Senior health, life and annuity products.  We continue to concentrate our efforts on the Senior segment because we believe this market has the potential for greater revenue growth and higher profit margins than our Medical segment. Our strategy is to expand this segment by emphasizing competitive markets, working with select distributors, exploring new marketing relationships, and increasing our agent base. The products in this segment are designed specifically for Americans age 55 and over which was estimated at over 65 million in 2004 and is one of the country’s fastest growing age segments that is projected to increase to 103 million people by 2025. In addition, the senior population controls more than 75% of the nation’s financial wealth. Our senior products supplement other programs, such as Medicare, and also include specialty supplemental coverages and life insurance. According to the Centers for Medicare and Medicaid Services (CMS), the number of Medicare enrollees, age 65 and over, nearlymore than doubled between 1966 and 2002,2004, growing to 34.742 million from 19.119 million. By 2007, the Medicare population is expected to exceed 44 million. Approximately 61% of individuals age 65 and over have private insurance as well as Medicare. To address this demand, we will continue to concentrate on our primary product, Medicare supplement, and increase our market reach through new plan offerings.

Catastrophic and comprehensive major medical insurance.  Historically, major medical insurance has been our core business, accounting for a greater percentage of our revenue than our Senior segment. Our Medical segment includes insurance for individuals (under age 65), families, associations, and small to mid-size businesses. With increasingly stringent federal and state restrictions on small group insurance, we emphasize the sale of individual and association products, which offer greater flexibility in both underwriting and plan design compared to small group products. The associations we market to are groups that are formed for the purpose of providing certain goods, services, and information to individuals who pay dues to be members in the association. Individual and association products, which are individually underwritten for each applicant, offer greater regulatory latitude in adjusting future premium rates, establishing premium rates based on individual risk factors and rejecting applicants with risk factors that exceed our pricing parameters. The currentBeginning in 2006, premium level islevels are expected to levelize or grow slightly as we continue to decrease as we concentrate on targeted states, strengthening relationships with selected distributors, emphasizing our most profitable products, adjusting premium rates as necessary to keep pace with medical inflation, and by focusing on increasing profit margins through our medical management and expense management programs.

We market and administer preferred provider organization (PPO) plans and administer our existing traditional indemnity medical plans. We believe that increased costs and consumer dissatisfaction with limitations on choice of doctors and treatment have caused health maintenance organization (HMO) enrollments to decrease. We believe that PPO coverage provides greater freedom of choice of doctors and opportunity to seek care from doctors and facilities within networks towhich deliver healthcare at favorable rates compared to HMOs and traditional indemnity plans. PPO members generally are charged periodic prepaid premiums, co-payments, and deductibles. Traditional indemnity insurance typically allows policyholders substantial freedom of choice in selecting healthcare providers without the financial incentives or cost-control measures typical of managed care plans. We also now market health savings accounts (HSA)-qualified — qualified products to individuals, families and small businesses. We believe these plans provide insureds with greater flexibility to control their healthcare dollars.

Principal elements of our business strategy include:

Increasing senior market focus.  Because of favorable demographics and higher profit potential in the Senior segment, we intend to continue to focus our sales efforts on this part of our business. We believe the senior market will continue to produce more predictable earnings, particularly since these products are not as sensitive to medical inflation as major medical products. We will be concentrating more on our agent recruiting and a significant amount of our product development efforts on the senior market. We also intend to transition our major medical insureds into our senior products as they age. For the year ended December 31, 20042005 our Senior segment comprised 43%48% of our total net premium revenues compared to 36%43% for 2003.2004. One of our continuing objectives is to balance our segments’ revenue equally over the next several years. Our Senior segment products are administered at our Kansas facility, which we believe has superior and efficient technology and administration.

Focusing on profitability in the major medical market.  While historically the Medical segment has been the largest percentage of our revenue, we, like all health insurance companies, continue to face challenges in this marketplace due

Our selective marketing approach has enabled us to serve the demand for health insurance products while remaining profitable. In addition,mid-2005, we continueintroduced our new Advantage Series of major medical products designed to improveoffer customers a choice of benefit levels and prices. The Advantage Series is built on a new rate manual that we believe allows for pricing consistency for all our underwriting practices.individual/association products and distribution channels.

