UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2005

OR

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

For the transition period from                      to                     

Commission File Number 001-31700

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)

(Registrant’s Telephone Number, Including Area Code) (714) 952-1121

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

There were approximately 87,850,000 shares of common stock outstanding on October 31, 2005.

PACIFICARE HEALTH SYSTEMS, INC.

FORM 10-Q

INDEX

		Page
	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004	1
	Condensed Consolidated Statements of Income for the Three Months Ended September 30, 2005 and 2004	2
	Condensed Consolidated Statements of Income for the Nine Months Ended September 30, 2005 and 2004	3
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004	4
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	50
Item 4.	Controls and Procedures	51
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	52
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Submission of Matters to a Vote of Security Holders	52
Item 5.	Other Information	52
Item 6.	Exhibits	52
Signatures		53
Exhibit Index		54

i

PART I. FINANCIAL INFORMATION

Item 1: Financial Statements

PACIFICARE HEALTH SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except per share data)

	September 30, 2005			December 31, 2004
	(unaudited)
ASSETS
Current assets:
Cash and equivalents	$	1,427,269		$	824,104
Marketable securities		2,175,096			1,936,765
Receivables, net		328,672			317,362
Prepaid expenses and other current assets		48,147			54,746
Deferred income taxes		159,208			148,702
Total current assets		4,138,392			3,281,679
Property, plant and equipment, net		250,404			226,594
Marketable securities-restricted		183,683			140,298
Goodwill		1,333,900			1,278,677
Intangible assets, net		226,403			227,122
Other assets		78,382			72,547
	$	6,211,164		$	5,226,917
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims and benefits payable	$	1,308,500		$	1,192,400
Accounts payable and accrued liabilities		539,698			514,336
Unearned premium revenue		605,853			89,496
Current portion of long-term debt		35,157			37,534
Total current liabilities		2,489,208			1,833,766
Long-term debt		883,403			916,520
Convertible subordinated debentures		135,000			135,000
Deferred income taxes		119,268			114,733
Other liabilities		59,358			38,460
Stockholders’ equity:
Common stock, $0.01 par value; 200,000 shares authorized; issued and outstanding 87,843 shares in 2005 and 86,072 shares in 2004		878			861
Unearned compensation		(55,645	)		(32,207	)
Additional paid-in capital		1,666,059			1,569,118
Accumulated other comprehensive income (loss)		(19,634	)		3,498
Retained earnings		933,269			647,168
Total stockholders’ equity		2,524,927			2,188,438
	$	6,211,164		$	5,226,917

See accompanying notes.

1

PACIFICARE HEALTH SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(Amounts in thousands, except per share data)

	Three Months Ended September 30,
	2005			2004
Revenue:
Commercial	$	1,731,062		$	1,419,140
Senior		1,763,833			1,480,778
Specialty and other		242,668			181,199
Net investment income		32,879			24,509
Total operating revenue		3,770,442			3,105,626
Expenses:
Health care services and other:
Commercial		1,415,012			1,192,632
Senior		1,493,221			1,257,631
Specialty and other		139,735			101,678
Total health care services and other		3,047,968			2,551,941
Selling, general and administrative expenses		528,951			401,050
Operating income		193,523			152,635
Interest expense, net		(19,611	)		(10,182	)
Income before income taxes		173,912			142,453
Provision for income taxes		55,802			54,285
Net income	$	118,110		$	88,168
Basic earnings per share	$	1.36		$	1.05
Diluted earnings per share	$	1.21		$	0.94

See accompanying notes.

2

PACIFICARE HEALTH SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(Amounts in thousands, except per share data)

	Nine Months Ended September 30,
	2005			2004
Revenue:
Commercial	$	4,976,111		$	4,219,045
Senior		5,021,313			4,332,078
Specialty and other		694,816			501,891
Net investment income		95,281			64,183
Total operating revenue		10,787,521			9,117,197
Expenses:
Health care services and other:
Commercial		4,071,329			3,559,411
Senior		4,333,357			3,730,703
Specialty and other		409,488			276,170
Total health care services and other		8,814,174			7,566,284
Selling, general and administrative expenses		1,453,811			1,142,525
Operating income		519,536			408,388
Interest expense, net		(55,117	)		(31,852	)
Income before income taxes		464,419			376,536
Provision for income taxes		168,026			145,343
Net income	$	296,393		$	231,193
Basic earnings per share	$	3.43		$	2.74
Diluted earnings per share	$	3.06		$	2.44

See accompanying notes.

3

PACIFICARE HEALTH SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Amounts in thousands)

	Nine Months Ended September 30,
	2005			2004
Operating activities:
Net income	$	296,393		$	231,193
Adjustments to reconcile net income to net cash flows used in operating activities:
Depreciation and amortization		46,567			37,407
Stock-based compensation expense		23,719			27,822
Tax benefit realized for stock option exercises		23,339			15,982
Amortization of intangible assets		16,318			14,839
Deferred income taxes		4,951			32,899
Amortization of capitalized loan fees		3,113			3,232
Amortization of notes receivable from sale of fixed assets		(2,626	)		(4,172	)
Provision for (recovery of) doubtful accounts		(2,582	)		425
Amortization of discount on 10 3/4% senior notes		977			213
Loss on disposal of property, plant and equipment and other		767			2,749
Amortization of deferred gain		(175	)		—
Changes in assets and liabilities, net of effects of acquisitions:
Receivables, net		(6,102	)		(41,555	)
Prepaid expenses and other assets		4,591			1,087
Medical claims and benefits payable		100,903			39,100
Accounts payable and accrued liabilities:
Accrued taxes		1,049			(971	)
Other changes in accounts payable and accrued liabilities		43,430			27,909
Unearned premium revenue		516,357			(394,223	)
Net cash flows provided by (used in) operating activities		1,070,989			(6,064	)
Investing activities:
Purchase of marketable securities, net		(276,133	)		(242,546	)
Purchase of property, plant and equipment		(68,850	)		(45,087	)
Acquisitions, net of cash acquired		(58,964	)		—
Sale (purchase) of marketable securities-restricted, net		(43,385	)		29,495
Proceeds from the sale of property, plant and equipment		2,458			—
Net cash flows used in investing activities		(444,874	)		(258,138	)
Financing activities:
Proceeds from issuance of common stock		28,507			43,206
Principal payments on long-term debt		(26,077	)		(1,365	)
Purchase and retirement of common stock		(14,986	)		(102,951	)
Adjustment to fair value of 10 3/4% senior notes		(7,487	)		—
Payments on software financing agreements		(2,907	)		(5,515	)
Net cash flows used in financing activities		(22,950	)		(66,625	)
Net increase (decrease) in cash and equivalents		603,165			(330,827	)
Beginning cash and equivalents		824,104			1,198,422
Ending cash and equivalents	$	1,427,269		$	867,595

Table continued on next page

See accompanying notes.

4

PACIFICARE HEALTH SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(unaudited)

(Amounts in thousands)

	Nine Months Ended September 30,
	2005			2004
Supplemental cash flow information:
Cash paid during the period for:
Income taxes, net of refunds	$	127,592		$	88,647
Interest	$	41,070		$	27,363
Supplemental schedule of noncash investing and financing activities:
Details of accumulated other comprehensive income:
Change in market value of marketable securities	$	(37,802	)	$	(15,661	)
Decrease in deferred tax liability		14,670			5,474
Change in stockholders’ equity	$	(23,132	)	$	(10,187	)
Stock-based compensation	$	2,270		$	3,952
Discount on 10 3/4% senior notes	$	(7,755	)	$	(1,316	)
Investment in preferred stock	$	7,000		$	—
Details of businesses acquired in purchase transactions:
Fair value of assets acquired	$	71,766		$	—
Less liabilities assumed or created		(12,802	)		—
Net cash paid for acquisitions	$	58,964		$	—

Table continued from previous page.

See accompanying notes.

5

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005

(unaudited)

1. Basis of Presentation

PacifiCare Health Systems, Inc. offers managed care and other health insurance products to employer groups, individuals and Medicare beneficiaries throughout most of the United States and Guam. Our commercial and senior medical plans are designed to deliver quality health care and customer service to members cost-effectively. These products include health insurance, health benefits administration and indemnity insurance products such as Medicare Supplement products offered through health maintenance organizations, or HMOs, and preferred provider organizations, or PPOs. 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.

Following the rules and regulations of the Securities and Exchange Commission, or SEC, we have omitted footnote disclosures that would substantially duplicate the disclosures contained in our annual audited financial statements. The accompanying unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and the notes included in our December 31, 2004 Annual Report on Form 10-K, filed with the SEC in February 2005.

The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting solely of normal recurring adjustments, needed to present fairly the financial results for these interim periods. The condensed consolidated results of operations presented for the interim periods are not necessarily indicative of the results for a full year.

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. Our condensed consolidated statements of income 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.

All intercompany transactions and accounts were eliminated in consolidation.

We reclassified certain prior year amounts in the accompanying condensed consolidated financial statements to conform to the 2005 presentation.

2. Stock-Based Compensation

Effective January 1, 2003, we adopted the fair value recognition provisions of Statements of Financial Accounting Standards, or SFAS, 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, costs related to stock-based employee and director compensation included in the determination of net income 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.

In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123 (Revised 2004), Share-Based Payment, or SFAS No. 123R, which is a revision of SFAS No. 123. SFAS No. 123R supersedes Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. In April 2004, the SEC delayed the implementation date of SFAS No. 123R. SFAS No. 123R, which will become

6

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

effective for us on January 1, 2006, will require us to expense share-based payments under the “modified prospective” method. Under this method, compensation expense is recognized for all share-based payments granted on or after January 1, 2006 and also for all awards granted prior to January 1, 2006 that remain unvested as of that date. We adopted the transitional provisions of SFAS No. 123 effective January 1, 2003 using the prospective method. Consequently, compensation expense for awards that we granted prior to January 1, 2003 that are not fully vested on January 1, 2006 will be subject to expense beginning January 1, 2006 under SFAS No. 123R. We do not expect that the adoption of SFAS No. 123R will have a significant impact on our results of operations or financial position.

The following table illustrates the effect on net income and earnings per share, as if the fair value method had been applied to all outstanding and unvested awards in each period:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
	(Amounts in thousands, except per share data)
Net income, as reported	$	118,110		$	88,168		$	296,393		$	231,193
Add stock-based compensation expense included in reported net income, net of related tax effect		2,541			3,200			8,230			13,000
Deduct total stock-based compensation expense determined under fair value method for all awards, net of related tax effect		(2,799	)		(3,831	)		(9,072	)		(15,197	)
Pro forma net income	$	117,852		$	87,537		$	295,551		$	228,996
Earnings per share:
Basic — as reported	$	1.36		$	1.05		$	3.43		$	2.74
Basic — pro forma	$	1.36		$	1.05		$	3.42		$	2.72
Diluted — as reported	$	1.21		$	0.94		$	3.06		$	2.44
Diluted — pro forma	$	1.21		$	0.93		$	3.05		$	2.42

The following table illustrates the components of our stock-based compensation expense for the three and nine months ended September 30, 2005 and 2004:

	Three Months Ended September 30,								Nine Months Ended September 30,
	2005				2004				2005				2004
	Pretax Charges		Net-of-Tax Amount		Pretax Charges		Net-of-Tax Amount		Pretax Charges		Net-of-Tax Amount		Pretax Charges		Net-of-Tax Amount
	(Amounts in thousands)
Stock options	$	2,930	$	1,793	$	2,360	$	1,461	$	8,696	$	5,322	$	7,631	$	4,685
Employee Stock Purchase Plan		1,223		748		2,810		1,739		4,752		2,908		13,542		8,315
		4,153		2,541		5,170		3,200		13,448		8,230		21,173		13,000
Restricted stock(1)		3,587		2,196		2,275		1,408		10,271		6,286		6,649		4,082
Total	$	7,740	$	4,737	$	7,445	$	4,608	$	23,719	$	14,516	$	27,822	$	17,082

(1) The recognition and measurement of restricted stock is the same under APB Opinion No. 25 and SFAS 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, as reported amounts in the pro forma net income table above. See Note 5, “Stockholders’ Equity.”

7

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

3. Business Combinations and Divestitures

Pending Merger with UnitedHealth Group Inc. On July 6, 2005, we entered into a definitive agreement to merge with UnitedHealth Group Inc., or UnitedHealth. Upon completion of the merger, we will operate as a wholly owned subsidiary of UnitedHealth. Under the terms of the agreement, at the effective time of the merger each outstanding share of our common stock will be converted into the right to receive 1.10 shares of UnitedHealth common stock plus $21.50 in cash. The transaction with UnitedHealth is subject to a number of conditions, including, the adoption of the Merger Agreement by our stockholders at a special stockholders’ meeting, the termination or expiration of the waiting period under the Hart Scott Rodino Antitrust Improvements Act, receipt of all other necessary regulatory approvals and the satisfaction or waiver of other customary conditions. The merger agreement contains certain termination rights for both us and UnitedHealth, and provides that, upon termination of the merger agreement under specified circumstances, we may be required to pay UnitedHealth a termination fee of $243.6 million. The special stockholders’ meeting to consider the adoption of the merger agreement is scheduled for Thursday, November 17, 2005 at 10:00 a.m. Pacific Time at the Residence Inn by Marriott, 4931 Katella Avenue, Los Alamitos, California 90720.

Pacific Life Insurance Company. On April 27, 2005, we completed the acquisition of the group health insurance business of Pacific Life Insurance Company, or Pacific Life. The transaction was structured as a coinsurance arrangement, whereby Pacific Life cedes to us all future premiums received for its group health operations, and we assume all future incurred claim liabilities. We also obtained renewal rights for the acquired membership. In conjunction with this acquisition, we entered into agreements for transitional and administrative services related to the acquired group health insurance business.

