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

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FORM 10-Q

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(Mark One)


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

For the quarterly period ended September 30, 2004

OR



For the transition period from ________to _________

Commission file number    1-8865

Sierra Health Services, Inc.(Exact name of registrant as specified in its charter)



|Nevada                                                         | 88-0200415                             
|-------------------------------------------------------------- | ---------------------------------------
|(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number)

2724 North Tenaya Way
Las Vegas, Nevada     89128

(702) 242-7000

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 reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
    Yes  
x    No

As of October 22, 2004,   there were  26,402,000  shares of common  stock
outstanding.

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SIERRA HEALTH SERVICES, INC.

          Quarterly Report on Form 10-Q

For the period ended September 30, 2004



|PART I.   FINANCIAL INFORMATION                                                                                                                                                                                                                                                                                                                                                                                | Page No.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------
|                                                                                                                                                                                                                                                                                                                                                                                                              
|Item 1. Financial Statements (Unaudited):                                                                                                                                                                                                                                                                                                                                                                      |         
|Condensed Consolidated Balance Sheets -
            
                   September 30, 2004 and December 31, 2003
          
        Condensed Consolidated Statements of Operations -
            
          three and nine months ended September 30, 2004 and 2003
          
        Condensed Consolidated Statements of Cash Flows -
            
          nine months ended September 30, 2004 and 2003 | 123     
|Notes to Condensed Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                           | 4 - 17  
|Item 2.   Management's Discussion and Analysis of Financial
                      Condition and Results of Operations                                                                                                                                                                                                                                                                                          | 18 - 31 
|Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                                                                                                                                                                                                                                                                                                                           | 32      
|Item 4.  Controls and Procedures                                                                                                                                                                                                                                                                                                                                                                               | 32      
|                                                                                                                                                                                                                                                                                                                                                                                                              
|PART II.  OTHER INFORMATION                                                                                                                                                                                                                                                                                                                                                                                    |         
|                                                                                                                                                                                                                                                                                                                                                                                                              
|Item 1.   Legal Proceedings                                                                                                                                                                                                                                                                                                                                                                                    | 33      
|Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                                                                                                                                                                                                                                                          | 34      
|Item 3. Defaults upon Senior Securities                                                                                                                                                                                                                                                                                                                                                                        | 34      
|Item 4. Submission of Matters to a Vote of Security Holders                                                                                                                                                                                                                                                                                                                                                    | 34      
|Item 5. Other Information                                                                                                                                                                                                                                                                                                                                                                                      | 34      
|Item 6.   Exhibits                                                                                                                                                                                                                                                                                                                                                                                             | 34 - 35 
|Signatures                                                                                                                                                                                                                                                                                                                                                                                                     | 36      

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i

PART I.  FINANCIAL INFORMATION

SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES

                      CONDENSED CONSOLIDATED BALANCE SHEETS

                      (In thousands, except per share data)

                                   (Unaudited)

`September 30,   December 31,
                                                                          2004          2003
                                                                     -------------  -------------
                              ASSETS                                                                
CURRENT ASSETS:
     Cash and Cash Equivalents..................................... $     194,061  $     118,473
     Investments...................................................       111,735        197,573
     Accounts Receivable (Less Allowance for Doubtful
         Accounts; 2004 - $6,635; 2003 - $7,342)...................        13,671         12,080
     Military Accounts Receivable (Less Allowance for Doubtful
         Accounts; 2004 and 2003 - $100)...........................        36,293         47,389
     Current Portion of Deferred Tax Asset.........................        22,589         33,708
     Prepaid Expenses and Other Current Assets.....................        44,088         37,478
     Assets of Discontinued Operations.............................         4,124        533,756
                                                                     -------------  -------------
         Total Current Assets......................................       426,561        980,457

PROPERTY AND EQUIPMENT, NET........................................        69,432         63,109
RESTRICTED CASH AND INVESTMENTS....................................        20,616         17,646
GOODWILL...........................................................        14,782         14,782
DEFERRED TAX ASSET (Less Current Portion)..........................        12,617         11,501
NOTE RECEIVABLE....................................................        62,000             --
OTHER ASSETS.......................................................        70,624         46,626
                                                                     -------------  -------------
TOTAL ASSETS....................................................... $     676,632  $   1,134,121
                                                                     =============  =============
                                                                                                    
               LIABILITIES AND STOCKHOLDERS' EQUITY                                                 
CURRENT LIABILITIES:
     Accrued Liabilities........................................... $      76,629  $      56,327
     Trade Accounts Payable........................................        18,289         37,787
     Accrued Payroll and Taxes.....................................        31,492         15,879
     Medical Claims Payable........................................       115,622        103,749
     Unearned Premium Revenue......................................        17,502         45,888
     Military Health Care Payable..................................        39,131         76,605
     Current Portion of Long-Term Debt.............................            78            163
     Liabilities of Discontinued Operations........................           759        472,407
                                                                     -------------  -------------
         Total Current Liabilities.................................       299,502        808,805

LONG-TERM DEBT (Less Current Portion)..............................       125,352        116,645
OTHER LIABILITIES..................................................        69,060         57,907
                                                                     -------------  -------------
TOTAL LIABILITIES..................................................       493,914        983,357
                                                                     -------------  -------------
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
  Preferred Stock, $.01 Par Value, 1,000
       Shares Authorized; None Issued or Outstanding
  Common Stock, $.005 Par Value, 60,000 Shares Authorized;
       2004 - 35,149; 2003 - 33,173 Shares Issued..................           176            166
  Treasury Stock: 2004 - 8,755; 2003 - 6,221 Common Stock Shares...      (217,122)      (112,737)
  Additional Paid-in Capital.......................................       276,299        227,417
  Deferred Compensation............................................        (2,233)           (22)
  Accumulated Other Comprehensive Loss.............................          (112)          (479)
  Retained Earnings................................................       125,710         36,419
                                                                     -------------  -------------
TOTAL STOCKHOLDERS' EQUITY.........................................       182,718        150,764
                                                                     -------------  -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......................... $     676,632  $   1,134,121
                                                                     =============  =============`

See accompanying notes to condensed consolidated financial statements.

1

SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

                      (In thousands, except per share data)

                                   (Unaudited)

`Three Months Ended September 30,    Nine Months Ended September 30,
                                                     --------------------------------   --------------------------------
                                                           2004            2003               2004            2003
OPERATING REVENUES:                                  ---------------  ---------------   ---------------  --------------- 
   Medical Premiums................................ $       288,485  $       242,875   $       834,584  $       717,097
   Military Contract Revenues......................          85,983          132,788           354,312          352,632
   Professional Fees...............................           8,705            8,984            26,268           27,403
   Investment and Other Revenues...................          10,107            4,590            27,545           14,580
                                                     ---------------  ---------------   ---------------  ---------------
         Total.....................................         393,280          389,237         1,242,709        1,111,712
                                                     ---------------  ---------------   ---------------  ---------------
OPERATING EXPENSES:
   Medical Expenses................................         224,219          191,248           650,705          572,009
   Military Contract Expenses......................          75,830          128,966           313,047          344,109
   General and Administrative Expenses.............          44,496           33,845           126,895          101,845
                                                     ---------------  ---------------   ---------------  ---------------
         Total ....................................         344,545          354,059         1,090,647        1,017,963
                                                     ---------------  ---------------   ---------------  ---------------
OPERATING INCOME FROM CONTINUING OPERATIONS........          48,735           35,178           152,062           93,749
Interest Expense...................................          (1,221)          (1,295)           (3,561)          (4,445)
Other Income (Expense), Net........................             (49)             100               114             (243)
                                                     ---------------  ---------------   ---------------  ---------------
INCOME FROM CONTINUING OPERATIONS
   BEFORE INCOME TAXES.............................          47,465           33,983           148,615           89,061
PROVISION FOR INCOME TAXES.........................         (16,738)         (11,806)          (53,352)         (30,946)
                                                     ---------------  ---------------   ---------------  ---------------
INCOME FROM CONTINUING OPERATIONS..................          30,727           22,177            95,263           58,115
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
    (net of income tax (provision) benefit of $0,
     ($54), $761, and $1,268), respectively........              --               30              (486)            (621)
                                                     ---------------  ---------------   ---------------  ---------------
NET INCOME ........................................ $        30,727  $        22,207   $        94,777  $        57,494
                                                     ===============  ===============   ===============  ===============
EARNINGS PER COMMON SHARE:
Income from Continuing Operations.................. $          1.16  $          0.78   $          3.56  $          2.05
Loss from Discontinued Operations..................              --               --             (0.02)           (0.02)
                                                     ---------------  ---------------   ---------------  ---------------
   Net Income ..................................... $          1.16  $          0.78   $          3.54  $          2.03
                                                     ===============  ===============   ===============  ===============
EARNINGS PER COMMON SHARE ASSUMING DILUTION:
Income from Continuing Operations.................. $          0.90  $          0.72   $          2.75  $          1.90
Loss from Discontinued Operations..................              --               --             (0.01)           (0.02)
                                                     ---------------  ---------------   ---------------  ---------------
   Net Income ..................................... $          0.90  $          0.72   $          2.74  $          1.88
                                                     ===============  ===============   ===============  ===============`

See accompanying notes to condensed consolidated financial statements.

2

SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (In thousands)

                                   (Unaudited)

`Nine Months Ended September 30,
                                                                      --------------------------------
                                                                            2004            2003
                                                                      ---------------  ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net Income ...................................................... $        94,777  $        57,494
   Adjustments to Reconcile Net Income to Net Cash
       Provided by Operating Activities:
          Loss from Discontinued Operations.........................             486              621
          Depreciation..............................................          12,372           11,750
          Stock Based Compensation Expense..........................           4,451              385
          Provision for Doubtful Accounts...........................           1,224            2,098
          (Gain) Loss on Disposal of Assets.........................            (126)             772
   Changes in Assets and Liabilities:
          Other Assets .............................................          (8,220)          (4,072)
          Deferred Tax Asset........................................          31,490           23,804
          Other Liabilities.........................................         (17,462)          21,571
          Other Current Assets......................................           5,076          (23,064)
          Military Accounts Receivable..............................          11,096          (23,570)
          Military Health Care Payable..............................         (37,474)          12,181
          Medical Claims Payable....................................          11,873            4,852
          Accrued Payroll and Taxes.................................          15,613           11,500
          Unearned Premium Revenue..................................         (28,386)         (28,286)
                                                                      ---------------  ---------------
       Net Cash Provided by Operating Activities
          of Continuing Operations..................................          96,790           68,036
                                                                      ---------------  ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Capital Expenditures, Net of Dispositions........................         (16,766)         (13,728)
   Change in Investments............................................          74,805           43,606
                                                                      ---------------  ---------------
       Net Cash Provided by Investing Activities of
          Continuing Operations.....................................          58,039           29,878
                                                                      ---------------  ---------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Payments on Debt and Capital Leases..............................          (1,544)         (60,496)
   Proceeds from Other Long-Term Debt...............................          10,000            1,327
   Purchase of Treasury Stock.......................................        (112,277)         (52,765)
   Exercise of Stock in Connection with Stock Plans.................          22,686           12,639
   Proceeds from Senior Convertible Debentures......................              --          115,000
   Debt Issue Costs.................................................              --           (5,834)
                                                                      ---------------  ---------------
       Net Cash (Used for) Provided by Financing Activities of
          Continuing Operations.....................................         (81,135)           9,871
                                                                      ---------------  ---------------
NET CASH PROVIDED BY (USED FOR) DISCONTINUED OPERATIONS.............           1,894          (25,013)
                                                                      ---------------  ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS...........................          75,588           82,772

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD....................         118,473           45,778
                                                                      ---------------  ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.......................... $       194,061  $       128,550
                                                                      ===============  ===============

Supplemental Condensed Consolidated Continuing Operations
  Statements of Cash Flows Information:
--------------------------------------------------------------------
  Cash Paid During the Period for Interest
   (Net of Amount Capitalized)...................................... $        (2,848) $        (3,283)
  Net Cash Paid During the Period for Income Taxes..................          (7,411)         (10,699)
Non-Cash Investing and Financing Activities:
  Assets and Liabilities Recorded in Conjunction with the Sale of
    the Workers' Compensation Operations............................          54,060               --
  Additions to Capital Leases.......................................             166               --`

See accompanying notes to condensed consolidated financial statements.