The major medical market requires careful monitoring. We regularly watch our claims inventories and analyze our loss ratios to ensure profitability. As we move forward, we will continue to focus our efforts on specific states, strengthening relationships with our best distributors, monitoring our new business activity, and emphasizing our most profitable products. We believe that this approach will allow us to remain competitive in this market.

In 2005,2006, we expect increased production levels andMedical Segment premium revenues to increase by approximately 5%, the declinefirst annual increase in major medical premium to moderate to approximately 5% on an annualized basis.premiums since 2001.

Promoting electronic distribution.  We promote the use of electronic distribution in both of our business segments to increase efficiency and agent productivity. This electronic platform brings significant benefits to both agents and consumers.

Through electronic submission, our agents have their business processed faster, and have access to pending policy and claims status information. Agents also receive valuable electronic marketing tools which enhance their ability to increase sales. Advance commissions are available to qualifying agents for select senior health and life insurance products and on select major medical products for certain distributors.

Consumers enjoy the advantages of faster policy issue, including an electronic issue option, and personal local service through an agent partner at no additional cost. Our highly-trainedtrained call center staff is available for agent support, as well as to answer consumer questions.

We primarily market health, life and annuity insurance products tailored to meet the needs of individuals, families, associations, small to mid-size businesses, and senior Americans. We have specialized teams that focus on new product development for each of our markets. These teams review our current product offerings and compare them with our competitors’ products and changing insured needs. We systematically review our individual and small group major medical plans to help us further develop our product mix.

Major medical.  Our major medical products include catastrophic, comprehensive, and basic coverage options from PPO benefit plans to traditional indemnity health insurance plans. Currently, we market onlyprimarily PPO plans. Some of our major medical plans can also be configured as HSA-qualified plans.

Our traditional indemnity health insurance products provide coverage for services from any qualified medical provider. Like our PPO products, most of our indemnity health insurance products offer access to providers at our negotiated network savings. Although our indemnity insureds are not required to use our network providers, we have established programs that reduce claims costs andout-of-pocket expenses for our insureds who do use network providers.

We also have a program that reduces claims costs for prescription drugs on our medical products that include prescription drug coverage. We developed a system with varying levels of co-payment amounts to encourage insureds to use generic drugs and a money-saving mail-order program for maintenance prescription drugs. OurIn addition, our care coordination program has been added to most of our major medical products to provide service enhancements for our insureds.

Our new products are designed with higher profit margins. These products provide higher deductibles and co-payments and are designed to shift to consumers a greater portion of the risk for discretionary medical and brand name pharmaceutical benefits. This benefit structure reduces premium payments for consumers and is designed to lower the level of future premium rate adjustments. We are also emphasizing HSA-qualified plans, which enablesenable insureds to lower their insurance costs and have more control over their healthcare dollars.

Short-term major medical.  This product provides major medical coverage for a limited amount of time for people who, for example, are between jobs or are recent graduates.

Small group products.  Our Professional Multi-Option (PMO) product is a comprehensive major medical plan offered to our small business customers. We also offer our Partnership Plan, a major medical product in which we share the medical cost risk with the employer, to small to mid-size businesses with 2-100 employees. This alternate funding mechanism allows the employer to limit expense and risk by self-insuring part of the coverage. This product can produce a year-end refund or carryover feature for low claims experience that is attractive to businesses with healthy employees. The savings generated with this plan can be used to provide other employee benefits. In 2004, we began marketingWe also market an HSA-qualified product to small employer groups. Sales of these products currently comprise 50%HSA-qualified plans comprised 73% of new sales to small employer groups.groups in 2005.

Life and annuity.  We also market group life insurance and annuity plans. We offer term life insurance as an ancillary product to our major medical insureds. We also offer various single premium deferred annuities.

Senior health insurance products.  Our senior market products include a wide range of comprehensive and supplemental major medical benefit products, including Medicare supplement (our cornerstone product), long-term care, and other supplemental products.