Sale of Guam Business Operations. On July 16, 2005, we entered into a definitive agreement to sell all of the outstanding shares of PacifiCare Health Insurance Company of Micronesia, Inc., a Guam domestic insurance company. Completion of this sale is subject to regulatory approvals and other customary conditions. We anticipate completing this sale in the fourth quarter of 2005.

4. Long-Term Debt and Other Commitments

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 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. While no debentures were converted as of September 30, 2005, they are considered common stock equivalents and are included in the calculation of weighted average shares outstanding on a diluted basis.

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.

8

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

10 ³/4% Senior Notes. 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; the initial discount is being amortized over the term of the notes. We may redeem the 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.

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. On April 20, 2005, we terminated our swap agreement. The remaining swap value of approximately $7.5 million, representing a discount of the fair value of our 10 ³/4% senior notes, is being amortized as a yield adjustment through June 2009, which correlates to the corresponding debt maturity.

Certain of our domestic subsidiaries fully and unconditionally guarantee the 10 ³/4% senior notes. See Note 12, “Financial Guarantees.”

Senior Credit Facility. In December 2004, we replaced our senior credit facility with a new syndicated senior Credit Agreement, or the Credit Agreement, with the Lenders named therein, JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, J.P. Morgan Securities Inc., as Sole Lead Arranger and Sole Bookrunner, Morgan Stanley Senior Funding, Inc., as Syndication Agent and Co-Arranger and CIBC, Inc., The Bank of New York, and Wells Fargo Bank, N.A., as Co-Documentation Agents. The new facility consists of a $200 million term A loan, which matures on December 13, 2009, a $425 million term B loan, which matures on December 13, 2010, and a $200 million revolving line of credit, which matures on December 13, 2009. We used the proceeds of the term A and term B loans to refinance approximately $149 million (including accrued interest and fees of approximately $1 million) outstanding under our previous senior credit facility entered into in June 2003, to refinance approximately $30 million outstanding under the senior credit facility of American Medical Security Group, Inc., or AMS, and to fund a portion of the merger consideration paid to acquire AMS. In connection with the Credit Agreement, we incurred approximately $9 million in fees and expenses that are being amortized over the life of the facility. As of September 30, 2005, we had $599 million outstanding on the term A and term B loans and no balance outstanding on the revolving line of credit. There were no borrowings under the revolving line of credit during the quarter or nine months ended September 30, 2005.

The credit facility provides us with two interest rate options for borrowings under the term loans, to which a margin spread is added: (1) the LIBO Rate multiplied by the Statutory Reserve Rate and (2) JPMorgan Chase Bank’s prime rate (or, if greater, the Federal Funds Rate plus 0.5%), which we refer to as the alternate base rate. The margin spread for the term loans is based upon our current Standard & Poor’s Ratings Services and Moody’s Investor Service debt ratings. The margin spread for LIBO Rate borrowings range from 0.75% to 1.75% per annum under the term A loan and 1.25% to 1.5% per annum under the term B loan. The margin spread for alternate base rate borrowings range from 0% to 0.75% per annum under the term A loan and 0.25% to 0.5% per annum under the term B loan. All of our borrowings under the term loans are currently LIBO Rate borrowings with rates ranging from 5.125% to 5.375%. The interest rates per annum applicable to revolving credit borrowings are, at our option, either LIBO Rate borrowings with the same margin spread as our term A loan or alternate base rate borrowings with the same margin spread applicable to the term A loan. We also pay a commitment fee on the average daily unused amount of the revolving credit commitment. The commitment fee range is based upon our current debt rating and ranges from 0.15% to 0.5% per annum. The current commitment fee rate is 0.375% per annum.

9

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

The Credit Agreement contains 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 Credit Agreement also requires we meet various financial ratios, including a maximum consolidated leverage ratio, a minimum consolidated net worth requirement and a minimum fixed charge coverage requirement. At September 30, 2005, we were in compliance with all of these covenants.

Certain of our domestic subsidiaries provide guarantees and have granted security interests to the lenders in substantially all of their personal property in order to secure our obligations and their guarantees under the Credit Agreement. See Note 12, “Financial Guarantees.” We have also pledged the equity of certain of our subsidiaries to the lenders as security for the Credit Agreement.

Database Financing Agreements. As of September 30, 2005, we had $1 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 October 2006. The interest imputed on the payment plan agreements ranges from 4.0% to 6.5%.

Letters of Credit. Letters of credit are purchased guarantees that assure our performance or payment to third parties in connection with professional liability and workers compensation insurance policies, lease commitments and other potential obligations. Letters of credit commitments totaled $17 million at September 30, 2005 and 2004. As of September 30, 2005, 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 provides 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 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 are approximately $700 million, 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. Additionally, in the event of contract termination, we may be responsible to pay termination fees to IBM and Keane. These termination fees decline as each successive year of the contract term is completed.

5. Stockholders’ Equity

Stock Repurchase Program. In May 2004, our Board of Directors authorized a share repurchase program under which up to $150 million of our common stock may be repurchased. Under the program, repurchases may be made from time to time in the open market or through privately negotiated transactions using available cash, and may be discontinued at any time. No shares were repurchased under the share repurchase program for the three and nine months ended September 30, 2005. During the three and nine months ended September 30, 2004, we repurchased approximately 2 million shares and 3 million shares, respectively, at a cost of approximately $62 million and $100 million, respectively. The remaining authorization under our stock repurchase program as of September 30, 2005 was $50 million.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

Restricted Stock Awards. For the three months ended September 30, 2005 and 2004, we granted 17,500 and 700 shares of restricted common stock, respectively, including stock deferred into restricted stock units, as part of an employee recognition and retention program. For the nine months ended September 30, 2005 and 2004, we granted 576,800 and 792,600 shares in connection with the same program, respectively. Restrictions on these shares will expire and related charges are being amortized as earned over the vesting period of up to four years. A total of approximately 10,800 and 38,700 shares were forfeited during the three months ended September 30, 2005 and 2004, respectively. For the nine months ended September 30, 2005 and 2004, 97,500 and 98,200 shares were forfeited, respectively.

All shares of restricted stock were issued from our 2005 Equity Incentive Plan and 1996 Officer and Key Employee Stock Option Plan, as amended. 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. Expenses related to the vesting of restricted stock (charged to selling, general and administrative expenses) were $3.6 million and $2.3 million for the three months ended September 30, 2005 and 2004, respectively. For the nine months ended September 30, 2005 and 2004, the related expenses were $10.3 million and $6.6 million, respectively.

6. Goodwill and Intangible Assets

Effective January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets. Under this rule, 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 SFAS No. 142, we use a discounted cash flow methodology to assess the fair values of our reporting units. Impairment is measured by comparing the goodwill derived from the hypothetical purchase price allocation to the carrying value of the goodwill balance. No goodwill impairment indicators existed for the nine months ended September 30, 2005 and, as a result, impairment testing was not required.

Other intangible assets are being amortized over their useful lives. We estimate our intangible asset amortization will be $22 million in 2005, $19 million in 2006, $18 million in 2007, $15 million in 2008 and $15 million in 2009. The following sets forth balances of identified intangible assets, by major class, for the periods indicated:

	Cost		Accumulated Amortization		Net Balance
	(Amounts in thousands)
Intangible assets:
Employer groups	$	252,320	$	140,854	$	111,466
Provider networks		122,751		24,132		98,619
Other		26,329		9,292		17,037
Balance at December 31, 2004	$	401,400	$	174,278	$	227,122
Intangible assets:
Employer groups	$	271,520	$	154,713	$	116,807
Provider networks		118,251		26,538		91,713
Other		27,229		9,346		17,883
Balance at September 30, 2005	$	417,000	$	190,597	$	226,403

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

The changes in the carrying amount of goodwill, by reportable segment are as follows:

	Health Plans			Specialty		Corporate and Other		Consolidated
	(Amounts in thousands)
Balance as of January 1, 2004	$	954,701		$	28,403	$	—	$	983,104
Goodwill acquired during 2004		295,573			—		—		295,573
Balance at December 31, 2004		1,250,274			28,403		—		1,278,677
Adjustments to goodwill acquired		(3,796	)		—		—		(3,796	)
Goodwill acquired during 2005, net		59,019			—		—		59,019
Balance at September 30, 2005	$	1,305,497		$	28,403	$	—	$	1,333,900

7. Health Care Services and Other Expenses

The following table presents the components of total health care services and other expenses for the three and nine months ended September 30, 2005 and 2004:

	Three Months Ended September 30,
	2005				2004
	Commercial		Senior		Commercial		Senior
	(Amounts in millions)
Capitation expense	$	374	$	841	$	387	$	724
All other health care services and other expenses		1,041		652		806		534
Total health care services and other expenses	$	1,415	$	1,493	$	1,193	$	1,258
	Nine Months Ended September 30,
	2005				2004
	Commercial		Senior		Commercial		Senior
	(Amounts in millions)
Capitation expense	$	1,135	$	2,389	$	1,188	$	2,137
All other health care services and other expenses		2,936		1,944		2,371		1,594
Total health care services and other expenses	$	4,071	$	4,333	$	3,559	$	3,731

8. Contingencies

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 pre-trial 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 physicians, along with several medical associations, including the California Medical Association, joined the “In re Managed Care” proceeding as plaintiffs. These physicians 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

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 need to be arbitrated. As a result, the order to compel arbitration does not cover part of the conspiracy and aiding and abetting claims of all plaintiffs or any of the direct claims by a subset of plaintiffs (non-contracted plaintiffs who provide services to our members but do not accept assignments from them).

On September 26, 2002, the District Court certified a nationwide RICO class of virtually all physicians in the country as well as a nationwide state-law subclass of physicians. On September 1, 2004, the Eleventh Circuit upheld part of the class certified by the District Court. Specifically, the Eleventh Circuit upheld the District Court’s certification of a nationwide RICO class of physicians, but reversed the District Court’s certification of plaintiffs’ state law claims. On July 25, 2005, the District Court amended the class certification to, among other things, exclude “any claims that the methods by which negotiated capitation rates are derived and calculated are actuarially unsound.” The District Court’s July 25, 2005 order amended and certified plaintiffs’ class as to both “In re Managed Care” and also as to the essentially identical lawsuit filed in the Southern District of Florida: Shane et al. v. Humana et al. Case No. 04-21589-CIV-MORENO (“Shane II”). On August 25, 2005, the District Court entered a summary judgment in our favor on all remaining capitation-related claims against us. The District Court has set a trial date for April 2006. We deny all material allegations and intend to defend the action vigorously.

Several additional lawsuits have been filed against us and the other defendants in the “In re Managed Care Litigation” by non-physician providers of health care services, such as chiropractors and podiatrists. Those lawsuits have been assigned to the District Court for pre-trial proceedings, but are currently stayed pending the completion of pre-trial matters in the physician class action.

Vivian Gadson, et al., v. American Medical Security, et al., (CV-02-1601) Circuit Court of Montgomery County, Alabama. On September 29, 2004, the Circuit Court of Montgomery County, Alabama, granted final approval of the certification and settlement of a class action lawsuit, Gadson v. United Wisconsin Life Insurance Company, although approval of the settlement has been appealed to the Alabama Supreme Court. Oral argument on this appeal was heard on August 2, 2005. The Circuit Court had granted preliminary approval of the certification and settlement in March 2004. The lawsuit was filed in 2001 and involves issues relating to the rating methodology formerly used by AMS for group health benefit plans marketed to individuals in Alabama and Georgia. All claims of participating class members have been dismissed in exchange for the settlement consideration. On June 14, 2004, the Superior Court of Cobb County, Georgia in Parker v. American Medical Security Group, Inc., issued an order enjoining AMS from settling with Georgia residents who are members of the Gadson class. On September 2, 2004, the Superior Court certified a class of Georgia residents. On March 31, 2005, the Georgia Supreme Court ruled that the Georgia plaintiffs lacked standing to challenge the Gadson settlement and held that the injunction was invalid.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

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 members of non-ERISA health plans and individuals with no prescription drug coverage 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. On May 5, 2004, Prescription Solutions filed a petition to compel arbitration. On July 9, 2004, the Superior Court granted the petition, holding that Irwin’s request for monetary relief can only be resolved in arbitration and staying Irwin’s request for injunctive relief against Prescription Solutions until an appropriate arbitration is completed. Discovery is stayed as to Prescription Solutions pending arbitration. 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 a variety of legal actions and claims that seek monetary damages (or punitive damages that are not covered by insurance) relating but not limited to the following: (i) denial of healthcare benefits, (ii) disputes related to managed care or cost containment activities, (iii) disputes with providers, agents or brokers over compensation or other matters, (iv) disputes related to claim administration errors and failure to disclose network rate discounts and other fee and rebate arrangements, (v) disputes over rating methodology and practices or termination of coverage, (vi) disputes over copayment calculations, (vii) customer audits of our administration of ERISA and other plans, and (viii) disputes with payers and other third parties over contracted services provided by us. Our establishment of drug formularies, support of clinical trials and PBM services may increase our exposure to product liability claims associated with 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.

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 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 $28 million at September 30, 2005 and $30 million at December 31, 2004.

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

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PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

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.

