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, 1997

                                       OR

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

                 For the transition period from ______ to ______

                         Commission file number: 1-8865

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

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

       Registrant's telephone number, including area code: (702) 242-7000
           Securities registered pursuant to Section 12(b) of the Act:

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

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

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. YES X NO

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

     The aggregate  market value of the voting stock held by  non-affiliates  of
the registrant on February 27, 1998 was $585,195,000.

     The  number of shares  of the  registrant's  common  stock  outstanding  on
February 27, 1998 was 18,275,000.

                       DOCUMENTS INCORPORATED BY REFERENCE
    DOCUMENT                                          WHERE INCORPORATED

Registrant's Current Report on Form 8-K dated              Part I
                    March 19, 1998.                        Part II, Item 7

Portions of the  registrant's  definitive  proxy Part III statement for its 1998
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.

                          1997 FORM 10-K ANNUAL REPORT

                                TABLE OF CONTENTS

                                      Page
                                     PART I

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

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

Item  3.      Legal Proceedings.....................................         15

Item  4.      Submission of Matters to a Vote of
                  Security Holders..................................         15


                                     PART II

Item  5.      Market for Registrant's Common Stock and
                 Related Stockholder Matters........................         16

Item  6.      Selected Financial Data...............................         17

Item  7.      Management's Discussion and Analysis of Financial
                  Condition and Results of Operations ..............         18

Item 7a.      Quantitative and Qualitative Disclosures
                  about Market Rate ................................         28

Item  8.      Financial Statements and Supplementary Data...........         29

Item  9.      Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure................         59


                                    PART III

Item 10.      Directors and Executive Officers
                  of the Registrant.................................         59

Item 11.      Executive Compensation................................         59

Item 12.      Security Ownership of Certain Beneficial
                  Owners and Management.............................         59

Item 13.      Certain Relationships and Related Transactions........         59


                                     PART IV

Item 14.      Exhibits, Financial Statement Schedules and
                  Reports on Form 8-K...............................         60

                                        i

<PAGE>



                                     PART I


ITEM 1.   BUSINESS
                                     GENERAL

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

During  the  third  quarter  of 1997,  Sierra  Military  Health  Services,  Inc.
("SMHS"),  a wholly owned  subsidiary  of the Company,  was notified it had been
awarded a multi-year  triple-option  health  benefits  ("TRICARE")  managed care
support  contract  by the  Department  of  Defense  to  serve  TRICARE  eligible
beneficiaries in Region 1. This region includes more than 600,000  beneficiaries
in 13 northeastern states and the District of Columbia. SMHS is currently in the
implementation  period of the  contract  with  actual  health  care  delivery to
commence on June 1, 1998. SMHS subcontracts for health care delivery,  including
some of the risk, for parts of the TRICARE contract.

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 for Region 1 and  recommended  that the contract be
re-bid. The TRICARE  Management  Activity ("TMA"),  along with the Company,  has
filed a motion requesting that the GAO reconsider its recommendation. If the GAO
does not change its recommendation and the TMA follows the recommendation, there
are several  possible  outcomes,  including  litigation.  The Company  currently
anticipates  providing  health care delivery for one year of the contract in the
event a re-bid occurs. (See "Management's Discussion and Analysis Overview")

In June 1996, the Department of Defense awarded a five-year  TRICARE contract to
TriWest Healthcare Alliance  ("TriWest"),  a consortium consisting of Sierra and
13 other health care  companies,  to provide health services to Regions 7 and 8,
which  includes a total of 16 states.  In April 1997,  TriWest  began  providing
health care to approximately 700,000 individuals, of which Sierra is responsible
for providing care to approximately 93,000 beneficiaries in Nevada and Missouri.

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


                                                         1

<PAGE>



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,  1997,  the Company  provided  HMO products to  approximately
192,000 members.  Of these HMO members,  approximately 90% reside in Nevada. The
POS products  allow members to choose one of the various  coverage  options when
medical  services  are  required  instead of one plan for the entire  year.  The
Company  also  provides  managed  indemnity  products  to  approximately  64,000
members,  Medicare  supplement  products to  approximately  25,000 members,  and
administrative  services to  approximately  328,000  members.  Medical  premiums
account for  approximately  71% of total revenues,  79% of such medical premiums
are derived from southern Nevada.

Health Maintenance Organizations. The Company operates mixed group network model
HMOs in Nevada,  and a network  model HMO in Texas.  Most of its managed  health
care  services  in Nevada are  provided  through  its  independently  contracted
network of over 2000  providers and 18  hospitals.  These  networks  include the
Company's  multi-specialty  medical group,  which provides  medical  services to
approximately  72% of the  Company's  Nevada HMO members  and  employs  over 145
primary care and other  providers in various  medical  specialties.  The Company
directly  provides  home health care,  hospice care and  behavioral  health care
services.  In addition,  the Company operates two 24-hour urgent care centers, a
radiology department,  a vision department,  an occupational medicine department
and two free-standing,  state-licensed and Medicare-approved  ambulatory surgery
centers.  The Company believes that this vertical integration of its health care
delivery system  provides a competitive  advantage as it has helped it to manage
health care costs effectively while delivering  quality care. As of December 31,
1997,  the Texas HMO  members  were  served by  approximately  1500  independent
contracted  providers and 32 hospitals.  Contracted  primary care physicians and
specialists   for  the  HMOs  are   compensated  on  a  capitation  or  modified
fee-for-service   basis.  Contracts  with  their  primary  hospitals  are  on  a
capitation  or  discounted  per diem  basis.  Members  receive  a wide  range of
coverage after paying a nominal  co-payment and are eligible for preventive care
coverage. The HMOs do not require deductibles, co-insurance or claim forms.

In addition to its commercial HMO plans, which involve  traditional HMO benefits
and Point of Service  benefits,  the Company offers prepaid health care programs
for Medicare-eligible beneficiaries called Senior Dimensions in Nevada and 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
certain  parts of Arizona.  Federal  legislation  has been enacted  which allows
delivery of health care to Medicare beneficiaries through HMOs. Such legislation
provides  that the  federal  government  will  reimburse  HMOs for  health  care
services to Medicare  beneficiaries  in an amount  equal to 95% of the  Medicare
payments to fee-for-service  providers in a defined service area. As of December
31,  1997,  approximately  33,000,  or 19%, of the  Company's  total  Nevada HMO
members were enrolled in Senior  Dimensions.  The Senior Dimensions plan enables
Medicare  beneficiaries  to reduce  their  out-of-pocket  expenses  and  receive
additional benefits not covered by Medicare. During 1996 the Company's Texas HMO
received  approval to offer a Medicare  risk  product  and at December  31, 1997
approximately  3,000, or 18%, of the Company's total Texas members were enrolled
in Golden Choice.

Social Health Maintenance Organization.  Effective November 1, 1996, the Company
entered into a multi-year  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,
1997.  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

                                        2

<PAGE>



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  ones  who  currently  have
difficulty  performing  such  daily  living  functions  because  of a health  or
physical  problem.  The additional  reimbursement  will be subject to adjustment
based on the  number  of  beneficiaries  who  need  assistance  with the  social
problems noted above and their individual health risk assessments.  The ultimate
payment received from the Health Care Financing  Administration ("HCFA") will be
based on these  and  other  factors.  At this  time,  however,  there  can be no
assurance as to what the final per member reimbursement will be.

Preferred  Provider  Organizations.  The Company  also offers  health  insurance
through its PPO. The Company's  managed indemnity plans generally offer insureds
the  option of  receiving  their  medical  care from  either  non-contracted  or
contracted  providers.  Insureds  pay higher  deductibles  and  co-insurance  or
co-payments when they receive care from non-contracted providers.  Out-of-pocket
costs  are  lowered  by  utilizing  contracted  providers  who  are  part of the
Company's Nevada PPO network,  consisting of approximately 2700 providers and 36
hospitals.  As of December 31, 1997,  approximately 64,000 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,  New
Mexico, Missouri, Iowa and South Carolina. The Company is also exploring further
expansion in certain other  states.  As of December 31, 1997 the PPO is licensed
in a total of 37 states and the  District of  Columbia.  During 1996 the Company
adopted a plan to restructure certain insurance  operations to allow the Company
to focus on more favorable  operating markets.  This plan significantly  reduced
the  Company's  presence in Arizona and Colorado for certain  managed  indemnity
products.

Workers' Compensation Subsidiary.  On October 31, 1995, the Company acquired CII
Financial,  Inc. ("CII"),  for approximately  $76.3 million of common stock in a
transaction  accounted  for as a  pooling  of  interests.  CII  writes  workers'
compensation insurance in the states of California,  Colorado, Kansas, Missouri,
Nebraska,  New  Mexico,  Texas and Utah.  CII has  licenses in 29 states and the
District of Columbia.  California and Colorado  represent  approximately 83% and
9%,  respectively,  of  CII's  fully  insured  workers'  compensation  insurance
premiums  in  1997.  Workers'   compensation   insurance  premiums  account  for
approximately  18% of the  Company's  total  revenue.  In  conjunction  with the
acquisition,   a  supplemental  indenture  was  filed  modifying  CII's  7  1/2%
convertible subordinated debentures (the "Debentures").  As a result each $1,000
in principal is now convertible into 16.921 shares of Sierra's common stock at a
conversion price of $59.097 per share.

Administrative Services. The Company's administrative services products provide,
among other things, utilization review and PPO services to large employer groups
that are usually  self-insured.  As of December 31, 1997,  approximately 328,000
members were enrolled in the Company's administrative services plans.

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.



                                        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 and
nuclear medicine services.  The Company also provides home health care services,
a hospice program and mental health and substance abuse services. These services
are  provided  to  members  of  the  Company's  HMOs,   managed   indemnity  and
administrative  services  plans.  The mental health and substance abuse services
are also  provided to  approximately  99,000  participants  from  non-affiliated
employer groups and an insurance company.

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.  As of  December  31,  1997,  the  Company  had
relationships  with  approximately 600 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.


                                        4

<PAGE>



Membership

Period End Membership:
<TABLE>
<CAPTION>
                                                                     Years Ended December 31,
                                                    -----------------------------------------
                                                     1997          1996         1995         1994         1993
                                                   --------      --------     --------     --------     ------
HMO:
<S>                                                  <C>          <C>          <C>          <C>           <C>
    Commercial..............................         156,000      147,000      116,000      107,000       89,000
    Medicare................................          36,000       30,000       25,000       20,000       15,000
Managed Indemnity...........................          64,000       46,000       31,000       24,000       30,000
Medicare Supplement.........................          25,000       23,000       15,000        9,000        4,000
Administrative Services (1) ................         328,000      338,000      117,000       65,000       59,000
                                                     -------      -------      -------      -------      -------
    Total Membership........................         609,000      584,000      304,000      225,000      197,000
                                                     =======      =======      =======      =======      =======
</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,  1997  and  1996,  the  Company   received
approximately  23.7% and 24.2%,  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.

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, 1997,  the Company's ten
largest  HMO  employer   groups  were,  in  the   aggregate,   responsible   for
approximately  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 72% of the Company's Nevada HMO members
receive  primary health care through the Company's own  multi-specialty  medical
group. The Company makes health care available through providers employed by the
multi-specialty  medical  group  and  an  independently  contracted  network  of
physicians, hospitals and other providers.

Under the  Company's  HMOs,  the member  selects a primary  care  physician  who
provides or  authorizes  any  non-emergency  medical  care given to that member.
These primary care physicians and some  specialists are compensated to a limited
extent on the basis of how well they coordinate appropriate medical care.

                                        5

<PAGE>



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

The  Company  also  believes  that it has  negotiated  favorable  rates with its
contracted  hospitals.  The  Company's  contracts  with its  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.  Since a majority of the
Company's  southern Nevada hospital days are at Columbia Sunrise Hospital,  this
contract  assists the Company in managing a  significant  portion of its medical
costs.  The  contract  expires in the year 2012.  The Company has  negotiated  a
capitation  arrangement  with  Columbia  Hospital,  Inc. for  hospital  services
provided in Houston to members of the Company's Texas HMO.

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

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

Risk Management

The Company maintains general and professional liability,  property and fidelity
insurance  coverage in amounts that it believes are adequate for its operations.
The  Company's   multi-specialty  medical  group  maintains  excess  malpractice
insurance for the providers  presently  employed by the group.  The Company has,
however,  assumed the risk for the first $250,000 per  malpractice  case, not to
exceed $1.5 million in

                                        6

<PAGE>



the aggregate per contract year up to its limits of coverage.  In addition,  the
Company requires all of its independently  contracted provider physician groups,
individual practice  physicians,  specialists,  dentists,  podiatrists and other
health care  providers  (with the  exception of certain  hospitals)  to maintain
professional liability coverage. Certain of the hospitals with which the Company
contracts are self-insured.  The Company also maintains stop-loss insurance that
reimburses  the  Company  between  50%  and 90% of  hospital  charges  for  each
individual  member of its HMO or managed indemnity plans whose hospital expenses
exceed  $200,000  during the contract year and up to $2.0 million per member per
lifetime.  Workers' compensation claims are reinsured between $350,000 and $60.0
million per occurrence.  Effective January 1, 1998, workers' compensation claims
are reinsured between $500,000 and $100.0 million per occurrence. 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.


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.

The Company is in the process of modifying or replacing its computer systems and
applications to accommodate the "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.  The Company currently expects to complete
all  material   replacements  or  modifications  of  its  computer  systems  and
applications  sufficiently  in  advance  of the Year 2000 to allow for  adequate
testing so as not to  negatively  impact its  operations.  The Company is in the
process of implementing  two major systems at an estimated cost of approximately
$20.0  million.  These  systems  will be Year 2000  compliant.  The  Company  is
expensing  the costs to make  modifications  as incurred.  Management  currently
estimates the remaining  modification  costs to be approximately $3.0 million to
$5.0 million over the next 12 to 18 months.  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
inability  of the Company to timely  complete  its Year 2000  modifications  and
replacements, or the inability of companies with which the Company does business
to timely complete their Year 2000  modifications,  could  adversely  affect the
Company's operations.