Senior life insurance and annuities.  Our life insurance and annuity products include lower face amount life insurance policies offering coverages up to $25,000 and annuity plans with first-year bonus interest or interest rate guarantees.

Medical cost management.  We focus on reducing medical costs for our insureds by actively managing medical inflation and utilization rate costs. National health expenditures have grown from $1,067 per capita in 1980 to $5,670$6,280 per capita in 20032004 and are projected to increase to $9,216$9,148 per capita in 2010, according to statistics compiled by CMS. Several factors have contributed to the dramatic increase in healthcare expenditures, including increased costs and utilization of high-technology diagnostic testing and treatments, the rising cost of malpractice insurance, higher operating costs for hospitals and physicians, changes in federal and state healthcare regulations, increased utilization and cost of pharmaceuticals, and the aging of the population.

We have numerous programs designed to lower medical costs for our insureds. Some of these programs include:

The purpose of these programs is to provide quality care and improve treatment outcomes while reducing total costs for both the Companycompany and our insureds. We also offer insureds opportunities to make changes in their benefits to lower their premium payments. Our benefit design department works with our insureds to structure benefit packages to meet their budgets.

Our care coordination program provides our insureds with24-hour access to medical information, case management early intervention programs and non-network negotiation processes to lower medical expenses, as well as additional services to help them extend and maximize insurance benefits.

Our distribution is critical for our continued growth. We market our products through independent agents with licenses in 48 states, the District of Columbia, and the U.S. Virgin Islands. We have initiated a systematic program to focus our marketing expenses on more productive agents. We compensate our agents for business produced by them on a commission basis at rates that we believe to be competitive with those of other life and health insurance companies.

Distribution Channels.  We use a variety of distribution systems in marketing our products. Because product lines vary among many of these distribution systems, we have some overlap of agents between channels. Some of our agents are licensed and contracted with more than one of our distribution channels.

We base our fivesix distribution channels on organization of the agents and specific markets or products:

Marketing Support.  We compete with other insurance companies and other sales operations for our agents. In addition, we compete with other companies that our independent agents represent. Our marketing systems

We provide comprehensive support programs to attract and retain agents, including:

We had approximately 244,000239,000 group certificates and individual policies in force as of December 31, 2004,2005, representing approximately 327,000309,000 insureds. Each group certificate represents an insured and any

Because of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and state regulatory restrictions, we place greater emphasis on the sale of individual and association major medical products. For 2004,2005, 67% of our major medical certificates included 65% forwere individual and association products and 35% for33% were small group products, which were consistent with levels experienced in 2003.2004.

The geographic distribution of direct and assumed premiums, before reinsurance ceded, on a statutory basis of all of our subsidiaries in 20042005 and 20032004 is presented in the table below. The presentation on a statutory basis differs from U.S. generally accepted accounting principles (GAAP) in that our fee income and annuity considerations are considered premiums for statutory purposes. Effective March 31, 2003, Continental General entered into a reinsurance agreement with Pyramid Life under which Continental General reinsured on a 100% coinsurance basis and, to the extent policyholders consent or are deemed to consent thereto, on an assumption reinsurance basis, certain interest sensitive whole-life policies. The policy liabilities assumed by Continental General of $12.2 million were reported as assumed premiums for statutory purposes. The 2003 statutory premiums presented in the table below exclude the $12.2 million in policy liabilities assumed from Pyramid Life.

Effective, consistent and accurate underwriting is a critical element of our profitability and depends on our ability to adequately predict claims liability when determining the prices for our products. Premiums charged on insurance products are based, in part, on assumptions about expected mortality and morbidity experience and competitive factors. Our uniform underwriting procedures are designed to assess and quantify certain insurance risks before issuing life insurance, certain health insurance policies, and certain annuity policies to individuals. These procedures are generally based on industry practices, reinsurer underwriting manuals and our prior underwriting experience. To implement these procedures, we employ an experienced professional underwriting staff.

In most circumstances, our pricing and underwriting decisions follow a prospective rating process. A fixed premium rate is determined at the beginning of the policy period. Unanticipated increases in medical costs may not be able to be recovered in the current policy year. However, prior experience, in the aggregate, is considered in determining premium rates for future periods.

