10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)
þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from           to           .

Commission file number 000-21949

PACIFICARE HEALTH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

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

5995 Plaza Drive, Cypress, California 90630

(Address of principal executive offices, including zip code)

(714) 952-1121

(Registrant’s telephone number, including area code)

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

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.01

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)    Yes þ         No o

Non-affiliates of the Registrant held approximately $1,833,500,000 of the aggregate market value of common stock on June 30, 2003.

There were approximately 85,682,000 shares of common stock outstanding on February 27, 2004.

The following sections of the definitive Proxy Statement for the 2004 Annual Meeting of Stockholders are incorporated by reference under Parts II and III of this Form 10-K:

1.	Board of Directors
2.	Director Compensation
3.	Executive Officers
4.	Section 16(a) Beneficial Ownership Reporting Compliance
5.	Activities of the Board of Directors and its Committees
6.	Audit Committee Report
7.	Code of Ethics
8.	Procedures for Stockholder Recommendations of Board Nominees and Stockholder Proposals
9.	Executive Compensation
10.	Principal Stockholders
11.	Equity-Based Instruments Held by Management
12.	Equity Compensation Plan Information
13.	Certain Relationships and Related Transactions
14.	Independent Auditor Fees

With the exception of the portions of the definitive Proxy Statement that are incorporated by reference under Parts II and III of this Form 10-K, the definitive Proxy Statement is not deemed filed as part of this Form 10-K.

PACIFICARE HEALTH SYSTEMS, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Year Ended December 31, 2003

		Page
PART I
Item 1.	Business		1
Item 2.	Properties		11
Item 3.	Legal Proceedings		11
Item 4.	Submission of Matters to a Vote of Security Holders		11
PART II
Item 5.	Market for the Company’s Common Equity and Related Stockholder Matters		12
Item 6.	Selected Financial Data		14
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		46
Item 8.	Consolidated Financial Statements and Supplementary Data		47
Item 9.	Changes in and Disagreements with Accountants and Accounting and Financial Disclosure		47
Item 9A.	Controls and Procedures		48
PART III
Item 10.	Directors and Executive Officers of the Registrant		49
Item 11.	Executive Compensation		49
Item 12.	Security Ownership of Certain Beneficial Owners and Management Related Stockholder Matters		49
Item 13.	Certain Relationships and Related Transactions		49
Item 14.	Principal Accounting Fees and Services		49
PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		50
EXHIBIT 3.04
EXHIBIT 4.06
EXHIBIT 10.10
EXHIBIT 21
EXHIBIT 10.30
EXHIBIT 10.35
EXHIBIT 10.36
EXHIBIT 14.1
EXHIBIT 21
EXHIBIT 23
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.01
EXHIBIT 32.02

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PART I

ITEM 1.     BUSINESS

Introduction

We offer managed care and other health insurance products to employer groups and Medicare beneficiaries primarily in eight Western states and Guam. Our commercial and senior plans are designed to deliver quality health care and customer service to members cost-effectively. These programs include health maintenance organizations, or HMOs, preferred provider organizations, or PPOs, and Medicare Supplement products. We also offer a variety of specialty managed care products and services that employees can purchase as a supplement to our basic commercial and senior medical plans or as stand-alone products. These products include pharmacy benefit management, or PBM, services, behavioral health services, group life and health insurance and dental and vision benefit plans. As of December 31, 2003, we had approximately 2.9 million HMO and other commercial and senior product members and approximately 9.4 million members in our PBM, dental and behavioral plans, including both members covered by our commercial or senior HMOs, and members who are unaffiliated with our HMOs.

We were formed in 1996 as a Delaware corporation and are the successor to a California corporation that was formed in 1983 and reincorporated as a Delaware corporation in 1985. Our principal executive offices are located at 5995 Plaza Drive, Cypress, California 90630, and our telephone number is (714) 952-1121.

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports that we file with the Securities and Exchange Commission, or SEC, are currently available free of charge to the general public through our website at www.pacificare.com. These reports are accessible on our website after being filed with the SEC. These reports are also available at the SEC’s public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.

This Annual Report on Form 10-K contains both historical and forward-looking information. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Cautionary Statements” for a description of a number of factors that could adversely affect our results.

Business Strategy

Our mission is to create long-term stockholder value as a consumer health organization committed to making people’s lives healthier and more secure. Our strategy to achieve this mission is to continue the innovative expansion of our health care services portfolio, increase membership in our commercial and specialty businesses, and maintain and grow our Medicare+Choice business. We intend to accomplish this by taking advantage of opportunities in some markets to compete with the standard government Medicare program for new members, and by aligning our organization to meet the financial, health and wellness needs of our members.

We believe that employers and consumers desire innovative health care products that provide flexible network benefit design and financing components. We are continuing to design and offer new products such as our self-directed health plan product, a low cost plan which offers incentives to consumers to help contain costs through a broad based PPO network, as well as tiered network products and value network products that allow consumers to make trade-offs based upon breadth of network, quality measures and costs.

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We operate one of the largest Medicare+Choice programs in the United States and we have used our long experience in working with seniors to operate our program cost-effectively in what was a declining Medicare funding environment. On December 8, 2003, the President signed the new Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or DIMA, into law. This law increases the Medicare+Choice reimbursement payment formula, creates a prescription drug discount card program in 2004-2005 and establishes a new Part D Medicare prescription drug benefit beginning in 2006. With the changes in Medicare funding, we expect to be able to improve our competitive position in Medicare+Choice beginning in 2004 for the following reasons:

•  Increased government funding under the newly enacted DIMA legislation allows us to improve previously reduced benefits and reduce member premiums, co-payments and deductibles;

•  Enhanced benefits, such as prescription drugs and lower out-of-pocket payments, should also make our Medicare+Choice HMO more competitive with the government’s traditional Medicare program. We already offer prescription drug coverage that will not be available under traditional Medicare until 2006; and

•  We are well positioned to establish a greater market presence due to our long standing commitment to the Medicare+Choice market even during times when adequate funding may not have been available.

Products

We have developed products and services in order to meet the needs of our commercial and senior customers. In developing our products and marketing plans, we take into account the differing needs of our customers and believe that we create cost-effective, quality health care service options.

Commercial Products

Our commercial HMO and PPO products may be offered on a stand-alone basis or may be bundled with our specialty products and services, including PBM, behavioral health services, group life and health insurance products, and dental and vision services, providing employer groups and individuals with more benefit options from a single source and the ability to design tailored benefit programs. We also sell our specialty products and services on a stand-alone basis to unaffiliated health plans and employer groups.

Our HMO plans provide health care benefits to commercial members through a defined provider network in which members typically pay a fixed copayment for services accessed. We have a broad network that as of December 31, 2003 included approximately 700 hospitals and 63,000 primary care and specialty physicians.

Our PPO network supplements our existing HMO network with additional health care providers and generally provides members with a broad selection of providers in any given geographic area. Additionally, access is extended to health care providers located outside of a given geographic area through out-of-network benefits that allow choice beyond the organized PPO network in exchange for reduced coverage or higher coinsurance or copayments. Our PPO products provide members open access to network providers, with no primary care physician coordinating care and simplified medical management practices.

We target a variety of plan sponsors including employer groups and other purchasing coalitions, as well as state and federal government agencies. We offer both HMO and PPO products in a broad spectrum of customer segments ranging from individuals and small groups to large employers. We also have contracts with the United States Office of Personnel Management, or OPM, to provide HMO services to members under the Federal Employee Health Benefit Program, or FEHBP, for federal employees, annuitants and their dependents.

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As of December 31, 2003, we had approximately 2 million commercial HMO numbers and over 182,000 enrollees in our PPO products.

Specialty Products

We use our existing employer group and senior relationships to offer our specialty products and services in conjunction with our commercial and senior products. These specialty products and services include PBM, behavioral health services, group life and health insurance products, and dental and vision services. In addition, we sell our specialty products and services to unaffiliated health plans, union trusts, third party administrators and employer groups.

Prescription Solutions®. Prescription Solutions offered integrated PBM services (including mail order pharmacy services) to approximately 5 million people, including approximately 682,000 seniors, as of December 31, 2003. Prescription Solutions offers a broad range of innovative programs, products and services designed to enhance clinical outcomes with appropriate financial results for employers and members.

We believe Prescription Solutions’ strength lies in its ability to influence medical outcomes and reduce overall health care costs by focusing on appropriate prescription drug use. For example, through its formulary management program, Prescription Solutions uses lists of physician-recommended drugs in different therapeutic classes that have been reviewed for safety, efficacy and value to ensure that drugs prescribed are the lowest cost option among equally effective alternatives. Prescription Solutions operates independently of pharmaceutical or retail drug organizations, which allows it to focus primarily on improving clinical outcomes.

We believe that Prescription Solutions’ mail order capabilities also differentiate us from our health insurance competitors who do not have captive PBMs. Prescription Solutions operates an 84,000 square foot, fully automated facility in Carlsbad, California, which we believe can support our projected internal growth for the foreseeable future. Prescription Solutions aggressively promotes mail order pharmacy services as a convenient and cost-effective service for our members.

Behavioral Health Services. We provide behavioral health care services including managed mental health, employee assistance, care management and chemical dependency benefit programs. As of December 31, 2003, we provided these behavioral health care services to approximately 3.7 million affiliated and unaffiliated members through our provider network. Managed mental health and chemical dependency services are offered as a standard part of most of our commercial health plans and are sold in conjunction with our other commercial and Medicare products, and are sold on a stand-alone basis to unaffiliated health plans and employer groups.

Dental and Vision Services. We provide a broad range of dental and vision insurance and discount services. Plans include HMO, PPO and indemnity fee-for-service dental, and PPO vision benefits to individuals and employer groups. We also provide dental services to seniors through Secure Horizons. We provide a complete range of dental and vision product offerings for small, mid-size and large employers, regardless of their existing medical plan offering. As of December 31, 2003, we provided these dental and vision services to approximately 720,000 affiliated and unaffiliated members.

Group Life and Health Insurance. We are licensed to issue life and health care insurance in 40 states, including each of the states where our HMOs operate, the District of Columbia and Guam. By marketing our commercial health care product line in conjunction with supplemental insurance products, we are able to offer multi-option health and financial benefit programs. Other supplementary benefits offered to employer groups include basic life insurance, group term life insurance, indemnity dental and indemnity behavioral health benefits. We also offer life, accidental death and dismemberment and short-term and long-term disability products to our commercial

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employer groups under a private label arrangement with Continental Assurance Company, Continental Casualty Company and CNA Group Life Assurance Company.

Senior Products

We offer eligible Medicare beneficiaries access to Medicare+Choice and Medicare Supplement products through our Secure Horizons programs.

Medicare+Choice HMO. We are one of the largest Medicare+Choice HMOs in the United States as measured by membership with approximately 682,000 members as of December 31, 2003. Medicare is a federal program that provides persons age 65 and over and some disabled persons under the age of 65 a variety of hospital and medical insurance benefits. Most individuals eligible for Medicare are entitled to receive inpatient hospital care under Part A without the payment of any premium, but are required to pay a premium to the federal government, which is adjusted annually, to be eligible for physician care and other services under Part B. Even though they participate in both Part A and Part B of the traditional Medicare program, beneficiaries are still required to pay out-of-pocket deductibles and coinsurance.

We contract with the Centers for Medicare and Medicaid Services, or CMS, under the Medicare+Choice program to provide health insurance coverage in exchange for a fixed monthly payment per member that varies based on the geographic areas in which the members reside. Individuals who elect to participate in the Medicare+Choice program are relieved of the obligation to pay some or all of the deductible or coinsurance amounts and may receive benefits greater than the government program such as pharmacy drug coverage, but are generally required to use the services provided by the HMO exclusively and are required to pay a Part B premium to the Medicare program. These individuals also may be required to pay a monthly premium to the HMO.

Medicare Supplement Products. We are licensed in 22 states to offer group and individual senior supplement products and have licenses pending in ten states. These products are designed to fill gaps left by traditional Medicare coverage. For example, the Individual Supplement products pay for hospital deductibles, physician copayments and coinsurance for which an individual enrolled in the traditional Medicare program would otherwise be responsible. The Senior Supplement product provides employer groups with similar coverage options for their Medicare eligible retirees. The Secure Horizons Prescription Advantages Plan has no annual deductible, no annual maximums, and provides unlimited coverage for approximately 400 generic medications covering many chronic conditions and ailments. This plan offers discounts on most other drugs depending on how the drugs are purchased.

Physician and Hospital Relationships

Contracting Arrangements with Physicians and Hospitals

We maintain a network of qualified physicians, hospitals and other health care providers in every geographic area where we offer managed care products and services. Our contracting strategy is to base the type of contract utilized on our assessment of the underlying structure and strengths of the medical communities within the applicable geographic markets. In HMO markets with physicians and hospitals that we believe have the necessary infrastructure and financial strength to accept delegation for certain administrative services and prepayment for health care services, we may elect to use delegation and capitation contracts. In other circumstances, we may elect to use fee-for-service or other shared risk arrangements. Most of our physician and hospital contracts have a one-year term, however, we may also enter into multiple-year contracts with physician groups and hospitals to enhance network stability or provide greater predictability of future health care costs. Contracts for our PPO products are all fee-for-service.

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Our provider contracting processes include analysis and modeling of underlying cost and utilization assumptions. Through these processes, we continually seek to identify strategies to better manage health care costs. We also focus on provider consultation and management tools, including thorough data reporting and financial analysis of expected performance of our contracts.

Underwriting

In establishing premium rates for our health care plans, we use underwriting criteria based upon our accumulated actuarial data, with adjustments for factors such as the physicians and hospitals utilized, claims experience, member demographic mix and industry differences. Predictive models using pharmacy data and health status are also used to identify health care costs that are likely to emerge. Our underwriting practices are filed and approved in states requiring those actions and in all states in which we operate in the individual, small group and Medicare Supplement markets. Because our members are in multiple states, our underwriting practices, especially in the individual, small group and Medicare Supplement markets, are subject to a variety of legislative and regulatory requirements and restrictions unique to the state in which a member resides.

Medical Management

Our profitability depends, in part, on our ability to control health care costs while providing quality care. Our medical management staff consists of doctors and nurses who monitor the medical treatment of our members in need of hospital and specialist care. In some cases, our medical managers are located on-site at some of our key hospitals.

Our medical management programs include:

•  Chronic Disease Management. We have created a wide range of disease management programs designed to provide specialized services to members with chronic disease states including among others, congestive heart failure, end-stage renal disease, chronic obstructive pulmonary disease and cancer. These programs focus on prevention, member education, and evidence-based care to improve our members’ lifestyle and reduce unnecessary or preventable hospitalization costs. These programs may be developed and managed internally or we may contract with third parties who have specialized expertise or technology within a specific diagnostic category;

•  Precertification of Admission. In the precertification stage, our medical managers verify that requests for hospitalization and specified health care procedures meet specific clinical criteria and are approved in advance;

•  Concurrent Review. Once our member has been admitted to the hospital for care, our on-site or telephonic medical managers provide administrative oversight of the hospitalization process. Our medical managers also monitor the discharge process and coordinate any outpatient services needed by the patient, including skilled nursing facility, home nursing care and rehabilitation therapy. We also contract with hospitalists to assist us in managing the care of hospitalized patients. Hospitalists are physicians who specialize in coordinating the care of patients during their stay in a hospital, including oversight of patients in the emergency room, coordinating appropriate admissions and level of care (including intensive care when appropriate), coordinating consultations with subspecialists and ordering tests and procedures;

•  Retrospective Review. Our retrospective review process involves confirming our certifications of services provided to our members when our medical management staff has not been concurrently involved in the hospitalization of our members. This process can also occur when our members receive emergency care at an out-of-area hospital or when medical claims may be disputed; and

•  Case Management. Our case management department provides multi-disciplinary coordination of personalized care for patients with complex medical conditions, including arranging access to

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appropriate medical and social services, to improve the health status and manage health care costs for these patients; in addition, specific case management programs have been implemented for the “frail member” and those with terminal illnesses.

Marketing

Our commercial products are marketed under the PacifiCare brand, which we believe has a reputation for quality and value. Our senior products are marketed under the Secure Horizons name, which we believe is one of the premier service marks in health care services among seniors in our markets in the western United States. We market our specialty products under the PacifiCare brand and our third-party unaffiliated PBM services under our Prescription Solutions service mark.

Marketing to our large group commercial customers is typically a two-step process in which we first market to the employer, then market directly to employees, primarily during their open enrollment periods, once the employer has selected our plan. For many of our larger commercial accounts the open enrollment periods typically occur during the fourth quarter of the calendar year. For some employer groups, we are the exclusive provider of health care products for their employees on a full-replacement basis. We also offer individual commercial products directly to consumers.

We use various techniques to attract commercial members, including work site presentations, direct mail, medical group tours and local advertising. We also use television, radio, billboard and print media to market our programs to potential commercial members. Further, we utilize multiple distribution channels such as general agents, an on-line price quoting service, and insurance brokers and consultants who represent many employer groups. These brokers and consultants work directly with employers to recommend or design employee benefits packages and select carriers to provide these services.

We believe that our understanding of the senior population and our attention to customer service differentiates our Secure Horizons program from competing products. We market our Secure Horizons programs to Medicare beneficiaries and caregivers for Medicare beneficiaries primarily through direct mail, telemarketing, our website, television, radio and community-based events with participating physician groups. Most Secure Horizons members enroll directly in a plan, generally without the involvement of insurance brokers, except when enrolling as part of an employer group retiree offering. We also have a national broker channel for some of our individual Medicare Supplement and Prescription Advantages products.

Management Information Systems and Claims Processing

We use computer-based information systems for various purposes, including e-commerce, marketing and sales tracking, underwriting, billing, claims processing, medical management, medical cost and utilization trending, financial and management accounting, reporting, planning and analysis. These systems also support on-line customer service functions, provider and member administration functions, and support our tracking and extensive analyses of health care costs and outcome data.

We have established corporate goals to have our information technology, or IT, systems operate under one business platform and improve operational efficiency. Simplification and integration of the systems servicing our business are important components of controlling health care and administrative expenses and improving member satisfaction. To accomplish these goals, we have outsourced data processing operations and maintenance of older software applications so we can focus internally on new technologies. Additionally, we are opportunistically insourcing data center operations and software development as part of our long-term sourcing strategy.

We use these computer-based information systems as an important component of claims processing. We receive medical claims from physicians and hospitals for services to our members. Claims are

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reviewed to determine member eligibility, the quantity and kind of services performed and whether services were authorized, then adjudicated against pricing, claims rules and benefits. To help ensure timely and accurate payments, we regularly review reports on inventory levels and claims statistics that focus on claims turn-around time and accuracy of payment processing. We also perform a variety of claim audits and cost containment programs. We have significantly increased the number and percentage of claims processed electronically to improve claims turnaround times and accuracy.

Government Regulation

General HMO and Indemnity Regulation

We are subject to extensive federal and state regulations that govern the scope of benefits provided to our members. These regulations can vary significantly from jurisdiction to jurisdiction. Broad latitude is given to the agencies administering these regulations. Changes in applicable laws and regulations are continually being considered, and the interpretation of existing laws and rules also may change periodically. Existing and future laws and rules could force to change how we do business, restrict revenue and enrollment growth, increase our health care and administrative costs and capital requirements and increase our liability in federal and state courts for coverage determinations, contract interpretation and other actions. We must obtain and maintain regulatory approvals to market many of our products, to increase prices for certain regulated products and to consummate acquisitions and dispositions of health plans.

We participate in federal, state and local government health care coverage programs. These programs generally are subject to frequent change, including changes that may reduce the number of persons enrolled or eligible, reduce the amount of reimbursement or payment levels, or increase our administrative or health care costs under such programs. Such changes have adversely affected our financial results and willingness to participate in such programs in the past and may do so in the future.

State legislatures and Congress continue to focus on health care issues. Bills and regulations at state and federal levels may affect certain aspects of our business, including:

•  increasing minimum capital or risk-based capital, or RBC, requirements;

•  mandating benefits and products;

•  restricting a health plan’s ability to limit coverage to medically necessary care;

•  reducing the reimbursement or payment levels for government funded programs;

•  imposing guidelines for pharmaceutical manufacturers that would cause pharmaceutical companies to restructure the financial terms of their business arrangements with PBMs, HMOs or other health plans;

•  patients’ bill of rights legislation at the state and federal level that would hold HMOs liable for medical malpractice;

•  limiting a health plan’s ability to capitate physicians and hospitals or delegate financial risk, utilization review, quality assurance or other medical decisions to our contracting physicians and hospitals;

•  restricting a health plan’s ability to select and terminate providers in our networks;

•  allowing independent physicians to collectively bargain with health plans on a number of issues, including financial compensation;

•  adding further restrictions and administrative requirements on the use, retention, transmission, processing, protection and disclosure of personally identifiable health information; and

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•  tightening time periods for the timely payment and administration of health care claims and imposing financial and other penalties for non-compliance.

Office of Personnel Management

We have commercial contracts with OPM to provide managed health care services to federal employees, annuitants and their dependents under FEHBP. Rather than negotiating rates with us, OPM requires us to provide the FEHBP with rates comparable to the rates charged to the two employer groups with enrollment closest in size to the FEHBP in the applicable community after making required adjustments. OPM further requires us to certify each year that its rates meet these requirements. Periodically, the Office of the Inspector General, or OIG, audits us to verify that the premiums charged are calculated and charged in compliance with these regulations and guidelines. OPM has the right to audit the premiums charged during any period for up to five years following the end of that contract year. The final resolution and settlement of audits have historically taken more than three years and as many as seven years. We have a formal compliance program to specifically address potential issues that may arise from the FEHBP rating process, to work with OPM to understand its interpretation of the rules and guidelines prior to completion of the rating process, to standardize the FEHBP rating process among all of our HMOs, and to help reduce the likelihood that future government audits will result in any significant findings.

Required Statutory Capital

By law, regulation and governmental policy, our HMO, indemnity and regulated specialty product subsidiaries, which we refer to as our regulated subsidiaries, are required to maintain minimum levels of statutory net worth. The minimum statutory net worth requirements differ by state and are generally based on a percentage of annualized premium revenue, a percentage of annualized health care costs or RBC requirements. The RBC requirements are based on guidelines established by the National Association of Insurance Commissioners, or NAIC. If adopted, the RBC requirements may be modified as each state legislature deems appropriate for that state. The RBC formula, based on asset risk, underwriting risk, credit risk, business risk and other factors, generates the authorized control level, or ACL, which represents the minimum amount of net worth believed to be required to support the regulated entity’s business. For states in which the RBC requirements have been adopted, the regulated entity typically must maintain the greater of the required ACL or the minimum statutory net worth requirement calculated pursuant to pre-RBC guidelines. As of December 31, 2003, the aggregate net worth of our regulated subsidiaries exceeded 300% of the aggregate ACL calculated under NAIC RBC guidelines. The amount of statutory capital in excess of state regulatory requirements was approximately $614 million as of December 31, 2003. In addition to the foregoing requirements, our regulated subsidiaries are subject to restrictions on their ability to make dividend payments, loans and other transfers of cash to the parent company.

The statutory framework for our regulated subsidiaries’ statutory net worth requirements may change over time. These subsidiaries are also subject to their state regulators’ overall oversight powers. Those regulators could require our subsidiaries to maintain minimum levels of statutory net worth in excess of the amount required under the applicable state laws if the regulators determine that maintaining such additional statutory net worth is in the best interest of our members.

Pharmacy Regulations

Our PBM business is subject to state and federal statutes and regulations governing the operation of pharmacies, labeling, packaging and repackaging of drug products, dispensing of controlled substances, disposal, advertising, security, recordkeeping and inventory control.

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Many states have laws and regulations that require out-of-state internet and mail-service pharmacies to register with, or be licensed by, the board of pharmacy or a similar regulatory body in the state. Other states generally permit the dispensing pharmacy to follow the laws of the state within which the dispensing pharmacy is located. Various other states, however, have enacted laws requiring, among other things, the hiring of a pharmacist licensed by that state or compliance with all laws of the states into which the out-of-state pharmacy dispenses medications, whether or not those laws conflict with the laws of the state in which the pharmacy is located. If these laws are applicable to us, they could restrict or prevent us from providing prescription internet or mail order in those states.

Other specific laws or regulations that may affect our PBM business include those that address any willing provider, contract limitations, benefit mandates, pharmacy management restrictions, limitations on price negotiations, changes in Medicaid “best price” rules, and the conduct of clinical trials.

Privacy Regulations

The use of individually identifiable data by our businesses is regulated at international, federal, state and local levels. These laws and rules are changed frequently by legislation or administrative interpretation. Various state laws address the use and maintenance of individually identifiable health data. Most are derived from the privacy provisions in the federal Gramm-Leach-Bliley Act and the Health Insurance Portability and Accountability Act of 1996, or HIPAA. HIPAA also imposes guidelines on our business associates (as this term is defined in the HIPAA regulations). Even though we provide for appropriate protections through our contracts with our business associates, we still have limited control over their actions and practices. Compliance with these proposals and new regulations may result in cost increases due to necessary systems changes, the development of new administrative processes, and the effects of potential noncompliance by our business associates. They also may impose further restrictions on our use of patient identifiable data that is housed in one or more of our administrative databases.

Risk Management

We maintain general liability, property, directors’ and officers’ liability and managed care errors and omissions, which includes medical malpractice, insurance coverage. Policies typically include varying and increasing levels of self-insured retention or deductibles that increase our risk of loss. We operate a wholly owned captive insurance company designed to assist us primarily in managing the risk of loss associated with our retained risk on errors and omissions claims and catastrophic medical claims. We require contracting physicians, physician groups and hospitals to maintain individual malpractice insurance coverage.

Competition

In offering HMOs, PPOs and related products, we compete with CIGNA Corporation, Aetna Inc., Health Net, Inc., WellPoint Health Networks Inc. and Anthem Inc., who are combining, other Blue Cross and Blue Shield plans and UnitedHealth Group Incorporated for membership from national employers. We also compete with regional HMOs and small group employers, which vary depending on the geographic market. Regional competitors include Kaiser Foundation Health Plan Inc., Health Net, Inc., WellPoint Health Networks Inc., Humana Inc., and the member companies of the Blue Cross and Blue Shield Association. We also offer a regional alternative for national employers who are willing to support multiple health plans to maintain plans that best suit the needs of employees within a specific region.

We are one of the largest Medicare+Choice health plans measured in terms of membership in the nation, both in absolute terms and as a percentage of overall membership, offering competitive advantages and economies of scale in the Medicare+Choice market. In 2002 and 2003, we reduced

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our benefits, raised member copays and deductibles, and replaced coverage of brand name prescription drugs with generic drugs in most of the counties where we participate in Medicare+Choice. This was in response to the rising health care costs of treating the senior population and the inadequate rate of increase in levels of Medicare reimbursement from the government. These changes caused members to leave our plans for competing plans or traditional Medicare coverage. Many competing HMO health plans also reduced their participation in the Medicare+Choice program and reduced benefits coverage.

Beginning in 2004, we expect to be able to improve our competitive position in Medicare+Choice for the following reasons:

•  Increased government funding under the newly enacted DIMA legislation allows us to improve previously reduced benefits and reduce member premiums, co-payments and deductibles;

•  Enhanced benefits, such as prescription drugs and lower out-of-pocket payments, should also make our Medicare+Choice HMO more competitive with the government’s traditional Medicare program. We already offer prescription drug coverage that will not be available under traditional Medicare until 2006; and

•  We are well positioned to establish a greater market presence due to our long standing commitment to the Medicare+Choice market even during times when adequate funding may not have been available.

Beginning in 2005, there is a greater risk that competition among private health plans for Medicare+Choice members could increase.

The Medicare Supplement product market is highly fragmented with few large competitors. Our primary competition in this market is the Medicare Supplement product marketed by the American Association of Retired Persons, or AARP, and underwritten by UnitedHealth Group Incorporated. We believe that our product offerings and distribution channels differentiate our Medicare Supplement products from competing products.

Prescription Solutions’ PBM services are sold as part of our commercial and Medicare products and on a stand-alone basis to unaffiliated health plans and employer groups. We believe our competitors include Medco Health Solutions Inc., MedImpact Healthcare Systems, Inc., Caremark Rx, Inc., Express Scripts Inc. and AdvancePCS. We believe because it is aligned with a managed care organization, Prescription Solutions differentiates itself from other pharmacy benefit organizations by managing prescription costs and outcomes for managed care organization members. Our mail order prescription drug service competes with national, regional and local pharmacies and other mail order prescription drug companies. Prescription Solutions also competes with firms offering prescription discount cards, such as large drugstore chains.

The managed behavioral health care industry is dominated by a few large companies, principally Magellan Health Services, Inc. and ValueOptions, Inc., as well as the behavioral health divisions of health insurers such as UnitedHealth Group Incorporated and CIGNA Corporation. Our ability to compete is affected by a limited national supply of providers, particularly psychiatrists and psychiatric hospital units. Our behavioral health subsidiary has a core competency in managing at-risk contracts, which we believe differentiates us competitively in states with mental health parity laws that mandate equal coverage for mental health benefits.

We believe that to retain our health plans’ competitive advantages we should continue to focus on developing additional products and services and eliminate or limit growth of unprofitable products. We believe that consumers want products and services that go beyond basic necessity, extending to

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areas such as lifestyle and wellness enhancing products. The factors that we believe give us competitive advantages are:

•  our existing market position in our geographic areas of operation;

•  our long-term operating experience in managed care;

•  our marketplace reputation with physicians, hospitals, members and employers;

•  a strong brand identity for PacifiCare, Secure Horizons and Prescription Solutions;

•  our benefit design and flexibility of features for employers;

•  our QUALITY INDEX® profile, which provides customers with certain provider performance quality measures; and

•  our emphasis on providing high quality customer service.

Intellectual Property

We own various federally registered trademarks, service marks and other trade names. Some of the more material marks we own include PacifiCare®, SecureHorizons®, Prescription Solutions® and QUALITY INDEX®. There is also a patent pending for certain methods used in creating our QUALITY INDEX®.

Employees

At February 27, 2004, we had approximately 7,700 full and part-time employees. None of our employees is presently covered by a collective bargaining agreement. We consider relations with our employees to be good and have never experienced any work stoppage.

ITEM 2.     PROPERTIES

As of December 31, 2003, we leased approximately 184,000 aggregate square feet of space for our principal corporate headquarters and executive offices in Cypress and Santa Ana, California. In connection with our operations, as of December 31, 2003, we leased approximately 1.7 million aggregate square feet for office space, subsidiary operations, customer service centers and space for computer facilities. Such space corresponds to areas in which our HMOs or specialty managed care products and services operate, or where we have satellite administrative offices. Our leases expire at various dates from 2004 through 2012.

In California and Guam, we own two buildings encompassing approximately 225,000 aggregate square feet of space primarily used for administrative operations. All of our facilities are in good working condition, are well maintained and are adequate for our present and currently anticipated needs. We believe that we can rent additional space at competitive rates when current leases expire, or if we need additional space.

ITEM 3.     LEGAL PROCEEDINGS

For information regarding our legal proceedings, see Note 13 of the Notes to Consolidated Financial Statements.

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

No matter was submitted to a vote of security holders during the three months ended December 31, 2003.

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PART II

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

On June 6, 2003, our common stock listing was transferred from the NASDAQ National Market under the symbol PHSY to the New York Stock Exchange (NYSE) under the symbol PHS.

On January 20, 2004, we effected a two-for-one stock split in the form of a stock dividend of one share of our common stock for every share of common stock outstanding to stockholders of record as of the close of business on January 7, 2004. All share price and per share data and numbers of common shares have been retroactively adjusted to reflect the stock split. See Note 6 of the Notes to Consolidated Financial Statements.

The following table indicates the high and low reported sale prices per share as furnished by the NYSE and NASDAQ.

	High		Low
Year ended December 31, 2002
First Quarter	$	11.67	$	7.30
Second Quarter	$	16.31	$	8.48
Third Quarter	$	13.33	$	9.85
Fourth Quarter	$	16.83	$	10.65
Year ended December 31, 2003
First Quarter	$	14.87	$	10.47
Second Quarter	$	25.99	$	11.38
Third Quarter	$	29.63	$	23.35
Fourth Quarter	$	34.20	$	24.17

We have never paid cash dividends on our common stock. We do not expect to declare cash dividends on our common stock in the future, retaining all earnings for business development. Any possible future dividends will depend on our earnings, financial condition, and regulatory requirements. If we decide to declare dividends on our common stock in the future, such dividends may only be made in compliance with our senior credit facility and our 10 3/4% senior notes.

As of February 27, 2004 there were 293 stockholders of record of our common stock.

We have $135 million in aggregate principal amount of 3% convertible subordinated debentures due in 2032 outstanding. The debentures are convertible into 6,428,566 shares of common stock under certain conditions, including satisfaction of a market price condition for our common stock, satisfaction of a trading price condition relating to the debentures, upon notice of redemption, or upon specified corporate transactions. Each $1,000 of the debentures is convertible into 47.619 shares of our common stock. The market price condition for conversion of the debentures is satisfied if the closing sale price of our common stock exceeds 110% of the conversion price (which is calculated at $23.10 per share) for the debentures for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of any fiscal quarter. In the event that the market price condition is satisfied during any fiscal quarter, the debentures are convertible, at the option of the holder, during the following fiscal quarter. The market price condition is evaluated each quarter to determine whether the debentures will be convertible at the option of the holder during the following fiscal quarter. During the fiscal year ended December 31, 2003, the market price condition described above was satisfied for the quarters ended September 30, 2003 and December 31, 2003. As a result, the debentures were convertible during the quarter ended December 31, 2003 and remain convertible at the option of the holder at any time during the quarter ended March 31, 2004. While no debentures

12

were converted as of December 31, 2003, they are considered common stock equivalents and are included in the calculation of weighted average shares outstanding on a diluted basis for the fourth quarter and fiscal year ended December 31, 2003.

Beginning in October 2007, we may redeem for cash all or any portion of the debentures, at a purchase price of 100% of the principal amount plus accrued interest, upon not less than 30 nor more than 60 days written notice to the holders. Beginning in October 2007, and in successive 5-year increments, our holders may require us to repurchase the debentures for cash at a repurchase price of 100% of the principal amount plus accrued interest. Our payment obligations under the debentures are subordinated to our senior indebtedness, and effectively subordinated to all indebtedness and other liabilities of our subsidiaries.

In November 2003, we issued 7.6 million shares of our common stock in a public offering. The net proceeds from the offering, approximately $200 million after underwriting fees, were used to redeem $175 million in principal of the company’s outstanding 10 3/4% senior notes. See Note 5 of the Notes to Consolidated Financial Statements.

With respect to information regarding our securities authorized for issuance under equity incentive plans, the information contained in the section entitled “Equity Compensation Plan Information” of our definitive Proxy Statement for the 2004 Annual Meeting of Stockholders is incorporated herein by reference.

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ITEM 6.     SELECTED FINANCIAL DATA

The following selected financial and operating data are derived from our audited consolidated financial statements. The selected financial and operating data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and also with “Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.”

Income Statement Data

		Year Ended December 31,
		2003			2002(2)			2001(3)			2000(4)			1999(5)
		(Amounts in thousands, except per-share data)
Operating revenue		$	11,008,511		$	11,156,502		$	11,843,972		$	11,576,298		$	10,073,140
Expenses:
	Health care services and other		9,065,794			9,485,701			10,367,657			9,913,657			8,368,690
	Selling, general and administrative expenses		1,452,542			1,370,160			1,288,374			1,286,790			1,181,773
	Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net		—			3,774			61,157			8,766			(2,233	)
Operating income			490,175			296,867			126,784			367,085			524,910
Interest expense, net			(100,531	)		(74,904	)		(70,282	)		(79,636	)		(43,001	)
Minority interest in consolidated subsidiary			—			—			—			637			—
Income before income taxes			389,644			221,963			56,502			288,086			481,909
Provision for income taxes			146,896			82,792			38,371			127,046			203,365
Income before cumulative effect of a change in accounting principle and extraordinary gain			242,748			139,171			18,131			161,040			278,544
Cumulative effect of a change in accounting principle(1)			—			(897,000	)		—			—			—
Extraordinary gain on early retirement of debt (less income taxes of $0.9 million)			—			—			875			—			—
Net income (loss)		$	242,748		$	(757,829	)	$	19,006		$	161,040		$	278,544
Basic earnings (loss) per share (1):
	Income before cumulative effect of a change in accounting principle and extraordinary gain	$	3.26		$	1.98		$	0.27		$	2.29		$	3.13
	Cumulative effect of a change in accounting principle		—			(12.73	)		—			—			—
	Extraordinary gain, net		—			—			0.01			—			—
	Basic earnings (loss)per share	$	3.26		$	(10.75	)	$	0.28		$	2.29		$	3.13
Diluted earnings (loss) per share (1):
	Income before cumulative effect of a change in accounting principle and extraordinary gain	$	3.04		$	1.98		$	0.26		$	2.29		$	3.11
	Cumulative effect of a change in accounting principle		—			(12.73	)		—			—			—
	Extraordinary gain, net		—			—			0.01			—			—
	Diluted earnings (loss) per share	$	3.04		$	(10.75	)	$	0.27		$	2.29		$	3.11
Operating Statistics
Fully-insured risk medical loss ratios:
	Consolidated		84.0	%		86.8	%		89.7	%		87.5	%		84.8	%
	Private — Commercial		84.0	%		87.1	%		89.3	%		85.1	%		81.7	%
	Private — Senior		63.4	%		53.5	%		79.7	%		—			—
	Private — Consolidated		83.7	%		86.7	%		89.2	%		85.1	%		81.7	%
	Government — Senior		84.2	%		86.9	%		90.1	%		89.4	%		86.9	%
	Government — Consolidated		84.2	%		86.9	%		90.1	%		89.4	%		86.9	%
Selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income)			13.3	%		12.4	%		11.0	%		11.2	%		11.8	%
Operating income as a percentage of operating revenue			4.5	%		2.7	%		1.1	%		3.2	%		5.2	%
Effective tax rate(6)			37.7	%		37.3	%		67.9	%		44.1	%		42.2	%

See footnotes following “Balance Sheet Data.”

Continued on next page

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Other Financial and Operating Data

	December 31,
	2003			2002			2001			2000			1999
	(Dollars in thousands)
Depreciation and amortization	$	66,621		$	73,884		$	148,704		$	130,563		$	118,097
Capital expenditures	$	52,271		$	59,274		$	77,301		$	105,256		$	66,211
Net cash flows provided by operating activities	$	414,130		$	242,379		$	38,923		$	631,236		$	569,698
Net cash flows (used in) provided by investing activities	$	(201,700	)	$	(278,137	)	$	(260,828	)	$	72,376		$	(250,859	)
Net cash flows provided by (used in) financing activities	$	34,303		$	9,688		$	(51,971	)	$	(301,041	)	$	(194,411	)
Membership Data
Commercial		2,202,900			2,361,900			2,520,400			3,061,200			2,728,300
Senior		709,200			776,100			959,500			1,057,200			1,014,600
Total HMO and other membership		2,912,100			3,138,000			3,479,900			4,118,400			3,742,900
Balance Sheet Data
Cash and equivalents	$	1,198,422		$	951,689		$	977,759		$	1,251,635		$	849,064
Marketable securities		1,359,720			1,195,517			1,062,353			864,013			999,194
Total assets		4,619,304			4,251,133			5,096,046			5,323,436			4,884,021
Medical claims and benefits payable		1,027,500			1,044,500			1,095,900			1,270,800			795,200
Long-term debt, due after one year		612,700			731,961			794,309			836,556			975,000
Stockholders’ equity		1,851,537			1,328,305			2,033,785			2,003,560			1,977,719

(1)	All applicable per-share amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004. See Note 6 of the Notes to Consolidated Financial Statements.
(2)	The 2002 results include impairment, disposition, restructuring, OPM and other net pretax charges totaling $3.8 million ($2.4 million or $0.03 diluted loss per share, net of tax). See Note 10 of the Notes to Consolidated Financial Statements. Operating income before net pretax charges as a percentage of operating revenue was 2.7%. The 2002 results include a cumulative effect of a change in accounting principle in connection with the goodwill impairment recognized upon the adoption of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, totaling $929 million ($897 million or $12.73 diluted loss per share, net of tax). See Note 7 of the Notes to Consolidated Financial Statements.
(3)	The 2001 results include impairment, disposition, restructuring, OPM and other net pretax charges totaling $61 million ($39 million or $0.56 diluted loss per share, net of tax). See Note 10 of the Notes to Consolidated Financial Statements. Operating income before net pretax charges as a percentage of operating revenue was 1.6%.
(4)	The 2000 results include impairment, disposition, restructuring, OPM and other net pretax charges totaling $9 million ($5 million or $0.07 diluted loss per share, net of tax). See Note 10 of the Notes to Consolidated Financial Statements. Operating income before net pretax charges as a percentage of operating revenue was 3.2%.
(5)	The 1999 results include impairment, disposition, restructuring and other net pretax credits totaling $2 million ($2 million or $0.02 diluted loss per share, net of tax). The after tax and per share amounts were losses because the goodwill impairment was not deductible for income tax

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	purposes. Operating income before net pretax credits as a percentage of operating revenue was 5.2%.
(6)	Effective income tax rate includes the effect of nondeductible pretax charges, primarily goodwill amortization for the years ended December 31, 1999 through 2001.

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

Results of Operations

In this Annual Report on Form 10-K, we refer to PacifiCare Health Systems, Inc. as “PacifiCare,” the “Company,” “we,” “us,” or “our”. Statements that are not historical facts are forward-looking statements within the meaning of the Federal Securities laws, and may involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated as of the date of this report. In addition, past financial and/or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. In evaluating these forward-looking statements, you should specifically consider the risks described below under “Cautionary Statements” which follows our discussion on Critical Accounting Policies and Estimates and in other parts of this report.

Overview. We offer managed care and other health insurance products to employer groups and Medicare beneficiaries in eight western states and Guam. Our commercial and senior plans are designed to deliver quality health care and customer service to members cost-effectively. These programs include health maintenance organizations, or HMOs, preferred provider organizations, or PPOs, and Medicare Supplement products. We also offer a variety of specialty managed care products and services that employees can purchase as a supplement to our basic commercial and senior medical plans or as stand-alone products. These products include pharmacy benefit management, or PBM, services, behavioral health services, group life and health insurance, dental and vision benefit plans.

Premium revenues are earned from products where we bear insured risk. Non-premium revenues are earned from all other sources, including revenues from our PBM mail order business, administrative fees and other income. Commencing with the first quarter of 2003, we reformatted our statement of operations to show total revenues (premium revenues and non-premium revenues) and health care services and other expenses by the following categories: commercial, senior and specialty and other. These changes are summarized below:

•  For our behavioral health and dental and vision subsidiaries, we previously included premium revenues in the commercial revenue line and non-premium revenues in the other income line. In 2003, all revenues (premium and non-premium) derived from our specialty companies (behavioral health, dental and vision and PBM) are now reported in the specialty and other revenues line.

•  All health care services and other expenses for our specialty companies were previously included within commercial health care costs. In 2003, all health care services and other expenses for our specialty companies are now reported in the specialty and other health care services and other expenses line.

•  Non-premium revenues earned by, and non-premium related fees charged by, our health plans or subsidiaries were previously included in the other income line. In 2003, these amounts are now included in the commercial, senior or specialty revenue and health care services and other expenses lines, as appropriate.

All intercompany transactions and accounts are eliminated in consolidation.

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Revenue

Commercial and Senior. Our commercial and senior revenues include all premium revenue we receive from our health plans, indemnity insurance subsidiary and Medicare Supplement and Senior Supplement products, as well as fee revenue we receive from administrative services we offer through our commercial and senior health plans and related subsidiaries. We receive a monthly payment on behalf of each subscriber enrolled in our commercial HMOs and our indemnity insurance service plans. Generally, our Medicare+Choice contracts entitle us to per member per month payments from the Centers for Medicare and Medicaid Services, or CMS, on behalf of each enrolled Medicare beneficiary. We report prepaid health care premiums received from our commercial plans’ enrolled groups, CMS, and our Medicare plans’ members as revenue in the month that members are entitled to receive health care. We record premiums received in advance as unearned premium revenue.

Premiums for our commercial products and Medicare+Choice products are generally fixed in advance of the periods covered. Of our commercial business, more than 50% of our membership renews on January 1 of each year, with premiums that are generally fixed for a period of one year. In addition, each of our subsidiaries that offers Medicare+Choice products must submit adjusted community rate proposals, generally by county or service area, to CMS, in early September for each Medicare+Choice product that will be offered in the subsequent year. As a result, increases in the costs of health care services in excess of the estimated future health care services expense reflected in the premiums or the adjusted community rate proposals generally cannot be recovered in the applicable contract year through higher premiums or changes in benefit designs.

Specialty and Other. Our specialty and other revenues include all premium revenues we receive from our behavioral health and dental and vision service plans and fee revenue we receive from administrative services we offer though our specialty companies, primarily from our PBM subsidiary. Our PBM subsidiary generates mail order revenue where we, rather than network retail pharmacies, collect the member copayments for both affiliated and unaffiliated members. Additionally, we record revenues for prescription drug costs and administrative fees charged on prescriptions dispensed by our mail order pharmacy when the prescription is filled. For prescription drugs dispensed through retail pharmacies, we record administrative services fees when a prescription claim is reviewed and approved, and the prescription is filled. For prescription drugs dispensed through retail pharmacies, we do not record revenues for drugs dispensed or the network pharmacies’ dispensing fees; nor do we record revenues for copayments our members make to the retail pharmacies.

Net Investment Income. Net investment income consists of interest income, gross realized gains and losses experienced on cash invested over each period.

Expenses

Commercial and Senior Health Care Services and Other. Health care services and other expenses for our commercial plans and our senior plans primarily comprise payments to physicians, hospitals and other health care providers under capitated or risk-based contracts for services provided to our commercial and senior health plan members and indemnity insurance plan members.

Our risk-based health care services expenses consist mostly of four cost of care components: outpatient care, inpatient care, professional services (primarily physician care) and pharmacy benefit costs. All four components are affected by both unit costs and utilization rates. Unit costs, for example, are the cost of outpatient medical procedures, inpatient hospital stays, physician fees for office visits and prescription drug prices. Utilization rates represent the volume of consumption of health services and vary with the age and health of our members and broader social and lifestyle patterns of the population as a whole.

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The cost of health care provided is accrued in the month services are provided to members, based in part on estimates of claims for hospital services and other health care costs that have been incurred but not yet reported (including those claims received but not yet paid), or IBNR, under our risk-based provider contracts as well as some services under our capitation contracts for which we retain financial liability, or carve-outs, primarily using standard actuarial methodologies based on historical data. These standard actuarial methodologies include, among other factors, contractual requirements, historical utilization trends, the interval between the date services are rendered and the date claims are paid, denied claims activity, disputed claims activity, benefit changes, expected health care cost inflation, seasonality patterns and changes in membership. These estimates are adjusted in future periods as we receive actual paid claims data, and can either increase or reduce our accrued health care costs. Included in health care services and other expenses for the year ended December 31, 2003 were net favorable adjustments of 2002 and prior period medical cost estimates of approximately $54 million of which the commercial and senior net favorable adjustments were $22 million and $32 million, respectively. For both commercial and senior, the net favorable adjustments were mainly from our Texas and California markets and were the result of lower than anticipated health care costs that materialized primarily in senior markets that we exited and recoveries of claims overpayments at rates higher than historic recovery patterns. The cost of prescription drugs covered under our commercial and senior plans is expensed when the prescription drugs are dispensed. Our commercial and senior plans also provide incentives, through a variety of programs, for health care providers that participate in those plans to control health care costs while providing quality health care. Expenses related to these programs, which are based in part on estimates, are recorded in the period in which the related services are provided. Historically, we have primarily arranged health care services for our members by contracting with health care providers on a capitated basis, regardless of the services provided to each member. Under our risk-based contracts, we generally bear or partially share the risk of excess health care expenses with health care providers, meaning that if member utilization of health care services exceeds agreed-upon amounts, we bear or partially share the excess expenses with the applicable health care provider.

Specialty and Other Health Care Services and Other. Health care services and other expenses for our specialty companies primarily comprise payments to physicians, hospitals and other health care providers under capitated or risk-based contracts for services provided to our behavioral health and dental and vision members and the cost of acquiring drugs for our mail order pharmacy benefit management subsidiary. Health care services and other expenses also include expenses for administrative services performed by our specialty companies.

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2003 Compared with 2002

Membership. Total HMO and other membership decreased 7% to approximately 2.9 million members at December 31, 2003 from approximately 3.1 million members at December 31, 2002.

			December 31, 2003						December 31, 2002
			Commercial		Senior		Total		Commercial		Senior		Total
HMO Membership Data:
	Arizona			148,500		86,600		235,100		141,300		88,400		229,700
	California			1,333,000		348,400		1,681,400		1,543,000		386,100		1,929,100
	Colorado			173,700		52,600		226,300		178,300		57,600		235,900
	Guam			26,400		—		26,400		32,200		—		32,200
	Nevada			25,800		25,300		51,100		24,300		27,400		51,700
	Oklahoma			87,200		18,400		105,600		101,100		19,800		120,900
	Oregon			58,200		24,000		82,200		68,000		25,300		93,300
	Texas			76,500		74,500		151,000		101,100		100,400		201,500
	Washington			65,500		52,500		118,000		62,700		55,500		118,200
		Total HMO membership		1,994,800		682,300		2,677,100		2,252,000		760,500		3,012,500
Other Membership Data:
	PPO and indemnity			183,500		—		183,500		75,100		—		75,100
	Employer self-funded			24,600		—		24,600		34,800		—		34,800
	Medicare Supplement			—		26,900		26,900		—		15,600		15,600
		Total other membership		208,100		26,900		235,000		109,900		15,600		125,500
		Total HMO and other membership		2,202,900		709,200		2,912,100		2,361,900		776,100		3,138,000

		December 31, 2003						As December 31, 2002
		PacifiCare		Unaffiliated		Total		PacifiCare		Unaffiliated		Total
Specialty Membership:
	Pharmacy benefit management(1)		2,912,100		2,071,400		4,983,500		3,138,000		1,635,100		4,773,100
	Behavioral health(2)		2,013,400		1,646,700		3,660,100		2,194,700		1,681,300		3,876,000
	Dental and vision(2)		485,000		234,600		719,600		442,500		244,800		687,300

(1)	PBM PacifiCare membership represents members that are in our commercial or senior HMO, PPO and indemnity, employer self-funded and Medicare Supplement plans. All of these members either have a prescription drug benefit or are able to purchase their prescriptions utilizing our retail network contracts or our mail order.
(2)	Behavioral health and dental and vision PacifiCare membership represents members that are in our commercial and senior HMO that are also enrolled in our behavioral health or dental and vision plans.

Commercial HMO membership decreased approximately 11%, or 257,200 members, at December 31, 2003 compared to the prior year. The decreases were primarily due to elimination of unprofitable commercial business and the termination of contracts with network providers. As previously announced, our contract with the California Public Employee Retirement System, or

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CalPERS, was not renewed for 2003, resulting in the loss of approximately 180,100 commercial HMO members in California effective January 1, 2003.

PPO and indemnity membership increased approximately 144% at December 31, 2003 compared to the prior year primarily due to enhanced marketing and the addition of approximately 14,900 members from new product initiatives primarily in California and Colorado.

Senior HMO membership decreased approximately 10%, or 78,200 members, at December 31, 2003 compared to the prior year. This decrease primarily resulted from county exits and member disenrollments attributable to reduced benefits and increased premiums effective January 1, 2003. As previously announced, we exited five counties in California and Texas resulting in the loss of approximately 63,000 senior HMO members effective January 1, 2003.

We anticipate that commercial and senior membership will increase in 2004.

Pharmacy benefit management unaffiliated membership at December 31, 2003 increased approximately 27%, or 436,300 members, compared to the prior year primarily due to an increase of approximately 400,000 from one group and the net addition of 20 clients. Pharmacy benefit management HMO membership at December 31, 2003 decreased approximately 7% compared to the prior year as a result of county exits and member disenrollments attributable to reduced benefits and increased premiums effective January 1, 2003 and the loss of our contract with CalPERS as discussed above.

PacifiCare behavioral health membership at December 31, 2003 decreased approximately 8% compared to the prior year primarily due to the loss of our contract with CalPERS as discussed above in commercial HMO membership. Behavioral health unaffiliated membership at December 31, 2003 decreased approximately 2%, or 34,600 members, compared to the prior year due to member disenrollments.

PacifiCare dental and vision membership at December 31, 2003 increased approximately 10%, or 42,500 members, compared to the prior year primarily due to increased cross-selling of these products in conjunction with our commercial products. Dental and vision unaffiliated membership at December 31, 2003 was comparable to the prior year.

We anticipate that total specialty membership will increase in 2004.

Commercial Revenue. Commercial revenue increased 5%, or $260 million, to $5 billion for the year ended December 31, 2003 compared to the prior year as follows:

	Year Ended
	December 31, 2003
	(Amounts in millions)
Revenue increases primarily due to premium rate increases of approximately 18% for the year ended December 31, 2003	$	743
Net membership decreases, primarily in California and Texas		(489	)
Other		6
Increase over prior year	$	260

We anticipate revenue increases in 2004 primarily due to membership and rate increases. However, we do not expect the same percentage premium rate increases in 2004 that we experienced in 2003.

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Senior Revenue. Senior revenue decreased 8%, or $492 million, to $5.4 billion for the year ended December 31, 2003 compared to the prior year as follows:

	Year Ended
	December 31, 2003
	(Amounts in millions)
Revenue increases primarily due to premium rate increases of approximately 4% for the year ended December 31, 2003	$	260
Net membership decreases, primarily in California and Texas		(752	)
Decrease over prior year	$	(492	)

We anticipate revenue increases in 2004 primarily due to membership and rate increases, and from changes as a result of the newly enacted DIMA legislation.

Specialty and Other Revenue. Specialty and other revenue of $499 million for the year ended December 31, 2003 increased 18%, or $77 million, compared to the same period in the prior year. The increase was primarily due to increased mail order revenues and unaffiliated membership from our pharmacy benefit management subsidiary.

Net Investment Income. Net investment income increased 11%, or $7 million, to $71 million for the year ended December 31, 2003, from $64 million for the year ended December 31, 2002. The increase was primarily due to the following:

•  write-off of a decline in the value of our investment in MedUnite, Inc. of $11 million during 2002, with no comparable activity in 2003;

•  write-down of certain telecommunication investments to market value resulting in a charge of approximately $2 million during 2002, with no comparable activity in 2003; partially offset by

•  lower pre-tax rates of return due to Federal Reserve rate reductions in 2003.

Commercial Margin. Our commercial margin increased 34%, or $195 million, to $773 million for the year ended December 31, 2003, compared to $578 million for the same period in the prior year as follows:

	Year Ended
	December 31, 2003
	(Amounts in millions)
Commercial revenue increases (as noted above)	$	260
Decreases in health care services and other expenses as a result of net HMO and PPO membership decreases, primarily in California and Texas		432
Increases in health care services and other expenses as a result of health care cost trends and increases in capitation expense		(481	)
Other		(16	)
Increase over the comparable period of the prior year	$	195

We anticipate our commercial margin in 2004 will be slightly higher than 2003.

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Senior Margin. Our senior margin increased 9%, or $72 million, to $855 million for the year ended December 31, 2003, compared to $783 million the same period in the prior year as follows:

	Year Ended
	December 31, 2003
	(Amounts in millions)
Senior revenue decreases (as noted above)	$	(492	)
Decreases in health care services and other expenses as a result of HMO membership decreases, primarily in California and Texas		614
Increases in health care services and other expenses as a result of health care cost trends partially offset by benefit adjustments		(43	)
Other		(7	)
Increase over the comparable period of the prior year	$	72

We anticipate our senior margin in 2004 will be lower than in 2003 primarily due to expected enhancement of benefits offered to our Medicare+Choice beneficiaries.

Specialty and Other Margin. Our specialty and other margin decreased 1%, or $2 million, to $244 million for the year ended December 31, 2003. The decrease was primarily driven by the loss of higher margin business, partially offset by an increase in unaffiliated membership in our behavioral health and PBM businesses.

Medical Loss Ratio. Our medical loss ratios, or MLRs, are calculated using premium revenue and related health care services and other expenses and cannot be directly calculated from the line items in the Consolidated Statement of Operations. Our MLRs are calculated using the following categories of revenue and expenses:

•  Private — Commercial: includes premium revenue and related health care services and other expenses for our commercial HMO products (including Federal Employees Health Benefit Program, or FEHBP, and state and local government contracts), PPO products, and other indemnity, behavioral, dental and vision plans;

•  Private — Senior: includes premium revenue and related health care services and other expenses for our Medicare Supplement and Senior Supplement products where premiums are paid in full by the employer or the consumer;

•  Government — Senior: includes premium revenue and related health care services and other expenses for our Medicare+ Choice, HMO and PPO products and other senior products where premiums are paid principally through government programs.

All non-premium revenues and related health care services and other expenses are excluded from the calculation of our MLR.

In 2002, we calculated our MLR for our commercial and senior products based on total premiums and total health care services expenses as reported on our statement of operations. This resulted in the inclusion of certain health care costs related to the cost of acquiring drugs for our mail order business of our PBM subsidiary within our commercial MLR calculation for which there was no corresponding revenues (the related revenues were included in the other income line). Since this inadvertently had the effect of slightly increasing the MLR of our commercial product, we changed this presentation in order to provide more transparency on the trends affecting the profitability of our insured products. Under our new format, only premium revenues and the related health care and other services expenses are included in the MLR calculations. The 2002 MLR calculations have been recalculated to conform to the 2003 presentation.

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The consolidated MLR and its components, unadjusted for any prior period changes in healthcare cost estimates, for the year ended December 31, 2003 and 2002 are as follows:

		Year Ended
		December 31,
		2003			2002
Medical loss ratio:
	Consolidated		84.0	%		86.8	%
	Private — Commercial		84.0	%		87.1	%
	Private — Senior		63.4	%		53.5	%
	Private — Consolidated		83.7	%		86.7	%
	Government — Senior		84.2	%		86.9	%
	Government — Consolidated		84.2	%		86.9	%

Private — Commercial Medical Loss Ratio. Our private — commercial medical loss ratio decreased to 84.0% for the year ended December 31, 2003 compared to 87.1% for the prior year. The decrease was driven by premium rate increases that outpaced an increase in health care services and other expenses on both an absolute dollar and per member per month basis.

Private — Senior Medical Loss Ratio. Our private — senior medical loss ratio increased to 63.4% for the year ended December 31, 2003 compared to 53.5% for the prior year. The increase was primarily driven by health care services and other expenses increases that outpaced premium revenue increases on a per member per month basis.

Government — Senior Medical Loss Ratio. Our government — senior medical loss ratio decreased to 84.2% for the year ended December 31, 2003 compared to 86.9% for the prior year. The decrease was driven by rate increases, benefit reductions and decreased utilization attributable to our medical management programs that outpaced an increase in health care services and other expenses on a per member per month basis.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $82 million to $1.5 billion for the year ended December 31, 2003, from $1.4 billion in the prior year. Selling, general and administrative expenses increased primarily due to increased spending for new product development and marketing costs, our expensing of stock-based compensation and increased write-off of certain property and equipment.

Selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income) increased compared to the prior year primarily due to declines in operating revenue (excluding net investment income) totaling $155 million for the year ended December 31, 2003.

	Year Ended
	December 31,
	2003			2002
Selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income)		13.3	%		12.4	%

Interest Expense. Interest expense increased 34%, or $26 million, to $101 million for the year ended December 31, 2003, from $75 million compared to the prior year. The increase was due to the following:

•  $28 million for the redemption premium and other write-offs associated with our redemption of $175 million in principal of our 10 3/4% senior notes in December 2003 with no comparable activity in the prior year,

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•  approximately $3 million for the write-off of unamortized loan fees in the second quarter of 2003 in connection with the replacement of our senior credit facility with no comparable activity in the prior year, partially offset by

•  $5 million of favorable effect of the interest rate swap on $300 million of our 10 3/4% senior notes with no comparable activity in the prior year, and

•  lower interest rate from our term loan under the senior credit facility which was effective June 2003.

Provision for Income Taxes. The effective income tax rate was 37.7% for the year ended December 31, 2003, compared with 37.3% in 2002. The increase in the effective tax rate from the prior year is primarily due to higher 2003 earnings resulting in a higher state tax expense while reducing the benefit that tax-exempt income had on our effective tax rate.

Our effective tax rate is based on statutory tax rates, reported income, certain permanent tax differences, and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our effective tax rate and in evaluating our tax positions. Despite our belief that our tax return positions are fully supportable, we may establish reserves when we believe that certain tax positions are likely to be challenged and we may not fully prevail in overcoming these challenges. We may adjust these reserves as relevant circumstances evolve, such as the progress of a tax audit. Our effective tax rate includes the impact of reserve provisions and changes to reserves that we consider appropriate, as well as related interest. In the event that there is a significant unusual or one-time item recognized in our operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the usual or one-time item.

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2002 Compared with 2001

Membership. Total HMO and other membership decreased 10% to approximately 3.1 million members at December 31, 2002 from approximately 3.5 million members at December 31, 2001.

			December 31, 2002						December 31, 2001
			Commercial		Senior		Total		Commercial		Senior		Total
HMO Membership Data:
	Arizona			141,300		88,400		229,700		144,000		104,600		248,600
	California			1,543,000		386,100		1,929,100		1,579,000		487,000		2,066,000
	Colorado			178,300		57,600		235,900		202,300		60,300		262,600
	Guam			32,200		—		32,200		36,400		—		36,400
	Nevada			24,300		27,400		51,700		36,100		30,900		67,000
	Oklahoma			101,100		19,800		120,900		91,300		30,200		121,500
	Oregon			68,000		25,300		93,300		93,200		26,800		120,000
	Texas			101,100		100,400		201,500		180,400		149,600		330,000
	Washington			62,700		55,500		118,200		76,900		59,100		136,000
		Total HMO membership		2,252,000		760,500		3,012,500		2,439,600		948,500		3,388,100
Other Membership Data:
	PPO and indemnity			75,100		—		75,100		38,400		—		38,400
	Employer self-funded			34,800		—		34,800		42,400		—		42,400
	Medicare Supplement			—		15,600		15,600		—		11,000		11,000
		Total other membership		109,900		15,600		125,500		80,800		11,000		91,800
		Total HMO and other membership		2,361,900		776,100		3,138,000		2,520,400		959,500		3,479,900

		December 31, 2002						As December 31, 2001
		PacifiCare		Unaffiliated		Total		PacifiCare		Unaffiliated		Total
Specialty Membership:
	Pharmacy benefit management(1)		3,138,000		1,635,100		4,773,100		3,479,900		1,129,000		4,608,900
	Behavioral health(2)		2,194,700		1,681,300		3,876,000		2,337,200		1,373,400		3,710,600
	Dental and vision(2)		442,500		244,800		687,300		685,300		222,800		908,100

(1)	PBM PacifiCare membership represents members that are in our commercial or senior HMO, PPO and indemnity, employer self-funded and Medicare Supplement plans. All of these members either have a prescription drug benefit or are able to purchase their prescriptions utilizing our retail network contracts or our mail order.
(2)	Behavioral health and dental and vision PacifiCare membership represents members that are in our commercial and senior HMO that are also enrolled in our behavioral health or dental and vision plans.

Commercial HMO membership decreased approximately 8% at December 31, 2002 compared to the prior year due to decreases of 79,300 members in Texas, 36,000 members in California, 25,200 members in Oregon and 24,000 members in Colorado. These decreases were primarily due to

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elimination of unprofitable commercial business and the termination of contracts with network providers.

Senior HMO membership decreased approximately 20% at December 31, 2002 compared to the prior year due to a decrease of 150,100 members in California and Texas. This decrease primarily resulted from county exits and member disenrollments attributable to reduced benefits and increased premiums effective January 1, 2002.

PPO and indemnity membership increased approximately 96% at December 31, 2002 compared to the prior year due to enhanced marketing and new product initiatives primarily in California and Texas.

Pharmacy benefit management unaffiliated membership at December 31, 2002 increased approximately 45% compared to the prior year due to increased marketing efforts. PacifiCare pharmacy benefit management membership at December 31, 2002 decreased approximately 10% compared to the prior year as a result of county exits and member disenrollments attributable to reduced benefits and increased premiums effective January 1, 2002.

PacifiCare behavioral health membership at December 31, 2002 decreased approximately 6% compared to the prior year due to declines in commercial HMO membership resulting from renewal premium rate increases primarily in Texas. Behavioral health unaffiliated membership at December 31, 2002 increased approximately 22% compared to the prior year due to the addition of one large employer group in the eastern United States.

PacifiCare dental and vision membership at December 31, 2002 decreased approximately 35% compared to the prior year primarily due to senior membership losses in California, attributable to dental benefit changes effective January 1, 2002. Dental and vision unaffiliated membership at December 31, 2002 increased approximately 10% compared to the prior year due to membership from new PPO product offerings.

Commercial Revenue. Commercial revenue increased 5%, or $229 million, for the year ended December 31, 2002 compared to the prior year as follows:

	Year Ended
	December 31, 2002
	(Amounts in millions)
Premium yield increases that averaged approximately 15% for the year ended December 31, 2002	$	634
Net membership decreases, primarily in California, Colorado and Texas		(420	)
Other		15
Increase over prior year	$	229

Senior Revenue. Senior revenue decreased 13%, or $911 million, for the year ended December 31, 2002 compared to the prior year as follows:

	Year Ended
	December 31, 2002
	(Amounts in millions)
Premium yield increases, including member premiums, that averaged approximately 8% for the year ended December 31, 2002	$	390
Membership decreases, primarily in California and Texas		(1,270	)
Other		(31	)
Decrease over prior year	$	(911	)

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Specialty and Other Revenue. Specialty and other revenue increased 11%, or $41 million, for the year ended December 31, 2002, compared to the same period in the prior year. The increase was primarily due to increased unaffiliated membership and mail order revenues of our pharmacy benefit management subsidiary.

Net Investment Income. Net investment income decreased 42%, or $47 million, to $64 million for the year ended December 31, 2002, from $111 million for the year ended December 31, 2001.

During 2002, we wrote off our entire $11 million investment in MedUnite Inc. In late 2002, MedUnite was acquired by ProxyMed Inc. Additionally, during 2002, we wrote down certain telecommunications investments to market value resulting in a charge of approximately $2 million during the second quarter of 2002. In total, we recorded a charge of $13 million ($8 million, or $0.11 diluted loss per share, net of tax) for other than temporary impairments to the value of these investments which is included in net investment income. In addition to the impairment of these investments, we experienced lower pretax rates of return on our portfolio as a result of lower investable balances and interest rates that have been declining since 2001.

Commercial Margin. Our commercial margin increased 28%, or $126 million, to $578 million for the year ended December 31, 2002, compared to $452 million for the same period in the prior year as follows:

	Year Ended
	December 31, 2002
	(Amounts in millions)
Commercial revenue increases (as noted above)	$	229
Decreases in health care services and other expenses as a result of net HMO and PPO membership decreases, primarily in California and Texas		366
Increases in health care services and other expenses as a result of health care cost trends and increases in capitation expense		(469	)
Increase over the comparable period of the prior year	$	126

Senior Margin. Our senior margin increased 18%, or $118 million, to $783 million for the year ended December 31, 2002, compared to $665 million the same period in the prior year as follows:

	Year Ended
	December 31, 2002
	(Amounts in millions)
Senior revenue decreases (as noted above)	$	(911	)
Decreases in health care services and other expenses as a result of HMO membership decreases, primarily in California and Texas		1,192
Increases in health care services and other expenses as a result of health care cost trends partially offset by benefit adjustments		(163	)
Increase over the comparable period of the prior year	$	118

Specialty and Other Margin. Our specialty and other margin decreased 1%, or $3 million, to $245 million for the year ended December 31, 2002. The decrease was primarily driven by the loss of PacifiCare senior dental and vision members attributable to dental benefit changes effective January 1, 2002.

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Medical Loss Ratio. The consolidated MLR and its components, unadjusted for any prior period changes in healthcare cost estimates, for the year ended December 31, 2002 and the prior year are as follows:

		Year Ended
		December 31,
		2002			2001
Medical loss ratio:
	Consolidated		86.8	%		89.7	%
	Private — Commercial		87.1	%		89.3	%
	Private — Senior		53.5	%		79.7	%
	Private — Consolidated		86.7	%		89.2	%
	Government — Senior		86.9	%		90.1	%
	Government — Consolidated		86.9	%		90.1	%

Private — Commercial Medical Loss Ratio. Our private — commercial medical loss ratio decreased to 87.1% for the year ended December 31, 2002 compared to 89.3% in the prior year. The decrease was driven by significant premium rate increases that outpaced an increase in health care services and other expenses on both an absolute dollar and per member per month basis.

Private — Senior Medical Loss Ratio. Our private — senior medical loss ratio decreased to 53.5% for year ended December 31, 2002 compared to 79.7% in the prior year. The decrease was driven by rate increases, benefit reductions primarily of prescription drugs, effective January 1, 2002 and decreased utilization attributable to our medical management programs that outpaced an increase in health care services and other expenses on a per member per month basis.

Government — Senior Medical Loss Ratio. Our government — senior medical loss ratio decreased to 86.9% for the year ended December 31, 2002 compared to 90.1% in the prior year. The decrease was driven by a 8% increase in premium revenue, offset partially by a 4% decrease in health care services and other expenses.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $82 million to $1.4 billion for the year ended December 31, 2002, from $1.3 billion in the prior year. Selling, general and administrative expenses increased primarily due to increased spending for information technology, or IT, initiatives, our PacifiCare and Secure Horizons brand building campaign and incentive compensation costs. These costs were partially offset by lower labor costs as a result of our 2001 corporate restructuring and no goodwill amortization in 2002 due to the adoption of SFAS No. 142, Goodwill and Other Intangible Assets. See Note 7 of the Notes to Consolidated Financial Statements.

Selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income) increased compared to the prior year primarily due to declines in operating revenue (excluding net investment income) totaling $641 million for the year ended December 31, 2002.

	Year Ended
	December 31,
	2002			2001
Selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income)		12.4	%		11.0	%

Impairment, Disposition, Restructuring, Office of Personnel Management, or OPM, and Other Charges. We recognized net pretax charges of approximately $3.7 million ($2.2 million or $0.04

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diluted loss per share, net of tax) for the year ended December 31, 2002. See Note 10 of the Notes to Consolidated Financial Statements.

Interest Expense. Interest expense increased 7%, or $5 million, to $75 million for the year ended December 31, 2002, from $70 million in the prior year due to our sale of $500 million in aggregate principal amount of 10 3/4% senior notes in May 2002, which carried a higher annual interest rate than the debt we repaid using the proceeds of that offering. The increase was partially offset by cash redemptions of a portion of our outstanding 7% FHP senior notes and our sale of $135 million in aggregate principal amount of 3% convertible subordinated debentures in the fourth quarter of 2002, which carried a lower annual interest rate than the debt we repaid using a portion of the proceeds of that offering. See Note 5 of the Notes to Consolidated Financial Statements.

Provision for Income Taxes. The effective income tax rate was 37.3% for the year ended December 31, 2002, compared with 67.9% in 2001. The decrease was primarily attributable to our adoption of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002. Under SFAS No. 142, beginning with the first quarter of 2002, goodwill is no longer being amortized. Because a significant portion of our goodwill amortization was nondeductible, this accounting change caused a significant reduction to our effective tax rate.

Liquidity and Capital Resources

Operating Cash Flows. Our consolidated cash, equivalents and marketable securities increased $411 million, or 19%, to $2.6 billion at December 31, 2003, from $2.1 billion at December 31, 2002.

Cash flows provided by operations were $414 million (or $397 million, excluding the impact of unearned premium revenue) for the year ended December 31, 2003 compared to cash flows provided by operations of $242 million (or $312 million, excluding the impact of unearned premium revenue) for the year ended December 31, 2002. The increase was primarily related to our increased net income for the year ended December 31, 2003 and the changes in assets and liabilities as discussed below in “Other Balance Sheet Change Explanations.”

Investing Activities. For the year ended December 31, 2003, investing activities used $202 million of cash, compared to $278 million used during the year ended December 31, 2002. The change was primarily related to decreased purchases of restricted marketable securities, partially offset by an increase in purchases of unrestricted marketable securities.

Financing Activities. For the year ended December 31, 2003, financing activities provided $34 million of cash, compared to $10 million provided during the year ended December 31, 2002. During the year ended December 31, 2003, the significant changes were as follows:

•  We redeemed $175 million in principal of our 10  3/4% senior notes, paid a redemption premium of $19 million and received approximately $200 million of net proceeds from our public offering of 7.6 million shares of common stock in 2003, after adjusting the number of shares for the two-for-one stock split in the form of a stock dividend.

•  We paid $151 million on our previous senior credit facility and received $150 million of proceeds from our new syndicated senior credit facility in 2003.

•  We paid $43 million on the remaining principal balance from the FHP senior notes by liquidating the restricted cash collateral which was established for this purpose, with no comparable activity during 2002.

•  We received $41 million from the issuance of common stock for year ended December 31, 2003 in connection with our Employee Stock Purchase Plan and exercises of employee stock options compared to $5 million during the same period in 2002.

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•  We paid $7 million in loan fees in connection with the replacement of our senior credit facility in June 2003. In 2002, we paid $38 million in loan fees, including $20 million in connection with the 10 3/4% senior notes offering, $13 million in connection with the amendment to the previous senior credit facility, and $5 million in connection with the 3% convertible subordinated debentures offering.

