UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

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


For the quarterly period ended ~~September 30, 2005~~March 31, 2006		Commission file number 0-8483

CERES GROUP, INC.

(Exact name of registrant as specified in its charter)


Delaware		34-1017531

(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)


17800 Royalton Road, Cleveland, Ohio		44136

(Address of principal executive offices)		(Zip Code)

(440) 572-2400

(Registrant’s telephone number, including area code)

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~~

YESþ NoNOo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, ~~(as defined~~or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange ~~Act)~~Act (check one). ~~Yes~~þ No


Large accelerated filero		Accelerated Filerþ		Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ~~Yes~~

YESo NoNOþ

The number of shares of common stock, par value $0.001 per share, outstanding as of ~~November 1, 2005~~April 26, 2006 was ~~33,207,800.~~33,295,044.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CERES GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands)


	September 30,			December 31,		March 31,			December 31,
	2005			2004		2006			2005
	(Unaudited)					(Unaudited)
ASSETS
Investments
Fixed maturities available-for-sale, at fair value	$	431,505		$	456,075	$	448,372		$	447,537
Fixed maturities trading, at fair value		¾			18,531
Equity securities available-for-sale, at fair value		27,937			7,658		27,786			27,466
Equity securities trading, at fair value		¾			4,938
Limited partnership		3,734			4,166		3,861			4,640
Policy and mortgage loans		6,623			3,583		11,198			9,263

Total investments		469,799			494,951		491,217			488,906
Cash and cash equivalents (of which $5,528 and $6,967 is restricted, respectively)		46,753			22,635
Cash and cash equivalents (of which $5,679 and $6,070 is restricted, respectively)							25,267			26,764
Accrued investment income		4,151			5,389		4,598			5,340
Premiums receivable		3,804			4,096		3,044			4,388
Reinsurance receivable		134,232			130,345		127,476			131,227
Property and equipment, net		4,905			5,277		4,515			4,708
Deferred acquisition costs		69,797			67,074		77,803			73,955
Value of business acquired		9,869			10,952		10,752			11,126
Goodwill and licenses		14,097			14,097
Goodwill							10,657			10,657
Licenses							3,440			3,440
Other assets		7,958			11,177		10,992			10,492

Total assets	$	765,365		$	765,993	$	769,761		$	771,003


LIABILITIES AND STOCKHOLDERS’ EQUITY
Policy liabilities and benefits accrued
Future policy benefits, losses and claims
Life	$	15,463		$	12,899	$	17,012		$	16,402
Deposit and investment contracts		238,644			236,127		237,937			237,928
Accident and health		113,163			103,161		113,250			112,242

Total future policy benefits, losses and claims		367,270			352,187		368,199			366,572
Unearned premiums		36,215			34,939		37,006			35,707
Other policy claims and benefits payable		100,771			102,703		101,583			105,744

Total policy liabilities and benefits accrued		504,256			489,829		506,788			508,023
Deferred reinsurance gain		5,620			6,562		5,147			5,451
Other policyholders’ funds		14,686			19,016		15,856			14,970
Debt		8,250			10,750		6,250			7,313
Deferred federal income taxes payable		5,202			7,071		2,393			3,524
Other liabilities		23,863			27,947		28,177			28,349

Total liabilities		561,877			561,175		564,611			567,630

Stockholders’ equity
Non-voting preferred stock, $0.001 par value, 1,900,000 shares authorized, none issued		—			—		¾			¾
Convertible voting preferred stock, $0.001 par value, at stated value, 100,000 shares authorized, none issued		—			—		¾			¾
Common stock, $0.001 par value, 50,000,000 shares authorized, 34,898,728 and 34,522,979 shares issued and outstanding, respectively		35			35
Common stock, $0.001 par value, 50,000,000 shares authorized, 34,966,698 and 34,929,181 shares issued, respectively; 33,262,995 and 33,225,478 shares outstanding, respectively							35			35
Additional paid-in capital		134,546			134,090		134,897			134,735
Retained earnings		76,446			63,495		84,084			78,542
Accumulated other comprehensive income		2,206			7,198
Treasury stock, at cost, 1,657,765 and 0 shares, respectively		(9,745	)		¾
Accumulated other comprehensive (loss) income							(3,847	)		80
Treasury stock, at cost, 1,703,703 shares at March 31, 2006 and December 31, 2005							(10,019	)		(10,019	)

Total stockholders’ equity		203,488			204,818		205,150			203,373

Total liabilities and stockholders’ equity	$	765,365		$	765,993	$	769,761		$	771,003

CERES GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(dollars in thousands, except share and per share amounts)


	Three Months Ended						Nine Months Ended					Three Months Ended
	September 30,						September 30,					March 31,
	2005			2004			2005			2004		2006			2005
REVENUES
Premiums, net
Medical	$	54,244		$	60,097		$	165,917		$	187,989	$	55,827		$	56,566
Senior and other		51,662			46,182			152,533			134,698		55,367			50,070