9. Earnings Per Share

The following table includes a reconciliation of the numerators and denominators for the computation of basic and diluted earnings per share:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
	(Amounts in thousands, except per share data)
Basic Earnings Per Share Calculation:
Numerator
Net income	$	118,110		$	88,168		$	296,393		$	231,193
Denominator
Shares outstanding at the beginning of the period(1)		86,652			84,421			85,162			83,339
Weighted average number of shares issued:
Treasury stock repurchases		(4	)		(1,229	)		(230	)		(922	)
Stock options exercised		160			499			1,441			1,879
Denominator for basic earnings per share		86,808			83,691			86,373			84,296
Basic earnings per share	$	1.36		$	1.05		$	3.43		$	2.74
Diluted Earnings Per Share Calculation:
Numerator
Net income	$	118,110		$	88,168		$	296,393		$	231,193
Adjustment for interest expense avoided on convertible subordinated debentures, net of tax		620			628			1,859			1,865
Net income, as adjusted for interest expense avoided on convertible subordinated debentures	$	118,730		$	88,796		$	298,252		$	233,058
Denominator
Denominator for basic earnings per share		86,808			83,691			86,373			84,296
Common stock equivalents related to convertible subordinated debentures		6,429			6,429			6,429			6,429
Employee stock options and other dilutive potential common shares(2)		4,659			4,372			4,603			4,691
Denominator for diluted earnings per share		97,896			94,492			97,405			95,416
Diluted earnings per share	$	1.21		$	0.94		$	3.06		$	2.44

(1) Excludes 958,000 and 956,000 shares of restricted common stock which have been granted under our stock-based compensation plans but have not vested as of September 30, 2005 and 2004, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

(2) 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 three months ended September 30, 2005 and 2004, these excluded weighted options outstanding totaled 0.5 million shares and 2.3 million shares, respectively, with exercise prices ranging from $32.37 to $72.52 per share. For the nine months ended September 30, 2005 and 2004, these weighted options outstanding totaled 0.5 million shares and 1.7 million shares, respectively, with exercise prices ranging from $32.37 to $72.52 per share. For the three months ended September 30, 2005 and 2004, the average market value used in the computation of dilutive employee stock options and other dilutive potential common shares was $76.08 and $33.50, respectively. For the nine months ended September 30, 2005 and 2004, the average market value used was $66.44 and $35.19, respectively.

10. Comprehensive Income

Comprehensive income represents our net income plus changes in equity, other than those changes resulting from investments by, and distributions to, our stockholders. Such changes include unrealized gains or losses on our available-for-sale securities. Our comprehensive income totaled $101 million and $99 million for the three months ended September 30, 2005 and 2004, respectively. For the nine months ended September 30, 2005 and 2004, our comprehensive income totaled $273 million and $221 million, respectively.

11. Business Segment Information

We sell health care services in the form of bundled managed care and supplemental managed care products to members of all ages. Thus, our customer is the individual. However, we are paid by employer groups and the Federal Government who offer our health plans, along with other health plans, to their employees (or in the case of Medicare, to the individual Medicare beneficiary). The member can select one of our plans, or a plan offered by another health care insurer. We also offer our health plans to individuals directly. We have identified our product lines as commercial, Medicare and supplemental managed care products based on the benefits offered and source of payment (commercial premiums are paid for by a combination of the employer and employee, whereas the government pays most of the premium for Medicare beneficiaries).

We have two reportable segments, the Health Plans segment, which is comprised of eight principal geographic operating segments and the Specialty segment which is comprised of pharmacy products, pharmacy benefit management, and dental, vision and behavioral health services. The operating segments within the reportable Health Plans segment all have similar economic characteristics. In addition, the operating segments within the reportable Health Plans segment meet the additional following five aggregation criteria as defined under paragraph 17 of SFAS No. 131, Disclosures About Segments of An Enterprise and Related Information:

1. All operating segments provide similar health care products to the same class of customers, individuals. We generally market similar health care products throughout the country for each of our customer groups. We provide a broad spectrum of health plans to our members through programs such as HMOs for members of all ages, including senior members, PPOs, and Medicare supplement products.

2. The production processes are substantially similar for all operating segments as they support similar customer groups and products.

3. Each operating segment has the same class of customers, individuals within large and small employer groups and senior and commercial individuals.

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September 30, 2005

(unaudited)

4. Each operating segment has similar distribution channels. We use multiple distribution channels such as general agents, an on-line price-quoting service, insurance brokers and consultants who represent many employer groups and direct plan enrollment for a portion of our senior members. These methods are similar across geographies.

5. The health care industry is highly regulated at both the federal and state levels. All of the geographies must comply with the same federal regulations. While each state’s laws are in some respects unique, many states have similar laws and regulations applicable to managed care and insurance companies.

The team which comprises the “chief operating decision maker” reviews commercial and senior product lines (Health Plans segment) and the specialty product line to operating income. We regularly review for changes in our segment reporting. Our reportable segments have not changed from December 31, 2004. Accordingly, we have provided disclosures related to our Health Plans and Specialty segments in the table below.

The accounting policies of the segments are consistent with generally accepted accounting principles in the United States. The following table presents segment information for the Health Plans and Specialty segments for the three and nine months ended September 30, 2005 and 2004, as if our segment reporting structure had been effective on January 1, 2004. Intersegment revenues include internal pharmaceutical sales by our mail order pharmacy to the Health Plans segment’s members and fees recognized by the Specialty segment for services provided to the Health Plans segment. Amounts under the heading “Corporate and Other” include revenues and expenses not allocable to reportable segments. Intersegment transactions are eliminated in consolidation under the heading “Corporate and Other.”

	Health Plan		Specialty		Corporate and Other			Consolidated
	(Amounts in thousands)
Three months ended September 30, 2005:
Operating revenue from external customers	$	3,494,895	$	242,668	$	—		$	3,737,563
Intersegment revenues		5,595		281,039		(286,634	)		—
Segment operating income		160,603		32,920		—			193,523
Segment assets	$	5,298,916	$	400,469	$	511,779		$	6,211,164
Three months ended September 30, 2004:
Operating revenue from external customers	$	2,899,918	$	181,199	$	—		$	3,081,117
Intersegment revenues		5,505		88,981		(94,486	)		—
Segment operating income		122,298		30,337		—			152,635
Segment assets	$	3,743,759	$	365,430	$	362,793		$	4,471,982
Nine months ended September 30, 2005:
Operating revenue from external customers	$	9,997,424	$	694,816	$	—		$	10,692,240
Intersegment revenues		16,576		811,178		(827,754	)		—
Segment operating income		424,729		94,807		—			519,536
Segment assets	$	5,298,916	$	400,469	$	511,779		$	6,211,164
Nine months ended September 30, 2004:
Operating revenue from external customers	$	8,551,123	$	501,891	$	—		$	9,053,014
Intersegment revenues		14,067		256,097		(270,164	)		—
Segment operating income		322,620		85,768		—			408,388
Segment assets	$	3,743,759	$	365,430	$	362,793		$	4,471,982

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

Our largest source of revenue 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 $1.9 billion and $1.6 billion for the three months ended September 30, 2005 and 2004, respectively. For the nine months ended September 30, 2005 and 2004, federal government revenues were $5.4 billion and $4.6 billion, respectively.

12. Financial Guarantees

Certain of our domestic subsidiaries fully and unconditionally guarantee the 10 ³/4% senior notes. The Guarantor Subsidiaries are also guarantors of our senior credit facility.

The following unaudited condensed consolidating financial statements quantify the financial position as of September 30, 2005 and December 31, 2004 and the operations for the three and nine months ended September 30, 2005 and 2004 and the cash flows for the nine months ended September 30, 2005 and 2004 of the Guarantor Subsidiaries listed below. The following unaudited condensed consolidating balance sheets, condensed consolidating statements of operations and condensed consolidating statements of cash flows present financial information for the following entities and utilize the following adjustments:

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

Guarantor Subsidiaries — (a) PacifiCare Health Plan Administrators, Inc., or PHPA, PacifiCare eHoldings, Inc., SeniorCo, Inc., RxSolutions, Inc., doing business as Prescription Solutions, PacifiCare Behavioral Health, Inc., American Medical Security Group, Inc., or AMSG, and SecureHorizons USA, Inc. on a stand-alone basis (carrying investments in subsidiaries under the equity method) and (b) PacifiCare of Arizona, Inc., PacifiCare of Oklahoma, Inc. and PacifiCare Southwest Operations, Inc., which are fully owned subsidiaries of PHPA, and Nurse Healthline, Inc. and Continental Plan Services, Inc., which are fully owned subsidiaries of AMSG.

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEETS

September 30, 2005

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
ASSETS
Current assets:
Cash and equivalents	$	—		$	625,772		$	801,497		$	—		$	1,427,269
Marketable securities		—			246,962			1,928,134			—			2,175,096
Receivables, net		1,304			60,313			272,701			(5,646	)		328,672
Intercompany		(19,359	)		57,626			(38,267	)		—			—
Prepaid expenses and other current assets		970			38,985			15,040			(6,848	)		48,147
Deferred income taxes		—			91,032			114,716			(46,540	)		159,208
Total current assets		(17,085	)		1,120,690			3,093,821			(59,034	)		4,138,392
Property, plant and equipment, net		—			184,065			66,339			—			250,404
Marketable securities-restricted		29,419			10,612			143,652			—			183,683
Deferred income taxes		—			111,686			30,060			(141,746	)		—
Investment in subsidiaries		3,582,485			2,758,038			9,609			(6,350,132	)		—
Goodwill and intangible assets, net		—			501,561			1,058,742			—			1,560,303
Other assets		22,293			34,222			21,867			—			78,382
	$	3,617,112		$	4,720,874		$	4,424,090		$	(6,550,912	)	$	6,211,164
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims and benefits payable	$	—		$	219,690		$	1,095,588		$	(6,778	)	$	1,308,500
Accounts payable and accrued liabilities		14,167			305,278			223,656			(3,403	)		539,698
Deferred income taxes		—			30,133			16,407			(46,540	)		—
Unearned premium revenue		—			90,955			517,221			(2,323	)		605,853
Current portion of long-term debt		34,250			684			223			—			35,157
Total current liabilities		48,417			646,740			1,853,095			(59,044	)		2,489,208
Long-term debt		882,309			64			1,030			—			883,403
Convertible subordinated debentures		135,000			—			—			—			135,000
Deferred income taxes		—			181,946			79,068			(141,746	)		119,268
Other liabilities		6,825			52,533			—			—			59,358
Stockholders’ equity:
Common stock		878			—			—			—			878
Unearned compensation		(55,645	)		—			—			—			(55,645	)
Additional paid-in capital		1,666,059			—			—			—			1,666,059
Accumulated other comprehensive loss		—			(4,563	)		(17,589	)		2,518			(19,634	)
Retained earnings		933,269			—			—			—			933,269
Equity in income of subsidiaries		—			3,844,154			2,508,486			(6,352,640	)		—
Total stockholders’ equity		2,544,561			3,839,591			2,490,897			(6,350,122	)		2,524,927
	$	3,617,112		$	4,720,874		$	4,424,090		$	(6,550,912	)	$	6,211,164

19

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

CONDENSED CONSOLIDATING BALANCE SHEETS

December 31, 2004

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
ASSETS
Current assets:
Cash and equivalents	$	—		$	394,305		$	429,799		$	—		$	824,104
Marketable securities		—			207,181			1,729,584			—			1,936,765
Receivables, net		996			89,426			235,527			(8,587	)		317,362
Intercompany		(49,021	)		85,013			(35,992	)		—			—
Prepaid expenses and other current assets		5,800			38,764			16,225			(6,043	)		54,746
Deferred income taxes		—			80,526			112,831			(44,655	)		148,702
Total current assets		(42,225	)		895,215			2,487,974			(59,285	)		3,281,679
Property, plant and equipment, net		—			133,033			93,561			—			226,594
Marketable securities-restricted		31,940			4,949			103,409			—			140,298
Deferred income taxes		—			111,201			30,060			(141,261	)		—
Investment in subsidiaries		3,273,114			2,646,361			7,341			(5,926,816	)		—
Goodwill and intangible assets, net		—			437,274			1,068,525			—			1,505,799
Other assets		21,069			29,778			21,700			—			72,547
	$	3,283,898		$	4,257,811		$	3,812,570		$	(6,127,362	)	$	5,226,917
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims and benefits payable	$	—		$	180,890		$	1,020,428		$	(8,918	)	$	1,192,400
Accounts payable and accrued liabilities		15,203			324,499			177,990			(3,356	)		514,336
Deferred income taxes		—			28,083			16,212			(44,295	)		—
Unearned premium revenue		—			4,671			87,181			(2,356	)		89,496
Current portion of long-term debt		34,250			3,028			256			—			37,534
Total current liabilities		49,453			541,171			1,302,067			(58,925	)		1,833,766
Long-term debt		914,505			627			1,388			—			916,520
Convertible subordinated debentures		135,000			—			—			—			135,000
Deferred income taxes		—			168,940			87,054			(141,261	)		114,733
Other liabilities		—			38,460			—			—			38,460
Stockholders’ equity:
Common stock		861			—			—			—			861
Unearned compensation		(32,207	)		—			—			—			(32,207	)
Additional paid-in capital		1,569,118			—			—			—			1,569,118
Accumulated other comprehensive income (loss)		—			(83	)		3,581			—			3,498
Retained earnings		647,168			—			—			—			647,168
Equity in income of subsidiaries		—			3,508,696			2,418,480			(5,927,176	)		—
Total stockholders’ equity		2,184,940			3,508,613			2,422,061			(5,927,176	)		2,188,438
	$	3,283,898		$	4,257,811		$	3,812,570		$	(6,127,362	)	$	5,226,917