•  We received $135 million from the 3% convertible subordinated debentures offering in 2002, with no comparable activity during 2003.

•  We paid $554 million under our senior credit facility, including $499 million under the term loan facility and $55 million under the revolving credit facility, and received $497 million of proceeds from the 10 3/4 senior notes offering in 2002.

•  We received $9 million in proceeds from a draw down on an equity commitment arrangement in 2002, with no comparable activity during 2003.

We have $135 million in aggregate principal amount of 3% convertible subordinated debentures due in 2032. The debentures are convertible into 6,428,566 shares of common stock under certain conditions, including satisfaction of a market price condition for our common stock, satisfaction of a trading price condition relating to the debentures, upon notice of redemption, or upon specified corporate transactions. Each $1,000 of the debentures is convertible into 47.619 shares of our common stock. The market price condition for conversion of the debentures is satisfied if the closing sale price of our common stock exceeds 110% of the conversion price (which is calculated at $23.10 per share) for the debentures for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of any fiscal quarter. In the event that the market price condition is satisfied during any fiscal quarter, the debentures are convertible, at the option of the holder, during the following fiscal quarter. The market price condition is evaluated each quarter to determine whether the debentures will be convertible at the option of the holder during the following fiscal quarter. During the fiscal year ended December 31, 2003, the market price condition described above was satisfied for the quarters ended September 30, 2003 and December 31, 2003. As a result, the debentures were convertible during the quarter ended December 31, 2003 and remain convertible at the option of the holder at any time during the quarter ended March 31, 2004. While no debentures were converted as of December 31, 2003, they are considered common stock equivalents and are included in the calculation of weighted average shares outstanding on a diluted basis for the fourth quarter and fiscal year ended December 31, 2003.

Beginning in October 2007, we may redeem for cash all or any portion of the debentures, at a purchase price of 100% of the principal amount plus accrued interest, upon not less than 30 nor more than 60 days’ written notice to the holders. Beginning in October 2007, and in successive 5-year increments, our holders may require us to repurchase the debentures for cash at a repurchase price of 100% of the principal amount plus accrued interest. Our payment obligations under the debentures are subordinated to our senior indebtedness, and effectively subordinated to all indebtedness and other liabilities of our subsidiaries.

We have $325 million in aggregate principal amount of 10 3/4% senior notes due in 2009 outstanding. The 10 3/4% senior notes were issued in May 2002 at 99.389% of the aggregate principal amount representing a discount of $3 million that is being amortized over the term of the notes. In December 2003, in accordance with the applicable provisions of the indenture, we redeemed $175 million in principal of the senior notes at a redemption price equal to 110.750%, plus accrued and unpaid interest on the notes as of the redemption date. We expensed approximately $28 million in connection with the redemption, including the pro-rata write-off of the initial discount, the redemption premium and other fees and expenses associated with the transaction. We may redeem the remaining 10 3/4% senior notes at any time on or after June 1, 2006 at an initial redemption price equal to 105.375% of their principal amount plus accrued and unpaid interest. The redemption price

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will thereafter decline annually. Additionally, at any time on or prior to June 1, 2006, we may redeem the 10 3/4% senior notes upon a change of control, as defined in the indenture for the notes, at 100% of their principal amount plus accrued and unpaid interest and a “make-whole” premium.

Certain of our domestic, unregulated subsidiaries fully and unconditionally guarantee the 10 3/4% senior notes. Prior to September 15, 2003, some of our domestic, unregulated subsidiaries were restricted from guaranteeing the 10 3/4% senior notes by the terms of the FHP senior notes. As the FHP senior notes were repaid in full on September 15, 2003, these subsidiaries now fully and unconditionally guarantee the 10 3/4% senior notes. See Note 15 of the Notes to Consolidated Financial Statements.

In April 2003, we entered into an interest rate swap on $300 million of our 10 3/4% senior notes for the purpose of hedging the fair value of our indebtedness. This fair value hedge is accounted for using the short-cut method under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, whereby the hedge is reported in our balance sheets at fair value, and the carrying value of the long-term debt is adjusted for an offsetting amount representing changes in fair value attributable to the hedged risk. Under the terms of the agreement, we make interest payments based on the three-month London Interbank Offered Rate (LIBOR) plus 692 basis points and receive interest payments based on the 10 3/4% fixed rate. Our rate under the swap agreement was 8.09%, at December 31, 2003 which is based on a 90-day LIBOR of 1.17% plus 692 basis points. The three-month LIBOR rate we use to determine our interest payments under the swap agreement was first established on June 2, 2003 and resets every three months thereafter, until expiration in June 2009.

In June 2003, we replaced our senior credit facility with a new syndicated facility with JPMorgan Chase Bank serving as the Administrative Agent. The new facility consists of a $150 million term loan, which matures on June 3, 2008, and a $150 million revolving line of credit, which matures on June 3, 2006. We used the proceeds from the term loan to repay the $131 million outstanding under the prior facility. The remaining $19 million was used to pay fees and expenses relating to the new facility and for general corporate purposes. As of December 31, 2003, we had $149 million outstanding on the term loan and no balance outstanding on the revolving line of credit. We borrowed and repaid $3 million under the revolving line of credit during the year ended December 31, 2003.

On December 17, 2003, our senior credit facility was amended to provide for reduced interest rates per annum applicable to term loan borrowings, with the amount of margin spread for the borrowing being determined by our current debt ratings. The amended applicable rates are, at our option, either JPMorgan Chase Bank’s prime rate (or, if greater, the Federal Funds Rate plus 0.5%) which we refer to as the alternative base rate, plus a margin spread of 1.25% to 1.75% per annum, or the LIBOR for the applicable interest period, plus a margin spread of 2.25% to 2.75% per annum. All of our borrowings under the term loan are currently LIBOR borrowings, and the current margin spread on our term loan borrowings is 2.50%. As of December 31, 2003, our term loan rate was 3.68% per annum, which is based on a 90-day LIBOR of 1.18% plus the applicable margin spread of 2.50%. The interest rates per annum under the senior credit facility applicable to revolving credit borrowings are, at our option, either the alternate base rate plus a margin spread of between 1.5% to 2.75% per annum, or the LIBOR for the applicable interest period plus a margin spread of between 2.5% to 3.75% per annum, with the amount of the margin for any borrowing being determined based on current credit ratings for the debt under the senior credit facility. Our current margins for revolving credit borrowings are 2.25% per annum for alternate base rate borrowings and 3.25% per annum for LIBOR borrowings.

The terms of the senior credit facility contain various covenants customary for financings of this type which place restrictions on our and/or our subsidiaries’ ability to incur debt, pay dividends, create liens, make investments, optionally repay, redeem or repurchase our securities, and enter into

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mergers, dispositions and transactions with affiliates. The senior credit facility also requires us to meet various financial ratios, including a minimum net worth requirement, a minimum fixed-charge coverage requirement and a maximum leverage ratio. At December 31, 2003, we were in compliance with all of these covenants. See Note 5 of the Notes to Consolidated Financial Statements.

Certain of our domestic, unregulated subsidiaries provide guarantees and have granted security interests to the lenders in substantially all of their personal property in order to secure our obligations under the senior credit facility. We have also pledged the equity of certain of our subsidiaries to the lenders. Prior to September 15, 2003, some of our domestic, unregulated subsidiaries were restricted from guaranteeing the senior credit facility by the terms of the FHP senior notes. As the FHP senior notes were repaid in full on September 15, 2003, these subsidiaries now fully and unconditionally guarantee the senior credit facility.

				Revolving
	Term Loan			Credit
	Facility			Facility			Total
	(Amounts in millions)
Balance at December 31, 2001	$	650		$	55		$	705
Proceeds applied from funding of 10 3/4% senior notes		(315	)		(54	)		(369	)
Scheduled payments		(60	)		—			(60	)
Proceeds applied from funding of convertible subordinated debentures		(53	)		—			(53	)
Proceeds applied from sales of property		(35	)		—			(35	)
Payments under amendment to senior credit facility		(32	)		—			(32	)
Proceeds applied from equity commitment arrangement		(4	)		(1	)		(5	)
Balance at December 31, 2002		151			—			151
Scheduled payments under prior senior credit facility		(20	)		—			(20	)
Repayment of outstanding balance under prior senior credit facility		(131	)		—			(131	)
Proceeds from borrowing under new senior credit facility		150			3			153
Scheduled payments under new senior credit facility		(1	)		(3	)		(4	)
Balance at December 31, 2003	$	149		$	—		$	149

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Our contractual cash obligations as of December 31, 2003, including long-term debt and other commitments, were as follows:

			Payments Due by Period
					Less than						More than
			Total		1 year		1 – 3 years		3 – 5 years		5 years
			(Amounts in millions)
Long-term debt:
	10 3/4% senior notes, net of discount		$	323	$	—	$	—	$	—	$	323
	Senior term loan			149		2		24		123		—
	Convertible subordinated debentures			135		—		—		—		135
	Database financing agreement			9		5		4		—		—
	Other			4		—		2		1		1
		Total long-term debt commitments, including current maturities		620		7		30		124		459
Other commitments:
Information technology outsourcing contracts(1)				1,118		175		306		263		374
Operating leases				107		27		44		25		11
Purchase obligations(2)				51		27		14		6		4
Interest on long-term debt, including current maturities(3)				288		37		74		68		109
Other long-term liabilities reflected on our balance sheet under GAAP				28		—		—		—		28
		Total other commitments		1,592		266		438		362		526
Total contractual cash obligations			$	2,212	$	273	$	468	$	486	$	985

(1)	Amounts under information technology outsourcing contracts reflect our payment obligations for the resource baselines specified in the applicable outsourcing contracts and do not take into consideration any rights we may have under these contracts to reduce or eliminate resource usage or baselines.
(2)	Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. This includes contracts which are cancelable with notice and the payment of an early termination penalty. Purchase obligations exclude agreements that are cancelable without penalty and also exclude liabilities to the extent presented on the balance sheet as of December 31, 2003. We are subject to various contracts with certain health care providers and facilities for the provision of health care services to its members. Such contracts involve payments from us, generally on a monthly basis, in the ordinary course of business and are not included in the above table because we are not required to make minimum payments under these contracts.
(3)	Interest on long-term debt is calculated using the stated rates per the financing agreements. For debt with variable rates, such as the swap on $300 million of our 10 3/4% senior notes and the senior term loan, the rate in place as of December 31, 2003 was used to estimate all remaining payments.

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As of December 31, 2003 we did not have any off-balance sheet arrangements that are required to be disclosed under Item 303(a)(4)(ii) of SEC Regulation S-K.

In February 2004, our debt was rated below investment grade by the major credit rating agencies as follows:

		Senior		10 3/4%		Convertible
		Credit		Senior		Subordinated
Agency	Outlook	Facility		Notes		Debentures
Moody’s	Positive		Ba3		B1		B2
Standard & Poor’s	Stable		BB+		BB+		B
Fitch IBCA	Positive		BB		BB		B+

Consequently, if we seek to raise funds in capital markets transactions, our ability to do so will be limited to issuing additional non-investment grade debt or issuing equity and/or equity-linked instruments.

We expect to fund our working capital requirements and capital expenditures during the next twelve months from our cash flow from operations or from capital market transactions. We have taken a number of steps to increase our internally generated cash flow, including increasing premiums, increasing our marketing of specialty product lines, introducing new products to generate new revenue sources and reducing our health care expenses by, among other things, exiting from unprofitable markets and cost savings initiatives. If our cash flow is less than we expect due to one or more of the risk factors described in “Cautionary Statements,” or our cash flow requirements increase for reasons we do not currently foresee or we make any acquisitions as part of our growth strategy, then we may need to draw down available funds on our revolving line of credit which matures in June 2006 or issue additional debt or equity securities. A failure to comply with any covenant in the senior credit facility could make funds under our revolving line of credit unavailable. We also may be required to take additional actions to reduce our cash flow requirements, including the deferral of planned investments aimed at reducing our selling, general and administrative expenses. The deferral or cancellation of any investments could have a material adverse impact on our ability to meet our short-term business objectives. We regularly evaluate cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. We may elect to raise additional funds for these purposes either through additional debt or equity, the sale of investment securities or otherwise as appropriate. We have an effective shelf registration statement on file with the Securities and Exchange Commission under which we may sell common stock, preferred stock, depositary shares, debt securities, warrants, stock purchase contracts and stock purchase units in one or more offerings from time to time up to a total dollar amount of $600 million. As of December 31, 2003, we have approximately $400 million available under the shelf registration after our common stock offering in November 2003. The actual amount of any securities issued, the terms of those securities and the intended use of the proceeds from any sale, will be determined at the time of sale, if any such sale occurs.

Other Balance Sheet Change Explanations

Receivables, Net. Receivables, net as of December 31, 2003, decreased $24 million from December 31, 2002 due to the decrease in provider receivables from collections and settlements primarily in California and Washington.

Medical Claims and Benefits Payable. The majority of our medical claims and benefits payable represents liabilities related to our risk-based contracts. Under risk-based contracts, claims are payable once incurred and cash disbursements are made to health care providers for services provided to members after the related claim has been submitted and adjudicated. Under capitated contracts, health care providers are prepaid on a fixed-fee per member per month basis, regardless of the

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services provided to members. The liabilities that arise for capitated contracts relate to timing issues primarily due to membership changes that may occur. As of December 31, 2003, approximately 85% of medical claims and benefits payable was attributable to risk-based contracts.

The following table presents the breakdown of our medical claims and benefits payable:

	December 31,		December 31,
	2003		2002
	(Amounts in millions)
Incurred But Not Reported (IBNR)	$	826	$	753
Capitation and All Other Medical Claims and Benefits Payable		202		292
Medical Claims and Benefits Payable	$	1,028	$	1,045

Medical claims and benefits payable as of December 31, 2003 decreased $17 million from the balance as of December 31, 2002, primarily due to a $90 million reduction in capitation and all other medical claims and benefits payable due primarily to annual settlements of provider risk sharing programs through payouts or by offsetting of risk program receivables against risk program liabilities. IBNR increased $73 million as a result of an increase in commercial risk membership and commercial health care costs per member, partially offset by a decrease in the elapsed time between the date health care services were provided and payment of the related claims liabilities as compared to December 31, 2002.

Accounts Payable and Accrued Liabilities. Accounts payable and accrued liabilities, including accrued compensation and employee benefits, increased $52 million from December 31, 2002, primarily due to an increase of $39 million related to increases in liabilities for reinsurance and legal expenses and the timing of payments of trade accounts payable and other accruals, an increase of $16 million in accrued compensation and an increase of $10 million in accrued taxes, partially offset by a decrease of $13 million in OPM reserves.

Stockholders’ Equity. The decrease in treasury stock and additional paid-in capital from December 31, 2002 were primarily due to the retirement of all 23 million shares of outstanding treasury stock, partially offset by the issuance of 7.6 million shares in connection with the public common stock offering and 1.5 million shares of restricted common stock that we granted as part of an employee recognition and retention program during the year ended December 31, 2003. All share data have been adjusted for the effect of the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004. See Note 6 of the Notes to Consolidated Financial Statements.

Adoption of New Accounting Policy — Stock-Based Compensation

For the year ended December 31, 2003, we recognized approximately $8 million, net of tax, of compensation expense related to stock-based compensation for employees and directors related to stock options and shares under the Employee Stock Purchase Plan. Prior to 2003, we accounted for our stock-based employee and director compensation plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Stock-based employee and director compensation cost was not reflected in the net loss for the year ended December 31, 2002, because all options granted under our plans had exercise prices equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, we adopted the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, on a prospective basis for all employee and director awards granted, modified, or settled after January 1, 2003. Awards to employees typically vest over four years. Therefore, the cost related to stock-based employee and director compensation included in the determination of net income for 2003 is less than that which would have been recognized if the

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fair value based method had been applied to all awards granted, modified or settled since October 1, 1995. See Note 2 of the Notes to Consolidated Financial Statements.

Critical Accounting Policies and Estimates

When we prepare our consolidated financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. The accounting estimates that we believe involve the most complex judgments, and are the most critical to the accurate reporting of our financial condition and results of operations include the following:

Incurred But Not Reported or Paid Claims Reserves. We estimate the amount of our reserves for claims incurred but not reported (including those received but not yet paid), or IBNR, under our risk-based provider contracts and our fee-for service carve-outs from our capitated provider contracts, primarily using standard actuarial methodologies based on historical data. These standard actuarial methodologies include, among other factors, contractual requirements, historical utilization trends, the interval between the date services are rendered and the date claims are paid, denied claims activity, disputed claims activity, benefit changes, expected health care cost inflation, seasonality patterns and changes in membership. In developing the IBNR estimate, we apply different estimation methods depending on the month for which incurred claims are being estimated. For example, we actuarially calculate completion factors using our analysis of claims payment patterns over the most recent 36-month period. The completion factor is an actuarial estimate, based upon historical experience, of the percentage of claims incurred during a given period that has been adjudicated by us as of the date of estimation. We then apply these completion factors to the actual claims paid to-date for each incurral month, except for the most recent months, to estimate the expected amount of ultimate incurred claims for each of these months. We do not believe that completion factors are a reliable basis for estimating claims incurred for the most recent two to four months, because claims likely have not had enough time to achieve a trendable level of completion. Therefore, for the more recent months, we estimate our claims incurred by applying observed trend factors to the per member per month (PMPM) costs for prior months, which costs have been estimated using completion factors, in order to estimate the PMPMs for the most recent months. We validate our estimates of the most recent PMPMs by comparing the most recent months’ utilization levels to the utilization levels in older months. This approach is consistently applied from period to period.

The completion factors and claims PMPM trend factors are the most significant factors we use in estimating our IBNR. The following table illustrates the sensitivity of these factors and the estimated potential impact on the Company’s operating results caused by these factors:

Completion Factor(a)			Increase (Decrease) in
Increase (Decrease) in Factor			Medical Claims Payable
			(Amounts in millions)
	(3	)%	$	41
	(2	)%		27
	(1	)%		13
	1	%		(13	)
	2	%		(26	)
	3	%		(39	)

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Claims Trend Factor(b)			Increase (Decrease) in
Increase (Decrease) in Factor			Medical Claims Payable
			(Amounts in millions)
	(3	)%	$	(2	)
	(2	)%		(1	)
	(1	)%		(1	)
	1	%		1
	2	%		1
	3	%		2

(a)	Reflects estimated potential changes in medical claims payable caused by changes in completion factors in each of the most recent four months.
(b)	Reflects estimated potential changes in medical claims payable caused by changes in annualized claims trend used for the estimation of per member per month claims for the most recent four months.

In addition, assuming a hypothetical 1% difference between our December 31, 2003 estimated claims liability and the actual claims incurred run-out, net income for the year ended December 31, 2003 would increase or decrease by approximately $8.3 million, while diluted net income per share would increase or decrease by $0.06 per share, net of tax, after adjusting for the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004.

The estimates for submitted claims and IBNR claims liabilities are made on an accrual basis and adjusted, based on actual claims data, in future periods as required. Adjustments to prior period estimates, if any, are included in the current period. We also consider exceptional situations that might require judgmental adjustments in establishing our best estimate, such as system conversions, processing interruptions, or environmental changes. None of these factors had a material impact on the development of our claims payable estimates during any of the periods reflected in this filing.

For new products, such as our PPO products, estimates are initially based on health care cost data provided by third parties. This data includes assumptions for member age, gender and geography. The models that we use to prepare estimates for each product are adjusted to be in line with the approach discussed above as we accumulate actual claims data. Such estimates could materially understate or overstate our actual liability for medical claims and benefits payable.

Provider Insolvency Reserves. We maintain insolvency reserves for our capitated contracts with providers that include estimates for potentially insolvent providers, where conditions indicate claims are not being paid or have slowed considerably, and we have determined that it is probable that we will be required to make the providers’ claim payments. These insolvency reserves include the estimated cost of unpaid health care claims that were previously the responsibility of the capitated provider. Depending on states’ laws, we may be held liable for unpaid health care claims that were previously the responsibility of the capitated provider and for which we have already paid capitation. These estimates could materially understate or overstate our actual liability for medical claims and benefits payable.

Ordinary Course Legal Proceedings. From time to time, we are involved in legal proceedings that involve claims for coverage and tort liability encountered in the ordinary course of business. The loss of even one of these claims, if it results in a significant punitive damage award, could have a material adverse effect on our business. In addition, our exposure to potential liability under punitive damage theories may significantly decrease our ability to settle these claims on reasonable terms.

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CAUTIONARY STATEMENTS

In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are hereby filing cautionary statements identifying important risk factors that could cause our actual results to differ materially from those projected in “forward looking statements” of the Company made by or on behalf of the Company (in this report or otherwise), within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. These forward looking statements relate to future events or our future financial and/or operating performance and can generally be identified as such because the context of the statement will include words such as “may,” “will,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,” or “opportunity,” the negative of these words or words of similar import. Similarly, statements that describe our reserves and our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward looking statements. These forward looking statements are based largely on our expectations and projections about future events and future trends affecting our business, and so are subject to risks and uncertainties, including the risks and uncertainties set forth below, that could cause actual results to differ materially from those anticipated as of the date of this report. In addition, past financial and/or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. In evaluating these statements, you should specifically consider the risks described below and in other parts of this report. Except as required by law, we undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report.

Risks Relating to Us and Our Industry

Our profitability will depend in part on accurately pricing our products and predicting health care costs and on our ability to control future health care costs.

Our profitability depends in part on our ability to price our products accurately, predict our health care costs and control future health care costs through underwriting criteria, medical and disease management programs, product design and negotiation of favorable provider and hospital contracts. We use our underwriting systems to establish and assess premium rates based on accumulated actuarial data, with adjustments for factors such as claims experience and hospital and physician contract changes. We may be less able to accurately price our new products than our other products because of our relative lack of experience and accumulated data for our new products. Premiums on our commercial products are generally fixed for one-year periods. Each of our subsidiaries that offers Medicare+Choice products must submit adjusted community rate proposals, generally by county or service area, to CMS in early September for each Medicare+Choice product that will be offered in a subsequent year. As a result, increases in the costs of health care services in excess of the estimated future health care costs reflected in the premiums or the adjusted community rate proposals generally cannot be recovered in the applicable contract year through higher premiums or benefit designs.

Our actual health care costs may exceed our estimates reflected in premiums and adjusted community rates due to various factors, including increased utilization of medical facilities and services, including prescription drugs, changes in demographic characteristics, the regulatory environment, changes in health care practices, medical cost inflation, new treatment and technologies, continued consolidation of physician, hospital and other provider groups, termination of capitation arrangements resulting in transfer of membership to risk based arrangements and contractual disputes with providers. Our failure to adequately price our products or predict and control health care costs may result in a material adverse effect on our financial condition, results of operations or cash flows.

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If we fail to implement successfully our strategic initiatives, our revenues could decline and our results of operations could be adversely affected.

Our performance depends in part upon our ability to implement our business strategy of expanding our product portfolio and increasing our commercial and specialty memberships, managing our participation in the Medicare+Choice program in light of the new Medicare legislation and growth opportunity, and ultimately evolving into a consumer health organization. In 2002 and 2003, we experienced a decline in revenue from our reduced participation in Medicare+Choice and a loss of unprofitable commercial membership. We are seeking to replace revenue and increase our commercial business through a number of new product initiatives. Our revenues could decline if we lose membership, fail to increase membership in targeted markets or fail to gain market acceptance for new products for any reason, including:

•  the effect of premium increases, benefit changes and member-paid supplemental premiums and copayments on the retention of existing members and the enrollment of new members;

•  the member’s assessment of our benefits, quality of service, our ease of use and our network stability for members in comparison to competing health plans;

•  reductions in work force by existing customers and/or reductions in benefits purchased by existing customers; and

•  negative publicity and news coverage about us or litigation or threats of litigation against us.

Our operating results could be adversely affected if our actual health care claims exceed our reserves or our liability for unpaid claims of insolvent providers under capitation agreements exceeds our insolvency reserves.

We estimate the amount of our reserves for submitted claims and claims that have been incurred but not yet reported or IBNR claims primarily using standard actuarial methodologies based upon historical data. The estimates for submitted claims and IBNR claims liabilities are made on an accrual basis, are continually reviewed and are adjusted in current operations as required. Given the uncertainties inherent in such estimates, the reserves could materially understate or overstate our actual liability for claims and benefits payable. Any increases to these prior estimates could adversely affect our results of operations in future periods.

Our capitated providers could become insolvent and expose us to unanticipated expenses. We maintain insolvency reserves that include estimates for potentially insolvent providers, where conditions indicate claims are not being paid or have slowed considerably. Depending on states’ laws, we may be held liable for unpaid health care claims that were previously the responsibility of the capitated provider and for which we have already paid capitation. We may also incur additional health care costs in the event of provider instability that causes us to replace a provider at less cost-effective rates to continue providing health care services to our members.

To reduce insolvency risk, we have developed contingency plans that include shifting members to other providers and reviewing operational and financial plans to monitor and maximize financial and network stability. As capitation contracts are renewed for providers we have also taken steps, where feasible, to have security reserves established for insolvency issues. Security reserves are most frequently in the forms of letters of credit or segregated funds that are held in the provider’s name in a third party financial institution. The reserves may be used to pay claims that are the financial responsibility of the provider. These security reserves may not be adequate to cover claims that are the financial responsibility of the provider.

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A disruption in our health care provider network could have an adverse effect on our ability to market our products and our profitability.

Our profitability is dependent in part upon our ability to contract with health care providers on favorable terms. In any particular market, health care providers could refuse to contract with us, demand higher payments or take other actions that could result in higher health care costs or our difficulty in meeting regulatory or accreditation requirements. In some markets, health care providers may have significant market positions or may be the only available health care provider. If health care providers refuse to contract with us, use their market position to negotiate favorable contracts, or place us at a competitive disadvantage, then our ability to market products or to be profitable in those markets could be adversely affected. Our provider networks could also be disrupted by the financial insolvency of large provider groups. Any disruption in our provider network could result in a loss of membership or higher health care costs.

We may be exposed to liability or fail to estimate IBNR accurately if we cannot process our increased volume of claims accurately and timely.

We have regulatory risk for the timely processing and payment of claims. If we, or any entities with whom we subcontract to process or pay claims, are unable to handle continued increased claims volume, or if we are unable to pay claims timely we may be subject to regulatory censure and penalties, which could have a material adverse effect on our operations and results of operations. In addition, if our claims processing system is unable to process claims accurately, the data we use for our IBNR estimates could be incomplete and our ability to estimate claims liabilities and establish adequate reserves could be adversely affected.

Our profitability may be adversely affected if we are unable to adequately control our prescription drug costs.

Overall, prescription drug costs have been rising for the past few years. The increases are due to the introduction of new drugs that treat new conditions or have fewer side effects, new medications costing significantly more than existing drugs, direct consumer advertising by the pharmaceutical industry creating consumer demand for particular brand drugs, patients seeking medications to address lifestyle changes, higher prescribed doses of medications and enhanced pharmacy benefits for members such as reduced copayments and higher benefit maximums. We may be unable to predict these costs when establishing our premiums or completely manage these costs, which could adversely impact our profitability.

Increases in our selling, general and administrative expenses could harm our profitability.

Our selling, general and administrative expenses have been rising due in part to our continued investment in strategic initiatives and could increase more than we anticipate as a result of a number of factors, which could adversely impact our profitability. These factors include:

•  our need for additional investments in PBM expansion, branding and advertising campaigns, medical management, underwriting and actuarial resources and technology;

•  our need for additional investments in information technology projects, including consolidation of our existing systems that manage membership, eligibility, capitation, claims processing and payment information and other important information;

•  our need for increased claims administration, personnel and systems;

•  our greater emphasis on small group and individual health insurance products, which may result in an increase in the broker commissions we pay;

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•  the necessity to comply with regulatory requirements;

•  the success or lack of success of our marketing and sales plans to attract new customers, and create customer acceptance for new products;

•  our ability to estimate costs for our self-insured retention for medical malpractice claims; and

•  our ability to estimate legal expenses and settlements associated with litigation that has been or could be brought against us.

In addition, our selling, general and administrative expenses as a percentage of our revenue could increase due to changes in our product mix among commercial, senior and specialty products and unexpected declines in our membership and related revenue. If we do not generate expected cash flow from operations, we could be forced to postpone or cancel some of these planned investments, which would adversely affect our ability to meet our short-term strategic plan.

The inability or failure to properly maintain management information systems, or any inability or failure to successfully update or expand processing capability or develop new capabilities to meet our business needs could result in operational disruptions and other adverse consequences.

Our business depends significantly on effective information systems. The information gathered and processed by our management information systems assists us in among other things, marketing and sales tracking, underwriting, billing, claims processing, capitation processing, medical management, medical cost and utilization trending, financial and management accounting, reporting, planning and analysis and e-commerce. These systems also support our on-line customer service functions, provider and member administrative functions and support our tracking and extensive analyses of health care costs and outcome data. Any inability or failure to properly maintain management information systems, or any inability or failure to successfully update or expand processing capability or develop new capabilities to meet our business needs, could result in operational disruptions, loss of existing customers, difficulty in attracting new customers, disputes with customers and providers, regulatory problems, increases in administrative expenses and other adverse consequences.

We are subject to class action lawsuits that could result in material liabilities to us or cause us to incur material costs, to change our operating procedures or comply with increased regulatory requirements.

Health care providers and members are currently attacking practices of the HMO industry through a number of lawsuits brought against us and other HMOs, including In re Managed Care. The class action lawsuits brought by health care providers allege that HMOs’ claims processing systems automatically and impermissibly alter codes included on providers’ reimbursement/ claims forms to reduce the amount of reimbursement, and that HMOs impose unfair contracting terms on health care providers, impermissibly delay making capitated payments under their capitated contracts, and negotiate capitation payments that are inadequate to cover the costs of health care services provided.

These lawsuits, including those filed to date against us, may take years to resolve and cause us to incur substantial litigation expenses. Depending upon the outcomes of these cases, these lawsuits may cause or force changes in practices of the HMO industry. These cases also may cause additional regulation of the industry through new federal or state laws. These actions and actions brought by state attorney generals ultimately could adversely affect the HMO industry and, whether due to damage awards, required changes to our operating procedures, increased regulatory requirements or otherwise, have a material adverse effect on our financial position, results of operations or cash flows and prospects.

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We are subject to other litigation in the ordinary course of business that may result in material liabilities to us, including liabilities for which we may not be insured.

We are, in the ordinary course of business, subject to the claims of our members arising out of decisions to deny or restrict reimbursement for services, including medical malpractice claims related to our taking a more active role in managing the cost of medical care. The loss of even one of these claims, if it results in a significant punitive damage award, could have a material adverse effect on our business. In addition, our exposure to potential liability under punitive damage theories may significantly decrease our ability to settle these claims on reasonable terms. We maintain general liability, property, excess managed care errors and omissions and medical malpractice insurance coverage. We are at risk for our self-insured retention on these claims, and are substantially self-insured for errors and omissions and medical malpractice claims through a combination of retention and through premiums we pay to a captive insurance carrier. Coverages typically include varying and increasing levels of self-insured retention or deductibles that increase our risk of loss.

As a government contractor, we are exposed to risks that could materially affect our revenue or profitability from our Medicare+Choice products or our willingness to participate in the Medicare program.

The Medicare program has accounted for 49% of our total revenue in 2003 and more than 50% of our total revenue in each of the prior five years. CMS regulates the benefits provided, premiums paid, quality assurance procedures, marketing and advertising for our Medicare+Choice products. CMS may terminate our Medicare+Choice contracts or elect not to renew those contracts when those contracts come up for renewal every 12 months. Although we expect to receive increased government funding under the newly enacted DIMA legislation, we may still face the risk of reduced or insufficient government reimbursement and the need to continue to exit unprofitable markets. The loss of Medicare contracts or changes in the regulatory requirements governing the Medicare+Choice program or the program itself could have a material adverse effect on our financial position, results of operations or cash flows.

We compete in highly competitive markets and our inability to compete effectively for any reason in any of those markets could adversely affect our profitability.

We operate in highly competitive markets. Consolidation of acute care hospitals and continuing consolidation of insurance carriers, other HMOs, employer self-funded programs and PPOs, some of which have substantially larger enrollments or greater financial resources than ours, has created competition for hospitals, physicians and members, impacting profitability and the ability to influence medical management. The cost of providing benefits is in many instances the controlling factor in obtaining and retaining employer groups as clients and some of our competitors have set premium rates at levels below our rates for comparable products. We anticipate that premium pricing will continue to be highly competitive. In addition, PBM companies have continued to consolidate, competing with our PBM, Prescription Solutions. Some PBMs possess greater financial, marketing and other resources than we possess. If we are unable to compete effectively in any of our markets, our business may be adversely affected.

Our business activities are highly regulated and new and proposed government regulation or legislative reforms could increase our cost of doing business, reduce our membership or subject us to additional litigation.

Our health plans are subject to substantial federal and state government regulations, including those relating to:

•  maintenance of minimum net worth or risk based capital;

42

•  licensing requirements;

•  approval of policy language and benefits;

•  mandated benefits and administrative processes;

•  Employment Retirement Income Security Act of 1974, or ERISA, claims and appeals review procedures for employer-sponsored and self-insured plans;

•  provider compensation arrangements;

•  member disclosure;

•  periodic audits and investigations by state and federal agencies;

•  restrictions on some investment activities; and

•  restrictions on our subsidiaries’ ability to make dividend payments, loans, loan repayments or other payments to us.

The laws and regulations governing our business and interpretations of these laws and regulations are subject to frequent change. In recent years, significant federal and state laws have been enacted that have increased our cost of doing business, exposed us to increased liability and had other adverse effects on our business. State and federal governments are continually considering changes to the laws and regulations regulating our industry, and are currently considering laws and regulations relating to:

•  increasing minimum capital or risk based capital requirements;

•  mandating benefits and products;

•  restricting a health plan’s ability to limit coverage to medically necessary care;

•  reducing the reimbursement or payment levels for government funded programs;

•  imposing guidelines for pharmaceutical manufacturers that would cause pharmaceutical companies to restructure the financial terms of their business arrangements with PBMs, HMOs or other health plans;

•  patients’ bill of rights legislation at the state and federal level that would hold HMOs liable for medical malpractice;

•  limiting a health plan’s ability to capitate physicians and hospitals or delegate financial risk, utilization review, quality assurance or other medical decisions to our contracting physicians and hospitals;

•  restricting a health plan’s ability to select and terminate providers in our networks;

•  allowing independent physicians to collectively bargain with health plans on a number of issues, including financial compensation;

•  adding further restrictions and administrative requirements on the use, retention, transmission, processing, protection and disclosure of personally identifiable health information; and

•  tightening time periods for the timely payment and administration of health care claims and imposing financial and other penalties for non-compliance.

All of these proposals could apply to us and could increase our health care costs, decrease our membership or otherwise adversely affect our revenue and our profitability.

43

Our investment portfolio is subject to economic and market conditions as well as regulation that may adversely affect the performance of the portfolio.

The market value of our investments fluctuates depending upon economic and market conditions. The investment income we earn has been negatively impacted by the lower interest rates prevailing in United States financial markets. In periods of declining interest rates, bond calls and mortgage loan prepayments generally increase, resulting in the reinvestment of these funds at the then lower market rates. Our regulated subsidiaries are also subject to state laws and regulations that require diversification of our investment portfolio and limit the amount of investments we can make in riskier investments that could generate higher returns. In some cases, these laws could require the sale of investments in our portfolio. We cannot be certain that our investment portfolio will produce total positive returns in future periods or that we will not sell investments at prices that are less than the carrying value of these investments.

We have a significant amount of indebtedness and may incur additional indebtedness in the future, which could adversely affect our operations.

We have substantial indebtedness outstanding and have available borrowing capacity under our senior credit facility of up to $150 million. We may also incur additional indebtedness in the future.

Our significant indebtedness poses risks to our business, including the risks that:

•  we could use a substantial portion of our consolidated cash flow from operations to pay principal and interest on our debt, thereby reducing the funds available to fund our strategic initiatives and working capital requirements;

•  insufficient cash flow from operations may force us to sell assets, or seek additional capital, which we may be unable to do at all or on terms favorable to us;

•  our level of indebtedness may make us more vulnerable to economic or industry downturns; and

•  our debt service obligations increase our vulnerabilities to competitive pressures, because many of our competitors are less leveraged than we are.

Our ability to repay debt depends in part on dividends and cash transfers from our subsidiaries.

Nearly all of our subsidiaries are subject to HMO regulations or insurance regulations and may be subject to substantial supervision by one or more HMO or insurance regulators. Subsidiaries subject to regulation must meet or exceed various capital standards imposed by HMO or insurance regulations, which may from time to time impact the amount of funds the subsidiaries can pay to us. Our subsidiaries are not obligated to make funds available to us. Additionally, from time to time, we advance funds in the form of a loan or capital contribution to our subsidiaries to assist them in satisfying state financial requirements. We may provide additional funding to a subsidiary if a state regulator imposes additional financial requirements due to concerns about the financial position of the subsidiary or if there is an adverse effect resulting from changes to the risk-based capital requirements. This may in turn affect the subsidiary’s ability to pay state-regulated dividends or make other cash transfers.

Our senior credit facility and our 10 3/4% senior notes contain restrictive covenants that may limit our ability to expand or pursue our business strategy.

Our senior credit facility and our 10 3/4% senior notes limit, and in some circumstances prohibit, our ability to incur additional indebtedness, pay dividends, make investments or other restricted payments, sell or otherwise dispose of assets, effect a consolidation or merger and engage in other activities.

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We are required under the senior credit facility to maintain compliance with certain financial ratios. We may not be able to maintain these ratios. Covenants in the senior credit facility and our 10 3/4% senior notes may impair our ability to expand or pursue our business strategies. Our ability to comply with these covenants and other provisions of the senior credit facility and our 10 3/4% senior notes may be affected by our operating and financial performance, changes in business conditions or results of operations, adverse regulatory developments or other events beyond our control. In addition, if we do not comply with these covenants, the lenders under the senior credit facility and our 10 3/4% senior notes may accelerate our debt repayment under the senior credit facility and our 10 3/4% senior notes. If the indebtedness under the senior credit facility or our 10 3/4% senior notes is accelerated, we could not assure you that our assets would be sufficient to repay all outstanding indebtedness in full.

The concentration of our commercial and government senior business in eight western states and Guam subjects us to risks from economic downturns in this region.

We offer managed care and other health insurance products to employer groups and Medicare beneficiaries primarily in eight western states and Guam. Due to this concentration of business in a small number of states, we are exposed to potential losses resulting from the risk of an economic downturn in these states and region of the country. If economic conditions deteriorate in any of these states, particularly in California where we have our largest membership, our membership and our margins may decline, which could have a material adverse effect on our business, financial conditions and results of operations.

We could incur unexpected health care and other costs as a result of terrorism or natural disasters.

We cannot predict or prevent the occurrence of bioterrorism or other acts of terrorism or natural disasters, such as earthquakes, which could cause increased and unexpected utilization of health care services. These events could also have adverse effects on general economic conditions in the states where we offer products, the price and availability of products and services we purchase, the availability and morale of our employees, our operations and facilities or the demand for our products. We maintain disaster recovery plans intended to enable us to continue to operate without major disruptions in service following disasters. However, a disaster could severely impair or delay service to our members, cause us to incur significant cost of recovery and cause a loss of members.

Our PBM subsidiary, Prescription Solutions, faces regulatory and other risks associated with the pharmacy benefits management industry that differ from the risks of providing managed care and health insurance products.

Our PBM is also subject to federal and state anti-remuneration laws that govern its relationships with pharmaceutical manufacturers. Federal and state legislatures are considering new regulations for the industry that could adversely affect current industry practices, including the receipt of rebates from pharmaceutical companies. In addition, if a court were to determine that our PBM acts as a fiduciary under ERISA, we could be subject to claims for alleged breaches of fiduciary obligations in implementation of formularies, preferred drug listings and therapeutic intervention programs and other transactions. We also conduct business as a mail-order pharmacy, which subjects us to extensive federal, state and local regulation, as well as risks inherent in the packaging and distribution of pharmaceuticals and other health care products. The failure to adhere to these regulations could expose our PBM subsidiary to civil and criminal penalties. We also face potential claims in connection with claimed errors by our mail-order pharmacy.

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Our forecasts and other forward looking statements are based upon various assumptions that are subject to significant uncertainties that may result in our failure to achieve our forecasted results.

From time to time in press releases, conference calls and otherwise, we may publish or make forecasts or other forward looking statements regarding our future results, including estimated earnings per share and other operating and financial metrics. Our forecasts are based upon various assumptions that are subject to significant uncertainties and any number of them may prove incorrect. Our estimated earnings per share are based in part upon a forecast of our weighted average shares outstanding at the time of our estimate. Our convertible subordinated debentures include a contingent conversion feature that may materially affect our weighted average shares outstanding in any quarter. If the conditions to conversion are satisfied during a quarter, then the debentures are convertible during the next quarter and the underlying shares of common stock into which they are convertible are included in the calculation of our weighted average shares outstanding. If the conditions to conversion are not met, then the underlying shares are excluded from the calculation.

Our achievement of any forecasts depends upon numerous factors, many of which are beyond our control. Consequently, we cannot assure you that our performance will be consistent with management forecasts. Variations from forecasts and other forward-looking statements may be material and adverse.

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

The principal objective of our asset/ liability management activities is to maximize net investment income, while maintaining acceptable levels of interest rate risk and facilitating our funding needs. Our net investment income and interest expense are subject to the risk of interest rate fluctuations. To mitigate the impact of fluctuations in interest rates, we manage the structure of the maturity of debt and investments and may use derivative financial instruments, primarily interest rate swaps.

In April 2003, we entered into an interest rate swap on $300 million of our 10 3/4% senior notes for the purpose of hedging the fair value of our indebtedness. This fair value hedge is accounted for using the short-cut method under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, whereby the hedge is reported in our balance sheets at fair value, and the carrying value of the long-term debt is adjusted for an offsetting amount representing changes in fair value attributable to the hedged risk. Under the terms of the agreement, we make interest payments based on the three-month London Interbank Offered Rate (LIBOR) plus 692 basis points and receive interest payments based on the 10 3/4% fixed rate. The three-month LIBOR rate we use to determine our interest payments under the swap agreement was first established on June 2, 2003 and resets every three months thereafter, until expiration in June 2009.

The following table provides information about our financial instruments that are sensitive to changes in interest rates as of December 31, 2003 and 2002. For investment securities and debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For debt with variable rates, the rates in place as of December 31, 2003 are used to determine average interest rates. Additionally, we have assumed our marketable securities and restricted marketable securities, comprised primarily of U.S. government, state, municipal, and corporate debt securities, are similar enough to aggregate into fixed rate and variable rate securities for presentation purposes. For terms relating to our long-term debt, see Note 5 of the Notes to Consolidated Financial Statements.

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As of December 31, 2003:

		2004			2005			2006			2007			2008			Beyond			Total			Fair Value
		(Amounts in thousands)
Assets:
Marketable securities:
	Fixed rate	$	144,335		$	79,464		$	126,485		$	111,437		$	148,452		$	686,113		$	1,296,286		$	1,326,317
	Average interest rate		2.82	%		5.55	%		4.57	%		5.16	%		4.71	%		5.49	%		4.99	%		—
	Variable rate	$	3,500		$	2,527		$	—		$	2,506		$	—		$	25,043		$	33,576		$	33,403
	Average interest rate		1.49	%		1.47	%		—			1.36	%		—			2.06	%		1.91	%		—
Marketable securities — restricted:
	Fixed rate	$	108,383		$	16,900		$	14,631		$	7,017		$	6,632		$	12,842		$	166,405		$	167,616
	Average interest rate		2.78	%		2.78	%		3.32	%		5.42	%		5.16	%		5.79	%		3.22	%		—
	Variable rate	$	—		$	—		$	—		$	—		$	—		$	141		$	141		$	144
	Average interest rate		—			—			—			—			—			6.24	%		6.24	%		—
Liabilities:
Long term debt, including debt due within one year:
	Fixed rate	$	5,996		$	4,532		$	905		$	270		$	289		$	458,954		$	470,946		$	470,946
	Average interest rate		4.36	%		4.51	%		6.17	%		6.77	%		6.77	%		6.73	%		—			—
	Variable rate	$	1,500		$	1,500		$	23,250		$	72,750		$	50,250		$	—		$	149,250		$	149,250
	Average interest rate		3.68	%		3.68	%		3.68	%		3.68	%		3.68	%		—			—			—

As of December 31, 2002:

		2003			2004			2005			2006			2007			Beyond			Total			Fair Value
		(Amounts in thousands)
Assets:
Marketable securities:
	Fixed rate	$	89,716		$	21,947		$	76,516		$	107,695		$	100,005		$	733,833		$	1,129,712		$	1,167,299
	Average interest rate		3.14	%		3.71	%		6.49	%		5.43	%		5.35	%		5.74	%		5.48	%		—
	Variable rate	$	—		$	3,500		$	2,527		$	—		$	—		$	25,021		$	31,048		$	28,218
	Average interest rate		—			6.53	%		2.17	%		—			—			2.65	%		3.05	%		—
Marketable securities — restricted:
	Fixed rate	$	56,097		$	85,105		$	3,342		$	7,956		$	10,596		$	22,946		$	186,042		$	190,172
	Average interest rate		1.34	%		3.30	%		6.16	%		5.73	%		5.45	%		5.80	%		3.12	%		—
	Variable rate	$	—		$	—		$	—		$	—		$	—		$	147		$	147		$	149
	Average interest rate		—			—			—			—			—			6.24	%		6.24	%		—
Liabilities:
Long term debt, including debt due within one year:
	Fixed rate	$	46,750		$	5,123		$	3,007		$	—		$	—		$	633,562		$	688,442		$	688,442
	Average interest rate		6.83	%		4.65	%		4.65	%		—			—			9.09	%		—			—
	Variable rate	$	60,484		$	81,103		$	9,000		$	—		$	—		$	—		$	150,587		$	150,587
	Average interest rate		6.40	%		6.40	%		6.40	%		—			—			—			—			—

ITEM 8.     CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See “Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.”

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

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

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ITEM 9A.     CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our chief executive officer, or CEO, and chief financial officer, or CFO, an evaluation was performed on the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this annual report. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of December 31, 2003.

An evaluation was also performed under the supervision and with the participation of our management, including our CEO and CFO, of any change in our internal controls over financial reporting that occurred during our last fiscal year and that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. That evaluation did not identify any change in our internal controls over financial reporting that occurred during our latest fiscal year and that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART III

ITEM 10.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information contained in the sections entitled “Board of Directors,” “Director Compensation,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” contained in Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

The information regarding the Registrant’s audit committee members and audit committee financial experts set forth in the sections entitled “Activities of the Board of Directors and its Committees” and “Audit Committee Report” contained in Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

The information regarding the Registrant’s code of ethics set forth in the section entitled “Code of Ethics” contained in Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

The information regarding the procedures for stockholders to recommend board nominees is set forth in the section entitled “Procedures for Stockholder Recommendations of Board Nominees and Stockholder Proposals” contained in Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 11.     EXECUTIVE COMPENSATION

The information contained in the section entitled “Executive Compensation” in the Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT RELATED STOCKHOLDER MATTERS

The information contained in the section entitled “Principal Stockholders” and “Equity-Based Instruments Held by Management” in the Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

The information contained in the section entitled “Equity Compensation Plan Information” in the Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is also incorporated herein by reference.

ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information set forth in the section entitled “Certain Relationships and Related Transactions” contained in the Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 14.     PRINCIPAL ACCOUNTANTS FEES AND SERVICES

The information contained in the section entitled “Independent Auditor Fees” in the Registrant’s definitive Proxy Statement for its 2004 Annual Meeting of Stockholders is incorporated herein by reference.

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

The following documents are filed as part of this report:

			Page
			Reference
(a)1.	Consolidated Financial Statements:
	Consolidated Balance Sheets as of December 31, 2003 and 2002			F-1
	Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001			F-2
	Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001			F-3
	Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001			F-4
	Notes to Consolidated Financial Statements			F-6
	Report of Ernst & Young LLP, Independent Auditors			F-42
	Quarterly Information for 2003 and 2002 (Unaudited)			F-43
2.	Financial Statement Schedule:
	Schedule II — Valuation and Qualifying Accounts			F-44
		All other schedules are omitted because they are not required or the information is included elsewhere in the consolidated financial statements.
3.	Exhibits: An “Exhibit Index” is filed as part of this Form 10-K beginning on page E-1 and is incorporated by reference.
(b)	Reports on Form 8-K:
	We filed the following reports on Form 8-K during the quarter ended December 31, 2003:
	On November 5, 2003, we filed a Form 8-K that filed a press release wherein we announced our financial results for the quarter ended September 30, 2003.
	On November 10, 2003, we filed a Form 8-K that filed a press release wherein we announced the appointment of Aida Alvarez and Linda Rosenstock to the Board of Directors.
	On November 12, 2003, we filed a Form 8-K that filed a press release wherein we announced a revision to our earnings per share guidance for the 2003 fourth quarter and the full year 2003 to reflect the costs associated with the redemption of $175 million in principal 10 3/4% senior notes and the dilutive effect of the 7.6 million shares of common stock issued in the public offering announced on November 10, 2003.
	On November 13, 2003, we filed a Form 8-K that filed a press release wherein we attached the Underwriting Agreement, dated as of November 10, 2003, between us and Goldman, Sachs & Co. in connection with the public offering of 7.6 million shares of our common stock.
	On December 23, 2003, we filed a Form 8-K that filed a press release wherein we announced that our Board of Directors had approved a two-for-one common stock split in the form of a stock dividend, which was distributed on January 20, 2004.

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SIGNATURES

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

PACIFICARE HEALTH SYSTEMS, INC.

By:  /s/ HOWARD G. PHANSTIEL

Howard G. Phanstiel

Chairman of the Board and Chief Executive Officer

(Principal Executive Officer)

Date: March 4, 2004

POWER OF ATTORNEY

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

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

Name	Title	Date
/s/ HOWARD G. PHANSTIEL Howard G. Phanstiel	Chairman of the Board and Chief Executive Officer (Principal Executive Officer)	March 4, 2004
/s/ GREGORY W. SCOTT Gregory W. Scott	Executive Vice President and Chief Financial Officer (Principal Financial Officer)	March 4, 2004
/s/ PETER A. REYNOLDS Peter A. Reynolds	Senior Vice President and Corporate Controller (Chief Accounting Officer)	March 4, 2004
/s/ DAVID A. REED David A. Reed	Lead Independent Director	March 4, 2004

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Name	Title	Date
/s/ AIDA ALVAREZ Aida Alvarez	Director	March 4, 2004
/s/ BRADLEY C. CALL Bradley C. Call	Director	March 4, 2004
/s/ SHIRLEY S. CHATER, PH.D. Shirley S. Chater, PH.D.	Director	March 4, 2004
/s/ TERRY O. HARTSHORN Terry O. Hartshorn	Director	March 4, 2004
/s/ GARY L. LEARY Gary L. Leary	Director	March 4, 2004
/s/ DOMINIC NG Dominic Ng	Director	March 4, 2004
/s/ WARREN E. PINCKERT II Warren E. Pinckert II	Director	March 4, 2004
/s/ CHARLES R. RINEHART Charles R. Rinehart	Director	March 4, 2004
/s/ LINDA ROSENSTOCK Linda Rosenstock	Director	March 4, 2004
/s/ LLOYD E. ROSS Lloyd E. Ross	Director	March 4, 2004

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PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

			December 31,			December 31,
			2003			2002
			(Amounts in thousands,
			except per share data)
ASSETS
Current assets:
	Cash and equivalents		$	1,198,422		$	951,689
	Marketable securities			1,359,720			1,195,517
	Receivables, net			265,943			289,900
	Prepaid expenses and other current assets			57,299			46,805
	Restricted cash collateral for FHP senior notes			—			43,346
	Deferred income taxes			149,817			100,758
		Total current assets		3,031,201			2,628,015
Property, plant and equipment at cost, net				149,407			161,685
Marketable securities-restricted				166,546			186,189
Goodwill, net				983,104			983,104
Intangible assets, net				221,108			243,016
Other assets				67,938			49,124
			$	4,619,304		$	4,251,133
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Medical claims and benefits payable		$	1,027,500		$	1,044,500
	Accounts payable			65,222			69,733
	Accrued liabilities			326,051			285,438
	Accrued compensation and employee benefits			99,537			83,471
	Unearned premium revenue			496,480			479,552
	Current portion of long-term debt			7,496			107,235
		Total current liabilities		2,022,286			2,069,929
Long-term debt				477,700			596,961
Convertible subordinated debentures				135,000			135,000
Deferred income taxes				104,777			103,790
Other liabilities				28,004			17,148
Stockholders’ equity:
	Common stock, $0.01 par value; 200,000 shares authorized; issued 84,854 shares in 2003 and 95,418 shares in 2002			848			954
	Unearned compensation			(16,843	)		(2,000	)
	Additional paid-in capital			1,458,310			1,560,308
	Accumulated other comprehensive income			18,815			21,730
	Retained earnings			390,407			350,369
	Treasury stock, at cost; no shares in 2003 and 23,409 shares in 2002			—			(603,056	)
		Total stockholders’ equity		1,851,537			1,328,305
			$	4,619,304		$	4,251,133

All applicable share and per-share amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004.

See accompanying notes.

F-1

PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

			Year Ended			Year Ended			Year Ended
			December 31,			December 31,			December 31,
			2003			2002			2001
			(Amounts in thousands, except per share data)
Revenue:
	Commercial		$	5,043,257		$	4,782,973		$	4,553,933
	Senior			5,395,265			5,887,603			6,798,637
	Specialty and other			498,668			421,439			380,139
	Net investment income			71,321			64,487			111,263
		Total operating revenue		11,008,511			11,156,502			11,843,972
Expenses:
Health care services and other:
	Commercial			4,270,329			4,205,376			4,101,936
	Senior			4,540,301			5,104,275			6,133,789
	Specialty and other			255,164			176,050			131,932
		Total health care services and other		9,065,794			9,485,701			10,367,657
Selling, general and administrative expenses				1,452,542			1,370,160			1,288,374
Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net				—			3,774			61,157
Operating income				490,175			296,867			126,784
Interest expense, net				(100,531	)		(74,904	)		(70,282	)
Income before income taxes				389,644			221,963			56,502
Provision for income taxes				146,896			82,792			38,371
Income before cumulative effect of a change in accounting principle and extraordinary gain				242,748			139,171			18,131
Cumulative effect of a change in accounting principle				—			(897,000	)		—
Extraordinary gain on early retirement of debt, net				—			—			875
Net income (loss)			$	242,748		$	(757,829	)	$	19,006
Basic earnings (loss) per share:
	Income before cumulative effect of a change in accounting principle and extraordinary gain		$	3.26		$	1.98		$	0.27
	Cumulative effect of a change in accounting principle			—			(12.73	)		—
	Extraordinary gain, net			—			—			0.01
	Basic earnings (loss) per share		$	3.26		$	(10.75	)	$	0.28
Diluted earnings (loss) per share:
	Income before cumulative effect of a change in accounting principle and extraordinary gain		$	3.04		$	1.98		$	0.26
	Cumulative effect of a change in accounting principle			—			(12.73	)		—
	Extraordinary gain, net			—			—			0.01
	Diluted earnings (loss) per share		$	3.04		$	(10.75	)	$	0.27

All applicable per-share amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004.

See accompanying notes.

F-2

PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

												Accumulated
												Other
									Additional			Comprehensive
			Common			Unearned			Paid-in			Income			Retained			Treasury
			Stock			Compensation			Capital			(Loss)			Earnings			Stock			Total
			(Amounts in thousands)
Balances at December 31, 2000			$	940		$	—		$	1,613,474		$	(2,975	)	$	1,089,192		$	(697,071	)	$	2,003,560
Comprehensive income:
	Net income			—			—			—			—			19,006			—			19,006
	Other comprehensive gain, net of tax:
		Change in unrealized gains on marketable securities, net of reclassification adjustment		—			—			—			4,926			—			—			4,926
Comprehensive income				—			—			—			4,926			19,006			—			23,932
Capital stock activity:
	Employee benefit plans			6			(1,153	)		4,357			—			—			—			3,210
	Reissuance of treasury stock			—			—			(28,621	)		—			—			38,821			10,200
Purchase of remaining minority interest in consolidated subsidiary				—			—			(7,138	)		—			—			—			(7,138	)
Tax benefit associated with exercise of stock options				—			—			21			—			—			—			21
Balances at December 31, 2001				946			(1,153	)		1,582,093			1,951			1,108,198			(658,250	)		2,033,785
Comprehensive income (loss):
	Net loss			—			—			—			—			(757,829	)		—			(757,829	)
	Other comprehensive gain, net of tax:
		Change in unrealized gains on marketable securities, net of reclassification adjustment		—			—			—			19,779			—			—			19,779
Comprehensive income (loss)				—			—			—			19,779			(757,829	)		—			(738,050	)
Capital stock activity:
	Employee benefit plans			8			(847	)		(7,649	)		—						28,301			19,813
	Reissuance of treasury stock			—			—			(15,145	)		—			—			26,893			11,748
Tax benefit associated with exercise of stock options				—			—			1,009			—			—			—			1,009
Balances at December 31, 2002				954			(2,000	)		1,560,308			21,730			350,369			(603,056	)		1,328,305
Comprehensive income (loss):
	Net income			—			—			—			—			242,748			—			242,748
	Other comprehensive loss, net of tax:
		Change in unrealized gains on marketable securities, net of reclassification adjustment		—			—			—			(2,915	)		—			—			(2,915	)
Comprehensive income (loss)				—			—			—			(2,915	)		242,748			—			239,833
Capital stock activity:
	Employee benefit plans			51			(14,843	)		78,974			—			—			2,448			66,630
	Purchase of treasury stock			—			—			—			—			—			(493	)		(493	)
Retirement of treasury stock				(233	)		—			(398,158	)		—			(202,710	)		601,101			—
Proceeds from equity offering				76			—			199,348			—			—			—			199,424
Tax benefit associated with exercise of stock options				—			—			17,838			—			—			—			17,838
Balances at December 31, 2003			$	848		$	(16,843	)	$	1,458,310		$	18,815		$	390,407		$	—		$	1,851,537

All applicable dollar amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004.

See accompanying notes.

F-3

PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

					Year Ended			Year Ended			Year Ended
					December 31,			December 31,			December 31,
					2003			2002			2001
					(Amounts in thousands)
Operating activities:
	Net income (loss)				$	242,748		$	(757,829	)	$	19,006
	Adjustments to reconcile net income (loss) to net cash flows provided by operating activities:
		Deferred income taxes				(46,088	)		18,559			(3,966	)
		Depreciation and amortization				44,713			50,284			65,808
		Expenses related to bond redemption				28,155			—			—
		Loss on disposal of property, plant and equipment and other				22,328			12,793			6,053
		Amortization of intangible assets				21,908			23,600			23,781
		Stock-based compensation expense				19,092			693			3,632
		Tax benefit realized for stock option exercises				17,838			1,009			21
		Provision for doubtful accounts				10,271			6,346			22,070
		Amortization of capitalized loan fees				7,481			7,784			7,560
		Amortization of notes receivable from sale of fixed assets				(5,641	)		(3,107	)		—
		Employer benefit plan contributions in treasury stock				1,363			12,132			—
		Amortization of discount on 10 3/4% senior notes				424			266			—
		Cumulative effect of a change in accounting principle				—			897,000			—
		Marketable and other securities impairment for other than temporary declines in value				—			12,543			—
		Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net				—			3,774			61,157
		Adjustment to cash received in purchase transaction				—			17			—
		Amortization of goodwill				—			—			59,115
		Gain on early retirement of debt				—			—			(1,800	)
		Changes in assets and liabilities:
			Receivables, net			19,327			82,369			16,186
			Prepaid expenses and other assets			(33,748	)		2,627			7,721
			Medical claims and benefits payable			(17,000	)		(52,226	)		(174,900	)
			Accounts payable and accrued liabilities:
				Payment for Office of Personnel Management settlement, net of amounts received		(10,000	)		(65,441	)		—
				Other changes in accounts payable and accrued liabilities		74,031			59,027			(25,216	)
			Unearned premium revenue			16,928			(69,841	)		(47,305	)
				Net cash flows provided by operating activities		414,130			242,379			38,923
Investing activities:
	Purchase of marketable securities, net					(169,102	)		(113,987	)		(190,401	)
	Purchase of property, plant and equipment					(52,271	)		(59,274	)		(77,301	)
	Sale (purchase) of marketable securities-restricted, net					19,643			(117,368	)		(17,765	)
	Proceeds from the sale of property, plant and equipment					30			12,492			25,139
	Net cash paid for acquisitions					—			—			(500	)
				Net cash flows used in investing activities		(201,700	)		(278,137	)		(260,828	)
Financing activities:
	Proceeds from equity offering used for redemption of $175 million of senior notes					199,424			—			—
	Principal payments on senior note redemption					(175,000	)		—			—
	Principal payments on long-term debt					(151,329	)		(554,308	)		(30,284	)
	Proceeds from borrowings of long-term debt					150,000			496,945			—
	Principal payments on FHP senior notes					(43,250	)		(41,750	)		—
	Use of restricted cash collateral for payment of FHP senior notes					43,250			—			—
	Proceeds from issuance of common and treasury stock					41,146			4,893			83
	Payment of premium to bondholders for senior note redemption					(18,813	)		—			—
	Loan fees					(6,949	)		(37,789	)		(12,949	)
	Payments on software financing agreement					(3,683	)		(2,231	)		—
	Common stock repurchases					(493	)		—			—
	Proceeds from issuance of convertible subordinated debentures					—			135,000			—
	Proceeds from draw down under equity commitment arrangement					—			8,928			—
	Purchase of minority interest in consolidated subsidiary					—			—			(8,821	)
				Net cash flows provided by (used in) financing activities		34,303			9,688			(51,971	)
Net increase (decrease) in cash and equivalents						246,733			(26,070	)		(273,876	)
Beginning cash and equivalents						951,689			977,759			1,251,635
Ending cash and equivalents					$	1,198,422		$	951,689		$	977,759

See accompanying notes.

Table continued on next page

F-4

PACIFICARE HEALTH SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

					Year Ended			Year Ended			Year Ended
					December 31,			December 31,			December 31,
					2003			2002			2001
					(Amounts in thousands)
Supplemental cash flow information:
	Cash paid (received) during the year for:
			Income taxes, net of refunds		$	168,933		$	(68,123	)	$	7,328
			Interest		$	67,363		$	68,732		$	73,140
Supplemental schedule of noncash investing and financing activities:
	Details of cumulative effect of a change in accounting principle:
		Goodwill impairment			$	—		$	929,436		$	—
		Less decrease in deferred liability				—			(32,436	)		—
		Goodwill impairment, net of tax			$	—		$	897,000		$	—
	Stock-based compensation				$	5,028		$	1,915		$	(506	)
	Treasury stock reissued in exchange for retirement of long-term debt:
		Treasury stock			$	—		$	5,218		$	38,821
		Additional paid-in capital				—			(2,398	)		(28,621	)
		Long-term debt retired				—			(3,000	)		(12,000	)
		Extraordinary gain on early retirement of debt			$	—		$	(180	)	$	(1,800	)
	Details of accumulated other comprehensive income:
		Change in unrealized gains on marketable securities			$	(4,899	)	$	31,720		$	7,939
		Less change in deferred income taxes				1,984			(11,941	)		(3,013	)
		Change in stockholders’ equity			$	(2,915	)	$	19,779		$	4,926
	Details of assets sold:
		Net book value of assets sold			$	—		$	—		$	(42,000	)
		Less cash received				—			—			25,000
		Note receivable from sale of assets			$	—		$	—		$	(17,000	)
	Details of businesses acquired in purchase transactions:
		Fair value of assets acquired			$	—		$	—		$	3,245
		Less liabilities assumed or created				—			—			(2,745	)
		Cash paid for fair value of assets acquired				—			—			500
		Cash acquired in acquisitions				—			—			—
				Net cash paid for acquisitions	$	—		$	—		$	500
	Details of discount on 10 3/4% senior notes:
		Discount			$	(2,789	)	$	(3,055	)	$	—
		Discount reduction related to bond redemption				836			—			—
		Amortization				424			266			—
		Net discount on notes payable			$	(1,529	)	$	(2,789	)	$	—
	Details of assets acquired:
		Net book value of assets acquired			$	(2,522	)	$	(13,674	)	$	—
		Note payable				3,002			—			—
		Prepaid software maintenance				(480	)		13,674			—
		Cash paid for assets acquired			$	—		$	—		$	—

See accompanying notes.

F-5

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

Organization and Operations. PacifiCare Health Systems, Inc. offers managed care and other health insurance products to employer groups and Medicare beneficiaries primarily in eight western states and Guam. Our commercial and senior medical plans are designed to deliver quality health care and customer service to members cost-effectively. These programs include health maintenance organizations, or HMOs, preferred provider organizations, or PPOs, and Medicare Supplement products. We also offer a variety of specialty managed care products and services that employees can purchase as a supplement to our basic commercial and senior plans or as stand-alone products. These products include pharmacy benefit management, or PBM, services, behavioral health services, group life and health insurance and dental and vision benefit plans.

Consolidation. Premium revenues are earned from products where we bear insured risk. Non-premium revenues are earned from all other sources, including revenues from our PBM mail order business, administrative fees and other revenue. Commencing with the first quarter of 2003, we reformatted our statement of operations to show total revenues (premium revenues and non-premium revenues) and health care services and other expenses by the following categories: commercial, senior and specialty and other. These changes are summarized below:

•  For our behavioral health and dental and vision subsidiaries, we previously included premium revenues in the commercial revenue line and non-premium revenues in the other income line. In 2003, all revenues (premium and non-premium) derived from our specialty companies (behavioral health, dental and vision and PBM) are now reported in the specialty and other revenues line.

•  All health care services and other expenses for our specialty companies were previously included within commercial health care costs. In 2003, all health care services and other expenses for our specialty companies are now reported in the specialty and other health care services and other expenses line.

•  Non-premium revenues earned by, and non-premium related fees charged by, our health plans or subsidiaries were previously included in the other income line. In 2003, these amounts are now included in the commercial, senior or specialty revenue and health care services and other expenses lines, as appropriate.

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

Segment Information. We present segment information externally the same way management uses financial data internally to make operating decisions and assess performance. Because we sell health care packages in the form of bundled managed care and supplemental managed care products to members of all ages, we have one reportable operating segment. These managed care members generally fall within two product lines, commercial and senior. Revenues from non-Medicare members, generally employees or early retirees of businesses, are reported in the commercial product line. Revenues from our Medicare customers are reported in the senior product line. Our single largest customer is the federal government. Sources of federal government revenues include revenues from Medicare beneficiaries and from federal employees covered by the Federal Employee Health Benefits Program, or FEHBP, who are included in our commercial product line. Federal government revenues were $5.9 billion in 2003, $6.3 billion in 2002, and $7.1 billion in 2001.

F-6

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

•  Allowances for doubtful premiums and accounts receivable;

•  Provider receivables and reserves;

•  Impairment of long-lived assets;

•  Medical claims and benefits payable;

•  Professional and general liability; and

•  Reserves relating to the United States Office of Personnel Management, or OPM.

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

Reclassifications. We reclassified certain prior year amounts in the accompanying consolidated financial statements to conform to the reformatted 2003 presentation. The reclassifications and changes in presentation do not have any effect on our total consolidated revenues or health care services and other expenses.

2. Significant Accounting Policies

Cash and Equivalents. Cash and equivalents include items such as money market funds and certificates of deposit, with maturity periods of three months or less when purchased.

Marketable Securities. All marketable securities (which include municipal bonds, corporate notes, commercial paper and U.S. government securities), except for certain marketable securities-restricted, are designated as available-for-sale. Accordingly, marketable securities are carried at fair value and unrealized gains or losses, net of applicable income taxes, are recorded in stockholders’ equity. Because marketable securities are available for use in current operations, they are classified as current assets without regard to the securities’ contractual maturity dates.

We are required by state regulatory agencies to set aside funds to comply with the laws of the various states in which we operate. These funds are classified as marketable securities-restricted (which include U.S. government securities and certificates of deposit held by trustees or state regulatory agencies). Certain marketable securities-restricted are designated as held-to-maturity since we have the intent and ability to hold such securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity, and are classified as noncurrent assets. See Note 3, “Marketable Securities.”

Concentrations of Credit Risk. Financial instruments that potentially subject us to concentrations of credit risk consist primarily of investments in marketable securities and receivables generated in the ordinary course of business. Our short-term investments in marketable securities are managed by professional investment managers within guidelines established by our board of directors that, as a matter of policy, limit the amounts that may be invested in any one issuer. Our receivables include premium receivables from commercial customers, rebate receivables from pharmaceutical manufacturers, receivables related to prepayment of claims on behalf of our self-funded customers, and receivables owed to us from providers under risk-sharing arrangements. We had no significant concentrations of credit risk at December 31, 2003.

F-7

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Fair Value of Financial Instruments. Our consolidated balance sheets include the following financial instruments: cash and equivalents, trade accounts and notes receivable, trade accounts payable and long-term obligations. We consider the carrying amounts of current assets and liabilities in the consolidated financial statements to approximate the fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. The carrying value of all long-term obligations approximates the fair value of such obligations.

Long-Lived Assets.

Property, Plant and Equipment. We record property, plant and equipment at cost. We capitalize replacements and major improvements and certain internal and external costs associated with the purchase or development of internal-use software. We charge repairs and maintenance to expense as incurred. We eliminate the costs and related accumulated depreciation when we sell property, plant and equipment, and any resulting gains or losses are included in net income. We depreciate property, plant and equipment, including assets under capital leases, evenly over the assets’ useful lives ranging from three to 25 years. We amortize leasehold improvements evenly over the shorter of the lease term or five years. We amortize software costs evenly over estimated useful lives ranging from three to five years. Accumulated depreciation and amortization on property, plant and equipment totaled $212 million at December 31, 2003 and $192 million at December 31, 2002.

Long-lived Asset Impairment. We review long-lived assets, including identified intangible assets, for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered. We consider assets to be impaired and write them down to fair value if expected associated undiscounted cash flows are less than the carrying amounts. Fair value is determined based on the present value of the expected associated cash flows.

Goodwill and Intangible Assets. When we acquire a business, we allocate the excess of the purchase price over the fair value of the net assets acquired to goodwill and identified intangible assets. Prior to 2002, we amortized goodwill and intangible assets evenly over periods ranging from three to 40 years. On January 1, 2002, we adopted Statements of Financial Accounting Standards, or SFAS, No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Under the new rules, goodwill is no longer amortized, but is subject to impairment tests on an annual basis or more frequently if impairment indicators exist. The tests for measuring goodwill impairment under SFAS No. 142 are more stringent than the previous tests required by SFAS No. 121. See Note 7, “Goodwill and Intangible Assets.”

Premiums and Revenue Recognition. We report prepaid health care premiums received from our HMOs’ enrolled groups as revenue in the month that enrollees are entitled to receive health care services. We record premiums received in advance as unearned premium revenue. Funds received under the federal Medicare program accounted for approximately 50% in 2003, 53% in 2002 and 58% in 2001 as a percentage of total premiums.

Health Care Services. Our HMOs arrange for comprehensive health care services to their members through capitation or risk-based arrangements. Capitation is a fixed monthly payment made without regard to the frequency, extent or nature of the health care services actually furnished. We provide benefits to enrolled members generally through our contractual relationships with physician groups and hospitals. Our capitated physicians and hospitals may, in turn, contract with specialists or referral physicians and hospitals for specific services and are generally responsible for any related payments to those referral physicians and hospitals. Risk-based arrangements include shared-risk and fee-for-

F-8

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

service contracts. Under the shared-risk contracts, we share the risk of health care costs with parties not covered by our capitation arrangements. Under fee-for-service contracts, we contract with certain hospitals and ancillary providers, as well as some individual physicians or physician organizations, to provide services to our members based on modified discounted fee schedules for the services provided. Expenses related to these programs that are based in part on estimates are recorded in the period in which the related services are dispensed. The cost of health care provided is accrued in the period it is dispensed to the enrolled members, based in part on estimates for hospital services and other health care costs that have been incurred but not yet reported, or IBNR. Management develops these estimates using standard actuarial methods which include, among other factors, the average interval between the date services are rendered and the date claims are paid, denied claims activity, disputed claims activity, expected health care cost inflation, utilization, seasonality patterns and changes in membership. The estimates for submitted claims and IBNR claims liabilities are made on an accrual basis and adjusted based on actual claims data in future periods as required. For new products, such as our PPO products, estimates are initially based on health care cost data provided by third parties. This data includes assumptions for member age, gender and geography. The models that we use to prepare estimates for each product are adjusted as we accumulate actual claims paid data. Such estimates could materially understate or overstate our actual liability for medical claims and benefits payable. These estimates are reviewed by outside parties and state regulatory authorities on a periodic basis. The estimates for submitted claims and IBNR claims liabilities are made on an accrual basis and adjusted in future periods as required. Adjustments to prior period estimates, if any, are included in current operations. We have also recorded reserves, based in part on estimates, to indemnify our members against potential claims made by specialists or other providers whose fees should have been paid by the insolvent medical groups. See Note 13, “Contingencies.”

Premium Deficiency Reserves on Loss Contracts. We assess the profitability of our contracts for providing health care services to our members when current operating results or forecasts indicate probable future losses. We compare anticipated premiums to health care related costs, including estimated payments for physicians and hospitals, commissions and cost of collecting premiums and processing claims. If the anticipated future costs exceed the premiums, a loss contract accrual is recognized.