Applications for insurance are reviewed on the basis of answers to application questions. Where appropriate, based on the type and amount of insurance applied for and the applicant’s age and medical history, additional information is required, such as medical examinations, statements from doctors who have treated the applicant in the past, and where indicated, special medical tests. For certain coverages, we may verify information with the applicant by telephone. After reviewing the information collected, we either issue the policy as applied for, issue the policy with an extra premium charge due to unfavorable factors, issue the policy excluding benefits for certain conditions, either permanently or for a period of time, issue the policy excluding a specific individual or dependent, or reject the application. For some of our products, we have

Our profitability depends on our ability to adequately increase rates for both new business and at renewal. We have implemented procedures that permit us to apply to regulatory authorities for corrective rate actions on a timely basis with respect to both new business rates and the current market rates. This allows us to analyze whether these rates sufficiently cover benefits, expenses and commissions. For renewal business, we analyze our loss ratios and

All claims for policy benefits are currently either processed by our claims department or outsourced to third party administrators. We currently outsource to third party vendors:

We periodically utilize the services of personnel from our medical cost management subsidiary to review certain claims. When a claim is filed, we may engage medical cost management personnel to review the claim, including the specific health problem of the insured and the nature and extent of healthcare services being provided. Medical cost management personnel often assist the insured by determining that the services provided to the insured, and the corresponding benefits paid, are appropriate under the circumstances.

All of our claims processing, including the claims that are outsourced, must apply the same claims management standards. In addition, we perform random audits of both our internal and outsourced claims processing.

Our ability to continue providing quality service to our insureds and agents, including policy issuance, billing, claims processing, commission reports, and accounting functions is critical to our ongoing success. We believe that our overall systems are an integral part in delivering that service. We regularly evaluate, upgrade and enhance the information systems that support our operations.

Our business depends significantly on effective information systems. We have many different information systems for our various businesses, including the use of our third party vendors’ systems. Our information systems require an ongoing commitment of significant capital and human resources to maintain and enhance existing systems and develop new systems or relationships with third party vendors in order to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards, and changing customer preferences.

We currently outsource the data center for our Cleveland facility to a third party vendor as well as administration of some blocks of business. We receive regular reports from our third party vendors that enable us to closely monitor our business on their systems.

We attempt to minimize our business risk through conservative investment policies. Our investment objectives are to maximize yields, preserve principal, and maintain liquidity. Investments for insurance companies must comply with the insurance laws of the state of domicile. These laws prescribe the kind, quality and concentration of investments that may be made. Due to the restrictive nature of these laws, there may be occasions when we may be precluded from making certain otherwise attractive investments. We periodically evaluate these securities. The effective durations of our investments vary from subsidiary to subsidiary with the life insurance subsidiaries between four and five years and the health companies between three and four years.

At December 31, 2004,2005, approximately $474.6$447.5 million or 95.9%91.5% of our invested assets were fixed maturity securities of which we designated $456.1 million as available-for-sale securities and $18.5 million as trading securities. At December 31, 2004, 97.0%2005, 95.2% of our fixed maturity securitiesavailable-for-sale were of investment grade quality with 82.8%83.5% in securities rated A or better (typically National Association of Insurance Commissioners (NAIC) I) and 14.2%11.7% in securities rated BBB (typically NAIC II). We do not invest in derivatives, such as futures, forwards, swaps, option contracts or other financial instruments with similar characteristics.

At December 31, 2004,2005, the fair value of our investments in mortgage-backed securities totaled $160.4$166.1 million, or 32.4%34.0% of total invested assets. We minimize the credit risk of our mortgage-backed securities by holding primarily issues of U.S. Government agencies or high-quality non-agency issuers rated AA or better. Among the agency mortgage-backed securities, which comprises 21.1%19.5% of the portfolio,total invested assets, the securities are comprised of pass-through securities and planned amortization class collateralized mortgage obligations. The pass-through securities primarily are invested in current market coupons that should exhibit only moderate prepayments in a declining interest rate environment, while the planned amortization class collateralized mortgage obligations provide strong average life protection over a wide range of interest rates. The non-agency mortgage-backed securities, which represent 13.2%14.4% of the portfolio,total invested assets, consist of commercial and jumbo residential mortgage securities. The commercial mortgage-backed securities provide very strong prepayment protection through lockout and yield maintenance provisions, while the residential mortgage-backed securities are concentrated in non-accelerating securities that have several years of principal lockout provisions.