20

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

CONSOLIDATING CONDENSED STATEMENTS OF INCOME

For the Three Months Ended September 30, 2005

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
Operating revenue	$	462		$	877,499		$	3,216,759		$	(324,278	)	$	3,770,442
Income from subsidiaries		137,102			180,075			109			(317,286	)		—
Total operating revenue		137,564			1,057,574			3,216,868			(641,564	)		3,770,442
Health care services and other expenses		—			723,465			2,634,527			(310,024	)		3,047,968
Selling, general and administrative expenses		34			226,641			315,726			(13,450	)		528,951
Operating income		137,530			107,468			266,615			(318,090	)		193,523
Interest expense, net		(19,420	)		(867	)		(128	)		804			(19,611	)
Income before income taxes		118,110			106,601			266,487			(317,286	)		173,912
Provision (benefit) for income taxes		—			(34,397	)		90,199			—			55,802
Net income	$	118,110		$	140,998		$	176,288		$	(317,286	)	$	118,110
For the Nine Months Ended September 30, 2005
	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
Operating revenue	$	1,232		$	2,519,728		$	9,202,553		$	(935,992	)	$	10,787,521
Income from subsidiaries		349,877			452,161			2,267			(804,305	)		—
Total operating revenue		351,109			2,971,889			9,204,820			(1,740,297	)		10,787,521
Health care services and other expenses		—			2,094,266			7,609,686			(889,778	)		8,814,174
Selling, general and administrative expenses		132			582,301			914,394			(43,016	)		1,453,811
Operating income		350,977			295,322			680,740			(807,503	)		519,536
Interest expense, net		(54,584	)		(3,534	)		(197	)		3,198			(55,117	)
Income before income taxes		296,393			291,788			680,543			(804,305	)		464,419
Provision (benefit) for income taxes		—			(67,049	)		235,075			—			168,026
Net income	$	296,393		$	358,837		$	445,468		$	(804,305	)	$	296,393

21

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

CONDENSED CONSOLIDATING STATEMENTS OF INCOME

For the Three Months Ended September 30, 2004

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
Operating revenue	$	254		$	581,475		$	2,650,369		$	(126,472	)	$	3,105,626
Income from subsidiaries		97,801			166,684			1,694			(266,179	)		—
Total operating revenue		98,055			748,159			2,652,063			(392,651	)		3,105,626
Health care services and other expenses		—			449,652			2,214,806			(112,517	)		2,551,941
Selling, general and administrative expenses		33			202,018			212,281			(13,282	)		401,050
Operating income		98,022			96,489			224,976			(266,852	)		152,635
Interest expense, net		(9,854	)		(892	)		(109	)		673			(10,182	)
Income before income taxes		88,168			95,597			224,867			(266,179	)		142,453
Provision (benefit) for income taxes		—			(8,269	)		62,554			—			54,285
Net income	$	88,168		$	103,866		$	162,313		$	(266,179	)	$	88,168
For the Nine Months Ended September 30, 2004
	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
Operating revenue	$	661		$	1,667,337		$	7,810,358		$	(361,159	)	$	9,117,197
Income from subsidiaries		261,806			430,268			2,540			(694,614	)		—
Total operating revenue		262,467			2,097,605			7,812,898			(1,055,773	)		9,117,197
Health care services and other expenses		—			1,308,163			6,580,689			(322,568	)		7,566,284
Selling, general and administrative expenses		147			506,575			672,844			(37,041	)		1,142,525
Operating income		262,320			282,867			559,365			(696,164	)		408,388
Interest expense, net		(31,127	)		(2,138	)		(137	)		1,550			(31,852	)
Income before income taxes		231,193			280,729			559,228			(694,614	)		376,536
Provision (benefit) for income taxes		—			(31,183	)		176,526			—			145,343
Net income	$	231,193		$	311,912		$	382,702		$	(694,614	)	$	231,193

22

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2005

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
Operating activities:
Net income	$	296,393		$	358,837		$	445,468		$	(804,305	)	$	296,393
Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:
Equity in income of subsidiaries		(349,877	)		(452,161	)		(2,267	)		804,305			—
Depreciation and amortization		—			37,952			8,615			—			46,567
Stock-based compensation expense		23,719			—			—			—			23,719
Tax benefit realized for stock option exercises		23,339			—			—			—			23,339
Amortization of intangible assets		—			6,536			9,782			—			16,318
Deferred income taxes		—			(7,029	)		11,980			—			4,951
Amortization of capitalized loan fees		3,113			—			—			—			3,113
Amortization of notes receivable from sale of fixed assets		—			(2,626	)		—			—			(2,626	)
Provision for (recovery of) doubtful accounts		—			575			(3,157	)		—			(2,582	)
Amortization of discount on 10 3/4% senior notes		977			—			—			—			977
Loss on disposal of property, plant and equipment and other		—			645			122			—			767
Amortization of deferred gain		(175	)		—			—			—			(175	)
Changes in assets and liabilities, net of effects of acquisitions		(12,465	)		149,064			523,629			—			660,228
Net cash flows provided by (used in) operating activities		(14,976	)		91,793			994,172			—			1,070,989
Investing activities:
Purchase of marketable securities, net		—			(44,443	)		(231,690	)		—			(276,133	)
Purchase of property, plant and equipment		—			(62,588	)		(6,262	)		—			(68,850	)
Acquisitions, net of cash acquired		(8,397	)		(50,567	)		—			—			(58,964	)
Sale (purchase) of marketable securities-restricted, net		2,521			(5,663	)		(40,243	)		—			(43,385	)
Proceeds from the sale of property, plant and equipment		—			—			2,458			—			2,458
Net cash flows used in investing activities		(5,876	)		(163,261	)		(275,737	)		—			(444,874	)
Financing activities:
Proceeds from issuance of common stock		28,507			—			—			—			28,507
Principal payments on long-term debt		(25,688	)		—			(389	)		—			(26,077	)
Purchase and retirement of common stock		(14,986	)		—			—			—			(14,986	)
Adjustment to fair value of 10 3/4% senior notes		(7,487	)		—			—			—			(7,487	)
Payments on software financing agreements		—			(2,907	)		—			—			(2,907	)
Intercompany activity:
Capital contributions received (paid)		506			67,716			(68,222	)		—			—
Dividends received (paid)		40,000			224,987			(264,987	)		—			—
Subordinated loans received (paid)		—			13,139			(13,139	)		—			—
Net cash flows provided by (used in) financing activities		20,852			302,935			(346,737	)		—			(22,950	)
Net increase in cash and equivalents		—			231,467			371,698			—			603,165
Beginning cash and equivalents		—			394,305			429,799			—			824,104
Ending cash and equivalents	$	—		$	625,772		$	801,497		$	—		$	1,427,269

23

PACIFICARE HEALTH SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2005

(unaudited)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2004

	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidating Adjustments			Company
	(Amounts in thousands)
Operating activities:
Net income	$	231,193		$	311,912		$	382,702		$	(694,614	)	$	231,193
Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:
Equity in income of subsidiaries		(261,806	)		(430,268	)		(2,540	)		694,614			—
Depreciation and amortization		—			30,957			6,450			—			37,407
Stock-based compensation expense		27,822			—			—			—			27,822
Tax benefit realized for stock option exercises		15,982			—			—			—			15,982
Amortization of intangible assets		—			2,142			12,697			—			14,839
Deferred income taxes		—			31,434			1,465			—			32,899
Amortization of capitalized loan fees		3,232			—			—			—			3,232
Amortization of notes receivable from sale of fixed assets		—			(4,172	)		—			—			(4,172	)
Provision for (recovery of) doubtful accounts		—			(5,972	)		6,397			—			425
Amortization of discount on 10 3/4% senior notes		213			—			—			—			213
Loss on disposal of property, plant and equipment		—			2,734			15			—			2,749
Changes in assets and liabilities		42,651			(110,996	)		(300,308	)		—			(368,653	)
Net cash flows provided by (used in) operating activities		59,287			(172,229	)		106,878			—			(6,064	)
Investing activities:
Purchase of marketable securities, net		—			(37,880	)		(204,666	)		—			(242,546	)
Purchase of property, plant and equipment		—			(41,018	)		(4,069	)		—			(45,087	)
Sale (purchase) of marketable securities-restricted, net		1,583			(2,041	)		29,953			—			29,495
Net cash flows provided by (used in) investing activities		1,583			(80,939	)		(178,782	)		—			(258,138	)
Financing activities:
Proceeds from issuance of common stock		43,206			—			—			—			43,206
Principal payments on long-term debt		(1,125	)		—			(240	)		—			(1,365	)
Purchase and retirement of common stock		(102,951	)		—			—			—			(102,951	)
Payments on software financing agreements		—			(5,515	)		—			—			(5,515	)
Intercompany activity:
Dividends received (paid)		—			257,846			(257,846	)		—			—
Capital contributions received (paid)		—			(20,000	)		20,000			—			—
Net cash flows provided by (used in) financing activities		(60,870	)		232,331			(238,086	)		—			(66,625	)
Net decrease in cash and equivalents		—			(20,837	)		(309,990	)		—			(330,827	)
Beginning cash and equivalents		—			373,527			824,895			—			1,198,422
Ending cash and equivalents	$	—		$	352,690		$	514,905		$	—		$	867,595

24

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

In this Quarterly Report on Form 10-Q, 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 Estimates and in other parts of this report.

We offer managed care and other health insurance products to employer groups, individuals and Medicare beneficiaries throughout most of the United States and Guam. Our commercial and senior plans are designed to deliver quality health care and customer service to members cost-effectively. These products include health insurance, health benefits administration and indemnity insurance products such as Medicare Supplement products offered through health maintenance organizations, or HMOs, and preferred provider organizations, or PPOs. We also offer a variety of specialty managed care products and services that employees and individuals 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.

Business Combinations

On July 6, 2005, we entered into a definitive agreement to merge with UnitedHealth Group Inc., or UnitedHealth. Upon completion of the merger, we will operate as a wholly owned subsidiary of UnitedHealth. Under the terms of the agreement, at the effective time of the merger each outstanding share of PacifiCare common stock will be converted into the right to receive 1.10 shares of UnitedHealth common stock plus $21.50 in cash. The transaction with UnitedHealth is subject to a number of conditions, including, the adoption of the Merger Agreement by PacifiCare stockholders at a special stockholders meeting, the termination or expiration of the waiting period under the Hart Scott Rodino Antitrust Improvements Act, receipt of all other necessary regulatory approvals and the satisfaction or waiver of other customary conditions. The merger agreement contains certain termination rights for both PacifiCare and UnitedHealth, and provides that, upon termination of the merger agreement under specified circumstances, we may be required to pay UnitedHealth a termination fee of $243.6 million. The special stockholders’ meeting to consider the adoption of the merger agreement is scheduled for Thursday, November 17, 2005 at 10:00 a.m. Pacific Time at the Residence Inn by Marriott, 4931 Katella Avenue, Los Alamitos, California 90720.

On December 13, 2004, we completed the acquisition of American Medical Security Group, Inc., or AMS. The acquisition of AMS provides an expansion of our commercial membership, strengthens our position in the individual and small group markets and adds new proprietary products including a health savings account and group life products. We paid $32.75 in cash for each share of AMS common stock outstanding and cashed out all outstanding options on a net basis for a total equity purchase price of approximately $505 million. We financed the acquisition through proceeds from a new $825 million credit facility and the use of internally generated cash. The new credit facility includes a total of $625 million of term debt, approximately $148 million of which was used to refinance our existing senior credit facility and approximately $30 million was used to refinance AMS’s senior credit facility, and a new $200 million un-utilized revolving credit facility.

On April 27, 2005, we completed the acquisition of the group health insurance business of Pacific Life Insurance Company, or Pacific Life. The transaction was structured as a coinsurance arrangement, whereby Pacific Life cedes to us all future premiums received for its group health operations, and we assume all future incurred claim

25

liabilities. We also obtained renewal rights for the acquired membership. In conjunction with this acquisition, we entered into agreements for transitional and administrative services related to the acquired group health insurance business.

Intercompany Transactions. All intercompany transactions and accounts are eliminated in consolidation.

Results of Operations

Revenue

Health Plans Segment. Our commercial and senior revenues include all premium revenue we receive from our health plans, indemnity insurance subsidiaries 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 Advantage, formerly 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 Advantage 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 Advantage products must submit competitive benefit plan bids, generally by county or service area, to CMS, for each Medicare Advantage 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 competitive benefit plan bids generally cannot be recovered in the applicable contract year through higher premiums or changes in benefit designs.

Specialty Segment. Our specialty and other revenues include all premium revenues we receive from our behavioral health, 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. Beginning in January 2004, our PBM subsidiary began entering into retail service contracts where we assume margin or pricing risk. Under these retail service contracts, we are separately obligated to pay our network pharmacy providers for benefits provided to our plan sponsors’ members, and as a result, we have included the total revenues we are contracted to receive from the plan sponsors as specialty and other revenue. Payments we are obligated to make under these retail service contracts to the network pharmacy providers are recorded as health care services and other expenses. For all contracts where we earn a fixed fee per transaction and we do not assume margin or pricing risk, specialty and other revenue and specialty and other health care services and other expenses do not include the network pharmacies’ drug costs and dispensing fees. Instead, we record administrative services fees that we are entitled to receive, in specialty and other revenue. In all retail pharmacy transactions, revenues recognized and expenses recorded are always exclusive of the member’s applicable copayment. Collection of copayments from members is the responsibility of the retail pharmacies.

Net Investment Income. Net investment income consists of interest income and gross realized gains and losses incurred on cash investments during each period.

Expenses

Health Plans Segment. 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 for services provided to our

26

commercial and senior health plan members and indemnity insurance plan members. We pay our providers under capitated contracts, fee-for-service contracts, or a combination of both. In the situation where we pay a provider under a combination of capitation and fee-for-service, a member, during the same episode of care, may incur services that are rendered and paid for under the capitated portion of a contract with a physician or hospital and also incur services that are rendered and paid for under the fee-for-service component of the same contract.

Our fee-for-service 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.

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 fee-for-service 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.