Stock-Based Compensation. We have stock-based employee and director compensation plans. See Note 9, “Employee Benefit Plans.” Prior to 2003, we accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee and director compensation cost was reflected in net income (loss) for the years ended December 31, 2002 and 2001, as all stock options granted under our plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, we adopted the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, on a prospective basis for all employee and director awards granted, modified or settled on or after January 1, 2003. Awards typically vest over four years. Therefore, cost related to stock-based employee and director compensation included in the determination of net income for 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards granted, modified or settled since October 1, 1995. The following table illustrates the effect on net income (loss) and earnings (loss) per share, after adjusting for the effect of the two-for-one stock split in the form of a

F-9

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

stock dividend that was effective January 20, 2004, as if the fair value method had been applied to all outstanding and unvested awards in each period.

		Year Ended
		2003			2002			2001
		(Amounts in thousands, except
		per-share data)
Net income (loss), as reported		$	242,748		$	(757,829	)	$	19,006
Add stock-based compensation expense included in reported net income (loss), net of related tax effect			8,228			—			—
Deduct total stock-based compensation expense determined under fair value method for all awards, net of related tax effect			(16,703	)		(18,360	)		(6,427	)
Pro forma net income (loss)		$	234,273		$	(776,189	)	$	12,579
Earnings (loss) per share:
	Basic — as reported	$	3.26		$	(10.75	)	$	0.28
	Basic — pro forma	$	3.15		$	(11.01	)	$	0.19
	Diluted — as reported	$	3.04		$	(10.75	)	$	0.27
	Diluted — pro forma	$	2.93		$	(11.01	)	$	0.19

The following table illustrates the components of our stock-based compensation expense:

	Year Ended
	2003				2002				2001
	Pretax		Net-of-Tax		Pretax		Net-of-Tax		Pretax		Net-of-Tax
	Charges		Amount		Charges		Amount		Charges		Amount
	(Amounts in thousands)
Stock options	$	7,545	$	4,512	$	—	$	—	$	—	$	—
Employee Stock Purchase Plan		6,214		3,716		—		—		—		—
		13,759		8,228		—		—		—		—
Restricted stock(1)		5,333		3,189		693		414		3,632		2,172
Total	$	19,092	$	11,417	$	693	$	414	$	3,632	$	2,172

(1)  The recognition and measurement of restricted stock is the same under APB Opinion No. 25 and FASB Statement No. 123. The related expenses for the fair value of restricted stock were charged to selling, general and administrative expenses and are included in the net income (loss), as reported amounts in the pro forma net income (loss) table above. See Note 6, “Stockholders’ Equity.”

Taxes Based on Premiums. Certain states in which we do business require the payment of excise, per capita or premium taxes based on a specified rate for enrolled members or a percentage of billed premiums. Such taxes may be levied instead of state income tax. These taxes are recorded in selling, general and administrative expenses, and totaled $34 million in 2003, $27 million in 2002 and $26 million in 2001.

F-10

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Income Taxes. We recognize deferred income tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. We measure deferred tax assets and liabilities by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. See Note 8, “Income Taxes.”

Earnings per Share. The following table includes a reconciliation of the denominators for the computation of basic and diluted earnings per share. All share and per share amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004. See Note 6 “Stockholders’ Equity”.

		2003		2002		2001
		(Amounts in thousands)
Shares outstanding at the beginning of the period(1)			71,782		68,894		66,908
Weighted average number of shares issued:
	Stock options exercised and treasury stock reissued, net		1,627		1,580		642
	Common stock offering(2)		1,000		—		—
Denominator for basic earnings per share			74,409		70,474		67,550
Employee stock options and other dilutive potential common shares(3)(4)			5,554		—		508
Denominator for diluted earnings per share(3)(4)			79,963		70,474		68,058

(1)	Excludes approximately 1,515,000, 226,000 and 180,000 shares of restricted common stock which have been granted but have not fully vested as of December 31, 2003, 2002 and 2001, respectively.
(2)	In November 2003, we issued 7.6 million shares of our common stock in a public offering. See Note 6 “Stockholders’ Equity”.
(3)	Certain options to purchase common stock were not included in the calculation of diluted earnings per share because their exercise prices were greater than the average market price of our common stock for the periods presented. For the years ended December 31, 2003 and 2001, these weighted options outstanding totaled 4.6 million shares and 12.2 million shares, respectively, with exercise prices ranging from $12.34 to $57.00 per share.
(4)	Employee stock options and other dilutive potential common shares for the year ended December 31, 2002 were not included in the calculation of diluted earnings per share because they were antidilutive.

F-11

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3.     Marketable Securities

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

					Gross		Gross
			Amortized		Unrealized		Unrealized
			Cost		Gains		Losses			Fair Value
			(Amounts in thousands)
Marketable securities:
	U.S. government and agency		$	337,323	$	4,084	$	(3,903	)	$	337,504
	State, municipal and state and local agency			537,179		20,037		(1,359	)		555,857
	Corporate debt and other securities			455,360		13,644		(2,645	)		466,359
		Total marketable securities		1,329,862		37,765		(7,907	)		1,359,720
Marketable securities-restricted:
	U.S. government and agency			111,442		523		(9	)		111,956
	State, municipal and state and local agency			17,305		432		(39	)		17,698
	Corporate debt and other securities			37,799		320		(13	)		38,106
		Total marketable securities-restricted		166,546		1,275		(61	)		167,760
Balance at December 31, 2003			$	1,496,408	$	39,040	$	(7,968	)	$	1,527,480

					Gross		Gross
			Amortized		Unrealized		Unrealized
			Cost		Gains		Losses			Fair Value
			(Amounts in thousands)
Marketable securities:
	U.S. government and agency		$	339,514	$	9,010	$	(1,696	)	$	346,828
	State, municipal and state and local agency			391,370		16,057		(759	)		406,668
	Corporate debt and other securities			429,876		15,726		(3,581	)		442,021
		Total marketable securities		1,160,760		40,793		(6,036	)		1,195,517
Marketable securities-restricted:
	U.S. government and agency			103,287		2,542		—			105,829
	State, municipal and state and local agency			25,679		736		(68	)		26,347
	Corporate debt and other securities			57,223		924		(2	)		58,145
		Total marketable securities-restricted		186,189		4,202		(70	)		190,321
Balance at December 31, 2002			$	1,346,949	$	44,995	$	(6,106	)	$	1,385,838

F-12

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

As of December 31, 2003 the contractual maturities of our marketable securities were as follows:

					Marketable Securities —
	Marketable Securities				Restricted
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Amounts in thousands)
Due in one year or less	$	147,337	$	143,199	$	108,881	$	109,273
Due after one year through five years		471,369		487,246		44,681		45,318
Due after five years through ten years		387,392		401,122		6,732		6,870
Due after ten years		323,764		328,153		6,252		6,299
	$	1,329,862	$	1,359,720	$	166,546	$	167,760

Proceeds from sales and maturities of marketable securities were $7.4 billion in 2003, $7.7 billion in 2002 and $8.8 billion in 2001. Gross realized gains and gross realized losses are included in net investment income under the specific identification method.

4.     Dispositions

2002 Dispositions. In the fourth quarter of 2002, we entered into an agreement with HEALTHvision under which HEALTHvision acquired the e-prescribing assets of our subsidiary MEDeMORPHUS Healthcare Solutions, Inc. in exchange for assuming certain liabilities. Under this agreement, HEALTHvision assumed responsibility for MEDeMORPHUS’s existing contracts with more than 1,600 physicians, including the delivery of MEDeMORPHUS’s handheld devices and wireless functionality. In connection with the sale of assets, we recognized pretax charges of $9 million ($6 million or $0.07 diluted loss per share, net of tax). See Note 10, “Impairment, Disposition, Restructuring, Office of Personnel Management and Other Charges (Credits).”

5.     Long-Term Debt and Other Commitments

Our contractual cash obligations as of December 31, 2003, including long-term debt and other commitments, were as follows:

			Payments Due by Period
			Total		2004		2005		2006		2007		2008		Thereafter
			(Amounts in millions)
Long-term debt:
	10 3/4% senior notes, net of discount		$	323	$	—	$	—	$	—	$	—	$	—	$	323
	JPMorgan Chase term loan			149		2		1		23		73		50		—
	Convertible subordinated debentures			135		—		—		—		—		—		135
	Database financing agreement			9		5		4		—		—		—		—
	Other			4		—		1		1		—		1		1
		Total long-term debt commitments		620		7		6		24		73		51		459
Other commitments:
Information technology outsourcing contracts				1,118		175		164		142		133		130		374
Operating leases				107		27		23		21		17		8		11
		Total other commitments		1,225		202		187		163		150		138		385
Total contractual cash obligations			$	1,845	$	209	$	193	$	187	$	223	$	189	$	844

Convertible Subordinated Debentures. We have $135 million in aggregate principal amount of 3% convertible subordinated debentures due in 2032. The debentures are convertible into 6,428,566

F-13

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

shares of common stock under certain conditions, including satisfaction of a market price condition for our common stock, satisfaction of a trading price condition relating to the debentures, upon notice of redemption, or upon specified corporate transactions. Each $1,000 of the debentures is convertible into 47.619 shares of our common stock. The market price condition for conversion of the debentures is satisfied if the closing sale price of our common stock exceeds 110% of the conversion price (which is calculated at $23.10 per share) for the debentures for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of any fiscal quarter. In the event that the market price condition is satisfied during any fiscal quarter, the debentures are convertible, at the option of the holder, during the following fiscal quarter. The market price condition is evaluated each quarter to determine whether the debentures will be convertible at the option of the holder during the following fiscal quarter. During the fiscal year ended December 31, 2003, the market price condition described above was satisfied for the quarters ended September 30, 2003 and December 31, 2003. As a result, the debentures were convertible during the quarter ended December 31, 2003 and remain convertible at the option of the holder at any time during the quarter ended March 31, 2004. While no debentures were converted as of December 31, 2003, they are considered common stock equivalents and are included in the calculation of weighted average shares outstanding on a diluted basis for the fourth quarter and fiscal year ended December 31, 2003. All share and per share amounts disclosed above reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004. See Note 6 “Stockholders’ Equity”.

Beginning in October 2007, we may redeem for cash all or any portion of the debentures, at a purchase price of 100% of the principal amount plus accrued interest, upon not less than 30 nor more than 60 days’ written notice to the holders. Beginning in October 2007, and in successive 5-year increments, our holders may require us to repurchase the debentures for cash at a repurchase price of 100% of the principal amount plus accrued interest. Our payment obligations under the debentures are subordinated to our senior indebtedness, and effectively subordinated to all indebtedness and other liabilities of our subsidiaries.

10 3/4% Senior Notes. We have $325 million in aggregate principal amount of 10 3/4% senior notes due in 2009. The 10 3/4% senior notes were issued in May 2002 at 99.389% of the aggregate principal amount representing a discount of $3 million that is being amortized over the term of the notes. In December 2003, in accordance with the applicable provisions of the debt agreement, we redeemed $175 million in principal of the senior notes at a redemption price equal to 110.750%, plus accrued and unpaid interest on the notes as of the redemption date. We expensed approximately $28 million in connection with the redemption, including the pro-rata write-off of the initial discount, the redemption premium and other fees and expenses associated with the transaction. We may redeem the remaining 10 3/4% senior notes at any time on or after June 1, 2006 at an initial redemption price equal to 105.375% of their principal amount plus accrued and unpaid interest. The redemption price will thereafter decline annually. Additionally, at any time on or prior to June 1, 2006, we may redeem the 10 3/4% senior notes upon a change of control, as defined in the indenture for the notes, at 100% of their principal amount plus accrued and unpaid interest and a “make-whole” premium.

Certain of our domestic, unregulated subsidiaries fully and unconditionally guarantee the 10 3/4% senior notes. Prior to September 15, 2003, some of our domestic, unregulated subsidiaries were restricted from guaranteeing the 10 3/4% senior notes by the terms of the FHP senior notes. As the FHP senior notes were repaid in full on September 15, 2003, these subsidiaries now fully and unconditionally guarantee the 10 3/4% senior notes. See “FHP Senior Notes” below and Note 15, “Financial Guarantees.”

F-14

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

In April 2003, we entered into an interest rate swap on $300 million of our 10 3/4% senior notes for the purpose of hedging the fair value of our indebtedness. This fair value hedge is accounted for using the short-cut method under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, whereby the hedge is reported in our balance sheets at fair value, and the carrying value of the long-term debt is adjusted for an offsetting amount representing changes in fair value attributable to the hedged risk. Under the terms of the agreement, we make interest payments based on the three-month London Interbank Offered Rate (LIBOR) plus 692 basis points and receive interest payments based on the 10 3/4% fixed rate. Our rate under the swap agreement was 8.09%, at December 31, 2003 which is based on a 90-day LIBOR of 1.17% plus 692 basis points. The three-month LIBOR rate we use to determine our interest payments under the swap agreement was first established on June 2, 2003 and resets every three months thereafter, until expiration in June 2009.

Senior Credit Facility. In June 2003, we replaced our senior credit facility with a new syndicated facility with JPMorgan Chase Bank serving as the Administrative Agent. The new facility consists of a $150 million term loan, which matures on June 3, 2008, and a $150 million revolving line of credit, which matures on June 3, 2006. We used the proceeds from the term loan to repay the $131 million outstanding under the prior facility. The remaining $19 million was used to pay fees and expenses relating to the new facility and for general corporate purposes. As of December 31, 2003, we had $149 million outstanding on the term loan and no balance outstanding on the revolving line of credit. We borrowed and repaid $3 million under the revolving line of credit during the year ended December 31, 2003.

On December 17, 2003 our senior credit facility was amended to provide for reduced interest rates per annum applicable to term loan borrowings, with the amount of margin spread for the borrowing being determined by our current debt ratings. The amended applicable rates are, at our option, either JPMorgan Chase Bank’s prime rate (or, if greater, the Federal Funds Rate plus 0.5%) which we refer to as the alternative base rate, plus a margin spread of 1.25% to 1.75% per annum, or the LIBOR for the applicable interest period, plus a margin spread of 2.25% to 2.75% per annum. All of our borrowings under the term loan are currently LIBOR borrowings, and the current margin spread on our term loan borrowings is 2.50%. As of December 31, 2003, our term loan rate was 3.68% per annum, which is based on a 90-day LIBOR of 1.18% plus the applicable margin spread of 2.50%. The interest rates per annum under the senior credit facility applicable to revolving credit borrowings are, at our option, either the alternate base rate plus a margin spread of between 1.5% to 2.75% per annum, or the LIBOR for the applicable interest period plus a margin spread of between 2.5% to 3.75% per annum, with the amount of the margin for any borrowing being determined based on current credit ratings for the debt under the senior credit facility. Our current margins for revolving credit borrowings are 2.25% per annum for alternate base rate borrowings and 3.25% per annum for LIBOR borrowings.

The terms of the senior credit facility contain various covenants customary for financings of this type which place restrictions on our and/or our subsidiaries’ ability to incur debt, pay dividends, create liens, make investments, optionally repay, redeem or repurchase our securities, and enter into mergers, dispositions and transactions with affiliates. The senior credit facility also requires us to meet various financial ratios, including a minimum net worth requirement, a minimum fixed-charge coverage requirement and a maximum leverage ratio. At December 31, 2003, we were in compliance with all of these covenants. See “FHP Senior Notes” below and Note 15, “Financial Guarantees.”

Certain of our domestic, unregulated subsidiaries provide guarantees and have granted security interests to the lenders in substantially all of their personal property in order to secure our obligations

F-15

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

under the senior credit facility. We have also pledged the equity of certain of our subsidiaries to the lenders. Prior to September 15, 2003, some of our domestic, unregulated subsidiaries were restricted from guaranteeing the senior credit facility by the terms of the FHP senior notes. As the FHP senior notes were repaid in full on September 15, 2003, these subsidiaries now fully and unconditionally guarantee the senior credit facility.

				Revolving
	Term Loan			Credit
	Facility			Facility			Total
	(Amounts in millions)
Balance at December 31, 2001	$	650		$	55		$	705
Proceeds applied from funding of 10 3/4% senior notes		(315	)		(54	)		(369	)
Scheduled payments		(60	)		—			(60	)
Proceeds applied from funding of convertible subordinated debentures		(53	)		—			(53	)
Proceeds applied from sales of property		(35	)		—			(35	)
Payments under amendment to senior credit facility		(32	)		—			(32	)
Proceeds applied from equity commitment arrangement		(4	)		(1	)		(5	)
Balance at December 31, 2002		151			—			151
Scheduled payments under prior senior credit facility		(20	)		—			(20	)
Repayment of outstanding balance under prior senior credit facility		(131	)		—			(131	)
Proceeds from borrowing under new senior credit facility		150			3			153
Scheduled payments under new senior credit facility		(1	)		(3	)		(4	)
Balance at December 31, 2003	$	149		$	—		$	149

FHP Senior Notes. In September 2003, we paid in full the senior notes that we assumed when we acquired FHP International Corporation, or FHP, in 1997. As a result, some of our domestic, unregulated subsidiaries which were previously restricted from guaranteeing our 10 3/4% senior notes and our senior credit facility by the provisions of the FHP senior notes, now fully and unconditionally guarantee the 10 3/4% senior notes and the senior credit facility. See Note 15, “Financial Guarantees”.

Database Financing Agreements. As of December 31, 2003, we had $9 million outstanding under various financing agreements related to the purchase of database licenses, financial accounting system software and related maintenance in connection with the implementation of our information technology, or IT, initiatives. Payments under the financing agreements are due quarterly through July 2005. The interest imputed on the payment plan agreement ranges from 4% to 5.3%.

Letters of Credit. Letters of credit are purchased guarantees that assure our performance or payment to third parties in connection with professional liability insurance policies, lease commitments and other potential obligations. Letters of credit commitments totaled $19 million at December 31, 2003 and 2002. As of December 31, 2003, our letters of credit commitments were backed by funds deposited in restricted cash accounts.

Information Technology Outsourcing Contracts. In December 2001, we entered into a 10-year contract to outsource our IT operations to International Business Machines Corporation, or IBM. Under the contract, IBM is the coordinator of our IT outsourcing arrangement, and will provide IT services and day-to-day management of our IT infrastructure, including data center operations, support services and information distribution. In January 2002, we entered into a 10-year contract to

F-16

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

outsource our IT software applications maintenance and enhancement services to Keane, Inc., or Keane. Our remaining cash obligations for base fees under these contracts over the initial 10-year terms is $1.1 billion, assuming our actual use of services equals the baselines specified in the contracts. However, because we have the ability to reduce services from the vendors under the contracts, our ultimate cash commitment may be less than the stated contract amounts. The contracts also provide for variable fees, based on services provided above certain contractual baselines. During 2002, we entered into additional services contracts with IBM totaling $127 million over the remaining term of the original contract. Additionally, in the event of contract termination, we would be responsible to pay termination fees to IBM and Keane. These termination fees decline as each successive year of the contract term is completed. In connection with these outsourcing agreements, we transitioned approximately 550 employee positions to IBM and Keane in March 2002.

In connection with the IBM outsourcing contract, we sold IBM computer equipment with a net book value of $42 million in December 2001. The consideration we received from IBM for the sale included $25 million in cash, and a note receivable for the $17 million balance. We will collect the note receivable, which bears interest at approximately 7% per annum, in the form of credits against our future base fee payments from 2002 through 2005. We used the $25 million we received from IBM to repay indebtedness under the term loan facility of our senior credit facility in January 2002.

Operating Leases. We lease office space and equipment under various non-cancelable operating leases. Rent expense totaled $46 million in 2003, $76 million in 2002 and $57 million in 2001.

6.     Stockholders’ Equity

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

Stock Split. On December 19, 2003, our board of directors approved a two-for-one split of our common stock in the form of a stock dividend. On January 20, 2004, we distributed one additional share of common stock for every share of common stock outstanding to stockholders of record as of the close of business on January 7, 2004. We had a sufficient number of authorized but unissued shares of common stock to effect this stock split. The par value of our common stock after the split remained at $0.01 per share, and additional paid-in capital was reduced by the par value of the additional common shares issued. The rights of the holders of these securities were not otherwise modified. In accordance with SFAS 128, Earnings per Share, which requires retroactive adjustment of per share computation of stock split that occurs after the close of the period but before issuance of the financial statements, all shares, per-share and market price data related to our common shares outstanding and under employee stock plans reflect the retroactive effects of this two-for-one stock split in the form of a dividend.

Common Stock Offering. In November 2003, we issued 7.6 million shares of our common stock in a public offering. The net proceeds from the offering, approximately $200 million after underwriting fees, were used to redeem $175 million in principal of the company’s outstanding 10 3/4% senior notes. See Note 5, “Long-Term Debt and Other Commitments”.

F-17

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Restricted Stock Awards. We granted approximately 1,489,000 and 106,000 shares of restricted common stock, including stock deferred into restricted stock units, as part of an employee recognition and retention program during the years ended December 31, 2003 and 2002, respectively. Restrictions on these shares will expire and related charges are being amortized as earned over the vesting period, not to exceed four years. A total of approximately 108,000 shares were forfeited for the year ended December 31, 2003. No shares were forfeited during the year ended December 31, 2002.

All shares of restricted stock were issued from our 1996 Officer and Key Employee Stock Option Plan, as amended. See Note 9, “Employee Benefits”. The amount of unearned compensation recorded is based on the market value of the shares on the date of issuance and is included as a separate component of stockholders’ equity, which was approximately $17 million and $2 million as of December 31, 2003 and 2002, respectively. Expenses related to the vesting of restricted stock (charged to selling, general and administrative expenses) were $5.3 million and $1.0 million for the year ended December 31, 2003 and 2002, respectively.

Acqua Wellington Arrangement. In December 2001, we entered into an equity commitment arrangement with Acqua Wellington North American Equities Fund Ltd., or Acqua Wellington, an institutional investor, for the purchase by Acqua Wellington of up to 13.8 million shares, or $150 million in our common stock. This equity commitment arrangement expired in June 2003.

Treasury Stock. In December 2003, our board of directors approved a resolution to retire all outstanding shares of the Company’s treasury stock. As a result of this resolution, approximately 23 million shares were permanently retired and have been added back to our shares authorized for future issuance.

7.     Goodwill and Intangible Assets.

In the first quarter of 2002, we recognized $897 million (net of $32 million of deferred tax liability reversals) of goodwill impairment as the cumulative effect of a change in accounting principle upon adopting FASB Statement No. 142, Goodwill and Other Intangible Assets. Under the new rules, goodwill is no longer amortized, but is subject to impairment tests on an annual basis or more frequently if impairment indicators exist. Under the guidance of FASB Statement No. 142, we used a discounted cash flow methodology to assess the fair values of our reporting units as of January 1, 2002. For reporting units with book equity values that exceeded the fair values, we performed a hypothetical purchase price allocation. Impairment was measured by comparing the goodwill derived from the hypothetical purchase price allocation to the carrying value of the goodwill balance. The same methodology was used for the years ended December 31, 2003 and 2002. Based on the results of our impairment testing, no additional adjustments were required.

The following table reflects consolidated results adjusted as though the adoption of the SFAS No. 142 non-amortization of goodwill provisions occurred for the year ended December 31, 2001,

F-18

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

after adjusting for the effect of the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004 as discussed in Note 6 “Stockholders’ Equity”:

	Year Ended December 31, 2001
	As Reported		Adjustments		As Adjusted
	(Amounts in thousands,
	except per-share data)
Net income	$	19,006	$	57,411	$	76,417
Basic earnings per share	$	0.28	$	0.85	$	1.13
Diluted earnings per share	$	0.27	$	0.84	$	1.12

Other intangible assets will continue to be amortized over their useful lives. We estimate our intangible asset amortization will be $20 million in 2004, $16 million in 2005, $15 million in 2006, $15 million in 2007 and $14 million in 2008. The following table sets forth balances of identified intangible assets, by major class, for the periods indicated:

					Accumulated
			Cost		Amortization		Net Balance
			(Amounts in thousands)
Intangible assets:
	Employer groups		$	243,820	$	124,170	$	119,650
	Provider networks			121,051		21,080		99,971
	Other			10,729		9,242		1,487
		Balance at December 31, 2003	$	375,600	$	154,492	$	221,108
Intangible assets:
	Employer groups		$	243,820	$	105,406	$	138,414
	Provider networks			121,051		17,986		103,065
	Other			10,729		9,192		1,537
		Balance at December 31, 2002	$	375,600	$	132,584	$	243,016

F-19

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8.     Income Taxes

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

		2003			2002
		(Amounts in thousands)
Current deferred tax assets (liabilities):
	Accrued expenses	$	44,243		$	48,632
	Medical claims and benefits payable		63,295			28,453
	Restructuring		7,325			11,275
	Accrued compensation		21,389			16,588
	Stock-based compensation		4,903			—
	Provider receivables		20,702			14,204
	Prepaid expenses		(12,673	)		(10,130	)
	State franchise taxes		6,963			2,039
	Unrealized gains on marketable securities		(11,043	)		(13,027	)
	Other		4,713			2,724
		$	149,817		$	100,758
Non-current deferred tax (liabilities) assets:
	Identifiable intangibles	$	(84,816	)	$	(91,402	)
	Goodwill amortization(1)		7,347			6,860
	Depreciation and software amortization		(27,308	)		(21,131	)
	Other		—			1,883
		$	(104,777	)	$	(103,790	)

(1)  Non-current deferred tax liabilities for 2002 reflect a $32 million adjustment for the tax impact of the cumulative effect of a change in accounting principle. See Note 7, “Goodwill and Intangible Assets.”

The provision for income taxes consisted of the following:

			2003			2002		2001
			(Amounts in thousands)
Current:
	Federal		$	165,009		$	60,063	$	34,286
	State			27,975			4,170		8,051
		Total current		192,984			64,233		42,337
Deferred:
	Federal			(39,148	)		15,321		959
	State			(6,940	)		3,238		(4,925	)
		Total deferred		(46,088	)		18,559		(3,966	)
	Provision for income taxes		$	146,896		$	82,792	$	38,371

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Reconciliation of the U.S. statutory income tax rate to our effective tax rate is as follows:

	2003			2002			2001
Computed expected provision		35.0	%		35.0	%		35.0	%
Amortization of intangibles		—			—			32.3
Tax-exempt interest		(1.6	)		(2.1	)		(8.6	)
State taxes, net of federal benefit		3.7			3.2			3.6
Nondeductible expenses		0.3			0.9			3.2
Other, net		0.3			0.3			2.4
Provision for income taxes		37.7	%		37.3	%		67.9	%

9.     Employee Benefit Plans

Savings and profit-sharing plans. Most of our employees may participate in our savings and profit-sharing plan. Features of the plan in 2003 were as follows:

•  Participants could defer up to 15% of annual compensation;

•  We matched one-half of the deferral, up to 3% of annual compensation per employee; and

•  We automatically contributed 3% of annual compensation per employee to all employees participating in the plan.

The plan authorizes us to contribute a discretionary amount to each employee’s account, generally based on a percentage of pretax income. We did not contribute a discretionary amount in 2003, 2002 or 2001. Charges to income for the plan were $21 million in 2003, $18 million in 2002 and $19 million in 2001.

Our Statutory Restoration Plan allows executive officers to defer the portion of their pay that due to statutory limitations are not available for deferral, and also to receive excess matching contributions, profit-sharing contributions and discretionary contributions in the same percentages as those provided by the 401(k) plan.

Supplemental Executive Retirement Plan. We maintain an unfunded, nonqualified executive pension plan covering certain senior executives. This plan provides defined benefits based on years of service and final average compensation. The accumulated benefit obligation for the Supplemental Executive Retirement Plan at the end of 2003 and 2002 was $10,043,000 and $1,715,000 respectively, of which $2,838,000 and $1,136,000 respectively, were the net amounts recognized (excludes unrecognized prior service costs which offsets the accumulated benefit obligation).

Employee Stock Purchase Plan. In September 2001, our board of directors adopted a non-compensatory employee stock purchase plan, or ESPP. The ESPP provides that up to 2,200,000 shares of our common stock can be sold to our employees, after adjusting for the effect of the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004. Features of the plan in 2003 were as follows:

•  Participants could have up to 15% of their after-tax earnings withheld and applied to the purchase of these shares;

•  The purchase price was 85% of the lower of the market price of our common stock on the offering date (generally the first day of each offering period), or on the purchase date;

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•  Each offering period was two years, and there were four purchase dates within each offering period; and

•  Purchase dates were the last day of each six-month purchase period within the offering period.

Approximately 1,500 employees are currently participating in this plan.

Equity Incentive Plans.

Employee Plans. As of December 31, 2003, under the 2000 and 1996 Employee Plans, we could award officers and employees the following equity incentives:

•  Options to purchase shares of common stock at no less than 100% of the market price on the date the options are granted;

•  Shares of restricted stock that could be deferred into restricted stock units; and

•  Stock appreciation rights.

Stock options typically vest over four years in equal increments, and expire 10 years after the grant date. In late 2001, we granted approximately four million options that vested over two years. Awards under the Employee Plans are generally subject to continuous employment. As of December 31, 2003, approximately 5.8 million shares were available for awards under the Employee Plans. All applicable share amounts reflect the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004.

In 2003, we began to award restricted stock and stock units as part of the annual performance cycle to enhance stock ownership, assist in retaining key talent and to reduce the use of our shares. These awards typically vest over four years. For our executive officers, the awards were subject to a mandatory minimum four-year deferral into restricted stock units. Upon expiration of the deferral period, executive officers receive shares of common stock equal to the number of vested shares underlying the restricted stock units. The deferral provisions promote stock retention and significant career share holdings. Vesting of the restricted stock and stock units accelerates upon the occurrence of certain events.

Restricted stock units are deferred under our Stock Unit Deferred Compensation Plan, or Stock Unit Plan. Under the Stock Unit Plan, executive officers may also defer all or a portion of their annual bonus and signing bonus. The chief executive officer could also defer all or a portion of his salary. Salary and bonus deferrals are converted into units of our common stock. The number of stock units converted is equal to the amount of bonus or salary deferred, multiplied by a risk premium, then divided by the price of our common stock on a predetermined date selected by the Compensation Committee. Distributions are made in shares of common stock.

Premium Plan. As of December 31, 2003, 0.4 million of the vested premium options were outstanding and will expire in 2007. The balance of the premium options expired because the closing market price of our common stock did not reach $57.00 prior to October 6, 2002. There are no shares available for future awards under the Premium Plan. All applicable share and per share amounts reflect the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004.

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Director Plans. As of December 31, 2003 under the 2000 and 1996 Director Plans, we could grant non-employee directors the following stock incentives, after adjusting for the effect of the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004:

•  Options to purchase 10,000 shares of common stock are automatically granted annually to all non-employee members of the board other than the Chairman of the Board on June 30, at no less than 100% of the market price on the date the options are granted;

•  Options to purchase 20,000 shares of common stock are automatically granted annually to the non-employee Chairman of the Board on June 30, at no less than 100% of the market price on the date the options are granted;

•  Options to purchase up to 30,000 shares of common stock are awarded when new members are elected or appointed to the board of directors;

•  Options to purchase shares of common stock may be granted on a discretionary basis; and

•  Stock units issued as a deferral of up to 50% of directors’ annual retainer, until directors reach targeted stock ownership levels.

All stock options, except for initial grants to new board members, vest immediately on the grant date, but the associated common stock may not be sold within six months after the grant date. Effective October 23, 2003, the initial grants to new board members vest one-third on the date of grant and one-third on the first and second anniversary of the date of grant. As of December 31, 2003, approximately 0.2 million shares were available for awards under the Director Plans.

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

Prior to 2003, we accounted for our stock option plans under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Effective January 1, 2003, we adopted the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, or FAS 123, on a prospective basis. Under the prospective method provisions of FASB Statement No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, or FAS 148, the recognition provisions will be applied to all employee awards granted, modified or settled after January 1, 2003.

Pro forma information regarding net income (loss) and earnings (loss) per share, as presented in Note 2, “Significant Accounting Policies,” is required by FAS 123, as amended by FAS 148, and has been determined as if we had accounted for our employee stock options and ESPP under the fair value method of that Statement upon its initial effective date. The fair value for these options was

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions for 2003, 2002 and 2001:

		Employee Stock Options									ESPP
		2003			2002			2001			2003			2002			2001
Expected dividend yield			0	%		0	%		0	%		0	%		0	%		NA
Risk-free interest rate			4	%		3	%		3	%		1	%		2	%		NA
Expected stock price volatility			80	%		83	%		110	%		59	%		67	%		NA
Expected term until exercise upon vesting (years)			2			2			2			0.5			0.5			NA
Weighted average fair value of options on grant date:
	Granted at market prices	$	9.11		$	6.75		$	6.30		$	11.49		$	5.04			NA

Nonqualified stock option activity for all plans was as follows, after adjusting for the effect of the two-for-one stock split in the form of a stock dividend that was effective January 20, 2004:

				Weighted Average		Options		Weighted Average
	Options			Exercise Price		Exercisable		Exercise Price
Outstanding at December 31, 2000		17,829,176		$	32.94		7,614,956	$	36.27
Granted at market price		5,524,324		$	8.88		—	$	—
Exercised		(9,600	)	$	8.63		—	$	—
Canceled		(7,359,198	)	$	36.08		—	$	—
Outstanding at December 31, 2001		15,984,702		$	23.20		7,195,034	$	31.91
Granted at market price		3,782,344		$	9.73		—	$	—
Exercised		(413,126	)	$	7.61		—	$	—
Canceled		(5,826,284	)	$	30.39		—	$	—
Outstanding at December 31, 2002		13,527,636		$	16.81		6,628,204	$	22.34
Granted at market price		1,712,400		$	15.51		—	$	—
Exercised		(3,205,864	)	$	11.16		—	$	—
Canceled		(966,420	)	$	23.48		—	$	—
Outstanding at December 31, 2003		11,067,752		$	17.66		6,383,252	$	21.55

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following is a summary of information about options outstanding and options exercisable at December 31, 2003:

	Options Outstanding						Options Exercisable
			Weighted		Weighted				Weighted
	Number		Average		Average		Number		Average
Range of Exercise Prices	Outstanding		Life(1)		Exercise Price		Exercisable		Exercise Price
$6.03 - $9.73		4,817,690		8	$	8.28		2,473,190	$	7.98
$11.09 - $19.25		2,280,576		9	$	13.76		346,326	$	13.67
$22.66 - $30.88		2,293,832		7	$	25.87		1,888,082	$	25.56
$32.78 - $46.25		1,675,654		4	$	38.69		1,675,654	$	38.69
		11,067,752						6,383,252

(1)  Weighted average contractual life remaining in years.

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

We recognized net pretax (credits) charges in 2003, 2002 and 2001 as follows:

				Pretax						Diluted Loss
			Quarter	(Credits)			Net-of-Tax			(Earnings)
			Recognized	Charges			Amount			per Share(1)
			(Amounts in millions, except per share data)
2003
Restructuring change in estimate			Total Fourth	$	(1.9	)	$	(1.2	)	$	(0.01	)
2002
OPM credits			Total First	$	(12.9	)	$	(8.1	)	$	(0.11	)
Write-off of unamortized senior credit facility fees and paid advisory fees			Total Second		18.3			11.4			0.16
OPM credits			Fourth		(11.1	)		(6.9	)		(0.09	)
Loss on disposition of subsidiary			Fourth		9.0			5.6			0.07
Write-off of unamortized senior credit facility fees and paid advisory fees			Fourth		1.1			0.7			0.01
Restructuring change in estimate			Fourth		(0.7	)		(0.5	)		—
	Total impairment, disposition, restructuring, OPM and other charges (credits)		Total Fourth		(1.7	)		(1.1	)		(0.01	)
		Total net 2002 impairment, disposition, restructuring, OPM and other charges (credits)		$	3.7		$	2.2		$	0.04

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

				Pretax						Diluted Loss
			Quarter	(Credits)			Net-of-Tax			(Earnings)
			Recognized	Charges			Amount			per Share(1)
			(Amounts in millions, except per share data)
2001
Gain from contract termination agreement			First	$	(1.2	)	$	(0.6	)	$	(0.01	)
Restructuring change in estimate			First		0.3			0.1			—
			Total First		(0.9	)		(0.5	)		(0.01	)
Restructuring change in estimate			Total Second		(0.3	)		(0.1	)		—
Debt offering costs			Third		3.1			1.5			0.02
Restructuring change in estimate			Third		(0.2	)		(0.1	)		—
			Total Third		2.9			1.4			0.02
Restructuring charge			Fourth		59.9			38.5			0.56
Restructuring change in estimate			Fourth		(0.5	)		(0.2	)		—
	Total impairment, disposition, restructuring and other charges		Total Fourth		59.4			38.3			0.56
		Total net 2001 impairment, disposition, restructuring, OPM and other charges (credits)		$	61.1		$	39.1		$	0.57

(1)  The year to date diluted loss (earnings) per share is computed using the year to date weighted average common shares and equivalents outstanding and may not agree to the sum of each quarter. Per share amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004.

2003. During the fourth quarter of 2003, we recognized a credit of $1.9 million for changes in our December 2001 restructuring estimates related to severance and related employee benefits.

2002. We recognized net pretax charges of $4 million as described below:

Write-Off of Unamortized Senior Credit Facility Fees. During 2002, we recognized other charges of $19 million for the write off of unamortized senior credit facility fees in connection with our repayment of a significant portion of our senior credit facility, and for advisory fees paid in connection with the restructuring of our long-term debt.

OPM. During 2002, we recognized OPM credits of $24 million, representing a reduction to the net liability we had established in prior periods as a result of settlements with the OPM, the U.S. Department of Justice, or DOJ, and a private individual to settle disputes and a private lawsuit under the False Claims Act regarding alleged premium overcharges to the government for the period 1990 through 1997, primarily related to contracts held by FHP health plans prior to our acquisition of FHP in 1997.

Loss on Disposition of Subsidiary. During the fourth quarter of 2002, we recognized disposition charges of $9 million, in connection with the sale of assets of our subsidiary, MEDeMORPHUS Healthcare Solutions, Inc. The charge included severance, legal and other expenses related to the disposition. See Note 4, “Dispositions.”

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Restructuring Change in Estimates. During the fourth quarter of 2002, we recognized a credit of $0.7 million for changes in our December 2001 restructuring estimates related to severance and related employee benefits.

2001.     We recognized net pretax charges of $61 million as described below:

Debt offering costs. During the third quarter of 2001, we recognized charges of $3 million for expenses related to our efforts to obtain senior note financing, which we discontinued during the third quarter of 2001.

Restructuring Change in Estimates. We recognized changes in our January 2000 and December 2000 restructuring estimates related to severance and related employee benefits. During the third quarter of 2001, we recognized a credit of $0.2 million for the January estimate. During the second quarter of 2001, we recognized a credit of $0.1 million for the January estimate and a credit of $0.2 million for the December estimate. During the first quarter of 2001, we recognized a credit of $0.1 million for the January estimate, offset by a charge of $0.4 million for the December estimate.

Gain from Contract Termination Agreement. During the first quarter of 2001, we recognized other credits of $1 million for a gain from a contract termination agreement.

Restructuring Charge. In December 2001, we recognized a restructuring charge of $60 million. Of the $60 million charge, approximately $34 million represented a liability for cash payments, of which approximately $22 million was paid during the fourth quarter of 2001 and during the year ended December 31, 2002. Approximately $20 million of the restructuring charge was for severance and related employee benefits for 1,450 employees whose positions were eliminated. As of December 31, 2003, approximately 1,240 employees have left the company and 200 employees, whose positions were eliminated, accepted other positions within the company. During 2003, we made severance payments totaling approximately $3 million to terminated employees.

The restructuring charge also included approximately $27 million related to the outsourcing of our IT production and $13 million related to lease terminations.

The following table presents the activity through December 31, 2003, on the restructuring charge we took in 2001:

			Initial											Balance at								Balance at
			Pretax		Non-cash			2001			2002			December 31,		2003			Changes in			December 31,
			Charge		Write-off			Activity			Activity			2002		Payments			Estimate			2003
			(Amounts in millions)
December 2001 restructuring:
	Lease cancellations and commitments		$	39.7	$	(25.8	)	$	—		$	(8.0	)	$	5.9	$	(3.1	)	$	—		$	2.8
	Severance and separation benefits			20.2		—			(0.6	)		(14.0	)		5.6		(2.9	)		(1.9	)		0.8
		Total December 2001 restructuring	$	59.9	$	(25.8	)	$	(0.6	)	$	(22.0	)	$	11.5	$	(6.0	)	$	(1.9	)	$	3.6

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11.     Incurred But Not Reported Claims Reserves

The following table presents the roll-forward of our incurred but not reported, or IBNR, claims reserves as of the periods indicated:

		Year Ended
		2003			2002			2001
		(Amounts in millions)
IBNR as of January 1		$	753		$	808		$	913
Health care claim expenses incurred during the period:
	Related to current year		4,682			4,343			4,514
	Related to prior years		(104	)		—			(45	)
	Total incurred		4,578			4,343			4,469
Health care claims paid during the period:
	Related to current year		(3,918	)		(3,689	)		(3,783	)
	Related to prior years		(587	)		(709	)		(791	)
	Total health care claims payments		(4,505	)		(4,398	)		(4,574	)
IBNR as of December 31		$	826		$	753		$	808

Included in IBNR is a provision for adverse claims development. The provision for adverse claims development at the beginning of each year is released against the health care claims expenses related to prior periods in each period presented. The provision for adverse claims development is then re-evaluated based on actuarial calculations and recorded in the current year expense. The release of the provision for adverse claims development into each year presented was $50 million, $51 million and $56 million for the years 2003, 2002 and 2001, respectively.

12.     Health Care Services and Other Expenses

The following table presents the components of total health care services and other expenses for the years ended December 31, 2003, 2002 and 2001:

	Year Ended December 31,
	2003				2002				2001
	Commercial		Senior		Commercial		Senior		Commercial		Senior
	(Amounts in millions)
Capitation expense	$	1,488	$	2,704	$	1,795	$	2,994	$	1,977	$	3,738
All other health care services and other expenses		2,782		1,836		2,410		2,110		2,125		2,396
Total health care services and other expenses	$	4,270	$	4,540	$	4,205	$	5,104	$	4,102	$	6,134

13.     Contingencies

Provider Instability and Insolvency. Our health care services and other expenses include write-offs of certain uncollectible receivables from providers, and the estimated cost of unpaid health care claims normally covered by our capitation payments. Depending on state law, we may be held liable for unpaid health care claims that were previously the responsibility of the capitated provider and for

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

which we have already paid capitation. Insolvency reserves also include estimates for potentially insolvent providers that we have specifically identified, where conditions indicate claims are not being paid or claim payments have slowed considerably, and we have determined that it is probable that we will be required to make the providers’ claim payments. We continue to monitor the financial condition of our providers where there is perceived risk of insolvency and adjust our insolvency reserves as necessary. Information provided by provider groups may be unaudited, self-reported information or may not ultimately be obtained. The balance of our insolvency reserves included in medical claims and benefits payable totaled $37 million at December 31, 2003 and $46 million at December 31, 2002.

To reduce insolvency risk, we have developed contingency plans that include shifting members to other providers and reviewing operational and financial plans to monitor and maximize financial and network stability. As capitation contracts are renewed for providers we have also taken steps, where feasible, to have security reserves established for insolvency issues. Security reserves are most frequently in the forms of letters of credit or segregated funds that are held in the provider’s name in a third party financial institution. The reserves may be used to pay claims that are the financial responsibility of the provider.

In Re Managed Care. In mid-2000, various federal actions against managed care companies, including us, were joined in a multi-district litigation that was coordinated for pretrial proceedings in the United States District Court for the Southern District of Florida. This litigation is known as “In re Managed Care Litigation.” Thereafter, Dr. Dennis Breen, Dr. Leonard Klay, Dr. Jeffrey Book and several other health care providers, along with several medical associations, including the California Medical Association, joined the “In re Managed Care” proceeding as plaintiffs. These health care providers sued several managed care companies, including us, alleging, among other things, that the companies have systematically underpaid providers for medical services to members, have delayed payments, and that the companies impose unfair contracting terms on providers and negotiate capitation payments that are inadequate to cover the costs of health care services provided.

We sought to compel arbitration of all of Dr. Breen’s, Dr. Book’s and other physician claims against us. The District Court granted our motion to compel arbitration against all of these claims except for claims for violations of the Racketeer Influenced and Corrupt Organizations Act, or RICO (“Direct RICO Claims”), and for their RICO conspiracy and aiding and abetting claims that stem from contractual relationships with other managed care companies. On April 7, 2003, the United States Supreme Court held that the District Court should have compelled arbitration of the Direct RICO Claims filed by Dr. Breen and Dr. Book. On September 15, 2003, the District Court entered another ruling on several of our motions to compel arbitration, ordering arbitration of all claims arising out of our contracts with plaintiffs containing arbitration clauses. The District Court, however, also ruled that (a) plaintiffs’ RICO conspiracy and aiding and abetting claims against us that stem from contractual relationships with other managed care companies and (b) plaintiffs’ claims based on services they provided to our members outside of any contractual relationship with us or assignments from our members do not arise out of our contracts with plaintiffs and thus do not need to be arbitrated. As a result, the order to compel arbitration does not cover any claims that may arise relating to our non-contracted providers. We have filed an appeal from the District Court’s ruling to the extent it did not compel arbitration of all of plaintiffs’ claims, but no oral argument has been scheduled on the appeal yet.

On September 26, 2002, the District Court certified a class action in the “In re Managed Care Litigation.” On November 20, 2002, the United States Court of Appeals for the Eleventh Circuit

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

granted our petition to appeal the class certification by the District Court. Oral argument for this appeal was held on September 11, 2003 and the court has not issued an opinion as of the date of this report. Discovery in this litigation is currently ongoing. We deny all material allegations and intend to defend the action vigorously.

PacifiCare of Texas v. The Texas Department of Insurance and the State of Texas. In November 2001, our Texas subsidiary, PacifiCare of Texas, filed a lawsuit against the Texas Department of Insurance, or TDI, and the State of Texas challenging the TDI’s interpretation and enforcement of state statutes and regulations that would make Texas a “double-pay” state. The lawsuit relates to the financial insolvency of three physician groups that had capitation contracts with PacifiCare of Texas. Under these contracts, the responsibility for claims payments to health care providers was delegated to the contracted physician groups. We made capitation payments to each of these physician groups, but they failed to pay all of the health care providers who provided health care services covered by the capitation payments. On February 11, 2002, after the date we filed our lawsuit, the Attorney General of Texas or AG, on behalf of the State of Texas and the TDI, filed a civil complaint against PacifiCare of Texas in the District Court of Travis County, Texas alleging violations of the Texas Health Maintenance Organization Act, Texas Insurance Code and regulations under the Code and the Texas Deceptive Trade Practices Consumer Protection Act. The AG’s complaint primarily alleges that despite its capitation payments to the physician groups, PacifiCare of Texas is still financially responsible for the failure of the physician groups to pay the health care providers who provided health care services covered by the capitation payments. The AG sought an injunction requiring us to comply with state laws plus unspecified damages, civil penalties and restitution.

On July 23, 2003, without the admission of any wrongdoing, our Texas subsidiary entered into a definitive settlement agreement with the State of Texas, the AG and the TDI. The settlement agreement provides that all pending litigation and related civil investigations will be stayed for up to twelve months from the date of execution of the settlement agreement or such additional period as the parties may mutually agree. While the proceedings are stayed, the parties will seek to settle the provider creditor claims in the remaining outstanding bankruptcies relating to Medical Select Management and Heritage Southwest Medical Group and engage in a review of provider claims of the Heritage Physicians Network, or HPN. We agreed to use our reasonable best efforts to reach settlements in the bankruptcies and resolve the HPN claims by specified dates and agreed to make contributions to fund provider creditor claims in the bankruptcies subject to the process set forth in the definitive settlement agreement.

As part of the settlement, we agreed to make payments totaling $4.25 million, including attorneys fees totaling $1.25 million to the AG, and administrative services reimbursements totaling $1.5 million and administrative penalties totaling $1.5 million to the TDI. Of the $4.25 million payment, $2.45 million was paid in July 2003, and the remaining $1.8 million will be paid upon the satisfaction of the conditions for the settlement. All amounts paid upon execution of the settlement agreement will be held in trust pending the effectiveness of the settlement. The settlement will become effective upon us completing settlements in the two bankruptcies in accordance with the settlement agreement, timely completion of the HPN claims process, payment of all settlement amounts to the AG and TDI, and compliance with certain Texas prompt payment obligations with respect to members enrolled in our commercial HMO plans. Concurrent with the settlement becoming effective: (i) the parties would enter into a permanent injunction with a term of one year that will require PacifiCare of Texas to comply with applicable provisions of the Texas prompt payment obligations with respect to members enrolled in our commercial HMO plans; (ii) all of the pending litigation between the parties will be dismissed with prejudice or with specified final

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

judgments; and (iii) the parties will enter into mutual releases. We cannot provide any assurances that we will be able to meet the conditions required to cause the settlement to become effective. If the settlement agreement does not become effective, then we are prepared to resume the litigation. We believe that recorded liabilities for this matter are adequate, including the satisfaction of all the terms and conditions of the settlement, or any liabilities that may arise if we are required to resume the litigation.

OPM Litigation.On April 12, 2002, we resolved issues raised in various audits of our health plans by the OIG as well as the False Claims investigations of the United States Department of Justice, or DOJ and a private lawsuit under the False Claims Act. The settlement primarily related to contracts we acquired through our merger with FHP International Corporation, or FHP, in 1997. As previously disclosed, the OIG and others alleged that the former FHP Arizona, California, Colorado, Guam and Ohio HMO subsidiaries, as well as the former FHP Illinois, New Mexico and Utah HMO subsidiaries that we sold in 1997 and 1998, substantially overcharged the government for premiums from 1990 through 1997. The allegations were referred to the DOJ for review of potential claims under the False Claims Act. In addition, a private individual filed a complaint under the False Claims Act in 1998 that remained under seal until the settlement. The OIG also conducted audits of our Oregon HMO for contract years 1991 through 1996 and our California HMO for contract years 1993 through 1996 and referred these audits to the DOJ for potential claims under the False Claims Act. The settlement resolved issues raised in OIG’s various audits of these 10 health plans, as well as the False Claims investigations of the DOJ and the private lawsuit under the False Claims Act.

We paid $88 million in 2002 and 2003 under the settlement agreement. As part of the settlement, we received from OPM in the second quarter of 2002 approximately $15 million in premiums that were either withheld pending resolution of these audits or were not paid by OPM for 2001 and earlier periods. This settlement and the results of other 2002 OPM audits resulted in OPM credits of $24 million ($15 million or $0.42 diluted earnings per share, net of tax) that we recorded in 2002, representing a reduction to the net liability we had established in prior periods. We did not admit to any wrongdoing as part of the settlement.

Irwin v. AdvancePCS, Inc. et al. On March 26, 2003, Robert Irwin filed a complaint in the California Superior Court of Alameda County, California, against our PBM company, Prescription Solutions, as well as nine other PBM companies. On July 17, 2003, the Irwin case was coordinated with American Federation of State, County & Municipal Employees v. AdvancedPCS, et al, and transferred to Los Angeles Superior Court for coordinated proceedings. The case purports to be filed on behalf of non-ERISA health plans and individuals with no prescription drug benefits who have purchased drugs at retail rates. The first amended complaint, filed on November 25, 2003, alleges that each of the defendants violated California’s unfair competition law. The complaint challenges alleged business practices of PBMs, including practices relating to pricing, rebates, formulary management, data utilization and accounting and administrative processes. The complaint seeks unspecified monetary damages and injunctive relief. We do not provide PBM services to non-ERISA plans in California and do not believe we were properly named as a defendant in this litigation. We deny all material allegations and intend to defend the action vigorously.

Other Litigation. We are involved in various legal actions in the normal course of business, including claims from our members and providers arising out of decisions to deny or restrict reimbursement for services and claims that seek monetary damages, including claims for punitive damages that are not covered by insurance. Our establishment of drug formularies, support of clinical trials and PBM services may increase our exposure to product liability claims associated with

F-31

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

pharmaceuticals and medical devices. Based on current information, including consultation with our lawyers, we believe any ultimate liability that may arise from these actions, including the In re Managed Care litigation, would not materially affect our consolidated financial position, results of operations or cash flows. However, our evaluation of the likely impact of these actions could change in the future and an unfavorable outcome, depending upon the amount and timing, could have a material effect on our results of operations or cash flows of a future period. For example, the loss of even one claim resulting in a significant punitive damage award could have a material adverse effect on our business. Moreover, our exposure to potential liability under punitive damage theories may decrease significantly our ability to settle these claims on reasonable terms.

14.     Comprehensive Income

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

				Income
				Tax
	Pretax			Benefit			Net-of-Tax
	Amount			(Expense)			Amount
	(Amounts in thousands)
2003:
Change in unrealized gains on marketable securities	$	2,743		$	(1,111	)	$	1,632
Less: reclassification adjustment for net gains realized in net income		(7,642	)		3,095			(4,547	)
Other comprehensive income (loss)	$	(4,899	)	$	1,984		$	(2,915	)
2002:
Change in unrealized gains on marketable securities	$	36,234		$	(13,638	)	$	22,596
Less: reclassification adjustment for net gains realized in net income		(4,514	)		1,697			(2,817	)
Other comprehensive income	$	31,720		$	(11,941	)	$	19,779
2001:
Change in unrealized gains on marketable securities	$	21,589		$	(8,200	)	$	13,389
Less: reclassification adjustment for net gains realized in net income		(13,650	)		5,187			(8,463	)
Other comprehensive income	$	7,939		$	(3,013	)	$	4,926

15. Financial Guarantees

Certain of our domestic, unregulated subsidiaries, which we refer to as the Initial Guarantor Subsidiaries and certain subsidiaries of PacifiCare Health Plan Administrators, Inc., or PHPA, which we refer to as the PHPA Guarantor Subsidiaries, fully and unconditionally guarantee the 10 3/4% senior notes. Prior to September 15, 2003, the PHPA Guarantor Subsidiaries were restricted from guaranteeing the 10 3/4% senior notes by the terms of the FHP senior notes. As the FHP senior notes were repaid in full on September 15, 2003, these subsidiaries now fully and unconditionally guarantee the 10 3/4% senior notes. The Initial Guarantor Subsidiaries and the PHPA Guarantor Subsidiaries, excluding MEDeMORPHUS Healthcare Solutions, Inc., are also guarantors of our

F-32

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

senior credit facility. The following unaudited consolidating condensed financial statements quantify the financial position as of December 31, 2002 and 2003 and the operations and cash flows for the years ended December 31, 2001, 2002 and 2003 of the Initial Guarantor Subsidiaries and the PHPA Guarantor Subsidiaries listed below. The following unaudited consolidating condensed balance sheets, consolidating condensed statements of operations and consolidating condensed statements of cash flows present financial information for the following entities and utilizing the following adjustments:

Parent — PacifiCare Health Systems, Inc. on a stand-alone basis (carrying investments in subsidiaries under the equity method); PacifiCare became the parent on February 14, 1997 effective with the acquisition of FHP.

Initial Guarantor Subsidiaries — PHPA, PacifiCare eHoldings, Inc., SeniorCo, Inc. and MEDeMORPHUS Healthcare Solutions, Inc. on a stand-alone basis (carrying investments in subsidiaries under the equity method.)

PHPA Guarantor Subsidiaries — RxSolutions, Inc., doing business as Prescription Solutions, PacifiCare Behavioral Health, Inc., and SecureHorizons USA, Inc. on a stand-alone basis.

Non-Guarantor Subsidiaries — Represents all other directly or indirectly wholly owned subsidiaries of the Parent on a consolidated basis.

Consolidating Adjustments — Entries that eliminate the investment in subsidiaries and intercompany balances and transactions.

The Company — The financial information for PacifiCare Health Systems, Inc. on a condensed consolidated basis.

Provision For Income Taxes — PacifiCare and its subsidiaries record the provision for income taxes in accordance with an intercompany tax-sharing agreement. Income tax benefits available to subsidiaries that arise from net operating losses can only be used to offset the subsidiaries’ taxable income from prior years in accordance with the Federal Tax Law and taxable income in future periods.

F-33

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS

For the Year Ended December 31, 2001

(Unaudited)

					Initial			PHPA
					Guarantor			Guarantor			Non-Guarantor			Consolidating
		Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
		(In thousands)
Operating revenue		$	176		$	33,280		$	447,687		$	11,733,870		$	(371,041	)	$	11,843,972
Income from subsidiaries			82,535			153,982			—			16,109			(252,626	)		—
	Total operating revenue		82,711			187,262			447,687			11,749,979			(623,667	)		11,843,972
Health care services and other expenses			—			320			294,709			10,416,632			(344,004	)		10,367,657
Selling, general and administrative expenses			(724	)		160,264			93,434			1,056,545			(21,145	)		1,288,374
Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net			3,097			52,254			178			5,628			—			61,157
Operating income (loss)			80,338			(25,576	)		59,366			271,174			(258,518	)		126,784
Interest expense			(61,332	)		(11,974	)		(62	)		(2,806	)		5,892			(70,282	)
Income (loss) before income taxes			19,006			(37,550	)		59,304			268,368			(252,626	)		56,502
(Benefit) provision for income taxes			—			(119,210	)		29,440			128,141			—			38,371
Income before extraordinary gain			19,006			81,660			29,864			140,227			(252,626	)		18,131
Extraordinary gain on early retirement of debt, net			—			875			—			—			—			875
Net income		$	19,006		$	82,535		$	29,864		$	140,227		$	(252,626	)	$	19,006

F-34

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS

For the Year Ended December 31, 2001

(Unaudited)

							Initial			PHPA
							Guarantor			Guarantor			Non-Guarantor			Consolidating
				Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
				(In thousands)
Operating activities:
	Net income			$	19,006		$	82,535		$	29,864		$	140,227		$	(252,626	)	$	19,006
	Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:
		Equity in income of subsidiaries			(82,535	)		(153,982	)		—			(16,109	)		252,626			—
		Amortization of goodwill and intangible assets			—			29,588			499			52,809			—			82,896
		Depreciation and amortization			—			48,063			5,507			12,238			—			65,808
		Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net			3,097			52,254			178			5,628			—			61,157
		Provision for doubtful accounts			—			—			47			22,023			—			22,070
		Amortization of capitalized loan fees			7,560			—			—			—			—			7,560
		(Gain) loss on disposal of property, plant and equipment and other			—			(1,141	)		(134	)		7,328			—			6,053
		Deferred income taxes			—			(14,473	)		1,112			9,395			—			(3,966	)
		Stock-based compensation expense			3,632			—			—			—			—			3,632
		Gain on early retirement of debt, net			—			(1,800	)		—			—			—			(1,800	)
		Tax benefit realized for stock option exercises			21			—			—			—			—			21
		Changes in assets and liabilities, net of effects from acquisitions and dispositions			110,907			(90,283	)		(40,875	)		(203,263	)		—			(223,514	)
			Net cash flows provided by (used in) operating activities		61,688			(49,239	)		(3,802	)		30,276			—			38,923
Investing activities:
	(Purchase) sale of marketable securities, net				(10,001	)		32,004			—			(212,404	)		—			(190,401	)
	Purchase of property, plant and equipment				—			(55,735	)		(3,369	)		(18,197	)		—			(77,301	)
	Proceeds from sale of property, plant and equipment				—			25,139			—			—			—			25,139
	Sale (purchase) of marketable securities-restricted, net				—			10			—			(17,775	)		—			(17,765	)
	Net cash (paid for) acquired from acquisitions				—			(873	)		—			373			—			(500	)
			Net cash flows (used in) provided by investing activities		(10,001	)		545			(3,369	)		(248,003	)		—			(260,828	)
Financing activities:
	Principal payments on long-term debt				(30,000	)		—			—			(284	)		—			(30,284	)
	Credit facility amendment fees and expenses				(12,949	)		—			—			—			—			(12,949	)
	Purchase of minority interest in consolidated subsidiary				(8,821	)		—			—			—			—			(8,821	)
	Proceeds from issuance of common and treasury stock				83			—			—			—			—			83
	Intercompany activity:
		Royalty dividends and loans received (paid)			—			161,439			—			(161,439	)		—			—
		Dividends received (paid)			—			42,300			—			(42,300	)		—			—
		Subordinated loans (paid) received			—			(99,536	)		—			99,536			—			—
			Net cash flows (used in) provided by financing activities		(51,687	)		104,203			—			(104,487	)		—			(51,971	)
Net increase (decrease) in cash and equivalents					—			55,509			(7,171	)		(322,214	)		—			(273,876	)
Beginning cash and equivalents								54,826			(67,580	)		1,264,389						1,251,635
Ending cash and equivalents				$	—		$	110,335		$	(74,751	)	$	942,175		$	—		$	977,759

F-35

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED BALANCE SHEETS

December 31, 2002

						Initial			PHPA
						Guarantor			Guarantor			Non-Guarantor			Consolidating
			Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
			(in thousands)
ASSETS
Current assets:
	Cash and equivalents		$	16,207		$	151,973		$	(47,595	)	$	831,104		$	—		$	951,689
	Marketable securities			—			—			—			1,195,517			—			1,195,517
	Receivables, net			33			(44,362	)		124,077			218,523			(8,371	)		289,900
	Intercompany			(537,199	)		415,167			137,002			(14,970	)		—			—
	Prepaid expenses and other current assets			1,015			24,853			8,596			16,073			(3,732	)		46,805
	Restricted cash collateral for FHP senior notes			43,346			—			—			—			—			43,346
	Deferred income taxes			—			61,399			3,508			63,108			(27,257	)		100,758
		Total current assets		(476,598	)		609,030			225,588			2,309,355			(39,360	)		2,628,015
Property, plant and equipment at cost, net				—			99,610			17,890			44,185			—			161,685
Marketable securities — restricted				34,812			—			—			151,377			—			186,189
Deferred income taxes				—			72,141			6,654			23,090			(101,885	)		—
Investment in subsidiaries				2,513,858			1,555,158			13,264			(15,453	)		(4,066,827	)		—
Goodwill and intangible assets, net				—			11,923			16,480			1,197,717			—			1,226,120
Other assets				22,615			25,533			1			975			—			49,124
			$	2,094,687		$	2,373,395		$	279,877		$	3,711,246		$	(4,208,072	)	$	4,251,133
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Medical claims and benefits payable		$	—		$	17,929		$	36,522		$	995,509		$	(5,460	)	$	1,044,500
	Accounts payable and accrued liabilities			5,313			253,597			47,971			135,434			(3,673	)		438,642
	Deferred income taxes			—			15,487			553			11,217			(27,257	)		—
	Unearned premium revenue			—			200			1,353			480,970			(2,971	)		479,552
	Current portion of long-term debt			60,484			46,546			—			205			—			107,235
		Total current liabilities		65,797			333,759			86,399			1,623,335			(39,361	)		2,069,929
Long-term debt				587,315			8,109			—			1,537			—			596,961
Convertible subordinated debentures				135,000			—			—			—			—			135,000
Deferred income taxes				—			100,833			8,445			96,397			(101,885	)		103,790
Other liabilities				—			17,148			—			—			—			17,148
Stockholders’ equity:
	Capital stock			954			—			—			—			—			954
	Unearned compensation			(2,000	)		—			—			—			—			(2,000	)
	Additional paid-in capital			1,560,308			—			—			—			—			1,560,308
	Accumulated other comprehensive income			—			—			—			21,730			—			21,730
	Retained earnings			350,369			—			—			—			—			350,369
	Treasury stock			(603,056	)		—			—			—			—			(603,056	)
	Equity in income of subsidiaries			—			1,913,546			185,033			1,968,247			(4,066,826	)		—
		Total stockholders’ equity		1,306,575			1,913,546			185,033			1,989,977			(4,066,826	)		1,328,305
			$	2,094,687		$	2,373,395		$	279,877		$	3,711,246		$	(4,208,072	)	$	4,251,133

F-36

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS

For the Year Ended December 31, 2002

(Unaudited)

					Initial			PHPA
					Guarantor			Guarantor			Non-Guarantor			Consolidating
		Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
		(In thousands)
Operating revenue		$	(10,346	)	$	29,204		$	450,770		$	11,027,550		$	(340,676	)	$	11,156,502
Income from subsidiaries			(661,977	)		(556,987	)		—			(4,591	)		1,223,555			—
	Total operating revenue		(672,323	)		(527,783	)		450,770			11,022,959			882,879			11,156,502
Health care services and other expenses			—			19,101			295,370			9,491,872			(320,642	)		9,485,701
Selling, general and administrative expenses			(121	)		261,742			98,799			1,026,808			(17,068	)		1,370,160
Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net			18,162			(12,687	)		(89	)		(1,612	)		—			3,774
Operating income			(690,364	)		(795,939	)		56,690			505,891			1,220,589			296,867
Interest expense			(67,465	)		(7,728	)		—			(2,677	)		2,966			(74,904	)
Income before income taxes			(757,829	)		(803,667	)		56,690			503,214			1,223,555			221,963
(Benefit) provision for income taxes			—			(141,413	)		22,275			201,930			—			82,792
(Loss) income before cumulative effect of a change in accounting principle			(757,829	)		(662,254	)		34,415			301,284			1,223,555			139,171
Cumulative effect of a change in accounting principle			—			—			—			(897,000	)		—			(897,000	)
Net (loss) income		$	(757,829	)	$	(662,254	)	$	34,415		$	(595,716	)	$	1,223,555		$	(757,829	)

F-37

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS

For the Year Ended December 31, 2002

(Unaudited)

							Initial			PHPA
							Guarantor			Guarantor			Non-Guarantor			Consolidating
				Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
				(In thousands)
Operating activities:
	Net (loss) income			$	(757,829	)	$	(662,254	)	$	34,415		$	(595,716	)	$	1,223,555		$	(757,829	)
	Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:
		Equity in income of subsidiaries			661,977			556,987			—			4,591			(1,223,555	)		—
		Cumulative effect of a change in accounting principle			—			—			—			897,000						897,000
		Amortization of intangible assets			—			1,249			—			22,351						23,600
		Deferred income taxes			—			(3,064	)		199			21,424						18,559
		(Gain) loss on disposal of property, plant and equipment			—			15,792			21			(3,020	)		—			12,793
		Marketable and other securities impairment for other than temporary declines in value			11,001			—			—			1,542			—			12,543
		Employee benefit plan contributions in treasury stock			12,132			—			—			—			—			12,132
		Amortization of capitalized loan fees			7,784			—			—			—			—			7,784
		Provision for doubtful accounts			—			—			329			6,017						6,346
		Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net			18,162			(12,687	)		(89	)		(1,612	)					3,774
		Amortization of notes receivable from sale of fixed assets			—			(3,107	)		—			—			—			(3,107	)
		Tax benefit realized for stock option exercises			1,009			—			—			—			—			1,009
		Stock-based compensation expense			693			—			—			—			—			693
		Amortization of discount on 10 3/4% senior notes			266			—			—			—			—			266
		Adjustment to cash received in purchase transaction			—			17			—			—			—			17
		Depreciation and amortization			—			33,281			6,100			10,903			—			50,284
		Changes in assets and liabilities			84,815			(64,224	)		(9,918	)		(54,158	)		—			(43,485	)
			Net cash flows provided by (used in) operating activities		40,010			(138,010	)		31,057			309,322			—			242,379
Investing activities:
	Purchase of marketable securities-restricted				(78,158	)		—			—			(39,210	)		—			(117,368	)
	Purchase of marketable securities, net				—			—			—			(113,987	)		—			(113,987	)
	Purchase of property, plant and equipment				—			(47,596	)		(3,901	)		(7,777	)		—			(59,274	)
	Proceeds from the sale of property, plant and equipment				—			104			—			12,388			—			12,492
			Net cash flows used in investing activities		(78,158	)		(47,492	)		(3,901	)		(148,586	)		—			(278,137	)
Financing activities:
	Principal payments on long-term debt				(554,412	)		—			—			104			—			(554,308	)
	Proceeds from borrowings of long-term debt				496,945			—			—			—			—			496,945
	Proceeds from issuance of convertible subordinated debentures				135,000						—			—			—			135,000
	Principal payments on FHP senior notes				—			(41,750	)		—			—			—			(41,750	)
	Credit facility amendment fees and expenses				(37,789	)		—			—			—			—			(37,789	)
	Proceeds from draw down under equity commitment arrangement				8,928			—			—			—			—			8,928
	Proceeds from issuance of common and treasury stock				4,893			—			—			—			—			4,893
	Payments on software financing agreement				—			(2,231	)		—			—			—			(2,231	)
	Intercompany activity:
		Dividends received (paid)			790			143,399			—			(144,189	)		—			—
		Royalty dividends and loans received (paid)			—			117,613			—			(117,613	)		—			—
		Subordinated loans (paid) received			—			(17,179	)		—			17,179			—			—
		Capital contributions received (paid)			—			27,288			—			(27,288	)		—			—
			Net cash flows provided by (used in) financing activities		54,355			227,140			—			(271,807	)		—			9,688
Net increase (decrease) in cash and equivalents					16,207			41,638			27,156			(111,071	)		—			(26,070	)
Beginning cash and equivalents					—			110,335			(74,751	)		942,175			—			977,759
Ending cash and equivalents				$	16,207		$	151,973		$	(47,595	)	$	831,104		$	—		$	951,689

F-38

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED BALANCE SHEETS

December 31, 2003

(Unaudited)

						Initial			PHPA
						Guarantor			Guarantor		Non-Guarantor			Consolidating
			Parent			Subsidiaries			Subsidiaries		Subsidiaries			Adjustments			Company
			(In thousands)
ASSETS
Current assets:
	Cash and equivalents		$	—		$	242,246		$	601	$	955,575		$	—		$	1,198,422
	Marketable securities			37			—			—		1,359,683			—			1,359,720
	Receivables, net			991			(70,112	)		125,622		217,138			(7,696	)		265,943
	Intercompany			10,110			38,248			24,424		(72,782	)		—			—
	Prepaid expenses and other current assets			8,074			32,033			7,672		13,427			(3,907	)		57,299
	Deferred income taxes			(15	)		65,497			5,511		107,464			(28,640	)		149,817
		Total current assets		19,197			307,912			163,830		2,580,505			(40,243	)		3,031,201
Property, plant and equipment at cost, net				—			95,805			15,689		37,913			—			149,407
Marketable securities-restricted				33,436			—			—		133,110			—			166,546
Deferred income taxes				—			80,431			9,327		26,907			(116,665	)		—
Investment in subsidiaries				2,376,929			1,713,296			13,264		(7,903	)		(4,095,586	)		—
Goodwill and intangible assets, net				—			11,923			16,480		1,175,809			—			1,204,212
Other assets				17,549			26,262			408		23,719			—			67,938
			$	2,447,111		$	2,235,629		$	218,998	$	3,970,060		$	(4,252,494	)	$	4,619,304
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Medical claims and benefits payable		$	—		$	15,581		$	50,874	$	965,704		$	(4,659	)	$	1,027,500
	Accounts payable and accrued liabilities			6,646			249,411			91,098		148,457			(4,802	)		490,810
	Deferred income taxes			—			17,010			734		10,896			(28,640	)		—
	Unearned premium revenue			—			254			1,288		497,080			(2,142	)		496,480
	Current portion of long-term debt			1,500			5,766			—		230			—			7,496
		Total current liabilities		8,146			288,022			143,994		1,622,367			(40,243	)		2,022,286
Long-term debt				471,221			4,883			—		1,596			—			477,700
Convertible subordinated debentures				135,000			—			—		—			—			135,000
Deferred income taxes				—			117,052			10,968		93,422			(116,665	)		104,777
Other liabilities				—			28,004			—		—			—			28,004
Stockholders’ equity:
	Common stock			848			—			—		—			—			848
	Unearned compensation			(16,843	)		—			—		—			—			(16,843	)
	Additional paid-in capital			1,458,310			—			—		—			—			1,458,310
	Accumulated other comprehensive loss			22			—			—		18,793			—			18,815
	Retained earnings			390,407			—			—		—			—			390,407
	Treasury stock			—			—			—		—			—			—
	Equity in income of subsidiaries			—			1,797,668			64,036		2,233,882			(4,095,586	)		—
		Total stockholders’ equity		1,832,744			1,797,668			64,036		2,252,675			(4,095,586	)		1,851,537
			$	2,447,111		$	2,235,629		$	218,998	$	3,970,060		$	(4,252,494	)	$	4,619,304

F-39

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS

For the Year Ended December 31, 2003

(Unaudited)

					Initial			PHPA
					Guarantor			Guarantor			Non-Guarantor			Consolidating
		Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
		(In thousands)
Operating revenue		$	841		$	31,287		$	529,607		$	10,810,692		$	(363,916	)	$	11,008,511
Income from subsidiaries			339,072			475,286			—			7,550			(821,908	)		—
	Total operating revenue		339,913			506,573			529,607			10,818,242			(1,185,824	)		11,008,511
Health care services and other			—			3,646			363,447			9,019,918			(321,217	)		9,065,794
Selling, general and administrative expenses			166			234,129			124,878			1,133,537			(40,168	)		1,452,542
Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net			—			619			(29	)		(590	)		—			—
Operating income			339,747			268,179			41,311			665,377			(824,439	)		490,175
Interest expense			(96,999	)		(5,337	)		—			(726	)		2,531			(100,531	)
Income before income taxes			242,748			262,842			41,311			664,651			(821,908	)		389,644
(Benefit) provision for income taxes			—			(77,064	)		16,308			207,652			—			146,896
Net income		$	242,748		$	339,906		$	25,003		$	456,999		$	(821,908	)	$	242,748

F-40

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS

For the Year Ended December 31, 2003

(Unaudited)

							Initial			PHPA
							Guarantor			Guarantor			Non-Guarantor			Consolidating
				Parent			Subsidiaries			Subsidiaries			Subsidiaries			Adjustments			Company
				(In thousands)
Operating activities:
	Net income			$	242,748		$	339,906		$	25,003		$	456,999		$	(821,908	)	$	242,748
	Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:
		Equity in income of subsidiaries			(339,071	)		(475,287	)		—			(7,550	)		821,908			—
		Deferred income taxes			—			5,354			(1,972	)		(49,470	)		—			(46,088	)
		Depreciation and amortization			—			28,779			6,462			9,472			—			44,713
		Expense related to bond redemption			28,155			—			—			—			—			28,155
		Loss on disposal of property, plant and equipment and other			—			19,877			15			2,436			—			22,328
		Amortization of intangible asset			—			—			—			21,908			—			21,908
		Stock-based compensation expense			19,092			—			—			—			—			19,092
		Tax benefit realized for stock option exercises			17,838			—			—			—			—			17,838
		Provision for doubtful accounts			—			4,213			6,058			—			—			10,271
		Amortization of capitalized loan fees			7,481			—			—			—			—			7,481
		Amortization of notes receivable from sale of fixed assets			—			(5,641	)		—			—			—			(5,641	)
		Employer benefit plan contributions in treasury stock			1,363			—			—			—			—			1,363
		Amortization of discount on 10 3/4% senior notes			424			—			—			—			—			424
		Changes in assets and liabilities, net of effects from acquisitions and dispositions			(552,849	)		398,268			16,884			187,235			—			49,538
			Net cash flows (used in) provided by operating activities		(574,819	)		315,469			52,450			621,030			—			414,130
Investing activities:
	Purchase of marketable securities, net				—			—			—			(169,102	)		—			(169,102	)
	Purchase of property, plant and equipment				—			(42,058	)		(4,268	)		(5,945	)		—			(52,271	)
	Sale of marketable securities-restricted, net				1,376			—			—			18,267			—			19,643
	Proceeds from the sale of property, plant and equipment				—			16			14			—			—			30
			Net cash flows provided by (used in) investing activities		1,376			(42,042	)		(4,254	)		(156,780	)		—			(201,700	)
Financing activities:
	Proceeds from equity offering used for redemption of $175 million of senior notes				199,424			—			—			—			—			199,424
	Principal payments on senior note redemption				(175,000	)		—			—			—			—			(175,000	)
	Principal payments on long-term debt				(151,329	)		—			—			—			—			(151,329	)
	Proceeds from borrowings of long-term debt				150,000			—			—			—			—			150,000
	Principal payments on FHP senior notes				—			(43,250	)		—			—			—			(43,250	)
	Use of restricted cash collateral for payment of FHP senior notes				43,250			—			—			—			—			43,250
	Proceeds from issuance of common and treasury stock				41,146			—			—			—			—			41,146
	Payments of premium to bondholders for senior note redemption				(18,813	)		—			—			—			—			(18,813	)
	Loan fees				(6,949	)		—			—			—			—			(6,949	)
	Payments on software financing agreements				—			(3,683	)		—			—			—			(3,683	)
	Common stock repurchases				(493	)		—			—			—			—			(493	)
	Intercompany activity:
		Dividends received (paid)			476,000			248,083			—			(724,083	)		—			—
		Royalty dividends and loans received (paid)			—			87,576			—			(87,576	)		—			—
		Capital contributions (paid) received			—			(471,880	)		—			471,880			—			—
			Net cash flows provided by (used in) financing activities		557,236			(183,154	)		—			(339,779	)		—			34,303
Net (decrease) increase in cash and equivalents					(16,207	)		90,273			48,196			124,471			—			246,733
Beginning cash and equivalents					16,207			151,973			(47,595	)		831,104			—			951,689
Ending cash and equivalents				$	—		$	242,246		$	601		$	955,575		$	—		$	1,198,422

F-41

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

PacifiCare Health Systems, Inc.

