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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


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FORM 10-K


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

For the fiscal year ended December 31, 2000

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 000-21949



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PACIFICARE HEALTH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)


|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 95-4591529                          
|                                                              
|                                                              
|                                                              
|                                                              
|(State or other jurisdiction
of incorporation or organization) |  | (IRS Employer Identification Number)

3120 Lake Center Drive, Santa Ana, California 92704

(Address of principal executive offices, including zip code)


(Registrants telephone number, including area code) (714) 825-5200

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01



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

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

Non-affiliates of the Registrant held approximately $964,800,000 of the
aggregate market value of common stock on February 28, 2001.

There were approximately 33,500,000 shares of common stock outstanding on
February 28, 2001.



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TABLE OF CONTENTS



|              |                                                                                               |  |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | ITEM 1. BUSINESS                                                                             
|              | ITEM 2. PROPERTIES                                                                           
|              | ITEM 3. LEGAL PROCEEDINGS                                                                    
|              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II      
|              | ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS               
|              | ITEM 6. SELECTED FINANCIAL DATA                                                              
|              | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|              | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|              | ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                             
|              | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND FINANCIAL DISCLOSURE
|PART III     
|              | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|              | ITEM 11. EXECUTIVE COMPENSATION                                                              
|              | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|              | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|PART IV      
|              | ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K                     
|EXHIBIT 10.06
|EXHIBIT 10.07
|EXHIBIT 10.08
|EXHIBIT 10.22
|EXHIBIT 10.24
|EXHIBIT 10.31
|EXHIBIT 10.32
|Exhibit 10.34
|EXHIBIT 21   
|EXHIBIT 23   



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PACIFICARE HEALTH SYSTEMS, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2000

|         |  |                                                                                       |  |      |    | 
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|         |  | PART I                                                                               
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|Item 1.  |  | Business                                                                              |  |      | 1  | 
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|Item 2.  |  | Properties                                                                            |  |      | 13 | 
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|Item 3.  |  | Legal Proceedings                                                                     |  |      | 14 | 
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|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  |      | 15 | 
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|         |  | PART II                                                                              
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|Item 5.  |  | Market for the Companys Common Equity and Related Stockholder Matters                |  |      | 16 | 
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|Item 6.  |  | Selected Financial Data                                                               |  |      | 17 | 
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|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  |      | 19 | 
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|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |      | 33 | 
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|Item 8.  |  | Consolidated Financial Statements and Supplementary Data                              |  |      | 34 | 
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|Item 9.  |  | Changes in and Disagreements with Accountants and Accounting and Financial Disclosure |  |      | 34 | 
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|         |  | PART III                                                                             
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|Item 10. |  | Directors and Executive Officers of the Registrant                                    |  |      | 35 | 
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|Item 11. |  | Executive Compensation                                                                |  |      | 39 | 
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|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                        |  |      | 47 | 
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|Item 13. |  | Certain Relationships and Related Transactions                                        |  |      | 48 | 
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|         |  | PART IV                                                                              
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|Item 14. |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  |      | 49 | 

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PART I







ITEM 1. BUSINESS

Overview.Committed to making peoples lives healthier and more secure,
PacifiCare Health Systems, Inc. is one of the nations largest health care
services companies. Primary operations include managed care products for
employer groups and Medicare beneficiaries in eight states and Guam, serving
approximately four million members. We operate health maintenance
organizations (HMOs) and offer HMO-related products and services. Our
commercial and Medicare programs are designed to deliver quality health care
and customer service to members cost-effectively. We also offer a variety of
specialty HMO managed care and HMO-related products and services that employers
can purchase to supplement our basic commercial plans, or as stand-alone
products. Other specialty products include pharmacy benefit management,
behavioral health services, life and health insurance and dental and vision
services. We generally provide these specialty services to our members
through subcontracts or referral relationships with physicians and hospitals.

Our single largest customer is the federal government. Sources of federal
government revenues include revenues from Federal Employee Health Benefits
Program (FEHBP) members as well as Medicare beneficiaries. Federal
government revenues were $6.7 billion in 2000, $6.2 billion in 1999 and $5.9
billion in 1998.

Events During 2000.On February 1, 2000, we completed our acquisition of
Harris Methodist Texas Health Plan, Inc. and Harris Methodist Health Insurance
Company, Inc. (together, Harris), a health plan and insurance company in
Texas, for an approximate purchase price of $122 million. This acquisition
added approximately 250,000 commercial members and 50,000 Medicare members to
our Texas HMO and was accounted for as a purchase. The related goodwill and
acquired intangible assets are being amortized over periods ranging from three
to 30 years. The operating results of these entities are included in our
consolidated financial statements from the acquisition date. See Note 4 of the
Notes to Consolidated Financial Statements.

We completed the exit of all HMO operations in Ohio. This exit affected
approximately 35,000 commercial members and 3,500 Medicare members located in
Ohio and Kentucky who were enrolled in our plans during 2000. See Note 4 of
the Notes to Consolidated Financial Statements.

See Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operations for additional business events.

BUSINESS OPERATIONS

Business Strategy

Our goal is to create long-term stockholder value by becoming a full service
health care insurer and consumer services company, committed to making peoples
lives healthier and more secure. To meet this goal, we plan to:

Take actions to strengthen our existing operations. We are focusing on
implementing programs to strengthen our physician and hospital networks,
and to reduce our medical care ratios and marketing, general and
administrative expenses to improve our operating margins for our HMO
business. We intend to:



| |  | Stabilize our medical care ratios through the pricing and design of
our products and through our contracts with physicians and hospitals;                                                                                  
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Continue to evaluate our product offerings and service areas to exit
unprofitable Medicare or commercial markets, invest in expanding
membership in profitable markets and make market-driven changes to
product offerings;
| 
| |  | Continue to market our Secure Horizons products to new members in
Medicare markets in which we choose to remain;                                                                                                           
| 
| |  | Continue to manage aggressively our marketing, general and
administrative expenses by reducing overall employee population, while
investing in key capabilities such as underwriting and claims
processing;                
| 
| |  | Continue to build key capabilities to operate in a risk-based
environment, including our underwriting, medical management and claims
processing systems;                                                                   

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| |  | Outsource some functions in the information technology and medical
management areas where we believe we can improve performance while
reducing our costs; and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| 



| |  | Continue to develop incentive programs to recruit, reward and retain key employees.
|- |  | -----------------------------------------------------------------------------------

Expand the health insurance portfolio.Responding to the desires of consumers to have more choice and flexibility in
health care coverage, we intend to evolve beyond our current HMO product lines to offer a broader array of health insurance
products. We intend to:



| |  | Launch a broader Preferred Provider Organization (PPO) product on a
stand-alone basis as the first step toward broadening into non-HMO
products;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
| 



| |  | Launch other health care insurance products with a hybrid of managed
care and PPO features, including Medicare Supplements and defined
contribution plans;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| 



| |  | Develop a program to sell Medicare Supplement products to
disenrolling Medicare+Choice members to diversify our Medicare risk;
and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------
| 



| |  | Grow our pharmacy benefit management business, Prescription
Solutions, by increasing sales of our services to third-party health
plans, expanding our mail-order business and, if Congress
approves a prescription drug benefit for the Medicare fee-for-service
program, participating in that program.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Move beyond traditional health insurance. We believe that consumers
want products and services that go beyond basic health insurance and
extend to areas such as lifestyle, senior independent living and financial
security. Over time, we plan to evolve into a health and consumer
services company offering health insurance, lifestyle products, health
technology services and other consumer products aimed at making people
feel healthier and more secure. During 2001, we intend to assess and
pilot potential product offerings.

Membership

Our commercial and Medicare membership at December 31, 2000 was as follows:

|                  |                      |                        |           |           |           |       |           |                  |           |  |           |           |           |  |       |      |      |  
|----------------- | -------------------- | ---------------------- | --------- | --------- | --------- | ----- | --------- | ---------------- | --------- |  | --------- | --------- | --------- |  | ----- | ---- | ---- | -
|Membership Data   |                      | Commercial             |           | Medicare  |           | Total |           | Percent of Total
|                  |                      |                        |           |           |           |       |           |                 
|HMO membership:  
|                 
|                 
|                 
|                 
|                  | Arizona              |                        |           | 124,700   |           |       |           | 103,100          |           |  |           | 227,800   |           |  |       | 5.5  | %   
|                 
|                 
|                 
|                 
|                  | California           |                        |           | 1,812,000 |           |       |           | 564,800          |           |  |           | 2,376,800 |           |  |       | 57.7 | %   
|                 
|                 
|                 
|                 
|                  | Colorado             |                        |           | 285,800   |           |       |           | 74,000           |           |  |           | 359,800   |           |  |       | 8.7  | %   
|                 
|                 
|                 
|                 
|                  | Guam                 |                        |           | 50,500    |           |       |           |                 |           |  |           | 50,500    |           |  |       | 1.3  | %   
|                 
|                 
|                 
|                 
|                  | Nevada               |                        |           | 34,300    |           |       |           | 32,200           |           |  |           | 66,500    |           |  |       | 1.6  | %   
|                 
|                 
|                 
|                 
|                  | Ohio                 |                        |           | 35,000    |           |       |           | 3,500            |           |  |           | 38,500    |           |  |       | 1.0  | %   
|                 
|                 
|                 
|                 
|                  | Oklahoma             |                        |           | 88,300    |           |       |           | 31,400           |           |  |           | 119,700   |           |  |       | 2.9  | %   
|                 
|                 
|                 
|                 
|                  | Oregon               |                        |           | 103,700   |           |       |           | 31,600           |           |  |           | 135,300   |           |  |       | 3.3  | %   
|                 
|                 
|                 
|                 
|                  | Texas                |                        |           | 319,100   |           |       |           | 151,400          |           |  |           | 470,500   |           |  |       | 11.4 | %   
|                 
|                 
|                 
|                 
|                  | Washington           |                        |           | 99,900    |           |       |           | 64,700           |           |  |           | 164,600   |           |  |       | 4.0  | %   
|                  |                      |                        |           |           |           |       |           |                  |           |  |           |           |           |  |       |     
|                  |                      | Total HMO membership   |           |           | 2,953,300 |       |           |                  | 1,056,700 |  |           |           | 4,010,000 |  |       |      | 97.4 | %
|                  |                      |                        |           |           |           |       |           |                  |           |  |           |           |           |  |       |     
|Other membership:
|                 
|                 
|                 
|                 
|                  | Employer self-funded |                        |           | 65,000    |           |       |           |                 |           |  |           | 65,000    |           |  |       | 1.6  | %   
|                 
|                 
|                 
|                 
|                  | PPO and indemnity    |                        |           | 42,900    |           |       |           |                 |           |  |           | 42,900    |           |  |       | 1.0  | %   
|                  |                      |                        |           |           |           |       |           |                  |           |  |           |           |           |  |       |     
|                  |                      | Total other membership |           |           | 107,900   |       |           |                  |          |  |           |           | 107,900   |  |       |      | 2.6  | %
|                  |                      |                        |           |           |           |       |           |                  |           |  |           |           |           |  |       |     
|Total membership  |                      |                        | 3,061,200 |           |           |       | 1,056,700 |                  |           |  | 4,117,900 |           |           |  | 100.0 | %   
|                  |                      |                        |           |           |           |       |           |                  |           |  |           |           |           |  |       |     

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Commercial Programs

General.Our commercial membership has grown from approximately 1.3 million
members at December 31, 1995 to 3.1 million members at December 31, 2000. For
the commercial employer market, we offer a range of products and benefit plan
designs that vary in the amount of member copayments. These options allow
employers flexibility in selecting cost-effective benefit packages for their
employees. Our employer group and individual products include HMO, PPO,
point-of-service (POS) and employer self-funded plans.



| |  | An HMO is a health care organization that combines aspects of a health care insurer with those of a health care provider by
arranging for health care services for its members through a defined provider network at a reduced deductible or a nominal
copayment.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | A PPO is a selected group of providers, such as physician groups, that offers discounted fee-for-service health care.                                                                                                                                            
| 
| |  | POS plans combine the features of an HMO with the features of a traditional indemnity insurance product, allowing members
to choose from a network of providers at a lower cost, or from physicians outside of the network at a higher deductible or
copayment.  
| 
| |  | Under employer self-funded plans, we administer claims on behalf of employers, but do not assume the risk of these claims.                                                                                                                                       

Specialty Products.In addition to our HMO operations, we provide a range of
specialty managed care products that supplement our HMO products and are
primarily sold with our commercial plans. These products include:



| |  | Pharmacy Benefit Management.RX Solutions, Inc., d.b.a. Prescription
Solutions is one of the industrys largest pharmacy benefit management
companies. Prescription Solutions offers pharmacy benefit management
services primarily to our HMOs and employer groups that are
self-insured for prescription drugs. Prescription Solutions clients
have access to a pharmacy provider network that features independent
and chain pharmacies and a variety of cost and quality management
capabilities. Prescription Solutions also provides its clients with
an array of fully integrated services, including mail-order
distribution, claims processing and sophisticated drug utilization
reporting. Prescription Solutions launched its e-commerce initiative
in 1999 as a means of improving member services and moving more
medications to its mail-service operation. Our mail-order
prescription volume has increased in excess of 100 percent over the
last three years. To support the increased consumer demand,
Prescription Solutions opened a new 84,000 square foot facility in
Carlsbad, California in August 2000. Nearly four times larger than
our current facility in Mira Mesa, California, the Carlsbad facility
is able to fill nearly three times as many prescriptions as the Mira
Mesa facility. With the addition of this new facility, we believe
Prescription Solutions can aggressively promote mail-service and
pursue new business opportunities such as offering over-the-counter
medications.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Behavioral Health Services.PacifiCare Behavioral Health of
California, Inc. is a California-licensed specialized health care
service plan that provides behavioral health care services, including
chemical dependency benefit programs, primarily to our California and
other HMO commercial members. Outside of California, PacifiCare
Behavioral Health, Inc. contracts with our HMOs and employers to
manage their respective mental health and chemical dependency benefit
programs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| 
| |  | Life and Health Insurance.We are licensed through our subsidiaries,
PacifiCare Life and Health Insurance Company and PacifiCare Life
Assurance Company, to issue life and health care insurance in 38
states, including each of the states where our HMOs operate, the
District of Columbia and Guam. When our sales and marketing
representatives promote our HMO commercial product line, they offer
managed health care insurance products to employer groups at the same
time. This allows us to form multi-option health benefits programs,
including our PPO and POS plans. In addition, other supplementary
insurance products offered to employer groups include group term life,
indemnity dental and indemnity behavioral health benefits.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| 
| |  | Dental and Vision Services.PacifiCare Dental, a California licensed
HMO dental plan, PacifiCare Dental of Colorado, Inc., a Colorado
licensed HMO dental plan, and a third-party administrator of indemnity and PPO
dental and vision plans, provide HMO, PPO and fee-for-service dental
and PPO vision benefits directly to individuals and employer groups
and indirectly to seniors through Secure Horizons. In 2000, we
offered these products in five states: California, Colorado, Nevada,
Oregon and Washington.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

Premiums.When pricing our commercial programs, we use underwriting criteria
as an integral part of our commercial risk management efforts. Underwriting is
the process by which a health plan assesses the risk of enrolling employer
groups (or

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individuals) and establishes appropriate or necessary premium rates.
The setting of premium rates directly affects a health plans profitability
and marketing success. See Health Care Costs and Physician and Hospital
Relationships.

Marketing.Commercial marketing is a two-step process in which we first market
to employer groups, then provide information directly to employees once the
employer has selected our plan. We use various techniques to attract
commercial members, including work site presentations, direct mail, medical
group tours and local advertising. We also use television, radio, billboard
and print media to market our programs. Insurance brokers and consultants
represent many employer groups under contract with us. These brokers and
consultants work directly with employers to recommend or design employee
benefits packages. We pay insurance brokers commissions over the life of the
contract, while employers generally pay consultants directly. Our commercial
membership growth is a result of in-market acquisitions as well as greater
penetration in existing employer groups. With each open enrollment, we
identify a specific approach for each employer group with the objective of
increasing the number of members from each employer to increase our
penetration.

Federal Employees.Our HMOs also have commercial contracts with the United
States Office of Personnel Management (OPM) to provide managed health care
services to approximately 173,000 members under the FEHBP for federal
employees, annuitants and their dependents. See Government Regulation and
Proposed Legislation  OPM and Note 10 of the Notes to Consolidated Financial
Statements.

Retiree Product.In response to the needs of employers to provide
cost-effective health care coverage to their retired employees who may or may
not be currently entitled to Medicare, we offer the commercial retiree product.
This product draws on our Medicare expertise by offering physician and
hospital networks that are similar to those offered to our Secure Horizons
enrollees. We set our premiums generally based on the same revenue
requirements needed to provide services to Secure Horizons members. The
retiree product gives us access to individuals who, once familiar with our
services and delivery system, may enroll in Secure Horizons when they become
eligible for Medicare benefits.

Small Group and Individual.An employer with 50 or fewer employees is
considered a small group. We now consider small groups as unique markets
managed independently within each of our regions. Since September 1999, we
have established agreements with several e-commerce distribution partners,
making our small group and individual products accessible from hundreds of
sites on the Internet to provide free health insurance quotes. We began by
offering individual health products at InsWeb in California, and have since
expanded to individual and small group offerings in our other states. In
February 2000, we announced the launch of our Premier plans in California, a
new line of small group products sold through the Internet. This products
pricing reflects the reduced distribution costs of doing business online. The
Premier plans are currently available to our California customers through
electronic brokers via online insurance channels, our website
(www.pacificare.com) and through traditional insurance brokers.

Secure Horizons Program

General.For Medicare beneficiaries, we offer access to health care services
through our Secure Horizons program. The Secure Horizons program is the
largest Medicare+Choice program in the United States (as measured by
membership). Secure Horizons membership has grown from approximately 0.6
million members at December 31, 1995 to approximately 1.1 million members at
December 31, 2000.

Premiums.As a general rule, our
Medicare+Choice contracts entitle us to
per-member per-month payments on behalf of each enrolled Medicare beneficiary.
In addition, we, and all participants in the Medicare+Choice program, are
subject to periodic adjustments to premiums based upon retroactive changes in
members status, such as Medicaid eligibility and risk adjustments. These
periodic adjustments can be positive or negative. Effective January 1, 2000,
our payments from the Health Care Financing Administration (HCFA) were
adjusted for each individual based upon demographic factors including the age,
gender, county of residence and Medicaid status, as well as certain health
status information relating to each enrollee. Under the provisions of HCFAs
risk adjusted methodology, plans with enrollees who were hospitalized for more
than one day in the previous year for select disease conditions, including
certain cancers, cardiovascular problems, diabetes, and neurological disorders
are paid more than for enrollees without these conditions. These higher
payments are determined from data that we, and all other
Medicare+Choice contracting organizations, are required to submit to HCFA. The current risk
adjuster, which is used to calculate 10 percent of the plans payment, will
continue to be used through 2003. Beginning in 2004, the risk adjuster will be
based on both inpatient hospitalization and ambulatory data. The risk adjuster
will continue to be modified according to the phase-in schedule, and is
expected to be at 100 percent by 2007. See Government Regulation and Proposed
Legislation  HCFA and Government Regulation and Proposed Legislation 
Adjusted Community Rate Filings.

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Our Medicare+Choice contracts are renewed every 12 months unless HCFA or the
Medicare+Choice plan elects to terminate or not to renew the contract. HCFA
may also terminate Medicare+Choice contracts if a plan fails to meet specified
compliance standards. Termination of our Medicare+Choice contracts would have
a material effect on our financial position, results of operations or cash
flows of a future period. Under our Medicare+Choice contracts, we also have
the ability to close enrollment to new members with limited exceptions through
either a formal capacity limit or a voluntary closure. In general, closing
enrollment requires a 30 day advance public notice.

Marketing.We market our Secure Horizons programs to Medicare beneficiaries
primarily through direct mail, telemarketing, our website, television, radio
and community based events with participating physician groups. Most Secure
Horizons members enroll directly in a plan, generally without the involvement
of insurance brokers, except when enrolling as part of an employer group
retiree offering.

Health Care Costs and Physician and Hospital Relationships

General.The cost of prescription drugs and health care services has been
rising over the past few years and we expect this trend to continue for the
foreseeable future, leading to an increase in premiums. The reasons for these
increases have been numerous, including:



| |  | An aging population that has greater medical needs;                                                                                                                                                                           
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | The availability of more costly diagnostic and therapeutic procedures;                                                                                                                                                        
| 
| |  | New laws and regulations specifying covered services;                                                                                                                                                                         
| 
| |  | Increased prices for medications and the introduction of more expensive medications;                                                                                                                                          
| 
| |  | Growth in the number of hospitals and medical specialists under non-capitated contracts;                                                                                                                                      
| 
| |  | Increased utilization of services;                                                                                                                                                                                            
| 
| |  | Defensive medical practices due to physicians fear of lawsuits;                                                                                                                                                              
| 
| |  | Significant investments by pharmaceutical companies in advertising campaigns for branded drugs, in turn driving consumer
demand for these drugs;                                                                              
| 
| |  | Increased instability in hospital and specialty networks, contributing to increased medical costs. Many hospitals have
merged with larger hospital systems resulting in increased contract negotiating leverage with HMOs; and
| 
| |  | Consumer demand for easy access to and choice of physicians and hospitals, low out-of-pocket costs and coverage of
lifestyle prescription drugs.                                                                              

Contracting Arrangements with Physicians and Hospitals.We use contracting
processes that include analysis and modeling of underlying cost and utilization
assumptions. Through these processes, we expect to identify strategies to
better manage health care costs. We provide incentives to the physician or
medical groups for improving the quality of care, as well as to encourage
appropriate utilization of hospital inpatient, outpatient surgery and emergency
room services. We believe improved business consultation and management tools,
including more thorough data reporting and financial analysis of expected
performance of our contracts, will enable us to create more financially
successful physician and hospital networks. We primarily focus on securing
cost-effective physician, hospital and other health care provider contracts to
maintain a qualified network of providers in each geographic area we serve, as
well as improving the medical management of health services to achieve both
better quality and cost-effective care. Many of our physician and hospital
contracts have one-year terms. However, we also have a number of multiple-year
contracts with physician groups and hospitals to ensure the quality and
stability of our network.



| |  | Capitation Arrangements.Traditionally, we have contracted with
physician organizations as well as many hospitals and ancillary providers
on a prepaid, capitated fixed-fee per-member per-month basis, regardless
of the services provided to each member. Capitation payments to
physicians and hospitals may be based on a percentage of the premium we
receive, which is especially true for our Secure Horizons contracts, or a
fixed per-member per-month amount that is adjusted to reflect membership
age, sex and benefit variation. Under our capitated contracts, medical
groups may assume administration functions, including physician
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | management and claims processing, to support
      management of health care services. We continue to believe that delegation
      of agreed upon functions empowers our physicians and hospitals to provide
      quality service and care.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Provider Delegated Administration.Most
      of our capitated physician and hospital networks have qualified through
      our assessment processes to perform some or all of the administrative functions
      associated with operating in a capitated environment, such as paying claims
      and providing medical management. In those situations, we provide support
      for their administrative functions to help them achieve greater levels of
      efficiency. Moreover, we only delegate medical management duties to physicians
      and hospitals with demonstrated and consistent acceptable performance of
      these functions.                                                                               
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | HMO Direct Administration.We perform
      all the direct management functions, such as claims payment and medical
      management, mainly on behalf of physician networks that do not have the
      capability to manage the administrative functions associated with operating
      in a capitated environment. In addition, we work with those physicians to
      assist them in developing the capability to assume a greater share of the
      administrative functions. We continue to develop our own expertise in this
      area to ensure that we can continue to build strong networks for our members
      in both existing and new markets where physicians may not be capable of
      performing these functions.



| |  | Risk-based Arrangements.We share the
      risk of health care costs with parties not covered by capitation arrangements.
      Under the majority of our risk-based arrangements, the physician group is
      capitated for physician services only. Therefore, our risk-based contracts
      generally include budgeted amounts for hospital inpatient, outpatient surgery,
      and emergency room service utilization. In some cases, if member utilization
      for hospital services exceeds the agreed upon budgeted amount, we share
      these excess costs with the physician group based on provisions specified
      in the contract. Depending on how the contract is arranged, health care
      costs may be apportioned between two or more entities. For example, we may
      share excess hospital costs with the physician group only or with both the
      physician group and the hospital provider.                                                                                                                                                                         
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Fee-for-Service Arrangements (including
      Directly Contracted Network Model).We contract with other hospitals
      and ancillary providers, as well as some individual physicians or physician
      organizations, to provide services to our members based on modified discounted
      fee schedules (such as the Medicare fee schedule) for the services provided.
      Where the provider community is not organized around aggregate physician
      groups or if it requires more extensive medical management and/or administrative
      services, we contract with physicians through our directly contracted network
      model. This model allows individual physicians to serve our members through
      a program that generally compensates physicians on a discounted fee-for-service
      basis and incorporates some elements of risk-sharing through the development
      and adherence to agreed-upon budgets. Under these arrangements, we perform
      all administrative functions required for effective management of quality,
      medical costs and claims payment.



| |  | The trend away from capitated contracts to risk-based and
      fee-for-service agreements continues, especially for hospital services.
      The percentages of membership by contract type at December 31, 2000
      and 1999 were as follows:
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                           |  |                 |    |           |  |      |    |      |  |  |    |   |  |  |    |  
|-------------------------- |  | --------------- | -- | --------- |  | ---- | -- | ---- |  |  | -- | - |  |  | -- | -
|                           |  | Hospital        |    | Physician
|                           |  |                 |    |          
|                           |  | At December 31,
|                           |  |                
|                           |  | 2000            |    | 1999      |  | 2000 |    | 1999
|                           |  |                 |    |           |  |      |    |     
|Commercial                
|                          
|                          
|                          
|                          
|Capitated                  |  |                 | 57 | %         |  |      | 77 | %    |  |  | 84 | % |  |  | 93 | %
|                          
|                          
|                          
|                          
|Risk-based/fee-for-service |  |                 | 43 | %         |  |      | 23 | %    |  |  | 16 | % |  |  | 7  | %
|                          
|Secure
          Horizons 
|                          
|                          
|                          
|                          
|Capitated                  |  |                 | 65 | %         |  |      | 79 | %    |  |  | 87 | % |  |  | 96 | %
|                          
|                          
|                          
|                          
|Risk-based/fee-for-service |  |                 | 35 | %         |  |      | 21 | %    |  |  | 13 | % |  |  | 4  | %
|                          
|Total                     
|                          
|                          
|                          
|                          
|Capitated                  |  |                 | 59 | %         |  |      | 78 | %    |  |  | 85 | % |  |  | 94 | %
|                          
|                          
|                          
|                          
|Risk-based/fee-for-service |  |                 | 41 | %         |  |      | 22 | %    |  |  | 15 | % |  |  | 6  | %

Physician and Hospital Contracting Risk.Our
  profitability depends, in part, on our ability to control health care costs
  while providing quality care. As we shift from our capitation model to a risk-based
  environment, we face the risk that we will not be able to control our health
  care costs to the same degree as was possible under fully capitated contracts.
  The following are risks associated with our physician and hospital contracting
  arrangements:

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| |  | Insolvency Risk.Under capitated arrangements, we face the risk of a
physician group or physician association becoming insolvent.
Depending on state law, we may be held liable for unpaid health care
claims that were previously the responsibility of the capitated
physician and for which we have already paid capitation. To reduce
this insolvency risk, we have developed contingency plans that include
shifting members to other physicians and reviewing operational and
financial plans to monitor and maximize financial and network
stability. Some of our physicians require more frequent monitoring.
We may incur additional health care costs in the event of physician instability where we are unable to reach an agreement that is
mutually beneficial. These costs may be incurred when we need to
contract with other physicians at less than cost-effective rates to
continue providing health care to our members.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Utilization Risk.Under fee-for-service and risk-based contracts, we
risk incurring higher than expected health care costs due to increased
utilization of hospital and physician services. To reduce the risk of
higher than medically warranted utilization, we are focused on
developing medical management programs to manage health care costs and
investing in the development of systems to monitor and manage the
utilization of health care services, while maintaining quality of
care.                                                                                                                                                                                                                                                                                                                                                                                                                                          

Medical Management.In efforts to reduce the financial risk associated with
risk-based and fee-for-service arrangements, we are focusing on enhancing our
internal medical management programs. Our medical management staff consists of
doctors and nurses who monitor the medical treatment of our members in need of
hospital care. In some cases, our medical managers are located on-site for some
of our key hospitals.

Our medical management programs are composed of:



| |  | a precertification of admission process;
|- |  | ----------------------------------------
| 
| |  | a concurrent review process; and        
| 
| |  | a retrospective review.                 

In the precertification stage, our medical managers are responsible for
determining that requests for hospitalization and specified health care
procedures meet specific clinical criteria and are approved in advance. Our
concurrent review process begins once our member has been admitted to the
hospital for care with our medical managers responsible for providing
administrative oversight of the hospital process. The medical manager is also
responsible for monitoring the discharge process, and coordinating any
outpatient services needed by the patient, including skilled nursing facility,
home nursing care and rehabilitation therapy.

Finally, our retrospective review process occurs when our medical management
staff is not directly involved in the hospitalization of our members. This can
occur when our members receive emergency care at an out-of-area hospital.

With our increased number of risk-based and fee-for-service arrangements, we
have an increased need for medical management. To meet this need, we plan to
increase medical management staffing by 20 percent to more than 800 full-time
employees in 2001.

A small number of our members with chronic diseases continue to drive a
significant portion of our health care costs. Our emphasis on disease
management focuses on member education and prevention to improve our members
health and reduce costs. Our analysis has shown that five percent of seniors
consume more than 50 percent of health care expenses within a year and four
diseases account for 90 percent of the costs within that subset. As a result,
we are developing programs in coronary artery disease, congestive heart
failure, chronic obstructive pulmonary disease and end stage renal disease to
better address the health needs of those patients. We are also entering into
contracts with outside parties to assist us with our disease management
programs.

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Health Care Quality

General.We are convinced that providing our members access to continually
improved health care services leads to improved health for our members. To
assure this, we focus on physician peer review procedures, physician and
hospital quality reviews, member quality initiatives and national industry
measures.

Physician Peer Review Procedures.We have established a comprehensive peer
review procedure at each HMO, governed by a quality improvement committee. The
medical director for each HMO chairs that HMOs committee. Each committee
consists of health plan clinical professionals and physician representatives
from the contracted physician groups. All physicians are initially
credentialed and approved by that HMOs quality improvement committee. The
quality assessment includes evaluating the performance of that physician, as
well as the quality of the providers medical facilities, medical records,
laboratory and x-ray licenses and their capacity to handle membership demands.

Physician and Hospital Quality Reviews.We also engage in ongoing quality
reviews of our existing physicians and hospitals to ensure that members are
receiving quality medical care. A highlight of our physician and hospital
management program is our provider profile, which is a comprehensive, quarterly
risk-adjusted report card of over 80 measures, which helps physicians and
hospitals manage their performance in the areas of clinical quality,
utilization management, service quality and administrative efficiency. In
addition, the provider profile serves as the data source for the Quality Index,
which is a public report on our contracting medical groups performance in the
areas of clinical, service and administrative data quality. This report
provides consumers with information to help them become more active
participants in their health care, beginning with their selection of health
care providers. In addition, the Quality Index has statistically proven to
significantly improve performance and consistency in virtually all indicators
that have been continually measured. Our member information materials
highlight best performing physician groups, so that members have credible and
relevant information by which to select physicians.

Member Quality Initiatives.To improve the quality of service and health for
our members, we have developed a comprehensive quality improvement program that
includes:



| |  | Implementing comprehensive health management programs in diabetes, congestive heart failure, cardiovascular risk reduction
and depression, aimed at improving health outcomes;                                                                                                                                                                                                     
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Conducting preventive health programs, cancer screening, smoking cessation, and senior health risk assessments;                                                                                                                                                                                                                                                                    
| 
| |  | Offering independent external review programs to members in which members can have a service or treatment denial of
coverage decision reviewed by a physician or panel of physicians outside their health plan;                                                                                                                                                                    
| 
| |  | Decreasing inappropriate denials and improving the appeals process for our members;                                                                                                                                                                                                                                                                                                
| 
| |  | Standardizing and streamlining our specialty provider referral process;                                                                                                                                                                                                                                                                                                            
| 
| |  | Utilizing our JustOne/Ready Reply approach in California, Oklahoma and Texas, which is designed to resolve members
issues and answer questions with a single phone call by the member. We handle all necessary contact between the plan,
physicians, hospitals and medical groups through the final resolution of the issue, and then report the outcome to the
member;         
| 
| |  | Participating in the Coalition for Affordable Quality Health Cares voluntary quality initiative. Along with 21 other
organizations, we have committed to enabling consumers to have access to quality coverage and information; improving
administrative simplicity for doctors and consumers; and working with doctors to improve overall health care quality and
patient safety;
| 
| |  | Monitoring member satisfaction through surveys and internal operational report cards compared to our current established
benchmarks; and                                                                                                                                                                                                                                           
| 
| |  | Providing members free access to in-depth health information on thousands of topics via the Internet at www.pacificare.com.                                                                                                                                                                                                                                                        

National Industry Measures.The National Committee for Quality Assurance
(NCQA) is an independent, non-profit organization that reviews and accredits
HMOs. Our HMOs provide quality and service information under NCQAs Health
Plan Employer Data Information Set program. NCQA also performs site reviews to
determine if an HMO complies with standards it has established for

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quality improvement, utilization management, physician and hospital credentialing and a
commitment to members rights and preventive health services. HMOs that comply
with NCQAs review requirements and quality standards receive NCQA
accreditation. We have improved our NCQA scores by implementing our membership
and physician and hospital quality programs. At
December 31, 2000, our HMOs in Arizona, California, Colorado, Nevada, Oklahoma,
Oregon, Texas and Washington (covering approximately 98 percent of our
membership) have received either commendable or excellent three-year NCQA
accreditation.

Risk Management

We shift part of our risk of catastrophic losses by maintaining reinsurance
coverage for specified hospital costs incurred in the treatment of catastrophic
illnesses. We require contracting physicians, physician groups and hospitals
to maintain individual malpractice insurance coverage. We also maintain
general liability, property, managed care errors and omissions and medical
malpractice insurance coverage in amounts that we believe to be adequate.

Government Regulation and Proposed Legislation

General.Our HMOs are subject to extensive federal and state regulations that
govern the scope of benefits provided to our members, financial solvency
requirements, claims processing, quality assurance and utilization review
procedures, member grievance procedures, physician and hospital contracts,
marketing and advertising. Our HMOs are also required to maintain restricted
cash reserves represented by interest-bearing investments that are held by
trustees or state regulatory agencies. These requirements, which limit the
ability of our subsidiaries to transfer funds, may also limit their ability to
pay dividends. From time to time, we advance funds to our subsidiaries to
assist them in satisfying federal or state financial requirements. Our
behavioral health, insurance and dental subsidiaries are also subject to
extensive federal and state regulation.

HCFA.Our Secure Horizons program is subject to regulations by HCFA, the
United States Department of Health and Human Services and state regulatory
entities. These agencies govern the benefits provided, premiums paid, quality
assurance procedures, marketing and advertising for our Medicare+Choice
products. See Business Operations  Secure Horizons Program. Congress
enacted the Balanced Budget Act of 1997 (BBA), which required the creation of
the Medicare+Choice program as a replacement to the Medicare Risk program.
HCFA has since promulgated regulations, operational policy letters and
contracts implementing Medicare+Choice, including the Balanced Budget
Refinement Act of 1999 and the Benefits Improvement and Protection Act of 2000
(BIPA). These contracts and regulations established new and expanded
requirements for Medicare+Choice organizations. They also establish new or
expanded standards for quality assurance, beneficiary protection, coordinated
open enrollment, program payment and audits, information disclosure and
physician and hospital participation. Compliance with Medicare+Choice
regulations has and will continue to increase our Medicare administration
costs. BIPA was passed by Congress in December 2000, effective for 2001.
Under the new law, Medicare+Choice will receive increased government funding
over the next five years beginning in March 2001. The changes for 2001 include
increases to the monthly minimum payment floors, increases in the minimum
annual payment update from two percent to three percent and modifications to
the risk adjuster. See Secure Horizons Program  Premiums.

It is possible that future legislation may create additional changes in the
payment formula or risk adjuster. However, it is not certain that efforts to
revise the laws governing the Medicare+Choice program will succeed. The loss
of Medicare contracts or changes in the program could have a material effect on
our financial position, results of operations or cash flows of a future period.

Adjusted Community Rate Filings. As a result of the Balanced Budget Act of
1997 and related HCFA rules and regulations, our HMO subsidiaries are required
to submit separate adjusted community rate (ACR) proposals for every
Medicare+Choice plan they offer to Medicare beneficiaries. These rates are
based upon our average commercial rate (for non-Medicare enrollees) modified by
a factor that represents the difference in utilization characteristics between
Medicare and non-Medicare enrollees within each geographic area. In effect,
our benefits structure for Secure Horizons is established based on these rates.

Each of our subsidiaries must submit the ACR proposals, generally by county or
service area, to HCFA by July 1 for each Medicare+Choice plan offered in the
subsequent year. In the normal course of business, all information submitted
as part of the ACR process is subject to audit by HCFA or any person or
organization designated by HCFA. Our ACR proposal is based on historical data
and information available to us at the time of the filing. Potential changes
to physician and hospital contracts and market and/or competitive conditions
may cause actual results to vary from the projections submitted. In January
2000, HCFA contracted with the Office of Inspector General of the United States
Department of Health and Human Services to conduct more comprehensive audits on
one-third of all ACR filings as mandated by law. During 2000, audits were
conducted in Colorado, Nevada and Texas. No violations were noted as a result
of the audits. In addition to the regular ACR proposals submitted in 2000,
Medicare+Choice plans were required to re-submit ACR proposals in January 2001
in accordance with BIPA. In our ACR resubmission, BIPA required that we

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use increased funding to do one or a combination of the following: to reduce member
premiums or cost sharing; to enhance benefits; to contribute to a benefits
stabilization fund; or to stabilize or enhance beneficiary access to physicians
and hospitals (so long as such action does not result in increased beneficiary
premiums, cost-sharing, or reduced benefits). Our January 2001 ACR submission
has been filed in accordance with BIPA and accompanying ACR instructions, and
has been accepted by HCFA.

Employee Retirement Income Security Act of 1974 (ERISA).Pursuant to ERISA,
the federal government regulates insured and self-insured health coverage plans
offered by employers. There have been recent highly publicized legislative
attempts to amend ERISA to remove the current limitation on the ability of
states to regulate employer health plans and the limitations on an employees
ability to sue a health plan under state law. If such proposals were enacted,
states may have the ability to regulate other aspects of our business
operations, and increase our exposure to state law claims that relate to
employee health benefits. If such proposals were enacted, the federal
government may propose rules on claims payment and appeals processes which
accomplish the intent of the proposed Patient Bill of Rights. Additionally, if
such proposals were enacted, they may result in increased operating costs.

Health Insurance Portability and Accountability Act of 1996 (HIPAA).HIPAA
s federal standards apply to both the group and individual health insurance
markets. HIPAA requires us to:



| |  | Guarantee the availability and renewability of health insurance for certain employers, employees and individuals;
|- |  | -----------------------------------------------------------------------------------------------------------------
| 
| |  | Limit the use of preexisting condition exclusions;                                                               
| 
| |  | Disclose prior coverage; and                                                                                     
| 
| |  | Make it easier for members to continue coverage in cases where an employee is terminated or changes employers.   

HIPAA also prohibits us from discriminating against potential enrollees on the
basis of health status. HIPAA includes administrative simplification
provisions directed at standardizing transactions and codes, establishing
uniform health care provider, payor, employer and patient identifiers and
seeking protections for confidentiality and security of patient data.
Publication of the HIPAA proposed and final rules has occurred in phases. The
first set of final rules, which focus on data standards and code sets, were
published in August 2000. Given the 26-month implementation window (from final
rule publication date), compliance is required for the data standards and code
sets by October 2002. We have reviewed our systems and processes for
compliance with the data standard requirements, and are planning 2001
activities to implement the new data requirements. We are also working with
various groups to find a common way to work with external business associates,
such as physicians and hospitals, to ensure their compliance with the HIPAA
rules. We estimate that our HIPAA compliance costs will approximate $20
million in 2001. Our estimate of HIPAA compliance costs may change as current
HIPAA rules evolve and additional rules are released or as we continue to
evaluate the work required to modify our existing information technology and
development systems.