3

1. 	BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated
financial statements include the consolidated accounts of Sierra Health
Services, Inc. ("Sierra", a holding company, together with its subsidiaries,
collectively referred to herein as the "Company"). All material intercompany
balances and transactions have been eliminated. These statements and the
Company's annual audited consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America; however, these statements do not contain all of the information and
disclosures that would be required in a complete set of audited financial
statements. They should, therefore, be read in conjunction with the Company's
annual audited consolidated financial statements and related notes thereto for
the year ended December 31, 2003. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements reflect all material
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial results for the interim periods presented.

The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates and
assumptions could change in the future as more information becomes available,
which could impact the amounts reported and disclosed herein. Actual results may
differ materially from estimates.

4

2.	EMPLOYEE STOCK PLANS

Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure"
requires prominent disclosures in interim as well as annual financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported net income.  The Company has continued to
account for its stock-based compensation using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," as amended.  Accordingly, no compensation cost
has been recognized for the Company's employee stock plans except for those
expenses associated with restricted stock units and certain stock options in
which vesting was or has been agreed to be accelerated.  Had compensation cost
for the Company's stock-based compensation plans been determined based on the
fair value at the grant dates for awards under those plans, the Company's net
income and earnings per share, would have been reduced to the pro forma amounts
indicated below:

`Three Months Ended September 30,    Nine Months Ended September 30,
                                                 --------------------------------   ---------------------------------
                                                       2004             2003              2004             2003
                                                 ----------------  --------------   ----------------  --------------- 
  (In thousands, except per share data)

Net income, as reported........................ $         30,727  $       22,207   $         94,777  $        57,494
Less: total stock-based employee compensation
   expense determined under fair value based
   methods for all  awards, net of tax.........           (1,439)         (1,451)            (6,260)          (4,868)
                                                 ----------------  --------------   ----------------  ---------------
Pro forma net income .......................... $         29,288  $       20,756   $         88,517  $        52,626
                                                 ================  ==============   ================  ===============

Net income per share, as reported.............. $           1.16  $         0.78   $           3.54  $          2.03
Pro forma net income, per share ...............             1.11            0.73               3.31             1.86

Net income per share
   assuming dilution, as reported.............. $           0.90  $         0.72   $           2.74  $          1.88
Pro forma net income, per share ...............             0.86            0.67               2.56             1.72`

3. 	LONG-TERM DEBT

Sierra Debentures - In March 2003, the Company
issued $115.0 million aggregate principal amount of its 21⁄4% senior convertible
debentures due March 15, 2023.  The debentures pay interest, which is due semi-
annually on March 15 and September 15 of each year.  Each $1,000 principal
amount of debentures is convertible, at the option of the holders, into 54.6747
shares of Sierra Health Services, Inc., common stock prior to March 15, 2023 if
(i) the market price of the Company's common stock for at least 20 trading days
in a period of 30 consecutive trading days ending on the last trading day of the
preceding fiscal quarter exceeds 120% of the conversion price per share of the
Company's common stock; (ii) the debentures are called for redemption; (iii)
there is an event of default with respect to the debentures; or (iv) specified
corporate transactions have occurred.  The conversion rate is subject to certain
adjustments. This conversion rate initially represents a conversion price of
$18.29 per share.  Holders of the debentures may require the Company to
repurchase all or a portion of their debentures on March 15 in 2008, 2013 and
2018 or upon certain corporate events including a change in control.  In either
case, the Company may choose to pay the purchase price of such debentures in
cash or common stock or a combination of cash and common stock.  The debentures
can be redeemed by the Company for cash beginning on or after March 20,
2008.

5

The Company evaluates the market price condition each quarter
to determine whether the debentures will be convertible, at the option of the
holder, during the subsequent quarter. The market price condition has been
satisfied in every quarter since the fourth quarter of 2003 and as a result, the
debentures have been convertible, at the option of the holder, since January 1,
2004 and are convertible at any time during the quarter ending December 31,
2004. Although no debentures were converted as of September 30, 2004, they are
considered common stock equivalents and are included in the calculation of
weighted average common shares outstanding assuming dilution for the three and
nine months ended September 30, 2004.



Revolving Credit Facility. On March 3, 2003, the
Company entered into a $65.0 million revolving credit facility, which replaced
its amended and restated credit facility.  Interest on the facility was
initially LIBOR plus 2.25% and has been LIBOR plus 2.00% since the third quarter
of 2003.  The facility was set to expire on April 30, 2006.  Effective October
19, 2004, the facility has been amended to extend the maturity of the facility
to December 31, 2009, increase the availability to $100.0 million and reduce the
interest to LIBOR plus 1.5% based on current ratios.  The facility is available
for general corporate purposes.  As of September 30, 2004, the Company has drawn
$10.0 million on this facility.

The credit facility remains secured by guarantees by certain
of the Company's subsidiaries and a first priority perfected security interest
in (i) all of the capital stock of each of the Company's unregulated, material
domestic subsidiaries (direct or indirect) as well as all of the capital stock
of certain regulated, material domestic subsidiaries; and (ii) all other present
and future assets and properties of the Company and those of its subsidiaries
that guarantee the credit agreement obligations (including, without limitation,
accounts receivable, inventory, real property, equipment, contracts, trademarks,
copyrights, patents, license rights and general intangibles) subject, in each
case, to the exclusion of the capital stock of CII Financial, Inc.
("CII") and certain other exclusions.

The revolving credit facility has
covenants that limit the Company's ability and the ability of the Company's
subsidiaries to dispose of assets, incur indebtedness, incur other liens, make
investments, loans or advances, make acquisitions, engage in mergers or
consolidations, make capital expenditures and otherwise restrict certain
corporate activities.  Per the most recent amendment dated October 19, 2004,
based on the Company exceeding a certain leverage ratio requirement, the
Company's ability to pay dividends, repurchase Company common stock and prepay
other debt is unlimited provided that the Company can still maintain the
required ratios after such transaction or any borrowing incurred as a result of
such transaction.  In addition, the Company is required to comply with specified
financial ratios as set forth in the credit agreement.  The Company believes it
is in compliance with all covenants of the credit agreement.

4. 	SHARE REPURCHASES

From January 1, 2004 through
September 30, 2004, the Company purchased 2.9 million shares of its common
stock, in the open market or negotiated transactions, for $112.3 million at an
average cost per share of $38.47.  During the quarter ended September 30, 2004,
the Company purchased 705,000 shares of its common stock, in the open market or
negotiated transactions, for $29.5 million at an average cost per share of
$41.87.  Based on approval by the Company's Board of Directors on May 20, 2004,
the Company currently has $43.0 million available for share repurchases.  The
Company's revolving credit facility, as amended, currently allows for unlimited
stock repurchases subject to the Company maintaining a certain covenant ratio.  The
Company has not repurchased any shares subsequent to September 30, 2004 through October 21, 2004.



Included in the repurchases for the first quarter of 2004 are
500,000 shares the Company purchased from

6

its CEO, at $32.00 per share, for a total of $16.0 million.  The closing price of the Company's common stock on the
date of the transaction, February 11, 2004, was $32.35.  Included in the
repurchases for the second quarter of 2004 are an additional 500,000 shares the
Company purchased from its CEO, at $43.20 per share, for a total of $21.6
million.  The closing price of the Company's common stock on the date of the
transaction, May 27, 2004, was $43.25.  The independent directors of the
Company's Board of Directors approved both of the purchases.



5. 	TEXAS DISCONTINUED OPERATIONS



During the third quarter of 2001, the Company announced its
plan to exit the Texas HMO health care market and received formal approval from
the Texas Department of Insurance to withdraw its HMO operations in mid-October
2001.  The Company ceased providing HMO health care coverage in Texas on April
17, 2002.



The Company elected to early adopt Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144"), effective January 1, 2001.
In accordance with SFAS No. 144, the Company's Texas HMO health care operations
were reclassified as discontinued operations.



The following are the unaudited condensed assets and
liabilities of the discontinued Texas HMO health care operations:

`September 30,      December 31,
                                                              2004              2003
                                                        ----------------  ----------------
  (In thousands)                                                                          
ASSETS                                                                                    
 Cash and Cash Equivalents............................ $          1,964  $             47
 Investments..........................................            2,155             4,048
 Other Assets.........................................                5               115
                                                        ----------------  ----------------
ASSETS OF DISCONTINUED OPERATIONS.....................            4,124             4,210
                                                        ----------------  ----------------
LIABILITIES                                                                               
 Accounts Payable and Other Liabilities...............              690             2,658
 Medical Claims Payable...............................               69               202
                                                        ----------------  ----------------
LIABILITIES OF DISCONTINUED OPERATIONS................              759             2,860
                                                        ----------------  ----------------
NET ASSETS OF DISCONTINUED OPERATIONS................. $          3,365  $          1,350
                                                        ================  ================`

7

The following are unaudited condensed statements of
operations of the discontinued Texas HMO health care operations:

`Three Months Ended September 30,    Nine Months Ended September 30,
                                                      --------------------------------    -------------------------------
                                                            2004            2003                2004            2003
                                                      ---------------  ---------------    ---------------  --------------
  (In thousands)
Operating Revenues.................................. $            10  $           111    $            96  $          182
                                                      ---------------  ---------------    ---------------  --------------

 Medical Expenses...................................             (87)             (70)              (270)         (1,521)
 General and Administrative Expenses, Net...........              97              254                 19            (146)
 Interest Expense and Other, Net
   (including rental income)........................              --             (503)                73          (3,160)
                                                      ---------------  ---------------    ---------------  --------------
 Total Expenses, Net................................              10             (319)              (178)         (4,827)
                                                      ---------------  ---------------    ---------------  --------------
 Income from Discontinued Operations Before Taxes...              --              430                274           5,009
 Income Tax Provision...............................              --             (179)               (78)         (1,779)
                                                      ---------------  ---------------    ---------------  --------------
 Net Income from Discontinued Operations............ $            --  $           251    $           196  $        3,230
                                                      ===============  ===============    ===============  ==============`

The operating revenues are all related to investment income.
All of the discontinued Texas HMO health care operations had previously been a
component of the "managed care and corporate operations" segment.

Management believes that the remaining liabilities, at
September 30, 2004, are appropriate and that no further revisions to the
estimates are necessary at this time.  Based on the current estimated Texas HMO
health care remaining liabilities, the Company believes the Texas HMO has
adequate funds available and the ability to fund the anticipated
obligations.



6.	CII FINANCIAL, INC. DISCONTINUED OPERATIONS



On January 15, 2003, the Company announced that it was
exploring strategic alternatives to sell its workers' compensation company, CII.
Sierra's Board of Directors authorized the plan to sell the operations on
December 31, 2002.  Accordingly, beginning in the fourth quarter of 2002, the
Company reclassified its workers' compensation insurance business as
discontinued operations.  CII represented the majority of the Company's previous
workers' compensation operations segment and specialty product income and
expenses.