We have audited the accompanying consolidated balance sheets of PacifiCare Health Systems, Inc. (the Company) as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PacifiCare Health Systems, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation, on a prospective basis for all employee and director awards granted, modified, or settled on or after January 1, 2003. Also, as discussed in Note 2 to the consolidated financial statements, the company adopted Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, in 2002.

/s/ ERNST & YOUNG LLP

Irvine, California

January 30, 2004

F-42

PACIFICARE HEALTH SYSTEMS, INC.

QUARTERLY INFORMATION FOR 2003 AND 2002 (Unaudited)

		Quarters Ended
		March 31			June 30			September 30			December 31
		(Amounts in thousands, except per share data)
2003
Operating revenue		$	2,739,595		$	2,730,234		$	2,742,167		$	2,796,515
Operating expenses			2,606,994			2,592,108			2,616,912			2,702,322
Interest expense			(19,550	)		(20,410	)		(16,924	)		(43,647	)
Income before income taxes			113,051			117,716			108,331			50,546
Provision for income taxes			42,281			44,718			40,841			19,056
Net income		$	70,770		$	72,998		$	67,490		$	31,490
Basic earnings per share(2)		$	0.98		$	1.00		$	0.91		$	0.40
Diluted earnings per share(2)		$	0.96		$	0.96		$	0.86		$	0.36
HMO and other membership(1)			2,897			2,885			2,883			2,912
2002
Operating revenue		$	2,863,451		$	2,769,360		$	2,779,745		$	2,743,946
Operating expenses			2,799,250			2,699,744			2,689,750			2,667,117
Interest expense			(16,191	)		(18,955	)		(20,205	)		(19,553	)
Impairment, disposition, restructuring, Office of Personnel Management and other charges (credits), net			(12,851	)		18,336			—			(1,711	)
Income before income taxes			60,861			32,325			69,790			58,987
Provision for income taxes			22,701			12,058			26,031			22,002
Income before cumulative effect of a change in accounting principle			38,160			20,267			43,759			36,985
Cumulative effect of a change in accounting principle			(897,000	)		—			—			—
Net (loss) income		$	(858,840	)	$	20,267		$	43,759		$	36,985
Basic (loss) earnings per share(2):
	Income before cumulative effect of a change in accounting principle	$	0.55		$	0.29		$	0.62		$	0.52
	Cumulative effect of a change in accounting principle		(12.98	)		—			—			—
	Basic (loss) earnings per share	$	(12.43	)	$	0.29		$	0.62		$	0.52
Diluted (loss) earnings per share(2):
	Income before cumulative effect of a change in accounting principle	$	0.55		$	0.28		$	0.60		$	0.50
	Cumulative effect of a change in accounting principle		(12.98	)		—			—			—
	Diluted (loss) earnings per share	$	(12.43	)	$	0.28		$	0.60		$	0.50
HMO and other membership(1)			3,330			3,263			3,189			3,138

(1)	HMO and other membership as of quarter end.
(2)	All applicable per-share amounts reflect the retroactive effects of the two-for-one common stock split in the form of a stock dividend that was effective January 20, 2004.

F-43

PACIFICARE HEALTH SYSTEMS, INC.

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

For The Years Ended December 31, 2003, 2002 and 2001

			Balance at		Charged to					Balance at
			Beginning		Provision for		Deductions or			End of
			of Period		Doubtful Accounts		Write-offs, net			Period
			(Amounts in thousands)
Allowance for doubtful accounts:
	Years ended December 31:
		2003	$	29,814		10,271		(16,953	)	$	23,132
		2002	$	36,230		6,346		(12,762	)	$	29,814
		2001	$	48,989		22,070		(34,829	)	$	36,230

F-44

PACIFICARE HEALTH SYSTEMS, INC.

EXHIBIT INDEX

Exhibit
Number		Description
	3.01	Amended and Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 99.1 to Registrant’s Registration Statement on Form S-3 (File No. 333-83069)).
	3.02	Certificate of Designation of Series A Junior Participating Preferred Stock (incorporated by reference to Exhibit 4.1 to Registrant’s Form 8-K, dated November 19, 1999).
	3.03	Amendment to Amended and Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3.03 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003).
	*3.04	First Amended and Restated Bylaws of Registrant, a copy of which is filed herewith.
	4.01	Form of Specimen Certificate For Registrant’s Common Stock (incorporated by reference to Exhibit 4.02 to Registrant’s Form 10-K for the year ended December 31, 1999).
	4.02	Indenture, dated as of November 22, 2002, between Registrant and U.S. Bank National Association (as Trustee) (incorporated by reference to Exhibit 4.4 to Registrant’s Registration Statement on Form S-3 (File No. 333-102909)).
	4.03	Registration Rights Agreement, dated as of November 22, 2002, between the Registrant and Morgan Stanley & Co. Incorporated and Goldman, Sachs & Co. (incorporated by reference to Exhibit 4.6 to Registrant’s Registration Statement on Form S-3 (File No. 333-102909)).
	4.04	Indenture dated as of May 21, 2002 among PacifiCare Health Systems, Inc., as issuer of 10 3/4% Senior Notes due 2009, PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., Rx-Connect, Inc. and SeniorCo, Inc., as initial subsidiary guarantors, and State Street Bank and Trust Company of California, N.A., as trustee (incorporated by reference to Exhibit 4.1 to Registrant’s Registration Statement on Form S-4 (File No. 333-91704)).
	4.05	Registration Rights Agreement dated May 21, 2002 by and among PacifiCare Health Systems, Inc., PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., Rx-Connect, Inc., SeniorCo, Inc., Morgan Stanley & Co. Incorporated, and UBS Warburg LLC (incorporated by reference to Exhibit 4.5 to Registrant’s Registration Statement on Form S-4 (File No. 333-91704)).
	*4.06	Supplemental Indenture, dated as of September 15, 2003, by and among PacifiCare Health Systems, Inc., PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., Rx-Connect, Inc., and SeniorCo, Inc., as initial subsidiary guarantors, Rx Solutions, Inc., PacifiCare Behavioral Health, Inc., and SecureHorizons USA, Inc., as PHPA subsidiary guarantors, U.S. Bank National Association, as successor to the State Street Bank and Trust Company of California, N.A., as trustee, a copy of which is filed herewith.
	4.07	Specimen form of Exchange Global Note for the 10 3/4% Senior Notes due 2009 (incorporated by reference to Exhibit 4.4 to Registrant’s Registration Statement on Form S-4 (File No. 333-91704).

E-1

Exhibit
Number		Description
	4.08	Rights Agreement, dated as of November 19, 1999, between the Registrant and ChaseMellon Shareholder Services, L.L.C. (incorporated by reference to Exhibit 99.2 to Registrant’s Form 8-K, dated November 19, 1999).
	†10.01	Senior Executive Employment Agreement, dated as of November 1, 2001, between the Registrant and Howard G. Phanstiel (incorporated by reference to Exhibit 10.01 to Registrant’s Form 10-K for the year ended December 31, 2001).
	†10.02	Senior Executive Employment Agreement, dated as of August 1, 2001, between the Registrant and Gregory W. Scott (incorporated by reference to Exhibit 10.04 to Registrant’s Form 10-K for the year ended December 31, 2001).
	†10.03	Senior Executive Employment Agreement, dated as of March 1, 2002, between Registrant and Bradford A. Bowlus (incorporated by reference to Exhibit 99.4 to Registrant’s Form 10-Q for the quarter ended March 31, 2002).
	†10.04	Senior Executive Employment Agreement, dated as of July 22, 2002, between the Registrant and Jacqueline B. Kosecoff, Ph.D. (incorporated by reference to Exhibit 10.2 to Registrant’s Form 10-Q for the quarter ended September 30, 2002).
	†10.05	Senior Executive Employment Agreement, dated as of March 30, 2001, between the Registrant and Kathy Feeny (incorporated by reference to Exhibit 10.06 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†10.06	First Amendment, dated as of March 30, 2001, to Senior Executive Agreement, dated as of March 30, 2001 between Registrant and Kathy Feeny (incorporated by reference to Exhibit 10.07 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†10.07	Second Amendment, dated as of April 15, 2002, to Senior Executive Agreement, dated as of March 30, 2001, as amended, between Registrant and Kathy Feeny (incorporated by reference to Exhibit 10.08 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†10.08	Senior Executive Employment Agreement, dated as of January 1, 2002, between the Registrant and Joseph S. Konowiecki (incorporated by reference to Exhibit 10.26 to Registrant’s Form 10-K for the year ended December 31, 2001).
	†10.09	Senior Executive Employment Agreement, dated as of December 2, 2002, between the Registrant and Sharon D. Garrett (incorporated by reference to Exhibit 10.10 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†*10.10	Senior Executive Employment Agreement, dated as of October 3, 2002, between the Registrant and Peter A. Reynolds, a copy of which is filed herewith.
	†10.11	1996 Stock Option Plan for Officers and Key Employees of the Registrant (incorporated by reference to Exhibit 10.05 to Registrant’s Form 8-B, dated January 23, 1997).
	†10.12	First Amendment to 1996 Stock Option Plan for Officers and Key Employees of the Registrant (incorporated by reference to Exhibit D to Registrant’s Proxy Statement, dated May 25, 1999).
	†10.13	Second Amendment to the 1996 Stock Option Plan for Officers and Key Employees of the Registrant (incorporated by reference to Exhibit 10.13 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003).
	†10.14	2000 Employee Plan (incorporated by reference to Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-44038)).

E-2

Exhibit
Number		Description
	†10.15	First Amendment to the 2000 Employee Plan of the Registrant (incorporated by reference to Exhibit 10.15 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003).
	†10.16	Amended and Restated 2000 Non-Employee Directors Stock Plan (incorporated by reference to Exhibit 1 to Registrant’s Proxy Statement, dated May 18, 2001).
	†10.17	First Amendment to the Amended and Restated 2000 Non-Employee Directors Stock Plan (incorporated by reference to Exhibit 10.17 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003).
	†10.18	Second Amendment to the Amended and Restated 2000 Non-Employee Directors Stock Plan (incorporated by reference to Exhibit 10.18 to Registrant’s Form 10-Q for the quarter ended September 30, 2003).
	†10.19	Amended and Restated 1996 Non-Officer Directors Stock Plan (incorporated by reference to Exhibit E to Registrant’s Proxy Statement, dated May 25, 1999).
	†10.20	First Amendment to Amended and Restated 1996 Non-Officer Directors Stock Option Plan (incorporated by reference to Exhibit 4.4 to Registrant’s Registration Statement on Form S-8, (File No. 333-49272)).
	†*10.21	2003 Incentive Bonus Plan of the Registrant, a copy of which is filed herewith.
	†10.22	2003 Management Incentive Compensation Plan of the Registrant (incorporated by reference to Annex B to Registrant’s Proxy Statement, dated May 8, 2003).
	†10.23	Amended 1997 Premium Priced Stock Option Plan of the Registrant (incorporated by reference to Exhibit A to Registrant’s Definitive Proxy Statement, dated April 28, 1998).
	†10.24	First Amendment to Amended 1997 Premium Priced Stock Option Plan, dated as of August 27, 1998 (incorporated by reference to Exhibit 10.12 to Registrant’s Form 10-K for the year ended December 31, 1998).
	†10.25	Third Amended and Restated PacifiCare Health Systems, Inc. Stock Unit Deferred Compensation Plan, dated January 1, 2002 (incorporated by reference to Exhibit 10.20 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†10.26	First Amendment, dated as of January 22, 2003, to the Third Amended and Restated PacifiCare Health Systems, Inc. Stock Unit Deferred Compensation Plan, dated January 1, 2002 (incorporated by reference to Exhibit 10.21 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†10.27	Third Amended and Restated PacifiCare Health Systems, Inc. Non-Qualified Deferred Compensation Plan, dated as of October 23, 2003 (incorporated by reference to Exhibit 10.27 to Registrant’s Form 10-Q for the quarter ended September 30, 2003).
	†10.28	Second Amended and Restated PacifiCare Health Systems, Inc. Statutory Restoration Plan, dated as of January 1, 2002 (incorporated by reference to Exhibit 10.23 to Registrant’s Form 10-K for the year ended December 31, 2002).
	†10.29	2001 Employee Stock Purchase Plan (incorporated by reference to Exhibit 1 to PacifiCare Health Systems Inc.’s Proxy Statement dated May 8, 2002 (File No. 000-21949)).
	*10.30	Form of Contract with Eligible Medicare+Choice Organization and the Centers for Medicare and Medicaid Services for the period January 1, 2004 to December 31, 2004, a copy of which is filed herewith.

E-3

Exhibit
Number		Description
	10.31	Form of Indemnification Agreement by and between the Registrant and certain of its Directors and Executive Officers (incorporated by reference to Exhibit 10.26 to Registrant’s Form 10-Q for the quarter ended March 31, 2003).
	10.32	Information Technology Services Agreement, dated as of December 31, 2001, between the Registrant and International Business Machines Corporation (incorporated by reference to Exhibit 10.27 to Registrant’s Form 10-K for the year ended December 31, 2001).
	10.33	Information Technology Services Agreement, dated as of January 11, 2002, between the Registrant and Keane, Inc. (incorporated by reference to Exhibit 10.28 to Registrant’s Form 10-K for the year ended December 31, 2001).
	10.34	Credit Agreement, dated as of June 3, 2003, between the Registrant, the Subsidiary Guarantors party thereto, the Lenders party thereto and JPMorgan Chase Bank as Administrative Agent and Collateral Agent (incorporated by reference to Exhibit 10.33 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003).
	*10.35	Amendment No. 1 to the Credit Agreement, dated as of November 13, 2003, between the Registrant, the Subsidiary Guarantors party thereto and JPMorgan Chase Bank as Administrative Agent, a copy of which is filed herewith.
	*10.36	Amendment No. 2 to the Credit Agreement, dated as of December 17, 2003, between the Registrant, the Subsidiary Guarantors party thereto and JPMorgan Chase Bank as Administrative Agent, a copy of which is filed herewith.
	10.37	Memorandum of Understanding, dated as of March 21, 2003, by and among the State of Texas, the Office of the Attorney General, the Texas Department of Insurance, including the Texas Insurance Commissioner, and PacifiCare of Texas, Inc. (incorporated by reference to Exhibit 10.35 to Registrant’s Form 10-Q for the quarter ended March 31, 2003).
	10.38	Definitive Settlement Agreement, dated as of July 23, 2003, by and among the State of Texas, the Office of the Attorney General, the Texas Department of Insurance, including the Texas Insurance Commissioner, and PacifiCare of Texas, Inc. (incorporated by reference to Exhibit 10.36 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003).
	11.1	Statement regarding computation of per share earnings (included in Note 2 to the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K).
	*14.1	Financial Code of Ethics, a copy of which is filed herewith.
	*21	List of Subsidiaries, a copy of which is filed herewith.
	*23	Consent of Ernst & Young LLP, Independent Auditors, a copy of which is filed herewith.
	*31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, a copy of which is filed herewith.
	*31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, a copy of which is filed herewith.

E-4

Exhibit
Number		Description
	*32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, a copy of which is filed herewith.
	*32.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, a copy of which is filed herewith.

*  A copy of this exhibit is being filed with this Annual Report on Form 10-K.

†  Management contract or compensatory plan or arrangement required to be filed (and/or incorporated by reference) as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K.

E-5 EX-3.04 3 a96836exv3w04.txt EXHIBIT 3.04 EXHIBIT 3.04 FIRST AMENDED AND RESTATED BYLAWS OF PACIFICARE HEALTH SYSTEMS, INC. (A DELAWARE CORPORATION) TABLE OF CONTENTS

PAGE ARTICLE I Offices................................................................................1 Section 1. Registered Office......................................................................1 Section 2. Other Offices..........................................................................1 ARTICLE II Corporate Seal.........................................................................1 Section 3. Corporate Seal.........................................................................1 ARTICLE III Stockholders' Meetings.................................................................1 Section 4. Place of Meetings......................................................................1 Section 5. Annual Meeting.........................................................................1 Section 6. Special Meetings.......................................................................3 Section 7. Notice of Meetings.....................................................................4 Section 8. Quorum.................................................................................5 Section 9. Adjournment and Notice of Adjourned Meetings...........................................5 Section 10. Voting Rights..........................................................................5 Section 11. Joint or Beneficial Owners of Stock....................................................6 Section 12. List of Stockholders...................................................................6 Section 13. Action without Meeting.................................................................6 Section 14. Organization...........................................................................7 ARTICLE IV Directors..............................................................................7 Section 15. Number and Term of Office..............................................................7 Section 16. Lead Independent Director..............................................................8 Section 17. Powers.................................................................................8 Section 18. Vacancies..............................................................................8 Section 19. Resignation............................................................................8 Section 20. Removal................................................................................9 Section 21. Meetings...............................................................................9 (a) Annual Meetings........................................................................9 (b) Regular Meetings.......................................................................9 (c) Special Meetings.......................................................................9 (d) Telephone Meetings.....................................................................9 (e) Notice of Meetings.....................................................................9

