<PAGE>
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                   FORM 10-K

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

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
                                       OR
      [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
          THE SECURITIES EXCHANGE ACT OF 1934

        FOR THE TRANSITION PERIOD FROM ______________ TO _______________
                         COMMISSION FILE NUMBER 0-20905

                     UNITED PAYORS & UNITED PROVIDERS, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                     51-0374698
(State or other jurisdiction of          (I.R.S. Employer Identification Number)
incorporation or organization)

         2275 RESEARCH BOULEVARD, 6TH FLOOR, ROCKVILLE, MARYLAND  20850
               (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, ZIP CODE)
                                 (301) 548-1000
                (Registrant's phone number, including area code)

                                Not Applicable
              --------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed since last report)

Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to 12(g) of the Act: Common Stock,$0.01 par value

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 the 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 number of shares of Common Stock, par value $.01 per share, outstanding on
March 1, 1999 was 17,553,803. As of March 5, 1999, assuming as fair value the
last sale price of $24.50 per share on The Nasdaq Stock Market, the aggregate
fair value of shares held by non-affiliates was approximately $124,000,000.

                      DOCUMENTS INCORPORATED BY REFERENCE:

The Company's Proxy Statement for its annual meeting of stockholders to be held
in June 1999, a definitive copy of which will be filed within 120 days of
December 31, 1998, is incorporated by reference in Part III of this Report on
Form 10-K.
<PAGE>
 
                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                Page
                                                                ----
PART I
  <S>       <C>                                                 <C>
  Item 1.   Business...........................................   3
  Item 2.   Properties.........................................  14
  Item 3.   Legal Proceedings..................................  14
  Item 4.   Submission of Matters for a Vote of Security
            Holders............................................  14
 
PART II
 
  Item 5.   Market for Registrant's Common Equity and Related
            Stockholder Matters................................  14
                                                               
  Item 6.   Selected Consolidated Financial Data...............  15
  Item 7.   Management's Discussion and Analysis of Financial
            Condition and Results of Operations................  16
  Item 7A.  Quantitative and Qualitative Disclosures About 
            Market Risk (Included in Item 7) 
  Item 8.   Financial Statements and Supplementary Data........  23
  Item 9.   Changes in and Disagreements with Accountants on
            Accounting and Financial Disclosure................  23
                                                        
 PART III
 
  Item 10.  Directors and Executive Officers of the Registrant.  23
  Item 11.  Executive Compensation.............................  24
  Item 12.  Security Ownership of Certain Beneficial Owners
            and Management.....................................  24
  Item 13.  Certain Relationships and Related Transactions.....  24
 
PART IV
 
  Item 14.  Exhibits, Financial Statement Schedules, and
            Reports on Form 8-K................................  24
</TABLE>

SIGNATURES

     THIS FORM 10-K, INCLUDING THE DOCUMENTS INCORPORATED BY REFERENCE, CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS, INCLUDING WITHOUT LIMITATION, STATEMENTS
CONCERNING THE COMPANY'S OPERATIONS, ECONOMIC PERFORMANCE AND FINANCIAL
CONDITION. THESE FORWARD-LOOKING STATEMENTS ARE MADE PURSUANT TO THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE WORDS
"BELIEVE," "EXPECT," "ANTICIPATE" AND OTHER SIMILAR EXPRESSIONS GENERALLY
IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THEIR
DATES. THESE FORWARD-LOOKING STATEMENTS ARE BASED LARGELY ON THE COMPANY'S
CURRENT EXPECTATIONS AND ARE SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES,
INCLUDING, WITHOUT LIMITATION, THOSE IDENTIFIED UNDER "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND ELSEWHERE IN
THIS FORM 10-K, INCLUDING THE DOCUMENTS INCORPORATED BY REFERENCE. ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM RESULTS REFERRED TO IN THE FORWARD-LOOKING
STATEMENTS. IN ADDITION, IMPORTANT FACTORS TO CONSIDER IN EVALUATING SUCH
FORWARD-LOOKING STATEMENTS INCLUDE CHANGES IN EXTERNAL MARKET FACTORS, CHANGES
IN THE COMPANY'S BUSINESS OR GROWTH STRATEGY OR AN INABILITY TO EXECUTE ITS
STRATEGY DUE TO CHANGES IN ITS INDUSTRY OR THE ECONOMY GENERALLY. IN LIGHT OF
THESE RISKS AND UNCERTAINTIES, THERE CAN BE NO ASSURANCES THAT THE RESULTS
REFERRED TO IN THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS FORM 10-K WILL
IN FACT OCCUR. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE
FORWARD-LOOKING STATEMENTS TO REFLECT ANY FUTURE EVENTS OR CIRCUMSTANCES.

                                       2

<PAGE>
 
                                     PART I

ITEM 1.  BUSINESS

GENERAL

  United Payors & United Providers, Inc. ("UP&UP" or the "Company") is a
Delaware corporation which is the successor to an Iowa corporation organized in
February 1995 by its Chairman and Chief Executive Officer, Thomas L. Blair, and
an affiliate of Principal Mutual Holding Company ("Principal Mutual"). Effective
December 31, 1995, the Company's original stockholders and a subsidiary of a
stockholder contributed to the Company certain complementary businesses,
including certain payor client contracts transferred to UP&UP under an agreement
with America's Health Plan, Inc. ("AHP"), an indirect wholly owned subsidiary of
Principal Mutual. Effective September 1997, the Company acquired the remaining
operations of AHP from an affiliate of Principal Mutual. In October 1996, the
Company acquired National Health Services, Inc. ("NHS"), a national health care
utilization and case management services subsidiary; and in December 1998, the
Company acquired ProAmerica Managed Care, Inc. ("ProAmerica"), which operates a
national network of health care providers.

  UP&UP has developed a network of providers ("Provider Network") offering
nationwide access to discounted health care services for payors of health care
services who contract with the Company ("Payor Clients"). UP&UP enters into
contractual arrangements with providers such as hospitals, ancillary facilities
and physicians ("Contracting Providers") who agree to provide services on a
discounted basis to its Payor Clients. These Payor Clients include traditional
indemnity insurance companies, self-insured entities, unions and federal
government health plans. UP&UP's Provider Network consisted of approximately
2,900 hospitals, 14,500 ancillary medical facilities and 153,000 physicians
located in all 50 states and the District of Columbia as of December 31, 1998.
In addition, as of that date, UP&UP had contracts with other local or regional
Provider Networks which furnish Payor Clients with access to an additional 3,600
facilities (including approximately 475 hospitals) and 62,000 physicians. In
1998, approximately $2.4 billion of medical claims were processed utilizing
UP&UP's Provider Network (and other local and regional networks accessed through
UP&UP). UP&UP also provides management and administrative outsourcing services
for Payor Clients with respect to their relationships with provider networks. In
addition, UP&UP offers a broad array of utilization review and case management
services through its subsidiary, NHS. NHS is the third largest independent
utilization management company in the United States, based on annual acute in-
patient admission volume.

  UP&UP derives its revenues primarily from the receipt of a percentage of the
price concessions that its Payor Clients receive from the Contracting Providers
in the UP&UP Provider Network, a percentage of cost savings realized by its
Payor Clients using its network management services, monthly membership-based
fees for utilization review services, and hourly fees for case management
services. UP&UP's contracts do not assume obligations to Contracting Providers
for payment of medical claims or to beneficiaries of Payor Clients for health
care services. Consequently, UP&UP is not subject to health care underwriting
risks.

  UP&UP's proprietary information systems capabilities and expertise are
designed to facilitate the repricing of claims under its Provider Network
contracts and promote the efficient transmission and processing of claims. UP&UP
offers its Payor Clients and Contracting Providers access to an extensive,
proprietary database of provider charges and other information regarding certain
medical procedures by geographic area. In addition, certain Payor Clients are
provided with an analysis of encounter and cost data for specific service areas.

  UP&UP has focused its marketing efforts on establishing relationships with
Payor Clients who have a nationwide presence and represent, in the aggregate,
large numbers of beneficiaries. As of December 31, 1998, UP&UP had contracts
with approximately 500 Payor Clients, including health insurance companies,
third party administrators, unions, self-insured entities and governmental
agencies. UP&UP intends to continue to market to national payors because of the
associated significant claims volume.

                                       3
<PAGE>
 
  UP&UP believes Contracting Providers participate in its Provider Network
because:

     .  Payor Clients include a significant number of major health care
        insurance companies, which collectively represent substantial claims
        volume to many Contracting Providers;

     .  UP&UP offers a prepayment option (the "Prepayment Option") to certain
        Contracting Provider hospitals that can enhance their cash flow and
        liquidity;

     .  Payor Clients are required to provide incentives, including shared cost
        savings or a reduction in deductibles, to encourage their beneficiaries
        to use Contracting Providers;

     .  UP&UP's consistent and reliable communications contribute to the prompt
        processing of claims for Contracting Providers by Payor Clients,
        increase information flow to Contracting Providers and enable more
        accurate accounting by Contracting Providers; and

     .  Contract terms generally require timely payment of claims.

  UP&UP believes that its Payor Clients subscribe to its Provider Network
because:

     .  Individual Payor Clients recognize the value of UP&UP's ability to focus
        the combined purchasing power of all of its Payor Clients in negotiating
        discounts with Contracting Providers, which generate substantial cost
        savings for the Payor Clients, and thereby enhance the ability of Payor
        Clients to offer competitively-priced health insurance products;

     .  UP&UP has a national Provider Network which can service national clients
        having multi-site accounts;

     .  Some Payor Clients lack either the critical mass, knowledge or
        technology needed to effectively contract with providers on a national
        basis and build a national network;

     .  Some Payor Clients determine it is more cost effective to contract with
        UP&UP rather than develop their own national or local provider network;
        and

     .  Payor clients are able to reprice efficiently a large volume of medical
        claims for the discounts offered by the Provider Network with the
        assistance provided by UP&UP's database management and information
        systems.

  UP&UP believes that its Payor Clients contract for its utilization and network
management services because:

     .  Payor Clients determine they can more efficiently manage costs through
        the clinical oversight performed by NHS' expert staff of nurses and
        physicians using its medical protocols and information systems;

     .  NHS has demonstrated its ability to improve clinical outcomes and reduce
        costs for Payor Clients and their insured beneficiaries under its case
        management programs; and

     .  Payor Clients can reduce certain of their management functions regarding
        their relationships with multiple provider networks by outsourcing these
        functions to UP&UP.

                                       4
<PAGE>
 
INDUSTRY OVERVIEW

  General

  The health care industry in the United States constitutes a substantial
portion of the Gross National Product, with 1996 expenditures exceeding $1
trillion, according to the United States Health Care Financing Administration
("HCFA"). Of this total, hospital charges represented approximately $360
billion, and physician charges represented approximately $200 billion. HCFA
estimates that annual United States health care expenses will grow to more than
$2.1 trillion, or approximately 7% per year, by 2007.

  The health care industry is rapidly changing. Traditionally, health care
services have been provided on a fee-for-service basis through a generally
fragmented system of health care providers. As of January 1, 1996, there were
approximately 6,400 hospitals, over 780,000 physicians and over 200,000
ancillary medical facilities according to HCFA. Historically, health insurers
offering traditional indemnity fee-for-service insurance were the principal
payors of health care benefits for employers and individuals. In response to
escalating health care costs, managed care plans, such as health maintenance
organizations ("HMOs"), have developed and expanded during the past two decades.
More recently there has been a shift in health care insurance towards managed
care products which provide more consumer choice than traditional, closed plan
HMOs. According to a 1998 William M. Mercer report, approximately 29% of the
health insured population in the United States is covered by traditional, closed
plan HMOs, 58% is covered by more flexible managed care systems, such as
preferred provider organizations ("PPO"), and similar plans, including point-of-
service products, and 13% continues to be covered by traditional indemnity
insurance plans.

  Trends

  Underlying the rapid changes which the health care industry has been
undergoing are the following trends:

  Demand for More Flexible Health Care Insurance. Employers and beneficiaries of
health plans are demanding lower cost health insurance plans with greater
patient flexibility (e.g., fewer provider restrictions) than is provided by
traditional HMOs. Employers and beneficiaries of health plans also are seeking
the ability to access providers across wider geographic areas in response to
decentralization and other trends in the workplace. As a result, there has been
a series of innovations that combine the aspects of both the cost savings'
benefits of managed care insurance with the provider choices afforded by
traditional indemnity insurance. Managed care companies now offer PPOs and
similar plans, including point-of-service plans and open-access plans that allow
out-of-network usage, often at substantially higher out-of-pocket costs to the
insured. A national network of health care providers offering services on a
discounted basis promotes the ability of health care payors to offer cost
effective flexible insurance plans which enable their health care beneficiaries
significant flexibility in choosing their own health care providers.

  Continued Cost Containment Pressures. From 1994 to 1998, the average medical
cost increase has exceeded the average premium increase. The reasons for
increased medical costs are numerous and include an increased number of
procedures, and an increased use and cost of pharmaceuticals and medical
supplies. Demographic changes resulting in an increasingly larger percentage of
the population being represented by the elderly have magnified these increases.
These cost increases have occurred despite significant cost containment efforts
through expansion of traditional, closed plan HMOs and other managed care
arrangements. Recently, demand for more flexible insurance plans has limited the
further expansion of HMOs and the ability to control costs through stringent
managed care structures. As a result, payors of medical claims continue to seek
cost savings opportunities.

  Emergence of Nationwide Service in Response to Customer Needs. Health care
payors are seeking to offer insurance plans that address customer needs on a
nationwide basis. In addition, payors are seeking to generate greater revenues
and profits from existing client relationships, especially large employers, by
capturing additional employees who are outside of the payors' traditional core
marketplace. As a result, payors are finding it increasingly important to have
an established national provider network through direct contracting or through
establishing a relationship with provider networks. National payors are
increasingly relying on contractual arrangements with other companies to: (i)
produce meaningful cost savings on medical claims; (ii) expand the provider
network available to their health care beneficiaries to a larger number of
geographic regions; and (iii) reduce their administrative costs.

                                       5
<PAGE>
 
  Information Technology-Driven Efficiencies. In order to influence and control
health care costs, payors and providers need the ability, either directly or
through a third party, to monitor health care encounters and corresponding costs
and process their claim volume in a cost-efficient manner. Thus, there is a need
for information technology systems that have the ability to: (i) interface with
a wide variety of medical claims processing systems; (ii) track provider cost
and clinical outcome data; (iii) analyze the tracked data; and (iv) process high
volumes of medical claims.

STRATEGY

  UP&UP's strategic objective is to enhance its position as a leading contractor
with health care payors by offering a comprehensive array of services which can
be customized to address specific Payor Client needs to maximize their cost
savings. To achieve this objective, the Company seeks to: (i) increase Provider
Network claims volume; (ii) establish relationships with new Payor Clients;
(iii) expand its utilization and network management services business; and (iv)
broaden its portfolio of complementary services. The Company intends to pursue
these objectives through internal means as well as through acquisitions.

  Increase Provider Network Claims Volume

  Existing Payor Clients. The Company believes significant growth opportunities
exist to capture greater claims volume from its existing base of Payor Clients,
which includes many of the leading indemnity insurers in the United States.
UP&UP plans to achieve this by expanding its Provider Network to increase the
number of claims covered by its Payor Clients eligible for the Company's
discount. The Company uses its information systems capability to identify those
providers which represent the highest claims volumes for the Company's Payor
Clients, but which do not have contracts with the Company. UP&UP then uses its
base of high volume Payor Clients, its Prepayment Option and its other services
to market to those providers.

  The Company also seeks to increase claim volumes with existing Payor Clients
by: (i) increasing utilization of the Provider Network by a greater variety of
insurance plans offered by the Payor Client; (ii) persuading Payor Clients to
use a greater portion of the Provider Network, particularly the 153,000
physician network primarily obtained in the Company's acquisition of AHP; (iii)
maintaining competitive discounts with Contracting Providers by leveraging its
Payor Client-base; (iv) continuing to provide high quality service to both Payor
Clients and Contracting Providers, and minimizing complexity and errors in
billing, while maximizing efficiency; and (v) providing incremental high quality
services, such as electronic claims transmission and customized provider
database analysis utilizing its information systems.

  New Payor Clients. The Company actively markets its Provider Network and
technological expertise to attract new Payor Clients. The Company's marketing
efforts target large payors who could achieve significant cost savings from the
Provider Network based on their volume of claims. In 1998, the Company added 381
Payor Clients, including 335 Payor Clients through the acquisition of
ProAmerica.

  Expand Utilization and Network Management Services Business

  The Company also markets NHS's existing utilization management services to
existing and potential Payor Clients. The Company considers mid-tier insurance
companies and insurance plan administrators as its primary market for these
utilization management services. In addition, NHS continues to develop new case
management services. During 1998, NHS added one Payor Client. Also, the Company
intends to continue to market its Provider Network management services, which
are designed to address the preference of Payor Clients to deal with as few
intermediaries as possible in their provider network arrangements. The Company
believes that its network management services are

                                       6
<PAGE>
 
complementary to its Provider Network and furnish an opportunity for the Company
to sell its array of services and establish multiple links with its existing
Payor Clients.

