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, 1998

                                       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. [ ]

     The aggregate  market value of the voting stock held by  non-affiliates  of
the registrant on February 26, 1999 was $353,058,000.

     The  number of shares  of the  registrant's  common  stock  outstanding  on
February 26, 1999 was 27,141,000.

                       DOCUMENTS INCORPORATED BY REFERENCE
          DOCUMENT                                          WHERE INCORPORATED

    Registrant's Current Report on Form 8-K dated                  Part I
                    March 17, 1999.                            Part II, Item 7

Portions of the registrant's definitive proxy statement for       Part III
its 1999 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.

                                           1998 FORM 10-K ANNUAL REPORT

                                                 TABLE OF CONTENTS
<TABLE>
<CAPTION>

                                                                                                               Page
                                                      PART I

<S>   <C>                                                                                                         <C>
Item  1.      Business .................................................................................          1

Item  2.      Properties................................................................................         17

Item  3.      Legal Proceedings.........................................................................         17

Item  4.      Submission of Matters to a Vote of Security Holders.......................................         17


                                                      PART II

Item  5.      Market for Registrant's Common Stock and
                 Related Stockholder Matters............................................................         18

Item  6.      Selected Financial Data...................................................................         19

Item  7.      Management's Discussion and Analysis of Financial Condition
                 and Results of Operations .............................................................         20

Item 7a.      Quantitative and Qualitative Disclosures about Market Risk ...............................         32

Item  8.      Financial Statements and Supplementary Data...............................................         33

Item  9.      Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure....................................................         62


                                                     PART III

Item 10.      Directors and Executive Officers of the Registrant........................................         62

Item 11.      Executive Compensation....................................................................         62

Item 12.      Security Ownership of Certain Beneficial Owners and Management............................         62

Item 13.      Certain Relationships and Related Transactions............................................         62


                                                      PART IV

Item 14.      Exhibits, Financial Statement Schedules and Reports on Form 8-K...........................         63
</TABLE>

                                                         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"),
managed  indemnity  plans,  a third-party  administrative  services  program for
employer-funded  health benefit plans,  workers' compensation medical management
programs and a subsidiary  that  administers a managed care federal  contact for
the  Department  of  Defense's  TRICARE  program in Region 1. This  contract  is
currently  structured as five one-year option periods. If all option periods are
exercised  by  the  Department  of  Defense  ("DOD")  and no  extensions  of the
performance  period are made,  health care delivery will end on May 31, 2003 for
Region 1. Ancillary  products and services that complement the Company's managed
health care and workers' compensation product lines are also offered.

On October 31, 1998,  Sierra and one of its  subsidiaries,  Texas Health Choice,
L.C.  ("TXHC"),  (formerly HMO Texas L.C.)  completed the acquisition of certain
assets of Kaiser Foundation Health Plan of Texas ("Kaiser-Texas"), a health plan
operating in Dallas/Ft. Worth with approximately 109,000 members, and Permanente
Medical Association of Texas ("Permanente"),  a medical group with approximately
150 physicians. The purchase price was $124 million, which is net $20 million in
operating  cost support to be paid to Sierra by Kaiser  Foundation  Hospitals in
five  quarterly  installments  following  the  closing of the  transaction.  The
purchase  price  includes  amounts for real estate and eight  medical and office
facilities  with  approximately  500,000 square feet. In December 1998,  certain
accreditation  goals were met by the health plan  resulting in a purchase  price
increase of $3.0 million, to $127 million. The purchase price may increase up to
an  additional  $27  million  over  three  years if  certain  growth  and member
retention goals are met by the health plan.  Sierra assumed no prior liabilities
for malpractice or other litigation, or for any unanticipated future adjustments
to claims  expenses for periods prior to closing.  The  transaction was financed
with a five-year  revolving  credit facility and a $35.2 million note payable to
Kaiser Foundation Health Plan of Texas. The note is secured by the acquired real
estate. Approximately $110 million of the $200 million revolving credit facility
was used to fund the transaction.

On December 31, 1998, Sierra completed the acquisition of the Nevada health care
business of Exclusive Healthcare,  Inc. ("EHI"),  United of Omaha Life Insurance
Company and United World Life  Insurance  Company  ("United"),  all of which are
subsidiaries of Mutual of Omaha Insurance Company. Sierra retained approximately
9,000 members  (approximately  4,400 HMO members) subsequent to the acquisition.
On January 27, 1999, Sierra signed a definitive  agreement to purchase the Texas
operations of EHI (6,900 HMO members) and United's  related  preferred  provider
organization  ("PPO")  that  is  part  of the  dual  option  HMO/PPO  plan.  The
transaction  is  expected  to be  completed  no later than April 30, 1999 and is
subject to regulatory  approvals.  The purchase  price of both  transactions  is
contingent based on how many members are retained through 2000 and 2001. No cash
will be paid until group renewals begin in 2000.

On September  30, 1997,  Sierra  Military  Health  Services,  Inc.  ("SMHS") was
awarded a TRICARE  contract to provide  managed health care coverage to eligible
beneficiaries in Region 1. In June 1998, the Company began providing health care
benefits to approximately 606,000 individuals in Connecticut,  Delaware,  Maine,
Maryland,  Massachusetts,  New Hampshire,  New Jersey,  New York,  Pennsylvania,
Rhode Island, Vermont, Virginia, West Virginia and Washington, D.C. In 1998, the
award resulted in a total of approximately $204.8

                                                         1

<PAGE>



million of revenue for the final  five-months  of the  implementation  phase and
seven  months of health care  delivery.  SMHS was  notified on February 13, 1998
that  the  United  States  General   Accounting   Office  ("GAO")   sustained  a
competitor's  protest of the  contract  award for TRICARE  Managed  Care Support
Region 1 and  recommended  that the contract be re-bid.  In December  1998,  the
Company  reached an agreement to settle the protest (See Note 14 of Notes to the
Consolidated  Financial Statements).  As part of the settlement,  the competitor
will forego any and all rights it may have to challenge  the contract  award and
seek a re-bid.

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,  1998,  the Company  provided  HMO products to  approximately
182,000  members in Nevada,  112,000 in Dallas,  25,000 in Houston  and 5,000 in
Arizona.  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
41,000 members,  Medicare supplement  products to approximately  26,000 members,
and administrative  services to approximately 318,000 members.  Medical premiums
account  for  approximately  59% of total  revenues.  Approximately  70% of such
medical premiums were derived from southern Nevada in 1998. With the acquisition
of  Kaiser-Texas,  medical premiums derived from southern Nevada in November and
December of 1998 were approximately 57% of medical premium revenue.

Health Maintenance Organizations. The Company operates mixed group network model
HMOs in Las Vegas, Nevada and Dallas/Ft. Worth, Texas and a network model HMO in
Reno,  Nevada  and  Houston,  Texas.  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 or claim forms.

Most of the  Company's  managed  health  care  services  in Nevada are  provided
through its  independently  contracted  network of over 2,200  providers  and 13
hospitals.  These Nevada networks include the Company's  multi-specialty medical
group,  which provides medical  services to  approximately  71% of the Company's
Nevada HMO members and employs  over 170  primary  care and other  providers  in
various medical  specialties.  The Company  directly  provides home health care,
hospice  care and  behavioral  health care  services and operates a company that
provides  home  infusion,  oxygen and durable  medical  equipment  services.  In
addition,  the Company  operates three 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 in Nevada provides a competitive  advantage as it has helped it to manage
health care costs effectively while delivering quality care.

On October 31, 1998,  the Company  acquired  certain assets of  Kaiser-Texas,  a
group model HMO with  approximately  109,000 members and a 150 physician medical
group in Dallas/Ft.  Worth,  Texas. The independently  contracted  medical group
provides  professional  services from nine health centers;  eight of which offer
primary care services while two offer specialty care services. In addition, TXHC
has contracts with 13 hospitals for inpatient care in Dallas/Ft.  Worth. Shortly
after the  acquisition,  the Company  changed the provider  model in  Dallas/Ft.
Worth  from a group  model to a mixed  network  model by  overlaying  individual
practice association ("IPA") delivery systems on top of the existing group model
to provide  members with more choice.  The first IPA was  contracted in November
1998 and added approximately

                                                         2

<PAGE>



1,500  physicians  to the  Dallas/Ft.  Worth  delivery  system.  The Houston HMO
members are served by approximately 1,600 independent  contracted  providers and
30 hospitals.

In addition to its commercial HMO plans, which involve  traditional HMO benefits
and  POS   benefits,   the   Company   offers  a  Medicare   risk   product  for
Medicare-eligible  beneficiaries called Senior Dimensions in Nevada and parts of
Arizona and Golden Choice in Texas.  Senior  Dimensions is marketed  directly to
Medicare-eligible  beneficiaries in the Company's Nevada service area as well as
contiguous  parts of Arizona.  The monthly payment received from the Health Care
Financing  Administration  ("HCFA")  is  determined  by formula  established  by
Federal law. The Balanced Budget Act of 1997 included  legislative changes which
affected  the  way  health  plans  are  compensated  for  Medicare   members  by
eliminating over five years amounts paid for graduate  medical  education and by
increasing  the blend of national  cost  factors  applied in  determining  local
reimbursement  rates over a six-year phase-in period. Both changes will have the
effect of reducing  reimbursement in high cost  metropolitan  areas with a large
number of teaching hospitals;  however, the legislation includes a provision for
a minimum increase of 2% annually in health plan Medicare  reimbursement for the
next five years.  Under the authority  provided by the 1997 Balanced  Budget Act
(see "Government Regulation and Recent Legislation"),  HCFA has begun to collect
hospital encounter data from Medicare risk contractors. The data will be used to
implement  a new  risk  adjustment  mechanism  which  will be  phased  in over a
five-year period  beginning  January 1, 2000. Given the relatively high Medicare
risk premium levels in certain of the Company's  market areas, the Company is in
jeopardy that the new risk adjustment  mechanism to be developed could adversely
affect the Company's Medicare premium rates going forward.  The Company does not
believe  that the risk  adjustment  mechanism  will be  applied  to  Social  HMO
capitation payments.

As of December  31,  1998,  the Company had 47,000  Medicare  members,  of which
33,500  were   located  in  Nevada,   8,300  in  Texas  and  5,200  in  Arizona.
Approximately  26,000 of the Nevada  Medicare  members were enrolled in a Social
Health Maintenance  Organization (see "Social Health  Maintenance  Organization"
following).

Social Health Maintenance Organization.  Effective November 1, 1996, the Company
entered  into a Social HMO  contract  pursuant  to which a large  portion of the
Company's Medicare risk enrollees will receive certain expanded benefits. Sierra
was one of six HMOs nationally to be awarded this contract, and is currently the
only  company to have  implemented  the program as of  December  31,  1998.  The
Company receives additional revenues for providing these expanded benefits.  The
additional  revenues are determined  based on health risk  assessments that have
been, and will continue to 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 and walking.  These members, as identified in the health risk
assessments,  are those who  currently  have  difficulty  performing  such daily
living functions because of a health or physical problem. HCFA has expressed the
intention to continue the current  reimbursement  methodology for the Social HMO
contract  through   December  31,  2000.  HCFA  has  considered   adjusting  the
reimbursement  factors for the Social HMO members. At this time, however,  there
can be no  assurance  as to what the final per member  reimbursement  will be or
that the social HMO contract will be renewed.

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 PPO network.  As of December 31, 1998,  approximately  41,000  members
were enrolled in Sierra's managed indemnity plans.

The  Company  currently  provides  managed  indemnity  and  Medicare  supplement
services  to  individuals  in  Nevada,  Arizona,  Colorado,  Texas,  California,
Louisiana,  Iowa and South  Carolina.  The  Company  is also  exploring  further
expansion  in  certain  other  states and  currently  provides  other  insurance
services in Missouri, New Mexico, and Pennsylvania.  As of December 31, 1998 the
PPO is licensed in a total of 43 states and the District of Columbia.

                                                         3

<PAGE>




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, nuclear
medicine  services,  and mental health and substance abuse services.  In Nevada,
the Company  also  provides  home health care  services,  a hospice  program and
vision  services.  These services are provided to members of the Company's HMOs,
managed  indemnity  and  administrative  services  plans.  The mental health and
substance abuse services are also provided to approximately 137,000 participants
from non-affiliated  employer groups and insurance companies.  In addition,  the
Company offers home infusion, oxygen and durable medical equipment services.

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, 1998,  approximately 318,000
members  were  enrolled in the  Company's  administrative  services  plans.  The
results of  operations  for these  services are  included in  specialty  product
revenues and expenses in the Consolidated Statements of Operations.

Workers' Compensation Operations

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, Missouri,
Nebraska,  New  Mexico,  Texas and Utah.  CII has  licenses in 31 states and the
District of Columbia.  California,  Colorado, and Texas represent  approximately
84%, 8%, and 5%,  respectively,  of CII's fully  insured  workers'  compensation
insurance premiums in 1998. Workers' compensation insurance premiums account for
approximately  13% of the Company's  total  revenue.  The workers'  compensation
subsidiary  applies the  discipline of managed care concepts to its  operations.
These concepts include, but are not limited to, the use of specialized preferred
provider networks,  utilization reviews by employed board certified occupational
medicine and orthopedic  surgeons as well as nurse case  managers,  medical bill
reviewers and job developers who facilitate early return to work.

Effective  September 30, 1997, the Company terminated its workers'  compensation
administrative  services contract with the state of Nevada.  The contract served
approximately  200,000  enrollees  and  provided  approximately  $3.2 million in
revenues for the year ended  December 31, 1997.  The contract was  terminated to
allow the Company to participate in the Nevada workers'  compensation  insurance
market when the state  allows  private  insurance  companies  to begin  offering
products on July 1, 1999.

Military Contract Services

Sierra  Military  Health  Services,  Inc. On September 30, 1997, the Company was
awarded a TRICARE  contract to provide  managed health care coverage to eligible
beneficiaries in Region 1. This region includes  approximately  606,000 eligible
individuals  in  Connecticut,  Delaware,  Maine,  Maryland,  Massachusetts,  New
Hampshire, New Jersey, New York, Pennsylvania,  Rhode Island, Vermont, Virginia,
West Virginia and Washington,  D.C. SMHS completed an eight month implementation
phase in May 1998 and began providing health care benefits on June 1, 1998 under
the TRICARE contract.

Under the TRICARE contract,  SMHS provides health care services to approximately
606,000  dependents of active duty military  personnel and military retirees and
their dependents through  subcontractor  partnerships and individual  providers.
Through such partnerships,  SMHS also performs specific administrative services,
such as health care appointment scheduling,  enrollment,  network management and
health  care  advice  line  services.  SMHS  performs  such  services  using DOD
information  systems. If all five option periods are exercised by the DOD and no
extensions of the performance  period are made, health care delivery will end on
May 31, 2003,  followed by an  additional  eight month  phaseout of the Region 1
managed care support contract.



                                                         4

<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 HMOs'
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. In addition,  the Company employs full-time field
underwriters who meet with agents and brokers and can provide an immediate quote
on a policy.  As of  December  31,  1998,  the Company  had  relationships  with
approximately  730  agents  and 20  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.

SMHS administers  marketing  initiatives in accordance with the TRICARE Region 1
managed  care  support  contract.  SMHS'  dedicated  Marketing  Division  uses a
multi-faceted  marketing approach to ensure that all beneficiaries within Region
1 have the opportunity to learn about the health care benefits under TRICARE and
have the  opportunity  to make health care choices that best fit their  specific
needs. Marketing initiatives include direct beneficiary briefings,  direct mail,
newspaper advertising, newsletters and web page briefs.


                                                         5

<PAGE>



Membership

Period End Membership:
<TABLE>

<CAPTION>
                                                                     Years Ended December 31,
                                                     1998          1997         1996         1995         1994
HMO:
<S>                                                  <C>          <C>          <C>          <C>          <C>
    Commercial..............................         277,000      156,000      147,000      116,000      107,000
    Medicare................................          47,000       36,000       30,000       25,000       20,000
Managed Indemnity...........................          41,000       64,000       46,000       31,000       24,000
Medicare Supplement.........................          26,000       25,000       23,000       15,000        9,000
Administrative Services (1) ................         318,000      328,000      338,000      117,000       65,000
TRICARE Eligibles...........................         606,000      _______      _______      _______      _______
    Total Membership........................       1,315,000      609,000      584,000      304,000      225,000
</TABLE>

(1)  For  comparability  purposes,  enrollment  information has been restated to
     reflect  the  September  30, 1997  termination  of the  Company's  workers'
     compensation  administrative  services  contract  with the state of Nevada.
     Enrollment in the terminated plan was 163,000, 94,000 and 79,000 members at
     December 31, 1996, 1995 and 1994, respectively.

For  the  years  ended  December  31,  1998  and  1997,  the  Company   received
approximately  23.0% and 23.7%,  respectively,  of its total  revenues  from its
contract with 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
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 (See "Government Regulation and Recent Regulation").

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, 1998,  the Company's ten
largest HMO employer  groups were, in the aggregate,  responsible  for less than
10% of the Company's  total  revenues.  Although  none of such  employer  groups
accounted for more than 2% 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 71% of the Company's Nevada HMO members
and 80% of its Texas  HMO  members  receive  primary  health  care  through  the
Company's  affiliated  multi-specialty  medical groups. The Company makes health
care  available  through  independently  contracted  providers  employed  by the
multi-specialty  medical groups and other  independently  contracted networks 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 limited  incentive  risk  arrangements  and  utilization
management with respect

                                                         6

<PAGE>



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. In Nevada, 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 limited
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  and  reduced   fee-for-service
agreements  with  certain  specialists  and primary  care  providers  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  hospital  providers
typically renew  automatically  with both parties granted the right to terminate
after  a  notice  period   ranging  from  between   three  and  twelve   months.
Reimbursement   arrangements   with  other  health  care  providers,   including
pharmacies,  generally renew  automatically  or are negotiated  annually and are
based on several  different  payment  methods,  including  per diems  (where the
reimbursement  rate  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.

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.  The per diem  rate
increased  1% in 1998 and is scheduled  for 2% in 1999.  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.  In Texas,  the  Company  has
negotiated a capitation  arrangement with Columbia  Hospital,  Inc. for hospital
services  provided in Houston and has contracts  with 13 hospitals for inpatient
care in Dallas/Ft. Worth.

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 manages health care costs through its large case management program,
urgent  care  centers  and by  educating  its members on how and when to use the
services of its plans and how to manage chronic disease conditions.  The Company
also audits hospital bills to identify inappropriate charges. Further, in Nevada
the Company  utilizes its home health care agency and its hospice which helps to
minimize hospital admissions and lengths of stay.

Military Health Services. Under the TRICARE contract,  dependents of active duty
military  personnel  and military  retirees and their  dependents  choose one of
three option plans available to them for health care services: (1) TRICARE Prime
(an  HMO  style  option  with  a  self-selected  primary  care  manager  and  no
deductibles),  (2) TRICARE Extra (a PPO style option),  or (3) TRICARE  Standard
(an indemnity style option with deductibles and cost shares).  Approximately 30%
of eligible beneficiaries receive their primary care

                                                         7

<PAGE>



through  existing  Military  Treatment  Facilities.  SMHS negotiated  discounted
contracts with approximately 20,000 individual providers, 1,200 institutions and
5,000  pharmacies to provide  supplemental  network access for TRICARE Prime and
Extra  beneficiaries.   SMHS'  contracts  with  providers  are  primarily  on  a
discounted  fee-for-service  basis with renewal and termination terms similar to
Sierra's  commercial  practice.  SMHS is at-risk for and manages the health care
service cost of all TRICARE Extra and Standard  beneficiaries as well as a small
percentage of TRICARE Prime beneficiaries.

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  groups  maintain  excess  malpractice
insurance  for the  providers  presently  employed  by the group.  In Nevada and
Arizona, the Company has assumed the risk for the first $250,000 per malpractice
claim,  not to exceed $1.5 million in the  aggregate per contract year up to its
limits of coverage. In Texas, the Company has assumed no self-insured  retention
per claim.  The  aggregate  maximum  exposure for each of these  policies is $30
million per year.  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,  depending on the  contract,
$100,000 to $200,000, during the contract year and up to $2.0 million per member
per lifetime.

Effective July 1, 1997, the Company also maintains excess catastrophic  coverage
for one of the Company's wholly-owned HMOs, Health Plan of Nevada, Inc. ("HPN"),
that  reimburses  the Company for amounts by which the ultimate net loss exceeds
$400,000,  but does not exceed the annual  maximum of $19.6 million per accident
and $39.2 million per contract. In the ordinary course of its business, however,
the Company is subject to claims that are not  insured,  principally  claims for
punitive damages.