TABLE OF CONTENTS (CONTINUED) (f) Waiver of Notice.......................................................................9 Section 22. Quorum and Voting.....................................................................10 Section 23. Action without Meeting................................................................10 Section 24. Fees and Compensation.................................................................10 Section 25. Committees............................................................................10 (a) Committees............................................................................10 (b) Term..................................................................................11 (c) Meetings..............................................................................11 Section 26. Organization..........................................................................11 ARTICLE V Officers..............................................................................11 Section 27. Officers Designated...................................................................11 Section 28. Tenure and Duties of Officers.........................................................12 (a) General...............................................................................12 (b) Duties of Chairman of the Board of Directors..........................................12 (c) Duties of Vice Chairman of the Board of Directors.....................................12 (d) Duties of Chief Executive Officer.....................................................12 (e) Duties of President and Chief Operating Officer.......................................13 (f) Duties of Vice Presidents.............................................................13 (g) Duties of Secretary...................................................................13 (h) Duties of Chief Financial Officer or Treasurer........................................13 Section 29. Delegation of Authority...............................................................14 Section 30. Resignations..........................................................................14 Section 31. Removal...............................................................................14 ARTICLE VI Execution Of Corporate Instruments And Voting Of Securities Owned By The Corporation...........................................................................14 Section 32. Execution of Corporate Instruments....................................................14 Section 33. Voting of Securities Owned by the Corporation.........................................15 ARTICLE VII Shares Of Stock.......................................................................15 Section 34. Form and Execution of Certificates....................................................15 Section 35. Lost Certificates.....................................................................15 TABLE OF CONTENTS (CONTINUED) Section 36. Transfers.............................................................................16 Section 37. Fixing Record Dates...................................................................16 Section 38. Registered Stockholders...............................................................17 ARTICLE VIII Other Securities Of The Corporation...................................................17 Section 39. Execution of Other Securities.........................................................17 ARTICLE IX Dividends.............................................................................18 Section 40. Declaration of Dividends..............................................................18 Section 41. Dividend Reserve......................................................................18 ARTICLE X Fiscal Year...........................................................................18 Section 42. Fiscal Year...........................................................................18 ARTICLE XI Indemnification.......................................................................18 Section 43. Indemnification of Directors, Officers, Employees and Other Agents....................18 (a) Directors and Executive Officers......................................................18 (b) Other Officers, Employees and Other Agents............................................18 (c) Good Faith............................................................................19 (d) Expenses..............................................................................19 (e) Enforcement...........................................................................20 (f) Non-Exclusivity of Rights.............................................................20 (g) Survival of Rights....................................................................20 (h) Insurance.............................................................................20 (i) Amendments............................................................................21 (j) Saving Clause.........................................................................21 (k) Certain Definitions...................................................................21 ARTICLE XII Notices...............................................................................22 Section 44. Notices...............................................................................22 (a) Notice to Stockholders................................................................22 (b) Notice to Directors...................................................................22 (c) Affidavit of Mailing..................................................................22 (d) Time Notices Deemed Given.............................................................22 TABLE OF CONTENTS (CONTINUED) (e) Methods of Notice.....................................................................22 (f) Failure to Receive Notice.............................................................22 (g) Notice to Person with Whom Communication is Unlawful..................................23 (h) Notice to Person with Undeliverable Address...........................................23 ARTICLE XIII Amendments............................................................................23 Section 45. Amendments............................................................................23 An extra section break has been inserted above this paragraph. Do not delete this section break if you plan to add text after the Table of Contents/Authorities. Deleting this break will cause Table of Contents/Authorities headers and footers to appear on any pages following the Table of Contents/Authorities. FIRST AMENDED AND RESTATED BYLAWS OF PACIFICARE HEALTH SYSTEMS, INC. (A DELAWARE CORPORATION) ARTICLE I OFFICES SECTION 1. REGISTERED OFFICE. The registered office of the corporation in the State of Delaware shall be in the City of Wilmington, County of New Castle. SECTION 2. OTHER OFFICES. The corporation shall also have and maintain an office or principal place of business at such place as may be fixed by the Board of Directors, and may also have offices at such other places, both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the corporation may require. ARTICLE II CORPORATE SEAL SECTION 3. CORPORATE SEAL. The corporate seal shall consist of a die bearing the name of the corporation and the inscription, "Corporate Seal-Delaware." Said seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. ARTICLE III STOCKHOLDERS' MEETINGS SECTION 4. PLACE OF MEETINGS. Meetings of the stockholders of the corporation shall be held at such place, either within or without the State of Delaware, as may be designated from time to time by the Board of Directors, or, if not so designated, then at the office of the corporation required to be maintained pursuant to Section 2 hereof. SECTION 5. ANNUAL MEETING. (a) The annual meeting of the stockholders of the corporation, for the purpose of election of directors and for such other business as may lawfully come before it, shall be held on such date and at such time as may be designated from time to time by the Board of Directors. Nominations of persons for election to the Board of Directors of the corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders: (i) pursuant to the corporation's notice of meeting of stockholders; (ii) by or at the direction of the Board of Directors; or (iii) by any stockholder of the corporation who was a stockholder of record at the time of giving of notice provided for in the following paragraph, 1. who is entitled to vote at the meeting and who complied with the notice procedures set forth in this Section 5. (b) At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (iii) of Section 5(a) of these Bylaws: (i) the stockholder must have given timely notice thereof in writing to the Secretary of the corporation; (ii) such other business must be a proper matter for stockholder action under the Delaware General Corporation Law; (iii) if the stockholder, or the beneficial owner on whose behalf any such proposal or nomination is made, has provided the corporation with a Solicitation Notice (as defined in this Section 5(b)), such stockholder or beneficial owner must, in the case of a proposal, have delivered a proxy statement and form of proxy to holders of at least the percentage of the corporation's voting shares required under applicable law to carry any such proposal, or, in the case of a nomination or nominations, have delivered a proxy statement and form of proxy to holders of a percentage of the corporation's voting shares reasonably believed by such stockholder or beneficial owner to be sufficient to elect the nominee or nominees proposed to be nominated by such stockholder, and must, in either case, have included in such materials the Solicitation Notice; and (iv) if no Solicitation Notice relating thereto has been timely provided pursuant to this section, the stockholder or beneficial owner proposing such business or nomination must not have solicited a number of proxies sufficient to have required the delivery of such a Solicitation Notice under this Section 5. To be timely, a stockholder's notice shall be delivered to the Secretary at the principal executive offices of the Corporation not later than the close of business on the ninetieth (90th) day nor earlier than the close of business on the one hundred twentieth (120th) day prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is advanced more than thirty (30) days prior to or delayed by more than thirty (30) days after the anniversary of the preceding year's annual meeting, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the one hundred twentieth (120th) day prior to such annual meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such annual meeting or the tenth (10th) day following the day on which public announcement of the date of such meeting is first made. In no event shall the public announcement of an adjournment of an annual meeting commence a new time period for the giving of a stockholder's notice as described above. Such stockholder's notice shall set forth: (A) as to each person whom the stockholder proposed to nominate for election or reelection as a director all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "1934 Act") and Rule 14a-11 thereunder (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (B) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (C) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the corporation's books, and of such beneficial owner, (ii) the class and number of shares of the corporation which are owned beneficially and of record by such stockholder and such beneficial owner, and (iii) 2. whether either such stockholder or beneficial owner intends to deliver a proxy statement and form of proxy to holders of, in the case of the proposal, at least the percentage of the corporation's voting shares required under applicable law to carry the proposal or, in the case of a nomination or nominations, a sufficient number of holders of the corporation's voting shares to elect such nominee or nominees (an affirmative statement of such intent, a "Solicitation Notice"). (c) Notwithstanding anything in the second sentence of Section 5(b) of these Bylaws to the contrary, in the event that the number of directors to be elected to the Board of Directors of the Corporation is increased and there is no public announcement naming all of the nominees for director or specifying the size of the increased Board of Directors made by the corporation at least one hundred (100) days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice required by this Section 5 shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the Secretary at the principal executive offices of the corporation not later than the close of business on the tenth (10th) day following the day on which such public announcement is first made by the corporation. (d) Only such persons who are nominated in accordance with the procedures set forth in this Section 5 shall be eligible to serve as directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section 5. Except as otherwise provided by law, the Chairman of the meeting shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made, or proposed, as the case may be, in accordance with the procedures set forth in these Bylaws and, if any proposed nomination or business is not in compliance with these Bylaws, to declare that such defective proposal or nomination shall not be presented for stockholder action at the meeting and shall be disregarded. (e) Notwithstanding the foregoing provisions of this Section 5, in order to include information with respect to a stockholder proposal in the proxy statement and form of proxy for a stockholder's meeting, stockholders must provide notice as required by the regulations promulgated under the 1934 Act. Nothing in these Bylaws shall be deemed to affect any rights of stockholders to request inclusion of proposals in the corporation's proxy statement pursuant to Rule 14a-8 under the 1934 Act. (f) For purposes of this Section 5, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the 1934 Act. SECTION 6. SPECIAL MEETINGS. (a) Special meetings of the stockholders of the corporation may be called, for any purpose or purposes, by (i) the Chairman of the Board of Directors, (ii) the Chief Executive Officer, (iii) the President, or (iv) the Board of Directors, pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in 3. previously authorized directorships at the time any such resolution is presented to the Board for adoption) and shall be held at such place, on such date, and at such time as they or he shall fix. (b) If a special meeting is properly called by any person or persons other than the Board of Directors, the request shall be in writing, specifying the time of such meeting and the general nature of the business proposed to be transacted, and shall be delivered personally or sent by registered mail or by telegraphic or other facsimile transmission to the Chairman of the Board of Directors, the Chief Executive Officer, the President, any Vice President, or the Secretary of the corporation (or if called by one of such officers to an alternative officer listed above) for delivery to the Board of Directors. No business may be transacted at such special meeting otherwise than specified in such notice. The Board of Directors shall determine the time and place of such special meeting, which shall be held not less than thirty-five (35) nor more than one hundred twenty (120) days after the date of the receipt of the request. Upon determination of the time and place of the meeting, the officer receiving the request shall cause notice to be given to the stockholders entitled to vote, in accordance with the provisions of Section 7 of these Bylaws. If the notice is not given within one hundred (100) days after the receipt of the request, the person or persons properly requesting the meeting may set the time and place of the meeting and give the notice. Nothing contained in this paragraph (b) shall be construed as limiting, fixing, or affecting the time when a meeting of stockholders called by action of the Board of Directors may be held. (c) Nominations of persons for election to the Board of Directors may be made at a special meeting of stockholders at which directors are to be elected pursuant to the corporation's notice of meeting (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the corporation who is a stockholder of record at the time of giving notice provided for in these Bylaws who shall be entitled to vote at the meeting and who complies with the notice procedures set forth in this Section 6(c). In the event the corporation calls a special meeting of stockholders for the purpose of electing one or more directors to the Board of Directors, any such stockholder may nominate a person or persons (as the case may be), for election to such position(s) as specified in the corporation's notice of meeting, if the stockholder's notice required by Section 5(b) of these Bylaws shall be delivered to the Secretary at the principal executive offices of the corporation not earlier than the close of business on the one hundred twentieth (120th) day prior to such special meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such meeting or the tenth (10th) day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. In no event shall the public announcement of an adjournment of a special meeting commence a new time period for the giving of a stockholder's notice as described above SECTION 7. NOTICE OF MEETINGS. Except as otherwise provided by law, written notice of each meeting of stockholders shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to vote at such meeting, such notice to specify the place, date and hour and purpose or purposes of the meeting. Notice of the time, place and purpose of any meeting of stockholders may be waived in writing, signed by the person entitled to notice thereof, either before or after such meeting, and will be waived by any stockholder by his attendance thereat in person or by proxy, except when the stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction 4. of any business because the meeting is not lawfully called or convened. Any stockholder so waiving notice of such meeting shall be bound by the proceedings of any such meeting in all respects as if due notice thereof had been given. SECTION 8. QUORUM. At all meetings of stockholders, except where otherwise provided by statute or by the Certificate of Incorporation, or by these Bylaws, the presence, in person or by proxy duly authorized, of the holders of a majority of the outstanding shares of stock entitled to vote shall constitute a quorum for the transaction of business. In the absence of a quorum any meeting of stockholders may be adjourned, from time to time, either by the chairman of the meeting or by vote of the holders of a majority of the shares represented thereat, but no other business shall be transacted at such meeting. The stockholders present at a duly called or convened meeting, at which a quorum is present, may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. Except as otherwise provided by statute, by Articles VI(C) and VII of the Certificate of Incorporation relating to removal of directors and approval of certain Business Transactions, or these Bylaws, in all matters other than the election of directors, the affirmative vote of the majority of shares present in person or represented by proxy at the meeting and entitled to vote subject matter shall be the act of the stockholders. Except as otherwise provided by statute or these Bylaws, directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors. Where a separate vote by a class or classes or series is required, except as otherwise provided by statute, by Articles VI(C) and VII of the Certificate of Incorporation relating to removal of directors and approval of certain Business Transactions or these Bylaws, a majority of the outstanding shares of such class or classes or series, present in person or represented by proxy, shall constitute a quorum entitled to take action with respect to that vote on that matter and, except where otherwise provided by statute, the aforementioned Articles of the Certificate of Incorporation or these Bylaws, the affirmative vote of the majority (plurality, in the case of the election of directors) of the votes cast by the holders of shares of such class or classes or series shall be the act of such class or classes or series. SECTION 9. ADJOURNMENT AND NOTICE OF ADJOURNED MEETINGS. Any meeting of stockholders, whether annual or special, may be adjourned from time to time either by the chairman of the meeting or by the vote of a majority of the shares casting votes. When a meeting is adjourned to another time or place, notice need not be given of the adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting the corporation may transact any business which might have been transacted at the original meeting. If the adjournment is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. SECTION 10. VOTING RIGHTS. For the purpose of determining those stockholders entitled to vote at any meeting of the stockholders, except as otherwise provided by law, only persons in whose names shares stand on the stock records of the corporation on the record date, as provided in Section 12 of these Bylaws, shall be entitled to vote at any meeting of stockholders. Every person entitled to vote or execute consents shall have the right to do so either in person or by an agent or agents authorized by a proxy granted in accordance with 5. Delaware law. An agent so appointed need not be a stockholder. No proxy shall be voted after three (3) years from its date of creation unless the proxy provides for a longer period. SECTION 11. JOINT OR BENEFICIAL OWNERS OF STOCK. (a) If shares or other securities having voting power stand of record in the names of two (2) or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, tenants by the entirety, or otherwise, or if two (2) or more persons have the same fiduciary relationship respecting the same shares, unless the Secretary is given written notice to the contrary and is furnished with a copy of the instrument or order appointing them or creating the relationship wherein it is so provided, their acts with respect to voting shall have the following effect: (a) if only one (1) votes, his act binds all; (b) if more than one (1) votes, the act of the majority so voting binds all; (c) if more than one (1) votes, but the vote is evenly split on any particular matter, each faction may vote the securities in question proportionally, or may apply to the Delaware Court of Chancery for relief as provided in the Delaware General Corporation Law, Section 217(b). If the instrument filed with the Secretary shows that any such tenancy is held in unequal interests, a majority or even-split for the purpose of this subsection (c) shall be a majority or even-split in interest. SECTION 12. LIST OF STOCKHOLDERS. The Secretary shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at said meeting, arranged in alphabetical order, showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not specified, at the place where the meeting is to be held. The list shall be produced and kept at the time and place of meeting during the whole time thereof, and may be inspected by any stockholder who is present. SECTION 13. ACTION WITHOUT MEETING. (a) Any action required by statute to be taken at any annual or special meeting of the stockholders, or any action which may be taken at any annual or special meeting of the stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. (b) Every written consent shall bear the date of signature of each stockholder who signs the consent, and no written consent shall be effective to take the corporate action referred to therein unless, within sixty (60) days of the earliest dated consent delivered to the corporation in the manner herein required, written consents signed by a sufficient number of stockholders to take action are delivered to the corporation by delivery to its registered office in the State of Delaware, its principal place of business or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. 6. Delivery made to a corporation's registered office shall be by hand or by certified or registered mail, return receipt requested. (c) Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. If the action which is consented to is such as would have required the filing of a certificate under any section of the Delaware General Corporation Law if such action had been voted on by stockholders at a meeting thereof, then the certificate filed under such section shall state, in lieu of any statement required by such section concerning any vote of stockholders, that written consent has been given in accordance with Section 228 of the Delaware General Corporation Law. SECTION 14. ORGANIZATION. (a) At every meeting of stockholders, the Chairman of the Board of Directors, or, if a Chairman has not been appointed or is absent, the President, or, if the President is absent the most senior Vice President present, or in the absence of any such officer, a chairman of the meeting chosen by a majority in interest of the stockholders entitled to vote, present in person or by proxy, shall act as chairman. The Secretary, or, in his absence, an Assistant Secretary directed to do so by the President, shall act as secretary of the meeting. (b) The Board of Directors of the corporation shall be entitled to make such rules or regulations for the conduct of meetings of stockholders as it shall deem necessary, appropriate or convenient. Subject to such rules and regulations of the Board of Directors, if any, the chairman of the meeting shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such chairman, are necessary, appropriate or convenient for the proper conduct of the meeting, including, without limitation, establishing an agenda or order of business for the meeting, rules and procedures for maintaining order at the meeting and the safety of those present, limitations on participation in such meeting to stockholders of record of the corporation and their duly authorized and constituted proxies, and such other persons as the chairman shall permit, restrictions on entry to the meeting after the time fixed for the commencement thereof, limitations on the time allotted to questions or comments by participants and regulation of the opening and closing of the polls for balloting on matters which are to be voted on by ballot. Unless, and to the extent determined by the Board of Directors or the chairman of the meeting, meetings of stockholders shall not be required to be held in accordance with rules of parliamentary procedure. ARTICLE IV DIRECTORS SECTION 15. NUMBER AND TERM OF OFFICE. The authorized number of directors of the corporation shall be not more than twelve (12) nor less than five (5) with the actual number of authorized directors within this range to be fixed from time to time by resolution of the Board of Directors. Directors need not be stockholders unless so required by the Certificate of Incorporation. If for any cause, the directors shall not have been elected at an annual meeting, 7. they may be elected as soon thereafter as convenient at a special meeting of the stockholders called for that purpose in the manner provided in these Bylaws. SECTION 16. LEAD INDEPENDENT DIRECTOR. The Board of Directors may appoint a Lead Independent Director from among the independent directors serving on the Board of Directors who shall have such duties as may be prescribed by resolution of the Board of Directors, or by policy or guidelines approved by resolution of the Board of Directors. SECTION 17. POWERS. The powers of the corporation shall be exercised, its business conducted and its property controlled by the Board of Directors, except as may be otherwise provided by statute or by the Certificate of Incorporation. SECTION 18. VACANCIES. (a) Unless otherwise provided in the Certificate of Incorporation, any vacancies on the Board of Directors resulting from death, resignation, disqualification, removal or other causes and any newly created directorships resulting from any increase in the number of Directors shall, unless the Board of Directors determines by resolution that any such vacancies or newly created directorships shall be filled by stockholders, be filled only by the affirmative vote of a majority of the directors then in office, even though less than a quorum of the Board of Directors. Any director elected in accordance with the preceding sentence shall hold office for the remainder of the full term of the Director for which the vacancy was created or occurred and until such director's successor shall have been elected and qualified. A vacancy in the Board of Directors shall be deemed to exist under this Section 18 in the case of the death, removal or resignation of any Director. (b) If at the time of filling any vacancy or any newly created directorship, the directors then in office shall constitute less than a majority of the whole board (as constituted immediately prior to any such increase), the Delaware Court of Chancery may, upon application of any stockholder or stockholders holding at least ten percent (10%) of the total number of the shares at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in offices as aforesaid, which election shall be governed by Section 211 of the Delaware General Corporation Law. SECTION 19. RESIGNATION. Any director may resign at any time by delivering his written resignation to the Secretary, such resignation to specify whether it will be effective at a particular time, upon receipt by the Secretary or at the pleasure of the Board of Directors. If no such specification is made, it shall be deemed effective at the pleasure of the Board of Directors. When one or more directors shall resign from the Board of Directors, effective at a future date, a majority of the directors then in office, including those who have so resigned, shall have power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall become effective, and each Director so chosen shall hold office for the unexpired portion of the term of the Director whose place shall be vacated and until his successor shall have been duly elected and qualified. 8. SECTION 20. REMOVAL. Subject to any limitation imposed by law, any individual director or directors may be removed with or without cause by the affirmative vote of at least two-thirds of the voting power of the corporation entitled to vote at an election of directors. SECTION 21. MEETINGS. (a) ANNUAL MEETINGS. The annual meeting of the Board of Directors shall be held immediately before or after the annual meeting of stockholders and at the place where such meeting is held. No notice of an annual meeting of the Board of Directors shall be necessary and such meeting shall be held for the purpose of electing officers and transacting such other business as may lawfully come before it. (b) REGULAR MEETINGS. Unless otherwise restricted by the Certificate of Incorporation, regular meetings of the Board of Directors may be held at any time or date and at any place within or without the State of Delaware which has been designated by the Board of Directors and publicized among all directors. No formal notice shall be required for regular meetings of the Board of Directors. (c) SPECIAL MEETINGS. Unless otherwise restricted by the Certificate of Incorporation, special meetings of the Board of Directors may be held at any time and place within or without the State of Delaware whenever called by the Chairman of the Board, the President or any two of the directors. (d) TELEPHONE MEETINGS. Any member of the Board of Directors, or of any committee thereof, may participate in a meeting by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting by such means shall constitute presence in person at such meeting. (e) NOTICE OF MEETINGS. Notice of the time and place of all special meetings of the Board of Directors shall be orally or in writing, by telephone, including a voice messaging system or other system or technology designed to record and communicate messages, facsimile, telegraph or telex, or by electronic mail or other electronic means, during normal business hours, at least twenty-four (24) hours before the date and time of the meeting, or sent in writing to each director by first class mail, charges prepaid, at least two (2) days before the date of the meeting. Notice of any meeting may be waived in writing at any time before or after the meeting and will be waived by any director by attendance thereat, except when the director attends the meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. (f) WAIVER OF NOTICE. The transaction of all business at any meeting of the Board of Directors, or any committee thereof, however called or noticed, or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present and if, either before or after the meeting, each of the directors not present shall sign a written waiver of notice. All such waivers shall be filed with the corporate records or made a part of the minutes of the meeting. SECTION 22. QUORUM AND VOTING. 9. (a) Unless the Certificate of Incorporation requires a greater number and except with respect to indemnification questions arising under Section 43 hereof, for which a quorum shall be one-third of the exact number of Directors fixed from time to time in accordance with Section 15 hereof, but not less than one (1), a quorum of the Board of Directors shall consist of a majority of the exact number of directors fixed from time to time by the Board of Directors in accordance with Section 15 of these Bylaws, but not less than one (1); provided, however, at any meeting whether a quorum be present or otherwise, a majority of the Directors present may adjourn from time to time until the time fixed for the next regular meeting of the Board of directors, without notice other than by announcement at the meeting. (b) At each meeting of the Board of Directors at which a quorum is present all questions and business shall be determined by the affirmative vote of a majority of the directors present, unless a different vote be required by law, the Certificate of Incorporation or these Bylaws. SECTION 23. ACTION WITHOUT MEETING. Unless otherwise restricted by the Certificate of Incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the Board of Directors or committee, as the case may be, consent thereto in writing, and such writing or writings are filed with the minutes of proceedings of the Board of Directors or committee. SECTION 24. FEES AND COMPENSATION. Directors shall be entitled to such compensation for their services as may be approved by the Board of Directors, including, if so approved, by resolution of the Board of Directors, a fixed sum and expenses of attendance, if any, for attendance at each regular or special meeting of the Board of Directors and at any meeting of a committee of the Board of Directors. Nothing herein contained shall be construed to preclude any director from serving the corporation in any other capacity as an officer, agent, employee, or otherwise and receiving compensation therefor. SECTION 25. COMMITTEES. (a) COMMITTEES. The Board of Directors may from time to time appoint such committees as may be permitted by law. Such committees appointed by the Board of Directors shall consist of one (1) or more members of the Board of Directors, and shall have such powers and perform such duties as may be prescribed by the resolution or resolutions creating such committees, but in no event shall any such committee have the power or authority in reference to (i) approving or adopting, or recommending to the stockholders, any action or matter expressly required by the Delaware General Corporation Law to be submitted to stockholders for approval, or (ii) adopting, amending or repealing any bylaw of the corporation. (b) TERM. Each member of a committee of the Board of Directors shall serve a term on such committee coexistent with such member's term on the Board of Directors. The Board of Directors, subject to the provisions of subsections (a) or (b) of this Bylaw, may at any time increase or decrease the number of members of a committee or terminate the existence of a committee. The membership of a committee member shall terminate on the date of his death or voluntary resignation from the committee or from the Board of Directors. The Board of Directors 10. may at any time for any reason remove any individual committee member and the Board of Directors may fill any committee vacancy created by death, resignation, removal or increase in the number of members of the committee. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee, and, in addition, in the absence or disqualification of any member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. (c) MEETINGS. Unless the Board of Directors shall otherwise provide, regular meetings of any committee appointed pursuant to this Section 25 shall be held at such times and places as are determined by the Board of Directors, or by any such committee, and when notice thereof has been given to each member of such committee, no further notice of such regular meetings need be given thereafter. Special meetings of any such committee may be held at any place which has been determined from time to time by such committee, and may be called by any director who is a member of such committee, upon written notice to the members of such committee of the time and place of such special meeting given in the manner provided for the giving of written notice to members of the Board of Directors of the time and place of special meetings of the Board of Directors. Notice of any special meeting of any committee may be waived in writing at any time before or after the meeting and will be waived by any director by attendance thereat, except when the director attends such special meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. A majority of the authorized number of members of any such committee shall constitute a quorum for the transaction of business, and the act of a majority of those present at any meeting at which a quorum is present shall be the act of such committee. SECTION 26. ORGANIZATION. At every meeting of the directors, the Chairman of the Board of Directors, or, if a Chairman has not been appointed or is absent, the President (if a Director), or if the President is absent, the most senior Vice President (if a Director), or, in the absence of any such person, a chairman of the meeting chosen by a majority of the directors present, shall preside over the meeting. The Secretary, or in his absence, any Assistant Secretary directed to do so by the President, shall act as secretary of the meeting. ARTICLE V OFFICERS SECTION 27. OFFICERS DESIGNATED. The officers of the corporation shall include a Chief Executive Officer (who shall be either the Chairman of the Board or President, as provided in these Bylaws), a President, a Chief Operating Officer, a Secretary and a Chief Financial Officer or Treasurer. The Corporation may also have, at the discretion of the Board of Directors such other officers as are desired, including a Chairman of the Board of Directors, a Vice Chairman of the Board of Directors, one or more Vice Presidents, one or more Assistant Secretaries, one or more Assistant Treasurers, and such other officers and agents with such powers and duties as it shall deem necessary, all of whom shall be elected at the annual organizational meeting of the 11. Board of Directors. The order of the seniority of the Vice Presidents shall be in the order of their nomination, unless otherwise determined by the Board of Directors. The Board of Directors may assign such additional titles to one or more of the officers as it shall deem appropriate. Any one person may hold any number of offices of the corporation at any one time unless specifically prohibited therefrom by law. The salaries and other compensation of the officers of the corporation shall be fixed by or in the manner designated by the Board of Directors. SECTION 28. TENURE AND DUTIES OF OFFICERS. (a) GENERAL. All officers shall hold office at the pleasure of the Board of Directors and until their successors shall have been duly elected and qualified, unless sooner removed. Any officer elected or appointed by the Board of Directors may be removed at any time by the Board of Directors. If the office of any officer becomes vacant for any reason, the vacancy may be filled by the Board of Directors. (b) DUTIES OF CHAIRMAN OF THE BOARD OF DIRECTORS. The Chairman of the Board of Directors, if such an officer is elected, shall preside when present at all meetings of the stockholders and the Board of Directors. The Chairman of the Board of Directors shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors shall designate from time to time. If there is a Chairman of the Board of Directors and if the Board of Directors designates such Chairman of the Board of Directors as the Chief Executive Officer of the corporation, then the Chairman of the Board of Directors shall also have the powers and duties prescribed in paragraph (d) of this Section 28. (c) DUTIES OF VICE CHAIRMAN OF THE BOARD OF DIRECTORS. The Vice Chairman of the Board, if such an officer is elected, shall be a director and shall preside at all meetings of the Board of Directors for which the Chairman of the Board is absent or unavailable. The Vice Chairman shall perform such other duties as may be prescribed periodically by the Chairman of the Board or the Board of Directors. (d) DUTIES OF CHIEF EXECUTIVE OFFICER. If there is a Chairman of the Board and the Board of Directors designates the Chairman of the Board as the Chief Executive Officer, then the Chairman of the Board shall be the Chief Executive Officer of the corporation. Otherwise, the President shall be the Chief Executive Officer of the corporation. The Chief Executive Officer shall preside at all meetings of the stockholders and at all meetings of the Board of Directors, unless a Chairman or Vice Chairman of the Board of Directors has been appointed and is present. The Chief Executive Officer shall be an ex-officio member of all committees and shall, subject to the control of the Board of Directors and such supervisory powers, if any, as may be given by the Board of Directors to the Chairman of the Board or the Vice Chairman of the Board, if there be such officers, shall have general supervision, direction and control of the business and officers of the corporation, shall have such duties and authority as are normally incident to the office of chief executive officer of a corporation and such duties and authority as may be prescribed from time to time by the Board of Directors or as are provided for elsewhere in these Bylaws. 12. (e) DUTIES OF PRESIDENT AND CHIEF OPERATING OFFICER. If there is a Chairman of the Board who is also the Chief Executive Officer, then the President shall be the Chief Operating Officer. If the President is the Chief Executive Officer, then the President shall also serve as the Chief Operating Officer unless the Board of Directors designates another officer of the corporation as the Chief Operating Officer. Subject to the direction and control of the Chief Executive Officer and the Board of Directors, the President and Chief Operating Officer shall supervise and control the operations of the corporation, shall have the duties and authority as are normally incident to the office of president and chief operating officer of a corporation and such other duties as may be prescribed from time to time by the Chief Executive Officer or the Board of Directors, and, in the absence or disability of the Chief Executive Officer, shall have the authority and perform the duties of the Chief Executive Officer. (f) DUTIES OF VICE PRESIDENTS. The Vice Presidents, in the order of their seniority, may assume and perform the duties of the President in the absence or disability of the President or whenever the office of President is vacant. The Vice Presidents shall perform other duties commonly incident to their office and shall also perform such other duties and have such other powers as the Board of Directors or the President shall designate from time to time. (g) DUTIES OF SECRETARY. The Secretary shall attend all meetings of the stockholders and of the Board of Directors, and shall record all acts and proceedings thereof in the minute book of the corporation. The Secretary shall give notice in conformity with these Bylaws of all meetings of the stockholders, and of all meetings of the Board of Directors and any committee thereof requiring notice. The Secretary shall perform all other duties given him in these Bylaws and other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors shall designate from time to time. The President may direct any Assistant Secretary to assume and perform the duties of the Secretary in the absence or disability of the Secretary, and each Assistant Secretary shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors or the President shall designate from time to time. (h) DUTIES OF CHIEF FINANCIAL OFFICER OR TREASURER. The Chief Financial Officer or Treasurer shall keep or cause to be kept the books of account of the corporation in a thorough and proper manner, and shall render statements of the financial affairs of the corporation in such form and as often as required by the Board of Directors or the President. The Chief Financial Officer or Treasurer, subject to the order of the Board of Directors, shall have the custody of all funds and securities of the corporation. The Chief Financial Officer or Treasurer shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors or the President shall designate from time to time. The President may direct any Assistant Treasurer to assume and perform the duties of the Chief Financial Officer or Treasurer in the absence or disability of the Chief Financial Officer or Treasurer, and each Assistant Treasurer shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors or the President shall designate from time to time. SECTION 29. DELEGATION OF AUTHORITY. The Board of Directors may from time to time delegate the powers or duties of any officer to any other officer or agent, notwithstanding any provision hereof. 13. SECTION 30. RESIGNATIONS. Any officer may resign at any time by giving written notice to the Board of Directors or to the President or to the Secretary. Any such resignation shall be effective when received by the person or persons to whom such notice is given, unless a later time is specified therein, in which event the resignation shall become effective at such later time. Unless otherwise specified in such notice, the acceptance of any such resignation shall not be necessary to make it effective. Any resignation shall be without prejudice to the rights, if any, of the corporation under any contract with the resigning officer. SECTION 31. REMOVAL. Any officer may be removed from office at any time, either with or without cause, by the affirmative vote of a majority of the directors in office at the time, or by the unanimous written consent of the directors in office at the time, or by any committee or superior officers upon whom such power of removal may have been conferred by the Board of Directors. ARTICLE VI EXECUTION OF CORPORATE INSTRUMENTS AND VOTING OF SECURITIES OWNED BY THE CORPORATION SECTION 32. EXECUTION OF CORPORATE INSTRUMENTS. The Board of Directors may, in its discretion, determine the method and designate the signatory officer or officers, or other person or persons, to execute on behalf of the corporation any corporate instrument or document, or to sign on behalf of the corporation the corporate name without limitation, or to enter into contracts on behalf of the corporation, except where otherwise provided by law or these Bylaws, and such execution or signature shall be binding upon the corporation. Unless otherwise specifically determined by the Board of Directors or otherwise required by law. promissory notes, deeds of trust, mortgages and other evidences of indebtedness of the corporation, and other corporate instruments or documents requiring the corporate seal, and certificates of shares of stock owned by the corporation, shall be executed, signed or endorsed by the Chairman of the Board of Directors, or the President or any Vice President, and by the Secretary or Chief Financial Officer or Treasurer or any Assistant Secretary or Assistant Treasurer. All other instruments and documents requiring the corporate signature, but not requiring the corporate seal, may be executed as aforesaid or in such other manner as may be directed by the Board of Directors. All checks and drafts drawn on banks or other depositaries on funds to the credit of the corporation or in special accounts of the corporation shall be signed by such person or persons as the Board of Directors shall authorize so to do. Unless authorized or ratified by the Board of Directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. SECTION 33. VOTING OF SECURITIES OWNED BY THE CORPORATION. All stock and other securities of other corporations owned or held by the corporation for itself, or for other parties in 14. any capacity, shall be voted, and all proxies with respect thereto shall be executed, by thc person authorized so to do by resolution of the Board of Directors, or, in the absence of such authorization, by the Chairman of the Board of Directors, the Chief Executive Officer, the President, or any Vice President. ARTICLE VII SHARES OF STOCK SECTION 34. FORM AND EXECUTION OF CERTIFICATES. Certificates for the shares of stock of the corporation shall be in such form as is consistent with the Certificate of Incorporation and applicable law. Every holder of stock in the corporation shall be entitled to have a certificate signed by or in the name of the corporation by the Chairman of the Board of Directors, or the President or any Vice President and by the Treasurer or Assistant Treasurer or the Secretary or Assistant Secretary, certifying the number of shares owned by him in the corporation. Any or all of the signatures on the certificate may be facsimiles. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued with the same effect as if he were such officer, transfer agent, or registrar at the date of issue. Each certificate shall state upon the face or back thereof, in full or in summary, all of the powers, designations, preferences, and rights, and the limitations or restrictions of the shares authorized to be issued or shall, except as otherwise required by law, set forth on the face or back a statement that the corporation will furnish without charge to each stockholder who so requests the powers, designations, preferences and relative, participating , optional, or other special rights of each class of stock or series thereof and the qualifications, limitations, or restrictions of such preferences and/or rights. Within a reasonable time after the issuance or transfer of uncertificated stock, the corporation shall send to the registered owner thereof a written notice containing the information required to be set forth or stated on certificates pursuant to this section or otherwise required by law or with respect to this section a statement that the corporation will furnish without charge to each stockholder who so requests the powers, designations, preferences and relative participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. Except as otherwise expressly provided by law, the rights and obligations of the holders of certificates representing stock of the same class and series shall be identical. SECTION 35. LOST CERTIFICATES. A new certificate or certificates shall be issued in place of any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen, or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen, or destroyed. The corporation may require, as a condition precedent to the issuance of a new certificate or certificates, the owner of such lost, stolen, or destroyed certificate or certificates, or his legal representative, to agree to indemnify the corporation in such manner as it shall require or to give the corporation a surety bond in such form and amount as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen, or destroyed. 15. SECTION 36. TRANSFERS. (a) Transfers of record of shares of stock of the corporation shall be made only upon its books by the holders thereof, in person or by attorney duly authorized, and upon the surrender of a properly endorsed certificate or certificates for a like number of shares. (b) The corporation shall have power to enter into and perform any agreement with any number of stockholders of any one or more classes of stock of the corporation to restrict the transfer of shares of stock of the corporation of any one or more classes owned by such stockholders in any manner not prohibited by the Delaware General Corporation Law. SECTION 37. FIXING RECORD DATES. (a) In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the Board of Directors may fix, in advance, a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date shall, subject to applicable law, not be more than sixty (60) nor less than ten (10) days before the date of such meeting. If no record date is fixed by the Board of Directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. (b) In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the Board of Directors may fix, in advance, a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which date shall not be more than ten (10) days after the date upon which the resolution fixing the record date is adopted by the Board of Directors. If no record date has been fixed by the Board of Directors, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the Board of Directors is required by law, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the Corporation by delivery to its registered office in the State of Delaware, its principal place of business or an officer or agent of the Corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery made to a Corporation's registered office shall be by hand or by certified or registered mail, return receipt requested. If no record date has been fixed by the Board of Directors and prior action by the Board of Directors is required by law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the day on which the Board of Directors adopts the resolution taking such prior action. (c) In order that the corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights or the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of 16. stock, or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted, and which record date shall be not more than sixty (60) days prior to such action. If no record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. SECTION 38. REGISTERED STOCKHOLDERS. The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. ARTICLE VIII OTHER SECURITIES OF THE CORPORATION SECTION 39. EXECUTION OF OTHER SECURITIES. All bonds, debentures and other corporate securities of the corporation, other than stock certificates (covered in Section 34), may be signed by the Chairman of the Board of Directors, the President or any Vice President, or such other person as may be authorized by the Board of Directors, and the corporate seal impressed thereon or a facsimile of such seal imprinted thereon and attested by the signature of the Secretary or an Assistant Secretary, or the Chief Financial Officer or Treasurer or an Assistant Treasurer; provided, however, that where any such bond, debenture or other corporate security shall be authenticated by the manual signature, or where permissible facsimile signature, of a trustee under an indenture pursuant to which such bond debenture or other corporate security shall be issued, the signatures of the persons signing and attesting the corporate seal on such bond, debenture or other corporate security may be the imprinted facsimile of the signatures of such persons. Interest coupons appertaining to any such bond debenture or other corporate security, authenticated by a trustee as aforesaid, shall be signed by the Treasurer or an Assistant Treasurer of the corporation or such other person as may be authorized by the Board of Directors, or bear imprinted thereon the facsimile signature of such person. In case any officer who shall have signed or attested any bond, debenture or other corporate security, or whose facsimile signature shall appear thereon or on any such interest coupon. shall have ceased to be such officer before the bond, debenture or other corporate security so signed or attested shall have been delivered, such bond, debenture or other corporate security nevertheless may be adopted by the corporation and issued and delivered as though the person who signed the same or whose facsimile signature shall have been used thereon had not ceased to be such officer of the corporation. ARTICLE IX DIVIDENDS SECTION 40. DECLARATION OF DIVIDENDS. Dividends upon the capital stock of the corporation, subject to the provisions of the Certificate of Incorporation and applicable law, if any, may be declared by the Board of Directors pursuant to law at any regular or special meeting. 17. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Certificate of Incorporation and applicable law. SECTION 41. DIVIDEND RESERVE. Before payment of any dividend, there may be set aside out of any funds of the corporation available for dividends such sum or sums as the Board of Directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the corporation, or for such other purpose as the Board of Directors shall think conducive to the interests of the corporation, and the Board of Directors may modify or abolish any such reserve in the manner in which it was created. ARTICLE X FISCAL YEAR SECTION 42. FISCAL YEAR. The fiscal year of the corporation shall be fixed by resolution of the Board of Directors. ARTICLE XI INDEMNIFICATION SECTION 43. INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND OTHER AGENTS. (a) DIRECTORS AND EXECUTIVE OFFICERS. The corporation shall indemnify its Directors and executive officers to the fullest extent not prohibited by the Delaware General Corporation Law or any other applicable law; provided, however, that the corporation may modify the extent of such indemnification by individual contracts with its directors and executive officers; and, provided, further, that the corporation shall not be required to indemnify any director or executive officer in connection with any proceeding (or part thereof) initiated by such person or any proceeding by such person against the corporation or its Directors, officers, employees or other agents unless (i) such indemnification is expressly required to be made by law, (ii) the proceeding was authorized by the Board of Directors of the corporation or (iii) such indemnification is provided by the corporation, in its sole discretion, pursuant to the powers vested in the corporation under the Delaware General Corporation Law or any other applicable law or (iv) such indemnification is required to be made under subsection (e). (b) OTHER OFFICERS, EMPLOYEES AND OTHER AGENTS. The corporation shall have power to indemnify its other officers, employees and other agents as set forth in the Delaware General Corporation Law or any other applicable law. The Board of Directors shall have the power to delegate the determination of whether indemnification shall be given to any such person, except executive officers, to such officers or other persons as the Board of Directors shall determine. (c) GOOD FAITH. (1) For purposes of any determination under this Bylaw, a Director or executive officer shall be deemed to have acted in good faith and in a manner he reasonably 18. believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, to have had no reasonable cause to believe that his conduct was unlawful, if his action is based on information, opinions, reports and statements, including financial statements and other financial data, in each case prepared or presented by: (i) one or more officers or employees of the corporation whom the Director or executive officer believed to be reliable and competent in the matters presented; (ii) counsel, independent accountants or other persons as to matters which the Director or executive officer believed to be within such person's professional competence; and (iii) with respect to a Director, a committee of the Board upon which such Director does not serve, as to matters within such Committee's designated authority, which committee the Director believes to merit confidence; so long as, in each case, the Director or executive officer acts without knowledge that would cause such reliance to be unwarranted. (2) The termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal proceeding, that he had reasonable cause to believe that his conduct was unlawful. (3) The provisions of this paragraph (c) shall not be deemed to be exclusive or to limit in any way the circumstances in which a person may be deemed to have met the applicable standard of conduct set forth by the Delaware General Corporation Law. (d) EXPENSES. The corporation shall advance to any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he is or was a director or executive officer of the corporation or is or was serving at the request of the corporation as a director or executive officer of another corporation, partnership, joint venture, trust or other enterprise, prior to the final disposition of the proceeding, promptly following request therefor, all expenses incurred by any director or executive officer in connection with such proceeding upon receipt of an undertaking by or on behalf of such person to repay said amounts if it should be determined ultimately that such person is not entitled to be indemnified under this Bylaw or otherwise. Notwithstanding the foregoing, unless otherwise determined pursuant to paragraph (f) of this Bylaw, no advance shall be made by the corporation to an executive officer of the corporation (except by reason of the fact that such executive officer is or was a director of the corporation in which event this paragraph shall not apply) in any action, suit or proceeding, whether civil, criminal, administrative or investigative, if a determination is reasonably and promptly made (i) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to the proceeding, or (ii) if such quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, that the facts known to the decision making party at the time such determination is made 19. demonstrate clearly and convincingly that such person acted in bad faith or in a manner that such person did not believe to be in or not opposed to the best interests of the corporation. (e) ENFORCEMENT. Without the necessity of entering into an express contract all rights to indemnification and advances to directors and executive officers under this Bylaw shall be deemed to be contractual rights and be effective to the same extent and as if provided for in a contract between the corporation and the director or executive officer. Any right to indemnification or advances granted by this Bylaw to a director or executive officer shall be enforceable by or on behalf of the person holding such right in any court of competent jurisdiction if (i) the claim for indemnification or advances is denied, in whole or in part, or (ii) no disposition of such claim is made within ninety (90) days of request therefor. The claimant in such enforcement action, if successful in whole or in part, shall be entitled to be paid also the expense of prosecuting his claim. In connection with any claim for indemnification, the corporation shall be entitled to raise as a defense to any such action that the claimant has not met the standards of conduct that make it permissible under the Delaware General Corporation Law or any other applicable law for the corporation to indemnify the claimant for the amount claimed. Neither the failure of the corporation (including its Board of Directors, independent legal counsel or its stockholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he has met the applicable standard of conduct set forth in the Delaware General Corporation Law or any other applicable law, nor an actual determination by the corporation (including its Board of Directors, independent legal counsel or its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that claimant has not met the applicable standard of conduct. (f) NON-EXCLUSIVITY OF RIGHTS. The rights conferred on any person by this Bylaw shall not be exclusive of any other right which such person may have or hereafter acquire under any applicable statute, provision of the Certificate of Incorporation, Bylaws, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding office. The corporation is specifically authorized to enter into individual contracts with any or all of its directors, officers, employees or agents respecting indemnification and advances, to the fullest extent not prohibited by the Delaware General Corporation Law, or by any other applicable law. (g) SURVIVAL OF RIGHTS. The rights conferred on any person by this Bylaw shall continue as to a person who has ceased to be a director, officer, employee or other agent and shall inure to the benefit of the heirs, executors and administrators of such a person. (h) INSURANCE. To the fullest extent permitted by the Delaware General Corporation Law or any other applicable law, the corporation, upon approval by the Board of Directors, may purchase insurance on behalf of any person required or permitted to be indemnified pursuant to this Bylaw (i) AMENDMENTS. Any repeal or modification of this Bylaw shall only be prospective and shall not affect the rights under this Bylaw in effect at the time of the alleged occurrence of any action or omission to act that is the cause of any proceeding against any agent of the corporation. 20. (j) SAVING CLAUSE. If this Bylaw or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the corporation shall nevertheless indemnify each director and executive officer to the full extent not prohibited by any applicable portion of this Bylaw that shall not have been invalidated, or by any other applicable law. If this Section 43 shall be invalid due to the application of the indemnification provisions of another jurisdiction, then the corporation shall indemnify each director and executive officer to the fullest extent under any other applicable law. (k) CERTAIN DEFINITIONS. For the purposes of this Bylaw, the following definitions shall apply: (1) The term "PROCEEDING" shall be broadly construed and shall include, without limitation, the investigation, preparation, prosecution, defense, settlement, arbitration and appeal of, and the giving of testimony in, any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative. (2) The term "EXPENSES" shall be broadly construed and shall include, without limitation, court costs, attorneys' fees, witness fees, fines, amounts paid in settlement or judgment and any other costs and expenses of any nature or kind incurred in connection with any proceeding. (3) The term the "CORPORATION" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Bylaw with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued. (4) References to a "DIRECTOR," "EXECUTIVE OFFICER," "OFFICER," "EMPLOYEE," or "AGENT" of the corporation shall include, without limitation, situations where such person is serving at the request of the corporation as, respectively, a director, executive officer, officer, employee, trustee or agent of another corporation, partnership, joint venture, trust or other enterprise. (5) References to "OTHER ENTERPRISES" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "SERVING AT THE REQUEST OF THE CORPORATION" shall include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "NOT OPPOSED TO THE BEST INTERESTS OF THE CORPORATION" as referred to in this Bylaw. 21. ARTICLE XII NOTICES SECTION 44. NOTICES. (a) NOTICE TO STOCKHOLDERS. Whenever, under any provisions of these Bylaws, notice is required to be given to any stockholder, it shall be given in writing, timely and duly deposited in the United States mail, postage prepaid, and addressed to his last known post office address as shown by the stock record of the corporation or its transfer agent. (b) NOTICE TO DIRECTORS. Any notice required to be given to any director may be given by the method stated in subsection (a), or by overnight delivery service, facsimile, electronic mail, telex or telegram, except that such notice other than one which is delivered personally shall be sent to such address as such director shall have filed in writing with the Secretary, or, in the absence of such filing, to the last known post office address of such Director. (c) AFFIDAVIT OF MAILING. An affidavit of mailing, executed by a duly authorized and competent employee of the corporation or its transfer agent appointed with respect to the class of stock affected, specifying the name and address or the names and addresses of the stockholder or stockholders, or director or directors, to whom any such notice or notices was or were given, and the time and method of giving the same, shall in the absence of fraud, be prima facie evidence of the facts therein contained. (d) TIME NOTICES DEEMED GIVEN. All notices given by mail or by overnight delivery service, as above provided, shall be deemed to have been given as at the time of mailing and all notices given by facsimile, telex or telegram shall be deemed to have been given as of the sending time recorded at time of transmission. (e) METHODS OF NOTICE. It shall not be necessary that the same method of giving notice be employed in respect of all directors, but one permissible method may be employed in respect of any one or more, and any other permissible method or methods may be employed in respect of any other or others. (f) FAILURE TO RECEIVE NOTICE. The period or limitation of time within which any stockholder may exercise any option or right, or enjoy any privilege or benefit, or be required to act, or within which any director may exercise any power or right, or enjoy any privilege, pursuant to any notice sent him in the manner above provided, shall not be affected or extended in any manner by the failure of such stockholder or such director to receive such notice. (g) NOTICE TO PERSON WITH WHOM COMMUNICATION IS UNLAWFUL. Whenever notice is required to be given, under any provision of law or of the Certificate of Incorporation or Bylaws of the corporation, to any person with whom communication is unlawful, the giving of such notice to such person shall not be required and there shall be no duty to apply to any governmental authority or agency for a license or permit to give such notice to such person. Any action or meeting which shall be taken or held without notice to any such person with whom communication is unlawful shall have the same force and effect as if such notice had been duly given. In the event that the action taken by the corporation is such as to require the filing of a 22. certificate under any provision of the Delaware General Corporation Law, the certificate shall state, if such is the fact and if notice is required, that notice was given to all persons entitled to receive notice except such persons with whom communication is unlawful. (h) NOTICE TO PERSON WITH UNDELIVERABLE ADDRESS. Whenever notice is required to be given, under any provision of law or the Certificate of Incorporation or Bylaws of the corporation, to any stockholder to whom (i) notice of two consecutive annual meetings, and all notices of meetings or of the taking of action by written consent without a meeting to such person during the period between such two consecutive annual meetings, or (ii) all, and at least two, payments (if sent by first class mail) of dividends or interest on securities during a twelve month period, have been mailed addressed to such person at his address as shown on the records of the corporation and have been returned undeliverable, the giving of such notice to such person shall not be required. Any action or meeting which shall be taken or held without notice to such person shall have the same force and effect as if such notice had been duly given. If any such person shall deliver to the corporation a written notice setting forth his then current address, the requirement that notice be given to such person shall be reinstated. In the event that the action taken by the corporation is such as to require the filing of a certificate under any provision of the Delaware General Corporation Law, the certificate need not state that notice was not given to persons to whom notice was not required to be given pursuant to this paragraph. ARTICLE XIII AMENDMENTS SECTION 45. AMENDMENTS. Subject to paragraph (i) of Section 43 of the Bylaws, the Bylaws may be altered, amended or repealed and new Bylaws adopted by the affirmative vote of the stockholders entitled to vote thereon. The Board of Directors shall also have the power to adopt, amend, or repeal Bylaws. 23. EX-4.06 4 a96836exv4w06.txt EXHIBIT 4.06 EXHIBIT 4.06 SUPPLEMENTAL INDENTURE This Supplemental Indenture (this "SUPPLEMENTAL INDENTURE") dated as of September 15, 2003, by and between PacifiCare Health Systems, Inc., a Delaware corporation (the "COMPANY"); PacifiCare Health Plan Administrators, Inc., an Indiana corporation, PacifiCare eHoldings, Inc., a California corporation, RxConnect, Inc., a California corporation and SeniorCo, Inc., a Delaware corporation (collectively, the "INITIAL SUBSIDIARY GUARANTORS"); Rx Solutions, Inc., a California corporation, PacifiCare Behavioral Health, Inc., a Delaware corporation and Secure Horizons USA, Inc., a California corporation (collectively, the "PHPA SUBSIDIARY GUARANTORS"); and U.S. Bank National Association, a national banking association, as successor to State Street Bank and Trust Company of California, N.A., as trustee under the Indenture referred to below (the "TRUSTEE"). Capitalized terms used but not defined herein shall have the meanings given to them in the Indenture referred to below. RECITALS WHEREAS, the Company and the Initial Subsidiary Guarantors heretofore executed and delivered to the Trustee an Indenture (the "INDENTURE") dated as of May 21, 2002 providing for the issuance of an aggregate principal amount of $500,000,000 of 10 3/4% Senior Notes due 2009 (the "NOTES"); WHEREAS, Section 4.07 of the Indenture provides that, immediately upon the prepayment, redemption, purchase, defeasance or other satisfaction in full of the 7% Senior Notes due 2003 (the "7% SENIOR NOTES DUE 2003") issued by FHP International Corporation (subsequently renamed PacifiCare Health Plan Administrators, Inc. [FHP INTERNATIONAL WAS ACTUALLY MERGED INTO PHPA; THEREFORE, WE PROBABLY SHOULD SAY THIS DIFFERENTLY, I.E., NOW KNOWN AS PHPA BY VIRTUE OF THE MERGER OF THESE ENTITIES]) pursuant to the terms of that certain indenture dated as of September 22, 1993 between FHP International Corporation and The Chase Manhattan Bank, N.A. [WE MAY WANT TO REFER TO THE SUPPLEMENTAL INDENTURE DATED 1996-1997 BY WHICH OLD PHS BECAME THE OBLIGOR UNDER THE FHP NOTES SINCE THE OLD PHS ENTITY LATER MERGED INTO PHPA MAKING PHPA THE OBLIGOR], the Company will cause each PHPA Subsidiary Guarantor to fully and unconditionally Guarantee, jointly and severally, on an unsecured unsubordinated basis the payment of principal, premium, if any, and interest on the Notes by the execution and delivery of a supplemental indenture to the Indenture; WHEREAS, the 7% Senior Notes due 2003 matured on September 15, 2003 and have been defeased in full; WHEREAS, pursuant to Section 9.01 of the Indenture, the Trustee, the Company and the Subsidiary Guarantors [SECTION 9.01 REFERS TO "SUBSIDIARY GUARANTORS" WHICH INCLUDES THE INITIAL SUBSIDIARY GUARANTORS, THE PHPA GUARANTORS AND ANY OTHER RESTRICTED SUBSIDIARY THAT LATER PROVIDES A NOTE GUARANTEE OF THE COMPANY'S OBLIGATIONS] are authorized, without notice to or the consent of any Holder, to execute and deliver this Supplemental Indenture to cause the PHPA Subsidiary Guarantors to Guarantee the Notes to comply with Section 4.07 of the Indenture; and WHEREAS, the Company, the Trustee, the Initial Subsidiary Guarantors and the PHPA Subsidiary Guarantors desire to enter into this Supplemental Indenture to provide for such Note Guarantees as contemplated by Section 4.07 of the Indenture. AGREEMENT NOW, THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt of which is hereby acknowledged, the Company, the Initial Subsidiary Guarantors, the PHPA Subsidiary Guarantors and the Trustee mutually covenant and agree as follows: 1. CREATION OF NOTE GUARANTEE. Each PHPA Subsidiary Guarantor hereby agrees, jointly and severally with all other Subsidiary Guarantors, to Guarantee the Notes and the performance of the Company's obligations under the Notes and the Indenture in accordance with the terms and provisions of Article Ten of the Indenture. Each PHPA Subsidiary Guarantor shall be bound by, and entitled to the benefits of, all other applicable terms and provisions of the Indenture as a Subsidiary Guarantor, including the provisions relating to the release of the Note Guarantees in certain circumstances. 2. RATIFICATION OF INDENTURE; SUPPLEMENTAL INDENTURE PART OF INDENTURE. Except as expressly amended hereby, the Indenture is in all respects ratified and confirmed and all the terms, conditions and provisions thereof shall remain in full force and effect. This Supplemental Indenture shall form a part of the Indenture for all purposes, and every holder of the Notes heretofore or hereafter authenticated and delivered shall be bound hereby. 3. GOVERNING LAW. THIS SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY THE LAWS OF THE STATE OF NEW YORK. 4. TRUSTEE MAKES NO REPRESENTATION. The Trustee makes no representation as to the validity or adequacy of this Supplemental Indenture. 5. COUNTERPARTS. The parties may sign any number of copies of this Supplemental Indenture. Each signed copy shall be an original, but all of them together represent the same agreement. 6. EFFECT OF HEADINGS. The Section headings herein are for convenience only and shall not effect the construction thereof. IN WITNESS WHEREOF, the parties hereto have caused this Supplemental Indenture to be duly executed as of the date first written above. PACIFICARE HEALTH SYSTEMS, INC. By: -------------------------------- Name: Title: PACIFICARE HEALTH PLAN ADMINISTRATORS, INC. By: -------------------------------- Name: Title: PACIFICARE EHOLDINGS, INC. By: -------------------------------- Name: Title: RXCONNECT, INC. By: -------------------------------- Name: Title: SENIORCO, INC. By: -------------------------------- Name: Title: RX SOLUTIONS, INC. By: -------------------------------- Name: Title: PACIFICARE BEHAVIORAL HEALTH, INC. By: -------------------------------- Name: Title: SECUREHORIZONS USA, INC. By: -------------------------------- Name: Title: U.S. BANK NATIONAL ASSOCIATION By: -------------------------------- Name: Title: EX-10.10 5 a96836exv10w10.txt EXHIBIT 10.10 EXHIBIT 10.10 SENIOR EXECUTIVE EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into as of October 3, 2002, by and between PACIFICARE HEALTH SYSTEMS, INC., a Delaware corporation (the "Company"), with its principal place of business located at 5995 Plaza Drive, Cypress, California 90630 and A. PETER REYNOLDS ("Executive"), residing at 1934 Pt. Locksleigh Place, Newport Beach, CA 92660. RECITALS WHEREAS, the Company desires to employ Executive in the capacity of Senior Vice President, Corporate Controller. WHEREAS, the Company and Executive are entering into this Agreement to establish the terms and conditions of the employment relationship. NOW, THEREFORE, in consideration of the following covenants, conditions and promises contained herein, and other good and valuable consideration, the Company and Executive hereby agree as follows: 1. EMPLOYMENT 1.1 Executive's General Duties. The Company employs Executive and Executive serves the Company in the capacity of Senior Vice President, Corporate Controller, having such usual and customary duties and authority as an officer of similar capacity in a corporation of comparable size, holdings, and business as that of the Company. Executive shall do and perform all services, acts, or things necessary or advisable to manage and conduct the business of the Company and shall preside over such other areas of corporate activity as specified from time to time by the Board of Directors of the Company. During the term of this Agreement, Executive shall perform such additional or different duties, and accept the election or appointment to such other offices or positions as may be assigned. 1.2 Devotion of Executive. During the term of this Agreement, Executive shall devote his entire productive time, ability, and attention to the business of the Company. Executive shall use Executive's best efforts, skills, and abilities to promote the general welfare and interests of the Company and to preserve, maintain, and foster the Company's business and business relationships with all persons and entities associated therewith, including, without limitation, employer groups, medical service providers, shareholders, affiliates, officers, employees, and banks and other financial institutions. The Company shall give Executive a reasonable opportunity to perform Executive's duties and shall neither expect Executive to - 1 - devote more time, nor assign more duties or functions to Executive, than are customary and reasonable for a person in Executive's position. 2. TERM AND TERMINATION 2.1 Term. The initial term of Executive's employment under this Agreement shall be 24 months, commencing on the effective date of this Agreement. The Company may extend this Agreement for successive one-year terms by giving Executive written notice at least 60 days prior to the expiration of the term. Notwithstanding the foregoing, if a Change-of-Control occurs, as defined in Section 5.1(c) of this Agreement, then the term of the Agreement shall be extended for a period of 24 months from the effective date of the Change-of-Control. Except as provided by Section 2.2(f), if the Company offers Executive a new employment agreement at the term of this Agreement, but Executive does not accept the new employment agreement, then Executive's continued employment with the Company will be without the benefit of a written employment agreement, in which case Executive's entitlement to severance benefits on termination shall be governed by then-existing Company policies and practices. 2.2 Termination. This Agreement, and Executive's employment with the Company, shall be terminated upon the occurrence of any one of the following events: a. The death of the Executive. b. Executive becomes incapacitated or disabled, which incapacity or disability prevents Executive from fully performing his duties to the Company for a period in excess of 90 days and, after such 90-day period, the Company and a physician, duly licensed and qualified in the specialty of Executive's incapacity, decide in their reasonable judgments, that such incapacity will be of such continued duration as to prevent Executive from resuming the rendition of services to the Company for at least an additional six-month period. For purposes of this Agreement, Executive shall be deemed permanently disabled, and this Agreement terminated upon the date Executive receives written notice from the Company that such determination has been made. c. Executive habitually neglects his duties to the Company or engages in gross misconduct during the term of this Agreement. For the purposes of this Agreement, "gross misconduct" shall mean Executive's misappropriation of funds; securities fraud; insider trading; unauthorized possession of corporate property; the sale, distribution, possession or use of a controlled substance; conviction of any criminal offense (whether or not such criminal offense is committed in connection with Executive's duties hereunder or in the course of his employment with the Company) or engaging in unlawful activity which places the Company at financial risk or which could reasonably be expected to embarrass the Company or cause damage to the Company's reputation. In such event, Executive's termination shall be effective immediately upon receipt of written notice from the Company. - 2 - d. Company may terminate this Agreement, with or without cause, upon written notice to Executive. Except for the circumstances described in Subsections (a), (b), (e) and (f) of this Section 2.2, Executive's termination shall be effective upon receipt of such written notice. Executive may terminate this Agreement upon 30 days written notice to Company. e. Upon the expiration of the term of this Agreement, the Company neither extends the Agreement pursuant to Section 2.1 nor offers Executive a new employment agreement. f. Executive voluntarily terminates his employment, upon written notice to the Company, to be effective at the end of the term of this Agreement, after the Company offers Executive a new employment agreement that either establishes duties materially inconsistent with those described in Section 1.1 or reduces Executive's salary by more than 10 percent below the salary in effect at the end of the term of this Agreement. 3. COMPENSATION DURING THE TERM OF THIS AGREEMENT 3.1 Base Salary. As long as Executive satisfactorily performs all of his obligations under this Agreement, the Company shall pay Executive an annual base salary, payable in equal installments on the Company's regular payroll dates. As of this date, Executive's annual base salary has been set at $250,000. On an annual basis, the Company shall review Executive's salary, but shall be under no obligation to increase Executive's salary. Executive authorizes the Company to take such deductions and withholdings from his salary as are required by law, directed by Executive, or as reasonably directed by the Company for its employees, which deductions shall include, without limitation, withholding for federal and state income taxes and social security. 3.2 Benefits. Executive shall be entitled to fully participate in all of the employee benefit plans and programs available to other high-level executives of the Company, including, without limitation, health, dental, and life insurance benefits for Executive and Executive's dependents, pension and profit sharing programs, and vacation and sick leave benefits, the Amended and Restated PacifiCare Health Systems, Inc. Savings and profit-sharing Plan, and the trust agreement implemented pursuant thereto, adopted as of July 1999, the Company's Statutory Restoration Plan and the Company's Deferred Compensation Plan. However, the terms of this Agreement shall not restrict the Company's right to change, amend, modify, or terminate any existing benefit plan or program, or to change any insurance company or modify any insurance policy adopted incident to such existing benefit plan and program. 3.3 Automobile Allowance. The Company shall provide Executive with a $750 (seven hundred fifty dollar) per month automobile allowance. The Company shall furnish - 3 - Executive with a cellular telephone. Executive shall provide and maintain automobile insurance for Executive's car including collision, comprehensive liability, personal and property damage, and uninsured and underinsured motorist coverage in amounts customarily obtained to cover such contingencies in the State of California. Executive shall provide proof of such coverage to the Company upon the Company's request. 3.4 Reimbursement of Expenses. The Company shall pay for or reimburse Executive for all reasonable travel, entertainment, and other business expenses incurred or paid for by Executive in connection with the performance of his services under this Agreement. The Company shall not be obligated to make any such reimbursement unless Executive presents corresponding expense statements or vouchers and such other supporting information as the Company may from time to time reasonably request. The Company reserves the right to place subsequent limitations or restrictions on business expenses to be incurred or reimbursed. 3.5 Annual Incentive Plan. Executive shall be entitled to participate fully in the Company's 1996 Management Incentive Compensation Plan, as amended (the "MICP"), and as may be further amended, modified, or replaced, from time to time, in accordance with the terms and conditions set forth herein and therein. 3.6 Stock Option Plans. Executive shall be entitled to participate in the applicable Stock Option Plans for Officers and Key Employees of PacifiCare Health Systems, Inc., as amended, and as may be further amended modified or replaced, from time to time, in accordance with the terms and conditions set forth herein and therein. 3.7 Insurance. During the term of this Agreement, the Company shall insure Executive under its general liability insurance for all conduct committed in good faith while acting in the capacity of Senior Vice President, Corporate Controller of the Company or in any other capacity to which Executive may be appointed or elected. 3.9 Promotional Grant of Stock Options. Company will recommend to its Compensation Committee a promotional stock option grant of 17,000 shares. Issuance of the options is subject to approval of the Compensation Committee. The grant date and exercise price will be determined as of the closing price of shares of PacifiCare stock on the effective date of the Executive's promotion. 4. COMPENSATION FOLLOWING TERMINATION OF EMPLOYMENT PURSUANT TO SECTION 2.2 4.1 Death. In the event that this Agreement is terminated by reason of Executive's death, Executive's estate or legal representative shall be entitled to receive the following: a. Payment of benefits under the life insurance policy purchased by the Company on Executive's behalf, if any; - 4 - b. Payments of benefits under the MICP set forth in Section 3.5 in accordance with the terms of the MICP plan document; c. Executive's legal representative shall be permitted to exercise any vested and unexercised options granted under the 1996 Stock Option Plan and any other existing stock option plans of the Company (collectively, the "Stock Option Plans") in accordance with their terms for a period of one year following Executive's death. 4.2 Disability. In the event that Executive is terminated because of incapacity or disability, the Company shall provide Executive with the following: a. Payment of benefits under the disability insurance policy maintained by the Company on Executive's behalf, if any; b. Payment of benefits under the MICP set forth in Section 3.5 in accordance with the terms of the MICP plan document; c. The right to exercise any vested and unexercised options under the Stock Option Plans in accordance with the terms stated therein; d. Payment of the automobile allowance as provided under Section 3.3 for a period of 18 months following the effective date of such termination. 4.3 Neglect, Misconduct or Voluntary Termination. In the event this Agreement is terminated because of Executive's habitual neglect or gross misconduct pursuant to Section 2.2(c) or because of Executive's voluntary termination (except for resignation pursuant to Section 2.2(f)), the Company shall be relieved from any and all further or future obligations to compensate Executive; provided, however, that Executive shall be able to exercise any vested and unexercised awards under the Stock Option Plans in accordance with the terms set forth therein. 4.4 Discharge by Company Pursuant to Section 2.2(d) or 2.2(e). In the event that the Company terminates Executive pursuant to Section 2.2(d) or 2.2(e) under circumstances other than a Change-of-Control (as defined herein) and for any reason other than Executive's incapacity or disability or neglect/misconduct as described in Sections 2.2(b) and 2.2(c), respectively, then Executive shall be entitled to the following compensation: a. An amount equal to one and one half times Executive's then current annual salary under Section 3.1; b. An amount equal to one and one half times the average of the last two MICP bonuses paid to Executive. If Executive has been employed by the Company for more than one, but less than two years, then the MICP bonus severance payment shall equal one and one half times the average of the MICP bonus paid to Executive for the - 5 - prior year and the target for Executive for the current year. If Executive has been employed by the Company for less than one year, Executive will not receive any bonus severance payment. For purposes of this Section 4.4(b), the word "paid" shall include $0.00 for any year in which Executive was eligible for, but was not paid, an MICP bonus; c. The right to exercise any vested and unexercised options under the Stock Option Plans in accordance with their terms within one year of the effective date of such termination; d. Continuation of Executive's and his dependents' medical, dental and vision benefits, on the same terms as other executives who remain employed with the Company, for a period of 18 months following the effective date of such termination; e. An amount equal to 18 months of Executive's automobile allowance; f. The Company shall provide to Executive outplacement services to assist Executive in securing a position comparable to the one from which Executive was terminated. The Company shall be obligated to provide those outplacement services which are customarily provided by companies of similar size and holdings as those of the Company to executives with comparable responsibility and longevity as Executive and for reasonable cost as approved by the Company. The Company's provision of such outplacement services shall not limit, restrict, or reduce, in any manner, any and all other compensation to which Executive is entitled hereunder; g. Executive shall receive, or have paid, the amounts of severance compensation provided in clauses (a), (b) and (e) above in equal installments over a period of 18 months. Payments will be made either in biweekly installments on the Company's regular paydays or as currently being paid to Executive; h. Notwithstanding the foregoing, in the event Executive engages in employment, whether as an employee, consultant or contractor with a competitor of the Company during the 18 month period in which Executive's salary continues pursuant to this Section 4.4, the severance compensation available to Executive under this Section 4.4 shall be reduced by the amount of any and all gross earnings Executive earns while engaged in employment with any such competitor or competitors. For the purposes of this Section 4.4, a "competitor of the Company" shall include, without limitation, managed care organizations, including a health maintenance organization, competitive medical plan, preferred provider organization, provider sponsored organization ("PSO"), or health or life insurance company which owns a managed care organization, plan or program. Executive agrees to provide immediate notice to Company upon receipt of any gross earnings received by Executive from a competitor of Company. Quarterly, Executive - 6 - shall provide the Company a certificate certifying as to his employment status and if employed, the name and business of his current employer; i. If Executive is rehired by Company, payments of severance compensation provided for in this Section 4.4 shall cease; and j. If Executive dies while receiving the salary continuation benefit as provided in this Section 4.4, Executive's estate will receive a lump sum payment of the remaining salary continuation benefit. 4.5 Resignation by Executive Pursuant to Section 2.2(f). In the event that Executive resigns pursuant to Section 2.2(f), then Executive shall be entitled to the compensation provided by Section 4.4 of this Agreement. 5. COMPENSATION FOLLOWING TERMINATION OF EMPLOYMENT AS A RESULT OF A CHANGE-OF-CONTROL 5.1 Termination of Employment or Resignation for Good Cause a. Executive's Rights. In the event that, during the term of this Agreement, the Company undergoes a Change-of-Control, (as that term is defined below) and if within 24 months after the consummation of such change either (1) Executive is involuntarily terminated, except as provided in Section 5.1(b), or (2) Executive voluntarily terminates his employment for "good cause" as defined in Section 5.1(d), then Executive shall be entitled to the following compensation: 1. A lump sum payment consisting of: (i) an amount equal to two times Executive's then annual salary; (ii) an amount equal to two times the average of the last two MICP bonuses paid to Executive; or if Executive has been employed by the Company for more than one, but less than two years, then the MICP bonus severance payment shall equal two times the average of the MICP bonus paid to Executive for the prior year and the target for Executive for the current year. If Executive has been employed by the Company for less than one year, Executive shall receive an amount equal to two times target bonus for the current year. For purposes of this Section 5.1(a)(1), the word "paid" shall include $0.00 for any year in which Executive was eligible for, but was not paid, an MICP bonus; (iii) a prorated bonus based on target opportunity for the year in which the Change-of-Control occurs; (iv) an amount equal to the equivalent of the cost of 24 months of COBRA benefits; and (v) an amount equal to 24 months of Executive's automobile allowance; 2. The right to exercise any and all unexercised stock options granted under the Stock Option Plans in accordance with their terms, as if all such - 7 - unexercised stock options were fully vested, within one year of the effective date of such termination; 3. A payment to executive to compensate for any excise penalty or other associated taxes resulting from severance payments exceeding the cap imposed by Internal Revenue Code Section 280(G); 4. The Company shall provide to Executive the outplacement services described in Section 4.4(f). b. Limitation of Benefits. In the event that Executive is terminated within 24 months after a Change-of-Control of the Company, and such termination results from either Executive's death, incapacity or disability or habitual neglect or gross misconduct, then, notwithstanding anything in this Article 5 to the contrary, Executive shall receive only that compensation, if any, to which he is entitled to under Sections 4.1, 4.2 and 4.3, respectively. c. Change-of-Control. As used in this Article 5, the term "Change-of-Control" means and refers to: 1. The acquisition by any Person (as hereinafter defined) of Beneficial Ownership (as hereinafter defined) of 20% or more of either the then outstanding Stock (the "Outstanding Company Stock") or the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"), provided that, for purposes of this subsection (1), the following acquisitions shall not constitute a Change of Control: (I) any acquisition by the Company, (II) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any Person that controls, is controlled by or is under common control with, the Company or (III) any acquisition by any Person pursuant to a transaction which complies with clauses (I), (II) and (III) of subsection (3) of this definition; or 2. Individuals who, as of the Effective Date, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board, provided that, for purposes of this subsection (2), any individual who becomes a director subsequent to the Effective Date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, excluding, however, any such individual who initially assumes office as a result of an actual or threatened election contest with respect to the election or removal of directors or - 8 - other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or 3. Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company or the acquisition of assets or stock of another corporation (a "Business Combination"), in each case, unless, following such Business Combination, (I) the Persons who had Beneficial Ownership, respectively, of the Outstanding Company Stock and Outstanding Company Voting Securities immediately prior to such Business Combination have Beneficial Ownership immediately following the consummation of such Business Combination, directly or indirectly, of more than 50% of, respectively, the then outstanding common shares and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting or surviving from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership immediately prior to such Business Combination of the Outstanding Company Stock and Outstanding Company Voting Securities, as the case may be, (II) no Person (excluding any entity resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such entity resulting from such Business Combination) has Beneficially Ownership, directly or indirectly, of 20% or more of, respectively, the then outstanding common shares of the entity resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such entity, except to the extent that such ownership existed in respect of the Company prior to such Business Combination and (III) at least a majority of the members of the board of directors or similar body of the entity resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board of Directors, providing for such Business Combination; or 4. Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. Notwithstanding the foregoing provisions of this definition, unless otherwise determined by the Board, no Change of Control shall be deemed to have occurred if (I) Executive is a member of a group that first announces a proposal which, if successful, would result in a Change of Control and which proposal (including any modifications thereof) is ultimately successful, or (II) Executive acquires a two percent (2%) or more equity interest in the entity which ultimately acquires the Company pursuant to the transaction described in clause (I), above. - 9 - For purposes of this definition, "Person" means an individual, partnership, joint venture corporation, trust, unincorporated organization, government (or agency or political subdivision thereof), group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act) or any other entity, and "Beneficial Ownership" means beneficial ownership within the meaning of Rule 13d-3 promulgated under the Exchange Act. d. Good Cause. As used in this Agreement "good cause" for Executive to terminate his employment shall be deemed to exist if Executive voluntarily terminates employment within 24 months of a Change-of-Control for any of the following reasons: 1. Without Executive's express prior written consent, Executive is assigned duties materially inconsistent with Executive's position, duties, responsibilities, or status with the Company which substantially varies from that which existed immediately prior to such Change-of-Control; 2. Without Executive's express prior written consent, Executive experiences a change in his reporting level, title, or business location (of more than 50 miles from Executive's current business location or residence whichever is closer to the new business location) which substantially varies from that which existed immediately prior to the Change-of-Control; except that if Executive is not located at the Company's corporate headquarters in California, a relocation to the Company's corporate headquarters in California shall not be deemed a substantial variation, unless Executive's reporting level or title is also substantially varied; 3. Without Executive's express prior written consent, Executive is removed from any position held immediately prior to the Change-of-Control, or if Executive fails to obtain reelection to any position held immediately prior to the Change-of-Control, which removal or failure to reelect is not directly related to Executive's incapacity or disability, habitual neglect, gross misconduct or death; 4. Without Executive's express prior written consent, Executive experiences a reduction in salary of more than 10 percent below that which existed immediately prior to the Change-of-Control; 5. Without Executive's express prior written consent, Executive experiences an elimination or reduction of any employee benefit, business expense reimbursement or allotment, incentive bonus program, or any other manner or form of compensation available to Executive immediately prior to the Change-of-Control and such change is not otherwise applied to others in the Company with Executive's position or title; - 10 - 6. The Company fails to obtain from any successor, before the succession takes place, a written commitment obligating the successor to perform this Agreement in accordance with all of its terms and conditions; or 7. The Company or any successor thereto purports to terminate Executive pursuant to Section 4.4 without first giving Executive prior written notice thereof that specifies the facts and circumstances, in reasonable detail, serving as the basis for Executive's termination. 5.2 Resignation for Other Than Good Cause After a Change-of-Control. In the event that the Company undergoes a Change-of-Control and Executive remains with the Company for 12 months following the effective date of the Change-of-Control, Executive will be given a 30-day "window period" in which to elect to voluntarily terminate Executive's employment for reasons other than good cause. Should Executive choose to terminate Executive's employment within the 30-day "window period," then Executive shall be entitled to the following compensation: a. One-half the lump sum payment referred to in Section 5.1(a)(1); b. The right to exercise all vested and unexercised stock options granted under the Stock Option Plans in accordance with their terms within one year of the effective date of such termination; c. Outplacement services as defined in Section 4.4(f). 6. CONFIDENTIALITY AND OWNERSHIP OF PROPRIETARY INFORMATION 6.1 Confidential Information. Executive acknowledges that, during the course of Executive's employment with the Company or with any subsidiary or affiliate of the Company, Executive will have access to certain confidential information in the form of know-how, trade secrets, or proprietary information of the Company or its subsidiaries or affiliates ("Confidential Information") and that such Confidential Information will be acquired in confidence and as a fiduciary of the Company or its subsidiaries or affiliates. For the purposes of this Agreement, Confidential Information shall include, without limitation, member health data and medical records and any other protected healthcare information, any and all cost and expense data, marketing and customer data, sales manuals, underwriting guidelines, case management policies and procedures, utilization review and quality assurance policies and procedures, provider manuals, individual and group subscriber information (including, the name, address, telephone number, or contact person for an individual or group subscriber), subscriber group manuals, processes, designs, devices, compilations of information, operational techniques operating manuals, symbols, service marks, logos, customer and vendor lists (including, without limitation, lists of subscribers, subscriber groups, clients, brokers, and providers contracting with the Company or any subsidiary or affiliate of the Company), - 11 - business information, marketing programs, plans, and strategies, research and development plans, contracts and licenses, licensing techniques and practices, advertising and promotional materials, financial information and strategies, computer software and other computer-related materials, copyrightable material, security controls, including computer system passwords, and other legally protected information owned by or used in the respective businesses of the Company or its subsidiaries or affiliates which are confidential or proprietary in nature and may include confidential or proprietary information received from third parties. In addition to the foregoing, Confidential Information also includes any information which is not generally known to the public, or within the market or trade in which the Company competes, and the physical embodiments of such information in any tangible form, whether written or machine-readable in nature, or any information which is marked or designated as "Confidential" or "Proprietary." 6.2 Ownership of Inventions. Executive agrees to assign and does hereby assign to the Company any and all ideas, designs, know-how, programs, improvements, inventions, discoveries and literary creations (collectively referred to as "Inventions") which Executive alone or with others may conceive or make, and which (a) are made wholly or partially with the Company's assets or confidential or trade secret information; or (b) are developed wholly or partially on the Company's time; or (c) relate at the time of conception or reduction to practice to the Company's business, including actual or demonstrably anticipated research or development of the Company; or (d) result from Executive's work for the Company. Such Inventions are and shall be the property of the Company and shall be deemed to be part of the Company's business, whether or not any applications for patents, trademarks or copyrights are filed thereon. Further, all such Inventions shall constitute Confidential Information. Executive shall not claim to own any Inventions relating to the business of the Company. Executive agrees that, upon request of the Company, Executive shall execute any and all papers and do all other lawful acts that may be required by the Company in order to make applications for Letters Patent, of the United States and of any and all other countries, on such Inventions, or that may be required to vest ownership of such applications, patents and copyrights in the Company, or that may be required to prosecute or obtain such patents, or to maintain, preserve or enforce the rights of the Company in such Inventions, patents and copyrights. Except as otherwise prohibited by law (including but not limited to California Labor Code section 2870), and except for Inventions made prior to commencement of Executive's employment with the Company, in addition to the above assignment of Inventions to the Company, without further consideration, Executive hereby fully, forever, and irrevocably assigns, transfers, and conveys to the Company: (i) all patents, patent applications, copyrights, mask works, trade secrets, and other intellectual property rights in any Invention; and (ii) any and all "Moral Rights" (as defined below) which Executive may have in, to, or with respect to any Invention. For purposes of this Agreement, "Moral Rights" shall mean any rights to claim authorship of an Invention, to object to or prevent the modification of any Invention, or to withdraw from circulation or control the publication or distribution of any Invention, and any similar right, existing under judicial or statutory law of any country in the world, or under any treaty, regardless of whether or not such right is - 12 - denominated or generally referred to as a "moral right." Executive will promptly disclose any Inventions to the Company whether developed or created alone or jointly with others. 6.3 Confidentiality Covenant. Executive acknowledges and agrees that maintaining the confidentiality of all of the Confidential Information is integral to the value of the Company and is vital to the successful operations of the Company and its subsidiaries and affiliates. In view of the foregoing, Executive agrees to maintain the confidentiality of all Confidential Information and to not disclose, divulge, exploit, or use, in any manner whatsoever, the Confidential Information for Executive's own benefit or the benefit of another person. Executive will additionally take all reasonable precautions to prevent the inadvertent or accidental exposure of the Confidential Information. Executive shall not remove any Confidential Information from the Company's premises or make copies of any of such information except for the benefit of the Company and in furtherance of Executive's duties as an employee of the Company. Upon Executive's termination of employment with the Company, Executive shall not remove from the Company's premises any materials containing any Confidential Information, and will promptly return to the Company any material which contain Confidential Information which are in Executive's possession or control. 6.4 No Solicitation. Executive acknowledges and agrees that Executive will not solicit or participate in or assist in any way in the solicitation of any employees of Company. For purposes of this provision, "solicitation" means directly or indirectly influencing or attempting to influence employees of Company to become employed with any other person, partnership, firm, or entity. 6.5 Equitable Relief. Executive acknowledges and agrees that it would be difficult to measure the damage to the Company (or any subsidiary or affiliate, as the case may be) from any breach of Executive's obligations under this Article 6, that injury to the Company (or to any subsidiary or affiliate, as the case may be) from any such breach would be impossible to calculate, and that money damages would therefore be an inadequate remedy for any such breach. Therefore, Executive acknowledges and agrees that the Company, in addition to any of its other rights or remedies, shall be entitled to seek injunctive or other equitable relief without bond or other security in the event of an actual or threatened breach of this Agreement. The obligations of Executive and the rights and remedies of the Company under this Agreement are cumulative and in addition to, and not in lieu of, any obligations, rights, or remedies created by applicable patent, copyright, or other laws, including the statutory and common laws governing unfair competition, misappropriation or theft of trade secrets, proprietary rights, or confidential information generally. 6.6. Survival of Obligations. Executive's obligations under this Article 6 shall survive the termination of Executive's employment regardless of the manner of such termination and shall be binding upon Executive's heirs, executors, administrators and legal representatives. The remedies to which the Company is entitled under this Article 6 shall survive the termination of Executive's employment with the Company. - 13 - 7. NOTICES All notices or other communications required or permitted to be made hereunder shall be given in writing and sent by either personal delivery, overnight delivery, or United States registered or certified mail, return receipt requested, all of which shall be properly addressed with postal or delivery charges prepaid, to the parties at their respective addresses set forth below, or to such other addresses as either party may designate to the other in accordance with this Article 7: If to the Company: PacifiCare Health Systems, Inc. 5995 Plaza Drive Cypress, California 90630 Attn: President and Chief Executive Officer If to Executive: A. Peter Reynolds 1934 Pt. Locksleigh Place Newport Beach, CA 92660 All notices sent by personal delivery shall be deemed given when actually received. All notices sent by overnight delivery shall be deemed received on the next business day. All other notices sent via United States mail shall be deemed received no later than two business days after mailing. Any notice given by any method not expressly authorized herein, shall nevertheless be effective if actually received, and shall be deemed given upon actual receipt. 8. GENERAL PROVISIONS 8.1 Severance Agreement. Any payments of compensation made pursuant to Articles 4 and 5 are contingent on Executive executing the Company's standard severance agreement, including a general release of the Company, its owners, partners, stockholders, directors, officers, employees, independent contractors, agents, attorneys, representatives, predecessors, successors and assigns, parents, subsidiaries, affiliated entities and related entities. Executive must execute the standard severance agreement and release within 45 days of being provided with the document to sign or the severance agreement offer will expire. 8.2 Assignability. This Agreement shall inure to the benefit of, and shall be binding upon the heirs, executors, administrators, successors, and legal representatives of Executive and shall inure to the benefit of, and be binding upon the Company and its successors and assigns. Executive shall not assign, delegate, subdelegate, transfer, pledge, encumber, hypothecate, or otherwise dispose of this Agreement, or any rights, obligations, or duties hereunder, and any such - 14 - attempted delegation or disposition shall be null and void and without any force or effect; provided, however, that nothing contained herein shall prevent Executive from designating beneficiaries for insurance, death or retirement benefits. 8.3 Entire Agreement. This Agreement is a fully integrated document and contains any and all promises, covenants, and agreements between the parties hereto with respect to Executive's employment. This Agreement supersedes any and all other, prior or contemporaneous, discussions, negotiations, representations, warranties, covenants, conditions, and agreements, whether written or oral, between the parties hereto. Except as expressed herein, the parties have not exchanged any other representations, warranties, inducements, promises, or agreements respecting Executive's employment with the Company. 8.4 Severability. In the event any one or more of the provisions of this Agreement shall be rendered by a court of competent jurisdiction to be invalid, illegal, or unenforceable, in any respect, such invalidity, illegality, or unenforceability shall not affect or impair the remainder of this Agreement which shall remain in full force and effect and enforced accordingly, unless a party demonstrates by a preponderance of the evidence that the invalidated provision was an essential economic term of this Agreement. 8.5 Amendment. This Agreement shall not be changed, amended, or modified, nor shall any performance or condition hereunder be waived, in whole or in part, except by written instrument signed by the party against whom enforcement or waiver is sought. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any other or subsequent breach of the same or any other term or condition of this Agreement. 8.6 Governing Law. This Agreement shall be governed by, enforced under, and construed in accordance with the laws of the State of California. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first written above. The Company: PACIFICARE HEALTH SYSTEMS, INC., a Delaware corporation Date: __/__/__ By: -------------------------------------- Gregory Scott Executive Vice President & CFO Executive: ------------------------------------------ Date: __/__/__ A. Peter Reynolds - 15 - EX-10.21 6 a96836exv10w21.txt EXHIBIT 21 EXHIBIT 10.21 PACIFICARE HEALTH SYSTEMS, INC. 2003 INCENTIVE BONUS PLAN Section 1. Purpose The purpose of the Management Incentive Compensation Plan is to promote the interests of the Company by attracting and retaining an outstanding management and key employee staff. Under the Plan, incumbents in stipulated key positions may receive Awards that vary with the success of the Company, the Subsidiary Operating Units as appropriate, and individual performance. Awards payable under this Plan are not intended to qualify as performance-based compensation with the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), and the Treasury Regulations promulgated thereunder. Section 2. Definitions (a) "Award" refers to a contingent right to receive cash at the end of a Plan Year. (b) "Committee" means a committee of the Board of Directors established to administer this Plan. (c) "Company" means PacifiCare Health Systems, Inc. (d) "Covered Employee" means (i) the Company's chief executive officer (or officers) on the last day of each Plan Year, and (ii) the four (4) highest compensated executive officers of the Company (as defined in Rule 3b-7 under the Securities Exchange Act of 1934, as amended) other than the chief executive officer (or officers), as determined on the last day of each Plan Year. (e) "Disability" means, with respect to a Participant, the Participant's permanent and total disability as defined in Section 22(e)(3) of the Code. (f) "Participant" means any officer or full-time employee of the Company or any subsidiary of the Company as are determined by the Committee to have a direct, significant, and measurable impact on the attainment of the Company's or subsidiary's long term growth and profitability objectives; provided, that a Covered Employee may not be a Participant under this Plan. (g) "Plan" refers to this 2003 Incentive Bonus Plan. (h) "Plan Year" refers to each annual fiscal year of the Company. (i) "Retirement" means, with respect to a Participant, the Participant's voluntary termination of his or her employment with the Company that occurs after the sum of the following two factors meet or 1 exceed fifty-five (55): (i) the Participant's age and (ii) the Participant's number of full years of service with the Company. (j) "Subsidiary Operating Units" refers to any profit center so designated by the Committee. Section 3. Administration The Plan will be administered by the Committee. The Committee will: (i) approve the Participants eligible to receive Awards under the Plan with respect to each Plan Year; (ii) determine the performance objectives; and (iii) determine the amount of Awards subject to the terms and conditions set forth in the Plan and to other terms and conditions consistent with the purpose and provisions of the Plan. The Committee may prescribe, amend, or rescind such rules, regulations, policies, interpretations, and guides as deemed appropriate for proper and effective Plan administration. In addition, only the Board of Directors may suspend or terminate the Plan. Any of the foregoing actions will affect future Plan Years only. No member of the Committee or employee of the Company will be personally liable for any action, failure to act, determination, or interpretation made in good faith with respect to the Plan or any transaction under the Plan. All decisions, determinations, and interpretations of the Committee will be final and binding. Section 4. Eligibility and Participation The persons eligible to participate in the Plan shall be those Participants designated by the Committee to participate in the Plan. The Committee will designate Participants who are to be granted Awards for an Award year and, in its discretion, may designate additional Participants during any Award year as deemed appropriate; provided, however, that adjustments shall be made to the minimum performance objectives applicable to new Participants to ensure that any Award payable to such new Participant is based solely on the attainment of future performance objectives. The Committee, through its designee, will notify Participants of their eligibility in writing. The Committee will not be bound by selections made for prior Award years. Section 5. Determination and Allocation of Awards (a) Establishment of Annual Objectives and Formulas. For each Plan Year, the Committee will establish, in writing, specific financial and/or strategic performance objectives for such Plan Year. At such time, the Committee will establish minimum performance objectives below which no Awards will be earned, maximum performance objectives above which Awards will not be affected, 2 and the formula for computing each Participant's Award. The performance objectives may, but need not, be based on the following criteria, either alone or in any combination, and on either a consolidated or Subsidiary Operating Unit level, and measured either on an absolute basis, relative basis against a pre-established target, and/or peer group, or prior year's performance as the Committee determine: (i) revenue(sales); (ii) cash flow; (iii) earnings per share (including earnings before interest, taxes and amortization); (iv) return on equity; (v) total shareholder return, (vi) return on capital; (vii) return on assets or net assets; (viii) income or net income; (ix) operating income or net operating income; (x) adjusted operating income; (xi) operating profit or net operating profit; (xii) operating margin; (xiii) market share; (xiv) member satisfaction; or (xv) employee satisfaction. The foregoing criteria shall have any reasonable definitions that the Committee may specify, which may include or exclude any or all of the following items as the Committee may specify: extraordinary, unusual or non-recurring items; effects of accounting changes; effects of financing activities; expenses for restructuring or productivity initiatives; other non-operating items; spending for acquisitions; and effects of divestitures. Any such performance objective or combination of such objectives may apply to a Participant's Award opportunity in its entirety or to any designated portion or portions of the Award opportunity, as the Committee may specify. Upon establishment of the performance objective(s) for a specific Plan Year, the appointed designee of the Committee will notify each participant in writing of the established objective(s). If the Committee determines the established performance objectives are no longer suitable due to a change in the Company's business, operations, corporate structure, capital structure, or other conditions deemed by the Committee to be material, the Committee will have sole discretion during the Plan Year to modify the performance objectives as considered appropriate and equitable. (b) Without limiting the generality of Section 5(a), the Committee may, in its sole discretion, reduce the amount of any Award made to any Participant from the potential Award allocated to that Participant under Section 5(a), taking into account such factors as it deems relevant, including, without limitation: (1) significant financial or strategic achievements during the year; (2) its subjective assessment of such Participant's overall performance for the Plan Year; and (3) information about compensation practices at other peer group companies for the purpose of evaluating competitive compensation levels so that the Committee may determine that the amount of the Award is within the targeted competitive compensation range of the Company's compensation program. The Committee shall determine the amount of any 3 reduction in a Participant's Award on the basis of the foregoing and other factors it deems relevant and shall not be required to establish any allocation or weighting formula with respect to the factors it considers. (c) No Stockholder Approval. Establishment of Awards for Participants shall not be subject to, nor contingent upon, the disclosure to the stockholders of the Company of the material terms of the performance objectives and stockholder approval of such terms. Section 6. Payment of Awards Earned The basis of Awards for a given Plan Year will be the achievement of the performance objectives and individual contributions as determined by the Committee. If minimum financial performance is not attained for a Plan Year, no payment will be made and all contingent rights will cease. Further, no additional payments will be made for financial performance above the maximum objective. If performance objectives are achieved, the Committee shall certify in writing, prior to the payment of any Award, that such performance goals (and any other material terms) were satisfied. The Award, if any, earned by each Participant will be paid as soon as administratively possible following the close of the applicable Plan year and the certification by the Committee, described in the preceding sentence. A Participant may elect in writing one year in advance of a Plan Year, upon approval by the Committee, to defer receipt of all or a portion of an Award earned for a specified time as approved by the Committee. Payment of deferred amounts may be in a lump sum on the designated payment date or in installments as approved by the Committee. A Participant's right to any deferred Award will be that of a general creditor of the Company; no trust will be deemed to be created by virtue of such deferral. Section 7. Termination of Employment In the event of a Participant's death, Disability, or Retirement during a Plan Year, payment of the Award earned will be prorated unless otherwise determined by the Committee. Such Awards will then be paid to the Participant, the Participant's estate or legal representative as determined by the Committee. In the event of a Participant's death, Disability, or Retirement, after the end of the Plan Year but before payment of an Award to which the Participant is entitled, such Award will be paid to the Participant, the Participant's estate or legal representative. In the event of termination of employment of a Participant or a Participant ceases to be an Officer, voluntarily or by the actions of the Company, with 4 or without cause, for reasons other than those specified above, at any time before payment of the incentive award, the Participant will forfeit all rights to any Award subject to the sole discretion of the Committee. Section 8. Discretionary Incentive Award. The Committee may, in its sole discretion, make an additional award to any Participant determined by the Committee to have positively impacted directly on the attainment of the performance objectives established by the Committee. Section 9. Adjustments Upon Changes in Capitalization In the event of a reorganization, merger, consolidation or similar transaction in which the Company is not the surviving corporation, or upon the sale of substantially all the assets of the Company to another corporation, or upon the dissolution or liquidation of the Company, then the Company or a successor corporation, if any, may continue the Plan and, if not, then the Plan will terminate on the effective date of such transaction. Provision will be made for determining the amount of cash payable for all Awards for a Plan Year which will end after such event based on the portion of the Plan Year occurring prior to such event, unless provisions are made for the continuance of the Plan and the assumption or substitution for such Awards of an equivalent value by the successor corporation. Adjustments under this section will be made by the Committee whose determination as to what adjustments will be made and the extent will be final, binding, and conclusive. Section 10. General Provisions (a) No right to Participate: Nothing in the Plan will be deemed to give a Participant or a Participant's legal representative or any other person or entity claiming under or through a Participant any contract or right to participate in the benefits of the Plan. (b) No Employment Right: Participation in the Plan will not be construed as constituting a commitment, guarantee, agreement, or understanding of any kind that the Company will continue to employ any individual. (c) Nontransferability: A Participant or any designed beneficiary has no right to assign, transfer, attach, or hypothecate any benefits or payments of the Plan. (d) Withholding: The Company has the right to deduct any sums federal, state, or local tax requires to be withheld with respect to the payment of any Award. (e) Restricted Liability: Payments held by the Company before distribution will not be liable for the debts, contracts, or obligations 5 of any Participant or beneficiary, or be taken in execution by attachment or garnishment, or by any other legal or equitable proceeding. Section 11. Amendment, Suspension, or Termination of Plan The Company may amend, suspend, or terminate the Plan at any time. Such amendment, suspension, or termination will not adversely alter or affect any right or obligation to any Award made before this action. The Committee will determine the effect on Awards that may be effected by such event and make adjustments and/or payments as it, in its sole discretion, determines appropriate. Section 12. Effective Date This Plan will be effective upon its adoption by the Company and may be applied retroactively to the beginning of the Company's fiscal year at the sole discretion of the Committee. 6 EX-10.30 7 a96836exv10w30.txt EXHIBIT 10.30 EXHIBIT 10.30 (Contract Period January 1, 2004 to December 31, 2004) Contract With Eligible Medicare+Choice (M+C) Organization Pursuant to sections 1851 through 1859 of the Social Security Act for the operation of a Medicare+Choice coordinated care plan(s) CONTRACT (P______ ) Between Centers for Medicare & Medicaid Services (hereinafter referred to as CMS) and ------------------------------------------------ (hereinafter referred to as the M+C Organization) CMS and the M+C Organization, an entity which has been determined to be an eligible Medicare+Choice Organization by the Administrator of the Centers for Medicare & Medicaid Services under 42 CFR 422.501, agree to the following for the purposes of sections 1851 through 1859 of the Social Security Act (hereinafter referred to as the Act): (NOTE: Citations indicated in brackets are placed in the text of this contract to note the authority for certain contract provisions in the regulations promulgated pursuant to the Balanced Budget Act of 1997, as amended. All references to part 422 are to 42 CFR part 422.) Article I Term of Contract The term of this contract shall be from January 1, 2004 through December 31, 2004, after which the contract may be renewed for successive one-year periods in accordance with 42 CFR 422.504(c). [422.504] This contract governs the respective rights and obligations of the parties as of the effective date set forth above, and supercedes any prior agreements between the M+C Organization and CMS as of such date. Article II Coordinated Care Plan The Medicare+Choice Organization agrees to operate coordinated care plans (as defined in 42 CFR 422.4(a)(1)), as described in its Adjusted Community Rate (ACR) proposal as approved annually by CMS, in compliance with the requirements of this contract and applicable Federal statutes, regulations, and policies. This contract is deemed to incorporate any changes that are required by statute to be implemented during the term of the contract and any regulations or policies implementing or interpreting such statutory provisions. However, CMS agrees that any regulation or policy statement it issues later than 30 days prior to the date by which M+C Organizations are required to submit ACR proposals to CMS, and which creates significant new operational costs of which the M+C Organization did not have reasonable notice prior to such date, shall not take effect in the next calendar year unless implementation during the next calendar year is required by statute or in connection with litigation challenging CMS' policies. CMS retains the authority to issue, with an effective date during the term of this contract, policies to implement the statutory requirement that M+C Organizations provide their enrollees those items and services for which benefits are available under Medicare Parts A and B. Clarifications or explanations of M+C operational requirements issued prior to 30 days prior to the date by which M+C Organizations are required to submit ACR proposals are not considered to create new operational costs of which the M+C organization did not have notice. Article III Functions To Be Performed By Medicare+Choice Organization A. PROVISION OF BENEFITS The M+C Organization agrees to provide enrollees in each of its M+C plans the basic benefits as required under ss.422.101 and, to the extent applicable, supplemental benefits under ss.422.102 and as established in the M+C Organization's adjusted community rate (ACR) proposal as approved by CMS. The M+C Organization agrees to provide access to such benefits as required under subpart C in a manner consistent with professionally recognized standards of health care and according to the access standards stated in ss. 422.112. The M+C Organization agrees to provide 1 post-hospital extended care services, should an M+C enrollee elect such coverage, through a home skilled nursing facility according to the requirements of section 1852(l) of the Act. A home skilled nursing facility is a facility in which an M+C enrollee resided at the time of admission to the hospital, a facility that provides services through a continuing care retirement community, or a facility in which the spouse of the enrollee is residing at the time of the enrollee's discharge from the hospital. [422.502(A)(3)] B. ENROLLMENT REQUIREMENTS 1. The M+C Organization agrees to accept new enrollments, make enrollments effective, process voluntary disenrollments, and limit involuntary disenrollments, as provided in subpart B of part 422. 2. The M+C Organization shall comply with the provisions of ss. 422.110 concerning prohibitions against discrimination in beneficiary enrollment. [422.502(A)(2)] C. BENEFICIARY PROTECTIONS 1. The Medicare+Choice Organization agrees to comply with all requirements in subpart M of part 422 governing coverage determinations, grievances, and appeals. [422.502(A)(7)] 2. The Medicare+Choice Organization agrees to comply with the enrollee notice and appeal procedures for the termination of provider services in ss. 422.624 and ss. 422.626. 3. The Medicare+Choice Organization agrees to comply with the confidentiality and enrollee record accuracy requirements in ss. 422.118. 4. Beneficiary Financial Protection. The M+C Organization agrees to comply with the following requirements: (a) Each M+C Organization must adopt and maintain arrangements satisfactory to CMS to protect its enrollees from incurring liability for payment of any fees that are the legal obligation of the M+C Organization. To meet this requirement the M+C Organization must-- (i) Ensure that all contractual or other written arrangements with providers prohibit the Organization's providers from holding any beneficiary enrollee liable for payment of any fees that are the legal obligation of the M+C Organization; and (ii) Indemnify the beneficiary enrollee for payment of any fees that are the legal obligation of the M+C Organization for services furnished by providers that do not contract, or that have not otherwise entered into an agreement with the M+C Organization, to provide services to the organization's beneficiary enrollees. [422.502(G)(1)] (b) The M+C Organization must provide for continuation of enrollee health care benefits- (i) For all enrollees, for the duration of the contract period for which CMS payments have been made; and (ii) For enrollees who are hospitalized on the date its contract with CMS terminates, or, in the event of an insolvency, through the date of discharge. [422.502(G)(2)] (c) In meeting the requirements of this section (C), other than the provider contract requirements specified in paragraph (C)(3)(a) of this Article, the M+C Organization may use-- (i) Contractual arrangements; (ii) Insurance acceptable to CMS; (iii) Financial reserves acceptable to CMS; or (iv) Any other arrangement acceptable to CMS. [422.502(G)(3)] 2 D. PROVIDER PROTECTIONS 1. The M+C Organization agrees to comply with all applicable provider requirements in subpart E of part 422, including provider certification requirements, anti-discrimination requirements, provider participation and consultation requirements, the prohibition on interference with provider advice, limits on provider indemnification, rules governing payments to providers, and limits on physician incentive plans. [422.502(A)(6)] 2. Prompt Payment. (a) The M+C Organization must pay 95 percent of the "clean claims" within 30 days of receipt if they are claims for covered services that are not furnished under a written agreement between the organization and the provider. (i) The M+C Organization must pay interest on clean claims that are not paid within 30 days in accordance with sections 1816(c)(2)(B) and 1842(c)(2)(B) of the Act. (ii) All other claims must be paid or denied within 60 calendar days from the date of the request. [422.520(A)] (b) Contracts or other written agreements between the M+C Organization and its providers must contain a prompt payment provision, the terms of which are developed and agreed to by both the M+C Organization and the relevant provider. [422.520(B)] (c) If CMS determines, after giving notice and opportunity for hearing, that the M+C Organization has failed to make payments in accordance with paragraph (2)(a) of this section, CMS may provide-- (i) For direct payment of the sums owed to providers; and (ii) For appropriate reduction in the amounts that would otherwise be paid to the M+C Organization, to reflect the amounts of the direct payments and the cost of making those payments. [422.520(C)] E. QUALITY ASSESSMENT AND PERFORMANCE IMPROVEMENT PROGRAM 1. The M+C Organization agrees to operate an ongoing quality assessment and performance improvement program (as stated in 422.152 of subpart D). 2. Quality Assessment and Performance Improvement Projects: The M+C Organization agrees to: (a) conduct quality assessment and performance improvement (QAPI) projects as directed annually by CMS. These projects must be outcomes-oriented and targeted at achieving demonstrable, sustained improvement in significant aspects of specified clinical and non-clinical areas which can be expected to have a favorable effect on enrollees' health outcomes and satisfaction. CMS shall establish the obligations of the M+C Organization for the number and distribution of projects among the required clinical and non-clinical areas. (b) In those years when CMS establishes a national improvement project for the Medicare+Choice program, the M+C Organization shall participate in the CMS-sponsored national QAPI initiative, unless the M+C Organization meets the requirements for an exemption from the initiative. 3. Performance Measurement and Reporting: The M+C Organization shall measure performance under its M+C plans using standard measures required by CMS, and report (at the organization level) its performance to CMS. The standard measures required by CMS during the term of this contract will be uniform data collection and reporting instruments, to include the 3 Health Plan and Employer Data Information Set (HEDIS), Consumer Assessment of Health Plan Satisfaction (CAHPS) survey, and Health Outcomes Survey (HOS). These measures will address clinical areas, including effectiveness of care, enrollee perception of care and use of services; and non-clinical areas including access to and availability of services, appeals and grievances, and organizational characteristics. [422.152(c)(1)&(2)]. 4. Utilization Review: If the M+C Organization uses written protocols for utilization review, those policies and procedures must reflect current standards of medical practice in processing requests for initial or continued authorization of SERVICES.[422.152(b)(3)]. The M+C Organization must also have in effect mechanisms to detect both underutilization and overutilization of services.[422.152(b)(4)] . 5. Information Systems: (a) The M+C Organization must make available to CMS information on quality and outcomes measures that will enable beneficiaries to compare health coverage options and select among them, as provided in ss. 422.64(c)(10). [422.152(b)(5)]. (b) The M+C Organization must maintain a health information system that: (i) collects, analyzes and integrates the data necessary to implement its quality assessment and performance improvement program, and (ii) assures that the information entered into the system (particularly that received from providers) is reliable and complete. (c) The M+C Organization must make all collected data, including information on quality and outcome measures, available to CMS to enable beneficiaries to compare health coverage options and select among them, as provided in ss. 422.64(c)(10). [422.152(b)(5)] 6. External Review: The M+C Organization will have an agreement with an independent quality review and improvement organization (review organization) approved by CMS. [422.154(a)] (a) The agreement will be consistent with CMS guidelines and will: (i) Require that the M+C Organization allocate adequate space for use of the review organization whenever it is conducting review activities and provide all pertinent data, including patient care data, at the time the review organization needs the data to carry out the reviews and make its determinations, and (ii) Except in the case of complaints about quality, exclude review activities that CMS determines would duplicate review activities conducted as part of an accreditation process or as part of CMS monitoring. [422.154(b)] F. COMPLIANCE PLAN The M+C Organization agrees to implement a compliance plan in accordance with the requirements of ss. 422.501(b)(3)(vi). [422.501(b)(3)(VI)] G. COMPLIANCE DEEMED ON THE BASIS OF ACCREDITATION: CMS may deem the M+C Organization to have met the quality assessment and performance improvement requirements of ss. 422.152, the confidentiality and accuracy of enrollee records requirements of ss. 422.118, the anti-discrimination requirements of ss. 1852(b) of the Act, the access to services requirements of ss. 1852(d) of the Act, the advance directives requirements of ss. 422.128, and/or the provider participation requirements of ss. 1852(j) of the Act if the M+C Organization is fully 4 accredited (and periodically reaccredited) by a private, national accreditation organization approved by CMS and the accreditation organization used the standards approved by CMS for the purposes of assessing the M+C Organization's compliance with Medicare requirements. The provisions of ss. 422.156 shall govern the M+C Organization's use of deemed status to meet M+C program requirements. Article IV CMS Payment to M+C Organization A. The M+C Organization agrees to develop its annual adjusted community rate (ACR) proposal and submit to CMS all required information on premiums, benefits, and cost sharing, as required under 42 CFR 422, subpart G. [422.502(a)(10)] B. Methodology. CMS agrees to pay the M+C Organization under this contract in accordance with the provisions of section 1853 of the Act and subpart F of part 422. [422.502(a)(9)] C. Attestation of payment data (Attachments A, B, and C). 1. As a condition for receiving a monthly payment under paragraph B of this article, subpart F of part 422, the M+C Organization agrees that its chief executive officer (CEO), chief financial officer (CFO), or an individual delegated with the authority to sign on behalf of one of these officers, and who reports directly to such officer, must request payment under the contract on the forms attached as Attachment A (enrollment attestation), Attachment B (risk adjustment data), and Attachment C (adjusted community rate (ACR) proposal information attestation), hereto which attest to (based on best knowledge, information and belief, as of the date specified on the attestation form) the accuracy, completeness, and truthfulness of the data identified on these attachments. Attachment A requires attestation based on best knowledge, information, and belief, that each enrollee for whom the M+C Organization is requesting payment is validly enrolled, or was validly enrolled during the period for which payment is requested, in an M+C plan offered by the M+C Organization. The M+C Organization shall submit completed enrollment attestation forms to CMS, or its contractor, on a monthly basis. (NOTE: The forms included as attachments to this contract are for reference only. CMS will provide instructions for the completion and submission of the forms in separate documents. M+C Organizations should not take any action on the forms until appropriate CMS instructions become available.) 2. Attachment B requires that the CEO, CFO, or an individual delegated with the authority to sign on behalf of one of these officers, and who reports directly to such officer, must attest to (based on best knowledge, information and belief, as of the date specified on the attestation form) that the risk adjustment data it submits to CMS under ss. 422.257 are accurate, complete, and truthful. The M+C Organization shall make annual attestations of risk adjustment data on Attachment B and according to a schedule to be published by CMS. If such risk adjustment data are generated by a related entity, contractor, or subcontractor of an M+CO, such entity, contractor, or subcontractor must similarly attest to (based on best knowledge, information, and 5 belief, as of the date specified on the attestation form) the accuracy, completeness, and truthfulness of the data. [422.502(l)] 3. The CEO, CFO, or an individual delegated with the authority to sign on behalf of one of these officers, and who reports directly to such officer, must attest (based on best knowledge, information and belief, as of the date specified on the attestation form) that the information and documentation comprising the ACR proposal is accurate, complete, and truthful and fully conforms to the ACRP requirements; and that the benefits described in the CMS-approved ACR proposal agree with the benefit package the M+C Organization will offer during the period covered by the ACR proposal. [422.502(l)] Article V M+C Organization Relationship with Related Entities, Contractors, and Subcontractors A. Notwithstanding any relationship(s) that the M+C Organization may have with related entities, contractors, or subcontractors, the M+C Organization maintains full responsibility for adhering to and otherwise fully complying with all terms and conditions of its contract with CMS. [422.502(i)(1)] B. The M+C Organization agrees to require all related entities, contractors, or subcontractors to agree that-- (1) HHS, the Comptroller General, or their designees have the right to inspect, evaluate, and audit any pertinent contracts, books, documents, papers, and records of the related entity(s), contractor(s), or subcontractor(s) involving transactions related to the contract; and (2) HHS's, the Comptroller General's, or their designee's right to inspect, evaluate, and audit any pertinent information for any particular contract period will exist through 6 years from the final date of the contract period or from the date of completion of any audit, whichever is later. [422.502(i)(2)] C. The M+C Organization agrees that all contracts or written arrangements into which the M+C Organization enters with providers, related entities, contractors, or subcontractors shall contain the following elements: (1) Enrollee protection provisions that provide-- (a) Consistent with Article III(C), arrangements that prohibit providers from holding an enrollee liable for payment of any fees that are the legal obligation of the M+C Organization; and (b) Consistent with Article III(C), provision for the continuation of benefits. (2) Accountability provisions that indicate that-- (a) The M+C Organization oversees and is accountable to CMS for any functions or responsibilities that are described in these standards; and (b) The M+C Organization may only delegate activities or functions to a provider, related entity, contractor, or subcontractor in a manner consistent with requirements set forth at paragraph D of this article. 6 (3) A provision requiring that any services or other activity performed by a related entity, contractor or subcontractor in accordance with a contract or written agreement between the related entity, contractor, or subcontractor and the M+C Organization will be consistent and comply with the M+C Organization's contractual obligations to CMS. [422.502(i)(3)] D. If any of the M+C Organization's activities or responsibilities under this contract with CMS are delegated to other parties, the following requirements apply to any related entity, contractor, subcontractor, or provider: (1) Written arrangements must specify delegated activities and reporting responsibilities. (2) Written arrangements must either provide for revocation of the delegation activities and reporting requirements or specify other remedies in instances where CMS or the M+C Organization determine that such parties have not performed satisfactorily. (3) Written arrangements must specify that the performance of the parties is monitored by the M+C Organization on an ongoing basis. (4) Written arrangements must specify that either-- (a) The credentials of medical professionals affiliated with the party or parties will be either reviewed by the M+C Organization; or (b) The credentialing process will be reviewed and approved by the M+C Organization and the M+C Organization must audit the credentialing process on an ongoing basis. (5) All contracts or written arrangements must specify that the related entity, contractor, or subcontractor must comply with all applicable Medicare laws, regulations, and CMS instructions. [422.502(i)(4)] E. If the M+C Organization delegates selection of the providers, contractors, or subcontractors to another organization, the M+C Organization's written arrangements with that organization must state that the M+C Organization retains the right to approve, suspend, or terminate any such arrangement. [422.502(i)(5)] Article VI Records Requirements A. MAINTENANCE OF RECORDS 1. The M+C Organization agrees to maintain for 6 years books, records, documents, and other evidence of accounting procedures and practices that-- (a) Are sufficient to do the following: (i) Accommodate periodic auditing of the financial records (including data related to Medicare utilization, costs, and computation of the ACR) of the M+C Organization. (ii) Enable CMS to inspect or otherwise evaluate the quality, appropriateness and timeliness of services performed under the contract, and the facilities of the M+C Organization. (iii) Enable CMS to audit and inspect any books and records of the M+C Organization that pertain to the ability of the organization to bear the risk of potential financial losses, or to services performed or determinations of amounts payable under the contract. 7 (iv) Properly reflect all direct and indirect costs claimed to have been incurred and used in the preparation of the ACR proposal. (v) Establish component rates of the ACR for determining additional and supplementary benefits. (vi) Determine the rates utilized in setting premiums for State insurance agency purposes and for other government and private purchasers; and (b) Include at least records of the following: (i) Ownership and operation of the M+C Organization's financial, medical, and other record keeping systems. (ii) Financial statements for the current contract period and six prior periods. (iii) Federal income tax or informational returns for the current contract period and six prior periods. (iv) Asset acquisition, lease, sale, or other action. (v) Agreements, contracts, and subcontracts. (vi) Franchise, marketing, and management agreements. (vii) Schedules of charges for the M+C Organization's fee-for-service patients. (viii) Matters pertaining to costs of operations. (ix) Amounts of income received, by source and payment. (x) Cash flow statements. (xi) Any financial reports filed with other Federal programs or State authorities. [422.502(d)] 2. Access to facilities and records. The M+C Organization agrees to the following: (a) The Department of Health and Human Services (HHS), the Comptroller General, or their designee may evaluate, through inspection or other means-- (i) The quality, appropriateness, and timeliness of services furnished to Medicare enrollees under the contract; (ii) The facilities of the M+C Organization; and (iii) The enrollment and disenrollment records for the current contract period and six prior periods. (b) HHS, the Comptroller General, or their designees may audit, evaluate, or inspect any books, contracts, medical records, documents, papers, patient care documentation, and other records of the M+C Organization, related entity, contractor, subcontractor, or its transferee that pertain to any aspect of services performed, reconciliation of benefit liabilities, and determination of amounts payable under the contract, or as the Secretary may deem necessary to enforce the contract. (c) The M+C Organization agrees to make available, for the purposes specified in section (A) of this article, its premises, physical facilities and equipment, records relating to its Medicare enrollees, and any additional relevant information that CMS may require, in a manner that meets CMS record maintenance requirements. (d) HHS, the Comptroller General, or their designee's right to inspect, evaluate, and audit extends through 6 years from the final date of the contract period or completion of audit, whichever is later unless- (i) CMS determines there is a special need to retain a particular record or group of records for a longer period and notifies the M+C Organization at least 30 days before the normal disposition date; 8 (ii) There has been a termination, dispute, or fraud or similar fault by the M+C Organization, in which case the retention may be extended to 6 years from the date of any resulting final resolution of the termination, dispute, or fraud or similar fault; or (iii) HHS, the Comptroller General, or their designee determine that there is a reasonable possibility of fraud, in which case they may inspect, evaluate, and audit the M+C Organization at any time. [422.502(e)] B. REPORTING REQUIREMENTS 1. The M+C Organization shall have an effective procedure to develop, compile, evaluate, and report to CMS, to its enrollees, and to the general public, at the times and in the manner that CMS requires, and while safeguarding the confidentiality of the doctor-patient relationship, statistics and other information as described in the remainder of this section (B). [422.516(a)] 2. The M+C Organization agrees to submit to CMS certified financial information that must include the following: (a) Such information as CMS may require demonstrating that the organization has a fiscally sound operation, including: (i) The cost of its operations; (ii) A description, submitted to CMS annually and within 120 days of the end of the fiscal year, of significant business transactions (as defined in ss. 422.500) between the M+C Organization and a party in interest showing that the costs of the transactions listed in paragraph (2)(a)(v) of this section do not exceed the costs that would be incurred if these transactions were with someone who is not a party in interest; or (iii) If they do exceed, a justification that the higher costs are consistent with prudent management and fiscal soundness requirements. (iv) A combined financial statement for the M+C Organization and a party in interest if either of the following conditions is met: (aa) Thirty-five percent or more of the costs of operation of the M+C Organization go to a party in interest. (bb) Thirty-five percent or more of the revenue of a party in interest is from the M+C Organization. [422.516(b)] (v)Requirements for combined financial statements. (aa) The combined financial statements required by paragraph (2)(a)(iv) must display in separate columns the financial information for the M+C Organization and each of the parties in interest. (bb) Inter-entity transactions must be eliminated in the consolidated column. (cc) The statements must have been examined by an independent auditor in accordance with generally accepted accounting principles and must include appropriate opinions and notes. (dd) Upon written request from the M+C Organization showing good cause, CMS may waive the requirement that the organization's combined financial statement include the financial information required in paragraph (2)(a)(v) with respect to a particular entity. [422.516(c)] (vi) A description of any loans or other special financial arrangements the M+C Organization makes with contractors, subcontractors, and related entities. (b) Such information as CMS may require pertaining to the disclosure of ownership and control of the M+C Organization. [422.502(f)(1)(II)] (c) Patterns of utilization of the M+C Organization's services. 9 3. The M+C Organization agrees to participate in surveys required by CMS and to submit to CMS all information that is necessary for CMS to administer and evaluate the program and to simultaneously establish and facilitate a process for current and prospective beneficiaries to exercise choice in obtaining Medicare services. This information includes, but is not limited to: (a) The benefits covered under the M+C plan; (b) The M+C monthly basic beneficiary premium and M+C monthly supplemental beneficiary premium, if any, for the plan. (c) The service area and continuation area, if any, of each plan and the enrollment capacity of each plan; (d) Plan quality and performance indicators for the benefits under the plan including -- (i) Disenrollment rates for Medicare enrollees electing to receive benefits through the plan for the previous 2 years; (ii) Information on Medicare enrollee satisfaction; (iii) The patterns of utilization of plan services; (iv) The availability, accessibility, and acceptability of the plan's services; (v) Information on health outcomes and other performance measures required by CMS; (vi) The recent record regarding compliance of the plan with requirements of this part, as determined by CMS; and (vii) Other information determined by CMS to be necessary to assist beneficiaries in making an informed choice among M+C plans and traditional Medicare; (e) Information about beneficiary appeals and their disposition; (f) Information regarding all formal actions, reviews, findings, or other similar actions by States, other regulatory bodies, or any other certifying or accrediting organization; (g) Any other information deemed necessary by CMS for the administration or evaluation of the Medicare program. [422.502(f)(2)] 4. The M+C Organization agrees to provide to its enrollees and upon request, to any individual eligible to elect an M+C plan, all informational requirements under ss. 422.64 and, upon an enrollee's, request, the financial disclosure information required under ss. 422.516. [422.502(f)(3)] 5. Reporting and disclosure under ERISA. (a) For any employees' health benefits plan that includes an M+C Organization in its offerings, the M+C Organization must furnish, upon request, the information the plan needs to fulfill its reporting and disclosure obligations (with respect to the M+C Organization) under the Employee Retirement Income Security Act of 1974 (ERISA). (b) The M+C Organization must furnish the information to the employer or the employer's designee, or to the plan administrator, as the term "administrator" is defined in ERISA. [422.516(d)] 6. Electronic communication. The M+C Organization must have the capacity to communicate with CMS electronically. [422.502(b)] 7. Risk Adjustment data. The M+C Organization agrees to comply with the requirements in ss. 422.257 for submitting risk adjustment data to CMS. [422.502(a)(8)] 10 Article VII Renewal of the M+C Contract A. Renewal of contract: In accordance with ss. 422.506, the contract is renewable annually only if- (1) CMS informs the M+C Organization that it authorizes a renewal; and (2) The M+C Organization has not provided CMS with a notice of intention not to renew. [422.504(c)] B. Nonrenewal of contract: (1) Nonrenewal by the Organization. (a) In accordance with ss. 422.506, the M+C Organization may elect not to renew its contract with CMS as of the end of the term of the contract for any reason, provided it meets the time frames for doing so set forth in paragraphs (b) and (c) of this paragraph. (b) If the M+C Organization does not intend to renew its contract, it must notify-- (i) CMS in writing, by the date established pursuant to ss. 422.506 or by the date established through statute. (ii) Each Medicare enrollee, at least 90 days before the date on which the nonrenewal is effective. This notice must include a written description of all alternatives available for obtaining Medicare services within the service area of the M+C plans that the M+C Organization offers, including alternative M+C plans, original Medicare, and Medigap options and must receive CMS approval. (iii) The general public, at least 90 days before the end of the current calendar year, by publishing a CMS-approved notice in one or more newspapers of general circulation in each community located in the M+C Organization's service area. (c) CMS may accept a nonrenewal notice submitted after the applicable annual non-renewal notice deadline if -- (i) The M+C Organization notifies its Medicare enrollees and the public in accordance with paragraph (1)(b)(ii) and (1)(b)(iii) of this section; and (ii) Acceptance is not inconsistent with the effective and efficient administration of the Medicare program. (d) If the M+C Organization does not renew a contract under this paragraph (1), CMS will not enter into a contract with the Organization for 2 years from the date of contract separation unless there are special circumstances that warrant special consideration, as determined by CMS. This provision shall not apply when statutory or regulatory changes are made to the M+C program within six (6) months of the M+C Organization's notice of withdrawal that would increase payments for the service area from which the M+C Organization had withdrawn. [422.506(a)] (2) CMS decision not to renew. (a) CMS may elect not to authorize renewal of a contract for any of the following reasons: (i) The M+C Organization has not fully implemented or shown discernable progress in implementing quality assessment and performance improvement projects as defined in Article III, section (E)(2) of this contract. 11 (ii) For any of the reasons listed in ss. 422.510(a) [Article VIII, section (B)(1)(a) of this contract], which would also permit CMS to terminate the contract. (iii) The M+C Organization has committed any of the acts in ss. 422.752(a) that would support the imposition of intermediate sanctions or civil money penalties under subpart O of part 422. (b) Notice. CMS shall provide notice of its decision whether to authorize renewal of the contract as follows: (i) To the M+C Organization by May 1 of the contract year. (ii) To the M+C Organization's Medicare enrollees by mail at least 90 days before the end of the current calendar year. (iii) To the general public at least 90 days before the end of the current calendar year, by publishing a notice in one or more newspapers of general circulation in each community or county located in the M+C Organization's service area. (c) Notice of appeal rights. CMS shall give the M+C Organization written notice of its right to reconsideration of the decision not to renew in accordance with ss. 422.644. [422.506(b)] Article VIII Modification or Termination of the Contract A. Modification or Termination of Contract by Mutual Consent 1. This contract may be modified or terminated at any time by written mutual consent. (a) If the contract is terminated by mutual consent, except as provided in section (B)(1)(c) of this article, the M+C Organization must provide notice to its Medicare enrollees and the general public as provided in ss. 422.512(b)(2) and (b)(3) [Article VIII, section B(2)(b) of this contract]. (b) If the contract is modified by mutual consent, the M+C Organization must notify its Medicare enrollees of any changes that CMS determines are appropriate for notification within time frames specified by CMS. 2. If this contract is terminated by mutual consent and replaced the day following such termination by a new M+C contract, the M+C Organization is not required to provide the notice specified in section B of this article. [422.508] B. Termination of the Contract by CMS or the M+C Organization 1. Termination by CMS. (a) CMS may terminate a contract for any of the following reasons: (i) The M+C Organization has failed substantially to carry out the terms of its contract with CMS. (ii) The M+C Organization is carrying out its contract with CMS in a manner that is inconsistent with the effective and efficient implementation of 42 CFR part 422. (iii) CMS determines that the M+C Organization no longer meets the requirements of this part for being a contracting organization. 12 (iv) The M+C Organization commits or participates in fraudulent or abusive activities affecting the Medicare program, including submission of fraudulent data. (v) The M+C Organization experiences financial difficulties so severe that its ability to make necessary health services available is impaired to the point of posing an imminent and serious risk to the health of its enrollees, or otherwise fails to make services available to the extent that such a risk to health exists. (vi) The M+C Organization substantially fails to comply with the requirements in subpart M of this part relating to grievances and appeals. (vii) The M+C Organization fails to provide CMS with valid risk adjustment data as required under ss. 422.257. (viii) The M+C Organization fails to implement an acceptable quality assessment and performance improvement program as required under subpart D of part 422. (ix) The M+C Organization substantially fails to comply with the prompt payment requirements in ss. 422.520. (x) The M+C Organization substantially fails to comply with the service access requirements in ss. 422.112 or ss. 422.114. (xi) The M+C Organization fails to comply with the requirements of ss. 422.208 regarding physician incentive plans. (xii) The M+CO substantially fails to comply with the marketing requirements in 422.80. (b) Notice. If CMS decides to terminate a contract for reasons other than the grounds specified in section (B)(1)(a) above, it will give notice of the termination as follows: (i) CMS will notify the M+C Organization in writing 90 days before the intended date of the termination. (ii) The M+C Organization will notify its Medicare enrollees of the termination by mail at least 30 days before the effective date of the termination. (iii) The M+C Organization will notify the general public of the termination at least 30 days before the effective date of the termination by publishing a notice in one or more newspapers of general circulation in each community or county located in the M+C Organization's service area. (c) Immediate termination of contract by CMS. (i) For terminations based on violations prescribed in paragraph (B)(1)(a)(v) of this article, CMS will notify the M+C Organization in writing that its contract has been terminated effective the date of notice of the termination decision by CMS. If termination is effective in the middle of a month, CMS has the right to recover the prorated share of the capitation payments made to the M+C Organization covering the period of the month following the contract termination. (ii) CMS will notify the M+C Organization's Medicare enrollees in writing of CMS' decision to terminate the M+C Organization's contract. This notice will occur no later than 30 days after CMS notifies the plan of its decision to terminate this contract. CMS will simultaneously inform the Medicare enrollees of alternative options for obtaining Medicare services, including alternative M+C Organizations in a similar geographic area and original Medicare. (iii) CMS will notify the general public of the termination no later than 30 days after notifying the M+C Organization of CMS' decision to terminate this contract. This notice will be 13 published in one or more newspapers of general circulation in each community or county located in the M+C Organization's service area. (d) Corrective action plan (i) General. Before terminating a contract for reasons other than the grounds specified in section (B)(1)(a)(v) of this article, CMS will provide the M+C Organization with reasonable opportunity, not to exceed time frames specified at subpart N of part 422, to develop and receive CMS approval of a corrective action plan to correct the deficiencies that are the basis of the proposed termination. (ii) Exception. If a contract is terminated under section (B)(1)(a)(v) of this article, the M+C Organization will not have the opportunity to submit a corrective action plan. (e) Appeal rights. If CMS decides to terminate this contract, it will send written notice to the M+C Organization informing it of its termination appeal rights in accordance with subpart N of part 422. [422.510] 2. Termination by the M+C Organization (a) Cause for termination. The M+C Organization may terminate this contract if CMS fails to substantially carry out the terms of the contract. (b) Notice. The M+C Organization must give advance notice as follows: (i) To CMS, at least 90 days before the intended date of termination. This notice must specify the reasons why the M+C Organization is requesting contract termination. (ii) To its Medicare enrollees, at least 60 days before the termination effective date. This notice must include a written description of alternatives available for obtaining Medicare services within the service area, including alternative M+C plans, Medigap options, and original Medicare and must receive CMS approval. (iii) To the general public at least 60 days before the termination effective date by publishing a CMS-approved notice in one or more newspapers of general circulation in each community or county located in the M+C Organization's geographic area. (c) Effective date of termination. The effective date of the termination will be determined by CMS and will be at least 90 days after the date CMS receives the M+C Organization's notice of intent to terminate. (d) CMS' liability. CMS' liability for payment to the M+C Organization ends as of the first day of the month after the last month for which the contract is in effect, but CMS shall make payments for amounts owed prior to termination but not yet paid. (e) Effect of termination by the organization. CMS will not enter into an agreement with the M+C Organization for a period of two years from the date the Organization has terminated this contract, unless there are circumstances that warrant special consideration, as determined by CMS. [422.512] Article IX Requirements of Other Laws and Regulations A. The M+C Organization agrees to comply with-- 14 (1) Title VI of the Civil Rights Act of 1964 as implemented by regulations at 45 CFR part 84; (2) The Age Discrimination Act of 1975 as implemented by regulations at 45 CFR part 91; (3) The Americans With Disabilities Act; (4) The Rehabilitation Act of 1973 ; (5) The Health Insurance Portability and Accountability Act; (6) Other laws applicable to recipients of Federal funds; and (7) All other applicable laws, regulations, and rules. [422.502(h)(1)] B. The M+C Organization is receiving Federal payments under this contract, and related entities, contractors, and subcontractors paid by the M+C Organization to fulfill its obligations under this contract are subject to certain laws that are applicable to individuals and entities receiving Federal funds. The M+C Organization agrees to inform all related entities, contractors and subcontractors that payments that they receive are, in whole or in part, from Federal funds. [422.502(h)(2)] C. In the event that any provision of this contract conflicts with the provisions of any statute or regulation applicable to an M+C Organization, the provisions of the statute or regulation shall have full force and effect. Article X Severability The M+C Organization agrees that, upon CMS' request, this contract will be amended to exclude any M+C plan or State-licensed entity specified by CMS, and a separate contract for any such excluded plan or entity will be deemed to be in place when such a request is made. [422.502(k)] 15 In witness whereof, the parties hereby execute this contract. FOR THE M+C ORGANIZATION - ---------------------------------------- ------------------------------- Printed Name Title - ---------------------------------------- ------------------------------- Signature Date - ---------------------------------------- ------------------------------- Organization Address FOR THE CENTERS FOR MEDICARE & MEDICAID SERVICES - ---------------------------------------- ------------------------------- Jean D. LeMasurier Date Acting Director Health Plan Benefits Group Center for Beneficiary Choices 16 ATTACHMENT A ATTESTATION OF ENROLLMENT INFORMATION RELATING TO CMS PAYMENT TO A MEDICARE+CHOICE ORGANIZATION Pursuant to the contract(s) between the Centers for Medicare & Medicaid Services (CMS) and (INSERT NAME OF M+C ORGANIZATION), hereafter referred to as the M+C Organization, governing the operation of the following Medicare +Choice plans (INSERT PLAN IDENTIFICATION NUMBERS HERE), the M+C Organization hereby requests payment under the contract, and in doing so, makes the following attestation concerning CMS payments to the M+C Organization. The M+C Organization acknowledges that the information described below directly affects the calculation of CMS payments to the M+C Organization and that misrepresentations to CMS about the accuracy of such information may result in Federal civil action and/or criminal prosecution. This attestation shall not be considered a waiver of the M+C Organization's right to seek payment adjustments from CMS based on information or data which does not become available until after the date the M+C Organization submits this attestation. 1. The M+C Organization has reported to CMS for the month of (INDICATE MONTH AND YEAR) all new enrollments, disenrollments, and changes in enrollees' institutional status with respect to the above-stated M+C plans. Based on best knowledge, information, and belief as of the date indicated below, all information submitted to CMS in this report is accurate, complete, and truthful. 2. The M+C Organization has reviewed the CMS monthly membership report and reply listing for the month of (INDICATE MONTH AND YEAR) for the above-stated M+C plans and has reported to CMS any discrepancies between the report and the M+C Organization's records. For those portions of the monthly membership report and the reply listing to which the M+C Organization raises no objection, the M+C Organization, through the certifying CEO/CFO, will be deemed to have attested, based on best knowledge, information, and belief as of the date indicated below, to their accuracy, completeness, and truthfulness. ----------------------------- (INDICATE TITLE [CEO, CFO, or delegate]) on behalf of (INDICATE M+C ORGANIZATION) ------------------------------------------ DATE 17 ATTACHMENT B ATTESTATION OF RISK ADJUSTMENT DATA INFORMATION RELATING TO CMS PAYMENT TO A MEDICARE+CHOICE ORGANIZATION Pursuant to the contract(s) between the Centers for Medicare & Medicaid Services (CMS) and (INSERT NAME OF M+C ORGANIZATION), hereafter referred to as the M+C Organization, governing the operation of the following Medicare +Choice plans (INSERT PLAN IDENTIFICATION NUMBERS HERE), the M+C Organization hereby requests payment under the contract, and in doing so, makes the following attestation concerning CMS payments to the M+C Organization. The M+C Organization acknowledges that the information described below directly affects the calculation of CMS payments to the M+C Organization or additional benefit obligations of the M+C Organization and that misrepresentations to CMS about the accuracy of such information may result in Federal civil action and/or criminal prosecution. The M+C Organization has reported to CMS for the period of (INDICATE DATES) all (INDICATE TYPE OF DATA - INPATIENT HOSPITAL, OUTPATIENT HOSPITAL, OR PHYSICIAN) risk adjustment data available to the M+C Organization with respect to the above-stated M+C plans. Based on best knowledge, information, and belief as of the date indicated below, all information submitted to CMS in this report is accurate, complete, and truthful. ----------------------------- (INDICATE TITLE [CEO, CFO, or delegate]) on behalf of (INDICATE M+C ORGANIZATION) ------------------------------------------ DATE 18 ATTACHMENT C ATTESTATION OF ADJUSTED COMMUNITY RATE INFORMATION RELATING TO CMS PAYMENT TO A MEDICARE+CHOICE ORGANIZATION Pursuant to the contract(s) between the Centers for Medicare & Medicaid Services (CMS) and (INSERT NAME OF M+C ORGANIZATION), hereafter referred to as the M+C Organization, governing the operation of the following Medicare +Choice plans (INSERT PLAN IDENTIFICATION NUMBERS HERE), the M+C Organization hereby requests payment under the contract, and in doing so, makes the following attestation concerning CMS payments to the M+C Organization. The M+C Organization acknowledges that the information described below directly affects the calculation of CMS payments to the M+C Organization or additional benefit obligations of the M+C Organization and that misrepresentations to CMS about the accuracy of such information may result in Federal civil action and/or criminal prosecution. The M+C Organization has submitted to CMS an adjusted community rate (ACR) proposal for the period (INDICATE DATES). Based on best knowledge, information, and belief as of the date indicated below, all of the information submitted to CMS in this ACR proposal is accurate, complete, and truthful, and the benefit package the M+C Organization will offer during the above-stated period agrees with the CMS-approved ACR proposal. ----------------------------- (INDICATE TITLE [CEO, CFO, or delegate]) on behalf of (INDICATE M+C ORGANIZATION) ------------------------------------------ DATE 19 EX-10.35 8 a96836exv10w35.txt EXHIBIT 10.35 EXHIBIT 10.35 ================================================================================ PACIFICARE HEALTH SYSTEMS INC. --------------------------------- AMENDMENT NO. 1 dated as of November 13, 2003 to CREDIT AGREEMENT dated as of June 3, 2003 --------------------------------- JPMORGAN CHASE BANK, as Administrative Agent ================================================================================ AMENDMENT NO. 1 AMENDMENT NO. 1 dated as of November 13, 2003 to the Credit Agreement referred to below, between: PACIFICARE HEALTH SYSTEMS INC. (the "Borrower"); the Subsidiary Guarantors party to the Credit Agreement; and JPMORGAN CHASE BANK, as Administrative Agent thereunder. The Borrower, the Subsidiary Guarantors, the Lenders, the Administrative Agent and the Collateral Agent are parties to a Credit Agreement dated as of June 3, 2003 (as amended and in effect from time to time, the "Credit Agreement"), providing, subject to the terms and conditions thereof, for extensions of credit to be made by the Lenders to the Borrower. The Borrower has requested certain amendments to the Credit Agreement and, accordingly, the parties hereto hereby agree as follows: Section 1. Definitions. Except as otherwise defined in this Amendment No. 1, terms defined in the Credit Agreement are used herein as defined therein. Section 2. Amendments. Subject to the satisfaction of the conditions precedent specified in Section 4 hereof, but effective as of the date hereof, the Credit Agreement shall be amended as follows: 2.01. General References. References in the Credit Agreement (including references to the Credit Agreement as amended hereby) to "this Agreement" (and indirect references such as "hereunder", "hereby", "herein" and "hereof") shall be deemed to be references to the Credit Agreement as amended hereby. 2.02. Mandatory Prepayments. Section 2.09(b)(i) of the Credit Agreement shall be amended by: (a) inserting in clause (x) thereof, immediately following the words "this paragraph (i) applies", the following words: "or to the extent to which the last sentence of this paragraph (i) applies"; and (b) inserting a new sentence at the end said Section 2.09(b)(i) to read as follows: "Notwithstanding anything herein to the contrary, the Borrower shall not be required to make any prepayment under this paragraph (i) from any Equity Issuance by the Borrower after the Effective Date, provided that (I) immediately prior to the consummation of such Equity Issuance, the Consolidated Leverage Ratio is less than or equal to 2.00 to 1, (II) at the time of such Equity Issuance, no Default shall have occurred and be continuing (III) the Net Available Proceeds of such Equity Issuance shall be applied, within a period of 80 days after receipt thereof, to the prepayment, repurchase or redemption of the Term Loans (or, after the payment in full of the Term Loans, the Revolving Credit Loans) and/or other senior Indebtedness of the Borrower (including the payment of accrued interest and premium thereon, if any) and (IV) to the extent any amount of the Net Available Proceeds of such Equity Issuance has not been so applied prior to the lapse of such 80-day period, such unapplied amount shall forthwith be applied by the Borrower to prepay the Term Loans to the extent then required under this paragraph (i)." Amendment No. 1 - 2 - 2.03. Optional Payments, Redemptions or Prepayments. Section 7.10 of the Credit Agreement shall be amended by inserting a new sentence at the end thereof to read as follows: "Notwithstanding anything herein to the contrary, the Borrower may prepay, repurchase or redeem any senior Indebtedness with the proceeds of any Equity Issuance subject only to compliance with the last sentence of Section 2.09(b)(i)." Section 3. Representations and Warranties. The Borrower represents and warrants to the Lenders as of the date hereof that (a) the representations and warranties of the Borrower set forth in the Credit Agreement, and of each Obligor in each of the other Loan Documents to which it is a party, are true and correct on and as of the date hereof with the same force and effect as if made on and as of the date hereof (or, if any such representation and warranty is expressly stated to have been made as of a specific date, as of such specific date) and as if each reference herein to "this Agreement" (or words of similar import) or in such other Loan Documents to "the Credit Agreement" (or words of similar import) included reference to this Amendment No. 1 and (b) no Default has occurred and is continuing. Section 4. Conditions Precedent. The amendments to the Credit Agreement set forth in Section 2 shall become effective as of the date hereof upon the satisfaction of each of the following conditions: 4.01. Amendment No. 1. The Administrative Agent shall have received one or more counterparts of this Amendment No. 1 executed by each Obligor and the Administrative Agent (with the written consent of the Required Lenders provided in the form of the Lender Consent attached hereto as Exhibit A). 4.02. Payment of Fees. The Administrative Agent shall have received evidence satisfactory to the Administrative Agent of payment (or irrevocable instructions for payment) by the Borrower in full of an amendment fee to the Administrative Agent for the account of each Lender that has approved this Amendment No. 1 on or before 5:00 p.m., New York City time, on November 13, 2003, such fee to be in an amount equal to 0.05% of the sum of the aggregate unpaid principal amount of the Term Loans, if any, held by such Lender and the Revolving Credit Commitment then in effect, if any, of such Lender. Section 5. Confirmation of Guarantees and Security Interests. Each of the Subsidiary Guarantors, by its execution of this Amendment No. 1, hereby confirms and ratifies that (i) all of its respective obligations as a guarantor under the Credit Agreement, including, without limitation, under Article III thereof, and (ii) all of its respective obligations under each of the Security Documents to which it is a party and the Liens granted thereunder shall, in each case, continue in full force and effect for the benefit of the Collateral Agent and the other Secured Parties with respect to the Credit Agreement as amended hereby. Section 6. Miscellaneous. Except as herein provided, the Credit Agreement shall remain unchanged and in full force and effect. This Amendment No. 1 may be executed in any number of counterparts, all of which taken together shall constitute one and the same amendatory instrument and any of the parties hereto may execute this Amendment No. 1 by signing any such Amendment No. 1 - 3 - counterpart. This Amendment No. 1 shall be governed by, and construed in accordance with, the law of the State of New York. Amendment No. 1 - 4 - IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 1 to be duly executed and delivered as of the day and year first above written. BORROWER PACIFICARE HEALTH SYSTEMS, INC. By ---------------------------------------- Name: Title: Amendment No. 1 - 5 - SUBSIDIARY GUARANTORS PACIFICARE HEALTH PLAN ADMINISTRATORS, INC. By ---------------------------------------- Name: Title: PACIFICARE eHOLDINGS, INC. By ---------------------------------------- Name: Title: SENIORCO, INC. By ---------------------------------------- Name: Title: RxSOLUTIONS, INC. By ---------------------------------------- Name: Title: Amendment No. 1 - 6 - PACIFICARE BEHAVIORAL HEALTH, INC. By ---------------------------------------- Name: Title: SECUREHORIZONS USA, INC. By ---------------------------------------- Name: Title: PACIFICARE OF ARIZONA, INC. By ---------------------------------------- Name: Title: PACIFICARE OF OKLAHOMA, INC. By ---------------------------------------- Name: Title: Amendment No. 1 - 7 - ADMINISTRATIVE AGENT JPMORGAN CHASE BANK, as Administrative Agent By ---------------------------------------- Name: Title: Amendment No. 1 EXHIBIT A LENDER CONSENT Reference is made to the Credit Agreement dated as of June 3, 2003 (as amended and in effect from time to time, the "Credit Agreement") between Pacificare Health Systems Inc., the Subsidiary Guarantors party to the Credit Agreement, the Lenders party to the Credit Agreement, JPMorgan Chase Bank, as Administrative Agent thereunder and JPMorgan Chase Bank, as Collateral Agent thereunder. Capitalized terms used and not otherwise defined herein are deemed to have the respective meanings assigned to such terms in the Credit Agreement. The undersigned Lender party to the Credit Agreement hereby (i) consents to Amendment No. 1 to the Credit Agreement, dated as of November 13, 2003, substantially in the form to which the form of this Lender Consent is attached ("Amendment No. 1") and (ii) authorizes and directs the Administrative Agent to execute and deliver Amendment No. 1 on behalf of such Lender. Full Name of Lender: -------------------------------------- By: ------------------------------------- Name: Title: Date: November __, 2003 Amendment No. 1 EX-10.36 9 a96836exv10w36.txt EXHIBIT 10.36 EXHIBIT 10.36 EXECUTION COPY ================================================================================ PACIFICARE HEALTH SYSTEMS INC. --------------------------------- AMENDMENT NO. 2 dated as of December 17, 2003 to CREDIT AGREEMENT dated as of June 3, 2003 --------------------------------- JPMORGAN CHASE BANK, as Administrative Agent --------------------------------- J.P. MORGAN SECURITIES INC. and MORGAN STANLEY SENIOR FUNDING, INC., as Joint Advisors, Joint Lead Arrangers and Joint Bookrunners ================================================================================ AMENDMENT NO. 2 AMENDMENT NO. 2 dated as of December 17, 2003 to the Credit Agreement referred to below, between: PACIFICARE HEALTH SYSTEMS INC. (the "Borrower"); the Subsidiary Guarantors party to the Credit Agreement; and JPMORGAN CHASE BANK, as Administrative Agent thereunder. The Borrower, the Subsidiary Guarantors, the Lenders, the Administrative Agent and the Collateral Agent are parties to a Credit Agreement dated as of June 3, 2003 (as amended and in effect from time to time, the "Credit Agreement"), providing, subject to the terms and conditions thereof, for extensions of credit to be made by the Lenders to the Borrower. The Borrower has requested certain amendments to the Credit Agreement and, accordingly, the parties hereto hereby agree as follows: Section 1. Definitions. Except as otherwise defined in this Amendment No. 2, terms defined in the Credit Agreement are used herein as defined therein. Section 2. Amendments. Subject to the satisfaction of the conditions precedent specified in Section 4 hereof, but effective as of the date hereof, the Credit Agreement shall be amended as follows: 2.01. General References. References in the Credit Agreement (including references to the Credit Agreement as amended hereby) to "this Agreement" (and indirect references such as "hereunder", "hereby", "herein" and "hereof") shall be deemed to be references to the Credit Agreement as amended hereby. 2.02. Definitions. Section 1.01 of the Credit Agreement is amended by adding the following new defined term in its appropriate alphabetical location: "Applicable Term Loan Margin" means for any day, with respect to any ABR Loan or Eurodollar Loan, the applicable rate per annum set forth below under the caption "ABR Spread" or "Eurodollar Spread", respectively, based upon the Ratings applicable on such date to the Loans (each a "Rating"):

