical  facility  and 180,000  square  foot  six-story  corporate  headquarters
building and accompanying  five-story parking  structure,  computer hardware and
software,  furniture and equipment,  and other requirements due to the Company's
projected  growth and expansion.  Completion of the medical facility is expected
in the fourth quarter of 1997 at an estimated cost

                                       23

<PAGE>



of  $7.3  million.  Completion  of the  additional  building  at  the  corporate
headquarters  complex is expected in the fourth  quarter of 1997 at an estimated
cost of $35.0  million,  of which $3.5 million was spent in 1996.  The Company's
liquidity  needs over the next 12 months will primarily be for the capital items
noted above to support growing membership in Nevada, as well as debt service and
expansion  of the  Company's  operations.  The Company  believes  that  existing
working capital,  operating cash flow and, if necessary,  mortgage financing and
equipment  leasing,  and amounts  available  under its credit  facility  will be
sufficient  to fund its capital  expenditures,  debt  service and any  expansion
activities  during the next 12 months.  Additionally,  subject to  unanticipated
cash  requirements,  the Company  believes that its existing working capital and
operating cash flow and, if necessary, its access to new credit facilities, will
enable it to meet its liquidity needs on a longer term basis.

     The  holding  company  may  receive  dividends  from its HMO and  insurance
subsidiaries  which  generally  must be  approved  by  certain  state  insurance
departments.  The Company's 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  had
restricted  assets on deposit in various states totaling $13.6 million and $12.5
million,  as of December 31, 1996 and December 31, 1995,  respectively.  The HMO
and  insurance   subsidiaries   also  meet   requirements  to  maintain  minimum
stockholder's equity ranging from $200,000 to $5.2 million. Of the cash and cash
equivalents  held at December 31, 1996, $85.2 million is designated for use only
by the  regulated  subsidiaries.  Such 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 terms of existing management  agreements
and by dividends.  Remaining amounts are available on an unrestricted basis. The
holding   company  will  not  receive   dividends  from  its  HMO  or  insurance
subsidiaries  that would  cause  violation  of  statutory  net worth and reserve
requirements.

     On March 18,  1997,  the Company  announced  it had  terminated  its merger
agreement  with PCA.  During the first quarter of 1997,  the Company  intends to
record certain costs and expenses incurred as a result of the terminated merger.
See Item 3. Legal Proceedings for discussion on associated litigation.

     On January 10,  1997,  the Company and PCA entered  into a credit and share
pledge  agreement  (the "PCA Loan")  pursuant to which the Company made a demand
loan to PCA in the amount of $16.8 million with an 8.25% fixed rate of interest.
The proceeds of the PCA Loan were used by PCA to make a principal  payment under
PCA's existing  credit facility in which Citibank N.A. is the agent ("PCA Credit
Facility"). The PCA Loan is subordinated as to payment of principal and interest
to the amount due under the PCA Credit  Facility  (estimated  to be in excess of
$100  million)  and is  secured  by a lien on the  stock  of  certain  of  PCA's
subsidiaries,  second in priority to the lien securing the PCA Credit  Facility.
The PCA Loan  provides  that the  Company  will not take any  action to  collect
payment until the earlier of the PCA Credit  Facility  being paid in full or six
months from the date the  Company  notifies  Citibank  N.A.,  as agent,  that it
intends to take such  action.  On March 20, 1997 the Company  notified  Citibank
N.A. of its intent to demand  payment.  There can be no assurance  that PCA will
have sufficient funds to pay the PCA Credit Facility and the PCA Loan in full.

     The Company has submitted a proposal as the prime contractor to OCHAMPUS to
provide managed health care coverage to CHAMPUS eligible beneficiaries in Region
1. This  region  includes  approximately  665,000  individuals  in  Connecticut,
Delaware, Maine, Maryland,  Massachusetts,  New Hampshire, New Jersey, New York,
Pennsylvania,  Rhode Island, Vermont, northern Virginia and Washington, D.C. The
Company expects to incur expenses of approximately  $8.0 to $10.0 million during
the Region 1 contract proposal  process.  The Company submitted its final bid on
February  14,  1997 and  anticipates  learning  of the  result of its bid in the
second quarter of 1997. The contract,  if awarded to the Company, will result in
approximately $1.8 billion in estimated revenues over the term of the contract.


                                       24

<PAGE>


Inflation

     Health  care costs  generally  continue  to rise at a faster  rate than the
Consumer Price Index. The Company has been able to lessen somewhat the impact of
inflation by managing medical costs. There can be no assurance,  however,  that,
in the  future,  the  Company's  ability  to manage  medical  costs  will not be
negatively impacted by items such as technological advances, utilization changes
and catastrophic  items,  which could, in turn, result in medical cost increases
equaling or exceeding premium increases.

Health Care Reform

     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 have a material  adverse  effect on the Company's
business.

     For example, recent news reports indicate that President Clinton may submit
a budget proposal to Congress that will reduce Medicare spending by $100 billion
and impose certain  limits on Medicaid  spending.  Although  neither the present
administration's health care reform proposals nor alternative health care reform
proposals introduced by certain members of Congress were previously adopted, the
Health Insurance Portability and Accountability Act of 1996 (the "Accountability
Act") was passed by Congress and signed into law by President  Clinton on August
21,  1996 and will  generally  take  effect  beginning  July 1, 1997.  While the
Accountability  Act contains  provisions  regarding  health  insurance or health
plans, such as portability and limitations on pre-existing condition exclusions,
guaranteed  availability and renewability,  it also contains several  anti-fraud
measures that significantly change health care fraud and abuse provisions.  Some
of the provisions include (i) creation of an anti-fraud and abuse trust fund and
coordination of fraud and abuse efforts by federal, state and local authorities,
(ii)  extension  of the  criminal  anti-kickback  statues to all federal  health
programs,  (iii)  expansion  of and  increase  in the  amount of civil  monetary
penalties and establishment of a knowledge  standard for individuals or entities
potentially subject to civil monetary  penalties,  and (iv) revisions to current
sanctions for fraud and abuse, including mandatory and permissive exclusion from
participation in the Medicare or Medicaid programs. The Company does not believe
that the  Accountability  Act  should  have a  material  adverse  effect  on the
Company's  operations,  but is  unable to  predict  the  ultimate  impact of any
federal or state restructuring of the health care financing and delivery system,
which  ultimately  could  have a  material  adverse  impact  on the  operations,
financial condition and prospects of the Company.


                                       25

<PAGE>



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                          INDEX TO FINANCIAL STATEMENTS
                                                                           Page

Management Report on Consolidated Financial Statements..................    27
Independent Auditors' Report............................................    28
Consolidated Balance Sheets at December 31, 1996 and 1995...............    29
Consolidated Statements of Operations for the Years Ended
   December 31, 1996, 1995, and 1994....................................    30
Consolidated Statements of Changes in Stockholders' Equity
   for the Years Ended December 31, 1996, 1995 and 1994.................    31
Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1996, 1995, and 1994....................................    32
Notes to Consolidated Financial Statements..............................    33


                                       26

<PAGE>



             MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS


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

The  accounting  systems and  controls  of the  Company are  designed to provide
reasonable   assurance  that   transactions  are  executed  in  accordance  with
management's  authorization,   that  the  financial  records  are  reliable  for
preparing  financial  statements and maintaining  accountability for assets, and
that assets are safeguarded against losses from unauthorized use or disposition.
Management  believes that for the year ended December 31, 1996, such systems and
controls were adequate to meet the objectives discussed herein.

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

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





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




James L. Starr
Vice President,
     Chief Financial Officer
     and Treasurer

                                       27

<PAGE>





                          INDEPENDENT AUDITORS' REPORT


Board of Directors
Sierra Health Services, Inc.:

We have audited the consolidated balance sheets of Sierra Health Services, Inc.,
and its  subsidiaries  as of  December  31,  1996  and  1995,  and  the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years in the period ended  December 31, 1996.  Our audits also
included  the  financial  statement  schedules  listed  in the  index at Item 14
(a)(2).  These financial  statements and financial  statement  schedules are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements and financial statement schedules based on
our audits. The consolidated financial statements give retroactive effect to the
merger of Sierra Health Services, Inc., and its subsidiaries, and CII Financial,
Inc.,  and its  subsidiaries,  which  has been  accounted  for as a  pooling  of
interests as described in Note 1 to the consolidated  financial  statements.  We
did not audit the statements of operations, stockholders' equity, and cash flows
of CII Financial,  Inc., and its  subsidiaries,  for the year ended December 31,
1994, which statements reflect total revenues of $106,280,000 for the year ended
December 31, 1994.  These statements were audited by other auditors whose report
has been furnished to us, and our opinion,  insofar as it relates to the amounts
included for CII Financial, Inc., and its subsidiaries, for 1994 is based solely
on the report of such other auditors.

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

In our opinion,  based on our audits and the report of the other  auditors,  the
consolidated  financial statements present fairly, in all material respects, the
financial  position of Sierra  Health  Services,  Inc. and its  subsidiaries  at
December 31, 1996 and 1995,  and the results of their  operations and their cash
flows for each of the three  years in the  period  ended  December  31,  1996 in
conformity with generally accepted accounting principles.  Also, in our opinion,
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.



DELOITTE & TOUCHE LLP
Las Vegas, Nevada
February 21, 1997
(March 28, 1997 as to Note 14)

                                       28

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1996 and 1995

                                     ASSETS
<TABLE>
                                                                                         1996                 1995
<CAPTION>
CURRENT ASSETS:
<S>                                                                                  <C>                   <C>
    Cash and Cash Equivalents..............................................          $103,587,000          $ 57,044,000
    Short-term Investments.................................................            83,688,000            72,579,000
    Accounts Receivable (Less:  Allowance for Doubtful
        Accounts 1996 - $7,324,000; 1995 - $5,000,000).....................            31,849,000            21,723,000
    Current Portion of Deferred Tax Asset .................................            13,713,000             7,629,000
    Prepaid Expenses and Other Current Assets..............................            20,098,000            16,442,000
        Total Current Assets...............................................           252,935,000           175,417,000

PROPERTY AND EQUIPMENT, NET................................................            99,804,000            91,176,000
LONG-TERM INVESTMENTS......................................................           160,482,000           234,698,000
RESTRICTED CASH AND INVESTMENTS............................................            13,648,000            12,482,000
REINSURANCE RECOVERABLE, Net of Current Portion............................            14,721,000            24,952,000
GOODWILL ..................................................................            44,602,000             8,351,000
OTHER ASSETS...............................................................            43,270,000            28,070,000
TOTAL ASSETS...............................................................          $629,462,000          $575,146,000

                                           LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Accrued Liabilities.......................................................         $  37,650,000         $ 21,576,000
    Accrued Payroll and Taxes.................................................            12,503,000           14,174,000
    Medical Claims Payable....................................................            46,969,000           37,463,000
    Current Portion of Reserve for
         Losses and Loss Adjustment Expense ..................................            52,878,000           54,679,000
    Unearned Premium Revenue..................................................            24,210,000           22,260,000
    Current Portion of Long-term Debt.........................................             2,195,000            7,108,000
         Total Current Liabilities............................................           176,405,000          157,260,000

RESERVE FOR LOSSES AND
    LOSS ADJUSTMENT EXPENSE (Less Current Portion) ...........................           134,898,000          127,639,000
LONG-TERM DEBT (Less Current Portion) ........................................            66,189,000           71,257,000
OTHER LIABILITIES ............................................................            17,488,000           11,275,000
TOTAL LIABILITIES.............................................................           394,980,000          367,431,000

STOCKHOLDERS' EQUITY:
    Preferred Stock, $.01 Par Value, 1,000,000
         Shares Authorized; None Issued or Outstanding
    Common Stock, $.005 Par Value, 40,000,000
         Shares Authorized; Shares Issued:  1996 --
         17,910,000; 1995-- 17,677,000........................................                89,000               88,000
    Additional Paid-in Capital................................................           152,035,000          147,240,000
    Treasury Stock; 1996 and 1995 - 100,200
         Common Shares........................................................              (130,000)            (130,000)
    Unrealized Holding Gain on Available-for-Sale Investment..................               487,000            9,659,000
    Retained Earnings.........................................................            82,001,000           50,858,000
         Total Stockholders' Equity...........................................           234,482,000          207,715,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY....................................          $629,462,000         $575,146,000
</TABLE>

        See the accompanying notes to consolidated financial statements.