Effective January 1, 1998,  workers'  compensation  claims are reinsured between
$500,000 and $100 million per occurrence. For claims occurring on and after July
1, 1998, that are below $500,000, the Company obtained quota share and excess of
loss reinsurance.  Under this agreement,  the Company reinsures 30% of the first
$10,000 of each claim,  75% of the next  $40,000 and 100% of the next  $450,000.
The  Company  receives  a ceding  commission  from the  reinsurer  as a  partial
reimbursement of operating expenses.

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.

Year 2000

The Year 2000 issue  exists  because  many  computer  systems  and  applications
currently  use  two-digit  date fields to designate a year.  As the century date
change occurs,  date-sensitive  systems will recognize the year 2000 as 1900, or
not at all.  This  inability to  recognize  or properly  treat the Year 2000 may
cause  systems  to  process  critical  financial  and  operational   information
incorrectly.


                                                         8

<PAGE>



The Company is currently  in the process of  modifying or replacing  its mission
critical financial and operational  computer systems. The Company is also in the
process  of  testing  its  non-information   system  technology  for  Year  2000
compliance.  The Year 2000  project has been broken down into five  phases:  (1)
inventorying  Year  2000  items;  (2)  assessing  the Year 2000  items  that are
determined to be material to the Company;  (3) renovating or replacing  material
items  that are  determined  not to be Year  2000  compliant;  (4)  testing  and
validating material items; and (5) implementing renovated and validated systems.

At December 31, 1998,  the inventory  and  assessment  phases are  substantially
complete as it relates to all material  computer systems and  approximately  50%
complete  as it  relates  to  non-information  system  technology.  The  Company
estimates  that the  replacement/renovation  phases  and the  testing/validation
phases will be 95% complete by October 31, 1999.  The Company  estimates that it
is  approximately  50% complete  with the total project as of December 31, 1998.
Contingency  planning for the mission critical business  operations is scheduled
to be  completed  by the end of  April  1999.  These  plans  focus  on  business
operations   involving   information   systems   and   non-information   systems
technologies.

The Company has initiated formal  communications with entities with whom it does
business to assess  their Year 2000  issues.  Evaluations  of the most  critical
third  parties  have been  initiated,  and  follow-up  reviews will be conducted
through 1999.  Contingency  plans are being developed based on these evaluations
and are  expected  to be  completed  by the  middle  of  1999.  There  can be no
assurances that the systems of other companies or governmental agencies, such as
HCFA and the DOD, on which the Company  relies will be timely  modified for Year
2000, or that the failure to modify by another company would not have a material
adverse  effect on the Company.  Based upon two separate  reports  issued by the
United States General Accounting Office it is doubtful that the computer systems
at both HCFA and the DOD will be fully Year 2000  compliant  by the end of 1999.
The Company does not currently have available data to predict the impact of such
non-compliance on its business  operations.  Should there be any material delays
caused  by Year 2000  issues,  the  Company  anticipates  that the  governmental
entities will make estimated payments.

The  Company  is in the  process  of  implementing  three  major  systems  at an
estimated cost of $36 million to $38 million,  which includes the implementation
costs related to the recently  acquired  Kaiser-Texas  operations.  To date, the
Company has spent  approximately  $19.0 million on the new computer  systems and
other Year 2000 items. The Company is expensing the costs to make  modifications
to existing computer systems and non-computer  equipment.  Management  currently
estimates the  remaining new computer  system costs and other Year 2000 costs to
be $13.0  million to $16.0  million for  operations  in  existence  prior to the
Kaiser-Texas  transaction and $6.0 million to $8.0 million for the  Kaiser-Texas
operations  that were acquired on October 31, 1998.  While this is a substantial
effort,   it  will  give  the  Company  the  benefits  of  new   technology  and
functionality  for many of its financial and  operational  computer  systems and
applications.

The  failure  to  correct  a  material  Year  2000  problem  could  result in an
interruption  of, or a failure of,  certain  business  activities or operations.
Such  failures  could  materially  adversely  affect the  Company's  operations,
liquidity and financial  condition.  Due to the general uncertainty  inherent in
the Year  2000  problem,  resulting  in part from  uncertainty  of the Year 2000
readiness of third parties with which the Company does business,  the Company is
unable to determine at this time whether the consequences of potential Year 2000
failures  will have a  material  adverse  impact  on the  Company's  results  of
operations, liquidity or financial condition. The Company's Year 2000 project is
expected to  significantly  reduce the Company's level of uncertainty  about the
Year 2000 problem. The Company believes that, with the implementation of the new
computer  systems  and  completion  of the  entire  project  as  scheduled,  the
possibility of significant interruptions of operations should be reduced.

The above contains  forward-looking  statements  including,  without limitation,
statements   relating   to  the   Company's   plans,   strategies,   objectives,
expectations,  intentions, and adequate resources, that are made pursuant to the
"safe harbor"  provisions  of the Private  Securities  Litigation  Reform Act of
1995.  Readers are cautioned that  forward-looking  statements  contained in the
Year 2000 disclosure should be read in conjunction with the following disclosure
of the Company:


                                                         9

<PAGE>



The costs of the project  and the dates on which the  Company  plans to complete
the necessary Year 2000  modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued  availability of certain resources and other factors.  However,  there
can be no guarantee  that these  estimates  will be achieved and actual  results
could differ materially from those plans. Specific factors that might cause such
material  differences include, but are not limited to, the availability and cost
of  personnel  trained in this area,  the  ability  to locate  and  correct  all
relevant  computer codes,  the ability of the Company's  significant  suppliers,
customers  and others with which it  conducts  business,  including  federal and
state governmental  agencies, to identify and resolve their own Year 2000 issues
and similar uncertainties.

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.

Several independent organizations have been formed for the purpose of responding
to external demands for accountability in the health care industry.  The Company
has  voluntarily  elected  to be  evaluated  by  these  external  organizations,
including the National  Committee for Quality  Assurance  ("NCQA") and the Joint
Commission on Accreditation of Healthcare Organizations ("JCAHO").

NCQA is an independent,  not-for-profit organization that evaluates managed care
organizations.  The NCQA  accreditation  process includes  rigorous  evaluations
conducted  by a team of  physicians  and managed  care  experts.  No  comparable
evaluation exists for  fee-for-service  health care. The NCQA evaluates plans on
approximately  50  quality  standards  that  fall into six  categories:  Quality
Management  and  Improvement;   Physician   Credentials;   Members'  Rights  and
Responsibilities;  Preventive  Health  Services;  Utilization  Management;  and,
Medical  Records.  In 1998,  Health Plan of Nevada  ("HPN") earned a three-year,
full  accreditation  from the NCQA for its HMO and Medicare  products in the Las
Vegas  metropolitan area and Pahrump.  TXHC in Dallas/Ft.  Worth currently has a
One-Year Accreditation from NCQA, pending a May 1999 acquisition review.

     The JCAHO reviews rights,  responsibilities and ethics,  continuum of care,
education and communication,  leadership,  management of information,  and human
resources and network  performance.  The Company's  home health care and hospice
subsidiaries are JCAHO accredited.

There can be no assurance, however, that the Company will 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  could  have on HPN's or  TXHC's
competitive   positions  in  southern   Nevada  and  Dallas/Ft.   Worth,   Texas
respectively.



                                                        10

<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
various 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  demographic  variations
specific  to each  employer  group  such  as the  average  age and sex of  their
employees,  group size and  industry.  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 similar  demographic  adjustment  factors
such as age, sex and industry factors to develop group-specific adjustments from
a given per member per month base rate by plan.  Actual health claims experience
is used in whole or in part 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.

Competition

HMO and Managed  Indemnity.  Managed care companies and HMOs operate in a highly
competitive  environment.  The Company's major  competition is from  self-funded
employer plans, PPO networks,  other HMOs, such as Humana Care Plus, Pacificare,
Inc., Aetna and Harris  Methodist 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  markets 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

                                                        11

<PAGE>



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.  Since open  rating  became  effective  for
policyholders  in  1995,  there  have  been,  and  continue  to be,  substantial
reductions  in  premiums.  The  Company  believes  that  there are more than 200
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.

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 and
Texas,  the National Council on Compensation  Insurance  ("NCCI") is usually the
designated rating organization. The NCCI accumulates statistical information and
recommends pure loss costs to the state's  Department of Insurance.  The Company
then selects loss cost multiplier, expense loads to derive premium rates. Rating
plans in those  states are more  "standardized"  and are usually  based on plans
developed by the NCCI.

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 been incurred but have not yet been reported to the Company ("incurred
by not reported" or "IBNR").

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

                                                        12

<PAGE>



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  insureds'  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 and quality 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  and  members,
licensing and financial condition.

Government  regulation  of health  care  coverage  products  and  services  is a
changing area of law that varies from  jurisdiction to jurisdiction.  Changes in
applicable  laws  and  regulations   are   continually   being   considered  and
interpretation  of  existing  laws and rules also may change  from time to time.
Regulatory agencies generally have broad discretion in promulgating  regulations
and in interpreting and enforcing laws and regulations.

While the Company is unable to predict what regulatory  changes may occur or the
impact on the Company of any  particular  change,  the Company's  operations and
financial  results could be negatively  affected by  regulatory  revisions.  For
example,  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.  The continued  consideration
and enactment of  "anti-managed  care" laws and regulations by federal and state
bodies may make it more  difficult for the Company to control  medical costs and
may adversely affect financial results.

In  addition  to changes in  applicable  laws and  regulations,  the  Company is
subject to various audits, investigations and enforcement actions. These include
possible  government actions relating to the federal Employee  Retirement Income
Security Act, which  regulates  insured and  self-insured  health coverage plans
offered by employers,  the Federal  Employees  Health Benefit Plan,  federal and
state fraud and abuse laws, and laws relating to utilization  management and the
delivery  of  health  care  and  payment  or  reimbursement  therefor.  Any such
government action could result in assessment of damages, civil or criminal fines
or

                                                        13

<PAGE>



penalties,  or  other  sanctions,  including  exclusion  from  participation  in
government  programs.  In addition,  disclosure of any adverse  investigation or
audit results or sanctions could negatively  affect the Company's  reputation in
various  markets and make it more difficult for the Company to sell its products
and services.

The Company has HMO licenses in Nevada,  Texas and Arizona.  The  Company's  HMO
operations  are subject to regulation by the Nevada  Division of Insurance,  the
Nevada  Division of Health,  the Texas  Department  of Insurance and the Arizona
Department of Insurance.  The Company's health insurance subsidiary is domiciled
and  incorporated in California and is licensed in 43 states and the District of
Columbia, with current operations primarily in Nevada, Arizona, Colorado, Texas,
California,  Louisiana,  Iowa and South Carolina. It is subject to licensing 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 $2.0 million and totalling  $17.8 million
at  December  31,  1998.  The  Company's  HMO and  insurance  subsidiaries  meet
requirements to maintain minimum  stockholder's equity ranging from $1.1 million
to $5.2 million. In addition, in conjunction with the Kaiser-Texas  acquisition,
TXHC  entered into a letter  agreement  with the Texas  Department  of Insurance
whereby  TXHC agreed to  maintain a net worth of $20.0  million.  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 greater 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 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

                                                        14

<PAGE>



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.

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 Antikickback
Statute.  The Office of the  Inspector  General  recently  proposed new rules to
clarify those safe harbors.  HHS has also recently proposed to establish certain
safe harbors under the Stark Amendments.  The Company believes that its business
arrangements and operations are in compliance with the Antikickback  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 Antikickback
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.

In 1997,  Congress  passed the  Balanced  Budget Act ("Act")  which  revised the
structure  of and  reimbursement  for private  health plan  options for Medicare
enrollees.  The Act seeks to expand the options available to Medicare  enrollees
by  permitting  HCFA to contract  with a variety of types of managed care plans,
creating  a new  Medicare  fee-for-service  option and  establishing  a Medicare
Medical Savings Account  Demonstration  Program. The legislation also encourages
provider  sponsored  organizations  to  contract  directly  with HCFA to provide
coverage for Medicare enrollees.  Federal reimbursement was modified so that the
premiums  paid by HCFA will be adjusted to take into  account,  on an increasing
basis, a blend of national and local health care cost factors,  rather than only
local  costs--starting  with a 10%  national  factor in 1998 and moving to a 50%
national  factor by 2003.  Congress  also  provided  for  gradual  removal  of a
graduate medical education factor in determining reimbursement.  As a result, it
is likely that  premiums  paid by HCFA will not match the rate of  increase  for
medical costs.

The  legislation  includes a provision for a minimum  increase of 2% annually in
health plan Medicare reimbursement for the next five years. The legislation also
provides for  expedited  licensure  of  provider-sponsored  Medicare  plans and 
a repeal  in 1999 of the  rule  requiring  health  plans  to have  one 
 commercial
enrollee for each  Medicare or Medicaid  enrollee.  These changes could have the
effect of increasing  competition  in the Medicare  market.  Further,  effective
January 1, 1999, the Company was required to implement new Medicare  regulations
including,  but not  limited to,  regulations  relating  to  discharge  notices,
additional  provider  contract  language and extensive  new quality  improvement
programs.   These  new   regulations  are  likely  to  increase  the  burden  of
administering  the  Company's  Medicare  plans  and  may  adversely  impact  the
Company's operations.

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  effective  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

                                                        15

<PAGE>



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.

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  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.



                                                        16

<PAGE>



Employees

The Company had  approximately  4,700 employees as of December 31, 1998. None of
these employees are covered by a collective  bargaining  agreement.  The Company
believes that its relations with its employees are good.


ITEM 2. PROPERTIES

The Company owns several administrative  facilities in southern Nevada totalling
approximately  406,000  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 an $800,000  loan balance from Bank of America.  Also
included  in this  total  is a  198,000  square  foot  six-story  administrative
headquarters  building  which became fully  occupied in 1998.  This building was
financed in January  1998 and is subject to a $13.4  million loan  balance.  The
Company  also owns  several  clinical  facilities  in the  southern  Nevada area
totalling  approximately  396,000 square feet and  consisting  primarily of nine
medical clinics and two surgery centers.  The Company leases  additional  office
and clinical space in Nevada totalling  approximately  145,000 and 86,000 square
feet, respectively.

In conjunction with the Kaiser-Texas  acquisition,  the Company  purchased eight
medical   facilities   totalling   approximately   323,000   square   feet   and
administrative  facilities  totalling  approximately  175,000 square feet. These
buildings  are subject to a deed of trust note securing a $35.2 million note. In
addition,  the Company  leases  additional  office and  clinical  space in Texas
totalling approximately 54,000 square feet and 77,000 square feet, respectively.
The above properties are utilized primarily for the managed care operations. The
workers'  compensation  subsidiary  is  headquartered  in  Nevada  and  occupies
approximately 25% of the 198,000 square foot administrative  building as well as
leases  approximately  67,000  square feet of office  space in  California.  The
Company  leases  approximately  150,000  square  feet of  office  space in other
various  states as needed for other  regional  operations,  for TRICARE  service
centers and for the military subsidiary's administrative headquarters.

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 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.

ITEM 3.   LEGAL PROCEEDINGS

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.  The
litigation with Humana  resulting from its acquisition of Physician  Corporation
of America  that was  discussed  in previous  filings has been  settled.  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


                                                        17

<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 for each  quarter of
1998 and 1997.
<TABLE>

<CAPTION>
         Period                                                     High            Low

         1998
<S>                                                                                <C> <C>             <C> <C>
             First Quarter........................................                 $26 7/8             $20 9/16
             Second Quarter.......................................                  27 37/64            23 1/4
             Third Quarter........................................                  26                  15 7/8
             Fourth Quarter.......................................                  24 15/16            17 15/16

         1997
             First Quarter........................................                 $18 1/2             $16 5/12
             Second Quarter.......................................                   21 5/12             16 1/12
             Third Quarter........................................                   24 11/12               20 19/24
             Fourth Quarter.......................................                   26 2/3              20 19/24
</TABLE>

On February 26, 1999, the closing sale price of the common stock was $14 3/8 per
share.

Note:    The  above  stock  prices  have  been   adjusted  to  account  for  the
         three-for-two stock split of the Company's common stock to stockholders
         of record as of May 18, 1998.

Holders

The number of record holders of Common Stock at February 26, 1999 was 254. 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  health  maintenance  organization  ("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.

                                                        18

<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, 1998 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>

<CAPTION>
                                                                                           Years Ended December 31,
                                                                      1998            1997         1996           1995         1994
                                                                                  (Amounts in thousands, except per share data)
Statement of Operations Data:
OPERATING REVENUES:
<S>                                                                <C>              <C>           <C>           <C>           <C>
   Medical Premiums.............................................   $  609,404       $513,857      $386,968      $319,475    $269,382
   Specialty Product Revenues ..................................      148,368        146,211       133,324       102,807     101,287
   Military Contract Revenues ..................................      204,838          4,346
   Professional Fees............................................       45,363         31,238        28,836        19,417      12,331
   Investment and Other Revenues................................       29,230         26,072        26,283        25,310      19,081
     Total......................................................    1,037,203        721,724       575,411       467,009     402,081

OPERATING EXPENSES:
   Medical Expenses.............................................      513,209        419,272       315,915       245,135     200,229
   Specialty Product Expenses...................................      142,258        143,082       130,758       102,859      96,600
   General, Administrative and Marketing Expenses...............      110,687         93,919        72,237        63,562      53,671
   Military Contract Expenses  .................................      196,625          4,193
   Integration, Settlement and Other Costs (1) .................       13,851         29,350        12,064        11,614
     Total......................................................                 976,630   689,816   530,974     423,170     350,500

OPERATING INCOME ...............................................       60,573         31,908        44,437        43,839      51,581

INTEREST EXPENSE AND OTHER, NET.................................       (7,181)        (4,433)       (2,823)       (3,737)    (6,401)

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES .......................................       53,392         27,475        41,614        40,102      45,180
PROVISION FOR INCOME TAXES......................................       13,796          3,234        10,471        12,198       8,236
INCOME FROM CONTINUING OPERATIONS...............................       39,596         24,241        31,143        27,904      36,944
LOSS FROM DISCONTINUED OPERATIONS ..............................                                                  (6,600)    (2,501)

NET INCOME .....................................................   $   39,596      $  24,241      $ 31,143      $ 21,304   $  34,443

EARNINGS PER COMMON SHARE (2):
   Income from Continuing Operations Per Share .................        $1.45           $.90         $1.17         $1.07       $1.57
   Loss Per Share from Discontinued Operations .................                                                    (.25)      (.11)
   Net Income Per Share ........................................        $1.45           $.90         $1.17         $ .82       $1.46

   Weighted Average Number of Common
     Shares Outstanding ........................................       27,391         27,013        26,589        26,121      23,517

EARNINGS PER COMMON SHARE ASSUMING
     DILUTION (2):
       Income from Continuing Operations Per Share .............        $1.43           $.88         $1.15         $1.05       $1.54
       Loss Per Share from Discontinued Operations .............          ___                                       (.25)      (.10)
       Net Income Per Share ....................................        $1.43           $.88         $1.15         $ .80       $1.44

   Weighted Average Number of Common
     Shares Outstanding Assuming Dilution ......................       27,747         27,426        27,191        26,601      23,999
</TABLE>

                                                                   19

<PAGE>


<TABLE>

<CAPTION>
                                                                                      Years Ended December 31,
                                                                      1998            1997         1996           1995         1994
                                                                                                  (Amounts in thousands)

Balance Sheet Data:


<S>                                                                <C>              <C>           <C>           <C>           <C>
   Working Capital .............................................   $    47,763      $  88,377     $ 76,530      $ 18,157    $ 71,337
   Total Assets.................................................     1,045,120        723,936      629,462       575,146     535,487
   Long-term Debt (Net of Current Maturities)...................       242,398         90,841       66,189        71,257      75,209
   Cash Dividends Per Common Share..............................          NONE           NONE         NONE          NONE        NONE
   Stockholders' Equity.........................................       303,714        265,682      234,482       207,715     168,157
</TABLE>

(1) The Company recorded certain identifiable integration,  settlement and other
costs.  See Note 14 of  Notes  to the  Consolidated  Financial  Statements.  (2)
Adjusted to account for three-for-two  stock split of the Company's common stock
to stockholders of record as of May 18, 1998.



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 an  assessment  and  understanding  of the  Company's
consolidated  financial  condition  and results of  operations.  The  discussion
should be read in conjunction  with the  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 1998 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 17, 1999,  incorporated
herein by reference.  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   materially  from  those  expressed  in  any  projected,   estimated  or
forward-looking statements relating to the Company.