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,

                                        7

<PAGE>



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  over the health  care  industry.  The
organizations  utilized by the Company are the  National  Committee  for Quality
Assurance  (the "NCQA"),  the Joint  Commission on  Accreditation  of Healthcare
Organizations  ("JCAHO") and the American Association for Ambulatory Health Care
(the  "AAAHC").  The NCQA  performs  site reviews of standards  established  for
quality management and improvement,  physician credentials,  members' rights and
responsibilities, preventive health services, utilization management and medical
records.  The JCAHO reviews rights,  responsibilities  and ethics,  continuum of
care,  education and  communication,  leadership,  management of information and
human resources and network  performance.  The AAAHC reviews rights of patients,
governance,  administration,  quality of care provided,  quality  management and
improvement,  clinical  records,  professional  improvement  and  facilities and
environment.  In June 1997 HPN and its Medicare  risk plan,  Senior  Dimensions,
received  one-year  accreditation  from  the  NCQA  for  its  operations  in the
metropolitan  Las Vegas area and  Pahrump.  The  Company's  home health care and
hospice subsidiaries are JCAHO accredited.  The Company's Nevada multi-specialty
clinic  has  received  a full  three-year  accreditation  from the  AAAHC -- the
highest  accreditation  issued to ambulatory care facilities.  The clinic is the
only multi-specialty site in Nevada to be awarded this accreditation.  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  competitive
position in southern Nevada.

Underwriting

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

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

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


                                        8

<PAGE>



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

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

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  and
Pacificare,  Inc., and traditional  indemnity carriers,  such as Blue Cross/Blue
Shield.  Many of the  Company's  competitors  have  substantially  larger  total
enrollments,  have  greater  financial  resources  and offer a broader  range of
products  than  the  Company.  Additional  competitors  with  greater  financial
resources  than the Company may enter the  Company's  market in the future.  The
Company believes that the most important competitive factors are the delivery of
reasonably  priced,  quality  medical  benefits to members and the  adequacy and
availability  of health  care  delivery  services  and  facilities.  The Company
depends  on a large PPO  network  and  flexible  benefit  plans to  attract  new
members.  Competitive  pressures are expected to limit the Company's  ability to
increase premium rates and, to a lesser extent,  to result in declining  premium
rates.  Accordingly,  the  profitability of the Company will, to a large extent,
depend on the  Company's  ability to manage the costs of  providing  health care
benefits to its  members.  The  inability  of the Company to manage  these costs
would have an adverse  impact on the Company's  future  results of operations by
reducing margins. In addition,  competitive pressures may also result in reduced
membership  levels.  Any such reductions could  materially  affect the Company's
results of operations.

Workers'   Compensation.   The  Company's  workers'   compensation  business  is
concentrated in California,  a state where the workers'  compensation  insurance
industry is extremely competitive. 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

                                        9

<PAGE>



greater distribution capability than the Company. The largest writer of workers'
compensation  insurance in California is the State Compensation  Insurance Fund.
Prior to 1995,  the  Company  concentrated  on  insuring  workers'  compensation
accounts  in the small- to  medium-size  range.  Under the  current  open rating
environment, the Company is actively pursuing accounts of all sizes.

In all states in which the Company is currently  writing  business,  competition
for workers' compensation insurance is primarily driven by price and secondarily
by services provided to insureds and agents. In states other than California 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.  As in California under
the open rating  environment,  the Company  then adds loss cost  multipliers  or
expense  loads to derive  premium  rates.  Rating plans in those states are more
"standardized"  and are usually  based on plans  developed  by the NCCI.  Unlike
California,  where the Company has  developed  subclasses,  the Company will use
standard classes in the other states.

Losses and Loss Adjustment Expenses

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

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

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

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

Once  an  employer  is  insured  by the  Company,  the  Company's  loss  control
department may assist the insured in developing and maintaining  safety programs
and procedures to minimize  on-the-job  injuries and industrial  health hazards.
The safety programs and procedures  vary from insured to insured.  The Company's
loss control  department  may recommend to the employer that a safety  committee
consisting of members of the employer's  management  staff and its general labor
force be established.  The Company's loss control department may then assist the
committee members in isolating safety hazards,  advising the committee on how to
correct the hazards and  assisting  the employer in  establishing  procedures to
enforce the corrections.  The Company's loss control department may also revisit
the

                                       10

<PAGE>



employer to determine  whether the  recommended  corrections and procedures have
been implemented. Depending upon the size, classifications,  and loss experience
of the employer, the Company's loss control department will periodically inspect
the employer's  places of business and may recommend  changes that could prevent
industrial accidents. In addition, severe or recurring injuries may also warrant
on-site inspections. In certain instances, members of the Company's loss control
department  may  conduct  special  educational  training  sessions  for  insured
employees  to assist in the  prevention  of  on-the-job  injuries.  For example,
employers  engaged in manufacturing  may be offered a training session on how to
prevent  back  injuries or  employers  engaged in  contracting  may be offered a
training session on general first aid and prevention of injuries that may result
from specific work exposures.

Government Regulation and Recent Legislation

HMOs and Managed Indemnity.  Federal and state governments have enacted statutes
extensively  regulating the activities of HMOs. In addition,  growing government
concerns  over  increasing  health care costs 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,  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 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 37 states and the District of
Columbia, with current operations primarily in Nevada, Arizona, Colorado, Texas,
California,  New Mexico,  Missouri,  Iowa and South  Carolina.  It is subject to
licensing by and other regulations of the California  Department of Insurance as
well as the insurance departments of other states in which it operates or holds

                                       11

<PAGE>



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  $16.5
million at December 31, 1997. The Company's HMO and insurance  subsidiaries meet
requirements to maintain minimum  stockholder's equity ranging from $1.1 million
to $5.2 million.  The  Company's  Nevada HMO and health  insurance  subsidiaries
currently maintain home offices and a regional home office, respectively, in Las
Vegas and, accordingly, are eligible for certain premium tax credits in Nevada.

The Company's HMO subsidiaries are also restricted by state law as to the amount
of dividends that can be declared and paid.  Moreover,  insurance  companies and
HMOs  domiciled  in  Texas,   Nevada  and  California   generally  may  not  pay
extraordinary  dividends without providing the state insurance commissioner with
30 days prior notice,  during which period the  commissioner  may disapprove the
payment.  An  "extraordinary  dividend" is generally defined as a dividend whose
fair market value together with that of other  dividends or  distributions  made
within the  preceding  12 months  exceeds  the 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 Med One Health Plan,
acquired at the end of 1996, is not federally-qualified under this Act. In order
to obtain federal  qualification,  an HMO must, among other things,  provide its
members certain services on a fixed, prepaid fee basis and set its premium rates
in accordance  with certain  rating  principles  established  by federal law and
regulation.  The HMO must also have  quality  assurance  programs  in place with
respect  to its health  care  providers.  Furthermore,  an HMO may not refuse to
enroll an employee, in most circumstances,  because of such person's health, and
may not expel or refuse to re-enroll  individual members because of their health
or their need for health services.

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

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

                                       12

<PAGE>



penalties are provided for violation of state  anti-kickback  and  anti-referral
laws. The Department of Health and Human Services ("HHS") has issued regulations
establishing  "safe  harbors" with respect to the Anti-  kickback  Statute.  The
Office of the  Inspector  General  recently  proposed new rules to clarify those
safe harbors.  HHS has also 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 Anti- kickback Statute and
the Stark Amendments will not assert that the Company or certain transactions in
which it is involved are in violation of those  statutes and (ii) such  statutes
will  ultimately be  interpreted by the courts in a manner  consistent  with the
Company's interpretation.

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 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'

                                       13

<PAGE>



compensation  insurance in that state each year to pay losses and LAE on covered
claims of insolvent insurers. In California and certain other states,  insurance
companies  are  allowed to recoup  such  assessments  from  policyholders  while
several  states allow an offset  against  premium  taxes.  Potential  assessment
expenses,  net of  recoupment,  if any, for  insolvencies  are not accrued until
after an  insolvency  has occurred  since the  likelihood  and the amount of the
assessment expense cannot be reasonably determined or estimated.  In California,
there have been no new assessments for insolvent workers' compensation insurance
companies since 1990.

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

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

Employees

The Company had  approximately  2,800  employees on December  31, 1997.  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  218,000  square  feet.  Such  facilities  include an  approximate
134,000  square foot six-story  home office  building and an approximate  43,000
square foot two-story corporate administrative headquarters. These buildings are
subject to liens  securing a $5.8  million  loan  balance  from Bank of America.
Also,  the Company  recently  constructed  an additional  approximately  180,000
square foot six-story administrative headquarters building which should be fully
occupied by the end of the first quarter.  This building was financed in January
1998 and subject to a $15.0 million loan balance.  The Company also owns several
clinical facilities in the southern Nevada area totalling  approximately 370,000
square feet and  consisting  primarily of seven medical  clinics and two surgery
centers  including  a newly  constructed  59,000  square foot  medical  building
completed in the fourth quarter of 1997.  Certain clinical space is subject to a
$3.1 million mortgage in favor of GE Capital Asset Management  Corporation.  The
Company  leases  additional  office  and  clinical  space  in  Nevada  totalling
approximately  122,000 and 70,000  square feet,  respectively.  The Company owns
real  estate and a  building  in Park City,  Utah  purchased  in 1996 to provide
entertainment and a meeting  environment for significant current and prospective
clients,  brokers and others who assist in the Company's  marketing efforts.  In
connection  with its workers'  compensation  insurance  subsidiary,  the Company
leases  approximately  67,000  square feet of office  space in  California.  The
Company also leases approximately 180,000 square feet of office space in various
states as needed  for other  regional  operations,  including  the Texas HMO and
TRICARE service centers.

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.




                                       14

<PAGE>



ITEM 3.   LEGAL PROCEEDINGS

On March 18, 1997, the Company  announced it had terminated its merger agreement
with Physician  Corporation of America ("PCA").  The original agreement had been
entered into in November  1996. On March 18, 1997,  prior to  termination of the
merger  agreement,  PCA filed a lawsuit against the Company in the United States
District  Court for the  Southern  District of Florida (the  "District  Court"),
seeking,  among other things,  specific  performance of the merger agreement and
monetary  damages  in excess of $20  million.  The  lawsuit  has been  dismissed
(without prejudice to PCA's claims) for failure to join an indispensable  party.
On March 27,  1997 the Company  commenced a lawsuit  against PCA in the Court of
Chancery of the State of Delaware  alleging,  among other things,  breach of the
merger  agreement  and  equitable  fraud,  and seeking a  declaratory  judgment,
monetary  damages and other  remedies.  No answer to the Company's  complaint or
counterclaims (if any) have been filed. The Company intends to vigorously pursue
all  remedies  available  to it,  however,  there can be no  assurance  that the
Company will prevail in such litigation.

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


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

None



                                       15

<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
1997 and 1996.

<TABLE>
<CAPTION>

         Period                                                                     High               Low

         1997
<S>                                                                                <C> <C>             <C> <C>
             First Quarter........................................                 $27 3/4             $24 5/8
             Second Quarter.......................................                   32 1/8              24 1/8
             Third Quarter........................................                   37 3/8              31 3/16
             Fourth Quarter.......................................                   40                  31 3/16

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

On February 27, 1998, the closing sale price of the common stock was $36 5/8 per
share.

Holders

The number of record holders of Common Stock at February 27, 1998 was 276. Based
upon  information  available  to it,  the  Company  believes  there are  several
thousand beneficial holders of the Common Stock.

Dividends

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

                                       16

<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, 1997 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,
                                                                      1997            1996         1995           1994         1993
                                                                   ----------      ----------   ----------    -----------   --------
                                                                                  (Amounts in thousands, except per share data)
Statement of Operations Data (1):
OPERATING REVENUES:
<S>                                                                <C>            <C>           <C>           <C>           <C>
   Medical Premiums...........................................     $513,857       $386,968      $319,475      $269,382      $240,691
   Specialty Product Revenues ................................      146,211        133,324       102,807       101,287       113,714
   Professional Fees..........................................       31,238         28,836        19,417        12,331        11,254
   Military Contract Revenues ................................        4,346
   Investment and Other Revenues..............................       26,072         26,283        25,310        19,081        17,771
                                                                   --------       --------      --------    ----------    ----------
     Total....................................................      721,724        575,411       467,009       402,081       383,430
                                                                   --------        -------       -------    ----------     ---------

OPERATING EXPENSES:...........................................
   Medical Expenses...........................................      419,272        315,915       245,135       200,229       178,526
   Specialty Product Expenses.................................      143,082        130,758       102,859        96,600       118,868
   General, Administrative and Marketing Expenses.............       93,919         72,237        63,562        53,671        50,715
   Military Contract Expenses  ...............................        4,193
   Merger, Restructuring, and Start-up Expenses (2) ..........       29,350         12,064        11,614
                                                                     ------       --------      --------
     Total....................................................      689,816        530,974       423,170       350,500       348,109
                                                                    -------       --------       -------     ---------     ---------

OPERATING INCOME .............................................       31,908         44,437        43,839        51,581        35,321
INTEREST EXPENSE AND OTHER, NET...............................       (4,433)        (2,823)       (3,737)       (6,401)      (4,437)
                                                                   --------       --------      --------      --------      --------

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES .....................................       27,475         41,614        40,102        45,180        30,884
PROVISION FOR INCOME TAXES....................................        3,234         10,471        12,198         8,236         8,435
                                                                     --------       --------        ------      --------    --------
INCOME FROM CONTINUING OPERATIONS.............................       24,241         31,143        27,904        36,944        22,449
LOSS FROM DISCONTINUED OPERATIONS ............................                                    (6,600)       (2,501)        (404)
CUMULATIVE EFFECT OF ADOPTING FAS 109.........................                                                                 5,250
                                                                -----------    -----------   -----------  ------------     ---------