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 some of our capitation contracts, we 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 or falls into certain defined categories, we partially share the excess expenses with the applicable health care provider. Under fee-for-service arrangements, we generally bear the full risk of member utilization of health care services.

Specialty Segment. Health care services and other expenses for our specialty companies primarily comprise payments to physicians, hospitals and other health care providers under capitated or fee-for-service based contracts for services provided to our behavioral health and dental and vision members and the cost of acquiring drugs by the PBM subsidiary in its mail operation and the cost of providing drugs in the retail environment for clients where we assume margin or pricing risk. Health care services and other expenses also include expenses for administrative services performed by our specialty companies.

Three and Nine Months Ended September 30, 2005 Compared to Three and Nine Months Ended September 30, 2004

Membership

Health Plans Segment Membership. Total managed care membership increased 12% to approximately 3.3 million members at September 30, 2005 from approximately 3.0 million members at September 30, 2004.

Commercial membership at September 30, 2005 increased approximately 14% compared to the prior year primarily due to an increase in membership of approximately 507,500 members in our PPO and employer

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self-funded products, of which approximately 407,700 were the result of the AMS and Pacific Life acquisitions. Membership increases in the PPO and employer self-funded products were offset by a net decrease in commercial HMO membership primarily due to the termination of large employer groups in Oklahoma, Colorado and California effective January 1, 2005.

Medicare Advantage membership increased approximately 6% at September 30, 2005 compared to the prior year primarily due to increased membership in Texas and Arizona due to improved field sales, service area expansions and sales through new broker channels.

Medicare Supplement membership at September 30, 2005 increased approximately 22% compared to the prior year primarily due to individual membership growth from the broker channel particularly in Texas, Michigan, Pennsylvania, and Georgia.

Below is a summary of our commercial and senior membership.

	September 30, 2005			September 30, 2004
	Commercial	Medicare Advantage	Total	Commercial	Medicare Advantage	Total
Managed Care Membership(1)
Arizona	170,300	110,600	280,900	154,700	95,600	250,300
California	1,481,200	357,500	1,838,700	1,488,300	357,100	1,845,400
Colorado	224,200	54,200	278,400	250,500	52,100	302,600
Florida	33,600	—	33,600	—	—	—
Guam	25,900	—	25,900	27,500	—	27,500
Illinois	41,800	—	41,800	—	—	—
Michigan	52,400	—	52,400	—	—	—
Nevada	52,100	26,100	78,200	38,900	25,500	64,400
Oklahoma	70,400	16,600	87,000	85,400	15,100	100,500
Oregon	55,500	23,100	78,600	58,600	23,000	81,600
Texas	156,700	101,100	257,800	93,800	79,900	173,700
Washington	69,100	40,700	109,800	71,500	45,000	116,500
Other States	164,300	1,700	166,000	—	—	—
Total Managed Care Membership	2,597,500	731,600	3,329,100	2,269,200	693,300	2,962,500
Total Membership
Commercial
HMO			1,744,500			1,923,700
PPO			749,000			304,800
Employer self-funded			104,000			40,700
Total Commercial			2,597,500			2,269,200
Senior
Medicare Advantage			731,600			693,300
Medicare Supplement			42,000			34,300
CMS Disease Management			4,300			1,500
Total Senior			777,900			729,100
Total Membership			3,375,400			2,998,300

(1) Managed care membership includes HMO and PPO membership whether risk or self-funded.

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Specialty Segment Membership.

PBM unaffiliated membership at September 30, 2005 increased approximately 5% compared to the prior year primarily due to a net addition of approximately 185,000 members including those from 19 new clients offset by membership reductions in existing clients. PBM PacifiCare membership at September 30, 2005 increased approximately 9% compared to the prior year primarily due to managed care membership growth.

Total behavioral health membership at September 30, 2005 increased approximately 27% compared to the prior year primarily due to the addition of unaffiliated membership on the east coast in January 2005, as well as to growth in the Employee Assistance Program and Administrative Services Only, or ASO, products, partially offset by internal membership losses in California, Colorado and Oklahoma.

Total dental and vision membership at September 30, 2005 increased approximately 43% compared to the prior year primarily due to the addition of 184,000 members as a result of the AMS acquisition and new PacifiCare vision product offerings which resulted in increased membership in Arizona, California and Nevada, as well as expansion of dental and vision benefits to ASO members in Colorado as of January 2005.

Below is a summary of our specialty membership.

	September 30, 2005			September 30, 2004
	PacifiCare	Unaffiliated	Total	PacifiCare	Unaffiliated	Total
Specialty Membership
Pharmacy benefit management(1)	3,263,500	2,654,300	5,917,800	2,998,300	2,528,000	5,526,300
Behavioral health(2)	2,010,100	2,760,000	4,770,100	2,055,800	1,706,500	3,762,300
Dental and vision(2)	929,200	242,400	1,171,600	647,900	173,200	821,100

(1) PBM PacifiCare membership represents members that are in our commercial, Medicare Advantage, Medicare Supplement or CMS Disease Management plans, excluding members covered under other PBM contracts. 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 service.

(2) Behavioral health, dental and vision PacifiCare membership represents members in our commercial and Medicare Advantage plans that are also enrolled in our behavioral health, dental and/or vision plans.

Revenues

Health Plans Segment Revenue

Commercial Revenue. Commercial revenue increased 22%, or $312 million, to $1.73 billion for the three months ended September 30, 2005, from $1.42 billion for the three months ended September 30, 2004 and increased 18%, or $757 million, to $4.98 billion for the nine months ended September 30, 2005, from $4.22 billion for the nine months ended September 30, 2004 as follows:

	Three Months Ended September 30, 2005		Nine Months Ended September 30, 2005
	(Amounts in millions)
Net membership increases primarily due to the acquisitions of AMS and Pacific Life, offset by membership decreases primarily in Oklahoma, Colorado and California	$	175	$	438
Premium rate increases		137		319
Increase over the comparable period of the prior year	$	312	$	757

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Senior Revenue. Senior revenue increased 19%, or $283 million, to $1.76 billion for the three months ended September 30, 2005 from $1.48 billion for the three months ended September 30, 2004 and increased 16%, or $689 million, to $5.02 billion for the nine months ended September 30, 2005, from $4.33 billion for the nine months ended September 30, 2004 as follows:

	Three Months Ended September 30, 2005		Nine Months Ended September 30, 2005
	(Amounts in millions)
Premium rate increases	$	188	$	443
Net membership increases, primarily in Texas and Arizona		95		246
Increase over the comparable period of the prior year	$	283	$	689

Premium rate increases are comprised of rate increases and include the nine month impact of increases in 2005 related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or MMA. For the nine months ended September 30, 2004, only the months of March through September included premium increases from MMA legislation. Additionally, revenues related to risk adjustment factors were accrued as earned in the nine months ended September 30, 2005, and were $87 million greater than the corresponding accrual in the same period of the prior year.

Specialty Segment Revenue. Specialty and other revenue increased 34%, or $61 million, to $243 million for the three months ended September 30, 2005, from $182 million for the three months ended September 30, 2004 and increased 38%, or $193 million, to $695 million for the nine months ended September 30, 2005, from $502 million for the nine months ended September 30, 2004. The increase was primarily due to increased volume of PBM service contracts where we assume margin or pricing risk and increased mail service business, increased revenue at our behavioral health subsidiary as a result of increased unaffiliated membership and increased dental revenues as a result of the acquisition of AMS.

Net Investment Income. Net investment income increased 34%, or $8 million, to $33 million for the three months ended September 30, 2005, from $25 million for the three months ended September 30, 2004. Net investment income increased 48%, or $31 million, to $95 million for the nine months ended September 30, 2005, from $64 million for the nine months ended September 30, 2004. The increases were primarily due to higher interest rates, higher investment balances obtained in the AMS acquisition and higher invested balances compared to the same period in the prior year.

Segment Margins

Health Plans Segment Margins

Commercial Margin. Our commercial margin increased 40%, or $90 million, to $316 million for the three months ended September 30, 2005, from $226 million for the three months ended September 30, 2004 and increased 37%, or $245 million, to $905 million for the nine months ended September 30, 2005, from $660 million for the nine months ended September 30, 2004 as follows:

	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
	(Amounts in millions)
Commercial revenue increases (as noted above)	$	312		$	757
Increases in health care services and other expenses primarily as a result of net membership increases primarily due to the acquisitions of AMS and Pacific Life, offset by membership decreases primarily in Oklahoma, Colorado and California		(147	)		(370	)
Increases in health care services and other expenses as a result of trend increases		(75	)		(142	)
Increase over the comparable period of the prior year	$	90		$	245

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Senior Margin. Our senior margin increased 21%, or $47 million, to $270 million for the three months ended September 30, 2005, from $223 million for the three months ended September 30, 2004 and increased 14%, or $87 million, to $688 million for the nine months ended September 30, 2005, from $601 million for the nine months ended September 30, 2004 as follows:

	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
	(Amounts in millions)
Senior revenue increases (as noted above)	$	283		$	689
Increases in health care services and other expenses as a result of trend increases and benefit adjustments		(155	)		(391	)
Increases in health care services and other expenses as a result of net senior membership increases, primarily in Texas and Arizona		(81	)		(211	)
Increase over the comparable period of the prior year	$	47		$	87

The risk adjustment factors payment we received from CMS during the three months ended September 30, 2005 was approximately $30 million greater than the amount previously recorded as a receivable, net of applicable capitation payments to physicians and hospitals.

Specialty Segment Margin. Our specialty and other margin increased 29%, or $23 million, to $103 million for the three months ended September 30, 2005, from $80 million for the three months ended September 30, 2004 and increased 26%, or $60 million, to $285 million for the nine months ended September 30, 2005, from $225 million for the nine months ended September 30, 2004, which was primarily driven by increased mail service business at our PBM, increased unaffiliated membership at our behavioral health subsidiary and increased dental business as a result of the acquisition of AMS.

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 Condensed Consolidated Statement of Income. 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 Advantage, 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.

The consolidated MLR and its components for the three and nine months ended September 30, 2005 and 2004 are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Medical loss ratio:
Consolidated	82.9	%	84.1	%	83.7	%	84.7	%
Private — Commercial	81.3	%	83.5	%	81.4	%	83.8	%
Private — Senior	74.1	%	69.5	%	75.4	%	72.4	%
Private — Consolidated	81.2	%	83.2	%	81.4	%	83.6	%
Government — Senior	84.7	%	84.9	%	86.3	%	85.9	%

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Private — Commercial MLR. Our private — commercial MLR decreased to 81.3% for the three months ended September 30, 2005 compared to 83.5% for the same period in 2004. The decrease was primarily due to a 23% increase in premium revenue, offset by a 20% increase in health care services and other expenses. For the nine months ended September 30, 2005, our private — commercial MLR decreased to 81.4% compared to 83.8% for the same period in 2004. The decrease was primarily due to a 19% increase in our commercial HMO premium revenue, offset by a 16% increase in our commercial HMO health care services and other expenses. The change is mainly due to a change in our business mix as we increased our focus on individual and small group membership as reflected by our recent acquisitions.

Private — Senior MLR. Our private — senior MLR increased to 74.1% for the three months ended September 30, 2005 compared to 69.5% for the same period in 2004 and increased to 75.4% for the nine months ended September 30, 2005 compared to 72.4% for the same period in 2004. The increases were driven by a 26% increase in health care services and other expenses that outpaced an 18% increase in premium revenue for the three months ended September 30, 2005 and a 19% increase in health care services and other expenses that outpaced a 15% increase in premium revenue for the nine months ended September 30, 2005.

Government — Senior MLR. Our government — senior MLR decreased to 84.7% for the three months ended September 30, 2005 compared to 84.9% for the same period in 2004 and increased to 86.3% for the nine months ended September 30, 2005 compared to 85.9% for the same period in 2004. The decrease was driven by a 19% increase in premium revenue applied against a 19% increase in health care services and other expenses for the three months ended September 30, 2005. The increase was driven by a 16% increase in health care services and other expenses applied against a 16% increase in premium revenue for the nine months ended September 30, 2005.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 32%, or $128 million, to $529 million for the three months ended September 30, 2005, from $401 million for the three months ended September 30, 2004. Selling, general and administrative expenses increased 27%, or $311 million, to $1.45 billion for the nine months ended September 30, 2005 from $1.14 billion for the nine months ended September 30, 2004. Total selling, general and administrative expenses increased primarily due to selling, general and administrative expenses associated with the recently acquired AMS and Pacific Life operations which are not included in the September 2004 results, increased broker commissions as a result of higher revenues and a shift in product mix, costs incurred in our preparations to become a national prescription drug plan administrator for the new Medicare Part D benefit, costs incurred in connection with our pending business combination with UnitedHealth, staffing growth at our PBM, and incentive compensation accruals reflective of improved operating results offset by legal matters either settled or reserved.

For the three and nine months ended September 30, 2005, selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income) increased compared to the same period in the prior year primarily due to the increase in selling, general and administrative expenses as described above.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Selling, general and administrative expenses as a percentage of operating revenue (excluding net investment income)	14.2	%	13.0	%	13.6	%	12.6	%

Interest Expense. Interest expense increased 93%, or $9 million, to $19 million for the three months ended September 30, 2005, from $10 million for the three months ended September 30, 2004 and increased 73%, or $23 million, to $55 million for the nine months ended September 30, 2005, from $32 million for the nine months ended September 30, 2004. The increase was due to higher outstanding balances on our new senior credit facility entered into in December 2004 in conjunction with our acquisition of AMS and lower swap interest payments received. Interest expense for the nine months ended September 30, 2004 was offset by the favorable impact of our interest rate swap on $300 million of our 10 ³/4% senior notes for the full nine months versus approximately four months for the same period in 2005 as a result of the termination of our swap agreement on April 20, 2005.