Acquisitions

On October 31, 1998,  Sierra and one of its  subsidiaries,  Texas Health Choice,
L.C.  (formerly HMO Texas L.C.)  completed the  acquisition of certain assets of
Kaiser  Foundation  Health  Plan of  Texas  ("Kaiser-  Texas"),  a  health  plan
operating in Dallas/Ft. Worth with approximately 109,000 members, and Permanente
Medical Association of Texas ("Permanente"),  a medical group with approximately
150 physicians. The purchase price was $124 million, which is net $20 million in
operating  cost support to be paid to Sierra by Kaiser  Foundation  Hospitals in
five  quarterly  installments  following  the  closing of the  transaction.  The
purchase price allocation  includes a premium  deficiency reserve of $25 million
for  estimated  losses on the  contracts  acquired  from  Kaiser-Texas.  Of this
amount,  $6.8  million  was  reversed in 1998 to offset  losses on the  acquired
contracts. The purchase price includes amounts for real estate and eight medical
and office facilities with approximately  500,000 square feet. In December 1998,
certain  accreditation goals were met by the health plan resulting in a purchase
price increase of $3.0 million to $127 million.  The purchase price may increase
up to an  additional  $27 million over three years if certain  growth and member
retention goals are met by the health plan.  Sierra assumed no prior liabilities
for malpractice or other litigation, or for any unanticipated future adjustments
to claims  expenses for periods prior to closing.  The  transaction was financed
with a five-year  revolving  credit facility and a $35.2 million note payable to
Kaiser Foundation Health Plan of Texas. The note is secured by the acquired real
estate. Approximately $110 million of the $200 million revolving credit facility
was used to fund the transaction.


                                                        20

<PAGE>



On December 31, 1998, Sierra completed the acquisition of the Nevada health care
business of Exclusive  Healthcare,  Inc., United of Omaha Life Insurance Company
and United World Life Insurance Company, all of which are subsidiaries of Mutual
of Omaha Insurance  Company.  The purchase price is contingent based on how many
members are  retained  through  2000 and 2001.  No cash will be paid until group
renewals   begin  in  2000.   Sierra   retained   approximately   9,000  members
(approximately 4,400 HMO members) subsequent to the acquisition.

In August 1997,  the Company  acquired the assets and  operations  of Total Home
Care, Inc. ("THC") for  approximately  $3.1 million,  net of cash acquired.  THC
provides home infusion, oxygen, and durable medical equipment services in Nevada
and Arizona.  The Company sold the Arizona  operations  in the first  quarter of
1998 for  approximately  $1.5 million.  Also, in the first quarter of 1998,  the
Company  purchased three medical  clinics in southern  Nevada for  approximately
$7.3 million.

Effective  December  31,  1996,  the  Company  purchased  Prime  Holdings,  Inc.
("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.

Overview

The Company derives revenues from its health maintenance organizations,  managed
indemnity,  military  health care services 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  58.8%,  71.2% and 67.3% of the Company's  total revenues for
1998,  1997 and 1996,  respectively.  The  decrease  in  medical  premiums  as a
percentage  of total  revenues  is  primarily  due to the  addition  of military
contract  revenues.  Continued  medical  premium  revenue  growth is principally
dependent  upon  continued   enrollment  in  the  Company's  products  and  upon
competitive and regulatory factors.

The Company's principal expenses consist of medical expenses,  military contract
expense,  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. Military contract expenses
represent  the  expenses of  delivering  health care as agreed to in the TRICARE
contract with the federal government as well as administrative  costs to operate
the  military  health care  subsidiary.  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.

On September  30, 1997,  Sierra  Military  Health  Services,  Inc.  ("SMHS") was
awarded a TRICARE  contract to provide  managed health care coverage to eligible
beneficiaries in Region 1. In June 1998, the Company began providing health care
benefits to approximately 606,000 individuals in Connecticut,  Delaware,  Maine,
Maryland,  Massachusetts,  New Hampshire,  New Jersey,  New York,  Pennsylvania,
Rhode Island, Vermont,

                                                        21

<PAGE>



Virginia,  West Virginia and  Washington,  D.C. In 1998, the award resulted in a
total  of  $204.8   million  of  revenue  for  the  final   five-months  of  the
implementation phase and seven months of health care delivery. SMHS was notified
on February 13, 1998 that the United States  General  Accounting  Office ("GAO")
sustained a competitor's  protest of the contract award for TRICARE Managed Care
Support Region 1 and recommended that the contract be re-bid.  In December 1998,
the  Company  reached  an  agreement  to  settle  the  protest.  As  part of the
settlement,  the  competitor  will  forego  any and all  rights  it may  have to
challenge  the  contract  award  and seek a re-bid  (See Note 14 of Notes to the
Consolidated Financial Statements).

Integration,  settlement and other expenses represent  identifiable  incremental
costs the Company has incurred  primarily in  connection  with various  mergers,
acquisitions  and planned  dispositions as well as expenses  associated with the
Company's  proposal to serve TRICARE  beneficiaries in Region 1 and the ultimate
cost to settle a bid protest.  Start-up expenses associated with the proposal to
serve TRICARE  beneficiaries  were charged to operations  upon  notification  of
award.

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,
                                                                     1998              1997             1996
OPERATING REVENUES:
<S>                                                                   <C>              <C>              <C>
     Medical Premiums........................................         58.8%            71.2%            67.3%
     Specialty Product Revenues .............................         14.3             20.3             23.2
     Military Contract Revenues                                       19.7               .6
     Professional Fees.......................................          4.4              4.3              5.0
     Investment and Other Revenues ..........................          2.8              3.6              4.5
        Total................................................        100.0            100.0            100.0

OPERATING EXPENSES:
     Medical Expenses........................................         49.5             58.1             54.9
     Specialty Product Expenses..............................         13.7             19.8             22.7
     General, Administrative and Marketing Expenses..........         10.7             13.0             12.6
     Military Contract Expenses .............................         19.0               .6
     Integration, Settlement and Other Costs.................          1.3              4.1              2.1

        Total................................................         94.2             95.6             92.3

OPERATING INCOME ............................................          5.8              4.4              7.7

INTEREST EXPENSE AND OTHER, NET..............................        (.7)             (.6)             (.5)

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES ....................................          5.1              3.8              7.2

PROVISION FOR INCOME TAXES...................................          1.3               .4              1.8

NET INCOME ..................................................          3.8%             3.4%             5.4%
</TABLE>



                                                              22

<PAGE>



1998 Compared to 1997

Revenues.   The  Company's   total   operating   revenues  for  1998   increased
approximately  43.7% to $1.04 billion from $721.7 million for 1997. The increase
was primarily due to military contract revenue of $204.8 million and an increase
in premium revenue of $95.5 million.  The military  contract revenue is a result
of the  implementation of the TRICARE contract as well as the first seven months
of health care delivery. Revenue under the TRICARE contract is recorded based on
the contract  price as agreed to by the federal  government.  The contract  also
contains  provisions which adjust the contract price based on actual experience.
The estimated effects of these adjustments are recognized on a monthly basis.

Medical premium revenue from the Company's HMO and managed  indemnity  insurance
subsidiaries  increased  $95.5  million,  or 18.6%.  Excluding the effect of the
Kaiser-Texas  acquisition  in  the  fourth  quarter  of  1998,  premium  revenue
increased $66.9 million, or 13.0%. The $66.9 million increase in premium revenue
reflects a 3.4%  increase  in member  months  (the number of months of each year
that an individual  is enrolled in a plan).  Medicare  member  months  increased
20.1% which contributed to the increase in medical premium revenue.  Such growth
in Medicare member months  contributes  significantly to the increase in premium
revenues as the  Medicare per member  premium  rates are over three times higher
than the average  commercial premium rate. The Company's premium rates increased
an  average of 3% to 4% for its HMO  commercial  groups and in excess of 10% for
managed indemnity commercial groups. The Company also realized a slight increase
in its  capitation  rate  established  by Health Care  Financing  Administration
("HCFA").  Approximately  78% of  the  Company's  Nevada  Medicare  members  are
enrolled in the Social HMO Medicare program.  HCFA is considering  adjusting the
reimbursement  factor  for  the  Social  HMO  members  in  the  future.  If  the
reimbursement  for these members  decreases  significantly  and related  benefit
changes are not made  timely,  there could be a material  adverse  effect on the
Company's business.

Specialty  product revenue  increased $2.2 million,  or 1.5%, for the year ended
December  31, 1998  compared to the prior year.  The increase was due to revenue
growth of $5.1 million in the workers'  compensation  insurance operation offset
in part by a  decrease  in  administrative  services  and other  revenue of $2.9
million due primarily to the termination of the Company's workers'  compensation
administrative  services  contract  with the  State  of  Nevada.  The  Company's
workers'  compensation  subsidiary  signed a  reinsurance  agreement  whereby  a
greater portion of premium is ceded thus reducing revenue. The agreement results
in a reduction of specialty  product expense as discussed later in this section.
Excluding the effect of the new reinsurance agreement, the workers' compensation
subsidiaries'  revenue would have increased $21.2 million  compared to the prior
year.  Professional fee revenue increased  approximately $14.1 million primarily
due to the January 1998  acquisition of the operations of two medical clinics in
southern  Nevada and the clinics  acquired  in the  Dallas/Ft.  Worth  area.  In
addition approximately $3.5 million of the increase in professional fees was due
to the operations of Total Home Care, Inc.  ("THC") which was acquired in August
1997.

Investment  and other  revenue  increased  approximately  $3.2  million over the
comparable  period in the prior year  primarily  due to an  increase in invested
balances and capital gains realized on the sale of investments.

Medical and  Specialty  Product  Expense.  Medical  expenses as a percentage  of
medical  premiums and  professional  fees ("Medical Care Ratio")  increased from
76.9% to 78.4%  for the year  ended  December  31,  1998  compared  to the prior
period.  The  increase  in the  medical  care  ratio was due to an  increase  in
Medicare members as a percentage of fully-insured  members,  continued expansion
in Texas,  northern  Nevada and Arizona  which have higher  medical care ratios,
higher  pharmacy costs and the  acquisitions  of THC and two medical clinics for
which  costs  of  operations  are  included  in  medical  expenses.  The cost of
providing  medical  care  to  Medicare  members  generally  requires  a  greater
percentage of the premiums received.  Pharmacy costs increased as the management
of the pharmacy  benefit was  transitioned  from a capitated  pharmacy  benefits
contract to in-house management in the third quarter of 1998. The costs

                                                        23

<PAGE>



under  such  capitation   contract  were   substantially   below  actual  claims
experience.  The medical care ratio is expected to further  increase in 1999 due
to the changes in member mix and pharmacy costs noted above. Included in medical
expenses is the reversal of $4.4 million of premium  deficiency reserve that was
used to offset losses on contracts from the  Kaiser-Texas  operations  that were
acquired on October 31, 1998.

Specialty product expenses decreased  approximately $800,000, or less than 1.0%,
due primarily to the  implementation  of the reinsurance  agreement as discussed
previously.  Specialty  product revenue and expense is primarily  related to the
workers'  compensation  insurance business.  Effective January 1, 1998, workers'
compensation  claims  are  reinsured  between  $500,000  and  $100  million  per
occurrence.  For claims  occurring  on and after  July 1,  1998,  that are below
$500,000, the Company obtained quota share and excess of loss reinsurance. Under
this  agreement,  the Company  reinsures 30% of the first $10,000 of each claim,
75% of the next $40,000 and 100% of the next  $450,000.  The Company  receives a
ceding  commission  from the reinsurer as a partial  reimbursement  of operating
expenses.  Excluding the effect of the reinsurance agreement,  specialty product
expense would have increased $19.5 million compared to the prior year.

The combined ratio for the workers'  compensation  insurance  business was 98.7%
compared to 101.9% for the comparable  prior year period.  The reduction was due
to a 198 basis point  decrease in the loss ratio and a 122 basis point  decrease
in the expense ratio.  The decrease in the loss ratio was largely due to the new
reinsurance  agreement  for losses  occurring on and after July 1, 1998 and as a
result of the Company's ability to overlay and implement managed care techniques
to the workers'  compensation claims. The combined ratio excluding the effect of
the new  reinsurance  agreement was 101.6% for the year ended December 31, 1998.
In addition,  favorable  loss  development on prior accident years totalled $9.6
million for the year ended  December 31, 1998,  compared to net  favorable  loss
development of $9.0 million for the comparable prior year period.  The favorable
loss  development  is largely due to actual paid  losses  being below  projected
losses. There can be no assurance that favorable  development,  or the magnitude
thereof,  will  continue in the future.  The  reduction in the expense ratio was
largely  due to a  reduction  in  agents'  commissions,  as a result of a ceding
commission related to the new reinsurance  agreement and from lower salaries and
related benefits expenses.  The losses and loss adjustment expense ratio for the
year ended  December 31, 1998 reflect the  Company's  current  projection of the
ultimate  costs of claims  occurring  in the  current as well as prior  accident
years.  Such projections are subject to change and any change would be reflected
in the income  statement.  Workers'  compensation  claims are paid over  several
years. Until payment is made, the Company invests the monies, earning a yield on
the invested balance.

Military Contract  Expense.  The military contract expense is comprised of those
expenses incurred in 1998 for five months of contract  implementation  and seven
months of health care  delivery.  This  expense  consists  primarily of costs to
provide  managed  health care services to eligible  beneficiaries  in accordance
with the Company's  TRICARE contract.  Under the contract,  SMHS provides health
care  services to  approximately  606,000  dependents  of active  duty  military
personnel  and military  retirees  and their  dependents  through  subcontractor
partnerships  and  individual  providers.  Health care costs are recorded in the
period when services are provided to eligible beneficiaries, including estimates
for  provider  costs which have been  incurred  but not reported to the Company.
Also,  included  in  military  contract  expense  are costs  incurred to perform
specific  administrative  services,  such as health care appointment scheduling,
enrollment,  network management and health care advice line services,  and other
administrative functions of the military health care subsidiary.

General,  Administrative  and Marketing  Expenses.  General,  administrative and
marketing ("G&A") cost increased $16.8 million, or 17.9%, compared to 1997. As a
percentage of revenues,  G&A costs for 1998 decreased to 10.7% from 13.0% during
1997. The decrease in the G&A ratio is primarily due to the addition of military
contract revenues offset in part by costs for additional  infrastructure  needed
to  support  overall  Company  growth.  Excluding  military  revenues,  G&A as a
percentage of revenues was 13.3% in 1998. Of the $16.8 million  increase in G&A,
$3.2 million was due to  additional  G&A related to the acquired HMO business in
the Dallas/Ft.  Worth area. The remaining increase of $13.6 million consisted of
$3.8

                                                        24

<PAGE>



million  increased  compensation  expense,  resulting  primarily from additional
employees  supporting expanded services and new benefit programs for management.
Broker,   third  party   administration   and  premium  tax  expense   increased
approximately  $900,000 due to increased membership.  In addition,  depreciation
expense increased $1.7 million.

Integration,  Settlement  and Other Costs.  In the fourth  quarter of 1998,  the
Company expensed  approximately $13.9 million, $10.3 million after tax, of costs
primarily  associated  with the  settlement  of the  protest  pertaining  to its
military  services  contract as well as costs associated with the integration of
the  Kaiser-Texas  business  acquired  October  31,  1998  (see  Note  14 to the
Consolidated Financial Statements).

On March 18, 1997, the Company  announced it had terminated its merger agreement
with  Physician  Corporation  of America,  Inc. and  recorded  expenses of $11.0
million,  $8.4 million after tax, for merger-  related  costs.  During the third
quarter  of  1997  SMHS  was  awarded  a  contract  to  serve  TRICARE  eligible
beneficiaries in Region 1. Development expenses of $18.4 million,  $10.6 million
net of  taxes,  were  recorded  in the  third  quarter  primarily  for  expenses
associated with the Company's  proposal to serve TRICARE Region 1. Such expenses
had been deferred until award notification.

Interest Expense and Other.  Interest expense and other increased  approximately
$2.7 million for the year ended  December 31, 1998,  compared to the same period
in the prior  year due to an  increase  in debt as a result of the  Kaiser-Texas
acquisition.

Income Taxes. For the period, the Company recorded  approximately  $13.8 million
of tax expense  for an  effective  tax rate of 25.8%  compared to 23.9% in 1997,
excluding  the tax effects of  identifiable  integration,  settlement  and other
costs.  The  Company's  current low  operating tax rate is primarily a result of
tax-preferred investments and the change in the deferred tax valuation 
allowance,
which is due  primarily  to the ability to use a portion of net  operating  loss
carryovers. The effective tax rate will increase to the 32% to 34% range in 1999
as most of the valuation  allowances for net operating loss  carryforwards  have
been utilized as of December 31, 1998.

1997 Compared to 1996

Revenues.  The Company's  total  operating  revenues for 1997 increased 25.4% to
$721.7  million from $575.4  million for 1996. The increase was primarily due to
medical premium revenue  increases of  approximately  $126.9 million,  or 32.8%,
from the  Company's  HMO and  managed  indemnity  insurance  subsidiaries.  Such
premium growth resulted principally from an approximate 30.3% increase in member
months.  The Company's HMO and insurance  subsidiaries'  premium rates increased
approximately 2.5%,  primarily due to an increase in its capitation rate for its
Medicare  members as  established  by HCFA.  The increase was due in part to the
Company's participation in HCFA's social HMO program. The Company realized 1% to
3% rate increases for its existing HMO  subsidiaries'  commercial groups and the
managed indemnity  subsidiary.  However,  these increases were offset in part by
lower premium rates at MedOne Health Plan, an HMO acquired on December 31, 1996.
The Company's  specialty  product revenue  increased $12.9 million,  or 9.7%, to
$146.2  million in 1997 from $133.3  million in 1996.  The  increase  was due to
specialty product revenue growth in the workers'  compensation  insurance market
of  approximately  $8.3 million and an increase in  administrative  services and
other of $4.6 million due primarily to the acquisition of Prime Health, Inc., at
the end of 1996.  Some of this increase will be offset in the future by the loss
of a portion  of the state of  Nevada's  self-insured  medical  business.  Also,
effective  September 30, 1997, the Company terminated its workers'  compensation
administrative  services contract with the state of Nevada.  The contract served
approximately  200,000  enrollees  and  provided  approximately  $3.2 million in
revenues for the year ended  December 31, 1997.  The contract was  terminated to
allow the Company to participate in the Nevada workers'  compensation  insurance
market when the state  allows  private  insurance  companies  to begin  offering
products,  which is  anticipated  for 1999.  Professional  fees  increased  $2.4
million,  or 8.3%,  over 1996 to $31.2 million.  This increase is due in part to
the acquisition of the

                                                        25

<PAGE>



assets and operations of THC during the third quarter of 1997. THC provides home
infusion,  oxygen and durable medical equipment  services in Nevada and Arizona.
During the fourth quarter of 1997, SMHS began the  implementation  period of its
TRICARE  contract.  The military contract revenue of $4.3 million is a result of
this contract. Investment and other revenue was consistent with the prior year.

Medical and Specialty  Product  Expenses.  Total medical  expenses  increased by
$103.4 million in 1997 compared to 1996.  This 32.7% increase  resulted from the
consolidated  member month growth discussed  previously.  The Medical Care Ratio
increased  from 76.0% to 76.9% due  primarily to member  growth and expansion in
areas with  higher  medical  expenses,  such as  northern  Nevada and Texas.  In
addition,  MedOne  Health Plan has a higher  Medical Care Ratio,  which  further
contributed  to the  increase  in the  Company's  overall  Medical  Care  Ratio.
Specialty  product  expenses  increased $12.3 million,  or 9.4%, over 1996. This
increase is due  primarily  to the  increase in workers'  compensation  premiums
noted above.  Specialty  product revenue and expense is primarily related to the
workers' compensation insurance business.

The combined ratio for the workers'  compensation  insurance business was 101.9%
for the year ended  December  31,  1997,  compared to 103.2% for the  comparable
prior year period.  The  reduction  was due to a 40 basis point  decrease in the
loss ratio along with a 90 basis point decrease in the expense  ratio.  Compared
to the prior year period,  incurred  losses for the current  accident  year were
reduced as a result of the Company's  ability to overlay and  implement  managed
care techniques to the workers'  compensation  claims. In addition,  the Company
had net favorable loss development on prior accident years totaling $9.0 million
compared to net favorable  loss  development of $15.3 million for the comparable
prior year  period.  The  favorable  development  is largely  due to actual paid
losses  being  below  projected  losses.  The  majority  of the  favorable  loss
development  occurred on the 1992 through 1995 accident  years.  There can be no
assurances that favorable  development,  or the magnitude thereof, will continue
in the future.  The losses and loss adjustment  expense ratio for the year ended
December 31, 1997  reflects the  Company's  current  projection  of the ultimate
costs of claims  occurring in the current as well as prior accident years.  Such
projections  are  subject  to change and any change  would be  reflected  in the
income  statement.  Workers'  compensation  claims are paid over several  years.
Until payment is made,  the Company  invests the monies,  earning a yield on the
invested balance.