NET INCOME ...................................................    $  24,241       $ 31,143      $ 21,304     $  34,443     $  27,295
                                                                  =========       ========      ========     =========     =========

EARNINGS PER COMMON SHARE:
   Income from Continuing Operations Per Share ...............        $1.35          $1.76         $1.60         $2.36         $1.50
   Loss Per Share from Discontinued Operations ...............                                      (.38)         (.16)        (.02)
   Cumulative Effect of Adopting FAS 109. ....................                                                                   .35
                                                                   --------       --------      --------      --------       -------
   Net Income Per Share ......................................        $1.35          $1.76         $1.22         $2.20         $1.83
                                                                      =====          =====         =====         =====         =====

   Weighted Average Number of Common
     Shares Outstanding ......................................       18,008         17,726        17,414        15,678        14,939
                                                                     ======      =========     =========     =========     =========

EARNINGS PER COMMON SHARE ASSUMING DILUTION:
   Income from Continuing Operations Per Share ...............        $1.33          $1.72         $1.57         $2.31         $1.47
   Loss Per Share from Discontinued Operations ...............                                      (.37)         (.16)        (.02)
   Cumulative Effect of Adopting FAS 109. ....................                                                                   .34
                                                                   --------       --------      --------      --------       -------
   Net Income Per Share ......................................        $1.33          $1.72         $1.20         $2.15         $1.79
                                                                      =====          =====         =====         =====         =====

   Weighted Average Number of Common
     Shares Outstanding Assuming Dilution ....................       18,284         18,127        17,734        15,999        15,256
                                                                     ======      =========     =========     =========     =========
</TABLE>


                                       17

<PAGE>


<TABLE>


<CAPTION>
                                                                                      Years Ended December 31,
                                                                      1997            1996         1995           1994          1993
                                                                   ----------      ----------   ----------    -----------   --------
                                                                                                  (Amounts in thousands)

Balance Sheet Data:
<S>                                                                  <C>            <C>           <C>           <C>           <C>
   Working Capital ...........................................     $  88,377      $ 76,530      $ 18,157      $ 71,337      $ 21,323
   Total Assets...............................................       723,936       629,462       575,146       535,487       445,510
   Long-term Debt (Net of Current Maturities).................        90,841        66,189        71,257        75,209        72,802
   Cash Dividends Per Common Share............................          NONE          NONE          NONE          NONE          NONE
   Stockholders' Equity.......................................       265,682       234,482       207,715       168,157        84,708
</TABLE>

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

     (2)  In  connection  with  certain   acquisitions  and
restructurings,  the Company recorded certain  non-recurring  incremental costs.
See Note 14 of Notes to the Consolidated Financial Statements.



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 1997 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 19, 1998  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 from those  expressed  in any  projected,  estimated  or  forward-looking
statements relating to the Company.

Acquisitions

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

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

On October 31,  1995,  the  Company  acquired  CII  Financial,  Inc.,  ("CII") a
workers' compensation insurance holding company, for approximately $76.3 million
of common stock, in a transaction  accounted for as a pooling of interests.  The
information contained in this Annual Report on Form 10-K includes the results of
CII for all periods presented.

                                       18

<PAGE>




Overview

The Company derives revenues from its health maintenance organizations,  managed
indemnity and workers' compensation insurance subsidiaries.  To a lesser extent,
the Company also derives additional  specialty product revenues from non-HMO and
insurance products (consisting of fees for workers' compensation administration,
utilization  management  services and  ancillary  products),  professional  fees
(consisting  primarily of fees for providing health care services to non-members
and co-payment  fees received from  members),  and investment and other revenue.
Medical premium revenues  accounted for approximately  71.2%, 67.3% and 68.4% of
the Company's  total revenues for 1997, 1996 and 1995,  respectively.  Continued
medical  premium   revenue  growth  is  principally   dependent  upon  continued
enrollment  in the  Company's  products  and  upon  competitive  and  regulatory
factors.  Effective  September  30, 1997,  the Company  terminated  its workers'
compensation  administrative contract with the state of Nevada. 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.

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

During  the  third  quarter  of 1997,  Sierra  Military  Health  Services,  Inc.
("SMHS"),  a wholly owned  subsidiary  of the Company,  was notified it had been
awarded a multi-year  triple-option  health  benefits  ("TRICARE")  managed care
contract by the Department of Defense to serve TRICARE eligible beneficiaries in
Region  1.  This  region  includes  more  than  600,000   beneficiaries   in  13
northeastern  states and the  District of  Columbia.  SMHS is  currently  in the
implementation  period of the  contract  with  actual  health  care  delivery to
commence  on June 1,  1998.  SMHS  subcontracts  for the health  care  delivery,
including  some of the risk,  for parts of the  TRICARE  contract.  The  Company
believes the TRICARE contract will add approximately  $240 million of annualized
revenues  when  health  care  delivery  begins in 1998.  Revenues  and  expenses
resulting   from  this  contract  are  recorded   separately  on  the  financial
statements.  There can be no assurance  that the Company will be  successful  in
managing  the  implementation  and  delivery of health care  services  under the
multi-year  TRICARE contract or that such contract will provide the Company with
an adequate level of profitability.

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. The TRICARE  Management  Activity ("TMA"),  along with the Company,  has
filed a motion requesting that the GAO reconsider its recommendation. If the GAO
does not change its recommendation and the TMA follows the recommendation, there
are several  possible  outcomes,  including  litigation.  The Company  currently
anticipates providing health care delivery for one year of the contract should a
re-bid occur.



                                       19

<PAGE>



Merger,   restructuring  and  start-up  expenses   represent  the  non-recurring
incremental  costs the Company has incurred 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. Such start-up
expenses 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,
                                                                     1997              1996             1995
                                                                  ----------        ----------       -------
OPERATING REVENUES:
<S>                                                                   <C>              <C>              <C>
     Medical Premiums........................................         71.2%            67.3%            68.4%
     Specialty Product Revenues .............................         20.3             23.2             22.0
     Professional Fees.......................................          4.3              5.0              4.2
     Military Contract Revenues .............................           .6
     Investment and Other Revenues ..........................          3.6              4.5              5.4
                                                                    ------           ------           ------
        Total................................................        100.0            100.0            100.0
                                                                     -----            -----            -----

OPERATING EXPENSES:
     Medical Expenses........................................         58.1             54.9             52.5
     Specialty Product Expenses..............................         19.8             22.7             22.0
     General, Administrative and Marketing Expenses..........         13.0             12.6             13.6
     Military Contract Expenses .............................           .6
     Merger, Restructuring and Start-up Expenses ............          4.1              2.1              2.5
                                                                    ------            -----            -----
        Total................................................         95.6             92.3             90.6
                                                                      ----            -----            -----

OPERATING INCOME ............................................          4.4              7.7              9.4

INTEREST EXPENSE AND OTHER, NET..............................        (.6)             (.5)             (.8)
                                                                    ----             ----             ----

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES ....................................          3.8              7.2              8.6

PROVISION FOR INCOME TAXES...................................           .4              1.8              2.6
                                                                     -----            -----            -----

INCOME FROM CONTINUING OPERATIONS ...........................          3.4              5.4              6.0

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

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

NET INCOME...................................................          3.4%             5.4%              4.6%
                                                                     =====            =====             =====
</TABLE>


                                       20

<PAGE>



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 number of months of each year that an  individual  is enrolled in a
plan).  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 the Health Care  Financing  Administration
("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 Med One 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 assets and operations of Total Home Care,  Inc.  ("THC")
during the third quarter. 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.  The  Company
expects these revenues to increase substantially in 1998, subject to the results
of the bid  protest  discussed  previously.  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.  Medical expenses as a
percentage of medical  premiums and  professional  fees  ("Medical  Loss 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,  Med One Health Plan has a higher  Medical Loss Ratio,  which  further
contributed  to the  increase  in the  Company's  overall  Medical  Loss  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%
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
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 below projected losses and 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

                                       21

<PAGE>



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.  General,  administrative and
marketing ("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 is 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 is 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.

Merger,  Restructuring and Start-up Expenses.  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,  Inc. ("PCA").  The
original  agreement  had been entered into in November  1996. On March 18, 1997,
prior to termination of the merger  agreement,  PCA filed a lawsuit  against the
Company in the United States District Court for the Southern District of Florida
(the "District Court"), seeking, among other things, specific performance of the
merger  agreement  and  monetary  damages.  The lawsuit has been  dismissed  for
failure to join a necessary  party.  The Company has also initiated a lawsuit in
the Court of Chancery of the State of Delaware seeking a declaratory judgment as
well as other remedies.  The Company  intends to vigorously  pursue all remedies
available  to it;  however,  there can be no  assurance  that the  Company  will
prevail in such litigation.

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 more than 600,000  TRICARE  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 eligible
beneficiaries  in  Region 1. Such  expenses  were  charged  to  operations  upon
notification  of award.  SMHS is currently in the  implementation  period of the
contract  with  actual  health care  delivery to commence on June 1, 1998.  SMHS
subcontracts for health care delivery,  including some of the risk, for parts of
the  TRICARE  contract.  The Company  believes  the  TRICARE  contract  will add
approximately  $240 million of  annualized  revenues  when health care  delivery
begins in 1998.

SMHS was  notified on February  13, 1998 that the 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.  The TMA, along with the Company,  has
filed a motion requesting that the GAO reconsider its recommendation. If the GAO
does not change its recommendation and the TMA follows the recommendation, there
are several  possible  outcomes,  including  litigation.  The Company  currently
anticipates providing health care delivery for one year of the contract should a
re-bid occur.

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.

                                       22

<PAGE>



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  non-recurring  charges
related to the PCA  acquisition  and start-up costs  associated with the TRICARE
contract.  Excluding these non-recurring  costs, the effective tax rate for 1997
is 23.9%. See Note 9 of Notes to Consolidated Financial Statements.

Net Income.  Excluding  non-recurring items and the related tax effects,  income
from ongoing operations for 1997 increased $3.1 million, or 7.6%. Net income for
1997, including all non-recurring items,  decreased $6.9 million, or 22.2%, from
1996.  This decrease was impacted in part by  non-recurring  items including the
merger-related  and start-up costs in 1997 and the  restructurings  and disposal
costs in 1996.

1996 Compared to 1995

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

Medical and Specialty  Product  Expenses.  Total medical  expenses  increased by
$70.8 million in 1996 compared to 1995.  This 28.9%  increase  resulted from the
consolidated  member  month  growth  discussed  above,  as well as the  clinical
expansions and increases associated with professional fee growth. These factors,
as well as an increase in Medicare  members as a  percentage  of total  members,
increased the Company's  medical loss ratio to 76.0% for the twelve months ended
December 31, 1996, from 72.3% for the comparable twelve months in 1995. The cost
of  providing  medical  care to Medicare  members  generally  requires a greater
percentage of the premium revenue received. Specialty product expenses increased
$27.9  million,  or 27.1%,  over 1995.  This  increase is due  primarily  to the
increase in workers'  compensation  premiums noted above,  offset in part by the
Company's  ability to overlay  managed care  techniques  on the  management  and
payment of certain workers' compensation claims. In addition,  specialty product
expenses  for 1996 and  1995  were  impacted  by the loss  development  on prior
accident years.  During the year, the Company had net favorable loss development
on prior  accident  years of  $15.3  million,  compared  to net  favorable  loss
development of $20.1 million for the comparable prior year period.  The majority
of the  favorable  loss  development  occurred on the 1992 through 1994 accident
years. The favorable development on the 1992 year appears to be primarily due to
the Company's aggressive actions to resolve claims. The favorable development on
the 1993 and 1994  accident  years  appears to have been  aided by the  workers'
compensation  reforms  that were  enacted  in July 1993 to combat  the abuses in
California's  workers'  compensation  system.  There can be no  assurances  that
favorable development, or the magnitude of the development, will continue in the
future. See Note 7 of Notes to Consolidated Financial Statements.


                                       23

<PAGE>



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

Merger,  Restructuring  and  Start-up  Expenses.  During  1995,  as  part of the
Company's clinical expansion and growth efforts,  the Company acquired a medical
facility in Mohave County,  Arizona,  across the border from  Laughlin,  Nevada.
This medical facility included a small 12-bed hospital.  During 1996 the Company
implemented a plan to exit the hospital business and actively pursued buyers for
this  business.  As a result of this  plan,  the  Company  took a charge of $3.8
million  ($2.8 million  after tax) in the fourth  quarter of 1996,  primarily to
recognize  the estimated  costs to dispose of the  hospital.  As of December 31,
1997, 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.  The plan  included  the sale or closure of
certain regional operations in California,  Arizona and Colorado.  The plan will
allow the  Company to focus on more  favorable  operating  markets  and  improve
operating efficiencies. The Company believes that this restructuring, over time,
will result in improved  cash flow and  operating  cost savings in excess of the
amount of the charge.

As a result of these  restructurings,  the  Company  recorded  expenses of $12.1
million. These costs included cancellation of certain contractual obligations of
$6.0 million, lease termination costs of $1.5 million, and $4.6 million of other
costs including the estimated costs to dispose of the hospital.

Income Taxes.  The Company's  effective tax rate for the year ended December 31,
1996 was 25.2%,  compared to 30.4% in 1995,  or 25.4% after  taking into account
the  non-deductible  merger costs incurred in 1995.  The difference  between the
Company's  effective tax rate and the current  federal tax rate is due primarily
to a $2.7  million  tax  benefit  recorded  as a result  of a  reduction  of the
deferred tax valuation allowance and the Company's  significant portfolio of tax
preferred investments. See Note 9 of Notes to Consolidated Financial Statements.

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

LIQUIDITY AND CAPITAL RESOURCES

The Company's cash and cash equivalents  decreased by approximately $6.8 million
to $96.8 million at December 31, 1997, from $103.6 million at December 31, 1996.
At December  31, 1997,  the Company had working  capital of $88.4  million.  The
primary  source of cash received  during the year ended  December 31, 1997,  was
operations.