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Provision for Income Taxes. The effective income tax rate was 32.1% for the three months ended September 30, 2005 and 36.2% for the nine months ended September 30, 2005, compared with 38.1% and 38.6% for the three and nine months ended September 30, 2004, respectively. We revised our effective income tax rate primarily due to a decrease in the level of non-deductible stock-based compensation in 2005. Additionally, during the three and nine months ended September 30, 2005, we recognized favorable adjustments of $11.7 million and $12.2 million, respectively, primarily related to the settlement of tax issues from prior years.

Our effective tax rate is based on expected income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant management estimates and judgments are required in determining our effective tax rate. We are routinely under audit by federal, state or local authorities regarding the timing and amount of deductions, nexus of income among various tax jurisdictions and compliance with federal, state and local tax laws. Tax assessments related to these audits may not arise until several years after tax returns have been filed. Although predicting the outcome of such tax assessments involves uncertainty, we believe that the recorded tax liabilities appropriately account for our analysis of probable outcomes, including interest and other potential obligations. Our tax liabilities are adjusted in light of changing facts and circumstances, such as the progress of audits, case law and emerging legislation and such adjustments are included in the effective tax rate.

Liquidity and Capital Resources

Operating Cash Flows. Our consolidated cash and equivalents and marketable securities increased $841 million or 30% to $3.6 billion at September 30, 2005, from $2.8 billion at December 31, 2004.

Cash flows provided by operations were $1.1 billion (or cash flows provided by operations of $555 million, excluding the impact of unearned premium revenue) for the nine months ended September 30, 2005 compared to cash flows used in operations of $6 million (or cash flows provided by operations of $388 million, excluding the impact of unearned premium revenue) for the nine months ended September 30, 2004. The increase was primarily related to the changes in assets and liabilities as discussed below in “Other Balance Sheet Change Explanations.”

Investing Activities. For the nine months ended September 30, 2005, investing activities used $445 million of cash, compared to $258 million used during the nine months ended September 30, 2004. The change was primarily related to increased purchases of unrestricted and restricted marketable securities, cash paid in connection with the acquisition of Pacific Life including a $40 million restricted investment which was a requirement for our New York Pacific Life business and increased purchases in property, plant and equipment.

Financing Activities. For the nine months ended September 30, 2005, financing activities used $23 million of cash, compared to $67 million used during the nine months ended September 30, 2004. The changes were as follows:

• We received $29 million from the issuance of common stock for the nine months ended September 30, 2005 in connection with our employee stock purchase plan and exercises of employee stock options and received $43 million during the same period in 2004.

• We repaid $26 million of our long-term debt during the nine months ended September 30, 2005 compared to $1 million during the same period in the prior year.

• We paid $15 million for the purchase and retirement of our common stock during the nine months ended September 30, 2005, primarily in connection with repurchases from our employees for payroll tax withholdings upon vesting of restricted stock, compared to $103 million during the same period in 2004 primarily in connection with repurchases under our stock repurchase program.

• We capitalized the remaining swap value of approximately $7 million representing a discount of the fair value of our 10 ³/4%senior notes due to the termination of our swap agreement on April 20, 2005 with no comparable activity in 2004. See Note 4 of the Notes to Condensed Consolidated Financial Statements.

• We repaid $3 million on our software financing agreements during the nine months ended September 30, 2005 as compared to $6 million during the same period in 2004.

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In May 2004, our Board of Directors authorized the repurchase of up to $150 million of our common stock under a stock repurchase program. Share repurchases are made under our stock repurchase program from time to time through open market purchases or through privately negotiated transactions using available cash, and may be discontinued at any time. Also, in connection with our employee equity incentive plans, we may repurchase shares of common stock from employees for the satisfaction of their individual payroll tax withholdings upon vesting of restricted stock.

A summary of our repurchase activity for the nine months ended September 30, 2005 and 2004 is as follows:

	Total Number of Shares Purchased(1)	Average Price Paid per Share		Total Number of Shares Purchased Under our Stock Repurchase Program(2)	Dollar Value of Shares that may yet be Purchased Under the Repurchase Program(2)
2005
January 1 – January 31	220,477	$	57.21	—	$	49,993,000
February 1 – February 28	620	$	62.00	—	$	49,993,000
March 1 – March 31	303	$	64.08	—	$	49,993,000
April 1 – April 30	15,919	$	56.73	—	$	49,993,000
May 1 – May 31	4,320	$	62.64	—	$	49,993,000
June 1 – June 30	—	$	—	—	$	49,993,000
July 1 – July 31	2,630	$	72.52	—	$	49,993,000
August 1 – August 31	—	$	—	—	$	49,993,000
September 1 – September 30	12,136	$	78.44	—	$	49,993,000
Total	256,405	$	58.45	—
2004
January 1 – January 31	70,200	$	33.87	—	$	—
February 1 – February 29	3,875	$	31.72	—	$	—
March 1 – March 31	303	$	37.16	—	$	—
April 1 – April 30	5,035	$	41.04	—	$	—
May 1 – May 31	221,928	$	35.84	218,500	$	142,172,000
June 1 – June 30	818,326	$	36.50	818,300	$	112,304,000
July 1 – July 31	350	$	37.91	—	$	112,304,000
August 1 – August 31	2,049,500	$	30.40	2,049,500	$	49,993,000
September 1 – September 30	2,590	$	32.58	—	$	49,993,000
Total	3,172,107	$	32.45	3,086,300

(1) The total number of shares purchased includes shares delivered to, or withheld by us in connection with employee payroll tax withholding upon vesting of restricted stock and shares purchased under our stock repurchase program.

(2) Our stock repurchase program authorized the repurchase of up to $150 million of our common stock. No shares were repurchased under the stock repurchase program for the three and nine months ended September 30, 2005.

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.

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

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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; the initial discount is being amortized over the term of the notes. We may redeem the 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.

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. On April 20, 2005, we terminated our swap agreement. The remaining swap value of approximately $7.5 million, representing a discount of the fair value of our 10 ³/4% senior notes, is being amortized as a yield adjustment through June 2009, which correlates to the corresponding debt maturity.

Certain of our domestic subsidiaries fully and unconditionally guarantee the 10 ³/4% senior notes. See Note 12 of the Notes to Condensed Consolidated Financial Statements.

In December 2004, we replaced our senior credit facility with a new syndicated senior Credit Agreement, or the Credit Agreement, with the Lenders named therein, JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, J.P. Morgan Securities Inc., as Sole Lead Arranger and Sole Bookrunner, Morgan Stanley Senior Funding, Inc., as Syndication Agent and Co-Arranger and CIBC, Inc., The Bank of New York, and Wells Fargo Bank, N.A., as Co-Documentation Agents. The new facility consists of a $200 million term A loan, which matures on December 13, 2009, a $425 million term B loan, which matures on December 13, 2010, and a $200 million revolving line of credit, which matures on December 13, 2009. We used the proceeds of the term A and term B loans to refinance approximately $149 million (including accrued interest and fees of approximately $1 million) outstanding under our previous senior credit facility entered into in June 2003, to refinance approximately $30 million outstanding under the senior credit facility of AMS and to fund a portion of the merger consideration paid to acquire AMS. In connection with the Credit Agreement, we incurred approximately $9 million in fees and expenses that are being amortized over the life of the facility. As of September 30, 2005, we had $599 million outstanding on the term A and term B loans and no balance outstanding on the revolving line of credit. There were no borrowings under the revolving line of credit during the three or nine months ended September 30, 2005.

The credit facility provides us with two interest rate options for borrowings under the term loans, to which a margin spread is added: (1) the LIBO Rate multiplied by the Statutory Reserve Rate and (2) JPMorgan Chase Bank’s prime rate (or, if greater, the Federal Funds Rate plus 0.5%), which we refer to as the alternate base rate. The margin spread for the term loans is based upon our current Standard & Poor’s Ratings Services and Moody’s Investor Service debt ratings. The margin spread for LIBO Rate borrowings range from 0.75% to 1.75% per annum under the term A loan and 1.25% to 1.5% per annum under the term B loan. The margin spread for alternate base rate borrowings range from 0% to 0.75% per annum under the term A loan and 0.25% to 0.5% per annum under the term B loan. All of our borrowings under the term loans are currently LIBO Rate borrowings with rates ranging from 5.125% to 5.375%. The interest rates per annum applicable to revolving credit borrowings are, at our option, either LIBO Rate borrowings with the same margin spread as our term A loan or alternate base rate borrowings with the same margin spread applicable to the term A loan. We also pay a commitment fee on the average daily unused amount of the revolving credit commitment. The commitment fee range is based upon our current debt rating and ranges from 0.15% to 0.5% per annum. The current commitment fee rate is 0.375% per annum.

The Credit Agreement contains 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

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repay, redeem or repurchase our securities and enter into mergers, dispositions and transactions with affiliates. The Credit Agreement also requires we meet various financial ratios, including a maximum consolidated leverage ratio, a minimum consolidated net worth requirement and a minimum fixed charge coverage requirement. At September 30, 2005, we were in compliance with all of these covenants.

Certain of our domestic subsidiaries provide guarantees and have granted security interests to the lenders in substantially all of their personal property in order to secure our obligations and their guarantees under the Credit Agreement. See Note 12 of the Notes to Condensed Consolidated Financial Statements. We have also pledged the equity of certain of our subsidiaries to the lenders as security for the Credit Agreement.

On July 6, 2005, we entered into a definitive agreement to merge with UnitedHealth. Upon completion of the merger, we will operate as a wholly owned subsidiary of UnitedHealth. Under the terms of the agreement, at the effective time of the merger each outstanding share of PacifiCare common stock will be converted into the right to receive 1.10 shares of UnitedHealth common stock plus $21.50 in cash. The transaction with UnitedHealth is subject to a number of conditions, including, the adoption of the Merger Agreement by PacifiCare stockholders at a special stockholders’ meeting, the termination or expiration of the waiting period under the Hart Scott Rodino Antitrust Improvements Act, receipt of all other necessary regulatory approvals and the satisfaction or waiver of other customary conditions. The merger agreement contains certain termination rights for both PacifiCare and UnitedHealth, and provides that, upon termination of the merger agreement under specified circumstances, we may be required to pay UnitedHealth a termination fee of $243.6 million. The special stockholders’ meeting to consider the adoption of the merger agreement is scheduled for Thursday, November 17, 2005 at 10:00 a.m. Pacific Time at the Residence Inn by Marriott, 4931 Katella Avenue, Los Alamitos, California 90720.

On December 13, 2004, we completed the acquisition of AMS. We paid $32.75 in cash for each share of AMS common stock outstanding and cashed out all outstanding options on a net basis for a total equity purchase price of approximately $505 million. We also repaid approximately $30 million of outstanding indebtedness of AMS in connection with the closing of the acquisition. We financed the acquisition through proceeds from a new $825 million credit facility as described above and the use of internally generated cash.

On April 27, 2005, we completed the acquisition of the group health insurance business of Pacific Life Insurance Company, or Pacific Life. The transaction was structured as a coinsurance arrangement, whereby Pacific Life cedes to us all future premiums received for its group health operations, and we assume all future incurred claim liabilities. We also obtained renewal rights for the acquired membership. In conjunction with this acquisition, we entered into agreements for transitional and administrative services related to the acquired group health insurance business.

On July 16, 2005, we entered into a definitive agreement to sell all of the outstanding shares of PacifiCare Health Insurance Company of Micronesia, Inc., a Guam domestic insurance company. Completion of this sale is subject to regulatory approvals and other customary conditions. We anticipate completing this sale in the fourth quarter of 2005.

In November 2005, our debt was rated by the major credit rating agencies as follows:

Agency	Outlook	Senior Credit Facility	10 3/4% Senior Notes	Convertible Subordinated Debentures
Moody’s	Possible Upgrade	Ba2	Ba3	B1
Standard & Poor’s	Watch Positive	BBB-	BBB-	BB+
Fitch IBCA	Watch Positive	BB+	BB+	BB

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

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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 2009 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 September 30, 2005, 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 September 30, 2005, increased $11 million from December 31, 2004 primarily due to a $32 million increase in premium receivables as a result of the acquisition of Pacific Life in April 2005, offset by a $21 million decrease in trade receivables primarily due to increased collections for rebate billings by our PBM.

Medical Claims and Benefits Payable. The majority of our medical claims and benefits payable represent liabilities related to our fee-for-service based contracts. Under fee-for-service 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 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 September 30, 2005, approximately 84% of medical claims and benefits payable was attributable to fee-for-service based contracts.

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

	September 30, 2005		December 31, 2004
	(Amount in millions)
Incurred But Not Reported (IBNR)	$	1,057	$	1,004
Capitation and All Other Medical Claims and Benefits Payable		251		188
Medical Claims and Benefits Payable	$	1,308	$	1,192

Medical claims and benefits payable as of September 30, 2005 increased $116 million from the balance as of December 31, 2004, primarily due to an increase in IBNR as a result of the acquisition of Pacific Life, an increase in provider capitation accruals for amounts due to providers related to amounts received from CMS and an increase in other health care accruals for the CMS disease management program and other estimated amounts owed to CMS.

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Accounts Payable and Accrued Liabilities. Accounts payable and accrued liabilities, including accrued compensation and employee benefits, increased $25 million from the balance as of December 31, 2004, primarily due to changes in the timing of trade payables.

Stockholders’ Equity. The increase of $336 million in stockholders’ equity from December 31, 2004, was primarily due to net income and the activity related to share-based compensation.