General,  Administrative  and  Marketing  Expenses.  G&A costs  increased  $21.7
million, or 30.0%, for the twelve months ended December 31, 1997 compared to the
twelve months ended  December 31, 1996.  As a percentage of revenues,  G&A costs
for the twelve  months  ended  December  31, 1997  increased to 13.0% from 12.6%
during the comparable period in 1996. Of the $21.7 million increase in G&A, $8.6
million was in compensation costs primarily resulting from additional  employees
supporting  expanded  services and increased  incentive  amounts for management.
Broker,   third-party   administration,   and  premium  tax  expenses  increased
approximately  $8.5  million  due  to  increased  membership.  Amortization  and
depreciation  costs increased  approximately  $1.9 million  primarily due to the
amortization of goodwill resulting from the Prime acquisition. The remaining G&A
increase  was  due to  additional  expenses  in  several  areas  including  data
processing maintenance.

     Military  Contract  Expense.  During the fourth quarter of 1997, SMHS began
the implementation period of its TRICARE contract. The military contract expense
is a result of this contract.

Integration,  Settlement  and  Other  Costs.  On March  18,  1997,  the  Company
announced it had terminated its merger  agreement with Physician  Corporation of
America,  Inc. and recorded and paid expenses of  approximately  $11.0  million,
$8.4 million after tax, for merger-related costs.

During  the third  quarter  of 1997,  SMHS,  a wholly  owned  subsidiary  of the
Company,  was  awarded a contract to serve  TRICARE  eligible  beneficiaries  in
Region 1. This region includes approximately 606,000 TRICARE beneficiaries in 13
northeastern states and the District of Columbia. Development expenses of

                                                        26

<PAGE>



$18.4  million,  $10.6 million net of taxes,  were recorded in the third quarter
primarily for expenses  associated with the Company's proposal to serve eligible
beneficiaries in Region 1.

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 $3.8  million,  ($2.9  million  after  tax) in the  fourth
quarter of 1996,  primarily to recognize the  estimated  costs to dispose of the
hospital.  As of  December  31,  1998,  the  Company has been unable to reach an
agreement to sell 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 $8.3 million, ($6.2 million after tax). These restructuring
costs included cancellation of certain contractual  obligations of $6.0 million,
lease  termination  costs of $1.5  million and  approximately  $750,000 of other
costs.

Interest Expense and Other.  Interest expense and other increased  approximately
$1.6 million over the prior year  primarily due to the $2.1 million  benefit for
minority  interests  recorded  in  1996,  offset  in  part  by  an  increase  in
capitalized  interest  related  to various  construction  projects  in 1997.  In
November 1996, the Company acquired  complete  ownership of a Texas HMO in which
it had previously held a 50% interest. That HMO began business in March 1995 and
experienced  losses in both years.  In the prior year, a portion of these losses
resulted in a benefit from minority interests.

Income Taxes.  The Company's  effective tax rate for the year ended December 31,
1997 was 11.8%,  compared to 25.2% in 1996. The difference between the Company's
effective  tax rate and the current  federal tax rate is due primarily to a $4.7
million tax benefit  recorded as a result of a  reduction  of the  deferred  tax
valuation  allowance and the Company's  portfolio of tax preferred  investments.
These benefits are more  significant  as a result of the charges  related to the
Physicians Corporation of America acquisition and start-up costs associated with
the TRICARE contract.  Excluding these costs, the effective tax rate for 1997 is
23.9%. See Note 9 of Notes to Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

The Company's  cash flow from  operating  activities of $50.1 million during the
twelve months ended  December 31, 1998 resulted  primarily from $39.6 million of
net income,  $19.3 million in depreciation  and amortization and $6.4 million in
provision for doubtful accounts offset by a $15.2 million decrease in cash flows
from changes in assets and liabilities. The decrease in cash flow resulting from
the  change in assets  and  liabilities  was  primarily  due to an  increase  in
reinsurance  recoverable  and  military  accounts  receivable.  The  increase in
reinsurance  recoverable  is  primarily  due to the  new  reinsurance  agreement
implemented  by  the  Company's  workers'  compensation  subsidiary  for  claims
occurring  on or after July 1, 1998 that are below  $500,000  (see Note 6 to the
Consolidated Financial  Statements).  Military accounts receivable increased due
to the  implementation  of  health  care  delivery  in 1998.  Military  accounts
receivable   consists  primarily  of  one  month's  contract  payment  from  the
government in arrears,  estimates of bid price  adjustments  ("BPAs")  under the
contract  based on  actual  experience  and any  change  orders  not  originally
specified in the contract.  These cash outflows were offset in part by increases
in military health care payable and other current  liabilities.  The increase in
military health care payable is a result of health care delivery  beginning June
1, 1998 for the Region 1 TRICARE contract. Military health care payable includes
the  estimated  cost for unpaid  claims for which health care services have been
provided to TRICARE  eligibles and a provision of the estimated costs for claims
that have been incurred but have not been

                                                        27

<PAGE>



reported. The increase in other current liabilities is primarily due to expenses
related to  operations  of the  military  services  subsidiary  and  reinsurance
premiums payable due to the new reinsurance contract.

SMHS receives  monthly cash payments  equivalent  to  one-twelfth  of its annual
contractual price with the Department of Defense ("DOD") and accrues health care
revenue on a monthly  basis for any monies owed above its monthly  cash  receipt
based on the number of at-risk eligible beneficiaries. Approximately $34 million
of the military  accounts  receivable  balance is associated with monies owed to
SMHS as a result of providing  health care  services for a larger than  expected
beneficiary population. SMHS expects to receive this amount at the completion of
the first BPA. The BPA process  serves to adjust the DOD's  monthly  payments to
SMHS,  because  such  payments  are  based  in part on 1996 DOD  estimates  for:
beneficiary  population,  beneficiary  population  baseline  health  care  cost,
inflation and military direct care system utilization.  As actual information is
made  available  for the above items,  quarterly  adjustments  are made to SMHS'
monthly  health  care  payment in  addition  to a lump sum  adjustment  for past
months.  SMHS  accrues  for  such  adjustments  on a  monthly  basis  as  actual
information  is made  available.  The  first  such  adjustment  did not occur as
scheduled on February 28, 1999 (SMHS anticipates  additional DOD delays of up to
6 months). If the timing or amount of the BPA reimbursement varies significantly
from the Company's expectations, there could be a material adverse effect on the
Company's business and cash flows.

Net cash used for investing  activities  during 1998  included  $40.7 million in
capital  expenditures for construction  costs associated with office facilities,
furniture  and  equipment  for the newly  constructed  six-story  administrative
headquarters building,  continued  implementation of three new computer systems,
computer and medical  equipment,  other  capital  needs to support the Company's
growth,  and  a  $24.2  million  net  increase  in  investments.   In  addition,
approximately  $111.4  million of cash was used to purchase  the  Dallas,  Texas
operations of Kaiser Foundation Health Plan.

Cash flows from  financing  activities  included  net  proceeds  from  long-term
borrowings  (proceeds  less  payments)  of $113.1  million.  The majority of net
proceeds  from  long-term   borrowings   was  used  to  fund  the   Kaiser-Texas
acquisition.  The  transaction  was financed with a five-year  revolving  credit
facility. As of December 31, 1998, the Company had $139 million in borrowings on
the $200 million line of credit.  Interest under the credit facility is variable
and  based  on the  London  Interbank  Offering  Rate  ("LIBOR")  plus a  margin
determined  by reference  to the  Company's  leverage  ratio.  In addition,  $50
million of the outstanding  balance is covered by interest-rate swap agreements.
The average cost of  borrowing on this line of credit for the fourth  quarter of
1998,  including the impact of the swap agreements,  was approximately 8.0%. The
terms of the credit facility contain a mandatory payment schedule that begins on
June 30, 2001 and ends on September  30, 2003 if the principal  balance  exceeds
certain  thresholds.  The terms of the credit facility contain certain covenants
including a minimum fixed charge  coverage ratio and a maximum  leverage  ratio.
The remaining $61 million available balance on the line of credit as of December
31, 1998, may be used for general corporate purposes, including working capital.

During  1998  and  1997,  the  Company  used  $9.2  million  and  $5.5  million,
respectively, to buy back Company stock on the open market.

In the second  quarter of 1997,  the Company's  Board of Directors  authorized a
$3.0 million line of credit from the Company to the  Company's  Chief  Executive
Officer ("CEO").  The CEO borrowed a total of $650,000 in 1998 and $2 million in
1997 at an interest rate equal to the LIBOR  Offering Rate plus 53 basis points.
During the first quarter of 1999, the CEO repaid  approximately  $360,000 of the
line of  credit.  The line of credit is  collateralized  by certain of the CEO's
rights to  compensation  from the  Company  and is due and payable no later than
August 15, 1999.

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.

                                                        28

<PAGE>



Each $1,000 in  principal is  convertible  into 25.382  shares of the  Company's
common stock at a  conversion  price of $39.40 per share.  Unamortized  issuance
costs of  $500,000  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  Health
Services, Inc. ("Sierra"). During the twelve months ended December 31, 1998, the
Company purchased $3.2 million of the Debentures on the open market.

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 Company had restricted assets on deposit in
various  states  totaling  $17.8  million as of December 31,  1998.  The HMO and
insurance   subsidiaries   must  also  meet  requirements  to  maintain  minimum
stockholder's  equity,  on a statutory basis,  ranging from $1.1 million to $5.2
million. In addition,  in conjunction with the Kaiser-Texas  acquisition,  Texas
Health  Choice,  L.C.  ("TXHC")  entered into a letter  agreement with the Texas
Department  of  Insurance  whereby  TXHC agreed to maintain a net worth of $20.0
million.  Of the cash and cash  equivalents  held at December  31,  1998,  $81.3
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 the
terms of existing management agreements and by dividends.  Remaining amounts are
generally available on an unrestricted basis.

The  National  Association  of Insurance  Commissioners  has adopted new minimum
capitalization  requirements for HMOs, health care insurance  entities and other
risk-bearing health care entities. Depending on the nature and extent of the new
minimum  capitalization  requirements  ultimately  adopted by each state,  there
could be an  increase  in the  capital  required  for  certain of the  Company's
regulated subsidiaries.  The Company intends to fund any increase from available
parent company cash reserves;  however, there can be no assurance that such cash
reserves will be sufficient to fund these minimum  capitalization  requirements.
The new requirements are expected to be effective on or before December 31, 1999
upon  enactment  by each  state.  The  Company  does not  believe  that any such
required  increase in the amount of funds to be contributed to the  subsidiaries
will be material.

The holding company will not receive  dividends from its regulated  subsidiaries
if such  dividend  payment  would cause  violation  of  statutory  net worth and
reserve requirements.

The Company has a 1999 capital budget of  approximately  $60 million,  primarily
for  computer   hardware  and  software,   furniture  and  equipment  and  other
requirements  due to the  Company's  computer  system  conversion  and projected
growth and expansion. The Company's liquidity needs over the next 12 months will
primarily be for the capital items noted above,  the Company's stock  repurchase
program,  debt service and  expansion  of the  Company's  operations,  including
potential  acquisitions.  The Company  believes that existing  working  capital,
operating cash flow and, if necessary,  mortgage  financing,  equipment leasing,
and amounts  available  under its credit facility will be sufficient to fund its
capital  expenditures and debt service.  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.

Year 2000

The Year 2000 issue  exists  because  many  computer  systems  and  applications
currently  use  two-digit  date fields to designate a year.  As the century date
change occurs,  date-sensitive  systems will recognize the year 2000 as 1900, or
not at all.  This  inability to  recognize  or properly  treat the Year 2000 may
cause  systems  to  process  critical  financial  and  operational   information
incorrectly.


                                                        29

<PAGE>



The Company is currently  in the process of  modifying or replacing  its mission
critical financial and operational  computer systems. The Company is also in the
process  of  testing  its  non-information   system  technology  for  Year  2000
compliance.  The Year 2000  project has been broken down into five  phases:  (1)
inventorying  Year  2000  items;  (2)  assessing  the Year 2000  items  that are
determined to be material to the Company;  (3) renovating or replacing  material
items  that are  determined  not to be Year  2000  compliant;  (4)  testing  and
validating material items; and (5) implementing renovated and validated systems.

At December 31, 1998,  the inventory  and  assessment  phases are  substantially
complete as it relates to all material  computer systems and  approximately  50%
complete  as it  relates  to  non-information  system  technology.  The  Company
estimates  that the  replacement/renovation  phases  and the  testing/validation
phases will be 95% complete by October 31, 1999.  The Company  estimates that it
is  approximately  50% complete  with the total project as of December 31, 1998.
Contingency  planning for the mission critical business  operations is scheduled
to be  completed  by  April  1999.  These  plans  focus on  business  operations
involving information systems and non-information systems technologies.

The Company has initiated formal  communications with entities with whom it does
business to assess  their Year 2000  issues.  Evaluations  of the most  critical
third  parties  have been  initiated,  and  follow-up  reviews will be conducted
through 1999.  Contingency  plans are being developed based on these evaluations
and are  expected  to be  completed  by the  middle  of  1999.  There  can be no
assurances that the systems of other companies or governmental agencies, such as
HCFA and the Department of Defense ("DOD"),  on which the Company relies will be
timely  modified for Year 2000, or that the failure to modify by another company
would not have a material adverse effect on the Company. Based upon two separate
reports  issued by the United States  General  Accounting  Office it is doubtful
that the  computer  systems  at both  HCFA and the DOD will be fully  Year  2000
compliant by the end of 1999. The Company does not currently have available data
to predict the impact of such non-compliance on its business operations.  Should
there be any material delays caused by Year 2000 issues, the Company anticipates
that the governmental entities will make estimated payments.

The  Company  is in the  process  of  implementing  three  major  systems  at an
estimated cost of $36 million to $38 million,  which includes the implementation
costs  related to the recently  acquired  Kaiser-Texas  operations.  To date the
Company has spent  approximately  $19.0 million on the new computer  systems and
other Year 2000 items. The Company is expensing the costs to make  modifications
to existing computer systems and non-computer  equipment.  Management  currently
estimates the  remaining new computer  system costs and other Year 2000 costs to
be $13.0  million to $16.0  million for  operations  in  existence  prior to the
Kaiser-Texas  transaction and $6.0 million to $8.0 million for the  Kaiser-Texas
operations  that were acquired on October 31, 1998.  While this is a substantial
effort,   it  will  give  the  Company  the  benefits  of  new   technology  and
functionality  for many of its financial and  operational  computer  systems and
applications.

The  failure  to  correct  a  material  Year  2000  problem  could  result in an
interruption  of, or a failure of,  certain  business  activities or operations.
Such  failures  could  materially  adversely  affect the  Company's  operations,
liquidity and financial  condition.  Due to the general uncertainty  inherent in
the Year  2000  problem,  resulting  in part from  uncertainty  of the Year 2000
readiness of third parties with which the Company does business,  the Company is
unable to determine at this time whether the consequences of potential Year 2000
failures  will have a  material  adverse  impact  on the  Company's  results  of
operations, liquidity or financial condition. The Company's Year 2000 project is
expected to  significantly  reduce the Company's level of uncertainty  about the
Year 2000 problem. The Company believes that, with the implementation of the new
computer  systems  and  completion  of the  entire  project  as  scheduled,  the
possibility of significant interruptions of operations should be reduced.

     The  above   contains   forward-looking   statements   including,   without
limitation, statements relating to the Company's plans, strategies,  objectives,
expectations,  intentions, and adequate resources, that are made pursuant to the
"safe harbor"  provisions  of the Private  Securities  Litigation  Reform Act of
1995. Readers

                                                        30

<PAGE>



are  cautioned  that  forward-looking  statements  contained  in the  Year  2000
disclosure  should be read in conjunction  with the following  disclosure of the
Company:

The costs of the project  and the dates on which the  Company  plans to complete
the necessary Year 2000  modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued  availability of certain resources and other factors.  However,  there
can be no guarantee  that these  estimates  will be achieved and actual  results
could differ materially from those plans. Specific factors that might cause such
material  differences include, but are not limited to, the availability and cost
of  personnel  trained in this area,  the  ability  to locate  and  correct  all
relevant  computer codes,  the ability of the Company's  significant  suppliers,
customers  and others with which it  conducts  business,  including  federal and
state governmental  agencies, to identify and resolve their own Year 2000 issues
and similar uncertainties.

Inflation

Health  care costs  continue to rise at a faster  rate than the  Consumer  Price
Index.  The Company uses various  strategies to mitigate the negative effects of
health care cost inflation,  including setting commercial  premiums based on its
anticipated  health care costs,  risk-sharing  arrangements  with the  Company's
various health care providers,  and other health care cost containment measures.
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, competitive pressures, applicable regulations, increases
in pharmacy costs,  utilization  changes and catastrophic items, which could, in
turn, result in medical cost increases equaling or exceeding premium increases.

Government Regulation

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

Government  regulation  of health  care  coverage  products  and  services  is a
changing area of law that varies from  jurisdiction to jurisdiction.  Changes in
applicable  laws  and  regulations   are   continually   being   considered  and
interpretation  of  existing  laws and rules also may change  from time to time.
Regulatory agencies generally have broad discretion in promulgating  regulations
and in interpreting and enforcing laws and regulations.

While the Company is unable to predict what regulatory  changes may occur or the
impact on the Company of any  particular  change,  the Company's  operations and
financial  results could be negatively  affected by  regulatory  revisions.  For
example,  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.  The continued  consideration
and enactment of  "anti-managed  care" laws and regulations by federal and state
bodies may make it more  difficult  for the Company to manage  medical costs and
may adversely affect financial results.

In  addition  to changes in  applicable  laws and  regulations,  the  Company is
subject to various audits, investigations and enforcement actions. These include
possible  government actions relating to the federal Employee  Retirement Income
Security Act, which  regulates  insured and  self-insured  health coverage plans
offered by employers,  the Federal  Employees  Health Benefit Plan,  federal and
state fraud and abuse laws, and laws relating to utilization  management and the
delivery of health care. Any such  government  action could result in assessment
of damages, civil or criminal fines or penalties, or other sanctions, including

                                                        31

<PAGE>



exclusion from participation in government programs. In addition,  disclosure of
any adverse  investigation or audit results or sanctions could negatively affect
the Company's  reputation in various  markets and make it more difficult for the
Company to sell its products and services.

Recently Issued Accounting Standards

In March 1998,  the  Accounting  Standards  Executive  Committee of the American
Institute of Certified Public Accountants ("AcSEC") issued Statement of Position
98-1 ("SOP 98-1"),  "Accounting for the Costs of Computer Software Developed For
or Obtained For Internal Use". SOP 98-1 requires certain computer software costs
to be capitalized  and amortized over the software's  estimated  useful life. In
June 1998, the AcSEC issued Statement of Position 98-5 ("SOP 98-5"),  "Reporting
on the Costs of Start-Up Activities".  This standard requires organization costs
and costs associated with start-up  activities to be expensed as incurred.  Both
statements  are  effective  for years  beginning  after  December 15, 1998.  The
Company will adopt SOP 98-1 and SOP 98-5 for the fiscal year ending December 31,
1999 and does not believe these  statements  will have a material  impact on its
financial statements.

In June 1998, The Financial  Accounting  Standards Board issued  "Accounting for
Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 is effective
for fiscal years beginning after June 15, 1999. FAS 133 addresses the accounting
for derivative  instruments including certain derivative instruments embedded in
other  contracts,  and hedging  activities.  The Company  does not believe  this
statement will have a material impact on its financial statements.

ITEM 7a.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of December 31, 1998, the Company has approximately  $392 million in cash and
cash equivalents,  and short-term,  long-term and restricted investments. Of the
investments,  approximately  $254.6 million is classified as  available-for-sale
investments  and $54.0 million is classified  as  held-to-maturity  investments.
These  investments are primarily in fixed income,  investment grade  securities.
The Company's  investment  policies  emphasize return of principal and liquidity
and are focused on fixed  returns that limit  volatility  and risk of principal.
Because of the Company's investment policies, the primary market risk associated
with the Company's portfolio is interest rate risk.

Assuming an immediate 10% increase in interest rates, the net hypothetical  loss
in fair value of  shareholders'  equity  related  to  financial  instruments  is
estimated  to  be  approximately   $7.5  million  (after  tax)  (2.5%  of  total
shareholders'  equity).  The Company  believes that such an increase in interest
rates would not have a material impact on future earnings or cash flows as it is
unlikely  that the Company would need or choose to  substantially  liquidate its
investment portfolio.

The effect of interest rate risk on potential  near-term  net income,  cash flow
and fair value was determined based on commonly used sensitivity  analyses.  The
models  project the impact of interest  rate changes on a wide range of factors,
including  duration and  prepayment.  Fair value was estimated  based on the net
present  value of cash flows or duration  estimates,  assuming an immediate  10%
increase in interest rates.

As of  December  31,  1998,  the  Company  had  approximately  $139  million  in
borrowings  outstanding  under a revolving credit facility that was entered into
in October 1998. Interest under the credit facility is variable and based on the
London  Interbank  Offering  Rate plus a margin,  except for $50  million of the
outstanding  balance  that is  covered by  interest-rate  swap  agreements.  The
average cost of borrowing  on this line of credit was  approximately  8% for the
fourth  quarter  of  1998.  If the  average  cost  of  borrowing  on the  amount
outstanding  as of December  31,  1998,  was to increase by 10%,  annual  income
before tax would decrease by approximately $900,000.