The Company's cash flow from operating  activities  resulted in $52.8 million of
cash flow for the twelve  months ended  December  31,  1997.  This cash flow was
primarily  generated  from  net  income  of  $24.2  million,  $13.5  million  in
depreciation  and  amortization  and $4.3  million  in  provision  for  doubtful
accounts,

                                       24

<PAGE>



as well as a net change in operating assets and liabilities,  excluding cash and
cash  equivalents,  of  approximately  $10.8 million.  The increase in cash from
fluctuations  in such operating  assets and  liabilities  is principally  due to
increases in the reserve for losses and loss adjustment  expense,  other current
liabilities and medical claims  payable.  These increases in cash were offset by
decreases  in cash due to  increases in accounts  receivable  and other  current
assets.

In 1997 the Company spent $3.1  million,  net of cash  received,  to acquire the
operations  and assets of a company  that  provides  home  infusion,  oxygen and
durable medical equipment  services in Nevada and Arizona.  In the first quarter
of 1998 the Arizona  business was sold for $1.5  million.  Capital  expenditures
were primarily for new  facilities as well as the expansion of existing  medical
facilities  and  include  $33.9  million for the  construction  of both a 59,000
square foot medical  facility in Las Vegas  completed  in the fourth  quarter of
1997, and an additional  administrative  headquarters  building of approximately
180,000  square  feet  which  should be fully  occupied  by the end of the first
quarter of 1998.  Other capital  expenditures  were  primarily for furniture and
equipment associated with the Company's new military health services subsidiary,
remodeling of certain existing  medical space, as well as business  expansion of
the HMO and insurance operations,  along with general corporate expansion.  Such
amounts  include $6.1 million in computer  hardware and software.  Additionally,
the Company  used $5.5  million to purchase  treasury  stock on the open market,
$2.4 million for the reduction of debt, and there was a $28.9 million net change
in  marketable  securities.  These cash  outflows  were offset by $10.3  million
received in connection with the purchase of stock through the Company's employee
stock plans.

In the second  quarter of 1997,  the  Company  amended and  increased  to $100.0
million  its  unsecured  line of credit  from Bank of America  National  Trust &
Savings Association  ("BofA") for a term of five years at an interest rate based
on the London  InterBank  Offering  Rate  ("LIBOR").  In March 1997 and December
1997,  the Company  borrowed $17.0 million and $8.0 million,  respectively,  for
general  corporate  purposes.  The  remaining  line of  credit  may be used  for
additional  working capital,  if necessary.  Also 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 $2.0 million in 1997, at an interest rate equal to the London InterBank
Offering  Rate plus 53 basis  points.  The line of credit is  collateralized  by
certain  amounts of the CEO's  Sierra  stock  options  and is due and payable no
later than June 30, 1998.

In  September  1991,  CII  issued  convertible   subordinated   debentures  (the
"Debentures")  due September 15, 2001.  The  Debentures  bear interest at 7 1/2%
which  is due  semi-annually  on March  15 and  September  15.  Each  $1,000  in
principal is convertible  into 16.921 shares of the Company's  common stock at a
conversion  price of $59.097 per share.  Unamortized  issuance costs of $800,000
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, 1997, the Company  purchased $30,000
of the Debentures on the open market. At December 31, 1997, CII had total assets
of $343.0 million, consisting primarily of investments, and total liabilities of
$285.4 million,  consisting primarily of reserves for losses and loss adjustment
expense and the  debentures.  For the year ended  December 31, 1997, CII had net
premiums  earned of  $129.2  million,  investment  and  other  revenue  of $17.4
million, and total operating expenses of $135.8 million.

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  more  than  600,000  individuals  in  Connecticut,   Delaware,  Maine,
Maryland,  Massachusetts,  New Hampshire,  New Jersey,  New York,  Pennsylvania,
Rhode Island, Vermont, Virginia, West Virginia and Washington, D.C. The contract
will  result in  approximately  $1.2  billion  in  estimated  revenues  over the
five-year  term of the  contract.  The  expenses  incurred  in  connection  with
obtaining  this  contract  were  expensed  in the third  quarter  as  previously
discussed.  The Company will fund approximately $25.0 million to SMHS during the
seven-month

                                       25

<PAGE>



implementation  period of the TRICARE  Region 1 contract.  These  monies will be
reimbursed by the Department of Defense in accordance with the provisions of the
contract.  SMHS was  notified  on  February  13,  1998 that the 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.  The TMA, along with the
Company,   has  filed  a  motion   requesting   that  the  GAO   reconsider  its
recommendation.  If the GAO  does  not  change  its  recommendation  and the TMA
follows the  recommendation,  there are  several  possible  outcomes,  including
litigation. The Company currently anticipates providing health care delivery for
one year of the contract should a re-bid occur.

The Company is in the process of modifying or replacing its computer systems and
applications to accommodate the "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.  The Company currently expects to complete
all  material   replacements  or  modifications  of  its  computer  systems  and
applications  sufficiently  in  advance  of the Year 2000 to allow for  adequate
testing so as not to  negatively  impact its  operations.  The Company is in the
process of implementing two major systems at an estimated cost of $20.0 million.
These systems will be Year 2000 compliant. The Company is expensing the costs to
make  modifications as incurred.  Management  currently  estimates the remaining
modification  costs to be  approximately  $3.0  million to $5.0 million over the
next 12 to 18  months.  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 inability of
the Company to timely complete its Year 2000 modifications and replacements,  or
the  inability  of  companies  with which the  Company  does  business to timely
complete  their Year 2000  modifications,  could  have a material  effect on the
Company's operations.

The Company has a 1998 capital budget of approximately $50.0 million,  primarily
for computer hardware and software,  medical buildings,  furniture and equipment
for the newly constructed 180,000 square foot, six-story corporate  headquarters
building,  and other  requirements  due to the  Company's  projected  growth and
expansion.   The   Company   financed  a  portion   of  the  newly   constructed
administrative  building in January 1998, and received $15.0 million. On January
12, 1998, $7.3 million of the projected capital  expenditure  budget was used by
the Company to purchase  all of the assets and  operations  of three  clinics in
southern  Nevada.  The  Company's  liquidity  needs over the next 12 months will
primarily be for the capital items noted above to support growing  membership in
Nevada,  implementation  of the Region 1 TRICARE  contract,  the Company's stock
repurchase  program,  as well as 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 and
equipment  leasing,  and amounts  available  under its credit  facility  will be
sufficient  to fund its capital  expenditures,  debt  service and any  expansion
activities  during the next 12 months.  Additionally,  subject to  unanticipated
cash  requirements,  the Company  believes that its existing working capital and
operating cash flow and, if necessary, its access to new credit facilities, will
enable it to meet its liquidity needs on a longer term basis.

The  holding   company  may  receive   dividends  from  its  HMO  and  insurance
subsidiaries  which  generally  must be  approved  by  certain  state  insurance
departments.  The Company's HMO and insurance subsidiaries are required by state
regulatory  agencies to maintain certain deposits and must also meet certain net
worth  and  reserve  requirements.   The  HMO  and  insurance  subsidiaries  had
restricted  assets on deposit in various states totaling $16.5 million and $13.6
million,  as of December 31, 1997 and December 31, 1996,  respectively.  The HMO
and  insurance   subsidiaries   also  meet   requirements  to  maintain  minimum
stockholder's  equity ranging from $1.1 million to $5.2 million. Of the cash and
cash  equivalents held at December 31, 1997, $82.2 million is designated for use
only by the regulated  subsidiaries.  Such amounts are available for transfer to
the holding company from the HMO and insurance  subsidiaries  only to the extent
that they can be  remitted  in  accordance  with  terms of  existing  management
agreements and by

                                       26

<PAGE>



dividends. Remaining amounts are available on an unrestricted basis. The holding
company will not receive  dividends from its HMO or insurance  subsidiaries that
would cause violation of statutory net worth and reserve requirements.

Inflation

Health care costs generally  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,  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 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. Any such  government  action could result in assessment
of damages, civil or criminal fines or penalties, or other sanctions,  including
exclusion from participation in government programs. In addition,  disclosure of
any adverse investigation1

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

     Statement of Financial Accounting No. 130, "Reporting Comprehensive Income"
is  effective  for  periods  beginning  after  December  15,  1997 and  requires
companies to classify items of other  comprehensive  income by their nature in a
financial  statement.  Management  does not believe this  statement  will have a
material impact on the Company's  financial  statements.  Statement of Financial
Accounting No. 131,

                                       27

<PAGE>


"Disclosures  about Segments of an Enterprise and Related  Information"  is also
effective  for  periods  beginning  after  December  15,  1997  and  establishes
additional  standards  for  segment  disclosures  in the  financial  statements.
Management  has not  determined  the effect of this  statement on its  financial
statement disclosure.


ITEM 7a.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Pursuant  to the  General  Instructions  to  Rule  305 of  Regulation  S-K,  the
quantitative and qualitative disclosures called for by this Item and by Rule 305
of Regulation S-K are inapplicable to the Company at this time.


                                       28

<PAGE>


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                          INDEX TO FINANCIAL STATEMENTS
                                                                           Page

Management Report on Consolidated Financial Statements....................   30
Independent Auditors' Report..............................................   31
Consolidated Balance Sheets at December 31, 1997 and 1996.................   32
Consolidated Statements of Operations for the Years Ended
   December 31, 1997, 1996, and 1995......................................   33
Consolidated Statements of Changes in Stockholders' Equity
   for the Years Ended December 31, 1997, 1996 and 1995...................   34
Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1997, 1996, and 1995......................................   35
Notes to Consolidated Financial Statements................................   36


                                       29

<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, 1997, such systems and
controls were adequate to meet the objectives discussed herein.

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

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





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




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

                                       30

<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, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period  ended  December  31, 1997.
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, 1997 and 1996,  and the results of their
operations  and their cash flows for each of the three years in the period ended
December 31, 1997 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 16, 1998


                                       31

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1997 and 1996
<TABLE>

                                                          ASSETS
<CAPTION>
                                                                                         1997                 1996
                                                                                   ---------------      ----------
CURRENT ASSETS:
<S>                                                                                 <C>                   <C>
    Cash and Cash Equivalents..............................................         $ 96,841,000          $103,587,000
    Short-term Investments.................................................          115,498,000            83,688,000
    Accounts Receivable (Less:  Allowance for Doubtful
        Accounts 1997 - $7,916,000; 1996 - $7,324,000).....................           42,041,000            31,849,000
    Current Portion of Deferred Tax Asset .................................           15,496,000            13,713,000
    Prepaid Expenses and Other Current Assets..............................           30,730,000            20,098,000
                                                                                    ------------          ------------
        Total Current Assets...............................................          300,606,000           252,935,000

PROPERTY AND EQUIPMENT, NET................................................          148,831,000            99,804,000
LONG-TERM INVESTMENTS......................................................          155,153,000           160,482,000
RESTRICTED CASH AND INVESTMENTS............................................           16,540,000            13,648,000
REINSURANCE RECOVERABLE, Net of Current Portion............................           20,245,000            14,721,000
GOODWILL ..................................................................           42,803,000            44,602,000
OTHER ASSETS...............................................................           39,758,000            43,270,000
                                                                                    ------------          ------------
TOTAL ASSETS...............................................................         $723,936,000          $629,462,000
                                                                                    ============          ============

                                           LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Accrued Liabilities.......................................................         $  43,601,000        $  37,650,000
    Accrued Payroll and Taxes.................................................            14,838,000           12,503,000
    Medical Claims Payable....................................................            55,943,000           46,969,000
    Current Portion of Reserve for
         Losses and Loss Adjustment Expense ..................................            63,358,000           52,878,000
    Unearned Premium Revenue..................................................            29,763,000           24,210,000
    Current Portion of Long-term Debt.........................................             4,726,000            2,195,000
                                                                                       -------------        -------------
         Total Current Liabilities............................................           212,229,000          176,405,000

RESERVE FOR LOSSES AND
    LOSS ADJUSTMENT EXPENSE (Less Current Portion) ...........................           139,341,000          134,898,000
LONG-TERM DEBT (Less Current Portion) ........................................            90,841,000           66,189,000
OTHER LIABILITIES ............................................................            15,843,000           17,488,000
                                                                                       -------------        -------------
TOTAL LIABILITIES.............................................................           458,254,000          394,980,000
                                                                                        ------------         ------------

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:  1997 --
         18,473,000; 1996-- 17,910,000........................................                92,000               89,000
    Additional Paid-in Capital................................................           164,294,000          152,035,000
    Treasury Stock; 1997-- 284,500; 1996--  100,200
         Common Shares........................................................            (5,601,000)            (130,000)
    Unrealized Holding Gain on Available-for-Sale Investment..................               655,000              487,000
    Retained Earnings.........................................................           106,242,000           82,001,000
                                                                                        ------------         ------------
         Total Stockholders' Equity...........................................           265,682,000          234,482,000
                                                                                        ------------         ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY....................................          $723,936,000         $629,462,000
                                                                                        ============         ============
</TABLE>

        See the accompanying notes to consolidated financial statements.