Ratings ABR Eurodollar (S&P/Moody's) Spread Spread --------------- -------- ----------- Category 1 > or = BB+ and > or = Ba2 1.25% 2.25% BB and > or = Ba2 Category 2 1.50% 2.50% > or = BB and Ba3 Other than in Category 3 Category 1 or 2 1.75% 2.75%

Amendment No. 2 - 2 - For purposes of the foregoing, (a) if one of S&P and Moody's shall not have in effect a Rating (other than by reason of the circumstances referred to in the last sentence of this definition), such rating agency shall be deemed to have a Rating equal to the level of the Rating of the other rating agency; (b) if neither S&P nor Moody's shall have in effect a Rating (other than by reason of the circumstances referred to in the last sentence of this definition), then each such rating agency shall be deemed to have established a Rating in Category 3; and (c) if the Ratings established or deemed to have been established by S&P and Moody's shall be changed (other than as a result of a change in the rating system of S&P or Moody's), such change shall be effective as of the date on which it is first announced by the applicable rating agency. Each change in the Applicable Term Loan Margin shall apply during the period commencing on the effective date of such change and ending on the date immediately preceding the effective date of the next such change; provided that no reduction in the Applicable Term Loan Margin shall be effective for so long as an Event of Default shall have occurred and be continuing. If the rating system of S&P or Moody's shall change, or if either such rating agency shall cease to be in the business of rating secured bank loans, the Borrower and the Lenders shall negotiate in good faith to amend this definition to reflect such changed rating system or the unavailability of ratings from such rating agency and, pending the effectiveness of any such amendment, the Applicable Term Loan Margin shall be determined by reference to the rating most recently in effect prior to such change or cessation. The Applicable Term Loan Margin in effect on effective date of Amendment No. 2 hereto dated as of December 17, 2003 shall be (i) in the case of Term Loans constituting an ABR Borrowing shall be 1.75% per annum and (ii) in the case of Term Loans constituting a Eurodollar Borrowing shall be 2.75% per annum. 2.03. Interest on ABR Term Loans. Section 2.11(a)(ii) shall be amended to read in its entirety as follows: "(ii) the Alternate Base Rate plus the Applicable Term Loan Margin (in the case of Term Loans constituting an ABR Borrowing)." 2.04. Interest on Eurodollar Term Loans. Section 2.11(b)(ii) shall be amended to read in its entirety as follows: "(ii) the Adjusted LIBO Rate for the Interest Period for such Borrowing plus the Applicable Term Loan Margin (in the case of Term Loans constituting a Eurodollar Borrowing)." Section 3. Representations and Warranties. The Borrower represents and warrants to the Lenders as of the date hereof that (a) the representations and warranties of the Borrower set forth in the Credit Agreement are true and correct, and of each Obligor in each of the other Loan Documents to which it is a party are true and correct in all material respects, in each case on and as of the date hereof with the same force and effect as if made on and as of the date hereof (or, if any such representation and warranty is expressly stated to have been made as Amendment No. 2 - 3 - of a specific date, as of such specific date) and as if each reference herein to "this Agreement" (or words of similar import) or in such other Loan Documents to "the Credit Agreement" (or words of similar import) included reference to this Amendment No. 2 and (b) no Default has occurred and is continuing. Section 4. Conditions Precedent. The amendments to the Credit Agreement set forth in Section 2 shall become effective as of the date hereof upon receipt by the Administrative Agent of one or more counterparts of this Amendment No. 2 executed by each Obligor and the Administrative Agent (with the written consent of each of the Term Loan Lenders and the Required Lenders provided in the form of the Lender Consent attached hereto as Exhibit A). Section 5. Confirmation of Guarantees and Security Interests. The Obligors hereby confirms and ratifies all of its respective obligations under the Loan Documents to which it is a party (including, in the case of each Subsidiary Guarantor, its respective obligations as a guarantor under Article III of the Credit Agreement (as amended hereby)) and the Liens granted by it under the respective Loan Documents (as amended hereby) and hereby represent, warrant and confirm that all references in such Loan Documents to the Credit Agreement (or words of similar import) fully and effectively mean the Credit Agreement as amended hereby without impairing any such obligations or Liens in any respect. Section 6. Miscellaneous. Except as herein provided, the Credit Agreement shall remain unchanged and in full force and effect. This Amendment No. 2 may be executed in any number of counterparts, all of which taken together shall constitute one and the same amendatory instrument and any of the parties hereto may execute this Amendment No. 2 by signing any such counterpart. This Amendment No. 2 shall be governed by, and construed in accordance with, the law of the State of New York. Amendment No. 2 - 4 - IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 2 to be duly executed and delivered as of the day and year first above written. BORROWER PACIFICARE HEALTH SYSTEMS, INC. By ------------------------------------------ Name: Title: Amendment No. 2 -5- SUBSIDIARY GUARANTORS PACIFICARE HEALTH PLAN ADMINISTRATORS, INC. By ------------------------------------------ Name: Title: PACIFICARE eHOLDINGS, INC. By ------------------------------------------ Name: Title: SENIORCO, INC. By ------------------------------------------ Name: Title: RxSOLUTIONS, INC. By ------------------------------------------ Name: Title: Amendment No. 2 -6- PACIFICARE BEHAVIORAL HEALTH, INC. By ------------------------------------------ Name: Title: SECUREHORIZONS USA, INC. By ------------------------------------------ Name: Title: PACIFICARE OF ARIZONA, INC. By ------------------------------------------ Name: Title: PACIFICARE OF OKLAHOMA, INC. By ------------------------------------------ Name: Title: Amendment No. 2 - 7 - ADMINISTRATIVE AGENT JPMORGAN CHASE BANK, as Administrative Agent By ------------------------------------------ Name: Title: EXHIBIT A LENDER CONSENT Reference is made to the Credit Agreement dated as of June 3, 2003 (as amended and in effect from time to time, the "Credit Agreement") between Pacificare Health Systems Inc., the Subsidiary Guarantors party to the Credit Agreement, the Lenders party to the Credit Agreement, JPMorgan Chase Bank, as Administrative Agent thereunder and JPMorgan Chase Bank, as Collateral Agent thereunder. Capitalized terms used and not otherwise defined herein are deemed to have the respective meanings assigned to such terms in the Credit Agreement. The undersigned Lender party to the Credit Agreement hereby (i) consents to Amendment No. 2 to the Credit Agreement, dated as of December 17, 2003, substantially in the form to which the form of this Lender Consent is attached ("Amendment No. 2") and (ii) authorizes and directs the Administrative Agent to execute and deliver Amendment No. 2 on behalf of such Lender. Full Name of Lender: --------------------------------------- By: --------------------------------------- Name: Title: Date: December 17, 2003 Amendment No. 2 EX-14.1 10 a96836exv14w1.txt EXHIBIT 14.1 EXHIBIT 14.1 Financial Code of Ethics PacifiCare is committed to full and accurate financial disclosure in compliance with applicable laws, rules and regulations and to maintaining our books and records in accordance with applicable accounting policies, laws, rules and regulations. This Financial Code of Ethics (this "CODE") applies to our Chief Executive Officer, Chief Financial Officer, Controller and other persons performing similar functions (together, "FINANCIAL Professionals"). This Code sets forth specific policies to guide PacifiCare's Financial Professionals in the performance of their duties. Although this Code addresses conduct that is particularly important to proper dealings with the people and entities with whom Financial Professionals interact, it cannot possibly describe every honest and ethical practice or principle related to financial reporting and accounting or the maintenance of corporate books and records. As an employee of PacifiCare, this Code reflects only one of many policies to which you are subject. Some of PacifiCare's other employee policies, including those described in the Employee Handbook, the Business Conduct Guidelines and the Insider Trading Policy, provide further guidance on and amplify this Code. IN ADDITION TO COMPLIANCE UNDER THOSE POLICIES, YOU ARE SEPARATELY BOUND BY THIS CODE AND IF YOU VIOLATE THIS CODE, YOU MAY BE SUBJECT TO DISCIPLINARY ACTION. Waivers of this Code may be made only by PacifiCare's Board of Directors or a committee of the Board of the Directors and will be disclosed in accordance with applicable law. All Financial Professionals shall adhere to, and advocate, the following general principles: o Engage in and promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interests between personal and professional relationships; o Provide full, fair, accurate, timely and understandable public disclosure, in reports and documents filed with, or submitted, to the Securities and Exchange Commission and in other public communications made by PacifiCare; o Take all reasonable measures to protect the confidentiality of non-public information about PacifiCare, our subsidiaries, our members, our providers and other contracting parties to whom we have an obligation of confidentiality obtained or created in connection with our financial activities and to prevent the unauthorized disclosure of such information unless required by applicable law, regulation, legal or regulatory process; o Comply with applicable governmental rules and regulations and other appropriate private and public regulatory agencies; and o Act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or failing to disclose material facts known to you or allowing your independent judgment to be subordinated. In addition, the integrity of our records and public disclosure depends on the validity, accuracy and completeness of the information supporting the entries to our books of account. Therefore, our corporate and business records should be completed accurately and honestly, and the making of false or misleading entries is strictly prohibited. Our records serve as a basis for managing our business and are important in meeting our obligations to stockholders, members, providers, suppliers, creditors, employees and others with whom we do business. As a result, it is important that our books, accounts and other records accurately and fairly reflect, in reasonable detail, our assets, liabilities, revenues, costs and expenses, as well as all transactions and changes in assets and liabilities. All Financial Professionals shall also adhere to and advocate the following principles: o No Financial Professional may take or authorize any action that would cause our financial records or financial disclosure to fail to comply with generally accepted accounting principles, the rules and regulations of the SEC or other applicable laws, rules and regulations; o All Financial Professionals must cooperate fully with our accounting department, as well as our independent public accountants and outside legal counsel, respond to their questions with candor and provide them with complete and accurate information to help ensure that our books and records, as well as our reports filed with the SEC, are accurate and complete; and o No Financial Professional shall knowingly make (or cause or encourage any other person to make) any false or misleading statement in any of our reports filed with the SEC or knowingly omit (or cause or encourage any other person to omit) any information necessary to make the disclosure in any of our reports accurate in all material respects; and o No Financial Professional or any person acting under the direction of any Financial Professional shall directly or indirectly take any action to fraudulently influence, coerce, manipulate or mislead any independent public accountant or internal auditor engaged in the performance of an audit or review of financial statements of PacifiCare or its subsidiaries. Each Financial Professional shall bring to the attention of the Audit and Ethics Committee any information he or she may have concerning: o Significant deficiencies in the design or operation of internal controls that could adversely affect PacifiCare's ability to record, process, summarize and report financial data; or o Any fraud, whether or not material, that involves any Financial Professional or any other employees who have a role in PacifiCare's financial reporting, disclosures or internal controls. Each Financial Professional shall promptly bring to the attention of the General Counsel and/or the Audit and Ethics Committee any information he or she may have concerning violations of this Code or evidence of material violations of securities or other applicable laws, rules or regulations. PacifiCare's non-retaliation policy applies to persons who in good faith report a violation or suspected violation of this Code. This Financial Code of Ethics is a statement of fundamental principles and key policies and procedures that govern PacifiCare's Financial Professionals in the conduct of PacifiCare's business. It is not intended to and does not constitute an employment contract or assurance of continued employment. This Code does not create any rights in any employee, member, provider, supplier, competitor, stockholder, creditor or any other person or entity. Failure to observe the terms of the Financial Code of Ethics may result in disciplinary action, including termination of employment. Violations of this Code may also constitute violations of federal securities laws and regulations which may result in civil and criminal penalties. Acknowledgment I acknowledge that I have received and read the PacifiCare Financial Code of Ethics. I agree to comply fully with the standards contained in the Code and PacifiCare's related policies and procedures. I understand that I have an obligation to report any suspected violations of the Financial Code of Ethics. - -------------------------------------------------------------------------------- Signature Title Date EX-21 11 a96836exv21.htm EXHIBIT 21

EXHIBIT 21

PACIFICARE HEALTH SYSTEMS, INC.

LIST OF SUBSIDIARIES

Name of Subsidiary	State of Incorporation
FHP Reinsurance Limited	Bermuda
PacifiCare Asia Pacific Insurance Brokers, Inc.	Guam
PacifiCare Behavioral Health of California, Inc.	Delaware
PacifiCare Behavioral Health, Inc.	Delaware
PacifiCare Behavioral Health of New Jersey, Inc.	New Jersey
PacifiCare Behavioral Health NY IPA, Inc.	New York
PacifiCare Dental	California
PacifiCare Dental of Colorado, Inc.	Colorado
PacifiCare eHoldings, Inc.	California
PacifiCare Health Insurance Company of Micronesia, Inc.	Guam
PacifiCare Health Plan Administrators, Inc.	Indiana
PacifiCare International Limited	Ireland
PacifiCare Investment Company	Arizona
PacifiCare Life and Health Insurance Company	Indiana
PacifiCare Life Assurance Company	Colorado
PacifiCare of Arizona, Inc.	Arizona
PacifiCare of California	California
PacifiCare of Colorado, Inc.	Colorado
PacifiCare of Nevada, Inc.	Nevada
PacifiCare of Oklahoma, Inc.	Oklahoma
PacifiCare of Oregon, Inc.	Oregon
PacifiCare of Texas, Inc.	Texas
PacifiCare of Washington, Inc.	Washington
MEDeMORPHUS Healthcare Solutions, Inc.	California
RxSolutions, Inc.	California
Salveo Holding, LLC	Cayman Islands
Salveo Insurance Company, Ltd.	Cayman Islands
SecureHorizons USA, Inc.	California
SeniorCo, Inc.	Delaware
Union Health Solutions, Inc.	California

EX-23 12 a96836exv23.htm EXHIBIT 23

EXHIBIT 23

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements (Forms S-8) and related Prospectuses pertaining to PacifiCare Health Systems, Inc.’s 1996 Stock Option Plan for Officers and Key Employees, as amended, Amended and Restated 1996 Non-Officer Directors Stock Option Plan, as amended, 1997 Premium Priced Stock Option Plan, as amended, Third Amended and Restated PacifiCare Health Systems, Inc. Non-Qualified Deferred Compensation Plan, Second Amended and Restated PacifiCare Health Systems, Inc. Statutory Restoration Plan, 2001 Amendment and Restatement of the PacifiCare Health Systems, Inc. Savings and Profit-Sharing Plan, as amended, 2000 Employee Plan, as amended, Amended and Restated 2000 Non-Employee Directors Stock Plan, as amended, and 2001 Employee Stock Purchase Plan; in the Registration Statement (Amendment No. 1 to Form S-3 number 333-74812) and related Prospectus, the Registration Statement (Form S-4 number 333-91704) and related Prospectus, the Registration Statement (Form S-4 number 333-102909) and related Prospectus, and the Registration Statement (Form S-3 number 333-107891) and related Prospectus of PacifiCare Health Systems, Inc. of our report dated January 30, 2004 with respect to the consolidated financial statements and schedule of PacifiCare Health Systems, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2003.

/s/ ERNST & YOUNG LLP

Irvine, California
March 1, 2004

EX-3.04

                                                                    EXHIBIT 3.04


                        FIRST AMENDED AND RESTATED BYLAWS

                                       OF

                         PACIFICARE HEALTH SYSTEMS, INC.
                            (A DELAWARE CORPORATION)






                                TABLE OF CONTENTS



                                                                                                               PAGE

                                                                                                            
ARTICLE I                  Offices................................................................................1

         Section 1.        Registered Office......................................................................1

         Section 2.        Other Offices..........................................................................1

ARTICLE II                 Corporate Seal.........................................................................1

         Section 3.        Corporate Seal.........................................................................1

ARTICLE III                Stockholders' Meetings.................................................................1

         Section 4.        Place of Meetings......................................................................1

         Section 5.        Annual Meeting.........................................................................1

         Section 6.        Special Meetings.......................................................................3

         Section 7.        Notice of Meetings.....................................................................4

         Section 8.        Quorum.................................................................................5

         Section 9.        Adjournment and Notice of Adjourned Meetings...........................................5

         Section 10.       Voting Rights..........................................................................5

         Section 11.       Joint or Beneficial Owners of Stock....................................................6

         Section 12.       List of Stockholders...................................................................6

         Section 13.       Action without Meeting.................................................................6

         Section 14.       Organization...........................................................................7

ARTICLE IV                 Directors..............................................................................7

         Section 15.       Number and Term of Office..............................................................7

         Section 16.       Lead Independent Director..............................................................8

         Section 17.       Powers.................................................................................8

         Section 18.       Vacancies..............................................................................8

         Section 19.       Resignation............................................................................8

         Section 20.       Removal................................................................................9

         Section 21.       Meetings...............................................................................9

                (a)        Annual Meetings........................................................................9

                (b)        Regular Meetings.......................................................................9

                (c)        Special Meetings.......................................................................9

                (d)        Telephone Meetings.....................................................................9

                (e)        Notice of Meetings.....................................................................9





                               TABLE OF CONTENTS
                                  (CONTINUED)

                                                                                                              
                (f)        Waiver of Notice.......................................................................9

         Section 22.       Quorum and Voting.....................................................................10

         Section 23.       Action without Meeting................................................................10

         Section 24.       Fees and Compensation.................................................................10

         Section 25.       Committees............................................................................10

                (a)        Committees............................................................................10

                (b)        Term..................................................................................11

                (c)        Meetings..............................................................................11

         Section 26.       Organization..........................................................................11

ARTICLE V                  Officers..............................................................................11

         Section 27.       Officers Designated...................................................................11

         Section 28.       Tenure and Duties of Officers.........................................................12

                (a)        General...............................................................................12

                (b)        Duties of Chairman of the Board of Directors..........................................12

                (c)        Duties of Vice Chairman of the Board of Directors.....................................12

                (d)        Duties of Chief Executive Officer.....................................................12

                (e)        Duties of President and Chief Operating Officer.......................................13

                (f)        Duties of Vice Presidents.............................................................13

                (g)        Duties of Secretary...................................................................13

                (h)        Duties of Chief Financial Officer or Treasurer........................................13

         Section 29.       Delegation of Authority...............................................................14

         Section 30.       Resignations..........................................................................14

         Section 31.       Removal...............................................................................14

ARTICLE VI                 Execution Of Corporate Instruments And Voting Of Securities Owned By The
                           Corporation...........................................................................14

         Section 32.       Execution of Corporate Instruments....................................................14

         Section 33.       Voting of Securities Owned by the Corporation.........................................15

ARTICLE VII                Shares Of Stock.......................................................................15

         Section 34.       Form and Execution of Certificates....................................................15

         Section 35.       Lost Certificates.....................................................................15





                               TABLE OF CONTENTS
                                  (CONTINUED)

                                                                                                              
         Section 36.       Transfers.............................................................................16

         Section 37.       Fixing Record Dates...................................................................16

         Section 38.       Registered Stockholders...............................................................17

ARTICLE VIII               Other Securities Of The Corporation...................................................17

         Section 39.       Execution of Other Securities.........................................................17

ARTICLE IX                 Dividends.............................................................................18

         Section 40.       Declaration of Dividends..............................................................18

         Section 41.       Dividend Reserve......................................................................18

ARTICLE X                  Fiscal Year...........................................................................18

         Section 42.       Fiscal Year...........................................................................18

ARTICLE XI                 Indemnification.......................................................................18

         Section 43.       Indemnification of Directors, Officers, Employees and Other Agents....................18

                (a)        Directors and Executive Officers......................................................18

                (b)        Other Officers, Employees and Other Agents............................................18

                (c)        Good Faith............................................................................19

                (d)        Expenses..............................................................................19

                (e)        Enforcement...........................................................................20

                (f)        Non-Exclusivity of Rights.............................................................20

                (g)        Survival of Rights....................................................................20

                (h)        Insurance.............................................................................20

                (i)        Amendments............................................................................21

                (j)        Saving Clause.........................................................................21

                (k)        Certain Definitions...................................................................21

ARTICLE XII                Notices...............................................................................22

         Section 44.       Notices...............................................................................22

                (a)        Notice to Stockholders................................................................22

                (b)        Notice to Directors...................................................................22

                (c)        Affidavit of Mailing..................................................................22

                (d)        Time Notices Deemed Given.............................................................22





                               TABLE OF CONTENTS
                                  (CONTINUED)

                                                                                                              

                (e)        Methods of Notice.....................................................................22

                (f)        Failure to Receive Notice.............................................................22

                (g)        Notice to Person with Whom Communication is Unlawful..................................23

                (h)        Notice to Person with Undeliverable Address...........................................23

ARTICLE XIII               Amendments............................................................................23

         Section 45.       Amendments............................................................................23







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this section break if you plan to add text after the Table of
Contents/Authorities. Deleting this break will cause Table of
Contents/Authorities headers and footers to appear on any pages following the
Table of Contents/Authorities.





                        FIRST AMENDED AND RESTATED BYLAWS

                                       OF

                         PACIFICARE HEALTH SYSTEMS, INC.
                            (A DELAWARE CORPORATION)


                                    ARTICLE I

                                     OFFICES

         SECTION 1. REGISTERED OFFICE. The registered office of the corporation
in the State of Delaware shall be in the City of Wilmington, County of New
Castle.

         SECTION 2. OTHER OFFICES. The corporation shall also have and maintain
an office or principal place of business at such place as may be fixed by the
Board of Directors, and may also have offices at such other places, both within
and without the State of Delaware as the Board of Directors may from time to
time determine or the business of the corporation may require.

                                   ARTICLE II

                                 CORPORATE SEAL

         SECTION 3. CORPORATE SEAL. The corporate seal shall consist of a die
bearing the name of the corporation and the inscription, "Corporate
Seal-Delaware." Said seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise.

                                   ARTICLE III

                             STOCKHOLDERS' MEETINGS

         SECTION 4. PLACE OF MEETINGS. Meetings of the stockholders of the
corporation shall be held at such place, either within or without the State of
Delaware, as may be designated from time to time by the Board of Directors, or,
if not so designated, then at the office of the corporation required to be
maintained pursuant to Section 2 hereof.

         SECTION 5. ANNUAL MEETING.

                  (a) The annual meeting of the stockholders of the corporation,
for the purpose of election of directors and for such other business as may
lawfully come before it, shall be held on such date and at such time as may be
designated from time to time by the Board of Directors. Nominations of persons
for election to the Board of Directors of the corporation and the proposal of
business to be considered by the stockholders may be made at an annual meeting
of stockholders: (i) pursuant to the corporation's notice of meeting of
stockholders; (ii) by or at the direction of the Board of Directors; or (iii) by
any stockholder of the corporation who was a stockholder of record at the time
of giving of notice provided for in the following paragraph,

                                       1.




who is entitled to vote at the meeting and who complied with the notice
procedures set forth in this Section 5.

                  (b) At an annual meeting of the stockholders, only such
business shall be conducted as shall have been properly brought before the
meeting. For nominations or other business to be properly brought before an
annual meeting by a stockholder pursuant to clause (iii) of Section 5(a) of
these Bylaws: (i) the stockholder must have given timely notice thereof in
writing to the Secretary of the corporation; (ii) such other business must be a
proper matter for stockholder action under the Delaware General Corporation Law;
(iii) if the stockholder, or the beneficial owner on whose behalf any such
proposal or nomination is made, has provided the corporation with a Solicitation
Notice (as defined in this Section 5(b)), such stockholder or beneficial owner
must, in the case of a proposal, have delivered a proxy statement and form of
proxy to holders of at least the percentage of the corporation's voting shares
required under applicable law to carry any such proposal, or, in the case of a
nomination or nominations, have delivered a proxy statement and form of proxy to
holders of a percentage of the corporation's voting shares reasonably believed
by such stockholder or beneficial owner to be sufficient to elect the nominee or
nominees proposed to be nominated by such stockholder, and must, in either case,
have included in such materials the Solicitation Notice; and (iv) if no
Solicitation Notice relating thereto has been timely provided pursuant to this
section, the stockholder or beneficial owner proposing such business or
nomination must not have solicited a number of proxies sufficient to have
required the delivery of such a Solicitation Notice under this Section 5. To be
timely, a stockholder's notice shall be delivered to the Secretary at the
principal executive offices of the Corporation not later than the close of
business on the ninetieth (90th) day nor earlier than the close of business on
the one hundred twentieth (120th) day prior to the first anniversary of the
preceding year's annual meeting; provided, however, that in the event that the
date of the annual meeting is advanced more than thirty (30) days prior to or
delayed by more than thirty (30) days after the anniversary of the preceding
year's annual meeting, notice by the stockholder to be timely must be so
delivered not earlier than the close of business on the one hundred twentieth
(120th) day prior to such annual meeting and not later than the close of
business on the later of the ninetieth (90th) day prior to such annual meeting
or the tenth (10th) day following the day on which public announcement of the
date of such meeting is first made. In no event shall the public announcement of
an adjournment of an annual meeting commence a new time period for the giving of
a stockholder's notice as described above. Such stockholder's notice shall set
forth: (A) as to each person whom the stockholder proposed to nominate for
election or reelection as a director all information relating to such person
that is required to be disclosed in solicitations of proxies for election of
directors in an election contest, or is otherwise required, in each case
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended
(the "1934 Act") and Rule 14a-11 thereunder (including such person's written
consent to being named in the proxy statement as a nominee and to serving as a
director if elected); (B) as to any other business that the stockholder proposes
to bring before the meeting, a brief description of the business desired to be
brought before the meeting, the reasons for conducting such business at the
meeting and any material interest in such business of such stockholder and the
beneficial owner, if any, on whose behalf the proposal is made; and (C) as to
the stockholder giving the notice and the beneficial owner, if any, on whose
behalf the nomination or proposal is made (i) the name and address of such
stockholder, as they appear on the corporation's books, and of such beneficial
owner, (ii) the class and number of shares of the corporation which are owned
beneficially and of record by such stockholder and such beneficial owner, and
(iii)

                                       2.



whether either such stockholder or beneficial owner intends to deliver a proxy
statement and form of proxy to holders of, in the case of the proposal, at least
the percentage of the corporation's voting shares required under applicable law
to carry the proposal or, in the case of a nomination or nominations, a
sufficient number of holders of the corporation's voting shares to elect such
nominee or nominees (an affirmative statement of such intent, a "Solicitation
Notice").

                  (c) Notwithstanding anything in the second sentence of Section
5(b) of these Bylaws to the contrary, in the event that the number of directors
to be elected to the Board of Directors of the Corporation is increased and
there is no public announcement naming all of the nominees for director or
specifying the size of the increased Board of Directors made by the corporation
at least one hundred (100) days prior to the first anniversary of the preceding
year's annual meeting, a stockholder's notice required by this Section 5 shall
also be considered timely, but only with respect to nominees for any new
positions created by such increase, if it shall be delivered to the Secretary at
the principal executive offices of the corporation not later than the close of
business on the tenth (10th) day following the day on which such public
announcement is first made by the corporation.

                  (d) Only such persons who are nominated in accordance with the
procedures set forth in this Section 5 shall be eligible to serve as directors
and only such business shall be conducted at a meeting of stockholders as shall
have been brought before the meeting in accordance with the procedures set forth
in this Section 5. Except as otherwise provided by law, the Chairman of the
meeting shall have the power and duty to determine whether a nomination or any
business proposed to be brought before the meeting was made, or proposed, as the
case may be, in accordance with the procedures set forth in these Bylaws and, if
any proposed nomination or business is not in compliance with these Bylaws, to
declare that such defective proposal or nomination shall not be presented for
stockholder action at the meeting and shall be disregarded.

                  (e) Notwithstanding the foregoing provisions of this Section
5, in order to include information with respect to a stockholder proposal in the
proxy statement and form of proxy for a stockholder's meeting, stockholders must
provide notice as required by the regulations promulgated under the 1934 Act.
Nothing in these Bylaws shall be deemed to affect any rights of stockholders to
request inclusion of proposals in the corporation's proxy statement pursuant to
Rule 14a-8 under the 1934 Act.

                  (f) For purposes of this Section 5, "public announcement"
shall mean disclosure in a press release reported by the Dow Jones News Service,
Associated Press or comparable national news service or in a document publicly
filed by the corporation with the Securities and Exchange Commission pursuant to
Section 13, 14 or 15(d) of the 1934 Act.

         SECTION 6. SPECIAL MEETINGS.

                  (a) Special meetings of the stockholders of the corporation
may be called, for any purpose or purposes, by (i) the Chairman of the Board of
Directors, (ii) the Chief Executive Officer, (iii) the President, or (iv) the
Board of Directors, pursuant to a resolution adopted by a majority of the total
number of authorized directors (whether or not there exist any vacancies in

                                       3.



previously authorized directorships at the time any such resolution is presented
to the Board for adoption) and shall be held at such place, on such date, and at
such time as they or he shall fix.

                  (b) If a special meeting is properly called by any person or
persons other than the Board of Directors, the request shall be in writing,
specifying the time of such meeting and the general nature of the business
proposed to be transacted, and shall be delivered personally or sent by
registered mail or by telegraphic or other facsimile transmission to the
Chairman of the Board of Directors, the Chief Executive Officer, the President,
any Vice President, or the Secretary of the corporation (or if called by one of
such officers to an alternative officer listed above) for delivery to the Board
of Directors. No business may be transacted at such special meeting otherwise
than specified in such notice. The Board of Directors shall determine the time
and place of such special meeting, which shall be held not less than thirty-five
(35) nor more than one hundred twenty (120) days after the date of the receipt
of the request. Upon determination of the time and place of the meeting, the
officer receiving the request shall cause notice to be given to the stockholders
entitled to vote, in accordance with the provisions of Section 7 of these
Bylaws. If the notice is not given within one hundred (100) days after the
receipt of the request, the person or persons properly requesting the meeting
may set the time and place of the meeting and give the notice. Nothing contained
in this paragraph (b) shall be construed as limiting, fixing, or affecting the
time when a meeting of stockholders called by action of the Board of Directors
may be held.

                  (c) Nominations of persons for election to the Board of
Directors may be made at a special meeting of stockholders at which directors
are to be elected pursuant to the corporation's notice of meeting (i) by or at
the direction of the Board of Directors or (ii) by any stockholder of the
corporation who is a stockholder of record at the time of giving notice provided
for in these Bylaws who shall be entitled to vote at the meeting and who
complies with the notice procedures set forth in this Section 6(c). In the event
the corporation calls a special meeting of stockholders for the purpose of
electing one or more directors to the Board of Directors, any such stockholder
may nominate a person or persons (as the case may be), for election to such
position(s) as specified in the corporation's notice of meeting, if the
stockholder's notice required by Section 5(b) of these Bylaws shall be delivered
to the Secretary at the principal executive offices of the corporation not
earlier than the close of business on the one hundred twentieth (120th) day
prior to such special meeting and not later than the close of business on the
later of the ninetieth (90th) day prior to such meeting or the tenth (10th) day
following the day on which public announcement is first made of the date of the
special meeting and of the nominees proposed by the Board of Directors to be
elected at such meeting. In no event shall the public announcement of an
adjournment of a special meeting commence a new time period for the giving of a
stockholder's notice as described above

         SECTION 7. NOTICE OF MEETINGS. Except as otherwise provided by law,
written notice of each meeting of stockholders shall be given not less than ten
(10) nor more than sixty (60) days before the date of the meeting to each
stockholder entitled to vote at such meeting, such notice to specify the place,
date and hour and purpose or purposes of the meeting. Notice of the time, place
and purpose of any meeting of stockholders may be waived in writing, signed by
the person entitled to notice thereof, either before or after such meeting, and
will be waived by any stockholder by his attendance thereat in person or by
proxy, except when the stockholder attends a meeting for the express purpose of
objecting, at the beginning of the meeting, to the transaction


                                       4.




of any business because the meeting is not lawfully called or convened. Any
stockholder so waiving notice of such meeting shall be bound by the proceedings
of any such meeting in all respects as if due notice thereof had been given.

         SECTION 8. QUORUM. At all meetings of stockholders, except where
otherwise provided by statute or by the Certificate of Incorporation, or by
these Bylaws, the presence, in person or by proxy duly authorized, of the
holders of a majority of the outstanding shares of stock entitled to vote shall
constitute a quorum for the transaction of business. In the absence of a quorum
any meeting of stockholders may be adjourned, from time to time, either by the
chairman of the meeting or by vote of the holders of a majority of the shares
represented thereat, but no other business shall be transacted at such meeting.
The stockholders present at a duly called or convened meeting, at which a quorum
is present, may continue to transact business until adjournment, notwithstanding
the withdrawal of enough stockholders to leave less than a quorum. Except as
otherwise provided by statute, by Articles VI(C) and VII of the Certificate of
Incorporation relating to removal of directors and approval of certain Business
Transactions, or these Bylaws, in all matters other than the election of
directors, the affirmative vote of the majority of shares present in person or
represented by proxy at the meeting and entitled to vote subject matter shall be
the act of the stockholders. Except as otherwise provided by statute or these
Bylaws, directors shall be elected by a plurality of the votes of the shares
present in person or represented by proxy at the meeting and entitled to vote on
the election of directors. Where a separate vote by a class or classes or series
is required, except as otherwise provided by statute, by Articles VI(C) and VII
of the Certificate of Incorporation relating to removal of directors and
approval of certain Business Transactions or these Bylaws, a majority of the
outstanding shares of such class or classes or series, present in person or
represented by proxy, shall constitute a quorum entitled to take action with
respect to that vote on that matter and, except where otherwise provided by
statute, the aforementioned Articles of the Certificate of Incorporation or
these Bylaws, the affirmative vote of the majority (plurality, in the case of
the election of directors) of the votes cast by the holders of shares of such
class or classes or series shall be the act of such class or classes or series.

         SECTION 9. ADJOURNMENT AND NOTICE OF ADJOURNED MEETINGS. Any meeting of
stockholders, whether annual or special, may be adjourned from time to time
either by the chairman of the meeting or by the vote of a majority of the shares
casting votes. When a meeting is adjourned to another time or place, notice need
not be given of the adjourned meeting if the time and place thereof are
announced at the meeting at which the adjournment is taken. At the adjourned
meeting the corporation may transact any business which might have been
transacted at the original meeting. If the adjournment is for more than thirty
(30) days, or if after the adjournment a new record date is fixed for the
adjourned meeting, a notice of the adjourned meeting shall be given to each
stockholder of record entitled to vote at the meeting.

         SECTION 10. VOTING RIGHTS. For the purpose of determining those
stockholders entitled to vote at any meeting of the stockholders, except as
otherwise provided by law, only persons in whose names shares stand on the stock
records of the corporation on the record date, as provided in Section 12 of
these Bylaws, shall be entitled to vote at any meeting of stockholders. Every
person entitled to vote or execute consents shall have the right to do so either
in person or by an agent or agents authorized by a proxy granted in accordance
with

                                       5.




Delaware law. An agent so appointed need not be a stockholder. No proxy shall be
voted after three (3) years from its date of creation unless the proxy provides
for a longer period.

         SECTION 11. JOINT OR BENEFICIAL OWNERS OF STOCK.

                  (a) If shares or other securities having voting power stand of
record in the names of two (2) or more persons, whether fiduciaries, members of
a partnership, joint tenants, tenants in common, tenants by the entirety, or
otherwise, or if two (2) or more persons have the same fiduciary relationship
respecting the same shares, unless the Secretary is given written notice to the
contrary and is furnished with a copy of the instrument or order appointing them
or creating the relationship wherein it is so provided, their acts with respect
to voting shall have the following effect: (a) if only one (1) votes, his act
binds all; (b) if more than one (1) votes, the act of the majority so voting
binds all; (c) if more than one (1) votes, but the vote is evenly split on any
particular matter, each faction may vote the securities in question
proportionally, or may apply to the Delaware Court of Chancery for relief as
provided in the Delaware General Corporation Law, Section 217(b). If the
instrument filed with the Secretary shows that any such tenancy is held in
unequal interests, a majority or even-split for the purpose of this subsection
(c) shall be a majority or even-split in interest.

         SECTION 12. LIST OF STOCKHOLDERS. The Secretary shall prepare and make,
at least ten (10) days before every meeting of stockholders, a complete list of
the stockholders entitled to vote at said meeting, arranged in alphabetical
order, showing the address of each stockholder and the number of shares
registered in the name of each stockholder. Such list shall be open to the
examination of any stockholder, for any purpose germane to the meeting, during
ordinary business hours, for a period of at least ten (10) days prior to the
meeting, either at a place within the city where the meeting is to be held,
which place shall be specified in the notice of the meeting, or, if not
specified, at the place where the meeting is to be held. The list shall be
produced and kept at the time and place of meeting during the whole time
thereof, and may be inspected by any stockholder who is present.

         SECTION 13. ACTION WITHOUT MEETING.

                  (a) Any action required by statute to be taken at any annual
or special meeting of the stockholders, or any action which may be taken at any
annual or special meeting of the stockholders, may be taken without a meeting,
without prior notice and without a vote, if a consent in writing, setting forth
the action so taken, shall be signed by the holders of outstanding stock having
not less than the minimum number of votes that would be necessary to authorize
or take such action at a meeting at which all shares entitled to vote thereon
were present and voted.

                  (b) Every written consent shall bear the date of signature of
each stockholder who signs the consent, and no written consent shall be
effective to take the corporate action referred to therein unless, within sixty
(60) days of the earliest dated consent delivered to the corporation in the
manner herein required, written consents signed by a sufficient number of
stockholders to take action are delivered to the corporation by delivery to its
registered office in the State of Delaware, its principal place of business or
an officer or agent of the corporation having custody of the book in which
proceedings of meetings of stockholders are recorded.


                                       6.




Delivery made to a corporation's registered office shall be by hand or by
certified or registered mail, return receipt requested.

                  (c) Prompt notice of the taking of the corporate action
without a meeting by less than unanimous written consent shall be given to those
stockholders who have not consented in writing. If the action which is consented
to is such as would have required the filing of a certificate under any section
of the Delaware General Corporation Law if such action had been voted on by
stockholders at a meeting thereof, then the certificate filed under such section
shall state, in lieu of any statement required by such section concerning any
vote of stockholders, that written consent has been given in accordance with
Section 228 of the Delaware General Corporation Law.

         SECTION 14. ORGANIZATION.

                  (a) At every meeting of stockholders, the Chairman of the
Board of Directors, or, if a Chairman has not been appointed or is absent, the
President, or, if the President is absent the most senior Vice President
present, or in the absence of any such officer, a chairman of the meeting chosen
by a majority in interest of the stockholders entitled to vote, present in
person or by proxy, shall act as chairman. The Secretary, or, in his absence, an
Assistant Secretary directed to do so by the President, shall act as secretary
of the meeting.

                  (b) The Board of Directors of the corporation shall be
entitled to make such rules or regulations for the conduct of meetings of
stockholders as it shall deem necessary, appropriate or convenient. Subject to
such rules and regulations of the Board of Directors, if any, the chairman of
the meeting shall have the right and authority to prescribe such rules,
regulations and procedures and to do all such acts as, in the judgment of such
chairman, are necessary, appropriate or convenient for the proper conduct of the
meeting, including, without limitation, establishing an agenda or order of
business for the meeting, rules and procedures for maintaining order at the
meeting and the safety of those present, limitations on participation in such
meeting to stockholders of record of the corporation and their duly authorized
and constituted proxies, and such other persons as the chairman shall permit,
restrictions on entry to the meeting after the time fixed for the commencement
thereof, limitations on the time allotted to questions or comments by
participants and regulation of the opening and closing of the polls for
balloting on matters which are to be voted on by ballot. Unless, and to the
extent determined by the Board of Directors or the chairman of the meeting,
meetings of stockholders shall not be required to be held in accordance with
rules of parliamentary procedure.

                                   ARTICLE IV

                                    DIRECTORS

         SECTION 15. NUMBER AND TERM OF OFFICE. The authorized number of
directors of the corporation shall be not more than twelve (12) nor less than
five (5) with the actual number of authorized directors within this range to be
fixed from time to time by resolution of the Board of Directors. Directors need
not be stockholders unless so required by the Certificate of Incorporation. If
for any cause, the directors shall not have been elected at an annual meeting,

                                       7.




they may be elected as soon thereafter as convenient at a special meeting of the
stockholders called for that purpose in the manner provided in these Bylaws.

         SECTION 16. LEAD INDEPENDENT DIRECTOR. The Board of Directors may
appoint a Lead Independent Director from among the independent directors serving
on the Board of Directors who shall have such duties as may be prescribed by
resolution of the Board of Directors, or by policy or guidelines approved by
resolution of the Board of Directors.

         SECTION 17. POWERS. The powers of the corporation shall be exercised,
its business conducted and its property controlled by the Board of Directors,
except as may be otherwise provided by statute or by the Certificate of
Incorporation.

         SECTION 18. VACANCIES.

                  (a) Unless otherwise provided in the Certificate of
Incorporation, any vacancies on the Board of Directors resulting from death,
resignation, disqualification, removal or other causes and any newly created
directorships resulting from any increase in the number of Directors shall,
unless the Board of Directors determines by resolution that any such vacancies
or newly created directorships shall be filled by stockholders, be filled only
by the affirmative vote of a majority of the directors then in office, even
though less than a quorum of the Board of Directors. Any director elected in
accordance with the preceding sentence shall hold office for the remainder of
the full term of the Director for which the vacancy was created or occurred and
until such director's successor shall have been elected and qualified. A vacancy
in the Board of Directors shall be deemed to exist under this Section 18 in the
case of the death, removal or resignation of any Director.

                  (b) If at the time of filling any vacancy or any newly created
directorship, the directors then in office shall constitute less than a majority
of the whole board (as constituted immediately prior to any such increase), the
Delaware Court of Chancery may, upon application of any stockholder or
stockholders holding at least ten percent (10%) of the total number of the
shares at the time outstanding having the right to vote for such directors,
summarily order an election to be held to fill any such vacancies or newly
created directorships, or to replace the directors chosen by the directors then
in offices as aforesaid, which election shall be governed by Section 211 of the
Delaware General Corporation Law.

         SECTION 19. RESIGNATION. Any director may resign at any time by
delivering his written resignation to the Secretary, such resignation to specify
whether it will be effective at a particular time, upon receipt by the Secretary
or at the pleasure of the Board of Directors. If no such specification is made,
it shall be deemed effective at the pleasure of the Board of Directors. When one
or more directors shall resign from the Board of Directors, effective at a
future date, a majority of the directors then in office, including those who
have so resigned, shall have power to fill such vacancy or vacancies, the vote
thereon to take effect when such resignation or resignations shall become
effective, and each Director so chosen shall hold office for the unexpired
portion of the term of the Director whose place shall be vacated and until his
successor shall have been duly elected and qualified.

                                       8.




         SECTION 20. REMOVAL. Subject to any limitation imposed by law, any
individual director or directors may be removed with or without cause by the
affirmative vote of at least two-thirds of the voting power of the corporation
entitled to vote at an election of directors.

         SECTION 21. MEETINGS.

                  (a) ANNUAL MEETINGS. The annual meeting of the Board of
Directors shall be held immediately before or after the annual meeting of
stockholders and at the place where such meeting is held. No notice of an annual
meeting of the Board of Directors shall be necessary and such meeting shall be
held for the purpose of electing officers and transacting such other business as
may lawfully come before it.

                  (b) REGULAR MEETINGS. Unless otherwise restricted by the
Certificate of Incorporation, regular meetings of the Board of Directors may be
held at any time or date and at any place within or without the State of
Delaware which has been designated by the Board of Directors and publicized
among all directors. No formal notice shall be required for regular meetings of
the Board of Directors.

                  (c) SPECIAL MEETINGS. Unless otherwise restricted by the
Certificate of Incorporation, special meetings of the Board of Directors may be
held at any time and place within or without the State of Delaware whenever
called by the Chairman of the Board, the President or any two of the directors.

                  (d) TELEPHONE MEETINGS. Any member of the Board of Directors,
or of any committee thereof, may participate in a meeting by means of conference
telephone or similar communications equipment by means of which all persons
participating in the meeting can hear each other, and participation in a meeting
by such means shall constitute presence in person at such meeting.

                  (e) NOTICE OF MEETINGS. Notice of the time and place of all
special meetings of the Board of Directors shall be orally or in writing, by
telephone, including a voice messaging system or other system or technology
designed to record and communicate messages, facsimile, telegraph or telex, or
by electronic mail or other electronic means, during normal business hours, at
least twenty-four (24) hours before the date and time of the meeting, or sent in
writing to each director by first class mail, charges prepaid, at least two (2)
days before the date of the meeting. Notice of any meeting may be waived in
writing at any time before or after the meeting and will be waived by any
director by attendance thereat, except when the director attends the meeting for
the express purpose of objecting, at the beginning of the meeting, to the
transaction of any business because the meeting is not lawfully called or
convened.

                  (f) WAIVER OF NOTICE. The transaction of all business at any
meeting of the Board of Directors, or any committee thereof, however called or
noticed, or wherever held, shall be as valid as though had at a meeting duly
held after regular call and notice, if a quorum be present and if, either before
or after the meeting, each of the directors not present shall sign a written
waiver of notice. All such waivers shall be filed with the corporate records or
made a part of the minutes of the meeting.

         SECTION 22. QUORUM AND VOTING.

                                       9.




                  (a) Unless the Certificate of Incorporation requires a greater
number and except with respect to indemnification questions arising under
Section 43 hereof, for which a quorum shall be one-third of the exact number of
Directors fixed from time to time in accordance with Section 15 hereof, but not
less than one (1), a quorum of the Board of Directors shall consist of a
majority of the exact number of directors fixed from time to time by the Board
of Directors in accordance with Section 15 of these Bylaws, but not less than
one (1); provided, however, at any meeting whether a quorum be present or
otherwise, a majority of the Directors present may adjourn from time to time
until the time fixed for the next regular meeting of the Board of directors,
without notice other than by announcement at the meeting.

                  (b) At each meeting of the Board of Directors at which a
quorum is present all questions and business shall be determined by the
affirmative vote of a majority of the directors present, unless a different vote
be required by law, the Certificate of Incorporation or these Bylaws.

         SECTION 23. ACTION WITHOUT MEETING. Unless otherwise restricted by the
Certificate of Incorporation or these Bylaws, any action required or permitted
to be taken at any meeting of the Board of Directors or of any committee thereof
may be taken without a meeting, if all members of the Board of Directors or
committee, as the case may be, consent thereto in writing, and such writing or
writings are filed with the minutes of proceedings of the Board of Directors or
committee.

         SECTION 24. FEES AND COMPENSATION. Directors shall be entitled to such
compensation for their services as may be approved by the Board of Directors,
including, if so approved, by resolution of the Board of Directors, a fixed sum
and expenses of attendance, if any, for attendance at each regular or special
meeting of the Board of Directors and at any meeting of a committee of the Board
of Directors. Nothing herein contained shall be construed to preclude any
director from serving the corporation in any other capacity as an officer,
agent, employee, or otherwise and receiving compensation therefor.

         SECTION 25. COMMITTEES.

                  (a) COMMITTEES. The Board of Directors may from time to time
appoint such committees as may be permitted by law. Such committees appointed by
the Board of Directors shall consist of one (1) or more members of the Board of
Directors, and shall have such powers and perform such duties as may be
prescribed by the resolution or resolutions creating such committees, but in no
event shall any such committee have the power or authority in reference to (i)
approving or adopting, or recommending to the stockholders, any action or matter
expressly required by the Delaware General Corporation Law to be submitted to
stockholders for approval, or (ii) adopting, amending or repealing any bylaw of
the corporation.

                  (b) TERM. Each member of a committee of the Board of Directors
shall serve a term on such committee coexistent with such member's term on the
Board of Directors. The Board of Directors, subject to the provisions of
subsections (a) or (b) of this Bylaw, may at any time increase or decrease the
number of members of a committee or terminate the existence of a committee. The
membership of a committee member shall terminate on the date of his death or
voluntary resignation from the committee or from the Board of Directors. The
Board of Directors


                                      10.



may at any time for any reason remove any individual committee member and the
Board of Directors may fill any committee vacancy created by death, resignation,
removal or increase in the number of members of the committee. The Board of
Directors may designate one or more directors as alternate members of any
committee, who may replace any absent or disqualified member at any meeting of
the committee, and, in addition, in the absence or disqualification of any
member of a committee, the member or members thereof present at any meeting and
not disqualified from voting, whether or not he or they constitute a quorum, may
unanimously appoint another member of the Board of Directors to act at the
meeting in the place of any such absent or disqualified member.

                  (c) MEETINGS. Unless the Board of Directors shall otherwise
provide, regular meetings of any committee appointed pursuant to this Section 25
shall be held at such times and places as are determined by the Board of
Directors, or by any such committee, and when notice thereof has been given to
each member of such committee, no further notice of such regular meetings need
be given thereafter. Special meetings of any such committee may be held at any
place which has been determined from time to time by such committee, and may be
called by any director who is a member of such committee, upon written notice to
the members of such committee of the time and place of such special meeting
given in the manner provided for the giving of written notice to members of the
Board of Directors of the time and place of special meetings of the Board of
Directors. Notice of any special meeting of any committee may be waived in
writing at any time before or after the meeting and will be waived by any
director by attendance thereat, except when the director attends such special
meeting for the express purpose of objecting, at the beginning of the meeting,
to the transaction of any business because the meeting is not lawfully called or
convened. A majority of the authorized number of members of any such committee
shall constitute a quorum for the transaction of business, and the act of a
majority of those present at any meeting at which a quorum is present shall be
the act of such committee.

         SECTION 26. ORGANIZATION. At every meeting of the directors, the
Chairman of the Board of Directors, or, if a Chairman has not been appointed or
is absent, the President (if a Director), or if the President is absent, the
most senior Vice President (if a Director), or, in the absence of any such
person, a chairman of the meeting chosen by a majority of the directors present,
shall preside over the meeting. The Secretary, or in his absence, any Assistant
Secretary directed to do so by the President, shall act as secretary of the
meeting.

                                    ARTICLE V

                                    OFFICERS

         SECTION 27. OFFICERS DESIGNATED. The officers of the corporation shall
include a Chief Executive Officer (who shall be either the Chairman of the Board
or President, as provided in these Bylaws), a President, a Chief Operating
Officer, a Secretary and a Chief Financial Officer or Treasurer. The Corporation
may also have, at the discretion of the Board of Directors such other officers
as are desired, including a Chairman of the Board of Directors, a Vice Chairman
of the Board of Directors, one or more Vice Presidents, one or more Assistant
Secretaries, one or more Assistant Treasurers, and such other officers and
agents with such powers and duties as it shall deem necessary, all of whom shall
be elected at the annual organizational meeting of the

                                      11.




Board of Directors. The order of the seniority of the Vice Presidents shall be
in the order of their nomination, unless otherwise determined by the Board of
Directors. The Board of Directors may assign such additional titles to one or
more of the officers as it shall deem appropriate. Any one person may hold any
number of offices of the corporation at any one time unless specifically
prohibited therefrom by law. The salaries and other compensation of the officers
of the corporation shall be fixed by or in the manner designated by the Board of
Directors.

         SECTION 28. TENURE AND DUTIES OF OFFICERS.

                  (a) GENERAL. All officers shall hold office at the pleasure of
the Board of Directors and until their successors shall have been duly elected
and qualified, unless sooner removed. Any officer elected or appointed by the
Board of Directors may be removed at any time by the Board of Directors. If the
office of any officer becomes vacant for any reason, the vacancy may be filled
by the Board of Directors.

                  (b) DUTIES OF CHAIRMAN OF THE BOARD OF DIRECTORS. The Chairman
of the Board of Directors, if such an officer is elected, shall preside when
present at all meetings of the stockholders and the Board of Directors. The
Chairman of the Board of Directors shall perform other duties commonly incident
to his office and shall also perform such other duties and have such other
powers as the Board of Directors shall designate from time to time. If there is
a Chairman of the Board of Directors and if the Board of Directors designates
such Chairman of the Board of Directors as the Chief Executive Officer of the
corporation, then the Chairman of the Board of Directors shall also have the
powers and duties prescribed in paragraph (d) of this Section 28.

                  (c) DUTIES OF VICE CHAIRMAN OF THE BOARD OF DIRECTORS. The
Vice Chairman of the Board, if such an officer is elected, shall be a director
and shall preside at all meetings of the Board of Directors for which the
Chairman of the Board is absent or unavailable. The Vice Chairman shall perform
such other duties as may be prescribed periodically by the Chairman of the Board
or the Board of Directors.

                  (d) DUTIES OF CHIEF EXECUTIVE OFFICER. If there is a Chairman
of the Board and the Board of Directors designates the Chairman of the Board as
the Chief Executive Officer, then the Chairman of the Board shall be the Chief
Executive Officer of the corporation. Otherwise, the President shall be the
Chief Executive Officer of the corporation. The Chief Executive Officer shall
preside at all meetings of the stockholders and at all meetings of the Board of
Directors, unless a Chairman or Vice Chairman of the Board of Directors has been
appointed and is present. The Chief Executive Officer shall be an ex-officio
member of all committees and shall, subject to the control of the Board of
Directors and such supervisory powers, if any, as may be given by the Board of
Directors to the Chairman of the Board or the Vice Chairman of the Board, if
there be such officers, shall have general supervision, direction and control of
the business and officers of the corporation, shall have such duties and
authority as are normally incident to the office of chief executive officer of a
corporation and such duties and authority as may be prescribed from time to time
by the Board of Directors or as are provided for elsewhere in these Bylaws.

                                      12.




                  (e) DUTIES OF PRESIDENT AND CHIEF OPERATING OFFICER. If there
is a Chairman of the Board who is also the Chief Executive Officer, then the
President shall be the Chief Operating Officer. If the President is the Chief
Executive Officer, then the President shall also serve as the Chief Operating
Officer unless the Board of Directors designates another officer of the
corporation as the Chief Operating Officer. Subject to the direction and control
of the Chief Executive Officer and the Board of Directors, the President and
Chief Operating Officer shall supervise and control the operations of the
corporation, shall have the duties and authority as are normally incident to the
office of president and chief operating officer of a corporation and such other
duties as may be prescribed from time to time by the Chief Executive Officer or
the Board of Directors, and, in the absence or disability of the Chief Executive
Officer, shall have the authority and perform the duties of the Chief Executive
Officer.

                  (f) DUTIES OF VICE PRESIDENTS. The Vice Presidents, in the
order of their seniority, may assume and perform the duties of the President in
the absence or disability of the President or whenever the office of President
is vacant. The Vice Presidents shall perform other duties commonly incident to
their office and shall also perform such other duties and have such other powers
as the Board of Directors or the President shall designate from time to time.