                                       29

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
              For the Years Ended December 31, 1996, 1995 and 1994

<TABLE>

<CAPTION>
                                                                             1996                1995                 1994
OPERATING REVENUES:
<S>                                                                        <C>                 <C>                 <C>
     Medical Premiums.............................................         $386,968,000        $319,475,000        $269,382,000
     Specialty Product Revenue....................................          133,324,000         102,807,000         101,287,000
     Professional Fees............................................           28,836,000          19,417,000          12,331,000
     Investment and Other Revenue.................................           26,283,000          25,310,000          19,081,000
        Total.....................................................          575,411,000         467,009,000         402,081,000

OPERATING EXPENSES:
     Medical Expenses.............................................          315,915,000         245,135,000         200,229,000
     Specialty Product Expenses...................................          130,758,000         102,859,000          96,600,000
     General, Administrative and Marketing Expenses...............           72,237,000          63,562,000          53,671,000
     Acquisition, Restructuring  and Other Expenses...............           12,064,000          11,614,000
        Total.....................................................          530,974,000         423,170,000         350,500,000

OPERATING INCOME..................................................           44,437,000          43,839,000          51,581,000

OTHER INCOME (EXPENSE):
     Minority Interests...........................................            2,065,000           2,471,000            (113,000)
     Interest Expense and Other, Net..............................           (4,888,000)         (6,208,000)         (6,288,000)
        Total.....................................................           (2,823,000)         (3,737,000)         (6,401,000)

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES .........................................           41,614,000          40,102,000          45,180,000

PROVISION FOR INCOME TAXES........................................           10,471,000          12,198,000           8,236,000

INCOME FROM CONTINUING OPERATIONS.................................           31,143,000          27,904,000          36,944,000

NET OPERATING LOSS ON
     DISCONTINUED OPERATIONS .....................................                               (2,010,000)         (2,501,000)

NET LOSS ON DISPOSAL OF
     DISCONTINUED OPERATIONS .....................................                               (4,590,000)

NET INCOME .......................................................         $ 31,143,000        $ 21,304,000        $ 34,443,000

EARNINGS PER COMMON SHARE
     Income from Continuing Operations ...........................                $1.76               $1.60               $2.36
     Net Operating Loss on Discontinued Operations ...............                                     (.12)               (.16)
     Net Loss on Disposal of Discontinued Operations .............                                     (.26)
         Net Income Per Share ....................................                $1.76               $1.22               $2.20
</TABLE>


        See the accompanying notes to consolidated financial statements.

                                       30

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
              For the Years Ended December 31, 1996, 1995 and 1994


<TABLE>


<CAPTION>
                                                                                            Unrealized
                                                                                              (Loss)
                                                                                              Gain on      Retained
                                                                   Additional                Available-    Earnings      Total
                                               Common Stock         Paid- In    Treasury      for-Sale   (Accumulated  Stockholders
                                            Shares       Amount     Capital      Stock       Investments   Deficit)     Equity


<S>              <C>                       <C>          <C>       <C>          <C>          <C>        <C>           <C>
BALANCE, JANUARY 1, 1994.................. 15,123,000   $75,000   $89,761,000  $(130,000)   $(109,000) $( 4,889,000) $84,708,000
  Issuance of Common Stock in
     Connection with Stock Plans.........     413,000     3,000     5,112,000                                          5,115,000
  Issuance of Common Stock
    in Connection with
   Public Offering, Net...................  1,800,000     9,000    44,570,000                                         44,579,000
  Income Tax Benefit Realized Upon
     Exercise of Stock Options...........                           1,955,000                                          1,955,000
  Change in Unrealized Holding Gains
     (Losses), Net of Taxes ..............                                                  (2,643,000)               (2,643,000)
  Net Income........................                                                                     34,443,000   34,443,000
BALANCE, DECEMBER 31, 1994...............  17,336,000    87,000   141,398,000   (130,000)   (2,752,000)  29,554,000  168,157,000
  Issuance of Common Stock in
     Connection with Stock Plans........      304,000     1,000     4,297,000                                          4,298,000
  Issuance of Stock in Connection
     with Acquisition ....................     37,000                  87,000                                             87,000
  Income Tax Benefit Realized Upon
     Exercise of Stock Options............                          1,458,000                                          1,458,000
  Change in Unrealized Holding Gains
     (Losses), Net of Taxes...............                                                  12,411,000                12,411,000
  Net Income........................                                                                     21,304,000   21,304,000
BALANCE, DECEMBER 31, 1995................ 17,677,000    88,000   147,240,000    (130,000)   9,659,000   50,858,000  207,715,000
  Issuance of Common Stock in
     Connection with Stock Plans.........     233,000     1,000     3,637,000                                          3,638,000
  Income Tax Benefit Realized Upon
     Exercise of Stock Options...........                           1,158,000                                          1,158,000
  Change in Unrealized Holding Gains
     (Losses), Net of Taxes                                                                 (9,172,000)               (9,172,000)
  Net Income........................                                                                     31,143,000   31,143,000
BALANCE, DECEMBER 31, 1996 .........       17,910,000   $89,000  $152,035,000   $(130,000) $   487,000  $82,001,000 $234,482,000
</TABLE>

        See the accompanying notes to consolidated financial statements.

                                       31

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              For the Years Ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>

                                                                                     1996             1995              1994

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                            <C>                <C>                <C>
      Net Income ..........................................................    $  31,143,000      $ 21,304,000       $ 34,443,000
      Adjustments to Reconcile Net Income to Net Cash
          Provided by Operating Activities:
          Loss on Discontinued Operations .................................                          6,600,000          2,501,000
          Depreciation and Amortization....................................       10,499,000         9,505,000          8,300,000
          Provision for Doubtful Accounts..................................        3,057,000         1,694,000          2,156,000
      Change in Assets and Liabilities, Net of
          Effects from Acquisitions:
          Other Assets.....................................................      (16,301,000)       (7,542,000)        (2,314,000)
          Reinsurance Recoverable .........................................       10,231,000         3,349,000         (3,366,000)
          Reserve for Losses and Loss Adjustment Expense                           7,259,000        (5,481,000)        (6,548,000)
          Other Liabilities ...............................................        6,985,000         1,665,000
          Minority Interests...............................................       (1,746,000)       (2,606,000)           511,000
          Accounts Receivable..............................................      (12,469,000)         (923,000)         3,837,000
          Other Current Assets.............................................       (4,738,000)       (2,434,000)         1,341,000
          Medical Claims Payable...........................................        4,973,000         6,341,000          3,858,000
          Other Current Liabilities........................................       13,553,000         5,709,000          4,743,000
      Net  Cash Provided by Continuing Operations .........................       52,446,000        37,181,000         49,462,000
      Net Cash Used by Discontinued Operations                                                      (2,651,000)        (2,875,000)
          Net Cash Provided by Operating Activities                               52,446,000        34,530,000         46,587,000

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures.................................................      (17,927,000)      (20,522,000)       (12,383,000)
      Property and Equipment Dispositions, Net.............................          172,000           725,000            475,000
      Purchase of Available-for-Sale Investments...........................     (712,503,000)     (368,875,000)      (131,661,000)
      Proceeds from Sales/Maturities of
          Available-for-Sale Investments...................................      752,279,000       365,539,000         59,956,000
      Purchase of Held-to-Maturity Investments                                   (25,835,000)      (11,735,000)       (17,605,000)
      Proceeds from Maturities of Held-to-Maturity Investments............        39,184,000        20,183,000          7,027,000
      Change in Financed Premium Receivable ...............................                         15,676,000         (2,810,000)
      Acquisitions, Net of Cash Acquired...................................      (36,310,000)      (11,023,000)        (4,000,000)
          Net Cash Used for Investing Activities...........................         (940,000)      (10,032,000)      (101,001,000)

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing....................................        1,000,000         2,625,000          8,000,000
      Payments on Debt and Capital Leases..................................       (9,601,000)      (11,931,000)        (8,735,000)
      Proceeds from Issuance of Common Stock...............................                                            44,579,000
      Exercise of Stock in Connection with Stock Plans.....................        3,638,000         3,807,000          4,385,000
          Net Cash (Used for) Provided by Financing Activities                    (4,963,000)       (5,499,000)        48,229,000

NET INCREASE (DECREASE) IN CASH
      AND CASH EQUIVALENTS.................................................       46,543,000        18,999,000         (6,185,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                    57,044,000        38,045,000         44,230,000

CASH AND CASH EQUIVALENTS AT END OF YEAR...................................     $103,587,000      $ 57,044,000       $ 38,045,000
</TABLE>

        See the accompanying notes to consolidated financial statements.

                                       32

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


1.   BUSINESS

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

     Acquisitions.  On October 31, 1995,  the Company issued  approximately  2.7
million shares of its common stock in exchange for all of the outstanding common
stock of CII  Financial,  Inc.,  and  subsidiaries  ("CII").  In  addition,  all
outstanding  CII stock  options  were  converted  into options to purchase up to
approximately  540,000  shares of the  Company's  common  stock.  The merger was
accounted  for  as a  pooling  of  interests  and,  accordingly,  the  Company's
consolidated financial statements have been restated to include the accounts and
operations of CII for all periods prior to the merger.

     In November 1996, the Company acquired complete  ownership of HMO Texas, LC
("HMO  Texas") for  $5,040,000.  The Company  had  previously  held a 50 percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996. The purchase resulted in goodwill of $5,040,000.

     Effective  December 31, 1996 the Company  purchased  Prime  Holdings,  Inc.
("Prime"),  for  approximately  $32,219,000  in cash. At December 31, 1996 Prime
operated  MedOne Health Plan, Inc.  ("MedOne"),  a 12,800 member HMO. Prime also
served  215,000  people  through  preferred  provider  organizations,   workers'
compensation  programs and  administrative  service  products  for  self-insured
employers and union welfare trust funds,  primarily in the state of Nevada.  The
acquisition resulted in goodwill of $31,117,000.

     The following pro forma information  (unaudited) has been prepared assuming
that  this  acquisition  had  taken  place at the  beginning  of the  respective
periods.  The pro forma  information  includes  adjustments for interest expense
that would have been  incurred to finance the purchase and the  amortization  of
intangibles arising from the transaction. The pro forma financial information is
not necessarily  indicative of the results of operations as they would have been
had the  transaction  been  effected on the  assumed  dates,  as Prime  incurred
significant startup costs associated with their HMO.
<TABLE>
<CAPTION>

                                                                         1996                        1995
<CAPTION>
<S>                                                                   <C>                         <C>
         Operating Revenues ..................................        $595,187,000                $483,507,000
         Income from Continuing Operations                              22,381,000                  22,202,000
         Net Income ..........................................          22,381,000                  15,602,000
         Earnings Per Common Share:
             Income from Continuing Operations                               $1.26                       $1.27
             Net Income ......................................                1.26                         .90
</TABLE>



                                       33

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation.  All significant intercompany transactions and
balances have been eliminated. Sierra's wholly owned subsidiaries include Health
Plan of Nevada,  Inc. ("HPN"),  HMO Texas and MedOne,  all 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
group,  CII Financial,  Inc.  ("CII"),  a holding company  primarily  engaged in
writing workers'  compensation  insurance through its wholly owned subsidiaries,
administrative  services  companies,  a home health care agency, a hospice and a
company that provides and manages mental health and substance abuse services.