  Acquire Complementary Services

  The Company continues to pursue possible acquisition opportunities which would
supplement its own expansion of services or would complement its existing array
of services. For example, UP&UP entered into an agreement to acquire a savings
bank and most recently acquired ProAmerica in December. In particular, the
Company intends to consider possible acquisitions of other local provider
networks, which would increase its core business, and to expand its utilization
review and case management services.

SERVICES PROVIDED

  National Provider Network

  General. As of December 31, 1998, UP&UP's Provider Network consisted of
approximately 2,900 hospitals, 14,500 ancillary health care facilities, and
153,000 physicians located in all 50 states and the District of Columbia. In
addition, as of that date, the Company had contracts with other local or
regional provider networks which furnish Payor Clients with access to an
additional 3,600 facilities (including approximately 475 hospitals) and 62,000
physicians. The Provider Network is designed to meet the medical, financial and
geographic needs of Payor Clients by enabling the health care beneficiaries of
such Payor Clients to access cost effective health care services nationwide or
in particular geographic regions. Price concessions are individually negotiated
with each Contracting Provider (or Contracting Provider group) and generally
consist of discounts from billed charges or per-diem rates. The Company believes
its ability to obtain price concessions for its Payor Clients results from its
ability to focus the aggregate claims volume of its Payor Clients and, with
respect to Contracting Provider hospitals, from the Prepayment Option. The
Provider Network accounted for approximately 74% of the Company's total revenue
for 1998.

  Prepayment Option Program for Hospitals. UP&UP offers Contracting Provider
hospitals interest-free cash advances through the Prepayment Option. The
Prepayment Option provides tangible benefits to hospitals in the form of
increased liquidity, and helps establish long-term financial linkages between
Contracting Provider hospitals and the Company. The Prepayment Option
demonstrates the financial commitment UP&UP makes to its Contracting Provider
hospitals. The Company's payment under a Prepayment Option is made at the option
of the Contracting Provider hospital, either at the beginning of a contract
period based on an estimate of claims volume or at the end of the contract
period based typically upon one-twelfth of the hospital's actual claims volume
with health care beneficiaries of the Company's Payor Clients in the preceding
12-month period. Hospitals exercising a Prepayment Option are obligated to
repay the amount of the advance, without interest, within 30 days of the
termination by either party of the contractual relationship. This repayment
obligation creates a cash flow consideration for those hospitals which decide to
leave the Provider Network. In many cases, UP&UP retains the right to reconcile
claims due to a Contracting Provider against such Contracting Provider's
obligation to repay the Prepayment Option.

  Automated Claims Repricing. UP&UP has developed a proprietary information
system that allows each Payor Client to automatically reprice a high volume of
claims. The Company has installed its proprietary software and related business
processes in the facilities of most of its large Payor Clients to allow those
clients to perform their own claims repricing. UP&UP also offers each Payor
Client the option of electronically transmitting claims to the Company's
information systems, for the Company to reprice those claims, and then transmit
the repriced claims back to the Payor Client. The Company's repricing system is
continually updated to ensure that Payor Clients realize the maximum amount of
savings to which they are entitled. Currently, the Company's software systems
interfaces have been installed in 20 Payor Clients and an additional 20 Payor
Clients reprice their claims through a remote dial-up with UP&UP's systems.
These Payor Clients represented approximately 72% and 8%, respectively, of the
Provider Network's annualized claims volume for 1998. In addition to these
claims repricing services, UP&UP can also serve as a payment agent on behalf of
the Payor Client and send payments to Contracting Providers, for which
additional service UP&UP typically receives a larger percentage of the savings
generated.

                                       7
<PAGE>
 
  Single-Source Interface. The Company also has the systems capabilities to
allow a Payor Client to utilize the Company as a single source interface with
all of its provider networks. The Company also can incorporate PPOs into its
Provider Network to enable a Payor Client to create health insurance plans that
utilize a network of providers tailored specifically for specific health
insurance plans.

  Provider Database. The Company maintains and updates a provider database that
tracks reimbursement rates, charges per day, occupancy rates, and the volume of
medical claims being generated by each Contracting Provider for each Payor
Client. This database is available to all Payor Clients to assist them in
evaluating which providers may be most cost effective for various geographic
areas, medical procedures, and types of care. This provider database also
assists the Company in the performance of its network management services.

  Network Management Services. The Company offers network management services
whereby it assumes all or a portion of the administration of a Payor Client's
relationships with provider networks, including evaluating prospective provider
organizations, negotiating access agreements with provider organizations and
providing day-to-day support in billing and dispute resolution. Services offered
by the Company include: (i) access analysis services, which include identifying
which provider organization should be used and the repricing of claims pursuant
to the applicable contractual arrangements; (ii) network development services,
which include identifying cost saving opportunities obtainable from alternative
provider organizations and negotiating arrangements with those organizations;
(iii) database management services, which include developing and updating
tracking processes to ensure timely claims flow and payments; and (iv) directory
management services, which include arranging production and distribution of
provider directories to be used by the Payor Client's insured population and
providing toll-free locator services which provide comprehensive listings of all
participant providers, differentiated by product, geography and coverage.

  Utilization Management Services
 
  The Company, through NHS, provides health care utilization review and case
management services for Payor Clients. Payor Clients can outsource their
utilization review and/or case management services in whole or in part to NHS.
NHS clinical personnel perform prospective and concurrent utilization reviews of
medical cases in order to ensure that appropriate medical care is provided while
avoiding unnecessary procedures or hospitalizations. The Company also provides
catastrophic case management, professional clinical opinions, ancillary therapy
review and physician consultations. These utilization review and case management
services are provided by a staff which includes 138 full-time registered nurses,
a full-time medical panel of 11 physicians and an 81 member sub-specialty
consulting physician panel. The NHS staff also analyzes and interprets
utilization data in order to identify and recommend the implementation of
treatment strategies that are designed to maximize the effectiveness of health
care dollars spent. The Company utilizes proprietary software, CareReview(R),
which integrates three critical modules: hospital admission pre-certification,
triage and medical case management. In 1998, the Company performed over 710,000
utilization reviews and provided specialized management for 18,000 cases on
behalf of 19 Payor Clients. NHS accounted for approximately 26% of UP&UP's
revenues for 1998.

  The Company considers its primary market for outsourced utilization review and
case management services to be mid-tier insurance companies.  NHS promotes a
"center of excellence concept" whereby it customizes its services to the needs
and standards of a particular client, including the applicable medical protocols
and software, and dedicates staff to a particular client to promote
understanding and application of the client's specific requirements.  The
Company offers sub-specialty case management programs in the areas of high risk
pregnancies, cardiovascular problems and asthma and intends to develop and
market other disease management programs for such problems as diabetes.  The
Company may seek to pursue acquisitions or alliances with other companies that
provide similar services, for example, a pharmacy management program.

FEDERAL SAVINGS BANK

  The Company on October 6, 1998 entered into an agreement to acquire for $2.5
million, Baltimore American Savings Bank, a federal savings bank (the "Bank"),
and Quantum Financial Holdings, Inc., its parent holding company, having total
assets of approximately $27 million, subject to the approval of shareholders of
the holding company and federal banking regulators. The holding company had a 
net income of $18,000 for 1997 and a net loss of $189,000 for

                                       8
<PAGE>
 
the first nine months of 1998. This acquisition would promote the Company's
strategy to develop an accounts receivable financing product for hospitals that
would complement the Company's Prepayment Option. After its acquisition, the
Company intends that the Bank would continue its traditional community oriented
lending activities. In addition, however, the Bank would serve as an incubator
to develop hospital accounts receivable financing business. The Bank initially
would focus on the financing of claims to be reimbursed by commercial insurance
companies. These insurance companies could be Payor Clients.

  The Bank is subject to extensive regulations, supervision and examination by
the Office of Thrift Supervision (the "OTS") and the Federal Deposit Insurance
Corporation (the "FDIC"). Upon acquisition of the Bank, the Company would become
a savings and loan holding company, subject to supervision and examination by
the OTS. UP&UP would be a unitary savings and loan holding company, if the
current control of UP&UP by Principal Mutual is divested, as proposed. As a
unitary savings and loan holding company, UP&UP generally will not be restricted
under existing laws as to the type of business activities in which it may
engage, provided the Bank continues to meet the standards as a qualified thrift
lender. Nevertheless, the OTS will have enforcement authority over the Company
and its non-savings association subsidiaries. Among other things, this authority
permits the OTS to restrict or prohibit activities that are determined to be a
serious risk to the subsidiary savings bank.

  There can be no assurance that the Company's acquisition of the Bank will be
approved by the OTS. The Company believes such approval will be given only,
among other things, if the OTS is satisfied as to the arrangements by Principal
Mutual to divest control of the Company within the meaning of the Holding
Company Act. Principal Mutual already is a unitary savings and loan holding
company.

  In connection with the Company's proposed acquisition of the Bank and its
parent holding company, Principal Mutual, which, at December 31, 1998 owned
6,600,000 shares or approximately 38.6% of the Company's outstanding common
stock, proposes to divest control of the Company within the meaning of the
Savings and Loan Holding Company Act, and the four directors of the Company who
may be considered to be affiliated with or nominated by Principal Mutual, will
resign from the Board of Directors of the Company. To accomplish, in part, such
divestiture of control, on February 25, 1999, Principal Mutual, sold 4,500,000
shares (the "Principal Shares") of common stock of the Company, or approximately
25.6% of the outstanding shares, to a trust (the "Trust"). Principal Mutual
received from the Trust $13,225,000 in cash and trust certificates entitling it
to the proceeds from the sale of the Principal Shares. At the same time, the
Trust agreed to sell the Principal Shares to Thomas L. Blair, the Chairman and
Chief Executive Officer of the Company, on or before four years from the date of
the transfer of the Principal Shares to the Trust.

HEALTH EXTRAS

  HealthExtras LLC ("HealthExtras") is a company that was founded by Thomas L.
Blair and Principal Mutual. UP&UP has no ownership interest in HealthExtras.
HealthExtras provides catastrophic benefits to plan members related to permanent
disability. HealthExtras intends to develop additional products that supplement
an individual's primary health coverage.

  UP&UP has a royalty agreement with HealthExtras that was effective January 1,
1999. The royalty agreement provides UP&UP with a per member/per month ("PMPM")
royalty fee in exchange for UP&UP granting HealthExtras members access to its
Provider Network at no fee over a four-year period. The royalty fee initially
starts at $1.00 PMPM in year one and increases to $1.50 PMPM in year four. The
royalty fee is based upon the tenure of each member participating in the
HealthExtras program. It is likely that any future HealthExtras product
development will integrate the use of the Provider Network.

  UP&UP also provides administrative services to HealthExtras at cost. These
services relate to operating, marketing and financial staff, as well as office
space and telecommunication services. 

CONTRACTS WITH PAYORS AND PROVIDERS

  The following discussion summarizes certain provisions typically included in
the various contractual arrangements of the Company.

                                       9
<PAGE>
 
Provider Network

  Payors. UP&UP enters into contracts with Payor Clients, including indemnity
insurance companies, government health plans and self-insured companies and
unions. Under these contracts, the discounted rates negotiated by UP&UP with its
Contracting Providers may be applied to medical services rendered to persons
eligible under a Payor Client's health insurance plan. Frequently, the contracts
obligate Payor Clients to make all reasonable efforts to promptly reimburse
(generally within 30 days of receipt of a clean claim) Contracting Providers for
such claims. Some contracts also require Payor Clients to provide to UP&UP
documentation regarding their insurance plan features, methods of identifying
covered persons, service relationships and other information relevant to the
processing of those claims which take advantage of discounts from Contracting
Providers.

  Under its Payor Client contracts, UP&UP is entitled to fees which are usually
derived from a percentage of the Payor Clients' savings (i.e., the difference
between the Payor Clients' payment obligations prior to receipt of discounts
through the Provider Network and the Payor Clients' payment obligations after
such application.) Frequently, UP&UP commits to target and attempt to contract
with additional providers identified by Payor Clients and to use its best
efforts to maintain its Provider Network. Frequently, the contracts require
UP&UP to obtain confirmation from, or contractually require that, Contracting
Providers meet appropriate accreditation and state licensing requirements. These
contracts also set forth the respective obligations of UP&UP and the Payor
Clients with regard to the repricing of claims, particularly identifying
detailed delivery schedules for repriced claims data depending on whether the
Payor Client or UP&UP has assumed primary responsibility under the contract for
such repricing.

  Payor contracts typically include a cross-indemnity provision for losses, 
damages and expenses incurred as a result of acts or omissions related to duties
performed under the agreements. The contracts frequently require UP&UP to
maintain liability insurance for claims that may arise from performance of its
obligations under the agreements. In addition, the contracts also contain mutual
confidentiality undertakings. Payor Client contracts typically have a one-year
term and renew automatically for an additional one-year term on each anniversary
date unless either party gives notice of termination by a specified date
(usually 30 or 90 days) prior to any such anniversary date. Either party may
terminate the contract for material breach and, in most instances, for any
reason upon expiration of a specified notice period (usually 30 or 90 days).

  A significant portion of UP&UP's revenues are derived from a small number of
payor clients. In 1998, Conseco, Inc. accounted for approximately 16% of
revenues, the Department of Health and Human Services of the State of Kentucky
accounted for approximately 11% of revenues and, an affiliate of Principal
Mutual accounted for approximately 10% of revenues. The loss of a contract with
a major Payor Client and the inability to replace any such client with
significant new clients could have a material adverse effect on UP&UP.

  Providers. UP&UP enters into contracts with those providers of medical
services, including hospitals, physicians and physician groups, that participate
in its Provider Network. Under these contracts, Contracting Providers agree to
render services to persons eligible under UP&UP's Payor Clients' health benefit
programs, subject to the availability of facilities and services, and to accept
as payment for these services an amount equal to the negotiated discounted fees.
The discount typically ranges from 5% to 30% of billed charges. In instances in
which a Contracting Provider hospital has elected to exercise the Prepayment
Option, the contracts require UP&UP to establish a prepaid balance with the
hospital in an amount equal to the monthly average of the previous 12 months'
charges for covered services on covered persons or to a mutually agreed-upon 
one-month estimate. The agreements obligate the hospital to repay to UP&UP the
prepaid balance within 30 days of termination of the agreement. Many Contracting
Provider hospital contracts also provide that "clean claims" not paid within 30
days of receipt must be paid at the hospital's non-discounted rate.

  The contracts also require Contracting Providers to meet applicable licensing
and certification requirements and accreditation standards. Generally, the
contracts require Contracting Providers to use their best efforts to participate
in the utilization review and necessity of care evaluation programs,
coordination of benefit activities and other cost containment activities
provided for under each Payor Clients' health benefit program. The contracts
also generally obligate UP&UP to use its best efforts in encouraging each Payor
Client to create incentives for covered persons to use Contracting Providers.
The contracts typically require Contracting Providers, and in some cases UP&UP,
to maintain

                                      10

<PAGE>
 

liability insurance in specified minimum amounts or in amounts required by
applicable state law. In addition, the contracts often mandate both Contracting
Providers and UP&UP to maintain the confidentiality of the medical records of
persons covered under the Payor Clients' benefit plans. The contracts typically
include a cross-indemnity provision for losses, damages and expenses incurred as
a result of acts or omissions related to duties performed under the contracts.
The contracts typically have a one-year term and renew automatically for an
additional one-year term on each anniversary date unless either party gives
notice of termination by a specified date (usually 90 days) prior to any such
anniversary date. Either party may terminate the contract for material breach
and, in most instances, for any reason upon expiration of a specified notice
period (usually 30 or 90 days).

  Other Provider Networks. UP&UP enters into contracts with other provider
networks ("Other Provider Networks"). UP&UP's contracts with Other Provider
Networks provide UP&UP's Payor Clients access to the providers covered by such
Other Provider Networks at the discounted rates available from such Other
Provider Networks. Under these contracts, UP&UP agrees to pay the Other Provider
Networks either a percentage of the fees to which UP&UP is entitled to be paid
by its Payor Clients from claims processed through the Other Provider Networks
or a percentage of savings realized by the Payor Client from claims processed
through the Other Provider Networks. Pursuant to these contracts, UP&UP,
generally, is prohibited from soliciting any Payor Client with whom an Other
Provider Network currently has contractual relationships during the term of the
contract and for one year thereafter and from soliciting certain providers
identified by an Other Provider Network. The contracts with Other Provider
Networks prohibit UP&UP from providing access to those networks to payors who
are not Payor Clients of UP&UP covered by the contract with the Other Provider
Network. These contracts generally provide that the failure by an UP&UP Payor
Client to promptly reimburse an Other Provider Network medical provider may
result in the loss of contractual fee discounts.