On March 31, 2004, the Company completed the sale of CII's
subsidiary, California Indemnity Insurance Company ("Cal Indemnity"),
which was CII's only significant asset.  Cal Indemnity's subsidiaries, which
were included in the sale, are Commercial Casualty Insurance Company, Sierra
Insurance Company of Texas, and CII Insurance Company.



The Company received $14.2 million in cash at the closing,
which was subsequently reduced by $2.7 million based on the audited closing date
balance sheet. The $2.7 million adjustment is expected to be repaid to the
Company over the next few years.  The transaction also includes a note
receivable of $62.0 million, plus accrued interest, payable to the Company in
January 2010. The note receivable can be increased or decreased depending on
favorable or adverse claim and expense development from the date of closing
through December 31, 2009, and other offsets and additions based on certain
agreements between the parties.  The note receivable can be increased on a
dollar for dollar basis for the first $15 million in positive loss reserve
development and $.50 per dollar on any positive development in excess of
$15 million.  The note receivable can also be decreased on a dollar for dollar basis
for the first $58 million in adverse loss development.  To date, no valuation
adjustment has been recorded on the note.

8

Certain other contractual assets and liabilities were
recorded in conjunction with the sale including a current asset of $15.8 million
and a non-current asset of $7.1 million that represent Cal Indemnity's
unallocated loss adjustment expense ("ULAE") reserves to be paid to
Sierra.  Offsetting these assets was a current liability of $15.8 million and a
non-current liability of $7.1 million, which represent the contractual services
to be performed by Sierra.  Including the cash proceeds, net assets of $68.3
million were recorded in conjunction with the sale of Cal Indemnity.
Previously, CII had recorded valuation adjustments to reduce the business to its
estimated net realizable value upon disposition.  No further adjustments were
required upon final disposition; therefore, no gain or loss on the sale was
recorded.



A third-party claims administrator was engaged to administer
claims for a period of 15 years. Under the terms of this agreement, the
administrator will provide certain claims services for Cal Indemnity and its
subsidiaries. Sierra will be responsible for this administrator's costs and for
providing certain transition services for varying terms to Cal Indemnity.  The
purchaser of Cal Indemnity will pay Sierra for these costs from an account
consisting of the ULAE reserves and accrued liabilities as of the closing, a
percentage of premiums earned after the closing, plus accrued interest on the
ULAE reserves.  In addition, Sierra is providing workers' compensation managed
care services at market rates to Cal Indemnity.



The Company's September 30, 2004 Condensed Consolidated
Balance Sheet does not include the assets and liabilities of Cal Indemnity due
to the disposal of those assets and liabilities at March 31, 2004.  The
Company's Condensed Consolidated Statement of Income for the nine months ended
September 30, 2004 reflects the activity of the discontinued operations through
the disposal date, March 31, 2004.  Any subsequent activity related to this
disposal will be reflected in continuing operations.



9

The following are the assets and liabilities of the
discontinued operations of CII:

`December 31,
                                                         2003
                                                     ------------  
  (In thousands)                                                   
ASSETS                                                             
Cash and Cash Equivalents.......................... $     58,634
Investments........................................      243,647
Reinsurance Recoverable............................      177,333
Property and Equipment, Net........................        1,612
Other Assets.......................................       48,320
                                                     ------------
TOTAL ASSETS.......................................      529,546
                                                     ------------
                                                                  
LIABILITIES                                                       
Accounts Payable and Other Accrued Expenses........       54,208
Reserve for Loss and Loss Adjustment Expenses......      415,339
                                                     ------------
TOTAL LIABILITIES..................................      469,547
                                                     ------------
NET ASSETS OF DISCONTINUED OPERATIONS.............. $     59,999
                                                     ============`

10

The following are the unaudited condensed statements of opertions of the discontinued operations of CII:

`Three            Three             Nine
                                        Months Ended     Months Ended     Months Ended
                                        September 30,      March 31,      September 30,
                                       --------------   --------------   --------------
                                            2003             2004             2003
                                       --------------   --------------   --------------
  (In thousands)
OPERATING REVENUES:
Specialty Product Revenues........... $       25,455   $       19,015   $       97,499
Investment and Other Revenues........          1,616            1,290            8,916
                                       --------------   --------------   --------------
    Total Revenues...................         27,071           20,305          106,415
                                       --------------   --------------   --------------

OPERATING EXPENSES:
Specialty Product Expenses...........         27,480           21,917          114,227
Interest Expense and Other
  (Income) Expense, Net..............            (63)             (91)            (914)
                                       --------------   --------------   --------------
    Total Operating Expenses.........         27,417           21,826          113,313
                                       --------------   --------------   --------------

Loss from Discontinued
   Operations Before Income Tax .....           (346)          (1,521)          (6,898)

Income Tax Benefit...................            125              839            3,047
                                       --------------   --------------   --------------
Net Loss from Discontinued
   Operations........................ $         (221)  $         (682)  $       (3,851)
                                       ==============   ==============   ==============`

The activity for 2004 is through the disposal date, March 31, 2004.
There is no activity for the discontinued operations beyond that date.
Specialty product revenues consist of workers' compensation insurance net earned
premiums.  Specialty product expenses consist of loss and loss adjustment
expenses incurred and general and administrative expenses.

11

7.	EARNINGS PER SHARE:



The following table
provides a reconciliation of basic and diluted earnings per share:

`Three Months Ended September 30,    Nine Months Ended September 30,
                                                   --------------------------------   --------------------------------
                                                        2004             2003              2004             2003
                                                   ---------------  ---------------   ---------------  ---------------    
  (In thousands, except per share data)
BASIC INCOME (LOSS) PER SHARE
Income from continuing operations................ $        30,727  $        22,177   $        95,263  $        58,115
Income (Loss) from discontinued operations.......              --               30              (486)            (621)
                                                   ---------------  ---------------   ---------------  ---------------
Net income....................................... $        30,727  $        22,207   $        94,777  $        57,494
                                                   ===============  ===============   ===============  ===============
Weighted average common shares outstanding.......          26,498           28,423            26,767           28,265
                                                   ===============  ===============   ===============  ===============
Earnings per common share:
Income from continuing operations................ $          1.16             0.78   $          3.56             2.05
Loss from discontinued operations................              --               --             (0.02)           (0.02)
                                                   ---------------  ---------------   ---------------  ---------------
Net income.......................................            1.16             0.78              3.54             2.03
                                                   ===============  ===============   ===============  ===============
DILUTED INCOME (LOSS) PER SHARE
Income from continuing operations................ $        30,727  $        22,177   $        95,263  $        58,115
Income (Loss) from discontinued operations.......              --               30              (486)            (621)
                                                   ---------------  ---------------   ---------------  ---------------
Net income.......................................          30,727           22,207            94,777           57,494
Interest expense on Sierra Debentures,
   net of tax....................................             421               --             1,262               --
                                                   ---------------  ---------------   ---------------  ---------------
Income for purposes of computing diluted
   net income per share.......................... $        31,148  $        22,207   $        96,039  $        57,494
                                                   ===============  ===============   ===============  ===============
Weighted average common shares outstanding.......          26,498           28,423            26,767           28,265
Dilutive options and restricted shares
   outstanding...................................           1,668            2,474             1,977            2,296
Dilutive impact of conversion of
   Sierra Debentures.............................           6,288               --             6,288               --
                                                   ---------------  ---------------   ---------------  ---------------
Weighted average common shares outstanding
   assuming dilution.............................          34,454           30,897            35,032           30,561
                                                   ===============  ===============   ===============  ===============
Earnings per common share assuming dilution:
Income from continuing operations................            0.90             0.72              2.75             1.90
Loss from discontinued operations................              --               --             (0.01)           (0.02)
                                                   ---------------  ---------------   ---------------  ---------------
Net income.......................................            0.90             0.72              2.74             1.88
                                                   ===============  ===============   ===============  ===============`

The Company evaluates the market price condition of its
convertible debentures each quarter to determine whether they will be
convertible, at the option of the holder, during the subsequent quarter. The
market price condition has been satisfied in every quarter since the fourth
quarter of 2003 and, as a result, the debentures have been convertible, at the
option of the holder, since January 1, 2004 and are convertible at any time
during the quarter ending December 31, 2004. Although no debentures were

12

converted as of September 30, 2004, they are considered common stock equivalents
and are included in the calculation of weighted average common shares
outstanding assuming dilution for the three and nine months ended September 30,
2004.

The Company issued 125,000 restricted
stock units ("units") to certain executives in the second quarter of
2004.  For the nine months ended September 30, 2004, the units were not dilutive
and, therefore, were not included in the computation of diluted earnings per
share.  For the nine months ended September 30, 2004, stock options to purchase
36,000 shares were not dilutive and, therefore, were also not included in the
computation of diluted earnings per share.

For the three and nine months ended September 30, 2003,
stock options to purchase 262,000 and 293,000 shares, respectively, were not
dilutive and, therefore, were not included in the computation of diluted
earnings per share.

8. 	DEFINED BENEFIT PLAN



The Company previously disclosed that it expects to
contribute approximately $800,000 to its defined benefit plan in 2004 to fund
expected benefit payments.  As of September 30, 2004, the Company has
contributed $588,000 to the plan to fund benefit payments and anticipates making
approximately $196,000 in additional contributions during 2004.

`Three Months Ended September 30,    Nine Months Ended September 30,
                                               --------------------------------    -------------------------------
                                                    2004             2003               2004             2003
                                               ---------------  ---------------    ---------------  --------------
  (In thousands)

Components of Net Periodic Benefit Cost:
Service Cost................................. $           106  $            82    $           318  $          240
Interest Cost................................             418              352              1,254           1,022
Amortization of Prior Service Credits........             303              231                909             694
Recognized Actuarial Loss....................             109              145                327             488
                                               ---------------  ---------------    ---------------  --------------
Net Periodic Benefit Cost.................... $           936  $           810    $         2,808  $        2,444
                                               ===============  ===============    ===============  ==============`

9. 	COMPREHENSIVE INCOME

The following table presents comprehensive
income for the periods indicated:

`Three Months Ended September 30,    Nine Months Ended September 30,
                                                     --------------------------------    -------------------------------
                                                           2004            2003                2004            2003
                                                     ---------------  ---------------    ---------------  -------------- 
  (In thousands)
Net Income ........................................ $        30,727  $        22,207    $        94,777  $       57,494
Change in Unrealized Holding Gain
  on Available-for-Sale Investments, net of tax....             719           (1,400)               367          (1,435)
Change in Minimum Pension Liability, net of tax....              --             (566)                --            (360)
                                                     ---------------  ---------------    ---------------  --------------
Comprehensive Income .............................. $        31,446  $        20,241    $        95,144  $       55,699
                                                     ===============  ===============    ===============  ==============`

13

10. 	SEGMENT REPORTING

The Company has two reportable
segments based on the products and services offered:  managed care and corporate
operations, and military health services operations. The managed care and corporate operations segment
includes managed health care services provided through an HMO, managed indemnity
plans, third-party administrative services programs for employer-funded health
benefit plans and self-insured workers' compensation plans, multi-specialty
medical groups, workers' compensation administration services, other ancillary
services and corporate operations.  The military health services segment
administers a managed care federal contract for the Department of Defense's
("DoD") TRICARE program in Region 1.  The military health services segment
includes an allocation of corporate overhead of $1.0 million per quarter for
direct and indirect services provided to Sierra Military Health Services, LLC
("SMHS").

SMHS completed the fifth year of a five-year contract in May
2003.  SMHS then operated under a negotiated contract extension period, which
ended August 31, 2004.  The new contractor became operational on September 1,
2004 and the new contract superseded the remainder of the Company's current
TRICARE Region 1 contract.  On September 1, 2004, SMHS commenced a six-month
phase-out of operations at prices previously negotiated with the DoD.  SMHS does
not meet the definition of discontinued operations since the Company does not
have plans to dispose of the operations before the phase-out is complete.