     Medical Premiums. Non-Medicare member enrollment is represented principally
by  employer  groups.  Medical  premiums  are billed to each  employer  group in
accordance  with  negotiated  contracts,  and such premium revenue is recognized
when earned.  Unearned premium revenue includes  payments under prepaid Medicare
contracts  with the Health Care  Financing  Administration  ("HCFA") and prepaid
HPN, HMO Texas and MedOne  commercial and SHL indemnity  premiums.  HPN offers a
prepaid health care program to Medicare  recipients.  Revenues  associated  with
these Medicare  recipients were  approximately  $140,611,000,  $111,584,000  and
$82,792,000, in 1996, 1995 and 1994, respectively.

     Specialty  Product Revenue.  These revenues  consist  primarily of workers'
compensation premiums.  Premiums are calculated by formula such that the premium
written  is  earned  pro rata  over the term of the  policy.  Also  included  in
specialty  product revenues are  administrative  services 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.
Premiums  written in excess of  premiums  earned  are  recorded  as an  unearned
premium  revenue  liability.  Premiums earned include an estimate for earned but
unbilled premiums.

     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 and
charitable allowances.

     Medical  Expenses.  Sierra  contracts with hospitals,  physicians and other
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 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.  Health  care costs are  recorded  in the  period  when  services  are
provided to enrolled members,  including estimates for provider costs which have
been incurred as of the balance sheet date but not reported.  Losses on specific
contracts, if any, are accrued when measurable.

     Specialty Product Expenses.  This expense consists  primarily of losses and
loss adjustment  expense ("LAE") and policy  acquisition  costs  associated with
issued  workers'  compensation  policies.  Losses  and  LAE is  based  upon  the
accumulation of cost estimates for reported claims  occurring  during the period
as well as an  estimate  for  losses  that have  occurred  but have not yet been
reported.  Policy  acquisition  costs consist of commissions,  premium taxes and
other  underwriting  costs,  which are directly  related to the  production  and
retention of new and renewal  business  and are  deferred  and  amortized as the
related premiums are earned. Should it be determined that future policy revenues
and earnings on invested funds relating to existing insurance contracts will not
be adequate to cover related costs and  expenses,  deferred  costs are expensed.
Also  included  in  specialty   product   expense  are  costs   associated  with
administrative services and certain ancillary products. These costs are recorded
when incurred.



                                       34

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     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.

     Marketable   Investments.   Short-  and   long-term   investments   consist
principally  of U.S.  Government  securities  and  municipal  bonds,  as well as
corporate and mortgage backed securities. Short-term investments have maturities
of one year or less.  Long-term  investments  have  maturities  in excess of one
year.

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

     Property  and  Equipment.  Property  and  equipment  are  stated  at  cost.
Maintenance and repairs that do not improve or extend the life of the respective
assets are charged to  operations.  Depreciation  and  amortization  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                     30 years
               Leasehold Improvements                         3 - 10 years
               Furniture, Fixtures and Equipment              3 - 5 years


     Goodwill.  Goodwill  has been  recorded  primarily  as a result of  various
business  acquisitions  by the Company.  Amortization  is provided on a straight
line basis over  periods  not  exceeding  30 years.  The Company  evaluates  the
carrying value of its intangible assets at each balance sheet date.

     Medical Claims Payable.  Medical claims payable includes the estimated cost
for unpaid claims for which health care services have been provided to enrollees
and a provision of the  estimated  costs for claims that have  occurred but have
not been reported.

     Reserve For Losses and Loss Adjustment Expense.  The reserve for losses and
LAE consists of estimated costs of each unpaid claim reported prior to the close
of the accounting  period,  as well as those incurred but not yet reported.  The
methods for establishing and reviewing such liabilities are continually reviewed
and adjustments are reflected in current operations.

     Earnings Per Share.  Earnings per common share for the years ended December
31, 1996,  1995, and 1994 have been calculated using the weighted average number
of  common  shares  outstanding  of  17,726,000,   17,414,000,   and  15,678,000
respectively. Earnings per share have been restated to reflect the merger of CII
accounted for as a pooling of interests.

     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 certain net operating losses,  accrued  expenses,  reserves and
depreciation.

     Discontinued Operations.  During 1995 CII sold its interest in a subsidiary
for  a  combination  of  common  stock  and  warrants  of  the  purchaser.  This
transaction was recorded as a discontinued operation.



                                       35

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     Concentration of Credit Risk. The Company's financial  instruments that are
exposed to credit risk consist primarily of investments and accounts receivable.
The  Company  maintains  cash and cash  equivalents,  and short-  and  long-term
investments with various financial  institutions.  These financial  institutions
are located in many  different  geographies,  and company  policy is designed to
limit exposure with any one institution.

     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. These customers are primarily
located  in the  states in which  the  Company  operates.  Such  operations  are
principally in Arizona,  California,  Colorado,  Nevada and Texas.  However, the
Company is licensed  and does  business  in several  other  states as well.  The
Company  performs  ongoing  credit  evaluations  of  its  customers'   financial
condition.

     Accounting for Stock-Based Compensation.  Statement of Financial Accounting
Standards  No.  123  ("FAS  123"),  "Accounting  for  Stock-Based  Compensation"
provides an alternative  to APB Opinion No. 25 ("APB 25").  FAS 123  encourages,
but does not require,  recognition against earnings of compensation  expense for
grants  of stock,  stock  options  and other  equity  instruments  by  employers
(collectively,  "options"),  based on fair  value at the date of grant.  FAS 123
provides a methodology for the  determination  of fair value;  however,  FAS 123
also  allows  companies  to  continue  to  measure  compensation  cost using the
intrinsic  value  method of  accounting  provided  by APB 25.  FAS 123  requires
companies  that  choose  not to adopt  the new fair  value  accounting  rules to
disclose  pro forma net income and earnings per share under the new method as if
it had been adopted.  The Company has continued with the intrinsic  value method
prescribed in APB 25 as disclosed in Note 11.

     Estimates  and  Assumptions.  The  preparation  of financial  statements in
conformity with generally accepted accounting  principles 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.  Estimates and  assumptions  include,  but are not
limited  to,  medical  and  specialty  product  expenses.   Actual  results  may
materially differ from estimates.

     Acquisition,  Restructuring and Other Expenses. Acquisition,  restructuring
and other  expenses  represent the  non-recurring  incremental  costs the
Company has  incurred in  connection  with  various  mergers,  acquisitions  and
planned dispositions.  Costs recorded for restructurings satisfy the definitions
and  criteria  set forth in Emerging  Issues  Task Force  Issue 94-3  "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity  (including  Certain  Costs  Incurred  in a  Restructuring),"  that are
directly related to the restructurings.

     Reclassifications. Certain amounts in the Consolidated Financial Statements
for the year ended December 31, 1995 and 1994 have been  reclassified to conform
with the current year presentation.




                                       36

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


3.   PROPERTY AND EQUIPMENT

     Property and equipment at December 31 consists of the following:
<TABLE>

<CAPTION>
        Classification                                                      1996                       1995
<S>                                                                       <C>                       <C>
           Land...................................................        $12,224,000               $11,988,000
           Buildings and Improvements.............................         58,962,000                55,796,000
           Furniture, Fixtures and Equipment.........................      35,785,000                34,885,000
           Data Processing Equipment and Software ................         21,034,000                15,311,000
           Leasehold Improvements.................................          4,267,000                 3,545,000
           Construction in Progress...............................          7,858,000                 1,200,000
           Less: Accumulated Depreciation ........................        (40,326,000)              (31,549,000)
               Net Property and Equipment.........................        $99,804,000               $91,176,000
</TABLE>


     The following is an analysis of property and equipment under capital leases
by classification:
<TABLE>

<CAPTION>
        Classification                                                       1996                       1995
<S>                                                                       <C>                       <C>
           Building...............................................        $   245,000               $   245,000
           Data Processing Equipment and Software ................          1,682,000                 1,682,000
           Furniture, Fixtures and Equipment .....................            730,000                   491,000
           Less: Accumulated Depreciation.........................         (1,496,000)               (1,271,000)
              Net Property and Equipment..........................         $1,161,000                $1,147,000
</TABLE>

     The  Company   capitalizes   interest  expense  as  part  of  the  cost  of
construction of facilities. Interest expense capitalized in 1996, 1995, and 1994
was $245,000, $183,000 and $119,000, respectively.

4.   CASH AND INVESTMENTS

     Marketable debt  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 marketable debt and equity investments have been
categorized  as  available-for-sale  and as a result  are  stated at their  fair
value. Unrealized holding gains and losses on available-for-sale  securities are
included as a separate component of stockholders'  equity until realized.  Gross
realized gains and losses in 1996 were $6,826,000 and $4,475,000,  respectively.
Realized  gains and  losses are  calculated  using the  specific  identification
method and are included in net income.

     After the merger of CII, the Company  evaluated the  consolidated  security
portfolio  and   reclassified   $80,597,000   held-to-maturity   investments  to
available-for-sale   investments.  The  reclassification  of  these  investments
resulted in $5,641,000 of net unrealized gains as of December 31, 1995. Also, an
unrealized  holding gain of  $1,711,000  resulting  from the transfer of certain
investments  from  available-for-sale  to  the  held-to-maturity   category  was
included in the net unrealized gains section of stockholders' equity and will be
amortized over the remaining lives of the maturities.



                                       37

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     The following  table  summarizes  the Company's  short-term,  long-term and
restricted investments as of December 31, 1996:
<TABLE>

<CAPTION>
                                                                                Gross               Gross              Estimated
                                                            Amortized         Unrealized          Unrealized            Fair
                                                            Cost               Gains               Losses               Value
Available-for-Sale Investments:
Classified as Short-term:
    U.S Government
<S>                                                      <C>                  <C>                 <C>               <C>
       and its Agencies.....................             $ 14,410,000         $   25,000                            $ 14,435,000
    Municipal Obligations.........................         36,363,000            164,000          $   78,000          36,449,000
    Corporate Bonds.........................               10,521,000             26,000               3,000          10,544,000
    Other. . . . ...........................               21,902,000             66,000             211,000          21,757,000
       Total Short-term.....................               83,196,000            281,000             292,000          83,185,000

Classified as Long-term:
    U.S.  Government
       and its Agencies.....................               67,108,000            131,000             791,000          66,448,000
    Municipal Obligations.........................         14,049,000             519,000             62,000          14,506,000
    Corporate Bonds.........................               32,315,000            199,000             184,000          32,330,000
    Other . . . . ..........................                  158,000                                 29,000             129,000
       Total Long-term......................              113,630,000            849,000           1,066,000         113,413,000

Classified as Restricted:
    U.S. Government
       and its Agencies.....................                6,997,000            102,000              12,000           7,087,000
    Municipal Obligations.........................          2,485,000            149,000                               2,634,000
    Corporate Bonds.........................                  492,000                                                    492,000
    Other. . . . . . . . . .                                1,797,000                                                  1,797,000
       Total Restricted ....................               11,771,000            251,000              12,000          12,010,000
          Total Available-for-Sale                       $208,597,000         $1,381,000          $1,370,000        $208,608,000


Held-to-Maturity Investments:
Classified as Short-term:
    Municipal Obligations    .....................     $      503,000         $    6,000                           $     509,000