Total premiums, net		105,906			106,279			318,450			322,687		111,194			106,636
Net investment income		6,753			6,285			19,634			19,234		6,974			6,083
Net realized gains		750			163			646			401
Net realized gains (losses)													109			(840	)
Fee and other income		3,970			4,800			12,721			14,663		4,627			4,588

													122,904			116,467
		117,379			117,527			351,451			356,985

BENEFITS, LOSSES AND EXPENSES
Benefits, claims, losses and settlement expenses
Medical		39,095			44,468			116,431			131,167		40,058			38,920
Senior and other		41,574			34,494			120,027			101,802		41,419			38,486

Total benefits, claims, losses and settlement expenses		80,669			78,962			236,458			232,969		81,477			77,406
Selling, general and administrative expenses		33,292			34,528			97,613			101,102		35,323			32,512
Net (deferral) amortization and change in deferred acquisition costs and value of business acquired		(787	)		187			(320	)		4,626
Net (deferral) amortization and change in acquisition costs and value of business acquired													(2,593	)		441
Interest expense and financing costs		178			169			533			507		159			175

		113,352			113,846			334,284			339,204		114,366			110,534

Income before federal income taxes		4,027			3,681			17,167			17,781		8,538			5,933
Federal income tax expense (benefit)		597			(1,729	)		4,216			1,305
Federal income tax expense													2,996			1,084

Net income	$	3,430		$	5,410		$	12,951		$	16,476	$	5,542		$	4,849


Net income per share
Basic	$	0.10		$	0.16		$	0.38		$	0.48	$	0.17		$	0.14
Diluted		0.10			0.16			0.37			0.47		0.17			0.14

Weighted average shares outstanding
Basic		34,206,025			34,495,077			34,415,330			34,449,631		33,239,294			34,536,410
Diluted		34,377,299			34,755,130			34,653,823			35,024,930		33,374,520			34,670,549

CERES GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the ~~Nine~~Three Months Ended ~~September 30, 2005~~March 31, 2006

Unaudited

(dollars in ~~thousands)~~thousands, except share amounts)


Common Stock
Balance at September 30, 2005	$	35
Balance at March 31, 2006				$	35


Additional Paid-in Capital
Balance at beginning of year	$	134,090		$	134,735
Issuance of stock:
Employee/agent benefit and stock purchase plans		380
Warrants and options exercised		76
Employee/agent benefit plans					162

Balance at September 30, 2005	$	134,546
Balance at March 31, 2006				$	134,897


Retained Earnings
Balance at beginning of year	$	63,495		$	78,542
Net income		12,951			5,542

Balance at September 30, 2005	$	76,446
Balance at March 31, 2006				$	84,084


Accumulated Other Comprehensive Income
Accumulated Other Comprehensive Income (Loss)
Balance at beginning of year	$	7,198		$	80
Unrealized loss on securities, net of tax benefit of $2,689 (1)		(4,992	)
Unrealized loss on securities, net of tax benefit of $2,115					(3,927	)

Balance at September 30, 2005	$	2,206
Balance at March 31, 2006				$	(3,847	)


Treasury Stock
Balance at beginning of year	$	¾		$	(10,019	)
Treasury stock purchased, at cost		(9,745	)		¾

Balance at September 30, 2005	$	(9,745	)
Balance at March 31, 2006				$	(10,019	)


Total Stockholders’ Equity	$	203,488		$	205,150


Number of Shares of Common Stock
Balance at beginning of year		34,522,979			34,929,181
Issuance of stock:
Employee/agent benefit and stock purchase plans		70,583
Warrants and options exercised		305,166
Employee/agent benefit plans					37,517

Balance at September 30, 2005		34,898,728
Balance at March 31, 2006					34,966,698


Number of Shares of Treasury Stock
Balance at beginning of year		¾			1,703,703
Treasury stock purchased		1,657,765			¾

Balance at September 30, 2005		1,657,765
Balance at March 31, 2006					1,703,703

CERES GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~COMPREHENSIVE INCOME

Unaudited

(dollars in thousands)

Nine Months Ended
September 30,
2005 2004
Operating activities

Net income $ 12,951 $ 16,476
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 2,278 2,716
Net realized gains (646 ) (401 )
Net change in fixed maturities trading 18,367 ¾
Net change in equity securities trading 4,447 ¾
Deferred federal income taxes 821 (3,506 )
Changes in assets and liabilities:
Accrued investment income 1,238 1,121
Reinsurance and premiums receivable (3,595 ) 8,214
Deferred acquisition costs (2,079 ) 2,985
Value of business acquired 1,759 1,641
Federal income taxes payable/recoverable 3,398 (1,393 )
Other assets (179 ) 901
Future policy benefits, claims and funds payable 2,611 (22,516 )
Unearned premium 1,276 1,532
Deferred reinsurance gain (942 ) (1,098 )
Other liabilities (3,740 ) (3,513 )

Net cash provided by operating activities 37,965 3,159

Investing activities

Net purchases of furniture and equipment (390 ) (910 )
Purchase of fixed maturities available-for-sale (57,850 ) (87,272 )
Purchase of equity securities available-for-sale (20,990 ) ¾
Investment in limited partnership (net of distributions) 432 (1,892 )
(Increase) decrease in policy and mortgage loans, net (3,040 ) 499
Proceeds from sales of fixed maturities available-for-sale 34,115 27,445
Proceeds from calls and maturities of fixed maturities available-for-sale 39,455 60,838