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

14

`Managed Care   Military Health
                                               and Corporate      Services
                                                Operations       Operations         Total
                                              ---------------  ---------------  --------------
  (In thousands)                                                                              
Three Months Ended September 30, 2004                                                         
Medical Premiums............................ $       288,485  $            --  $      288,485
Military Contract Revenues..................              --           85,983          85,983
Professional Fees...........................           8,705               --           8,705
Investment and Other Revenues...............           9,839              268          10,107
                                              ---------------  ---------------  --------------
   Total Revenue............................ $       307,029  $        86,251  $      393,280
                                              ===============  ===============  ==============

Segment Operating Profit.................... $        38,314  $        10,421  $       48,735
Interest Expense............................          (1,218)              (3)         (1,221)
Other Income (Expense), Net.................             (54)               5             (49)
                                              ---------------  ---------------  --------------
Income from Continuing Operations
   Before Income Taxes...................... $        37,042  $        10,423  $       47,465
                                              ===============  ===============  ==============
                                                                                              
Three Months Ended September 30, 2003                                                         
Medical Premiums............................ $       242,875  $            --  $      242,875
Military Contract Revenues..................              --          132,788         132,788
Professional Fees...........................           8,984               --           8,984
Investment and Other Revenues...............           3,979              611           4,590
                                              ---------------  ---------------  --------------
   Total Revenue............................ $       255,838  $       133,399  $      389,237
                                              ===============  ===============  ==============

Segment Operating Profit.................... $        30,745  $         4,433  $       35,178
Interest Expense............................          (1,228)             (67)         (1,295)
Other Income (Expense), Net.................              56               44             100
                                              ---------------  ---------------  --------------
Income from Continuing Operations
   Before Income Taxes...................... $        29,573  $         4,410  $       33,983
                                              ===============  ===============  ==============
                                                                                              
Nine Months Ended September 30, 2004                                                          
Medical Premiums............................ $       834,584  $            --  $      834,584
Military Contract Revenues..................              --          354,312         354,312
Professional Fees...........................          26,268               --          26,268
Investment and Other Revenues...............          26,346            1,199          27,545
                                              ---------------  ---------------  --------------
   Total Revenue............................ $       887,198  $       355,511  $    1,242,709
                                              ===============  ===============  ==============

Segment Operating Profit.................... $       109,598  $        42,464  $      152,062
Interest Expense............................          (3,515)             (46)         (3,561)
Other Income (Expense), Net.................             146              (32)            114
                                              ---------------  ---------------  --------------
Income from Continuing Operations
   Before Income Taxes...................... $       106,229  $        42,386  $      148,615
                                              ===============  ===============  ==============
                                                                                              
Nine Months Ended September 30, 2003                                                          
Medical Premiums............................ $       717,097  $            --  $      717,097
Military Contract Revenues..................              --          352,632         352,632
Professional Fees...........................          27,403               --          27,403
Investment and Other Revenues...............          13,138            1,442          14,580
                                              ---------------  ---------------  --------------
   Total Revenue............................ $       757,638  $       354,074  $    1,111,712
                                              ===============  ===============  ==============

Segment Operating Profit.................... $        83,784  $         9,965  $       93,749
Interest Expense............................          (4,248)            (197)         (4,445)
Other Income (Expense), Net.................            (649)             406            (243)
                                              ---------------  ---------------  --------------
Income from Continuing Operations
   Before Income Taxes...................... $        78,887  $        10,174  $       89,061
                                              ===============  ===============  ==============`

15

11. 	INVESTMENTS



Of the cash and cash equivalents and current investments
that total $305.8 million in the accompanying Consolidated Balance Sheet at
September 30, 2004, $195.8 million is limited for use only by the Company's
regulated subsidiaries.  Such amounts are available for transfer to Sierra from
the regulated subsidiaries only to the extent that they can be remitted in
accordance with terms of existing management agreements and by dividends, which
customarily must be approved by regulating state insurance departments.  The
remainder is available to Sierra on an unrestricted basis.



Investments consist primarily of U.S. Government and its
agencies' securities, municipal bonds, corporate bonds, securities and first
trust deed mortgage notes.  At September 30, 2004, approximately 80% of the
Company's investment portfolio is invested in U.S. Government and its agencies'
securities and municipal bonds.  All investments that have not been designated
as held-to-maturity are designated as available-for-sale and are stated at fair
value.  Fair value is estimated primarily from published market values at the
balance sheet date.  All non-restricted available-for-sale investments are
classified as current assets.    These investments are available for use in the
current operations regardless of contractual maturity dates.  Restricted
investments are classified as non-current assets. Realized gains and losses are
calculated using the specific identification method and are included in
investment and other revenues.  Unrealized holding gains and losses on
available-for-sale securities are included as a separate component of
stockholders' equity, net of income tax effects, until realized.



Investments that the Company has the intention and ability to
hold to maturity are stated at amortized cost and categorized as held-to-maturity.
All non-restricted investments designated as held-to-maturity are
classified as current assets if expected maturity is within one year of the
balance sheet date.  Otherwise, they are classified as long-term investments.
The Company's held-to-maturity investments consist of first trust deed mortgage
notes.  The Company does not believe any of its investments are impaired.

12. 	COMMITMENTS AND CONTINGENCIES

On March 15, 2004, SMHS entered into a lease assignment
agreement relative to one of its administrative locations.  The agreement
assigns the remainder of the lease term, which expires September 30, 2012.
Under the assignment, SMHS remains contingently liable should the new tenant not
perform under its obligation.  At September 30, 2004, the future lease payments
due under the lease agreement total $5.4 million.  SMHS did not record a
liability for its obligation under this agreement as the likelihood of non-
performance is considered remote at this time and SMHS would have the ability to
sublease or enter into another assignment arrangement if required to perform on
this obligation.

Although the Company is not a named defendant, the Company is
aware that it has been named as a co-conspirator in the class action lawsuit, In
Re: Managed Care Litigation: MDL No. 1334.  The following summary is based upon
information obtained from certain publicly filed documents.  Beginning in 1999,
a series of class action lawsuits were filed against most other major entities
in the health benefits business. A multi-district litigation panel has
consolidated most of these cases in the Southern District Court of Florida,
Miami division. The plaintiffs assert that the defendants improperly paid
providers' claims and "downcoded" their claims by paying lesser
amounts than they submitted. The complaint alleges, among other things, multiple
violations under the Racketeer Influenced and Corrupt Organizations Act, or
RICO, as well as various breaches of contract and violations of regulations
governing the timeliness of claim payments. The consolidated suits seek
injunctive, compensatory and equitable relief as well as restitution, costs,
fees and interest payments. Discovery commenced on September 30, 2002.  In

16

November 2002, the Eleventh Circuit Court granted the industry defendants'
petition to review the class certification order. That appeal is pending. On
April 7, 2003, the United States Supreme Court determined that the RICO claims
against certain defendants should be arbitrated. On September 15, 2003, the
district court granted in part and denied in part the industry defendants'
further motion to compel arbitration. Significantly, the court denied the
industry defendants' motion with respect to plaintiffs' derivative RICO claims.
On September 19, 2003, the industry defendants appealed the district court's
arbitration order to the Eleventh Circuit Court of Appeals. Discovery is ongoing
and a trial date has been set for March 14, 2005. In the meantime, two of the
defendants, Aetna Inc. and Cigna Corporation, have entered into settlement
agreements, which have been approved by the Court.

The Company is subject to other various claims and litigation
in the ordinary course of business.  Such litigation includes, but is not
limited to, claims of medical malpractice, claims for coverage or payment for
medical services rendered to HMO and other members and claims by providers for
payment for medical services rendered to HMO and other members.  Some litigation
may also include claims for punitive damages that are not covered by insurance.
These actions are in various stages of litigation and some may ultimately be
brought to trial.  With respect to certain pending actions, the Company
maintains commercial insurance coverage with varying deductibles for which the
Company maintains estimated reserves for its self-insured portion based upon its
current assessment of such litigation.  Due to recent unfavorable changes in the
commercial insurance market, the Company has, for certain risks, purchased
coverage with higher deductibles and lower limits of coverage.  In the opinion
of management, based on information presently available, the amount or range of
any potential loss cannot be reasonably estimated but the ultimate resolution of
these pending legal proceedings should not have a material adverse effect on the
Company's financial condition.

17

ITEM 2.

The following discussion and analysis provides
information which management believes is relevant for an assessment and
understanding of our consolidated financial condition and results of operations.
The discussion should be read in conjunction with our audited consolidated
financial statements and accompanying notes for the year ended December 31,
2003, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in our 2003 annual report on Form 10-K filed
with the Securities and Exchange Commission on March 5, 2004, and in conjunction
with our unaudited condensed consolidated financial statements and accompanying
notes for the three and nine month periods ended September 30, 2004 and 2003,
included in this Form 10-Q. The information contained below is subject to risk
factors. We urge the reader to review carefully the section "Risk Factors" in
Part 1, Item 1 of our 2003 annual report on Form 10-K for a more complete
discussion of the risks associated with an investment in our securities. See
"Note on Forward-Looking Statements and Risk Factors" under Part 1, Item 1 of
our 2003 annual report on Form 10-K.

This report on Form 10-Q contains "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933
and Section 21E of the Securities Exchange Act of 1934, both as amended.  The
forward-looking statements regarding our business and results of operations
should be considered by our stockholders or any reader of our business or
financial information along with the risk factors discussed in our 2003 annual
report on Form 10-K.  All statements other than statements of historical fact
are forward-looking statements for purposes of federal and state securities
laws. The cautionary statements are made pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, as amended,
and identify important factors that could cause our actual results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to us.  These forward-looking statements are generally
identified by their use of terms and phrases such as "anticipate,"
"believe," "continue," "could,"  "estimate,"
"expect,"  "hope,"  "intend,"  "may,"
"plan,"  "predict,"  "project,"
"seeks," "will," and other similar
terms and phrases, including all references to assumptions.

Although we believe that the expectations reflected in any of
our forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements. Readers are cautioned not to place undue reliance on these forward-looking
statements that speak only as of the date hereof. We undertake no
obligation to publish revised forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

Overview

Our continuing operations derive revenues from our health
maintenance organization, or HMO, and managed indemnity plans.  To a lesser
extent, we also derive revenues from professional fees (consisting primarily of
fees for providing health care services to non-members, co-payment fees received
from members and ancillary products), and investment and other revenue
(consisting of fees for workers' compensation third party administration,
utilization management services and ancillary products).

We also receive revenues from our military health services
subsidiary, which completed its contract extension August 31, 2004.  We will
continue to receive substantially reduced revenues from this subsidiary through
a six-month phase-out of operations at prices previously negotiated with the
Department of Defense, or DoD.

Our principal expenses consist of medical expenses, military
contract expenses, and general and administrative expenses.  Medical expenses
represent capitation fees and other fee-for-service payments paid to independent
contracted physicians, hospitals and other health care providers to cover members,

18

pharmacy costs, as well as the aggregate expenses to operate and manage
our wholly-owned multi-specialty medical group and other provider subsidiaries.
As a provider of health care management services, we seek to positively affect
quality of care and expenses by contracting with physicians, hospitals and other
health care providers at negotiated price levels, by adopting quality assurance
programs, monitoring and managing utilization of physician and hospital services
and providing incentives to use cost-effective providers.  Military contract
expenses represent payments to providers for health care services rendered under
the TRICARE program, as well as administrative costs to pay claims and operate
the military health care subsidiary.  General and administrative expenses
generally represent operational costs other than those directly associated with
the delivery of health care services and military contract services.