                                                        32

<PAGE>




ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>

<CAPTION>
                                           INDEX TO FINANCIAL STATEMENTS
                                                                                                          Page

<S>                                                                                                          <C>
Management Report on Consolidated Financial Statements....................................................   34
Independent Auditors' Report..............................................................................   35
Consolidated Balance Sheets at December 31, 1998 and 1997.................................................   36
Consolidated Statements of Operations for the Years Ended
   December 31, 1998, 1997, and 1996......................................................................   37
Consolidated Statements of Changes in Stockholders' Equity
   for the Years Ended December 31, 1998, 1997 and 1996...................................................   38
Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1998, 1997, and 1996......................................................................   39
Notes to Consolidated Financial Statements................................................................   40
</TABLE>


                                                        33

<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, 1998, 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




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

                                                        34

<PAGE>





                          INDEPENDENT AUDITORS' REPORT


Board of Directors
Sierra Health Services, Inc.:

We have audited the  accompanying  consolidated  balance sheets of Sierra Health
Services,  Inc., and its  subsidiaries as of December 31, 1998 and 1997, and the
related consolidated  statements of operations,  stockholders'  equity, and cash
flows for each of the three years in the period ended  December  31,  1998.  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.

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

In our opinion,  such consolidated  financial  statements present fairly, in all
material respects,  the financial  position of Sierra Health Services,  Inc. and
its  subsidiaries  at  December  31,  1998 and 1997,  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
December 31, 1998 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 8, 1999


                                                        35

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1998 and 1997
<TABLE>

                                     ASSETS
<CAPTION>
                                                                                         1998                 1997
CURRENT ASSETS:
<S>                                                                               <C>                    <C>
    Cash and Cash Equivalents..............................................       $    83,910,000        $  96,841,000
    Short-term Investments.................................................           110,008,000          115,498,000
    Accounts Receivable (Less:  Allowance for Doubtful
        Accounts 1998 - $10,540,000 ; 1997 - $7,916,000)...................            44,100,000           37,695,000
    Military Accounts Receivable...........................................            69,552,000            4,346,000
    Current Portion of Deferred Tax Asset .................................            14,311,000           15,496,000
    Reinsurance Recoverable................................................            32,076,000            5,159,000
    Prepaid Expenses and Other Current Assets..............................            39,974,000           25,571,000
        Total Current Assets...............................................           393,931,000          300,606,000

PROPERTY AND EQUIPMENT, NET................................................           229,164,000          148,831,000
LONG-TERM INVESTMENTS......................................................           180,816,000          155,153,000
RESTRICTED CASH AND INVESTMENTS............................................            17,758,000           16,540,000
REINSURANCE RECOVERABLE, Net of Current Portion............................            34,946,000           20,245,000
GOODWILL (Less:  Accumulated Amortization
         1998 - $5,213,000; 1997 - $2,898,000).............................           142,471,000           42,803,000
OTHER ASSETS...............................................................            46,034,000           39,758,000
TOTAL ASSETS...............................................................        $1,045,120,000         $723,936,000

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Accounts Payable and Accrued Liabilities..................................      $     69,284,000        $  43,601,000
    Accrued Payroll and Taxes.................................................            19,942,000           14,838,000
    Medical Claims Payable....................................................            78,022,000           55,943,000
    Current Portion of Reserve for
         Losses and Loss Adjustment Expense ..................................            79,869,000           63,358,000
    Unearned Premium Revenue..................................................            39,968,000           29,763,000
    Military Health Care Payable..............................................            53,820,000
    Current Portion of Long-term Debt.........................................             5,263,000            4,726,000
         Total Current Liabilities............................................           346,168,000          212,229,000

RESERVE FOR LOSSES AND
    LOSS ADJUSTMENT EXPENSE (Less Current Portion) ...........................           132,394,000          139,341,000
LONG-TERM DEBT (Less Current Portion) ........................................           242,398,000           90,841,000
OTHER LIABILITIES ............................................................            20,446,000           15,843,000
TOTAL LIABILITIES.............................................................           741,406,000          458,254,000

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:  1998 -- 28,236,000;
         1997 - 27,709,000....................................................               141,000              139,000
    Additional Paid-in Capital................................................           173,583,000          164,247,000
    Treasury Stock; 1998 - 966,900; 1997 - 426,800
         Common Shares........................................................           (14,821,000)          (5,601,000)
    Accumulated Other Comprehensive Income:
         Unrealized Holding (Loss) Gain on Available-for-Sale
              Investment......................................................            (1,027,000)             655,000
    Retained Earnings.........................................................           145,838,000          106,242,000
         Total Stockholders' Equity...........................................           303,714,000          265,682,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY....................................        $1,045,120,000         $723,936,000
</TABLE>

                                See  the  accompanying   notes  to  consolidated
financial statements.

                                                               36

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
              For the Years Ended December 31, 1998, 1997 and 1996

<TABLE>

<CAPTION>
                                                                             1998                1997                 1996
OPERATING REVENUES:
<S>                                                                       <C>                  <C>                 <C>
     Medical Premiums.............................................        $ 609,404,000        $513,857,000        $386,968,000
     Specialty Product Revenues ..................................          148,368,000         146,211,000         133,324,000
     Military Contract Revenues ..................................          204,838,000           4,346,000
     Professional Fees............................................           45,363,000          31,238,000          28,836,000
     Investment and Other Revenues ...............................           29,230,000          26,072,000          26,283,000
        Total.....................................................        1,037,203,000         721,724,000         575,411,000

OPERATING EXPENSES:
     Medical Expenses.............................................          513,209,000         419,272,000         315,915,000
     Specialty Product Expenses...................................          142,258,000         143,082,000         130,758,000
     General, Administrative and Marketing Expenses...............          110,687,000          93,919,000          72,237,000
     Military Contract Expenses ..................................          196,625,000           4,193,000
     Integration, Settlement and Other Costs......................           13,851,000          29,350,000          12,064,000
        Total.....................................................          976,630,000         689,816,000         530,974,000

OPERATING INCOME..................................................           60,573,000          31,908,000          44,437,000

INTEREST EXPENSE AND OTHER, NET...................................           (7,181,000)         (4,433,000)         (2,823,000)

INCOME FROM OPERATIONS
     BEFORE INCOME TAXES .........................................           53,392,000          27,475,000          41,614,000

PROVISION FOR INCOME TAXES........................................           13,796,000           3,234,000          10,471,000

NET INCOME .......................................................        $  39,596,000        $ 24,241,000        $ 31,143,000

EARNINGS PER COMMON SHARE:
         Net Income Per Share ....................................                $1.45                $.90               $1.17

EARNINGS PER COMMON SHARE ASSUMING DILUTION:
         Net Income Per Share ....................................                $1.43                $.88               $1.15

</TABLE>

                         See the  accompanying  notes to consolidated  financial
statements.

                                                        37

<PAGE>







                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
               CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'
                  EQUITY For the Years Ended December 31, 1998,
                                  1997 and 1996
                             (Amounts in thousands)


<TABLE>

<CAPTION>
                                                                                            Accumu-
                                                                                            lated
                                                                    Addi-                   Other                            Total
                                                                   tional                   Compre-     Compre-              Stock-
                                              Common Stock         Paid-In     Treasury    hensive      hensive   Retained  holders'
                                          Shares       Amount      Capital       Stock       Income     Income    Earnings   Equity




<S>              <C>                       <C>          <C>      <C>        <C>           <C>               <C>    <C>      <C>     
BALANCE, JANUARY 1, 1996..............     26,516       $133     $147,195   $    (130)    $9,659            0      $50,858  $207,715
 Comprehensive Income:
     Net Income.......................                                                                $31,143       31,143    31,143
     Other Comprehensive Income, Net of Tax
      Unrealized Loss on Available-for-sale-
          Investments ................                                                    (9,172)      (9,172)               (9,172)
 Comprehensive Income.................                                                                $21,971
 Common Stock Issued in Connection
     With Stock Plans.................        349          1        3,637                                                      3,638
Income Tax Benefit Realized Upon
     Exercise of Stock Options........                              1,158                                           ______     1,158
BALANCE, DECEMBER 31, 1996 ...........     26,865        134      151,990        (130)       487                    82,001   234,482
 Comprehensive Income:
     Net Income.......................                                                                $24,241       24,241    24,241
     Other Comprehensive Income,
        Net of Tax
     Unrealized Gain on Available-for-sale-
              Investments ............                                                       168          168                    168
 Comprehensive Income.................                                                                $24,409
 Common Stock Issued in Connection
     with Stock Plans.................        844          5       10,253                                                     10,258
  Purchase of Treasury Stock .........                                         (5,471)                                       (5,471)
  Income Tax Benefit Realized Upon
     Exercise of Stock Options........                              2,004                                                      2,004
BALANCE, DECEMBER 31, 1997 ...........     27,709        139      164,247      (5,601)       655                   106,242   265,682
 Comprehensive Income:
     Net Income.......................                                                                 $39,596      39,596    39,596
     Other Comprehensive Income,
         Net of Tax
     Unrealized Holding Loss on Available-
                 for-sale Investments Arising
                        During Period.                                                     (3,960)     (3,960)               (3,960)
            Reclassification Adjustment for
               Gains Included in Net Income                                                 2,278        2,278                 2,278
 Comprehensive Income.................                                                                 $37,914
 Common Stock Issued in Connection
     with Stock Plans.................        527          2        8,052                                                      8,054
  Purchase of Treasury Stock .........                                         (9,220)                                       (9,220)
  Income Tax Benefit Realized Upon
     Exercise of Stock Options........                              1,284                                                      1,284
  BALANCE, DECEMBER 31, 1998 .........     28,236       $141     $173,583    $(14,821)    $(1,027)                $145,838  $303,714
</TABLE>


                                       See    the    accompanying    notes    to
consolidated financial statements.

                                                                      38

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>

<CAPTION>
                                                                                     1998             1997              1996

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                            <C>              <C>                  <C>
      Net Income ........................................................      $  39,596,000    $   24,241,000       $ 31,143,000
      Adjustments to Reconcile Net Income to Net Cash
         Provided by Operating Activities:
          Depreciation and Amortization..................................         19,263,000        13,510,000         10,499,000
          Provision for Doubtful Accounts................................          6,379,000         4,283,000          3,057,000
      Change in Assets and Liabilities, Net of
         Effects from Acquisitions:
          Other Assets...................................................         (5,362,000)       (5,851,000)       (16,301,000)
          Reinsurance Recoverable .......................................        (41,618,000)       (5,635,000)        10,164,000
          Reserve for Losses and Loss Adjustment Expense ................          9,564,000        14,923,000          5,458,000
          Other Liabilities .............................................          4,594,000         6,838,000          6,985,000
          Minority Interests.............................................              9,000           (12,000)        (1,746,000)
          Accounts Receivable............................................         (2,870,000)       (7,944,000)       (12,469,000)
          Other Current Assets...........................................        (10,674,000)      (11,853,000)        (4,671,000)
          Military Accounts Receivable...................................        (69,552,000)       (4,346,000)
          Military Health Care Payable...................................         53,820,000
          Medical Claims Payable.........................................         12,333,000         8,974,000          4,973,000
          Other Current Liabilities......................................         34,606,000        15,692,000         15,354,000
          Net Cash Provided by Operating Activities .....................         50,088,000        52,820,000         52,446,000

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures...............................................        (40,743,000)      (55,642,000)       (17,927,000)
      Property and Equipment Dispositions, Net...........................                              772,000            172,000
      Purchase of Available-for-Sale Investments.........................       (901,542,000)   (1,078,396,000)      (712,503,000)
      Proceeds from Sales/Maturities of
          Available-for-Sale Investments.................................        884,288,000     1,046,523,000        752,279,000
      Purchase of Held-to-Maturity Investments...........................        (51,887,000)       (7,523,000)       (25,835,000)
      Proceeds from Maturities of Held-to-Maturity Investments...........         44,964,000        10,449,000         39,184,000
      Corporate Acquisitions, Net of Cash Acquired.......................       (111,408,000)       (3,145,000)       (36,310,000)
      Corporate Disposition, Net of Cash Disposed........................          1,373,000
          Net Cash Used for Investing Activities.........................       (174,955,000)      (86,962,000)          (940,000)

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing..................................        172,200,000        25,000,000          1,000,000
      Payments on Debt and Capital Leases................................        (59,098,000)       (2,391,000)        (9,601,000)
      Purchase of Treasury Stock ........................................         (9,220,000)       (5,471,000)
      Exercise of Stock in Connection with Stock Plans...................          8,054,000        10,258,000          3,638,000
          Net Cash Provided by (Used for) Financing Activities...........        111,936,000        27,396,000         (4,963,000)

NET (DECREASE) INCREASE IN CASH
      AND CASH EQUIVALENTS...............................................        (12,931,000)       (6,746,000)        46,543,000
CASH AND CASH EQUIVALENTS AT BEGINNING
       OF YEAR...........................................................         96,841,000       103,587,000         57,044,000

CASH AND CASH EQUIVALENTS AT END OF YEAR.................................      $  83,910,000    $   96,841,000       $103,587,000
</TABLE>

                   See the accompanying notes to consolidated
financial statements.

                                                                   39

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


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,
workers'  compensation  medical  management  programs  and its  military  health
services programs. Ancillary products and services that complement the Company's
managed health care product lines are also offered.

Acquisitions.  On October 31, 1998, Texas Health Choice, L.C. ("TXHC") (formerly
HMO Texas,  L.C.), a subsidiary of Sierra,  completed the acquisition of certain
assets of Kaiser Foundation Health Plan of Texas ("Kaiser-Texas"), a health plan
operating in Dallas/Ft. Worth with approximately 109,000 members, and Permanente
Medical  Association  of Texas  ("Permanente"),  a 150  physician  medical group
operating in that area. The purchase price was $124 million, which is net of $20
million in  operating  cost  support  to be paid to Sierra by Kaiser  Foundation
Hospitals  in  five  quarterly   installments   following  the  closing  of  the
transaction. The purchase price allocation includes a premium deficiency reserve
of approximately $25 million for estimated losses on the contracts acquired from
Kaiser-Texas.  The  purchase  price  includes  amounts for real estate and eight
medical and office facilities  encompassing  approximately  500,000 square feet.
During the first  quarter of 1999  certain  accreditation  goals were met by the
health plan  resulting in a purchase  price  increase of $3.0  million,  to $127
million.  The purchase  price may increase an additional  $27 million over three
years if certain growth and member retention goals are met by the health plan.

The  acquisition  has been recorded using purchase  accounting and the excess of
the  purchase  price over the fair value of the assets  acquired was recorded as
goodwill. The goodwill, in the amount of $102.0 million, is being amortized on a
straight line basis over 40 years.

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 the  amortization of goodwill
arising from the transaction and interest  expense that would have been incurred
to finance the purchase.  The pro forma financial information is not necessarily
indicative of the results of operations had the transaction been effected on the
assumed dates. <TABLE>

<CAPTION>
                                                                         1998                        1997

<S>                                                                 <C>                           <C>         
         Total Revenue .......................................      $1,207,000,000                $923,797,000
         Net Income (Loss)....................................         (2,818,000)                (20,239,000)
         Net Income (Loss) Per Common Share...................               (.10)                       (.75)
         Net Income (Loss) Per Common Share
              Assuming Dilution...............................               (.10)                       (.75)
</TABLE>

On December 31, 1998, Sierra completed the acquisition of the Nevada health care
business of Exclusive  Healthcare,  Inc., United of Omaha Life Insurance Company
and United World Life Insurance Company, all of which are subsidiaries of Mutual
of Omaha Insurance  Company.  The purchase price is contingent based on how many
members are  retained  through  2000 and 2001.  No cash will be paid until group
renewals   begin  in  2000.   Sierra   retained   approximately   9,000  members
(approximately 4,400 HMO members) subsequent to the acquisition.

In August 1997,  the Company  acquired the assets and  operations  of Total Home
Care, Inc. ("THC") for  approximately  $3.1 million,  net of cash acquired.  THC
provides home infusion, oxygen, and durable medical equipment services in Nevada
and Arizona. The Company sold the Arizona operations in the first

                                                        40

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


quarter of 1998 for  approximately  $1.5 million.  Also, in the first quarter of
1998,  the  Company  purchased  three  medical  clinics in  southern  Nevada for
approximately $7.3 million.

Effective  December  31,  1996  the  Company  purchased  Prime  Holdings,   Inc.
("Prime"),  for  approximately  $32 million 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 million.

In  November  1996,  the  Company  acquired  complete   ownership  of  TXHC  for
$5,040,000.  The  Company  had  previously  held a 50  percent  interest  in the
Houston-based health plan. The purchase resulted in goodwill of $5,040,000.

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"),  TXHC and MedOne, all licensed HMOs; Sierra
Health and Life Insurance  Company,  Inc.  ("SHL"),  a health and life insurance
company;  Southwest Medical Associates,  Inc. ("SMA"),  and The Medical Group of
Texas ("TMGT"),  multi-specialty medical groups; CII Financial,  Inc. ("CII"), a
holding company  primarily  engaged in writing workers'  compensation  insurance
through its wholly owned  subsidiaries;  Sierra Military Health Services,  Inc.,
("SMHS"),  a company that has been contracted to provide and administer  managed
care services to certain TRICARE eligible beneficiaries from June 1, 1998 to May
31,  2003;  administrative  services  companies;  a home health care  agency;  a
hospice;  a home medical  products  subsidiary;  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, TXHC and MedOne commercial and SHL indemnity premiums. HPN and TXHC offer a
prepaid health care program to Medicare  recipients.  Revenues  associated  with
these Medicare  recipients were  approximately  $238,913,000,  $186,105,000  and
$140,611,000 in 1998, 1997 and 1996, respectively.

Specialty  Product  Revenues.  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.  Also  included in  specialty  product  revenue are revenues
associated with administrative services and certain ancillary products.

Military Contract Revenues. Revenue under the TRICARE contract is recorded based
on the contract price as agreed to by the federal government.  The contract also
contains  provisions which adjust the contract price based on actual experience.
The estimated effects of these adjustments are recognized on a monthly basis. In
addition,  the Company  records revenue based on estimates of the earned portion
of any contract change orders not originally specified in the contract.



                                                        41

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


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 to the  Company.
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.

Military Contract Expenses.  This expense consists primarily of costs to provide
managed health care services to eligible  beneficiaries  in accordance  with the
Company's  TRICARE  contract.  Under the  contract,  SMHS  provides  health care
services to approximately  606,000  dependents of active duty military personnel
and military retirees and their dependents  through  subcontractor  partnerships
and  individual  providers.  Health  care costs are  recorded in the period when
services are provided to eligible beneficiaries including estimates for provider
costs which have been  incurred as of the balance sheet date but not reported to
the Company.  Also included in military  contract  expense are costs incurred to
perform  specific  administrative  services,  such as  health  care  appointment
scheduling, enrollment, network management and health care advice line services,
and other administrative functions of the military health care subsidiary.

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

     Investments.  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.

Military Accounts Receivable.  Amounts receivable under government contracts are
comprised  primarily  of one month's  contract  payment from the  government  in
arrears, estimates of adjustments under the contract based on actual experience,
and  estimates  of the  earned  portion  of any  change  orders  not  originally
specified in the contract.



                                                        42

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


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
               Data Processing Hardware and Software          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 40 years. The Company evaluates the carrying value of
its intangible assets at each balance sheet date.

Medical Claims Payable and Military Health Care Payable.  Medical claims payable
and Military  health care payable  include the estimated  cost for unpaid claims
for which  health care  services  have been  provided to  enrollees  and TRICARE
eligibles  and a  provision  of the  estimated  costs for claims  that have been
incurred 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 to the Company 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.

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.

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  regions,  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, other than
gaming, 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 California, Nevada and Texas. However, the Company
is licensed and does  business in several  other states as well.  As of December
31, 1998, the Company has receivables  outstanding  from the federal  government
related to its TRICARE contract in the amount of $69.6 million. The Company also
has receivables from certain  reinsurers.  Reinsurance  contracts do not relieve
the Company  from its  obligations  to enrollees  or  policyholders.  Failure of
reinsurers to honor their obligations could result in losses to the Company. The
Company  evaluates  the  financial  condition of its  reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies.  All reinsurers that
the Company has  reinsurance  contracts  with are rated A- or better by the A.M.
Best Company.