Net cash used in investing activities (8,268 ) (1,292 )

Financing activities

Increase in annuity account balances 19,061 19,462
Decrease in annuity account balances (12,851 ) (15,349 )
Principal payments on debt (2,500 ) (1,687 )
Proceeds from issuance of common stock 456 371
Purchases of treasury stock (9,745 ) ¾

Net cash (used in) provided by financing activities (5,579 ) 2,797

Net increase in cash
24,118 4,664
Cash and cash equivalents at beginning of year 22,635 26,394

Cash and cash equivalents at end of period
$ 46,753 $ 31,058

Supplemental disclosures of cash flow information

Cash paid during the period for interest $ 495 $ 433
Cash paid during the period for federal income taxes ¾ 6,204


	Three Months Ended
	March 31,
	2006			2005

Net income	$	5,542		$	4,849

Other comprehensive income (loss):
Unrealized holding losses on securities		(6,931	)		(7,393	)
Reclassification adjustments for realized losses (gains) included in net income		8			(233	)
Unrealized gain adjustment to deferred acquisition costs and value of business acquired		881			1,113

Total other comprehensive loss before federal income tax benefit		(6,042	)		(6,513	)
Income tax benefit related to items of other comprehensive loss		(2,115	)		(2,279	)

Other comprehensive loss, net of tax		(3,927	)		(4,234	)

Total comprehensive income	$	1,615		$	615

The accompanying notes are an integral part of these condensed consolidated financial statements.

CERES GROUP, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(dollars in thousands)


	Three Months Ended
	March 31,
	2006			2005
Operating activities
Net income	$	5,542		$	4,849
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		577			774
Stock-based compensation expense		174			¾
Net realized (gains) losses		(109	)		840
Net change in fixed maturities trading		¾			336
Net change in equity securities trading		¾			(1,177	)
Equity in limited partnership earnings		(128	)		(92	)
Deferred federal income taxes		982			1,084
Changes in assets and liabilities:
Accrued investment income		742			920
Reinsurance and premiums receivable		5,095			(1,158	)
Deferred acquisition costs		(3,329	)		(172	)
Value of business acquired		736			613
Federal income taxes payable/recoverable		173			(2	)
Other assets		(654	)		1,289
Future policy benefits, claims and funds payable		(3,255	)		1,099
Unearned premium		1,299			2,011
Deferred reinsurance gain		(304	)		(469	)
Other liabilities		(67	)		(2,495	)

Net cash provided by operating activities		7,474			8,250


Investing activities
Net purchases of furniture and equipment		(58	)		(187	)
Purchase of fixed maturities available-for-sale		(25,181	)		(14,360	)
Return of capital from/(investment in) limited partnership		816			(82	)
Cash distributions from limited partnership		91			93
(Increase)/decrease in policy and mortgage loans, net		(1,935	)		20
Proceeds from sales of fixed maturities available-for-sale		5,594			9,972
Proceeds from calls and maturities of fixed maturities available-for-sale		11,158			11,468

Net cash (used in) provided by investing activities		(9,515	)		6,924


Financing activities
Increase in annuity account balances		7,982			5,528
Decrease in annuity account balances		(6,375	)		(4,191	)
Principal payments on debt		(1,063	)		(625	)
Proceeds from issuance of common stock related to employee benefit plans		¾			93

Net cash provided by financing activities		544			805

Net (decrease) increase in cash		(1,497	)		15,979
Cash and cash equivalents at beginning of year		26,764			22,635

Cash and cash equivalents at end of period	$	25,267		$	38,614


Supplemental disclosures of cash flow information
Cash paid during the period for interest	$	147		$	163
Cash paid during the period for federal income taxes		1,839			¾

The accompanying notes are an integral part of these condensed consolidated financial statements.

CERES GROUP, INC. and SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

~~September 30, 2005~~March 31, 2006

Unaudited

A. Summary of Business and Significant Accounting Policies

Summary of Business

The accompanying unaudited condensed consolidated financial statements of Ceres Group, Inc. and subsidiaries, included herein, have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the ~~nine~~three months ended ~~September 30, 2005~~March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2005.~~2006.

The condensed consolidated financial statements for ~~September 30, 2005~~March 31, 2006 include the continuing operations of Central Reserve Life Insurance Company, Provident American Life and Health Insurance Company, Continental General Corporation and its wholly-owned subsidiary, Continental General Insurance Company, and United Benefit Life Insurance Company.

The condensed consolidated balance sheet presented at December 31, ~~2004~~2005 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, ~~2004.~~2005.

Unless the context indicates otherwise, “we,” “our” and “us” refers to Ceres Group, Inc. and its subsidiaries on a consolidated basis.

Significant Accounting Policies

For further information, refer to “Critical Accounting Policies” and “Other Accounting Policies and Insurance Business Factors” in our Annual Report on Form 10-K for the year ended December 31, ~~2004.~~2005.