Critical Accounting Policies and Estimates

When we prepare our consolidated financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. We base these estimates on historical results and various other assumptions believed to be reasonable, the results of which form the basis for making estimates concerning the carrying value of assets and liabilities that are not readily available from other sources. Actual results could differ from the amounts previously estimated, which were based on the information available at the time the estimates were made. Changes in estimates are recorded if and when better information becomes available.

We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make an assumption about a matter that was highly uncertain at the time the estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of a different estimate that we reasonably could have used in the current period, would have a material impact on our consolidated results of operations or financial condition.

Although these critical accounting estimates are primarily the responsibility of our management, our management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the disclosure presented below relating to them.

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 fee-for-service 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 along with a provision for adverse claims development. Because the reserve methodology is based upon historical information, it must be adjusted for known or suspected operational and environmental changes. These adjustments are made by our actuaries based on their estimate of emerging impacts to benefit costs and payment speed. The provision for adverse claims development is intended to account for variability in the following types of current and other environmental factors:

• changes in claims payment patterns to the extent to which emerging claims payment patterns differ from the historical payment patterns selected to calculate the IBNR reserve estimate;

• differences between the estimated per member per month, or PMPM, incurred expense for the most recent months and the expected PMPM based on historical PMPM incurred estimates and the estimated trend from the historical period to the most recent months;

• differences between the estimated impact of known differences in environmental factors and the actual impact of known environmental factors; and

• the healthcare expense impact of present but unknown environmental factors that differ from historical norms.

All of the above factors are and have been considered in our estimates for every quarter.

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We believe that the provision for adverse claims development is appropriate because it provides a relatively constant addition to the liability calculated by our standard model and hindsight has shown that often at least a portion of this reserve has been used to cover additional claims not covered by the standard model IBNR estimate and that were incurred prior to the end of a quarter but paid after quarter end.

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 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 our operating results caused by these factors:

Completion Factor(a) Increase (Decrease) in Factor	Increase (Decrease) in Medical Claims Payable
	(Amounts in millions)
(3)%	$ 58
(2)%	38
(1)%	19
1%	(19)
2%	(37)
3%	(54)
Claims Trend(b) Increase (Decrease) in Factor	Increase (Decrease) in Medical Claims Payable
	(Amounts in millions)
(3)%	$(23)
(2)%	(15)
(1)%	(8)
1%	8
2%	15
3%	22

(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 PMPM claims for the most recent four months.

In addition, assuming a hypothetical 1% difference between our September 30, 2005 estimated claims liability and the actual claims incurred run-out, net income for the nine months ended September 30, 2005 would increase or decrease by approximately $11 million, while diluted net income per share would increase or decrease by $.07 per share, net of tax.

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

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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, 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.

Intangible Assets and Goodwill. In June 2001, the Financial Accounting Standards Board, or FASB, issued Statements of Financial Accounting Standards, or SFAS, No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. SFAS No. 142, which became effective for fiscal years beginning after December 15, 2001, eliminates amortization of goodwill and other intangible assets with indefinite useful lives. Rather, these assets are subject to impairment tests at least annually. We are required to make estimates of fair value and apply certain assumptions, such as a discount factor in applying these annual impairment tests. Such estimates could produce significantly different results if other assumptions, which could also be considered reasonable, were to be used. Intangible assets with definite useful lives are being amortized using a straight-line basis or the timing of related cash flows. An intangible asset subject to amortization must be reviewed for impairment pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

We adopted SFAS No. 142 on January 1, 2002 and, accordingly, no longer amortize goodwill and other intangible assets with indefinite useful lives. In accordance with SFAS No. 142, we determined no adjustments to recorded amounts were required as of September 30, 2005 and 2004.

Ordinary Course Legal Proceedings. We are routinely 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

In order for the proposed merger with UnitedHealth Group to be completed, PacifiCare and UnitedHealth Group must obtain several governmental consents, which, if delayed, not granted or granted with conditions may jeopardize the merger.

PacifiCare and UnitedHealth Group must obtain specified approvals and consents in a timely manner from federal and state agencies prior to the completion of the proposed merger. If these approvals are not received on terms that satisfy the conditions to completing the merger in the merger agreement, then the parties will not be obligated to complete the merger. The governmental agencies from which the parties are seeking approvals have broad discretion in administering relevant laws and regulations. As a condition to approval of the proposed merger, agencies may impose conditions, restrictions, qualifications, requirements or limitations that could negatively affect the way the combined company conducts business. UnitedHealth Group is not obligated to complete the proposed merger if a governmental agency or agencies impose certain conditions, restrictions, qualifications, requirements or limitations when it grants the specified approvals and consents.

Whether or not the proposed merger with UnitedHealth Group is completed, the announcement and pendency of the proposed merger could cause disruptions in the businesses of PacifiCare, which could have an adverse effect on its business and financial results.

Whether or not the proposed merger with UnitedHealth Group is completed, the announcement and pendency of the proposed merger could cause disruptions in the businesses of PacifiCare. Specifically:

• current and prospective employees may experience uncertainty about their future roles with the combined company, which might adversely affect PacifiCare’s ability to retain key managers and other employees;

• the merger agreement with UnitedHealth Group imposes certain restrictions on the operations of PacifiCare’s businesses until completion of the merger; and

• current or prospective customers may experience uncertainty about potential merger transition complexities.

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,

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product design and negotiation of favorable provider, provider network 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 Advantage products must submit competitive benefit plan bids, generally by county or service area, to CMS for each Medicare Advantage 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 costs reflected in the premiums or the competitive benefit plan bids 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 competitive benefit plans 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 fee-for-service 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.

If we fail to implement our strategic initiatives successfully, 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 Advantage program in light of the MMA legislation and ultimately evolving into a consumer health organization. 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

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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. In a limited number of circumstances, we have also taken steps to establish security reserves for insolvency issues. Security reserves are most frequently in the forms of letter 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. If our reserves are inadequate to cover these claims, our operating results could be adversely affected.

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 and provider networks on favorable terms. In any particular market, health care providers or provider networks could refuse to contract with us, demand higher payments or take other actions that could result in higher health care costs or difficulty in meeting our 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 higher unit costs for currently available medications, 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 the extent to which these factors will impact our costs when establishing our premiums or we may otherwise be unable to 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, medical management, underwriting and actuarial resources and technology;

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• our investment in new products that do not generate adequate revenue;

• 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 commissions we pay to brokers and agents;

• the necessity to comply with regulatory requirements, including, without limitation, the MMA legislation and other recent changes in privacy and health care laws;

• 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- and long-term strategic plans.

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 including, among other things, ensuring that such management information systems comply with the security standards mandated by the Health Insurance Portability and Accountability Act of 1996, 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.

Efforts to bring suit against health plans continue, with a number of lawsuits brought against us and other health plans, including “In re Managed Care.” In general, the “In re Managed Care” lawsuits brought by health care providers allege that health plans’ claims processing systems automatically and impermissibly alter codes included on providers’ reimbursement/claims forms to reduce the amount of reimbursement, and that health plans impose unfair contracting terms on health care providers, delay making capitated payments under their capitated contracts, and negotiate capitation payments that are inadequate to cover the costs of health care services provided.

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We are also subject to class action litigation that was pending against AMS when we acquired AMS. For example, AMS recently received final approval from an Alabama Circuit Court of the certification and settlement of a class action lawsuit involving the rating methodology formerly used by AMS for group health benefit plans marketed to individuals in Alabama and Georgia. For additional information, see Note 8 of the Notes to Condensed Consolidated Financial Statements.

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 health care 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 health care 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.

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 Advantage and prescription drug plan products or our willingness to participate in the Medicare program.

The Medicare program has accounted for approximately 47% of our total revenue in 2004 and approximately 4% additional revenue was attributable to the Federal Employee Health Benefits Program. CMS regulates the benefits provided, premiums paid, quality assurance procedures, marketing and advertising for our Medicare Advantage and Prescription Drug Plan products. CMS may terminate our Medicare Advantage or Prescription Drug Plan contracts or elect not to renew those contracts when those contracts come up for renewal every 12 months. Although we are receiving increased government funding under the MMA, 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 Advantage program, Part D program or the Medicare program itself could have a material adverse effect on our financial position, results of operations or cash flows.

In January 2005, CMS published final regulations for Title I (Prescription Drug Plan) and Title II (Medicare Advantage Program) of the MMA. During 2005, CMS has continued to issue refining interpretative guidance regarding these regulations. We have made progress towards achieving timely compliance with the rules, but implementation is not yet complete. We are significantly dependent on key interfaces with CMS and their vendors, and some of the CMS systems are either still in development or testing with plans has not yet been completed. Our operational readiness may be impeded or additional investments in modifying our existing systems and work processes could be required.

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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 health plans 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;

• licensing requirements;

• approval of policy language and benefits;

• mandated benefits and administrative processes;

• mandated claims and appeals review procedures;

• provider compensation arrangements;

• member disclosure;

• privacy concerns;

• periodic audits and investigations by state and federal agencies;

• rating practices;

• 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 could cause pharmaceutical companies to restructure the financial terms of their business arrangements with PBMs or health plans;

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

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• 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, including transmission of information to employees or contractors in other countries;

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

• limiting the ability of small employer group health plans to use risk selection to control costs and health status and industry codes to set rates, as well as limiting the amount of rate increases that can be given from year to year;

• allowing employers to leverage their purchasing power through associations or other multiple employer arrangements; and

• adding further restrictions and administrative requirements related to the compensatory arrangements pertaining to our agents and brokers in connection with the sale of our products and disclosure of such compensatory arrangements.

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.

Current investigations of the insurance industry by regulators may result in changes in industry practices that could have an adverse affect on our ability to market our products.

Like other health care companies, we use agents and independent brokers to sell our products. While we are not aware of any unlawful practices by our agents and brokers in connection with the sale of our products, current investigations of the insurance industry by the New York Attorney General, the Commissioner of Insurance of California and other regulators could result in changes in industry practices that could have an adverse affect on our ability to market our products.

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. Since virtually all of our investments consist of fixed-income securities, increases in interest rates may adversely affect the market value, and in certain instances, the duration of investments in our portfolios. 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 $200 million. We may also incur additional indebtedness in the future.

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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 health plan regulations or insurance regulations and may be subject to substantial supervision by one or more health plan or insurance regulators. Subsidiaries subject to regulation must meet or exceed various capital standards imposed by health plan 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.

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.

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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 the Employee Retirement Income Security Act, or 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.

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 requires that our convertible subordinated debenture be included in our calculation of weighted average shares outstanding in every quarter.

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.

Our acquisitions may increase costs, liabilities, or create disruptions in our business.

We have recently acquired AMS and Pacific Life’s group health insurance business and we may pursue other acquisitions of other companies or businesses from time to time. Although we review the records of companies or businesses we plan to acquire, even an in-depth review of records may not reveal existing or potential problems or permit us to become familiar enough with a business to assess fully its capabilities and deficiencies. As a result, we may assume unanticipated liabilities or adverse operating conditions, or an acquisition may not perform as well as expected. We face the risk that the returns on acquisitions will not support the expenditures or indebtedness incurred to acquire such businesses, or the capital expenditures needed to develop such businesses. We also face the risk that we will not be able to integrate acquisitions into our existing operations effectively without substantial expense, delay or other operational or financial problems. Integration may be hindered by, among other things, differing procedures, including internal controls, business practices and technology systems. We may need to divert more management resources to integration than we planned, which may adversely affect our ability to pursue other profitable activities.

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Item 3: Quantitative and Qualitative Disclosures About Market Risk

Market Risk

The principal objectives of our asset management activities are to ensure liquidity and maximize net investment income, while maintaining acceptable levels of interest rate and credit 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.

Investments

We are exposed to interest rate and credit risk due to our investing and borrowing activities. Interest rate risk is the risk of loss of principal value on financial securities as a result of changes in market interest rates. Our fixed income portfolio consists of U.S. dollar-denominated assets, invested primarily in U.S. Treasury and federal agency securities, corporate bonds and notes, mortgage and asset-backed securities, and municipal bonds, all of which represent an exposure to changes in the level of market interest rates. We are also exposed to credit quality risk which is defined as the risk of a credit downgrade to an individual security and the potential loss attributable to that downgrade.

We manage our asset interest rate risk within a duration band established by us, and tied to our liabilities. Credit risk is managed by maintaining a high level of average credit ratings and both sector and issuer diversification. We regularly evaluate our interest rate risks, as well as the appropriateness of investments, relative to our internal investment guidelines and those of the states in which we do business. We operate within these guidelines by maintaining a well-diversified portfolio, both across market sectors and within asset classes. No material changes to our interest rate or credit quality risks have occurred since December 31, 2004.

Changes in the value of our investment portfolio which is available-for-sale are recognized, net of tax, in the balance sheet through stockholders’ equity. We believe that our cash flows and short duration of our investment portfolio allow us to hold securities to maturity, thereby avoiding realized losses should interest rates rise significantly.

Debt

In April 2003, we entered into an interest rate swap on $300 million in aggregate principal of our 10 ³/4% senior notes for the purpose of hedging the fair value of our indebtedness. On April 20, 2005, we terminated our swap agreement. The remaining swap value of approximately $7.5 million, representing a discount of the fair value of our 10 ³/4% senior notes, is being amortized through June 2009 as a yield adjustment, which correlates to the corresponding debt maturity.

Our senior notes, due in 2009, have a fixed interest rate of 10 ³/4%. Our convertible subordinated debentures, due in 2032, have a fixed interest rate of 3%. The fair value of these instruments is affected by changes in market interest rates, and in the case of the convertible subordinated debentures, the value of the underlying shares. As of September 30, 2005, the combined carrying value of our senior notes and convertible subordinated debentures, net of discount, was $452 million. The combined fair value of our senior notes and convertible subordinated debentures was $866 million. Considerable judgment is required to develop estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amounts we could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

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The following table presents the expected cash outflows relating to our fixed rate long-term borrowings as of September 30, 2005. These outflows include both expected principal and interest payments consistent with the terms of the outstanding debt as of September 30, 2005. For terms relating to our long-term debt, see Note 4 of the Notes to Condensed Consolidated Financial Statements.