Classified as Long-term:
    U.S.  Government
       and its Agencies.....................               20,644,000             28,000          $  460,000          20,212,000
    Municipal Obligations...................                6,359,000            456,000                               6,815,000
    Corporate Bonds.........................               20,066,000            398,000             194,000          20,270,000
       Total Long-term......................               47,069,000            882,000             654,000          47,297,000

Classified as Restricted:
    Municipal Obligations...................                  575,000             38,000                                 613,000
    Corporate Bonds.........................                1,063,000             28,000                               1,091,000
       Total Restricted ....................                1,638,000             66,000                               1,704,000
          Total Held-to-Maturity ...................     $ 49,210,000         $  954,000          $  654,000        $ 49,510,000
</TABLE>


                                       38

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     The following  table  summarizes  the Company's  short-term,  long-term and
restricted investments as of December 31, 1995:
<TABLE>
<CAPTION>

                                                                                Gross               Gross              Estimated
                                                            Amortized         Unrealized          Unrealized            Fair
                                                            Cost               Gains               Losses               Value
Available-for-Sale Investments:
Classified as Short-term:
    U.S Government
<S>                                                     <C>                  <C>                 <C>                <C>
       and its Agencies.....................            $   6,229,000                                               $  6,229,000
    Municipal Obligations.........................         55,317,000        $   340,000                              55,657,000
    Corporate Bonds.........................                1,499,000              6,000                               1,505,000
    Other . . . . . ........................                9,473,000            815,000         $ 1,250,000           9,038,000
       Total Short-term.....................               72,518,000          1,161,000           1,250,000          72,429,000

Classified as Long-term:
    U.S.  Government
       and its Agencies.....................               58,192,000          1,594,000               7,000          59,779,000
    Municipal Obligations...................               85,559,000          6,125,000              16,000          91,668,000
    Corporate Bonds.........................               21,397,000            815,000              47,000          22,165,000
    Other . . . . ..........................                1,225,000                                121,000           1,104,000
       Total Long-term......................              166,373,000          8,534,000             191,000         174,716,000

Classified as Restricted:
    U.S. Government
       and its Agencies.....................                5,432,000              9,000              76,000           5,365,000
    Municipal Obligations...................                  650,000             15,000                                 665,000
    Corporate Bonds.........................                3,403,000             26,000                               3,429,000
    Other. . . . . . . . . .................                  435,000                                                    435,000
       Total Restricted ....................                9,920,000             50,000              76,000           9,894,000
          Total Available-for-Sale .........             $248,811,000        $ 9,745,000          $1,517,000        $257,039,000


Held-to-Maturity Investments:
Classified as Short-term:
    Municipal Obligations...................            $     150,000                                              $     150,000
       Total Short-term.....................                  150,000                                                    150,000

Classified as Long-term:
    U.S.  Government
       and its Agencies.....................               22,590,000        $    41,000        $      5,000          22,626,000
    Municipal Obligations ..................               11,482,000            773,000                              12,255,000
    Corporate Bonds.........................               25,910,000             63,000               3,000          25,970,000
       Total Long-term......................               59,982,000            877,000               8,000          60,851,000

Classified as Restricted:
    U.S. Government
       and its Agencies  ...................                1,000,000                                                  1,000,000
    Municipal Obligations...................                  575,000             28,000                                 603,000
    Corporate Bonds.........................                  673,000                                 23,000             650,000
    Other . . . . . ........................                  340,000                                                    340,000
       Total Restricted ....................                2,588,000             28,000              23,000           2,593,000
          Total Held-to-Maturity ...........             $ 62,720,000         $  905,000         $    31,000        $ 63,594,000
</TABLE>

                                                                 39

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


              The  contractual  maturities  of  available-for-sale   short-term,
long-term  and  restricted  investments  at December  31, 1996 are shown  below.
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations.
 <TABLE>
 <CAPTION>

                                                                           Amortized               Estimated
                                                                               Cost                         Fair Value

<S>                                                                       <C>                      <C>
Due in one year or less......................................             $  70,629,000            $  69,541,000
Due after one year through five years........................                71,052,000               70,502,000
Due after five years through ten years.......................                22,733,000               24,916,000
Due after ten years..........................................                44,183,000               43,649,000
     Total...................................................              $208,597,000             $208,608,000
</TABLE>


     The contractual  maturities of held-to-maturity  short-term,  long-term and
restricted investments at December 31, 1996 were as follows:
<TABLE>
<CAPTION>
                                                                           Amortized               Estimated
                                                                               Cost                         Fair Value

<S>                                                                      <C>                      <C>
Due in one year or less......................................            $      665,000           $      671,000
Due after one year through five years........................                13,816,000               14,138,000
Due after five years through ten years.......................                16,762,000               16,731,000
Due after ten years..........................................                17,967,000               17,970,000
     Total...................................................               $49,210,000              $49,510,000
</TABLE>


     Of  the  cash  and  cash  equivalents   that  total   $103,587,000  in  the
accompanying  Consolidated  Balance Sheet at December 31, 1996,  $85,187,000  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  and by dividends  which  customarily  must be approved by regulating
state  insurance  departments.  The  remainder  is  available  to  Sierra  on an
unrestricted basis.

5.   REINSURANCE

     In the normal  course of business,  the Company  seeks to reduce  potential
losses  that  may  arise  from   catastrophic   events  that  cause  unfavorable
underwriting  results  by  reinsuring  certain  levels of such  risk with  other
reinsurers.  Amounts  recoverable  from  reinsurers  are  estimated  in a manner
consistent with the claim liability associated with the reinsurance policy.

     The Company is covered under a medical reinsurance  agreement that provides
coverage  for 50-90% of hospital  costs in excess of $75,000  per case,  up to a
maximum of $2,000,000 per member per lifetime for both the managed indemnity and
HMO subsidiaries. Reinsurance premiums of $3,235,000, $2,827,000 and $2,234,000,
net of  reinsurance  recoveries of  $2,276,000,  $1,133,000  and  $584,000,  are
included in medical expense for 1996, 1995 and 1994, respectively.  In addition,
SHL maintains reinsurance on certain other insurance products.


                                                        40

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     CII also has  reinsurance  treaties in effect.  The reinsurers have assumed
the liability on that portion of workers'  compensation  claims between $350,000
and $60,000,000 per occurrence for 1996 and between $250,000 and $60,000,000 per
occurrence  for 1995 and 1994.  At  December  31,  1996 and 1995,  the amount of
reinsurance  recoverable  for unpaid  losses  and loss  adjustment  expense  was
$15,676,000 and $25,871,000,  respectively. The amount of reinsurance receivable
for  paid  losses  and  loss  adjustment   expense  was  $103,000  and  $73,000,
respectively.

     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  that  the  Company  has  reinsurance
contracts with are rated A+ or better by the A.M. Best Company.


     The following table provides workers' compensation  reinsurance information
by reinsurer for the three years ended December 31, 1996:
<TABLE>
<CAPTION>
                                                                                Change in
                                                    Recoveries                 Recoverable
                                                     on Paid                   on Unpaid                 Premiums
                                                    Losses/LAE                 Losses/LAE                 Ceded

1996:
<S>                                                      <C>                    <C>                     <C>
 General Reinsurance Corporation...............          $3,076,000             $(10,195,000)           $4,713,000
 Others .......................................                                                            456,000
 Total ........................................          $3,076,000             $(10,195,000)           $5,169,000

1995:
 General Reinsurance Corporation...............          $2,426,000             $ (3,472,000)           $3,727,000
 Others .......................................                                                            300,000
 Total ........................................          $2,426,000             $ (3,472,000)           $4,027,000

1994:
 General Reinsurance Corporation.............            $1,117,000               $ 3,501,000           $3,679,000
 Others .......................................                                                            205,000
 Total ........................................          $1,117,000               $ 3,501,000           $3,884,000
</TABLE>




                                                        41

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


6.   LOSSES AND LOSS ADJUSTMENT EXPENSES

 The  following  table  provides a  reconciliation  of the  beginning and ending
reserve  balances  for unpaid LAE.  There can be no  assurances  that  favorable
development,  or the magnitude of the development,  will continue in the future.
<TABLE>
<CAPTION>

                                                                            Year ended December 31,
                                                                               1996              1995             1994


<S>                                                                                 <C>               <C>          <C>
Net Beginning Losses and LAE Reserve ...........................................    $156,447,000      $161,620,000 $174,515,000
</TABLE>

Net Provision for Insured Events Incurred in:
<TABLE>
<CAPTION>

<S>                                                                 <C>               <C>               <C>
   Current Year ..........................................          101,401,000       75,978,000        67,642,000
   Prior Years............................................          (15,284,000)     (20,079,000)      (13,953,000)
     Total Net Provision..................................           86,117,000       55,899,000        53,689,000
</TABLE>

Net Payments for Losses and LAE
<TABLE>
<CAPTION>

   Attributable to Insured Events Incurred in:
<S>                                                                  <C>              <C>               <C>
   Current Year ..........................................           24,733,000       16,553,000        16,374,000
   Prior Years............................................           45,731,000       44,519,000        50,210,000
     Total Net Payments ..................................           70,464,000       61,072,000        66,584,000
</TABLE>
<TABLE>
<CAPTION>

<S>                                                                 <C>               <C>              <C>
Net Ending Losses and LAE Reserve ........................          172,100,000       156,447,000      161,620,000
Reinsurance Recoverable ..................................           15,676,000       25,871,000        29,342,000
</TABLE>
<TABLE>
<CAPTION>

<S>                                                                 <C>               <C>               <C>
Gross Ending Losses and LAE Reserve......................           $187,776,000      $182,318,000      $190,962,000
</TABLE>



                                       42

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


7.   LONG-TERM DEBT

Long-term debt at December 31 consists of the following:
<TABLE>
<CAPTION>
                                                                                1996                     1995


<C>                                                                           <C>                      <C>
7 1/2% Convertible Subordinated Debentures                                      $54,497,000              $56,800,000
7 3/8% Mortgage Note  ...............................................           7,833,000                9,802,000
Adjustable Rate Mortgage Note .......................................           3,167,000                3,213,000
Other................................................................           2,887,000                8,550,000
  Total..............................................................          68,384,000               78,365,000
Less Current Portion.................................................          (2,195,000)              (7,108,000)
Long-term Debt.......................................................         $66,189,000              $71,257,000
</TABLE>


     7 1/2% Convertible  Subordinated  Debentures.  In September 1991 CII issued
convertible  subordinated  debentures (the "Debentures") due September 15, 2001.
The Debentures  bear interest at 7-1/2% which is due  semi-annually  on March 15
and September 15. Each $1,000 in principal is convertible  into 16.921 shares of
the  Company's  common  stock  at a  conversion  price  of  $59.097  per  share.
Unamortized  issuance  costs of  $1,114,000  are included in other assets on the
balance sheet and are being amortized over the life of the  Debentures.  Accrued
interest on the  Debentures as of December 31, 1996 and 1995 was  $1,192,000 and
$1,243,000,  respectively.  The Debentures are redeemable by CII, in whole or in
part, at redemption prices ranging from 103.00% in 1997 to 100.75% in 2000, plus
accrued  interest  for the twelve  month  period  beginning  September 15 of the
applicable  year. The Debentures are general  unsecured  obligations of CII only
and were not assumed or  guaranteed  by Sierra.  During the twelve  months ended
December 31, 1996,  the Company  purchased  $2,303,000 of the  debentures on the
open market.

     7 3/8% Mortgage Note. In December  1993,  the Company  obtained a loan from
Bank of America,  Nevada. This loan is secured by a deed of trust, assignment of
rents and leases,  and a security  agreement  and fixture  filing  covering  the
Company's administrative headquarters complex and underlying real property.