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include cash and all liquid securities with maturities of 90 days or less when purchased. At ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, restricted cash was ~~$5.5~~$5.7 million and ~~$7.0~~$6.1 million, respectively. Restricted cash primarily represents cash held

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
~~September 30, 2005~~March 31, 2006
Unaudited

related to fully insured employer shared risk plans, which is restricted from any other use. We are entitled to the investment income from these funds. A corresponding liability is included in the accompanying condensed consolidated balance sheets.

Investments

Our insurance subsidiaries had certificates of deposit and fixed maturity securities on deposit with various state insurance departments to satisfy regulatory requirements.

Property and Equipment

Property and equipment are carried at cost less allowances for depreciation and amortization. Office buildings are depreciated on the straight-line method over 35 years, except for certain components, which are depreciated over 15 years. Depreciation for other property and equipment is computed on the straight-line basis over the estimated useful ~~life~~lives of the equipment, principally three to seven years.

~~Stock-Based Compensation~~New Accounting Pronouncements

~~We account for our stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,~~~~Accounting for Stock Issued to Employees~~~~(APB Opinion No. 25), as amended. Accordingly, no compensation expense has been recognized for our stock option plans in our Consolidated Statements of Operations.~~

~~The following table illustrates the effect on net income and net income per share if~~On January 1, 2006 we ~~had applied the fair-value-based method and recognition provisions of~~adopted Statement of Financial Accounting Standards ~~No. 123,~~~~Accounting for Stock-Based Compensation~~~~(SFAS No. 123), to stock-based compensation.~~

Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
(dollars in thousands, except per share amounts)
Net income, as reported $ 3,430 $ 5,410 $ 12,951 $ 16,476

Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of tax (34 ) (146 ) (20 ) (28 )

Pro forma net income
$ 3,396 $ 5,264 $ 12,931 $ 16,448

Earnings per share
Basic-as reported $ 0.10 $ 0.16 $ 0.38 $ 0.48
Basic-pro forma
0.10 0.15 0.38 0.48

Diluted-as reported $ 0.10 $ 0.16 $ 0.37 $ 0.47
Diluted-pro forma
0.10 0.15 0.37 0.47

~~CERES GROUP, INC. and SUBSIDIARIES~~
~~Notes to Condensed Consolidated Financial Statements — Continued~~
~~September 30, 2005~~
~~Unaudited~~

~~In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)~~ No. 123R, (Revised 2004),Share-Based Payment(SFAS ~~No.~~ 123R), which amends SFAS ~~No. 123. In April 2005, the Securities~~123 and ~~Exchange Commission delayed the implementation of~~supersedes APB 25. SFAS ~~No.~~ 123R from July 1, 2005 until January 1, 2006 for calendar year companies. SFAS No. 123R eliminates the intrinsic value method under APB Opinion No. 25 as an alternative method of accounting for stock-based compensation. SFAS No. 123R also revises the fair-value-based method of accounting forrequires that all share-based payment ~~liabilities, forfeitures and modifications~~transactions, including grants of ~~stock-based awards and clarifies SFAS No. 123’s guidance~~employee stock options, be recognized in ~~several areas, including measuring~~the Consolidated Statement of Operations based on their fair ~~value, classifying an award as equity or as a liability and attributing compensation cost to reporting periods.~~values. In addition, SFAS ~~No.~~ 123R amends SFAS No. 95,Statement of Cash Flows,to require that excess tax benefits be reported as a financing cash flow rather than as a reduction to taxes paid, which is included within operating cash flows. Upon adoption, pro forma disclosures ~~previously permitted under SFAS No. 123 will~~are no longer be an ~~alternative to financial statement recognition. The new statement may be~~alternative. We adopted ~~in one of two ways –~~SFAS 123R using the modified prospective transition method. Under this method, fair value accounting and recognition provisions of SFAS 123R are applied to share-based awards granted or modified subsequent to the ~~modified retrospective method. We are currently evaluating the method~~date of adoption and prior periods are not restated. In addition, for awards granted prior to the ~~effect that~~effective date, the unvested portion of the awards shall be recognized in periods subsequent to the adoption based on the grant date fair value determined for recognition or pro forma disclosure purposes under SFAS 123. For the three months ended March 31, 2006, we recognized additional pre-tax stock-based compensation expense of approximately $0.1 million related to the adoption of SFAS 123R.

Prior to the adoption of SFAS 123R in January 2006, we accounted for our stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. ~~123R will have~~25,Accounting for Stock Issued to Employees(APB Opinion No. 25). Accordingly, no compensation expense was recognized for our stock option plans in our Consolidated Statements of Operations.

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
March 31, 2006
Unaudited

The following table illustrates the effect on net income and net income per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation for the three months ended March 31, 2005.