	2006		2007		2008		2009		2010		Thereafter		Total
	(Amounts in millions)
Fixed rate borrowings:
Principal	$	—	$	—	$	—	$	325.0	$	—	$	135.0	$	460.0
Interest		39.0		39.0		39.0		18.7		4.1		89.1		228.9
	$	39.0	$	39.0	$	39.0	$	343.7	$	4.1	$	224.1	$	688.9

Item 4: Controls and Procedures

We maintain disclosure controls and procedures, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer, or CEO, and chief financial officer, or CFO, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our CEO and 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 quarterly report. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of September 30, 2005.

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 quarter 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 quarter and that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART II: OTHER INFORMATION

Item 1: Legal Proceedings

See Note 8 of the Notes to Condensed Consolidated Financial Statements.

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

A description of our stock repurchase program and tabular disclosure of the information required under this Item 2 is contained under the caption “Financing Activities” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part I of this Quarterly Report on Form 10-Q.

Item 3: Defaults Upon Senior Securities

None.

Item 4: Submission of Matters to a Vote of Security Holders

None.

Item 5: Other Information

(a) Other information not previously reported on Form 8-K

None.

(b) Information required by Item 401(j) of Regulation S-K (§229.401)

None.

Item 6: Exhibits

An “Exhibit Index” is filed as part of this Form 10-Q on page 54 and is incorporated by reference.

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SIGNATURES

Pursuant to the requirements 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.
	(Registrant)
Date: November 2, 2005	By:	/s/    GREGORY W. SCOTT
		Gregory W. Scott Executive Vice President, Finance and Enterprise Services and Chief Financial Officer (Principal Financial Officer)
Date: November 2, 2005	By:	/s/    PETER A. REYNOLDS
		Peter A. Reynolds Senior Vice President and Corporate Controller (Chief Accounting Officer)

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PACIFICARE HEALTH SYSTEMS, INC.

EXHIBIT INDEX

2.01	Agreement and Plan of Merger, dated as of September 15, 2004 between the Registrant, Ashland Acquisition Corp., and American Medical Security Group, Inc. (incorporated by reference to Exhibit 2.01 of Registrant’s Form 8-K, dated September 15, 2004).
2.02	Agreement and Plan of Merger, dated as of July 6, 2005, between the Registrant, UnitedHealth Group, Inc. and Point Acquisition LLC (incorporated by reference to Exhibit 2.1 to Registrant’s Form 8-K dated July 12, 2005).
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 (incorporated by reference to Exhibit 3.04 to Registrant’s Form 10-K for the year ended December 31, 2003).
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., 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, RxSolutions, Inc., PacifiCare Behavioral Health, Inc. and Secure Horizons 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 (incorporated by reference to Exhibit 4.06 to Registrant’s Form 10-K for the year ended December 31, 2003).
4.07	Second Supplemental Indenture, dated as of November 19, 2003, by and among PacifiCare Health Systems, Inc., as issuer of 10 3/4% Senior Notes due 2009, PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., MEDeMORPHUS Healthcare Solutions, Inc. (formerly known as Rx-Connect, Inc.) and SeniorCo, Inc., as initial subsidiary guarantors, RxSolutions, Inc., PacifiCare Behavioral Health, Inc. and Secure Horizons USA, Inc., as PHPA subsidiary guarantors, PacifiCare of Arizona, Inc. and PacifiCare of Oklahoma, Inc., as additional subsidiary guarantors, U.S. Bank National Association, as successor to the State Street Bank and Trust Company of California, N.A., as trustee (incorporated by reference to Exhibit 4.07 to Registrant’s Form 10-Q for the quarter ended September 30, 2004).

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4.08	Third Supplemental Indenture, dated as of January 14, 2004, by and among PacifiCare Health Systems, Inc., as issuer of 10 3/4% Senior Notes due 2009, PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., MEDeMORPHUS Healthcare Solutions, Inc. (formerly known as Rx-Connect, Inc.), SeniorCo, Inc., RxSolutions, Inc., PacifiCare Behavioral Health, Inc., Secure Horizons USA, Inc., PacifiCare of Arizona, Inc. and PacifiCare of Oklahoma, Inc., as existing subsidiary guarantors, PacifiCare Southwest Operations, Inc., as additional subsidiary guarantor, U.S. Bank National Association, as successor to the State Street Bank and Trust Company of California, N.A., as trustee (incorporated by reference to Exhibit 4.08 to Registrant’s Form 10-Q for the quarter ended September 30, 2004).
4.09	Fourth Supplemental Indenture, dated as of December 13, 2004, by and among PacifiCare Health Systems, Inc., as issuer of 10 3/4% Senior Notes due 2009, PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., MEDeMORPHUS Healthcare Solutions, Inc. (formerly known as Rx-Connect, Inc.), SeniorCo, Inc., RxSolutions, Inc., PacifiCare Behavioral Health, Inc., Secure Horizons USA, Inc., PacifiCare of Arizona, Inc., PacifiCare of Oklahoma, Inc., and PacifiCare Southwest Operations, Inc., as existing subsidiary guarantors, American Medical Security Group, Inc., as additional subsidiary guarantor, U.S. Bank National Association, as successor to the State Street Bank and Trust Company of California, N.A., as trustee (incorporated by reference to Exhibit 4.09 to Registrant’s Form 10-K for the year ended December 31, 2004).
4.10	Fifth Supplemental Indenture, dated as of March 11, 2005, by and among PacifiCare Health Systems, Inc., as issuer of 10 3/4% Senior Notes due 2009, PacifiCare Health Plan Administrators, Inc., PacifiCare eHoldings, Inc., MEDeMORPHUS Healthcare Solutions, Inc. (formerly known as Rx-Connect, Inc.), SeniorCo, Inc., RxSolutions, Inc., PacifiCare Behavioral Health, Inc., Secure Horizons USA, Inc., PacifiCare of Arizona, Inc., PacifiCare of Oklahoma, Inc., PacifiCare Southwest Operations, Inc. and American Medical Security Group, Inc., as existing subsidiary guarantors, Nurse Healthline, Inc. and Continental Plan Services, Inc. as additional subsidiary guarantors and U.S. Bank National Association, as successor to the State Street Bank and Trust Company of California, N.A., (incorporated by reference to Exhibit 4.10 to Registrant’s Form 10-Q for the quarter ended March 31, 2005).
4.11	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)).
4.12	Rights Agreement, dated as of November 19, 1999, between the Registrant and Chase Mellon Shareholder Services, LLC (incorporated by reference to Exhibit 99.2 to Registrant’s Form 8-K, dated November 19, 1999).
4.13	Amendment No. 1 to the Rights Agreement, dated as of February 1, 2005, between Registrant, Mellon Investor Services, LLC and Computershare Investor Services, LLC (incorporated by reference to Exhibit 4.1 to Registrant’s Current Report on Form 8-K (File No. 001-31700) dated July 12, 2005).
4.14	Amendment No. 2 to the Rights Agreement, dated as of July 6, 2005, between Registrant and Computershare Investor Services, LLC, as rights agent (incorporated by reference to Exhibit 4.2 to Registrant’s Current Report on Form 8-K (File No. 001-31700) dated July 12, 2005).
10.01	Senior Executive Employment Agreement, dated as of March 30, 2004, between the Registrant and Howard G. Phanstiel (incorporated by reference to Exhibit 10.01 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).
10.02	Senior Executive Employment Agreement, dated as of August 1, 2004, between the Registrant and Gregory W. Scott (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated October 13, 2004).
10.03	Senior Executive Employment Agreement, dated as of May 3, 2005, between Registrant and Bradford A. Bowlus (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated May 3, 2005).

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10.04	Senior Executive Employment Agreement, dated as of June 13, 2005, between the Registrant and Jacqueline B. Kosecoff, Ph.D. (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated June 13, 2005).
10.05	Senior Executive Employment Agreement, dated as of March 31, 2005, between the Registrant and Katherine F. Feeny (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated April 4, 2005).
10.06	Senior Executive Employment Agreement, dated as of January 1, 2005, between the Registrant and Joseph S. Konowiecki (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated January 4, 2005).
10.07	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).
10.08	Senior Executive Employment Agreement, dated as of December 2, 2005, between the Registrant and Sharon D. Garrett (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated October 11, 2005).
10.09	Senior Executive Employment Agreement, dated as of October 3, 2004, between the Registrant and Peter A. Reynolds (incorporated by reference to Exhibit 99.2 to Registrant’s Form 8-K, dated October 13, 2004).
10.10	Senior Executive Employment Agreement, dated as of March 1, 2005, between the Registrant and James Frey (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated March 25, 2005).
10.11	Senior Executive Employment Agreement, dated as of March 1, 2005, between the Registrant and Sam W. Ho (incorporated by reference to Exhibit 99.1 to Registrant’s Form 8-K, dated April 13, 2005).
10.12	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).
10.13	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).
10.14	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).
10.15	Form of Restricted Stock Grant Notice and Restricted Stock Grant Agreement under the 1996 Stock Option Plan for Officers and Key Employees of the Registrant, as amended (incorporated by reference to Exhibit 10.12 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).
10.16	Form of Stock Option Agreement under the 1996 Stock Option Plan for Officers and Key Employees of the Registrant, as amended (incorporated by reference to Exhibit 10.13 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).
10.17	2000 Employee Plan (incorporated by reference to Exhibit 4.1 to Registrant’s Registration Statement on Form S-8 (File No. 333-44038)).
10.18	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).
10.19	Form of Restricted Stock Grant Notice and Restricted Stock Grant Agreement under the 2000 Employee Plan of the Registrant, as amended (incorporated by reference to Exhibit 10.16 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).
10.20	Form of Stock Option Agreement under the 2000 Employee Plan of the Registrant, as amended (incorporated by reference to Exhibit 10.17 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).

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10.21	Amended and Restated 2000 Non-Employee Directors Stock Plan (incorporated by reference to Exhibit 1 to Registrant’s Proxy Statement, dated May 18, 2001).
10.22	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).
10.23	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).
10.24	Form of Stock Option Agreement under the Amended and Restated 2000 Non-Employee Directors Stock Plan of the Registrant, as amended (incorporated by reference to Exhibit 10.21 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).
10.25	Amended and Restated 1996 Non-Officer Directors Stock Plan (incorporated by reference to Exhibit E to Registrant’s Proxy Statement, dated May 25, 1999).
10.26	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)).
10.27	Form of Stock Option Agreement under the Amended and Restated 1996 Non-Officer Directors Stock Option Plan of the Registrant, as amended (incorporated by reference to Exhibit 10.24 to Registrant’s Form 10-Q for the quarter ended March 31, 2004).
10.28	2005 Equity Incentive Plan of the Registrant (incorporated by reference to Annex A to Registrant’s Proxy Statement, dated April 13, 2005).
10.29	First Amendment to the 2005 Equity Incentive Plan of the Registrant dated May 19, 2005 (incorporated by reference to Exhibit 10.28 to Registrant’s Form 10-Q for the quarter ended June 30, 2005).
10.30	Form of Non-Qualified Stock Option Agreement under the 2005 Equity Incentive Plan of the Registrant (incorporated by reference to Registrant’s Form 8-K, dated May 19, 2005).
10.31	2003 Incentive Bonus Plan of the Registrant (incorporated by reference to Exhibit 10.21 to Registrant’s Form 10-K for the year ended December 31, 2003).
10.32	2003 Management Incentive Compensation Plan of the Registrant (incorporated by reference to Annex B to Registrant’s Proxy Statement, dated May 8, 2003).
10.33	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).
10.34	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).
10.35	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).
10.36	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).
10.37	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).
10.38	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).

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10.39	Amended and Restated 2001 Employee Stock Purchase Plan (incorporated by reference to Exhibit A to Registrant’s Proxy Statement dated April 22, 2004).
10.40	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 (incorporated by reference to Exhibit 10.30 to Registrant’s Form 10-K for the year ended December 31, 2003).
10.41	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).
10.42	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).
10.43	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).
10.44	Credit Agreement, dated as of December 13, 2004, 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 10.01 to the Registrant’s Form 8-K, dated December 13, 2004).
10.45	Form of Stock Option Agreement under the 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.44 to Registrant’s Form 10-Q for the quarter ended June 30, 2005).
10.46	Form of Executive Restricted Stock Agreement under the 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.45 to Registrant’s Form 10-Q for the quarter ended June 30, 2005).
10.47	Form of Restricted Stock Agreement under the 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.46 to Registrant’s Form 10-Q for the quarter ended June 30, 2005).
10.48	PacifiCare Supplemental Executive Retirement Plan, dated as of January 1, 2002 (incorporated by reference to Exhibit 10.47 to Registrant’s Form 10-Q for the quarter ended June 30, 2005).
10.49	First Amendment to the PacifiCare Executive Retirement Plan, dated as of December 17, 2003 (incorporated by reference to Exhibit 10.48 to Registrant’s Form 10-Q for the quarter ended June 30, 2005).
11.1	Statement regarding computation of per share earnings (included in Note 9 to the Notes to Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q).
14.1	Financial Code of Ethics (incorporated by reference to Exhibit 14.1 to Registrant’s Form 10-K for the year ended December 31, 2003).
*15.1	Letter re: Unaudited Interim Financial Information, a copy of which is filed herewith.
*20.1	Report of Independent Registered Public Accounting Firm, 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.
*32.1	Certification of Principal Executive Officer 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 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 Quarterly Report on Form 10-Q.

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