                                       32

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
              For the Years Ended December 31, 1997, 1996 and 1995

<TABLE>

<CAPTION>
                                                                             1997                1996                 1995
                                                                      -----------------   -----------------    -----------
OPERATING REVENUES:
<S>                                                                        <C>                 <C>                 <C>
     Medical Premiums.............................................         $513,857,000        $386,968,000        $319,475,000
     Specialty Product Revenues ..................................          146,211,000         133,324,000         102,807,000
     Professional Fees............................................           31,238,000          28,836,000          19,417,000
     Military Contract Revenues ..................................            4,346,000
     Investment and Other Revenues ...............................           26,072,000          26,283,000          25,310,000
                                                                           ------------       -------------      --------------
        Total.....................................................          721,724,000         575,411,000         467,009,000
                                                                          -------------        ------------       -------------

OPERATING EXPENSES:
     Medical Expenses.............................................          419,272,000         315,915,000         245,135,000
     Specialty Product Expenses...................................          143,082,000         130,758,000         102,859,000
     General, Administrative and Marketing Expenses...............           93,919,000          72,237,000          63,562,000
     Military Contract Expenses ..................................            4,193,000
     Merger, Restructuring  and Start-up Expenses.................           29,350,000          12,064,000          11,614,000
                                                                           ------------        ------------       -------------
        Total.....................................................          689,816,000         530,974,000         423,170,000
                                                                            -----------        ------------       -------------

OPERATING INCOME..................................................           31,908,000          44,437,000          43,839,000

INTEREST EXPENSE AND OTHER, NET...................................           (4,433,000)         (2,823,000)         (3,737,000)
                                                                             ----------        ------------       -------------

INCOME FROM CONTINUING OPERATIONS
     BEFORE INCOME TAXES .........................................           27,475,000          41,614,000          40,102,000

PROVISION FOR INCOME TAXES........................................            3,234,000          10,471,000          12,198,000
                                                                           ------------         -----------       -------------

INCOME FROM CONTINUING OPERATIONS.................................           24,241,000          31,143,000          27,904,000

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

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

NET INCOME .......................................................         $ 24,241,000        $ 31,143,000        $ 21,304,000
                                                                           ============        ============        ============

EARNINGS PER COMMON SHARE:
     Income from Continuing Operations ...........................                $1.35               $1.76               $1.60
     Net Operating Loss on Discontinued Operations ...............                                                         (.12)
     Net Loss on Disposal of Discontinued Operations .............                                                         (.26)
                                                                               --------            --------              ------
         Net Income Per Share ....................................                $1.35               $1.76               $1.22
                                                                                  =====               =====               =====

EARNINGS PER COMMON SHARE ASSUMING DILUTION:
     Income from Continuing Operations ...........................                $1.33               $1.72               $1.57
     Net Operating Loss on Discontinued Operations ...............                                                         (.11)
     Net Loss on Disposal of Discontinued Operations .............                                                         (.26)
                                                                               --------            --------              ------
         Net Income Per Share ....................................                $1.33               $1.72               $1.20
                                                                                  =====               =====               =====
</TABLE>


        See the accompanying notes to consolidated financial statements.

                                       33

<PAGE>








                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
              For the Years Ended December 31, 1997, 1996 and 1995



<TABLE>


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



<S>              <C>                <C>          <C>        <C>             <C>           <C>             <C>           <C>         
BALANCE, JANUARY 1, 1995..........  17,336,000   $87,000    $141,398,000    $(130,000)    $(2,752,000)    $29,554,000   $168,157,000
  Issuance of Common Stock in
     Connection with Stock Plans....   304,000     1,000       4,297,000                                                   4,298,000
  Issuance of Stock in Connection
     with Acquisition ..............    37,000                    87,000                                                      87,000
  Income Tax Benefit Realized Upon
     Exercise of Stock Options......                           1,458,000                                                   1,458,000
  Change in Unrealized Holding Gains
    (Losses), Net of Taxes.........                                                        12,411,000                     12,411,000
  Net Income........................                                                                       21,304,000     21,304,000
                                    ------------ ----------- -----------     ---------     ---------      -----------      ---------
BALANCE, DECEMBER 31, 1995........  17,677,000    88,000     147,240,000     (130,000)      9,659,000      50,858,000    207,715,000
  Issuance of Common Stock in
     Connection with Stock Plans....   233,000     1,000       3,637,000                                                   3,638,000
  Income Tax Benefit Realized Upon
     Exercise of Stock Options......                           1,158,000                                                   1,158,000
  Change in Unrealized Holding Gains
     (Losses), Net of Taxes ........                                                      (9,172,000)                    (9,172,000)
  Net Income........................                                                                       31,143,000     31,143,000
                                    ----------  ----------  ------------     ---------    -----------     -----------
BALANCE, DECEMBER 31, 1996 .......  17,910,000    89,000     152,035,000      (130,000)      487,000       82,001,000    234,482,000
  Issuance of Common Stock in
     Connection with Stock Plans....   563,000     3,000      10,255,000                                                  10,258,000
  Purchase of Treasury Stock .......                                        (5,471,000)                                  (5,471,000)
  Income Tax Benefit Realized Upon
     Exercise of Stock Options......                           2,004,000                                                   2,004,000
  Change in Unrealized Holding Gains
     (Losses), Net of Taxes ........                                                         168,000                         168,000
  Net Income........................                                                                       24,241,000     24,241,000
                                    ---------- -----------  ------------   -----------     ---------   ------------      -----------
BALANCE, DECEMBER 31, 1997 .......  18,473,000   $92,000    $164,294,000   $(5,601,000)     $655,000     $106,242,000   $265,682,000
                                    ==========   =======    ============   ===========     ========    ============     ============
</TABLE>






        See the accompanying notes to consolidated financial statements.

                                       34

<PAGE>



                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              For the Years Ended December 31, 1997, 1996 and 1995
<TABLE>

<CAPTION>
                                                                                     1997             1996              1995
                                                                                -------------    --------------     --------

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                              <C>             <C>                 <C>
      Net Income ........................................................        $24,241,000     $  31,143,000       $ 21,304,000
      Adjustments to Reconcile Net Income to Net Cash
         Provided by Operating Activities:
          Loss on Discontinued Operations ...............................                                               6,600,000
          Depreciation and Amortization..................................         13,510,000        10,499,000          9,505,000
          Provision for Doubtful Accounts................................          4,283,000         3,057,000          1,694,000
      Change in Assets and Liabilities, Net of
         Effects from Acquisitions:
          Other Assets...................................................         (5,851,000)      (16,301,000)        (7,542,000)
          Reinsurance Recoverable .......................................         (5,635,000)       10,164,000          3,464,000
          Reserve for Losses and Loss Adjustment Expense ................         14,923,000         5,458,000         (8,645,000)
          Other Liabilities .............................................          6,838,000         6,985,000          1,665,000
          Minority Interests.............................................            (12,000)       (1,746,000)        (2,606,000)
          Accounts Receivable............................................        (12,290,000)      (12,469,000)          (923,000)
          Other Current Assets...........................................        (11,853,000)       (4,671,000)        (2,549,000)
          Medical Claims Payable.........................................          8,974,000         4,973,000          6,341,000
          Other Current Liabilities......................................         15,692,000        15,354,000          8,873,000
                                                                                ------------      ------------        -----------
      Net  Cash Provided by Continuing Operations .......................         52,820,000        52,446,000         37,181,000
      Net Cash Used by Discontinued Operations ..........................                                              (2,651,000)
                                                                           ----------------- -----------------       ------------
          Net Cash Provided by Operating Activities .....................         52,820,000        52,446,000         34,530,000
                                                                                ------------      ------------        -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures...............................................        (55,642,000)      (17,927,000)       (20,522,000)
      Property and Equipment Dispositions, Net...........................            772,000           172,000            725,000
      Purchase of Available-for-Sale Investments.........................     (1,078,396,000)     (712,503,000)      (368,875,000)
      Proceeds from Sales/Maturities of
          Available-for-Sale Investments.................................      1,046,523,000       752,279,000        365,539,000
      Purchase of Held-to-Maturity Investments...........................         (7,523,000)      (25,835,000)       (11,735,000)
      Proceeds from Maturities of Held-to-Maturity Investments...........         10,449,000        39,184,000         20,183,000
      Change in Financed Premium Receivable .............................                                              15,676,000
      Acquisitions, Net of Cash Acquired.................................         (3,145,000)      (36,310,000)       (11,023,000)
                                                                                ------------      ------------        -----------
          Net Cash Used for Investing Activities.........................        (86,962,000)         (940,000)       (10,032,000)
                                                                                ------------     -------------        -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing..................................         25,000,000         1,000,000          2,625,000
      Payments on Debt and Capital Leases................................         (2,391,000)       (9,601,000)       (11,931,000)
      Purchase of Treasury Stock ........................................         (5,471,000)
      Exercise of Stock in Connection with Stock Plans...................         10,258,000         3,638,000          3,807,000
                                                                                ------------       -----------         ----------
          Net Cash Provided by (Used for) Financing Activities...........         27,396,000        (4,963,000)        (5,499,000)
                                                                                ------------        ----------         ----------

NET (DECREASE) INCREASE IN CASH
      AND CASH EQUIVALENTS...............................................         (6,746,000)       46,543,000         18,999,000
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR...........................        103,587,000        57,044,000         38,045,000
                                                                               -------------      ------------        -----------

CASH AND CASH EQUIVALENTS AT END OF YEAR.................................       $ 96,841,000      $103,587,000       $ 57,044,000
                                                                                ============      ============       ============
</TABLE>

        See the accompanying notes to consolidated financial statements.

                                       35

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


1.   BUSINESS

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

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

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

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

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of  Consolidation.  All  significant  intercompany  transactions  and
balances have been eliminated. Sierra's wholly owned subsidiaries include Health
Plan of Nevada,  Inc. ("HPN"),  HMO Texas and Med One, all licensed HMOs, Sierra
Health and Life Insurance  Company,  Inc.  ("SHL"),  a health and life insurance
company,  Southwest Medical Associates,  Inc. ("SMA"), a multi-specialty medical
group, CII, 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,
administrative  services  companies,  a home health care agency, a hospice and a
company that provides and manages mental health and substance abuse services.

Medical Premiums.  Non-Medicare member enrollment is represented  principally by
employer  groups.  Medical  premiums  are  billed  to  each  employer  group  in
accordance  with  negotiated  contracts,  and such premium revenue is recognized
when earned.  Unearned premium revenue includes  payments under prepaid Medicare
contracts  with the Health Care  Financing  Administration  ("HCFA") and prepaid
HPN, HMO Texas and Med One  commercial and SHL indemnity  premiums.  HPN and HMO
Texas offer a prepaid  health  care  program to  Medicare  recipients.  Revenues
associated  with these  Medicare  recipients  were  approximately  $186,105,000,
$140,611,000, and $111,584,000 in 1997, 1996 and 1995, respectively.

                                       36

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995



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

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

Medical  Expenses.  Sierra  contracts  with  hospitals,   physicians  and  other
providers  of  health  care  under   capitated  or  discounted   fee-for-service
arrangements  including  hospital per diems to provide  medical care services to
enrollees. Capitated providers are at risk for the cost of medical care services
provided to the Company's enrollees in the relevant  geographic areas;  however,
the  Company is  ultimately  responsible  for the  provision  of services to its
enrollees  should the  capitated  provider be unable to provide  the  contracted
services.  Health  care costs are  recorded  in the  period  when  services  are
provided to enrolled members,  including estimates for provider costs which have
been  incurred as of the  balance  sheet date but not  reported 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.

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

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

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



                                       37

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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 30 years. The Company evaluates the carrying value of
its intangible assets at each balance sheet date.

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

Reserve for Losses and Loss Adjustment  Expense.  The reserve for losses and LAE
consists of estimated  costs of each unpaid claim  reported 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.

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

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

Credit risk with respect to accounts receivable is generally  diversified due to
the large number of entities  comprising  the Company's  customer base and their
dispersion  across many  different  industries.  These  customers  are primarily
located  in the  states in which  the  Company  operates.  Such  operations  are
principally in California,  Colorado,  Nevada and Texas. However, the Company is
licensed and does business in several other states as well. 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.

                                       38

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995



Recently Issued Accounting Standards. Statement of Financial Accounting No. 130,
"Reporting  Comprehensive  Income" is  effective  for  periods  beginning  after
December   15,  1997  and  requires   companies  to  classify   items  of  other
comprehensive income by their nature in a financial  statement.  Management does
not  believe  this  statement  will  have a  material  impact  on the  Company's
financial  statements.  Statement of Financial Accounting No. 131,  "Disclosures
about Segments of an Enterprise and Related  Information"  is also effective for
periods beginning after December 15, 1997 and establishes  additional  standards
for  segment  disclosures  in  the  financial  statements.  Management  has  not
determined the effect of this statement on its financial statement disclosure.

Estimates and Assumptions. The preparation of financial statements in conformity
with  generally  accepted  accounting  principles  requires  management  to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the  financial  statements  and the  reported  amounts of revenues  and expenses
during the reporting  period.  Estimates and  assumptions  include,  but are not
limited  to,  medical  and  specialty  product  expenses.   Actual  results  may
materially differ from estimates.

Merger,  Restructuring and Start-up Expenses. Merger, restructuring and start-up
expenses represent the non-recurring  incremental costs the Company has incurred
in connection with various  mergers,  acquisitions  and planned  dispositions as
well as costs  associated with the Company's  proposal to serve eligible TRICARE
beneficiaries  in  Region 1.  Costs  recorded  for  restructurings  satisfy  the
definitions  and  criteria  set forth in  Emerging  Issues Task Force Issue 94-3
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)," that
are directly related to the restructurings.

Reclassifications.  Certain amounts in the Consolidated Financial Statements for
the years ended  December  31, 1996 and 1995 have been  reclassified  to conform
with the current year presentation.




                                       39

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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, 1997:
<S>                                                           <C>                                         <C>
Income from Continuing Operations..............               $24,241,000                                 $24,241,000
Shares.........................................                18,008,000               276,000            18,284,000
Per Share Amount...............................                      1.35                                        1.33

For the Year Ended December 31, 1996:
Income from Continuing Operations..............                31,143,000                                  31,143,000
Shares.........................................                17,726,000               401,000            18,127,000
Per Share Amount...............................                      1.76                                        1.72

For the Year Ended December 31, 1995:
Income from Continuing Operations..............                27,904,000                                  27,904,000
Shares.........................................                17,414,000               320,000            17,734,000
Per Share Amount...............................                      1.60                                        1.57
</TABLE>

CII issued convertible  subordinated debentures (the "Debentures") due September
15,  2001.  Each $1,000 in principal is  convertible  into 16.921  shares of the
Company's  common  stock  at a  conversion  price  of  $59.097  per  share.  The
Debentures  were not  included in the  computation  of EPS because  their effect
would be anti-dilutive.