The amortized cost and estimated fair value ofavailable-for-sale securities as of December 31, 2004,2005, were as follows:

For more information, see Note B. Cash and Investments to our audited consolidated financial statements.

We establish and report liabilities or reserves on our balance sheet for unpaid healthcare costs by estimating the ultimate cost of incurred claims that have not yet been reported to us by our policyholders or their providers and reported claims that we have not yet paid. Since these reserves represent our estimates, the

Such assumptions and other factors include:

The majority of Central Reserve’s and Provident American Life’s and United Benefit Life’s reserves and liabilities for claims are for the health insurance business. The majority of Continental General’s reserves and liabilities for claims are for the life and annuity and long-term care business due to the long duration nature of these productions. For our individual and

Liabilities for future policy reserves on traditional life insurance have generally been provided on a net level premium method based upon estimates of future investment yield, mortality, and withdrawals using our experience and actuarial judgment with an allowance for possible unfavorable deviation from the expected experience. The various actuarial factors are determined from mortality tables and interest rates in effect when the policy is issued.

Liabilities for interest sensitive contracts such as deferred annuities and universal life-type contracts are based on the retrospective deposit method. This is the full account value before any surrender charges are applied.

We may from time to time need to increase or decrease our claims reserves significantly in excess ofabove or below our initial estimates and any adjustments would be reflected in our earnings. An inadequate estimate in reserves could have a material adverse impact on our business, financial condition and results of operations. For more information, please see “Critical Accounting Policies” section under Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations.

General.Consistent with the general practice of the insurance industry, we reinsure portions of the coverage provided by our insurance products to unaffiliated insurance companies under reinsurance agreements. Reinsurance provides a greater diversification of underwriting risk, minimizes our aggregate exposure on major risks and limits our potential losses on reinsured business. Reinsurance involves one or more insurance companies participating in the liabilities or risks of another insurance company in exchange for a portion of the premiums. Although the effect of reinsurance is to lessen our risks, it may lower net income. We have entered into a variety of reinsurance arrangements under which we cede business to other insurance companies to mitigate risk. We also have assumed risk on a “quota share” basis from other insurance companies.

Under quota share reinsurance, the reinsurer assumes or cedes an agreed percentage of certain risks insured by the ceding insurer and shares premium revenue and losses proportionately. When we cede business

Existing Arrangements.In the ordinary course of business, we maintain reinsurance arrangements designed to limit the maximum amount of exposure that we retain on a given policy.

A significant portion of our risks are reinsured with a single reinsurance company, Hannover Life Reassurance Company of America, a health and life reinsurance company. In 2004,2005, Hannover accounted for 93.4%94.1% of the total premiums ceded by our subsidiaries. Hannover has entered into reinsurance agreements with several of our subsidiaries, including Central Reserve, Provident American Life, United Benefit Life and Continental General. Our reinsurance agreements with Hannover are not cancelable or terminable by Hannover. In recent years, we have reduced our reliance on reinsurance. Our arrangements are generally for closed blocks of business, which means that Hannover is not reinsuring any new sales or business of any of our subsidiaries under these reinsurance agreements.

In July 2001, we implemented a program to terminate or replace the United Benefit Life and Provident American Life medical policies. Some policyholders in some states were offered a replacement product, HealthEdge, underwritten by Provident American Life. Through June 30, 2002, Hannover reinsured the HealthEdge product on the same basis as the reinsurance under the prior reinsurance agreements. Beginning July 1, 2002, Provident American Life retained 100% of the business and risk on the remaining HealthEdge policies in force. At

To evaluate the claims paying ability and financial strength of Hannover, we review financial information provided to us by Hannover, and hold meetings with its management to review operations, marketing, reinsurance and financial issues. Hannover suffered significant losses as a result of our reinsurance agreements with respect to United Benefit Life and Provident American Life. We believe our relations with Hannover are good.