Both federal and state regulators have enforcement responsibilities for HIPAA.
As a result, we may encounter different interpretations of HIPAAs provisions
in the different states, as well as varying enforcement philosophies in states
where we operate HMOs. These differences may inhibit our ability to
standardize our products and services across state lines. Ultimately, under
HIPAA and other state laws, cost control through physician and hospital
contracting and coordinating care may become more important, and we believe our
experience in these areas will allow us to compete effectively.

OPM.We have commercial contracts with OPM to provide managed health care
services to federal employees, annuitants and their dependents under the FEHBP.
Rather than negotiating rates with us, OPM requires us to provide the FEHBP
with rates comparable to the rates charged to the two employer groups with
enrollment closest in size to the FEHBP in the applicable community after
making required adjustments. OPM further requires us to certify each year that
its rates meet these requirements.

Periodically, OPMs Office of Inspector General (OIG) audits us to verify
that the premiums charged are calculated and charged in compliance with these
regulations and guidelines. Each audit encompasses a period of up to six
years. Following the governments initial on-site audit, OPM will provide us
with a post-audit briefing indicating its preliminary results. Interpretations
of the rating regulations and audit findings often raise complex issues. The
final resolution and settlement of audits have historically taken more than
three years and as many as seven years. We have a number of pending audits
that we are seeking to resolve with the United States Department of Justice
(DOJ).

During the audit process, OPM may refer its findings to the DOJ if it believes
that we knowingly overcharged the government or otherwise submitted false
documentation or certifications in violation of the False Claims Act. Under
the False Claims Act, an action

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can be considered knowingly committed if the government contractor acted with actual knowledge, or with reckless disregard
or deliberate ignorance of the governments rules and regulations. If the
government were to win a False Claims Act lawsuit against us, the government
could obtain trebled damages, a civil penalty of not less than $5,000 nor more
than $10,000 for each separate alleged false claim, and the government could
permanently disqualify us from participating in all federal government
programs.

In late 1997, we established a formal compliance program to specifically
address potential issues that may arise from the FEHBP rating process, to work
with OPM to understand its interpretation of the rules and guidelines prior to
completion of the rating process, to standardize the FEHBP rating
process among all of our HMOs, and
to help reduce the likelihood that future government audits will result in any
significant findings. Based on the results of a limited number of audits that
have been conducted for contract years 1998 and later, we believe that this
program has been effective. See Item 3. Legal Proceedings  OPM Litigation and
Note 10 of the Notes to Consolidated Financial Statements for a further
discussion of OPM matters referred to the DOJ.

Management Information Systems

General.We use computer-based management information systems for various
purposes, including e-commerce, marketing and sales tracking, underwriting,
billing, claims processing, medical management, medical cost and utilization
trending, financial and management accounting, reporting, planning and
analysis. These systems also support member, employer group and physician and
hospital service functions, including on-line access to membership
verification, claims and referral status and information regarding hospital
admissions and lengths of stay. In addition, these systems support our
tracking and extensive analyses of cost and outcome data.

We continually enhance and upgrade our computer information systems to preserve
our investment in existing systems, embrace new technologies, improve the cost
effectiveness and quality of our services, introduce new products, and continue
to meet legal and regulatory requirements. Ongoing system investments include
upgrading system platforms, enhancing existing software, implementing purchased
software, migrating to more suitable software database environments and making
other investments required to make our systems comply with HIPAA.
Simplification, integration and expansion of the systems servicing our business
are important components of controlling health care and administrative expenses
and improving member and physician and hospital satisfaction. We selectively
outsource some technical functions and employ third-party data collection
agencies for electronic data interfaces (EDI) to receive claims
electronically. We have recovery plans in place to mitigate the effect of
information systems outages, if necessary. To the extent that these systems
fail to operate, however, it could have a material effect on results of
operations or cash flows of a future period.

Claims Processing Systems.We use computer based information systems as an
important component of claims processing. We receive medical claims from
physicians and hospitals for services to our members. Claims are reviewed to
determine member eligibility, the quantity and kind of services performed and
whether services were authorized. To ensure accuracy, we regularly review
reports on inventory levels and claims statistics that focus on claims
turn-around and accuracy of payment.

Under our capitated contracts, most of our physicians and hospitals have
qualified through our assessment processes to perform administration functions,
including claims processing. Under our risk-based contracts, we perform
administrative functions, including claims processing. Due to the trend away
from capitated contracts to risk-based and fee-for-service arrangements, we
have increasing financial and regulatory risk for the accurate and timely
processing of claims.

The California Department of Managed Health Care issued a censure against us
for late payment of claims to physicians and hospitals. In March of 2001, we
reached a settlement with the Department of Managed Health Care, whereby
related interest and penalties will not exceed $3 million. We expect to
complete payment for the claims and interest by the end of March 2001, bringing
us in full compliance. The late payments were caused by the rapid shift from
capitation contracts to risk-based and fee-for-service arrangements. Because
of the shift, we experienced a dramatic increase in claims volume in
California. We have taken steps to correct the situation.

As part of our efforts, we upgraded our claims processing software and enhanced
our EDI submission and batch processing capabilities. To further reduce our
financial and regulatory risk associated with the accurate and timely
processing of claims, we intend to:



| |  | Eliminate retroactive provider contracts to better manage our costs and claims volume fluctuations;
|- |  | ---------------------------------------------------------------------------------------------------
| 
| |  | Streamline medical management practices to improve administration;                                 

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| |  | Increase claims processing staff to support the higher level of claims volume associated with risk-based arrangements; and
|- |  | --------------------------------------------------------------------------------------------------------------------------
| 
| |  | When necessary, consider using third-party administrators to leverage our existing claims processing capabilities.        

Competition

In general, the health care industry has experienced significant consolidation.
Acute care hospitals have consolidated, increasing their leverage in the
market place. Continued consolidation of insurance carriers, other HMOs,
employer self-funded programs and PPOs, some of which have substantially larger
enrollments or greater financial resources than ours, have created competition
for physicians, hospitals and members, impacting profitability and the ability
to influence medical management. Pharmacy benefit management companies have
continued to consolidate, competing with the pharmacy cost management
capability of our wholly owned subsidiary, Prescription Solutions.

In offering health insurance coverage, we compete with CIGNA Health
Corporation, Aetna U.S. Healthcare Inc. and UnitedHealth Group for membership
from national employers. We also compete with regional HMOs and small group
employers, which vary depending on the geographic market. Regional competitors
include Kaiser Foundation Health Plan, Health Net Inc., WellPoint Health
Networks Inc., and Humana Inc. We also offer a regional alternative for
national employers who are willing to support multiple health plans to maintain
plans that best suit the needs of employees within a specific region.

We have the highest Medicare membership in the nation, both in absolute terms
and as a percentage of overall membership, offering competitive advantages and
economies of scale in the Medicare+Choice market. Many health plans have
exited the Medicare HMO market due to changes in federal law that reduced
Medicare reimbursement rates. While we have benefited in certain regions from
our competitors market exits, the long-term impact of reduced federal funding
on enrollment trends in Medicare+Choice HMO programs is uncertain.

Other competitors include hospitals, health care facilities and other health
care providers. These competitors have combined to form their own networks to
contract directly with employer groups, and other prospective customers for the
delivery of health care services.

Our pharmacy benefit management company, Prescription Solutions, is an integral
part of our commercial and Medicare products; however, Prescription Solutions
is also sold as a stand-alone product supporting members of other health plans
and employer groups. Competitors include Merck-Medco Managed Care, WellPoint
Pharmacy Management, Med Impact, Express Scripts and Advance PCS. We believe,
when aligned with an HMO, Prescription Solutions differentiates itself from
other pharmacy benefit organizations by managing prescription costs and
outcomes for the HMO members. Our mail-order prescription drug service
competes with national, regional and local pharmacies and other mail-order
prescription drug companies.

PacifiCare Behavioral Health of California, Inc. and PacifiCare Behavioral
Health, Inc. serve our HMO members in California, Colorado, Oklahoma, Oregon,
Texas and Washington, as well as non-PacifiCare HMO members in Arizona and New
Mexico. California is among many states that have adopted parity legislation,
requiring employers to offer equal coverage for mental health benefits, which
we believe enhances our behavioral health business future growth potential.
Competitors may include other behavioral health plans and employers that move
to self-insurance.

We believe that to retain our health plans competitive advantages we should
continue to focus on developing additional products and services and eliminate
or limit growth of unprofitable products. We believe that consumers want
products and services that go beyond basic necessity and extend to areas such
as lifestyle, senior independent living and financial security. The factors
that we believe give us competitive advantages are:



| |  | Our significant existing market position in our geographic areas of operation;                   
|- |  | -------------------------------------------------------------------------------------------------
| 
| |  | Our long-term operating experience in managed care;                                              
| 
| |  | Our generally favorable marketplace reputation with physicians, hospitals, members and employers;
| 
| |  | A strong brand identity for Secure Horizons;                                                     
| 
| |  | Our emphasis on providing high quality customer service; and                                     



| |  | Our continual improvement of the quality of care provided to our members.
|- |  | -------------------------------------------------------------------------

12



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##### Table of Contents



Trademarks

We own the federally registered service marks
PacifiCare®, SecureHorizons® and Prescription Solutions®. These service marks are material to our
business.

Employees

At February 28, 2001, we had approximately 9,200 full and part-time employees.
None of our employees are presently covered by a collective bargaining
agreement. We consider relations with our employees to be good and have never
experienced any work stoppage.







ITEM 2. PROPERTIES

As of December 31, 2000, we leased approximately 178,000 aggregate square feet
of space for its principal corporate headquarters and executive offices in
Costa Mesa and Santa Ana, California. In connection with our operations, as of
December 31, 2000, we leased approximately 1.9 million aggregate square feet
for office space, subsidiary operations, customer service centers and space for
computer facilities. Such space corresponds to areas in which our HMOs or
specialty managed care products and services operate, or where we have
satellite administrative offices. Our leases expire at various dates from 2001
through 2010.

We own seven buildings encompassing approximately 367,000 aggregate square feet
of space. Two of the buildings, representing approximately 225,000 aggregate
square feet of space, are primarily used for administrative operations and are
located in California and Guam. The remaining five buildings are medical
office buildings, of which four are leased to third parties under a master
lease agreement. All five medical buildings are being marketed for sale. We
also own one parcel of vacant land for a total of two acres, which is being
marketed for sale.

Our facilities are in good working condition, are well maintained and are
adequate for our present and currently anticipated needs. We believe that we
can rent additional space at competitive rates when current leases expire, or
if we need additional space.

13



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##### Table of Contents









ITEM 3. LEGAL PROCEEDINGS

OPM Litigation.We have contracts that were audited by the OIG, that we
acquired through our merger with FHP International Corporation (FHP) in 1997.
The OIG is alleging that the former FHP Arizona, California, Colorado, Guam
and Ohio HMO subsidiaries as well as former FHP Illinois, New Mexico and Utah
HMO subsidiaries that we sold in 1997 and 1998, overcharged the government from
1990 through 1997. Several of these contract years have already been audited,
but are yet to be settled. We responded to the audit reports, challenging
many of the auditors assertions. OIGs allegations were referred to the DOJ
for review of potential claims under the False Claims Act. We do not believe
there is any evidence that we engaged in any action that would violate
the False Claims Act.

The OIG conducted an audit of our Oregon HMO subsidiary. The OIG issued a
draft audit report in July 1997, alleging that we overcharged the government
for contract years 1991 through 1996. We responded to this draft audit report
in April 1998, strongly disagreeing with OIGs claims. In March 2000, we were
notified that the auditors had referred the above-mentioned audit report to the
DOJ for review of potential claims under the False Claims Act. We do not
believe there is any evidence that we engaged in any action that would
violate the False Claims Act. When our legal counsel met with the U.S.
Attorney in May 2000, the U.S. Attorney stated that a letter would be sent
specifying additional information that was needed. No letter has been received
to date. The DOJ has until June 1, 2001 to decide whether to file a claim.

The OIG conducted an audit of our California HMO subsidiary. The OIG issued a
draft audit report in January 1998, alleging that we overcharged the government
for contract years 1993 through 1996. We responded to this draft audit report
in May 1998, strongly disagreeing with OIGs claims. In January 2001, we were
notified that the auditors had referred the above-mentioned audit report to the
DOJ for review of potential claims under the False Claims Act. We do not
believe there is any evidence that we engaged in any action that would
violate the False Claims Act.

We intend to continue to negotiate with OPM on any existing or future
unresolved matters to attain a mutually satisfactorily result. We cannot be
certain that any ongoing future negotiations will be concluded satisfactorily,
that additional audits will not be referred to the DOJ or that additional,
possibly material, liabilities will not be incurred. Such liability could have
a material effect on our results of operations or cash flows of a future period
if resolved unfavorably.

Class Action Legal Proceedings.On November 21, 2000, Michael Russ filed a
purported class action complaint against PacifiCare and several of our present
and former directors and executive officers in the Central District of
California. At least four other complaints have been filed against PacifiCare
and several present and former directors and executive officers in the same
court. Each of these complaints relates to the same subject matter and will
likely be consolidated. The complaints relate to the period between October
27, 1999 and October 10, 2000. The complaints primarily allege that we made
false projections about our financial performance in 2000. We deny all
material allegations and intend to defend the actions vigorously.

On November 2, 1999, Jose Cruz filed a purported class action complaint against
PacifiCare, our California subsidiary, and FHP in the San Francisco Superior
Court. On November 9, 1999, Cruz filed a first amended purported class action
complaint that omitted FHP as a defendant. The amended complaint relates to
the period from November 2, 1995 to the present and purports to be filed on
behalf of all enrollees in our health care plans operating in California other
than Medicare and Medicaid enrollees. The amended complaint alleges that we
have engaged in unfair business acts in violation of California law, engaged in
false, deceptive and misleading advertising in violation of California law and
violated the California Consumer Legal Remedies Act. It also alleges that we
have received unjust payments as a result of our conduct. The amended
complaint seeks injunctive and declaratory relief, an order requiring the
defendants to inform and warn all California consumers regarding our financial
compensation programs, unspecified monetary damages for restitution of premiums
and disgorgement of improper profits, attorneys fees and interest. We moved
to compel arbitration and the court denied our motion. We have filed an appeal
on this denial and deny all material allegations in the amended complaint and
intend to defend the action vigorously.

On November 22, 1999, Debbie Hitsman filed a purported class action complaint
against PacifiCare in the United States District Court for the Southern
District of Mississippi, Hattiesburg Division. The complaint relates to the
period from November 22, 1995 to the present and purports to be on behalf of
all enrollees in our health care plans other than Medicare and Medicaid
enrollees. The complaint alleges causes of action for violations of the
Racketeer-Influenced and Corrupt Organizations Act and ERISA. The complaint
seeks an unspecified amount of compensatory and treble damages, injunctive and
restitutionary relief, attorneys fees, the imposition of a constructive trust
and interest. On June 23, 2000, Hitsman filed and served an additional
complaint in the United States District Court for the Southern District of
Miami as a purported part of a multi-district litigation proceeding against
another managed care company, Humana. Subsequently, Dr. Dennis Breen and other
doctors joined the Florida proceeding making

14



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##### Table of Contents



allegations similar to those from
other providers. These providers, including the California Medical
Association, accuse us of imposing unfair contract terms, unnecessarily denying
health care for our members, delaying payments for authorized health care and
reimbursing physicians at rates that are not sufficient to cover the
physicians cost of providing the health care.

In October 2000, the multi-district litigation panel consolidated the Hitsman
cases, the Breen case, the California Medical Association case and certain provider cases in the Southern District of
Florida. In December 2000, the court granted our motion to compel arbitration
of all of the Hitsman claims and all of Dr. Breens claims except for his
claims for violations of the Racketeer-Influenced and Corrupt Organizations Act
and conspiracy and aiding and abetting claims that stem from contractual
relationships with other managed care companies. We have appealed the denial
of the arbitration of these claims. Our motion to dismiss the Breen claims
was granted, with permission to amend. An amended complaint is
anticipated. We deny all material allegations and
intend to defend the actions vigorously.

In 1997, William Madruga and another individual filed a purported class action
suit against PacifiCare and several of our directors and officers in the United
States District Court for the Central District of California. The complaint
relates to the period from the date of proxy statement for the FHP acquisition
through our November 1997 announcement that earnings for the fourth quarter of
1997 would be lower than expected. The complaint primarily alleges that we
previously omitted and/or misrepresented material facts with respect to our
costs, earnings and profits. In November 1999, May 2000 and again in January
2001, the court dismissed the Madruga case in part without permission to amend
and in part with permission to amend the complaint. The plaintiffs filed a
fourth amended complaint in March 2001. We deny all material allegations and intend to defend the actions
vigorously.

Industry Litigation.In 2000, Aetna U.S. Healthcare, Inc. and affiliated
entities (Aetna) settled claims brought by the Attorney General of Texas by
consenting to modify some of its business practices in Texas. The Attorney
General of Texas has filed similar claims against our Texas HMO and has
proposed to settle the lawsuit on the same terms as the Aetna settlement. The
business practices in question relate primarily to our Texas HMOs commercial
operations. Resolution of a proposed settlement is still pending. We are
unable to predict whether we will ultimately reach a settlement with the
Attorney General on these or other terms or the impact that the ultimate
settlement could have on our operations. These changes ultimately could
adversely affect the HMO industry and could have a material effect on our
financial position, results of operations or cash flows of a future period.

We are involved in legal actions in the normal course of business, some of
which seek monetary damages, including claims for punitive damages which are
not covered by insurance. Based on current information and review, including
consultation with our lawyers, we believe any ultimate liability that may arise
from these actions (including all OPM litigation, class action
legal proceedings and industry litigation) would not materially affect our
consolidated financial position, results of operations or cash flows. However,
our evaluation of the likely impact of these actions could change in the future
and an unfavorable outcome, depending upon the amount and timing, could have a
material effect on our results of operations or cash flows of a future period.







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

No matter was submitted to a vote of security holders during the three months
ended December 31, 2000.

15



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##### Table of Contents









PART II







ITEM 5. MARKET FOR THE COMPANYS COMMON
  EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed on the Nasdaq National Market under
  the symbol PHSY. The following table indicates the high and low reported sale
  prices per share as furnished by Nasdaq.

|                                       |                             |  |      |         |     |  |   |        | 
|-------------------------------------- | --------------------------- |  | ---- | ------- | --- |  | - | ------ | 
|                                       |                             |  | High |         | Low
|                                       |                             |  |      |         |    
|Year
          ended December 31, 2000
|                                      
|                                      
|                                      
|                                      
|                                       | First
          Quarter     |  | $    | 53.750  |     |  | $ | 40.500 | 
|                                      
|                                      
|                                      
|                                      
|                                       | Second
          Quarter    |  | $    | 72.313  |     |  | $ | 43.625 | 
|                                      
|                                      
|                                      
|                                      
|                                       | Third
          Quarter     |  | $    | 72.313  |     |  | $ | 34.625 | 
|                                      
|                                      
|                                      
|                                      
|                                       | Fourth
          Quarter    |  | $    | 38.250  |     |  | $ | 9.813  | 
|                                      
|                                      
|                                      
|                                      
|                                      
|Year
          ended December 31, 1999
|                                      
|                                      
|                                      
|                                      
|                                       | First
          Quarter(1)  |  | $    | 82.875  |     |  | $ | 63.500 | 
|                                      
|                                      
|                                      
|                                      
|                                       | Second
          Quarter(1) |  | $    | 100.375 |     |  | $ | 60.500 | 
|                                      
|                                      
|                                      
|                                      
|                                       | Third
          Quarter     |  | $    | 72.125  |     |  | $ | 42.000 | 
|                                      
|                                      
|                                      
|                                      
|                                       | Fourth
          Quarter    |  | $    | 59.000  |     |  | $ | 31.125 | 



---

|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) |  | At our June 24, 1999 annual meeting, our
      Class A and Class B common stockholders approved an amended and
      restated certificate of incorporation, which combined and reclassified our
      Class A and Class B common stock into a single class of voting
      common stock. The 1999 first and second quarter information listed above
      indicate the high and low reported sales price per share for the Class B
      common stock. See Note 6 of the Notes to Consolidated Financial Statements.

We have never paid cash dividends on our common stock. We do
  not expect to declare dividends on our common stock in the future, retaining
  all earnings for business development. Any possible future dividends will depend
  on our earnings, financial condition, and regulatory requirements. If we decide
  to declare common stock dividends in the future, such dividends may only be
  made in shares of our common stock, according to the terms of our credit facility.
  See Note 6 of the Notes to Consolidated Financial Statements.

As of February 28, 2001 there were 287 stockholders of
  record of our common stock.

16



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##### Table of Contents









ITEM 6. SELECTED FINANCIAL DATA

In February 1997, our board of directors approved a change
  in our fiscal year end from September 30 to December 31. This resulted
  in a transition period for October 1, 1996 through December 31, 1996.
  The following selected financial and operating data are derived from our audited
  consolidated financial statements, or from our unaudited internal financial
  data. For clarity of presentation and comparability, the following selected
  financial and operating data includes the unaudited period for the twelve months
  ended December 31, 1996. The selected financial and operating data should
  be read in conjunction with Item 7. Managements Discussion
  and Analysis of Financial Condition and Results of Operations, and also
  with Item 8. Consolidated Financial Statements and Supplementary
  Data.

INCOME STATEMENT DATA

|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |           |  
|--------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | - | ----------------------------------------------------- | --------- | ------------ | - | ------------ | --------- | ------------ | - | ------------ | --------- | ------------ | - | ------------- | --------- | - | - | ----------- | --------- | ------- | - | ----------- | --------- | - | - | --------- | --------- | -
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   | (Transition
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   | (Unaudited) |           | Period)
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   | Twelve      |           | Three  
|                                                                                              |                                                                              |   | Year Ended                                            |           | Year Ended   |   | Year Ended   |           | Year Ended   |   | Months Ended |           | Months Ended |   | Year Ended   
|                                                                                              |                                                                              |   | December 31,                                          |           | December 31, |   | December 31, |           | December 31, |   | December 31, |           | December 31, |   | September 30,
|                                                                                              |                                                                              |   | 2000 (1)                                              |           | 1999 (2)     |   | 1998 (3)     |           | 1997 (4)     |   | 1996 (5)     |           | 1996         |   | 1996 (5)     
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |              
|                                                                                              |                                                                              |   | (amounts in thousands,
        except per share data)
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Operating
          revenue                                                                   |                                                                              | $ | 11,467,927                                            |           |              | $ | 9,989,090    |           |              | $ | 9,521,482    |           |              | $ | 8,982,680     |           |   | $ | 4,807,856   |           |         | $ | 1,234,875   |           |   | $ | 4,637,305 |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Expenses:                                                                                    
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Health
          care services                                               |   |                                                       | 9,913,657 |              |   |              | 8,368,690 |              |   |              | 8,002,260 |              |   |               | 7,658,879 |   |   |             | 4,017,383 |         |   |             | 1,039,345 |   |   |           | 3,872,747 |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Other
          operating expenses                                           |   |                                                       | 1,286,790 |              |   |              | 1,181,773 |              |   |              | 1,166,011 |              |   |               | 1,125,299 |   |   |             | 605,546   |         |   |             | 154,996   |   |   |           | 585,081   |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Impairment,
          disposition, restructuring and other charges (credits) |   |                                                       | 11,730    |              |   |              | (2,233    | )            |   |              | 15,644    |              |   |               | 154,507   |   |   |             | 75,840    |         |   |             |          |   |   |           | 75,840    |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Office
          of Personnel Management (credits) charges                   |   |                                                       | (2,964    | )            |   |              |          |              |   |              | (4,624    | )            |   |               |          |   |   |             | 25,000    |         |   |             |          |   |   |           | 25,000    |  
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Operating
          income                                                                    |                                                                              |   | 258,714                                               |           |              |   | 440,860      |           |              |   | 342,191      |           |              |   | 43,995        |           |   |   | 84,087      |           |         |   | 40,534      |           |   |   | 78,637    |          
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Net investment
          income and interest expense                                          |                                                                              |   | 28,735                                                |           |              |   | 41,049       |           |              |   | 43,383       |           |              |   | 16,129        |           |   |   | 44,696      |           |         |   | 12,302      |           |   |   | 44,143    |          
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Minority
          interest in consolidated subsidiary                                        |                                                                              |   | 637                                                   |           |              |   |             |           |              |   |             |           |              |   |              |           |   |   |            |           |         |   |            |           |   |   |          |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Income
          before income taxes                                                          |                                                                              |   | 288,086                                               |           |              |   | 481,909      |           |              |   | 385,574      |           |              |   | 60,124        |           |   |   | 128,783     |           |         |   | 52,836      |           |   |   | 122,780   |          
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Provision
          for income taxes                                                          |                                                                              |   | 127,046                                               |           |              |   | 203,365      |           |              |   | 183,147      |           |              |   | 81,825        |           |   |   | 53,052      |           |         |   | 21,079      |           |   |   | 50,827    |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Net income
          (loss)                                                                   |                                                                              | $ | 161,040                                               |           |              | $ | 278,544      |           |              | $ | 202,427      |           |              | $ | (21,701       | )         |   | $ | 75,731      |           |         | $ | 31,757      |           |   | $ | 71,953    |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Preferred
          dividends                                                                 |                                                                              |   |                                                      |           |              |   |             |           |              |   | (5,259       | )         |              |   | (8,792        | )         |   |   |            |           |         |   |            |           |   |   |          |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Net income
          (loss) available to common stockholders                                  |                                                                              | $ | 161,040                                               |           |              | $ | 278,544      |           |              | $ | 197,168      |           |              | $ | (30,493       | )         |   | $ | 75,731      |           |         | $ | 31,757      |           |   | $ | 71,953    |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Basic
          earnings (loss) per share (6)                                                 |                                                                              | $ | 4.59                                                  |           |              | $ | 6.26         |           |              | $ | 4.50         |           |              | $ | (0.75         | )         |   | $ | 2.43        |           |         | $ | 1.01        |           |   | $ | 2.31      |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|Diluted
          earnings (loss) per share (6)                                               |                                                                              | $ | 4.58                                                  |           |              | $ | 6.23         |           |              | $ | 4.40         |           |              | $ | (0.75         | )         |   | $ | 2.39        |           |         | $ | 1.00        |           |   | $ | 2.27      |          
|                                                                                              |                                                                              |   |                                                       |           |              |   |              |           |              |   |              |           |              |   |               |           |   |   |             |           |         |   |             |           |   |   |           |          
|OPERATING
          STATISTICS                                                               
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Medical
          care ratio (health care services as a percentage of premium revenue)       
|                                                                                              |                                                                             
|                                                                                              | Consolidated                                                                 |   |                                                       | 87.5      | %            |   |              | 84.8      | %            |   |              | 85.0      | %            |   |               | 85.7      | % |   |             | 84.5      | %       |   |             | 85.1      | % |   |           | 84.4      | %
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Commercial                                                                   |   |                                                       | 85.1      | %            |   |              | 81.7      | %            |   |              | 82.8      | %            |   |               | 85.8      | % |   |             | 82.8      | %       |   |             | 84.4      | % |   |           | 83.1      | %
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Medicare                                                                     |   |                                                       | 89.4      | %            |   |              | 86.9      | %            |   |              | 86.5      | %            |   |               | 85.6      | % |   |             | 85.6      | %       |   |             | 85.5      | % |   |           | 85.4      | %
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Marketing,
          general and administrative expenses as a percentage of operating revenue |                                                                              |   | 10.5                                                  | %         |              |   | 11.1         | %         |              |   | 11.4         | %         |              |   | 11.7          | %         |   |   | 12.4        | %         |         |   | 12.4        | %         |   |   | 12.4      | %        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Operating
          income as a percentage of operating revenue                               |                                                                              |   | 2.3                                                   | %         |              |   | 4.4          | %         |              |   | 3.6          | %         |              |   | 0.5           | %         |   |   | 1.7         | %         |         |   | 3.3         | %         |   |   | 1.7       | %        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Effective
          tax rate (7)                                                              |                                                                              |   | 44.1                                                  | %         |              |   | 42.2         | %         |              |   | 47.5         | %         |              |   | 136.1         | %         |   |   | 41.2        | %         |         |   | 39.9        | %         |   |   | 41.4      | %        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Return
          on average stockholders equity                                              |                                                                              |   | 8.1                                                   | %         |              |   | 13.2         | %         |              |   | 9.4          | %         |              |   | (1.5          | )%        |   |   | 9.3         | %         |         |   | 3.9         | %         |   |   | 9.3       | %        

See footnotes following Balance Sheet Data.Continued on next page.

17



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##### Table of Contents



|                                                         |  |              |           |              |  |              |           |              |  |              |           |               |  |   |           |  |  |   |           |  |  |   |           | 
|-------------------------------------------------------- |  | ------------ | --------- | ------------ |  | ------------ | --------- | ------------ |  | ------------ | --------- | ------------- |  | - | --------- |  |  | - | --------- |  |  | - | --------- | 
|                                                         |  | December 31, |           | December 31, |  | December 31, |           | December 31, |  | December 31, |           | September 30,
|                                                         |  | 2000         |           | 1999         |  | 1998         |           | 1997         |  | 1996         |           | 1996         
|                                                         |  |              |           |              |  |              |           |              |  |              |           |              
|MEMBERSHIP
          DATA                               
|                                                        
|                                                        
|                                                        
|                                                        
|Commercial                                               |  |              | 2,953,300 |              |  |              | 2,643,400 |              |  |              | 2,554,100 |               |  |   | 2,790,000 |  |  |   | 1,451,500 |  |  |   | 1,434,500 | 
|                                                        
|                                                        
|                                                        
|                                                        
|Medicare                                                 |  |              | 1,056,700 |              |  |              | 1,014,600 |              |  |              | 972,800   |               |  |   | 1,001,100 |  |  |   | 593,600   |  |  |   | 596,200   | 
|                                                         |  |              |           |              |  |              |           |              |  |              |           |               |  |   |           |  |  |   |           |  |  |   |           | 
|Total
          HMO membership                           |  |              | 4,010,000 |              |  |              | 3,658,000 |              |  |              | 3,526,900 |               |  |   | 3,791,100 |  |  |   | 2,045,100 |  |  |   | 2,030,700 | 
|                                                         |  |              |           |              |  |              |           |              |  |              |           |               |  |   |           |  |  |   |           |  |  |   |           | 
|BALANCE
          SHEET DATA                            
|                                                        
|                                                        
|                                                        
|                                                        
|(amounts
          in thousands)                        
|                                                        
|                                                        
|                                                        
|                                                        
|Cash and
          equivalents and marketable securities |  | $            | 2,115,648 |              |  | $            | 1,848,258 |              |  | $            | 1,600,189 |               |  | $ | 1,545,382 |  |  | $ | 962,482   |  |  | $ | 700,093   | 
|                                                        
|                                                        
|                                                        
|                                                        
|Total
          assets                                   |  | $            | 5,323,436 |              |  | $            | 4,884,021 |              |  | $            | 4,630,944 |               |  | $ | 4,963,046 |  |  | $ | 1,561,472 |  |  | $ | 1,299,462 | 
|                                                        
|                                                        
|                                                        
|                                                        
|Medical
          claims and benefits payable            |  | $            | 1,270,800 |              |  | $            | 795,200   |              |  | $            | 645,300   |               |  | $ | 721,500   |  |  | $ | 282,500   |  |  | $ | 268,000   | 
|                                                        
|                                                        
|                                                        
|                                                        
|Long-term
          debt, due after one year             |  | $            | 836,556   |              |  | $            | 975,000   |              |  | $            | 650,006   |               |  | $ | 1,011,234 |  |  | $ | 1,370     |  |  | $ | 5,183     | 
|                                                        
|                                                        
|                                                        
|                                                        
|Stockholders
          equity                           |  | $            | 2,003,560 |              |  | $            | 1,977,719 |              |  | $            | 2,238,096 |               |  | $ | 2,062,187 |  |  | $ | 860,102   |  |  | $ | 823,224   | 



---

|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) |  | The 2000 results include impairment, disposition,
      restructuring, OPM and other net pretax charges (credits) totaling
      $9 million ($5 million or $0.15 diluted loss per share, net of
      tax). See Note 9 of the Notes to Consolidated Financial Statements. Operating
      income before pretax credits and charges as a percentage of operating revenue
      was 2.3 percent. Return on average stockholders equity before
      pretax credits and charges was 8.5 percent.                                                                                                                                                                                                                                                                                                         
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(2) |  | The 1999 results include impairment, disposition,
      restructuring and other net pretax credits totaling $2 million ($2 million
      or $0.04 diluted loss per share, net of tax). The after tax and per share
      amounts were losses because the goodwill impairment was not deductible for
      income tax purposes. See Note 9 of the Notes to Consolidated Financial Statements.
      Operating income before pretax credits and charges as a percentage of operating
      revenue was 4.4 percent. Return on average stockholders equity
      before pretax credits and charges was 13.3 percent.                                                                                                                                                                                     
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(3) |  | The 1998 results include $11 million of
      net pretax charges ($6 million or $0.12 diluted loss per share, net
      of tax). See Note 9 of the Notes to Consolidated Financial Statements. Operating
      income before pretax credits and charges as a percentage of operating revenue
      was 3.7 percent. Return on average stockholders equity before
      pretax credits and charges was 9.7 percent.                                                                                                                                                                                                                                                                                                                                                                                    
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(4) |  | The 1997 results include the results of operations
      for the FHP International Corporation acquisition from February 14,
      1997. The 1997 results also include $155 million of pretax charges
      ($129 million or $3.18 diluted loss per share, net of tax) for the
      impairment of long-lived assets, restructuring and certain other charges.
      Operating income before pretax charges as a percentage of operating revenue
      was 2.2 percent. Return on average stockholders equity before
      pretax charges was 6.9 percent.                                                                                                                                                                                                                                            
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(5) |  | The 1996 results include $101 million
      of pretax charges ($62 million or $1.96 diluted loss per share, net
      of tax for the fiscal year ended September 30 and $1.97 diluted loss
      per share for the twelve months ended December 31) for the impairment
      of long-lived assets, potential government claims, dispositions and certain
      restructuring charges. Operating income before pretax charges as a percentage
      of operating revenue for 1996 was 3.8 percent for the fiscal year ended
      September 30 and 3.9 percent for the twelve months ended December 31.
      Return on average stockholders equity before pretax charges for the
      fiscal year ended September 30 was 17.2 percent and 17.0 percent
      for the twelve months ended December 31.
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(6) |  | Earnings per share were restated to conform
      with the provisions of Statement of Financial Accounting Standards No. 128,
      Earnings per Share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(7) |  | Effective income tax rate includes the effect
      of nondeductible pretax charges.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

18



---



##### Table of Contents









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

Results of Operations

Overview.We sell HMO and HMO-related products primarily to members in two
groups: the commercial programs for employer-group members and individuals and
the Secure Horizons program for Medicare beneficiaries. Our specialty managed
care HMOs and HMO-related products and services supplement our commercial and
Secure Horizons programs. These include pharmacy benefit management,
behavioral health services, life and health insurance and dental and vision
services.

Events significant to our business in 2000 included the following:



| |  | 2000 results include impairment, disposition, restructuring, OPM and
other net pretax charges totaling $9 million ($5 million or $0.15 diluted
loss per share, net of tax). See Note 9 of the Notes to Consolidated
Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                               
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | In December 2000, we limited the enrollment of new members in our
Medicare+Choice health plan, Secure Horizons, through a combination of
capacity waivers and voluntary closure notices. This plan affected a
total of 42 counties in California, Colorado, Oregon, Texas and
Washington. Voluntary closures, did not affect current or recently
enrolled members in these counties, nor did they affect newly eligible
Medicare beneficiaries (those turning 65 or becoming disabled).
Retiree enrollment with January 1, 2001 effective dates were accepted,
except for those areas affected by the capacity waivers in the
Houston, Texas and Washington State areas.
| 
| |  | In October 2000, we announced our intention to withdraw our commercial
HMO and POS products from 15 Colorado counties. This plan affects
approximately 25,000 commercial HMO and POS members. The effective
date for this withdrawal is May 1, 2001. We will retain our
commercial HMO products in other Colorado counties where the vast
majority of our members reside. Qualified employers may apply for our
PPO, which is not affected by this service area change.                                                                                                                                                                                                 
| 
| |  | In June 2000, we submitted our 2001 proposed Medicare benefit plan
changes to HCFA for approval. These changes include exiting (or
partially exiting) Medicare operations in a total of 15 counties in
Arizona, Colorado, Ohio, Texas and Washington. This proposal will
affect approximately 20,500 Medicare members.                                                                                                                                                                                                                                                                                                                                                  
| 
| |  | We completed the exit of all HMO operations in Ohio. This exit
affected approximately 35,000 commercial members and 3,500 Medicare
members located in Ohio and Kentucky who were enrolled in our plans
during 2000. (These 3,500 Medicare members were included in our 2001
proposed Medicare benefits plan changes submitted to HCFA as discussed
above.) We entered into an agreement with Anthem Blue Cross and Blue
Shield to assist in transitioning Ohios commercial membership.
Medicare members were provided a choice of another Medicare+Choice HMO
or traditional fee-for-service Medicare. See Note 4 of the Notes to
Consolidated Financial Statements.   
| 
| |  | During the first half of 2000, we assumed approximately 18,000 members
in Colorado and 21,000 members in Washington as a result of transition
agreements signed with QualMed Plans for Health of Colorado and with
QualMed Washington Health Plans, Inc. (together, QualMed), each a
subsidiary of Health Net, Inc. See Note 4 of the Notes to
Consolidated Financial Statements.                                                                                                                                                                                                                                                                                     
| 
| |  | On February 1, 2000, we completed our acquisition of Harris Methodist
Texas Health Plan, Inc. and Harris Methodist Health Insurance Company
Inc. (together, Harris), a health plan and insurance company in
Texas with approximately 250,000 commercial and 50,000 Medicare
members. See Note 4 of the Notes to Consolidated Financial
Statements.                                                                                                                                                                                                                                                                                                                    

19



---



##### Table of Contents



2000 Compared With 1999

Membership.Total HMO membership increased 10 percent to approximately 4.0
million members at December 31, 2000 from approximately 3.7 million members at
December 31, 1999. Our total HMO membership excludes employer self-funded
members and PPO and indemnity members.

|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |           |           |  |           |           |           |  |           |         |           |  |           |           |           | 
|----------------- | -------------------- | ---------------------- | --------- | -------------------- | --------- | -------------------- | --------- | ---------- | --------- | -------- | --------- | --------- | --------- |  | --------- | --------- | --------- |  | --------- | ------- | --------- |  | --------- | --------- | --------- | 
|                  |                      |                        |           | At December 31, 2000 |           | At December 31, 1999
|                  |                      |                        |           |                      |           |                     
|Membership Data   |                      | Commercial             |           | Medicare             |           | Total                |           | Commercial |           | Medicare |           | Total    
|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |          
|HMO membership:  
|                 
|                 
|                 
|                 
|                  | Arizona              |                        |           | 124,700              |           |                      |           | 103,100    |           |          |           | 227,800   |           |  |           | 105,000   |           |  |           | 89,300  |           |  |           | 194,300   |          
|                 
|                 
|                 
|                 
|                  | California           |                        |           | 1,812,000            |           |                      |           | 564,800    |           |          |           | 2,376,800 |           |  |           | 1,720,000 |           |  |           | 608,100 |           |  |           | 2,328,100 |          
|                 
|                 
|                 
|                 
|                  | Colorado             |                        |           | 285,800              |           |                      |           | 74,000     |           |          |           | 359,800   |           |  |           | 318,300   |           |  |           | 78,200  |           |  |           | 396,500   |          
|                 
|                 
|                 
|                 
|                  | Guam                 |                        |           | 50,500               |           |                      |           |           |           |          |           | 50,500    |           |  |           | 41,500    |           |  |           |        |           |  |           | 41,500    |          
|                 
|                 
|                 
|                 
|                  | Nevada               |                        |           | 34,300               |           |                      |           | 32,200     |           |          |           | 66,500    |           |  |           | 35,100    |           |  |           | 28,500  |           |  |           | 63,600    |          
|                 
|                 
|                 
|                 
|                  | Ohio                 |                        |           | 35,000               |           |                      |           | 3,500      |           |          |           | 38,500    |           |  |           | 42,700    |           |  |           | 16,500  |           |  |           | 59,200    |          
|                 
|                 
|                 
|                 
|                  | Oklahoma             |                        |           | 88,300               |           |                      |           | 31,400     |           |          |           | 119,700   |           |  |           | 84,300    |           |  |           | 29,000  |           |  |           | 113,300   |          
|                 
|                 
|                 
|                 
|                  | Oregon               |                        |           | 103,700              |           |                      |           | 31,600     |           |          |           | 135,300   |           |  |           | 109,000   |           |  |           | 36,500  |           |  |           | 145,500   |          
|                 
|                 
|                 
|                 
|                  | Texas (1)            |                        |           | 319,100              |           |                      |           | 151,400    |           |          |           | 470,500   |           |  |           | 112,600   |           |  |           | 64,100  |           |  |           | 176,700   |          
|                 
|                 
|                 
|                 
|                  | Washington           |                        |           | 99,900               |           |                      |           | 64,700     |           |          |           | 164,600   |           |  |           | 74,900    |           |  |           | 64,400  |           |  |           | 139,300   |          
|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |           |           |  |           |           |           |  |           |         |           |  |           |          
|                  |                      | Total HMO membership   |           |                      | 2,953,300 |                      |           |            | 1,056,700 |          |           |           | 4,010,000 |  |           |           | 2,643,400 |  |           |         | 1,014,600 |  |           |           | 3,658,000 | 
|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |           |           |  |           |           |           |  |           |         |           |  |           |          
|Other membership:
|                 
|                 
|                 
|                 
|                  | Employer self-funded |                        |           | 65,000               |           |                      |           |           |           |          |           | 65,000    |           |  |           | 55,100    |           |  |           |        |           |  |           | 55,100    |          
|                 
|                 
|                 
|                 
|                  | PPO and indemnity    |                        |           | 42,900               |           |                      |           |           |           |          |           | 42,900    |           |  |           | 29,800    |           |  |           |        |           |  |           | 29,800    |          
|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |           |           |  |           |           |           |  |           |         |           |  |           |          
|                  |                      | Total other membership |           |                      | 107,900   |                      |           |            |          |          |           |           | 107,900   |  |           |           | 84,900    |  |           |         |          |  |           |           | 84,900    | 
|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |           |           |  |           |           |           |  |           |         |           |  |           |          
|Total membership  |                      |                        | 3,061,200 |                      |           |                      | 1,056,700 |            |           |          | 4,117,900 |           |           |  | 2,728,300 |           |           |  | 1,014,600 |         |           |  | 3,742,900 |          
|                  |                      |                        |           |                      |           |                      |           |            |           |          |           |           |           |  |           |           |           |  |           |         |           |  |           |          

---

|(1) |  | Texas membership includes Harris members totaling approximately 130,000
commercial and 43,000 Medicare at December 31, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------

Commercial HMO membership increased approximately 12 percent at December 31,
2000 compared to the prior year due to:



| |  | Net membership increases from acquired membership in Colorado, Texas and Washington, partially offset by membership
decreases in Colorado attributable to premium rate increases that averaged 14 percent in 2000; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Growth in California primarily from marketing efforts to retain membership and renew major employer accounts.                                                                                                         

Medicare membership increased four percent at December 31, 2000 compared to the prior year due to:



| |  | Members acquired primarily in Washington and Texas; and                                                                                                                                                    
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Competitor exits in markets where Secure Horizons will remain, primarily in Arizona, Nevada and Texas; partially offset by                                                                                 
| 
| |  | Membership decreases primarily in California due to disenrollment resulting from reduced benefits, increased copayments
and instituted or increased member-paid supplemental premiums in some counties; and
| 
| |  | Membership decreases as a result of our January 2000 county exits in California, Ohio, Oregon and Washington.                                                                                              

Employer self-funded membership increased approximately 18 percent at December
31, 2000 compared to the same period in the prior year primarily due to
additional membership from the Harris acquisition, partially offset by
membership losses in Colorado. PPO and indemnity membership increased
approximately 44 percent at December 31, 2000 compared to the prior year
primarily due to additional Harris membership.