  The contracts with Other Provider Networks typically include a cross-indemnity
provision for losses, damages and expenses incurred as a result of acts or
omissions related to duties performed under the agreements and in some instances
require both the Other Provider Network and UP&UP to maintain liability
insurance in specified minimum amounts. In addition, the contracts also require
both the Other Provider Network and UP&UP to maintain the confidentiality of the
medical records of persons covered under Payor Client benefit plans and any
proprietary information of the other party. These contracts typically have
initial terms of one to three years and renew automatically for an additional
one-year term on each anniversary date unless either party gives notice of
termination by a specified date (usually 90 days) prior to any such anniversary
date. Either party may terminate the contract for material breach and, in most
instances, without cause upon expiration of a specified notice period (usually
30 or 90 days).

Network Management

  Under its network management contracts, UP&UP is entitled to fees which may
consist of a percentage of savings realized by the Payor Client due to UP&UP's
management services and/or fixed monthly payments. Fees for the production and
distribution of provider directories are based on cost plus a fixed margin.
These contracts typically include a cross-indemnity provision for losses,
damages and expenses incurred as a result of acts or omissions related to duties
performed under the agreements and, in some instances, require both the network
management client and UP&UP to maintain liability insurance in certain specified
minimum amounts. In addition, these contracts include mutual confidentiality
undertakings.

Utilization Management

  The Company's utilization management contracts typically identify (a) the
types of services to be provided, (b) a schedule for the delivery of reports, in
form and detail determined by the client, (c) detailed performance targets and
(d) the fees to be paid to UP&UP for such services. The Company's utilization
review contracts pertaining to the review of medical necessity and
appropriateness of the allocation of health care resources establish fees for
UP&UP on the basis of number of contacts, time expended or number of covered
persons. On a limited basis, the Company has contracted for its utilization
review services under terms that impose fee reduction penalties for failure to
meet negotiated savings targets and fee incentives for exceeding such targets.
Case management revenues is generally based on fee for service or hourly rates
over the term of the contractual agreements.

                                      11
<PAGE>
 
  These contracts typically include a cross-indemnity provision for losses,
damages and expenses incurred as a result of acts or omissions related to duties
performed under the agreements. The contracts typically require both the Payor 
Client and UP&UP to maintain certain liability insurance in specified minimum
amounts. In addition, these contracts also include mutual confidentiality
undertakings.

COMPETITION

  The health care industry is fragmented, competitive and evolving. The Company
potentially competes with any entity that contracts with Payor Clients to offer
them a means to contain or reduce the cost of their medical claims expenses.
Existing or potential competitors include HMOs, PPOs, physician hospital
organizations and other managed care providers.

  The health care industry is considered to be a growing industry and may
attract additional competitors of the Company. In addition, many Payor Clients
have developed or may in the future develop their own provider networks,
utilization and management services, and other services similar to those offered
by the Company. Alternatively, Payor Clients are seeking to develop or expand
managed care type insurance which eliminate or reduce the need for access to the
Company's provider network. Likewise, Contracting Providers could elect to
contract directly with Payor Clients. These actions could have an adverse effect
on the business of the Company. With respect to utilization review and case
management services, NHS competes principally with national and regional
utilization review and case management providers and with internal departments
of large payors that provide these services.

  Several potential competitors are significantly larger and better capitalized
than the Company. Many competitors and potential competitors have ongoing access
to greater resources, provide a more comprehensive range of services, and have
greater experience in providing those services than the Company. Furthermore,
various competitors and potential competitors have longer term business
relationships with payors and providers than does the Company.

GOVERNMENT REGULATION

  General. As an entity conducting business within the health care industry, the
Company's operations are potentially subject to extensive and increasing
regulation by a number of governmental entities at the federal, state and local
levels. The Company and its affiliates are also subject to laws and regulations
relating to business corporations in general. The Company believes its
operations are in material compliance with applicable laws as currently
interpreted. Nevertheless, because of the structure of the Company, certain
aspects of the Company's current or anticipated business operations could fall
within the regulatory oversight of federal or state authorities, and there can
be no assurances that a review of the Company's business by courts or regulatory
authorities will not result in a determination that could have a material
adverse effect on the Company's business, financial condition, or results of
operations. There also can be no assurances that the regulatory environment in
which the Company operates will not change significantly in the future, which
change could restrict the Company's existing operations, expansion, financial
condition or opportunities for success.

  Health Care Reform. The agencies and legislative bodies of states and the
federal government recently have focused significant attention on reforming the
health care system in the United States. Within the past several years, a broad
range of health care reform measures have been introduced in Congress and in
certain state legislatures. Additional health care reform measures have been
brought before the public in state voter initiatives. These initiatives range
from those that would tend to encourage managed care, such as allowing physician
and hospital groups to accept risk, to those that would impede managed care,
such as mandating that any willing provider could participate in any health
plan. Among the proposals that have been considered are cost controls on
hospitals, insurance market reforms to increase the availability of group health
insurance to small businesses, requirements that all businesses offer health
insurance coverage to their employees and the creation of a single government
health insurance plan at the state or federal level that would cover all
citizens. Legislative interest recently has focused on the effect of managed
care reimbursement mechanisms on health care service utilization and quality of
service. It is not clear at this time what proposals, if any, will be adopted
or, if adopted, what effect, if any, such proposals would have on the Company.
Certain proposals, such as containment of health care costs that could include a
freeze on prices charged by physicians, hospitals or other health care
providers, could have a material adverse effect on the Company's business,
financial condition or results of operations. There can be no assurances that
currently proposed or future health care legislation or policies or other
changes in the administration or interpretation of governmental health care
programs, laws,

                                      12
<PAGE>
 
regulations or policies will not have a material adverse effect on the Company's
business, financial condition or results of operations.

  State Licensure. The Company's subsidiary, NHS, maintains utilization
management certification in all states in which it is required to do so and
monitors state legislation on a regular basis to ensure ongoing compliance.

  The Company believes that its other current business activities are not
subject to state licensure, other than such general business licensure as may be
required of all domestic or foreign business corporations in a jurisdiction.
However, it is possible that regulatory authorities in some states might
conclude that some of the Company's activities subject it to licensure as a PPO
or similar entity. In some states, such licensure may be conditioned on the
licensed entity engaging in practices, such as quality assurance or utilization
review, that are beyond the scope of the Company's current or anticipated
operations. Although the Company believes that, in general, it would be able to
modify its operations to obtain any licenses that were deemed to be required,
there can be no assurances that the Company would be able to modify its
operations, or otherwise obtain or maintain any such licenses.

  ERISA Regulation. It is possible that in the usual course of its business the
Company could be deemed to provide services to employee benefit plans regulated
under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"),
including self-insured health benefit plans. Recently, the United States
Department of Labor ("DOL"), the federal agency that administers ERISA, has been
auditing certain insurance companies in connection with their practices
involving medical provider discounts and the transfer of those discounts to 
self-insured ERISA plans. In connection with these audits, DOL has indicated
that the negotiation and administration of provider discount arrangements by
these insurance companies for the benefit of ERISA plans could constitute the
activities of an ERISA fiduciary. Although the Company believes that its
practices relating to provider discount arrangements are beyond the scope of
ERISA regulation, there can be no assurances that DOL or some other person would
not assert that the Company acts as an ERISA fiduciary with respect to its
limited activities for self-insured ERISA plans. In the event that the Company
were deemed to be an ERISA fiduciary, the Company believes that it would be
viewed as being in compliance with applicable ERISA rules.

  In a recent decision interpreting a health insurance policy under ERISA, a
federal district court invalidated a PPO discount taken by an insurance company
where the applicable insurance policy did not provide for the utilization by the
insured of the PPO in question. HCA Health Services of Georgia, Ins. Co., 22
F. Supp.2d 1390 (N.D.Ga. 1998). The Company does not believe that this case 
will have any material impact on its business operations. The Company believes 
that the contractual arrangements between Payor Clients and their insureds 
permit the discounts taken through the Provider Network.

  Anti-Remuneration Laws. Medicare and Medicaid law provides civil and criminal
penalties for paying or receiving any remuneration to induce the referral of
Medicare or Medicaid patients, or to induce the purchase or the arranging for,
or recommending of, the purchase of items or services for which payment may be
made under Medicare, Medicaid or other federally-funded state health care
programs. None of the Company's contracts with Payor Clients provide for access
to Contracting Providers by Medicaid or Medicare beneficiaries. Several states
also have similar laws which are not limited to services for which Medicare or
Medicaid payment may be made. State laws vary and have been infrequently
interpreted by courts or regulatory agencies. It is possible that enforcement
officials could seek to review the fees paid to or by the Company to determine
whether such fees should be deemed to be unlawful remuneration given indirectly
by Contracting Providers in exchange for arranging for the referral of patients
from their Payor Clients. While there can be no assurances that the Company's
position would be upheld if challenged, the Company believes that their fee
arrangements represent reasonable compensation for legitimate services actually
provided to or by the Company and should not be deemed to be unlawful
remuneration under these anti-remuneration laws.

EMPLOYEES

  As of January 31, 1999, the Company employed 486 people on a full-time basis.
The Company believes that its relations with its employees are good. None of the
Company's employees are represented by a union.

                                      13
<PAGE>
 
ITEM 2.   PROPERTIES

  The Company's principal executive office is located in Rockville, Maryland in
approximately 22,000 square feet of leased space. The Company also leases
approximately 29,300 square feet of office space in Louisville, Kentucky,
approximately 19,217 square feet of office space in Bethesda, Maryland and
approximately 22,000 square feet in Arlington, Texas. The Rockville, Maryland
and the Louisville, Kentucky leases expire in 2001. The Bethesda, Maryland lease
expires in 2007. The Arlington, Texas lease expires in 2003. The Company
believes that its current facilities are adequate for its existing needs and
that suitable additional space will be available as required.


ITEM 3.   LEGAL PROCEEDINGS

  On April 26, 1996, First Health Group (formerly known as HealthCARE COMPARE),
a Delaware corporation and competitor of the Company, filed a civil complaint
against the Company in the United States District Court for the Northern
District of Illinois. The complaint, in its present amended form, is seeking
permanent injunctive relief, as well as an unspecified amount of damages, and
alleges violations of the Lanham Act, 15 U.S.C. Sections 1125(a)(1)(A) and
(a)(1(B), as well as common law claims of deceptive trade practices, fraud,
interference with contract, interference with prospective economic relations and
unfair competition. The complaint also seeks treble damages pursuant to the
Lanham Act. The complaint is based upon allegations that representatives of the
Company made false and misleading statements during contract negotiations with
providers in order to cause them to join the UP&UP Network. In response to
written requests and in depositions, the Plaintiff has alleged that it has
suffered actual damages of approximately $41 million. The Company denies the
allegations in the complaint and believes them to be without merit. The Company
has asserted a counterclaim against the Plaintiff for violations of the Lanham
Act, as well as common law claims for unfair competition, commercial
disparagement and service mark cancellation. Fact discovery in the action is
ongoing and the trial date has not yet been set by the Court. Based upon the
available information, management believes that its potential liability, if any,
arising from such litigation will not be material to the consolidated financial
statements of the Company.

  The Company is also a party to other legal actions arising in the ordinary
course of business. Management believes that damages arising from these actions,
if any, will not be material to the consolidated financial statements of the
Company. Nevertheless, there can be no assurance that any pending or future
litigation to which the Company is or becomes a party, including the litigation
involving First Health Group, will not have a material adverse effect on the
Company.

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

  There were no matters submitted to a vote of security holders during the
quarter ended December 31, 1998.

                                    PART II

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

  The common stock has been quoted on the Nasdaq National Market under the
symbol "UPUP" since the Company's initial public offering in July 1996. The
following table sets forth, for the periods indicated, the high and low sale
prices for the common stock:

<TABLE>
<CAPTION>
                                          High      Low
                                         ------    ------
<S>                                      <C>       <C>
1997
----                                         
First quarter..........................  $ 9.50    $ 6.92
Second quarter.........................    9.50      7.83
Third quarter..........................   12.33      8.33
Fourth quarter.........................   14.25     11.33
</TABLE>


                                      14
<PAGE>
 
<TABLE>
<CAPTION>
1998
----
<S>                                            <C>       <C>
First quarter...............................   22.69     11.50
Second quarter..............................   24.38     19.00
Third quarter...............................   29.75     14.00
Fourth quarter..............................   29.63     14.25

1999
----
First quarter (through March 5, 1999).......   29.25     20.88
</TABLE>

  On March 5, 1999, the last closing sale price of the common stock, as reported
by the Nasdaq National Market, was $24.50 per share. As of March 5, 1999, the
Company had approximately 1,050 stockholders of record. The Company did not pay
any cash dividends in 1996, 1997 or 1998 and has no plans to do so in the
foreseeable future.

ITEM 6.   SELECTED CONSOLIDATED FINANCIAL DATA
          (In thousands, except per share data)/(1)/

  The following selected consolidated financial data as of and for the years
ended December 31, 1998, 1997, 1996 and 1995 have been derived from the audited
financial statements of the Company. The selected consolidated financial data
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements of the Company, including notes thereto.

<TABLE>
<CAPTION>
                                                          Years Ended December 31,
                                                   ----------------------------------------------
                                                     1998         1997         1996        1995
                                                   --------     --------     -------     --------
<S>                                                <C>          <C>          <C>         <C>
STATEMENT OF OPERATIONS DATA
Revenue
   Provider network.............................   $ 57,952       41,195     $31,259     $   877
   Utilization management services..............     20,497       19,833       4,190          --
                                                   --------     --------     -------     -------
      Total revenue.............................     78,449       61,028      35,449         877
                                                   --------     --------     -------     -------
Operating expenses
   Direct contract expenses.....................     33,524       29,173      15,295       2,238
   General and administrative...................      8,365        6,221       2,783         334
   Depreciation and amortization................      4,028        1,695         538         114
                                                   --------     --------     -------     -------
      Total operating expenses..................     45,917       37,089      18,616       2,686
                                                   --------     --------     -------     -------
Operating income (loss).........................     32,532       23,939      16,833      (1,809)
Other income, net...............................        729        1,426         971         699
                                                   --------     --------     -------     -------
   Income (loss) before income taxes............     33,261       25,365      17,804      (1,110)
Income taxes....................................    (13,682)     (10,388)     (7,158)        399
                                                   --------     --------     -------     -------
Net income (loss)...............................   $ 19,579     $ 14,977     $10,646     $  (711)
                                                   ========     ========     =======     =======
Net income (loss) per share - basic.............   $   1.15     $   0.87     $  0.70     $ (0.05)
Weighted average common shares - basic..........     17,065       17,239      15,189      13,200
Net income (loss) per share - diluted...........   $   1.09     $   0.86     $  0.70     $ (0.05)
Weighted average common shares - diluted........     17,981       17,486      15,193      13,200


                                                     1998         1997         1996        1995
                                                   --------     --------     -------     -------
BALANCE SHEET DATA
Working capital.................................   $ 27,147     $ 24,513     $28,113     $ 3,384
Total assets....................................    115,945       82,515      53,248      12,763
Long-term debt, including current portion.......     22,064       15,241         655         160
Total stockholders' equity......................     78,458       58,297      45,176       5,296
</TABLE>

---------------
(1) All periods reflect the effect of the three-for-two stock split in the form
    of a stock dividend paid on May 4, 1998.


                                      15
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
          AND RESULTS OF OPERATIONS

  This Form 10-K may contain forward-looking statements (see "Certain Factors
That May Affect Future Operating Results or Stock Prices") within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-
looking statements involve a number of risks and uncertainties. The Company
undertakes no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may arise after the date of this report.
Readers are urged to carefully review and consider the various disclosures made
by the Company in this report and in the Company's other filings with the
Securities and Exchange Commission that attempt to advise interested parties of
the risks and factors that may affect the Company's business.

GENERAL

  UP&UP is a Delaware corporation which is the successor to an Iowa corporation
organized in February 1995 by its Chairman and Chief Executive Officer, Thomas
L. Blair, and an affiliate of Principal Mutual. Effective December 31, 1995, the
Company's original stockholders and a subsidiary of a stockholder contributed to
the Company certain complementary businesses, including certain Payor Client
contracts transferred to UP&UP under an agreement with AHP, an indirect wholly
owned subsidiary of Principal Mutual.

  In October 1996, the Company acquired NHS, the Company's national health care
utilization and network management services subsidiary. Effective September 1,
1997, the Company acquired the remaining operations of AHP from an affiliate of
Principal Mutual. Effective December 1, 1998, the Company acquired ProAmerica, a
national preferred provider network that operates a network of health care
providers. The acquisitions of AHP, NHS and ProAmerica have been accounted for
as purchases and, accordingly, the results of operations for AHP, NHS and
ProAmerica have been included in the Selected Consolidated Financial Data since
the effective date of the respective acquisitions.

  UP&UP has developed a network of providers offering nationwide access to
discounted health care services for payors of health care services who contract
with it. UP&UP enters into contractual arrangements with providers such as
hospitals, ancillary facilities and physicians who agree to provide services on
a discounted basis to its Payor Clients. The Payor Clients include traditional
indemnity insurance companies, self-insured entities, unions and federal
government health plans. UP&UP also provides management and administrative
outsourcing services for Payor Clients with respect to their relationships with
provider networks. In addition, UP&UP offers a broad array of utilization review
and case management services through its subsidiary, NHS, the third largest
independent utilization management company in the United States, based on an
annual acute in-patient admission volume.