The total premiums ceded by our subsidiaries in 20042005 to unaffiliated reinsurers amounted to $79.2$68.4 million, of which Hannover represented approximately 93.4%94.1%. Our gross reinsurance receivables from unaffiliated reinsurers amounted to $130.3$131.2 million as of December 31, 2004,2005, of which approximately 99.3%99.2% was attributable to Hannover, and of which approximately $128.8$127.2 million represented reserves held by our reinsurers under our various reinsurance treaties in place. Cash settlements are made quarterly with Hannover and timely paid.

Hannover is a subsidiary of Hannover Rueckversicherungs, a German corporation, which had assets of $41.5$47.9 billion and total stockholders’ equity of $3.0$3.5 billion at December 31, 2003.2004. Moody’s has assigned Hannover Rueckversicherungs a financial strength rating of Baa1 (adequate). Hannover and Hannover Rueckversicherungs each have an A (excellent) rating from A.M. Best Company, Inc. In addition, Hannover Rueckversicherungs has a financial strength rating of AA- (very strong) from Standard & Poor’s. Hannover’s failure to pay our claims in full or on a timely basis could have a material adverse effect on our business, financial condition and results of operations.

For ordinary and group life claims, Continental General’s maximum retention is $125,000 and, at December 31, 2005, Central Reserve’s maximum retention iswas $50,000 with no retention maintained over age 70. As of 2006, Central Reserve did not cede its group life claims due to a substantial reduction in its exposure. For accident and health claims, maximum retention on individual claims is $500,000. For a complete discussion of our material reinsurance agreements, including recent reinsurance agreements, see Note K. Reinsurance Arrangements to our audited consolidated financial statements.

Our future growth may be dependent on our ability to obtain reinsurance in the future. While we expect to continue our relationship with Hannover in the future, we will continue to identify new companies with respect to new reinsurance agreements. The amount and cost of reinsurance available to us would be subject, in large part, to prevailing market conditions beyond our control. We may be unable to obtain reinsurance in the future, if necessary, at competitive rates or at all.

The insurance business is highly competitive. In our major medical business, we compete with large national, regional and specialty health insurers, including Golden Rule Resources Ltd., Fortis Benefits Insurance Company, Assurant, World Insurance/American Republic, various Blue Cross/Blue Shield companies, and United Healthcare Corporation. In our senior business, we compete with other national, regional and specialty insurers, including Universal American Financial Corp., Banker’s Life and Casualty, United Teachers Associates Insurance Company, Torchmark, Pacificare, United Healthcare, Mutual of Omaha, Conseco, Inc., Blue Cross organizations, and Medicare HMOs. Many of our competitors have substantially greater financial resources, broader product lines, or greater experience than we do. In addition to claims paying ratings, we compete on the basis of price, reputation, diversity of product offerings and flexibility of coverage, ability to attract and retain agents, and the quality and level of services provided to agents and insureds.

We face additional competition due to a trend among healthcare providers and insurance companies to combine and form networks in order to contract directly with small businesses and other prospective customers to provide healthcare services. In addition, because many of our products are marketed through independent agents, most of which represent more than one company, we compete with other companies for the marketing focus of each agent.

Our ratings assigned by A.M. Best Company, Inc. and other nationally recognized rating agencies are important in evaluating our competitive position. A.M. Best ratings are based on an analysis of the financial

In April 2004,October 2005, Fitch upgradedaffirmed Central Reserve’s rating toand Continental General’s financial strength ratings of BBB (good credit quality) and affirmed Continental General’s BBB (good credit quality) financial strength rating..

Government regulation of health and life insurance, annuities and healthcare coverage and health plans is a changing area of law and varies from state to state. We strive to maintain compliance with the various federal and state regulations applicable to our operations. To maintain compliance with these constantly evolving regulations, we may need to make changes occasionally to our services, products, structure or operations. We are unable to predict what additional government regulations affecting our business may be enacted in the future or how existing or future regulations might be interpreted. Additional governmental regulation or future interpretation of existing regulations could increase the cost of our compliance or materially affect our operations, products or profitability. We carefully monitor state and federal legislative and regulatory activity as it affects our business. We believe that we are compliant in all material respects with all applicable federal and state regulations.