     Adjustable  Rate  Mortgage  Note.  The Company has a mortgage  which has an
adjustable  rate with an interest  margin of 3% over the Federal  Home Loan Bank
Board  11th  District  Cost of Funds  Index,  a  maximum  interest  rate of five
percentage  points above the initial rate of 11.85% and a minimum  interest rate
of 8%. The interest  rate at December 31, 1996 was 8%. This  mortgage is secured
by a medical facility.

     Other. The Company has obligations under capital leases with interest rates
from 7.8% to  15.6%.  In  addition,  the  Company  has a term loan due July 1998
including  cumulative  interest  at 7%.  During  1994,  the  Company  assumed  a
$4,860,000  mortgage  note in  conjunction  with a  related  party  transaction.
Monthly  installments of $36,144,  including interest at 7.12%, were due through
July 1996, at which time the balance of the note was paid.



                                       43

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     In April  1996,  the Company  obtained a $50.0  million  unsecured  line of
credit from Bank of America National Trust & Savings Association  ("BofA") for a
term of five years at an interest  rate equal to the LIBOR plus 32 basis points.
Such rate would have been 5.875% at December  31, 1996 if the line of credit had
been drawn upon.

     Scheduled  maturities  of the Company's  notes  payable and future  minimum
payments  under  capital  leases,  together  with the  present  value of the net
minimum lease payments at December 31, 1996, are as follows:

<TABLE>
<CAPTION>
                                                                                                     Obligations
                                                                                Notes               Under Capital
     Year ending December 31,                                                  Payable                 Leases
<S>      <C>                                                                 <C>                       <C>
         1997.................................................               $ 1,887,000               $371,000
         1998.................................................                 2,058,000                252,000
         1999.................................................                 7,010,000                154,000
         2000.................................................                 2,000,000                135,000
         2001.................................................                54,497,000                 31,000
         Thereafter...........................................                                          336,000
            Total.............................................               $67,452,000              1,279,000
         Less:  Amounts Representing Interest.................                                          347,000
         Present Value of Minimum Lease Payments..............                                         $932,000
</TABLE>


     The fair value of the  Debentures  at December  31,  1996 was  $48,502,000,
which was  determined  based on the quoted  market  price at December  31, 1996.
Excluding  the  Debentures,  the fair value of  long-term  debt,  including  the
current  portion,  is  $13,582,000,  based  on  the  borrowing  rates  currently
available  to the  Company  for  bank  loans  with  similar  terms  and  average
maturities.



                                       44

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


8.   INCOME TAXES

     A summary of the provision for income taxes for the years ended December 31
     is as follows:
<TABLE>

<CAPTION>
                                                             1996                 1995                  1994

     Provision for Income Taxes:
<S>                                                       <C>                   <C>                   <C>
        Current..................................         $11,860,000           $11,736,000           $11,031,000
        Deferred.................................          (1,389,000)              462,000            (2,795,000)
                                                          $10,471,000           $12,198,000           $ 8,236,000
</TABLE>


     The following  reconciles  the difference  between the 1996,  1995 and 1994
current and statutory provision for income taxes:
<TABLE>
<CAPTION>

                                                             1996                 1995                  1994


<S>                                                            <C>                   <C>                   <C>
Statutory Rate ..................................              35%                   35%                   35%
Tax Preferred Investments .......................              (6)                   (9)                   (5)
Change in Valuation Allowance ...................              (6)                   (2)                   (9)
Non-deductible Acquisition Costs ................                                     5
Other ...........................................               2                     1                    (3)
   Provision for Income Taxes ...................              25%                   30%                   18%
</TABLE>




                                       45

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     The tax effects of significant  items comprising the Company's net deferred
tax assets are as follows:
<TABLE>
<CAPTION>

                                                                                    1996                 1995
Deferred Tax Assets:

<S>                                                                              <C>                   <C>
    Medical and Losses and LAE Reserves ...............................          $ 5,277,000           $ 7,147,000
    Accruals Not Currently Deductible.........................                     5,334,000             2,254,000
    Vacation and Deferred Compensation.................................            2,960,000             2,485,000
    Bad Debt Allowances.......................................                     2,946,000             1,637,000
    Loss Carryforwards and Credits............................                    13,389,000            12,202,000
    Other ....................................................                       803,000               744,000

                                                                                  30,709,000            26,469,000

Deferred Tax Liabilities:
    Deferred Policy Acquisition Costs .................................              613,000               647,000
    Depreciation and Amortization ............................                     4,102,000             3,164,000
    Other ....................................................                       825,000             1,021,000
                                                                                   5,540,000             4,832,000
    Net Deferred Tax Asset Before
       Valuation Allowance....................................                    25,169,000            21,637,000

    Valuation Allowance ......................................                   (10,929,000)          (12,039,000)
    Net Deferred Tax Asset ...................................                   $14,240,000           $ 9,598,000
</TABLE>

     At December 31, 1996, the Company had approximately  $30,100,000 of regular
tax net  operating  loss  carryforwards  which are limited to use at the rate of
approximately  $6,600,000  per year  during  the  carryforward  period.  The net
operating loss  carryforwards  can be used to reduce future taxable income until
they expire through the year 2011. The Company has  alternative  minimum tax net
operating loss  carryforwards of approximately  $11,000,000 which expire through
the year 2011. The Company also has California net operating loss  carryforwards
of approximately  $15,900,000 which expire through the year 2001. In addition to
these net operating loss carryforwards,  the Company has alternative minimum tax
credits  of  approximately  $800,000  which  can be used to reduce  regular  tax
liabilities  in future years.  There is no expiration  date for the  alternative
minimum tax credits.  The majority of the above items are subject to both annual
and separate company limitations required by the Internal Revenue Code.

     Due to the above referenced limitations, a valuation allowance has been set
up  to  reflect  the  Company's  inability  to  use  tax  benefits  from  recent
acquisitions  currently or in the near future. As the benefits are realizable by
the Company, the valuation allowance will be reduced as required by Statement of
Financial  Accounting  Standards  No. 109  "Accounting  for Income  Taxes" ("FAS
109").  For the years ended  December 31, 1996 and 1995, the Company was able to
realize a portion of the tax benefits  previously  allowed for. As a result, the
Company reduced its valuation allowance by $2,685,000 and $750,000 for the years
ended  December  31,  1996 and 1995,  respectively.  In  addition,  the  Company
recorded a $1,575,000  valuation allowance in connection with the acquisition of
Prime on a gross  deferred tax asset of $5,300,000.  The valuation  allowance of
$10,929,000  at December  31, 1996 is  necessary  under the more likely than not
criteria required by FAS 109.



                                       46

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


9.   COMMITMENTS AND CONTINGENCIES

     Ongoing Initiatives.  On February 14, 1997, the Company submitted its final
bid to be the prime contractor to the Civilian Health and Medical Program of the
Uniformed  Services  ("CHAMPUS")  to provide  managed  health  care  coverage to
CHAMPUS eligible  beneficiaries in Region 1. This region includes  approximately
665,000 individuals in Connecticut,  Delaware,  Maine, Maryland,  Massachusetts,
New  Hampshire,  New Jersey,  New York,  Pennsylvania,  Rhode  Island,  Vermont,
northern  Virginia  and  Washington,  D.C.  The  Company  expects to incur total
expenses of approximately $8,000,000 to $10,000,000 during the Region 1 contract
proposal  process.  The Company submitted its final bid on February 14, 1997 and
anticipates learning of the result of its bid in the second quarter of 1997. The
contract,  if awarded to the Company,  will result in approximately $1.8 billion
in estimated revenues over the term of the contract.

     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:
<TABLE>
<CAPTION>

     Year Ending December 31,
<S>       <C>                                                                <C>
          1997...................................................            $ 6,896,000
          1998...................................................              5,854,000
          1999...................................................              4,297,000
          2000...................................................              2,929,000
          2001...................................................              2,455,000
          Thereafter.............................................              7,221,000
               Total.............................................            $29,652,000
</TABLE>

         Rent expense  totaled  $6,374,000,  $4,942,000  and $4,873,000 in 1996,
1995 and 1994, respectively.

     Litigation and Legal Matters.  The Company is subject to legal  proceedings
and claims  that arise in the  ordinary  course of  business.  In the opinion of
management,  the  amount of  ultimate  liability  with  respect  to these  legal
proceedings will not materially impact the consolidated  financial statements of
the Company.
See Note 14 "Subsequent Events".

10.       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 contributes
2% of  eligible  employees'  compensation  and  matches  50% of a  participant's
elective deferral up to a maximum of either 10% of an employee's compensation or
the maximum  allowable  under  current  IRS  statute.  Prior to the merger,  CII
maintained a 401(k) plan as well. As part of the merger of CII, the CII plan was
frozen in November 1995.  The Company merged the two plans during 1996.  Expense
under both Sierra plans totaled  $3,216,000,  $2,516,000 and $2,573,000 in 1996,
1995 and 1994, respectively.


                                       47

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     Supplemental Retirement Plan. 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.  The Company also matches
50% of those  contributions that participants are restricted from deferring,  if
any,  under the  Company's  pension  and 401(k)  plan.  As  contracted  with the
Company, the participants or their designated beneficiaries may begin to receive
benefits  under  the  SRPs  upon  participant  death,  disability,   retirement,
termination  of employment or certain other  circumstances  including  financial
hardship.

     Other CII Plans.  Prior to the  acquisition of CII, CII maintained  various
supplemental benefit, executive benefit, and profit sharing plans. Subsequent to
the  merger  all  such  plans  have  been,  or  are  in the  process  of  being,
discontinued,  terminated,  or merged into the Company's existing plans.  During
the  years  ended  December  31,  1995 and 1994,  CII  expensed  $1,574,000  and
$2,485,000,  respectively,  under the various plans.  Eligible CII employees are
included in the Company's plans discussed above.

11.       CAPITAL STOCK PLANS

     Stockholders'  Rights  Plan.  On June 14,  1994,  the Board of Directors of
Sierra authorized and declared a dividend  distribution of one right (a "Right")
for each share of Sierra  common  stock,  par value $.005 per share.  The Rights
were  distributed  to the  holders  of record  of Common  Shares at the close of
business on June 30, 1994. Each Right entitles the registered holder to purchase
from Sierra a unit  consisting of one  one-hundredth  of a share of the Series A
Junior  Participating  Preferred Shares (a "Unit"), par value $.01 per share, of
Sierra,  or a combination  of securities  and assets of equivalent  value,  at a
purchase  price of $100.00  per Unit,  subject to  adjustment.  The Rights  have
certain  anti-takeover  effects. The Rights will cause substantial dilution to a
person or group  that  attempts  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  should not interfere
with any merger or other business combination approved by the Board of Directors
since  Sierra may redeem the Rights at the price of $.02 per Right  prior to the
time that a person or group has acquired beneficial  ownership of 20% or more of
Sierra common stock.

     Stock Option Plans.  During 1995 the  shareholders of the Company  approved
the 1995 Long-Term  Incentive Plan ("LTIP").  The LTIP provides for the granting
of Options,  Stock,  and other  stock-based  awards.  Under the LTIP 1.2 million
shares were reserved along with remaining  shares reserved from certain previous
stock option and capital  accumulation plans which have not been and will not be
issued  under those  plans.  Awards are granted by a committee  appointed by the
Board  of  Directors.  Options  become  exercisable  at such  times  and in such
installments  as set by the  committee.  Under this plan,  the exercise price of
each option equals the market price of the Company's stock on the date of grant.
Options  currently  granted  under the LTIP vest for the  employees at a rate of
20-25% per year. Options expire one year after the end of the vesting period.