  UP&UP derives its revenues primarily from the receipt of a percentage of the
price concessions that Payor Clients receive from the Contracting Providers in
the Provider Network, a percentage of cost savings realized by Payor Clients
using its network management services, monthly membership-based fees for
utilization review services, and hourly fees for case management services.
UP&UP's contracts do not assume obligations to Contracting Providers for payment
of medical claims or to beneficiaries of Payor Clients for health care services.
Consequently, UP&UP is not subject to health care underwriting risks.

  Effective January 1, 1998, the operating infrastructures of UP&UP and AHP were
fully integrated into a single business, administrative and financial reporting
unit. During the second quarter of 1998, the Company completed the merger of the
UP&UP and AHP individual provider networks into a single, fully integrated
provider network.

  Period-to-period comparisons are not necessarily meaningful due to the impact
of acquisitions and formation transactions completed during the periods.

DIRECT CONTRACT EXPENSES

  Direct contract expenses include access fees paid by the Company for the
utilization of other provider networks, marketing commissions, and other direct
costs of services, such as personnel, related to repricing of claims, client
services, and other costs incurred in connection with the generation of revenues
and the development of the Company's


                                      16
<PAGE>
 
Provider Network. Direct contract expenses also include the costs of medical
personnel (nurses and doctors) and other expenses related to utilization review
and case management services. Marketing commissions are payable to consultants
and marketing organizations who became entitled to such commissions for their
role in obtaining contracts with certain Payor Clients.

GENERAL AND ADMINISTRATIVE EXPENSES

  General and administrative expenses include salaries and related costs for
personnel involved in the administration of the Company and other costs, such as
professional services and general overhead expenses.

RESULTS OF OPERATIONS

  Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

  Total revenues increased by $17.4 million, from $61.0 million in 1997 to $78.4
million in 1998. Provider network revenues increased by $16.7 million, from
$41.2 million in 1997 to $57.9 million in 1998. This increase was attributable
to the acquisitions of AHP and ProAmerica, the addition of new Payor Clients,
the growth in the overall claims volume from existing Payor Clients and the
expansion of the Company's Provider Network. Because of the merger of the UP&UP
and AHP provider networks, the Company is not able to quantify the portion of
the increase attributable to the acquisition of AHP. At December 31, 1998, the
Provider Network consisted of direct contracts with approximately 17,400 medical
facilities and approximately 153,000 physicians compared to approximately 14,700
medical facilities and approximately 125,000 physicians at December 31, 1997.
Utilization management services revenues increased by approximately $0.7
million, from $19.8 million in 1997 to $20.5 million in 1998.

  Direct contract expenses increased by $4.3 million, from $29.2 million in 1997
to $33.5 million in 1998. Access fees to other provider networks as a percentage
of Provider Network revenues decreased by 3.7%, from 11.8% ($4.9 million) in
1997 to 8.1% ($4.7 million) in 1998. This percentage decrease was attributable
to the growth in the number of providers contracting directly with UP&UP and
Payor Clients accessing more direct contracts. Other direct costs of services
increased by approximately $4.5 million, from $24.3 million in 1997 to $28.8
million in 1998. The increase was primarily attributable to the acquisitions of
AHP and ProAmerica and an overall increase in expenses of UP&UP resulting
primarily from an increase in the number of employees to accommodate growth in
the provider network business, increased provider network development activities
and the continued development of new products and services. Because of the
integration of the operations of UP&UP and AHP, the Company is not able to
quantify the portion of the increase in expenses attributable to each of the
components.

  General and administrative expenses increased by approximately $2.1 million,
from approximately $6.2 million in 1997 to approximately $8.3 million in 1998.
The increase was primarily attributable to the acquisitions of AHP and
ProAmerica and an overall increase in expenses of UP&UP resulting from an
increase in the number of employees in the administrative and executive areas
and an increase in professional fees for accounting and legal services. Because
of the integration of the operations of UP&UP and AHP, the Company is not able
to quantify the portion of the overall increase in expenses attributable to each
of the components.

  Depreciation and amortization increased by approximately $2.3 million, from
approximately $1.7 million in 1997 to approximately $4.0 million in 1998. The
increase was primarily attributable to the amortization of goodwill of AHP and
other intangible assets and the depreciation of investments made to achieve the
consolidation of the UP&UP and AHP operations and to enhance the information
technology infrastructure in order to allow for future growth and capabilities.

  Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

  Total revenues increased by $25.6 million, from $35.4 million in 1996 to $61.0
million in 1997. Provider Network revenues increased by $9.9 million, from $31.3
million in 1997 to $41.2 million in 1997. Of this increase, $5.8 million was
attributable to the addition of new Payor Clients, the growth in the overall
claims volume from existing Payor Clients and the expansion of the Company's
Provider Network. The remainder of the increase was attributable to the
acquisition of AHP. At December 31, 1997, the Provider Network consisted of
approximately 14,700 medical facilities


                                      17
<PAGE>
 
and approximately 125,000 physicians compared to approximately 6,000 medical
facilities and 12,000 physicians at December 31, 1996. Utilization management
services revenues increased $15.6 million, from $4.2 million in 1996 to $19.8
million in 1997. The increase was attributable primarily to the inclusion of the
operations of NHS for a full year in 1997 as compared to three months in 1996.

  Direct contract expenses increased by $13.9 million, from $15.3 million in
1996 to $29.2 million in 1997. Access fees to other provider networks as a
percentage of Provider Network revenues decreased by 6.2%, from 18.0% ($5.6
million) in 1996 to 11.8% ($4.9 million) in 1997. This percentage decrease was
attributable to the growth in the number of providers contracting directly with
the Company, Payor Clients accessing more direct contracts and the negotiation
of lower rates in agreements with other provider networks. Other direct costs of
services increased by approximately $14.6 million, from $9.7 million in 1996 to
$24.3 million in 1997. Of this increase, approximately $11.2 million was
attributable to the acquisitions of NHS and AHP, which were acquired effective
October 1, 1996 and September 1, 1997, respectively. The remainder of the
increase was attributable to an overall increase in expenses resulting primarily
from a significant increase in the number of employees to accommodate growth in
the provider network business, increased provider network development activities
and the continued development of new products and services.

  General and administrative expenses increased approximately $3.4 million, from
approximately $2.8 million in 1996 to approximately $6.2 million in 1997. Of
this increase, approximately $1.6 million represented expenses of NHS and AHP.
The remainder of the increase was attributable to an overall increase in
expenses resulting from the addition of employees in the administrative and
executive areas, expenses related to bonus and other benefit programs which
became effective subsequent to the initial public offering and an increase in
professional fees for accounting and legal services.

  Depreciation and amortization increased by approximately $1.2 million, from
approximately $0.5 million in 1996 to approximately $1.7 million in 1997. The
increase was primarily attributable to the depreciation expense and amortization
of goodwill of NHS and AHP, as well as depreciation on increased capital
expenditures to accommodate growth.
 
LIQUIDITY AND CAPITAL RESOURCES

  At December 31, 1998 and December 31, 1997, the Company had working capital of
approximately $27.1 million and $24.5 million, respectively. Net cash provided
by operating activities increased by $9.2 million, from $13.3 million in 1997 to
$22.5 million in 1998. In December 1998, the Company utilized the proceeds from
a $10 million line of credit with a bank as part of the consideration paid for
the acquisition of ProAmerica. In February 1999, the Company entered into a 
five-year $10 million term loan with the same bank and utilized the proceeds
from the term loan to replenish the amount drawn under the line of credit.

  The Company's primary capital resources commitment is to fund advances to
contracting providers upon exercise of Prepayment Options granted to contracting
providers. Depending on increases in claims volume and in the number of Payor
Clients and contracting provider hospitals electing to accept the Prepayment
Option, the Company estimates that $15 million to $20 million could be required
to fund the Prepayment Options during 1999. In 1997, the Board of Directors of
the Company approved a common stock repurchase program of up to $5 million. The
Company canceled the common stock repurchase program as of February 1, 1998. As
of December 31, 1998, the Company had repurchased 389,625 shares of its
outstanding common stock under the program, at an aggregate purchase price of
$3.5 million, and reissued 116,474 of the shares for an aggregate consideration
of $0.9 million.

  The Company believes that its existing liquidity sources, anticipated funds
from operations, and credit arrangements will satisfy cash requirements for its
operations for the next twenty-four months. However, in the event of additional
acquisitions and/or in the event that the advances for Prepayment Options exceed
the Company's currently anticipated estimates and/or other available sources of
liquidity to fund such payments are not as great as anticipated, or in the event
that, if acquired the Bank requires funding to maintain its capital requirements
or to expand its business, the Company could be required to borrow additional
funds or issue additional equity securities to fund the balance of such
advances. There can be no assurances that the Company will be able to effect any
such additional borrowings or issue additional equity securities on acceptable
terms.

INTEREST RATE SENSITIVITY

  The Company is subject to interest rate risk on its short-term investments 
portfolio and its outstanding bank loans. The Company has determined that a 10% 
move in the current weighted average interest rates of its short-term 
investments and its outstanding bank loans would not have a material effect on 
the Company's financial position, results of operations and cash flows over the 
next fiscal year.

                                      18
<PAGE>
 
IMPACT OF INFLATION

  Since the Company's revenues are based on medical costs, the impact of
inflation on operating costs and expenses should be offset by the impact of
inflation of medical costs.

CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS OR STOCK PRICES

  A significant portion of UP&UP's revenues are derived from a small number of
payor clients. In 1998, three payor clients accounted for approximately 37% of
revenues. The loss of a contract with a major payor client and the inability to
replace any such client with significant new clients could have a material
adverse effect on UP&UP.

  UP&UP's contracts with its Payor Clients for access to the provider network
generally permits the annual renegotiation of terms and permits either party to
terminate the contract at any time upon satisfaction of notice requirements.
Also, those contracts do not prohibit Payor Clients from entering into contracts
with or utilizing other provider networks or developing their own provider
networks. Therefore, even if a Payor Client does not terminate its contract with
UP&UP, UP&UP could experience a decrease in claims from that Payor Client as a
result of the use of their own provider networks, other provider networks, or
other managed care systems. UP&UP's contract with the State of Kentucky is
terminable for the convenience of the government.

  Furthermore, the health insurance industry has been experiencing significant
consolidation, particularly consolidation designed to promote an increase in
managed health care insurance programs, as opposed to the indemnity style
programs for which the UP&UP provider network is most attractive. UP&UP believes
these consolidation trends have in the past reduced utilization of the UP&UP
provider network by particular health insurance programs, and, in the future,
could further reduce utilization of the UP&UP provider network, as a result of
both a decrease in the number of Payor Clients and a decrease in the need for
payor clients to utilize the UP&UP provider network.

YEAR 2000 READINESS DISCLOSURE

  The Company is aware of the issues associated with the programming code in
existing computer and software systems regarding the Year 2000. The Company,
like other organizations, is in the process of assessing and modifying or
replacing its information technology and non-information technology to ensure,
to the extent within the control of the Company, their functionality with
respect to the "Year 2000" millennium change and to identify and evaluate
potential risks to the Company to the extent that Year 2000 problems not within
the Company's control could impact the Company. The Company's primary computer
systems operate from an IBM platform and were designed in the 1990's, generally
with four digit year capability. With respect to non-information technology, all
of the Company's facilities are relatively modern, post-1990, and are believed,
based on the evaluation to date, not to have any significant Year 2000 problems.
The Company has budgeted $1 million, as a conservative estimate of the maximum
cost to it, to address "Year 2000 problems," and has presently spent
approximately $300,000. The Company anticipates that it will be Year 2000
compliant by July 1, 1999 and will spend the remainder of 1999 testing. While
there can be no guarantee, the Company believes that Year 2000 issues with
respect to both the information technology and non-information technology
systems within its control will be adequately addressed by it and will not cause
material disruption to the Company's operations. The Company intends to monitor
its progress towards addressing its Year 2000 issues successfully and intends to
develop contingency plans if necessary.

  However, the Company's operations are dependent to a substantial extent on the
ability of its Payor Clients, and to a lesser extent, possibly its Contracting
Providers, to address successfully their Year 2000 issues in connection with
their claims processing. The Company has no guarantee, however, that its Payor
Clients or Contracting Providers will be able to resolve all of their own Year
2000 problems in a timely manner. The Company has had discussions with its major
Payor Clients and the Company believes, based on the discussions and other
information available to it, that all of its major Payor Clients are aware of
the Year 2000 issue and are expending significant resources to identify and
resolve all of their Year 2000 problems. The Company could be materially and
adversely affected as a result of Year 2000 problems incurred by Payor Clients
or Contracting Providers or their inability to interface with the Company's
systems, or as a result of unforeseen problems regarding the Company's own
system. The Company intends to continue to monitor to the best of its ability
the likelihood of significant problems experienced by such entities which could
materially affect the Company or its operations.

                                      19
<PAGE>
 
DEPENDENCE ON CONTRACTING PROVIDERS

  UP&UP's growth depends on its ability to retain existing contracting
providers, to attract additional contracting providers, and to retain or improve
the price concessions granted by contracting providers. The termination of a
significant number of contracts with contracting providers having a high volume
of claims with UP&UP's payor clients, the inability to replace those contracts
with similar contracting providers and/or the renegotiation of contracts
resulting in reduced price concessions could have a material adverse effect on
UP&UP. UP&UP's contracts with contracting providers typically have a one-year
term, renewable automatically for successive one-year terms unless either party
gives notice of intent not to renew, and may be terminated at any time, for any
reason, upon satisfaction of the notification requirements. Also the contracts
do not prohibit the contracting providers from entering into discounted
arrangements with others.

POSSIBILITY OF CHANGES IN INDUSTRY PRACTICES AND GOVERNMENT REGULATION ADVERSE
TO UP&UP

  UP&UP's business is dependent in significant part on its ability to enter into
contracts with payors and providers on terms attractive to all parties and the
absence of substantial changes in the health care industry that would decrease
the need for the services offered by it. UP&UP's ability to continue conducting
business in its current manner could be seriously jeopardized if, among other
things, a significant number of payors, such as insurance companies, were to
seek price concessions directly from providers. In addition, UP&UP's
opportunities to maintain or expand its existing operations could be limited by
substantial changes in the health care industry, such as further adoption of
capitation payment systems, which have become more prevalent in recent years, or
the enactment of legislation or the adoption of regulations unfavorable to UP&UP
and/or its relationships with payors or providers. Any of these developments
could have a material adverse effect on UP&UP and could cause it to alter
substantially its business objectives and methods of operation.

  During the past several years, the United States health care industry has been
subject to changing and increasing government regulation. A number of proposals
for health care reform have been made at the federal and state levels, including
proposals to provide greater government control of health care spending, to
reduce fraud and abuse, to broaden access to health care services and to change
the operating environment for health care providers and payors. UP&UP cannot
predict what impact, if any, these activities, which include efforts to effect
reform through legislation and changes in the administration or interpretation
of government health care programs, laws, regulations or policies, might have on
it. Any of these activities could have a material adverse effect on UP&UP.

RISKS RELATED TO GROWTH

  UP&UP's strategy is to continue to grow aggressively, both internally and
through acquisitions. Since its initial Public Offering in July 1996, UP&UP has
made three acquisitions, most recently the ProAmerica acquisition in December
1998. This strategy is likely to place significant demands on UP&UP's financial,
operational and management resources, and to expose it to a variety of risks,
including the risk that UP&UP will be unable to attract and retain the personnel
or obtain the financial and other resources necessary to pursue and manage its
growth. UP&UP's growth makes for greater demands on the time and attention of
its key personnel. Expenses arising from UP&UP's efforts to complete
acquisitions, develop new products or increase its existing market penetration
could have an material adverse effect on it. Furthermore, UP&UP may not be able
to identify, acquire or integrate acquisition candidates successfully or manage
profitably any additional products and services resulting from acquisitions.
Acquired businesses, products and services may not contribute to UP&UP's overall
strategy or produce returns that justify the related investment or
implementation by UP&UP. In addition, UP&UP may acquire companies or seek to
develop products or services in areas in which it does not currently operate or
have meaningful experience. For example, UP&UP has recently entered into an
agreement to acquire a federal savings bank. These acquisitions or developments
may require UP&UP's management to develop expertise in new areas and to attract
a new customer base and could have a material adverse effect on UP&UP. UP&UP may
not be able to implement its growth strategy successfully or, if successful in
consummating acquisitions, be able to manage its expanded operations effectively
and profitably.

                                      20
<PAGE>
 
RISKS OF INTEGRATING ACQUIRED OPERATIONS

  UP&UP must successfully combine and integrate the operations of acquired
entities in order to realize the anticipated benefits of acquisitions.
Integrating management services, administrative organizations, facilities,
management information systems and other operational aspects of acquired
businesses, products or services can be time consuming and costly and may
distract management from day-to-day operations. Challenges in coordinating
geographically separated organizations, integrating personnel with disparate
business backgrounds and combining different corporate cultures could magnify
integration problems. UP&UP cannot guarantee that its integration processes will
be successful or that the anticipated benefits of any past or future
acquisitions will be realized. Furthermore, UP&UP may experience substantial
unanticipated costs or liabilities or other material adverse effects associated
with past or future acquisitions and integration activities conducted by it.