Executive Summary

Continuing
Operations



Our military health services operations segment represented
28.6% of our operating revenues and 27.9% of our operating income from
continuing operations for the nine months ended September 30, 2004.  This
segment had operating income of $42.5 million for the nine months ended
September 30, 2004, compared to $10.0 million for the same period in 2003.  For
2003, excluding TRICARE Next Generation, or T-Nex, bid related expenses, the
military health services operations segment would have had operating income of
$18.1 million.   The improvement over 2003 is primarily due to change orders and
final bid price adjustments on option periods three and four of the TRICARE
Region 1 contract.  The impact on income before taxes of the change orders,
final bid price adjustments for option periods three and four and other
contractual settlements was an increase of $16.3 million.



We were not awarded the T-Nex North Region contract and our appeal
to the United States General Accounting Office was denied in December 2003.
Health care services under our current TRICARE contract for Region 1 ended on
August 31, 2004.  On September 1, 2004, we entered a six-month phase-out period
at substantially reduced revenues and earnings.



For the nine months ended September 30, 2004, compared to
September 30, 2003, investment and other revenues increased from $14.6 million
to $27.5 million, an increase of approximately $13.0 million or 88.9%.  Of the
increase, $10.1 million is related to the services we are providing relative to
our sales agreement for the workers' compensation insurance operations,
beginning April 1, 2004.  For a further description of this agreement, see below
in the discussion of investment and other revenues.



For the nine months ended September 30, 2004, compared to
September 30, 2003, our general and administrative, or G&A, expenses
increased from $101.8 million to $126.9 million, an increase of approximately
$25.1 million or 24.6%.  Of the increase, $10.1 million is for the cost to
provide services related to the sale of the workers' compensation insurance
operations referred to above.  The remaining

19

increase is due to increases in payroll and benefits, premium taxes, brokers' fees and legal expenses.  As a
percentage of total operating revenues, G&A expenses were 10.2% for 2004,
compared to 9.2% in 2003.  As a percentage of medical premium revenue, G&A
expenses were 15.2% for 2004, compared to 14.2% for 2003.  Excluding the
services relative to our sales agreement for the workers' compensation insurance
operations described above, our 2004 G&A expenses, as a percentage of total
operating revenues and medical premium revenue for the nine month period, were
9.4% and 14.0%, respectively.



We had cash flows from operating activities of continuing
operations for the nine months ended September 30, 2004, of $96.8 million
compared to $68.0 million for 2003.  We received eight monthly payments from the
Centers for Medicare and Medicaid Services during the first three quarters of
2004 and 2003 as the January payments were received at the end of December.
When the first quarters are adjusted to reflect three monthly payments from the
Centers for Medicare and Medicaid Services, or CMS, the cash flow from
continuing operations would be $129.7 million in 2004 and $97.9 million in 2003.
We believe presenting this adjustment for the timing of the CMS payments is
useful for making a nine-month period-to-period comparison of our cash flow from
continuing operations.  The improvement in cash flows from continuing operations
over 2003 is primarily attributable to cash from earnings.



Discontinued Operations.  On January 15, 2003, we
announced that we were exploring strategic alternatives to dispose of CII
Financial, Inc., or CII.  Sierra's Board of Directors authorized the sale of the
operations on December 31, 2002.  Accordingly, beginning in the fourth quarter
of 2002, we reclassified our workers' compensation insurance business as
discontinued operations.



On November 25, 2003, we announced that we had reached an
agreement to sell California Indemnity Insurance Company, or Cal Indemnity, and
its subsidiaries.  In the fourth quarter of 2003, we recorded a charge of $15.6
million, gross and net of tax, to write down the investment in Cal Indemnity to
its estimated net sales proceeds.



On March 31, 2004, we completed the sale of CII's subsidiary,
Cal Indemnity, which was CII's only significant asset.  Cal Indemnity's
subsidiaries, which were included in the sale, are Commercial Casualty Insurance
Company, Sierra Insurance Company of Texas, and CII Insurance Company.



We received $14.2 million in cash at the closing, which was
subsequently reduced by $2.7 million based on the audited closing date balance
sheet.  The $2.7 million adjustment is expected to be repaid to us over the next
few years.  The transaction also includes a note receivable of $62.0 million,
plus accrued interest, payable to us in January 2010. The note receivable can be
increased or decreased depending on favorable or adverse claim and expense
development from the date of closing through December 31, 2009, and other
offsets and additions based on certain agreements between the parties.  The note
receivable can be increased on a dollar for dollar basis for the first $15
million in positive loss reserve development and $.50 per dollar on any positive
development in excess of $15 million.  The note receivable can also be decreased
on a dollar for dollar basis for the first $58 million in adverse loss
development.  To date, no valuation adjustment has been recorded on the note.



Certain other contractual assets and liabilities were
recorded in conjunction with the sale including a current asset of $15.8 million
and a non-current asset of $7.1 million that represent Cal Indemnity's
unallocated loss adjustment expense, or ULAE, reserves to be paid to Sierra.
Offsetting these assets was a current liability of $15.8 million and a non-current
liability of $7.1 million, which represent the contractual services to
be performed by Sierra.  Including the cash proceeds, net assets of $68.3
million were recorded in conjunction with the sale of Cal Indemnity.



A third-party claims administrator was engaged to administer
claims for a period of 15 years. Under the terms of this agreement, the
administrator will provide certain claims services for Cal Indemnity and its

20

subsidiaries. Sierra will be responsible for this administrator's costs and for
providing certain transition services for varying terms to Cal Indemnity.  The
purchaser of Cal Indemnity will pay Sierra for these costs from an account
consisting of the ULAE reserves and accrued liabilities as of the closing, a
percentage of premiums earned after the closing, plus accrued interest on the
ULAE reserves.  In addition, Sierra is providing workers' compensation managed
care services at market rates to Cal Indemnity.



RESULTS OF OPERATIONS, THREE MONTHS ENDED SEPTEMBER 30, 2004,
COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003



Total Operating Revenues increased approximately
1.0% from $389.2 million to $393.3 million.

The change in operating revenues was comprised of the
following:

- An increase in medical premiums of $45.6
million
- A decrease in military contract revenues of $46.8
million
- A decrease in professional fees of $279,000
- An increase in investment and other revenues of $5.5
million

Medical Premiums from our HMO and managed
indemnity insurance subsidiaries increased from $242.9 million to $288.5
million, an increase of $45.6 million or 18.8%. The increase in premium revenue
reflects a 12.3% increase in commercial member months (the number of months
individuals are enrolled in a plan), a 32.9% increase in Medicaid member months
and a 5.2% increase in Medicare member months.  The growth in Medicare member
months contributes significantly to the increase in premium revenues as the
Medicare per member premium rates are more than three times higher than the
average commercial premium rate.  Of the 32.9% increase in Medicaid member
months, 19.8% is due to the expansion of our Medicaid service area to Reno
beginning February 2004.

HMO and POS premium rates for renewing commercial groups increased over
9% while the overall recorded per member per month revenue increase, including new and continuing
business, was approximately 5%, net of changes in benefits.  We did not receive a Medicaid rate
increase in 2004 or 2003.  The basic Medicare rate increase received for 2004 was approximately 2.2%.
In addition, we received a Medicare rate increase on March 1, 2004, of over 15% due to the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003, or MMA, as
described below.

In December 2003, President Bush signed MMA into law, which,
among other changes to Medicare, alters the Medicare+Choice program. Under the
MMA, Medicare+Choice plans are renamed Medicare Advantage plans and received
increased funding from CMS starting March 2004.  Because of the way in which the
increased funding was calculated, both our non-Social HMO Medicare Advantage
benefit plans and our Social HMO benefit plans received the increased funding.
MMA increased our Medicare premium rates by over 15% starting March 1, 2004.
The increased funding must be used in one or more of the following ways: to
reduce beneficiary premiums; to reduce beneficiary cost sharing; to enhance
benefits; to be placed into a benefit stabilization fund; to retain providers or
expand the provider network as long as the benefit stabilization fund or
enhancement does not result in increased premiums, increased cost sharing or
reduced benefits.  We are using the additional funding to enhance various plan
benefits, including a reduction in the amount of Medicare Part B premium that
our members pay to the federal government, and to stabilize our provider
network.

Effective January 2004, CMS adopted a new risk adjustment
payment methodology for Medicare beneficiaries who are enrolled in managed care
programs, including the Social HMO. In addition, CMS  revised the payment
factors for the Social HMO members to include a frailty adjuster that uses
measures of functional impairment to predict expenditures.  Under the new
payment methodology, we are being paid 90% based on the previous payment
approach and 10% based on the new approach for 2004.  For

21

2004, excluding the effects of MMA, the new payment methodology reduced our rate increase by 60
basis points.  The Social HMO program has been administratively extended by CMS
through 2007.  For 2005, 2006 and 2007, we will be paid 70%, 50% and 25% based
on the previous payment approach and 30%, 50% and 75%, based on the new
approach, respectively.  The extension of the Social HMO program will serve as a
transition plan so that we can convert to a Medicare Advantage plan in 2008.

Continued medical premium revenue growth is principally
dependent upon continued enrollment in our products and upon competitive and
regulatory factors.

Our commercial membership increased from 199,400 at September
30, 2003 to 222,200 at September 30, 2004.  Our commercial member retention was
over 95% for our third quarter 2004 renewals, which represent approximately 26%
of our total commercial membership.  The increase in commercial membership
during the third quarter of 2004 is primarily attributed to in-case growth,
movement from self-insured plans to our commercial products and new
accounts.



Military Contract Revenues decreased from $132.8
million to $86.0 million, a decrease of $46.8 million or 35.2%. The decreased
revenue is the result of Sierra Military Health Services LLC, or SMHS completing
its final month of health care operations under the TRICARE contract on August
31, 2004.



SMHS completed the fifth year of a five-year contract in May
2003.  SMHS then operated under a negotiated contract extension period, which
ended August 31, 2004.  The new contractor became operational in Region 1 on
September 1, 2004 and the new contract superseded the remainder of our current
TRICARE Region 1 contract.  On September 1, 2004, SMHS commenced a six-month
phase-out of operations at prices previously negotiated with the DoD.  SMHS does
not meet the definition of discontinued operations since we do not have plans to
dispose of the operations before the phase-out is complete.



In March 2004, SMHS entered into a definitive agreement with
the new T-Nex North Region Contractor to provide certain transition services and
to sell certain portions of its TRICARE business, including its provider network
and certain other assets.  The value of the transaction is up to $4 million with
the final value contingent on SMHS' operational performance through August 2004.
SMHS recorded revenue of approximately $2.0 million pursuant to this agreement
in the third quarter of 2004.



Professional Fees decreased from $9.0 million to $8.7
million, a decrease of $279,000 or 3.1% primarily as a result of the outsourcing
of our eye care unit in late 2003.  The outsourcing of these services reduced
both our revenue and corresponding expenses.



Investment and Other Revenues increased from $4.6
million to $10.1 million, an increase of $5.5 million or 120.2%.  The primary
increase in investment and other revenues is in administrative services revenue
due to the services we are providing relative to our sales agreement for the
workers' compensation insurance operations, beginning April 1, 2004.  On March
31, 2004, we completed the sale of the workers' compensation insurance
operations and we have been engaged to administer claims through a third party
claims administrator for a period of fifteen years as well as perform certain
transition and managed care services.  Total revenue associated with these
services for the three months ended September 30, 2004 was $4.3 million.  The
cost to provide these services is reflected in our general and administrative
expenses.  In addition, we recorded accrued interest of $620,000 on the $62.0
million note receivable.