     In  addition,  in 1995 the  shareholders  of the Company  approved the 1995
Non-Employee  Directors' Stock Plan  ("Directors'  Plan").  Under the Directors'
Plan  non-employee  directors are granted an option to purchase  3,000 shares of
common  stock.  Options are granted  annually on January 20 at the current  fair
market  value and  become  exercisable  over a five  year  period.  The  Company
reserved 60,000 shares under the Directors' Plan.


                                       48

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     The following table reflects the activity of the stock option plans:
<TABLE>
<CAPTION>

                                                                Number of                Option
                                                                  Shares                 Price

<S>                 <C>                                          <C>                    <C>          <C>
Outstanding January 1, 1994...............................       1,434,000              $   .81  -   $27.03
   Granted..................................                       198,000                14.53  -    28.63
   Exercised................................                      (355,000)                3.38  -    21.00
   Canceled.................................                        (5,000)                3.38  -    21.00
Outstanding December 31, 1994.............................       1,272,000                 2.44  -    28.63
   Granted..................................                       882,000                14.86  -    31.75
   Exercised................................                      (241,000)                2.44  -    21.00
   Canceled.................................                       (53,000)                3.38  -    28.63
Outstanding December 31, 1995.............................       1,860,000                 3.38  -    31.75
   Granted..................................                       320,000                25.00  -    35.00
   Exercised................................                      (166,000)                3.38  -    28.63
   Canceled.................................                       (15,000)               10.69  -    31.75
Outstanding December 31, 1996                                    1,999,000                 7.50  -    35.00

Exercisable at December 31, 1996 .........................         803,000                 7.50  -    31.75

Available for Grant at
   December 31, 1996 .......................                       643,000

</TABLE>

     The following table summarizes  information about stock options outstanding
at December 31, 1996:
<TABLE>

<CAPTION>
                                         Number                Weighted-Average
          Range of Exercise          Outstanding at                Remaining             Weighted-Average
               Prices                   12-31-96               Contractual Life           Exercise Price

<S>     <C>          <C>                   <C>                       <C>                     <C>
        $ 7.50  -    $10.69                92,000                    487 Days                $  9.88
         12.00  -     16.38               316,000                    943 Days                  15.92
         17.56  -     25.13             1,159,000                  1,588 Days                  23.47
         26.38  -     35.00               432,000                  1,658 Days                  29.82
</TABLE>

     Employee  Stock  Purchase  Plan. The Company has an employee stock purchase
plan (the "Purchase Plan") whereby employees may purchase newly-issued shares of
stock through payroll  deductions at 85% of the fair market value of such shares
on specified dates as defined in the Purchase Plan. As of December 31, 1996, the
Company had 423,321 shares reserved for purchase under the Purchase Plan. During
1996, a total of 67,997 shares were purchased at prices of $20.83 and $26.45 per
share. During January 1997, 38,094 shares were issued to employees at $20.93 per
share in connection with the Purchase Plan.



                                       49

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


     Accounting for Stock-Based Compensation.  At December 31, 1996, the Company
had three  stock- based  compensation  plans,  which are  described  above.  The
Company applies APB 25 and related  Interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its fixed stock option
plans nor the Purchase  Plan.  Had  compensation  cost for the  Company's  three
stock- based  compensation  plans been determined based on the fair value at the
grant dates for awards under those plans  consistent with the method of FAS 123,
the  Company's  net income and earnings per share would have been reduced to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>

                                                                              1996                      1995

<S>                                                                          <C>                       <C>
Net Income                                         As reported               $31,143,000               $21,304,000
                                                   Pro forma                  29,703,000                20,203,000

Net Income Per Share                               As reported                     $1.76                    $1.22
                                                   Pro forma                        1.68                     1.16
</TABLE>

      The fair  value of each  option  grant is  estimated  on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1995 and 1996, respectively: dividend yield of 0%
for all years;  expected  volatility of 34% and 29%; risk-free interest rates of
6.12% and 5.92%;  and expected  lives of four years for all years.  The weighted
fair  value  of  options   granted  in  1995  and  1996  was  $9.49  and  $8.47,
respectively.

      The fair value of the  look-back  option  implicit in each offering of the
Purchase Plan is estimated on the date of grant using the  Black-Scholes  option
pricing model with the following weighted average assumptions used for grants in
1995  and  1996,  respectively:  dividend  yield of 0% for all  years;  expected
volatility  of 34% and 29%;  risk-free  interest  rates of 6.07% and 5.29%;  and
expected lives of six months for all years.

      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 FAS 123
been applicable to all years of previous option grants. The above numbers do not
include the effect of options granted prior to 1995.




                                       50

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


12.       STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION

     Supplemental  statements  of cash  flows  information  for the years  ended
December 31, is presented below:
<TABLE>
<CAPTION>

                                                                       1996              1995           1994

Cash Paid During the Year for Interest
<S>                                                                   <C>              <C>               <C>
    (Net of Amount Capitalized)...............................        $5,275,000       $ 6,430,000       $ 6,433,000
Cash Paid During the Year for Income Taxes....................         7,966,000        10,509,000         9,650,000

Noncash Investing and Financing Activities:
    Liabilities Assumed in Connection with
       Corporate Acquisitions.................................         7,890,000         3,113,000         7,279,000
    Reductions to Funds Withheld by Ceding
       Insurance Company and Future
       Policy Benefits........................................           773,000           990,000           447,000
    Stock Issued for Exercise of Options
       and Related Tax Benefits...............................         1,158,000         1,949,000         2,685,000
    Assumption of Liability in Connection with
       Land Purchase .........................................              --           1,956,000              --
    Additions to Capital Leases...............................              --             278,000           552,000
    Stock and Warrants Received on Sale
       of Discontinued Operations ............................              --           1,000,000              --
</TABLE>


13.        ACQUISITION, RESTRUCTURING AND OTHER EXPENSES

           During 1995, as part of the Company's  clinical  expansion and growth
efforts,  the Company  acquired a medical  facility in Mohave  County,  Arizona,
across the border from Laughlin, Nevada. This medical facility included a 12 bed
hospital.  During  1996 the  Company  implemented  a plan to exit  the  hospital
business and has actively pursued buyers for this business.  As a result of this
plan, the Company recorded a charge of $3,814,000  ($2,860,000 after tax) in the
fourth quarter of 1996, primarily to recognize the estimated costs to dispose of
the hospital.

           As a result of higher than expected  claim and  administrative  costs
relative to premium  rates that can be obtained  in certain  regional  insurance
operations and the Company's  inability to negotiate adequate provider contracts
due to its limited presence in some of these markets, the Company adopted a plan
to restructure certain insurance operations during the third quarter of 1996 and
recorded a charge of $8,250,000  ($6,187,000 after tax). The plan will allow the
Company to focus on more  favorable  operating  markets  and  improve  operating
efficiencies.  The Company  believes that this  restructuring,  over time,  will
result in improved cash flow and operating cost savings.

           These   restructuring   costs   included   cancellation   of  certain
contractual obligations of $6,000,000, lease termination costs of $1,500,000 and
approximately $4,564,000 of other costs including the estimated costs to dispose
of the  hospital.  As of December 31, 1996,  approximately  $4,100,000  of these
costs had been paid or  otherwise  charged  against  the accrual and the Company
estimates  that most of the remaining  cash  expenditures  will be paid over the
next twelve months.

                                       51

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994



           In connection with the merger and integration of CII,  $11,614,000 of
costs and expenses  ($9,677,000  after tax) were incurred and charged to expense
in the fourth quarter of 1995.  These costs include  $6,400,000 in  professional
fees,  $1,700,000 for the write-off of certain redundant  hardware and software,
$1,300,000 for the  cancellation  of certain  contractual  obligations and other
settlement costs, $900,000 related to transition and severance-related  payments
and approximately $1,314,000 for other integration costs.

14.  SUBSEQUENT EVENTS

           On March 18, 1997, the Company announced it had terminated its merger
agreement with Physician  Corporation of America ("PCA"). The original agreement
had been entered into in November 1996. On March 18, 1997,  prior to termination
of the merger  agreement,  PCA filed a lawsuit against the Company in the United
States  District  Court for the  Southern  District  of Florida  (the  "District
Court"),  seeking,  among  other  things,  specific  performance  of the  merger
agreement and monetary  damages.  While the Company  believes the PCA lawsuit is
without  merit,  there can be no assurance as to the outcome of the PCA lawsuit.
The Company has filed a motion in the District  Court seeking a dismissal of the
PCA lawsuit for lack of diversity jurisdiction. The Company has also initiated a
lawsuit in the Court of Chancery of the State of Delaware  seeking a declaratory
judgment as well as other remedies. The Company intends to vigorously pursue all
remedies  available to it,  however,  there can be no assurance that the Company
will prevail in such  litigation or that PCA will have  sufficient  funds to pay
any damages  that the Company may be awarded.  During the first  quarter of 1997
the Company intends to record certain costs and expenses incurred as a result of
the terminated merger.

           On January 10,  1997,  the Company and PCA entered  into a credit and
share  pledge  agreement  (the "PCA Loan")  pursuant to which the Company made a
demand  loan to PCA in the  amount of  $16,750,000  with an 8.25%  fixed rate of
interest.  The  proceeds  of the PCA Loan were  used by PCA to make a  principal
payment under PCA's existing credit facility in which Citibank N.A. is the agent
("PCA Credit Facility"). The PCA Loan is subordinated as to payment of principal
and interest to the amount due under the PCA Credit Facility (estimated to be in
excess of  $100,000,000)  and is  secured  by a lien on the stock of  certain of
PCA's  subsidiaries,  second in  priority  to the lien  securing  the PCA Credit
Facility.  The PCA Loan  provides  that the Company  will not take any action to
collect  payment until the earlier of the PCA Credit Facility being paid in full
or six months from the date the Company notifies  Citibank N.A., as agent,  that
it intends to take such action.  On March 20, 1997 the Company notified Citibank
N.A. of its intent to demand  payment.  There can be no assurance  that PCA will
have sufficient funds to pay the PCA Credit Facility and the PCA Loan in full.



                                       52

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1996, 1995 and 1994


15.        UNAUDITED QUARTERLY INFORMATION
           (In thousands, except per share data)
<TABLE>
<CAPTION>
                                                            March             June              September        December
                                                            31                30                30               31

Year Ended December 31, 1996:
<S>                                                        <C>               <C>               <C>              <C>
  Operating Revenues..............................         $136,012          $141,362          $146,245         $151,792
  Operating Income................................           14,375            14,250             6,137            9,675
  Income From Continuing Operations
     Before Income Taxes .........................           13,566            13,688             5,422            8,938
  Net Income......................................           10,164            10,211             4,067            6,701
  Earnings Per Share .............................              .58               .58               .23              .38

Year Ended December 31, 1995:
  Operating Revenues..............................         $108,272          $111,743          $115,616         $131,378
  Operating Income................................           12,822            12,777            14,430            3,810
  Income From Continuing Operations
     Before Income Taxes .........................           11,786            11,694            13,727            2,895
  Net Income......................................            7,675             3,260             9,699              670
  Earnings Per Share .............................              .44               .19               .56              .04
</TABLE>

                                       53

<PAGE>



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

      None.

                                    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 1997  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  1997  Annual  Meeting  of
Stockholders, is incorporated herein by reference.


ITEM 12.         SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

      The information set forth under the caption "Security Ownership of Certain
Beneficial  Owners and  Management"  in Sierra's  Proxy  Statement  for its 1997
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 1997 Annual Meeting of
Stockholders, is incorporated herein by reference.