                  (g) DUTIES OF SECRETARY. The Secretary shall attend all
meetings of the stockholders and of the Board of Directors, and shall record all
acts and proceedings thereof in the minute book of the corporation. The
Secretary shall give notice in conformity with these Bylaws of all meetings of
the stockholders, and of all meetings of the Board of Directors and any
committee thereof requiring notice. The Secretary shall perform all other duties
given him in these Bylaws and other duties commonly incident to his office and
shall also perform such other duties and have such other powers as the Board of
Directors shall designate from time to time. The President may direct any
Assistant Secretary to assume and perform the duties of the Secretary in the
absence or disability of the Secretary, and each Assistant Secretary shall
perform other duties commonly incident to his office and shall also perform such
other duties and have such other powers as the Board of Directors or the
President shall designate from time to time.

                  (h) DUTIES OF CHIEF FINANCIAL OFFICER OR TREASURER. The Chief
Financial Officer or Treasurer shall keep or cause to be kept the books of
account of the corporation in a thorough and proper manner, and shall render
statements of the financial affairs of the corporation in such form and as often
as required by the Board of Directors or the President. The Chief Financial
Officer or Treasurer, subject to the order of the Board of Directors, shall have
the custody of all funds and securities of the corporation. The Chief Financial
Officer or Treasurer shall perform other duties commonly incident to his office
and shall also perform such other duties and have such other powers as the Board
of Directors or the President shall designate from time to time. The President
may direct any Assistant Treasurer to assume and perform the duties of the Chief
Financial Officer or Treasurer in the absence or disability of the Chief
Financial Officer or Treasurer, and each Assistant Treasurer shall perform other
duties commonly incident to his office and shall also perform such other duties
and have such other powers as the Board of Directors or the President shall
designate from time to time.

         SECTION 29. DELEGATION OF AUTHORITY. The Board of Directors may from
time to time delegate the powers or duties of any officer to any other officer
or agent, notwithstanding any provision hereof.

                                      13.



         SECTION 30. RESIGNATIONS. Any officer may resign at any time by giving
written notice to the Board of Directors or to the President or to the
Secretary. Any such resignation shall be effective when received by the person
or persons to whom such notice is given, unless a later time is specified
therein, in which event the resignation shall become effective at such later
time. Unless otherwise specified in such notice, the acceptance of any such
resignation shall not be necessary to make it effective. Any resignation shall
be without prejudice to the rights, if any, of the corporation under any
contract with the resigning officer.

         SECTION 31. REMOVAL. Any officer may be removed from office at any
time, either with or without cause, by the affirmative vote of a majority of the
directors in office at the time, or by the unanimous written consent of the
directors in office at the time, or by any committee or superior officers upon
whom such power of removal may have been conferred by the Board of Directors.

                                   ARTICLE VI

                     EXECUTION OF CORPORATE INSTRUMENTS AND
                  VOTING OF SECURITIES OWNED BY THE CORPORATION

         SECTION 32. EXECUTION OF CORPORATE INSTRUMENTS. The Board of Directors
may, in its discretion, determine the method and designate the signatory officer
or officers, or other person or persons, to execute on behalf of the corporation
any corporate instrument or document, or to sign on behalf of the corporation
the corporate name without limitation, or to enter into contracts on behalf of
the corporation, except where otherwise provided by law or these Bylaws, and
such execution or signature shall be binding upon the corporation.

Unless otherwise specifically determined by the Board of Directors or otherwise
required by law. promissory notes, deeds of trust, mortgages and other evidences
of indebtedness of the corporation, and other corporate instruments or documents
requiring the corporate seal, and certificates of shares of stock owned by the
corporation, shall be executed, signed or endorsed by the Chairman of the Board
of Directors, or the President or any Vice President, and by the Secretary or
Chief Financial Officer or Treasurer or any Assistant Secretary or Assistant
Treasurer. All other instruments and documents requiring the corporate
signature, but not requiring the corporate seal, may be executed as aforesaid or
in such other manner as may be directed by the Board of Directors.

All checks and drafts drawn on banks or other depositaries on funds to the
credit of the corporation or in special accounts of the corporation shall be
signed by such person or persons as the Board of Directors shall authorize so to
do.

Unless authorized or ratified by the Board of Directors or within the agency
power of an officer, no officer, agent or employee shall have any power or
authority to bind the corporation by any contract or engagement or to pledge its
credit or to render it liable for any purpose or for any amount.

         SECTION 33. VOTING OF SECURITIES OWNED BY THE CORPORATION. All stock
and other securities of other corporations owned or held by the corporation for
itself, or for other parties in

                                      14.




any capacity, shall be voted, and all proxies with respect thereto shall be
executed, by thc person authorized so to do by resolution of the Board of
Directors, or, in the absence of such authorization, by the Chairman of the
Board of Directors, the Chief Executive Officer, the President, or any Vice
President.

                                   ARTICLE VII

                                 SHARES OF STOCK

         SECTION 34. FORM AND EXECUTION OF CERTIFICATES. Certificates for the
shares of stock of the corporation shall be in such form as is consistent with
the Certificate of Incorporation and applicable law. Every holder of stock in
the corporation shall be entitled to have a certificate signed by or in the name
of the corporation by the Chairman of the Board of Directors, or the President
or any Vice President and by the Treasurer or Assistant Treasurer or the
Secretary or Assistant Secretary, certifying the number of shares owned by him
in the corporation. Any or all of the signatures on the certificate may be
facsimiles. In case any officer, transfer agent, or registrar who has signed or
whose facsimile signature has been placed upon a certificate shall have ceased
to be such officer, transfer agent, or registrar before such certificate is
issued, it may be issued with the same effect as if he were such officer,
transfer agent, or registrar at the date of issue. Each certificate shall state
upon the face or back thereof, in full or in summary, all of the powers,
designations, preferences, and rights, and the limitations or restrictions of
the shares authorized to be issued or shall, except as otherwise required by
law, set forth on the face or back a statement that the corporation will furnish
without charge to each stockholder who so requests the powers, designations,
preferences and relative, participating , optional, or other special rights of
each class of stock or series thereof and the qualifications, limitations, or
restrictions of such preferences and/or rights. Within a reasonable time after
the issuance or transfer of uncertificated stock, the corporation shall send to
the registered owner thereof a written notice containing the information
required to be set forth or stated on certificates pursuant to this section or
otherwise required by law or with respect to this section a statement that the
corporation will furnish without charge to each stockholder who so requests the
powers, designations, preferences and relative participating, optional or other
special rights of each class of stock or series thereof and the qualifications,
limitations or restrictions of such preferences and/or rights. Except as
otherwise expressly provided by law, the rights and obligations of the holders
of certificates representing stock of the same class and series shall be
identical.

         SECTION 35. LOST CERTIFICATES. A new certificate or certificates shall
be issued in place of any certificate or certificates theretofore issued by the
corporation alleged to have been lost, stolen, or destroyed, upon the making of
an affidavit of that fact by the person claiming the certificate of stock to be
lost, stolen, or destroyed. The corporation may require, as a condition
precedent to the issuance of a new certificate or certificates, the owner of
such lost, stolen, or destroyed certificate or certificates, or his legal
representative, to agree to indemnify the corporation in such manner as it shall
require or to give the corporation a surety bond in such form and amount as it
may direct as indemnity against any claim that may be made against the
corporation with respect to the certificate alleged to have been lost, stolen,
or destroyed.

                                      15.




         SECTION 36. TRANSFERS.

                  (a) Transfers of record of shares of stock of the corporation
shall be made only upon its books by the holders thereof, in person or by
attorney duly authorized, and upon the surrender of a properly endorsed
certificate or certificates for a like number of shares.

                  (b) The corporation shall have power to enter into and perform
any agreement with any number of stockholders of any one or more classes of
stock of the corporation to restrict the transfer of shares of stock of the
corporation of any one or more classes owned by such stockholders in any manner
not prohibited by the Delaware General Corporation Law.

         SECTION 37. FIXING RECORD DATES.

                  (a) In order that the corporation may determine the
stockholders entitled to notice of or to vote at any meeting of stockholders or
any adjournment thereof, the Board of Directors may fix, in advance, a record
date, which record date shall not precede the date upon which the resolution
fixing the record date is adopted by the Board of Directors, and which record
date shall, subject to applicable law, not be more than sixty (60) nor less than
ten (10) days before the date of such meeting. If no record date is fixed by the
Board of Directors, the record date for determining stockholders entitled to
notice of or to vote at a meeting of stockholders shall be at the close of
business on the day next preceding the day on which notice is given, or if
notice is waived, at the close of business on the day next preceding the day on
which the meeting is held. A determination of stockholders of record entitled to
notice of or to vote at a meeting of stockholders shall apply to any adjournment
of the meeting; provided, however, that the Board of Directors may fix a new
record date for the adjourned meeting.

                  (b) In order that the corporation may determine the
stockholders entitled to consent to corporate action in writing without a
meeting, the Board of Directors may fix, in advance, a record date, which record
date shall not precede the date upon which the resolution fixing the record date
is adopted by the Board of Directors, and which date shall not be more than ten
(10) days after the date upon which the resolution fixing the record date is
adopted by the Board of Directors. If no record date has been fixed by the Board
of Directors, the record date for determining stockholders entitled to consent
to corporate action in writing without a meeting, when no prior action by the
Board of Directors is required by law, shall be the first date on which a signed
written consent setting forth the action taken or proposed to be taken is
delivered to the Corporation by delivery to its registered office in the State
of Delaware, its principal place of business or an officer or agent of the
Corporation having custody of the book in which proceedings of meetings of
stockholders are recorded. Delivery made to a Corporation's registered office
shall be by hand or by certified or registered mail, return receipt requested.
If no record date has been fixed by the Board of Directors and prior action by
the Board of Directors is required by law, the record date for determining
stockholders entitled to consent to corporate action in writing without a
meeting shall be at the close of business on the day on which the Board of
Directors adopts the resolution taking such prior action.

                  (c) In order that the corporation may determine the
stockholders entitled to receive payment of any dividend or other distribution
or allotment of any rights or the stockholders entitled to exercise any rights
in respect of any change, conversion or exchange of


                                      16.




stock, or for the purpose of any other lawful action, the Board of Directors may
fix, in advance, a record date, which record date shall not precede the date
upon which the resolution fixing the record date is adopted, and which record
date shall be not more than sixty (60) days prior to such action. If no record
date is fixed, the record date for determining stockholders for any such purpose
shall be at the close of business on the day on which the Board of Directors
adopts the resolution relating thereto.

         SECTION 38. REGISTERED STOCKHOLDERS. The corporation shall be entitled
to recognize the exclusive right of a person registered on its books as the
owner of shares to receive dividends, and to vote as such owner, and shall not
be bound to recognize any equitable or other claim to or interest in such share
or shares on the part of any other person whether or not it shall have express
or other notice thereof, except as otherwise provided by the laws of Delaware.

                                  ARTICLE VIII

                       OTHER SECURITIES OF THE CORPORATION

         SECTION 39. EXECUTION OF OTHER SECURITIES. All bonds, debentures and
other corporate securities of the corporation, other than stock certificates
(covered in Section 34), may be signed by the Chairman of the Board of
Directors, the President or any Vice President, or such other person as may be
authorized by the Board of Directors, and the corporate seal impressed thereon
or a facsimile of such seal imprinted thereon and attested by the signature of
the Secretary or an Assistant Secretary, or the Chief Financial Officer or
Treasurer or an Assistant Treasurer; provided, however, that where any such
bond, debenture or other corporate security shall be authenticated by the manual
signature, or where permissible facsimile signature, of a trustee under an
indenture pursuant to which such bond debenture or other corporate security
shall be issued, the signatures of the persons signing and attesting the
corporate seal on such bond, debenture or other corporate security may be the
imprinted facsimile of the signatures of such persons. Interest coupons
appertaining to any such bond debenture or other corporate security,
authenticated by a trustee as aforesaid, shall be signed by the Treasurer or an
Assistant Treasurer of the corporation or such other person as may be authorized
by the Board of Directors, or bear imprinted thereon the facsimile signature of
such person. In case any officer who shall have signed or attested any bond,
debenture or other corporate security, or whose facsimile signature shall appear
thereon or on any such interest coupon. shall have ceased to be such officer
before the bond, debenture or other corporate security so signed or attested
shall have been delivered, such bond, debenture or other corporate security
nevertheless may be adopted by the corporation and issued and delivered as
though the person who signed the same or whose facsimile signature shall have
been used thereon had not ceased to be such officer of the corporation.

                                   ARTICLE IX

                                    DIVIDENDS

         SECTION 40. DECLARATION OF DIVIDENDS. Dividends upon the capital stock
of the corporation, subject to the provisions of the Certificate of
Incorporation and applicable law, if any, may be declared by the Board of
Directors pursuant to law at any regular or special meeting.

                                      17.




Dividends may be paid in cash, in property, or in shares of the capital stock,
subject to the provisions of the Certificate of Incorporation and applicable
law.

         SECTION 41. DIVIDEND RESERVE. Before payment of any dividend, there may
be set aside out of any funds of the corporation available for dividends such
sum or sums as the Board of Directors from time to time, in their absolute
discretion, think proper as a reserve or reserves to meet contingencies, or for
equalizing dividends, or for repairing or maintaining any property of the
corporation, or for such other purpose as the Board of Directors shall think
conducive to the interests of the corporation, and the Board of Directors may
modify or abolish any such reserve in the manner in which it was created.

                                    ARTICLE X

                                   FISCAL YEAR

         SECTION 42. FISCAL YEAR. The fiscal year of the corporation shall be
fixed by resolution of the Board of Directors.

                                   ARTICLE XI

                                 INDEMNIFICATION

         SECTION 43. INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND OTHER
AGENTS.

                  (a) DIRECTORS AND EXECUTIVE OFFICERS. The corporation shall
indemnify its Directors and executive officers to the fullest extent not
prohibited by the Delaware General Corporation Law or any other applicable law;
provided, however, that the corporation may modify the extent of such
indemnification by individual contracts with its directors and executive
officers; and, provided, further, that the corporation shall not be required to
indemnify any director or executive officer in connection with any proceeding
(or part thereof) initiated by such person or any proceeding by such person
against the corporation or its Directors, officers, employees or other agents
unless (i) such indemnification is expressly required to be made by law, (ii)
the proceeding was authorized by the Board of Directors of the corporation or
(iii) such indemnification is provided by the corporation, in its sole
discretion, pursuant to the powers vested in the corporation under the Delaware
General Corporation Law or any other applicable law or (iv) such indemnification
is required to be made under subsection (e).

                  (b) OTHER OFFICERS, EMPLOYEES AND OTHER AGENTS. The
corporation shall have power to indemnify its other officers, employees and
other agents as set forth in the Delaware General Corporation Law or any other
applicable law. The Board of Directors shall have the power to delegate the
determination of whether indemnification shall be given to any such person,
except executive officers, to such officers or other persons as the Board of
Directors shall determine.

                  (c)      GOOD FAITH.

                          (1) For purposes of any determination under this
Bylaw, a Director or executive officer shall be deemed to have acted in good
faith and in a manner he reasonably

                                      18.




believed to be in or not opposed to the best interests of the corporation, and,
with respect to any criminal action or proceeding, to have had no reasonable
cause to believe that his conduct was unlawful, if his action is based on
information, opinions, reports and statements, including financial statements
and other financial data, in each case prepared or presented by:

                                    (i) one or more officers or employees of the
corporation whom the Director or executive officer believed to be reliable and
competent in the matters presented;

                                   (ii) counsel, independent accountants or
other persons as to matters which the Director or executive officer believed to
be within such person's professional competence; and

                                  (iii) with respect to a Director, a committee
of the Board upon which such Director does not serve, as to matters within such
Committee's designated authority, which committee the Director believes to merit
confidence; so long as, in each case, the Director or executive officer acts
without knowledge that would cause such reliance to be unwarranted.

                        (2) The termination of any proceeding by judgment,
order, settlement, conviction or upon a plea of nolo contendere or its
equivalent shall not, of itself, create a presumption that the person did not
act in good faith and in a manner which he reasonably believed to be in or not
opposed to the best interests of the corporation, and, with respect to any
criminal proceeding, that he had reasonable cause to believe that his conduct
was unlawful.

                        (3) The provisions of this paragraph (c) shall not be
deemed to be exclusive or to limit in any way the circumstances in which a
person may be deemed to have met the applicable standard of conduct set forth by
the Delaware General Corporation Law.

                  (d) EXPENSES. The corporation shall advance to any person who
was or is a party or is threatened to be made a party to any threatened, pending
or completed action, suit or proceeding, whether civil, criminal, administrative
or investigative, by reason of the fact that he is or was a director or
executive officer of the corporation or is or was serving at the request of the
corporation as a director or executive officer of another corporation,
partnership, joint venture, trust or other enterprise, prior to the final
disposition of the proceeding, promptly following request therefor, all expenses
incurred by any director or executive officer in connection with such proceeding
upon receipt of an undertaking by or on behalf of such person to repay said
amounts if it should be determined ultimately that such person is not entitled
to be indemnified under this Bylaw or otherwise.

Notwithstanding the foregoing, unless otherwise determined pursuant to paragraph
(f) of this Bylaw, no advance shall be made by the corporation to an executive
officer of the corporation (except by reason of the fact that such executive
officer is or was a director of the corporation in which event this paragraph
shall not apply) in any action, suit or proceeding, whether civil, criminal,
administrative or investigative, if a determination is reasonably and promptly
made (i) by the Board of Directors by a majority vote of a quorum consisting of
directors who were not parties to the proceeding, or (ii) if such quorum is not
obtainable, or, even if obtainable, a quorum of disinterested directors so
directs, by independent legal counsel in a written opinion, that the facts known
to the decision making party at the time such determination is made

                                      19.




demonstrate clearly and convincingly that such person acted in bad faith or in a
manner that such person did not believe to be in or not opposed to the best
interests of the corporation.

                  (e) ENFORCEMENT. Without the necessity of entering into an
express contract all rights to indemnification and advances to directors and
executive officers under this Bylaw shall be deemed to be contractual rights and
be effective to the same extent and as if provided for in a contract between the
corporation and the director or executive officer. Any right to indemnification
or advances granted by this Bylaw to a director or executive officer shall be
enforceable by or on behalf of the person holding such right in any court of
competent jurisdiction if (i) the claim for indemnification or advances is
denied, in whole or in part, or (ii) no disposition of such claim is made within
ninety (90) days of request therefor. The claimant in such enforcement action,
if successful in whole or in part, shall be entitled to be paid also the expense
of prosecuting his claim. In connection with any claim for indemnification, the
corporation shall be entitled to raise as a defense to any such action that the
claimant has not met the standards of conduct that make it permissible under the
Delaware General Corporation Law or any other applicable law for the corporation
to indemnify the claimant for the amount claimed. Neither the failure of the
corporation (including its Board of Directors, independent legal counsel or its
stockholders) to have made a determination prior to the commencement of such
action that indemnification of the claimant is proper in the circumstances
because he has met the applicable standard of conduct set forth in the Delaware
General Corporation Law or any other applicable law, nor an actual determination
by the corporation (including its Board of Directors, independent legal counsel
or its stockholders) that the claimant has not met such applicable standard of
conduct, shall be a defense to the action or create a presumption that claimant
has not met the applicable standard of conduct.

                  (f) NON-EXCLUSIVITY OF RIGHTS. The rights conferred on any
person by this Bylaw shall not be exclusive of any other right which such person
may have or hereafter acquire under any applicable statute, provision of the
Certificate of Incorporation, Bylaws, agreement, vote of stockholders or
disinterested directors or otherwise, both as to action in his official capacity
and as to action in another capacity while holding office. The corporation is
specifically authorized to enter into individual contracts with any or all of
its directors, officers, employees or agents respecting indemnification and
advances, to the fullest extent not prohibited by the Delaware General
Corporation Law, or by any other applicable law.

                  (g) SURVIVAL OF RIGHTS. The rights conferred on any person by
this Bylaw shall continue as to a person who has ceased to be a director,
officer, employee or other agent and shall inure to the benefit of the heirs,
executors and administrators of such a person.

                  (h) INSURANCE. To the fullest extent permitted by the Delaware
General Corporation Law or any other applicable law, the corporation, upon
approval by the Board of Directors, may purchase insurance on behalf of any
person required or permitted to be indemnified pursuant to this Bylaw

                  (i) AMENDMENTS. Any repeal or modification of this Bylaw shall
only be prospective and shall not affect the rights under this Bylaw in effect
at the time of the alleged occurrence of any action or omission to act that is
the cause of any proceeding against any agent of the corporation.

                                      20.




                  (j) SAVING CLAUSE. If this Bylaw or any portion hereof shall
be invalidated on any ground by any court of competent jurisdiction, then the
corporation shall nevertheless indemnify each director and executive officer to
the full extent not prohibited by any applicable portion of this Bylaw that
shall not have been invalidated, or by any other applicable law. If this Section
43 shall be invalid due to the application of the indemnification provisions of
another jurisdiction, then the corporation shall indemnify each director and
executive officer to the fullest extent under any other applicable law.

                  (k) CERTAIN DEFINITIONS. For the purposes of this Bylaw, the
following definitions shall apply:

                        (1) The term "PROCEEDING" shall be broadly construed
and shall include, without limitation, the investigation, preparation,
prosecution, defense, settlement, arbitration and appeal of, and the giving of
testimony in, any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative.

                        (2) The term "EXPENSES" shall be broadly construed and
shall include, without limitation, court costs, attorneys' fees, witness fees,
fines, amounts paid in settlement or judgment and any other costs and expenses
of any nature or kind incurred in connection with any proceeding.

                        (3) The term the "CORPORATION" shall include, in
addition to the resulting corporation, any constituent corporation (including
any constituent of a constituent) absorbed in a consolidation or merger which,
if its separate existence had continued, would have had power and authority to
indemnify its directors, officers, and employees or agents, so that any person
who is or was a director, officer, employee or agent of such constituent
corporation, or is or was serving at the request of such constituent corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise, shall stand in the same position under
the provisions of this Bylaw with respect to the resulting or surviving
corporation as he would have with respect to such constituent corporation if its
separate existence had continued.

                        (4) References to a "DIRECTOR," "EXECUTIVE OFFICER,"
"OFFICER," "EMPLOYEE," or "AGENT" of the corporation shall include, without
limitation, situations where such person is serving at the request of the
corporation as, respectively, a director, executive officer, officer, employee,
trustee or agent of another corporation, partnership, joint venture, trust or
other enterprise.

                        (5) References to "OTHER ENTERPRISES" shall include
employee benefit plans; references to "fines" shall include any excise taxes
assessed on a person with respect to an employee benefit plan; and references to
"SERVING AT THE REQUEST OF THE CORPORATION" shall include any service as a
director, officer, employee or agent of the corporation which imposes duties on,
or involves services by, such director, officer, employee, or agent with respect
to an employee benefit plan, its participants, or beneficiaries; and a person
who acted in good faith and in a manner he reasonably believed to be in the
interest of the participants and beneficiaries of an employee benefit plan shall
be deemed to have acted in a manner "NOT OPPOSED TO THE BEST INTERESTS OF THE
CORPORATION" as referred to in this Bylaw.


                                      21.




                                   ARTICLE XII

                                     NOTICES

         SECTION 44. NOTICES.

                  (a) NOTICE TO STOCKHOLDERS. Whenever, under any provisions of
these Bylaws, notice is required to be given to any stockholder, it shall be
given in writing, timely and duly deposited in the United States mail, postage
prepaid, and addressed to his last known post office address as shown by the
stock record of the corporation or its transfer agent.

                  (b) NOTICE TO DIRECTORS. Any notice required to be given to
any director may be given by the method stated in subsection (a), or by
overnight delivery service, facsimile, electronic mail, telex or telegram,
except that such notice other than one which is delivered personally shall be
sent to such address as such director shall have filed in writing with the
Secretary, or, in the absence of such filing, to the last known post office
address of such Director.

                  (c) AFFIDAVIT OF MAILING. An affidavit of mailing, executed by
a duly authorized and competent employee of the corporation or its transfer
agent appointed with respect to the class of stock affected, specifying the name
and address or the names and addresses of the stockholder or stockholders, or
director or directors, to whom any such notice or notices was or were given, and
the time and method of giving the same, shall in the absence of fraud, be prima
facie evidence of the facts therein contained.

                  (d) TIME NOTICES DEEMED GIVEN. All notices given by mail or by
overnight delivery service, as above provided, shall be deemed to have been
given as at the time of mailing and all notices given by facsimile, telex or
telegram shall be deemed to have been given as of the sending time recorded at
time of transmission.

                  (e) METHODS OF NOTICE. It shall not be necessary that the same
method of giving notice be employed in respect of all directors, but one
permissible method may be employed in respect of any one or more, and any other
permissible method or methods may be employed in respect of any other or others.

                  (f) FAILURE TO RECEIVE NOTICE. The period or limitation of
time within which any stockholder may exercise any option or right, or enjoy any
privilege or benefit, or be required to act, or within which any director may
exercise any power or right, or enjoy any privilege, pursuant to any notice sent
him in the manner above provided, shall not be affected or extended in any
manner by the failure of such stockholder or such director to receive such
notice.

                  (g) NOTICE TO PERSON WITH WHOM COMMUNICATION IS UNLAWFUL.
Whenever notice is required to be given, under any provision of law or of the
Certificate of Incorporation or Bylaws of the corporation, to any person with
whom communication is unlawful, the giving of such notice to such person shall
not be required and there shall be no duty to apply to any governmental
authority or agency for a license or permit to give such notice to such person.
Any action or meeting which shall be taken or held without notice to any such
person with whom communication is unlawful shall have the same force and effect
as if such notice had been duly given. In the event that the action taken by the
corporation is such as to require the filing of a

                                      22.




certificate under any provision of the Delaware General Corporation Law, the
certificate shall state, if such is the fact and if notice is required, that
notice was given to all persons entitled to receive notice except such persons
with whom communication is unlawful.

                  (h) NOTICE TO PERSON WITH UNDELIVERABLE ADDRESS. Whenever
notice is required to be given, under any provision of law or the Certificate of
Incorporation or Bylaws of the corporation, to any stockholder to whom (i)
notice of two consecutive annual meetings, and all notices of meetings or of the
taking of action by written consent without a meeting to such person during the
period between such two consecutive annual meetings, or (ii) all, and at least
two, payments (if sent by first class mail) of dividends or interest on
securities during a twelve month period, have been mailed addressed to such
person at his address as shown on the records of the corporation and have been
returned undeliverable, the giving of such notice to such person shall not be
required. Any action or meeting which shall be taken or held without notice to
such person shall have the same force and effect as if such notice had been duly
given. If any such person shall deliver to the corporation a written notice
setting forth his then current address, the requirement that notice be given to
such person shall be reinstated. In the event that the action taken by the
corporation is such as to require the filing of a certificate under any
provision of the Delaware General Corporation Law, the certificate need not
state that notice was not given to persons to whom notice was not required to be
given pursuant to this paragraph.

                                  ARTICLE XIII

                                   AMENDMENTS

         SECTION 45. AMENDMENTS. Subject to paragraph (i) of Section 43 of the
Bylaws, the Bylaws may be altered, amended or repealed and new Bylaws adopted by
the affirmative vote of the stockholders entitled to vote thereon. The Board of
Directors shall also have the power to adopt, amend, or repeal Bylaws.

                                      23.

EX-4.06

                                                                    EXHIBIT 4.06

                             SUPPLEMENTAL INDENTURE

         This Supplemental Indenture (this "SUPPLEMENTAL INDENTURE") dated as of
September 15, 2003, by and between PacifiCare Health Systems, Inc., a Delaware
corporation (the "COMPANY"); PacifiCare Health Plan Administrators, Inc., an
Indiana corporation, PacifiCare eHoldings, Inc., a California corporation,
RxConnect, Inc., a California corporation and SeniorCo, Inc., a Delaware
corporation (collectively, the "INITIAL SUBSIDIARY GUARANTORS"); Rx Solutions,
Inc., a California corporation, PacifiCare Behavioral Health, Inc., a Delaware
corporation and Secure Horizons USA, Inc., a California corporation
(collectively, the "PHPA SUBSIDIARY GUARANTORS"); and U.S. Bank National
Association, a national banking association, as successor to State Street Bank
and Trust Company of California, N.A., as trustee under the Indenture referred
to below (the "TRUSTEE"). Capitalized terms used but not defined herein shall
have the meanings given to them in the Indenture referred to below.

                                    RECITALS

         WHEREAS, the Company and the Initial Subsidiary Guarantors heretofore
executed and delivered to the Trustee an Indenture (the "INDENTURE") dated as of
May 21, 2002 providing for the issuance of an aggregate principal amount of
$500,000,000 of 10 3/4% Senior Notes due 2009 (the "NOTES");

         WHEREAS, Section 4.07 of the Indenture provides that, immediately upon
the prepayment, redemption, purchase, defeasance or other satisfaction in full
of the 7% Senior Notes due 2003 (the "7% SENIOR NOTES DUE 2003") issued by FHP
International Corporation (subsequently renamed PacifiCare Health Plan
Administrators, Inc. [FHP INTERNATIONAL WAS ACTUALLY MERGED INTO PHPA;
THEREFORE, WE PROBABLY SHOULD SAY THIS DIFFERENTLY, I.E., NOW KNOWN AS PHPA BY
VIRTUE OF THE MERGER OF THESE ENTITIES]) pursuant to the terms of that certain
indenture dated as of September 22, 1993 between FHP International Corporation
and The Chase Manhattan Bank, N.A. [WE MAY WANT TO REFER TO THE SUPPLEMENTAL
INDENTURE DATED 1996-1997 BY WHICH OLD PHS BECAME THE OBLIGOR UNDER THE FHP
NOTES SINCE THE OLD PHS ENTITY LATER MERGED INTO PHPA MAKING PHPA THE OBLIGOR],
the Company will cause each PHPA Subsidiary Guarantor to fully and
unconditionally Guarantee, jointly and severally, on an unsecured unsubordinated
basis the payment of principal, premium, if any, and interest on the Notes by
the execution and delivery of a supplemental indenture to the Indenture;

         WHEREAS, the 7% Senior Notes due 2003 matured on September 15, 2003 and
have been defeased in full;

         WHEREAS, pursuant to Section 9.01 of the Indenture, the Trustee, the
Company and the Subsidiary Guarantors [SECTION 9.01 REFERS TO "SUBSIDIARY
GUARANTORS" WHICH INCLUDES THE INITIAL SUBSIDIARY GUARANTORS, THE PHPA
GUARANTORS AND ANY OTHER RESTRICTED SUBSIDIARY THAT LATER PROVIDES A NOTE
GUARANTEE OF THE COMPANY'S OBLIGATIONS] are authorized, without notice to or the
consent of any Holder, to execute and deliver this Supplemental Indenture to
cause the PHPA Subsidiary Guarantors to Guarantee the Notes to comply with
Section 4.07 of the Indenture; and



         WHEREAS, the Company, the Trustee, the Initial Subsidiary Guarantors
and the PHPA Subsidiary Guarantors desire to enter into this Supplemental
Indenture to provide for such Note Guarantees as contemplated by Section 4.07 of
the Indenture.

                                   AGREEMENT

         NOW, THEREFORE, in consideration of the foregoing and for other good
and valuable consideration, the receipt of which is hereby acknowledged, the
Company, the Initial Subsidiary Guarantors, the PHPA Subsidiary Guarantors and
the Trustee mutually covenant and agree as follows:

         1. CREATION OF NOTE GUARANTEE. Each PHPA Subsidiary Guarantor hereby
agrees, jointly and severally with all other Subsidiary Guarantors, to Guarantee
the Notes and the performance of the Company's obligations under the Notes and
the Indenture in accordance with the terms and provisions of Article Ten of the
Indenture. Each PHPA Subsidiary Guarantor shall be bound by, and entitled to the
benefits of, all other applicable terms and provisions of the Indenture as a
Subsidiary Guarantor, including the provisions relating to the release of the
Note Guarantees in certain circumstances.

         2. RATIFICATION OF INDENTURE; SUPPLEMENTAL INDENTURE PART OF INDENTURE.
Except as expressly amended hereby, the Indenture is in all respects ratified
and confirmed and all the terms, conditions and provisions thereof shall remain
in full force and effect. This Supplemental Indenture shall form a part of the
Indenture for all purposes, and every holder of the Notes heretofore or
hereafter authenticated and delivered shall be bound hereby.

         3. GOVERNING LAW. THIS SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY THE
LAWS OF THE STATE OF NEW YORK.

         4. TRUSTEE MAKES NO REPRESENTATION. The Trustee makes no representation
as to the validity or adequacy of this Supplemental Indenture.

         5. COUNTERPARTS. The parties may sign any number of copies of this
Supplemental Indenture. Each signed copy shall be an original, but all of them
together represent the same agreement.

         6. EFFECT OF HEADINGS. The Section headings herein are for convenience
only and shall not effect the construction thereof.





         IN WITNESS WHEREOF, the parties hereto have caused this Supplemental
Indenture to be duly executed as of the date first written above.


                                            PACIFICARE HEALTH SYSTEMS, INC.


                                            By:
                                               --------------------------------
                                            Name:
                                            Title:


                                            PACIFICARE HEALTH PLAN
                                            ADMINISTRATORS,  INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:

                                            PACIFICARE EHOLDINGS, INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:

                                            RXCONNECT, INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:

                                            SENIORCO, INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:

                                            RX SOLUTIONS, INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:

                                            PACIFICARE BEHAVIORAL HEALTH, INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:


                                            SECUREHORIZONS USA, INC.

                                            By:
                                               --------------------------------
                                            Name:
                                            Title:





                                            U.S. BANK NATIONAL ASSOCIATION


                                            By:
                                               --------------------------------
                                            Name:
                                            Title:

EX-10.10

                                                                   EXHIBIT 10.10


                      SENIOR EXECUTIVE EMPLOYMENT AGREEMENT


         This EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into
as of October 3, 2002, by and between PACIFICARE HEALTH SYSTEMS, INC., a
Delaware corporation (the "Company"), with its principal place of business
located at 5995 Plaza Drive, Cypress, California 90630 and A. PETER REYNOLDS
("Executive"), residing at 1934 Pt. Locksleigh Place, Newport Beach, CA 92660.

                                    RECITALS

         WHEREAS, the Company desires to employ Executive in the capacity of
Senior Vice President, Corporate Controller.

         WHEREAS, the Company and Executive are entering into this Agreement to
establish the terms and conditions of the employment relationship.

         NOW, THEREFORE, in consideration of the following covenants, conditions
and promises contained herein, and other good and valuable consideration, the
Company and Executive hereby agree as follows:

1.       EMPLOYMENT

         1.1 Executive's General Duties. The Company employs Executive and
Executive serves the Company in the capacity of Senior Vice President, Corporate
Controller, having such usual and customary duties and authority as an officer
of similar capacity in a corporation of comparable size, holdings, and business
as that of the Company.

         Executive shall do and perform all services, acts, or things necessary
or advisable to manage and conduct the business of the Company and shall preside
over such other areas of corporate activity as specified from time to time by
the Board of Directors of the Company. During the term of this Agreement,
Executive shall perform such additional or different duties, and accept the
election or appointment to such other offices or positions as may be assigned.

         1.2 Devotion of Executive. During the term of this Agreement, Executive
shall devote his entire productive time, ability, and attention to the business
of the Company. Executive shall use Executive's best efforts, skills, and
abilities to promote the general welfare and interests of the Company and to
preserve, maintain, and foster the Company's business and business relationships
with all persons and entities associated therewith, including, without
limitation, employer groups, medical service providers, shareholders,
affiliates, officers, employees, and banks and other financial institutions. The
Company shall give Executive a reasonable opportunity to perform Executive's
duties and shall neither expect Executive to


                                       - 1 -


devote more time, nor assign more duties or functions to Executive, than are
customary and reasonable for a person in Executive's position.

2.       TERM AND TERMINATION

         2.1 Term. The initial term of Executive's employment under this
Agreement shall be 24 months, commencing on the effective date of this
Agreement. The Company may extend this Agreement for successive one-year terms
by giving Executive written notice at least 60 days prior to the expiration of
the term. Notwithstanding the foregoing, if a Change-of-Control occurs, as
defined in Section 5.1(c) of this Agreement, then the term of the Agreement
shall be extended for a period of 24 months from the effective date of the
Change-of-Control. Except as provided by Section 2.2(f), if the Company offers
Executive a new employment agreement at the term of this Agreement, but
Executive does not accept the new employment agreement, then Executive's
continued employment with the Company will be without the benefit of a written
employment agreement, in which case Executive's entitlement to severance
benefits on termination shall be governed by then-existing Company policies and
practices.

         2.2 Termination. This Agreement, and Executive's employment with the
Company, shall be terminated upon the occurrence of any one of the following
events:

                  a.       The death of the Executive.

                  b.       Executive becomes incapacitated or disabled, which
         incapacity or disability prevents Executive from fully performing his
         duties to the Company for a period in excess of 90 days and, after such
         90-day period, the Company and a physician, duly licensed and qualified
         in the specialty of Executive's incapacity, decide in their reasonable
         judgments, that such incapacity will be of such continued duration as
         to prevent Executive from resuming the rendition of services to the
         Company for at least an additional six-month period. For purposes of
         this Agreement, Executive shall be deemed permanently disabled, and
         this Agreement terminated upon the date Executive receives written
         notice from the Company that such determination has been made.

                  c.       Executive habitually neglects his duties to the
         Company or engages in gross misconduct during the term of this
         Agreement. For the purposes of this Agreement, "gross misconduct" shall
         mean Executive's misappropriation of funds; securities fraud; insider
         trading; unauthorized possession of corporate property; the sale,
         distribution, possession or use of a controlled substance; conviction
         of any criminal offense (whether or not such criminal offense is
         committed in connection with Executive's duties hereunder or in the
         course of his employment with the Company) or engaging in unlawful
         activity which places the Company at financial risk or which could
         reasonably be expected to embarrass the Company or cause damage to the
         Company's reputation. In such event, Executive's termination shall be
         effective immediately upon receipt of written notice from the Company.


                                     - 2 -


                  d.       Company may terminate this Agreement, with or without
         cause, upon written notice to Executive. Except for the circumstances
         described in Subsections (a), (b), (e) and (f) of this Section 2.2,
         Executive's termination shall be effective upon receipt of such written
         notice. Executive may terminate this Agreement upon 30 days written
         notice to Company.

                  e.       Upon the expiration of the term of this Agreement,
         the Company neither extends the Agreement pursuant to Section 2.1 nor
         offers Executive a new employment agreement.

                  f.       Executive voluntarily terminates his employment, upon
         written notice to the Company, to be effective at the end of the term
         of this Agreement, after the Company offers Executive a new employment
         agreement that either establishes duties materially inconsistent with
         those described in Section 1.1 or reduces Executive's salary by more
         than 10 percent below the salary in effect at the end of the term of
         this Agreement.

3.       COMPENSATION DURING THE TERM OF THIS AGREEMENT

         3.1 Base Salary. As long as Executive satisfactorily performs all of
his obligations under this Agreement, the Company shall pay Executive an annual
base salary, payable in equal installments on the Company's regular payroll
dates. As of this date, Executive's annual base salary has been set at $250,000.
On an annual basis, the Company shall review Executive's salary, but shall be
under no obligation to increase Executive's salary. Executive authorizes the
Company to take such deductions and withholdings from his salary as are required
by law, directed by Executive, or as reasonably directed by the Company for its
employees, which deductions shall include, without limitation, withholding for
federal and state income taxes and social security.

         3.2 Benefits. Executive shall be entitled to fully participate in all
of the employee benefit plans and programs available to other high-level
executives of the Company, including, without limitation, health, dental, and
life insurance benefits for Executive and Executive's dependents, pension and
profit sharing programs, and vacation and sick leave benefits, the Amended and
Restated PacifiCare Health Systems, Inc. Savings and profit-sharing Plan, and
the trust agreement implemented pursuant thereto, adopted as of July 1999, the
Company's Statutory Restoration Plan and the Company's Deferred Compensation
Plan. However, the terms of this Agreement shall not restrict the Company's
right to change, amend, modify, or terminate any existing benefit plan or
program, or to change any insurance company or modify any insurance policy
adopted incident to such existing benefit plan and program.

         3.3 Automobile Allowance. The Company shall provide Executive with a
$750 (seven hundred fifty dollar) per month automobile allowance. The Company
shall furnish


                                     - 3 -


Executive with a cellular telephone. Executive shall provide and maintain
automobile insurance for Executive's car including collision, comprehensive
liability, personal and property damage, and uninsured and underinsured motorist
coverage in amounts customarily obtained to cover such contingencies in the
State of California. Executive shall provide proof of such coverage to the
Company upon the Company's request.

         3.4 Reimbursement of Expenses. The Company shall pay for or reimburse
Executive for all reasonable travel, entertainment, and other business expenses
incurred or paid for by Executive in connection with the performance of his
services under this Agreement. The Company shall not be obligated to make any
such reimbursement unless Executive presents corresponding expense statements or
vouchers and such other supporting information as the Company may from time to
time reasonably request. The Company reserves the right to place subsequent
limitations or restrictions on business expenses to be incurred or reimbursed.

         3.5 Annual Incentive Plan. Executive shall be entitled to participate
fully in the Company's 1996 Management Incentive Compensation Plan, as amended
(the "MICP"), and as may be further amended, modified, or replaced, from time to
time, in accordance with the terms and conditions set forth herein and therein.

         3.6 Stock Option Plans. Executive shall be entitled to participate in
the applicable Stock Option Plans for Officers and Key Employees of PacifiCare
Health Systems, Inc., as amended, and as may be further amended modified or
replaced, from time to time, in accordance with the terms and conditions set
forth herein and therein.

         3.7 Insurance. During the term of this Agreement, the Company shall
insure Executive under its general liability insurance for all conduct committed
in good faith while acting in the capacity of Senior Vice President, Corporate
Controller of the Company or in any other capacity to which Executive may be
appointed or elected.

         3.9 Promotional Grant of Stock Options. Company will recommend to its
Compensation Committee a promotional stock option grant of 17,000 shares.
Issuance of the options is subject to approval of the Compensation Committee.
The grant date and exercise price will be determined as of the closing price of
shares of PacifiCare stock on the effective date of the Executive's promotion.

4.       COMPENSATION FOLLOWING TERMINATION OF EMPLOYMENT PURSUANT TO SECTION
2.2

         4.1 Death. In the event that this Agreement is terminated by reason of
Executive's death, Executive's estate or legal representative shall be entitled
to receive the following:

                  a.       Payment of benefits under the life insurance policy
         purchased by the Company on Executive's behalf, if any;


                                     - 4 -


                  b.       Payments of benefits under the MICP set forth in
         Section 3.5 in accordance with the terms of the MICP plan document;

                  c.       Executive's legal representative shall be permitted
         to exercise any vested and unexercised options granted under the 1996
         Stock Option Plan and any other existing stock option plans of the
         Company (collectively, the "Stock Option Plans") in accordance with
         their terms for a period of one year following Executive's death.

         4.2 Disability. In the event that Executive is terminated because of
incapacity or disability, the Company shall provide Executive with the
following:

                  a.       Payment of benefits under the disability insurance
         policy maintained by the Company on Executive's behalf, if any;

                  b.       Payment of benefits under the MICP set forth in
         Section 3.5 in accordance with the terms of the MICP plan document;

                  c.       The right to exercise any vested and unexercised
         options under the Stock Option Plans in accordance with the terms
         stated therein;

                  d.       Payment of the automobile allowance as provided under
         Section 3.3 for a period of 18 months following the effective date of
         such termination.

         4.3 Neglect, Misconduct or Voluntary Termination. In the event this
Agreement is terminated because of Executive's habitual neglect or gross
misconduct pursuant to Section 2.2(c) or because of Executive's voluntary
termination (except for resignation pursuant to Section 2.2(f)), the Company
shall be relieved from any and all further or future obligations to compensate
Executive; provided, however, that Executive shall be able to exercise any
vested and unexercised awards under the Stock Option Plans in accordance with
the terms set forth therein.

         4.4 Discharge by Company Pursuant to Section 2.2(d) or 2.2(e). In the
event that the Company terminates Executive pursuant to Section 2.2(d) or 2.2(e)
under circumstances other than a Change-of-Control (as defined herein) and for
any reason other than Executive's incapacity or disability or neglect/misconduct
as described in Sections 2.2(b) and 2.2(c), respectively, then Executive shall
be entitled to the following compensation:

                  a.       An amount equal to one and one half times Executive's
         then current annual salary under Section 3.1;

                  b.       An amount equal to one and one half times the average
         of the last two MICP bonuses paid to Executive. If Executive has been
         employed by the Company for more than one, but less than two years,
         then the MICP bonus severance payment shall equal one and one half
         times the average of the MICP bonus paid to Executive for the


                                     - 5 -


         prior year and the target for Executive for the current year. If
         Executive has been employed by the Company for less than one year,
         Executive will not receive any bonus severance payment. For purposes of
         this Section 4.4(b), the word "paid" shall include $0.00 for any year
         in which Executive was eligible for, but was not paid, an MICP bonus;

                  c.       The right to exercise any vested and unexercised
         options under the Stock Option Plans in accordance with their terms
         within one year of the effective date of such termination;

                  d.       Continuation of Executive's and his dependents'
         medical, dental and vision benefits, on the same terms as other
         executives who remain employed with the Company, for a period of 18
         months following the effective date of such termination;

                  e.       An amount equal to 18 months of Executive's
         automobile allowance;

                  f.       The Company shall provide to Executive outplacement
         services to assist Executive in securing a position comparable to the
         one from which Executive was terminated. The Company shall be obligated
         to provide those outplacement services which are customarily provided
         by companies of similar size and holdings as those of the Company to
         executives with comparable responsibility and longevity as Executive
         and for reasonable cost as approved by the Company. The Company's
         provision of such outplacement services shall not limit, restrict, or
         reduce, in any manner, any and all other compensation to which
         Executive is entitled hereunder;

                  g.       Executive shall receive, or have paid, the amounts of
         severance compensation provided in clauses (a), (b) and (e) above in
         equal installments over a period of 18 months. Payments will be made
         either in biweekly installments on the Company's regular paydays or as
         currently being paid to Executive;

                  h.       Notwithstanding the foregoing, in the event Executive
         engages in employment, whether as an employee, consultant or contractor
         with a competitor of the Company during the 18 month period in which
         Executive's salary continues pursuant to this Section 4.4, the
         severance compensation available to Executive under this Section 4.4
         shall be reduced by the amount of any and all gross earnings Executive
         earns while engaged in employment with any such competitor or
         competitors. For the purposes of this Section 4.4, a "competitor of the
         Company" shall include, without limitation, managed care organizations,
         including a health maintenance organization, competitive medical plan,
         preferred provider organization, provider sponsored organization
         ("PSO"), or health or life insurance company which owns a managed care
         organization, plan or program. Executive agrees to provide immediate
         notice to Company upon receipt of any gross earnings received by
         Executive from a competitor of Company. Quarterly, Executive


                                     - 6 -


         shall provide the Company a certificate certifying as to his employment
         status and if employed, the name and business of his current employer;

                  i.       If Executive is rehired by Company, payments of
         severance compensation provided for in this Section 4.4 shall cease;
         and

                  j.       If Executive dies while receiving the salary
         continuation benefit as provided in this Section 4.4, Executive's
         estate will receive a lump sum payment of the remaining salary
         continuation benefit.

         4.5      Resignation by Executive Pursuant to Section 2.2(f). In the
event that Executive resigns pursuant to Section 2.2(f), then Executive shall be
entitled to the compensation provided by Section 4.4 of this Agreement.

5.       COMPENSATION FOLLOWING TERMINATION OF EMPLOYMENT AS A RESULT OF A
         CHANGE-OF-CONTROL

         5.1      Termination of Employment or Resignation for Good Cause

                  a.       Executive's Rights. In the event that, during the
         term of this Agreement, the Company undergoes a Change-of-Control, (as
         that term is defined below) and if within 24 months after the
         consummation of such change either (1) Executive is involuntarily
         terminated, except as provided in Section 5.1(b), or (2) Executive
         voluntarily terminates his employment for "good cause" as defined in
         Section 5.1(d), then Executive shall be entitled to the following
         compensation:

                           1. A lump sum payment consisting of: (i) an amount
                  equal to two times Executive's then annual salary; (ii) an
                  amount equal to two times the average of the last two MICP
                  bonuses paid to Executive; or if Executive has been employed
                  by the Company for more than one, but less than two years,
                  then the MICP bonus severance payment shall equal two times
                  the average of the MICP bonus paid to Executive for the prior
                  year and the target for Executive for the current year. If
                  Executive has been employed by the Company for less than one
                  year, Executive shall receive an amount equal to two times
                  target bonus for the current year. For purposes of this
                  Section 5.1(a)(1), the word "paid" shall include $0.00 for any
                  year in which Executive was eligible for, but was not paid, an
                  MICP bonus; (iii) a prorated bonus based on target opportunity
                  for the year in which the Change-of-Control occurs; (iv) an
                  amount equal to the equivalent of the cost of 24 months of
                  COBRA benefits; and (v) an amount equal to 24 months of
                  Executive's automobile allowance;

                           2. The right to exercise any and all unexercised
                  stock options granted under the Stock Option Plans in
                  accordance with their terms, as if all such


                                     - 7 -


                  unexercised stock options were fully vested, within one year
                  of the effective date of such termination;

                           3. A payment to executive to compensate for any
                  excise penalty or other associated taxes resulting from
                  severance payments exceeding the cap imposed by Internal
                  Revenue Code Section 280(G);

                           4. The Company shall provide to Executive the
                  outplacement services described in Section 4.4(f).

                  b.       Limitation of Benefits. In the event that Executive
         is terminated within 24 months after a Change-of-Control of the
         Company, and such termination results from either Executive's death,
         incapacity or disability or habitual neglect or gross misconduct, then,
         notwithstanding anything in this Article 5 to the contrary, Executive
         shall receive only that compensation, if any, to which he is entitled
         to under Sections 4.1, 4.2 and 4.3, respectively.

                  c.       Change-of-Control. As used in this Article 5, the
         term "Change-of-Control" means and refers to:

                           1. The acquisition by any Person (as hereinafter
                  defined) of Beneficial Ownership (as hereinafter defined) of
                  20% or more of either the then outstanding Stock (the
                  "Outstanding Company Stock") or the combined voting power of
                  the then outstanding voting securities of the Company entitled
                  to vote generally in the election of directors (the
                  "Outstanding Company Voting Securities"), provided that, for
                  purposes of this subsection (1), the following acquisitions
                  shall not constitute a Change of Control: (I) any acquisition
                  by the Company, (II) any acquisition by any employee benefit
                  plan (or related trust) sponsored or maintained by the Company
                  or any Person that controls, is controlled by or is under
                  common control with, the Company or (III) any acquisition by
                  any Person pursuant to a transaction which complies with
                  clauses (I), (II) and (III) of subsection (3) of this
                  definition; or

                           2. Individuals who, as of the Effective Date,
                  constitute the Board (the "Incumbent Board") cease for any
                  reason to constitute at least a majority of the Board,
                  provided that, for purposes of this subsection (2), any
                  individual who becomes a director subsequent to the Effective
                  Date whose election, or nomination for election by the
                  Company's shareholders, was approved by a vote of at least a
                  majority of the directors then comprising the Incumbent Board
                  shall be considered as though such individual were a member of
                  the Incumbent Board, excluding, however, any such individual
                  who initially assumes office as a result of an actual or
                  threatened election contest with respect to the election or
                  removal of directors or


                                     - 8 -


                  other actual or threatened solicitation of proxies or consents
                  by or on behalf of a Person other than the Board; or

                           3. Consummation of a reorganization, merger or
                  consolidation or sale or other disposition of all or
                  substantially all of the assets of the Company or the
                  acquisition of assets or stock of another corporation (a
                  "Business Combination"), in each case, unless, following such
                  Business Combination, (I) the Persons who had Beneficial
                  Ownership, respectively, of the Outstanding Company Stock and
                  Outstanding Company Voting Securities immediately prior to
                  such Business Combination have Beneficial Ownership
                  immediately following the consummation of such Business
                  Combination, directly or indirectly, of more than 50% of,
                  respectively, the then outstanding common shares and the
                  combined voting power of the then outstanding voting
                  securities entitled to vote generally in the election of
                  directors, as the case may be, of the corporation resulting or
                  surviving from such Business Combination (including, without
                  limitation, a corporation which as a result of such
                  transaction owns the Company or all or substantially all of
                  the Company's assets either directly or through one or more
                  subsidiaries) in substantially the same proportions as their
                  ownership immediately prior to such Business Combination of
                  the Outstanding Company Stock and Outstanding Company Voting
                  Securities, as the case may be, (II) no Person (excluding any
                  entity resulting from such Business Combination or any
                  employee benefit plan (or related trust) of the Company or
                  such entity resulting from such Business Combination) has
                  Beneficially Ownership, directly or indirectly, of 20% or more
                  of, respectively, the then outstanding common shares of the
                  entity resulting from such Business Combination or the
                  combined voting power of the then outstanding voting
                  securities of such entity, except to the extent that such
                  ownership existed in respect of the Company prior to such
                  Business Combination and (III) at least a majority of the
                  members of the board of directors or similar body of the
                  entity resulting from such Business Combination were members
                  of the Incumbent Board at the time of the execution of the
                  initial agreement, or of the action of the Board of Directors,
                  providing for such Business Combination; or

                           4. Approval by the shareholders of the Company of a
                  complete liquidation or dissolution of the Company.

                  Notwithstanding the foregoing provisions of this definition,
         unless otherwise determined by the Board, no Change of Control shall be
         deemed to have occurred if (I) Executive is a member of a group that
         first announces a proposal which, if successful, would result in a
         Change of Control and which proposal (including any modifications
         thereof) is ultimately successful, or (II) Executive acquires a two
         percent (2%) or more equity interest in the entity which ultimately
         acquires the Company pursuant to the transaction described in clause
         (I), above.


                                     - 9 -


                  For purposes of this definition, "Person" means an individual,
         partnership, joint venture corporation, trust, unincorporated
         organization, government (or agency or political subdivision thereof),
         group (within the meaning of Section 13(d)(3) or 14(d)(2) of the
         Exchange Act) or any other entity, and "Beneficial Ownership" means
         beneficial ownership within the meaning of Rule 13d-3 promulgated under
         the Exchange Act.

                  d.       Good Cause. As used in this Agreement "good cause"
         for Executive to terminate his employment shall be deemed to exist if
         Executive voluntarily terminates employment within 24 months of a
         Change-of-Control for any of the following reasons:

                           1. Without Executive's express prior written consent,
                  Executive is assigned duties materially inconsistent with
                  Executive's position, duties, responsibilities, or status with
                  the Company which substantially varies from that which existed
                  immediately prior to such Change-of-Control;

                           2. Without Executive's express prior written consent,
                  Executive experiences a change in his reporting level, title,
                  or business location (of more than 50 miles from Executive's
                  current business location or residence whichever is closer to
                  the new business location) which substantially varies from
                  that which existed immediately prior to the Change-of-Control;
                  except that if Executive is not located at the Company's
                  corporate headquarters in California, a relocation to the
                  Company's corporate headquarters in California shall not be
                  deemed a substantial variation, unless Executive's reporting
                  level or title is also substantially varied;

                           3. Without Executive's express prior written consent,
                  Executive is removed from any position held immediately prior
                  to the Change-of-Control, or if Executive fails to obtain
                  reelection to any position held immediately prior to the
                  Change-of-Control, which removal or failure to reelect is not
                  directly related to Executive's incapacity or disability,
                  habitual neglect, gross misconduct or death;

                           4. Without Executive's express prior written consent,
                  Executive experiences a reduction in salary of more than 10
                  percent below that which existed immediately prior to the
                  Change-of-Control;

                           5. Without Executive's express prior written consent,
                  Executive experiences an elimination or reduction of any
                  employee benefit, business expense reimbursement or allotment,
                  incentive bonus program, or any other manner or form of
                  compensation available to Executive immediately prior to the
                  Change-of-Control and such change is not otherwise applied to
                  others in the Company with Executive's position or title;


                                     - 10 -


                           6. The Company fails to obtain from any successor,
                  before the succession takes place, a written commitment
                  obligating the successor to perform this Agreement in
                  accordance with all of its terms and conditions; or

                           7. The Company or any successor thereto purports to
                  terminate Executive pursuant to Section 4.4 without first
                  giving Executive prior written notice thereof that specifies
                  the facts and circumstances, in reasonable detail, serving as
                  the basis for Executive's termination.

         5.2 Resignation for Other Than Good Cause After a Change-of-Control. In
the event that the Company undergoes a Change-of-Control and Executive remains
with the Company for 12 months following the effective date of the
Change-of-Control, Executive will be given a 30-day "window period" in which to
elect to voluntarily terminate Executive's employment for reasons other than
good cause. Should Executive choose to terminate Executive's employment within
the 30-day "window period," then Executive shall be entitled to the following
compensation:

                  a.       One-half the lump sum payment referred to in Section
         5.1(a)(1);

                  b.       The right to exercise all vested and unexercised
         stock options granted under the Stock Option Plans in accordance with
         their terms within one year of the effective date of such termination;

                  c.       Outplacement services as defined in Section 4.4(f).

6.       CONFIDENTIALITY AND OWNERSHIP OF PROPRIETARY INFORMATION

         6.1      Confidential Information. Executive acknowledges that, during
the course of Executive's employment with the Company or with any subsidiary or
affiliate of the Company, Executive will have access to certain confidential
information in the form of know-how, trade secrets, or proprietary information
of the Company or its subsidiaries or affiliates ("Confidential Information")
and that such Confidential Information will be acquired in confidence and as a
fiduciary of the Company or its subsidiaries or affiliates. For the purposes of
this Agreement, Confidential Information shall include, without limitation,
member health data and medical records and any other protected healthcare
information, any and all cost and expense data, marketing and customer data,
sales manuals, underwriting guidelines, case management policies and procedures,
utilization review and quality assurance policies and procedures, provider
manuals, individual and group subscriber information (including, the name,
address, telephone number, or contact person for an individual or group
subscriber), subscriber group manuals, processes, designs, devices, compilations
of information, operational techniques operating manuals, symbols, service
marks, logos, customer and vendor lists (including, without limitation, lists of
subscribers, subscriber groups, clients, brokers, and providers contracting with
the Company or any subsidiary or affiliate of the Company),


                                     - 11 -


business information, marketing programs, plans, and strategies, research and
development plans, contracts and licenses, licensing techniques and practices,
advertising and promotional materials, financial information and strategies,
computer software and other computer-related materials, copyrightable material,
security controls, including computer system passwords, and other legally
protected information owned by or used in the respective businesses of the
Company or its subsidiaries or affiliates which are confidential or proprietary
in nature and may include confidential or proprietary information received from
third parties. In addition to the foregoing, Confidential Information also
includes any information which is not generally known to the public, or within
the market or trade in which the Company competes, and the physical embodiments
of such information in any tangible form, whether written or machine-readable in
nature, or any information which is marked or designated as "Confidential" or
"Proprietary."

         6.2      Ownership of Inventions. Executive agrees to assign and does
hereby assign to the Company any and all ideas, designs, know-how, programs,
improvements, inventions, discoveries and literary creations (collectively
referred to as "Inventions") which Executive alone or with others may conceive
or make, and which (a) are made wholly or partially with the Company's assets or
confidential or trade secret information; or (b) are developed wholly or
partially on the Company's time; or (c) relate at the time of conception or
reduction to practice to the Company's business, including actual or
demonstrably anticipated research or development of the Company; or (d) result
from Executive's work for the Company. Such Inventions are and shall be the
property of the Company and shall be deemed to be part of the Company's
business, whether or not any applications for patents, trademarks or copyrights
are filed thereon. Further, all such Inventions shall constitute Confidential
Information. Executive shall not claim to own any Inventions relating to the
business of the Company. Executive agrees that, upon request of the Company,
Executive shall execute any and all papers and do all other lawful acts that may
be required by the Company in order to make applications for Letters Patent, of
the United States and of any and all other countries, on such Inventions, or
that may be required to vest ownership of such applications, patents and
copyrights in the Company, or that may be required to prosecute or obtain such
patents, or to maintain, preserve or enforce the rights of the Company in such
Inventions, patents and copyrights. Except as otherwise prohibited by law
(including but not limited to California Labor Code section 2870), and except
for Inventions made prior to commencement of Executive's employment with the
Company, in addition to the above assignment of Inventions to the Company,
without further consideration, Executive hereby fully, forever, and irrevocably
assigns, transfers, and conveys to the Company: (i) all patents, patent
applications, copyrights, mask works, trade secrets, and other intellectual
property rights in any Invention; and (ii) any and all "Moral Rights" (as
defined below) which Executive may have in, to, or with respect to any
Invention. For purposes of this Agreement, "Moral Rights" shall mean any rights
to claim authorship of an Invention, to object to or prevent the modification of
any Invention, or to withdraw from circulation or control the publication or
distribution of any Invention, and any similar right, existing under judicial or
statutory law of any country in the world, or under any treaty, regardless of
whether or not such right is


                                     - 12 -


denominated or generally referred to as a "moral right." Executive will promptly
disclose any Inventions to the Company whether developed or created alone or
jointly with others.

         6.3      Confidentiality Covenant. Executive acknowledges and agrees
that maintaining the confidentiality of all of the Confidential Information is
integral to the value of the Company and is vital to the successful operations
of the Company and its subsidiaries and affiliates. In view of the foregoing,
Executive agrees to maintain the confidentiality of all Confidential Information
and to not disclose, divulge, exploit, or use, in any manner whatsoever, the
Confidential Information for Executive's own benefit or the benefit of another
person. Executive will additionally take all reasonable precautions to prevent
the inadvertent or accidental exposure of the Confidential Information.
Executive shall not remove any Confidential Information from the Company's
premises or make copies of any of such information except for the benefit of the
Company and in furtherance of Executive's duties as an employee of the Company.
Upon Executive's termination of employment with the Company, Executive shall not
remove from the Company's premises any materials containing any Confidential
Information, and will promptly return to the Company any material which contain
Confidential Information which are in Executive's possession or control.

         6.4      No Solicitation. Executive acknowledges and agrees that
Executive will not solicit or participate in or assist in any way in the
solicitation of any employees of Company. For purposes of this provision,
"solicitation" means directly or indirectly influencing or attempting to
influence employees of Company to become employed with any other person,
partnership, firm, or entity.

         6.5      Equitable Relief. Executive acknowledges and agrees that it
would be difficult to measure the damage to the Company (or any subsidiary or
affiliate, as the case may be) from any breach of Executive's obligations under
this Article 6, that injury to the Company (or to any subsidiary or affiliate,
as the case may be) from any such breach would be impossible to calculate, and
that money damages would therefore be an inadequate remedy for any such breach.
Therefore, Executive acknowledges and agrees that the Company, in addition to
any of its other rights or remedies, shall be entitled to seek injunctive or
other equitable relief without bond or other security in the event of an actual
or threatened breach of this Agreement. The obligations of Executive and the
rights and remedies of the Company under this Agreement are cumulative and in
addition to, and not in lieu of, any obligations, rights, or remedies created by
applicable patent, copyright, or other laws, including the statutory and common
laws governing unfair competition, misappropriation or theft of trade secrets,
proprietary rights, or confidential information generally.

         6.6.     Survival of Obligations. Executive's obligations under this
Article 6 shall survive the termination of Executive's employment regardless of
the manner of such termination and shall be binding upon Executive's heirs,
executors, administrators and legal representatives. The remedies to which the
Company is entitled under this Article 6 shall survive the termination of
Executive's employment with the Company.


                                     - 13 -


7.       NOTICES

         All notices or other communications required or permitted to be made
hereunder shall be given in writing and sent by either personal delivery,
overnight delivery, or United States registered or certified mail, return
receipt requested, all of which shall be properly addressed with postal or
delivery charges prepaid, to the parties at their respective addresses set forth
below, or to such other addresses as either party may designate to the other in
accordance with this Article 7:

         If to the Company:  PacifiCare Health Systems, Inc.
                             5995 Plaza Drive
                             Cypress, California 90630
                             Attn: President and
                             Chief Executive Officer


         If to Executive:    A. Peter Reynolds
                             1934 Pt. Locksleigh Place
                             Newport Beach, CA 92660

All notices sent by personal delivery shall be deemed given when actually
received. All notices sent by overnight delivery shall be deemed received on the
next business day. All other notices sent via United States mail shall be deemed
received no later than two business days after mailing. Any notice given by any
method not expressly authorized herein, shall nevertheless be effective if
actually received, and shall be deemed given upon actual receipt.

8.       GENERAL PROVISIONS

         8.1      Severance Agreement. Any payments of compensation made
pursuant to Articles 4 and 5 are contingent on Executive executing the Company's
standard severance agreement, including a general release of the Company, its
owners, partners, stockholders, directors, officers, employees, independent
contractors, agents, attorneys, representatives, predecessors, successors and
assigns, parents, subsidiaries, affiliated entities and related entities.
Executive must execute the standard severance agreement and release within 45
days of being provided with the document to sign or the severance agreement
offer will expire.

         8.2      Assignability. This Agreement shall inure to the benefit of,
and shall be binding upon the heirs, executors, administrators, successors, and
legal representatives of Executive and shall inure to the benefit of, and be
binding upon the Company and its successors and assigns. Executive shall not
assign, delegate, subdelegate, transfer, pledge, encumber, hypothecate, or
otherwise dispose of this Agreement, or any rights, obligations, or duties
hereunder, and any such


                                     - 14 -


attempted delegation or disposition shall be null and void and without any force
or effect; provided, however, that nothing contained herein shall prevent
Executive from designating beneficiaries for insurance, death or retirement
benefits.

         8.3      Entire Agreement. This Agreement is a fully integrated
document and contains any and all promises, covenants, and agreements between
the parties hereto with respect to Executive's employment. This Agreement
supersedes any and all other, prior or contemporaneous, discussions,
negotiations, representations, warranties, covenants, conditions, and
agreements, whether written or oral, between the parties hereto. Except as
expressed herein, the parties have not exchanged any other representations,
warranties, inducements, promises, or agreements respecting Executive's
employment with the Company.

         8.4      Severability. In the event any one or more of the provisions
of this Agreement shall be rendered by a court of competent jurisdiction to be
invalid, illegal, or unenforceable, in any respect, such invalidity, illegality,
or unenforceability shall not affect or impair the remainder of this Agreement
which shall remain in full force and effect and enforced accordingly, unless a
party demonstrates by a preponderance of the evidence that the invalidated
provision was an essential economic term of this Agreement.

         8.5      Amendment. This Agreement shall not be changed, amended, or
modified, nor shall any performance or condition hereunder be waived, in whole
or in part, except by written instrument signed by the party against whom
enforcement or waiver is sought. The waiver of any breach of any term or
condition of this Agreement shall not be deemed to constitute the waiver of any
other or subsequent breach of the same or any other term or condition of this
Agreement.

         8.6      Governing Law. This Agreement shall be governed by, enforced
under, and construed in accordance with the laws of the State of California.

         IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first written above.

The Company:                          PACIFICARE HEALTH SYSTEMS, INC.,
                                      a Delaware corporation

Date:   __/__/__
                                      By:
                                          --------------------------------------
                                               Gregory Scott
                                               Executive Vice President & CFO




Executive:
                                      ------------------------------------------
Date:  __/__/__                       A. Peter Reynolds


                                     - 15 -

EX-10.21

                                                                   EXHIBIT 10.21


                         PACIFICARE HEALTH SYSTEMS, INC.
                            2003 INCENTIVE BONUS PLAN


Section 1.        Purpose

                           The purpose of the Management Incentive Compensation
                           Plan is to promote the interests of the Company by
                           attracting and retaining an outstanding management
                           and key employee staff. Under the Plan, incumbents in
                           stipulated key positions may receive Awards that vary
                           with the success of the Company, the Subsidiary
                           Operating Units as appropriate, and individual
                           performance. Awards payable under this Plan are not
                           intended to qualify as performance-based compensation
                           with the meaning of Section 162(m) of the Internal
                           Revenue Code of 1986, as amended (the "Code"), and
                           the Treasury Regulations promulgated thereunder.

Section 2.        Definitions

                           (a)      "Award" refers to a contingent right to
                                    receive cash at the end of a Plan Year.

                           (b)      "Committee" means a committee of the Board
                                    of Directors established to administer this
                                    Plan.

                           (c)      "Company" means PacifiCare Health Systems,
                                    Inc.

                           (d)      "Covered Employee" means (i) the Company's
                                    chief executive officer (or officers) on the
                                    last day of each Plan Year, and (ii) the
                                    four (4) highest compensated executive
                                    officers of the Company (as defined in Rule
                                    3b-7 under the Securities Exchange Act of
                                    1934, as amended) other than the chief
                                    executive officer (or officers), as
                                    determined on the last day of each Plan
                                    Year.

                           (e)      "Disability" means, with respect to a
                                    Participant, the Participant's permanent and
                                    total disability as defined in Section
                                    22(e)(3) of the Code.

                           (f)      "Participant" means any officer or full-time
                                    employee of the Company or any subsidiary of
                                    the Company as are determined by the
                                    Committee to have a direct, significant, and
                                    measurable impact on the attainment of the
                                    Company's or subsidiary's long term growth
                                    and profitability objectives; provided, that
                                    a Covered Employee may not be a Participant
                                    under this Plan.

                           (g)      "Plan" refers to this 2003 Incentive Bonus
                                    Plan.

                           (h)      "Plan Year" refers to each annual fiscal
                                    year of the Company.

                           (i)      "Retirement" means, with respect to a
                                    Participant, the Participant's voluntary
                                    termination of his or her employment with
                                    the Company that occurs after the sum of the
                                    following two factors meet or

                                       1




                                    exceed fifty-five (55): (i) the
                                    Participant's age and (ii) the Participant's
                                    number of full years of service with the
                                    Company.

                           (j)      "Subsidiary Operating Units" refers to any
                                    profit center so designated by the
                                    Committee.

Section 3.        Administration

                           The Plan will be administered by the Committee. The
                           Committee will: (i) approve the Participants eligible
                           to receive Awards under the Plan with respect to each
                           Plan Year; (ii) determine the performance objectives;
                           and (iii) determine the amount of Awards subject to
                           the terms and conditions set forth in the Plan and to
                           other terms and conditions consistent with the
                           purpose and provisions of the Plan.

                           The Committee may prescribe, amend, or rescind such
                           rules, regulations, policies, interpretations, and
                           guides as deemed appropriate for proper and effective
                           Plan administration. In addition, only the Board of
                           Directors may suspend or terminate the Plan. Any of
                           the foregoing actions will affect future Plan Years
                           only.

                           No member of the Committee or employee of the Company
                           will be personally liable for any action, failure to
                           act, determination, or interpretation made in good
                           faith with respect to the Plan or any transaction
                           under the Plan.

                           All decisions, determinations, and interpretations of
                           the Committee will be final and binding.

Section 4.        Eligibility and Participation

                           The persons eligible to participate in the Plan shall
                           be those Participants designated by the Committee to
                           participate in the Plan.

                           The Committee will designate Participants who are to
                           be granted Awards for an Award year and, in its
                           discretion, may designate additional Participants
                           during any Award year as deemed appropriate;
                           provided, however, that adjustments shall be made to
                           the minimum performance objectives applicable to new
                           Participants to ensure that any Award payable to such
                           new Participant is based solely on the attainment of
                           future performance objectives. The Committee, through
                           its designee, will notify Participants of their
                           eligibility in writing. The Committee will not be
                           bound by selections made for prior Award years.

Section 5.        Determination and Allocation of Awards

                           (a)      Establishment of Annual Objectives and
                                    Formulas. For each Plan Year, the Committee
                                    will establish, in writing, specific
                                    financial and/or strategic performance
                                    objectives for such Plan Year. At such time,
                                    the Committee will establish minimum
                                    performance objectives below which no Awards
                                    will be earned, maximum performance
                                    objectives above which Awards will not be
                                    affected,


                                       2



                                    and the formula for computing each
                                    Participant's Award. The performance
                                    objectives may, but need not, be based on
                                    the following criteria, either alone or in
                                    any combination, and on either a
                                    consolidated or Subsidiary Operating Unit
                                    level, and measured either on an absolute
                                    basis, relative basis against a
                                    pre-established target, and/or peer group,
                                    or prior year's performance as the Committee
                                    determine: (i) revenue(sales); (ii) cash
                                    flow; (iii) earnings per share (including
                                    earnings before interest, taxes and
                                    amortization); (iv) return on equity; (v)
                                    total shareholder return, (vi) return on
                                    capital; (vii) return on assets or net
                                    assets; (viii) income or net income; (ix)
                                    operating income or net operating income;
                                    (x) adjusted operating income; (xi)
                                    operating profit or net operating profit;
                                    (xii) operating margin; (xiii) market share;
                                    (xiv) member satisfaction; or (xv) employee
                                    satisfaction. The foregoing criteria shall
                                    have any reasonable definitions that the
                                    Committee may specify, which may include or
                                    exclude any or all of the following items as
                                    the Committee may specify: extraordinary,
                                    unusual or non-recurring items; effects of
                                    accounting changes; effects of financing
                                    activities; expenses for restructuring or
                                    productivity initiatives; other
                                    non-operating items; spending for
                                    acquisitions; and effects of divestitures.
                                    Any such performance objective or
                                    combination of such objectives may apply to
                                    a Participant's Award opportunity in its
                                    entirety or to any designated portion or
                                    portions of the Award opportunity, as the
                                    Committee may specify.