	Three Months
	Ended
	March 31, 2005
	*(dollars in*
	*thousands, except*
	*per share amounts)*
Net income, as reported	$	4,849

Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax		(18)


Pro forma net income	$	4,831


Net income per share
Basic-as reported	$	0.14
Basic-pro forma		0.14

Diluted-as reported	$	0.14
Diluted-pro forma		0.14

See Note H. Stock Plans for further information on our ~~consolidated results of operations, cash flows and financial position.~~stock-based compensation plans.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

B. Debt

September 30, December 31,
2005 2004
(dollars in thousands)
Bank Credit Facility $ 8,250 $ 10,750


	March 31,		December 31,
	2006		2005
	*(dollars in thousands)*
Bank credit facility	$	6,250	$	7,313

At ~~September 30, 2005,~~March 31, 2006, our credit facility ~~as amended,~~ consisted of a ~~$2.3~~$1.6 million term loan A and a ~~$6.0~~$4.6 million term loan B with National City Bank. The term loan A has remaining quarterly principal payments of ~~$250,000 through December 2005,~~ $375,000 through December 2006, and a payment of $500,000 on March 1, 2007. The ~~$6.0 million~~ term loan B has remaining quarterly principal payments of ~~$687,500 through March 2006,~~ $375,000 through December 2006, $562,500 through December 2007, and a payment of $1,250,000 inon March 1, 2008.

~~CERES GROUP, INC. and SUBSIDIARIES~~
~~Notes to Condensed Consolidated Financial Statements — Continued~~
~~September 30, 2005~~
~~Unaudited~~

Our obligations under the credit agreement ~~as amended,~~ are guaranteed by four of our non-regulated subsidiaries and are secured by pledges of the capital stock of Central Reserve, Continental General and our non-regulated subsidiaries, as well as security interests in certain equipment and other tangible property of Ceres and the non-regulated subsidiaries.

The credit agreement contains various covenants including financial covenants relating to leverage, fixed charge coverage, risk-based capital of regulated insurance subsidiaries and tangible net worth. It also has a number of affirmative and negative covenants, including limitations relating to indebtedness, liens, mergers, purchases and sales of assets, investments, dividends and stock repurchases. At ~~September 30, 2005,~~March 31, 2006, we were in compliance with these covenants.

C. Reinsurance

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. 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. 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 to others, reinsurance does not discharge us from our primary liability to our insureds. The reinsurance company that provides the reinsurance coverage agrees to become the ultimate source of payment for the portion of the liability it is reinsuring and indemnifies us for that portion. However, we remain liable to our insureds with respect to ceded reinsurance if any reinsurer fails to meet its obligations to us. Initial ceding allowances received from reinsurers are accounted for as deferred reinsurance gain and are amortized into income over the estimated remaining life of the underlying policies reinsured, except for interest sensitive products, which are amortized over the expected profit stream of the in force business.

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
~~September 30, 2005~~March 31, 2006
Unaudited

In December 2005, Continental General entered into a quota share reinsurance agreement with Coventry Health Care and its affiliates. Under the terms of the treaty, Continental General agreed to assume 25% of the risk of all Medicare Part D policies with Coventry sold by our agents effective January 1, 2006 and after.

The following table summarizes the net impact of our reinsurance arrangements on premiums and benefits, claims, losses and settlement expenses, commissions, and other operating expenses:


	Three Months Ended						Nine Months Ended						Three Months Ended
	September 30,						September 30,						March 31,
	2005			2004			2005			2004			2006			2005
	*(dollars in thousands)*												*(dollars in thousands)*
Premiums, net
Direct	$	121,767		$	125,172		$	369,871		$	382,642		$	125,741		$	124,758
Assumed		242			241			722			748			1,086			241
Ceded		(16,103	)		(19,134	)		(52,143	)		(60,703	)		(15,633	)		(18,363	)

Total premiums, net	$	105,906		$	106,279		$	318,450		$	322,687		$	111,194		$	106,636


Benefits, claims, losses and settlement expenses, net
Benefits, claims, losses and settlement expenses	$	96,183		$	89,637		$	284,038		$	274,229		$	93,999		$	94,394
Reinsurance recoveries		(15,514	)		(10,675	)		(47,580	)		(41,260	)		(12,522	)		(16,988	)

Total benefits, claims, losses and settlement expenses, net	$	80,669		$	78,962		$	236,458		$	232,969		$	81,477		$	77,406


Selling, general and administrative expenses
Commissions	$	17,669		$	17,190		$	51,919		$	50,582		$	19,016		$	17,401
Other operating expenses		18,591			18,035			55,931			59,950			19,374			18,861
California litigation settlements		¾			3,250			¾			3,250
Reinsurance allowances		(2,968	)		(3,947	)		(10,237	)		(12,680	)		(3,067	)		(3,750	)

Total selling, general and administrative expenses	$	33,292		$	34,528		$	97,613		$	101,102		$	35,323		$	32,512

~~CERES GROUP, INC. and SUBSIDIARIES~~
~~Notes to Condensed Consolidated Financial Statements — Continued~~
~~September 30, 2005~~
~~Unaudited~~

E. Net Income Per Share

Basic and diluted net income per common share is calculated in accordance with SFAS No. 128,Earnings per Share. Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period including the effect of the assumed exercise of dilutive stock options and warrants under the treasury stock method. Basic and diluted weighted average shares of common stock are as follows:


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
	2005		2004		2005		2004		2006		2005
Weighted average shares:

Basic		34,206,025		34,495,077		34,415,330		34,449,631		33,239,294		34,536,410
Stock awards and incremental shares from assumed exercise of stock options and warrants		171,274		260,053		238,493		575,299
Incremental shares from assumed exercise of stock options and warrants										135,226		134,139

Diluted		34,377,299		34,755,130		34,653,823		35,024,930		33,374,520		34,670,549

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
March 31, 2006
Unaudited

F. E.Contingencies and Commitments

The nature of our business subjects us to a variety of legal actions (including class actions) and claims relating to such things as denial of healthcare benefits, premium rate increases, termination of coverage, claims administration, our relationship with the associations that market our products, and alleged violations of state and federal statutes.