SUBSTANTIAL COMPETITION

  The market for UP&UP's services is highly competitive. UP&UP competes (or may
in the future have to compete) for clients with national, regional and local
provider networks, managed care organizations and health care information
companies. Several of UP&UP's competitors have significantly greater financial,
technical and marketing resources than UP&UP, which could put UP&UP at a
significant competitive disadvantage. UP&UP may not be able to compete
effectively with any of these parties in attracting and retaining clients.

EXPOSURE TO PROFESSIONAL LIABILITY

  UP&UP, through its subsidiary, National Health Services, applies medical
treatment guidelines in its utilization review and case management services. As
a result, National Health Services could become subject to claims related to
adverse medical consequences as a result of, or for the costs of, services
denied, and claims, such as malpractice, arising from the errors or omissions of
health care professionals. A successful claim against UP&UP or a subsidiary
could have a material adverse effect on it. Furthermore, UP&UP may incur
substantial costs in defending against claims, regardless of their merit or
eventual outcome. Procedures implemented by UP&UP may not limit its liability or
be effective, and litigation to which UP&UP is or may become subject could have
a material adverse effect on it. UP&UP maintains insurance coverage that it
believes is reasonable in light of its experience to date. However, this
insurance may be insufficient to protect UP&UP from liability and may not
continue to be available to it at reasonable cost or at all.

SIGNIFICANT UNCERTAINTY REGARDING POSSIBLE FUTURE SALES OF SIGNIFICANT BLOCKS OF
UP&UP COMMON STOCK; POSSIBLE EFFECT ON THE TRADING MARKET FOR UP&UP COMMON STOCK
AND THE CONTROL OF UP&UP

  Thomas L. Blair, Chairman of the Board and Chief Executive Officer of UP&UP
beneficially owns an aggregate of 7,183,150 shares, or approximately 40.9% of
UP&UP's common stock. This beneficial ownership includes 4,500,000 shares, or
approximately 25.6% of outstanding shares, which Mr. Blair has committed to
purchase on or prior to February 25, 2003. These 4,500,000 shares currently are
held by Independent Divestment Trust, which acquired them from Principal Mutual
Holding Company. In addition, Capital Z Financial Services Fund II, L.P.
recently purchased 1,750,000 shares from officers and employees of UP&UP and an
option to purchase from Mr. Blair an additional 2,250,000 shares of common stock
on or prior to February 25, 2003.

  Effect on Trading Market For UP&UP Common Stock. If the 4,500,000 shares of
UP&UP common stock are not purchased by February 25, 2003 by Mr. Blair, as he is
obligated to do, those shares would have to be sold by the trust in which they
have been placed. Further, Mr. Blair likely would seek to sell shares to pay the
purchase price of at least some of the shares he purchases from the trust. Also,
Capital Z Financial Services Fund II could seek to sell shares it has purchased,
and/or shares it purchases from Mr. Blair upon the exercise of the option.
Registration rights held by Capital Z Financial Services Fund II would
facilitate public resales of its shares of UP&UP common stock. Thus, it is
likely that a significant number of shares of UP&UP common stock would be resold
during the next four years. The possibility of a sale of those shares could have
an adverse effect on the trading market for UP&UP's common stock. A private sale
of a significant number of shares could effect a change in control of UP&UP.

  Effect on Control of UP&UP. The controlling influence Mr. Blair has with
respect to UP&UP is enhanced by his agreement to purchase the 4,500,000 shares
of common stock. However, Mr. Blair has no right to vote those 4,500,000

                                      21
<PAGE>
 
shares until he actually purchases them from the trust. The trust is required to
vote the UP&UP shares it holds in the same proportion as all other UP&UP
stockholders vote their shares. In effect, the voting power held by all other
stockholders is increased while the trust holds these shares. Mr. Blair's power
to vote 2,683,150 shares, giving effect to the trust voting arrangement, would
mean that he has approximately 20.6% of the voting power.

  In addition, UP&UP has agreed to nominate two designees of Capital Z Financial
Services Fund II for election as directors. Thus, Capital Z Financial Services
Fund II could gain a significant influence in the business of UP&UP.

REGULATION OF UP&UP AS A SAVINGS AND LOAN HOLDING COMPANY

  UP&UP has entered into an agreement to acquire for $2.5 million a savings and
loan holding company and its wholly owned, federal savings bank subsidiary,
subject to the approval of shareholders of the holding company and federal
banking regulators. The bank is subject to extensive regulation, supervision and
examination by the Office of Thrift Supervision and the Federal Deposit
Insurance Corporation. If this acquisition is completed, UP&UP would become a
savings and loan holding company, subject to supervision and examination by the
Office of Thrift Supervision of the U.S. Department of Treasury. UP&UP would be
a unitary savings and loan holding company, if the current control of UP&UP by
Principal Mutual Holding Company is divested, as proposed. As a unitary savings
and loan holding company, UP&UP generally will not be restricted under existing
laws as to the type of business activities in which it may engage, provided the
bank continues to meet the standards as a qualified thrift lender. Nevertheless,
the Office of Thrift Supervision will have enforcement authority over UP&UP and
its non-savings association subsidiaries. Among other things, this authority
permits the Office of Thrift Supervision to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings bank.

DEPENDENCE ON KEY PERSONNEL

  UP&UP depends to a significant extent on its Chairman and Chief Executive
Officer, Thomas L. Blair, its President and Chief Operating Officer, Edward S.
Civera, its Vice President of Operations, Spiro A. Karadimas and its Vice
President and Chief Financial Officer, S. Joseph Bruno. UP&UP's growth and
future success will depend in large part on its ability to retain and attract
highly qualified personnel. UP&UP has entered into a five-year employment
agreement with Mr. Civera extending to January, 2004, and has entered into two-
year employment agreements with Messrs. Karadimas, Blair and Bruno, extending to
January, 2001. If UP&UP were to lose any of its key personnel, particularly any
of its executive officers, or be unable to retain or hire qualified personnel,
then it could be potentially and adversely affected.

POTENTIAL IMPEDIMENTS TO TAKEOVER

  The concentration of ownership of its common stock could also impede any
effort by a third party to effect a change of control of UP&UP. In addition,
UP&UP's certificate of incorporation and bylaws contain a number of provisions
that could inhibit a change of control by means of a tender offer, merger, proxy
contest or otherwise, including advance notice and supermajority provisions,
provisions that establish a classified board of directors and provisions that
enable UP&UP to issue "blank check" preferred stock. These provision could
reduce or eliminate any takeover premium in the market price for UP&UP 's common
stock or otherwise limit the price certain investors might be willing to pay for
UP&UP's common stock.

  Also, if UP&UP acquires the federal savings bank as it proposes, UP&UP would
be subject to regulation by the Office of Thrift Supervision as a savings and
loan holding company. The regulatory approval or notice requirements applicable
to persons seeking to acquire control of a savings and loan holding company
could inhibit or delay possible acquisition of UP&UP, even acquisitions desired
by UP&UP's stockholders. For regulatory purposes, presumptions of control can
arise once a person's beneficial ownership, together with that of persons acting
in concert, of outstanding voting stock exceeds 10%.

                                      22
<PAGE>
 
UP&UP'S ANNUAL AND QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATION

  UP&UP's annual and quarterly operating results could fluctuate in the future
as a result of a number of factors, including:

     .  the expiration or termination of contracts with significant payor
        clients or contracting providers;
     .  the timing of new product and service introductions;
     .  changes in pricing;
     .  increases in operating expenses;
     .  increases in selling, general and administrative expenses;
     .  increased competition;
     .  the impact of acquisitions;
     .  regulatory changes; and
     .  conditions in the healthcare industry and the economy generally.

  Historical annual or quarter-to-quarter comparisons of UP&UP's results of
operations may not be an indication of future performance. It is possible that
in some future periods UP&UP's results of operations may be below the
expectations of public market analysts and investors. If this were to occur, the
price of UP&UP's common stock may decline.

LACK OF DIVIDENDS

  UP&UP does not plan to pay any dividends on its common stock for the
foreseeable future.

THE MARKET PRICE OF UP&UP'S COMMON STOCK COULD BE ADVERSELY AFFECTED BY THE
RISKS TO UP&UP AND OTHER FACTORS

  The potential impact of all of the above risk factors is difficult for UP&UP
to forecast. Nevertheless, these or other factors, such as fluctuations in
UP&UP's earnings, changes in estimates of those earnings by security analysts
and sales of substantial amounts of UP&UP's common stock in the public market,
may materially adversely affect UP&UP's operating results and/or the trading
price of the common stock. Recently, the stock market has experienced extreme
price and volume fluctuations that have particularly affected the market prices
of securities of many companies, for reasons frequently unrelated to the
performance of the specific companies. These fluctuations, as well as general
economic, political and market conditions, may materially adversely affect the
market price of UP&UP's common stock. UP&UP does not guarantee that the trading
price for the common stock will remain at or above the public offering price in
this offering.
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  The Company's Audited Consolidated Financial Statements are contained in a
separate section of this Annual Report on Form 10-K on pages F-1 through F-18,
attached hereto.

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

  Information required under this item is contained in the section entitled
"Executive Officers and Directors" in the Company's 1999 Proxy Statement and is
incorporated herein by reference.

                                      23
<PAGE>
 
ITEM 11.  EXECUTIVE COMPENSATION

  Information required under this item is contained in the sections entitled
"Directors Compensation" and "Executive Compensation" in the Company's 1999
Proxy Statement and is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  Information required under this item is contained in the section entitled
"Stock Ownership" in the Company's 1999 Proxy Statement and is incorporated
herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  Information required under this item is contained in the section entitled
"Certain Transactions" on the Company's 1999 Proxy Statement and is incorporated
herein by reference.

                                    PART IV

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

  (a) Documents filed as part of this report

      (1)  Financial Statements
           Report of Independent Accountants
           Consolidated Balance Sheets as of December 31, 1998 and 1997
           Consolidated Statements of Operations for the Years Ended December
           31, 1998, 1997 and 1996
           Consolidated Statements of Stockholders' Equity for the Years Ended
           December 31, 1998, 1997 and 1996
           Consolidated Statements of Cash Flows for the Years Ended December
           31, 1998, 1997 and 1996
           Notes to Consolidated Financial Statements

      (2)  All schedules have been omitted because they are not applicable, not
           required or the information is included elsewhere in the Company's
           consolidated financial statements or notes thereto.

  (b) Reports on Form 8-K

  The Company filed a Current Report on Form 8-K for December 31, 1998 on
January 4, 1999 reporting Item 2 in connection with the Company's acquisition of
ProAmerica Managed Care, Inc.

  (c) Exhibits

  The following exhibits are filed as part of this report unless noted
otherwise:

<TABLE> 
<CAPTION> 

Exhibit No.                          Description
-----------                          -----------
<S>            <C> 
    2.1        Agreement with America's Health Plan, Inc. (1)
    2.2        Plan and Agreement of Merger of IM&I, Inc. into PB Newco (1) 
    2.3        Plan and Agreement of Merger of PB Newco, Inc. into United Payors
               & United Providers, Inc. (1)
    3.1        Certificate of Incorporation of United Payors & United Providers,
               Inc. (1)
    3.2        Bylaws of United Payors & United Providers, Inc. (1)
    4.1        Specimen Stock Certificate of United Payors & United Providers,
               Inc. (1)
    4.2        Shareholder Agreement (1)
   10.1        Form of Indemnification Agreement (1)
</TABLE> 

                                      24
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>            <C>   
     10.2      Stock Purchase Agreement between Preferred Health Choice and
               United Payors & United Providers, Inc., dated October 22, 
               1996 (2)
     10.3      Warrants to Purchase 150,000 Shares of Common Stock of United
               Payors & United Providers, Inc. Issued to Preferred Health
               Choice, Inc., dated October 23, 1996 (3)
     10.4      Warrants to Purchase 168,000 Shares of Common Stock of United
               Payors & United Providers, Inc. Issued to Preferred Health
               Choice, Inc., dated October 27, 1996 (3)
     10.5      Stock Purchase Agreement between United Payors & United
               Providers, Inc. and Principal Holding Company, a wholly owned
               subsidiary of Principal Mutual Life Insurance Company, dated
               September 29, 1997 (4)
     10.6      Stock Purchase Agreement by and between United Payors & United
               Providers, Inc. and The MetraHealth Employee Benefits Company,
               Inc., dated December 17, 1998(5)
     10.7      Employment Agreement by and among United Payors & United
               Providers, Inc., Thomas L. Blair, Chairman of the Board and Chief
               Executive Officer of United Payors & United Providers, Inc., and
               Edward S. Civera (6)
     10.8      First Amendment to the Employment Agreement by and between United
               Payors & United Providers, Inc., Thomas L. Blair, Chairman of the
               Board and Chief Executive Officer of United Payors & United
               Providers, Inc., and Edward S. Civera (filed herewith)
     10.9      Employment Agreement by and between United Payors & United
               Providers, Inc. and Thomas L. Blair (filed herewith)
     10.10     Employment Agreement by and between United Payors & United
               Providers, Inc. and S. Joseph Bruno (filed herewith)
     10.11     Employment Agreement by and between United Payors & United
               Providers, Inc. and Spiro A. Karadimas (filed herewith)
     10.12     Registration Rights Agreement by and among Capital Z Financial
               Services Fund II, L.P. and United Payors & United Providers,
               Inc., dated February 25, 1999 (filed herewith)
     10.13     Registration Rights Agreement by and among Thomas L. Blair and
               United Payors & United Providers, Inc., dated February 25, 1999
               (filed herewith)
     10.14     Stockholders Agreement by and between Capital Z Financial
               Services Fund II, L.P., Thomas L. Blair and United Payors &
               United Providers, Inc., dated February 25, 1999 (filed herewith)
     10.15     Royalty Agreement between United Payors & United Providers, Inc.
               and HealthExtras LLC (filed herewith)
     21.1      Subsidiaries of United Payors & United Providers, Inc. (filed
               herewith)
     23.1      Consent of Independent Accountants (filed herewith)
     27.1      Financial Data Schedule (filed herewith)
</TABLE> 
---------------------
(1) Incorporated herein by reference into this document from the Exhibits to the
    Form S-1 Registration Statement, as amended, Registration No. 333-3814,
    initially filed on April 19, 1996.
(2) Incorporated herein by reference into this document from the Exhibits to the
    Form 10-Q for the quarter ended September 30, 1996.
(3) Incorporated herein by reference into this document from the Exhibits A-1
    and A-2 to the Stock Purchase Agreement filed as Exhibit 10.4 to the Form
    10-Q for the quarter ended September 30, 1996.
(4) Incorporated herein by reference into this document from the Exhibits to the
    Form 8-K dated October 13, 1997.
(5) Incorporated herein by reference into this document from the Exhibits to the
    Form 8-K dated December 31, 1998.
(6) Incorporated here in by reference into this document from Exhibit 10.8 to
    the Form 10-K dated December 31, 1997.

                                      25
<PAGE>
 
                                   SIGNATURES

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


                              UNITED PAYORS & UNITED PROVIDERS, INC.


Date: March  15, 1999         By: /s/   Thomas L. Blair
                                  --------------------------------------------
                                  Thomas L. Blair
                                  Chairman of the Board, President and
                                  Chief Executive Officer


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

Date:  March 15, 1999         By: /s/   Thomas L. Blair
                                  --------------------------------------------
                                  Thomas L. Blair
                                  Chairman of the Board and
                                  Chief Executive Officer

Date:  March 15, 1999         By: /s/   Edward S. Civera
                                  --------------------------------------------
                                  Edward S. Civera
                                  President and Chief Operating Officer

Date:  March 15, 1999         By: /s/   S. Joseph Bruno
                                  --------------------------------------------
                                  S. Joseph Bruno
                                  Chief Financial Officer

Date:  March 15, 1999         By: /s/   Eduardo V. Feito
                                  --------------------------------------------
                                  Eduardo V. Feito
                                  Chief Accounting Officer

Date:  March 15, 1999         By: /s/   Bette B. Anderson
                                  --------------------------------------------
                                  Bette B. Anderson
                                  Director

Date:  March 15, 1999         By: /s/   William E. Brock
                                  --------------------------------------------
                                  William E. Brock
                                  Director

Date:  March 15, 1999         By: /s/   David J. Drury
                                  --------------------------------------------
                                  David J. Drury
                                  Director

Date:  March 15, 1999         By: /s/   Michael H. Gersie
                                  --------------------------------------------
                                  Michael H. Gersie
                                  Director

Date:  March 15, 1999         By: /s/   Thomas J. Graf
                                  --------------------------------------------
                                  Thomas J. Graf
                                  Director

                                       26
<PAGE>
 
Date:  March 15, 1999         By: /s/   Frederick H. Graefe
                                  --------------------------------------------
                                  Frederick H. Graefe
                                  Director

Date:  March 15, 1999         By: /s/   Kenneth J. Linde
                                  --------------------------------------------
                                  Kenneth J. Linde
                                  Director

<PAGE>
 
                     UNITED PAYORS & UNITED PROVIDERS, INC.
 