Recently Issued Accounting  Standards.  In March 1998, the Accounting  Standards
Executive  Committee of the American  Institute of Certified Public  Accountants
("AcSEC")  issued  Statement of Position 98-1 ("SOP 98-1"),  "Accounting for the
Costs of Computer Software Developed For or Obtained For Internal Use". SOP 98-1
requires  certain  computer  software costs to be capitalized and amortized over
the software's  estimated  useful life. In June 1998, the AcSEC issued Statement
of Position 98-5 ("SOP 98-5"),  "Reporting on the Costs of Start-Up Activities".
This standard requires organization costs and costs

                                                        43

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


associated with start-up activities to be expensed as incurred.  Both statements
are  effective for years  beginning  after  December 15, 1998.  The Company will
adopt SOP 98-1 and SOP 98-5 for the fiscal  year  ending  December  31, 1999 and
does not believe these  statements  will have a material impact on its financial
statements.

In June 1998, The Financial  Accounting  Standards Board issued  "Accounting for
Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 is effective
for fiscal years beginning after June 15, 1999. FAS 133 addresses the accounting
for derivative  instruments including certain derivative instruments embedded in
other  contracts,  and hedging  activities.  The Company  does not believe  this
statement will have a material impact on its financial statements.

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 and military  revenue and
expenses. Actual results may materially differ from estimates.

Reclassifications.  Certain amounts in the Consolidated Financial Statements for
the years ended  December  31, 1997 and 1996 have been  reclassified  to conform
with the current year presentation.

3.   EARNINGS PER SHARE

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

<CAPTION>
                                                                                     Dilutive
                                                                Basic              Stock Options           Diluted

For the Year Ended December 31, 1998:
<S>                                                           <C>                             <C>         <C>
Net Income.....................................               $39,596,000                     0           $39,596,000
Shares.........................................                27,391,000               356,000            27,747,000
Per Share Amount...............................                     $1.45                                       $1.43

For the Year Ended December 31, 1997:
Net Income.....................................               $24,241,000                                 $24,241,000
Shares.........................................                27,013,000               413,000            27,426,000
Per Share Amount...............................                      $.90                                        $.88

For the Year Ended December 31, 1996:
Net Income.....................................               $31,143,000                                 $31,143,000
Shares.........................................                26,589,000               602,000            27,191,000
Per Share Amount...............................                     $1.17                                       $1.15
</TABLE>

Stock Split. On May 5, 1998, the Company announced a three-for-two  stock split.
Each  stockholder of record of the Company owning one share of common stock, par
value of $.005,  as of the close of business on the record date of May 18, 1998,
received  an  additional  one-half  share  on  June  18,  1998.  In  lieu of any
fractional  share resulting from the stock split, a stockholder  received a cash
payment based on the closing  price of the Company's  common stock on the record
date. The par value remains $.005 per share. Common stock and earnings per share
amounts have been retroactively adjusted to account for the split.



                                                          44

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


CII issued convertible  subordinated debentures (the "Debentures") due September
15,  2001.  Each $1,000 in principal is  convertible  into 25.382  shares of the
Company's common stock at a conversion price of $39.40 per share. The Debentures
were not  included in the  computation  of EPS  because  their  effect  would be
anti-dilutive.

4.   PROPERTY AND EQUIPMENT

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


<CAPTION>
        Classification                                                      1998                       1997


<S>                                                                     <C>                       <C>
           Land...................................................      $  28,588,000             $  14,296,000
           Buildings and Improvements.............................        145,308,000               109,307,000
           Furniture, Fixtures and Equipment......................         57,261,000                38,692,000
           Data Processing Equipment and Software.................         43,643,000                31,452,000
           Software in Development and Construction
              in Progress.........................................         20,324,000                 4,170,000
           Less: Accumulated Depreciation ........................        (65,960,000)              (49,086,000)
               Net Property and Equipment.........................       $229,164,000              $148,831,000
</TABLE>

The following is an analysis of property and equipment  under capital  leases by
classification as of December 31:
<TABLE>

<CAPTION>
        Classification                                                       1998                       1997
<S>                                                                        <C>                       <C>
           Data Processing Equipment and Software ................         $4,736,000                $4,779,000
           Furniture, Fixtures and Equipment......................          3,783,000                   728,000
           Building...............................................            245,000                   245,000
           Less: Accumulated Depreciation.........................         (2,185,000)                 (467,000)
              Net Property and Equipment..........................         $6,579,000                $5,285,000
</TABLE>

The Company capitalizes  interest expense as part of the cost of construction of
facilities  and  the  implementation  of  computer  systems.   Interest  expense
capitalized  in 1998,  1997 and 1996 was  $1,037,000,  $1,621,000  and $245,000,
respectively.

5.   CASH AND INVESTMENTS

Investments  that the Company has the  intention and ability to hold to maturity
are stated at amortized cost and categorized as held-to-maturity.  The remaining
investments  have been  categorized  as  available-for-sale  and 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  on
investments in 1998 were $4.8 million and $2.5 million,  respectively.  Realized
gains and losses are calculated using the specific identification method and are
included in net income.



                                                          45

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


     The following  table  summarizes  the Company's  short-term,  long-term and
restricted investments as of December 31, 1998:
<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.....................            $  19,180,000        $    52,000         $   219,000        $ 19,013,000
    Municipal Obligations...................               24,974,000             88,000               5,000          25,057,000
    Corporate Bonds.........................               31,419,000             45,000              60,000          31,404,000
    Other. . . . ...........................               13,795,000             41,000             548,000          13,288,000
       Total Short-term.....................               89,368,000            226,000             832,000          88,762,000

Classified as Long-term:
    U.S.  Government
       and its Agencies.....................               61,034,000            608,000           1,357,000          60,285,000
    Mortgage Backed.........................                6,209,000              1,000             216,000           5,994,000
    Municipal Obligations...................               33,086,000            229,000             408,000          32,907,000
    Corporate Bonds.........................               51,198,000            714,000             769,000          51,143,000
       Total Long-term......................              151,527,000          1,552,000           2,750,000         150,329,000

Classified as Restricted:
    U.S. Government
       and its Agencies.....................                8,549,000             87,000                               8,636,000
    Municipal Obligations...................                2,594,000            124,000                               2,718,000
    Corporate Bonds.........................                2,071,000             19,000                               2,090,000
    Other. . . . . . . . . .................                2,081,000                                                  2,081,000
       Total Restricted ....................               15,295,000            230,000                              15,525,000
          Total Available-for-Sale .........             $256,190,000         $2,008,000          $3,582,000        $254,616,000

Held-to-Maturity Investments:
Classified as Short-term:
    U.S.  Government
       and its Agencies.....................            $   8,468,000       $      9,000         $   432,000       $   8,045,000
    Mortgage Backed.........................                5,936,000                                266,000           5,670,000
    Municipal Obligations...................                1,570,000             44,000                               1,614,000
    Corporate Bonds.........................                5,272,000             66,000                               5,338,000
       Total Short-term.....................               21,246,000            119,000             698,000          20,667,000

Classified as Long-term:
    U.S.  Government
       and its Agencies.....................                6,529,000             29,000              51,000           6,507,000
   Mortgage Backed..........................               14,331,000                                672,000          13,659,000
   Municipal Obligations....................                4,154,000            259,000                               4,413,000
   Corporate Bonds..........................                5,473,000            441,000                               5,914,000
       Total Long-term......................               30,487,000            729,000             723,000          30,493,000

Classified as Restricted:
    U.S.  Government
       and its Agencies.....................                  495,000              9,000                                 504,000
    Municipal Obligations...................                  574,000             17,000                                 591,000
    Corporate Bonds.........................                1,164,000             50,000                               1,214,000
       Total Restricted ....................                2,233,000             76,000                               2,309,000
          Total Held-to-Maturity ...........             $ 53,966,000        $   924,000          $1,421,000        $ 53,469,000

</TABLE>

                                                                 46

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


     The following  table  summarizes  the Company's  short-term,  long-term and
restricted investments as of December 31, 1997:
<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...........................      $   7,577,000        $    31,000           $   1,000       $   7,607,000
    Municipal Obligations.........................         41,732,000             88,000             194,000          41,626,000
    Corporate Bonds.....................48,945,000            345,000             74,000          49,216,000
    Other . . . . . ..............................          6,163,000              9,000              99,000           6,073,000
       Total Short-term...........................        104,417,000            473,000             368,000         104,522,000

Classified as Long-term:
    U.S.  Government
       and its Agencies...........................         38,031,000            169,000              59,000          38,141,000
    Municipal Obligations.........................          3,160,000            139,000               1,000           3,298,000
    Corporate Bonds.....................81,299,000            776,000             43,000          82,032,000
    Other . . . . . ...............         63,000                                                    63,000
       Total Long-term............................        122,553,000          1,084,000             103,000         123,534,000

Classified as Restricted:
    U.S. Government
       and its Agencies...........................          8,639,000             34,000              12,000           8,661,000
    Municipal Obligations.........................          3,166,000            104,000                               3,270,000
    Corporate Bonds........................497,000              1,000                                498,000
    Other. . . . . . . . . .......................          2,373,000                                                  2,373,000
       Total Restricted ..........................         14,675,000            139,000              12,000          14,802,000
          Total Available-for-Sale ...............       $241,645,000         $1,696,000            $483,000        $242,858,000

Held-to-Maturity Investments:
Classified as Short-term:
    U.S. Government
       and its Agencies...........................      $   2,884,000        $    33,000                           $   2,917,000
    Corporate Bonds ..............................          8,092,000            189,000                               8,281,000
       Total Short-term...........................         10,976,000            222,000                              11,198,000

Classified as Long-term:
    U.S.  Government
       and its Agencies...........................         14,313,000             20,000           $  38,000          14,295,000
    Municipal Obligations.........................          6,038,000            372,000                               6,410,000
    Corporate Bonds..................   11,268,000            509,000             11,000          11,766,000
       Total Long-term............................         31,619,000            901,000              49,000          32,471,000

Classified as Restricted:
    Municipal Obligations.........................            575,000             26,000                                 601,000
    Corporate Bonds..................    1,163,000             22,000                              1,185,000
       Total Restricted ..........................          1,738,000             48,000                               1,786,000
          Total Held-to-Maturity .................       $ 44,333,000         $1,171,000           $  49,000       $  45,455,000
</TABLE>


                                                                 47

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


The  contractual  maturities  of  available-for-sale  short-term,  long-term and
restricted investments at December 31, 1998 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......................................             $  64,036,000            $  63,497,000
Due after one year through five years........................                54,609,000               55,362,000
Due after five years through ten years.......................                16,763,000               17,063,000
Due after ten years..........................................               120,782,000              118,694,000
     Total...................................................              $256,190,000             $254,616,000
</TABLE>


The  contractual  maturities  of  held-to-maturity  short-term,   long-term  and
restricted investments at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
                                                                           Amortized               Estimated
                                                                               Cost                Fair Value

<S>                                                                         <C>                      <C>
Due in one year or less......................................               $12,563,000              $12,417,000
Due after one year through five years........................                12,209,000               12,957,000
Due after five years through ten years.......................                 2,954,000                2,988,000
Due after ten years..........................................                26,240,000               25,107,000
     Total...................................................               $53,966,000              $53,469,000
</TABLE>

Of  the  cash  and  cash  equivalents  that  total  $83,910,000  million  in the
accompanying  Consolidated  Balance  Sheet at  December  31,  1998,  $81,328,000
million is limited for use only by the Company's  regulated  subsidiaries.  Such
amounts are  available  for transfer to Sierra from the  regulated  subsidiaries
only to the  extent  that  they can be  remitted  in  accordance  with  terms of
existing  management  agreements  and by  dividends  which  customarily  must be
approved by regulating state insurance  departments.  The remainder is available
to Sierra on an unrestricted basis.

6.   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  medical  reinsurance  agreements  that  provide
coverage  for 50% - 90% of hospital  and other costs in excess of,  depending on
the contract,  $100,000 to $200,000, per case, up to a maximum of $2,000,000 per
member per  lifetime for both the managed  indemnity  and HMO  subsidiaries.  In
addition,  certain  of the  Company's  HMO  members  are  covered  by an  excess
catastrophe reinsurance contract. Reinsurance premiums of $2,860,000, $3,156,000
and  $3,235,000  net of  reinsurance  recoveries of  $1,185,000,  $1,729,000 and
$2,276,000   are  included  in  medical   expense  for  1998,   1997  and  1996,
respectively.  In addition, SHL maintains reinsurance on certain other insurance
products.

CII also has reinsurance treaties in effect. Effective January 1, 1998, workers'
compensation  claims  between  $500,000  and  $100,000,000  per  occurrence  are
reinsured.  In 1997 and 1996, workers'  compensation claims between $350,000 and
$60,000,000 per occurrence were reinsured. In addition,  effective July 1, 1998,
workers'  compensation  claims below $500,000 per occurrence are reinsured under
quota  share  and  excess  reinsurance  agreements  (referred  to as "low  level
reinsurance") with an A+ rated carrier. Under this agreement,  CII reinsures 30%
of the first $10,000 of each loss, 75% of the next $40,000

                                                        48

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


     and 100% of the next $450,000.  CII receives a ceding  commission  from the
reinsurer as a partial reimbursement of its operating expenses.

The low level  reinsurance  agreement  contains both retroactive and prospective
reinsurance coverage and CII has bifurcated the low level reinsurance  agreement
to account  for the  different  accounting  treatments.  The amount by which the
estimated ceded liabilities exceed the amount paid for the retroactive  coverage
is amortized to income over the estimated remaining  settlement period using the
interest method.  For the year ended December 31, 1998, CII amortized a deferred
gain of $1,038,000. Any subsequent changes in estimated or actual cash flows are
accounted for by adjusting the previously  recorded deferred gain to the balance
that would have existed had the revised estimate been available at the inception
of the  reinsurance  transactions,  with a  corresponding  charge  or  credit to
income.

At  December  31, 1998 and 1997,  the amount of  reinsurance  recoverable  under
prospective reinsurance contracts for unpaid losses and loss adjustment expenses
for CII was $37,797,000 and $21,056,000, respectively. At December 31, 1998, the
amount of reinsurance recoverable under the retroactive reinsurance contract was
$18,710,000.  The  amount of  reinsurance  receivable  for paid  losses and loss
adjustment expenses was $1,917,000 and $358,000,  at December 31, 1998 and 1997,
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  prospective  reinsurance
information for the three years ended December 31, 1998:
<TABLE>

<CAPTION>
                                                             Change in
Recoveries                                                   Recoverable
on Paid                                                      on Unpaid               Premiums
  Losses/LAE                                                  Losses/LAE            Ceded

1998:
 Travelers Indemnity Company
<S>                                                           <C>                 <C>                  <C>
     of Illinois...............................               $1,379,000          $19,664,000          $16,095,000
 General Reinsurance Corporation...............                3,292,000           (2,923,000)          3,533,000
 Others .......................................                                                           202,000
 Total ........................................               $4,671,000          $16,741,000         $19,830,000

1997:
 General Reinsurance Corporation.................            $   841,000          $ 5,380,000         $ 4,872,000
 Others .........................................                                                         187,000
 Total ..........................................            $   841,000          $ 5,380,000         $ 5,059,000

1996:
 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
</TABLE>



                                                        49

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


7.   LOSSES AND LOSS ADJUSTMENT EXPENSES

The  following  table  provides a  reconciliation  of the  beginning  and ending
reserve  balances for unpaid  losses and 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,
                                                                               1998              1997             1996


<S>                                                                <C>              <C>               <C>
Net Beginning Losses and LAE Reserve .....................         $181,643,000     $172,100,000      $156,447,000

Net Provision for Insured Events Incurred in:
   Current Year ..........................................          103,990,000      102,301,000       101,401,000
   Prior Years............................................           (9,643,000)      (8,970,000)      (15,284,000)
     Total Net Provision..................................           94,347,000       93,331,000        86,117,000

Net Payments for Losses and LAE
   Attributable to Insured Events Incurred in:
   Current Year ..........................................           29,592,000       26,811,000        24,733,000
   Prior Years............................................           71,932,000       56,977,000        45,731,000
     Total Net Payments ..................................          101,524,000       83,788,000        70,464,000

Net Ending Losses and LAE Reserve ........................          174,466,000      181,643,000       172,100,000
Reinsurance Recoverable ..................................           37,797,000       21,056,000        15,676,000

Gross Ending Losses and LAE Reserve ......................         $212,263,000     $202,699,000      $187,776,000
</TABLE>

8.   LONG-TERM DEBT

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

<CAPTION>
                                                                                1998                     1997

<S>                                                                          <C>                      <C>
Revolving Credit Facility............................................        $139,000,000             $ 25,000,000
7 1/2% Convertible Subordinated Debentures ..........................          51,251,000               54,467,000
6% Mortgage Note.....................................................          35,171,000
7 1/5% Mortgage Note.................................................          13,440,000
7 3/8% Mortgage Note  ...............................................             821,000                5,833,000
Adjustable Rate Mortgage Note .......................................                                    3,116,000
Other................................................................           7,978,000                7,151,000
  Total..............................................................         247,661,000               95,567,000
Less Current Portion.................................................          (5,263,000)              (4,726,000)
Long-term Debt.......................................................        $242,398,000              $90,841,000
</TABLE>

Revolving Credit  Facility.  On October 31, 1998, the Company replaced its prior
line of credit  with a $200  million  credit  facility  under  which it has $139
million in borrowings  outstanding  as of December 31, 1998.  Interest under the
credit facility is variable and based on the London Interbank Offering Rate plus
a margin  determined  by  reference  to the  Company's  leverage  ratio.  Of the
outstanding balance,  $50.0 million is covered by interest-rate swap agreements.
The average cost of  borrowing on this line of credit for the fourth  quarter of
1998,  including the impact of the swap agreements,  was approximately 8.0%. The
terms of the credit facility contain a mandatory payment schedule that begins on
June 30, 2001 and ends on September  30, 2003 if the principal  balance  exceeds
certain thresholds. The terms of the credit facility

                                                        50

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


contain certain covenants  including a minimum fixed charge coverage ratio and a
maximum  leverage  ratio. In November 1998, the Company  borrowed  approximately
$110 million to fund the acquisition of Kaiser- Texas.

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 25.382 shares of
the  Company's  common  stock  at  a  conversion  price  of  $39.40  per  share.
Unamortized  issuance  costs of $509,000  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, 1998 and 1997 was  $1,117,000 and
$1,191,000,  respectively.  The Debentures are redeemable by CII, in whole or in
part,  at  redemption  prices of 101.05% in 1999 and  100.75%  thereafter,  plus
accrued interest.  The Debentures are general unsecured  obligations of CII only
and were not assumed or  guaranteed  by Sierra.  During the twelve  months ended
December  31,  1998 and 1997,  the Company  purchased  $3,216,000  and  $30,000,
respectively, of the debentures on the open market.

6.0% Mortgage Note. In conjunction  with the acquisition of  Kaiser-Texas,  TXHC
executed a deed of trust note for  $35,200,000.  The note is secured by deeds of
trust  covering the underlying  real estate and fixtures.  The terms of the note
include  fixed  monthly  payments of  $211,000  for five years at which time the
remaining principal is due.

7 1/5% Mortgage Note. In January 1998, the Company  obtained a $15,000,000  loan
from Bank of America, Nevada at an interest rate of 7 1/5%. This loan is secured
by a deed of trust, assignment of rents and leases, and a security agreement and
fixture  filing  covering  the  newly  constructed   portion  of  the  Company's
administrative headquarters complex and underlying real property.

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 a portion of
the Company's administrative headquarters complex and underlying real property.

Adjustable  Rate Mortgage Note. In 1998, the Company repaid a mortgage which had
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%.

Other. The Company has obligations under capital leases with interest rates from
6.3% to  13.4%.  In  addition,  the  Company  has  term  loans  with the City of
Baltimore and the State of Maryland.



                                                        51

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


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, 1998, are as follows:
<TABLE>

<CAPTION>
                                                                                                   Obligations
                                                                              Notes               Under Capital
     Year ending December 31,                                              Payable                  Leases
<S>      <C>                                                              <C>                      <C>
         1999.................................................            $   2,761,000            $2,932,000
         2000.................................................                2,310,000             1,967,000
         2001.................................................               53,263,000             1,314,000
         2002.................................................                2,150,000             1,278,000
         2003 ................................................              173,984,000               105,000
         Thereafter...........................................                6,379,000               276,000
            Total.............................................             $240,847,000             7,872,000
         Less:  Amounts Representing Interest.................                                     (1,058,000)
         Present Value of Minimum Lease Payments..............                                     $6,814,000
</TABLE>

The fair value of the Debentures at December 31, 1998 was $48,176,000  which was
determined  based  on the  market  price  on  January  7,  1999.  Excluding  the
Debentures,  the fair value of long-term debt, including the current portion, is
$195,057,000 based on the borrowing rates currently available to the Company for
bank loans with similar terms and average maturities.