20



---



##### Table of Contents



Commercial Premiums.Commercial premiums increased
  23 percent or $918 million for the year ended December 31, 2000
  compared to the prior year as follows:

|                                                                                                                          |  |                       |     | 
|------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | --- | 
|                                                                                                                          |  | Year Ended           
|                                                                                                                          |  | December 31, 2000    
|                                                                                                                          |  |                      
|                                                                                                                          |  | (amounts in millions)
|Premium
          rate increases that averaged approximately eight percent for the year
          ended December 31, 2000 |  | $                     | 337 | 
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|The inclusion
          of premiums from the Harris acquisition                                                           |  |                       | 316 | 
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|Net membership
          increases, primarily in California                                                               |  |                       | 265 | 
|                                                                                                                          |  |                       |     | 
|Increase
          over prior year                                                                                        |  | $                     | 918 | 
|                                                                                                                          |  |                       |     | 

Medicare Premiums.Medicare premiums increased
  nine percent or $540 million for the year ended December 31, 2000
  compared to the prior year as follows:

|                                                                                                                          |  |                       |      |  
|------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | ---- | -
|                                                                                                                          |  | Year Ended           
|                                                                                                                          |  | December 31, 2000    
|                                                                                                                          |  |                      
|                                                                                                                          |  | (amounts in millions)
|Premium
          rate increases that averaged approximately seven percent for the year
          ended December 31, 2000 |  | $                     | 425  |  
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|The inclusion
          of premiums from the Harris acquisition                                                           |  |                       | 221  |  
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|                                                                                                                         
|Net membership
          losses, primarily in California                                                                  |  |                       | (106 | )
|                                                                                                                          |  |                       |      |  
|Increase
          over prior year                                                                                        |  | $                     | 540  |  
|                                                                                                                          |  |                       |      |  

Other Income.Other income increased approximately
  17 percent or $21 million for the year ended December 31, 2000
  compared to the prior year. The increases were primarily due to increased mail-service
  revenues of Prescription Solutions, including mail-service revenues from the
  acquired Harris business. Prescription Solutions generates mail-service revenues,
  where we, rather than network retail pharmacies, collect the member copayments.

Consolidated Medical Care Ratio.The consolidated,
  commercial and Medicare medical care ratios (health care services as a percentage
  of premium revenue), including favorable changes in estimates for the first
  quarter, increased for the year ended December 31, 2000 compared to the
  prior year primarily due to:



| |  | Higher physician, hospital, outpatient, emergency
      service utilization and higher cost of claims under fee-for-service or risk-based
      contracts; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Higher prescription drug costs; partially offset
      by                                                                                                     
| 
| |  | Premium rate increases.                                                                                                                                       

|                              |              |  |              |      |      |  |  |      |  
|----------------------------- | ------------ |  | ------------ | ---- | ---- |  |  | ---- | -
|                              |              |  | Year Ended  
|                              |              |  | December 31,
|                              |              |  |             
|                              |              |  | 2000         |      | 1999
|                              |              |  |              |      |     
|Medical
          care ratio:
|                             
|                             
|                             
|                             
|                              | Consolidated |  |              | 87.5 | %    |  |  | 84.8 | %
|                             
|                             
|                             
|                             
|                              | Commercial   |  |              | 85.1 | %    |  |  | 81.7 | %
|                             
|                             
|                             
|                             
|                              | Medicare     |  |              | 89.4 | %    |  |  | 86.9 | %

The commercial medical care ratio includes the specialty HMOs
  and indemnity insurance results.

21



---



##### Table of Contents



Health care costs for the year ended December 31, 2000, were reduced by $9
million ($5 million or $0.14 diluted earnings per share, net of tax), of which
$6 million is related to our commercial product line. These reductions were a
result of our favorable first quarter 2000 resolution of prior period estimates
relating to a provider contract. Excluding the effects of these favorable
changes in estimates, the medical care ratios were as follows:

|                                                  |              |  |              |      |      |  |  |      |  
|------------------------------------------------- | ------------ |  | ------------ | ---- | ---- |  |  | ---- | -
|                                                  |              |  | Year Ended  
|                                                  |              |  | December 31,
|                                                  |              |  |             
|                                                  |              |  | 2000         |      | 1999
|                                                  |              |  |              |      |     
|Medical care ratio excluding the provider credit:
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Consolidated |  |              | 87.6 | %    |  |  | 84.8 | %
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Commercial   |  |              | 85.2 | %    |  |  | 81.7 | %
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Medicare     |  |              | 89.4 | %    |  |  | 86.9 | %

Marketing, General and Administrative Expenses.For the year ended December
31, 2000, marketing, general and administrative expenses as a percentage of
operating revenue decreased compared to the prior year due to higher operating
revenue in 2000.

|                                                                                    |  |              |      |      |  |  |      |  
|----------------------------------------------------------------------------------- |  | ------------ | ---- | ---- |  |  | ---- | -
|                                                                                    |  | Year Ended  
|                                                                                    |  | December 31,
|                                                                                    |  |             
|                                                                                    |  | 2000         |      | 1999
|                                                                                    |  |              |      |     
|Marketing, general and administrative
expenses as a percentage of operating
revenue |  |              | 10.5 | %    |  |  | 11.1 | %

Impairment, Disposition, Restructuring, Office of Personnel Management (OPM)
and Other Charges (Credits).We recognized net pretax charges of $9 million
($5 million or $0.15 diluted loss per share, net of tax) for the year ended
December 31, 2000. See Note 9 of the Notes to Consolidated Financial
Statements.

Operating Income.Factors contributing to the changes are discussed above.

|                                                   |  |              |     |      |  |  |     |  
|-------------------------------------------------- |  | ------------ | --- | ---- |  |  | --- | -
|                                                   |  | Year Ended  
|                                                   |  | December 31,
|                                                   |  |             
|                                                   |  | 2000         |     | 1999
|                                                   |  |              |     |     
|Operating income as a percent of operating revenue |  |              | 2.3 | %    |  |  | 4.4 | %

Net Investment Income.Net investment income increased approximately 29
percent for the year ended December 31, 2000 compared to the prior year due to:



| |  | Higher average invested balances; and                                                                                                            
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Increases in short- and long-term interest rates combined with the
gradual shift of tax-exempt investments to higher yielding taxable
securities.

Interest Expense.Interest expense increased approximately 85 percent for the
year ended December 31, 2000 compared to the prior year due to:



| |  | Increased borrowings on our credit facility to fund our share repurchase program; and                           
|- |  | ----------------------------------------------------------------------------------------------------------------
| 
| |  | Higher short-term interest rates combined with a higher interest fee structure in the credit facility agreement.

Provision for Income Taxes.The effective income tax rate was 44.1 percent for
the year ended December 31, 2000, compared with 42.2 percent in 1999. Because
of lower 2000 earnings, the non-deductible goodwill amortization expense is a
higher percentage of pretax income, increasing our 2000 effective tax rate.

Significant Fourth Quarter Items.During the fourth quarter of 2000, our claims
incurred but not reported increased by $21 million for periods prior to
September 30, 2000, primarily due to increased utilization and cost of claims
under risk-based hospital arrangements. This increase was partially offset by
$15 million of reductions in related ancillary reserves, such as reserves for
claims backlog and vision and mental health claims. Additionally,
during the fourth quarter of 2000, our marketing, general and administrative
expenses decreased by $11 million, related to incentive compensation and other
accruals.

22



---



##### Table of Contents



1999 Compared with 1998

Membership.Total HMO membership increased four
  percent to approximately 3.7 million members at December 31, 1999 from
  approximately 3.5 million members at December 31, 1998.

|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |        |        |  |           |        |        |  |         |   |   |  |           |        |        | 
|------------------------------ | ------------------------------ | -------------------------------- | --------- | ---------------------------- | ------ | ---------------------------- | --------- | ---------- | - | -------- | --------- | ------ | ------ |  | --------- | ------ | ------ |  | ------- | - | - |  | --------- | ------ | ------ | 
|                               |                                |                                  |           | At December 31,
        1999 |        | At December 31,
        1998
|                               |                                |                                  |           |                              |        |                             
|Membership Data                |                                | Commercial                       |           | Medicare                     |        | Total                        |           | Commercial |   | Medicare |           | Total 
|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |       
|Arizona                        |                                |                                  | 105,000   |                              |        |                              | 89,300    |            |   |          | 194,300   |        |        |  | 107,100   |        |        |  | 86,500  |   |   |  | 193,600   |       
|                              
|                              
|                              
|                              
|California                     |                                |                                  | 1,720,000 |                              |        |                              | 608,100   |            |   |          | 2,328,100 |        |        |  | 1,595,000 |        |        |  | 599,800 |   |   |  | 2,194,800 |       
|                              
|                              
|                              
|                              
|Colorado                       |                                |                                  | 318,300   |                              |        |                              | 78,200    |            |   |          | 396,500   |        |        |  | 296,600   |        |        |  | 58,500  |   |   |  | 355,100   |       
|                              
|                              
|                              
|                              
|Guam                           |                                |                                  | 41,500    |                              |        |                              |          |            |   |          | 41,500    |        |        |  | 39,800    |        |        |  |        |   |   |  | 39,800    |       
|                              
|                              
|                              
|                              
|Nevada                         |                                |                                  | 35,100    |                              |        |                              | 28,500    |            |   |          | 63,600    |        |        |  | 38,900    |        |        |  | 22,900  |   |   |  | 61,800    |       
|                              
|                              
|                              
|                              
|Ohio                           |                                |                                  | 42,700    |                              |        |                              | 16,500    |            |   |          | 59,200    |        |        |  | 44,000    |        |        |  | 16,600  |   |   |  | 60,600    |       
|                              
|                              
|                              
|                              
|Oklahoma                       |                                |                                  | 84,300    |                              |        |                              | 29,000    |            |   |          | 113,300   |        |        |  | 96,300    |        |        |  | 26,900  |   |   |  | 123,200   |       
|                              
|                              
|                              
|                              
|Oregon                         |                                |                                  | 109,000   |                              |        |                              | 36,500    |            |   |          | 145,500   |        |        |  | 114,700   |        |        |  | 39,300  |   |   |  | 154,000   |       
|                              
|                              
|                              
|                              
|Texas                          |                                |                                  | 112,600   |                              |        |                              | 64,100    |            |   |          | 176,700   |        |        |  | 127,100   |        |        |  | 61,900  |   |   |  | 189,000   |       
|                              
|                              
|                              
|                              
|Washington                     |                                |                                  | 74,900    |                              |        |                              | 64,400    |            |   |          | 139,300   |        |        |  | 94,600    |        |        |  | 60,400  |   |   |  | 155,000   |       
|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |        |        |  |           |        |        |  |         |   |   |  |           |       
|Total
          HMO membership |                                |                                  | 2,643,400 |                              |        |                              | 1,014,600 |            |   |          | 3,658,000 |        |        |  | 2,554,100 |        |        |  | 972,800 |   |   |  | 3,526,900 |       
|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |        |        |  |           |        |        |  |         |   |   |  |           |       
|Other
          membership:   
|                              
|                              
|                              
|                              
|                               | Employer
          self-funded |                                  |           | 55,100                       |        |                              |           |           |   |          |           | 55,100 |        |  |           | 55,100 |        |  |         |  |   |  |           | 55,100 |       
|                              
|                              
|                              
|                              
|                               | PPO and
          indemnity    |                                  |           | 29,800                       |        |                              |           |           |   |          |           | 29,800 |        |  |           | 28,200 |        |  |         |  |   |  |           | 28,200 |       
|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |        |        |  |           |        |        |  |         |   |   |  |           |       
|                               |                                | Total
          other membership |           |                              | 84,900 |                              |           |            |  |          |           |        | 84,900 |  |           |        | 83,300 |  |         |   |  |  |           |        | 83,300 | 
|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |        |        |  |           |        |        |  |         |   |   |  |           |       
|Total
          membership     |                                |                                  | 2,728,300 |                              |        |                              | 1,014,600 |            |   |          | 3,742,900 |        |        |  | 2,637,400 |        |        |  | 972,800 |   |   |  | 3,610,200 |       
|                               |                                |                                  |           |                              |        |                              |           |            |   |          |           |        |        |  |           |        |        |  |         |   |   |  |           |       

Commercial HMO membership increased approximately three percent
  at December 31, 1999 compared to membership at December 31, 1998 due
  to:



| |  | Membership increases in California primarily
      due to improved sales efforts, and in Colorado as a result of the acquisition
      of ANTERO Health Plans; partially offset by            
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Membership losses attributable to our continued
      focus on renewing commercial contracts with sufficient price increases to
      improve gross margin, primarily in Washington and Texas.

Medicare membership increased four percent at December 31,
  1999 compared to membership at December 31, 1998 due to:



| |  | Competitor exits in markets where Secure Horizons
      will remain, primarily Arizona, Colorado, Nevada and Washington; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------
| 
| |  | The positive results of retention programs
      initiated during 1998 in California.                                       

Commercial Premiums.Commercial premiums
  increased four percent or $171 million for the year ended December 31,
  1999 compared to premiums in the prior year as follows:

|                                                                                                                        |  |                       |      |  
|----------------------------------------------------------------------------------------------------------------------- |  | --------------------- | ---- | -
|                                                                                                                        |  | Year Ended           
|                                                                                                                        |  | December 31, 1999    
|                                                                                                                        |  |                      
|                                                                                                                        |  | (amounts in millions)
|Premium
          rate increases that averaged approximately six percent for the year
          ended December 31, 1999 |  | $                     | 228  |  
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Net membership
          increases (excluding Utah), primarily in California                                            |  |                       | 62   |  
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Membership
          losses resulting from the disposition of Utah                                                      |  |                       | (100 | )
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Discontinued
          indemnity and workers compensation products                                                     |  |                       | (19  | )
|                                                                                                                        |  |                       |      |  
|Increase
          over prior year                                                                                      |  | $                     | 171  |  
|                                                                                                                        |  |                       |      |  

23



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##### Table of Contents



Medicare Premiums.Medicare premiums increased
  five percent or $289 million for the year ended December 31, 1999
  compared to premiums in the prior year as follows:

|                                                                                                                                                |  |                       |     |  
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------- | --- | -
|                                                                                                                                                |  | Year Ended           
|                                                                                                                                                |  | December 31, 1999    
|                                                                                                                                                |  |                      
|                                                                                                                                                |  | (amounts in millions)
|Premium
          rate increases that averaged approximately three percent for the year
          ended December 31, 1999                       |  | $                     | 205 |  
|                                                                                                                                               
|                                                                                                                                               
|                                                                                                                                               
|                                                                                                                                               
|Net membership
          increases (excluding Utah), primarily due to competitors exits
          in markets where Secure Horizons will remain |  |                       | 131 |  
|                                                                                                                                               
|                                                                                                                                               
|                                                                                                                                               
|                                                                                                                                               
|Membership
          losses resulting from the disposition of Utah                                                                              |  |                       | (47 | )
|                                                                                                                                                |  |                       |     |  
|Increase
          over prior year                                                                                                              |  | $                     | 289 |  
|                                                                                                                                                |  |                       |     |  

Medicare premium rates on a per member basis increased due to
  higher HCFA premiums received, changes in membership demographics and health
  status, higher retiree supplemental premiums and the exit of the Utah Medicaid
  business.

Other Income.Other income increased for the year
  ended December 31, 1999 compared to the prior year. The increase was primarily
  due to increased mail-service revenues from Presciption Solutions, where we,
  rather than network retail pharmacies, collect the member copayments.

Consolidated Medical Care Ratio.The 1999 consolidated
  medical care ratio (health care services as a percentage of premium revenue)
  declined slightly compared to 1998 primarily because current year provider reserves
  were significantly less than in 1998.

|                              |              |  |              |      |      |  |  |      |  
|----------------------------- | ------------ |  | ------------ | ---- | ---- |  |  | ---- | -
|                              |              |  | Year Ended  
|                              |              |  | December 31,
|                              |              |  |             
|                              |              |  | 1999         |      | 1998
|                              |              |  |              |      |     
|Medical
          care ratio:
|                             
|                             
|                             
|                             
|                              | Consolidated |  |              | 84.8 | %    |  |  | 85.0 | %
|                             
|                             
|                             
|                             
|                              | Commercial   |  |              | 81.7 | %    |  |  | 82.8 | %
|                             
|                             
|                             
|                             
|                              | Medicare     |  |              | 86.9 | %    |  |  | 86.5 | %

Excluding 1998 net provider reserves, the increase in the 1999
  consolidated medical care ratio compared to 1998 was primarily due to higher
  contracted physician costs, increased pharmacy utilization, pharmacy benefit
  enhancements and higher prescription drug costs for our Secure Horizons members.

Commercial Medical Care Ratio.The commercial
  medical care ratio includes the specialty HMOs and indemnity insurance results.
  The commercial medical care ratio for the year ended December 31, 1999
  decreased compared to the prior year due to the following:



| |  | Premium rate increases;                                                                   
|- |  | ------------------------------------------------------------------------------------------
| 
| |  | The sale of our Utah HMO and workers
      compensation subsidiaries; partially offset by
| 
| |  | Higher contracted physician costs.                                                        

Medicare Medical Care Ratio.The Medicare medical
  care ratio for the year ended December 31, 1999 increased compared to the
  prior year due to:



| |  | Higher contracted physician costs; and                                                                                     
|- |  | ---------------------------------------------------------------------------------------------------------------------------
| 
| |  | Increased pharmacy utilization, pharmacy benefit
      enhancements and higher prescription drug costs; partially offset by
| 
| |  | Higher premiums; and                                                                                                       
| 
| |  | Reduced hospital expenses, primarily because
      current year provider reserves were significantly less than in 1998.    

Marketing, General and Administrative Expenses.
  For the year ended December 31, 1999 compared to 1998, marketing, general and
  administrative expenses as a percentage of operating revenue decreased because
  of:

24



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##### Table of Contents





| |  | Higher operating revenues;                                                  
|- |  | ----------------------------------------------------------------------------
| 
| |  | The Utah HMO disposition; and                                               
| 
| |  | The improved efficiencies of our regional customer
      service operations.

|                                                                                              |  |              |      |      |  |  |      |  
|--------------------------------------------------------------------------------------------- |  | ------------ | ---- | ---- |  |  | ---- | -
|                                                                                              |  | Year Ended  
|                                                                                              |  | December 31,
|                                                                                              |  |             
|                                                                                              |  | 1999         |      | 1998
|                                                                                              |  |              |      |     
|Marketing,
          general and administrative expenses as a percentage of operating revenue |  |              | 11.1 | %    |  |  | 11.4 | %

Impairment, Disposition, Restructuring and Other Charges
  (Credits).We recognized impairment, disposition, restructuring and
  other pretax credits in 1999 totaling $2 million (after tax charges of
  $2 million or $0.04 diluted loss per share). The after tax and per-share
  amounts were losses because the goodwill impairment was not deductible for income
  tax purposes. See Note 9 of the Notes to Consolidated Financial Statements.

Operating Income.Factors contributing
  to the increase in operating income are discussed above.

|                                                                |  |              |     |      |  |  |     |  
|--------------------------------------------------------------- |  | ------------ | --- | ---- |  |  | --- | -
|                                                                |  | Year Ended  
|                                                                |  | December 31,
|                                                                |  |             
|                                                                |  | 1999         |     | 1998
|                                                                |  |              |     |     
|Operating
          income as a percentage of operating revenue |  |              | 4.4 | %    |  |  | 3.6 | %

Net Investment Income.Net investment income
  decreased approximately 19 percent for the year ended December 31, 1999
  compared to the prior year due to the following:



| |  | Fewer realized gains on sales of marketable
      securities in the current year; and               
|- |  | ----------------------------------------------------------------------------------------------------
| 
| |  | The shift of more portfolio holdings to tax-exempt
      investments that have lower interest rates.

Interest Expense.Interest expense decreased approximately
  29 percent for the year ended December 31, 1999 compared to the prior
  year due to the reduction in outstanding borrowings until December 1999,
  when we borrowed $400 million to fund our share repurchase program, and
  lower overall average interest rates paid on our credit facility.

Provision for Income Taxes.The effective income
  tax rate was 42.2 percent in 1999, compared with 47.5 percent in 1998.
  The rate declined significantly because:



| |  | Nondeductible goodwill amortization was a smaller
      percentage of pretax income;                                                                                                    
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | We benefited from certain tax strategies, in
      particular our legal reorganization, which resulted in lower state income
      taxes;                                               
| 
| |  | The 1998 effective tax rate included an increase
      related to nondeductible losses recognized for the dispositions of the Utah
      HMO and workers compensation subsidiaries; and
| 
| |  | 1999 investment strategies resulted in increased
      tax-exempt earnings.                                                                                                             

Liquidity and Capital Resources

Operating Cash Flows.Our consolidated cash, equivalents
  and marketable securities increased to $2.1 billion at December 31,
  2000 from $1.8 billion at December 31, 1999. The combined increase
  in cash, equivalents and marketable securities occurred primarily due to the
  trend away from capitated contracts to risk-based and fee-for-service agreements.
  This shift resulted in the delay of medical expense payments, causing cash levels
  to build. Cash flows from operations, excluding the impact of deferred revenue,
  increased $91 million to $605 million at December 31, 2000. The
  increase is primarily related to changes in assets and liabilities as discussed
  below in Other Balance Sheet Change Explanations.

25



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##### Table of Contents



Investing Activities.For the year ended December 31, 2000, our investing
activities provided $72 million in cash. This compared to the use of $251
million during the year ended December 31, 1999. The sale of marketable
securities resulted in $178 million of the $323 million net increase over the
prior year. The increase was partially offset by $105 million of purchases of
property, plant and equipment primarily related to computer equipment and software.

Financing Activities.For the year ended December 31, 2000, we used $301
million of cash for financing activities compared to $194 million used for the
same period in the prior year. The increase of $107 million was the result of
the following:



| |  | We paid a net $138 million in 2000 on our long-term debt (net of other borrowings), including net credit facility payments
of $140 million, compared to borrowing a net $325 million under the credit facility (net of payments) for the same period
in 1999;                                                                                                                                                                                                                                                                                
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | We repurchased 4.0 million shares of our common stock in 2000 for $173 million and 8.8 million shares of our common stock
in 1999 for $480 million under our stock repurchase program;                                                                                                                                                                                                                                                                                                                                                       
| 
| |  | In 1999, we paid UniHealth Foundation $60 million in consideration for UniHealth Foundations vote in favor of the
reclassification of our stock and in consideration for the agreements and covenants contained in the stock repurchase
agreement between PacifiCare and UniHealth Foundation. In addition, we incurred $2 million of expenses related to the
reclassification of our common stock and the registration of the shares held by UniHealth Foundation. No consideration of
this type was paid in 2000; partially offset because
| 
| |  | We received $8 million in 2000 from minority stockholders of a subsidiary; and                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| 
| |  | We received $2 million in proceeds from issuing common shares in 2000 compared to $23 million in 1999.                                                                                                                                                                                                                                                                                                                                                                                                                                       

Other Balance Sheet Change Explanations

Receivables, Net.Receivables, net increased $104 million from December 31,
1999 as follows:



| |  | $68 million net increase in premium receivables primarily due to premium rate increases;                              
|- |  | ----------------------------------------------------------------------------------------------------------------------
| 
| |  | $19 million increase attributable to the Harris acquisition;                                                          
| 
| |  | $13 million net increase in other trade receivables primarily due to higher prescription drug rebate receivables; and 
| 
| |  | $4 million net increase in provider receivables as a result of our higher proportion of risk-based hospital contracts.

Goodwill and Intangible Assets, Net.Goodwill and intangible assets increased $17 million from December 31, 1999 as follows:



| |  | $86 million increase attributable to the Harris acquisition; and                                                                     
|- |  | -------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | $14 million increase primarily attributable to membership acquisition and assumptions in Colorado and Washington;
partially offset by
| 
| |  | $83 million decrease attributable to goodwill and intangible amortization expense.                                                   

Medical Claims and Benefits Payable.Medical claims and benefits payable
increased $476 million from December 31, 1999 as follows:



| |  | $329 million increase in claims incurred but not reported attributable to increases in the number of risk-based hospital
arrangements. Under capitation arrangements, physicians and hospitals are prepaid based on a fixed-fee per-member
per-month amount, regardless of the services provided to each member. Under risk-based arrangements, claims are payable
once incurred. The increase in risk-based arrangements results in an increase in payables for claims incurred, but not yet
paid as well as an increase in the estimate of claims incurred but not yet reported to us;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

26



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##### Table of Contents





| |  | $104 million increase attributable to the Harris acquisition, including $28 million in loss contract reserves to be
amortized through the fourth quarter of 2001;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | $26 million increase in physician and hospital capitation liabilities primarily due to the timing of capitation for members
shifting to new physicians; and      
| 
| |  | $17 million increase in incentive and other physician and hospital liabilities.                                                                                  

Accrued Liabilities.Accrued liabilities increased $32 million from December
31, 1999 primarily due to the timing of payment of the current year income tax
provision and increased accrued interest for amounts borrowed under our credit
facility.

New Accounting Pronouncements.See Note 2 of the Notes to Consolidated
Financial Statements for a discussion of future application of accounting
standards.

Forward-Looking Information under the Private Securities Litigation Act of 1995

This document contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future
financial performance. In some cases, you can identify forward-looking
statements by terminology including, may, will, could, should,
intend, expect, plan, anticipate, believe, estimate, predict,
potentially, continue, or opportunity or the negative of these terms or
other comparable terminology. The statements about our plans, strategies,
intentions, expectations and prospects contained throughout the document are
forward-looking and are based on current expectations. Actual results may
differ materially from those we predict as of the date of this report in the
forward-looking statements. In addition, past financial performance is not
necessarily a reliable indicator of future performance and investors should not
use historical performance to anticipate results or future period trends. In
evaluating these statements, you should specifically consider factors,
including the risks described below and in other parts of this document.

Membership and Premium Risk Factors.An unforeseen loss of profitable
membership or a change in premium expectations could negatively affect our
financial position, results of operations or cash flows. Factors that could
contribute to the loss of membership or lower premiums include:



| |  | The inability of our marketing and sales plans to attract new customers or retain existing customers;                                        
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | The effect of premium increases, benefit changes and member-paid supplemental premiums and copayments;                                       
| 
| |  | Our exit from selected service areas;                                                                                                        
| 
| |  | Our limits on enrollment of new Secure Horizons members in selected markets, through a combination of capacity waivers and
voluntary notices;
| 
| |  | Reductions in work force by existing customers;                                                                                              
| 
| |  | Negative publicity and news coverage or threats of litigation;                                                                               
| 
| |  | Our failure to successfully complete and/or integrate acquisitions; and                                                                      
| 
| |  | The loss of key sales and marketing employees.                                                                                               

Health Care Costs.Our profitability depends, in part, on our ability to
control health care costs while providing quality care. Our primary focus is
securing cost-effective physician, hospital and other health care contracts to
maintain our qualified network in each geographic area we serve.

We have increased the capitation rates we pay some of our physicians and
hospitals to improve network stability and to reflect the increased costs
incurred by our capitated physicians and hospitals. We have reduced benefits,
increased copayments and instituted or increased member-paid supplemental
premiums in some markets for our Secure Horizons members. The various changes
we made to premium rates, benefits, copayments and member paid supplemental
premiums did not offset our increased health care costs for 2000 for two
primary reasons. During 2000 more of our hospital providers shifted to
per-diem, fee-for-service or risk-based contracts than

27



---



##### Table of Contents



we anticipated when we
designed our 2000 programs. Hospital utilization by our members and cost of
claims under risk-based hospital arrangements also significantly exceeded our
expectations. We also expect that the changes to our benefits programs and
increased premiums for our Secure Horizons members in 2001 will not offset our
rising health care costs in some markets.

As a result of these trends, the following are potential risks:



| |  | Insolvency Risk.Under capitated arrangements, we face the risk of a
physician group or a physician association becoming insolvent.
Depending on state law, we may be held liable for unpaid health care
claims that were previously the responsibility of the capitated
physician and for which we have already paid capitation. To reduce
this insolvency risk, we have developed contingency plans that include
shifting members to other physicians and reviewing operational and
financial plans to monitor and maximize financial and network
stability. Some of our physicians require more frequent monitoring.
We may incur additional health care costs in the event of physician
instability where we are unable to reach an agreement that is mutually
beneficial. These costs may be incurred when we need to contract with
other physicians at less than cost-effective rates to continue
providing health care to our members. We believe that our December
31, 2000 insolvency reserves, intended to pay for December 31, 2000
and prior health care services that may not be paid by insolvent or
unstable physicians, are adequate.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Utilization Risk.Under fee-for-service and risk-based contracts, we
risk incurring higher than expected health care costs due to increased
utilization of hospital and physician services. To reduce the risk of
higher than medically warranted utilization, we are focusing on
developing medical management programs to manage health care costs and
investing in the development of systems to monitor and manage the
utilization of health care services, while maintaining quality of
care. However, our consolidated medical care ratio could continue to
increase if our programs for controlling utilization are not
successful.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| 
| |  | Retroactive Adjustments Risk.Some of the fee-for-service and
risk-based arrangements may be signed following the effective date of
the contract and may provide for retroactive adjustments to the
beginning of the contract year. The
retroactive adjustment feature can result in a material change in our
estimate of
health care costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| 
| |  | Underwriting Risk.We are enhancing our underwriting systems so that
we can better price our commercial products and make market exit
decisions for our Medicare markets. The development and
implementation of these systems will take time and the investment of
substantial resources, including the hiring of additional personnel
with the requisite experience and skills. If we are not able to
develop and implement these systems in a timely and cost effective
manner, our results of operations and cash flows of a future period
may be materially and adversely affected.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

Pharmacy.Our prescription drug costs have been rising for the past few years.
The increases are due to the introduction of new drugs costing significantly
more than existing drugs, direct consumer advertising by the pharmaceutical
industry creating consumer demand for particular brand drugs, patients seeking
medications to address lifestyle changes, higher prescribed doses of
medications and enhanced pharmacy benefits for members such as reduced
copayments and higher benefit maximums. Our efforts to mitigate these trends
and ensure appropriate utilization include formulary management, physician
education, successful pharmaceutical contracting and increased utilization of
our in-house mail-service pharmacy operated by Prescription Solutions.

Formularies are lists of physician-recommended drugs in different therapeutic
classes that have been reviewed for safety, efficacy and value. These lists
help ensure that members get the right prescription at the right time in the
right dose, avoiding potential adverse effects. Formularies also ensure that
the costs are effectively managed; if two medications have the same effect, the
less expensive option is recommended. Medically necessary drugs not included
in the formulary can be obtained through our authorization process provided
they are not specifically excluded from coverage or for the treatment of
excluded benefits. We continue to conduct member and physician education
programs to provide information on the appropriate use of generic drugs, over
the counter drugs and antibiotics. Many of our medical groups share the
financial risk for prescription drugs as an incentive to find the most
effective and cost-efficient treatments for our members. As a way of
controlling this health care cost component, we have implemented a decrease in
prescription drug benefits for Secure Horizons members in almost all of our
geographic areas in 2001.

Medical Care Ratio Risk Factors.An increase in our consolidated medical care
ratio could have an adverse effect on our profitability. Uncertainties that
could have a negative impact on our medical care ratio include:



| |  | Changes in the mix of our capitated, risk-based and fee-for-service physician and hospital contracts;
|- |  | -----------------------------------------------------------------------------------------------------

28



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##### Table of Contents





| |  | The capability of our current claims processing system, which could affect our ability to estimate claims liabilities and
establish receivables;                  
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Medical and prescription drug costs that rise faster than premium increases;                                                                                      
| 
| |  | Increases in utilization and costs of medical and hospital services;                                                                                              
| 
| |  | Our inability to successfully implement our new medical management initiatives, including hospital utilization and disease
management initiatives;                
| 
| |  | The effect of federal and/or state legislation on our ability to secure cost-effective contracts with physicians and hospitals;                                   
| 
| |  | The effect of actions by competitors; and                                                                                                                         
| 
| |  | Termination of physician or hospital contracts, physician or hospital instability or renegotiations of such contracts at less
favorable rates or terms of payment.

Legislation and Regulation.Recent changes in state and federal legislation
have increased and will continue to increase the costs of regulatory
compliance, and proposed changes in the law may negatively impact our financial
and operating results. These changes may increase our health care costs,
decrease our membership or otherwise adversely affect our revenues and our
profitability. Regulation and enforcement is increasing both at the state and
federal level. Increased regulations, mandated benefits and more oversight,
audits and investigations may increase our administrative, litigation and
health care costs. The following recent or proposed legislation, regulation or
initiatives could materially affect our financial position:



| |  | New and proposed legislation that would hold HMOs liable for medical
malpractice (including proposed federal legislation that would remove
or limit the federal preemption set forth in ERISA that precludes most
individuals from suing their employer-based health plans for causes of
action based upon state law). To date, Arizona, California, Oklahoma,
Texas and Washington have enacted legislation that may increase the
likelihood of lawsuits against HMOs for malpractice liability;                                                                                                                                                                                                                          
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Existing and proposed legislation that would limit our ability to
manage care and utilization such as any willing provider and direct
access laws;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| 
| |  | New state and proposed federal laws mandating benefits including those
that mandate equal coverage for mental health benefits, commonly
called mental health parity;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| 
| |  | Federal regulations that place additional restrictions and
administrative requirements on the use, electronic retention,
transmission and disclosure of personally identifiable health
information (see HIPAA);                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| 
| |  | New and proposed legislation that permits and would permit independent
physicians to collectively bargain with health plans on a number of
issues including financial compensation;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| 
| |  | Proposed legislation to add a prescription drug benefit, provide
payment relief for the Medicare+Choice program and regulate drug
pricing by the state and federal government could include provisions
that impact Secure Horizons;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| 
| |  | Proposed legislation and regulation could also include adverse actions
of governmental payors, including reduced Medicare premiums;
discontinuance of, or limitation on, governmentally funded programs;
recovery by governmental payors of previously paid amounts; the
inability to increase premiums or prospective or retroactive
reductions to premium rates for federal employees; and adverse
regulatory actions;                                                                                                                                                                                                                                                                                                   
| 
| |  | New and increased initiatives at the DOJ, the Office of Inspector
General of the United States Department of Health and Human Services,
the Office of Inspector General of the United States Office of
Personnel Management and the various enforcement divisions of the
state regulatory agencies governing health care programs. These
initiatives pursue both civil and criminal investigations against
physicians, hospitals, payors, and pharmaceutical companies for
misconduct relating to potential health care fraud and abuse, false
claims, ERISA violations, violations of the Medicare program,
overbilling of government programs, incorrect reporting of data, and
improper denial or mismanagement of care;

29



---



##### Table of Contents





| |  | Existing state legislation and regulation that may increase the
financial capital requirements of physicians and hospitals who
contract with HMOs to accept financial risk for health services.
Proposed state legislation, regulation, or litigation that would
otherwise limit our ability to capitate physicians and hospitals or
delegate financial risk, utilization review, quality assurance or
other medical decisions to our contracting physicians and hospitals;
and
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Existing state legislation and regulation that may require increases
in minimum capital, reserves, and other financial liability
requirements. In addition, proposed state legislation that may limit
the admissibility of certain assets.                                                                                                                                                                                                                                     

Regulatory Oversight.In November 2000, our Texas subsidiary was placed under
administrative oversight by the Texas Department of Insurance due to various
issues including delegated and non-delegated claims processing timeliness. The
Texas Department of Insurance continues to monitor our Texas HMO. We are
working with them to resolve any remaining concerns.

Industry Risk.Consumers, physicians and hospitals are currently attacking
practices of the HMO industry through a number of separate purported class
action lawsuits against us (see Note 10 of the Notes to Consolidated Financial
Statements) and against other national HMOs. These lawsuits, including those
filed to date against us, may take years to resolve and, depending upon the
outcomes of these cases, may cause or force changes in practices of the HMO
industry. These cases also may cause additional regulation of the industry
through new federal or state laws. These actions ultimately could adversely
affect the HMO industry and could have a material effect on our financial
position, results of operations or cash flows of a future period and prospects
of PacifiCare.