                       CONSOLIDATED FINANCIAL STATEMENTS
 
                                     INDEX
 
<TABLE>
<S>                                                                        <C>
Report of Independent Accountants......................................... F-1
 
Consolidated Balance Sheets as of December 31, 1998 and 1997.............. F-2
 
Consolidated Statements of Operations for the Years Ended December 31,
 1998, 1997 and 1996...................................................... F-3
 
Consolidated Statements of Stockholders' Equity for the Years Ended
 December 31, 1998, 1997 and 1996......................................... F-4
 
Consolidated Statements of Cash Flows for the Years Ended December 31,
 1998, 1997 and 1996...................................................... F-5
 
Notes to the Consolidated Financial Statements............................ F-6
</TABLE>
 
 
 
                                       47
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Stockholders of
 United Payors & United Provides, Inc.
 
  In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of United
Payors & United Providers, Inc. and subsidiaries (the "Company") as of
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
 
                                                PricewaterhouseCoopers LLP
 
Washington, D.C.
February 12, 1999, except for Note 12,
as to which the date is February 25, 1999
 
 
                                      F-1
<PAGE>
 
                     UNITED PAYORS & UNITED PROVIDERS, INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                     December 31,  December 31,
                                                         1998          1997
                                                     ------------  ------------
<S>                                                  <C>           <C>
                       ASSETS
Current assets:
  Cash and cash equivalents......................... $ 27,510,647  $14,456,069
  Short-term investments............................    3,855,195    8,366,547
  Accounts receivable...............................   12,729,631   11,233,277
  Deferred income taxes.............................    1,332,491      811,059
  Other current assets..............................    1,109,584      441,343
                                                     ------------  -----------
    Total current assets............................   46,537,548   35,308,295
Fixed assets, net...................................    4,301,944    3,858,532
Advances to contracting providers, net..............   24,414,030   17,265,730
Intangible and other assets, net....................   40,691,477   26,082,296
                                                     ------------  -----------
    Total assets.................................... $115,944,999  $82,514,853
                                                     ============  ===========
         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable and accrued expenses............. $ 11,487,823  $ 5,791,505
  Income and other taxes payable....................    2,861,841    1,871,934
  Notes payable and capital leases, current
   portion..........................................    5,040,951    3,131,772
                                                     ------------  -----------
    Total current liabilities.......................   19,390,615   10,795,211
Other accrued expenses..............................    1,073,333    1,313,333
Notes payable and capital leases, less current
 portion............................................   17,022,738   12,109,606
                                                     ------------  -----------
    Total liabilities...............................   37,486,686   24,218,150
Commitments and contingencies
Stockholders' equity:
  Preferred stock, $0.01 par value, 5,000,000 shares
   authorized, none issued and outstanding at
   December 31, 1998 and 1997.......................          --           --
  Common stock, $0.01 par value, 35,000,000 shares
   authorized, 17,360,454 shares issued at December
   31, 1998 and 1997................................      173,605      173,605
  Additional paid-in capital........................   37,123,886   37,123,886
  Treasury stock, 273,151 and 307,725 shares at
   December 31, 1998 and 1997, respectively, at
   cost.............................................   (2,634,490)  (3,029,450)
  Retained earnings.................................   44,491,012   24,911,862
  Deferred compensation.............................     (695,700)    (883,200)
                                                     ------------  -----------
    Total stockholders' equity......................   78,458,313   58,296,703
                                                     ------------  -----------
    Total liabilities and stockholders' equity...... $115,944,999  $82,514,853
                                                     ============  ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-2
<PAGE>
 
                     UNITED PAYORS & UNITED PROVIDERS, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
             For the Years Ended December 31, 1998, 1997 and 1996,
 
<TABLE>
<CAPTION>
                                           1998          1997         1996
                                       ------------  ------------  -----------
<S>                                    <C>           <C>           <C>
Revenue
  Provider network revenue............ $ 57,951,926  $ 41,195,238  $31,258,853
  Utilization management services.....   20,497,393    19,832,853    4,190,476
                                       ------------  ------------  -----------
    Total revenue.....................   78,449,319    61,028,091   35,449,329
                                       ------------  ------------  -----------
Operating expenses
  Direct contract expenses............   33,524,429    29,173,204   15,294,892
  General and administrative..........    8,364,594     6,221,269    2,783,212
  Depreciation and amortization.......    4,028,416     1,695,142      538,593
                                       ------------  ------------  -----------
    Total operating expenses..........   45,917,439    37,089,615   18,616,697
                                       ------------  ------------  -----------
Other income
  Realized gain on sale of marketable
   securities.........................      419,060       355,325      149,383
  Interest income, net of interest
   expense............................      155,966     1,045,350      693,003
  Other income, net...................      154,244        25,553      128,781
                                       ------------  ------------  -----------
    Total other income, net...........      729,270     1,426,228      971,167
                                       ------------  ------------  -----------
Income before income taxes............   33,261,150    25,364,704   17,803,799
Income tax provision..................  (13,682,000)  (10,388,000)  (7,158,000)
                                       ------------  ------------  -----------
Net income............................ $ 19,579,150  $ 14,976,704  $10,645,799
                                       ============  ============  ===========
Net income per share--basic........... $       1.15  $       0.87  $      0.70
                                       ============  ============  ===========
Weighted average shares outstanding--
 basic................................   17,064,954    17,239,065   15,188,938
                                       ============  ============  ===========
Net income per share--diluted......... $       1.09  $       0.86  $      0.70
                                       ============  ============  ===========
Weighted average shares--diluted......   17,981,445    17,486,467   15,192,585
                                       ============  ============  ===========
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-3
<PAGE>
 
                     UNITED PAYORS & UNITED PROVIDERS, INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              For the Years Ended December 31, 1998, 1997 and 1996
 
<TABLE>
<CAPTION>
                        Convertible
                      Preferred Stock         Common Stock      Additional                 Retained
                      -------------------  --------------------   Paid-in     Treasury     Earnings      Deferred
                      Shares     Amount      Shares     Amount    Capital       Stock      (Deficit)   Compensation    Total
                      -------    --------  ----------  -------- -----------  -----------  -----------  ------------ -----------
<S>                   <C>        <C>       <C>         <C>      <C>          <C>          <C>          <C>          <C>
Balance at December
 31, 1995...........         1    $    --   6,600,000  $ 66,000 $ 5,941,099  $       --   $  (710,641)  $     --    $ 5,296,458
Conversion of
 preferred stock....        (1)        --   6,600,000    66,000     (66,000)         --           --          --            --
Shares issued in
 public offering....       --          --   4,140,000    41,400  26,834,057          --           --          --     26,875,457
Shares issued in
 connection with
 investment.........       --          --      20,454       205     149,795          --           --          --        150,000
Warrants issued in
 connection with
 acquisition........       --          --         --        --    1,088,000          --           --          --      1,088,000
Stock options issued
 in connection with
 non-compete and
 restructuring of
 marketing
 agreement..........       --          --         --        --    1,150,000          --           --          --      1,150,000
Acquisition of
 treasury stock.....       --          --     (33,750)      --          --       (30,000)         --          --        (30,000)
Net income..........       --          --         --        --          --           --    10,645,799         --     10,645,799
                       -------    -------- ----------  -------- -----------  -----------  -----------   ---------   -----------
Balance at December
 31, 1996...........       --          --  17,326,704   173,605  35,096,951      (30,000)   9,935,158         --     45,175,714
Acquisition of
 treasury stock.....       --          --    (339,375)      --          --    (3,299,450)         --          --     (3,299,450)
Treasury shares
 reissued in
 connection with
 acquisition........       --          --      37,500                            300,000          --          --        300,000
Stock options
 issued.............       --          --         --        --    1,643,350          --           --          --      1,643,350
Treasury shares
 reissued...........       --          --      27,900       --      233,585          --           --          --        233,585
Options issued in
 connection with
 network management
 agreement..........       --          --         --        --      150,000          --           --          --        150,000
Deferred
 compensation, net..       --          --         --        --          --           --           --     (883,200)     (883,200)
Net income..........       --          --         --        --          --           --    14,976,704         --     14,976,704
                       -------    -------- ----------  -------- -----------  -----------  -----------   ---------   -----------
Balance at December
 31, 1997...........       --          --  17,052,729   173,605  37,123,886   (3,029,450)  24,911,862    (883,200)   58,296,703
Acquisition of
 treasury stock.....       --          --     (16,500)      --          --      (207,574)         --          --       (207,574)
Treasury shares
 reissued under the
 Employee Stock
 Purchase Plan......       --          --      25,574       --          --       370,524          --          --        370,524
Treasury shares
 reissued upon
 exercise of stock
 options............       --          --      24,000       --          --       205,760          --          --        205,760
Other treasury
 shares reissued....                            1,500                             26,250                                 26,250
Compensation
 expense, net.......       --          --         --        --          --           --           --      187,500       187,500
Net income..........       --          --         --        --          --                 19,579,150         --     19,579,150
                       -------    -------- ----------  -------- -----------  -----------  -----------   ---------   -----------
Balance at December
 31, 1998...........       --     $    --  17,087,303  $173,605 $37,123,886  $(2,634,490) $44,491,012   $(695,700)  $78,458,313
                       =======    ======== ==========  ======== ===========  ===========  ===========   =========   ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-4
<PAGE>
 
                     UNITED PAYORS & UNITED PROVIDERS, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
              For the Years Ended December 31, 1998, 1997 and 1996
 
<TABLE>
<CAPTION>
                                           1998          1997          1996
                                       ------------  ------------  ------------
<S>                                    <C>           <C>           <C>
Operating activities
 Net income..........................  $ 19,579,150  $ 14,976,704  $ 10,645,799
 Adjustment to reconcile net income
  to net cash provided by operations
  Realized gain on sale of marketable
   securities........................      (419,060)     (355,325)     (149,383)
  Depreciation and amortization......     4,028,416     1,695,142       538,593
  Loss on sale of assets.............           --        143,138           --
  Amortization of deferred costs.....       384,000       384,000           --
  Noncash compensation expense.......       187,500       705,435           --
  Deferred income taxes..............      (521,432)     (180,459)      274,700
  Changes in reserves and
   allowances........................     1,287,646       148,000       115,000
  Changes in assets and liabilities,
   net of effects of acquisitions:
   Accounts receivable...............    (1,114,948)   (6,912,399)   (4,998,837)
   Accounts payable and accrued
    expenses.........................      (759,095)    1,944,024    (1,324,495)
   Current and other assets..........      (674,337)      (10,622)       (1,307)
   Income and other taxes payable....       520,987       787,981       730,691
                                       ------------  ------------  ------------
Net cash provided by operating
 activities..........................    22,498,827    13,325,619     5,830,761
                                       ------------  ------------  ------------
Investing activities
 Purchases of fixed assets...........    (1,386,465)   (1,495,599)     (865,827)
 Purchases of marketable securities..    (5,245,401)   (4,989,131)   (5,958,812)
 Proceeds from sale of marketable
  securities.........................     5,650,291     5,307,940     6,108,195
 Purchases of short-term
  investments........................    (3,803,609)   (8,330,031)  (10,448,564)
 Proceeds from sale of short-term
  investments........................     8,329,131    10,448,564           --
 Advances to contracting providers...    (7,564,300)  (13,113,000)   (4,290,730)
 Payments for acquisitions, net of
  cash acquired......................   (11,689,432)  (13,447,439)   (5,304,221)
 Other, net..........................    (1,000,415)     (379,392)     (629,354)
                                       ------------  ------------  ------------
Net cash used in investing
 activities..........................   (16,710,200)  (25,998,088)  (21,389,313)
                                       ------------  ------------  ------------
Financing activities
 Proceeds from initial public
  offering...........................           --            --     26,875,457
 Proceeds from bank borrowings.......    10,000,000    15,000,000           --
 Purchase of treasury stock..........      (207,574)   (3,299,450)      (30,000)
 Reissuance of treasury stock to
  employees and upon exercise of
  stock options......................       602,534           --            --
 Repayment of loan from stockholder..           --            --     (3,700,000)
 Repayment of notes payable..........    (3,129,009)     (606,196)     (253,856)
                                       ------------  ------------  ------------
Net cash provided by financing
 activities..........................     7,265,951    11,094,354    22,891,601
                                       ------------  ------------  ------------
Increase (decrease) in cash and cash
 equivalents.........................    13,054,578    (1,578,115)    7,333,049
Cash and cash equivalents
 Beginning of the period.............    14,456,069    16,034,184     8,701,135
                                       ------------  ------------  ------------
 End of the period...................  $ 27,510,647  $ 14,456,069  $ 16,034,184
                                       ============  ============  ============
Supplemental disclosures of cash flow
 information
 Interest paid during the year.......  $  1,137,323  $    194,044  $     85,497
 Taxes paid during the year..........  $ 14,315,610  $ 10,183,484  $  6,509,000
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-5
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. Business, Organization and Basis of Presentation
 
  United Payors & United Providers, Inc. ("UP&UP" or the "Company"), a
Delaware corporation, serves as an intermediary between health care payors
(e.g., insurance companies) and health care providers (e.g., hospitals) by
entering into contractual arrangements designed generally to produce cost
savings and other benefits for payors and increased liquidity and improved
efficiency in claims submissions for providers. UP&UP derives its revenue
primarily from a portion of the price concessions offered by the providers
under such contractual arrangements. Effective October 1, 1996, UP&UP acquired
National Health Services, Inc. ("NHS"), a national health care utilization
management services company. NHS offers medical utilization management
services to insurance underwriters, self-insured businesses, provider
organizations, and others. Such services include pre-certification of in-
patient and out-patient medical care, and case management.
 
  Effective December 31, 1995, UP&UP entered into an agreement with America's
Health Plan, Inc., an indirect wholly-owned subsidiary of Principal Mutual
Holding Company (Principal Mutual Holding Company and its affiliated entities
collectively are referred to as "Principal Mutual"), whereby specified payor
clients of America's Health Plan, Inc. ("AHP") were transferred to UP&UP.
Principal Mutual beneficially owns approximately 38% of the Company's common
stock. Effective September 1, 1997, UP&UP acquired the remaining operations of
AHP. AHP develops and markets its proprietary health care provider network for
access by payors of health care costs such as insurers, third-party
administrators and unions. The name of America's Health Plan, Inc. was changed
to UP&UP, Inc. immediately prior to the acquisition. In connection with the
acquisition, the Company was granted the right to operate the health care
provider network under the name America's Health Plan.
 
  Effective December 1, 1998, the Company acquired ProAmerica Managed Care,
Inc. ("ProAmerica"), a national preferred provider organization that operates
a network of health care providers.
 
  On April 13, 1998, the Company's Board of Directors approved a three-for-two
stock split in the form of a stock dividend payable on May 4, 1998, to
stockholders of record on April 24, 1998. The stock split resulted in the
issuance of a total of 5,786,818 additional shares of common stock. The par
value of the common stock was not changed. Accordingly, the issuance of the
additional shares resulted in the transfer of $57,869 from additional paid-in
capital to common stock to reflect the aggregate par value of the shares
issued. The effect of the stock split has been retroactively reflected in the
consolidated balance sheets and the consolidated statements of stockholders'
equity for all periods prior to the date of the stock split. All references in
the financial statements to number of shares, related prices and per share
amounts have also been restated to reflect the stock split.
 
2. Initial Public Offering
 
  The Company filed a Registration Statement on Form S-1 with the Securities
and Exchange Commission which offered to the public 3,600,000 shares at $7.33
per share (4,140,000 shares, including the over-allotment) of the Company's
common stock. This registration statement was declared effective on June 28,
1996.
 
  The closings of the sale of stock for an aggregate of 4,140,000 shares were
effected on July 8, 1996 and July 15, 1996 for which the Company received
proceeds (net of underwriters' commissions and expenses) of $23.4 million and
$3.5 million, respectively.
 
3. Summary of Significant Accounting Policies
 
 Principles of consolidation
 
  The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles and include the
accounts and operations, after intercompany eliminations, of the Company and
its subsidiaries.
 
 
                                      F-6
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 Revenue recognition
 
  The Company recognizes provider network revenue, under the accrual method,
based on a contracted percentage of the amount of cost savings realized by
payor clients which access the Company's contracting provider network. Revenue
is recorded in the period in which claims are repriced.
 
  For medical utilization management services revenue is recorded based on the
contractual arrangements. Contracts may reflect a capitated rate, fee for
service or hourly rate. Pre-certification revenue is generally based on
monthly capitation calculations and is earned during the month for which the
services are provided. Case management revenue is generally based on fee for
service or hourly rates over the term of the contractual agreements.
 
 Use of estimates
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the period.
Actual results could differ from those estimates.
 
 Fair value information
 
  The carrying amounts of financial instruments, principally notes payable,
approximate their fair values.
 