We are involved in various ~~other~~ legal and regulatory actions occurring in the normal course of business that could result in significant liabilities and costs. Based on current information, including consultation with outside counsel, we believe that any ultimate liability that may arise from any of these other actions would not materially affect our consolidated financial position or results of operations. However, we cannot predict with certainty the outcome of any of these actions against us or the potential costs involved. Our evaluation of the likely impact of any of these actions could change in the future and an unfavorable outcome in any case could have a material adverse effect on our consolidated financial position, results of operations or cash flows of a future period.

G. F.Federal Income Taxes

We account for federal income taxes using the liability method in accordance with SFAS No. 109,Accounting for Income Taxes.Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the

~~CERES GROUP, INC. and SUBSIDIARIES~~
~~Notes to Condensed Consolidated Financial Statements — Continued~~
~~September 30, 2005~~
~~Unaudited~~

period that includes the enactment date. Deferred tax assets are reviewed for recoverability and a valuation allowance is established, if necessary.

At ~~September 30,~~March 31, 2006 and December 31, 2005, we had a ~~deferred~~federal income tax ~~asset~~receivable, which is included in other assets on our Condensed Consolidated Balance Sheets, of ~~approximately $0.6~~$0.9 million ~~established relating to the remaining net operating loss (NOL) carryforwards of $1.8 million. We have determined that no valuation allowance is required due to our continued profitability~~ and the projection of a continued pattern of taxable income sufficient to utilize these NOLs. During the first nine months of 2004, we evaluated and reduced our valuation allowance for deferred taxes by $5.0$1.0 million, ~~due to our continued profitability and the projection of a continued pattern of taxable income in future periods sufficient to utilize these net operating losses.~~respectively.

Prior to 1984, the Life Insurance Company Income Tax Act of 1959, as amended by the Deficit Reduction Act of 1984 (DRA), permitted the deferral from taxation of a portion of statutory income under certain circumstances. In these situations, the deferred income was accumulated in the Policyholders Surplus Account (PSA). On January 1, 1984 the balance of the PSA account was fixed and only subject to taxation in the event amounts in the PSA account were distributed to shareholders, or if the balance of the account exceeded certain limitations prescribed by the IRS. On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004. Included among the various provisions of the Act was a two-year suspension of the taxation on distributions of amounts from a company’s PSA and reordering rules for current distributions. ~~At December 31, 2004, the accumulated untaxed PSA balance at Central Reserve was $2.9 million.~~

At December 31, 2004, management was evaluating any actions that may enable us to provide current distributions, thus reducing or eliminating the PSA balance. At the close of the suspension period, the previous ordering rules will be reinstated. We previously established a general tax contingency reserve for the untaxed PSA balance exposure because distribution prior to the end of the suspension period was not certain.

On February 24, 2005, Central Reserve received approval from the Ohio Department of Insurance to pay an extraordinary dividend to Ceres Group. Accordingly, we made a $2.9 million tax free distribution from the PSA account and reduced the corresponding tax contingency reserve byof $1.0 million in the first quarter of 2005.

~~CERES GROUP, INC. and SUBSIDIARIES~~
~~Notes to Condensed Consolidated Financial Statements — Continued~~
~~September 30, 2005~~
~~Unaudited~~

The following table presents the revenues, expenses, and profit (loss) before federal income taxes, for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~ attributable to our industry segments. Investment income is allocated by segment based on the level of policy liabilities and benefits accrued and allocated capital. We assume that the longer duration, higher yielding investments support the life, annuity and long-term care blocks of business. The remaining investments, which tend to be shorter in duration, support the major medical and Medicare supplement blocks of business. We do not separately allocate assets or income tax expenses (benefits) by industry segment. Revenues from each segment are primarily generated from premiums charged to external policyholders and interest earned on cash and investments.