                                    Upon establishment of the performance
                                    objective(s) for a specific Plan Year, the
                                    appointed designee of the Committee will
                                    notify each participant in writing of the
                                    established objective(s).

                                    If the Committee determines the established
                                    performance objectives are no longer
                                    suitable due to a change in the Company's
                                    business, operations, corporate structure,
                                    capital structure, or other conditions
                                    deemed by the Committee to be material, the
                                    Committee will have sole discretion during
                                    the Plan Year to modify the performance
                                    objectives as considered appropriate and
                                    equitable.

                           (b)      Without limiting the generality of Section
                                    5(a), the Committee may, in its sole
                                    discretion, reduce the amount of any Award
                                    made to any Participant from the potential
                                    Award allocated to that Participant under
                                    Section 5(a), taking into account such
                                    factors as it deems relevant, including,
                                    without limitation: (1) significant
                                    financial or strategic achievements during
                                    the year; (2) its subjective assessment of
                                    such Participant's overall performance for
                                    the Plan Year; and (3) information about
                                    compensation practices at other peer group
                                    companies for the purpose of evaluating
                                    competitive compensation levels so that the
                                    Committee may determine that the amount of
                                    the Award is within the targeted competitive
                                    compensation range of the Company's
                                    compensation program. The Committee shall
                                    determine the amount of any

                                       3




                                    reduction in a Participant's Award on the
                                    basis of the foregoing and other factors it
                                    deems relevant and shall not be required to
                                    establish any allocation or weighting
                                    formula with respect to the factors it
                                    considers.


                           (c)      No Stockholder Approval. Establishment of
                                    Awards for Participants shall not be subject
                                    to, nor contingent upon, the disclosure to
                                    the stockholders of the Company of the
                                    material terms of the performance objectives
                                    and stockholder approval of such terms.

Section 6.        Payment of Awards Earned

                           The basis of Awards for a given Plan Year will be the
                           achievement of the performance objectives and
                           individual contributions as determined by the
                           Committee. If minimum financial performance is not
                           attained for a Plan Year, no payment will be made and
                           all contingent rights will cease. Further, no
                           additional payments will be made for financial
                           performance above the maximum objective.

                           If performance objectives are achieved, the Committee
                           shall certify in writing, prior to the payment of any
                           Award, that such performance goals (and any other
                           material terms) were satisfied. The Award, if any,
                           earned by each Participant will be paid as soon as
                           administratively possible following the close of the
                           applicable Plan year and the certification by the
                           Committee, described in the preceding sentence.

                           A Participant may elect in writing one year in
                           advance of a Plan Year, upon approval by the
                           Committee, to defer receipt of all or a portion of an
                           Award earned for a specified time as approved by the
                           Committee. Payment of deferred amounts may be in a
                           lump sum on the designated payment date or in
                           installments as approved by the Committee. A
                           Participant's right to any deferred Award will be
                           that of a general creditor of the Company; no trust
                           will be deemed to be created by virtue of such
                           deferral.

Section 7.        Termination of Employment

                           In the event of a Participant's death, Disability, or
                           Retirement during a Plan Year, payment of the Award
                           earned will be prorated unless otherwise determined
                           by the Committee. Such Awards will then be paid to
                           the Participant, the Participant's estate or legal
                           representative as determined by the Committee.

                           In the event of a Participant's death, Disability, or
                           Retirement, after the end of the Plan Year but before
                           payment of an Award to which the Participant is
                           entitled, such Award will be paid to the Participant,
                           the Participant's estate or legal representative.

                           In the event of termination of employment of a
                           Participant or a Participant ceases to be an Officer,
                           voluntarily or by the actions of the Company, with

                                       4




                           or without cause, for reasons other than those
                           specified above, at any time before payment of the
                           incentive award, the Participant will forfeit all
                           rights to any Award subject to the sole discretion of
                           the Committee.

Section 8.        Discretionary Incentive Award.

                           The Committee may, in its sole discretion, make an
                           additional award to any Participant determined by the
                           Committee to have positively impacted directly on the
                           attainment of the performance objectives established
                           by the Committee.

Section 9.        Adjustments Upon Changes in Capitalization

                           In the event of a reorganization, merger,
                           consolidation or similar transaction in which the
                           Company is not the surviving corporation, or upon the
                           sale of substantially all the assets of the Company
                           to another corporation, or upon the dissolution or
                           liquidation of the Company, then the Company or a
                           successor corporation, if any, may continue the Plan
                           and, if not, then the Plan will terminate on the
                           effective date of such transaction. Provision will be
                           made for determining the amount of cash payable for
                           all Awards for a Plan Year which will end after such
                           event based on the portion of the Plan Year occurring
                           prior to such event, unless provisions are made for
                           the continuance of the Plan and the assumption or
                           substitution for such Awards of an equivalent value
                           by the successor corporation.

                           Adjustments under this section will be made by the
                           Committee whose determination as to what adjustments
                           will be made and the extent will be final, binding,
                           and conclusive.


Section 10.       General Provisions

                           (a)      No right to Participate: Nothing in the Plan
                                    will be deemed to give a Participant or a
                                    Participant's legal representative or any
                                    other person or entity claiming under or
                                    through a Participant any contract or right
                                    to participate in the benefits of the Plan.

                           (b)      No Employment Right: Participation in the
                                    Plan will not be construed as constituting a
                                    commitment, guarantee, agreement, or
                                    understanding of any kind that the Company
                                    will continue to employ any individual.

                           (c)      Nontransferability: A Participant or any
                                    designed beneficiary has no right to assign,
                                    transfer, attach, or hypothecate any
                                    benefits or payments of the Plan.

                           (d)      Withholding: The Company has the right to
                                    deduct any sums federal, state, or local tax
                                    requires to be withheld with respect to the
                                    payment of any Award.

                           (e)      Restricted Liability: Payments held by the
                                    Company before distribution will not be
                                    liable for the debts, contracts, or
                                    obligations

                                       5




                                    of any Participant or beneficiary, or be
                                    taken in execution by attachment or
                                    garnishment, or by any other legal or
                                    equitable proceeding.

Section 11.       Amendment, Suspension, or Termination of Plan

                           The Company may amend, suspend, or terminate the Plan
                           at any time. Such amendment, suspension, or
                           termination will not adversely alter or affect any
                           right or obligation to any Award made before this
                           action. The Committee will determine the effect on
                           Awards that may be effected by such event and make
                           adjustments and/or payments as it, in its sole
                           discretion, determines appropriate.

Section 12.       Effective Date

                           This Plan will be effective upon its adoption by the
                           Company and may be applied retroactively to the
                           beginning of the Company's fiscal year at the sole
                           discretion of the Committee.


                                       6

EX-10.30

                                                                   EXHIBIT 10.30

             (Contract Period January 1, 2004 to December 31, 2004)

     Contract With Eligible Medicare+Choice (M+C) Organization Pursuant to
    sections 1851 through 1859 of the Social Security Act for the operation
                 of a Medicare+Choice coordinated care plan(s)


                               CONTRACT (P______ )

                                    Between

   Centers for Medicare & Medicaid Services (hereinafter referred to as CMS)

                                      and

                ------------------------------------------------
               (hereinafter referred to as the M+C Organization)

CMS and the M+C Organization, an entity which has been determined to be an
eligible Medicare+Choice Organization by the Administrator of the Centers for
Medicare & Medicaid Services under 42 CFR 422.501, agree to the following for
the purposes of sections 1851 through 1859 of the Social Security Act
(hereinafter referred to as the Act):

(NOTE: Citations indicated in brackets are placed in the text of this contract
to note the authority for certain contract provisions in the regulations
promulgated pursuant to the Balanced Budget Act of 1997, as amended. All
references to part 422 are to 42 CFR part 422.)






                                   Article I

                                Term of Contract

The term of this contract shall be from January 1, 2004 through December 31,
2004, after which the contract may be renewed for successive one-year periods in
accordance with 42 CFR 422.504(c). [422.504]

This contract governs the respective rights and obligations of the parties as of
the effective date set forth above, and supercedes any prior agreements between
the M+C Organization and CMS as of such date.

                                   Article II

                             Coordinated Care Plan

The Medicare+Choice Organization agrees to operate coordinated care plans (as
defined in 42 CFR 422.4(a)(1)), as described in its Adjusted Community Rate
(ACR) proposal as approved annually by CMS, in compliance with the requirements
of this contract and applicable Federal statutes, regulations, and policies.
This contract is deemed to incorporate any changes that are required by statute
to be implemented during the term of the contract and any regulations or
policies implementing or interpreting such statutory provisions. However, CMS
agrees that any regulation or policy statement it issues later than 30 days
prior to the date by which M+C Organizations are required to submit ACR
proposals to CMS, and which creates significant new operational costs of which
the M+C Organization did not have reasonable notice prior to such date, shall
not take effect in the next calendar year unless implementation during the next
calendar year is required by statute or in connection with litigation
challenging CMS' policies. CMS retains the authority to issue, with an effective
date during the term of this contract, policies to implement the statutory
requirement that M+C Organizations provide their enrollees those items and
services for which benefits are available under Medicare Parts A and B.
Clarifications or explanations of M+C operational requirements issued prior to
30 days prior to the date by which M+C Organizations are required to submit ACR
proposals are not considered to create new operational costs of which the M+C
organization did not have notice.

                                  Article III

           Functions To Be Performed By Medicare+Choice Organization

A. PROVISION OF BENEFITS

The M+C Organization agrees to provide enrollees in each of its M+C plans the
basic benefits as required under ss.422.101 and, to the extent applicable,
supplemental benefits under ss.422.102 and as established in the M+C
Organization's adjusted community rate (ACR) proposal as approved by CMS. The
M+C Organization agrees to provide access to such benefits as required under
subpart C in a manner consistent with professionally recognized standards of
health care and according to the access standards stated in ss. 422.112. The M+C
Organization agrees to provide



                                       1


post-hospital extended care services, should an M+C enrollee elect such
coverage, through a home skilled nursing facility according to the requirements
of section 1852(l) of the Act. A home skilled nursing facility is a facility in
which an M+C enrollee resided at the time of admission to the hospital, a
facility that provides services through a continuing care retirement community,
or a facility in which the spouse of the enrollee is residing at the time of the
enrollee's discharge from the hospital. [422.502(A)(3)]

B. ENROLLMENT REQUIREMENTS

1. The M+C Organization agrees to accept new enrollments, make enrollments
effective, process voluntary disenrollments, and limit involuntary
disenrollments, as provided in subpart B of part 422.

2. The M+C Organization shall comply with the provisions of ss. 422.110
concerning prohibitions against discrimination in beneficiary enrollment.
[422.502(A)(2)]

C. BENEFICIARY PROTECTIONS

1. The Medicare+Choice Organization agrees to comply with all requirements in
subpart M of part 422 governing coverage determinations, grievances, and
appeals. [422.502(A)(7)]

2. The Medicare+Choice Organization agrees to comply with the enrollee notice
and appeal procedures for the termination of provider services in ss. 422.624
and ss. 422.626.

3. The Medicare+Choice Organization agrees to comply with the confidentiality
and enrollee record accuracy requirements in ss. 422.118.

4. Beneficiary Financial Protection. The M+C Organization agrees to comply with
the following requirements:

         (a) Each M+C Organization must adopt and maintain arrangements
satisfactory to CMS to protect its enrollees from incurring liability for
payment of any fees that are the legal obligation of the M+C Organization. To
meet this requirement the M+C Organization must--

         (i) Ensure that all contractual or other written arrangements with
providers prohibit the Organization's providers from holding any beneficiary
enrollee liable for payment of any fees that are the legal obligation of the M+C
Organization; and

         (ii) Indemnify the beneficiary enrollee for payment of any fees that
are the legal obligation of the M+C Organization for services furnished by
providers that do not contract, or that have not otherwise entered into an
agreement with the M+C Organization, to provide services to the organization's
beneficiary enrollees. [422.502(G)(1)]

         (b) The M+C Organization must provide for continuation of enrollee
health care benefits-

         (i) For all enrollees, for the duration of the contract period for
which CMS payments have been made; and

         (ii) For enrollees who are hospitalized on the date its contract with
CMS terminates, or, in the event of an insolvency, through the date of
discharge. [422.502(G)(2)]

         (c) In meeting the requirements of this section (C), other than the
provider contract requirements specified in paragraph (C)(3)(a) of this Article,
the M+C Organization may use--

         (i) Contractual arrangements;

         (ii) Insurance acceptable to CMS;

         (iii) Financial reserves acceptable to CMS; or

         (iv) Any other arrangement acceptable to CMS. [422.502(G)(3)]



                                       2


D. PROVIDER PROTECTIONS

1. The M+C Organization agrees to comply with all applicable provider
requirements in subpart E of part 422, including provider certification
requirements, anti-discrimination requirements, provider participation and
consultation requirements, the prohibition on interference with provider advice,
limits on provider indemnification, rules governing payments to providers, and
limits on physician incentive plans. [422.502(A)(6)]

2. Prompt Payment.

         (a) The M+C Organization must pay 95 percent of the "clean claims"
within 30 days of receipt if they are claims for covered services that are not
furnished under a written agreement between the organization and the provider.

         (i) The M+C Organization must pay interest on clean claims that are not
paid within 30 days in accordance with sections 1816(c)(2)(B) and 1842(c)(2)(B)
of the Act.

         (ii) All other claims must be paid or denied within 60 calendar days
from the date of the request. [422.520(A)]

         (b) Contracts or other written agreements between the M+C Organization
and its providers must contain a prompt payment provision, the terms of which
are developed and agreed to by both the M+C Organization and the relevant
provider. [422.520(B)]

         (c) If CMS determines, after giving notice and opportunity for hearing,
that the M+C Organization has failed to make payments in accordance with
paragraph (2)(a) of this section, CMS may provide--

         (i) For direct payment of the sums owed to providers; and

         (ii) For appropriate reduction in the amounts that would otherwise be
paid to the M+C Organization, to reflect the amounts of the direct payments and
the cost of making those payments. [422.520(C)]

E. QUALITY ASSESSMENT AND PERFORMANCE IMPROVEMENT PROGRAM

1. The M+C Organization agrees to operate an ongoing quality assessment and
performance improvement program (as stated in 422.152 of subpart D).

2. Quality Assessment and Performance Improvement Projects: The M+C Organization
agrees to:

         (a) conduct quality assessment and performance improvement (QAPI)
projects as directed annually by CMS. These projects must be outcomes-oriented
and targeted at achieving demonstrable, sustained improvement in significant
aspects of specified clinical and non-clinical areas which can be expected to
have a favorable effect on enrollees' health outcomes and satisfaction. CMS
shall establish the obligations of the M+C Organization for the number and
distribution of projects among the required clinical and non-clinical areas.

         (b) In those years when CMS establishes a national improvement project
for the Medicare+Choice program, the M+C Organization shall participate in the
CMS-sponsored national QAPI initiative, unless the M+C Organization meets the
requirements for an exemption from the initiative.

3. Performance Measurement and Reporting: The M+C Organization shall measure
performance under its M+C plans using standard measures required by CMS, and
report (at the organization level) its performance to CMS. The standard measures
required by CMS during the term of this contract will be uniform data collection
and reporting instruments, to include the



                                       3


Health Plan and Employer Data Information Set (HEDIS), Consumer Assessment of
Health Plan Satisfaction (CAHPS) survey, and Health Outcomes Survey (HOS). These
measures will address clinical areas, including effectiveness of care, enrollee
perception of care and use of services; and non-clinical areas including access
to and availability of services, appeals and grievances, and organizational
characteristics. [422.152(c)(1)&(2)].

4. Utilization Review: If the M+C Organization uses written protocols for
utilization review, those policies and procedures must reflect current standards
of medical practice in processing requests for initial or continued
authorization of SERVICES.[422.152(b)(3)]. The M+C Organization must also have
in effect mechanisms to detect both underutilization and overutilization of
services.[422.152(b)(4)] .

5. Information Systems:

         (a) The M+C Organization must make available to CMS information on
quality and outcomes measures that will enable beneficiaries to compare health
coverage options and select among them, as provided in ss. 422.64(c)(10).
[422.152(b)(5)].

         (b) The M+C Organization must maintain a health information system
that:

         (i) collects, analyzes and integrates the data necessary to implement
its quality assessment and performance improvement program, and

         (ii) assures that the information entered into the system (particularly
that received from providers) is reliable and complete.

         (c) The M+C Organization must make all collected data, including
information on quality and outcome measures, available to CMS to enable
beneficiaries to compare health coverage options and select among them, as
provided in ss. 422.64(c)(10). [422.152(b)(5)]

6. External Review: The M+C Organization will have an agreement with an
independent quality review and improvement organization (review organization)
approved by CMS. [422.154(a)]

         (a) The agreement will be consistent with CMS guidelines and will:

         (i) Require that the M+C Organization allocate adequate space for use
of the review organization whenever it is conducting review activities and
provide all pertinent data, including patient care data, at the time the review
organization needs the data to carry out the reviews and make its
determinations, and

         (ii) Except in the case of complaints about quality, exclude review
activities that CMS determines would duplicate review activities conducted as
part of an accreditation process or as part of CMS monitoring. [422.154(b)]

F. COMPLIANCE PLAN

The M+C Organization agrees to implement a compliance plan in accordance with
the requirements of ss. 422.501(b)(3)(vi).
         [422.501(b)(3)(VI)]

G. COMPLIANCE DEEMED ON THE BASIS OF ACCREDITATION: CMS may deem the M+C
Organization to have met the quality assessment and performance improvement
requirements of ss. 422.152, the confidentiality and accuracy of enrollee
records requirements of ss. 422.118, the anti-discrimination requirements of ss.
1852(b) of the Act, the access to services requirements of ss. 1852(d) of the
Act, the advance directives requirements of ss. 422.128, and/or the provider
participation requirements of ss. 1852(j) of the Act if the M+C Organization is
fully



                                       4


accredited (and periodically reaccredited) by a private, national accreditation
organization approved by CMS and the accreditation organization used the
standards approved by CMS for the purposes of assessing the M+C Organization's
compliance with Medicare requirements. The provisions of ss. 422.156 shall
govern the M+C Organization's use of deemed status to meet M+C program
requirements.

                                   Article IV

                        CMS Payment to M+C Organization

A. The M+C Organization agrees to develop its annual adjusted community rate
(ACR) proposal and submit to CMS all required information on premiums, benefits,
and cost sharing, as required under 42 CFR 422, subpart G. [422.502(a)(10)]

B. Methodology. CMS agrees to pay the M+C Organization under this contract in
accordance with the provisions of section 1853 of the Act and subpart F of part
422. [422.502(a)(9)]

C. Attestation of payment data (Attachments A, B, and C).

1. As a condition for receiving a monthly payment under paragraph B of this
article, subpart F of part 422, the M+C Organization agrees that its chief
executive officer (CEO), chief financial officer (CFO), or an individual
delegated with the authority to sign on behalf of one of these officers, and who
reports directly to such officer, must request payment under the contract on the
forms attached as Attachment A (enrollment attestation), Attachment B (risk
adjustment data), and Attachment C (adjusted community rate (ACR) proposal
information attestation), hereto which attest to (based on best knowledge,
information and belief, as of the date specified on the attestation form) the
accuracy, completeness, and truthfulness of the data identified on these
attachments. Attachment A requires attestation based on best knowledge,
information, and belief, that each enrollee for whom the M+C Organization is
requesting payment is validly enrolled, or was validly enrolled during the
period for which payment is requested, in an M+C plan offered by the M+C
Organization. The M+C Organization shall submit completed enrollment attestation
forms to CMS, or its contractor, on a monthly basis. (NOTE: The forms included
as attachments to this contract are for reference only. CMS will provide
instructions for the completion and submission of the forms in separate
documents. M+C Organizations should not take any action on the forms until
appropriate CMS instructions become available.)

2. Attachment B requires that the CEO, CFO, or an individual delegated with the
authority to sign on behalf of one of these officers, and who reports directly
to such officer, must attest to (based on best knowledge, information and
belief, as of the date specified on the attestation form) that the risk
adjustment data it submits to CMS under ss. 422.257 are accurate, complete, and
truthful. The M+C Organization shall make annual attestations of risk adjustment
data on Attachment B and according to a schedule to be published by CMS. If such
risk adjustment data are generated by a related entity, contractor, or
subcontractor of an M+CO, such entity, contractor, or subcontractor must
similarly attest to (based on best knowledge, information, and



                                       5


belief, as of the date specified on the attestation form) the accuracy,
completeness, and truthfulness of the data. [422.502(l)]

3. The CEO, CFO, or an individual delegated with the authority to sign on behalf
of one of these officers, and who reports directly to such officer, must attest
(based on best knowledge, information and belief, as of the date specified on
the attestation form) that the information and documentation comprising the ACR
proposal is accurate, complete, and truthful and fully conforms to the ACRP
requirements; and that the benefits described in the CMS-approved ACR proposal
agree with the benefit package the M+C Organization will offer during the period
covered by the ACR proposal. [422.502(l)]


                                   Article V

       M+C Organization Relationship with Related Entities, Contractors,
                               and Subcontractors

A. Notwithstanding any relationship(s) that the M+C Organization may have with
related entities, contractors, or subcontractors, the M+C Organization maintains
full responsibility for adhering to and otherwise fully complying with all terms
and conditions of its contract with CMS. [422.502(i)(1)]

B. The M+C Organization agrees to require all related entities, contractors, or
subcontractors to agree that--

         (1) HHS, the Comptroller General, or their designees have the right to
inspect, evaluate, and audit any pertinent contracts, books, documents, papers,
and records of the related entity(s), contractor(s), or subcontractor(s)
involving transactions related to the contract; and

         (2) HHS's, the Comptroller General's, or their designee's right to
inspect, evaluate, and audit any pertinent information for any particular
contract period will exist through 6 years from the final date of the contract
period or from the date of completion of any audit, whichever is later.
[422.502(i)(2)] C. The M+C Organization agrees that all contracts or written
arrangements into which the M+C Organization enters with providers, related
entities, contractors, or subcontractors shall contain the following elements:

         (1) Enrollee protection provisions that provide--

         (a) Consistent with Article III(C), arrangements that prohibit
providers from holding an enrollee liable for payment of any fees that are the
legal obligation of the M+C Organization; and

         (b) Consistent with Article III(C), provision for the continuation of
benefits.

         (2) Accountability provisions that indicate that--

         (a) The M+C Organization oversees and is accountable to CMS for any
functions or responsibilities that are described in these standards; and

         (b) The M+C Organization may only delegate activities or functions to a
provider, related entity, contractor, or subcontractor in a manner consistent
with requirements set forth at paragraph D of this article.


                                       6


         (3) A provision requiring that any services or other activity performed
by a related entity, contractor or subcontractor in accordance with a contract
or written agreement between the related entity, contractor, or subcontractor
and the M+C Organization will be consistent and comply with the M+C
Organization's contractual obligations to CMS.

         [422.502(i)(3)]

D. If any of the M+C Organization's activities or responsibilities under this
contract with CMS are delegated to other parties, the following requirements
apply to any related entity, contractor, subcontractor, or provider:

         (1) Written arrangements must specify delegated activities and
reporting responsibilities.

         (2) Written arrangements must either provide for revocation of the
delegation activities and reporting requirements or specify other remedies in
instances where CMS or the M+C Organization determine that such parties have not
performed satisfactorily.

         (3) Written arrangements must specify that the performance of the
parties is monitored by the M+C Organization on an ongoing basis.

         (4) Written arrangements must specify that either--

         (a) The credentials of medical professionals affiliated with the party
or parties will be either reviewed by the M+C Organization; or

         (b) The credentialing process will be reviewed and approved by the M+C
Organization and the M+C Organization must audit the credentialing process on an
ongoing basis.

         (5) All contracts or written arrangements must specify that the related
entity, contractor, or subcontractor must comply with all applicable Medicare
laws, regulations, and CMS instructions. [422.502(i)(4)]

E. If the M+C Organization delegates selection of the providers, contractors, or
subcontractors to another organization, the M+C Organization's written
arrangements with that organization must state that the M+C Organization retains
the right to approve, suspend, or terminate any such arrangement.
[422.502(i)(5)]

                                   Article VI

                              Records Requirements

A. MAINTENANCE OF RECORDS

1. The M+C Organization agrees to maintain for 6 years books, records,
documents, and other evidence of accounting procedures and practices that--

         (a) Are sufficient to do the following:

         (i) Accommodate periodic auditing of the financial records (including
data related to Medicare utilization, costs, and computation of the ACR) of the
M+C Organization.

         (ii) Enable CMS to inspect or otherwise evaluate the quality,
appropriateness and timeliness of services performed under the contract, and the
facilities of the M+C Organization.

         (iii) Enable CMS to audit and inspect any books and records of the M+C
Organization that pertain to the ability of the organization to bear the risk of
potential financial losses, or to services performed or determinations of
amounts payable under the contract.



                                       7


         (iv) Properly reflect all direct and indirect costs claimed to have
been incurred and used in the preparation of the ACR proposal.

         (v) Establish component rates of the ACR for determining additional and
supplementary benefits.

         (vi) Determine the rates utilized in setting premiums for State
insurance agency purposes and for other government and private purchasers; and

         (b) Include at least records of the following:

         (i) Ownership and operation of the M+C Organization's financial,
medical, and other record keeping systems.

         (ii) Financial statements for the current contract period and six prior
periods.

         (iii) Federal income tax or informational returns for the current
contract period and six prior periods.

         (iv) Asset acquisition, lease, sale, or other action.

         (v) Agreements, contracts, and subcontracts.

         (vi) Franchise, marketing, and management agreements.

         (vii) Schedules of charges for the M+C Organization's fee-for-service
patients.

         (viii) Matters pertaining to costs of operations.

         (ix) Amounts of income received, by source and payment.

         (x) Cash flow statements.

         (xi) Any financial reports filed with other Federal programs or State
authorities. [422.502(d)]

2. Access to facilities and records. The M+C Organization agrees to the
following:

         (a) The Department of Health and Human Services (HHS), the Comptroller
General, or their designee may evaluate, through inspection or other means--

         (i) The quality, appropriateness, and timeliness of services furnished
to Medicare enrollees under the contract;

         (ii) The facilities of the M+C Organization; and

         (iii) The enrollment and disenrollment records for the current contract
period and six prior periods.

         (b) HHS, the Comptroller General, or their designees may audit,
evaluate, or inspect any books, contracts, medical records, documents, papers,
patient care documentation, and other records of the M+C Organization, related
entity, contractor, subcontractor, or its transferee that pertain to any aspect
of services performed, reconciliation of benefit liabilities, and determination
of amounts payable under the contract, or as the Secretary may deem necessary to
enforce the contract.

         (c) The M+C Organization agrees to make available, for the purposes
specified in section (A) of this article, its premises, physical facilities and
equipment, records relating to its Medicare enrollees, and any additional
relevant information that CMS may require, in a manner that meets CMS record
maintenance requirements.

         (d) HHS, the Comptroller General, or their designee's right to inspect,
evaluate, and audit extends through 6 years from the final date of the contract
period or completion of audit, whichever is later unless-

         (i) CMS determines there is a special need to retain a particular
record or group of records for a longer period and notifies the M+C Organization
at least 30 days before the normal disposition date;



                                       8


         (ii) There has been a termination, dispute, or fraud or similar fault
by the M+C Organization, in which case the retention may be extended to 6 years
from the date of any resulting final resolution of the termination, dispute, or
fraud or similar fault; or

         (iii) HHS, the Comptroller General, or their designee determine that
there is a reasonable possibility of fraud, in which case they may inspect,
evaluate, and audit the M+C Organization at any time. [422.502(e)]

B. REPORTING REQUIREMENTS

1. The M+C Organization shall have an effective procedure to develop, compile,
evaluate, and report to CMS, to its enrollees, and to the general public, at the
times and in the manner that CMS requires, and while safeguarding the
confidentiality of the doctor-patient relationship, statistics and other
information as described in the remainder of this section (B). [422.516(a)]

2. The M+C Organization agrees to submit to CMS certified financial information
that must include the following:

         (a) Such information as CMS may require demonstrating that the
organization has a fiscally sound operation, including:

         (i) The cost of its operations;

         (ii) A description, submitted to CMS annually and within 120 days of
the end of the fiscal year, of significant business transactions (as defined in
ss. 422.500) between the M+C Organization and a party in interest showing that
the costs of the transactions listed in paragraph (2)(a)(v) of this section do
not exceed the costs that would be incurred if these transactions were with
someone who is not a party in interest; or

         (iii) If they do exceed, a justification that the higher costs are
consistent with prudent management and fiscal soundness requirements.

(iv) A combined financial statement for the M+C Organization and a party in
interest if either of the following conditions is met:

         (aa) Thirty-five percent or more of the costs of operation of the M+C
Organization go to a party in interest.

         (bb) Thirty-five percent or more of the revenue of a party in interest
is from the M+C Organization. [422.516(b)]

         (v)Requirements for combined financial statements.

         (aa) The combined financial statements required by paragraph (2)(a)(iv)
must display in separate columns the financial information for the M+C
Organization and each of the parties in interest.

         (bb) Inter-entity transactions must be eliminated in the consolidated
column.

         (cc) The statements must have been examined by an independent auditor
in accordance with generally accepted accounting principles and must include
appropriate opinions and notes.

         (dd) Upon written request from the M+C Organization showing good cause,
CMS may waive the requirement that the organization's combined financial
statement include the financial information required in paragraph (2)(a)(v) with
respect to a particular entity. [422.516(c)]

         (vi) A description of any loans or other special financial arrangements
the M+C Organization makes with contractors, subcontractors, and related
entities.

         (b) Such information as CMS may require pertaining to the disclosure of
ownership and control of the M+C Organization.
[422.502(f)(1)(II)]

         (c) Patterns of utilization of the M+C Organization's services.



                                       9


3. The M+C Organization agrees to participate in surveys required by CMS and to
submit to CMS all information that is necessary for CMS to administer and
evaluate the program and to simultaneously establish and facilitate a process
for current and prospective beneficiaries to exercise choice in obtaining
Medicare services. This information includes, but is not limited to:

         (a) The benefits covered under the M+C plan;

         (b) The M+C monthly basic beneficiary premium and M+C monthly
supplemental beneficiary premium, if any, for the plan.

         (c) The service area and continuation area, if any, of each plan and
the enrollment capacity of each plan;

         (d) Plan quality and performance indicators for the benefits under the
plan including --

         (i) Disenrollment rates for Medicare enrollees electing to receive
benefits through the plan for the previous 2 years;

         (ii) Information on Medicare enrollee satisfaction;

         (iii) The patterns of utilization of plan services;

         (iv) The availability, accessibility, and acceptability of the plan's
services;

         (v) Information on health outcomes and other performance measures
required by CMS;

         (vi) The recent record regarding compliance of the plan with
requirements of this part, as determined by CMS; and

         (vii) Other information determined by CMS to be necessary to assist
beneficiaries in making an informed choice among M+C plans and traditional
Medicare;

         (e) Information about beneficiary appeals and their disposition;

         (f) Information regarding all formal actions, reviews, findings, or
other similar actions by States, other regulatory bodies, or any other
certifying or accrediting organization;

         (g) Any other information deemed necessary by CMS for the
administration or evaluation of the Medicare program.

[422.502(f)(2)]

4. The M+C Organization agrees to provide to its enrollees and upon request, to
any individual eligible to elect an M+C plan, all informational requirements
under ss. 422.64 and, upon an enrollee's, request, the financial disclosure
information required under ss. 422.516. [422.502(f)(3)]

5. Reporting and disclosure under ERISA.

         (a) For any employees' health benefits plan that includes an M+C
Organization in its offerings, the M+C Organization must furnish, upon request,
the information the plan needs to fulfill its reporting and disclosure
obligations (with respect to the M+C Organization) under the Employee Retirement
Income Security Act of 1974 (ERISA).

         (b) The M+C Organization must furnish the information to the employer
or the employer's designee, or to the plan administrator, as the term
"administrator" is defined in ERISA. [422.516(d)]

6. Electronic communication. The M+C Organization must have the capacity to
communicate with CMS electronically. [422.502(b)]

7. Risk Adjustment data. The M+C Organization agrees to comply with the
requirements in ss. 422.257 for submitting risk adjustment data to CMS.
[422.502(a)(8)]



                                       10



                                   Article VII

                          Renewal of the M+C Contract

A. Renewal of contract: In accordance with ss. 422.506, the contract is
renewable annually only if-

         (1) CMS informs the M+C Organization that it authorizes a renewal; and

         (2) The M+C Organization has not provided CMS with a notice of
intention not to renew. [422.504(c)]

B. Nonrenewal of contract:

         (1) Nonrenewal by the Organization.

         (a) In accordance with ss. 422.506, the M+C Organization may elect not
to renew its contract with CMS as of the end of the term of the contract for any
reason, provided it meets the time frames for doing so set forth in paragraphs
(b) and (c) of this paragraph.

         (b) If the M+C Organization does not intend to renew its contract, it
must notify--

         (i) CMS in writing, by the date established pursuant to ss. 422.506 or
by the date established through statute.

         (ii) Each Medicare enrollee, at least 90 days before the date on which
the nonrenewal is effective. This notice must include a written description of
all alternatives available for obtaining Medicare services within the service
area of the M+C plans that the M+C Organization offers, including alternative
M+C plans, original Medicare, and Medigap options and must receive CMS approval.

         (iii) The general public, at least 90 days before the end of the
current calendar year, by publishing a CMS-approved notice in one or more
newspapers of general circulation in each community located in the M+C
Organization's service area.

         (c) CMS may accept a nonrenewal notice submitted after the applicable
annual non-renewal notice deadline if --

         (i) The M+C Organization notifies its Medicare enrollees and the public
in accordance with paragraph (1)(b)(ii) and (1)(b)(iii) of this section; and

         (ii) Acceptance is not inconsistent with the effective and efficient
administration of the Medicare program.

         (d) If the M+C Organization does not renew a contract under this
paragraph (1), CMS will not enter into a contract with the Organization for 2
years from the date of contract separation unless there are special
circumstances that warrant special consideration, as determined by CMS. This
provision shall not apply when statutory or regulatory changes are made to the
M+C program within six (6) months of the M+C Organization's notice of withdrawal
that would increase payments for the service area from which the M+C
Organization had withdrawn. [422.506(a)]

         (2) CMS decision not to renew.

         (a) CMS may elect not to authorize renewal of a contract for any of the
following reasons:

         (i) The M+C Organization has not fully implemented or shown discernable
progress in implementing quality assessment and performance improvement projects
as defined in Article III, section (E)(2) of this contract.



                                       11


         (ii) For any of the reasons listed in ss. 422.510(a) [Article VIII,
section (B)(1)(a) of this contract], which would also permit CMS to terminate
the contract.

         (iii) The M+C Organization has committed any of the acts in ss.
422.752(a) that would support the imposition of intermediate sanctions or civil
money penalties under subpart O of part 422.

         (b) Notice. CMS shall provide notice of its decision whether to
authorize renewal of the contract as follows:

         (i) To the M+C Organization by May 1 of the contract year.

         (ii) To the M+C Organization's Medicare enrollees by mail at least 90
days before the end of the current calendar year.

         (iii) To the general public at least 90 days before the end of the
current calendar year, by publishing a notice in one or more newspapers of
general circulation in each community or county located in the M+C
Organization's service area.

         (c) Notice of appeal rights. CMS shall give the M+C Organization
written notice of its right to reconsideration of the decision not to renew in
accordance with ss. 422.644.
         [422.506(b)]

                                  Article VIII

                  Modification or Termination of the Contract

A. Modification or Termination of Contract by Mutual Consent

1. This contract may be modified or terminated at any time by written mutual
consent.

         (a) If the contract is terminated by mutual consent, except as provided
in section (B)(1)(c) of this article, the M+C Organization must provide notice
to its Medicare enrollees and the general public as provided in ss.
422.512(b)(2) and (b)(3) [Article VIII, section B(2)(b) of this contract].

         (b) If the contract is modified by mutual consent, the M+C Organization
must notify its Medicare enrollees of any changes that CMS determines are
appropriate for notification within time frames specified by CMS.

2. If this contract is terminated by mutual consent and replaced the day
following such termination by a new M+C contract, the M+C Organization is not
required to provide the notice specified in section B of this article.
         [422.508]

B. Termination of the Contract by CMS or the M+C Organization

1. Termination by CMS.

         (a) CMS may terminate a contract for any of the following reasons:

         (i) The M+C Organization has failed substantially to carry out the
terms of its contract with CMS.

         (ii) The M+C Organization is carrying out its contract with CMS in a
manner that is inconsistent with the effective and efficient implementation of
42 CFR part 422.

         (iii) CMS determines that the M+C Organization no longer meets the
requirements of this part for being a contracting organization.



                                       12


         (iv) The M+C Organization commits or participates in fraudulent or
abusive activities affecting the Medicare program, including submission of
fraudulent data.

         (v) The M+C Organization experiences financial difficulties so severe
that its ability to make necessary health services available is impaired to the
point of posing an imminent and serious risk to the health of its enrollees, or
otherwise fails to make services available to the extent that such a risk to
health exists.

         (vi) The M+C Organization substantially fails to comply with the
requirements in subpart M of this part relating to grievances and appeals.

         (vii) The M+C Organization fails to provide CMS with valid risk
adjustment data as required under ss. 422.257.

         (viii) The M+C Organization fails to implement an acceptable quality
assessment and performance improvement program as required under subpart D of
part 422.

         (ix) The M+C Organization substantially fails to comply with the prompt
payment requirements in ss. 422.520.

         (x) The M+C Organization substantially fails to comply with the service
access requirements in ss. 422.112 or ss. 422.114.

         (xi) The M+C Organization fails to comply with the requirements of ss.
422.208 regarding physician incentive plans.

         (xii) The M+CO substantially fails to comply with the marketing
requirements in 422.80.

         (b) Notice. If CMS decides to terminate a contract for reasons other
than the grounds specified in section (B)(1)(a) above, it will give notice of
the termination as follows:

         (i) CMS will notify the M+C Organization in writing 90 days before the
intended date of the termination.

         (ii) The M+C Organization will notify its Medicare enrollees of the
termination by mail at least 30 days before the effective date of the
termination.

         (iii) The M+C Organization will notify the general public of the
termination at least 30 days before the effective date of the termination by
publishing a notice in one or more newspapers of general circulation in each
community or county located in the M+C Organization's service area.

         (c) Immediate termination of contract by CMS.

         (i) For terminations based on violations prescribed in paragraph
(B)(1)(a)(v) of this article, CMS will notify the M+C Organization in writing
that its contract has been terminated effective the date of notice of the
termination decision by CMS. If termination is effective in the middle of a
month, CMS has the right to recover the prorated share of the capitation
payments made to the M+C Organization covering the period of the month following
the contract termination.

         (ii) CMS will notify the M+C Organization's Medicare enrollees in
writing of CMS' decision to terminate the M+C Organization's contract. This
notice will occur no later than 30 days after CMS notifies the plan of its
decision to terminate this contract. CMS will simultaneously inform the Medicare
enrollees of alternative options for obtaining Medicare services, including
alternative M+C Organizations in a similar geographic area and original
Medicare.

         (iii) CMS will notify the general public of the termination no later
than 30 days after notifying the M+C Organization of CMS' decision to terminate
this contract. This notice will be



                                       13


published in one or more newspapers of general circulation in each community or
county located in the M+C Organization's service area.

         (d) Corrective action plan

         (i) General. Before terminating a contract for reasons other than the
grounds specified in section (B)(1)(a)(v) of this article, CMS will provide the
M+C Organization with reasonable opportunity, not to exceed time frames
specified at subpart N of part 422, to develop and receive CMS approval of a
corrective action plan to correct the deficiencies that are the basis of the
proposed termination.

         (ii) Exception. If a contract is terminated under section (B)(1)(a)(v)
of this article, the M+C Organization will not have the opportunity to submit a
corrective action plan.

         (e) Appeal rights. If CMS decides to terminate this contract, it will
send written notice to the M+C Organization informing it of its termination
appeal rights in accordance with subpart N of part 422.
         [422.510]

2. Termination by the M+C Organization

         (a) Cause for termination. The M+C Organization may terminate this
contract if CMS fails to substantially carry out the terms of the contract.

         (b) Notice. The M+C Organization must give advance notice as follows:

         (i) To CMS, at least 90 days before the intended date of termination.
This notice must specify the reasons why the M+C Organization is requesting
contract termination.

         (ii) To its Medicare enrollees, at least 60 days before the termination
effective date. This notice must include a written description of alternatives
available for obtaining Medicare services within the service area, including
alternative M+C plans, Medigap options, and original Medicare and must receive
CMS approval.

         (iii) To the general public at least 60 days before the termination
effective date by publishing a CMS-approved notice in one or more newspapers of
general circulation in each community or county located in the M+C
Organization's geographic area.

         (c) Effective date of termination. The effective date of the
termination will be determined by CMS and will be at least 90 days after the
date CMS receives the M+C Organization's notice of intent to terminate.

         (d) CMS' liability. CMS' liability for payment to the M+C Organization
ends as of the first day of the month after the last month for which the
contract is in effect, but CMS shall make payments for amounts owed prior to
termination but not yet paid.

         (e) Effect of termination by the organization. CMS will not enter into
an agreement with the M+C Organization for a period of two years from the date
the Organization has terminated this contract, unless there are circumstances
that warrant special consideration, as determined by CMS. [422.512]

                                   Article IX

                   Requirements of Other Laws and Regulations


A. The M+C Organization agrees to comply with--



                                       14


         (1) Title VI of the Civil Rights Act of 1964 as implemented by
regulations at 45 CFR part 84;

         (2) The Age Discrimination Act of 1975 as implemented by regulations at
45 CFR part 91;

         (3) The Americans With Disabilities Act;

         (4) The Rehabilitation Act of 1973 ;

         (5) The Health Insurance Portability and Accountability Act;

         (6) Other laws applicable to recipients of Federal funds; and

         (7) All other applicable laws, regulations, and rules.
         [422.502(h)(1)]

B. The M+C Organization is receiving Federal payments under this contract, and
related entities, contractors, and subcontractors paid by the M+C Organization
to fulfill its obligations under this contract are subject to certain laws that
are applicable to individuals and entities receiving Federal funds. The M+C
Organization agrees to inform all related entities, contractors and
subcontractors that payments that they receive are, in whole or in part, from
Federal funds.
         [422.502(h)(2)]

C. In the event that any provision of this contract conflicts with the
provisions of any statute or regulation applicable to an M+C Organization, the
provisions of the statute or regulation shall have full force and effect.

                                   Article X

                                  Severability

The M+C Organization agrees that, upon CMS' request, this contract will be
amended to exclude any M+C plan or State-licensed entity specified by CMS, and a
separate contract for any such excluded plan or entity will be deemed to be in
place when such a request is made.
         [422.502(k)]



                                       15


In witness whereof, the parties hereby execute this contract.

FOR THE M+C ORGANIZATION



- ----------------------------------------        -------------------------------
Printed Name                                    Title


- ----------------------------------------        -------------------------------
Signature                                       Date


- ----------------------------------------        -------------------------------
Organization                                    Address

FOR THE CENTERS FOR MEDICARE & MEDICAID SERVICES



- ----------------------------------------        -------------------------------
Jean D. LeMasurier                              Date
Acting Director
Health Plan Benefits Group
Center for Beneficiary Choices




                                       16


                                  ATTACHMENT A

                     ATTESTATION OF ENROLLMENT INFORMATION
                            RELATING TO CMS PAYMENT
                       TO A MEDICARE+CHOICE ORGANIZATION

         Pursuant to the contract(s) between the Centers for Medicare & Medicaid
Services (CMS) and (INSERT NAME OF M+C ORGANIZATION), hereafter referred to as
the M+C Organization, governing the operation of the following Medicare +Choice
plans (INSERT PLAN IDENTIFICATION NUMBERS HERE), the M+C Organization hereby
requests payment under the contract, and in doing so, makes the following
attestation concerning CMS payments to the M+C Organization. The M+C
Organization acknowledges that the information described below directly affects
the calculation of CMS payments to the M+C Organization and that
misrepresentations to CMS about the accuracy of such information may result in
Federal civil action and/or criminal prosecution. This attestation shall not be
considered a waiver of the M+C Organization's right to seek payment adjustments
from CMS based on information or data which does not become available until
after the date the M+C Organization submits this attestation.

         1. The M+C Organization has reported to CMS for the month of (INDICATE
MONTH AND YEAR) all new enrollments, disenrollments, and changes in enrollees'
institutional status with respect to the above-stated M+C plans. Based on best
knowledge, information, and belief as of the date indicated below, all
information submitted to CMS in this report is accurate, complete, and truthful.

         2. The M+C Organization has reviewed the CMS monthly membership report
and reply listing for the month of (INDICATE MONTH AND YEAR) for the
above-stated M+C plans and has reported to CMS any discrepancies between the
report and the M+C Organization's records. For those portions of the monthly
membership report and the reply listing to which the M+C Organization raises no
objection, the M+C Organization, through the certifying CEO/CFO, will be deemed
to have attested, based on best knowledge, information, and belief as of the
date indicated below, to their accuracy, completeness, and truthfulness.



                                          -----------------------------
                                     (INDICATE TITLE [CEO, CFO, or delegate])
                                                   on behalf of

                                     (INDICATE M+C ORGANIZATION)

                                     ------------------------------------------
                                     DATE



                                       17


                                  ATTACHMENT B

           ATTESTATION OF RISK ADJUSTMENT DATA INFORMATION RELATING TO
                 CMS PAYMENT TO A MEDICARE+CHOICE ORGANIZATION

         Pursuant to the contract(s) between the Centers for Medicare & Medicaid
Services (CMS) and (INSERT NAME OF M+C ORGANIZATION), hereafter referred to as
the M+C Organization, governing the operation of the following Medicare +Choice
plans (INSERT PLAN IDENTIFICATION NUMBERS HERE), the M+C Organization hereby
requests payment under the contract, and in doing so, makes the following
attestation concerning CMS payments to the M+C Organization. The M+C
Organization acknowledges that the information described below directly affects
the calculation of CMS payments to the M+C Organization or additional benefit
obligations of the M+C Organization and that misrepresentations to CMS about the
accuracy of such information may result in Federal civil action and/or criminal
prosecution.

         The M+C Organization has reported to CMS for the period of (INDICATE
DATES) all (INDICATE TYPE OF DATA - INPATIENT HOSPITAL, OUTPATIENT HOSPITAL, OR
PHYSICIAN) risk adjustment data available to the M+C Organization with respect
to the above-stated M+C plans. Based on best knowledge, information, and belief
as of the date indicated below, all information submitted to CMS in this report
is accurate, complete, and truthful.



                                          -----------------------------
                                     (INDICATE TITLE [CEO, CFO, or delegate])
                                                   on behalf of

                                     (INDICATE M+C ORGANIZATION)

                                     ------------------------------------------
                                     DATE



                                       18


                                  ATTACHMENT C

           ATTESTATION OF ADJUSTED COMMUNITY RATE INFORMATION RELATING
                TO CMS PAYMENT TO A MEDICARE+CHOICE ORGANIZATION

         Pursuant to the contract(s) between the Centers for Medicare & Medicaid
Services (CMS) and (INSERT NAME OF M+C ORGANIZATION), hereafter referred to as
the M+C Organization, governing the operation of the following Medicare +Choice
plans (INSERT PLAN IDENTIFICATION NUMBERS HERE), the M+C Organization hereby
requests payment under the contract, and in doing so, makes the following
attestation concerning CMS payments to the M+C Organization. The M+C
Organization acknowledges that the information described below directly affects
the calculation of CMS payments to the M+C Organization or additional benefit
obligations of the M+C Organization and that misrepresentations to CMS about the
accuracy of such information may result in Federal civil action and/or criminal
prosecution.

         The M+C Organization has submitted to CMS an adjusted community rate
(ACR) proposal for the period (INDICATE DATES). Based on best knowledge,
information, and belief as of the date indicated below, all of the information
submitted to CMS in this ACR proposal is accurate, complete, and truthful, and
the benefit package the M+C Organization will offer during the above-stated
period agrees with the CMS-approved ACR proposal.



                                          -----------------------------
                                     (INDICATE TITLE [CEO, CFO, or delegate])
                                                   on behalf of

                                     (INDICATE M+C ORGANIZATION)

                                     ------------------------------------------
                                     DATE


                                       19

EX-10.35

                                                                   EXHIBIT 10.35

================================================================================


                         PACIFICARE HEALTH SYSTEMS INC.

                        ---------------------------------



                                 AMENDMENT NO. 1

                                   dated as of

                                November 13, 2003

                                       to

                                CREDIT AGREEMENT

                                   dated as of

                                  June 3, 2003

                        ---------------------------------


                              JPMORGAN CHASE BANK,
                             as Administrative Agent




================================================================================






                                 AMENDMENT NO. 1

         AMENDMENT NO. 1 dated as of November 13, 2003 to the Credit Agreement
referred to below, between: PACIFICARE HEALTH SYSTEMS INC. (the "Borrower"); the
Subsidiary Guarantors party to the Credit Agreement; and JPMORGAN CHASE BANK, as
Administrative Agent thereunder.

         The Borrower, the Subsidiary Guarantors, the Lenders, the
Administrative Agent and the Collateral Agent are parties to a Credit Agreement
dated as of June 3, 2003 (as amended and in effect from time to time, the
"Credit Agreement"), providing, subject to the terms and conditions thereof, for
extensions of credit to be made by the Lenders to the Borrower.

         The Borrower has requested certain amendments to the Credit Agreement
and, accordingly, the parties hereto hereby agree as follows:

         Section 1. Definitions. Except as otherwise defined in this Amendment
No. 1, terms defined in the Credit Agreement are used herein as defined therein.

         Section 2. Amendments. Subject to the satisfaction of the conditions
precedent specified in Section 4 hereof, but effective as of the date hereof,
the Credit Agreement shall be amended as follows:

         2.01. General References. References in the Credit Agreement (including
references to the Credit Agreement as amended hereby) to "this Agreement" (and
indirect references such as "hereunder", "hereby", "herein" and "hereof") shall
be deemed to be references to the Credit Agreement as amended hereby.

         2.02. Mandatory Prepayments. Section 2.09(b)(i) of the Credit Agreement
shall be amended by: (a) inserting in clause (x) thereof, immediately following
the words "this paragraph (i) applies", the following words: "or to the extent
to which the last sentence of this paragraph (i) applies"; and (b) inserting a
new sentence at the end said Section 2.09(b)(i) to read as follows:

         "Notwithstanding anything herein to the contrary, the Borrower shall
         not be required to make any prepayment under this paragraph (i) from
         any Equity Issuance by the Borrower after the Effective Date, provided
         that (I) immediately prior to the consummation of such Equity Issuance,
         the Consolidated Leverage Ratio is less than or equal to 2.00 to 1,
         (II) at the time of such Equity Issuance, no Default shall have
         occurred and be continuing (III) the Net Available Proceeds of such
         Equity Issuance shall be applied, within a period of 80 days after
         receipt thereof, to the prepayment, repurchase or redemption of the
         Term Loans (or, after the payment in full of the Term Loans, the
         Revolving Credit Loans) and/or other senior Indebtedness of the
         Borrower (including the payment of accrued interest and premium
         thereon, if any) and (IV) to the extent any amount of the Net Available
         Proceeds of such Equity Issuance has not been so applied prior to the
         lapse of such 80-day period, such unapplied amount shall forthwith be
         applied by the Borrower to prepay the Term Loans to the extent then
         required under this paragraph (i)."


                                 Amendment No. 1



                                     - 2 -

         2.03. Optional Payments, Redemptions or Prepayments. Section 7.10 of
the Credit Agreement shall be amended by inserting a new sentence at the end
thereof to read as follows:

         "Notwithstanding anything herein to the contrary, the Borrower may
         prepay, repurchase or redeem any senior Indebtedness with the proceeds
         of any Equity Issuance subject only to compliance with the last
         sentence of Section 2.09(b)(i)."

         Section 3. Representations and Warranties. The Borrower represents and
warrants to the Lenders as of the date hereof that (a) the representations and
warranties of the Borrower set forth in the Credit Agreement, and of each
Obligor in each of the other Loan Documents to which it is a party, are true and
correct on and as of the date hereof with the same force and effect as if made
on and as of the date hereof (or, if any such representation and warranty is
expressly stated to have been made as of a specific date, as of such specific
date) and as if each reference herein to "this Agreement" (or words of similar
import) or in such other Loan Documents to "the Credit Agreement" (or words of
similar import) included reference to this Amendment No. 1 and (b) no Default
has occurred and is continuing.

         Section 4. Conditions Precedent. The amendments to the Credit Agreement
set forth in Section 2 shall become effective as of the date hereof upon the
satisfaction of each of the following conditions:

         4.01. Amendment No. 1. The Administrative Agent shall have received one
     or more counterparts of this Amendment No. 1 executed by each Obligor and
     the Administrative Agent (with the written consent of the Required Lenders
     provided in the form of the Lender Consent attached hereto as Exhibit A).

         4.02. Payment of Fees. The Administrative Agent shall have received
     evidence satisfactory to the Administrative Agent of payment (or
     irrevocable instructions for payment) by the Borrower in full of an
     amendment fee to the Administrative Agent for the account of each Lender
     that has approved this Amendment No. 1 on or before 5:00 p.m., New York
     City time, on November 13, 2003, such fee to be in an amount equal to 0.05%
     of the sum of the aggregate unpaid principal amount of the Term Loans, if
     any, held by such Lender and the Revolving Credit Commitment then in
     effect, if any, of such Lender.

         Section 5. Confirmation of Guarantees and Security Interests. Each of
the Subsidiary Guarantors, by its execution of this Amendment No. 1, hereby
confirms and ratifies that (i) all of its respective obligations as a guarantor
under the Credit Agreement, including, without limitation, under Article III
thereof, and (ii) all of its respective obligations under each of the Security
Documents to which it is a party and the Liens granted thereunder shall, in each
case, continue in full force and effect for the benefit of the Collateral Agent
and the other Secured Parties with respect to the Credit Agreement as amended
hereby.

         Section 6. Miscellaneous. Except as herein provided, the Credit
Agreement shall remain unchanged and in full force and effect. This Amendment
No. 1 may be executed in any number of counterparts, all of which taken together
shall constitute one and the same amendatory instrument and any of the parties
hereto may execute this Amendment No. 1 by signing any such


                                 Amendment No. 1




                                     - 3 -


counterpart. This Amendment No. 1 shall be governed by, and construed in
accordance with, the law of the State of New York.


                                 Amendment No. 1



                                     - 4 -


         IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 1
to be duly executed and delivered as of the day and year first above written.



                                      BORROWER

                                      PACIFICARE HEALTH SYSTEMS, INC.





                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:




                                 Amendment No. 1


                                     - 5 -


                                     SUBSIDIARY GUARANTORS

                                     PACIFICARE HEALTH PLAN ADMINISTRATORS, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:



                                      PACIFICARE eHOLDINGS, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:



                                      SENIORCO, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:



                                      RxSOLUTIONS, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:




                                 Amendment No. 1




                                     - 6 -



                                      PACIFICARE BEHAVIORAL HEALTH, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:



                                      SECUREHORIZONS USA, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:



                                      PACIFICARE OF ARIZONA, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:



                                      PACIFICARE OF OKLAHOMA, INC.



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:




                                 Amendment No. 1




                                     - 7 -

                                      ADMINISTRATIVE AGENT

                                      JPMORGAN CHASE BANK,
                                         as Administrative Agent



                                      By
                                        ----------------------------------------
                                        Name:
                                        Title:




                                 Amendment No. 1


                                                                       EXHIBIT A

                                 LENDER CONSENT

         Reference is made to the Credit Agreement dated as of June 3, 2003 (as
amended and in effect from time to time, the "Credit Agreement") between
Pacificare Health Systems Inc., the Subsidiary Guarantors party to the Credit
Agreement, the Lenders party to the Credit Agreement, JPMorgan Chase Bank, as
Administrative Agent thereunder and JPMorgan Chase Bank, as Collateral Agent
thereunder. Capitalized terms used and not otherwise defined herein are deemed
to have the respective meanings assigned to such terms in the Credit Agreement.

         The undersigned Lender party to the Credit Agreement hereby (i)
consents to Amendment No. 1 to the Credit Agreement, dated as of November 13,
2003, substantially in the form to which the form of this Lender Consent is
attached ("Amendment No. 1") and (ii) authorizes and directs the Administrative
Agent to execute and deliver Amendment No. 1 on behalf of such Lender.





Full Name of Lender:
                    --------------------------------------


By:
    -------------------------------------
    Name:
    Title:

Date:  November __, 2003



                                 Amendment No. 1

EX-10.36

                                                                   EXHIBIT 10.36

                                                                  EXECUTION COPY






================================================================================

                         PACIFICARE HEALTH SYSTEMS INC.

                        ---------------------------------



                                 AMENDMENT NO. 2

                                   dated as of

                                December 17, 2003

                                       to

                                CREDIT AGREEMENT

                                   dated as of

                                  June 3, 2003

                        ---------------------------------


                              JPMORGAN CHASE BANK,
                             as Administrative Agent

                        ---------------------------------



                           J.P. MORGAN SECURITIES INC.
                                       and
                      MORGAN STANLEY SENIOR FUNDING, INC.,
          as Joint Advisors, Joint Lead Arrangers and Joint Bookrunners


================================================================================





                                 AMENDMENT NO. 2

         AMENDMENT NO. 2 dated as of December 17, 2003 to the Credit Agreement
referred to below, between: PACIFICARE HEALTH SYSTEMS INC. (the "Borrower"); the
Subsidiary Guarantors party to the Credit Agreement; and JPMORGAN CHASE BANK, as
Administrative Agent thereunder.

         The Borrower, the Subsidiary Guarantors, the Lenders, the
Administrative Agent and the Collateral Agent are parties to a Credit Agreement
dated as of June 3, 2003 (as amended and in effect from time to time, the
"Credit Agreement"), providing, subject to the terms and conditions thereof, for
extensions of credit to be made by the Lenders to the Borrower.

         The Borrower has requested certain amendments to the Credit Agreement
and, accordingly, the parties hereto hereby agree as follows:

         Section 1. Definitions. Except as otherwise defined in this Amendment
No. 2, terms defined in the Credit Agreement are used herein as defined therein.

         Section 2. Amendments. Subject to the satisfaction of the conditions
precedent specified in Section 4 hereof, but effective as of the date hereof,
the Credit Agreement shall be amended as follows:

         2.01. General References. References in the Credit Agreement (including
references to the Credit Agreement as amended hereby) to "this Agreement" (and
indirect references such as "hereunder", "hereby", "herein" and "hereof") shall
be deemed to be references to the Credit Agreement as amended hereby.

         2.02. Definitions. Section 1.01 of the Credit Agreement is amended by
adding the following new defined term in its appropriate alphabetical location:

         "Applicable Term Loan Margin" means for any day, with respect to any
     ABR Loan or Eurodollar Loan, the applicable rate per annum set forth below
     under the caption "ABR Spread" or "Eurodollar Spread", respectively, based
     upon the Ratings applicable on such date to the Loans (each a "Rating"):




                                      Ratings                       ABR                    Eurodollar
                                   (S&P/Moody's)                   Spread                    Spread
                                  ---------------                 --------                 -----------

                                                                                
          Category 1        > or = BB+ and > or = Ba2               1.25%                    2.25%


                                BB and > or = Ba2

          Category 2                                                1.50%                    2.50%
                               > or = BB and Ba3

                                 Other than in
          Category 3             Category 1 or 2                    1.75%                    2.75%




                                 Amendment No. 2



                                     - 2 -

         For purposes of the foregoing, (a) if one of S&P and Moody's shall not
     have in effect a Rating (other than by reason of the circumstances referred
     to in the last sentence of this definition), such rating agency shall be
     deemed to have a Rating equal to the level of the Rating of the other
     rating agency; (b) if neither S&P nor Moody's shall have in effect a Rating
     (other than by reason of the circumstances referred to in the last sentence
     of this definition), then each such rating agency shall be deemed to have
     established a Rating in Category 3; and (c) if the Ratings established or
     deemed to have been established by S&P and Moody's shall be changed (other
     than as a result of a change in the rating system of S&P or Moody's), such
     change shall be effective as of the date on which it is first announced by
     the applicable rating agency. Each change in the Applicable Term Loan
     Margin shall apply during the period commencing on the effective date of
     such change and ending on the date immediately preceding the effective date
     of the next such change; provided that no reduction in the Applicable Term
     Loan Margin shall be effective for so long as an Event of Default shall
     have occurred and be continuing. If the rating system of S&P or Moody's
     shall change, or if either such rating agency shall cease to be in the
     business of rating secured bank loans, the Borrower and the Lenders shall
     negotiate in good faith to amend this definition to reflect such changed
     rating system or the unavailability of ratings from such rating agency and,
     pending the effectiveness of any such amendment, the Applicable Term Loan
     Margin shall be determined by reference to the rating most recently in
     effect prior to such change or cessation.

         The Applicable Term Loan Margin in effect on effective date of
     Amendment No. 2 hereto dated as of December 17, 2003 shall be (i) in the
     case of Term Loans constituting an ABR Borrowing shall be 1.75% per annum
     and (ii) in the case of Term Loans constituting a Eurodollar Borrowing
     shall be 2.75% per annum.

         2.03. Interest on ABR Term Loans. Section 2.11(a)(ii) shall be amended
to read in its entirety as follows:

         "(ii) the Alternate Base Rate plus the Applicable Term Loan Margin (in
     the case of Term Loans constituting an ABR Borrowing)."

         2.04. Interest on Eurodollar Term Loans. Section 2.11(b)(ii) shall be
amended to read in its entirety as follows:

         "(ii) the Adjusted LIBO Rate for the Interest Period for such Borrowing
     plus the Applicable Term Loan Margin (in the case of Term Loans
     constituting a Eurodollar Borrowing)."

         Section 3. Representations and Warranties. The Borrower represents and
warrants to the Lenders as of the date hereof that (a) the representations and
warranties of the Borrower set forth in the Credit Agreement are true and
correct, and of each Obligor in each of the other Loan Documents to which it is
a party are true and correct in all material respects, in each case on and as of
the date hereof with the same force and effect as if made on and as of the date
hereof (or, if any such representation and warranty is expressly stated to have
been made as





                                 Amendment No. 2



                                      - 3 -

of a specific date, as of such specific date) and as if each reference herein to
"this Agreement" (or words of similar import) or in such other Loan Documents to
"the Credit Agreement" (or words of similar import) included reference to this
Amendment No. 2 and (b) no Default has occurred and is continuing.

         Section 4. Conditions Precedent. The amendments to the Credit Agreement
set forth in Section 2 shall become effective as of the date hereof upon receipt
by the Administrative Agent of one or more counterparts of this Amendment No. 2
executed by each Obligor and the Administrative Agent (with the written consent
of each of the Term Loan Lenders and the Required Lenders provided in the form
of the Lender Consent attached hereto as Exhibit A).

         Section 5. Confirmation of Guarantees and Security Interests. The
Obligors hereby confirms and ratifies all of its respective obligations under
the Loan Documents to which it is a party (including, in the case of each
Subsidiary Guarantor, its respective obligations as a guarantor under Article
III of the Credit Agreement (as amended hereby)) and the Liens granted by it
under the respective Loan Documents (as amended hereby) and hereby represent,
warrant and confirm that all references in such Loan Documents to the Credit
Agreement (or words of similar import) fully and effectively mean the Credit
Agreement as amended hereby without impairing any such obligations or Liens in
any respect.

         Section 6. Miscellaneous. Except as herein provided, the Credit
Agreement shall remain unchanged and in full force and effect. This Amendment
No. 2 may be executed in any number of counterparts, all of which taken together
shall constitute one and the same amendatory instrument and any of the parties
hereto may execute this Amendment No. 2 by signing any such counterpart. This
Amendment No. 2 shall be governed by, and construed in accordance with, the law
of the State of New York.




                                 Amendment No. 2



                                     - 4 -

         IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 2
to be duly executed and delivered as of the day and year first above written.



                                    BORROWER

                                    PACIFICARE HEALTH SYSTEMS, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                 Amendment No. 2



                                      -5-


                                    SUBSIDIARY GUARANTORS

                                    PACIFICARE HEALTH PLAN
                                    ADMINISTRATORS, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                    PACIFICARE eHOLDINGS, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                    SENIORCO, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                    RxSOLUTIONS, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:


                                 Amendment No. 2


                                      -6-


                                    PACIFICARE BEHAVIORAL HEALTH, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                    SECUREHORIZONS USA, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                    PACIFICARE OF ARIZONA, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                    PACIFICARE OF OKLAHOMA, INC.



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:



                                 Amendment No. 2



                                     - 7 -

                                    ADMINISTRATIVE AGENT

                                    JPMORGAN CHASE BANK,
                                      as Administrative Agent



                                    By
                                      ------------------------------------------
                                      Name:
                                      Title:





                                                                       EXHIBIT A

                                 LENDER CONSENT

                  Reference is made to the Credit Agreement dated as of June 3,
2003 (as amended and in effect from time to time, the "Credit Agreement")
between Pacificare Health Systems Inc., the Subsidiary Guarantors party to the
Credit Agreement, the Lenders party to the Credit Agreement, JPMorgan Chase
Bank, as Administrative Agent thereunder and JPMorgan Chase Bank, as Collateral
Agent thereunder. Capitalized terms used and not otherwise defined herein are
deemed to have the respective meanings assigned to such terms in the Credit
Agreement.

                  The undersigned Lender party to the Credit Agreement hereby
(i) consents to Amendment No. 2 to the Credit Agreement, dated as of December
17, 2003, substantially in the form to which the form of this Lender Consent is
attached ("Amendment No. 2") and (ii) authorizes and directs the Administrative
Agent to execute and deliver Amendment No. 2 on behalf of such Lender.





Full Name of Lender:
                    ---------------------------------------


By:
    ---------------------------------------
    Name:
    Title:

Date:  December 17, 2003




                                 Amendment No. 2

EX-14.1

                                                                    EXHIBIT 14.1

Financial Code of Ethics


PacifiCare is committed to full and accurate financial disclosure in compliance
with applicable laws, rules and regulations and to maintaining our books and
records in accordance with applicable accounting policies, laws, rules and
regulations. This Financial Code of Ethics (this "CODE") applies to our Chief
Executive Officer, Chief Financial Officer, Controller and other persons
performing similar functions (together, "FINANCIAL Professionals"). This Code
sets forth specific policies to guide PacifiCare's Financial Professionals in
the performance of their duties.

Although this Code addresses conduct that is particularly important to proper
dealings with the people and entities with whom Financial Professionals
interact, it cannot possibly describe every honest and ethical practice or
principle related to financial reporting and accounting or the maintenance of
corporate books and records. As an employee of PacifiCare, this Code reflects
only one of many policies to which you are subject. Some of PacifiCare's other
employee policies, including those described in the Employee Handbook, the
Business Conduct Guidelines and the Insider Trading Policy, provide further
guidance on and amplify this Code. IN ADDITION TO COMPLIANCE UNDER THOSE
POLICIES, YOU ARE SEPARATELY BOUND BY THIS CODE AND IF YOU VIOLATE THIS CODE,
YOU MAY BE SUBJECT TO DISCIPLINARY ACTION.

Waivers of this Code may be made only by PacifiCare's Board of Directors or a
committee of the Board of the Directors and will be disclosed in accordance with
applicable law.

All Financial Professionals shall adhere to, and advocate, the following general
principles:

o        Engage in and promote honest and ethical conduct, including the ethical
         handling of actual or apparent conflicts of interests between personal
         and professional relationships;

o        Provide full, fair, accurate, timely and understandable public
         disclosure, in reports and documents filed with, or submitted, to the
         Securities and Exchange Commission and in other public communications
         made by PacifiCare;

o        Take all reasonable measures to protect the confidentiality of
         non-public information about PacifiCare, our subsidiaries, our members,
         our providers and other contracting parties to whom we have an
         obligation of confidentiality obtained or created in connection with
         our financial activities and to prevent the unauthorized disclosure of
         such information unless required by applicable law, regulation, legal
         or regulatory process;



o        Comply with applicable governmental rules and regulations and other
         appropriate private and public regulatory agencies; and

o        Act in good faith, responsibly, with due care, competence and
         diligence, without misrepresenting material facts or failing to
         disclose material facts known to you or allowing your independent
         judgment to be subordinated.

In addition, the integrity of our records and public disclosure depends on the
validity, accuracy and completeness of the information supporting the entries to
our books of account. Therefore, our corporate and business records should be
completed accurately and honestly, and the making of false or misleading entries
is strictly prohibited. Our records serve as a basis for managing our business
and are important in meeting our obligations to stockholders, members,
providers, suppliers, creditors, employees and others with whom we do business.
As a result, it is important that our books, accounts and other records
accurately and fairly reflect, in reasonable detail, our assets, liabilities,
revenues, costs and expenses, as well as all transactions and changes in assets
and liabilities.

All Financial Professionals shall also adhere to and advocate the following
principles:

o        No Financial Professional may take or authorize any action that would
         cause our financial records or financial disclosure to fail to comply
         with generally accepted accounting principles, the rules and
         regulations of the SEC or other applicable laws, rules and regulations;

o        All Financial Professionals must cooperate fully with our accounting
         department, as well as our independent public accountants and outside
         legal counsel, respond to their questions with candor and provide them
         with complete and accurate information to help ensure that our books
         and records, as well as our reports filed with the SEC, are accurate
         and complete; and

o        No Financial Professional shall knowingly make (or cause or encourage
         any other person to make) any false or misleading statement in any of
         our reports filed with the SEC or knowingly omit (or cause or encourage
         any other person to omit) any information necessary to make the
         disclosure in any of our reports accurate in all material respects; and

o        No Financial Professional or any person acting under the direction of
         any Financial Professional shall directly or indirectly take any action
         to fraudulently influence, coerce, manipulate or mislead any
         independent public accountant or internal auditor engaged in the
         performance of an audit or review of financial statements of PacifiCare
         or its subsidiaries.



Each Financial Professional shall bring to the attention of the Audit and Ethics
Committee any information he or she may have concerning:

o        Significant deficiencies in the design or operation of internal
         controls that could adversely affect PacifiCare's ability to record,
         process, summarize and report financial data; or

o        Any fraud, whether or not material, that involves any Financial
         Professional or any other employees who have a role in PacifiCare's
         financial reporting, disclosures or internal controls.

Each Financial Professional shall promptly bring to the attention of the General
Counsel and/or the Audit and Ethics Committee any information he or she may have
concerning violations of this Code or evidence of material violations of
securities or other applicable laws, rules or regulations. PacifiCare's
non-retaliation policy applies to persons who in good faith report a violation
or suspected violation of this Code.

This Financial Code of Ethics is a statement of fundamental principles and key
policies and procedures that govern PacifiCare's Financial Professionals in the
conduct of PacifiCare's business. It is not intended to and does not constitute
an employment contract or assurance of continued employment. This Code does not
create any rights in any employee, member, provider, supplier, competitor,
stockholder, creditor or any other person or entity.

Failure to observe the terms of the Financial Code of Ethics may result in
disciplinary action, including termination of employment. Violations of this
Code may also constitute violations of federal securities laws and regulations
which may result in civil and criminal penalties.



Acknowledgment

I acknowledge that I have received and read the PacifiCare Financial Code of
Ethics. I agree to comply fully with the standards contained in the Code and
PacifiCare's related policies and procedures. I understand that I have an
obligation to report any suspected violations of the Financial Code of Ethics.



- --------------------------------------------------------------------------------
Signature                               Title                               Date

EX-21

Exhibit 21

EX-23

Exhibit 23

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Howard G. Phanstiel, certify that:

1.     I have reviewed this annual report on Form 10-K of PacifiCare Health Systems, Inc.;

2.     Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.     Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

           a)     designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

           b)     evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and

           c)     disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal year that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

           a)     all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial data information; and

           b)     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 4, 2004

By:  /s/ HOWARD G. PHANSTIEL

Howard G. Phanstiel

Chairman of the Board

and Chief Executive Officer

(Principal Executive Officer)

EX-31.2 14 a96836exv31w2.htm EXHIBIT 31.2

EXHIBIT 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Gregory W. Scott, certify that:

1.     I have reviewed this annual report on Form 10-K of PacifiCare Health Systems, Inc.;

2.     Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.     Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

           a)     designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

           b)     evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and

           c)     disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal year that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

           a)     all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial data information; and

           b)     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 4, 2004

By:  /s/ GREGORY W. SCOTT

Gregory W. Scott

Executive Vice President and

Chief Financial Officer

(Principal Financial Officer)

EX-32.1 15 a96836exv32w1.htm EXHIBIT 32.01

EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of PacifiCare Health Systems, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on or about the date hereof (the “Report”), I, Howard G. Phanstiel, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

1.     the Report fully complies with the requirements of section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and

2.     the information contained in the Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by the Report and results of operations of the Company for the period covered by the Report.

Date: March 4, 2004

By:  /s/ HOWARD G. PHANSTIEL

Howard G. Phanstiel

Chairman of the Board

and Chief Executive Officer

This certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act. Such certification shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.

EX-32.2 16 a96836exv32w2.htm EXHIBIT 32.02

EXHIBIT 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of PacifiCare Health Systems, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on or about the date hereof (the “Report”), I, Gregory W. Scott, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

1.     the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and

2.     the information contained in the Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by the Report and results of operations of the Company for the period covered by the Report.

Date: March 4, 2004

By:  /s/ GREGORY W. SCOTT

Gregory W. Scott

Executive Vice President and

Chief Executive Officer

This certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act. Such certification shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.

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EX-31.2

Exhibit 31.2

EX-32.1

Exhibit 32.01

EX-32.2

Exhibit 32.02