Medical Expenses increased from $191.2 million
to $224.2 million, an increase of $33.0 million or 17.2%.  The increase is due
primarily to our increased membership, which is in part offset by a lower
medical care ratio.  This ratio, which is medical expenses as a percentage of
medical premiums and professional fees, decreased from 75.9% to 75.4%.  The
favorable decrease in our medical care ratio is

22

due primarily to premium increases in excess of cost increases.  The number of days in claims payable,
which is the medical claims payable balance divided by the average medical
expense per day for the period, at September 30, 2004, was 47.5 compared to 49.5
at September 30, 2003.  In an effort to further improve service and customer
relations with our medical providers, we have enhanced several claims processes,
including electronic data interchange and optical character recognition, to
reduce the time required to make claim payments.  The decrease in days in claims
payable is primarily a result of these enhancements.

We contract with hospitals, physicians and other independent contracted
providers of health care under capitated or discounted fee-for-service
arrangements, including hospital per diems, to provide medical care services to
members.  Capitated providers are at risk for a portion of the cost of medical
care services provided to our members in the relevant geographic areas; however,
we are ultimately responsible for the provision of services to our members
should the capitated provider be unable to provide the contracted services.  We
incurred capitation expenses with non-affiliated providers of $29.0 million and
$26.1 million, or 12.9% and 13.7%, of our total medical expenses for 2004 and
2003, respectively.



Military Contract Expenses decreased from $129.0
million to $75.8 million, a decrease of $53.1 million or 41.2%. The decrease is
consistent with the decrease in revenues discussed previously and includes T-Nex
bid related costs of $3.8 million in 2003.  Included in our military contract
expenses for both periods is an allocation of corporate overhead of $1.0 million
per quarter for direct and indirect services provided to SMHS.



Health care delivery expenses consist primarily of costs to
provide managed health care services to eligible beneficiaries in accordance
with Sierra's TRICARE contract through August 31, 2004.  Under the contract,
SMHS provided health care services to 710,000 eligible individuals of active
duty military personnel, military retirees under the age of 65 and dependents of
military retirees through a network of approximately 50,300 health care
providers and certain other subcontractor partnerships.  Also included in
military contract expenses are costs incurred to perform specific administrative
services, such as health care appointment scheduling, enrollment, medical and
network management services as well as health care advice line services, and
other administrative functions of the military health care subsidiary. These
administrative services were performed for active duty personnel and family
members as well as retired military families.



General and Administrative Expenses increased
from $33.8 million to $44.5 million, an increase of approximately $10.7 million
or 31.5%.  The primary increase in G&A expenses is the $4.3 million to
provide services relative to our sales agreement for the workers' compensation
insurance operations as discussed above.  The remaining increases in G&A
expenses are primarily due to increases in payroll and benefits and brokers'
fees.  As a percentage of revenues, G&A expenses were 11.3% for 2004,
compared to 8.7% in 2003.   As a percentage of medical premium revenue, G&A
expenses were 15.4% for 2004, compared to 13.9% for 2003.  Excluding the
services relative to our sales agreement for the workers' compensation insurance
operations described above, our 2004 G&A expenses, as a percentage of total
operating revenues and medical premium revenue for the three month period, were
10.4% and 14.0%, respectively.



Interest Expense decreased from $1.3 million to
$1.2 million, a decrease of $74,000 or 5.7%.  The decrease is due to costs
incurred relative to the senior convertible debentures in 2003.  We incurred a
facility fee of 0.375% on our revolving credit facility through September 30,
2004.  Our revolving credit facility amendment on October 19, 2004 will reduce
that fee to 0.3%.



Other Income (Expense), Net resulted in expense of
$49,000 for 2004 compared to income of $100,000 for 2003.  The expense in 2004
was primarily related to the loss on sale of certain assets.

23



Provision for Income Taxes was recorded at $16.7
million for 2004 compared to $11.8 million for 2003. The effective tax rate for
2004 was 35.3% compared to 34.7% for 2003. Our effective tax rate is greater
than the statutory rate due to state income taxes and other non-deductible
expenses.



Discontinued Operations consist of our Texas HMO
health care operations and the CII workers' compensation operations. The net
income from discontinued operations for 2003 was approximately $30,000.



Discontinued Texas HMO health care operations. There is
very little activity remaining relative to our discontinued Texas operations and
there was no income or loss for the current period.  We have discontinued paying
most Texas claims, as our evidence of coverage requires that all claims must be
settled within 18 months of the time of service.



Discontinued CII workers' compensation operations.  On
March 31, 2004, we completed the sale of CII's subsidiary, Cal Indemnity.  The
activity related to this transaction, subsequent to the March 31, 2004 closing
date, has been discussed above.

The sale of Cal Indemnity includes a note receivable of $62.0
million, plus accrued interest, payable in January 2010. The note receivable can
be increased or decreased depending on favorable or adverse claim and expense
development from the date of closing through December 31, 2009, and other
offsets and additions based on certain agreements between the parties.  No
adjustment to the note was recorded in the quarter.  Interest accrues quarterly
on the note at 4.0% per annum.



RESULTS OF OPERATIONS, NINE MONTHS ENDED SEPTEMBER 30, 2004,
COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2003

Total Operating Revenues increased approximately
11.8% from $1.11 billion to $1.24 billion.

The change in operating revenues was comprised of the
following:

- An increase in medical premiums of $117.5
million
- An increase in military contract revenues of $1.7
million
- A decrease in professional fees of $1.1 million
- An increase in investment and other revenues of $13.0
million



Medical Premiums from our HMO and managed
indemnity insurance subsidiaries increased from $717.1 million to $834.6
million, an increase of $117.5 million or 16.4%. The increase in premium revenue
reflects an 11.7% increase in commercial member months (the number of months
individuals are enrolled in a plan), a 5.7% increase in Medicare member months
and a 29.3% increase in Medicaid member months.  The growth in Medicare member
months contributes significantly to the increase in premium revenues as the
Medicare per member premium rates are more than three times higher than the
average commercial premium rate.

HMO and POS premium rates for renewing commercial groups
increased approximately 7% while the overall recorded per member per month
revenue increase, including new and continuing business, was approximately 4%,
net of changes in benefits.  We did not receive a Medicaid rate increase in 2004
or 2003.  The basic Medicare rate increase received in 2004 was approximately
2.2%.  Our overall Medicare rate increase was approximately 14.2% due primarily
to the impact of the MMA, as previously described, which started in March
2004.

24

Our commercial membership increased from 199,400 at September
30, 2003 to 222,200 at September 30, 2004.  Our commercial member retention was
over 95% on renewals through September 30, 2004, which represents approximately
78% of our total commercial membership.

Military Contract Revenues increased from
$352.6 million to $354.3 million, an increase of $1.7 million or 0.5%.  Revenue
increases were the result of increased health care bid revenue consistent with
the terms of SMHS' negotiated contract extension period along with incremental
change order revenues and final bid price adjustments on option periods three
and four.  These revenue increases were partially offset by eight months of
health care delivery in 2004 compared to nine months in 2003.  The final bid
price adjustments resulted in revenue increases of approximately $6.1 million
for option period three (June 1, 2000 to May 31, 2001), which is 3.4% of the
final revenue settlement amount for that period and $4.3 million for option
period four (June 1, 2001 to May 31, 2002), which is 2.3% of the final revenue
settlement amount for that period.  The impact on income before taxes of the
final bid price adjustments for option periods three and four was an increase of
$6.6 million.  The total impact on income before taxes of the change orders, bid
price adjustments and other contractual settlements was an increase of $16.3
million.  Offsetting these increases is one less month of revenue under the
contract, which ended August 31, 2004, as previously described.



In March 2004, SMHS entered into a definitive agreement with
the new T-Nex North Region Contractor to provide certain transition services and
to sell certain portions of its TRICARE business, including its provider network
and certain other assets.  The value of the transaction is up to $4 million with
the final value contingent on SMHS' operational performance through August 2004.
SMHS has recorded revenue of approximately $2.8 million pursuant to this
agreement during 2004.



Professional Fees decreased from $27.4 million to
$26.3 million, a decrease of $1.1 million, or 4.1% primarily as a result of the
outsourcing of our eye care unit in late 2003.  The outsourcing of these
services reduced both our revenue and corresponding expenses.



Investment and Other Revenues increased from $14.6
million to $27.5 million, an increase of $13.0 million or 88.9%.  The primary
increase in investment and other revenues is in administrative services revenue
due to the services we are providing relative to our sales agreement for the
workers' compensation insurance operations, beginning April 1, 2004.  On March
31, 2004, we completed the sale of the workers' compensation insurance
operations and we have been engaged to administer claims through a third party
claims administrator for a period of fifteen years as well as perform certain
transition and managed care services.  Total revenue associated with these
services for 2004 was $10.1 million.  The cost to provide these services is
reflected in our general and administrative expenses.  The remaining increase in
investment and other revenues is due primarily to higher average invested
balances.



Medical Expenses increased from $572.0 million to
$650.7 million, an increase of $78.7 million or 13.8%.  The increase is due
primarily to our increased membership, which is in part offset by a lower
medical care ratio.  This ratio, which is medical expenses as a percentage of
medical premiums and professional fees, decreased from 76.8% to 75.6%.  The
favorable decrease in our medical care ratio is due primarily to premium
increases in excess of cost increases.  We incurred capitation expenses with
non-affiliated providers of $85.1 million and $75.2 million, or 13.1% and 13.1%,
of our total medical expenses for the nine months ended September 30, 2004 and
2003, respectively.



Military Contract Expenses decreased from $344.1 million to $313.0
million, a decrease of $31.1 million or 9.0%.  The decreased expenses are the
result of SMHS completing its final month of health care operations under the
TRICARE contract in August.  In addition, the 2004 contract expenses included
final bid price adjustments on option periods three and four of the TRICARE
Region 1 contract.  The final

25

adjustments resulted in a contract expense increase of approximately $1.9 million for option period three, which is 0.9% of
the final contract expense settlement amount for that period and a contract
expense increase of $1.9 million for option period four, which is 0.8 % of the
final contract expense settlement
amount for that period.  There were no final settlements of bid price adjustments in 2003, however, 2003 includes T-Nex
related costs of $8.1 million. Included in our military contract expenses for
both periods is an allocation of corporate overhead of $1.0 million per quarter
for direct and indirect services provided to SMHS.

General and Administrative Expenses increased
from $101.8 million to $126.9 million, an increase of approximately $25.1
million or 24.6%. The primary increase in G&A expenses is the $10.1 million
to provide services relative to our sales agreement for the workers'
compensation insurance operations as discussed above.  The remaining increases
in G&A expenses are primarily due to increases in payroll and benefits,
premium taxes, and brokers' fees.  As a percentage of revenues, G&A expenses
were 10.2% for 2004, compared to 9.2% in 2003.  As a percentage of medical
premium revenue, G&A expenses were 15.2% for 2004, compared to 14.2% for
2003.  Excluding the services relative to our sales agreement for the workers'
compensation insurance operations described above, our 2004 G&A expenses, as
a percentage of total operating revenues and medical premium revenue for the
nine month period, were 9.4% and 14.0%, respectively.



Interest Expense decreased from $4.4 million to
$3.6 million, a decrease of approximately $900,000 or 19.9%.  The decrease was
primarily due to the write off of the remaining deferred financing fees on our
amended and restated credit facility of approximately $800,000 in 2003.



Other Income (Expense), Net resulted in income of
$114,000 for 2004 compared to expense of approximately $243,000 for 2003.  The
expense in 2003 was primarily related to the loss on sale of certain assets.