	Three Months Ended						Nine Months Ended						Three Months Ended
	September 30,						September 30,						March 31,
	2005			2004			2005			2004			2006			2005
	*(dollars in thousands)*												*(dollars in thousands)*
Medical
Revenues
Net premiums	$	54,244		$	60,097		$	165,917		$	187,989		$	55,827		$	56,566
Net investment income		742			964			2,603			3,458			878			971
Net realized gains (losses)		82			(6	)		204			20			3			(81	)
Fee and other income		3,477			4,236			11,171			12,893			4,075			3,961

		58,545			65,291			179,895			204,360			60,783			61,417

Expenses
Benefits and claims		39,095			44,468			116,431			131,167			40,058			38,920
Other operating expenses		18,539			22,593			56,106			67,414			17,500			19,415

		57,634			67,061			172,537			198,581			57,558			58,335

Segment profit (loss) before federal income taxes	$	911		$	(1,770	)	$	7,358		$	5,779
Segment profit before federal income taxes													$	3,225		$	3,082

Senior and Other
Revenues
Net premiums	$	51,662		$	46,182		$	152,533		$	134,698		$	55,367		$	50,070
Net investment income		5,943			5,317			16,911			15,772			6,025			5,112
Net realized gains		560			56			104			47
Net realized losses														(9	)		(874	)
Fee and other income		493			564			1,550			1,770			552			627

		58,658			52,119			171,098			152,287			61,935			54,935

Expenses
Benefits and claims		41,574			34,494			120,027			101,802			41,419			38,486
Other operating expenses		13,613			11,837			40,086			37,096			14,797			13,167

		55,187			46,331			160,113			138,898			56,216			51,653

Segment profit before federal income taxes	$	3,471		$	5,788		$	10,985		$	13,389		$	5,719		$	3,282

Corporate and Other
Revenues
Net investment income	$	68		$	4		$	120		$	4		$	71		$	—
Net realized gains		108			113			338			334			115			115

		176			117			458			338			186			115

Expenses
Interest expense and financing costs		178			169			533			507			159			175
Other operating expenses		353			285			1,101			1,218			433			371

		531			454			1,634			1,725			592			546

Segment loss before federal income taxes	$	(355	)	$	(337	)	$	(1,176	)	$	(1,387	)	$	(406	)	$	(431	)


Income before federal income taxes	$	4,027		$	3,681		$	17,167		$	17,781		$	8,538		$	5,933

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
March 31, 2006
Unaudited

The following table presents net premiums by major product line for the three months ended March 31, 2006 and 2005:


	Three Months Ended
	March 31,
	2006		2005
	*(dollars in thousands)*
Medical
Individual	$	39,910	$	39,758
Group		15,917		16,808

Total medical premiums, net	$	55,827	$	56,566


Senior and Other
Medicare	$	43,085	$	38,409
Long-term care		6,013		5,746
Life and annuity		4,219		3,582
Dental		1,132		1,325
Other		918		1,008

Total senior and other premiums, net	$	55,367	$	50,070


Total premiums, net	$	111,194	$	106,636

H.Stock Plans

We have a stock plan, the 1998 Key Employee Share Incentive Plan, which provides for the granting of stock options, stock appreciation rights, stock and restricted stock awards to certain employees, non-employee directors, consultants and advisors. This plan permits the granting of up to 3,000,000 shares of our common stock. In general, such grants vest over three years and expire ten years from the date of the grant. In the event of a change in control, all options granted immediately vest and become exercisable in full. At March 31, 2006, there were options outstanding under this plan to purchase 1,187,603 shares.

In 1999, 372 employees each received 1,000 common stock options under the 1998 Employee Stock Option Plan. A second grant was made for new employees hired from January 1, 1999 through September 30, 1999, and still employed as of December 31, 1999. Under this second grant in 2000, 75 employees each received 1,000 common stock options. Each grant vests after three years and expires ten years from the date of the grant, with accelerated vesting upon an event of a change in control. We terminated this plan in December 2000. At March 31, 2006, there were options outstanding under the plan to purchase 285,000 shares.

In 1998 and 1999, pursuant to various individual employment agreements, we granted non-qualified options to purchase 815,000 shares of our common stock to certain key employees. Such grants generally vest over three years and expire ten years from the date of grant. At March 31, 2006, there were options outstanding pursuant to these grants to purchase 315,000 shares.

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
~~September 30, 2005~~March 31, 2006
Unaudited

In 1999, pursuant to the 1999 Special Agents’ Stock Option Plan, we granted 78,706 common stock options to certain regional sales directors and managing general agents. Each grant vested immediately and expires ten years from the date of grant. We terminated this plan at the end of 2000. At March 31, 2006, there were options outstanding under the plan to purchase 78,706 shares.

The following table presents ~~net premiums by major product line~~our stock option activity for the three ~~and nine~~ months ended ~~September 30, 2005~~March 31, 2006 :


								Weighted
				Weighted				Average
	Number			Average		Aggregate		Remaining
	of			Exercise		Intrinsic		Contractual
	Shares			Price		Value		Term
Outstanding at beginning of year		1,882,973		$	6.24

Granted		—			—

Exercised		—			—

Expired		—			—

Forfeited		(16,664	)		4.60


Outstanding at March 31, 2006		1,866,309			6.25	$	—		4.8


Exercisable at March 31, 2006		1,628,809			6.35	$	—		4.3

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the market price of our stock on March 31, 2006 and ~~2004:~~

Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
(dollars in thousands)
Medical

Individual $ 37,634 $ 42,736 $ 115,352 $ 134,567
Group 16,610 17,361 50,565 53,422