9.   INCOME TAXES

A summary of the  provision  for income  taxes for the years ended  December 31,
1998, 1997, and 1996 is as follows:
<TABLE>

<CAPTION>
                                                             1998                 1997                  1996

Provision for Income Taxes:
<S>                                                        <C>                   <C>                  <C>
     Current.....................................          $12,595,000           $5,528,000           $11,860,000
     Deferred....................................            1,201,000           (2,294,000)           (1,389,000)
                                                           $13,796,000           $3,234,000           $10,471,000
</TABLE>


The following  reconciles the difference between the 1998, 1997 and 1996 current
and statutory provision for income taxes:
<TABLE>

<CAPTION>
                                                             1998                 1997                  1996


<S>                                                           <C>                    <C>                   <C>
Statutory Rate ..................................             35%                    35%                   35%
Tax Preferred Investments .......................           (2)                    (5)                   (6)
Change in Valuation Allowance ...................           (9)                   (17)                   (6)
Other ...........................................            2                     (1)                    2
     Provision for Income Taxes .................             26%                    12%                   25%

</TABLE>


                                                        52

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


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

                                                                                    1998                 1997
Deferred Tax Assets:
<S>                                                                             <C>                   <C>
    Medical and Losses and LAE Reserves ......................                  $  4,398,000          $  7,428,000
    Accruals Not Currently Deductible.........................                     4,875,000             7,269,000
    Compensation Accruals ....................................                     4,569,000             2,344,000
    Bad Debt Allowances.......................................                     2,189,000             2,041,000
    Loss Carryforwards and Credits............................                     9,878,000            11,543,000
    Unearned Premiums.........................................                       850,000               902,000
    Deferred Reinsurance Gains................................                     2,188,000
    Other ....................................................                       551,000
                                                                                  29,498,000            31,527,000

Deferred Tax Liabilities:
    Deferred Policy Acquisition Costs ........................                       586,000               596,000
    Depreciation and Amortization ............................                     6,249,000             4,872,000
    Other ....................................................                       558,000             1,096,000
                                                                                   7,393,000             6,564,000
    Net Deferred Tax Asset Before
       Valuation Allowance....................................                    22,105,000            24,963,000

    Valuation Allowance ......................................                    (1,575,000)           (6,266,000)
    Net Deferred Tax Asset ...................................                   $20,530,000           $18,697,000
</TABLE>


At December 31, 1998, the Company had  approximately  $20,022,000 of regular tax
net  operating  loss  carryforwards  which  are  limited  to use at the  rate of
approximately  $7,021,000  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.  In  addition  to the net  operating  loss
carryforwards,  the Company has alternative minimum tax credits of approximately
$848,000  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.

A valuation  allowance has been set up to reflect the Company's inability to use
tax benefits from certain acquisitions  currently or in the near future. For the
years  ended  December  31,  1998 and 1997,  the  Company  was able to realize a
portion of the tax benefits for which a valuation  allowance had been previously
established.  As a result,  the  Company  reduced  its  valuation  allowance  by
$4,691,000  and  $4,663,000  for the years  ended  December  31,  1998 and 1997,
respectively.


                                                        53

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


10.  COMMITMENTS AND CONTINGENCIES

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

<CAPTION>
     Year Ending December 31,
<S>       <C>                                                               <C>
          1999...................................................           $  8,811,000
          2000...................................................              6,896,000
          2001...................................................              6,060,000
          2002...................................................              5,665,000
          2003 ..................................................              3,740,000
          Thereafter.............................................              5,038,000
               Total.............................................            $36,210,000
</TABLE>

Rent expense  totaled  $8,763,000,  $5,827,000 and $4,945,000 in 1998,  1997 and
1996, respectively.

Litigation and Legal Matters. 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.

11.       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 a
maximum  of  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.  Expense under
the plan totaled  $4,522,000,  $3,929,000 and $3,216,000 in 1998, 1997 and 1996,
respectively.

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.

Executive Life Insurance Plan. Effective July 1, 1997 the Company has funded and
entered into split dollar life insurance  agreements  with certain  officers and
key  executives  (selected and approved by the Sierra Board of  Directors).  The
premiums paid by the Company will be reimbursed  upon the  occurrence of certain
events as specified in the contract.

     Supplemental Executive Retirement Plan (SERP).  Effective July 1, 1997, the
Company  adopted  a  defined  benefit   retirement  plan  covering  certain  key
employees. The Company is funding the benefits through the

                                                        54

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


purchase of certain life insurance policies.  Benefits are based on, among other
things,  the  employee's  average  earnings over the  five-year  period prior to
retirement  or  termination,  and length of service.  Benefits  attributable  to
service  prior to the  adoption  of the plan are  amortized  over the  estimated
remaining service period for those employees participating in the plan. In 1998,
the Company expanded the SERP to include more participants. The effect of adding
these participants is included in plan amendments in the reconciliation below.

A reconciliation of ending year balances is as follows:
<TABLE>
<CAPTION>
                                                                                        For the Year Ended
                                                                                            December 31,
                                                                                    1998                  1997
     Change in Benefit Obligation:
         Projected Benefit Obligation at Beginning of Period
<S>                        <C>                                                   <C>                   <C>
            (Inception for 1997) ......................................          $ 9,515,000           $ 9,008,000
         Service Cost .................................................              408,000               132,000
         Interest Cost ................................................              875,000               375,000
         Plan Amendments...............................................              995,000
         Actuarial Gains/Losses........................................            1,925,000
         Benefits Paid ................................................              (97,000)
         Benefit Obligation at End of Period...........................           13,621,000             9,515,000

     Change in Plan Assets:
         Fair Value of Plan Assets at Beginning of Period..............            1,872,000
         Actual Return on Plan Assets .................................              (58,000)             (308,000)
         Company Contributions ........................................            2,679,000             2,180,000
         Fair Value of Plan Assets at End of Period....................            4,493,000             1,872,000

         Funded Status of the Plan ....................................           (9,128,000)           (7,643,000)
         Unrecognized Actuarial Change.................................            1,858,000
         Unrecognized Prior Service Credit ............................            8,757,000             8,647,000
         Unrecognized Net Loss ........................................              748,000               394,000
         Total Recognized .............................................          $ 2,235,000           $ 1,398,000

     Total Recognized Amounts in the Financial
        Statements Consist of:
         Accrued Benefit Liability ....................................          $(3,325,000)          $(2,964,000)
         Intangible Asset .............................................            5,560,000             4,362,000
         Total ........................................................          $ 2,235,000           $ 1,398,000

     Assumptions:
         Discount Rate ................................................                  7.0%                 7.0%
         Expected Return on Plan Assets ...............................                  8.0%                 8.0%
         Rate of Compensation Increase ................................                  5.0%                 5.0%

     Components of Net Periodic Benefit Cost:

         Service Cost..................................................          $   408,000            $  132,000
         Interest Cost ................................................              875,000               375,000
         Expected Return on Plan Assets................................             (295,000)              (87,000)
         Amortization of Prior Service Credits.........................              885,000               361,000
         Recognized Actuarial Loss.....................................               68,000
         Net Periodic Benefit Cost.....................................           $1,941,000            $  781,000
</TABLE>

                                                        55

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


12.       CAPITAL STOCK PLANS

Stockholders'  Rights Plan.  Each share of Sierra common stock,  par value $.005
per share,  contains one right (a "Right").  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.   The  Company  has  several  plans  that  provide  common
stock-based awards to employees and to non-employee directors. The plans provide
for the granting of Options,  Stock, and other  stock-based  awards.  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.  The
exercise price of each option equals the market price of the Company's  stock on
the date of grant. Stock options generally vest at a rate of 20% - 25% per year.
Options generally expire one year after the end of the vesting period.

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

<CAPTION>
                                                       Number of                  Option              Weighted
                                                         Shares                    Price           Average Price

<S>                 <C>                                <C>                  <C>        <C>              <C>
Outstanding January 1, 1996.................           2,790,000            $  2.25  - $21.17           $14.36
   Granted..................................             480,000              16.67  -  23.33            17.43
   Exercised................................            (249,000)              2.25  -  19.09             8.38
   Canceled.................................             (23,000)              7.13  -  21.17            14.47
Outstanding December 31, 1996 ..............           2,998,000               5.00  -  23.33            15.34
   Granted..................................             459,000              16.25  -  24.50            23.15
   Exercised................................            (705,000)              5.00  -  21.17            11.81
   Canceled.................................             (97,000)              6.31  -  23.33            17.33
Outstanding December 31, 1997 ..............           2,655,000               6.31  -  24.50            17.53
   Granted..................................             468,000              16.94  -  24.83            22.49
   Exercised................................            (386,000)              6.31  -  23.33            14.25
   Canceled.................................              (7,000)              7.13  -  24.50            17.01
Outstanding December 31, 1998...............           2,730,000               6.31  -  24.83            18.89

Exercisable at December 31, 1998 ...........           1,274,000              $6.31    $24.50           $17.16

Available for Grant at
   December 31, 1998 .......................           3,002,000
</TABLE>



                                                        56

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


     The following table summarizes  information about stock options outstanding
at December 31, 1998: <TABLE>

<CAPTION>
                                Weighted Average                                                Weighted Average
        Range of Exercise           Remaining                    Options                         Exercise Price
            Prices              Contractual Life        Outstanding      Exercisable      Outstanding       Exercisable

<S>           <C>                       <C>                <C>               <C>            <C>
  $ 6.31  -   6.311,264 days            16,000             16,000            $ 6.31         $ 6.31
9.91  - 12.083,068 days                189,000            136,000             11.10          11.11
16.25  - 21.171,081 days             1,678,000          1,034,000             17.53          17.52
22.17  - 24.831,986 days               847,000             88,000             23.57          24.30
</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, 1998, the
Company had 353,000 shares reserved for purchase under the Purchase Plan. During
1998,  a total of 144,000  shares were  purchased at prices of $17.75 and $19.06
per share. During January 1999, 72,000 shares were issued to employees at $17.85
per share in connection with the Purchase Plan.

Accounting for  Stock-Based  Compensation.  The Company uses the intrinsic value
method in accounting for its stock-based  compensation  plans.  Accordingly,  no
compensation  cost has been  recognized  for its employee stock option plans nor
the Stock  Purchase Plan. Had  compensation  cost for the Company's  stock-based
compensation  plans been  determined  based on the fair value at the grant dates
for awards under those plans,  the  Company's  net income and earnings per share
would have been reduced to the pro forma amounts indicated below: <TABLE>

<CAPTION>
                                                                              For the Years Ended
                                                                1998                  1997               1996

<S>                                                         <C>                   <C>                  <C>
Net Income                          As reported             $39,596,000           $24,241,000          $31,143,000
                                    Proforma                 37,106,000            22,177,000           29,703,000

Net Income Per Share                As reported                   $1.45                  $.90                $1.17
                                    Proforma                       1.35                   .82                 1.12

Net Income Per Share
    Assuming Dilution               As reported                   $1.43                  $.88                $1.15
                                    Proforma                       1.34                   .81                 1.09
</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 1998, 1997 and 1996, respectively: dividend yield
of 0% for all years; expected volatility of 37%, 35% and 29%; risk-free interest
rates of 4.46%, 5.89% and 5.92%; and expected lives of five years for all years.
The  weighted  fair value of options  granted in 1998,  1997 and 1996 was $9.92,
$8.27 and $5.65, 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 1998,
1997  and  1996,  respectively:  dividend  yield of 0% for all  years;  expected
volatility of 32%, 35% and 29%;  risk-free  interest  rates of 5.30%,  5.32% and
5.29%; and expected lives of six months for all years.


                                                        57

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


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.

13.  STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION

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

<CAPTION>
                                                                  1998              1997           1996

Cash Paid During the Year for Interest
<S>                                                                  <C>                <C>               <C>
    (Net of Amount Capitalized)...............................       $ 8,737,000        $4,463,000        $5,275,000
Cash Paid During the Year for Income Taxes....................        15,003,000         7,943,000         7,966,000

Noncash Investing and Financing Activities:
    Liabilities Assumed in Connection with
       Corporate Acquisitions.................................        53,461,000           195,000         7,890,000
    Reductions to Funds Withheld by Ceding
       Insurance Company and Future
       Policy Benefits........................................                           8,471,000           773,000
    Stock Issued for Exercise of Options
       and Related Tax Benefits...............................         1,284,000         2,004,000         1,158,000
    Additions to Capital Leases...............................         3,070,000         4,574,000
</TABLE>


14.        INTEGRATION, SETTLEMENT AND OTHER COSTS

1998

During the fourth  quarter of 1998,  the Company  incurred  settlement  expenses
totaling $8 million,  $5.9 million  after tax,  related to the  settlement  of a
competitor's protest for the Region 1 TRICARE contract. All this amount was paid
during fiscal year 1998.  On September  30, 1997,  SMHS was awarded a five-year,
$1.2 billion  contract to  administer  managed  health care services to military
families and retirees in 13 northeastern states and Washington, D.C. A competing
bidder  protested the contract award and claimed,  among other issues,  that the
United States Department of Defense failed to adequately disclose the weights of
the  significant  factors used to evaluate  proposals.  In December  1998,  SMHS
reached an  agreement  to settle the  protest.  As part of the  settlement,  the
competitor has foregone any and all rights it may have to challenge the contract
award and seek re-bid.

During the fourth quarter of 1998, the Company incurred integration,  transition
and other  charges  totaling  $3.1  million,  $2.3  million  after tax,  related
primarily to its acquisition of the Texas operations of Kaiser Foundation Health
Plan. In addition,  the Company  incurred  certain legal expenses  totaling $2.7
million, $2.0 million after tax, resulting primarily from the TRICARE settlement
and acquisition and integration  activity. As of December 31, 1998, $2.8 million
was included in accrued  expenses for these  integration,  transition  and legal
costs incurred through December 31, 1998.

1997

During 1997,  the Company  recorded  and paid  expenses of  approximately  $11.0
million,  $8.4 million after tax, for  merger-related  costs. On March 18, 1997,
the Company  announced it had  terminated  its merger  agreement  with Physician
Corporation of America. The original agreement had been entered into in November
1996.


                                                             58

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


During  the third  quarter  of 1997,  SMHS was  notified  it had been  awarded a
TRICARE  managed care contract by the  Department  of Defense to serve  eligible
beneficiaries in Region 1. This region includes more than 600,000  beneficiaries
in 13 northeastern states and the District of Columbia.  Development expenses of
$18.4 million $10.6  million net of taxes,  were recorded in the third  quarter,
primarily for expenses  associated with the Company's  proposal to serve TRICARE
beneficiaries  in  Region  1.  Such  expenses  had  been  deferred  until  award
notification. SMHS began health care delivery on June 1, 1998. SMHS subcontracts
for health care  delivery,  including some of the risk, for parts of the TRICARE
contract.

1996

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 $3.8 million, $2.9 million after tax, in the fourth quarter
of 1996,  primarily to recognize the estimated costs to dispose of the hospital.
As of December  31,  1998,  the Company has been unable to reach an agreement to
sell 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 $8.3 million,  $6.2 million after tax. These  restructuring
costs included cancellation of certain contractual  obligations of $6.0 million,
lease  termination  costs of $1.5  million and  approximately  $750,000 of other
costs.

15.        UNAUDITED  QUARTERLY  INFORMATION  (Amounts in thousands,  except per
           share data)
<TABLE>

<CAPTION>
                                                                 March             June              September         December
                                                                 31                30                30               31
Year Ended December 31, 1998:
<S>                                                              <C>              <C>               <C>              <C>
  Operating Revenues....................................         $210,409         $244,545          $281,082         $301,167
  Operating Income......................................           17,663           18,550            18,213            6,147
  Income Before Income Taxes ...........................           16,382           16,931            17,006            3,073
  Net Income .....................................12,187           12,551           12,584             2,274
  Earnings Per Share ...................................              .44              .46               .46              .08
  Earnings Per Share Assuming Dilution .................              .44              .45               .46              .08

Year Ended December 31, 1997:
  Operating Revenues....................................         $170,578         $176,321         $183,859          $190,966
  Operating Income (Loss) ..............................            3,242           15,103           (2,765)           16,328
  Income (Loss) From Continuing Operations
     Before Income Taxes ...............................            1,840           13,896           (3,705)           15,444
  Net Income............................................            1,398           10,561              495            11,787
  Earnings Per Share ...................................              .05              .39              .02               .43
  Earnings Per Share Assuming Dilution .................              .05              .39              .02               .43
</TABLE>



                                                               59

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


16.     SEGMENT REPORTING

The Company has three  reportable  segments  based on the  products and services
offered: managed care and corporate operations, workers' compensation operations
and military  health  services  operations.  The managed  care segment  includes
managed health care services  provided  through HMOs,  managed  indemnity plans,
third-party  administrative services programs for employer-funded health benefit
plans,  multi-specialty  medical groups,  other ancillary services and corporate
operations.  The workers'  compensation  segment assumes  workers'  compensation
claims risk in return for premium revenues. The military health services segment
administers  a five-year,  managed care federal  contract for the  Department of
Defense's TRICARE program in Region 1.

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



                                                               60

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1998, 1997 and 1996


Information concerning the operations of the reportable segments is as follows:
(Amounts in thousands)
<TABLE>

<CAPTION>
                                                          Managed Care            Workers'              Military
                                                         and Corporate            Compensation        Health Services
                                                         Operations              Operations             Operations          Total
1998
<S>                                                       <C>                            <C>                    <C>      <C>
Medical Premiums..................................        $609,404                       0                      0        $  609,404
Specialty Product Revenues........................          12,843                $135,525                                  148,368
Professional Fees ................................          45,363                                                           45,363
Military Contract Revenues........................                                                       $204,838           204,838
Investment and Other Revenues.....................           8,594                  20,229                    407            29,230
   Total Revenue..................................        $676,204                $155,754               $205,245        $1,037,203

Depreciation and Amortization.....................       $  15,545              $    1,551             $    2,167       $    19,263

Interest Expense and Other                                   2,610                   3,998                    573             7,181

Segment Profit.  .......................                 $  40,704               $  18,492             $    8,047       $    67,243
Integration, Settlement and Other Costs...........          (4,869)                                        (8,982)          (13,851)
Net Income (Loss) Before Income Taxes.............       $  35,835               $  18,492             $     (935)      $    53,392

Segment Assets.  ........................                $ 593,332                $377,911               $ 73,877        $1,045,120
Capital Expenditures..............................          32,520                   3,208                  5,015            40,743

1997
Medical Premiums..................................        $513,857                                                       $  513,857
Specialty Product Revenues........................          16,297                $129,914                                  146,211
Professional Fees ................................          31,238                                                           31,238
Military Contract Revenues........................                                                      $   4,346             4,346
Investment and Other Revenues.....................           8,711                  17,361                                   26,072
   Total Revenue..................................        $570,103                 $147,275        $   4,346 $  721,724

Depreciation & Amortization.......................       $  12,491              $      950             $       69       $    13,510

Interest Expense and Other                                     371                   4,062                                    4,433

Segment Profit.  .......................                 $  45,662               $  11,010                    153       $    56,825
Integration, Settlement and Other Costs...........         (12,600)                                       (16,750)          (29,350)
Net Income (Loss) Before Income Taxes.............       $  33,062               $  11,010               $(16,597)      $    27,475

Segment Assets.  ........................                $373,652                 $343,425             $   6,859         $  723,936
Capital Expenditures..............................          43,825                  11,178                   639             55,642

1996
Medical Premiums..................................        $386,968                                                       $  386,968
Specialty Product Revenues........................          11,983                $121,341                                  133,324
Professional Fees ................................          28,836                                                           28,836
Investment and Other Revenues.....................           7,595                  18,688                                   26,283
   Total Revenue..................................        $435,382                $140,029               $  575,411

Depreciation & Amortization.......................      $    9,599              $      900                               $   10,499

Interest Expense and Other                                  (1,247)                  4,070                                    2,823

Segment Profit.  .......................                 $  42,930               $  10,748                              $    53,678
Integration, Settlement and Other Costs...........         (12,064)                                                          12,064
Net Income Before Income Taxes....................       $  30,866               $  10,748                              $    41,614

Segment Assets.  .......................                  $313,463                $315,999                               $  629,462
Capital Expenditures..............................          17,361                     566                                   17,927
</TABLE>



                                                                 61

<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 1999 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 1999 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 1999
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 1999  Annual  Meeting  of
Stockholders, is incorporated herein by reference.



                                                        62

<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:
<TABLE>

<CAPTION>
                                                                                                     Page

<S>                                                                                                    <C>
        Independent Auditors' Report.............................................................      35
        Consolidated Balance Sheets at December 31, 1998 and 1997................................      36
        Consolidated Statements of Operations for the Years Ended
           December 31, 1998, 1997 and 1996......................................................      37
        Consolidated Statements of Changes in Stockholders' Equity
           for the Years Ended December 31, 1998, 1997 and 1996..................................      38
        Consolidated Statements of Cash Flows for the Years Ended
           December 31, 1998, 1997 and 1996......................................................      39
        Notes to Consolidated Financial Statements...............................................      40


(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
</TABLE>

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  December  12,  1997,  incorporated  by  reference  to
                  Exhibit 3.3 to the Registrant's Annual Report on Form 10-K for
                  the fiscal year ended December 31, 1997.