                                       40

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


4.   PROPERTY AND EQUIPMENT

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

<CAPTION>
        Classification                                                      1997                       1996
<S>                                                                       <C>                       <C>
           Land...................................................        $14,296,000               $12,224,000
           Buildings and Improvements.............................        109,307,000                63,229,000
           Furniture, Fixtures and Equipment......................         38,692,000                35,785,000
           Data Processing Equipment and Software.................         31,452,000                21,034,000
           Construction in Progress...............................          4,170,000                 7,858,000
           Less: Accumulated Depreciation ........................       ( 49,086,000)              (40,326,000)
                                                                         ------------               -----------
               Net Property and Equipment.........................       $148,831,000               $99,804,000
                                                                         ============               ===========
</TABLE>


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

<CAPTION>
        Classification                                                       1997                       1996
<S>                                                                        <C>                       <C>
           Data Processing Equipment and Software ................         $4,779,000                $1,682,000
           Furniture, Fixtures and Equipment......................            728,000                   730,000
           Building...............................................            245,000                   245,000
           Less: Accumulated Depreciation.........................           (467,000)               (1,496,000)
                                                                           ----------                ----------
              Net Property and Equipment..........................         $5,285,000                $1,161,000
                                                                           ==========                ==========
</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  1997,  1996 and 1995 was  $1,621,000,  $245,000  and  $183,000,
respectively.

5.   CASH AND INVESTMENTS

Marketable  debt  investments  that the Company has the intention and ability to
hold  to   maturity   are  stated  at   amortized   cost  and   categorized   as
held-to-maturity. The remaining marketable debt and equity investments have been
categorized  as  available-for-sale  and as a result  are  stated at their  fair
value. Unrealized holding gains and losses on available-for-sale  securities are
included as a separate component of stockholders'  equity until realized.  Gross
realized gains and losses in 1997 were $2,878,000 and $2,373,000,  respectively.
Realized  gains and  losses are  calculated  using the  specific  identification
method and are included in net income.



                                       41

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


     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>

                                       42

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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

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

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

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


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

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

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


                                       43

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


The  contractual  maturities  of  available-for-sale  short-term,  long-term and
restricted investments at December 31, 1997 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......................................              $ 61,517,000             $ 61,339,000
Due after one year through five years........................                92,459,000               93,201,000
Due after five years through ten years.......................                66,406,000               66,961,000
Due after ten years..........................................                21,263,000               21,357,000
                                                                           ------------             ------------
     Total...................................................              $241,645,000             $242,858,000
                                                                           ============             ============
</TABLE>


The  contractual  maturities  of  held-to-maturity  short-term,   long-term  and
restricted investments at December 31, 1997 were as follows:
<TABLE>

<CAPTION>
                                                                           Amortized               Estimated
                                                                               Cost                Fair Value

<S>                                                                        <C>                      <C>
Due in one year or less......................................              $  1,140,000             $  1,140,000
Due after one year through five years........................                16,111,000               16,767,000
Due after five years through ten years.......................                 8,707,000                9,005,000
Due after ten years..........................................                18,375,000               18,543,000
                                                                            -----------              -----------
     Total...................................................               $44,333,000              $45,455,000
                                                                            ===========              ===========
</TABLE>


Of the cash and cash  equivalents  that total  $96,841,000  in the  accompanying
Consolidated Balance Sheet at December 31, 1997,  $82,194,000 is limited for use
only by the  Company's  regulated  subsidiaries.  Such amounts are available for
transfer to Sierra from the regulated  subsidiaries only to the extent that they
can be remitted in accordance with terms of existing  management  agreements and
by dividends which  customarily  must be approved by regulating  state insurance
departments. The remainder is available to Sierra on an unrestricted basis.

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 $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 $3,156,000,  $3,235,000 and $2,827,000 net of reinsurance recoveries
of $1,729,000,  $2,276,000  and  $1,133,000 are included in medical  expense for
1997, 1996 and 1995,  respectively.  In addition,  SHL maintains  reinsurance on
certain other insurance products.


                                       44

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


CII also has  reinsurance  treaties in effect.  The reinsurers  have assumed the
liability on that portion of workers'  compensation  claims between $350,000 and
$60,000,000  per  occurrence  for  1997  and  1996  and  between   $250,000  and
$60,000,000  per  occurrence for 1995. At December 31, 1997 and 1996, the amount
of reinsurance  recoverable  for unpaid losses and loss  adjustment  expense was
$21,056,000 and $15,676,000,  respectively. The amount of reinsurance receivable
for  paid  losses  and  loss  adjustment  expense  was  $358,000  and  $103,000,
respectively.

Reinsurance  contracts  do not  relieve  the  Company  from its  obligations  to
enrollees or  policyholders.  Failure of reinsurers  to honor their  obligations
could  result in losses to the  Company.  The Company  evaluates  the  financial
condition of its reinsurers to minimize its exposure to significant  losses from
reinsurer  insolvencies.   All  reinsurers  that  the  Company  has  reinsurance
contracts with are rated A or better by the A.M. Best Company.

The following table provides workers' compensation  reinsurance  information for
the three years ended December 31, 1997:
<TABLE>

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

1997:
<S>                                                         <C>                   <C>                 <C>
 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
                                                             ==========          ============          ==========

1995:
 General Reinsurance Corporation.................            $2,426,000          $ (3,472,000)         $3,727,000
 Others .........................................                                                         300,000
                                                        ---------------    ------------------         -----------
 Total ..........................................            $2,426,000          $ (3,472,000)         $4,027,000
                                                             ==========          ============          ==========
</TABLE>




                                       45

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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


<S>                                                                <C>              <C>               <C>
Net Beginning Losses and LAE Reserve .....................         $172,100,000     $156,447,000      $161,620,000

Net Provision for Insured Events Incurred in:
   Current Year ..........................................          102,301,000      101,401,000        75,978,000
   Prior Years............................................           (8,970,000)     (15,284,000)      (20,079,000)
                                                                   ------------    -------------     -------------
     Total Net Provision..................................           93,331,000       86,117,000        55,899,000
                                                                   ------------    -------------     -------------

Net Payments for Losses and LAE
   Attributable to Insured Events Incurred in:
   Current Year ..........................................           26,811,000       24,733,000        16,553,000
   Prior Years............................................           56,977,000       45,731,000        44,519,000
                                                                   ------------     ------------      ------------
     Total Net Payments ..................................           83,788,000       70,464,000        61,072,000
                                                                   ------------     ------------      ------------

Net Ending Losses and LAE Reserve ........................          181,643,000      172,100,000       156,447,000
Reinsurance Recoverable ..................................           21,056,000       15,676,000        25,871,000
                                                                   ------------     ------------      ------------

Gross Ending Losses and LAE Reserve ......................         $202,699,000     $187,776,000      $182,318,000
                                                                   ============     ============      ============
</TABLE>



                                       46

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


8.   LONG-TERM DEBT

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

<CAPTION>
                                                                              1997                     1996
                                                                           --------------          ----------


<S> <C>                                                                           <C>                      <C>        
  7 1/2% Convertible Subordinated Debentures ........................         $54,467,000              $54,497,000
Revolving Loan ......................................................          25,000,000                        0
7 3/8% Mortgage Note  ...............................................           5,833,000                7,833,000
Adjustable Rate Mortgage Note .......................................           3,116,000                3,167,000
Other................................................................           7,151,000                2,887,000
                                                                             ------------             ------------
  Total..............................................................          95,567,000               68,384,000
Less Current Portion.................................................          (4,726,000)              (2,195,000)
                                                                              -----------              -----------
Long-term Debt.......................................................         $90,841,000              $66,189,000
                                                                              ===========              ===========
</TABLE>


7 1/2%  Convertible  Subordinated  Debentures.  In  September  1991  CII  issued
convertible  subordinated  debentures (the "Debentures") due September 15, 2001.
The Debentures  bear interest at 7-1/2% which is due  semi-annually  on March 15
and September 15. Each $1,000 in principal is convertible  into 16.921 shares of
the  Company's  common  stock  at a  conversion  price  of  $59.097  per  share.
Unamortized  issuance  costs of $803,000  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, 1997 and 1996 was  $1,191,000 and
$1,192,000,  respectively.  The Debentures are redeemable by CII, in whole or in
part, at redemption prices ranging from 102.25% in 1998 to 100.75% in 2000, 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, 1997 and 1996,  the  Company  purchased  $30,000  and  $2,303,000,
respectively, of the debentures on the open market.

Revolving  Loan. As of December 31, 1997, the Company has drawn $25.0 million on
its $100.0  million line of credit ("LOC") for general  corporate  purposes at a
current  interest  rate of 6.3%.  The  remaining  line of credit may be used for
general corporate  purposes,  including  acquisitions,  and may be available for
additional working capital, if necessary.

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.
In January 1998, the Company  obtained a $15,000,000  loan from Bank of America,
Nevada at an  interest  rate of 7.11%.  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. This note is not reflected in
the Company's financial statements at December 31, 1997.

Adjustable  Rate  Mortgage  Note.  The  Company  has a  mortgage  which  has  an
adjustable  rate with an interest  margin of 3% over the Federal  Home Loan Bank
Board  11th  District  Cost of Funds  Index,  a  maximum  interest  rate of five
percentage  points above the initial rate of 11.85% and a minimum  interest rate
of 8%. The interest rate at December 31, 1997 was 8.0%. This mortgage is secured
by a medical facility.


                                       47

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


Other. The Company has obligations under capital leases with interest rates from
6.3% to 13.4%. In addition,  the Company has a term loan due July 1998 including
cumulative interest at 7.0%.

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, 1997, are as follows:
<TABLE>

<CAPTION>
                                                                                                     Obligations
                                                                                Notes               Under Capital
     Year ending December 31,                                                  Payable                Leases
<S>      <C>                                                                <C>                     <C>
         1998.................................................              $ 3,846,000             $1,247,000
         1999.................................................                5,058,000              1,260,000
         2000.................................................                2,000,000              1,301,000
         2001.................................................               54,467,000              1,137,000
         2002 ................................................               25,000,000              1,133,000
         Thereafter...........................................                      --                 401,000
                                                                         --------------             ----------
            Total.............................................              $90,371,000              6,479,000
                                                                            ===========
         Less:  Amounts Representing Interest.................                                      (1,283,000)
                                                                                                    ----------
         Present Value of Minimum Lease Payments..............                                      $5,196,000
                                                                                                    ==========
</TABLE>


The fair value of the Debentures at December 31, 1997 was $51,744,000  which was
determined based on the quoted market price at December 31, 1997.  Excluding the
Debentures,  the fair value of long-term debt, including the current portion, is
$41,410,000 based on the borrowing rates currently  available to the Company for
bank loans with similar terms and average maturities.



                                       48

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


9.   INCOME TAXES

A summary of the  provision  for income  taxes for the years ended  December 31,
1997, 1996, and 1995 is as follows:
<TABLE>


<CAPTION>
                                                             1997                 1996                  1995
                                                         ------------         ------------          --------

Provision for Income Taxes:
<S>                                                        <C>                  <C>                   <C>        
     Current.....................................          $5,528,000           $11,860,000           $11,736,000
     Deferred....................................          (2,294,000)           (1,389,000)              462,000
                                                           ----------            ----------           -----------
                                                           $3,234,000           $10,471,000           $12,198,000
                                                           ==========           ===========           ===========
</TABLE>


The following  reconciles the difference between the 1997, 1996 and 1995 current
and statutory provision for income taxes:
<TABLE>

<CAPTION>
                                                             1997                 1996                  1995
                                                         ------------         ------------          --------


<S>                                                            <C>                   <C>                   <C>
Statutory Rate ..................................              35%                   35%                   35%
Tax Preferred Investments .......................             (5)                  (6)                   (9)
Change in Valuation Allowance ...................            (17)                  (6)                   (2)
Non-deductible Acquisition Costs ................                                                         5
Other .......................................  (1)              2                     1
                                               --             ---                   ---
     Provision for Income Taxes .................              12%                   25%                   30%
                                                               ==                   ===                   ===
</TABLE>




                                       49

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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

<CAPTION>
                                                                                    1997                 1996
                                                                               --------------       ---------
Deferred Tax Assets:
<S>                                                                              <C>                   <C>
    Medical and Losses and LAE Reserves ......................                   $ 7,428,000           $ 5,277,000
    Accruals Not Currently Deductible.........................                     7,269,000             5,334,000
    Compensation Accruals ....................................                     2,344,000             2,960,000
    Bad Debt Allowances.......................................                     2,041,000             2,946,000
    Loss Carryforwards and Credits............................                    11,543,000            13,389,000
    Other ....................................................                       872,000               803,000
                                                                                 -----------          ------------
                                                                                  31,497,000            30,709,000
                                                                                 -----------           -----------

Deferred Tax Liabilities:
    Deferred Policy Acquisition Costs ........................                       596,000               613,000
    Depreciation and Amortization ............................                     4,872,000             4,102,000
    Other ....................................................                     1,066,000               825,000
                                                                                 -----------          ------------
                                                                                   6,534,000             5,540,000
                                                                                 -----------           -----------
    Net Deferred Tax Asset Before
       Valuation Allowance....................................                    24,963,000            25,169,000

    Valuation Allowance ......................................                    (6,266,000)          (10,929,000)
                                                                                ------------           -----------
    Net Deferred Tax Asset ...................................                   $18,697,000           $14,240,000
                                                                                 ===========           ===========
</TABLE>


At December 31, 1997, the Company had  approximately  $27,048,000 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. The Company also has California net operating
loss  carryforwards  of  approximately  $7,492,000 which expire through the year
2000. In addition to these 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.

Due to the above referenced  limitations,  a valuation allowance has been set up
to reflect the Company's  inability to use tax benefits from recent acquisitions
currently or in the near future.  As the benefits are realizable by the Company,
the  valuation  allowance  will be reduced as required by Statement of Financial
Accounting  Standards No. 109 "Accounting for Income Taxes" ("FAS 109"). For the
years  ended  December  31,  1997 and 1996,  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
$4,663,000  and  $2,685,000  for the years  ended  December  31,  1997 and 1996,
respectively.  The  valuation  allowance of  $6,266,000  at December 31, 1997 is
considered  necessary  under the more likely than not  criteria  required by FAS
109.