HIPAA.We expect to modify all of our information systems to comply with the
HIPAA regulations regarding standardizing transactions and codes. We also
expect to incur expense developing systems and contracts to comply with the
HIPAA privacy rules. We estimate that our HIPAA compliance costs will
approximate $20 million in 2001. Our estimate of HIPAA compliance costs may
change as current HIPAA rules evolve and additional rules are released or as we
continue to evaluate the work required to modify our existing information
technology and development systems.

Marketing, General and Administrative Risk Factors.The following factors
could have an adverse impact on marketing, general and administrative expenses:



| |  | HIPAA compliance costs;                                                                                                           
|- |  | ----------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Our need for additional advertising, marketing, administrative or management information systems expenditures;                    
| 
| |  | The success or lack of success of our marketing and sales plans to attract new customers;                                         
| 
| |  | Our need for increased claims administration, personnel and systems;                                                              
| 
| |  | Our need for additional investments in medical management, claims processing, underwriting and actuarial resources and
technology;
| 
| |  | Integration costs for acquisitions that exceed our expectations; and                                                              
| 
| |  | Our inability to achieve efficiency goals and resulting cost savings.                                                             

Future Dispositions, Impairments and Restructurings.While we previously
announced our decision to withdraw all operations in Ohio and commercial HMO
and POS products from certain counties in Colorado, we may announce in the
future other dispositions of assets or product exits as we continue to evaluate
whether our subsidiaries or products fit within our strategy. In accordance
with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, using the undiscounted cash flow method,
we review long-lived assets for impairment when events or changes in business
conditions indicate that we may be unable to recover such assets full carrying
value. Our subsidiaries with operating losses will require more frequent
monitoring. If one or more of these subsidiaries generates less operating cash
flows than we currently expect, an impairment charge could be necessary. In
addition, as we refocus and retool our workforce to shift from a capitated to a
risk-based business model, we expect some positions to change or be eliminated,
which could result in future restructuring charges. We cannot be certain that
the dispositions, impairments or restructuring charges will not result in
additional pretax charges. We believe that any disposition, impairment or
restructuring charges would not materially affect our current consolidated
financial position. However, the disposition, impairment or restructuring
charges could have a material effect on the results of operations or cash flows
of a future period.
30Table of ContentsOffice of Personnel Management Contingencies.We intend to negotiate with OPM
on any existing or future unresolved matters to attain a mutually satisfactory
result. We cannot be certain that any ongoing and future negotiations will be
concluded satisfactorily, that additional audits will not be referred to the
DOJ, or that additional, possibly material, liability will not be incurred.
Such liability could have a material effect on results of operations or cash
flows of a future period if resolved unfavorably. See Note 10 of the Notes to
Consolidated Financial Statements.Adjusted Community Rate Filings.In addition to the regular ACR proposals
submitted in June 2000, we were required to re-submit ACR proposals in January
2001 in accordance with BIPA. In our ACR resubmission, BIPA required that we
use increased funding to do one or a combination of the following: to reduce
member premiums or cost sharing; to enhance benefits; to contribute to a
benefits stabilization fund; or to stabilize or enhance beneficiary access to
physicians and hospitals (so long as such action does not result in increased
beneficiary premiums, cost-sharing, or reduced benefits). Our January 2001 ACR
submission has been filed in accordance with BIPA and accompanying ACR
instructions, and has been accepted by HCFA.We have been notified by HCFA that audits of the ACR proposals will be
conducted in Arizona, Oklahoma, Oregon and Washington in 2001. We cannot be
certain that any ongoing and future audits will be concluded satisfactorily.
We may incur additional, possibly material, liability as a result of these
audits. The incurrence of such liability could have a material effect on
results of operations or cash flows of a future period.Risk-Based Capital Requirements.The National Association of Insurance
Commissioners has proposed that states adopt risk-based capital standards that,
if implemented, would require increased minimum capitalization limits for
health care coverage provided by HMOs and other risk-bearing health care
entities. Risk-based capital requirements currently apply for Arizona,
Colorado, Indiana, Nevada, Texas and Washington. We do not expect California
to adopt risk-based capital in 2001. We do not expect this legislation to have
a material impact on our consolidated financial position.Liquidity and Capital Resources.The final maturity date on our credit
facility is January 1, 2002. Our ability to refinance this credit facility
depends on our credit rating, results of operations and cash flows from
operations. Our ability to repay amounts owed under the credit facility
depends on dividends and cash transfers from our subsidiaries. Nearly all of
the subsidiaries are subject to HMO regulations or insurance regulations and
may be subject to substantial supervision by one or more HMO or insurance
regulators. Subsidiaries subject to regulation must meet or exceed various
capital standards imposed by HMO or insurance regulations, which may from time
to time impact the amount of funds the subsidiaries can pay to us. Our
subsidiaries are not obligated to make funds available to us and creditors of
our subsidiaries have superior claim to our subsidiaries assets.
Additionally, from time to time, we advance funds in the form of a loan or
capital contribution to our subsidiaries to assist them in satisfying federal
or state financial requirements. We may provide additional funding to a
subsidiary if a federal or state legislator imposes additional financial
requirements due to concerns about the financial position of the subsidiary or
if there is an adverse effect resulting from changes to the risk-based capital
requirements. This may in turn affect the subsidiarys ability to pay
dividends or make other cash transfers. We will pursue several options to
maintain liquidity and refinance our current credit facility. Options include
issuing long-term debt and restructuring the existing line of credit.Other.Results may also differ materially from those projected, forecasted,
estimated and budgeted by us due to adverse results in ongoing audits or in
other reviews conducted by federal or state agencies or health care purchasing
cooperatives; adverse results in significant litigation matters; and changes in
interest rates causing changes in interest expense and net investment income.Expectations.We believe the fourth quarter of 2000 most accurately depicts
the environment we face as we enter 2001. As a result, 2001 expectations
represent a transition year for us. Our expectations highlight the positive
effects of current action plans, and are based on annual operations. We expect
the individual quarters to fluctuate based on the seasonality of our business.Contracting.We expect the percentage of commercial membership under hospital
risk-based contracts to increase only six percent and the percentage of
Medicare membership under hospital risk-based contracts to increase only three
percent compared to the percentage at December 31, 2000.Membership.We expect commercial and Medicare membership to decline compared
to membership at December 31, 2000, as we exit high-cost service areas and
provider contracts. We expect commercial membership to decline 10 to 12
percent compared to
December 31, 2000. We expect Medicare membership to decline six to eight
percent compared to December 31, 2000.31Table of ContentsPremiums.We expect an increase in commercial premium revenue of approximately
three percent in 2001. We expect commercial HMO premium rate increases to be
about 13 percent in 2001. We expect HCFA premium rate increases, combined with
supplemental member premiums, to be about six percent in 2001.Medical Care Ratio.We plan to implement premium increases sufficient to
offset health care cost increases, to regain long-term stability in our medical
care ratio. We expect the commercial medical care ratio for 2001 to range
between 86 and 87 percent. We expect the Medicare medical care ratio for 2001
to range between 90 and 91 percent.Marketing, General and Administrative Expenses.For the year ending December
31, 2001, we expect our marketing, general and administrative expense ratio to
be comparable to the 10.5 percent reported for the year ending
December 31, 2000. Additional efficiencies
are planned for 2001 but will be partially offset by continued investments in
legislative compliance (HIPAA), and investments in underwriting, medical
management and claims processing.Diluted Earnings Per Share.We expect 2001 diluted earnings per share to be
approximately $2.94, compared to 2000 diluted earnings per share of $4.73,
excluding credits and charges.Effective Tax Rate.We expect our effective tax rate for 2001 to be
approximately 47.5 percent. The increase over the prior-year rate of 44.1
percent is primarily due to nondeductible goodwill increasing as a percentage
of pretax income.Weighted Average Number of Shares.We expect the weighted average number of
shares used to compute diluted earnings per share to be approximately 33.6
million shares for the year ended December 31, 2001.32Table of Contents

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
  ABOUT MARKET RISKMarket RiskThe principal objective of our asset/liability management activities
  is to maximize net investment income, while maintaining acceptable levels of
  interest rate risk and facilitating our funding needs. Our net investment income
  and interest expense are subject to the risk of interest rate fluctuations.
  To mitigate the impact of fluctuations in interest rates, we manage the structure
  of the maturity of debt and investments and use derivative financial instruments,
  primarily interest rate swaps.The following table provides information about our financial
  instruments that are sensitive to changes in interest rates as of December 31,
  2000 and 1999. For investment securities and debt obligations, the table presents
  principal cash flows and related weighted average interest rates by expected
  maturity dates. Additionally, we have assumed our marketable securities and
  marketable securities-restricted, comprised primarily of U.S. government, state,
  municipal, and corporate debt securities, are similar enough to aggregate into
  fixed rate and variable rate securities for presentation purposes. For terms
  relating to our long term debt, see Note 5 of the Notes to Consolidated Financial
  Statements.As of December 31, 2000:

|                                                            |                                 |  |                        |        |      |  |      |         |      |  |      |         |        |  |       |        |            |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         | 
|----------------------------------------------------------- | ------------------------------- |  | ---------------------- | ------ | ---- |  | ---- | ------- | ---- |  | ---- | ------- | ------ |  | ----- | ------ | ---------- |  | - | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | 
|                                                            |                                 |  | 2001                   |        | 2002 |  | 2003 |         | 2004 |  | 2005 |         | Beyond |  | Total |        | Fair Value
|                                                            |                                 |  |                        |        |      |  |      |         |      |  |      |         |        |  |       |        |           
|                                                            |                                 |  | (amounts in thousands)
|Assets:                                                    
|                                                           
|                                                           
|                                                           
|                                                           
|Marketable
          securities:                           
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Fixed
          rate            |  | $                      | 93,821 |      |  | $    | 29,453  |      |  | $    | 37,092  |        |  | $     | 38,770 |            |  | $ | 54,311 |   |  | $ | 533,169 |   |  | $ | 786,616 |   |  | $ | 784,799 | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Average
          interest rate |  |                        | 2.71   | %    |  |      | 6.01    | %    |  |      | 5.78    | %      |  |       | 6.18   | %          |  |   | 6.32   | % |  |   | 5.71    | % |  |   | 5.40    | % |  |   |        | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Variable
          rate         |  | $                      | 10,010 |      |  | $    | 13,714  |      |  |      |        |        |  | $     | 5,000  |            |  | $ | 7,000  |   |  | $ | 46,575  |   |  | $ | 82,299  |   |  | $ | 79,214  | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Average
          interest rate |  |                        | 6.48   | %    |  |      | 6.47    | %    |  |      |        |        |  |       | 6.53   | %          |  |   | 6.30   | % |  |   | 5.34    | % |  |   | 5.82    | % |  |   |        | 
|                                                           
|                                                           
|                                                           
|                                                           
|Marketable
          securities  restricted:              
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Fixed
          rate            |  | $                      | 37,600 |      |  | $    | 27,088  |      |  |      |        |        |  | $     | 4,875  |            |  | $ | 5,721  |   |  | $ | 17,867  |   |  | $ | 93,151  |   |  | $ | 93,937  | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Average
          interest rate |  |                        | 2.22   | %    |  |      | 6.19    | %    |  |      |        |        |  |       | 5.74   | %          |  |   | 6.68   | % |  |   | 5.40    | % |  |   | 4.45    | % |  |   |        | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Variable
          rate         |  |                        |       |      |  |      |        |      |  |      |        |        |  |       |       |            |  |   |       |   |  | $ | 1,251   |   |  | $ | 1,251   |   |  | $ | 1,256   | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Average
          interest rate |  |                        |       |      |  |      |        |      |  |      |        |        |  |       |       |            |  |   |       |   |  |   | 6.25    | % |  |   | 6.25    | % |  |   |        | 
|                                                           
|                                                           
|                                                           
|                                                           
|Liabilities:                                               
|                                                           
|                                                           
|                                                           
|                                                           
|Long term debt, including debt due within
        one year:
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Variable
          rate         |  | $                      | 161    |      |  | $    | 735,171 |      |  | $    | 100,172 |        |  | $     | 184    |            |  | $ | 197    |   |  | $ | 832     |   |  | $ | 836,717 |   |  | $ | 836,717 | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Average
          interest rate |  |                        | 6.68   | %    |  |      | 7.88    | %    |  |      | 7.00    | %      |  |       | 6.77   | %          |  |   | 6.77   | % |  |   | 6.77    | % |  |   |        |   |  |   |        | 

As of December 31, 1999:

|                                                          |                               |  |                        |         |      |  |      |        |      |  |      |         |        |  |       |         |            |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         | 
|--------------------------------------------------------- | ----------------------------- |  | ---------------------- | ------- | ---- |  | ---- | ------ | ---- |  | ---- | ------- | ------ |  | ----- | ------- | ---------- |  | - | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | 
|                                                          |                               |  | 2000                   |         | 2001 |  | 2002 |        | 2003 |  | 2004 |         | Beyond |  | Total |         | Fair Value
|                                                          |                               |  |                        |         |      |  |      |        |      |  |      |         |        |  |       |         |           
|                                                          |                               |  | (amounts in thousands)
|Assets:                                                  
|                                                         
|                                                         
|                                                         
|                                                         
|Marketable
        securities:                           
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Fixed rate                    |  | $                      | 144,799 |      |  | $    | 23,725 |      |  | $    | 38,320  |        |  | $     | 38,528  |            |  | $ | 39,065 |   |  | $ | 686,989 |   |  | $ | 971,426 |   |  | $ | 932,259 | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Average
        interest rate |  |                        | 2.56    | %    |  |      | 6.20   | %    |  |      | 5.88    | %      |  |       | 5.69    | %          |  |   | 5.90   | % |  |   | 5.26    | % |  |   | 4.94    | % |  |   |        | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Variable
        rate         |  |                        |        |      |  | $    | 5,010  |      |  | $    | 6,364   |        |  |       |        |            |  |   |       |   |  | $ | 56,231  |   |  | $ | 67,605  |   |  | $ | 66,935  | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Average
        interest rate |  |                        |        |      |  |      | 6.55   | %    |  |      | 5.76    | %      |  |       |        |            |  |   |       |   |  |   | 4.94    | % |  |   | 5.14    | % |  |   |        | 
|                                                         
|                                                         
|                                                         
|                                                         
|Marketable
        securities  restricted:              
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Fixed rate                    |  | $                      | 56,437  |      |  | $    | 8,457  |      |  | $    | 2,931   |        |  |       |        |            |  | $ | 500    |   |  | $ | 16,784  |   |  | $ | 85,109  |   |  | $ | 84,521  | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Average
        interest rate |  |                        | 3.09    | %    |  |      | 5.68   | %    |  |      | 5.89    | %      |  |       |        |            |  |   | 5.68   | % |  |   | 4.95    | % |  |   | 3.82    | % |  |   |        | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Variable
        rate         |  |                        |        |      |  |      |       |      |  |      |        |        |  |       |        |            |  |   |       |   |  | $ | 1,362   |   |  | $ | 1,362   |   |  | $ | 1,367   | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Average
        interest rate |  |                        |        |      |  |      |       |      |  |      |        |        |  |       |        |            |  |   |       |   |  |   | 5.91    | % |  |   | 5.91    | % |  |   |        | 
|                                                         
|                                                         
|                                                         
|                                                         
|Liabilities:                                             
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|Long term debt, including debt due within one
      year: |                               |  |                        |         |      |  |      |        |      |  |      |         |        |  |       |         |            |  |   |        |   |  |   |         |   |  |   |         |   |  |   |        
|                                                          | Variable
        rate         |  |                        |        |      |  | $    | 75,000 |      |  | $    | 800,000 |        |  | $     | 100,000 |            |  |   |       |   |  |   |        |   |  | $ | 975,000 |   |  | $ | 975,000 | 
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Average
        interest rate |  |                        |        |      |  |      | 6.76   | %    |  |      | 6.76    | %      |  |       | 7.00    | %          |  |   |       |   |  |   |        |   |  |   |        |   |  |   |        | 

33



---



##### Table of Contents









ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the Index included at Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K.







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

We have not changed our independent auditors, nor have we had disagreements
with our auditors on accounting principles,
practices or financial statement disclosure.
34Table of Contents

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTThe following table provides information about each of our current directors
and executive officers. Executive officers are elected by and serve at the
discretion of our board of directors.Directors
        
        Age
        
        TitleDavid A. Reed
        
        
        68
        
        
        Chairman of the BoardHoward G. Phanstiel
        
        
        52
        
        
        Director, President and Chief Executive OfficerBradley C. Call
        
        
        58
        
        
        DirectorTerry O. Hartshorn
        
        
        56
        
        
        DirectorArthur B. Laffer, Ph.D.
        
        
        60
        
        
        DirectorGary L. Leary
        
        
        66
        
        
        DirectorSanford M. Litvack
        
        
        64
        
        
        DirectorWarren E. Pinckert II
        
        
        57
        
        
        DirectorLloyd E. Ross
        
        
        60
        
        
        DirectorJean Bixby Smith
        
        
        63
        
        
        DirectorCorporate Executive OfficersBary G. Bailey
        
        
        42
        
        
        Executive Vice President and Chief Strategic OfficerBradford A. Bowlus
        
        
        45
        
        
        Executive Vice President and President and Chief Executive
Officer, PacifiCare Health PlansJoseph S. Konowiecki
        
        
        48
        
        
        Executive Vice President, General Counsel and SecretaryGregory W. Scott
        
        
        47
        
        
        Executive Vice President and Chief Financial OfficerSusan L. Berkel
        
        
        39
        
        
        Senior Vice President, Finance and Corporate ControllerMaria Z. Fitzpatrick
        
        
        43
        
        
        Senior Vice President and Chief Information OfficerRobert N. Franklin
        
        
        57
        
        
        Senior Vice President, Public AffairsJames A. Frey II
        
        
        34
        
        
        Senior Vice President, Strategic Programs and Chief of StaffJohn F. Fritz
        
        
        56
        
        
        Senior Vice President and Chief ActuaryMary C. Langsdorf
        
        
        41
        
        
        Senior Vice President, FinanceWanda A. Lee
        
        
        60
        
        
        Senior Vice President, Human ResourcesHealth
Plans Division Executive OfficersJames W. Cassity
        
        
        49
        
        
        Regional Vice President, Southwest Region and President and
Chief Executive Officer, PacifiCare of Texas, Inc. and
PacifiCare of Oklahoma, Inc.Donald E. Costa
        
        
        46
        
        
        Regional Vice President, Northwest Region and President and
Chief Executive Officer, PacifiCare of Oregon, Inc. and
PacifiCare of Washington, Inc.Val C. Dean, M.D.
        
        
        52
        
        
        Regional Vice President, Central Region, and President and
Chief Executive Officer, PacifiCare of Colorado, Inc.Ace M. Hodgin Jr., M.D.
        
        
        45
        
        
        Regional Vice President, Desert Region and President and Chief
Executive Officer, PacifiCare of Arizona, Inc.Christopher P. Wing
        
        
        43
        
        
        Regional Vice President, Western Region and President and Chief
Executive Officer, PacifiCare of CaliforniaEdward C. Cymerys
        
        
        48
        
        
        Senior Vice President, Pricing and UnderwritingRonald M. Davis
        
        
        41
        
        
        Senior Vice President and Chief Administrative OfficerKatherine F. Feeny
        
        
        48
        
        
        Senior Vice President, Secure Horizons Sales and MarketingMichael A. Kaufman, M.D.
        
        
        54
        
        
        Senior Vice President, Health Services and Chief Medical OfficerDavid A. Taaffe
        
        
        48
        
        
        Senior Vice President, National Account Sales and MarketingMr. Reed has been Chairman of the Board since 1999. Mr. Reed currently is the
President of DAR Consulting Group, and served as past chairman of the American
Hospital Association. Mr. Reed has served as a Director of In-Vitro
International since 1996 and as a Director of Medstone Intern since
1998.35Table of ContentsMr. Phanstiel was appointed President and Chief Executive Officer in December
2000 after having served as acting Chief Executive Officer since October 2000.
Mr. Phanstiel was appointed Executive Vice President and Chief Financial
Officer in July 2000. Mr. Phanstiel was an executive of NetCatalyst from
January 2000 until June 2000. Mr. Phanstiel was Chairman and Chief Executive
Officer of ARV Assisted Living, Inc. from 1997 to 1999. Mr. Phanstiel was
Executive Vice President of Finance and Information Services at WellPoint
Health Networks from 1994 to 1997.Mr. Call has been a Director, President and Chief Executive Officer of Stellex
Aerospace, Inc., a privately held aerospace component manufacturing firm with
multiple plant operations throughout the U.S., since 1998. Mr. Call has been a
Director of UniHealth Foundation since 1998, and served as Director of
UniHealth, the predecessor of UniHealth Foundation, from 1995 to 1998.Mr. Hartshorn was Chairman of the Board of PacifiCare from 1993 to 1998. Mr.
Hartshorn was President and Chief Executive Officer of UniHealth from 1993 to
1997.Dr. Laffer was appointed to PacifiCares Board in February 2001. Dr. Laffer
has served as the founder and chairman of Laffer Associates, an economics
research and consulting firm that provides investment-research services to
institutional asset managers, since 1979. Dr. Laffer has served as a member of
the Board of Directors of MasTec, Inc. since 1999, Neff Corp. since 1998,
Oxigene, Inc. since 1998, Nichols-Applegate Growth Equity Fund since 1987 and
Vivendi Environment since October 2000.Mr. Leary currently serves as a consultant to
UniHealth Foundation and as a director of several of its
subsidiaries. From 1998 through 1999, Mr. Leary served as an
Executive Vice President and President of UniHealth Foundation. He
was also General Counsel to UniHealth Foundation from 1998 through
April 15, 2000. Mr. Leary was an Executive Vice President and
General Counsel of UniHealth from 1992 to 1998.Mr. Litvack was appointed to PacifiCares
Board in February 2001. Mr. Litvack has served as Vice
Chairman of the Board of Directors of Walt Disney Company since 1999.
Since December 2000, Mr. Litvack has been in this position on a
less than full time basis. From 1994 through 1999, Mr. Litvack
served as Senior Vice President and Chief of Corporate Operations of
the Walt Disney Corporation. Mr. Litvack is a member of the
Board of Directors of Euro Disneyland, Compaq, Antigenics and Cyber
Capital.Mr. Pinckert has been a Director, President and Chief Executive Officer of
Cholestech Corporation, a medical device manufacturing firm, since 1993, and is
a certified public accountant.Mr. Ross was Managing Partner of InverMex, L.P. from 1996 to 1997. Mr. Ross
served as Vice President/Division Manager of SMI Corporation, a division of
ARB, Inc., a commercial and industrial building company and as President/CEO of
SMI Construction from 1961 to 1996. Mr. Ross is Chairman of the Board of
Directors of the Southern California Water Company.Ms. Smith has been Chairman of Bixby Land Company since 1994 and President of
Alamitos Land Company since 1991, both of which are engaged in the development
and management of commercial and industrial real estate. Ms. Smith has also
been a Director and Vice President of UniHealth Foundation since 1998.Mr. Bailey was appointed Executive Vice President and Chief Strategic Officer
in July 2000. Mr. Bailey was Executive Vice President of Finance, Information
Technology and Strategic Initiatives and Chief Financial Officer at Premier
Inc., a hospital alliance, from 1995 to July 2000. Mr. Bailey is a Director of
LTC Healthcare, Inc. and a member of its compensation committee.Mr. Bowlus has been Executive Vice President and President and Chief Executive
Officer of PacifiCare Health Plans since 1999. Mr. Bowlus was Regional Vice
President, Western Region and President and Chief Executive Officer of
PacifiCare of California from 1997 to 1999. From 1994 to 1997, Mr. Bowlus
served in various capacities for PacifiCare, including President and Chief
Executive Officer of PacifiCare of Washington, Inc., President and Chief
Executive Officer of PacifiCare Dental and Vice President of
PacifiCare of California.Mr. Konowiecki has been Executive Vice President since 1999, General Counsel of
PacifiCare since 1989, and Secretary of PacifiCare since 1993. Mr. Konowiecki
has been a partner of Konowiecki & Rank LLP, including a professional
corporation, or its predecessor, since 1980 and has over 21 years of practice
in business, corporate and health care law.Mr. Scott was appointed Executive Vice President and Chief Financial Officer in
January 2001. Prior to joining PacifiCare, Mr. Scott was Chief Operating
Officer and Chief Financial Officer of Medsite, Inc., an e-commerce
and pharmaceutical services company from 1999 through January 2001.
Mr. Scott was Senior Vice President and Chief
Financial Officer of Prudential HealthCare Group from 1995 to 1999.36Table of ContentsMs. Berkel was appointed Senior Vice President, Finance and Corporate
Controller in December 2000. Ms. Berkel was Vice President, Finance and
Assistant Corporate Controller from 1999 to December 2000 and Director, Finance
from 1995 to 1999.Ms. Fitzpatrick has been Senior Vice President and Chief Information Officer
since September 2000. From March 2000 through September 2000, Ms. Fitzpatrick
was Interim Chief Information Officer. Ms. Fitzpatrick was Vice President,
Information Technology-Systems Development from 1996 to 2000.Mr. Franklin has been Senior Vice President, Public Affairs since 1997. From
1993 to 1997, Mr. Franklin was Senior Vice President, Public Affairs of FHP
International Corporation, which merged with PacifiCare in 1997.Mr. Frey was appointed Senior Vice President, Strategic Programs and Chief of
Staff in November 2000. Mr. Frey was Senior Vice President, Operations from
February 2000 to November 2000. Mr. Frey was President, PacifiCare of Nevada,
Inc. during 1999, and was Vice President of Operations, Desert Region from 1997
to 1999. Mr. Frey was Director of Regulatory Affairs, Desert Region from 1996
to 1997.Mr. Fritz was appointed Senior Vice President and Chief Actuary in January
2001. Prior to joining PacifiCare, Mr. Fritz was a Partner with Ernst & Young
LLP from 1996 to January 2001.Ms. Langsdorf has been Senior Vice President, Finance since January 1999, and
was Interim Chief Financial Officer from 1999 to July 2000. Ms. Langsdorf was
PacifiCares Corporate Controller from 1996 to December 2000. From 1995 to
1999, Ms. Langsdorf was Vice President, Finance.Ms. Lee has been Senior Vice President, Corporate Human Resources since 1993.Mr. Cassity has been Regional Vice President, Southwest Region and President
and Chief Executive Officer of PacifiCare of Texas, Inc. and PacifiCare of
Oklahoma, Inc., since March 2000. From 1997 through 1999, Mr. Cassity was
President, Central Division, Prudential HealthCare, a national healthcare
company, and Vice President, Prudential HealthCare, from 1996 to 1997.Mr. Costa has been Regional Vice President, Northwest Region and President and
Chief Executive Officer of PacifiCare of Oregon, Inc. and PacifiCare of
Washington, Inc., since December 2000. Mr. Costa was Chief Financial Officer
of PacifiCare of Oregon, Inc. and PacifiCare of Washington, Inc. from 1997 to
December 2000 and PacifiCare of California in 1997. From 1993 to 1997, Mr.
Costa was Vice President and Chief Accounting Officer, PacifiCare of
California.Dr. Dean has been Regional Vice President, Central Region and President and
Chief Executive Officer of PacifiCare of Colorado, Inc. since May 2000. Dr.
Dean was Chief Operating Officer of PacifiCare of Colorado Inc., formerly FHP
of Colorado, from 1994 to May 2000. Dr. Dean was also Senior Medical Director
of FHP of Colorado from 1993 to 1997.Dr. Hodgin has been Regional Vice President, Desert Region and President and
Chief Executive Officer, PacifiCare of Arizona, Inc. since 1999. Dr. Hodgin
was Vice President, Health Services, PacifiCare of Arizona, Inc. from 1997 to
1999, and Medical Director, PacifiCare of Arizona, Inc. from 1994 to 1997.Mr. Wing has been Regional Vice President, Western Region and President and
Chief Executive Officer of PacifiCare of California since August 2000. From
1997 to August 2000, Mr. Wing was Regional Vice President, Northwestern Region,
and President and Chief Executive Officer, PacifiCare of Washington, Inc. From
1994 to 1997, Mr. Wing served in various capacities for PacifiCare, including
President and Chief Executive Officer, PacifiCare of Utah, Inc., Senior Vice
President, Health Services of PacifiCare of California and Vice President,
General Manager, PacifiCare of California.Mr. Cymerys was appointed Senior Vice President, Pricing and Underwriting in
February 2001. Mr. Cymerys was Vice President, Actuary, Pricing and
Underwriting from 1998 to February 2001. Prior to joining PacifiCare, Mr.
Cymerys was the senior actuary for the San Francisco health care industry
consulting practice of Towers Perrin from 1995 to 1998.Mr. Davis has been Senior Vice President and Chief Administrative Officer,
Health Plans Division since 1999. Mr. Davis was Senior Vice President,
Corporate Operations from 1995 to 1999.
37Table of ContentsMs. Feeny has been Senior Vice President, Secure Horizons Sales and Marketing
since January 2000. During 1999, Ms. Feeny was Vice President, Sales and
Marketing, Secure Horizons of California, and was Regional Sales Director,
Secure Horizons of California from 1995 to 1997.Dr. Kaufman has been Senior Vice President and Chief Medical Officer since
December 2000. Prior to joining PacifiCare, Dr. Kaufman was Senior Vice
President and Chief Medical Officer for WellPoint from 1996 to January 2000.Mr. Taaffe has been Senior Vice President, National Account Sales and Marketing
since January 2000. Prior to joining PacifiCare, Mr. Taaffe was the East Coast
Vice President of Sales, Prudential HealthCare from 1997 to 1999. From 1994 to
1997, he was Vice President of Sales for Prudentials Southern California
operations.SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCEPacifiCare believes that during 2000, all filings with the SEC by its officers,
directors and 10 percent stockholders complied with requirements for reporting
ownership and changes in ownership of PacifiCares common stock under Section
16(a) of the Securities Exchange Act of 1934, except that Richard M. Burdge (a
former director) did not file a report for one transaction on a timely basis.
Once discovered, this oversight was promptly corrected.38Table of Contents

ITEM 11. EXECUTIVE COMPENSATIONThis table shows, for the last three years, compensation information
  for PacifiCares Chief Executive Officer and the next four most highly
  compensated executive officers. We refer to each of these officers as a named
  executive officer.SUMMARY COMPENSATION TABLE

|                                    |                                                           |                                          |      |               |      |               |         |                     |         |                     |         |           |           |         |         |              |         |            |         |           |        |              |   |         |   |   |        |        |        | 
|----------------------------------- | --------------------------------------------------------- | ---------------------------------------- | ---- | ------------- | ---- | ------------- | ------- | ------------------- | ------- | ------------------- | ------- | --------- | --------- | ------- | ------- | ------------ | ------- | ---------- | ------- | --------- | ------ | ------------ | - | ------- | - | - | ------ | ------ | ------ | 
|                                    |                                                           |                                          |      |               |      |               |         |                     |         |                     |         |           |           |         |         |              |         |            |         | Long-Term
|                                    |                                                           |                                          |      |               |      |               |         | Annual Compensation |         | Compensation Awards
|                                    |                                                           |                                          |      |               |      |               |         |                     |         |                    
|                                    |                                                           |                                          |      |               |      |               |         |                     |         |                     |         |           |           |         |         | Other Annual |         | Securities |         | LTIP      |        | All Other   
|                                    |                                                           |                                          |      |               |      |               |         |                     |         |                     |         |           |           |         |         | Compensation |         | Underlying |         | Payouts   |        | Compensation
|Name and Principal
        Position |                                                           | Year                                     |      | Salary ($)(1) |      | Bonus ($) (2) |         | ($) (3)             |         | Options (#)         |         | ($) (4)   |           | ($) (5)
|                                    |                                                           |                                          |      |               |      |               |         |                     |         |                     |         |           |           |        
|Howard
          G. Phanstiel (6)   |                                                           |                                          | 2000 |               |      | $             | 259,808 |                     |         | $                   | 350,000 |           |           | $       | 109,962 |              |         |            | 500,000 |           |        | $            |  |         |   | $ | 8,423  |       
|                                   
|                                   
|                                   
|                                   
|                                    | President
          and                                   |                                          |      | 1999          |      |               | $       |                    |         |                     | $       |          |           |         | $       |             |         |            |         |          |        |              | $ |        |   |   | $      |       |       
|                                   
|                                   
|                                   
|                                   
|                                    | Chief
          Executive Officer                         |                                          |      | 1998          |      |               | $       |                    |         |                     | $       |          |           |         | $       |             |         |            |         |          |        |              | $ |        |   |   | $      |       |       
|                                   
|                                   
|                                   
|                                   
|Bary G.
          Bailey (6)        |                                                           |                                          | 2000 |               |      | $             | 219,231 |                     |         | $                   | 250,000 |           |           | $       |        |              |         |            | 400,000 |           |        | $            |  |         |   | $ | 5,919  |       
|                                   
|                                   
|                                   
|                                   
|                                    | Executive
          Vice President and                    |                                          |      | 1999          |      |               | $       |                    |         |                     | $       |          |           |         | $       |             |         |            |         |          |        |              | $ |        |   |   | $      |       |       
|                                   
|                                   
|                                   
|                                   
|                                    | Chief
          Strategic Officer                         |                                          |      | 1998          |      |               | $       |                    |         |                     | $       |          |           |         | $       |             |         |            |         |          |        |              | $ |        |   |   | $      |       |       
|                                   
|                                   
|                                   
|                                   
|Bradford
          A. Bowlus        |                                                           |                                          | 2000 |               |      | $             | 600,001 |                     |         | $                   | 200,000 |           |           | $       |        |              |         |            | 100,000 |           |        | $            |  |         |   | $ | 45,100 |       
|                                   
|                                   
|                                   
|                                   
|                                    | Executive
          Vice President and                    |                                          |      | 1999          |      |               | $       | 501,923             |         |                     | $       | 449,856   |           |         | $       | 188,953      |         |            |         | 140,000   |        |              | $ | 75,504  |   |   | $      | 43,908 |       
|                                   
|                                   
|                                   
|                                   
|                                    | President
          and CEO, PacifiCare Health Plans      |                                          |      | 1998          |      |               | $       | 363,463             |         |                     | $       | 253,681   |           |         | $       | 294,697      |         |            |         | 10,000    |        |              | $ |        |   |   | $      | 23,929 |       
|                                   
|                                   
|                                   
|                                   
|Christopher
          P. Wing       |                                                           |                                          | 2000 |               |      | $             | 332,308 |                     |         | $                   | 200,000 |           |           | $       |        |              |         |            | 170,000 |           |        | $            |  |         |   | $ | 22,182 |       
|                                   
|                                   
|                                   
|                                   
|                                    | Regional
          Vice President,                        |                                          |      | 1999          |      |               | $       | 290,000             |         |                     | $       | 50,000    |           |         | $       | 85,433       |         |            |         | 40,000    |        |              | $ | 54,740  |   |   | $      | 20,165 |       
|                                   
|                                   
|                                   
|                                   
|                                    | Western
          Region, PacifiCare Health Plans         |                                          |      | 1998          |      |               | $       | 301,154             |         |                     | $       | 183,816   |           |         | $       | 176,542      |         |            |         | 10,000    |        |              | $ |        |   |   | $      | 15,851 |       
|                                   
|                                   
|                                   
|                                   
|Ronald
          M. Davis           |                                                           |                                          | 2000 |               |      | $             | 330,000 |                     |         | $                   | 156,750 |           |           | $       |        |              |         |            | 50,000  |           |        | $            |  |         |   | $ | 17,578 |       
|                                   
|                                   
|                                   
|                                   
|                                    | Senior
          Vice President and Chief                 |                                          |      | 1999          |      |               | $       | 284,231             |         |                     | $       | 231,540   |           |         | $       | 80,001       |         |            |         | 75,000    |        |              | $ | 47,400  |   |   | $      | 17,109 |       
|                                   
|                                   
|                                   
|                                   
|                                    | Administrative
          Officer, PacifiCare Health Plans |                                          |      | 1998          |      |               | $       | 249,232             |         |                     | $       | 155,149   |           |         | $       | 52,803       |         |            |         | 10,000    |        |              | $ |        |   |   | $      | 13,589 |       
|                                   
|                                   
|                                   
|                                   
|Robert
          W. OLeary (7)     |                                                           |                                          | 2000 |               |      | $             | 304,634 |                     |         | $                   |        |           |           | $       | 607,034 |              |         |            |         |           |        | $            |  |         |   | $ | 6,093  |       
|                                   
|                                   
|                                   
|                                   
|                                    | President
          and Chief Executive Officer           |                                          |      | 1999          |      |               | $       |                    |         |                     | $       |          |           |         | $       |             |         |            |         |          |        |              | $ |        |   |   | $      |       |       
|                                   
|                                   
|                                   
|                                   
|                                    |                                                           | From July 2000
          to October 2000 |      |               | 1998 |               |         | $                   |        |                     |         | $         |          |         |         | $            |        |            |         |           |       |              |   | $       |  |   |        | $      |       | 
|                                   
|                                   
|                                   
|                                   
|Alan R.
          Hoops (8)         |                                                           |                                          | 2000 |               |      | $             | 920,001 |                     |         | $                   |        |           |           | $       | 102,981 |              |         |            |        |           |        | $            |  |         |   | $ | 54,255 |       
|                                   
|                                   
|                                   
|                                   
|                                    | President
          and Chief Executive Officer           |                                          |      | 1999          |      |               | $       | 920,000             |         |                     | $       | 1,104,995 |           |         | $       | 544,543      |         |            |         | 160,000   |        |              | $ | 298,996 |   |   | $      | 46,649 |       
|                                   
|                                   
|                                   
|                                   
|                                    |                                                           | From January 2000
          to July 2000 |      |               | 1998 |               |         | $                   | 893,078 |                     |         | $         | 1,161,001 |         |         | $            | 575,527 |            |         |           | 15,000 |              |   | $       |  |   |        | $      | 36,364 | 



---

|(1) |  | 1998 salaries included one extra pay period
      because of year-end payroll timing. Base salaries in 1998 were $350,000
      for Mr. Bowlus, $290,000 for Mr. Wing, $240,000 for Mr. Davis
      and $860,000 for Mr. Hoops.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|   
|   
|   
|   
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|(2) |  | The amounts shown in this column include bonuses
      awarded and accrued during the years earned, but paid in the following year
      under PacifiCares annual incentive plan. Portions of the 1998 bonuses
      for Mr. Bowlus, Mr. Wing, Mr. Davis and Mr. Hoops were
      attributable to incentives where executive officers received bonuses in
      excess of the maximum payable under the annual incentive plan for the achievement
      of maximum performance objectives. Bonuses awarded under these incentives
      are generally payable in installments over a three-year period. To receive
      each installment, the executive officer must be employed by PacifiCare at
      the time of payment and PacifiCare must achieve target earnings per share
      for the prior year. No bonuses were made to the named executive officers
      in excess of the maximum payable in 2000 or 1999.