                                       54

<PAGE>



                                     PART IV


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

(a)(1) The following  consolidated financial statements are included in Part II,
Item 8 of this Report:

                                                                           Page

        Independent Auditors' Report.....................................    28
        Consolidated Balance Sheets at December 31, 1996 and 1995 .......    29
        Consolidated Statements of Operations for the Years Ended
           December 31, 1996, 1995 and 1994..............................    30
        Consolidated Statements of Changes in Stockholders' Equity
           for the Years Ended December 31, 1996, 1995 and 1994 .........    31
        Consolidated Statements of Cash Flows for the Years Ended
           December 31, 1996, 1995 and 1994..............................    32
        Notes to Consolidated Financial Statements.......................    33
        The Independent Auditors' Report for a Predecessor Company
           for the Year Ended December 31, 1994 is included in Exhibit 13

(a)(2)     Financial Statement Schedules:

        Schedule I - Condensed Financial
           Information of Registrant ...................................    S-1

        Schedule V - Supplemental Information Concerning
           Property-Casualty Insurance ..................................   S-4

        Section 403.04 b - Reconciliation of Beginning and Ending Loss
                             and Loss Adjustment Expense Reserves
                             and Exhibit of Redundancies (Deficiencies)..   S-5

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)and (c) 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,  together with amendments  thereto to
               date, incorporated by reference to the Registrant's Annual Report
               on Form 10-K for the fiscal year ended December 31, 1990.

       (3.2)   Certificate of Division of Shares into Smaller  Denominations  of
               the  registrant,  incorporated by reference to Exhibit 3.3 to the
               Registrant's Annual Report on Form 10-K for the fiscal year ended
               December 31, 1992.

       (3.3)   Amended and Restated Bylaws of the Registrant, as amended through
               March 22, 1995,  incorporated  by reference to Exhibit 3.3 to the
               Registrant's Annual Report on Form 10-K for the fiscal year ended
               December 31, 1994.


                                       55

<PAGE>



       (4.1)   Rights  Agreement,  dated  as  of  June  14,  1994,  between  the
               registrant  and  Continental  Stock  Transfer  &  Trust  Company,
               incorporated  by  reference  to Exhibit  3.4 to the  Registrant's
               Registration  Statement  on Form S-3  effective  October 11, 1994
               (Reg. No. 33-83664).

       (4.2)   Specimen Common Stock  Certificate,  incorporated by reference to
               Exhibit 4(e) to the Registrant's  Registration  Statement on Form
               S-8 as filed and effective on August 5, 1994 (Reg. No. 33-82474).

       (4.3)   Form of Indenture, of 7 1/2% convertible  subordinated debentures
               due 2001 from CII Financial,  Inc. to Manufacturers Hanover Trust
               Company as Trustee  dated  September  15, 1991,  incorporated  by
               reference  to Exhibit 4.2 of  Post-Effective  Amendment  No. 1 on
               Form S-3 to  Registration  Statement on Form S-4 dated October 6,
               1995 (Reg. No. 33-60591).

       (4.4)   First Supplemental Indenture between CII Financial,  Inc., Sierra
               Health Services,  Inc. and Chemical Bank as Trustee,  dated as of
               October  31,  1995,  to  Indenture   dated  September  15,  1991,
               incorporated  by  reference  to  Exhibit  4.3  of  Post-Effective
               Amendment No. 2 on Form S-3 to Registration Statement on Form S-4
               dated October 31, 1995 (Reg. No. 33-60591).

      (10.1)   Administrative  Services agreement between Health Plan of Nevada,
               Inc. and the Registrant  dated December 1, 1987,  incorporated by
               reference to Exhibit 10.17 to Registrant's  Annual Report on Form
               10-K for the fiscal year ended December 31, 1991.

      (10.2)   Administrative  Services agreement between Sierra Health and Life
               Insurance  Company,  Inc. and the Registrant dated April 1, 1989,
               incorporated by reference to Exhibit 10.18 to Registrant's Annual
               Report on Form 10-K for the fiscal year ended December 31, 1991.

     (10.3)   Agreement  between  Health  Plan of Nevada,  Inc.  and the United
               States Health Care Financing  Administration dated July 24, 1992,
               incorporated  by reference to Exhibit  10.18 to the  Registrant's
               Annual  Report  on Form  10-K  filed for the  fiscal  year  ended
               December 31, 1992.

     (10.4)   Loan Agreement  among Bank of America,  Nevada,  the  Registrant,
               Health Plan of Nevada,  Inc. and Sierra Health and Life Insurance
               Company,  Inc. dated November 30, 1993 in the principal amount of
               $14,000,000,  incorporated  by reference to Exhibit  10.19 to the
               Registrant's Annual Report on Form 10-K for the fiscal year ended
               December 31, 1993.

     (10.5)   Loan Agreement  between Home Federal Savings and Loan Association
               and 2314 West Charleston  Partnership dated September 15, 1989 in
               the principal amount of $3,400,000,  incorporated by reference to
               Exhibit 10.22 to the Registrant's  Annual Report on Form 10-K for
               the fiscal year ended December 31, 1992.

     (10.6)   Assumption  and  Reaffirmation  Agreements  dated March 25, 1994,
               incorporated  by reference to Exhibit  10.23 to the  Registrant's
               Annual Report on Form 10-K for the fiscal year ended December 31,
               1993.

     (10.7)   Unconditional  Guarantees  dated March 25, 1994,  incorporated by
               reference to Exhibit 10.24 to the  Registrant's  Annual Report on
               Form 10-K for the fiscal year ended December 31, 1993.



                                       56

<PAGE>



     (10.8)   Compensatory Plans, Contracts and Arrangements.

               (1)  Employment  Agreements with Anthony M. Marlon, M.D.; Erin E.
                    MacDonald; Frank E. Collins; William R. Godfrey; Lawrence S.
                    Howard; Michael A. Montalvo; Jerry D. Reeves, M.D.; Marie H.
                    Soldo;  and James L. Starr with various dates,  incorporated
                    by  reference  to Exhibit 10 to the  Registrant's  Quarterly
                    Report on Form 10-Q for the fiscal  quarter ended  September
                    30, 1994.

               (2)  The  Registrant's  Second  Amended and  Restated  1986 Stock
                    Option Plan as amended to date, incorporated by reference to
                    Exhibit 10.24 to the Registrant's Annual Report on Form 10-K
                    for the fiscal year ended December 31, 1992.

               (3)  The Registrant's Second Restated Capital  Accumulation Plan,
                    as amended to date,  incorporated  by  reference  to Exhibit
                    10.24 to the Registrant's Annual Report on Form 10-K for the
                    fiscal year ended December 31, 1992.

               (4)  The Registrant's Supplemental Retirement Plan, as amended to
                    date,  incorporated  by  reference  to Exhibit  10.24 to the
                    Registrant's  Annual Report on Form 10-K for the fiscal year
                    ended December 31, 1992.

               (5)  The  Registrant's  Deferred  Compensation  Plan, as amended,
                    effective May 1, 1996.

               (6)  Protocols for cash bonus awards,  incorporated  by reference
                    to Exhibit  10.17 (5) to the  Registrant's  Annual Report on
                    Form 10-K for the fiscal year ended December 31, 1994.

               (7)  The  Company's  Long-Term  Incentive  Plan  incorporated  by
                    reference to Form S-8 filed July 7, 1995.

               (8)  The  Company's  1995  Non-Employee   Directors'  Stock  Plan
                    incorporated by reference to Form S-8 filed July 7, 1995.

     (10.9)       Agreement  and Plan of Merger dated as of June 12, 1995 among
                   the Registrant,  Health Acquisition Corp., and CII Financial,
                   Inc.,  incorporated  by  reference  to the Report on Form 8-K
                   dated June 13, 1995, as amended.

     (10.10)       Agreement between the Registrant and First Option Health Plan
                   to  develop  and  implement  a Medicare  risk  product in New
                   Jersey dated  January 6, 1995,  incorporated  by reference to
                   Exhibit 10.20 to the Registrant's  Annual Report on Form 10-K
                   for the fiscal year ended December 31, 1994.

        (11)       Computation of earnings per share.

        (13)       Independent Auditors' Report for CII Financial, Inc. for the
                    year ended December 31, 1994.


                                       57

<PAGE>



        (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:

                                                                Jurisdiction of
                                                                  Incorporation
                   Sierra Health and Life Insurance Company, Inc.    California
                   Health Plan of Nevada, Inc.                       Nevada
                   Sierra Healthcare Options, Inc. and Subsidiary    Nevada
                   Behavioral Healthcare Options, Inc.               Nevada
                   Family Health Care Services                       Nevada
                   Family Home Hospice, Inc.                         Nevada
                   Southwest Medical Associates, Inc.                Nevada
                   Sierra Medical Management, Inc. and Subsidiaries  Nevada
                   Southwest Realty, Inc.                            Nevada
                   Sierra Health Holdings, Inc. (HMO Texas, L.C.)    Texas
                   Sierra Texas Systems, Inc.                        Texas
                   CII Financial, Inc., and Subsidiaries             California
                   Northern Nevada Health Network, Inc.              Nevada
                   Intermed, Inc.                                    Arizona
                   Prime Holdings, Inc. and Subsidiaries             Nevada

      (23.1)       Consent of Deloitte & Touche LLP

      (23.2)       Consent of BDO Seidman LLP

        (27)       Financial Data Schedule

        (99)       Registrant's current report on Form 8-K dated March 28, 1997,
                   incorporated herein.

                   All  other   Exhibits  are  omitted   because  they  are  not
                   applicable.

         (b)       Reports on Form 8-K

         (d)       Financial Statement Schedules


            The Exhibits set forth in Item 14 (a)(2) are filed herewith.





                                       58

<PAGE>



                                   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
                                                     Anthony M. Marlon
Date:  March 28, 1997

         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.      Chief Executive Officer       March 28, 1997
Anthony M. Marlon, M.D.          and Chairman of the Board
                                 (Chief Executive Officer)


/S/ JAMES L. STARR               Vice President of Finance     March 28, 1997
James L. Starr                   Chief Financial Officer
                                 and Treasurer
                                 (Chief Accounting Officer)


/S/ ERIN E. MACDONALD            President and                 March 28, 1997
Erin E. MacDonald                Chief Operating Officer
                                 Director


/S/ CHARLES L. RUTHE             Director                      March 28, 1997
Charles L. Ruthe


/S/ WILLIAM J. RAGGIO            Director                      March 28, 1997
William J. Raggio


/S/ THOMAS Y. HARTLEY            Director                       March 28, 1997
Thomas Y. Hartley


                                       59

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
           SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                 CONDENSED BALANCE SHEETS - Parent Company Only


<TABLE>
<CAPTION>

                                                                                                December 31,
                                                                                      1996                1995
CURRENT ASSETS:
<S>                                                                               <C>                 <C>
     Cash and Cash Equivalents ..........................................         $ 17,761,000        $ 11,814,000
     Short-term Investments..............................................           12,055,000          26,196,000
     Prepaid Expenses and Other Current Assets ..........................            8,103,000           2,144,000
           Total Current Assets..........................................           37,919,000          40,154,000

PROPERTY AND EQUIPMENT - NET ............................................           32,596,000          26,828,000
EQUITY IN NET ASSETS OF SUBSIDIARIES ....................................          145,939,000         119,856,000
NOTES RECEIVABLE FROM SUBSIDIARIES ......................................            9,804,000          12,593,000
LONG-TERM INVESTMENTS ...................................................            6,021,000          12,940,000
GOODWILL AND OTHER INTANGIBLE ASSETS ....................................           14,896,000           2,612,000
OTHER ...................................................................           10,330,000           6,850,000

TOTAL ASSETS ............................................................         $257,505,000        $221,833,000

CURRENT LIABILITIES:
     Accounts Payable and Other Accrued Liabilities .....................         $ 13,268,000        $  9,715,000
     Current Portion of Long-term Debt ..................................              444,000             667,000
           Total Current Liabilities ....................................           13,712,000          10,382,000