                                       50

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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>
          1998...................................................             $6,894,000
          1999...................................................              6,351,000
          2000...................................................              5,745,000
          2001...................................................              5,153,000
          2002 ..................................................              4,832,000
          Thereafter.............................................              7,089,000
                                                                            ------------
               Total.............................................            $36,064,000
                                                                             ===========
</TABLE>

Rent expense  totaled  $5,827,000,  $4,945,000 and $4,942,000 in 1997,  1996 and
1995, respectively.

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

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 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
$3,929,000, $3,216,000 and $2,516,000 in 1997, 1996 and 1995, 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 and certain
officers  and key  executives  selected  and  approved  by the  Sierra  Board of
Directors  entered  into split  dollar  life  insurance  agreements  whereby the
Company has funded the insurance premiums. The premiums paid by the Company will
be  reimbursed  upon the  occurrence  of  certain  events  as  specified  in the
contract.


                                       51

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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

A reconciliation of ending year balances is as follows:
<TABLE>

<CAPTION>
     Change in Benefit Obligation:
<S>                                                                                   <C>
         Projected Benefit Obligation at Inception ....................               $9,008,000
         Service Cost .................................................                  132,000
         Interest Cost ................................................                  375,000
         Benefits Paid ................................................
         Benefit Obligation at December 31, 1997 ......................                9,515,000
                                                                                      ----------

     Change in Plan Assets:
         Actual Return on Plan Assets .................................                 (308,000)
         Company Contributions ........................................                2,180,000
         Benefits Paid ................................................
         Fair Value of Plan Assets at December 31, 1997 ...............                1,872,000

         Funded Status of the Plan ....................................               (7,643,000)
         Unrecognized Prior Service Credit ............................                8,647,000
                                                                                     -----------
         Total Recognized .............................................               $1,004,000
                                                                                      ==========

     Total Recognized Amounts in the Financial
        Statements Consist of:
         Unrecognized Net Loss ........................................               $ (394,000)
         Accrued Benefit Liability ....................................               (2,964,000)
         Intangible Asset .............................................                4,362,000
                                                                                      ----------
         Total ........................................................               $1,004,000
                                                                                      ==========

     Assumptions as of December 31, 1997
         Discount Rate ................................................                      7.0%
         Expected Return on Plan Assets ...............................                      8.0%
         Rate of Compensation Increase ................................                      5.0%

     Benefit Cost .....................................................               $  781,000
</TABLE>

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



                                       52

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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

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


                                       53

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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, 1995.................           1,272,000            $  2.44  - $28.63           $16.29
   Granted..................................             882,000              14.86  -  31.75            26.30
   Exercised................................            (241,000)              2.44  -  21.00            12.14
   Canceled.................................             (53,000)              3.38  -  28.63            17.49
                                                      ----------
Outstanding December 31, 1995...............           1,860,000               3.38  -  31.75            21.54
   Granted..................................             320,000              25.00  -  35.00            26.15
   Exercised................................            (166,000)              3.38  -  28.63            12.57
   Canceled.................................             (15,000)             10.69  -  31.75            21.70
                                                       ----------
Outstanding December 31, 1996 ..............           1,999,000               7.50  -  35.00            23.01
   Granted..................................             306,000              24.38  -  36.75            34.73
   Exercised................................            (470,000)              7.50  -  31.75            17.71
   Canceled.................................           (  65,000)              9.46  -  35.00            26.00
                                                       ---------
Outstanding December 31, 1997 ..............           1,770,000               9.46  -  36.75            26.30
                                                       =========

Exercisable at December 31, 1997 ...........             696,000             $ 9.46  - $36.75           $23.79
                                                       =========

Available for Grant at
   December 31, 1997 .......................             402,000
                                                         =======
</TABLE>


     The following table summarizes  information about stock options outstanding
at December 31, 1997:
<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>               <C>              <C>
      $ 9.46  -  $10.69               156 days             29,000          29,000            $ 9.76           $ 9.76
       14.86  -   21.00               598 days            244,000         154,000             17.15            17.47
       24.38  -   31.75             1,385 days          1,230,000         508,000             26.35            26.39
       34.50  -   36.75             1,762 days            267,000           5,000             36.60            34.98
</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, 1997, the
Company had 331,000 shares reserved for purchase under the Purchase Plan. During
1997,  a total of 92,000  shares were  purchased at a price of $20.93 per share.
During January 1998,  48,000 shares were issued to employees at $26.62 per share
in connection with the Purchase Plan.


                                       54

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


Accounting for Stock-Based  Compensation.  At December 31, 1997, the Company had
three  stock-based  compensation  plans,  which are described above. The Company
uses the intrinsic  value method in accounting  for its plans.  Accordingly,  no
compensation  cost has been  recognized for its fixed stock option plans nor the
Purchase  Plan.  Had  compensation  cost  for the  Company's  three  stock-based
compensation  plans been  determined  based on the fair value at the grant dates
for awards under those plans,  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                                             1997                  1996               1995
-------------------------------------------------------------------------------------------------------------

<S>                                                         <C>                   <C>                  <C>
Net Income                          As reported             $24,241,000           $31,143,000          $21,304,000
                                    Pro forma                22,177,000            29,703,000           20,203,000

Net Income Per Share                As reported                   $1.35                 $1.76                $1.22
                                    Pro forma                      1.23                  1.68                 1.16

Net Income Per Share
    Assuming Dilution               As reported                   $1.33                 $1.72                $1.20
                                    Pro forma                      1.21                  1.64                 1.14
</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 1997, 1996 and 1995, respectively: dividend yield
of 0% for all years; expected volatility of 35%, 29% and 34%; risk-free interest
rates of 5.89%,  5.92%,  and  6.12%;  and  expected  lives of four years for all
years.  The weighted  fair value of options  granted in 1997,  1996 and 1995 was
$12.40, $8.47 and $9.49, 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 1997,
1996  and  1995,  respectively:  dividend  yield of 0% for all  years;  expected
volatility of 35%, 29% and 34%;  risk-free  interest  rates of 5.32%,  5.29% and
6.07%; and expected lives of six months for all years.

Due to the fact that the  Company's  stock option  programs vest over many years
and  additional  awards are made each year,  the above pro forma numbers are not
indicative of the financial impact had the disclosure provisions of FAS 123 been
applicable  to all years of previous  option  grants.  The above  numbers do not
include the effect of options granted prior to 1995.




                                       55

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 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>
                                                                  1997              1996           1995
                                                              ------------      ------------   --------


Cash Paid During the Year for Interest
<S>                                                                   <C>               <C>              <C>
    (Net of Amount Capitalized)...............................        $4,463,000        $5,275,000       $ 6,430,000
Cash Paid During the Year for Income Taxes....................         7,943,000         7,966,000        10,509,000

Noncash Investing and Financing Activities:
    Liabilities Assumed in Connection with
       Corporate Acquisitions.................................           195,000         7,890,000         3,113,000
    Reductions to Funds Withheld by Ceding
       Insurance Company and Future
       Policy Benefits........................................         8,471,000           773,000           990,000
    Stock Issued for Exercise of Options
       and Related Tax Benefits...............................         2,004,000         1,158,000         1,949,000
    Assumption of Liability in Connection with
       Land Purchase .........................................              --                --           1,956,000
    Additions to Capital Leases...............................         4,574,000              --             278,000
    Stock and Warrants Received on Sale
       of Discontinued Operations ............................              --                --           1,000,000
</TABLE>


14.        MERGER, RESTRUCTURING AND START-UP EXPENSES

During  1997,   the  Company   recorded  and  paid  expenses  of   approximately
$11,000,000,  $8,360,000 after tax, for merger-related costs. On March 18, 1997,
the Company  announced  it had  terminated  its merger  agreement  with PCA. The
original  agreement  had been entered into in November  1996. On March 18, 1997,
prior to termination of the merger  agreement,  PCA filed a lawsuit  against the
Company in the United States District Court for the Southern District of Florida
(the "District Court"), seeking, among other things, specific performance of the
merger  agreement  and  monetary  damages.  The lawsuit has been  dismissed  for
failure to join a necessary  party.  The Company has also initiated a lawsuit in
the Court of Chancery of the State of Delaware seeking a declaratory judgment as
well as other remedies.  The Company  intends to vigorously  pursue all remedies
available  to it;  however,  there can be no  assurance  that the  Company  will
prevail in such litigation.

During  the third  quarter  of 1997,  SMHS was  notified  it had been  awarded a
multi-year  triple-option  health benefits  ("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 $18,350,000,  $10,600,000 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 is currently in the
implementation  period of the  contract  with  actual  health  care  delivery to
commence on June 1, 1998. SMHS subcontracts for health care delivery,  including
some of the risk, for parts of the TRICARE contract.


                                       56

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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. The TRICARE  Management  Activity ("TMA"),  along with the Company,  has
filed a motion requesting that the GAO reconsider its recommendation. If the GAO
does not change its recommendation and the TMA follows the recommendation, there
are several  possible  outcomes,  including  litigation.  The Company  currently
anticipates providing health care delivery for one year of the contract should a
re-bid occur.

During 1995, as part of the Company's clinical expansion and growth efforts, the
Company acquired a medical facility in Mohave County, Arizona, across the border
from Laughlin,  Nevada. This medical facility included a 12-bed hospital. During
1996 the  Company  implemented  a plan to exit  the  hospital  business  and has
actively pursued buyers for this business. As a result of this plan, the Company
recorded a charge of $3,814,000  ($2,860,000 after tax) in the fourth quarter of
1996, primarily to recognize the estimated costs to dispose of the hospital.  As
of December 31, 1997,  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 $8,250,000  ($6,187,000 after tax). The plan will allow the
Company to focus on more  favorable  operating  markets  and  improve  operating
efficiencies.  The Company  believes that this  restructuring,  over time,  will
result in improved cash flow and operating  cost  savings.  These  restructuring
costs included  cancellation of certain  contractual  obligations of $6,000,000,
lease termination costs of $1,500,000 and approximately $750,000 of other costs.

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



                                       57

<PAGE>


                  SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              For the Years Ended December 31, 1997, 1996 and 1995


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, 1997:
<S>                                                              <C>              <C>              <C>               <C>
  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 ..................................               .08              .59              .03               .65
  Earnings Per Share Assuming Dilution ................               .08              .58              .03               .64

Year Ended December 31, 1996:
  Operating Revenues...................................          $136,012         $141,362         $146,245          $151,792
  Operating Income.....................................            14,375           14,520            6,137             9,405
  Income From Continuing Operations
     Before Income Taxes ..............................            13,566           13,688            5,422             8,938
  Net Income...........................................            10,164           10,211            4,067             6,701
  Earnings Per Share ..................................               .58              .58              .23               .38
  Earnings Per Share Assuming Dilution ................               .56              .56              .22               .37
</TABLE>

                                       58

<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 1998 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 1998 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 1998
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 1998  Annual  Meeting  of
Stockholders, is incorporated herein by reference.


                                       59

<PAGE>



                                     PART IV


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

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

                                                                           Page

        Independent Auditors' Report...................................      31
        Consolidated Balance Sheets at December 31, 1997 and 1996......      32
        Consolidated Statements of Operations for the Years Ended
           December 31, 1997, 1996 and 1995............................      33
        Consolidated Statements of Changes in Stockholders' Equity
           for the Years Ended December 31, 1997, 1996 and 1995........      34
        Consolidated Statements of Cash Flows for the Years Ended
           December 31, 1997, 1996 and 1995............................      35
        Notes to Consolidated Financial Statements.....................      36

(a)(2)     Financial Statement Schedules:

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

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

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

All other schedules are omitted  because they are not applicable,  not required,
or because the required information is in the consolidated  financial statements
or notes thereto.

(a)(3)            and (c) The  following  exhibits  are  filed  as part  of,  or
                  incorporated  by  reference  into,  this Report as required by
                  Item 601 of Regulation S-K:

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

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

       (3.3)      Amended  and  Restated  Bylaws of the  Registrant,  as amended
                  through December 12, 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).


                                       60

<PAGE>



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

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

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

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

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

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

      (10.4)      Credit  Agreement  dated as of April  11,  1996  among  Sierra
                  Health Services,  Inc., as Borrower,  Bank of America National
                  Trust and Savings Association,  as Agent and Issuing Bank, and
                  the Other  Financial  Institutions  Party  thereto for a $50.0
                  million  Line of  Credit,  incorporated  by  reference  to the
                  Registrant's  Quarterly  Report  on Form  10-Q for the  fiscal
                  quarter ended March 31, 1996.

     (10.5) First  Amendment,  dated as of May 31, 1997, to Credit Agreement and
Waiver among Sierra Health Services, Inc., as Borrower, Bank of America National
Trust and Savings Association, as Agent and Issuing Bank and the Other Financial
Institutions  Party Hereto,  originally  dated as of April 11, 1996 and filed as
Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q for the three-month
period  ended March 31, 1996,  incorporated  by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
1997.

      (10.6)      Compensatory Plans, Contracts and Arrangements.

                  (1)  Employment   Agreement  with  Jonathon  W.  Bunker  dated
November 15, 1997.

                  (2) Employment  Agreement with Frank E. Collins dated November
15, 1997.

                  (3)  Employment   Agreement  with  William  R.  Godfrey  dated
November 15, 1997.

                  (4)  Employment   Agreement  with  Laurence  S.  Howard  dated
November 15, 1997.


                                       61

<PAGE>



                  (5) Employment  Agreement  with Anthony M. Marlon,  M.D. dated
November 15, 1997.

                  (6) Employment Agreement with Erin E. MacDonald dated November
15, 1997.

                  (7)  Employment  Agreement  with  Michael  A.  Montalvo  dated
November 15, 1997.

                  (8)  Employment  Agreement  with Marie H. Soldo dated November
15, 1997.

                  (9)  Employment  Agreement  with James L. Starr dated November
15, 1997.