39



---



##### Table of Contents





|(3) |  | Other Annual Compensation includes a risk premium applied to
amounts deferred under PacifiCares Stock Unit Deferred Compensation
Plan (explained below). Additionally, this column includes signing
bonuses, relocation expenses and other perquisites as shown in the
following chart.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|              |  |         |         |                     |  |                   |        |       |  |      |         |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |         |  |  |   |        |  |  |   |         | 
|------------- |  | ------- | ------- | ------------------- |  | ----------------- | ------ | ----- |  | ---- | ------- | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------- |  |  | - | ------ |  |  | - | ------- | 
|              |  | Signing
|              |  | Bonuses |         | Relocation Expenses |  | Other Perquisites |        | Total
|              |  |         |         |                     |  |                   |        |      
|              |  | 2000    |         | 1999                |  | 1998              |        | 2000  |  | 1999 |         | 1998 |  | 2000 |        | 1999 |  | 1998
|              |  |         |         |                     |  |                   |        |       |  |      |         |      |  |      |        |      |  |     
|Mr. Phanstiel |  | $       | 100,000 |                     |  | $                 |       |       |  | $    |        |      |  | $    | 9,962  |      |  | $    |       |  |  | $ |       |  |  | $ | 109,962 |  |  | $ |       |  |  | $ |        | 
|             
|             
|             
|             
|Mr. Bowlus    |  | $       |        |                     |  | $                 |       |       |  | $    | 227,656 |      |  | $    |       |      |  | $    | 44,999 |  |  | $ | 26,452 |  |  | $ |        |  |  | $ | 44,999 |  |  | $ | 254,108 | 
|             
|             
|             
|             
|Mr. Wing      |  | $       |        |                     |  | $                 | 52,385 |       |  | $    | 72,013  |      |  | $    |       |      |  | $    | 23,048 |  |  | $ | 31,002 |  |  | $ |        |  |  | $ | 75,433 |  |  | $ | 103,015 | 
|             
|             
|             
|             
|Mr. Davis     |  | $       |        |                     |  | $                 |       |       |  | $    |        |      |  | $    |       |      |  | $    | 33,693 |  |  | $ | 21,773 |  |  | $ |        |  |  | $ | 33,693 |  |  | $ | 21,773  | 
|             
|             
|             
|             
|Mr. OLeary   |  | $       | 600,000 |                     |  | $                 |       |       |  | $    |        |      |  | $    | 7,034  |      |  | $    |       |  |  | $ |       |  |  | $ | 607,034 |  |  | $ |       |  |  | $ |        | 
|             
|             
|             
|             
|Mr. Hoops     |  | $       |        |                     |  | $                 |       |       |  | $    |        |      |  | $    | 22,981 |      |  | $    | 22,545 |  |  | $ | 21,819 |  |  | $ | 22,981  |  |  | $ | 22,545 |  |  | $ | 21,819  | 



| |  | SEC regulations exclude from proxy statement reporting requirements a
named executive officers perquisites if their value in any year does not
exceed the lesser of (a) $50,000 or (b) 10 percent of the total of the
named executive officers annual salary and bonus for that year.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Under the Stock Unit Plan, executive officers may defer all or a portion
of their annual bonus. The Chief Executive Officer may also defer all or
a portion of his salary. Amounts deferred are converted into units of
PacifiCares common stock. The number of stock units converted is equal
to the amount of bonus or salary deferred, multiplied by a risk premium,
then divided by the price of PacifiCares common stock on the Nasdaq
National Market on a predetermined date. The stock price is based on a
date selected by the Compensation Committee. Distributions are made
in shares of common stock. In 2000, 1999 and 1998, the risk premium applied
to amounts deferred was 40 percent. Stock unit activity for the named
executive officers was as follows:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|           |  |  |      |  |  |              |           |             |  |           |         |  |  |  |        | 
|---------- |  |  | ---- |  |  | ------------ | --------- | ----------- |  | --------- | ------- |  |  |  | ------ | 
|           |  |  |      |  |  | Amount       |           | Risk        |  | Stock    
|           |  |  |      |  |  | Deferred ($) |           | Premium ($) |  | Units (#)
|           |  |  |      |  |  |              |           |             |  |          
|Mr. Bowlus |  |  | 2000 |  |  | $            |          |             |  | $         |        |  |  |  |       | 
|          
|          
|          
|          
|           |  |  | 1999 |  |  | $            | 359,885   |             |  | $         | 143,954 |  |  |  | 6,338  | 
|          
|          
|          
|          
|           |  |  | 1998 |  |  | $            | 101,472   |             |  | $         | 40,589  |  |  |  | 2,713  | 
|          
|          
|          
|          
|Mr. Wing   |  |  | 2000 |  |  | $            |          |             |  | $         |        |  |  |  |       | 
|          
|          
|          
|          
|           |  |  | 1999 |  |  | $            | 25,000    |             |  | $         | 10,000  |  |  |  | 441    | 
|          
|          
|          
|          
|           |  |  | 1998 |  |  | $            | 183,816   |             |  | $         | 73,527  |  |  |  | 4,914  | 
|          
|          
|          
|          
|Mr. Davis  |  |  | 2000 |  |  | $            |          |             |  | $         |        |  |  |  |       | 
|          
|          
|          
|          
|           |  |  | 1999 |  |  | $            | 115,770   |             |  | $         | 46,308  |  |  |  | 2,039  | 
|          
|          
|          
|          
|           |  |  | 1998 |  |  | $            | 77,574    |             |  | $         | 31,030  |  |  |  | 2,074  | 
|          
|          
|          
|          
|Mr. Hoops  |  |  | 2000 |  |  | $            | 200,000   |             |  | $         | 80,000  |  |  |  | 5,286  | 
|          
|          
|          
|          
|           |  |  | 1999 |  |  | $            | 1,304,995 |             |  | $         | 521,998 |  |  |  | 22,984 | 
|          
|          
|          
|          
|           |  |  | 1998 |  |  | $            | 1,384,270 |             |  | $         | 553,708 |  |  |  | 37,005 | 

40



---



##### Table of Contents





|(4) |  | Includes amounts awarded and accrued under PacifiCares Long-Term
Performance Incentive Plan during the years earned, but paid in the
following year. In 1999, the last performance cycle of the Plan, 60
percent of the awards were paid in cash and 40 percent of the awards were
paid in shares of common stock. The shares of common stock distributed
were valued at $45.13 per share in 1999 (the fair market values of the
common stock at the time the payments were awarded). No awards were made
under the long-term plan to the named executive officers for 1998.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|           |  |               |         |            |  |           |       | 
|---------- |  | ------------- | ------- | ---------- |  | --------- | ----- | 
|           |  | 1999         
|           |  |              
|           |  |               |         |            |  | Number of
|           |  | Cash Paid ($) |         | Shares (#)
|           |  |               |         |           
|Mr. Bowlus |  | $             | 45,302  |            |  |           | 669   | 
|          
|          
|          
|          
|Mr. Wing   |  | $             | 32,854  |            |  |           | 485   | 
|          
|          
|          
|          
|Mr. Davis  |  | $             | 28,448  |            |  |           | 420   | 
|          
|          
|          
|          
|Mr. Hoops  |  | $             | 179,398 |            |  |           | 2,650 | 



|(5) |  | Represents PacifiCare contributions under the Amended and Restated
PacifiCare Health Systems, Inc. Savings and Profit-Sharing (401(k)) Plan,
and the Statutory Restoration Plan as follows:
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|              |  |             |        |                            |  |      |        |      |  |      |        |      |  |   |        |  |  |   |        |  |  |   |        | 
|------------- |  | ----------- | ------ | -------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|              |  | 401(k) Plan |        | Statutory Restoration Plan
|              |  |             |        |                           
|              |  | 2000        |        | 1999                       |  | 1998 |        | 2000 |  | 1999 |        | 1998
|              |  |             |        |                            |  |      |        |      |  |      |        |     
|Mr. Phanstiel |  | $           | 8,423  |                            |  | $    |       |      |  | $    |       |      |  | $ |       |  |  | $ |       |  |  | $ |       | 
|             
|             
|             
|             
|Mr. Bailey    |  | $           | 2,960  |                            |  | $    |       |      |  | $    |       |      |  | $ | 2,960  |  |  | $ |       |  |  | $ |       | 
|             
|             
|             
|             
|Mr. Bowlus    |  | $           | 10,200 |                            |  | $    | 12,759 |      |  | $    | 10,997 |      |  | $ | 34,610 |  |  | $ | 30,859 |  |  | $ | 12,642 | 
|             
|             
|             
|             
|Mr. Wing      |  | $           | 10,200 |                            |  | $    | 12,759 |      |  | $    | 10,997 |      |  | $ | 11,692 |  |  | $ | 7,116  |  |  | $ | 4,564  | 
|             
|             
|             
|             
|Mr. Davis     |  | $           | 10,200 |                            |  | $    | 12,759 |      |  | $    | 10,997 |      |  | $ | 7,088  |  |  | $ | 4,060  |  |  | $ | 2,302  | 
|             
|             
|             
|             
|Mr. OLeary   |  | $           | 3,047  |                            |  | $    |       |      |  | $    |       |      |  | $ | 3,047  |  |  | $ |       |  |  | $ |       | 
|             
|             
|             
|             
|Mr. Hoops     |  | $           | 10,200 |                            |  | $    | 12,759 |      |  | $    | 10,997 |      |  | $ | 43,765 |  |  | $ | 33,600 |  |  | $ | 25,077 | 



| |  | All PacifiCare employees who have completed 3 1/2 months of continuous service
are eligible to participate in the 401(k) Plan. The Statutory Restoration
Plan allows participants to defer the portion of their pay that otherwise
would be deferred under the 401(k) Plan, but for statutory limitations, and
to receive excess matching contributions, profit-sharing contributions and
discretionary contributions in the same percentages as those provided by the
401(k) Plan. Employees in PacifiCares two highest salary grades are
eligible to participate in the Statutory Restoration Plan.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|   
|---
|(6)
|   
|   
|   
|   
|   
|(7)
|   
|   
|   
|   
|   
|(8)

41



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##### Table of Contents



OPTION GRANTS

This table shows stock option grants to the named executive officers during the
last fiscal year.

OPTIONS GRANTED IN 2000

|                    |  |                 |         |            |  |             |      |            |  |               |        |            |  |  |          |  |  |   |           | 
|------------------- |  | --------------- | ------- | ---------- |  | ----------- | ---- | ---------- |  | ------------- | ------ | ---------- |  |  | -------- |  |  | - | --------- | 
|                    |  |                 |         |            |  | Percent    
|                    |  | Number of       |         | Options    |  | Exercise or
|                    |  | Securities      |         | Granted to |  | Base Price  |      |            |  |               |        | Grant Date
|                    |  | Underlying      |         | Employees  |  | Per Share   |      | Expiration |  | Present Value
|Name                |  | Options (#) (1) |         | in 2000    |  | ($/SH) (2)  |      | Date       |  | ($) (3)      
|                    |  |                 |         |            |  |             |      |            |  |              
|Howard G. Phanstiel |  |                 | 200,000 |            |  |             | 6.8  |            |  | $             | 57.875 |            |  |  | 7/18/10  |  |  | $ | 7,082,740 | 
|                   
|                   
|                   
|                   
|                    |  |                 | 300,000 |            |  |             | 10.2 |            |  | $             | 12.063 |            |  |  | 11/03/10 |  |  | $ | 2,214,315 | 
|                   
|                   
|                   
|                   
|                   
|Bary G. Bailey      |  |                 | 200,000 |            |  |             | 6.8  |            |  | $             | 57.875 |            |  |  | 7/18/10  |  |  | $ | 7,082,740 | 
|                   
|                   
|                   
|                   
|                    |  |                 | 200,000 |            |  |             | 6.8  |            |  | $             | 12.063 |            |  |  | 11/03/10 |  |  | $ | 1,476,210 | 
|                   
|                   
|                   
|                   
|                   
|                   
|Bradford A. Bowlus  |  |                 | 100,000 |            |  |             | 3.4  |            |  | $             | 53.875 |            |  |  | 8/24/10  |  |  | $ | 3,296,610 | 
|                   
|                   
|                   
|                   
|                   
|Christopher P. Wing |  |                 | 50,000  |            |  |             | 1.7  |            |  | $             | 53.875 |            |  |  | 8/24/10  |  |  | $ | 1,648,305 | 
|                   
|                   
|                   
|                   
|                    |  |                 | 20,000  |            |  |             | 0.7  |            |  | $             | 54.625 |            |  |  | 9/01/10  |  |  | $ | 688,501   | 
|                   
|                   
|                   
|                   
|                    |  |                 | 100,000 |            |  |             | 3.4  |            |  | $             | 12.063 |            |  |  | 11/03/10 |  |  | $ | 738,105   | 
|                   
|                   
|                   
|                   
|                   
|Ronald M. Davis     |  |                 | 50,000  |            |  |             | 1.7  |            |  | $             | 53.875 |            |  |  | 8/24/10  |  |  | $ | 1,648,305 | 



---



|(1) |  | Option grants in 2000 were made under the Amended and Restated 1996 Stock
Option Plan for Officers and Key Employees, and the 2000 Employee Plan.
These options:
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | are granted at an exercise price equal to 100 percent of the fair
market value of the common stock on the date of grant,                       
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | expire 10 years from the date of grant, unless otherwise earlier
terminated because of certain events related to termination of
employment, and
|
| |  | vest in 25 percent increments on each anniversary date of the
grant, subject to the terms and conditions of the Plan.                          



| |  | Options that have been held for more than six months, and not already
exercisable or expired, will automatically become exercisable upon a change
of control, as defined in the Plan.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Options with exercise prices of:
|--- |  | --------------------------------



| |  | $67.125 were granted on June 19, 2000,        
|- |  | ----------------------------------------------
|
| |  | $57.875 were granted on July 18, 2000,        
|
| |  | $53.875 were granted on August 24, 2000,      
|
| |  | $54.625 were granted on September 1, 2000, and
|
| |  | $12.063 were granted on November 3, 2000.     





|(3) |  | Grant date present values were calculated using the Black-Scholes option
valuation model with the following assumptions:
|--- |  | ------------------------------------------------------------------------------------------------------------------------

|  |  |                              |  |  |    |           
|- |  | ---------------------------- |  |  | -- | ----------
| |  | Expected Volatility          |  |  | 64 | %         
| 
| 
| 
| 
| |  | Risk-Free Interest Rate      |  |  | 6  | %         
| 
| 
| 
| 
| |  | Expected Life until Exercise |  |  | 2  | to 4 years
| 
| 
| 
| 
| |  | Dividend Yield               |  |  | 0  | %         
| 
| 
| 
| 
| |  | Forfeiture Rate              |  |  | 0  | %         



| |  | The actual value, if any, that a named executive officer may realize will be
based on the difference between the market price of PacifiCares common stock
on the date of exercise and the exercise price. There is no assurance that
the actual realized value, if any, will be at or near the value estimated by
the Black-Scholes model. The Black-Scholes model is only one method of
valuing options, and PacifiCares use of the model should not be construed as
an endorsement of its accuracy.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

42



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##### Table of Contents



OPTIONS EXERCISED

This table shows stock option exercises and the value of unexercised stock
options held by the named executive officers during the last fiscal year.

AGGREGATED OPTION EXERCISES IN 2000
AND FISCAL YEAR-END OPTION VALUES

|                    |  |              |        |          |  |                       |           |                   |  |                        |         |                      |  |  |         |  |  |   |   |  |  |   |         | 
|------------------- |  | ------------ | ------ | -------- |  | --------------------- | --------- | ----------------- |  | ---------------------- | ------- | -------------------- |  |  | ------- |  |  | - | - |  |  | - | ------- | 
|                    |  |              |        |          |  |                       |           |                   |  | Number of Securities   |         | Value of Unexercised
|                    |  |              |        |          |  |                       |           |                   |  | Underlying Unexercised |         | In-the-Money Options
|                    |  | Shares       |        | Value    |  | Options at FY-End (#) |           | at FY-End ($) (2)
|                    |  | Acquired On  |        | Realized |  |                       |           |                  
|Name                |  | Exercise (#) |        | ($) (1)  |  | Exercisable           |           | Unexercisable     |  | Exercisable            |         | Unexercisable       
|                    |  |              |        |          |  |                       |           |                   |  |                        |         |                     
|Howard G. Phanstiel |  |              |       |          |  | $                     |          |                   |  |                        |        |                      |  |  | 500,000 |  |  | $ |  |  |  | $ | 881,250 | 
|                   
|                   
|                   
|                   
|Bary G. Bailey      |  |              |       |          |  | $                     |          |                   |  |                        |        |                      |  |  | 400,000 |  |  | $ |  |  |  | $ | 587,500 | 
|                   
|                   
|                   
|                   
|Bradford A. Bowlus  |  |              |       |          |  | $                     |          |                   |  |                        | 159,750 |                      |  |  | 293,750 |  |  | $ |  |  |  | $ |        | 
|                   
|                   
|                   
|                   
|Christopher P. Wing |  |              |       |          |  | $                     |          |                   |  |                        | 112,875 |                      |  |  | 280,625 |  |  | $ |  |  |  | $ | 293,750 | 
|                   
|                   
|                   
|                   
|Ronald M. Davis     |  |              |       |          |  | $                     |          |                   |  |                        | 133,175 |                      |  |  | 184,225 |  |  | $ |  |  |  | $ |        | 
|                   
|                   
|                   
|                   
|Alan R. Hoops       |  |              | 23,000 |          |  | $                     | 1,187,375 |                   |  |                        | 457,500 |                      |  |  | 337,500 |  |  | $ |  |  |  | $ |        | 



---



|(1) |  | This number is calculated as follows:
|--- |  | -------------------------------------



| |  | using the sale price as the market price,                                                                
|- |  | -----------------------------------------------------------------------------------------------------------
|
| |  | then subtracting the option exercise price from the market price to get the value realized per share, and
|
| |  | then multiplying the value realized per share by the number of options exercised.                          



| |  | The amounts in this column may not represent amounts actually realized by the
named executive officers.
| |  | -------------------------------------------------------------------------------------------------------



|(2) |  | This number is calculated by:
|--- |  | -----------------------------



| |  | subtracting the option exercise price from PacifiCares December 29,
2000 closing market price ($15 per share, as reported by Nasdaq
National Market) to get
the average value per option, and
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | multiplying the average value per option by the number of exercisable
and unexercisable options.                                                                                                



| |  | The amounts in this column may not represent amounts that will actually be
realized by the named executive officers.
| |  | --------------------------------------------------------------------------------------------------------------------

EMPLOYMENT AND SEVERANCE AGREEMENTS

PacifiCare has entered into employment agreements with the named executive
officers. Each agreement continues until the death, disability, misconduct or
written notice of termination by either PacifiCare or the named executive
officer. The agreements provide entitlement to base salary, participation in
all employee benefit programs, reimbursement for business expenses and
participation in PacifiCares annual incentive plan and employee stock option
plans. The agreements also entitle the officer to receive severance benefits
if the officers employment with PacifiCare is terminated for various reasons,
including death, disability, termination without cause and termination
following a change of ownership or control of PacifiCare.

Termination Without Cause.If the named executive officer is terminated by
PacifiCare without cause (other than for incapacity, disability, habitual
neglect or gross misconduct), the employment agreements provide for severance
payments in equal installments over the severance period. The severance
periods are 24 months for Mr. Phanstiel and Mr. Bailey, 36 months for Mr.
Bowlus, and 18 months for Mr. Wing and Mr. Davis. Severance benefits include
the following:



| |  | base salary,                                        
|- |  | ----------------------------------------------------
|
| |  | historical average incentive plan bonus,            
|
| |  | continuation of medical, dental and vision coverage,
|
| |  | automobile allowance,                               
|
| |  | outplacement services, and                          

43



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##### Table of Contents





| |  | any other bonus amounts or benefits to which the named executive
officer may be entitled under any of PacifiCares benefit plans.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------

Additionally, upon termination the named executive officers retain the right to
exercise any vested options for one year following the effective date of
termination.

The contingent liability for severance payments that PacifiCare would be
required to make for termination without cause under the employment agreements
(excluding amounts that may be payable under incentive plans and the value of
certain benefits) would be approximately $1,620,400 to Mr. Phanstiel,
$1,120,400 to Mr. Bailey, $1,827,000 to Mr. Bowlus, $688,500 to Mr. Wing, and
$508,500 to Mr. Davis.

Termination Within 24 months of a Change of Control.Under the employment
agreements, a change of ownership or control would result from:



| |  | any merger, consolidation or sale of securities that result in any individual, entity or group as defined under securities
law acquires beneficial ownership of 20 percent or more of PacifiCares common stock;                                                                                                    
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | any transaction in which PacifiCare sells substantially all of its material assets;                                                                                                                                                                                                                                 
|
| |  | a dissolution or liquidation of PacifiCare;                                                                                                                                                                                                                                                                         
|
| |  | PacifiCare becomes a non-publicly held company; or                                                                                                                                                                                                                                                                  
|
| |  | any change in the composition of PacifiCares board of directors during an 18-month period such that the individuals who at
the beginning of such 18-month period were directors of PacifiCare cease for any reason (other than death, disability or
retirement) to constitute a majority of the board of directors.

If the named executive officers, other than Mr. Hoops, are terminated by
PacifiCare within 24 months of a change of control (other than for incapacity,
disability, habitual neglect or gross misconduct), the employment agreements
provide for lump-sum payment of base salary and specified benefits. The
lump-sum payments would include 36 months of benefits for Mr. Phanstiel, Mr.
Bailey and Mr. Bowlus, and 24 months of benefits for Mr. Wing and Mr. Davis.
The lump-sum payments would include the same items described under Termination
Without Cause, plus the following:



| |  | prorated annual incentive plan bonus, and 
|- |  | ------------------------------------------
|
| |  | amounts to cover any excise tax penalties.

Additionally, the named executive officers would receive the right to exercise
all unexercised stock options as if all such options were fully vested, within
one year of the effective date of termination.

The contingent liability for severance payments that PacifiCare would be
required to make for change of control under the employment agreements
(excluding amounts that may be payable under incentive plans and the value of
certain benefits) would be approximately $2,430,600 to Mr. Phanstiel,
$1,680,600 to Mr. Bailey, $1,827,000 to Mr. Bowlus, $918,000 to Mr. Wing,
$678,000 to Mr. Davis.

1997 Premium Priced Stock Option Plan.Upon a change of control (as defined in
the employee stock option plan), and if a minimum per-share consideration is
paid for the transaction, Mr. Bowlus, Mr. Wing, Mr. Davis and Mr. Hoops will
receive a cash payment for each unexercised premium priced option equal to the
difference between (x) 110 percent of the price per share at which the
PacifiCare common stock is sold in the change of control transaction and (y)
the exercise price of the premium priced option. If the per-share
consideration equals or exceeds $115.00 per share, the executive officers will
not receive a cash payment. The exercise price for one-half of the premium
priced options outstanding is $92.50 per share. The exercise price for the
balance is $114.00 per share. For Mr. Bowlus, Mr. Wing, Mr. Davis and Mr.
Hoops, the maximum cash payments under this program could total approximately
$18 million.

Mr. Hoops.Since July 2000, Mr. Hoops has been a consultant to PacifiCare.
Until March 31, 2001, Mr. Hoops will receive salary, be eligible to participate
in PacifiCares benefit programs and be reimbursed for business expenses.
After March 31, 2001, Mr. Hoops will receive an amount equal to: (a) 36 months
of his current salary, (b) three times his average bonus under the annual
incentive plan for the last two years, (c) continuation of health benefits, (d)
36 months of his automobile allowance, (e) outplacement services and (f) the
ability to exercise all vested stock options for one year. Mr. Hoops will
receive the severance benefits over a period of 36 months. Upon a change in
control, Mr. Hoops would receive a lump-sum payment for the severence benefits.
During 2000, we recorded $6 million for these benefits.

44



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##### Table of Contents



Noncompetition Arrangements. If, while receiving severance payments following
their involuntary termination, any named executive officer is employed by a
competitor, their severance payments will be reduced by an amount equal to the
payment received from the competitor.

DIRECTOR COMPENSATION

We do not pay directors who are also employees of PacifiCare additional
compensation for their service as directors. In 2000, compensation for
non-employee directors included the following:

Cash Compensation



| |  | an annual retainer of $35,000,                                                                                              
|- |  | ----------------------------------------------------------------------------------------------------------------------------
|
| |  | $1,200 to directors for each board meeting attended (telephone attendance is paid at 50 percent),                           
|
| |  | $1,000 to directors for each board committee meeting attended (telephone attendance is paid at 50 percent),                 
|
| |  | $2,400 to the chairman for each board meeting attended (telephone attendance is paid at 50 percent),                        
|
| |  | $2,000 to committee chairpersons for each board committee meeting attended (telephone attendance is paid at 50 percent), and
|
| |  | expenses of attending board and board committee meetings.                                                                   

In 2001, the board approved an increase of $5,000 in the annual retainer for a
total annual retainer equal to $40,000. This increase was retroactive to July
1, 2000. Each non-employee director, other than Dr. Laffer and Mr. Litvack,
was given the choice of receiving the additional $5,000 retainer payment in
cash or in nonqualified options to purchase shares of PacifiCares common
stock. All of the directors elected to receive options. The number of shares
underlying the options was calculated based on a formula where the cash amount
was multiplied by a factor of four, then divided by the closing price of
PacifiCares common stock on the Nasdaq National Market on February 5, 2001.
Based on this formula, each director was granted options to purchase 784 shares
with an exercise price of $25.50 per share. Dr. Laffer and Mr. Litvack will
receive a pro-rata amount of the annual retainer for their service on the board
from February 2001.

Stock Units

Each non-employee director will have the ability to receive one-half of his or her
annual retainer payment in deferred stock units beginning in July 2001. Any
amounts deferred will be converted into units of PacifiCares common stock.
The number of stock units will be equal to the amount of annual retainer
deferred, divided by the closing price of PacifiCares common stock on the
Nasdaq National Market on July 1 of each year. Distributions are made in
shares of our common stock. In the future, each director will be required to
defer one-half of the annual retainer payment in stock units.

As an incentive to defer one-half of the 2001 annual retainer payment in stock
units, each non-employee director, other than Dr. Laffer and Mr. Litvack,
received a grant of nonqualified options to purchase 10,000 shares of
PacifiCares common stock. These options were granted on February 5, 2001 with
an exercise price of $25.50 per share, and are subject to stockholder approval
of the 2000 Non-Employee Directors Stock Option Plan.

Stock Options

In 2000, under the 2000 Non-Employee Directors Stock Option Plan, each director
received an annual, automatic grant of nonqualified options to purchase 5,000
shares of PacifiCares common stock, with an exercise price equal to 100
percent of the fair market value of PacifiCares common stock on the grant
date. The chairman received 10,000 options. These options were granted on
June 30, 2000 with an exercise price of $60.19 per share, and are subject to
stockholder approval of the Plan.

Beginning with the 2001-2002 board year, each non-employee director will have
the ability to receive the other half of his or her annual retainer payment in
stock options rather than cash. The number of shares underlying the options
granted will be calculated based on a formula where the cash amount is
multiplied by a factor of four, then divided by the closing price of
PacifiCares common stock on the Nasdaq National Market on July 1 of each year.
The options will be granted under the 2000 Non-Employee Directors Stock Option
Plan.

The Plan also provided for an automatic grant of nonqualified stock options to
purchase 10,000 shares of PacifiCares common stock to new directors when first
elected to the board. In 2001, the board approved an increase in the number of
options granted to new

45



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##### Table of Contents



directors from 10,000 shares to 25,000 shares. Dr.
Laffer and Mr. Litvack each received 25,000 options on February 13, 2001 with
an exercise price of $38.50. Additionally, they each received the annual,
automatic grant of 5,000 options for the 2001-2002 board year. These options
were also granted on February 13, 2001 with an exercise price of $38.50, the
closing price of PacifiCares common stock on the Nasdaq National Market.

Nonqualified stock options granted under the Plan vest immediately on the grant
date. The underlying common stock, however, may not be sold within the first
six months after the grant date.

Grants under the Plan are subject to the condition that during the previous 12
months, the director must have served on the board continuously, and was not
eligible to receive awards under the employee stock option plans.

Other

In 2000, Mr. Hartshorn received medical and dental benefits valued at $6,000.
In 2001, each director is eligible, at their election, to receive medical and
dental coverage under our health care programs.

Chairman of the Board

During 2000, Mr. Reed received $250,000 for his services as chairman under a
consulting agreement. In addition to the annual consulting fees, Mr. Reed also
received all of the items described under Cash Compensation. Under the terms
of the agreement, Mr. Reed will continue his term as chairman until the earlier
of:



| |  | his resignation from or failure to be reelected as chairman,            
|- |  | ------------------------------------------------------------------------
|
| |  | a written election to terminate the agreement by PacifiCare or Mr. Reed,
|
| |  | automatic termination or breach of the agreement, or                    
|
| |  | nonpayment of Mr. Reeds annual compensation by PacifiCare.             

Under the agreement, Mr. Reed is also entitled to receive 10,000 options for
the annual, automatic grant of options to non-employee directors.

46



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##### Table of Contents









ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

PRINCIPAL STOCKHOLDERS

This table shows how much PacifiCare common stock is owned by the directors,
named executive officers and owners of more than five percent of PacifiCares
outstanding common stock, as of February 28, 2001.

AMOUNT AND NATURE OF SHARES BENEFICIALLY OWNED

|                                                                 |  |           |           |             |  |             |           |            |  |  |      | 
|---------------------------------------------------------------- |  | --------- | --------- | ----------- |  | ----------- | --------- | ---------- |  |  | ---- | 
|                                                                 |  | Number    |           |             |  |             |           | Percent Of
|                                                                 |  | Of Shares |           | Right To    |  | Outstanding
|Name                                                             |  | Owned (1) |           | Acquire (2) |  | Shares (3) 
|                                                                 |  |           |           |             |  |            
|Capital Group International, Inc. (4)                            |  |           | 4,578,830 |             |  |             |          |            |  |  | 13.7 | 
|                                                                
|                                                                
|                                                                
|                                                                
|UniHealth Foundation (5)                                         |  |           | 3,694,500 |             |  |             |          |            |  |  | 11.0 | 
|                                                                
|                                                                
|                                                                
|                                                                
|FMR Corp. (6)                                                    |  |           | 2,285,000 |             |  |             |          |            |  |  | 6.8  | 
|                                                                
|                                                                
|                                                                
|                                                                
|AXA Financial, Inc. (7)                                          |  |           | 2,279,889 |             |  |             |          |            |  |  | 6.8  | 
|                                                                
|                                                                
|                                                                
|                                                                
|David A. Reed                                                    |  |           | 1,000     |             |  |             | 49,117    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Howard G. Phanstiel                                              |  |           | 10,600    |             |  |             |          |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Bradley C. Call                                                  |  |           | 1,000     |             |  |             | 40,784    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Terry O. Hartshorn                                               |  |           | 204,732   |             |  |             | 100,784   |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Arthur B. Laffer Ph.D.                                           |  |           |          |             |  |             | 30,000    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Gary L. Leary                                                    |  |           | 1,000     |             |  |             | 54,234    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Sanford M. Litvack                                               |  |           |          |             |  |             | 30,000    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Warren E. Pinckert II                                            |  |           | 1,632     |             |  |             | 51,834    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Lloyd E. Ross                                                    |  |           | 1,600     |             |  |             | 51,834    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Jean Bixby Smith                                                 |  |           | 1,000     |             |  |             | 46,534    |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Bary G. Bailey                                                   |  |           | 300       |             |  |             |          |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Bradford A. Bowlus                                               |  |           |          |             |  |             | 172,250   |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Christopher P. Wing                                              |  |           |          |             |  |             | 119,125   |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Ronald M. Davis                                                  |  |           |          |             |  |             | 138,775   |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Robert W. OLeary                                                |  |           | 5,000     |             |  |             |          |            |  |  | *    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Alan R. Hoops                                                    |  |           | 243,723   |             |  |             | 461,250   |            |  |  | 2.1  | 
|                                                                
|All Directors and Executive Officers as a Group (8)
(33 persons) |  |           | 548,205   |             |  |             | 1,796,681 |            |  |  | 6.6  | 



---

|   
|---
|*  
|   
|(1)



| |  | has sole voting and investment power,                                                                                 
|- |  | ----------------------------------------------------------------------------------------------------------------------
| 
| |  | has shared voting and investment power with his or her spouse, or                                                     
| 
| |  | holds in an account under the PacifiCare Savings and Profit-Sharing Plan, unless otherwise indicated in the footnotes.



|(2) |  | Shares that can be acquired through stock option exercises through April 27, 2001.                                                                                                                                                                                                         
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(3) |  | The percentage of beneficial ownership is based on 33,480,800 shares of
common stock outstanding as of February 28, 2001.                                                                                                                                                                  
|   
|(4) |  | Based on information contained in a report on Schedule 13-G/A filed with
the SEC on February 13, 2001. The address of Capital Group International,
Inc. is 11100 Santa Monica Boulevard, 15th Floor, Los Angeles, California
90025.                                                        
|   
|(5) |  | Based on information contained in a report on Schedule 13-D/A filed with
the SEC on March 6, 2001. UniHealth Foundation is a California nonprofit
public benefit corporation. The address of UniHealth Foundation is 5959
Topanga Canyon Boulevard, #390, Woodland Hills, California 91367.

47



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##### Table of Contents





|(6) |  | Based on information contained in a report on Schedule 13-G filed with
the SEC on February 14, 2001. The address of FMR Corp. is 82 Devonshire
Street, Boston, Massachusetts, 02109.             
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(7) |  | Based on information contained in a report on Schedule 13-G filed with
the SEC on February 12, 2001. The address of AXA Financial, Inc. is 1290
Avenue of the Americas, New York, New York 10104.
|   
|(8) |  | In addition to the officers and directors named in this table, 17 other
executive officers are members of the group.                                                                             







ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

PacifiCare and its subsidiaries purchased health care services from various
medical service organizations owned by UniHealth Foundation totaling $29
million for the year ended December 31, 2000.

We contract with Joseph S. Konowiecki, a professional corporation, for his
services as Executive Vice President, General Counsel and Secretary of
PacifiCare. For these services, we pay his professional corporation $132,000
per year. Mr. Konowiecki also receives an automobile allowance. In addition,
Mr. Konowiecki is eligible to participate in the employee stock option plan and
the Premium Priced Stock Option Plan. During 2000, he received 35,000 options
with an exercise price of $53.88 per share. As of January 10, 2001, Mr.
Konowiecki held 209,625 vested nonqualified stock options at a weighted average
exercise price of $70.57 per share. In January 2001, PacifiCare granted Mr.
Konowiecki 60,000 shares of restricted common stock. The stock vests in 25
percent increments on the anniversary of the grant. If Mr. Konowiecki
voluntarily terminates his relationship with us or if we terminate the
relationship for cause, Mr. Konowiecki would lose all rights to any of the
unvested stock. The vesting of the stock will accelerate if a change of
control occurs or in the event of Mr. Konowieckis death or disability.

Mr. Konowieckis contract has an indefinite term. If the contract is
terminated for reasons other than his incapacity, disability or misconduct, Mr.
Konowieckis professional corporation will receive its annual fee for two
years. In addition, Mr. Konowiecki will have the right to exercise all of his
vested options within one year of the date of termination. However, if
following involuntary termination, Mr. Konowiecki is retained on a similar
basis by any of our competitors, the termination payments are reduced by
amounts equal to the payments received from the competitor.

Further, if this contract is terminated within 24 months following a change of
control of PacifiCare, Mr. Konowieckis professional corporation will receive
its annual fee for two years. Upon a change of control (as defined in the
employee stock option plan) all of Mr. Konowieckis nonqualified options will
automatically vest and become fully exercisable. In addition, Mr. Konowiecki
will receive the cash payment on his premium priced stock options similar to
the cash payment the named executive officers will receive. The maximum cash
payment to Mr. Konowiecki could be approximately $2 million.

We contract with Konowiecki & Rank LLP to manage the legal services for
PacifiCare, including providing legal services for us and arranging for other
law firms to provide legal services for us. We do not have an in-house legal
staff. Mr. Konowieckis professional corporation is a partner of Konowiecki & Rank and receives income through the limited liability
partnership. Our contract has a three-year term that is automatically extended
by one year on each January 1. The contract currently expires on December 31,
2003. Either Konowiecki & Rank or PacifiCare may prevent the extension of the
term on any January 1 by providing notice at least six months prior to the
extension date. We pay Konowiecki & Rank for its legal services on an hourly
basis at rates established each year, with a fixed monthly charge for Mr.
Konowieckis time. In addition, we have agreed to pay Konowiecki & Rank 50
percent of any savings we achieve for legal services based upon the difference
between our actual legal costs (with some exclusions) and our budgeted legal
fees for the year. During 2000, we paid Konowiecki & Rank $10 million in legal
fees.

PacifiCare extended a loan in the amount of $540,000 to Mr. Bailey as part of
his compensation package for joining PacifiCare as an executive officer. The
loan bears interest at the Internal Revenue Service mandated rate, and will
lapse in a series of annual installments over a three-year period beginning
July 17, 2001. If Mr. Bailey is terminated for cause or Mr. Bailey terminates
his employment for reasons other than death or disability, Mr. Bailey will be
obligated to repay the outstanding balance of the loan. As of December 31,
2000, the entire principal amount remained outstanding.

48



---



##### Table of Contents









PART IV







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

The following documents are filed as part of this report:

|      |  |                                                                                                                                                                  |  |          
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------
|      |  |                                                                                                                                                                  |  | Page     
|      |  |                                                                                                                                                                  |  | Reference
|      |  |                                                                                                                                                                  |  |          
|(a)1. |  | Consolidated Financial Statements:                                                                                                                              
|     
|     
|     
|     
|      |  | Consolidated Balance Sheets as of December 31, 2000 and 1999                                                                                                     |  | F-1      
|     
|     
|     
|     
|      |  | Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998                                                                       |  | F-2      
|     
|     
|     
|     
|      |  | Consolidated Statements of Stockholders Equity for the years ended December 31, 2000,
1999 and 1998                                                             |  | F-3      
|     
|     
|     
|     
|      |  | Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998                                                                       |  | F-4      
|     
|     
|     
|     
|      |  | Notes to Consolidated Financial Statements                                                                                                                       |  | F-6      
|     
|     
|     
|     
|      |  | Report of Ernst & Young LLP, Independent Auditors                                                                                                                |  | F-24     
|     
|     
|     
|     
|      |  | Quarterly Information for 2000 and 1999 (unaudited)                                                                                                              |  | F-25     
|     
|     
|     
|     
|2.    |  | Financial Statement Schedule:                                                                                                                                   
|     
|     
|     
|     
|      |  | Schedule II  Valuation and Qualifying Accounts                                                                                                                  |  | F-26     
|     
|     
|     
|     
|      |  | All other schedules are omitted because they are not required or the information is
included elsewhere in
   the consolidated financial statements.             
|     
|     
|     
|     
|3.    |  | Exhibits: An Exhibit Index is filed as part of this Form 10-K beginning on page E-1 and
is incorporated    by reference.                                      
|     
|     
|     
|     
|(b)   |  | Reports on Form 8-K: On October 25, 2000, we filed a Form 8-K in connection with the
resignation of    Robert W. OLeary, President and Chief Executive Officer.

49



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##### Table of Contents






SIGNATURES




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

| |                                                 |                                                                                        
| | ----------------------------------------------- | ---------------------------------------------------------------------------------------
| | PACIFICARE HEALTH SYSTEMS, INC.                
|
| | By:                    /s/ 
HOWARD G. PHANSTIEL
| |                                                
| |                                                 | Howard G. Phanstiel
President and Chief Executive Officer
(Principal Executive Officer)

Date: March 22, 2001

POWER OF ATTORNEY

We, the undersigned directors and officers of PacifiCare Health Systems, Inc.,
do hereby constitute and appoint Howard G. Phanstiel and Gregory W. Scott, or
either of them, our true and lawful attorneys and agents, to do any and all
acts and things in our name and on our behalf in our capacities as directors
and officers and to execute any and all instruments for us and in our names in
the capacities indicated below, which said attorneys and agents, or either of
them, may deem necessary or advisable to enable said corporation to comply with
the Securities Exchange Act of 1934, and any rules, regulations, and
requirements of the Securities and Exchange Commission, in connection with this
Report, including specifically, but without limitation, power and authority to
sign any and all amendments hereto; and we do hereby ratify and confirm all
that said attorneys and agents, or either of them, shall do or cause to be done
by virtue hereof.