Insurance Regulation.  We are subject to regulation and supervision by state insurance regulatory agencies. This regulation is primarily intended to protect insureds rather than investors. These regulatory bodies have broad administrative powers relating to standards of solvency, which must be met on a continuing basis, granting and revoking of licenses, licensing of agents, approval of policy forms, approval of rate increases, maintenance of adequate reserves, claims payment practices, form and content of financial statements, types of investments permitted, issuance and sale of stock, payment of dividends, and other matters pertaining to insurance. We are required to file detailed annual statements with the state insurance regulatory bodies and are subject to periodic examination. The most recent completed regulatory examination for Central Reserve, Provident American Life and United Benefit Life was performed by the State of Ohio as

Although many states’ insurance laws and regulations are based on models developed by the National Association of Insurance Commissioners (NAIC) and are therefore similar, variations among the laws and regulations of different states are common. The NAIC is a voluntary association of all of the state insurance commissioners in the United States. The primary function of the NAIC is to develop model laws on key insurance regulatory issues that can be used as guidelines for individual states in adopting or enacting insurance legislation. While the NAIC model laws are accorded substantial deference within the insurance industry, these laws are not binding on insurance companies unless adopted by a state, and variation from the model laws within the state is common.

The NAIC has risk-based capital (RBC) requirements for life and health insurers to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators to monitor trends in statutory capital and surplus for the purpose of initiating regulatory action. In general, under these laws, an insurance company must submit a report of its RBC level to the insurance department of its state of domicile as of the end of the previous calendar year. These laws require increasing degrees of regulatory oversight and intervention as an insurance company’s RBC declines. The level of regulatory oversight ranges from requiring the insurance company to inform and obtain approval from the domiciliary insurance commissioner of a comprehensive financial plan for increasing its RBC, to mandatory regulatory intervention requiring an insurance company to be placed under regulatory control in a rehabilitation or liquidation proceeding.

The RBC Model Act provides for four different levels of regulatory attention depending on the ratio of a company’s total adjusted capital, defined as the total of its statutory capital, surplus and asset valuation reserve, to its risk-based capital.

We calculated the risk-based capital for our insurance subsidiaries as of December 31, 2004,2005, using the applicable RBC formula. Based on these calculations, the risk-based capital levels for each of our subsidiaries exceeded the levels required by regulatory authorities.

Dividends paid by our insurance subsidiaries to Ceres are limited by state insurance regulations. The insurance regulator in the insurer’s state of domicile may disapprove any dividend which, together with other

Many states have also enacted insurance holding company laws, which require registration and periodic reporting by insurance companies controlled by other corporations. These laws vary from state to state, but typically require periodic disclosure concerning the corporation which controls the insurer, and prior notice to, or approval by, the applicable regulator of inter-company transfers of assets and other transactions, including payments of dividends in excess of specified amounts by the insurer, within the holding company system. These laws often also require the prior approval for the acquisition of a significant direct or indirect ownership interest (for example, 10% or more) in an insurance company. Our insurance subsidiaries are subject to these laws and we believe they are in compliance in all material respects with all applicable insurance holding company laws and regulations.

Additional regulatory initiatives may be undertaken in the future, either at the federal or state level, to engage in structural reform of the insurance industry in order to reduce the escalation of insurance costs or to make insurance more accessible. These future regulatory initiatives could have a material adverse effect on our business, financial condition and results of operations.

Healthcare Regulation and Reform.  Government regulation and reform of the healthcare industry also affects the manner in which we conduct our business. There continues to be diverse legislative and regulatory

HIPAA requires certain guaranteed issuance and renewability of health insurance coverage for individuals and small employer groups and limits exclusions on pre-existing conditions. HIPAA has also mandated the adoption of extensive standards for the use and disclosure of health information. HIPAA also mandated the adoption of standards for the exchange of electronic health information in an effort to encourage overall administrative simplification and enhance the effectiveness and the efficiency of the healthcare industry. We have developed, and continue to enhance, electronic data interface (EDI) systems and relationships, relating to our claim adjudication operations. These electronic processes increase the efficiencies in the service provided to our customers.