     (10) 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.

                  (11)  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.

                  (12)  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.

                  (13)  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.

                  (14)  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.

                  (15)  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.

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

      (10.7)      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.

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


                                       62

<PAGE>



      (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.

        (21)      Subsidiaries of the Registrant (listed herein):

                  There is no  parent  of the  Registrant.  The  following  is a
                  listing of the active subsidiaries of the Registrant:

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

      (23.1)      Consent of Deloitte & Touche LLP

      (27.1)      Financial Data Schedule  --  1997

      (27.2)      Financial Data Schedule  --  1996, 1995

        (99)  Registrant's  current  report  on Form 8-K dated  March 19,  1998,
incorporated herein.

            All other Exhibits are omitted because they are not applicable.

(b)         Reports on Form 8-K

                  None

(d)         Financial Statement Schedules

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





                                       63

<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 25, 1998

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 25, 1998
---------------------------------
   Anthony M. Marlon, M.D.                     and Chairman of the Board
                                               (Chief Executive Officer)


   /S/ JAMES L. STARR                          Senior Vice President of Finance,         March 25, 1998
---------------------------------------
   James L. Starr                              Chief Financial Officer,
                                               and Treasurer
                                               (Chief Accounting Officer)


   /S/ ERIN E. MACDONALD             _         President and                             March 25, 1998
---------------------------------------
   Erin E. MacDonald                           Chief Operating Officer
                                               Director


   /S/ PAUL H. PALMER                          Assistant Vice President                  March 25, 1998
---------------------------------------
   Paul H. Palmer                              and Corporate Controller


   /S/ CHARLES L. RUTHE                        Director                                  March 25, 1998
---------------------------------------
        Charles L. Ruthe


   /S/ WILLIAM J. RAGGIO                       Director                                  March 25, 1998
---------------------------------------
        William J. Raggio


   /S/ THOMAS Y. HARTLEY                       Director                                  March 25, 1998
---------------------------------------
        Thomas Y. Hartley
</TABLE>


                                       64

<PAGE>



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

<TABLE>


<CAPTION>
                                                                                            December 31,
                                                                                      1997               1996
                                                                                ---------------    ----------
CURRENT ASSETS:
<S>                                                                               <C>                 <C>
     Cash and Cash Equivalents ..........................................         $ 15,115,000        $ 17,761,000
     Short-term Investments..............................................            2,090,000          12,055,000
     Prepaid Expenses and Other Current Assets...........................           10,415,000           8,103,000
                                                                                  ------------        ------------
           Total Current Assets..........................................           27,620,000          37,919,000

PROPERTY AND EQUIPMENT - NET ............................................           55,251,000          32,596,000
EQUITY IN NET ASSETS OF SUBSIDIARIES ....................................          204,204,000         145,939,000
NOTES RECEIVABLE FROM SUBSIDIARIES ......................................            9,744,000           9,804,000
LONG-TERM INVESTMENTS ...................................................               86,000           6,021,000
GOODWILL AND OTHER INTANGIBLE ASSETS ....................................            2,362,000          14,896,000
OTHER ...................................................................           24,081,000          10,330,000
                                                                                  ------------        ------------

TOTAL ASSETS ............................................................         $323,348,000        $257,505,000
                                                                                  ============        ============

CURRENT LIABILITIES:
     Accounts Payable and Other Accrued Liabilities .....................         $ 16,757,000        $ 13,268,000
     Current Portion of Long-term Debt ..................................            2,349,000             444,000
                                                                                   -----------        ------------
           Total Current Liabilities ....................................           19,106,000          13,712,000

LONG-TERM DEBT (Less Current Portion)....................................           25,858,000           3,241,000
OTHER LIABILITIES .......................................................           12,702,000           6,070,000
                                                                                  ------------       -------------
TOTAL LIABILITIES .......................................................           57,666,000          23,023,000
                                                                                  ------------        ------------

STOCKHOLDERS' EQUITY:
     Capital Stock ......................................................               92,000              89,000
     Additional Paid-in Capital .........................................          164,294,000         152,035,000
     Treasury Stock .....................................................           (5,601,000)           (130,000)
     Unrealized Holding Gain on Available-for-sale Investments ..........              655,000             487,000
     Retained Earnings ..................................................          106,242,000          82,001,000
                                                                                  ------------        ------------
           Total Stockholders' Equity ...................................          265,682,000         234,482,000
                                                                                  ------------        ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...............................         $323,348,000        $257,505,000
                                                                                  ============        ============
</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>
          1998...........................................................           $2,349,000
          1999...........................................................              429,000
          2000...........................................................              429,000
          2001...........................................................                   --
          2002 ..........................................................           25,000,000
          Thereafter.....................................................                   --
                                                                                 -------------
              Total......................................................          $28,207,000
                                                                                   ===========
</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,
                                                                     1997              1996            1995
                                                               ---------------   --------------  ----------
OPERATING REVENUES:
<S>                                                              <C>               <C>              <C>
    Management Fees........................................      $47,303,000       $44,139,000      $40,115,000
    Subsidiary Dividends...................................        1,700,000         3,733,000          250,000
    Investment and Other Income............................        6,688,000         5,145,000        4,087,000
                                                                 -----------       -----------     ------------
       Total Operating Revenues............................       55,691,000        53,017,000       44,452,000
                                                                 -----------       -----------      -----------

GENERAL AND ADMINISTRATIVE EXPENSES:
    Payroll and Benefits...................................       17,616,000        11,579,000       12,805,000
    Depreciation...........................................        3,707,000         3,433,000        3,323,000
    Rent...................................................          615,000           649,000          738,000
    Repairs and Maintenance................................          459,000           408,000          382,000
    Legal..................................................          293,000         1,874,000          226,000
    Consulting.............................................          769,000           827,000          583,000
    Other..................................................        7,047,000         5,145,000        4,252,000
    Acquisition, Restructuring and Other Expenses .........       29,350,000        12,064,000       11,614,000
                                                                 -----------       -----------      -----------
       Total General and Administrative....................       59,856,000        35,979,000       33,923,000

INTEREST EXPENSE AND OTHER, NET............................         (676,000)         (503,000)        (396,000)

EQUITY IN UNDISTRIBUTED
    EARNINGS OF SUBSIDIARIES...............................       25,615,000        21,991,000       15,785,000
                                                                 -----------       -----------      -----------

INCOME BEFORE INCOME TAXES.................................       20,774,000        38,526,000       25,918,000

BENEFIT FROM (PROVISION FOR)
     INCOME TAXES..........................................        3,467,000        (7,383,000)      (4,614,000)
                                                                 -----------      ------------     ------------

NET INCOME.................................................      $24,241,000       $31,143,000      $21,304,000
                                                                 ===========       ===========      ===========

</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,
                                                                                    1997              1996               1995
                                                                               --------------    --------------     ---------

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                               <C>               <C>               <C>
      Net Income...........................................................       $24,241,000       $31,143,000       $21,304,000
      Adjustments to Reconcile Net Income to Net Cash
          Provided by Operating Activities:
          Depreciation and Amortization....................................         3,885,000         3,611,000         3,449,000
      Equity in Undistributed Earnings of Subsidiaries.....................       (25,615,000)      (21,991,000)      (15,787,000)
      Change in Assets and Liabilities:
          Other Assets.....................................................        (1,177,000)      (15,917,000)       (5,021,000)
          Current Assets...................................................        (2,312,000)       (5,959,000)         (504,000)
          Current Liabilities..............................................         5,493,000         4,712,000         7,429,000
          Other Long-term Liabilities .....................................         6,634,000         6,069,000
                                                                                  -----------       -----------
          Net Cash Provided by Operating Activities........................        11,149,000         1,668,000        10,870,000
                                                                                  -----------       -----------       -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital Expenditures, Net ...........................................       (26,453,000)       (9,292,000)       (8,763,000)
      Decrease in Short-term Securities....................................         9,732,000        14,136,000        22,990,000
      Decrease (Increase) in Other Assets..................................         5,820,000         6,942,000        (8,963,000)
      Dividends from Subsidiary............................................         1,700,000         3,733,000           250,000
      Acquisitions, Net of Cash Acquired ..................................        (3,145,000)      (31,270,000)
      (Decrease) Increase in Net Assets in Subsidiaries....................       (30,816,000)       14,321,000        (1,572,000)
                                                                                 ------------      ------------       -----------
          Net Cash (Used for) Provided by Investing Activities ............       (43,162,000)       (1,430,000)        3,942,000
                                                                                  -----------      ------------       -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from Long-term Borrowing ...................................        25,000,000
      Loans to Subsidiaries ...............................................                                           (12,593,000)
      Reductions in Long-term Obligations and
          Payments on Capital Leases.......................................          (480,000)         (718,000)         (789,000)
      Proceeds from Note Receivable to Subsidiary..........................            60,000         2,789,000
      Purchase of Treasury Stock ..........................................        (5,471,000)
      Exercise of Stock in Connection with Stock Plans.....................        10,258,000         3,638,000         3,807,000
                                                                                  -----------       -----------       -----------
          Net Cash Provided by (Used for) Financing Activities.............        29,367,000         5,709,000        (9,575,000)
                                                                                  -----------       -----------       -----------

Net (Decrease) Increase in Cash and Cash Equivalents.......................        (2,646,000)        5,947,000         5,237,000
Cash and Cash Equivalents at Beginning of Year.............................        17,761,000        11,814,000         6,577,000
                                                                                  -----------      ------------      ------------
Cash and Cash Equivalents at End of Year...................................       $15,115,000       $17,761,000       $11,814,000
                                                                                  -----------       ===========       ===========


Supplemental condensed statements of cash flows information:

Cash Paid During the Year for Interest
      (Net of Amount Capitalized)..........................................          $632,000        $  443,000        $  455,000
Cash Paid During the Year for Income Taxes.................................         7,916,000         6,423,000         2,746,000

Noncash Investing and Financing Activities:
      Additions to Capital Leases..........................................                --               --            278,000
      Assumptions of Liability in Connection with
          Land Purchase....................................................                --               --          1,956,000
      Stock Issued for Exercise of Options
          and Related Tax Benefits.........................................         2,004,000         1,158,000         1,949,000
</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, 1997........     $1,800      $202,699            --     $11,285      $134,262     $16,780     
     December 31, 1996........      1,832       187,776            --       9,885       126,121      16,422     
     December 31, 1995 .......      1,928       182,318            --       9,282        94,611      14,301     
</TABLE>





<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, 1997........  $102,301     $(8,970)    $26,211      $83,788      $135,580
     December 31, 1996........   101,401     (15,284)     21,968       70,464       126,497
     December 31, 1995 .......    75,978     (20,079)     22,028       67,071        94,953
</TABLE>



















                                       S-4

<PAGE>


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

<TABLE>


<CAPTION>
                                                             Year ended December 31
                            1997       1996       1995       1994       1993       1992       1991       1990       1989      1988
                          --------   --------   --------   --------   --------   --------   --------   --------   --------  ------
Losses and LAE

<S>                       <C>        <C>        <C>        <C>        <C>        <C>       <C>        <C>        <C>         <C>    
   Reserve.............   $202,699   $187,776   $182,318   $190,962   $200,356   $178,460  $112,749   $ 67,593   $ 37,466    $10,277

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

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

Cumulative Net Paid
 as of:
 One Year Later                        56,977     45,731     44,519     50,210     50,360    57,611    39,118     14,820       3,954
 Two Years Later                                  70,854     68,619     79,788     84,465    89,177    65,165     28,657       6,609
 Three Years Later                                           80,645     94,865    104,569   108,849    76,988     36,579       8,198
 Four Years Later                                                      102,395    114,293   120,539    83,822     39,345       8,938
 Five Years Later                                                                 119,462   126,100    87,618     41,043       9,235
 Six Years Later                                                                            129,060    89,607     41,962       9,398
 Seven Years Later                                                                                     90,721     42,541       9,471
 Eight Years Later                                                                                                42,818       9,517
 Nine Years Later                                                                                                              9,541

Net Reserve Re-estimated
 as of:
 One Year Later                       163,130    141,163    139,741    160,562    154,388   140,815      83,841     37,463    10,072
 Two Years Later                                 132,193    125,279    141,100    147,167   142,447      96,011     39,753     9,902
 Three Years Later                                          117,792    126,483    134,747   143,433      97,142     43,528     9,598
 Four Years Later                                                      122,517    132,193   137,143      97,942     44,404     9,330
 Five Years Later                                                                 131,112   135,249      94,852     45,027    10,042
 Six Years Later                                                                            135,299      93,561     44,543    10,110
 Seven Years Later                                                                                       93,672     43,741    10,124
 Eight Years Later                                                                                                  43,682     9,695
 Nine Years Later                                                                                                              9,768

Cumulative Redundancy
 (Deficiency)                           8,970     24,254     43,828     51,998     27,141   (22,550)   (26,079)    (6,216)       509

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

Net Re-estimated Reserve                                    163,130    132,193    117,792    122,517
Re-estimated Reinsurance
Recoverables                                      16,333     19,184     19,891     14,656
                                                --------   --------   --------   --------
Gross Re-Estimated
   Reserve ............               179,463    151,377    137,683    137,173
                                     --------    -------    -------    -------
Gross Cumulative
   Redundancy..........              $  8,313   $ 30,941   $ 53,279   $ 63,183
                                     ========   ========   ========   ========
</TABLE>


(1)     The Company adopted Financial  Accounting  Standards Board Statement No.
        113 ("FAS  113"),  "Accounting  and  Reporting  for  Short-Duration  and
        Long-Duration  Reinsurance  Contracts"  for the year ended  December 31,
        1992. As permitted,  prior financial  statements have not been restated.
        Reinsurance  recoverables on unpaid losses and LAE are shown as an asset
        on the  balance  sheets at  December  31,  1997 and 1996.  However,  for
        purposes of the  reconciliation  and  development  tables,  loss and LAE
        information will be shown net of reinsurance.


               See the notes to consolidated financial statements.


                                       S-5

<PAGE>