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.

|                                                   |  |                                                                                      |  |               
|-------------------------------------------------- |  | ------------------------------------------------------------------------------------ |  | --------------
|Name                                               |  | Title                                                                                |  | Date          
|                                                   |  |                                                                                      |  |               
|                                                  
|/s/ HOWARD G.
PHANSTIELHoward G. Phanstiel         |  | President and
Chief Executive Officer
(Principal Executive Officer)                  |  | March 22, 2001
|                                                  
|/s/ GREGORY W.
SCOTTGregory W. Scott               |  | Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)   |  | March 22, 2001
|                                                  
|/s/ SUSAN L. BERKELSusan L. Berkel                 |  | Senior Vice President of Finance and
Corporate Controller
(Chief Accounting Officer) |  | March 22, 2001
|                                                  
|/s/ DAVID A. REEDDavid A. Reed                     |  | Chairman of the Board                                                                |  | March 22, 2001
|                                                  
|/s/ BRADLEY C. CALLBradley C. Call                 |  | Director                                                                             |  | March 22, 2001
|                                                  
|/s/ TERRY O.
HARTSHORNTerry O. Hartshorn           |  | Director                                                                             |  | March 22, 2001
|                                                  
|/s/ ARTHUR B.
LAFFER, PH.D.Arthur B. Laffer, Ph.D. |  | Director                                                                             |  | March 22, 2001

50



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##### Table of Contents



|                                               |  |          |  |               
|---------------------------------------------- |  | -------- |  | --------------
|Name                                           |  | Title    |  | Date          
|                                               |  |          |  |               
|                                              
|/s/ GARY L. LEARYGary L. Leary                 |  | Director |  | March 22, 2001
|                                              
|/s/ SANFORD M. LITVACK Sanford M. Litvack      |  | Director |  | March 22, 2001
|                                              
|/s/ WARREN E.
PINCKERT IIWarren E. Pinckert II |  | Director |  | March 22, 2001
|                                              
|/s/ LLOYD E.
ROSSLloyd E. Ross                 |  | Director |  | March 22, 2001
|                                              
|/s/ JEAN BIXBY
SMITHJean Bixby Smith           |  | Director |  | March 22, 2001

51



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##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share data)

|                                           |                                                                                                                  |                            |           |              |           |              |           |           |           | 
|------------------------------------------ | ---------------------------------------------------------------------------------------------------------------- | -------------------------- | --------- | ------------ | --------- | ------------ | --------- | --------- | --------- | 
|                                           |                                                                                                                  |                            |           | December 31, |           | December 31,
|                                           |                                                                                                                  |                            |           | 2000         |           | 1999        
|                                           |                                                                                                                  |                            |           |              |           |             
|ASSETS                                    
|                                          
|                                          
|                                          
|                                          
|Current assets:                           
|                                          
|                                          
|                                          
|                                          
|                                           | Cash and equivalents                                                                                             |                            | $         | 1,251,635    |           |              | $         | 849,064   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Marketable securities                                                                                            |                            |           | 864,013      |           |              |           | 999,194   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Receivables, net                                                                                                 |                            |           | 410,694      |           |              |           | 306,652   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Prepaid expenses and other current assets                                                                        |                            |           | 42,852       |           |              |           | 48,412    |          
|                                          
|                                          
|                                          
|                                          
|                                           | Deferred income taxes                                                                                            |                            |           | 139,712      |           |              |           | 141,169   |          
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|                                           |                                                                                                                  | Total current assets       |           |              | 2,708,906 |              |           |           | 2,344,491 | 
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|Property, plant and equipment at cost, net |                                                                                                                  |                            | 225,551   |              |           |              | 177,521   |          
|                                          
|                                          
|                                          
|                                          
|Marketable securities-restricted           |                                                                                                                  |                            | 94,402    |              |           |              | 86,471    |          
|                                          
|                                          
|                                          
|                                          
|Goodwill and intangible assets, net        |                                                                                                                  |                            | 2,261,637 |              |           |              | 2,244,243 |          
|                                          
|                                          
|                                          
|                                          
|Other assets                               |                                                                                                                  |                            | 32,940    |              |           |              | 31,295    |          
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|                                           |                                                                                                                  | $                          | 5,323,436 |              |           | $            | 4,884,021 |          
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|LIABILITIES AND STOCKHOLDERS EQUITY      
|                                          
|                                          
|                                          
|                                          
|Current liabilities:                      
|                                          
|                                          
|                                          
|                                          
|                                           | Medical claims and benefits payable                                                                              |                            | $         | 1,270,800    |           |              | $         | 795,200   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Accounts payable                                                                                                 |                            |           | 131,196      |           |              |           | 131,121   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued liabilities                                                                                              |                            |           | 241,927      |           |              |           | 209,786   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued compensation and employee benefits                                                                       |                            |           | 72,958       |           |              |           | 84,264    |          
|                                          
|                                          
|                                          
|                                          
|                                           | Unearned premium revenue                                                                                         |                            |           | 598,215      |           |              |           | 565,815   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Long-term debt due within one year                                                                               |                            |           | 161          |           |              |           |          |          
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|                                           |                                                                                                                  | Total current liabilities  |           |              | 2,315,257 |              |           |           | 1,786,186 | 
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|Long-term debt due after one year          |                                                                                                                  |                            | 836,556   |              |           |              | 975,000   |          
|                                          
|                                          
|                                          
|                                          
|Deferred income taxes                      |                                                                                                                  |                            | 145,633   |              |           |              | 127,469   |          
|                                          
|                                          
|                                          
|                                          
|Other liabilities                          |                                                                                                                  |                            | 20,746    |              |           |              | 17,314    |          
|                                          
|                                          
|                                          
|                                          
|Minority interest                          |                                                                                                                  |                            | 1,684     |              |           |              | 333       |          
|                                          
|                                          
|                                          
|                                          
|Commitments and contingencies             
|                                          
|                                          
|                                          
|                                          
|Stockholders equity:                     
|                                          
|                                          
|                                          
|                                          
|                                           | Common stock, $0.01 par value; 200,000 shares authorized;
issued 46,986 shares in 2000 and 46,803 shares in 1999 |                            |           | 470          |           |              |           | 468       |          
|                                          
|                                          
|                                          
|                                          
|                                           | Additional paid-in capital                                                                                       |                            |           | 1,613,944    |           |              |           | 1,597,485 |          
|                                          
|                                          
|                                          
|                                          
|                                           | Accumulated other comprehensive loss                                                                             |                            |           | (2,975       | )         |              |           | (24,396   | )        
|                                          
|                                          
|                                          
|                                          
|                                           | Retained earnings                                                                                                |                            |           | 1,089,192    |           |              |           | 928,152   |          
|                                          
|                                          
|                                          
|                                          
|                                           | Treasury stock, at cost; 13,532 shares in 2000 and 9,551 shares in 1999                                          |                            |           | (697,071     | )         |              |           | (523,990  | )        
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|                                           |                                                                                                                  | Total stockholders equity |           |              | 2,003,560 |              |           |           | 1,977,719 | 
|                                           |                                                                                                                  |                            |           |              |           |              |           |          
|                                           |                                                                                                                  | $                          | 5,323,436 |              |           | $            | 4,884,021 |          
|                                           |                                                                                                                  |                            |           |              |           |              |           |          

See accompanying notes.

F-1



---



##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share data)

|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |           |           | 
|------------------------------------------------------------------ | ------------------- | -------------------------- | --------- | ------------ | ---------- | ------------ | --------- | ------------ | --------- | - | --------- | --------- | --------- | 
|                                                                   |                     |                            |           | Year Ended   |            | Year Ended   |           | Year Ended  
|                                                                   |                     |                            |           | December 31, |            | December 31, |           | December 31,
|                                                                   |                     |                            |           | 2000         |            | 1999         |           | 1998        
|                                                                   |                     |                            |           |              |            |              |           |             
|Revenue:                                                          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Commercial premiums |                            | $         | 4,912,216    |            |              | $         | 3,994,475    |           |   | $         | 3,823,587 |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Medicare premiums   |                            |           | 6,416,039    |            |              |           | 5,875,687    |           |   |           | 5,586,592 |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Other income        |                            |           | 139,672      |            |              |           | 118,928      |           |   |           | 111,303   |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|                                                                   |                     | Total operating revenue    |           |              | 11,467,927 |              |           |              | 9,989,090 |   |           |           | 9,521,482 | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Expenses:                                                         
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Health care services:                                             
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Commercial services |                            |           | 4,178,701    |            |              |           | 3,262,261    |           |   |           | 3,167,622 |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                   | Medicare services   |                            |           | 5,734,956    |            |              |           | 5,106,429    |           |   |           | 4,834,638 |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|                                                                   |                     | Total health care services |           |              | 9,913,657  |              |           |              | 8,368,690 |   |           |           | 8,002,260 | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Marketing, general and administrative expenses                     |                     |                            | 1,203,573 |              |            |              | 1,105,816 |              |           |   | 1,089,418 |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Amortization of goodwill and intangible assets                     |                     |                            | 83,217    |              |            |              | 75,957    |              |           |   | 76,593    |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Impairment, disposition, restructuring and other charges (credits) |                     |                            | 11,730    |              |            |              | (2,233    | )            |           |   | 15,644    |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Office of Personnel Management credits                             |                     |                            | (2,964    | )            |            |              |          |              |           |   | (4,624    | )        
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Operating income                                                   |                     |                            | 258,714   |              |            |              | 440,860   |              |           |   | 342,191   |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Net investment income                                              |                     |                            | 108,371   |              |            |              | 84,050    |              |           |   | 104,306   |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Interest expense                                                   |                     |                            | (79,636   | )            |            |              | (43,001   | )            |           |   | (60,923   | )        
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Minority interest in consolidated subsidiary                       |                     |                            | 637       |              |            |              |          |              |           |   |          |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Income before income taxes                                         |                     |                            | 288,086   |              |            |              | 481,909   |              |           |   | 385,574   |          
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Provision for income taxes                                         |                     |                            | 127,046   |              |            |              | 203,365   |              |           |   | 183,147   |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Net income                                                         |                     | $                          | 161,040   |              |            | $            | 278,544   |              |           | $ | 202,427   |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Preferred dividends                                                |                     |                            |          |              |            |              |          |              |           |   | (5,259    | )        
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Net income available to common stockholders                        |                     | $                          | 161,040   |              |            | $            | 278,544   |              |           | $ | 197,168   |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Basic earnings per share                                           |                     | $                          | 4.59      |              |            | $            | 6.26      |              |           | $ | 4.50      |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          
|Diluted earnings per share                                         |                     | $                          | 4.58      |              |            | $            | 6.23      |              |           | $ | 4.40      |          
|                                                                   |                     |                            |           |              |            |              |           |              |           |   |           |          

See accompanying notes.

F-2



---



##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(amounts in thousands)

|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |          |         |  
|------------------------------------------------------------------------- | --------------------------------------------- | ------------------------------------------------------------------- | --- | --------- | - | ------ | --- | ------- | - | ------------- | --------- | ---------- | - | -------- | ------- | ----------- | ------- | - | --------- | ------- | - | - | -------- | -------- | - | - | --------- | -------- | ------- | -
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         | Accumulated
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           | Additional |   | Other   
|                                                                          |                                               |                                                                     |     | Preferred |   | Common |     | Paid-in |   | Comprehensive |           | Retained   |   | Treasury
|                                                                          |                                               |                                                                     |     | Stock     |   | Stock  |     | Capital |   | Income (Loss) |           | Earnings   |   | Stock    |         | Total      
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |            
|Balances at December 31, 1997                                             |                                               | $                                                                   | 105 |           |   | $      | 420 |         |   | $             | 1,599,229 |            |   | $        | 9,993   |             |         | $ | 452,440   |         |   | $ |         |          |   | $ | 2,062,187 |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Comprehensive income:                                                    
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Net income                                    |                                                                     |     |          |   |        |     |        |   |               |           |           |   |          |         |            |         |   |           | 202,427 |   |   |          |         |   |   |           | 202,427  |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Other comprehensive loss, net of tax:        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                               | Unrealized losses on securities, net of
reclassification adjustment |     |           |  |        |     |         |  |               |           |            |  |          |         |             | (2,634  | ) |           |         |  |   |          |          |  |   |           |          | (2,634  | )
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Comprehensive income                                                      |                                               |                                                                     |    |           |   |        |    |         |   |               |          |            |   |          | (2,634  | )           |         |   | 202,427   |         |   |   |         |          |   |   | 199,793   |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Capital stock activity:                                                  
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Conversion of preferred stock to common stock |                                                                     |     | (105      | ) |        |     | 39      |   |               |           | (344       | ) |          |         |            |         |   |           |        |   |   |          |         |   |   |           | (410     | )      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Employee benefit plans                        |                                                                     |     |          |   |        |     | 5       |   |               |           | 19,438     |   |          |         |            |         |   |           |        |   |   |          | 704      |   |   |           | 20,147   |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Purchase of treasury stock                    |                                                                     |     |          |   |        |     |        |   |               |           |           |   |          |         |            |         |   |           |        |   |   |          | (44,658  | ) |   |           | (44,658  | )      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Tax benefit associated with exercise of stock options                     |                                               |                                                                     |    |           |   |        |    |         |   |               | 6,296     |            |   |          |        |             |         |   |          |         |   |   |         |          |   |   | 6,296     |         
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Preferred dividends                                                       |                                               |                                                                     |    |           |   |        |    |         |   |               |          |            |   |          |        |             |         |   | (5,259    | )       |   |   |         |          |   |   | (5,259    | )       
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Balances at December 31, 1998                                             |                                               |                                                                     |    |           |   |        | 464 |         |   |               | 1,624,619 |            |   |          | 7,359   |             |         |   | 649,608   |         |   |   | (43,954  | )        |   |   | 2,238,096 |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Comprehensive income:                                                    
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Net income                                    |                                                                     |     |          |   |        |     |        |   |               |           |           |   |          |         |            |         |   |           | 278,544 |   |   |          |         |   |   |           | 278,544  |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Other comprehensive loss, net of tax:        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                               | Unrealized losses on securities, net of
reclassification adjustment |     |           |  |        |     |         |  |               |           |            |  |          |         |             | (31,755 | ) |           |         |  |   |          |          |  |   |           |          | (31,755 | )
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Comprehensive income                                                      |                                               |                                                                     |    |           |   |        |    |         |   |               |          |            |   |          | (31,755 | )           |         |   | 278,544   |         |   |   |         |          |   |   | 246,789   |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Capital stock activity:                                                   |                                               |                                                                     |    |           |   |        |    |         |   |               |          |            |   |          |        |             |         |   |          |         |   |   |         |          |   |   |          |         
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Employee benefit plans                        |                                                                     |     |          |   |        |     | 4       |   |               |           | 29,803     |   |          |         |            |         |   |           |        |   |   |          |         |   |   |           | 29,807   |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Purchase of treasury stock                    |                                                                     |     |          |   |        |     |        |   |               |           |           |   |          |         |            |         |   |           |        |   |   |          | (480,036 | ) |   |           | (480,036 | )      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Common stock reclassification payments to UniHealth
Foundation and others |                                               |                                                                     |    |           |   |        |    |         |   |               | (61,880   | )          |   |          |        |             |         |   |          |         |   |   |         |          |   |   | (61,880   | )       
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Tax benefit associated with exercise of stock options                     |                                               |                                                                     |    |           |   |        |    |         |   |               | 4,943     |            |   |          |        |             |         |   |          |         |   |   |         |          |   |   | 4,943     |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Balances at December 31, 1999                                             |                                               |                                                                     |    |           |   |        | 468 |         |   |               | 1,597,485 |            |   |          | (24,396 | )           |         |   | 928,152   |         |   |   | (523,990 | )        |   |   | 1,977,719 |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Comprehensive income:                                                    
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Net income                                    |                                                                     |     |          |   |        |     |        |   |               |           |           |   |          |         |            |         |   |           | 161,040 |   |   |          |         |   |   |           | 161,040  |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Other comprehensive gain, net of tax:        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                               | Unrealized gains on securities, net of
reclassification adjustment  |     |           |  |        |     |         |  |               |           |            |  |          |         |             | 21,421  |   |           |         |  |   |          |          |  |   |           |          | 21,421  |  
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Comprehensive income                                                      |                                               |                                                                     |    |           |   |        |    |         |   |               |          |            |   |          | 21,421  |             |         |   | 161,040   |         |   |   |         |          |   |   | 182,461   |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Capital stock activity:                                                  
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Employee benefit plans                        |                                                                     |     |          |   |        |     | 2       |   |               |           | 8,538      |   |          |         |            |         |   |           |        |   |   |          | 251      |   |   |           | 8,791    |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Purchase of treasury stock                    |                                                                     |     |          |   |        |     |        |   |               |           |           |   |          |         |            |         |   |           |        |   |   |          | (173,332 | ) |   |           | (173,332 | )      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Contribution for minority interest in consolidated
subsidiary             |                                               |                                                                     |    |           |   |        |    |         |   |               | 6,120     |            |   |          |        |             |         |   |          |         |   |   |         |          |   |   | 6,120     |         
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Tax benefit associated with exercise of stock options                     |                                               |                                                                     |    |           |   |        |    |         |   |               | 1,801     |            |   |          |        |             |         |   |          |         |   |   |         |          |   |   | 1,801     |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         
|Balances at December 31, 2000                                             |                                               | $                                                                   |    |           |   | $      | 470 |         |   | $             | 1,613,944 |            |   | $        | (2,975  | )           |         | $ | 1,089,192 |         |   | $ | (697,071 | )        |   | $ | 2,003,560 |         
|                                                                          |                                               |                                                                     |     |           |   |        |     |         |   |               |           |            |   |          |         |             |         |   |           |         |   |   |          |          |   |   |           |         

See accompanying notes.

F-3



---



##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)

|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |          |         |         |          |  
|------------------------------------ | ------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------ | --------------------------------------------------------- | ------ | ------------ | -------- | ------------ | ------ | ------------ | -------- | -------- | ------- | ------- | -------- | -
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        | Year Ended   |          | Year Ended   |        | Year Ended  
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        | December 31, |          | December 31, |        | December 31,
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        | 2000         |          | 1999         |        | 1998        
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |             
|Operating activities:               
|                                    
|                                    
|                                    
|                                    
|                                     | Net income                                                                                        |                                                                                       | $                                                                                    | 161,040                                                   |        |              | $        | 278,544      |        |              | $        | 202,427  |        
|                                    
|                                    
|                                    
|                                    
|                                     | Adjustments to reconcile net income to net cash flows
provided by (used in) operating activities:
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Amortization of goodwill and intangible assets                                        |                                                                                      |                                                           | 83,217 |              |          |              | 75,957 |              |          |          | 76,593  |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Depreciation and amortization                                                         |                                                                                      |                                                           | 47,346 |              |          |              | 42,140 |              |          |          | 44,436  |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Impairment, disposition, restructuring and other charges (credits)                    |                                                                                      |                                                           | 11,730 |              |          |              | (2,233 | )            |          |          | 15,644  |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Loss on disposal of property, plant and equipment and other                           |                                                                                      |                                                           | 7,664  |              |          |              | 9,283  |              |          |          | 12,547  |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Deferred income taxes                                                                 |                                                                                      |                                                           | 6,107  |              |          |              | 26,668 |              |          |          | (19,299 | )      
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Provision for doubtful accounts                                                       |                                                                                      |                                                           | 5,525  |              |          |              | 1,634  |              |          |          | 1,485   |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Office of Personnel Management credits                                                |                                                                                      |                                                           | (2,964 | )            |          |              |       |              |          |          | (4,624  | )      
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Tax benefit realized for stock option exercises                                       |                                                                                      |                                                           | 1,801  |              |          |              | 4,943  |              |          |          | 6,296   |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Minority interest in consolidated subsidiary                                          |                                                                                      |                                                           | (637   | )            |          |              |       |              |          |          |        |        
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   | Changes in assets and liabilities, net of effects from
acquisitions and dispositions:
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   |                                                                                       | Receivables, net                                                                     |                                                           |        | (90,121      | )        |              |        | (32,331      | )        |          |         | 24,516  |         
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   |                                                                                       | Prepaid expenses and other assets                                                    |                                                           |        | 4,870        |          |              |        | (31,805      | )        |          |         | 102,696 |         
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   |                                                                                       | Medical claims and benefits payable                                                  |                                                           |        | 371,584      |          |              |        | 158,655      |          |          |         | (47,421 | )       
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   |                                                                                       | Accounts payable, accrued liabilities and accrued compensation
and employee benefits |                                                           |        | (2,079       | )        |              |        | (17,713      | )        |          |         | 25,253  |         
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                   |                                                                                       | Unearned premium revenue                                                             |                                                           |        | 26,153       |          |              |        | 55,956       |          |          |         | 15,038  |         
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|                                     |                                                                                                   |                                                                                       |                                                                                      | Net cash flows provided by operating activities           |        |              | 631,236  |              |        |              | 569,698  |          |         |         | 455,587  |  
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|Investing activities:               
|                                    
|                                    
|                                    
|                                    
|                                     | Sale (purchase) of marketable securities, net                                                     |                                                                                       |                                                                                      | 177,598                                                   |        |              |          | (175,368     | )      |              |          | (16,546  | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Purchase of property, plant and equipment                                                         |                                                                                       |                                                                                      | (105,256                                                  | )      |              |          | (66,211      | )      |              |          | (41,631  | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Purchase of marketable securities-restricted                                                      |                                                                                       |                                                                                      | (7,660                                                    | )      |              |          | (3,811       | )      |              |          | (17,980  | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Net cash acquired from (paid for) acquisitions                                                    |                                                                                       |                                                                                      | 4,098                                                     |        |              |          | (21,234      | )      |              |          | (750     | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Proceeds from the sale of property, plant and equipment                                           |                                                                                       |                                                                                      | 3,596                                                     |        |              |          | 15,765       |        |              |          | 41,187   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Proceeds from dispositions                                                                        |                                                                                       |                                                                                      |                                                          |        |              |          |             |        |              |          | 16,809   |        
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|                                     |                                                                                                   |                                                                                       |                                                                                      | Net cash flows provided by (used in) investing activities |        |              | 72,376   |              |        |              | (250,859 | )        |         |         | (18,911  | )
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|Financing activities:               
|                                    
|                                    
|                                    
|                                    
|                                     | Principal payments on long-term debt                                                              |                                                                                       |                                                                                      | (400,200                                                  | )      |              |          | (75,093      | )      |              |          | (391,295 | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Proceeds from borrowings of long-term debt                                                        |                                                                                       |                                                                                      | 261,917                                                   |        |              |          | 400,000      |        |              |          | 30,000   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Common stock repurchases                                                                          |                                                                                       |                                                                                      | (173,332                                                  | )      |              |          | (480,036     | )      |              |          | (44,658  | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Cash received from minority stockholders                                                          |                                                                                       |                                                                                      | 8,108                                                     |        |              |          |             |        |              |          |         |        
|                                    
|                                    
|                                    
|                                    
|                                     | Proceeds from issuance of common and treasury stock                                               |                                                                                       |                                                                                      | 2,466                                                     |        |              |          | 22,598       |        |              |          | 18,908   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Common
stock reclassification payments to UniHealth Foundation                                    |                                                                                       |                                                                                      |                                                          |        |              |          | (61,880      | )      |              |          |         |        
|                                    
|                                    
|                                    
|                                    
|                                     | Preferred dividends paid                                                                          |                                                                                       |                                                                                      |                                                          |        |              |          |             |        |              |          | (5,259   | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Redemption of preferred stock                                                                     |                                                                                       |                                                                                      |                                                          |        |              |          |             |        |              |          | (410     | )      
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|                                     |                                                                                                   |                                                                                       |                                                                                      | Net cash flows used in financing activities               |        |              | (301,041 | )            |        |              | (194,411 | )        |         |         | (392,714 | )
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|Net increase in cash and equivalents |                                                                                                   |                                                                                       | 402,571                                                                              |                                                           |        |              | 124,428  |              |        |              | 43,962   |         
|                                    
|                                    
|                                    
|                                    
|Beginning cash and equivalents       |                                                                                                   |                                                                                       | 849,064                                                                              |                                                           |        |              | 724,636  |              |        |              | 680,674  |         
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         
|Ending cash and equivalents          |                                                                                                   | $                                                                                     | 1,251,635                                                                            |                                                           |        | $            | 849,064  |              |        | $            | 724,636  |         
|                                     |                                                                                                   |                                                                                       |                                                                                      |                                                           |        |              |          |              |        |              |          |         

See accompanying notes.Table continued on next page.

F-4



---



##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
  (amounts in thousands)

|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |         |        | 
|------------------------------------------------------------------------------ | ----------------------------------------------------- | ------------------------------------------------------ | - | ------------ | ------- | ------------ | - | ------------ | ------- | - | ------- | ------- | ------ | 
|                                                                               |                                                       |                                                        |   | Year Ended   |         | Year Ended   |   | Year Ended  
|                                                                               |                                                       |                                                        |   | December 31, |         | December 31, |   | December 31,
|                                                                               |                                                       |                                                        |   | 2000         |         | 1999         |   | 1998        
|                                                                               |                                                       |                                                        |   |              |         |              |   |             
|Supplemental
          cash flow information:                                 
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Cash paid
          during the year for:             
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               |                                                       | Income
          taxes, net of refunds                 |   | $            | 115,092 |              |   | $            | 209,754 |   |         | $       | 28,696 | 
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               |                                                       | Interest                                               |   | $            | 71,034  |              |   | $            | 35,621  |   |         | $       | 55,735 | 
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Supplemental
          schedule of noncash investing and financing activities:
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Stock-based
          compensation                    |                                                        | $ | 6,325        |         |              | $ | 7,209        |         |   | $       | 1,239   |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Details
          of accumulated other comprehensive income (loss):           
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Change
          in marketable securities             |                                                        | $ | 34,935       |         |              | $ | (51,727      | )       |   | $       | (4,652  | )     
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Less change
          in deferred income taxes        |                                                        |   | (13,514      | )       |              |   | 19,972       |         |   |         | 2,018   |       
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        
|                                                                               | Change
          in stockholders equity              |                                                        | $ | 21,421       |         |              | $ | (31,755      | )       |   | $       | (2,634  | )     
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        
|Details
          of businesses acquired in purchase transactions:            
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Fair value
          of assets acquired               |                                                        | $ | 263,936      |         |              | $ | 21,234       |         |   | $       | 750     |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Less liabilities
          assumed or created         |                                                        |   | (134,243     | )       |              |   |             |         |   |         |        |       
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        
|                                                                               | Cash paid
          for fair value of assets acquired |                                                        |   | 129,693      |         |              |   | 21,234       |         |   |         | 750     |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Cash acquired
          in acquisitions               |                                                        |   | (133,791     | )       |              |   |             |         |   |         |        |       
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        
|                                                                               |                                                       | Net cash
          (acquired in) paid for acquisitions |   | $            | (4,098  | )            |   | $            | 21,234  |   |         | $       | 750    | 
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        
|Purchase
          accounting accrual adjustment:                             
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Reduction
          of purchase accounting accruals   |                                                        | $ |             |         |              | $ |             |         |   | $       | (79,340 | )     
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Deferred
          income taxes                       |                                                        |   |             |         |              |   |             |         |   |         | 10,165  |       
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        
|Net goodwill
          adjustment                                              |                                                       | $                                                      |  |              |         | $            |  |              |         | $ | (69,175 | )      
|                                                                               |                                                       |                                                        |   |              |         |              |   |              |         |   |         |        

See accompanying notes.Table continued from previous page.

F-5



---



##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

Organization and Operations.PacifiCare Health Systems, Inc. owns and operates
health maintenance organizations (HMOs), that arrange health care services
principally for a predetermined, prepaid periodic fee to enrolled subscriber
groups through independent health care organizations under contract. Our
commercial plans and Medicare program are designed to deliver quality health
care and customer service to members at cost-effective prices. We also offer a
variety of specialty HMO managed care and HMO-related products and services
that employees can purchase as a supplement to our basic commercial plans or as
stand-alone products. These products include pharmacy benefit management,
behavioral health services, life and health insurance and dental and vision
services. UniHealth Foundation, a California non-profit public benefit
corporation, owned approximately 14 percent of our outstanding shares of common
stock at December 31, 2000.

Consolidation.The accompanying consolidated financial statements include the
accounts of the parent company and all significant subsidiaries that are more
than 50 percent owned and controlled. All significant intercompany
transactions and balances were eliminated in consolidation.

Segment Information.We present segment information externally the same way
management uses financial data internally to make operating decisions and
assess performance. Because we sell health care packages in the form of
bundled HMO and supplemental HMO products to members of all ages, we have one
reportable operating segment. These HMO members generally fall within two
product lines. Revenues from non-Medicare members, generally employees or
early retirees of businesses, are reported in the commercial product line.
Revenues from our Medicare customers are reported in the Medicare product line.
Our single largest customer is the federal government. Sources of federal
government revenues include revenues from Medicare beneficiaries and from
federal employees covered by the Federal Employee Health Benefits Program
(FEHBP). Federal government revenues were $6.7 billion in 2000, $6.2 billion
in 1999 and $5.9 billion in 1998.

Use of Estimates.In preparing the consolidated financial statements, we must
use some estimates and assumptions that may affect reported amounts and
disclosures. We use estimates most often when accounting for:



| |  | Allowances for doubtful premiums and accounts receivable;                         
|- |  | ----------------------------------------------------------------------------------
| 
| |  | Provider receivables and reserves;                                                
| 
| |  | Internally developed software;                                                    
| 
| |  | Medical claims and benefits payable;                                              
| 
| |  | Professional and general liability;                                               
| 
| |  | Reserves relating to the United States Office of Personnel Management (OPM); and
| 
| |  | Certain other reserves.                                                           

We are also subject to risks and uncertainties that may cause actual results to
differ from estimated results, such as changes in the health care environment,
competition and legislation.

Reclassifications.We reclassified certain prior year amounts in the
accompanying consolidated financial statements to conform to the 2000
presentation.
F-6Table of Contents2. Significant Accounting PoliciesCash and Equivalents.Cash and equivalents include items such as money market
funds and certificates of deposit, with maturity periods of three months or
less when purchased.Marketable Securities.All marketable securities (which include municipal
bonds, corporate notes, commercial paper and U.S. government securities),
except for certain marketable securities-restricted, are designated as
available-for-sale. Accordingly, marketable securities are carried at fair
value and unrealized gains or losses, net of applicable income taxes, are
recorded in stockholders equity. Because marketable securities are available
for use in current operations, they are classified as current assets without
regard to the securities contractual maturity dates.We are required by state regulatory agencies to set aside funds to comply with
the laws of the various states in which we operate. These funds are classified
as marketable securities-restricted (which include U.S. government securities
and certificates of deposit held by trustees or state regulatory agencies).
Certain marketable securities-restricted are designated as held-to-maturity
since we have the intent and ability to hold such securities to maturity.
Held-to-maturity securities are stated at amortized cost, adjusted for
amortization of premiums and accretion of discounts to maturity, and are
classified as noncurrent assets. See Note 3, Marketable Securities.Concentrations of Credit Risk.Financial instruments that potentially subject
us to concentrations of credit risk consist primarily of investments in
marketable securities and commercial premiums receivable. Our short-term
investments in marketable securities are managed by professional investment
managers within guidelines established by our board of directors, that, as a
matter of policy, limit the amounts that may be invested in any one issuer.
Concentrations of credit risk with respect to commercial premiums receivable
are limited due to the large number of employer groups comprising our customer
base. We had no significant concentrations of credit risk at December 31,
2000.Fair Value of Financial Instruments.Our consolidated balance sheets include
the following financial instruments: cash and equivalents, trade accounts and
notes receivable, trade accounts payable and long-term obligations. We
consider the carrying amounts of current assets and liabilities in the
consolidated financial statements to approximate the fair value for these
financial instruments because of the relatively short period of time between
origination of the instruments and their expected realization. The carrying
value of all long-term obligations approximates the fair value of such
obligations.Long-Lived Assets.Property, Plant and Equipment.We record property, plant and equipment at
cost. We capitalize replacements and major improvements. We also capitalize
certain internal and external costs associated with the purchase or development
of internal-use software. We charge repairs and maintenance to expense as
incurred. We eliminate the costs and related accumulated depreciation when we
sell property, plant and equipment, and any resulting gains or losses are
included in net income. We depreciate property, plant and equipment, including
assets under capital leases, evenly over the assets useful lives ranging from
three to 25 years. We amortize leasehold improvements evenly over the shorter
of the lease term or five years. We amortize software costs evenly over
estimated useful lives ranging from three to five years. Accumulated
depreciation and amortization on property, plant and equipment totaled $166
million at December 31, 2000 and $124 million at December 31, 1999.Goodwill and Intangible Assets.When we acquire a business, we allocate the
excess of the purchase price over the fair value of the net assets acquired to
goodwill and identifiable intangible assets. Identifiable intangible assets
can include employer group contracts, Medicare contracts, physician and
hospital networks and assembled work force. We amortize goodwill and
intangible assets evenly over periods ranging from three to 40 years.
Accumulated amortization totaled $318 million at December 31, 2000 and $236
million at December 31, 1999.Long-lived Asset Impairment.We review long-lived assets for impairment when
events or changes in business conditions indicate that their full carrying
value may not be recovered. We consider assets to be impaired and write them
down to fair value if expected associated cash flows are less than the carrying
amounts. Fair value is the present value of the expected associated cash
flows. We recorded pretax charges for the impairment of goodwill and
intangible assets totaling $14 million in 1999. See Note 9, Impairment,
Disposition, Restructuring, Office of Personnel Management and Other Charges
(Credits).Minority Interest.In June 2000, PacifiCare and Compaq Computer Corporation
(Compaq) agreed to jointly invest up to approximately $19 million in a newly
formed Internet company for seniors called SeniorCo, Inc. PacifiCare has
majority ownershipF-7Table of Contentsof approximately 80 percent of the outstanding voting shares
at December 31, 2000. We agreed to contribute up to $5 million in cash ($3
million was contributed as of December 31, 2000), as well as certain assets,
such as marketing support and management personnel. Compaq agreed to
contribute up to $14 million in cash ($8 million was contributed as of December
31, 2000). The operating results of this entity are included in our
consolidated financial statements from the date of its formation, partially
offset by the portion of operating results allocated to minority stockholders,
primarily Compaq.Premiums and Revenue Recognition.We report prepaid health care premiums
received from our HMOs enrolled groups as revenue in the month that enrollees
are entitled to receive health care. We record premiums received in advance as
unearned premium revenue. Funds received under the federal Medicare program
accounted for approximately 57 percent in 2000, 60 percent in 1999 and 59
percent in 1998 as a percentage of total premiums.Health Care Services.Our HMOs arrange for comprehensive health care services
to their members through capitation or risk-based arrangements. Capitation is a
fixed monthly payment made without regard to the frequency, extent or nature of
the health care services actually furnished. We provide benefits to enrolled
members generally through our contractual relationships with physician groups
and hospitals. Our contracted physicians and hospitals may, in turn, contract
with specialists or referral physicians and hospitals for specific services and
are responsible for any related payments to those referral physicians and
hospitals. Risk-based arrangements include shared-risk and fee-for-service
contracts. Under the shared-risk contracts, we share the risk of health care
costs with parties not covered by our capitation arrangements. Under
fee-for-service contracts, we contract with certain hospitals and ancillary
providers, as well as some individual physicians or physician organizations, to
provide services to our members based on modified discounted fee schedules for
the services provided. Our HMOs provide incentives to participating medical
groups through the use of risk-sharing agreements and other programs. Payments
are made to medical groups based on their performance in controlling health
care costs while providing quality health care. Expenses related to these
programs, that are based in part on estimates, are recorded in the period in
which the related services are dispensed. The cost of health care provided is
accrued in the period it is dispensed to the enrolled members, based in part on
estimates for hospital services and other health care costs that have been
incurred but not yet reported. Management develops these estimates using
actuarial methods based upon historical data for payment patterns, cost trends,
product mix, seasonality, utilization of health care services and other
relevant factors. We have also recorded reserves, based in part on estimates,
to indemnify our members against potential referral claims related to insolvent
medical groups. See Note 10, Commitments and Contingencies. Our HMOs have
stop-loss insurance to cover unusually high costs of care when incurred beyond
a predetermined annual amount per enrollee.Premium Deficiency Reserves on Loss Contracts.We assess the profitability of
our contracts for providing health care services to our members when current
operating results or forecasts indicate probable future losses. We compare
anticipated premiums to health care related costs, including estimated payments
for physicians and hospitals, commissions and cost of collecting premiums and
processing claims. If the anticipated future costs exceed the premiums, a loss
contract accrual is recognized.Stock-Based Compensation.We use Accounting Principles Board Opinion No. 25 to
account for our stock-based compensation plans. Because we typically set the
exercise price of options granted at our stocks market price on the grant
date, there is no associated compensation expense. We have, however, granted
certain options that vest only if target stock prices are met. Because these
options have variable terms, there may be compensation expense incurred for the
difference between the exercise price and the closing market price on the
vesting dates.In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, Accounting for Certain Transactions Involving Stock Compensation.
This Interpretation provides guidance on certain implementation issues related
to Accounting Principles Board Opinion No. 25. Our adoption of this
Interpretation as of July 1, 2000 did not have a material impact on our results
of operations or financial position for the period ended December 31, 2000.
See Note 8, Employee Benefit Plans.Taxes Based on Premiums.Certain states in which we do business require the
payment of excise, per capita or premium taxes based on a specified rate for
enrolled members or a percentage of billed premiums. Such taxes may be levied
instead of state income tax. These taxes are recorded in marketing, general
and administrative expenses, and totaled $30 million in 2000, $15 million in
1999 and $17 million in 1998.Income Taxes.We recognize deferred income tax assets and liabilities for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns. Deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax bases of assets and liabilities. We measure deferred tax assets and
liabilities by applying enacted tax rates and laws to taxable years in which
such differences are expected to reverse. See Note 7, Income Taxes.
F-8Table of ContentsEarnings per Share.We calculated the denominators for the computation of
basic and diluted earnings per share as follows:

|                                                                      |                                               |  |                        |        |      |  |        |        |   |  |        |       |  
|--------------------------------------------------------------------- | --------------------------------------------- |  | ---------------------- | ------ | ---- |  | ------ | ------ | - |  | ------ | ----- | -
|                                                                      |                                               |  | 2000                   |        | 1999 |  | 1998  
|                                                                      |                                               |  |                        |        |      |  |       
|                                                                      |                                               |  | (amounts in thousands)
|Shares outstanding at the beginning of the period                     |                                               |  | 37,252                 |        |      |  | 45,616 |        |   |  | 41,995 |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Weighted average number of shares issued:                            
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Conversion of Series A preferred stock        |  |                        |       |      |  |        |       |   |  |        | 2,067 |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Treasury stock acquired, net of shares issued |  |                        | (2,274 | )    |  |        | (1,387 | ) |  |        | (543  | )
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Stock options exercised                       |  |                        | 94     |      |  |        | 277    |   |  |        | 261   |  
|                                                                      |                                               |  |                        |        |      |  |        |        |   |  |        |      
|Denominator for basic earnings per share                              |                                               |  | 35,072                 |        |      |  | 44,506 |        |   |  | 43,780 |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Assumed conversion of Series A preferred stock                        |                                               |  |                       |        |      |  |       |        |   |  | 1,862  |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Employee stock options and other dilutive potential common shares (1) |                                               |  | 95                     |        |      |  | 211    |        |   |  | 363    |      
|                                                                      |                                               |  |                        |        |      |  |        |        |   |  |        |      
|Denominator for diluted earnings per share                            |                                               |  | 35,167                 |        |      |  | 44,717 |        |   |  | 46,005 |      
|                                                                      |                                               |  |                        |        |      |  |        |        |   |  |        |      



---

|
|

|(1) |  | Certain options to purchase common stock were not included in the
calculation of diluted earnings per share because their exercise
prices were greater than the average market price of our common
stock for the periods presented. For the year ended December 31,
2000, these weighted options outstanding totaled 8.0 million
shares, with exercise prices ranging from $44.19 to $114.00 per
share. For the years ended December 31, 1999 and 1998, these
weighted options outstanding totaled 6.3 million shares and 3.0
million shares respectively, with exercise prices ranging from
$64.65 to $114.00 per share.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Derivatives.In June 1998, the Financial Accounting Standards Board issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.
This standard requires companies to record all derivatives on the balance sheet
as either assets or liabilities and measure those instruments at their fair
value. The manner in which companies are to record gains or losses resulting
from changes in the values of those derivatives depends on the use of the
derivative and whether it qualifies for hedge accounting. This standard is
effective for our consolidated financial statements beginning January 1, 2001,
although early adoption is permitted. We believe that the adoption of this
statement will not have a material impact on our consolidated financial
position or results of operations.