       (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).

                                                        63

<PAGE>




     (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)      Credit  Agreement  dated as of October 30, 1998,  among Sierra
                  Health  Services,  Inc. as Borrower,  Bank of America National
                  Trust and  Savings  Association  as  Administrative  Agent and
                  Issuing Bank, First Union National Bank as Syndication  Agent,
                  and the Other Financial  Institutions Party Thereto,  dated as
                  of October 30, 1998.

      (10.5)      First  Amendment  to  Credit  Agreement  among  Sierra  Health
                  Services,  Inc., as Borrower,  Bank of America  National Trust
                  and Savings  Association as  Administrative  Agent and Issuing
                  Bank and the Other Financial Institutions Party Thereto, dated
                  as of November 23, 1998.

      (10.6)      Second  Amendment  to Credit  Agreement  among  Sierra  Health
                  Services, Inc. as borrower, Bank of America National Trust and
                  Savings  Association  as  Administrative  Agent  and the Other
                  Financial  Institutions Party Thereto, dated as of January 15,
                  1999.

      (10.7)      Compensatory Plans, Contracts and Arrangements.

                  (1)   Employment  Agreement  with  Jonathon  W.  Bunker  dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.

                  (2)   Employment   Agreement   with  Frank  E.  Collins  dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.

                  (3)   Employment  Agreement  with  William  R.  Godfrey  dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.

                  (4)   Employment  Agreement  with  Laurence  S.  Howard  dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.

                  (5)   Employment  Agreement with Anthony M. Marlon, M.D. dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.


                                                        64

<PAGE>



                  (6)   Employment   Agreement  with  Erin  E.  MacDonald  dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.

                  (7)   Employment  Agreement  with  Michael A.  Montalvo  dated
                        November 15, 1997,  incorporated by reference to Exhibit
                        10.6 to Registrant's  Annual Report on Form 10-K for the
                        fiscal year ended December 31, 1997.

                  (8)   Employment  Agreement with Marie H. Soldo dated November
                        15, 1997,  incorporated  by reference to Exhibit 10.6 to
                        Registrant's  Annual  Report on Form 10-K for the fiscal
                        year ended December 31, 1997.

                  (9)   Employment  Agreement with James L. Starr dated November
                        15, 1997,  incorporated  by reference to Exhibit 10.6 to
                        Registrant's  Annual  Report on Form 10-K for the fiscal
                        year ended December 31, 1997.

                  (10)  Employment  Agreement with Paul H. Palmer dated November
20, 1998.

     (11) Draft of Split Dollar Life Insurance Agreement effective as of July 1,
1997, by and between Sierra Health Services,  Inc., and Jonathon W. Bunker,  Ria
Marie Carlson, Frank E. Collins, William R. Godfrey, Laurence S. Howard, Erin E.
MacDonald,  Anthony M. Marlon,  M.D.,  Kathleen M. Marlon,  Michael A. Montalvo,
John A.  Nanson,  M.D.,  Marie H.  Soldo,  and James L. Starr,  incorporated  by
reference to Exhibit 10.2 to the Registrant's  Quarterly Report on Form 10-Q for
the fiscal quarter ended June 30, 1997.

                  (12)     Sierra Health Services,  Inc.  Deferred  Compensation
                           Plan  effective  May 1, 1996 as Amended and  Restated
                           Effective  July 1,  1997,  dated as of July 1,  1997,
                           incorporated  by  reference  to  Exhibit  10.3 to the
                           Registrant's  Quarterly  Report  on Form 10-Q for the
                           fiscal quarter ended June 30, 1997.

                  (13)  Sierra  Health  Services,  Inc.  Supplemental  Executive
                        Retirement  Plan effective as of July 1, 1997,  dated as
                        of July 7, 1997,  incorporated  by  reference to Exhibit
                        10.4 to the  Registrant's  Quarterly Report on Form 10-Q
                        for the fiscal quarter ended June 30, 1997.

                  (14)  Sierra  Health  Services,  Inc.  Supplemental  Executive
                        Retirement   Plan   effective   as  of  March  1,  1998,
                        incorporated   by   reference   to  Exhibit  10  to  the
                        Registrant's  Quarterly  Report  on  Form  10-Q  for the
                        fiscal quarter ended March 31, 1998.

                  (15)  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.

                  (16)  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.

                  (17)  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.

                  (18)  Sierra Health  Services,  Inc. 1995 Long-Term  Incentive
                        Plan,  as amended and  restated  through  May 18,  1998,
                        incorporated   by  reference  to  Exhibit  10.4  to  the
                        Registrant's  Quarterly  Report  on  Form  10-Q  for the
                        fiscal quarter ended June 30, 1998.

                                                        65

<PAGE>




                  (19)  Sierra   Health   Services,   Inc.   1995   Non-Employee
                        Directors'  Stock Plan, as amended and restated  through
                        May 18, 1998,  incorporated by reference to Exhibit 10.5
                        to the  Registrant's  Quarterly  Report on Form 10-Q for
                        the fiscal quarter ended June 30, 1998.

      (10.8)      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.

      (10.9)      Loan  Agreement  dated August 11, 1997 between the Company and
                  Anthony  M.  Marlon for a  revolving  credit  facility  in the
                  maximum  aggregate  amount  of  $3,000,000,   incorporated  by
                  reference to the  Registrant's  Quarterly  Report on Form 10-Q
                  for the fiscal quarter ended September 30, 1997.

     (10.10)      Master Purchase and Sale Agreement  between Kaiser  Foundation
                  Health  Plan of Texas (as  Seller)  and HMO  Texas,  L.C.  (as
                  Buyer),  dated  June 5, 1998,  incorporated  by  reference  to
                  Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q
                  for the fiscal quarter ended June 30, 1998.*

     (10.11)      Asset Sale and Purchase  Agreement  between Kaiser  Foundation
                  Health Plan of Texas, A Texas  Non-Profit  Corporation and HMO
                  Texas, L.C., a Texas Limited Liability Company,  dated June 5,
                  1998,  incorporated  by  reference  to  Exhibit  10.2  to  the
                  Registrant's  Quarterly  Report  on Form  10-Q for the  fiscal
                  quarter ended June 30, 1998.*

     (10.12)      Asset Sale and Purchase  Agreement between  Permanente Medical
                  Association of Texas, a Texas Professional Association and HMO
                  Texas, L.C., a Texas Limited Liability Company,  dated June 5,
                  1998,  incorporated  by  reference  to  Exhibit  10.3  to  the
                  Registrant's  Quarterly  Report  on Form  10-Q for the  fiscal
                  quarter ended June 30, 1998.*

     (10.13) Amendment No. 2 to Asset Sale and Purchase Agreement between Kaiser
Foundation  Health Plan of Texas and Texas Health  Choice,  L.C.  (formerly  HMO
Texas, L.C.)*


                                                        66

<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. (Texas Health Choice, 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
Sierra Military Health Services, Inc.                           Nevada
Sierra Home Medical Products, Inc.                              Nevada
Nevada Administrators, Inc.                                     Nevada
MedOne Health Plan, Inc.                                        Nevada

      (23.1)      Consent of Deloitte & Touche LLP

      (27.1)      Financial Data Schedule -  1998

        (99)  Registrant's  current  report  on Form 8-K dated  March 17,  1999,
incorporated herein.

            All other Exhibits are omitted because they are not applicable.

(b)         Reports on Form 8-K

                  The Company filed a Current Report on Form 8-K, dated November
                  11,  1998,  with the  Securities  and Exchange  Commission  to
                  present  pro  forma  financial   information  related  to  the
                  acquisition  of  Kaiser-Texas   and  the  required   financial
                  statements.

(d)         Financial Statement Schedules

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


*The agreements  contain certain  schedules and exhibits which were not included
 in this filing.  The Company will furnish  supplementally a copy of any omitted
 schedule or exhibit to the Commission upon request.


                                                        67

<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, M.D.
Date:  March 17, 1999

     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.
<TABLE>

<CAPTION>
Signature                                          Title                                     Date


<S>                                                                                                <C> <C> 
   /S/ ANTHONY M. MARLON, M.D.                     Chief Executive Officer                   March 17, 1999
   Anthony M. Marlon, M.D.                         and Chairman of the Board
                                                   (Chief Executive Officer)


   /S/ PAUL H. PALMER                              Vice President of Finance,                March 17, 1999
   Paul H. Palmer                                  Chief Financial Officer,
                                                   and Treasurer
                                                   (Chief Accounting Officer)


   /S/ ERIN E. MACDONALD                           President and                             March 17, 1999
   Erin E. MacDonald                               Chief Operating Officer
                                                   Director


   /S/ CHARLES L. RUTHE                            Director                                  March 17, 1999
        Charles L. Ruthe


   /S/ WILLIAM J. RAGGIO                           Director                                  March 17, 1999
        William J. Raggio


   /S/ THOMAS Y. HARTLEY                           Director                                  March 17, 1999
        Thomas Y. Hartley

</TABLE>

                                                        68

<PAGE>



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



<CAPTION>
                                                                                            December 31,
                                                                                      1998               1997
CURRENT ASSETS:
<S>                                                                              <C>                 <C>
     Cash and Cash Equivalents ..........................................        $   7,945,000       $  15,115,000
     Short-term Investments..............................................            2,831,000           2,090,000
     Prepaid Expenses and Other Current Assets...........................            9,189,000          10,415,000
           Total Current Assets..........................................           19,965,000          27,620,000

PROPERTY AND EQUIPMENT - NET ............................................           45,699,000          55,251,000
EQUITY IN NET ASSETS OF SUBSIDIARIES ....................................          375,910,000         204,204,000
NOTES RECEIVABLE FROM SUBSIDIARIES ......................................            9,677,000           9,744,000
LONG-TERM INVESTMENTS ...................................................            1,088,000              86,000
GOODWILL AND OTHER INTANGIBLE ASSETS ....................................            2,275,000           2,362,000
OTHER ...................................................................           30,817,000          24,081,000

TOTAL ASSETS ............................................................         $485,431,000        $323,348,000

CURRENT LIABILITIES:
     Accounts Payable and Other Accrued Liabilities .....................        $  24,422,000       $  16,757,000
     Current Portion of Long-term Debt ..................................              393,000           2,349,000
           Total Current Liabilities ....................................           24,815,000          19,106,000

LONG-TERM DEBT (Less Current Portion)....................................          139,429,000          25,858,000
OTHER LIABILITIES .......................................................           17,473,000          12,702,000
TOTAL LIABILITIES .......................................................          181,717,000          57,666,000

STOCKHOLDERS' EQUITY:
     Capital Stock ......................................................              141,000             139,000
     Additional Paid-in Capital .........................................          173,583,000         164,247,000
     Treasury Stock .....................................................          (14,821,000)         (5,601,000)
     Accumulated Other Comprehensive Income:
           Unrealized Holding (Loss) on Available-for-sale
                Investments .............................................           (1,027,000)            655,000
     Retained Earnings ..................................................          145,838,000         106,242,000
           Total Stockholders' Equity ...................................          303,714,000         265,682,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...............................         $485,431,000        $323,348,000
</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>
          1999...........................................................       $      393,000
          2000...........................................................              429,000
          2001...........................................................                   --
          2002...........................................................                   --
          2003 ..........................................................          139,000,000
          Thereafter.....................................................                   --
              Total......................................................         $139,822,000
</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,
                                                                     1998              1997            1996
OPERATING REVENUES:
<S>                                                              <C>               <C>              <C>
    Management Fees........................................      $52,773,000       $47,303,000      $44,139,000
    Subsidiary Dividends...................................        4,085,000         1,700,000        3,733,000
    Investment and Other Income............................        5,564,000         6,688,000        5,145,000
       Total Operating Revenues............................       62,422,000        55,691,000       53,017,000

GENERAL AND ADMINISTRATIVE EXPENSES:
    Payroll and Benefits...................................       22,238,000        17,616,000       11,579,000
    Depreciation...........................................        5,329,000         3,707,000        3,433,000
    Data Processing Maintenance............................        2,556,000         2,370,000        1,115,000
    Rent...................................................          620,000           615,000          649,000
    Repairs and Maintenance................................          879,000           459,000          408,000
    Legal..................................................          691,000           293,000        1,874,000
    Consulting.............................................        1,242,000           769,000          827,000
    Other..................................................        6,489,000         4,677,000        4,030,000
    Integration, Settlement and Other Costs ..... .........        4,569,000        29,350,000       12,064,000
       Total General and Administrative....................       44,613,000        59,856,000       35,979,000

INTEREST EXPENSE AND OTHER, NET............................       (2,566,000)         (676,000)        (503,000)

EQUITY IN UNDISTRIBUTED
    EARNINGS OF SUBSIDIARIES...............................       28,364,000        25,615,000       21,991,000

INCOME BEFORE INCOME TAXES.................................       43,607,000        20,774,000       38,526,000

(PROVISION FOR) BENEFIT FROM
     INCOME TAXES..........................................       (4,011,000)        3,467,000       (7,383,000)

NET INCOME.................................................      $39,596,000       $24,241,000      $31,143,000
</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,
                                                                                    1998              1997               1996

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                               <C>               <C>               <C>
      Net Income...........................................................       $39,596,000       $24,241,000       $31,143,000
      Adjustments to Reconcile Net Income to Net Cash
          Provided by Operating Activities:
          Depreciation and Amortization....................................         5,416,000         3,885,000         3,611,000
      Equity in Undistributed Earnings of Subsidiaries.....................       (28,364,000)      (25,615,000)      (21,991,000)
      Change in Assets and Liabilities:
          Other Assets.....................................................        (6,890,000)       (1,177,000)      (15,917,000)
          Current Assets...................................................         1,192,000        (2,312,000)       (5,959,000)
          Current Liabilities..............................................         8,949,000         5,493,000         4,712,000
          Other Long-term Liabilities .....................................         4,770,000         6,634,000         6,069,000
          Net Cash Provided by Operating Activities........................        24,669,000        11,149,000         1,668,000

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures, Net ...........................................       (22,294,000)      (26,453,000)       (9,292,000)
      (Increase) Decrease in Short-term Securities.........................          (606,000)        9,732,000        14,136,000
      (Increase) Decrease in Other Assets..................................          (886,000)        5,820,000         6,942,000
      Dividends from Subsidiary............................................         4,085,000         1,700,000         3,733,000
      Acquisitions, Net of Cash Acquired ..................................        (7,500,000)       (3,145,000)      (31,270,000)
      Dispositions, Net of Cash Disposed ..................................         1,373,000
      (Increase) Decrease  in Net Assets in Subsidiaries...................      (125,488,000)      (30,816,000)       14,321,000
          Net Cash Used for Investing Activities ..........................      (151,316,000)      (43,162,000)       (1,430,000)

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing ...................................       166,000,000        25,000,000
      Reductions in Long-term Obligations and
          Payments on Capital Leases.......................................       (45,424,000)         (480,000)         (718,000)
      Proceeds from Note Receivable to Subsidiary..........................            67,000            60,000         2,789,000
      Purchase of Treasury Stock ..........................................        (9,220,000)       (5,471,000)
      Exercise of Stock in Connection with Stock Plans.....................         8,054,000        10,258,000         3,638,000
          Net Cash Provided by Financing Activities........................       119,477,000        29,367,000         5,709,000

Net (Decrease) Increase in Cash and Cash Equivalents.......................        (7,170,000)       (2,646,000)        5,947,000
Cash and Cash Equivalents at Beginning of Year.............................        15,115,000        17,761,000        11,814,000
Cash and Cash Equivalents at End of Year...................................      $  7,945,000       $15,115,000       $17,761,000


Supplemental condensed statements of cash flows information:

Cash Paid During the Year for Interest
      (Net of Amount Capitalized)..........................................      $  2,030,000       $   632,000      $    443,000
Cash Paid During the Year for Income Taxes.................................        14,788,000         7,916,000         6,423,000

Noncash Investing and Financing Activities:
      Stock Issued for Exercise of Options
          and Related Tax Benefits.........................................         1,284,000         2,004,000         1,158,000
      Liabilities Assumed in Connection
          with Corporate Acquisition.......................................         1,233,000
</TABLE>


                                                                  S-3

<PAGE>



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



<TABLE>
<CAPTION>

                                                 Gross
                                                 Reserves
                                Deferred        for Unpaid
                                 Policy         Claims and      Discount if any                         Gross             Net
                               Acquisition      Adjustment        Deducted in       Unearned           Earned         Investment
Affiliation With                  Costs          Expenses          Column C         Premiums          Premiums          Income
Registrant Column A             Column B         Column C          Column D         Column E          Column F         Column G

Consolidated Property and
  Casualty Entities of CII
  Financial, Inc. for
  Years Ended:
<S>           <C> <C>             <C>             <C>                              <C>               <C>               <C>
     December 31, 1998........    $1,804          $212,263           --            $11,158           $154,104          $18,241
     December 31, 1997........     1,800           202,699           --             11,285            134,262           16,780
     December 31, 1996........     1,832           187,776           --              9,885            126,121           16,422

</TABLE>
























                                                    Table continued on next page


<PAGE>



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



<TABLE>
<CAPTION>

                                     Claims & Claim
                                       Adjustment        Amortization
                                    Expenses Incurred     of Deferred        Paid Claims
                                       Related to           Policy           and Claims       Direct
                                      (1)        (2)       Acquisition        Adjustment     Premiums
Affiliation With                    Current  Prior Year       Costs           Expenses        Written
Registrant Column A                  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>
     December 31, 1998........     $103,990   $(9,643)      $28,243          $101,524       $153,914
     December 31, 1997........      102,301    (8,970)       26,211            83,788        135,580
     December 31, 1996........      101,401   (15,284)       21,968            70,464        126,497
</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>

                                                                                          Year ended December 31

<CAPTION>
                           1998       1997       1996       1995       1994       1993       1992       1991       1990      1989

Losses and LAE

<S>                      <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>       <C>       <C>     
Reserve...............   $212,263   $202,699   $187,776   $182,318   $190,962   $200,356   $178,460   $112,749  $ 67,593  $ 37,466

Less Reinsurance
Recoverables (1)......     37,797     21,056     15,676     25,871     29,342     25,841     20,207

Net Loss and LAE
Reserves .............    174,466    181,643    172,100    156,447    161,620    174,515    158,253

Cumulative Net Paid
as of:
One Year Later .......                71,933     56,977     45,731     44,519     50,210     50,360     57,611     39,118    14,820
Two Years Later ......                           91,765     70,854     68,619     79,788     84,465     89,177     65,165    28,657
Three Years Later ....                                      83,674     80,645     94,865    104,569    108,849     76,988    36,579
Four Years Later .....                                                 86,381    102,395    114,293    120,539     83,822    39,345
Five Years Later .....                                                           106,012    119,462    126,100     87,618    41,043
Six Years Later ......                                                                      122,000    129,060     89,607    41,962
Seven Years Later ....                                                                                 130,649     90,721    42,541
Eight Years Later ....                                                                                             91,354    42,818
Nine Years Later .....                                                                                                       43,054

Net Reserve Re-estimated
as of:
One Year Later .......               172,000    163,130    141,163    139,741    160,562    154,388   140,815     83,841    37,463
Two Years Later ......                          146,987    132,193    125,279    141,100    147,167   142,447     96,011    39,753
Three Years Later ....                                     113,766    117,792    126,483    134,747   143,433     97,142    43,528
Four Years Later .....                                                102,955    122,517    132,193   137,143     97,942    44,404
Five Years Later .....                                                           114,443    131,112   135,249     94,852    45,027
Six Years Later ......                                                                      127,258   135,299     93,561    44,543
Seven Years Later ....                                                                                133,729     93,672    43,741
Eight Years Later ....                                                                                            92,851    43,682
Nine Years Later .....                                                                                                      43,682

Cumulative Redundancy
(Deficiency) .........                 9,643     25,113     42,681     58,665     60,072     30,995   (20,980)   (25,258)   (6,216)

Net Reserve.............. 174,466    181,643    172,100    156,447    161,620    174,515
Reinsurance 
     Recoverables......    37,797     21,056     15,676     25,871     29,342     25,841
Gross Reserve .........  $212,263    202,699    187,776    182,318    190,962    200,356

Net Re-estimated Reserve .....       172,000    146,987    113,766    102,955    114,443
Re-estimated Reinsurance
        Recoverables .........        17,856     14,154     15,000     14,502     12,523
Gross Re-Estimated
        Reserve ..............       189,856    161,141    128,766    117,457    126,966
Gross Cumulative
        Redundancy............      $ 12,843   $ 26,635   $ 53,552   $ 73,505   $ 73,390
</TABLE>


(1)     Amounts reflect  reinsurance  recoverable under prospective  reinsurance
        contracts only. 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, 1998 and 1997.
        However, for purposes of the reconciliation and development tables, loss
        and LAE information are shown net of reinsurance.


                                      See the  notes to  consolidated  financial
statements.

                                                              S-5

<PAGE>