LONG-TERM DEBT(Less Current Portion).....................................            3,241,000           3,736,000
OTHER LIABILITIES .......................................................            6,070,000
TOTAL LIABILITIES .......................................................           23,023,000          14,118,000

STOCKHOLDERS' EQUITY:
     Capital Stock ......................................................               89,000              88,000
     Additional Paid-in Capital .........................................          152,035,000         147,240,000
     Treasury Stock .....................................................             (130,000)           (130,000)
     Unrealized Holding Gain on Available-for-sale Investments ..........              487,000           9,659,000
     Retained Earnings ..................................................           82,001,000          50,858,000
           Total Stockholders' Equity ...................................          234,482,000         207,715,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...............................         $257,505,000        $221,833,000
</TABLE>

Note:     Scheduled  maturities  of  long-term  debt,  including  the  principal
          portion of obligations under capital leases, are as follows:
<TABLE>
<CAPTION>

     Year Ending December 31,
<S>       <C>                                                                <C>
          1997...................................................            $   444,000
          1998...................................................                429,000
          1999...................................................              2,384,000
          2000...................................................                428,000
          2001...................................................                    --
          Thereafter.............................................                    --
              Total..............................................             $3,685,000
</TABLE>

                                       S-1

<PAGE>



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

<TABLE>
<CAPTION>


                                                                       Year Ended December 31,
                                                                 1996               1995             1994
OPERATING REVENUES:
<S>                                                              <C>               <C>              <C>
    Management Fees........................................      $44,139,000       $40,115,000      $37,324,000
    Subsidiary Dividends...................................        3,733,000           250,000        1,350,000
    Investment and Other Income............................        5,145,000         4,087,000          928,000
       Total Operating Revenues............................       53,017,000        44,452,000       39,602,000

GENERAL AND ADMINISTRATIVE EXPENSES:
    Payroll and Benefits...................................       11,579,000        12,805,000       12,162,000
    Depreciation...........................................        3,433,000         3,323,000        3,494,000
    Rent...................................................          649,000           738,000        1,186,000
    Repairs and Maintenance................................          408,000           382,000          303,000
    Legal..................................................        1,874,000           226,000        1,109,000
    Consulting.............................................          827,000           583,000          480,000
    Other..................................................        5,145,000         4,252,000        5,053,000
    Acquisition, Restructuring and Other Expenses ..........      12,064,000        11,614,000
       Total General and Administrative....................       35,979,000        33,923,000       23,787,000

INTEREST EXPENSE AND OTHER, NET............................         (503,000)         (396,000)        (467,000)

EQUITY IN UNDISTRIBUTED
    EARNINGS OF SUBSIDIARIES...............................       21,991,000        15,785,000       24,788,000

INCOME BEFORE INCOME TAXES.................................       38,526,000        25,918,000       40,136,000

PROVISION FOR INCOME TAXES.................................       (7,383,000)       (4,614,000)      (5,693,000)

NET INCOME.................................................      $31,143,000       $21,304,000      $34,443,000
</TABLE>


                                       S-2

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
     SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
            CONDENSED STATEMENTS OF CASH FLOWS -- Parent Company Only
<TABLE>
<CAPTION>

                                                                                               Year Ended December 31,
                                                                                    1996              1995               1994

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                               <C>               <C>               <C>
      Net Income...........................................................       $31,143,000       $21,304,000       $34,443,000
      Adjustments to Reconcile Net Income to Net Cash
          Provided by Operating Activities:
          Depreciation and Amortization....................................         3,611,000         3,449,000         3,533,000
      Equity in Undistributed Earnings of Subsidiaries......................      (21,991,000)      (15,787,000)      (24,788,000)
      Change in Assets and Liabilities:
          Other Assets.....................................................       (15,917,000)       (5,021,000)          996,000
          Current Assets...................................................        (5,959,000)         (504,000)         (635,000)
          Current Liabilities..............................................         4,712,000         7,429,000           239,000
          Other Long-term Liabilities .....................................         6,069,000
          Net Cash Provided by Operating Activities.........................        1,668,000        10,870,000        13,788,000

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures.................................................        (9,292,000)       (8,763,000)       (1,935,000)
      Decrease (Increase) in Short-term Securities..........................       14,136,000        22,990,000       (45,316,000)
      Decrease (Increase) in Other Assets..................................         6,942,000        (8,963,000)       (2,659,000)
      Dividends from Subsidiary............................................         3,733,000           250,000         1,350,000
      Acquisitions, Net of Cash Acquired ..................................       (31,270,000)
      (Decrease) Increase in Net Assets in Subsidiaries.....................       14,321,000        (1,572,000)       (7,189,000)
          Net Cash  Provided by (Used for) Investing Activities                    (1,430,000)        3,942,000       (55,749,000)

CASH FLOWS FROM FINANCING ACTIVITIES:
      Loans to Subsidiaries ...............................................                         (12,593,000)
      Reductions in Long-term Obligations and
          Payments on Capital Leases.......................................          (718,000)         (789,000)       (3,688,000)
      Proceeds from Note Receivable to Subsidiary.................................  2,789,000
      Proceeds from Issuance of Common Stock...............................                                            44,579,000
      Exercise of Stock in Connection with Stock Plans..............................3,638,000         3,807,000         4,385,000
          Net Cash (Used for) Provided by Financing Activities.............         5,709,000        (9,575,000)       45,276,000

Net increase in Cash and Cash Equivalents..................................         5,947,000         5,237,000         3,315,000
Cash and Cash Equivalents at Beginning of Year..............................       11,814,000         6,577,000         3,262,000
Cash and Cash Equivalents at End of Year...................................       $17,761,000       $11,814,000       $ 6,577,000
</TABLE>


Supplemental condensed statements of cash flows information:
<TABLE>
<CAPTION>

Cash Paid During the Year for Interest
<S>                                                                                <C>               <C>               <C>
      (Net of Amount Capitalized)..........................................        $  443,000        $  455,000        $  662,000
Cash Paid During the Year for Income Taxes.................................         6,423,000         2,746,000         2,592,000

Noncash Investing and Financing Activities:
      Additions to Capital Leases..........................................               --            278,000           552,000
      Assumptions of Liability in Connection with
          Land Purchase....................................................               --          1,956,000              --
      Stock Issued for Exercise of Options
          and Related Tax Benefits.........................................         1,158,000         1,949,000         2,685,000
</TABLE>


                                       S-3

<PAGE>



                          SIERRA HEALTH SERVICES, INC.
                            SUPPLEMENTAL INFORMATION
                    CONCERNING PROPERTY -- CASUALTY INSURANCE
                             (amounts in thousands)



<TABLE>
<CAPTION>

                                    Gross                                                 Claims & Claim   Amortization
                                   Reserves                                                 Adjustment        of
                      Deferred    for Unpaid  Discount                                  Expenses Incurred  Deferred Paid Claims
                       Policy     Claims and   if any                 Gross    Net          Related to    Policy   and Claims Direct
                     Acquisition  Adjustment  Deducted in  Unearned   Earned   Investment  (1)     (2)      Acq. Adjustment Premiums
Affiliation With        Costs     Expenses    Column C     Premiums  Premiums  Income   Current Prior Year Costs  Expenses   Written
Registrant Column A    Column B   Column C    Column D     Column E  Column F  Column G   Year  Column H  Column I Column J Column K

Consolidated
 Property and
 Casualty Entities
 of CII Financial,
 Inc. for
 Years Ended:
<S>       <C> <C>       <C>       <C>          <C>       <C>       <C>       <C>      <C>      <C>       <C>      <C>     <C>
 December 31, 1996      $1,832    $187,776     --        $9,885    $126,121  $16,422  $101,401 $(15,284) $21,968  $70,464 $126,497
 December 31, 1995       1,928     182,318     --         9,282      94,611   14,301    75,978  (20,079)  22,028   61,071   94,953
 December 31, 1994       2,285     190,962     --         8,940      94,684   12,506    67,642  (13,953)  23,238   66,584   92,983
</TABLE>















                                       S-4

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                                 SECTION 403.04b
              RECONCILIATION OF BEGINNING AND ENDING LOSS AND LOSS
                           ADJUSTMENT EXPENSE RESERVES
                   AND EXHIBIT OF REDUNDANCIES (DEFICIENCIES)
                                 (in thousands)

<TABLE>
<CAPTION>

                                                                                             Year ended December 31
                                       1996       1995       1994       1993       1992       1991       1990       1989      1988

Losses and LAE
<S>                                  <C>        <C>        <C>        <C>         <C>       <C>       <C>        <C>        <C>
   Reserve......................     $187,776   $182,318   $190,962   $200,356    $178,460  $112,749  $ 67,593   $ 37,466   $ 10,277

Less Reinsurance
   Recoverables (1).............       15,676     25,871     29,342     25,841      20,207

Net Loss and LAE
   Reserves ....................      172,100    156,447    161,620    174,515     158,253

Cumulative Net Paid
   as of:
   One Year Later ..............                  45,731     44,519     50,210      50,360    57,611    39,118     14,820      3,954
   Two Years Later .............                             68,619     79,788      84,465    89,177    65,165     28,657      6,609
   Three Years Later                                                    94,865     104,569   108,849    76,988     36,579      8,198
   Four Years Later                                                                114,293   120,539    83,822     39,345      8,938
   Five Years Later                                                                          126,100    87,618     41,043      9,235
   Six Years Later .............                                                                        89,607     41,962      9,398
   Seven Years Later                                                                                               42,541      9,471
   Eight Years Later                                                                                                           9,517

Net Reserve Re-estimated
   as of:
   One Year Later ..............                 141,163    139,741    160,562     154,388   140,815    83,841     37,463     10,072
   Two Years Later .............                            125,279    141,100     147,167   142,447    96,011     39,753      9,902
   Three Years Later                                                   126,483     134,747   143,433    97,142     43,528      9,598
   Four Years Later                                                                132,193   137,143    97,942     44,404      9,330
   Five Years Later                                                                          135,249    94,852     45,027     10,042
   Six Years Later .............                                                                        93,561     44,543     10,110
   Seven Years Later                                                                                               43,741     10,124
   Eight Years Later                                                                                                           9,695

Cumulative Redundancy
   (Deficiency) ................                  15,284     36,341     48,032      26,060   (22,500)  (25,968)    (6,275)       582

Net Reserve.....................      172,100    156,447    161,620    174,515
Reinsurance Recoverables                          15,676     25,871     29,342      25,841
Gross Reserve ..................      187,776    182,318    190,962    200,356

Net Re-estimated Reserve                         141,164    125,279    126,483
Re-estimated Reinsurance
   Recoverables ................                  17,428     17,682     13,987
Gross Re-Estimated
   Reserve .....................                 158,592    142,961    140,470
Gross Cumulative
   Redundancy...................               $  23,726   $ 48,001   $ 59,886
</TABLE>


(1)     The Company adopted Financial  Accounting  Standards Board Statement No.
        113 ("FAS  113"),  "Accounting  and  Reporting  for  Short-Duration  and
        Long-Duration  Reinsurance  Contracts"  for the year ended  December 31,
        1992. As permitted,  prior financial  statements have not been restated.
        Reinsurance  recoverables on unpaid losses and LAE are shown as an asset
        on the  balance  sheets at  December  31,  1996 and 1995.  However,  for
        purposes of the  reconciliation  and  development  tables,  loss and LAE
        information will be shown net of reinsurance.

(2)     The above table includes the nine years of data since the commencement
        of workers' compensation insurance operations by the Company.

               See the notes to consolidated financial statements.



                                       S-5