 Cash equivalents
 
  The Company considers all highly liquid instruments with original maturities
of three months or less to be cash equivalents. The Company maintains its cash
and cash equivalents in bank accounts which, at times, may exceed federally
insured amounts. The Company has not experienced any losses in such accounts
and believes it is not exposed to any significant credit risk on cash and cash
equivalents. At December 31, 1998 and 1997, the Company had approximately
$15,865,387 and $4,257,200, respectively, of cash and cash equivalents on
deposit with commercial banks in excess of insured amounts.
 
 Short-term investments
 
  From time to time, the Company invests in various marketable securities. The
sales of marketable securities resulted in realized gains of $808,919 and
realized losses of $389,859 in 1998, realized gains of $602,012 and realized
losses of $246,687 in 1997, and realized gains of $402,197 and realized losses
of $252,814 in 1996. Cost was determined using the specific identification
method. Short-term investments in 1998 and 1997 consist of $1,895,215 and
$5,489,368, respectively, of securities backed by the United States
Government; $1,632,849 and $997,524, respectively, of other debt securities;
and certificates of deposit of $327,131 and $1,879,655, respectively. These
investments are reflected at fair value which approximates the respective
amortized cost. There were no unrealized gains or losses on these investments
in 1998 or 1997.
 
 Advances to contracting providers
 
  The Company enters into contracts directly with providers of medical
services ("contracting providers"). The Company's contracts with contracting
providers prescribe specific fee concessions on medical services rendered by
the contracting providers to patients covered by medical plans of payor
clients. In partial consideration for the price concessions furnished by them,
contracting hospitals are offered the option by the Company of receiving an
advance (prepayment) of a portion of the estimated annual claims volume that
such
 
                                      F-7
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
contracting hospitals have with payor clients. As of December 31, 1998 and
1997 the amount of advances (prepayments) was $25,093,030 and $17,528,730,
respectively. Upon termination of a provider contract by either party, the
amount of advances (prepayments) through the date of termination becomes fully
due and payable to the Company. The Company considers deposits with
contracting providers recoverable. Allowances of $679,000 and $263,000 have
been established for these deposits as of December 31, 1998 and 1997,
respectively.
 
 Fixed assets
 
  Fixed assets are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the various assets
which range from five to seven years. Leasehold improvements are amortized
using the straight-line method over the shorter of the estimated useful lives
of the assets or the lease term.
 
 Intangible assets
 
  Intangible assets represent the cost in excess of net assets of businesses
acquired (goodwill) and the value of options to purchase an aggregate of
273,000 shares of the Company's common stock issued in connection with the
Company obtaining a covenant not to compete upon the restructuring of a
marketing agreement. These intangibles are amortized on a straight-line basis
over 3 to 20 years. Accumulated amortization at December 31, 1998 and 1997
amounted to $4,359,783 and $1,278,167, respectively. Amortization expense for
the years ended December 31, 1998, 1997 and 1996 amounted to $2,702,464,
$773,726 and $120,411, respectively. The Company annually evaluates the
recoverability of intangible assets utilizing qualitative factors. At such
time as an impairment in value is identified, the impairment will be
quantitatively measured using a discounted cash flow methodology and charged
to expense.
 
 Income taxes
 
  Income taxes have been recorded using the liability method. The income tax
provision includes federal and state income taxes both currently payable and
changes in deferred taxes due to differences between financial reporting and
tax bases of assets and liabilities. Deferred tax assets and liabilities are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
 
 Net income per common share
 
  Basic net income per share is based on the weighted average number of common
stock outstanding during the period. Diluted income per share is based on the
weighted average number of common stock and common stock equivalent shares
outstanding during the year.
 
 Concentration of payor clients
 
  A significant portion of the Company's revenue is derived from a small
number of payor clients. The inability to replace any such clients with
significant new payor clients would have a material adverse effect on the
Company's business. The Company's revenue was concentrated (as a percentage of
total revenue) in the following payor clients during 1998, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                                 1998  1997  1996
                                                                 ----  ----  ----
      <S>                                                        <C>   <C>   <C>
      Payor client A............................................  16%   20%  --
      Payor client B............................................  11%   13%  --
      Payor client C............................................ --    --     22%
      Payor client D............................................ --    --     13%
      Payor client E............................................ --    --     12%
      Payor client F............................................  10%  --    --
</TABLE>
 
                                      F-8
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  No other payor client accounted for 10% or more of the Company's revenue.
 
  At December 31, 1998, payor clients A, B and F represented 16%, 6% and 7%,
respectively, of the Company's accounts receivable. At December 31, 1997,
payor clients A and B represented 16% and 13%, respectively, of the Company's
accounts receivable.
 
 Comprehensive Income
 
  The Company had no other comprehensive income items during the years ended
December 31, 1998, 1997 and 1996.
 
 Reclassifications
 
  Certain amounts in the 1997 and 1996 financial statements have been
reclassified to conform to the 1998 presentation.
 
4. Business Combinations
 
  Effective October 1, 1996, the Company acquired NHS for a purchase price of
approximately $11.0 million, consisting of $5.9 million in cash, warrants to
purchase an aggregate of 477,000 shares of the Company's common stock valued
at $1.1 million and the assumption of approximately $4.0 million in
liabilities. NHS is a national health care management services company. The
acquisition has been accounted for as a purchase and, accordingly, the results
of operations of NHS have been included in the accompanying consolidated
statements of operations since the effective date of the acquisition. The
acquisition resulted in goodwill of $7.2 million which is being amortized over
15 years.
 
  Effective September 1, 1997, the Company acquired AHP for a purchase price
of approximately $19.9 million, consisting of $15.1 million in cash and the
assumption of approximately $4.8 million in liabilities. The acquisition has
been accounted for as a purchase and, accordingly, the results of operations
of AHP have been included in the accompanying consolidated statements of
operations since the effective date of the acquisition. The acquisition
resulted in goodwill of approximately $15.5 million which is being amortized
over 20 years. Under the terms of the acquisition agreement, the purchase
price of AHP was subject to adjustment through the year 2000, if AHP revenues
exceeded pre-determined targets. In August, 1998, the Company and the seller
entered into an agreement to set the purchase price of AHP and eliminate the
contingent consideration provisions in the original acquisition agreement.
Under the terms of the August 1998 agreement, the Company agreed to pay the
seller $4.0 million in twelve equal monthly installments commencing November
1, 1998. The $4.0 million has been recorded as additional goodwill and is
being amortized over the remaining amortization period of the original
goodwill. The unpaid balance of the $4.0 million at December 31, 1998 is
included in accounts payable and accrued expenses in the accompanying
consolidated balance sheet.
 
  Effective December 1, 1998, the Company acquired ProAmerica for a purchase
price of approximately $14.3 million, consisting of $11.7 million in cash and
the assumption of approximately $2.6 million in liabilities based on a
preliminary determination of the liabilities assumed. The acquisition has been
accounted for as a purchase and accordingly, the results of operations of
ProAmerica have been included in the accompanying consolidated statements of
operations since the effective date of the acquisition. A preliminary
allocation of the purchase price resulted in goodwill of $12.6 million which
is being amortized over 15 years.
 
                                      F-9
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  The following unaudited pro forma consolidated results of operations for the
years ended December 31, 1998 and 1997 are presented as though AHP and
ProAmerica had been acquired at the beginning of 1997, after giving effect to
purchase accounting adjustments relating to interest, the amortization of
goodwill and income taxes.
 
<TABLE>
<CAPTION>
                                                           1998        1997
                                                        ----------- -----------
                                                            (In thousands,
                                                        except per share data)
      <S>                                               <C>         <C>
      Revenue.......................................... $    92,054 $    86,507
      Net income....................................... $    19,735 $    16,643
      Net income per share--basic...................... $      1.16 $      0.97
      Weighted average shares--basic...................      17,065      17,239
      Net income per share--diluted.................... $      1.10 $      0.95
      Weighted average shares--diluted.................      17,981      17,486
</TABLE>
 
  The pro forma results of operations are not necessarily indicative of the
results that would have occurred had the AHP and ProAmerica acquisitions been
consummated as of January 1, 1997, nor are they necessarily indicative of
future operating results.
 
5. Fixed Assets
 
  Fixed assets consist of the following:
 
<TABLE>
<CAPTION>
                                              December 31,
                                         ------------------------  Depreciable
                                            1998         1997         Lives
                                         -----------  -----------  -----------
   <S>                                   <C>          <C>          <C>
   Computer equipment................... $ 3,062,223  $ 2,170,494     5 years
   Furniture, fixtures, and office
    equipment...........................   2,796,787    2,165,105   5-7 years
   Leasehold improvements...............   1,113,965      912,054     5 years
   Vehicles.............................      62,772       21,426     5 years
                                         -----------  -----------
     Total fixed assets.................   7,035,747    5,269,079
   Accumulated depreciation and
    amortization........................  (2,733,803)  (1,410,547)
                                         -----------  -----------
     Fixed assets, net.................. $ 4,301,944  $ 3,858,532
                                         ===========  ===========
</TABLE>
 
  Depreciation expense for the years ended December 31, 1998, 1997 and 1996
approximated $1,326,000, $915,000, and $412,000, respectively.
 
6. Notes Payable
 
  In connection with the acquisition of AHP, the Company entered into a loan
agreement with a bank for an aggregate amount of $15 million. The loan balance
outstanding at December 31, 1998 and 1997 was $12 million and $15 million,
respectively. The loan bears interest at the London Interbank Offered Rate
("LIBOR") plus 1 1/8% (approximately 6.8% at December 31, 1998). The principal
amount of the loan is to be repaid in equal quarterly installments over a
period of five years, commencing March 31, 1998. Interest is payable in
arrears on the last business day of each quarter, commencing December 31,
1997.
 
  In December 1998, the Company utilized the proceeds from a $10 million line
of credit with a bank, bearing interest at LIBOR plus 1 1/8%, as part of the
consideration paid for the acquisition of ProAmerica. In February 1999, the
Company entered into a $10 million term loan with the same bank and utilized
the proceeds to replenish the amount drawn under the line of credit. The term
loan bears interest at the rate of LIBOR plus 1 1/8% (approximately 6.8% at
December 31, 1998). The principal amount of the loan is to be repaid in equal
quarterly installments over a period of five years, commencing March 31, 1999.
Interest is payable in arrears on the last business day of each quarter,
commencing March 31, 1999.
 
                                     F-10
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  Both term loans contain restrictive covenants, the most restrictive of which
require the Company to maintain certain financial ratios above stated levels,
restrict the Company from incurring additional debt, other than with the bank,
in excess of $10 million and restrict the Company from paying dividends in
excess of 50% of consolidated net income, as defined in the loan agreement.
 
7. Income Taxes
 
  The provision for income taxes consists of the following:
 
<TABLE>
<CAPTION>
                                              1998         1997         1996
                                           -----------  -----------  ----------
   <S>                                     <C>          <C>          <C>
   Current provision...................... $14,203,400  $10,568,500  $6,883,300
   Deferred provision (benefit)...........    (521,400)    (180,500)    274,700
                                           -----------  -----------  ----------
     Total provision...................... $13,682,000  $10,388,000  $7,158,000
                                           ===========  ===========  ==========
</TABLE>
 
  The provision for income taxes varies from the amount of income tax
determined by applying the applicable United States statutory tax rate to pre-
tax income as follows:
 
<TABLE>
<CAPTION>
                                                                  1998  1997  1996
                                                                  ----  ----  ----
   <S>                                                            <C>   <C>   <C>
   Statutory United States tax rate..............................  35%   35%   34%
   State taxes, net of Federal benefit...........................   6     6     6
                                                                  ---   ---   ---
     Effective tax rate..........................................  41%   41%   40%
                                                                  ===   ===   ===
</TABLE>
 
  A summary of the tax effect of the significant components of deferred income
tax assets follows:
 
<TABLE>
<CAPTION>
                                                              1998       1997
                                                           ----------  --------
   <S>                                                     <C>         <C>
   Deferred compensation.................................. $  488,000  $411,000
   Depreciation and amortization..........................   (426,000)   66,000
   Reserves and allowances................................  1,068,000    88,000
   Accrual versus cash method of accounting...............        --     60,000
   Other accrued expenses.................................    202,000   186,000
                                                           ----------  --------
     Net deferred tax assets.............................. $1,332,000  $811,000
                                                           ==========  ========
</TABLE>
 
8. Stockholders' Equity
 
 Stock option and employee stock purchase plans
 
  In October, 1996, the Company adopted the United Payors & United Providers,
Inc. Stock Option Plan ("SOP"). Stock options may be granted under the plan as
either incentive stock options or non-qualified stock options. The maximum
number of shares of the Company's common stock reserved for purchase pursuant
to the exercise of options granted under the SOP is 2,325,000 shares. All
Company employees, outside directors and consultants are eligible to receive
option awards. A Committee of the Board of Directors determines award amounts,
exercise prices, terms and vesting periods. The maximum term over which
incentive stock options and non-qualified stock options may be exercised may
not exceed 10 years and 12 years, respectively. The following table summarizes
information regarding transactions under the SOP:
 
 
                                     F-11
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
<TABLE>
<CAPTION>
                                1998                1997             1996
                         ------------------- ------------------ ---------------
                                    Weighted           Weighted        Weighted
                                    Average            Average         Average
                                    Exercise           Exercise        Exercise
                          Shares     Price    Shares    Price   Shares  Price
                         ---------  -------- --------- -------- ------ --------
<S>                      <C>        <C>      <C>       <C>      <C>    <C>
Outstanding at January
 1,..................... 1,800,000   $ 7.90     86,250  $7.43      --   $  --
Granted.................   168,000    16.50  1,713,750   7.92   86,250   7.43
Exercised...............   (24,000)   (8.58)       --     --       --     --
Canceled................       --       --         --     --       --     --
                         ---------   ------  ---------  -----   ------  -----
Outstanding at December
 31,.................... 1,944,000   $ 8.64  1,800,000  $7.90   86,250  $7.43
                         =========   ======  =========  =====   ======  =====
Exercisable at December
 31,.................... 1,185,250   $ 9.03  1,048,125  $9.19   36,250  $7.57
                         =========   ======  =========  =====   ======  =====
</TABLE>
 
  The following table summarizes information about stock options outstanding
at December 31, 1998:
 
<TABLE>
<CAPTION>
                                                                    Weighted
                                                    Weighted        Average
     Range of                                       Average        Remaining
   Exercise Price                        Shares  Exercise Price Contractual Life
   --------------                        ------- -------------- ----------------
   <S>                                   <C>     <C>            <C>
   $ 4.00 - 7.34........................ 855,000     $ 5.88        8.8 years
     7.35 - 9.34........................ 534,750       8.19        8.2 years
     9.35 - 12.00....................... 401,250      11.94        9.8 years
    12.01 - 21.59....................... 153,000      16.99        5.0 years
</TABLE>
 
  Information regarding stock options exercisable at December 31, 1998 is
summarized as follows:
 
<TABLE>
<CAPTION>
                                                                     Weighted
     Range of                                                        Average
   Exercise Price                                         Shares  Exercise Price
   --------------                                         ------- --------------
   <S>                                                    <C>     <C>
   $ 4.00 - 7.34......................................... 330,000     $ 6.39
     7.35 - 9.34......................................... 437,250       8.10
     9.35 - 12.00........................................ 390,000      11.95
    12.01 - 21.59........................................  28,000      14.04
</TABLE>
 
  Effective January 1, 1998, the Company implemented the Employee Stock
Purchase Plan ("ESPP") approved by the Company's stockholders on June 3, 1997.
The maximum number of shares reserved for purchase by employees under the ESPP
is 525,000 shares. The ESPP is administered over consecutive quarterly
offering periods commencing on the first trading day of January, April, July
and October of each year. Under the ESPP eligible employees may purchase
shares of common stock through payroll deductions up to an annual amount of
shares having a market value of $25,000 at the date of grant. Shares are
purchased on the last trading day of each offering period at 85% of the market
price of the common stock at the beginning of the offering period or the end
of the offering period, whichever is lower. Shares issuable to employees may
be purchased in the open market or issued from treasury shares held by the
Company. During 1998, 25,574 shares were issued under the ESPP at an average
purchase price of $14.49 per share.
 