F-9



---



##### Table of Contents



3. Marketable Securities

The following table summarizes marketable securities as of the dates indicated:

|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |         |         | 
|--------------------------------- | ------------------------------------------- | -------------------------------------- | --------- | ---------------------- | --------- | ---------- | ----- | ---------- | ----- | ---------- | ------- | ------- | ------- | - | --------- | ------- | ------- | 
|                                  |                                             |                                        |           |                        |           |            |       | Gross      |       | Gross     
|                                  |                                             |                                        |           | Amortized              |           | Unrealized |       | Unrealized
|                                  |                                             |                                        |           | Cost                   |           | Gains      |       | Losses     |       | Fair Value
|                                  |                                             |                                        |           |                        |           |            |       |            |       |           
|                                  |                                             |                                        |           | (amounts in thousands)
|Marketable securities:           
|                                 
|                                 
|                                 
|                                 
|                                  | U.S. government and agency                  |                                        | $         | 44,999                 |           |            | $     | 403        |       |            | $       | (582    | )       |   | $         | 44,820  |        
|                                 
|                                 
|                                 
|                                 
|                                  | State, municipal and state and local agency |                                        |           | 323,205                |           |            |       | 2,796      |       |            |         | (1,351  | )       |   |           | 324,650 |        
|                                 
|                                 
|                                 
|                                 
|                                  | Corporate debt and other securities         |                                        |           | 500,711                |           |            |       | 2,361      |       |            |         | (8,529  | )       |   |           | 494,543 |        
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|                                  |                                             | Total marketable securities            |           |                        | 868,915   |            |       |            | 5,560 |            |         |         | (10,462 | ) |           |         | 864,013 | 
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|Marketable securities-restricted:
|                                 
|                                 
|                                 
|                                 
|                                  | U.S. government and agency                  |                                        |           | 45,885                 |           |            |       | 444        |       |            |         | (24     | )       |   |           | 46,305  |        
|                                 
|                                 
|                                 
|                                 
|                                  | Municipal and local agency                  |                                        |           | 13,060                 |           |            |       | 168        |       |            |         | (55     | )       |   |           | 13,173  |        
|                                 
|                                 
|                                 
|                                 
|                                  | Corporate debt and other securities         |                                        |           | 35,457                 |           |            |       | 347        |       |            |         | (89     | )       |   |           | 35,715  |        
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|                                  |                                             | Total marketable securities-restricted |           |                        | 94,402    |            |       |            | 959   |            |         |         | (168    | ) |           |         | 95,193  | 
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|Balance at December 31, 2000      |                                             | $                                      | 963,317   |                        |           | $          | 6,519 |            |       | $          | (10,630 | )       |         | $ | 959,206   |        
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|Marketable securities:           
|                                 
|                                 
|                                 
|                                 
|                                  | U.S. government and agency                  |                                        | $         | 178,684                |           |            | $     | 15         |       |            | $       | (8,941  | )       |   | $         | 169,758 |        
|                                 
|                                 
|                                 
|                                 
|                                  | State, municipal and state and local agency |                                        |           | 389,623                |           |            |       | 173        |       |            |         | (12,397 | )       |   |           | 377,399 |        
|                                 
|                                 
|                                 
|                                 
|                                  | Corporate debt and other securities         |                                        |           | 470,724                |           |            |       | 167        |       |            |         | (18,854 | )       |   |           | 452,037 |        
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|                                  |                                             | Total marketable securities            |           |                        | 1,039,031 |            |       |            | 355   |            |         |         | (40,192 | ) |           |         | 999,194 | 
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|Marketable securities-restricted:
|                                 
|                                 
|                                 
|                                 
|                                  | U.S. government and agency                  |                                        |           | 41,704                 |           |            |       | 40         |       |            |         | (194    | )       |   |           | 41,550  |        
|                                 
|                                 
|                                 
|                                 
|                                  | Municipal and local agency                  |                                        |           | 12,311                 |           |            |       | 25         |       |            |         | (322    | )       |   |           | 12,014  |        
|                                 
|                                 
|                                 
|                                 
|                                  | Corporate debt and other securities         |                                        |           | 32,456                 |           |            |       | 14         |       |            |         | (146    | )       |   |           | 32,324  |        
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|                                  |                                             | Total marketable securities-restricted |           |                        | 86,471    |            |       |            | 79    |            |         |         | (662    | ) |           |         | 85,888  | 
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        
|Balance at December 31, 1999      |                                             | $                                      | 1,125,502 |                        |           | $          | 434   |            |       | $          | (40,854 | )       |         | $ | 1,085,082 |        
|                                  |                                             |                                        |           |                        |           |            |       |            |       |            |         |         |         |   |           |        

As of December 31, 2000 the contractual maturities of our marketable securities
were as follows:

|                                       |  |                        |         |            |  |                |         |            |  |                         |        |  |  |   |        | 
|-------------------------------------- |  | ---------------------- | ------- | ---------- |  | -------------- | ------- | ---------- |  | ----------------------- | ------ |  |  | - | ------ | 
|                                       |  |                        |         |            |  |                |         |            |  | Marketable Securities 
|                                       |  | Marketable Securities  |         | Restricted
|                                       |  |                        |         |           
|                                       |  | Amortized Cost         |         | Fair Value |  | Amortized Cost |         | Fair Value
|                                       |  |                        |         |            |  |                |         |           
|                                       |  | (amounts in thousands)
|Due in one year or less                |  | $                      | 103,831 |            |  | $              | 103,079 |            |  | $                       | 37,600 |  |  | $ | 37,642 | 
|                                      
|                                      
|                                      
|                                      
|Due after one year through five years  |  |                        | 185,340 |            |  |                | 185,449 |            |  |                         | 37,684 |  |  |   | 38,237 | 
|                                      
|                                      
|                                      
|                                      
|Due after five years through ten years |  |                        | 290,406 |            |  |                | 287,275 |            |  |                         | 14,237 |  |  |   | 14,443 | 
|                                      
|                                      
|                                      
|                                      
|Due after ten years                    |  |                        | 289,338 |            |  |                | 288,210 |            |  |                         | 4,881  |  |  |   | 4,871  | 
|                                       |  |                        |         |            |  |                |         |            |  |                         |        |  |  |   |        | 
|                                       |  | $                      | 868,915 |            |  | $              | 864,013 |            |  | $                       | 94,402 |  |  | $ | 95,193 | 
|                                       |  |                        |         |            |  |                |         |            |  |                         |        |  |  |   |        | 

Proceeds from sales and maturities of marketable securities were $7.1 billion
in 2000, $6.9 billion in 1999 and 1.4 billion in 1998. Gross realized gains
and gross realized losses are included in net investment income under the
specific identification method.

4. Acquisitions and Dispositions

2000 Acquisitions.On February 1, 2000, we completed our acquisition of Harris
Methodist Texas Health Plan, Inc. and Harris Methodist Health Insurance
Company, Inc. (together, Harris), a health plan and insurance company in
Texas, for an approximate purchase price of $122 million. This acquisition
added approximately 250,000 commercial members and 50,000 Medicare members to
our Texas HMO and was accounted for as a purchase. The related goodwill and
acquired intangible assets are being amortized over periods ranging from three
to 30 years. The operating results of these entities are included in our
consolidated financial statements from the acquisition date.

During the first half of 2000, we assumed approximately 18,000 members in
Colorado and approximately 21,000 members in Washington for a purchase price of
approximately $6 million. These membership assumptions are the result of
transition agreements signed with QualMed Plans for Health of Colorado, Inc. in
September 1999 and with QualMed Washington Health Plans, Inc. in October 1999,
each a subsidiary of Health Net, Inc.

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##### Table of Contents



2000 Dispositions.In June 2000, we announced our intention to exit our Ohio
HMO operations. This plan affected approximately 35,000 commercial members and
3,500 Medicare members located in Ohio and Kentucky who were enrolled in our
plans during 2000. The exit was completed in January 2001. We entered into an
agreement with Anthem Blue Cross and Blue Shield to assist in transitioning
Ohios commercial membership. Medicare members were provided a choice of
another Medicare+Choice HMO or traditional fee-for-service Medicare. In
connection with the disposition, we recognized pretax charges of approximately
$4 million ($2 million or $0.07 diluted loss per share, net of tax). See Note
9, Impairment, Disposition, Restructuring, Office of Personnel Management and
Other Charges (Credits).

1999 Acquisitions.In September 1999, we acquired Antero Health Plans in
Colorado for a purchase price of $14 million. This acquisition added
approximately 32,000 commercial members and 4,000 Medicare members to our
Colorado HMO. In February 1999, we assumed approximately 15,000 commercial
members in Texas for $4 million. These acquisitions were accounted for as
purchases with substantially the entire purchase price allocated to goodwill
and other acquired intangible assets. The goodwill and acquired intangible
assets are being amortized over periods ranging from three to 20 years. The
operating results of these entities are included in our consolidated financial
statements from the acquisition date.

1998 Dispositions. On September 30, 1998, we sold our Utah HMO subsidiary.
We guaranteed the buyer that the Utah HMO would have a minimum net equity of
$10 million, based on the values of the Utah HMOs assets and liabilities as of
September 30, 1998. We also extended a $700,000 subordinated loan to the Utah
HMO which was paid off in August 1999, to increase its statutory net equity.
We sold all of the issued and outstanding shares of capital stock of the Utah
HMO to the buyer for no other consideration. As of September 30, 1998, the
Utah HMO served approximately 102,000 commercial and 19,000 government members.
On October 31, 1998, we sold our workers compensation subsidiary for $17
million. We recognized pretax charges (credits) for these dispositions in 1998
and 1999. See Note 9, Impairment, Disposition, Restructuring, Office of
Personnel Management and Other Charges (Credits).

Pro Forma Financial Statements.The pro forma information below presents our
consolidated results of operations as if the Harris acquisition occurred at the
beginning of each period presented. The pro forma information gives effect to
actual results prior to these transactions plus adjustments for depreciation
expense, goodwill amortization, net investment income and income taxes.
Because our 1999 membership acquisitions in Colorado and Texas as well as our
2000 membership assumptions in Colorado and Washington were not material to our
consolidated results of operations, these transactions were not included in the
pro forma information below.

|                           |  |                               |            |      |  |   |            | 
|-------------------------- |  | ----------------------------- | ---------- | ---- |  | - | ---------- | 
|                           |  | Year Ended December 31,      
|                           |  |                              
|                           |  | 2000                          |            | 1999
|                           |  |                               |            |     
|                           |  | (amounts in thousands, except
|                           |  | per share data)              
|Total operating revenue    |  | $                             | 11,525,825 |      |  | $ | 10,746,745 | 
|                          
|                          
|                          
|                          
|Income before income taxes |  | $                             | 280,460    |      |  | $ | 403,417    | 
|                          
|                          
|                          
|                          
|Net income                 |  | $                             | 156,434    |      |  | $ | 231,135    | 
|                          
|                          
|                          
|                          
|Basic earnings per share   |  | $                             | 4.46       |      |  | $ | 5.19       | 
|                          
|                          
|                          
|                          
|Diluted earnings per share |  | $                             | 4.45       |      |  | $ | 5.17       | 

5. Long-Term Debt

Beginning January 1, 1999, and continuing through the January 1, 2002 final
maturity date, the amount available to borrow under our credit facility
declines incrementally every six months. The next mandatory incremental
reduction will occur on July 1, 2001. At that time the total amount available
for borrowing will be $800 million. At December 31, 2000, we had an
outstanding balance of $735 million. The facility also requires mandatory
step-down payments if the principal balance exceeds certain thresholds. Based
on the December 31, 2000 balance, no payments are required until the final
maturity date.

Interest under the credit facility is variable and is presently based on the
London Interbank Offered Rate (LIBOR) plus a spread. Based on the
outstanding balance at December 31, 2000, the average overall rate, excluding
the facility fee, was 7.9 percent. The terms of the credit facility contain
various covenants, usual for financings of this type, including a minimum net
worth requirement, a minimum fixed charge coverage requirement, leverage ratios
and limits on the amount of stock we may repurchase. At December 31, 2000, we
were in compliance with all such covenants. Our wholly owned subsidiary, PacifiCare Health Plan
Administrators, Inc., fully and unconditionally guarantees the credit
facility. We have no assets or operations separate from our wholly
owned subsidiaries. Our non-guarantor subsidiaries were immaterial to
our consolidated financial position as of December 31, 2000.

We also have $100 million in
senior notes outstanding that we assumed when we acquired FHP International
Corporation in 1997. These notes mature on September 15, 2003 and bear an
interest rate of seven percent payable semiannually.

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##### Table of Contents



6. Stockholders Equity

Stockholder Rights Agreement.In November 1999, our board of directors adopted
a stockholder rights agreement to protect stockholder rights in the event of a
proposed takeover. The board of directors declared a dividend of one right for
each share of our common stock outstanding as of November 19, 1999. The right
entitles the registered holder to purchase from PacifiCare 1/100th of a share
of Series A junior participating preferred stock at a price of $180 per 1/100th
of a preferred share. Similar rights will generally be issued in respect of
common stock issued after November 19, 1999.

Treasury Stock. In October 1999, our board of directors approved a stock
repurchase program that allows us to repurchase up to 12 million shares of our
outstanding common stock, including any shares purchased from UniHealth
Foundation, a non-profit public benefit corporation and our largest stockholder
(see UniHealth Foundation Stock Purchase Agreement below). To purchase these
shares, we negotiated an amendment to our existing credit facility that
increases the maximum allowable amount of share repurchases to $1 billion from
$500 million. We may fund the stock repurchase program through a combination
of cash flows from operations, additional borrowings under the credit facility
and long- and short-term debt. We have suspended the repurchase of our shares
on the open market.

As of December 31, 2000, we held approximately 14 million treasury shares
totaling $697 million. These shares were purchased pursuant to the October
1999 program discussed above and prior repurchase programs. We have reissued,
and will continue to reissue these shares for our employee benefit plans or for
other corporate purposes.

Reclassification of Common Stock. At our June 1999 annual meeting, our Class A
and Class B common stockholders, including UniHealth Foundation, approved an
amended and restated certificate of incorporation. The amended and restated
certificate combined and reclassified our Class A and Class B common stock into
a single class of voting common stock. The reclassified common stock has the
same rights, powers and limitations as the previously existing Class A common
stock. The reclassification of the Class A and Class B common stock had no
impact on the total number of our issued and outstanding shares of common
stock.

Prior to the combination and reclassification of our Class A and Class B common
stock, UniHealth Foundation owned approximately 40 percent of our voting Class
A common stock and approximately one percent of our non-voting Class B common
stock. As of December 31, 2000, UniHealth Foundation owned approximately 14
percent of our outstanding voting common stock. In consideration for UniHealth
Foundations vote in favor of the amended and restated certificate of
incorporation, and in consideration of the agreements and covenants contained
in the stock purchase agreement discussed below, we paid UniHealth Foundation
$60 million in June 1999, when our stockholders approved the amended and
restated certificate of incorporation. We also incurred $2 million of expenses
related to the reclassification of our common stock and the registration of the
shares held by UniHealth Foundation. These amounts were recorded as a
reduction of stockholders equity in 1999.

UniHealth Foundation Stock Purchase Agreement. In May 1999, we entered into a
stock purchase agreement with UniHealth Foundation to repurchase up to 5.9
million shares of our common stock held by UniHealth Foundation. During 2000,
we purchased 1.5 million shares for a total of $57 million under this
agreement. No shares were purchased during 1999. See Note 12, Subsequent
Events.

Preferred Stock Redemption. In May 1998, we announced the redemption of 10.5
million shares of our Series A preferred stock. Substantially all of the
preferred shares were converted into 3.9 million shares of common stock as of
the June 1998 redemption date. We paid approximately $5 million in dividends
to our preferred stockholders during the year ended December 31, 1998.

F-12



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##### Table of Contents



7. Income Taxes

The tax effects of the major items recorded as deferred tax assets and
liabilities were as follows:

|                                               |                                            |   |                        |          |      |   |          |          |  
|---------------------------------------------- | ------------------------------------------ | - | ---------------------- | -------- | ---- | - | -------- | -------- | -
|                                               |                                            |   | 2000                   |          | 1999
|                                               |                                            |   |                        |          |     
|                                               |                                            |   | (amounts in thousands)
|Current deferred tax assets (liabilities):    
|                                              
|                                              
|                                              
|                                              
|                                               | Accrued expenses                           |   | $                      | 82,844   |      |   | $        | 67,886   |  
|                                              
|                                              
|                                              
|                                              
|                                               | Medical claims and benefits payable        |   |                        | 45,612   |      |   |          | 42,228   |  
|                                              
|                                              
|                                              
|                                              
|                                               | Accrued compensation                       |   |                        | 20,168   |      |   |          | 15,224   |  
|                                              
|                                              
|                                              
|                                              
|                                               | Provider receivables                       |   |                        | (8,264   | )    |   |          |         |  
|                                              
|                                              
|                                              
|                                              
|                                               | Prepaid expenses                           |   |                        | (6,171   | )    |   |          | (4,672   | )
|                                              
|                                              
|                                              
|                                              
|                                               | State franchise taxes                      |   |                        | 4,497    |      |   |          | 7,620    |  
|                                              
|                                              
|                                              
|                                              
|                                               | Pharmacy rebates                           |   |                        | (2,257   | )    |   |          | (3,987   | )
|                                              
|                                              
|                                              
|                                              
|                                               | Unrealized losses on marketable securities |   |                        | 1,927    |      |   |          | 15,440   |  
|                                              
|                                              
|                                              
|                                              
|                                               | Other                                      |   |                        | 1,356    |      |   |          | 1,430    |  
|                                               |                                            |   |                        |          |      |   |          |         
|                                               |                                            | $ | 139,712                |          |      | $ | 141,169  |         
|                                               |                                            |   |                        |          |      |   |          |         
|Non-current deferred tax (liabilities) assets:
|                                              
|                                              
|                                              
|                                              
|                                               | Identifiable intangibles                   |   | $                      | (106,905 | )    |   | $        | (115,484 | )
|                                              
|                                              
|                                              
|                                              
|                                               | Depreciation and software amortization     |   |                        | (26,908  | )    |   |          | (12,742  | )
|                                              
|                                              
|                                              
|                                              
|                                               | Goodwill amortization                      |   |                        | (15,281  | )    |   |          | (2,498   | )
|                                              
|                                              
|                                              
|                                              
|                                               | Other                                      |   |                        | 3,461    |      |   |          | 3,255    |  
|                                               |                                            |   |                        |          |      |   |          |         
|                                               |                                            | $ | (145,633               | )        |      | $ | (127,469 | )       
|                                               |                                            |   |                        |          |      |   |          |         

The provision for income taxes consisted of the following:

|          |                            |                |   |                        |         |      |   |         |         |  |   |         |         |  
|--------- | -------------------------- | -------------- | - | ---------------------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | -
|          |                            |                |   | 2000                   |         | 1999 |   | 1998   
|          |                            |                |   |                        |         |      |   |        
|          |                            |                |   | (amounts in thousands)
|Current: 
|         
|         
|         
|         
|          | Federal                    |                | $ | 106,529                |         |      | $ | 156,958 |         |  | $ | 171,478 |        
|         
|         
|         
|         
|          | State                      |                |   | 14,410                 |         |      |   | 19,739  |         |  |   | 30,968  |        
|          |                            |                |   |                        |         |      |   |         |         |  |   |        
|          |                            | Total current  |   |                        | 120,939 |      |   |         | 176,697 |  |   |         | 202,446 |  
|          |                            |                |   |                        |         |      |   |         |         |  |   |        
|Deferred:
|         
|         
|         
|         
|          | Federal                    |                |   | 6,507                  |         |      |   | 19,973  |         |  |   | (13,615 | )      
|         
|         
|         
|         
|          | State                      |                |   | (400                   | )       |      |   | 6,695   |         |  |   | (5,684  | )      
|          |                            |                |   |                        |         |      |   |         |         |  |   |        
|          |                            | Total deferred |   |                        | 6,107   |      |   |         | 26,668  |  |   |         | (19,299 | )
|          |                            |                |   |                        |         |      |   |         |         |  |   |        
|          | Provision for income taxes |                | $ | 127,046                |         |      | $ | 203,365 |         |  | $ | 183,147 |        
|          |                            |                |   |                        |         |      |   |         |         |  |   |        

Reconciliations of the U.S. statutory income tax
rate to our effective tax rate were as
follows:

|                                      |  |      |      |      |  |      |      |   |  |  |      |  
|------------------------------------- |  | ---- | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                                      |  | 2000 |      | 1999 |  | 1998
|                                      |  |      |      |      |  |     
|Computed expected provision           |  |      | 35.0 | %    |  |      | 35.0 | % |  |  | 35.0 | %
|                                     
|                                     
|                                     
|                                     
|Amortization of intangibles           |  |      | 6.4  |      |  |      | 3.8  |   |  |  | 5.1  |  
|                                     
|                                     
|                                     
|                                     
|State taxes, net of federal benefit   |  |      | 3.2  |      |  |      | 3.6  |   |  |  | 4.3  |  
|                                     
|                                     
|                                     
|                                     
|Tax exempt interest                   |  |      | (2.1 | )    |  |      | (1.3 | ) |  |  | (1.4 | )
|                                     
|                                     
|                                     
|                                     
|Impairment of non-deductible goodwill |  |      |     |      |  |      | 0.8  |   |  |  |     |  
|                                     
|                                     
|                                     
|                                     
|Disposition of subsidiaries           |  |      |     |      |  |      |     |   |  |  | 1.6  |  
|                                     
|                                     
|                                     
|                                     
|Other, net                            |  |      | 1.6  |      |  |      | 0.3  |   |  |  | 2.9  |  
|                                      |  |      |      |      |  |      |      |   |  |  |      |  
|Provision for income taxes            |  |      | 44.1 | %    |  |      | 42.2 | % |  |  | 47.5 | %
|                                      |  |      |      |      |  |      |      |   |  |  |      |  

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##### Table of Contents



8. Employee Benefit Plans

Savings and profit-sharing plans.Most of our employees may participate in our
savings and profit-sharing plan. Features of the plan in 2000 were as follows:



| |  | Participants could defer up to 15 percent of annual compensation;                                
|- |  | -------------------------------------------------------------------------------------------------
| 
| |  | We matched one-half of the deferral, up to three percent of annual compensation per employee; and
| 
| |  | We automatically contributed three percent of annual compensation per employee.                  

The plan authorizes us to contribute a discretionary amount to each employees
account, generally based on a percentage of pretax income. We did not
contribute a discretionary amount in 2000, but did in 1999 and 1998. Charges
to income for the plan were $19 million in 2000, $28 million in 1999 and $20
million in 1998.

Stock Incentive Plans.

Employee Plans. As of December 31, 2000, under the 2000 and 1996 Employee
Plans, we could grant officers and employees the following stock incentives:



| |  | Options to purchase shares of common stock at no less than 100 percent
of the market price on the date the options are granted;
|- |  | -------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Shares of vested or unvested common stock; and                                                                                 
| 
| |  | Stock appreciation rights.                                                                                                     

Stock options typically vest over four years in equal increments, and expire 10
years after the grant date. Awards under the Employee Plans are generally
subject to continuous employment. As of December 31, 2000, approximately 0.5
million shares were available for awards under the Employee Plans.

Premium Plan.In 1997 and 1998, we granted certain executives options to
purchase 2.6 million shares of our common stock under the Premium Plan.
One-half of these options vested in 1999 when the closing market price of our
common stock reached $92.50.
One million of the vested premium options were outstanding as of December 31,
2000, and will expire in 2007. The balance of the premium options, totaling
0.8 million outstanding as of December 31, 2000, vest if the closing market
price of our common stock reaches $114.00 by 2002. If these options vest, they
will expire in 2007. If they do not vest, they will expire in 2002. There are
no shares available for future awards under the Premium Plan. We recorded
compensation expense totaling $1 million when the options vested in 1999,
according to variable-plan accounting.

Director Plans.As of December 31, 2000 under the 2000 and 1996 Director
Plans, we could grant non-employee directors the following stock incentives:



| |  | Options to purchase 5,000 shares of common stock annually to members
of the board, at no less than 100 percent of the market price on the
date the options are granted;      
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Options to purchase 10,000 shares of common stock annually to the
Chairman of the Board, at no less than 100 percent of the market price
on the date the options are granted;
| 
| |  | Options to purchase 10,000 shares of common stock when new members are
elected or appointed to the board of directors; and                                                   
| 
| |  | Options to purchase shares of common stock on a discretionary basis.                                                                                                         

F-14



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##### Table of Contents



Stock options granted under the Director Plans vest immediately on the grant
date, but once the options are exercised, the associated common stock may not
be sold within six months after the grant date. As of December 31, 2000,
approximately 0.4 million shares were available for awards under the Director
Plans. All grants under the 2000 Director Plan are subject to stockholder
approval of the plan at the 2001 annual meeting of stockholders.

Our stock incentive plans provide for accelerated exercisability of plan awards
if certain events relating to a change of control, merger, sale of assets or
liquidation of PacifiCare were to occur.

Nonqualified stock option activity for all plans was as follows:

|                                           |  |         |            |                |  |                  |        |                |  |                  |           |  |  |   |       | 
|------------------------------------------ |  | ------- | ---------- | -------------- |  | ---------------- | ------ | -------------- |  | ---------------- | --------- |  |  | - | ----- | 
|                                           |  |         |            |                |  | Weighted Average |        | Options        |  | Weighted Average
|                                           |  | Options |            | Exercise Price |  | Exercisable      |        | Exercise Price
|                                           |  |         |            |                |  |                  |        |               
|Outstanding at December 31, 1997           |  |         | 5,902,506  |                |  | $                | 72.83  |                |  |                  | 1,502,760 |  |  | $ | 47.36 | 
|                                          
|                                          
|                                          
|                                          
|Granted at market price                    |  |         | 1,068,810  |                |  | $                | 77.76  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Granted in excess of market price          |  |         | 112,500    |                |  | $                | 92.50  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Granted in excess of market price          |  |         | 112,500    |                |  | $                | 114.00 |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Exercised                                  |  |         | (454,751   | )              |  | $                | 39.81  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Canceled                                   |  |         | (424,707   | )              |  | $                | 84.49  |                |  |                  |          |  |  | $ |      | 
|                                           |  |         |            |                |  |                  |        |                |  |                  |           |  |  |   |       | 
|Outstanding at December 31, 1998           |  |         | 6,316,858  |                |  | $                | 80.38  |                |  |                  | 1,532,079 |  |  | $ | 55.61 | 
|                                          
|                                          
|                                          
|                                          
|Granted at market price                    |  |         | 2,422,098  |                |  | $                | 58.96  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Exercised                                  |  |         | (395,031   | )              |  | $                | 54.88  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Canceled                                   |  |         | (602,285   | )              |  | $                | 87.76  |                |  |                  |          |  |  | $ |      | 
|                                           |  |         |            |                |  |                  |        |                |  |                  |           |  |  |   |       | 
|Outstanding at December 31, 1999           |  |         | 7,741,640  |                |  | $                | 74.41  |                |  |                  | 2,981,611 |  |  | $ | 72.89 | 
|                                          
|                                          
|                                          
|                                          
|Granted at market price                    |  |         | 3,026,498  |                |  | $                | 46.72  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Exercised                                  |  |         | (143,913   | )              |  | $                | 14.89  |                |  |                  |          |  |  | $ |      | 
|                                          
|                                          
|                                          
|                                          
|Canceled                                   |  |         | (1,709,637 | )              |  | $                | 74.86  |                |  |                  |          |  |  | $ |      | 
|                                           |  |         |            |                |  |                  |        |                |  |                  |           |  |  |   |       | 
|Outstanding
          at December 31, 2000 |  |         | 8,914,588  |                |  | $                | 65.88  |                |  |                  | 3,807,478 |  |  | $ | 72.55 | 
|                                           |  |         |            |                |  |                  |        |                |  |                  |           |  |  |   |       | 

The following is a summary of information about options outstanding
  and options exercisable at December 31, 2000:

|                         |  |                     |           |                     |  |                |    |             |  |                |        |  |  |          |           |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | -------------- | -- | ----------- |  | -------------- | ------ |  |  | -------- | --------- |  |  | - | ----- | 
|                         |  | Options Outstanding |           | Options Exercisable
|                         |  |                     |           |                    
|                         |  |                     |           |                     |  | Weighted       |    | Weighted    |  |                |        |  |  | Weighted
|                         |  | Number              |           | Average             |  | Average        |    | Number      |  | Average       
|Range of Exercise Prices |  | Outstanding         |           | Life (1)            |  | Exercise Price |    | Exercisable |  | Exercise Price
|                         |  |                     |           |                     |  |                |    |             |  |               
|$  10.06 - $19.75        |  |                     | 681,800   |                     |  |                | 10 |             |  | $              | 12.16  |  |  |          | 16,800    |  |  | $ | 19.04 | 
|                        
|                        
|                        
|                        
|$  31.34 - $46.03        |  |                     | 1,259,325 |                     |  |                | 8  |             |  | $              | 44.35  |  |  |          | 535,608   |  |  | $ | 43.30 | 
|                        
|                        
|                        
|                        
|$  48.85 - $73.00        |  |                     | 4,080,505 |                     |  |                | 8  |             |  | $              | 62.16  |  |  |          | 1,681,222 |  |  | $ | 67.43 | 
|                        
|                        
|                        
|                        
|$  74.63 - $92.50        |  |                     | 2,127,958 |                     |  |                | 7  |             |  | $              | 85.67  |  |  |          | 1,573,848 |  |  | $ | 88.55 | 
|                        
|                        
|                        
|                        
|$114.00                  |  |                     | 765,000   |                     |  |                | 7  |             |  | $              | 114.00 |  |  |          |          |  |  | $ |      | 
|                         |  |                     |           |                     |  |                |    |             |  |                |        |  |  |          |           | 
|                         |  |                     | 8,914,588 |                     |  |                |    |             |  |                |        |  |  |          | 3,807,478 | 
|                         |  |                     |           |                     |  |                |    |             |  |                |        |  |  |          |           | 



---

|
|

|(1) |  | Weighted average contractual life remaining
      in years.
|--- |  | -----------------------------------------------------------

Pro Forma Stock Option Disclosure.We used the Black-Scholes
  option pricing model to calculate the fair value of grants in the years presented
  below. We applied the following assumptions to determine pro forma compensation
  expense:

|                                                                |                                             |  |      |       |      |  |      |       |  |  |    |       | 
|--------------------------------------------------------------- | ------------------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- |  |  | -- | ----- | 
|                                                                |                                             |  | 2000 |       | 1999 |  | 1998
|                                                                |                                             |  |      |       |      |  |     
|Expected
          dividend yield                               |                                             |  | 0    | %     |      |  | 0    | %     |  |  | 0  | %    
|                                                               
|                                                               
|                                                               
|                                                               
|Risk-free
          interest rate                               |                                             |  | 6    | %     |      |  | 5    | %     |  |  | 6  | %    
|                                                               
|                                                               
|                                                               
|                                                               
|Expected
          stock price volatility                       |                                             |  | 64   | %     |      |  | 52   | %     |  |  | 45 | %    
|                                                               
|                                                               
|                                                               
|                                                               
|Expected
          term until exercise (years)                  |                                             |  | 2    |       |      |  | 2    |       |  |  | 2  |      
|                                                               
|                                                               
|                                                               
|                                                               
|Weighted
          average fair value of options on grant date:
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Granted
          at market prices          |  | $    | 27.86 |      |  | $    | 27.15 |  |  | $  | 30.92 | 
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Granted
          in excess of market price |  | $    |      |      |  | $    |      |  |  | $  | 29.76 | 

F-15



---



##### Table of Contents



We generally do not record compensation expense for stock option grants to
employees. The following table summarizes results as if we had recorded
compensation expense for the 2000, 1999 and 1998:

|                            |             |  |      |         |      |  |      |         |  |  |   |         | 
|--------------------------- | ----------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                            |             |  | 2000 |         | 1999 |  | 1998
|                            |             |  |      |         |      |  |     
|Net income:                
|                           
|                           
|                           
|                           
|                            | As reported |  | $    | 161,040 |      |  | $    | 278,544 |  |  | $ | 202,427 | 
|                           
|                           
|                           
|                           
|                            | Pro forma   |  | $    | 135,098 |      |  | $    | 246,113 |  |  | $ | 168,382 | 
|                           
|                           
|                           
|                           
|Basic earnings per share:  
|                           
|                           
|                           
|                           
|                            | As reported |  | $    | 4.59    |      |  | $    | 6.26    |  |  | $ | 4.50    | 
|                           
|                           
|                           
|                           
|                            | Pro forma   |  | $    | 3.85    |      |  | $    | 5.53    |  |  | $ | 3.85    | 
|                           
|                           
|                           
|                           
|Diluted earnings per share:
|                           
|                           
|                           
|                           
|                            | As reported |  | $    | 4.58    |      |  | $    | 6.23    |  |  | $ | 4.40    | 
|                           
|                           
|                           
|                           
|                            | Pro forma   |  | $    | 3.84    |      |  | $    | 5.50    |  |  | $ | 3.66    | 

These figures reflect only the impact of grants since October 1, 1995, and
reflect only part of the possible compensation expense that we amortize over
the vesting period of the grants (generally up to four years). Therefore, the
effect on net income and earnings per share may differ in future years from the
amounts shown above.

F-16



---



##### Table of Contents



9. Impairment, Disposition, Restructuring, Office of Personnel Management and Other Charges (Credits)

We recognized net pretax charges (credits) in 2000, 1999 and 1998 as follows:

|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |       |  
|---------------------------------------------------------------------- | --------------------------------------------------------------------------------- |  | -------------------------------------------- | ------------ | -------------- | - | ---------- | ---- | -------------------- | - | ---- | ---- | - | - | ----- | ----- | -
|                                                                       |                                                                                   |  | Quarter                                      |              | Pretax Charges |   | Net-of-Tax |      | Diluted Loss        
|                                                                       |                                                                                   |  | Recognized                                   |              | (Credits)      |   | Amount     |      | (Earnings) per Share
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                     
|                                                                       |                                                                                   |  | (amounts in millions, except per share data)
|2000                                                                  
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Restructuring charge                                                   |                                                                                   |  | First                                        |              |                | $ | 9.0        |      |                      | $ | 5.2  |      |   | $ | 0.14  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Other changes in estimates                                             |                                                                                   |  | First                                        |              |                |   | (3.4       | )    |                      |   | (2.0 | )    |   |   | (0.05 | )    
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|OPM credits                                                            |                                                                                   |  | First                                        |              |                |   | (3.0       | )    |                      |   | (1.7 | )    |   |   | (0.05 | )    
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total impairment, disposition,
restructuring, OPM and other charges               |  |                                              | Total First  |                |   |            | 2.6  |                      |   |      | 1.5  |   |   |       | 0.04  |  
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                      
|Loss on disposition of Ohio HMO                                        |                                                                                   |  | Second                                       |              |                |   | 3.8        |      |                      |   | 2.2  |      |   |   | 0.06  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Restructuring change in estimate                                       |                                                                                   |  | Second                                       |              |                |   | (1.0       | )    |                      |   | (0.6 | )    |   |   | (0.01 | )    
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total impairment, disposition,
restructuring and other charges                    |  |                                              | Total Second |                |   |            | 2.8  |                      |   |      | 1.6  |   |   |       | 0.05  |  
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                      
|Gain from license termination agreement                                |                                                                                   |  | Third                                        |              |                |   | (6.9       | )    |                      |   | (3.8 | )    |   |   | (0.11 | )    
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Loss on disposition of Ohio HMO                                        |                                                                                   |  | Third                                        |              |                |   | 0.5        |      |                      |   | 0.2  |      |   |   | 0.01  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Restructuring change in estimate                                       |                                                                                   |  | Third                                        |              |                |   | (0.4       | )    |                      |   | (0.2 | )    |   |   | (0.01 | )    
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total impairment, disposition,
restructuring and other credits                    |  |                                              | Total Third  |                |   |            | (6.8 | )                    |   |      | (3.8 | ) |   |       | (0.11 | )
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                      
|Restructuring charge                                                   |                                                                                   |  | Fourth                                       |              |                |   | 15.2       |      |                      |   | 8.5  |      |   |   | 0.25  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Gain from contract termination agreement                               |                                                                                   |  | Fourth                                       |              |                |   | (4.4       | )    |                      |   | (2.5 | )    |   |   | (0.07 | )    
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Restructuring change in estimate                                       |                                                                                   |  | Fourth                                       |              |                |   | (0.6       | )    |                      |   | (0.3 | )    |   |   | (0.01 | )    
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total impairment, disposition,
restructuring and other charges                    |  |                                              | Total Fourth |                |   |            | 10.2 |                      |   |      | 5.7  |   |   |       | 0.17  |  
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total net 2000 impairment, disposition,
restructuring, OPM and other charges      |  |                                              |              |                |   | $          | 8.8  |                      |   | $    | 5.0  |   |   | $     | 0.15  |  
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|1999                                                                  
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Ohio HMO goodwill impairment                                           |                                                                                   |  | Third                                        |              |                | $ | 14.1       |      |                      | $ | 11.3 |      |   | $ | 0.25  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Utah HMO disposition changes in estimates                              |                                                                                   |  | Third                                        |              |                |   | (10.7      | )    |                      |   | (6.3 | )    |   |   | (0.14 | )    
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Other disposition changes in estimates                                 |                                                                                   |  | Third                                        |              |                |   | (5.6       | )    |                      |   | (3.3 | )    |   |   | (0.07 | )    
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total net 1999 impairment, disposition,
restructuring and other charges (credits) |  |                                              |              |                |   | $          | (2.2 | )                    |   | $    | 1.7  |   |   | $     | 0.04  |  
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|1998                                                                  
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|Loss on disposition of Utah HMO and workers
compensation subsidiaries |                                                                                   |  | Third                                        |              |                | $ | 15.6       |      |                      | $ | 8.2  |      |   | $ | 0.18  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|OPM charges                                                            |                                                                                   |  | Third                                        |              |                |   | 3.8        |      |                      |   | 2.0  |      |   |   | 0.04  |      
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       |                                                                                   |  | Total Third                                  |              |                |   | 19.4       |      |                      |   | 10.2 |      |   |   | 0.22  |      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|                                                                      
|OPM credits                                                            |                                                                                   |  | Total Fourth                                 |              |                |   | (8.4       | )    |                      |   | (4.4 | )    |   |   | (0.10 | )    
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      
|                                                                       | Total net 1998 impairment, disposition,
restructuring, OPM and other charges      |  |                                              |              |                |   | $          | 11.0 |                      |   | $    | 5.8  |   |   | $     | 0.12  |  
|                                                                       |                                                                                   |  |                                              |              |                |   |            |      |                      |   |      |      |   |   |       |      

F-17



---



##### Table of Contents



2000.We recognized net pretax charges of $9 million as described below.



| |  | Gain from contract termination agreement.In the fourth quarter, we
recognized other credits of $4 million for a gain from a contract
termination agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Gain from license termination agreement.In the third quarter, we
recognized other credits of $7 million for a gain from a license
termination agreement relating to our subsidiary, Secure Horizons USA,
Inc. This gain was a result of an early termination of the license
agreement between Presbyterian Healthcare Services, Inc. and Secure
Horizons USA, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| 
| |  | Loss on Disposition of Ohio HMO.In the second quarter, we recognized
disposition charges of $4 million to exit our Ohio HMO operations.
The charge included severance and legal costs. In the third quarter,
we recognized additional disposition charges of $0.5 million as a
result of changes in estimated legal costs. See Note 4, Acquisitions
and Dispositions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| 
| |  | Other Changes in Estimates.In the first quarter, we recognized other
credits for changes in estimates of $3 million. We successfully
settled certain contingencies related to acquisitions and dispositions
in 1997 and 1998 including pending and threatened litigation, as well
as indemnifications made to the buyers of sold subsidiaries.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| 
| |  | OPM Credits.In the first quarter, we recognized OPM credits of $3
million as a result of Oklahoma HMO premiums received from rate
reconciliations re-filed for years 1996 and 1997.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| 
| |  | Restructuring Charges.In January 2000, we announced a plan to
strengthen our operations and improve our competitive advantage and
growth opportunities. In connection with this plan, we recognized
restructuring charges of $9 million in the first quarter of 2000. The
restructuring charge included severance and related employee benefits
for approximately 270 employees whose positions were eliminated by
December 31, 2000. The majority of the terminations were in the sales
and marketing and human resources departments where the corporate and
regional functions were centralized and consolidated. We recognized a
credit for a change in estimate of $1 million in the second quarter
and $0.4 million in the third quarter. This was as a result of
employees who accepted other positions within the company and
employees who resigned. During the fourth quarter, we recognized a
credit for a change in the restructuring estimate of $0.6 million,
primarily as a result of outplacement services that terminated
employees did not use. We paid approximately $1 million to terminated
employees during the quarter ended December 31, 2000.



| |                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Approximately $2 million of the January 2000 restructuring balance will be
paid by the end of 2001, and the remainder will be paid in 2002. We plan to
use cash flows from operations to fund the restructuring payments. We
realized net annualized marketing, general and administrative salary savings
of approximately $11 million from the centralization and consolidation of
corporate and regional functions.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In December 2000 we announced plans to further streamline our operations to
enhance cost efficiency. In connection with this plan, we recognized
restructuring charges of $15 million in the fourth quarter. Approximately
$11 million of the restructuring charge was for severance and related
employee benefits for approximately 500 employees whose positions will be
eliminated by August 2001. More than half of the reductions are related to
sales and marketing positions, primarily for the Medicare+Choice program,
resulting from our decision to limit new enrollment for 2001 in approximately
40 percent of our Medicare markets due to rising health care costs and
insufficient federal funding. The remaining reductions affected many areas
throughout the regions and our corporate headquarters. The other $4 million
of the restructuring charge related to lease terminations for excess office
space.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The elimination of positions began January 2, 2001, therefore no payments
were made during 2000. We expect that approximately $10 million of the
restructuring charge will be paid by the end of 2001, and the remainder will
be paid in 2002. Cash flows from operations are expected to fund the
restructuring charge. We expect net annual marketing, general and
administrative salary savings of approximately $27 million (unaudited) as a
result of streamlining our operations.