HIPAA’s Security standards becomebecame effective April 20, 2005 and further mandatemandated that specific requirements be met relating to maintaining the confidentiality and integrity of electronic health information and protecting it from anticipated hazards or uses and disclosures that are not permitted.

The Medicare Prescription Drug Improvement and Modernization Act of 2003, or DIMA. DIMA, makesmade many significant changes to the Medicarefee-for-service and Medicare+Choice programs, as well as other changes to the commercial health insurance marketplace. Most significantly, DIMA createscreated a prescription drug benefit for Medicare beneficiaries, establishesestablished a new Medicare Advantage program to replace the Medicare+Choice program, and enactsenacted health savings accounts (HSAs) for non-Medicare eligible individuals and groups. The effects of DIMA on our business, including any impact on our future prospects, are still unknown. We will continue to assess the impact, if any, of DIMA and any other new or proposed Medicare legislation.

In addition to federal regulation and reform, many states have enacted, or are considering, various healthcare reform statutes. These reforms relate to, among other things, managed care practices, prompt pay payment practices, health insurer liability and mandated benefits. Most states have also enacted patient confidentiality laws that prohibit the disclosure of confidential information. As with all areas of legislation, the federal regulations establish minimum standards and preempt conflicting state laws that are less restrictive but will allow state

Most states have also enacted small group insurance and rating reforms, which generally limit the ability of insurers and health plans to use risk selection as a method of controlling costs for small group businesses. These laws may generally limit or eliminate use of pre-existing condition exclusions, experience rating, and industry class rating and limit the amount of rate increases from year to year. We have discontinued selling certain policies in states where, due to these healthcare reform measures, we cannot operate profitably. We may discontinue sales in other states in the future. Our operations also may be subject to PPO or managed care laws and regulations in certain states. PPO and managed care regulations generally contain requirements pertaining to provider networks, provider contracting, and reporting requirements that vary from state to state.

One of the significant techniques we use to manage healthcare costs and facilitate care delivery is contracting with networks to give our insureds access to physicians, hospitals and other providers, who accept negotiated reimbursement and do not balance bill our insured. A number of organizations are advocating for legislation that would exempt some providers from federal and state antitrust laws. In any particular market, providers could refuse to contract, demand higher payments or take actions that could result in higher healthcare costs, less desirable products for insureds or difficulty meeting regulatory or accreditation requirements. In some markets, some providers, particularly hospitals, physician/hospital organizations or multi-specialty physician groups, may have significant market positions or near monopolies. In addition, physician or practice management companies, that aggregate physician practices for administrative efficiency and marketing leverage, continue to expand. These providers may compete directly with us. If these providers refuse to contract with the network we use, use their market position to negotiate less favorable contracts or place us at a competitive disadvantage, those activities could adversely affect our ability to market products or to be profitable in those areas.

(d) Issuer Purchases of Equity Securities.  The following is a summary of stock repurchases, pursuant to our previously-announced stock repurchase program, for the Ohio Departmentfourth quarter of Insurance2005. See Note N. Treasury Stock, to pay an extraordinary dividend of $12.0 million to Ceres Group.our audited consolidated financial statements for further information.

The selected audited consolidated financial data presented below as of and for each of the five years ended December 31, 2005, 2004, 2003, 2002 2001 and 20002001 have been derived from our audited consolidated financial statements. However, financial data for 2001 and 2000 was reclassified to reflect the sale of Pyramid Life.Life Insurance Company on March 31, 2003. For further information, see Note D. Discontinued Operations to our audited consolidated financial statements. The financial information for the years ended December 31, 2005, 2004, 2003, 2002 2001 and 20002001 includes the operations of all our subsidiaries for the entire year except for Pyramid Life. Pyramid Life, which is presented separately as discontinued operations, was acquired on July 26, 2000 and sold on March 31, 2003. The data for 2005, 2004 2003 and 20022003 should be read in conjunction with the more detailed information contained in the audited consolidated financial statements and accompanying notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this filing.