Provision for Income Taxes was recorded at $53.4
million for 2004 compared to $30.9 million for 2003. The effective tax rate for
2004 was 35.9% compared to 34.7% for 2003. Our effective tax rate is higher than
the statutory rate due primarily to state income taxes and other non-deductible
expenses.



Discontinued Operations consist of our Texas HMO
health care operations and the CII workers' compensation operations. The net
loss from discontinued operations for 2004 was $486,000 compared to
approximately $621,000 for 2003.  The Texas HMO health care operations had net
income of $196,000 for 2004, which was offset by a net loss on the CII workers'
compensation operations of $682,000.



Discontinued Texas HMO health care operations. The income
from the Texas HMO health care operations for 2004 is the result of favorable
development in the medical claim liabilities and legal reserves.



Discontinued CII workers' compensation operations.  On
March 31, 2004, we completed the sale of CII's subsidiary, Cal Indemnity.  Our
Condensed Consolidated Statement of Income for the nine months ended September
30, 2004 reflects the activity of the discontinued operations through the disposal date, March 31,
2004.  Any future activity related to this disposal will be
reflected in continuing operations as previously discussed.



The discontinued workers' compensation operations for 2004
had a net loss of $682,000 compared to a loss of $3.9 million for 2003.  Net
earned premiums decreased by $78.5 million or 80.5% and investment and other
revenue decreased by $7.6 million or 85.5% as the 2004 results include activity
through March 31, 2004.  Expenses decreased in the CII workers' compensation
operations by $91.5 million or 80.7% due to the overall decrease in
premiums.

26



LIQUIDITY AND CAPITAL RESOURCES

We had cash flows from
operating activities for continuing operations of $96.8 million for the nine
months ended September 30, 2004 compared to $68.0 million in 2003.  We received
eight monthly CMS payments during the first nine months of 2004 and 2003 as the
January payments were received at the end of December.  When the first quarters
are adjusted to reflect three monthly payments from CMS, the cash flow from
continuing operations would be $129.7 million in 2004 and $97.9 million in 2003.
We believe presenting this adjustment for the timing of the CMS payments is
useful for making a nine-month period-to-period comparison of our cash flow from
continuing operations.  We used the majority of the cash flow for the repurchase
of the Company's common stock.  The improvement in cash flows from continuing
operations over 2003 is primarily attributable to cash from earnings.



We expect that the loss of the T-Nex contract will adversely
affect our cash flow from operations in the fourth quarter of 2004
through the first half of 2005.  During the phase-out period, we expect that
SMHS will use $20.0 million to $25.0 million of its cash, as the payout of the
remaining liabilities will exceed SMHS' accounts receivable and other non-cash
asset balances.



Net cash used for investing activities of continuing
operations during 2004 included $19.6 million in capital expenditures associated
with clinical expansion, continued implementation of new computer systems,
leasehold improvements on facilities, furniture and equipment and other capital
purchases to support our growth.  The primary expenditures during the third
quarter were for two separate parcels of land for future clinics totaling $8.7
million. The net cash change in investments for the year was a decrease in
investments of $74.8 million as investments were converted to cash equivalents
and used to repurchase the Company's common stock.



Net cash used for financing activities of continuing
operations during 2004 included borrowing on our revolving credit facility of
$10.0 million offset by payments of $1.5 million on other debt.  Proceeds from
the issuance of stock in connection with stock plans were $22.7 million and cash
of $112.3 million was used to repurchase Sierra common stock.



Discontinued operations provided cash of $1.9 million in
2004, compared to cash used of $25.0 million in 2003. Cash provided in 2004 was
primarily the result of the sale of Cal Indemnity.



Sierra Debentures



In March 2003, we issued $115.0 million aggregate
principal amount of 21⁄4% senior convertible debentures due March 15, 2023.  The
debentures pay interest, which is due semi-annually on March 15 and September 15
of each year.  Each $1,000 principal amount of debentures is convertible, at the
option of the holders, into 54.6747 shares of Sierra Health Services, Inc.,
common stock prior to March 15, 2023 if (i) the market price of our common stock
for at least 20 trading days in a period of 30 consecutive trading days ending
on the last trading day of the preceding fiscal quarter exceeds 120% of the
conversion price per share of our common stock; (ii) the debentures are called
for redemption; (iii) there is an event of default with respect to the
debentures; or (iv) specified corporate transactions have occurred.  The
conversion rate is subject to certain adjustments.  This conversion rate
initially represents a conversion price of $18.29 per share.  Holders of the
debentures may require us to repurchase all or a portion of their debentures on
March 15 in 2008, 2013 and 2018 or upon certain corporate events including a
change in control.  In either case, we may choose to pay the purchase price of
such debentures in cash or common stock or a combination of cash and common
stock.  The debentures can

27

be redeemed by us for cash beginning on or after March 20, 2008.

Sierra used the net proceeds of the offering to repay the
$39.0 million outstanding under the then existing
credit facility and to contribute $35.0 million to SMHS.  The $35.0 million contribution to SMHS was
subsequently repaid to Sierra in February 2004.  Sierra also used $19.9 million
of the proceeds to purchase 1.6 million shares of Sierra's common stock under
our repurchase program. The remainder of the net proceeds were used for working
capital and general corporate purposes including additional share
repurchases.



Revolving Credit
Facility



On March 3, 2003, we
entered into a $65.0 million revolving credit facility, which replaced our
amended and restated credit facility.  Interest on the facility was initially
LIBOR plus 2.25% and has been LIBOR plus 2.00% since the third quarter of 2003.
The facility was set to expire on April 30, 2006.  Effective October 19, 2004,
the facility has been amended to extend the maturity of the facility to December
31, 2009, increase the availability to $100.0 million and reduce the interest to
LIBOR plus 1.5% based on current ratios.  The facility is available for general
corporate purposes.  As of September 30, 2004, the Company has drawn $10.0
million on this facility.



The credit facility is secured by guarantees by certain of
our subsidiaries and a first priority perfected security interest in (i) all of
the capital stock of each of our unregulated, material domestic subsidiaries
(direct or indirect) as well as all of the capital stock of certain regulated,
material domestic subsidiaries; and (ii) all other present and future assets and
properties of ours and those of our subsidiaries that guarantee our credit
agreement obligations (including, without limitation, accounts receivable,
inventory, real property, equipment, contracts, trademarks, copyrights, patents,
license rights and general intangibles) subject, in each case, to the exclusion
of the capital stock of CII and certain other exclusions.



The revolving credit facility has covenants that limit our
ability and the ability of our subsidiaries to dispose of assets, incur
indebtedness, incur other liens, make investments, loans or advances, make
acquisitions, engage in mergers or consolidations, make capital expenditures and
otherwise restrict certain corporate activities.  Per the most recent
amendment, based on us exceeding a certain covenant ratio requirement, our
ability to pay dividends, repurchase our common stock and prepay other debt is
unlimited provided that we can still maintain the required ratios after such
transaction or any borrowing incurred as a result of such transaction.  In
addition, we are required to comply with specified financial ratios as set forth
in the credit agreement.  We believe that we are in compliance with all
covenants of the credit agreement.



Sierra Share Repurchases

From January 1, 2004 through
September 30, 2004, we purchased 2.9 million shares of our common stock, in the
open market or negotiated transactions, for $112.3 million at an average cost
per share of $38.47.  During the quarter ended September 30, 2004, we purchased
705,000 shares of our common stock, in the open market or negotiated
transactions, for $29.5 million at an average cost per share of $41.87.  Based
on approval by our Board of Directors on May 20, 2004, we currently have $43.0
million available for share repurchases.  Our revolving credit facility, as
amended, currently allows for unlimited stock repurchases.  We have not
repurchased any shares subsequent to September 30, 2004 through October 21, 2004.



Included in the repurchases
for the first quarter of 2004 are 500,000 shares we purchased from our CEO, at
$32.00 per share, for a total of $16.0 million.  The closing price of our common
stock on the date of the transaction, February 11, 2004, was $32.35.  Included
in the repurchases for the second quarter of 2004 are an additional 500,000
shares we purchased from our CEO, at $43.20 per share, for a total of $21.6

28

million.  The closing price of our common stock on the date of the transaction,
May 27, 2004, was $43.25.  The independent directors of our Board of Directors
approved both of the purchases.

Statutory Capital and Deposit Requirements

Our HMO and insurance
subsidiaries are required by state regulatory agencies to maintain certain
deposits and must also meet certain net worth and reserve requirements.  The HMO
and insurance subsidiaries, including the discontinued operations, had
restricted assets on deposit in various states totaling $16.8 million at
September 30, 2004. The HMO and insurance subsidiaries must also meet
requirements to maintain minimum stockholders' equity, on a statutory basis, as
well as minimum risk-based capital requirements, which are determined annually.
In conjunction with the exit from the Texas HMO health care market, the Texas
Department of Insurance approved a plan of withdrawal and Texas Health Choice,
L.C., is now required to maintain deposits of $1.5 million and net worth of at
least $3.5 million. We believe we are in material compliance with our regulatory
requirements.



Of the $196.0 million in
cash and cash equivalents held at September 30, 2004, including discontinued
operations, $2.0 million was held by discontinued operations and $122.0 million
was designated for use only by the regulated subsidiaries.  Amounts are
available for transfer to the holding company from the HMO and insurance
subsidiaries only to the extent that they can be remitted in accordance with the
terms of existing management agreements and by dividends. The holding company
will not receive dividends from its regulated subsidiaries if such dividend
payment would cause violation of statutory net worth and reserve
requirements.

Obligations and Commitments

The following schedule represents our obligations and
commitments for long-term debt, capital leases and operating leases at September
30, 2004.  The amounts presented below include all future payments associated
with each obligation including interest expense.

`Long-Term   Capital   Operating
                                              Debt      Leases     Leases      Total
                                            ---------  ---------  ---------  ---------
  (In thousands)

Continuing Operations
------------------------
Payments due within 12 months............. $   2,588  $     115  $  19,063  $  21,766
Payments due in 13 to 36 months...........    15,175        231     35,297     50,703
Payments due in 37 to 60 months...........     5,175        123     33,265     38,563
Payments due in more than 60 months.......   149,931        100    101,977    252,008
                                            ---------  ---------  ---------  ---------
     Total Continuing Operations.......... $ 172,869  $     569  $ 189,602  $ 363,040
                                            =========  =========  =========  =========
Discontinued Operations
------------------------
Payments due within 12 months............. $      --  $     235  $      --  $     235
Payments due in 13 to 36 months...........        --         --         --         --
Payments due in 37 to 60 months...........        --         --         --         --
Payments due in more than 60 months.......        --         --         --         --
                                            ---------  ---------  ---------  ---------
     Total Discontinued Operations........ $      --  $     235  $      --  $     235
                                            =========  =========  =========  =========`

Other

The 2004 planned expenditures are primarily for a new medical
clinic, the purchase of computer hardware and software, furniture and equipment
and other normal capital requirements.  Our liquidity needs over the next 12
months will primarily be for the capital items noted above and the phase-out of
the military operations.  We believe that our existing working capital,
operating cash flow and, if necessary,

29

equipment leasing, divestitures of certain non-core assets and amounts available under our credit facility should
be sufficient to fund our capital expenditures and debt service.  Additionally,
subject to unanticipated cash requirements, we believe that our existing working
capital and operating cash flow should enable us to meet our liquidity needs on
a long-term basis.