F-18



---



##### Table of Contents



The following table presents the activity for the year ended December 31, 2000:

|                             |                                     |                                   |      |                       |      |          |      |          |   |                   |      |            |   |            |      |      |      | 
|---------------------------- | ----------------------------------- | --------------------------------- | ---- | --------------------- | ---- | -------- | ---- | -------- | - | ----------------- | ---- | ---------- | - | ---------- | ---- | ---- | ---- | 
|                             |                                     |                                   |      |                       |      |          |      |          |   |                   |      | Changes in |   | Balance at
|                             |                                     |                                   |      | Pretax Charge         |      | Payments |      | Estimate |   | December 31, 2000
|                             |                                     |                                   |      |                       |      |          |      |          |   |                  
|                             |                                     |                                   |      | (amounts in millions)
|January 2000 restructuring: 
|                            
|                            
|                            
|                            
|                             | Severance and separation benefits   |                                   | $    | 9.0                   |      |          | $    | (4.7     | ) |                   | $    | (2.0       | ) |            | $    | 2.3  |     
|                             |                                     |                                   |      |                       |      |          |      |          |   |                   |      |            |   |            |      |     
|December 2000 restructuring:
|                            
|                            
|                            
|                            
|                             | Severance and separation benefits   |                                   |      | 11.0                  |      |          |      |         |   |                   |      |           |   |            |      | 11.0 |     
|                            
|                            
|                            
|                            
|                             | Lease cancellations and commitments |                                   |      | 4.2                   |      |          |      |         |   |                   |      |           |   |            |      | 4.2  |     
|                             |                                     |                                   |      |                       |      |          |      |          |   |                   |      |            |   |            |      |     
|                             |                                     | Total
December 2000 restructuring |      |                       | 15.2 |          |      |          |  |                   |      |            |  |            |      |      | 15.2 | 
|                             |                                     |                                   |      |                       |      |          |      |          |   |                   |      |            |   |            |      |     
|Total restructuring          |                                     | $                                 | 24.2 |                       |      | $        | (4.7 | )        |   | $                 | (2.0 | )          |   | $          | 17.5 |     
|                             |                                     |                                   |      |                       |      |          |      |          |   |                   |      |            |   |            |      |     

1999.We recognized net pretax credits of $2 million as described below.



| |  | Ohio HMO Goodwill Impairment.We recognized $14 million of Ohio HMO
goodwill impairment charges. Third quarter operating losses, provider
contract terminations and a lower membership base did not support the
recoverability of goodwill. The majority of the impairment was not
deductible for income tax purposes.                                                                                                                                                                                                                                      
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Utah HMO Disposition Changes in Estimates.We recognized $11 million
of disposition credits. When we sold our Utah HMO, we retained
responsibility for all medical claims and benefits payable for
services rendered through September 30, 1998. Payments made through
September 30, 1999, plus our current estimate of claims incurred but
not reported, were $7 million less than original reserves existing at
disposition. In addition, $4 million of severance, legal, and
receivable reserves were settled for amounts less than originally
estimated.
| 
| |  | Other Disposition Changes in Estimates.We recognized $6 million of
other disposition credits for changes in estimates. We have or expect
to successfully settle certain contingencies related to other
dispositions from 1996 to 1998. Contingencies include pending and
threatened litigation as well as indemnifications made to the buyers
of sold subsidiaries.                                                                                                                                                                                        

1998.We recognized net pretax charges of $11 million as described below.



| |  | Loss on Dispositions.We recognized $16 million of disposition
charges with the sales of our Utah HMO and workers compensation
subsidiaries. See Note 4, Acquisitions and Dispositions.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | OPM Charges and Credits.Partially offsetting the disposition charges
were net OPM credits of $5 million. See Note 10, Commitments and
Contingencies.                                   

10. Commitments and Contingencies

Physician Instability and Insolvency.Our insolvency reserves include
write-offs of certain uncollectable receivables from our physicians and the
estimated cost of unpaid health care claims normally covered by our capitation
payments. Depending on state law, we may be held liable for unpaid health care
claims that were previously the responsibility of the capitated physician and
for which we have already paid capitation. The balance of our insolvency
reserves included in medical claims and benefit payable was $34 million at
December 31, 2000 and $46 million at December 31, 1999. Our insolvency
reserves relate to specific physicians. These reserves include estimates for
potentially insolvent physicians, where conditions indicate claims are not
being paid or have slowed considerably. Based on information currently
available, we believe that any liability in excess of amounts accrued would not
materially affect our consolidated financial position. However, our evaluation
of the likely impact of claims asserted against us could change in the future
and an unfavorable outcome, depending on the amount and timing, could have a
material effect on our results of operations or cash flows for a future period.



| |  | KPC Medical Management.In the second quarter of 2000, we, along with
other HMOs loaned approximately $12 million to KPC Medical Management,
Inc. (KPC), a purchaser of some of the MedPartners Network practices, and Chaudhuri
Medical Corporation, an affiliate of KPC. Our portion of the loan was
approximately $3 million. The principal and interest of the loan are
guaranteed by Caremark Rx, Inc.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-19



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In the third quarter of 2000, we, along with six other HMOs loaned
approximately $30 million to real estate entities affiliated with KPC. Our
portion of this loan was approximately $10 million. A portion of each plans
loan was used to pay outstanding physician and hospital claims for its
members and operating expenses of certain KPC medical entities. In November
2000, KPC and its medical affiliates filed for reorganization under Chapter
11 of the bankruptcy code.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because we believed that KPC was in uncertain financial condition, we fully
reserved both loans in the quarter each loan was made. KPC is in the process
of liquidating its assets through the Chapter 11 bankruptcy protection. We
are monitoring KPCs bankruptcy as well as the financial condition of the KPC
real estate entities. KPC has asserted claims against us, but has not yet
quantified these claims. As a result, we cannot be certain that our loans
are the extent of our exposure. We believe that any ultimate insolvency
liability would not materially affect our consolidated financial position.
However, our evaluation of the likely impact of claims asserted against us
could change in the future and an unfavorable outcome, depending on the
amount and timing, could have a material effect on our results of operations
or cash flows for a future period.



| |  | MedPartners Network.The California Department of Managed Health Care
(DMHC; a newly created department assuming the managed care regulatory
authority of the Department of Corporations) entered into a settlement
with Alabama-based Caremark Rx, Inc. (Caremark; formerly MedPartners,
Inc.) regarding its California subsidiary, MedPartners Network (MPN).
MPN was a provider organization licensed by the DMHC that arranged health
care services for HMO members through arrangements between HMOs and
hospitals and physician groups. MPN was one of our significant networks
in California. In March 1999, California regulators seized MPN and
appointed a conservator to oversee MPN. The conservator placed MPN in
bankruptcy.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In June 1999, the State of California, the DMHC, MPN and Caremark entered
into an Operations and Settlement Agreement to ensure continuing patient care
and to resolve certain claims by and against MPN and Caremark. We agreed to
participate in the agreement, which required us to waive or subordinate
certain claims against MPN in exchange for waivers of claims against us in
connection with services provided by MPN or its affiliates in California.
MPN ceased doing business and all of MPNs affiliated medical groups in
California were sold.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In connection with the MPN bankruptcy, we asserted claims against MPN for
amounts owed by MPN. In September 2000, the MPN Chapter 11 Plan of
Reorganization was confirmed by the bankruptcy court. As a result, we
received $2 million in approved claims payments and additional claims
payments of $5 million from a third party. Because these negotiations were
not successfully completed by December 15, 2000, we received an additional $4
million in approved claims directly from MPN.

OPM and Related Litigation.

General.Our HMO subsidiaries have commercial contracts with OPM to provide
managed health care services to federal employees, annuitants and their
dependents under the FEHBP. Rather than negotiating rates with HMOs, OPM
requires HMOs to provide the FEHBP with rates comparable to the rates charged
to the two employer groups with enrollment closest in size to the FEHBP in the
applicable community after making required adjustments. OPM further requires
that every HMO certify each year that its rates meet these requirements.

Periodically, OPMs Office of Inspector General (OIG) audits each HMO to
verify that the premiums charged are calculated and charged in compliance with
these regulations and guidelines. Each audit encompasses a period of up to six
years. Following the governments initial on-site audit, OPM will provide the
HMO with a post-audit briefing indicating its preliminary results.
Interpretations of the rating regulations and audit findings often raise
complex issues. The final resolution and settlement of audits have
historically taken more than three years and as many as seven years.
We have a number of pending audits that we are seeking to resolve
with the United States Department of Justice ("DOJ").

During the audit process, OPM may refer its findings to the DOJ if it believes that the health plan knowingly
overcharged the government or otherwise submitted false documentation or
certifications in violation of the False Claims Act. Under the False Claims
Act, an action can be considered knowingly committed if the government
contractor acted with actual knowledge, or with reckless disregard or
deliberate ignorance of the governments rules and regulations. If the
government were to win a False Claims Act lawsuit against an HMO, the
government could obtain trebled damages, a civil penalty of not less than
$5,000 nor more than $10,000 for each separate alleged false claim, and the
government could permanently disqualify the HMO from participating in all
federal government programs.

In late 1997, we established a formal corporate compliance program to
specifically address potential issues that may arise from the FEHBP rating
process, to work with OPM to understand its interpretation of the rules and
guidelines prior to completion of the rating

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##### Table of Contents



process, to standardize the FEHBP
rating process among all of our HMOs, and to help reduce the likelihood that
future government audits will result in any significant findings. Based upon
the results of a limited number of audits that have been conducted for contract
years 1998 and later, we believe that this program has been effective.

OPM Litigation.We have contracts that were audited by the OIG, that we
acquired through our merger with FHP International Corporation (FHP) in 1997.
The OIG is alleging that the former FHP Arizona, California, Colorado, Guam
and Ohio HMO subsidiaries as well as former FHP Illinois, New Mexico and Utah
HMO subsidiaries that we sold in 1997 and 1998, overcharged the government from
1990 through 1997. Several of these contract years have already been audited,
but are yet to be settled. We responded to the audit reports, challenging
many of the auditors assertions. OIGs allegations were referred to the DOJ
for review of potential claims under the False Claims Act. We do not believe
there is any evidence that we engaged in any action that would violate
the False Claims Act.

The OIG conducted an audit of our Oregon HMO subsidiary. The OIG issued a
draft audit report in July 1997, alleging that we overcharged the government
for contract years 1991 through 1996. We responded to this draft audit report
in April 1998, strongly disagreeing with OIGs claims. In March 2000, we were
notified that the auditors had referred the above-mentioned audit report to the
DOJ for review of potential claims under the False Claims Act. We do not
believe there is any evidence that we engaged in any action that would
violate the False Claims Act. When our legal counsel met with the U.S.
Attorney in May 2000, the U.S. Attorney stated that a letter would be sent
specifying additional information that was needed. No letter has been received
to date. The DOJ has until June 1, 2001 to decide whether to file a claim.

The OIG conducted an audit of our California HMO subsidiary. The OIG issued a
draft audit report in January 1998, alleging that we overcharged the government
for contract years 1993 through 1996. We responded to this draft audit report
in May 1998, strongly disagreeing with OIGs claims. In January 2001, we were
notified that the auditors had referred the above-mentioned audit report to the
DOJ for review of potential claims under the False Claims Act. We do not
believe there is any evidence that we engaged in any action that would
violate the False Claims Act.

We intend to continue to negotiate with OPM on any existing or future
unresolved matters to attain a mutually satisfactorily result. We cannot be
certain that any ongoing future negotiations will be concluded satisfactorily,
that additional audits will not be referred to the DOJ or that additional,
possibly material, liabilities will not be incurred. Such liability could have
a material effect on our results of operations or cash flows of a future period
if resolved unfavorably.

Class Action Legal Proceedings.On November 21, 2000, Michael Russ filed a
purported class action complaint against PacifiCare and several of our present
and former directors and executive officers in the Central District of
California. At least four other complaints have been filed against PacifiCare
and several present and former directors and executive officers in the same
court. Each of these complaints relates to the same subject matter and will
likely be consolidated. The complaints relate to the period between October
27, 1999 and October 10, 2000. The complaints primarily allege that we made
false projections about our financial performance in 2000. We deny all
material allegations and intend to defend the actions vigorously.

On November 2, 1999, Jose Cruz filed a purported class action complaint against
PacifiCare, our California subsidiary, and FHP in the
San Francisco Superior Court. On November 9, 1999, Cruz filed a first amended
purported class action complaint that omitted FHP as a defendant. The amended
complaint relates to the period from November 2, 1995 to the present and
purports to be filed on behalf of all enrollees in our health care plans
operating in California other than Medicare and Medicaid enrollees. The
amended complaint alleges that we have engaged in unfair business acts in
violation of California law, engaged in false, deceptive and misleading
advertising in violation of California law and violated the California Consumer
Legal Remedies Act. It also alleges that we have received unjust payments as a
result of our conduct. The amended complaint seeks injunctive and declaratory
relief, an order requiring the defendants to inform and warn all California
consumers regarding our financial compensation programs, unspecified monetary
damages for restitution of premiums and disgorgement of improper profits,
attorneys fees and interest. We moved to compel arbitration and the court
denied our motion. We have filed an appeal on this denial and deny all
material allegations in the amended complaint and intend to defend the action
vigorously.

On November 22, 1999, Debbie Hitsman filed a purported class action complaint
against PacifiCare in the United States District Court for the Southern
District of Mississippi, Hattiesburg Division. The complaint relates to the
period from November 22, 1995 to the present and purports to be on behalf of
all enrollees in our health care plans other than Medicare and Medicaid
enrollees. The complaint alleges causes of action for violations of the
Racketeer-Influenced and Corrupt Organizations Act and Employee Retirement
Income Security Act of 1974 (ERISA). The complaint seeks an unspecified
amount of compensatory and treble damages, injunctive and restitutionary
relief, attorneys fees, the imposition of a constructive trust and interest.
On June 23, 2000,

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Hitsman filed and served an additional complaint in the
United States District Court for the Southern District of Miami as a purported
part of a multi-district litigation proceeding against another managed care
company, Humana. Subsequently, Dr. Dennis Breen and other doctors joined the
Florida proceeding making allegations similar to those from other providers.
These providers, including the California Medical Association, accuse us of
imposing unfair contract terms, unnecessarily denying health care for our
members, delaying payments for authorized health care and reimbursing
physicians at rates that are not sufficient to cover the physicians cost of
providing the health care.

In October 2000, the multi-district litigation panel consolidated the Hitsman
cases, the Breen case, the California Medical Association case and certain
provider cases in the Southern District of Florida. In December 2000, the
court granted our motion to compel arbitration of all of the Hitsman claims and
all of Dr. Breens claims except for his claims for violations of the
Racketeer-Influenced and Corrupt Organizations Act and conspiracy and aiding
and abetting claims that stem from contractual relationships with other managed
care companies. We have appealed the denial of the arbitration of these
claims. Our motion to dismiss the Breen claims was granted, with
permission to amend. An amended complaint is anticipated. We deny all
material allegations and intend to defend the actions vigorously.

In 1997, William Madruga and another individual filed a purported class action
suit against PacifiCare and several of our directors and officers in the United
States District Court for the Central District of California. The complaint
relates to the period from the date of proxy statement for the FHP acquisition
through our November 1997 announcement that earnings for the fourth quarter of
1997 would be lower than expected. The complaint primarily alleges that we
previously omitted and/or misrepresented material facts with respect to our
costs, earnings and profits. In November 1999, May 2000, and again in January
2001, the court dismissed the Madruga case in part without permission to amend
and in part with permission to amend the complaint. The plaintiffs filed a
fourth amended complaint in March 2001. We deny all material allegations and
intend to defend the actions vigorously.

Industry Litigation.In 2000, Aetna U.S. Healthcare, Inc. and affiliated
entities (Aetna) settled claims brought by the Attorney General of Texas by
consenting to modify some of its business practices in Texas. The Attorney
General of Texas has filed similar claims against our Texas HMO and has
proposed to settle the lawsuit on the same terms as the Aetna settlement. The
business practices in question relate primarily to our Texas HMOs commercial
operations. Resolution of a proposed settlement is still pending. We are
unable to predict whether we will ultimately reach a settlement with the
Attorney General on these or other terms or the impact that the ultimate
settlement could have on our operations. These changes ultimately could
adversely affect the HMO industry and could have a material effect on our
financial position, results of operations or cash flows of a future period.

We are involved in legal actions in the normal course of business, some of
which seek monetary damages, including claims for punitive damages which are
not covered by insurance. Based on current information and review, including
consultation with our lawyers, we believe any ultimate liability that may arise
from these actions (including all OPM and related litigation, class action
legal proceedings and industry litigation) would not materially affect our
consolidated financial position, results of operations or cash flows. However,
our evaluation of the likely impact of these actions could change in the future
and an unfavorable outcome, depending upon the amount and timing, could have a
material effect on our results of operations or cash flows of a future period.

Lease Commitments.We lease office space and equipment under various
non-cancelable operating leases. Rental expense totaled
$62 million in 2000, $55 million in 1999 and $59 million in 1998. Future
minimum lease payments will be $58 million in 2001, $43 million in 2002, $30
million in 2003, $24 million in 2004 and $18 million in 2005. Minimum lease
payments after 2005 will be $35 million.

In 1997, we entered into a real estate and equipment master transfer agreement
that allows us to lease, sublease or assign certain facilities and equipment
that we own or lease. At December 31, 2000 all of the equipment and a portion
of the real estate covered by the master transfer agreement had been sold. The
net book value of the remaining real estate was approximately $13 million at
December 31, 2000 and $18 million at December 31, 1999. The leases are
accounted for as operating leases, and subleases are accounted for as rental
income. The agreement includes extensions of the individual leases to December
31, 2005, and two five-year extension options at prevailing market rates.
These options are exercisable solely at the lessees discretion.

Employment Agreements.We have employment agreements with our chief executive
officer and certain other executives. The agreements entitle these executives
to receive severance benefits, payable if employment is terminated for various
reasons, including termination following a change of control of PacifiCare.
The maximum severance amount we would owe these executives according to their
employment agreements (excluding amounts that may be payable under incentive
plans and the value of certain other benefits) was approximately $55 million at
December 31, 2000.

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11. Comprehensive Income

The following tables summarize the components of other comprehensive income
(loss) for the periods indicated:

|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  
|----------------------------------------------------------------------- |  | ---------------------- | ------- | --------- |  | ------ | ------- | ------- |  | - | ------- | -
|                                                                        |  |                        |         |           |  | Income
|                                                                        |  |                        |         |           |  | Tax    |         | Net-of-
|                                                                        |  | Pretax                 |         | Expense   |  | Tax   
|                                                                        |  | Amount                 |         | (Benefit) |  | Amount
|                                                                        |  |                        |         |           |  |       
|                                                                        |  | (amounts in thousands)
|2000:                                                                  
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Unrealized holding gains arising during the period                      |  | $                      | 34,700  |           |  | $      | 13,423  |         |  | $ | 21,277  |  
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Less: reclassification adjustment for net losses realized in net income |  |                        | 235     |           |  |        | 91      |         |  |   | 144     |  
|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  
|Other comprehensive income                                              |  | $                      | 34,935  |           |  | $      | 13,514  |         |  | $ | 21,421  |  
|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  
|1999:                                                                  
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Unrealized holding losses arising during the period                     |  | $                      | (50,739 | )         |  | $      | (19,591 | )       |  | $ | (31,148 | )
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Less: reclassification adjustment for net gains realized in net income  |  |                        | (988    | )         |  |        | (381    | )       |  |   | (607    | )
|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  
|Other comprehensive loss                                                |  | $                      | (51,727 | )         |  | $      | (19,972 | )       |  | $ | (31,755 | )
|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  
|1998:                                                                  
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Unrealized holding gains arising during the period                      |  | $                      | 12,766  |           |  | $      | 5,538   |         |  | $ | 7,228   |  
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Less: reclassification adjustment for net gains realized in net income  |  |                        | (17,418 | )         |  |        | (7,556  | )       |  |   | (9,862  | )
|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  
|Other comprehensive loss                                                |  | $                      | (4,652  | )         |  | $      | (2,018  | )       |  | $ | (2,634  | )
|                                                                        |  |                        |         |           |  |        |         |         |  |   |         |  

12. Subsequent Events

On February 9, 2001, we announced an agreement with UniHealth Foundation,
whereby UniHealth Foundation agreed to waive its right to sell 909,500 shares
of our common stock back to us. In exchange for this waiver, we agreed not to
exercise our right of first refusal to acquire up to 1 million shares of our
common stock.

On March 8, 2001, we announced an agreement with UniHealth Foundation. This
agreement allows UniHealth Foundation to sell its remaining 3.5 million shares
of our common stock on the open market through June 15, 2001.
See Note 6,
Stockholders Equity.

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##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
PacifiCare Health Systems, Inc.

We have audited the accompanying consolidated balance sheets of PacifiCare
Health Systems, Inc. (the Company) as of December 31, 2000, and 1999 and the
related consolidated statements of operations, stockholders equity and cash
flows for each of the three years in the period ended December 31, 2000. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a)(2). These consolidated financial statements and schedule are the
responsibility of the Companys management. Our responsibility is to express
an opinion on these consolidated financial statements and schedule based on our
audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
PacifiCare Health Systems, Inc. at December 31, 2000 and 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 2000 in conformity with accounting
principles generally accepted in the United States. Also in our opinion, the
related financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.



| | ERNST & YOUNG LLP
| | -----------------

Irvine, California
January 31, 2001,
        Except for Note 12, as to which the date is
        March 8, 2001

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PACIFICARE HEALTH SYSTEMS, INC.

QUARTERLY INFORMATION FOR 2000 AND 1999 (UNAUDITED)

|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|-------------------------------------------- |  | --------------------------------------------- | --------- | ------- |  | ------------ | --------- | ----------- |  | - | --------- | - |  | - | --------- | -
|                                             |  | Quarters Ended                               
|                                             |  |                                              
|                                             |  | March 31                                      |           | June 30 |  | September 30 |           | December 31
|                                             |  |                                               |           |         |  |              |           |            
|                                             |  | (amounts in thousands, except per share data)
|2000 (1)                                    
|                                            
|                                            
|                                            
|                                            
|Operating revenue                            |  | $                                             | 2,802,663 |         |  | $            | 2,854,183 |             |  | $ | 2,867,921 |   |  | $ | 2,943,160 |  
|                                            
|                                            
|                                            
|                                            
|Operating expenses                           |  |                                               | 2,679,350 |         |  |              | 2,739,582 |             |  |   | 2,857,859 |   |  |   | 2,932,422 |  
|                                            
|                                            
|                                            
|                                            
|Net investment income                        |  |                                               | 25,108    |         |  |              | 24,404    |             |  |   | 28,443    |   |  |   | 30,416    |  
|                                            
|                                            
|                                            
|                                            
|Interest expense                             |  |                                               | (20,182   | )       |  |              | (20,250   | )           |  |   | (19,252   | ) |  |   | (19,952   | )
|                                            
|                                            
|                                            
|                                            
|Minority interest in consolidated subsidiary |  |                                               |          |         |  |              | 131       |             |  |   | 252       |   |  |   | 254       |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Income before income taxes                   |  |                                               | 128,239   |         |  |              | 118,886   |             |  |   | 19,505    |   |  |   | 21,456    |  
|                                            
|                                            
|                                            
|                                            
|Provision for income taxes                   |  |                                               | 53,604    |         |  |              | 49,694    |             |  |   | 14,286    |   |  |   | 9,462     |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Net income                                   |  | $                                             | 74,635    |         |  | $            | 69,192    |             |  | $ | 5,219     |   |  | $ | 11,994    |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Basic earnings per share                     |  | $                                             | 2.04      |         |  | $            | 1.97      |             |  | $ | 0.15      |   |  | $ | 0.35      |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Diluted earnings per share                   |  | $                                             | 2.04      |         |  | $            | 1.96      |             |  | $ | 0.15      |   |  | $ | 0.35      |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|HMO Membership (3)                           |  |                                               | 4,005     |         |  |              | 3,991     |             |  |   | 4,016     |   |  |   | 4,010     |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|1999 (2)                                    
|                                            
|                                            
|                                            
|                                            
|Operating revenue                            |  | $                                             | 2,451,909 |         |  | $            | 2,454,747 |             |  | $ | 2,517,917 |   |  | $ | 2,564,517 |  
|                                            
|                                            
|                                            
|                                            
|Operating expenses                           |  |                                               | 2,335,563 |         |  |              | 2,347,900 |             |  |   | 2,405,181 |   |  |   | 2,459,586 |  
|                                            
|                                            
|                                            
|                                            
|Net investment income                        |  |                                               | 20,201    |         |  |              | 20,242    |             |  |   | 20,304    |   |  |   | 23,303    |  
|                                            
|                                            
|                                            
|                                            
|Interest expense                             |  |                                               | (10,293   | )       |  |              | (9,512    | )           |  |   | (9,742    | ) |  |   | (13,454   | )
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Income before income taxes                   |  |                                               | 126,254   |         |  |              | 117,577   |             |  |   | 123,298   |   |  |   | 114,780   |  
|                                            
|                                            
|                                            
|                                            
|Provision for income taxes                   |  |                                               | 52,270    |         |  |              | 48,676    |             |  |   | 54,041    |   |  |   | 48,378    |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Net income                                   |  | $                                             | 73,984    |         |  | $            | 68,901    |             |  | $ | 69,257    |   |  | $ | 66,402    |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Basic earnings per share                     |  | $                                             | 1.62      |         |  | $            | 1.50      |             |  | $ | 1.54      |   |  | $ | 1.60      |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|Diluted earnings per share                   |  | $                                             | 1.61      |         |  | $            | 1.49      |             |  | $ | 1.54      |   |  | $ | 1.59      |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  
|HMO Membership (3)                           |  |                                               | 3,585     |         |  |              | 3,577     |             |  |   | 3,660     |   |  |   | 3,658     |  
|                                             |  |                                               |           |         |  |              |           |             |  |   |           |   |  |   |           |  



---

|   
|---
|(1)
|   
|   
|   
|   
|   
|(2)
|   
|   
|   
|   
|   
|(3)

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PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS
(amounts in thousands)

|                                 |                       |                                            |   |                   |        |                   |   |                   |       |  |   |        |        |  
|-------------------------------- | --------------------- | ------------------------------------------ | - | ----------------- | ------ | ----------------- | - | ----------------- | ----- |  | - | ------ | ------ | -
|                                 |                       |                                            |   | Year Ended        |        | Year Ended        |   | Year Ended       
|                                 |                       |                                            |   | December 31, 2000 |        | December 31, 1999 |   | December 31, 1998
|                                 |                       |                                            |   |                   |        |                   |   |                  
|Allowance for doubtful accounts:
|                                
|                                
|                                
|                                
|                                 | Beginning balance     |                                            | $ | 11,173            |        |                   | $ | 8,529             |       |  | $ | 13,598 |       
|                                
|                                
|                                
|                                
|                                 | Additions:           
|                                
|                                
|                                
|                                
|                                 |                       | Charged to provision for doubtful accounts |   |                   | 5,525  |                   |   |                   | 1,634 |  |   |        | 1,485  |  
|                                
|                                
|                                
|                                
|                                 |                       | Charged to health care services            |   |                   | 13,921 |                   |   |                   | 2,074 |  |   |        | (4,850 | )
|                                
|                                
|                                
|                                
|                                 | Deductions/write offs |                                            |   | (8,331            | )      |                   |   | (1,064            | )     |  |   | (1,704 | )     
|                                 |                       |                                            |   |                   |        |                   |   |                   |       |  |   |       
|                                 | Ending balance        |                                            | $ | 22,288            |        |                   | $ | 11,173            |       |  | $ | 8,529  |       
|                                 |                       |                                            |   |                   |        |                   |   |                   |       |  |   |       

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##### Table of Contents



PACIFICARE HEALTH SYSTEMS, INC.

EXHIBIT INDEX

|        |  |                                                                                                                                                                                                                                                                                 
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
|Number  |  | Description                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                 
|3.01    |  | Amended and Restated Certificate of Incorporation of Registrant (including Certificate of Designation of Series A
Junior Participating Preferred Stock) [incorporated by reference to Exhibit 99.1 to Registrants Registration
Statement on Form S-3 (File No. 333-83069)]. (1)
|       
|3.02    |  | Bylaws of Registrant [incorporated by reference to Exhibit 99.2 to Registrants Registration Statement on Form
S-3 (File No. 333-83069)].                                                                                                                                       
|       
|4.01    |  | Form of Specimen Certificate for Registrants Common Stock [incorporated by reference to Exhibit 4.02 to
Registrants Form 10-K for the year ended December 31, 1999].                                                                                                          
|       
|4.02    |  | First Supplemental Indenture, dated as of February 14, 1997, by and among the Registrant, FHP International
Corporation and The Chase Manhattan Bank, N.A. [incorporated by reference to Exhibit 4.01 to Registrants
Form 10-Q for the quarter ended March 31, 1997].          
|       
|4.03    |  | Registration Rights Agreement, dated as of May 4, 1999, between the Registrant and UniHealth Foundation
[incorporated by reference to Exhibit 99.4 to Registrants Registration Statement on Form S-3 (File No.
333-83069)].                                                    
|       
|4.04    |  | Rights Agreement, dated as of November 19, 1999, between the Registrant and ChaseMellon Shareholder Services,
L.L.C [incorporated by reference to Exhibit 99.1 to Registrants Form 8-K, dated November 22, 1999].                                                              
|       
|10.01   |  | Senior Executive Employment Agreement, dated as of July 17, 2000, between the Registrant and Howard G. Phanstiel
[incorporated by reference to Exhibit 10.01 to Registrants Form 10-Q for the quarter ended June 30, 2000]. (2)                                                
|       
|10.02   |  | First Amendment to Senior Executive Employment Agreement, dated as of July 17, 2000, between the Registrant and
Howard G. Phanstiel [incorporated by reference to Exhibit 10.01 to Registrants Form 10-Q for the quarter ended
June 30, 2000]. (2)                             
|       
|10.03   |  | Senior Executive Employment Agreement, dated as of July 17, 2000, between the Registrant and Bary G. Bailey
[incorporated by reference to Exhibit 10.01 to Registrants Form 10-Q for the quarter ended June 30, 2000]. (2)                                                     
|       
|10.04   |  | First Amendment to Senior Executive Employment Agreement, dated as of July 17, 2000, between the Registrant and
Bary G. Bailey [incorporated by reference to Exhibit 10.01 to Registrants Form 10-Q for the quarter ended June
30, 2000]. (2)                                  
|       
|10.05   |  | Senior Executive Employment Agreement, dated as of April 3, 2000, between the Registrant and Bradford A. Bowlus.
[incorporated by reference to Exhibit 10.01 to Registrants Form 10-Q for the quarter ended September 30, 2000].
(2)                                           
|       
|10.06   |  | Senior Executive Employment Agreement, dated as of April 3, 2000, between the Registrant and Christopher P. Wing.
(2)                                                                                                                                                           
|       
|10.07   |  | Senior Executive Employment Agreement, dated as of April 3, 2000, between the Registrant and Ronald M. Davis. (2)                                                                                                                                                               
|       
|10.08   |  | Consulting Agreement, dated as of April 8, 2000, between the Registrant and David A. Reed. (2)                                                                                                                                                                                  
|       
|10.09   |  | Second Amended and Restated Employment Agreement, dated December 31, 1999, between the Registrant and Alan R.
Hoops [incorporated by reference to Exhibit 99.1 to Registrants Form 8-K, dated February 18, 2000]. (2)                                                          
|       
|10.10   |  | Senior Executive Employment Agreement, dated as of June 19, 2000, between the Registrant and Robert W. OLeary
[incorporated by reference to Exhibit 99.1 to Registrants Form 8-K, dated June 22, 2000]. (2)                                                                   

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##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
|Number  |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|       
|       
|       
|       
|10.11   |  | First Amendment to Senior Executive Employment Agreement, dated as of June 19, 2000, between the Registrant and
Robert W. OLeary [incorporated by reference to Exhibit 99.2 to Registrants Form 8-K, dated June 22, 2000]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|       
|       
|       
|       
|       
|10.12   |  | Form of Contract With Eligible Medicare+Choice Organization for the period January 1, 2000 through December 31,
2000 between PacifiCare of California and the Health Care Financing Administration [incorporated by reference to Exhibit 10.09 to Registrants Form 10-K for the year ended December 31, 1999].                                                                                                                                                                                                                                                                                                                                                                                  
|       
|       
|       
|       
|       
|10.13   |  | 1996 Stock Option Plan for Officers and Key Employees of the
Registrant [incorporated by reference to Exhibit 10.05 to Registrants Form 8-B, dated January 23, 1997]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|       
|       
|       
|       
|       
|10.14   |  | First Amendment to 1996 Stock Option Plan for Officers and Key
Employees of the Registrant [incorporated by
reference to Exhibit D to Registrants Proxy Statement, dated May 25, 1999]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|       
|       
|       
|       
|       
|10.15   |  | 2000 Employee Plan [incorporated by reference to Exhibit 4.1 to Registrants Registration Statement on Form S-8
(File No. 333-44038)]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|       
|       
|       
|       
|       
|10.16   |  | 2000 Non-Employee Directors Stock Option Plan [incorporated by reference to Exhibit 4.2 to Registrants
Registration Statement on Form S-8 (File No. 333-49272)]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|       
|       
|       
|       
|       
|10.17   |  | Amended and Restated 1996 Non-Officer Directors Stock Option Plan of
the Registrant [incorporated by reference to
Exhibit E to Registrants Proxy Statement, dated May 25, 1999]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|       
|       
|       
|       
|       
|10.18   |  | First Amendment to Amended and Restated 1996 Non-Officer Directors Stock Option Plan [incorporated by reference
to Exhibit 4.4 to Registrants Registration Statement on Form S-8, (File No. 333-49272)].                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|       
|       
|       
|       
|       
|10.19   |  | 1996 Management Incentive Compensation Plan of the Registrant [incorporated by reference to Exhibit 10.07 to
Registrants Form 8-B, dated January 23, 1997]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|       
|       
|       
|       
|       
|10.20   |  | Amended 1997 Premium Priced Stock Option Plan of the Registrant
[incorporated by reference to Exhibit A to
Registrants Definitive Proxy Statement, dated April 28, 1998]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|       
|       
|       
|       
|       
|10.21   |  | First Amendment to Amended 1997 Premium Priced Stock Option Plan,
dated as of August 27, 1998 [incorporated by
reference to Exhibit 10.12 to Registrants Form 10-K for the year ended December 31, 1998]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|       
|       
|       
|       
|       
|10.22   |  | PacifiCare Health Systems, Inc. Amended and Restated Non-Qualified
Deferred Compensation Plan. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|       
|       
|       
|       
|       
|10.23   |  | PacifiCare Health Systems, Inc. Statutory Restoration Plan [incorporated by reference to Exhibit 10.16 to Registrants Form 10-K for the year ended December 31, 1997]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|       
|       
|       
|       
|       
|10.24   |  | First Amendment to the PacifiCare Health Systems, Inc. Statutory Restoration Plan, dated November 1, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|       
|       
|       
|       
|       
|10.25   |  | PacifiCare Health Systems, Inc. Stock Unit Deferred Compensation Plan
[incorporated by reference to Exhibit 10.17
to Registrants Form 10-K for the year ended December 31, 1997]. (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|       
|       
|       
|       
|       
|10.26   |  | Credit Agreement, dated as of October 31, 1996, among Registrant, the several financial institutions from time to
time party to the Credit Agreement, The Bank of New York, The Bank of Nova Scotia, Banque Nationale de Paris,
Dai-Ichi Kangyo Bank, Ltd., The Industrial Bank of Japan Limited, RaboBank Nederland, Sanwa Bank of California,
The Sumitomo Bank, Limited and Wells Fargo Bank, N.A., as co-agents, The Chase Manhattan Bank and CitiCorp USA,
Inc. as managing agents, and Bank of America National Trust and Savings Association, as agent for the Banks
[incorporated by reference to Exhibit 10.01 to Registrants Registration Statement on Form S-4 (File No.
333-16271)].

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##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                    
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
|Number  |  | Description                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                    
|       
|       
|       
|       
|10.27   |  | First Amendment to Credit Agreement, dated as of August 15, 1997, among the Registrant, the Banks party to the
Credit Agreement, dated as of October 31, 1996, and Bank of America National Trust and Savings Association, as
Agent [incorporated by reference to Exhibit 10.12 to Registrants Form 10-K for the year ended December 31,
1997].   
|       
|10.28   |  | Second Amendment to Credit Agreement, dated as of December 31, 1997, among the Registrant, the Banks party to the
Credit Agreement, dated as of October 31, 1996, and Bank of America National Trust and Savings Association, as
Agent [incorporated by reference to Exhibit 10.13 to Registrants Form 10-K for the year ended December 31,
1997].
|       
|10.29   |  | Third Amendment to Credit Agreement, dated as of December 8, 1999, among the Registrant, the Banks party to the
Credit Agreement, dated as of October 31, 1996, and Bank of America National Trust and Savings Association, as
Agent
[incorporated by reference to Exhibit 10.22 to Registrant's Form 10-K for the year ended December 31, 1999].  
|       
|10.30   |  | Stock Purchase Agreement, dated as of May 4, 1999, between the Registrant and UniHealth Foundation [incorporated
by reference to Exhibit B to Registrants Proxy Statement, dated May 25, 1999].                                                                                                                                                   
|       
|10.31   |  | Modification of Stock Purchase Agreement, dated February 8,
2001, between the Registrant and UniHealth Foundation.                                                                                                                                                                                                                                 
|       
|10.32   |  | Modification of Stock Purchase Agreement, dated March 7, 2001,
between the Registrant and UniHealth Foundation.                                                                                                                                                                                                                                    
|       
|10.33   |  | Amended Services Agreement, dated as of June 1, 1999, between the Registrant and Joseph S. Konowiecki, a
professional corporation [incorporated by reference to Exhibit 10.24 to Registrant's Form 10-K for the year ended December 31, 1999].                                                                                                     
|       
|10.34   |  | Legal Services Agreement, dated as of January 1, 1999, between the Registrant and Konowiecki & Rank, a law
partnership.                                                                                                                                                                                                                            
|       
|21      |  | List of Subsidiaries.                                                                                                                                                                                                                                                                                                                              
|       
|23      |  | Consent of Ernst & Young LLP, Independent Auditors.                                                                                                                                                                                                                                                                                                



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E-3