  During 1995, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 123 ("FAS 123"), Accounting for Stock-Based
Compensation. This pronouncement requires that the Company calculate the fair
value of stock options and shares issued under employee stock purchase plans
at the date of grant using an option pricing model. The Company has elected
the "pro forma, disclosure only" option permitted under FAS 123, instead of
recording a charge to operations. The following table reflects pro forma net
income and net income per share had the Company elected to adopt the fair
value approach of FAS 123:
 
 
                                     F-12
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
<TABLE>
<CAPTION>
                                                1998        1997        1996
                                             ----------- ----------- -----------
      <S>                                    <C>         <C>         <C>
      Net income
        As reported......................... $19,579,150 $14,976,704 $10,645,799
        Pro forma...........................  18,658,341  14,466,736  10,597,438
      Net income per share
        As reported--basic.................. $      1.15 $      0.87 $      0.70
        As reported--diluted................        1.09        0.86        0.70
        Pro forma--basic....................        1.09        0.84        0.70
        Pro forma--diluted..................        1.04        0.83        0.70
</TABLE>
 
  The weighted-average exercise price and the weighted-average grant date fair
value of options granted whose exercise price equals, exceeds or is less than
the market price of the stock at the date of grant is as follows:
 
<TABLE>
<CAPTION>
                                1998              1997              1996
                          ----------------- ----------------- -----------------
                          Weighted Weighted Weighted Weighted Weighted Weighted
                          Average  Average  Average  Average  Average  Average
                          Exercise   Fair   Exercise   Fair   Exercise   Fair
   Exercise Price          Price    Value    Price    Value    Price    Value
   --------------         -------- -------- -------- -------- -------- --------
   <S>                    <C>      <C>      <C>      <C>      <C>      <C>
    Equals...............  $13.43   $5.69    $7.66    $5.60    $ --     $ --
    Exceeds..............   14.67    7.09    11.07     5.15      --       --
    Less.................   19.70    8.41     4.51     6.84     7.43     2.73
</TABLE>
 
  The estimated fair value of each option was calculated using the Black-
Scholes option-pricing model. The following table summarizes the weighted-
average of the assumptions used for stock options granted during 1998, 1997
and 1996:
 
<TABLE>
<CAPTION>
                                                               1998  1997  1996
                                                               ----  ----  ----
      <S>                                                      <C>   <C>   <C>
      Risk-free interest rate.................................  5.4%  6.9%  6.3%
      Expected years until exercise...........................  3.2   9.5   2.0
      Expected volatility..................................... 55.7% 45.0% 34.0%
      Dividend yield..........................................  --    --    --
</TABLE>
 
  The weighted average fair value per share common stock purchased under the
ESPP during 1998 was $5.70 per share. The weighted average of the assumption
used to calculate the fair value of the shares was as follows:
 
<TABLE>
      <S>                                                              <C>
      Risk-free interest rate.........................................      5.0%
      Expected life................................................... 3 months
      Expected volatility.............................................     55.7%
      Dividend yield..................................................      --
</TABLE>
 
 Other stock options and warrants
 
  In connection with certain business transactions during 1996, the Company
granted options and warrants as follows: (a) 273,000 shares of its common
stock (at $8.33 per share) pursuant to a non-compete agreement related to a
marketing commission restructuring; (b) 75,000 shares of its common stock (at
$11.33 per share) pursuant to a contractual arrangement with a client; and (c)
477,000 shares of its common stock (at $10.67 per share) in the form of stock
warrants pursuant to the acquisition of NHS. These options and warrants expire
from 3 to 10 years from the date of the respective agreements. The weighted
average exercise price of the options or warrants granted during 1996 was
$9.95. At December 31, 1998, all these options and warrants were exercisable.
 
                                     F-13
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  The options related to the above transactions have been valued using the
modified American Black Scholes economic model. The resultant valuation is
reflected in the accompanying financial statements.
 
 Treasury stock
 
  On June 3, 1997, the Board of Directors authorized the Company to repurchase
such number of shares of its common stock that have an aggregate purchase
price not in excess of $5,000,000. Pursuant to this authorization, the Company
began repurchasing on the open market or in negotiated transactions at prices
deemed appropriate by the Company. Purchased shares are deposited in the
Company's treasury and are to be used principally for its employee stock
purchase and stock option plans and for general corporate purposes. As of
December 31, 1998, the Company had repurchased 389,625 shares having an
aggregate purchase price of $3,537,024 and reissued 116,474 of the shares for
an aggregate consideration of $902,534. The Company canceled the common stock
repurchase program as of February 1, 1998.
 
9. 401(k) Savings Plan
 
  In October 1996, the Company authorized the establishment of an employee
401(k) Savings Plan. The 401(k) Savings Plan, which became effective in 1997,
is available to all of its employees subject to certain service requirements.
For 1998 and 1997, the Company matched the first $1,000 of the employee's
contribution and 50% thereafter. The Company's contribution vests after the
employee has participated in the 401(k) Savings Plan for five years. For 1998
and 1997, the amounts of the Company's contribution were $445,000 and
$404,000, respectively.
 
10. Related Party Transactions
 
  The Company utilizes, for corporate business purposes, the services of an
aircraft owned by a corporation of Thomas L. Blair, Chairman and Chief
Executive Officer of the Company. The amount paid by the Company to this
corporation in 1998, 1997, and 1996 was approximately $445,000, $263,000, and
$153,000, respectively.
 
  During 1996, Principal Mutual became a payor client of the Company.
Principal Mutual has also been a payor client of AHP since 1992. Approximately
$7,376,000, $2,342,000 and $80,000 of the Company's provider network revenue
for 1998, 1997 and 1996, respectively, was derived from its contract with
Principal Mutual. At December 31, 1998 and 1997, approximately, $904,000 and
$341,000, respectively, is due from Principal Mutual and is included in
accounts receivable.
 
  During 1997, the Company purchased medical and life insurance from Principal
Mutual. The Company did not purchase health insurance from Principal Mutual
during 1998. Principal Mutual has also administered the Company's 401(k) plan
since 1997. Amounts paid to Principal Mutual in 1998 and 1997 for these
insurance products and services approximated $159,000 and $386,000,
respectively.
 
  The Company performs certain administrative services for HealthExtras LLC
("HealthExtras"), an entity formed by Principal Mutual and Thomas L. Blair,
that markets such products as catastrophic and supplemental health benefits.
During 1998, HealthExtras reimbursed the Company approximately $839,000 for
staffing and other costs incurred by the Company, in the performance of
services, on behalf of HealthExtras. The Company has also entered into a
royalty arrangement with HealthExtras effective January 1, 1999. The royalty
arrangement provides the Company with a per member/per month ("PMPM") royalty
fee. The royalty fee initially starts at $1.00 PMPM in year one and increases
to $1.50 PMPM in year four. The royalty fee is based upon the tenure of each
member participating in the HealthExtras program. The royalty arrangement was
entered into in exchange for the Company granting HealthExtras' members access
to its national network of health care providers at no fee over a four-year
period. It is likely that HealthExtras' future product development will
integrate the use of the provider network. The Company has guaranteed a credit
facility of HealthExtras in the amount of $3.0 million.
 
                                     F-14
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
11. Lease Commitments
 
  The Company leases office space under non-cancelable operating leases. The
agreements provide for annual escalations and for the payment by the Company
of a proportionate share of the increase in the costs of operating the
building. For financial reporting purposes, the Company recognizes rent
expense on a straight-line basis over the term of the lease. The Company has
also entered into various operating lease agreements for office equipment.
Rent expense under the Company's non-cancelable operating leases aggregated
$1,496,000, $1,137,000, and $470,000 in 1998, 1997, and 1996, respectively.
 
  Future minimum lease payments under non-cancelable operating leases are as
follows:
 
<TABLE>
<CAPTION>
                                                                      Operating
                                                                        Leases
                                                                      ----------
      <S>                                                             <C>
      1999........................................................... $1,703,251
      2000...........................................................  1,740,783
      2001...........................................................  1,276,984
      2002...........................................................    852,569
      2003...........................................................    861,669
      Thereafter.....................................................  1,414,408
                                                                      ----------
        Total........................................................ $7,849,664
                                                                      ==========
</TABLE>
 
12. Commitments and Contingencies
 
  Effective April 1, 1997, the Company entered into a five-year employment
agreement with its President and Chief Operating Officer. The agreement
provides for, among other things, options to purchase 1,125,000 shares of the
Company's common stock that will vest over an eight-year period (with
acceleration provision based on performance) and a retirement benefit
(approximately $1 million) in the form of vested trust arrangements that is
earned over a five-year period. A portion of the stock options have an
exercise price which is lower than the market price of the Company's common
stock at the date of grant ("in the money"). The compensation element of these
"in the money" options, net of the related tax effect, has been recorded as
deferred compensation and is being amortized as compensation expense over a
period of eight years. The unamortized portion of the deferred compensation at
December 31, 1998 and 1997 is included in stockholders' equity. In December
1997, the Company accelerated the vesting on 750,000 stock options which had
an exercise price at the date of grant equal to or above the market price.
 
  The Company offers its contracting providers an advance (prepayment) option
based on the percentage of claims volume for the preceding year. The advance
(prepayment) option may be requested at the execution of a contract between
the Company and contracting provider, or at the anniversary date. The Company
estimates that the amount of prepayment options that may be requested in 1999
should not exceed $20 million.
 
  During 1996, the Company restructured a 1994 marketing commission agreement
with Direct Resource Managers ("DRM"). The restructured agreement contains
provisions for: (a) payment to DRM of $50,000 per month for 26 months
commencing January, 1997 and (b) options to purchase 273,000 shares of the
Company's common stock at $8.33 per share (or alternatively receive cash
consideration in lieu of the options under certain conditions) in exchange for
consulting and marketing assistance and a covenant not to compete for three
years. Amounts paid to DRM in 1998, 1997, and 1996 by the Company approximated
$600,000, $600,000, and $1,425,000, respectively.
 
  The Company on October 6, 1998 entered into an agreement to acquire for $2.5
million a federal savings bank (the "Bank") and its parent holding company,
having total assets of approximately $27 million, subject to
 
                                     F-15
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
the approval of shareholders of the holding company and federal banking
regulators. Upon acquisition of the Bank, the Company would become a savings
and loan holding company, subject to supervision and examination by the Office
of Thrift Supervision (the "OTS"). The Bank is subject to extensive
regulations, supervision and examination by the OTS and the Federal Deposit
Insurance Corporation (the "FDIC"). In connection with the Company's proposed
acquisition of the Bank and its parent holding company, Principal Mutual,
which, at December 31, 1998 owned 6,600,000 shares or approximately 38.6% of
the Company's outstanding common stock, proposes to divest control of the
Company within the meaning of the Savings and Loan Holding Company Act
("Holding Company Act"), and the four directors of the Company who may be
considered to be affiliated with or nominated by Principal Mutual, will resign
from the Board of Directors of the Company. To accomplish such divestiture of
control, on February 25, 1999, Principal Mutual, sold 4,500,000 shares (the
"Principal Shares") of common stock of the Company, or approximately 25.6% of
the outstanding shares, to a trust (the "Trust"). Principal Mutual received
from the Trust $13,225,000 in cash and trust certificates entitling it to the
proceeds from the sale of the Principal Shares. At the same time, the Trust
agreed to sell the Principal Shares to Thomas L. Blair, the Chairman and Chief
Executive Officer of the Company, on or before four years from the date of the
transfer of the Principal Shares to the Trust. UP&UP would be a unitary
savings and loan holding company, if the current control of UP&UP by Principal
Mutual is divested, as proposed. As a unitary savings and loan company, UP&UP
generally will not be restricted under existing laws as to the type of
business activities in which it may engage, provided the Bank continues to
meet the standards as a qualified thrift leader. There can be no assurance
that the Company's acquisition of the Bank will be approved by the OTS. The
Company believes such approval will be given only, among other things, if the
OTS is satisfied as to the arrangements by Principal Mutual to divest control
of the Company within the meaning of the Holding Company Act. Principal Mutual
already is a savings and loan holding company. In light of the regulatory
uncertainty regarding the proposed acquisition of the Bank, the Company is not
treating the acquisition as probable for financial reporting purposes.
 
  On April 26, 1996, First Health Group (formerly known as HealthCARE
COMPARE), a Delaware corporation and competitor of the Company, filed a civil
complaint against the Company in the United States District Court for the
Northern District of Illinois. The complaint, in its present amended form, is
seeking permanent injunctive relief, as well as an unspecified amount of
damages, and alleges violations of the Lanham Act, 15 U.S.C. (S)(S)
1125(a)(1)(A) and (a)(1)(B), as well as common law claims of deceptive trade
practices, fraud, interference with contract, interference with prospective
economic relations and unfair competition. The complaint also seeks treble
damages pursuant to the Lanham Act. The complaint is based upon allegations
that representatives of the Company made false and misleading statements
during contract negotiations with providers in order to cause them to join the
UP&UP Network. In response to written requests and in depositions, Plaintiff
has alleged that it has suffered actual damages of approximately $41 million.
The Company denies the allegations in the Complaint and believes them to be
without merit. The Company has asserted a counterclaim against the Plaintiff
for violations of the Lanham Act, as well as common law claims for unfair
competition, commercial disparagement and service mark cancellation. Fact
discovery in the action is ongoing and the trial date has not yet been set by
the Court. Based upon the available information, management believes that it's
potential liability, if any, arising from such litigation will not be material
to the consolidated financial statements of the Company.
 
  The Company is also a party to other legal actions arising in the ordinary
course of business. Management believes that damages arising from these
actions, if any, will not be material to the consolidated financial statements
of the Company.
 
 
                                     F-16
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
13. Earnings Per Share
 
  A reconciliation of the numerators and denominators of the basic earnings
per share computations for the years ended December 31, 1998, 1997 and 1996 to
the numerators and denominators of the diluted earnings per share computations
for the respective periods follows:
 
<TABLE>
<CAPTION>
                                     1998                          1997                          1996
                         ----------------------------  ----------------------------  ----------------------------
                                                 Per                           Per                           Per
                         Net Income    Shares   Share  Net Income    Shares   Share  Net Income    Shares   Share
                         ----------- ---------- -----  ----------- ---------- -----  ----------- ---------- -----
<S>                      <C>         <C>        <C>    <C>         <C>        <C>    <C>         <C>        <C>
Basic................... $19,579,150 17,064,954 $1.15  $14,976,704 17,239,065 $0.87  $10,645,799 15,188,398 $0.70
Effect of Dilutive
 Options and Warrants...         --     916,491 (0.06)         --     247,402 (0.01)         --       4,187   --
                         ----------- ---------- -----  ----------- ---------- -----  ----------- ---------- -----
Diluted................. $19,579,150 17,981,445 $1.09  $14,976,704 17,486,467 $0.86  $10,645,799 15,192,585 $0.70
                         =========== ========== =====  =========== ========== =====  =========== ========== =====
</TABLE>
 
  Stock options to purchase 4,500 shares of common stock at an exercise price
of $21.59 per share were outstanding during 1998 but were not included in the
computation of diluted earnings per share because the exercise price of the
stock options was greater than the average market price of the common shares
and, therefore, were antidilutive. These stock options expire in April 2008.
 
  Stock options to purchase 461,250 shares of common stock at a weighted
average exercise price of $11.85 per share and warrants to purchase 477,000
shares of common stock at $10.67 per share were outstanding during 1997 but
were not included in the computation of diluted earnings per share because the
exercise prices of the stock options and warrants were greater than the
average market price of the common shares and, therefore, were antidilutive.
These stock options and warrants have expiration dates ranging from October,
1999 to March, 2009.
 
14. Selected Quarterly Financial Data (Unaudited)
 
<TABLE>
<CAPTION>
                         Quarter Ended Quarter Ended Quarter Ended Quarter Ended
                           March 31       June 30    September 30   December 31
                         ------------- ------------- ------------- -------------
                                  (in thousands, except per share data)
<S>                      <C>           <C>           <C>           <C>
1998:
Revenue.................    $18,598       $19,097       $19,516       $21,238
Operating profit........      7,558         8,168         8,954         9,044
Net income..............      4,396         4,812         5,037         5,334
Net income per share--
 basic..................       0.26          0.28          0.29          0.31
Net income per share--
 diluted................       0.25          0.27          0.28          0.30
1997:
Revenue.................    $13,598       $13,726       $15,256       $18,448
Operating profit........      4,971         5,761         5,886         7,320
Net income..............      3,150         3,661         3,979         4,187
Net income per share--
 basic..................       0.18          0.21          0.23          0.25
Net income per share--
 diluted................       0.18          0.21          0.23          0.24
</TABLE>
 
 
                                     F-17
<PAGE>
 
                    UNITED PAYORS & UNITED PROVIDERS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Concluded)
 
15. Supplemental Disclosure of Non-Cash Investing and Financing Activities
 
 1998
 
  The Company entered into an agreement with the seller of AHP to set the
purchase price of AHP for an amount of $4.0 million, payable in twelve monthly
installments commencing November 1, 1998.
 
  The Company assumed liabilities of approximately $2.6 million in connection
with the acquisition of ProAmerica.
 
 1997
 
  The Company assumed liabilities of approximately $4.8 million in connection
with the acquisition of AHP.
 
  The Company issued 37,500 shares from treasury stock valued at $300,000 in
connection with an acquisition.
 
  The Company issued 27,900 shares valued at approximately $200,000 from
treasury stock to its employees.
 
 1996
 
  In connection with the acquisition of NHS, the Company assumed liabilities
in the amount of approximately $4.0 million and issued warrants to purchase
common stock of the Company valued at approximately $1.1 million.
 
  A capital lease obligation was incurred when the Company entered into a
lease for new equipment.
 
  Shares of common stock were issued in connection with the investment in
EDIComm.
 
  Options to purchase shares of common stock were issued in connection with
obtaining a covenant not to compete upon the restructuring of a marketing
agreement.
 
  Shares of common stock were issued in connection with the conversion of
preferred stock.
 
 
                                     F-18