Inflation

Health care costs continue to rise at a rate faster than the
Consumer Price Index.  We use various strategies to mitigate the negative
effects of health care cost inflation, including setting commercial premiums
based on our anticipated health care costs, risk-sharing arrangements with our
various health care providers and other health care cost containment measures
including member co-payments.  There can be no assurance, however, that in the
future, our ability to manage medical costs will not be negatively impacted by
items such as technological advances, competitive pressures, applicable
regulations, increases in pharmacy costs, utilization changes and catastrophic
items, which could, in turn, result in medical cost increases equaling or
exceeding premium increases.

Government Regulation

Our business, offering health care
coverage, health care management services and, to a lesser extent, the delivery
of medical services, is heavily regulated at both the federal and state levels.

Government regulation of health care coverage products and
services is a dynamic area of law that varies from jurisdiction to jurisdiction.
Amendments to existing laws and regulations are continually being considered and
interpretation of the existing laws and rules changes from time to time.
Regulatory agencies generally exercise broad discretion in interpreting laws and
promulgating regulations to enforce their interpretations.

While we are unable to predict what legislative or regulatory
changes may occur or the impact of any particular change, our operations and
financial results could be negatively affected by any legislative or regulatory
requirements.  For example, any proposals to eliminate or reduce the Employee
Retirement Income Security Act, or ERISA, which regulates insured and self-
insured health care coverage plans offered by employers, to eliminate or reduce
the pre-emption of state laws that would increase litigation exposure, affect
underwriting practices, limit rate increases, require new or additional benefits
or affect contracting arrangements (including proposals to require HMOs and PPOs
to accept any health care provider willing to abide by an HMO's or PPO's
contract terms or commission arrangements) may have a material adverse effect on
our business.  The continued consideration and enactment of "anti-managed
care" laws and regulations by federal and state bodies may make it more
difficult for us to manage medical costs and may adversely affect financial
results.

In addition to changes in existing laws and regulations, we
are subject to audits, investigations and enforcement actions.  These include,
but are not limited to, possible government actions relating to ERISA, the
Federal Employees Health Benefit Plan, federal and state fraud and abuse laws
and laws relating to utilization management and the delivery and payment of
health care.  In addition, our Medicare business is subject to Medicare
regulations promulgated by CMS.  Violation of government laws and regulations
may result in an assessment of damages, civil or criminal fines or penalties, or
other sanctions, including exclusion from participation in government programs.
In addition, disclosure of any adverse investigation or audit results or
sanctions could negatively affect our reputation in various markets and make it
more difficult for us to sell our products and services.

In addition to the items described above, we urge you to
review carefully the section "Risk Factors" in Part 1, Item 1 of our
2003 Form 10-K for a more complete discussion of the risks associated with an

30

investment in our securities.  See "Note on Forward-Looking Statements and
Risk Factors" in Part 1, Item 1.

Critical Accounting Policies and Estimates

Our consolidated financial
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America.  In preparing these financial
statements, we are required to make judgments, assumptions and estimates, which
we believe are reasonable and prudent based on the available facts and
circumstances.  These judgments, assumptions and estimates affect certain of our
revenues and expenses and their related balance sheet accounts and in disclosing
our contingent assets and liabilities.  Our most significant accounting
estimates are for our premium allowance, the liability for medical claims
payable, military contract revenues and expenses, investment impairment,
litigation and legal accruals and deferred tax assets and liabilities. We base
our assumptions and estimates primarily on historical experience and trends and
factor in known and projected trends.  On an on-going basis, we re-evaluate our
selection of assumptions and the method of calculating our estimates.  Actual
future results, however, may materially differ from our calculated estimates and
this difference would be reported in our then current operations.

For a more detailed description of our critical accounting
policies and estimates, see Part II, Item 7 of our 2003 annual report on Form
10-K.  As of September 30, 2004, our critical accounting policies have not
changed from those described on our annual report on Form 10-K.  For a more
extensive discussion of our accounting policies, see Note 2, Summary of
Significant Accounting Policies, in the Notes to the Consolidated Financial
Statements in our 2003 annual report on Form 10-K filed on March 5, 2004.

Membership

`Number of Members at September 30,
                                           ----------------------------------
                                                 2004              2003
                                           ----------------  ----------------
HMO
  Commercial.............................          222,200           199,400
  Medicare...............................           53,000            50,400
  Medicaid...............................           49,100            38,800
Managed Indemnity........................           25,600            23,700
Medicare Supplement......................           16,600            17,900
Administrative Services..................          186,600           191,800
                                           ----------------  ----------------
  Subtotal...............................          553,100           522,000
TRICARE Eligibles........................               --           704,300
                                           ----------------  ----------------
Total Members............................          553,100         1,226,300
                                           ================  ================`

31

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK

At September 30, 2004, we had unrealized holding losses
on available for sale investments of $112,000, net of tax, compared to
unrealized holding losses of $479,000, net of tax, at December 31, 2003.  We
believe that changes in market interest rates, resulting in unrealized holding
gains or losses, should not have a material impact on future earnings or cash
flows, as it is unlikely that we would need or choose to substantially liquidate
our investment portfolio.



At September 30, 2004, we had outstanding $115.0 million in
aggregate principal amount of our 21⁄4% senior convertible debentures due March
15, 2023.  The debentures are fixed rate, and therefore, the interest expense on
the debentures will not be impacted by future interest rate fluctuations.  The
interest rate on our revolving credit facility is currently LIBOR plus 1.5%.  At
September 30, 2004, we have $10.0 million outstanding on this facility.



ITEM 4.
CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



The Company's management, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of the Company's disclosure controls and procedures as of the end
of the period covered by this report.  Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures as of the end of the period covered by this
report were designed and were functioning effectively to provide reasonable
assurance that the information required to be disclosed by the Company in
reports filed under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.  The Company believes that a system of controls, no matter how well
designed and operated, cannot provide absolute assurance that the objectives of
the controls are met, and no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within a
company have been detected.



Change in Internal Control over Financial Reporting

No change in the Company's
internal control over financial reporting occurred during the Company's most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.

32

SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
PART II.  OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS

Although Sierra is not a named defendant, we have been
notified that we have been named as a co-conspirator in the class action
lawsuit, In Re: Managed Care Litigation: MDL No. 1334.  The following summary is
based upon information obtained from certain publicly filed documents.
Beginning in 1999, a series of class action lawsuits were filed against most
other major entities in the health benefits business. A multi-district
litigation panel has consolidated most of these cases in the Southern District
Court of Florida, Miami division. The plaintiffs assert that the defendants
improperly paid providers' claims and "downcoded" their claims by
paying lesser amounts than they submitted. The complaint alleges, among other
things, multiple violations under the Racketeer Influenced and Corrupt
Organizations Act, or RICO, as well as various breaches of contract and
violations of regulations governing the timeliness of claim payments. The
consolidated suits seek injunctive, compensatory and equitable relief as well as
restitution, costs, fees and interest payments. Discovery commenced on September
30, 2002.  In November 2002, the Eleventh Circuit Court granted the industry
defendants' petition to review the class certification order. That appeal is
pending. On April 7, 2003, the United States Supreme Court determined that the
RICO claims against certain defendants should be arbitrated. On September 15,
2003, the district court granted in part and denied in part the industry
defendants' further motion to compel arbitration. Significantly, the court
denied the industry defendants' motion with respect to plaintiffs' derivative
RICO claims. On September 19, 2003, the industry defendants appealed the
district court's arbitration order to the Eleventh Circuit Court of Appeals.
Discovery is ongoing and a trial date has been set for March 14, 2005. In the
meantime, two of the defendants, Aetna Inc. and Cigna Corporation, have entered
into settlement agreements, which have been approved by the Court.

We are subject to other various claims and litigation in the
ordinary course of business.  Such litigation includes, but is not limited to,
claims of medical malpractice, claims for coverage or payment for medical
services rendered to HMO and other members and claims by providers for payment
for medical services rendered to HMO and other members.  Some litigation may
also include claims for punitive damages that are not covered by insurance.
These actions are in various stages of litigation and some may ultimately be
brought to trial.  With respect to certain pending actions, we maintain
commercial insurance coverage with varying deductibles for which we maintain
estimated reserves for our self-insured portion based upon our current
assessment of such litigation.  Due to recent unfavorable changes in the
commercial insurance market, we have, for certain risks, purchased coverage with
higher deductibles and lower limits of coverage.  In the opinion of management,
based on information presently available, the amount or range of any potential
loss cannot be reasonably estimated but the ultimate resolution of these pending
legal proceedings should not have a material adverse effect on our financial
condition.

33

ITEM 2.	UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS

(c)    Below, is a summary of stock repurchases for the nine
months ended September 30, 2004.  See Note 4 of our Notes to Condensed
Consolidated Financial Statements for information regarding our stock repurchase
plan.

`Total number      Maximum number   Approximate doll
                                                                            of shares purchased   of shares that   value of shares
(In thousands, except per share data)        Total number        Average    as part of publicly     may yet be     that may yet be
                                              of shares        price paid      announced plan    purchased under   purchased under
                 Period                      repurchased (1)    per share        or program        the plan (2)      the plan (3)
-------------------------------------------  -------------    ------------- -------------------- ----------------  ----------------
Beginning shares available to be purchased                                                                 2,270                --
January 1, 2004 - January 31, 2004                     --               --                   --            2,270                --
February 1, 2004 - February 29, 2004 (4)              663    $       31.86                  663            1,607                --
March 1, 2004 - March 31, 2004                        317            34.19                  317            1,290                --
April 1, 2004 - April 30, 2004                         16            34.91                   16            1,274                --
May 1, 2004 - May 31, 2004                            590            39.20                  590              684 $          70,000
June 1, 2004 - June 30, 2004 (5)                      628            43.20                  628               56            70,000
July 1, 2004 - July 31, 2004                           95            43.46                   95               --            68,334
August 1, 2004 - August 31, 2004                      610            41.62                  610               --            42,963
September 1, 2004 - September 30, 2004                 --               --                   --               --            42,963`

1. Certain repurchases were made pursuant to a 10b-5
plan.
2. On October 28, 2003, the Company announced that its Board
of Directors had authorized the Company to purchase an additional 3.0 million
shares of its common stock in addition to the 4.6 million shares that had
previously been authorized. The repurchase program has no stated expiration
date.  Through December 31, 2003, the Company had purchased 5.3 million shares
leaving 2.3 million shares authorized to be repurchased.
3. On May 20, 2004, the Company's Board of Directors
authorized the Company to purchase an additional $70.0 million of its common
stock.  The repurchase program has no stated expiration date, and  commenced
after the previously authorized share repurchase was completed.
4. Includes 500,000 shares the Company purchased from its
CEO at $32.00 per share.
5. Includes 500,000 shares the Company purchased from its
CEO at $43.20 per share.

ITEM 3.	DEFAULTS UPON SENIOR
SECURITIES

None

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

None

ITEM 5.	OTHER INFORMATION

None

ITEM
6.	EXHIBITS



|       |                                                                                                                       
|------ | ----------------------------------------------------------------------------------------------------------------------
|(10.5) | Sierra Health Services, Inc. Deferred Compensation Plan effective May 1, 1996, as Amended and Restated August 5, 2004.
|(31.1) | Rule 13a - 14(a) or 15d - 14(a) Certification of
Chief Executive Officer.                                             

34



|(31.2) | Rule 13a - 14(a) or 15d - 14(a) Certification of
Chief Financial Officer.                                                                            
|------ | -----------------------------------------------------------------------------------------------------------------------------------------------------
|(32.1) | Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Principal
Executive Officer.
|(32.2) | Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Principal
Financial Officer.



35

SIGNATURES

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



| | SIERRA HEALTH SERVICES, INC. 
Registrant 
By:/s/ Paul H. Palmer 
Paul H. Palmer
Senior Vice President of Finance, 
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: October 25, 2004

36