Total medical premiums, net $ 54,244 $ 60,097 $ 165,917 $ 187,989

Senior and Other

Medicare supplement $ 39,669 $ 34,410 $ 117,135 $ 98,758
Long-term care 5,945 5,595 17,608 16,883
Life and annuity 3,848 3,738 11,006 11,225
Dental 1,242 1,875 3,869 4,720
Other 958 564 2,915 3,112

Total senior and other premiums, net $ 51,662 $ 46,182 $ 152,533 $ 134,698

Total premiums, net
$ 105,906 $ 106,279 $ 318,450 $ 322,687

~~I. Treasury Stock~~the exercise price, times the number of shares) that would have been received by option holders had all option holders exercised their options on March 31, 2006. This amount is subject to change based on the market price of our stock. At March 31, 2006, the market price of our stock was $5.52 which was less than the weighted average exercise price. Therefore, there was no aggregate intrinsic value associated with our stock options at March 31, 2006.

On ~~May 4, 2005, our Board~~January 1, 2006, we adopted SFAS 123R using a modified prospective transition method. Under this method, we are required to record compensation expense for all awards granted after the date of ~~Directors authorized~~adoption and for the ~~repurchase~~unvested portion of ~~up to $10~~previously granted awards at the date of adoption. Prior period amounts are not restated. For the three months ended March 31, 2006, we recognized additional pre-tax stock-based compensation expense of approximately $0.1 million ~~of our outstanding common stock in the open market or in private transactions utilizing a $10 million extraordinary dividend from our Central Reserve subsidiary.~~

~~In the second and third quarters of 2005, we repurchased 657,765 shares of our common stock, or approximately $3.8 million, in open market transactions at an average price per share of $5.82.~~

On September 8, 2005, we purchased, in a private transaction, 1,000,000 shares of our common stock for $5.9 million from International Managed Care funds (IMC). Two of our directors, Robert A. Spass and Bradley E. Cooper, are affiliated with the IMC funds. The purchase price of $5.92 per share represented a discount of 3%related to the ~~average closing~~adoption of SFAS 123R.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. Option valuation models require the input of highly subjective assumptions including the expected stock price ~~of Ceres’ stock for~~volatility. For the ~~five trading days~~three months ended ~~August~~March 31, 2006 and 2005, ~~and a discount of 5% from the closing price of the common stock on August 31, 2005. There~~there were no ~~commissions paid on this transaction.~~additional stock options granted.

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
March 31, 2006
Unaudited

Warrants

On December 23, 2003, we issued a warrant to purchase 25,000 shares of our common stock at an exercise price of $5.27 per share to a current marketing agency of the Company which exchanged its QQLink stock for cash and the warrant. This warrant, which expires in 2008, was outstanding at March 31, 2006.

Stock Purchase Plan

Our 2000 Employee Stock Purchase Plan was adopted by our stockholders on June 27, 2000. Under the plan, employees may purchase shares of our common stock at a 15% discount from fair value. All of our full time employees, including officers, are eligible to participate in the employee stock purchase plan, subject to limited exceptions. Eligible employees participate voluntarily, and may withdraw from an offering at any time before the stock is purchased. Participation terminates automatically upon termination of employment other than for death, disability or retirement. Six-month offerings are made available beginning May 1 and November 1 of each year. The purchase price per share in an offering will not be less than 85% of the lesser of the stock’s fair value at the beginning of the offering period or on the applicable exercise date and may be paid through payroll deductions.

Agent Stock Purchase Plan

We also have a 2000 Agent Stock Purchase Plan similar to the employee plan under which certain of our agents may purchase shares of our common stock at the same discount from fair value. The agent stock purchase plan does not qualify as an employee stock purchase plan within the meaning of Section 423 of the Code. There are 1,000,000 shares of common stock reserved for issuance in the aggregate under both plans. Both of the plans will terminate when all of the shares reserved for issuance under the plans have been purchased unless sooner terminated by our Board.

Stock Awards

Pursuant to the 1998 Key Employee Share Incentive Plan, as amended, 55,000 shares of restricted stock awards were granted to executive officers in 2004. The awards vest 25% over four years. In addition, 21,771 and 11,263 shares of our common stock were granted to non-employee directors of our Board during the three months ended March 31, 2006 and 2005, respectively.

CERES GROUP, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — Continued
March 31, 2006
Unaudited

The following table reflects the activity for non-vested shares for the three months ended March 31, 2006:


				Weighted
	Number			Average
	of			Grant Date
	Shares			Fair Value
Nonvested shares at beginning of year		41,250		$	6.97

Granted		—			—

Vested		(13,750	)		6.97

Canceled		—			—


Nonvested shares at March 31, 2006		27,500		$	6.97

I.Subsequent Event

On May 1, 2006, we entered into a definitive merger agreement with Great American Financial Resources, Inc. (GAFRI), whereby GAFRI will acquire all of our outstanding shares of common stock through a cash merger. Under the terms of the merger agreement, GAFRI will pay $6.13 in cash for each outstanding share of Ceres common stock, for a total equity price of approximately $205 million on a fully diluted basis. We anticipate that the transaction will be completed in the third quarter of 2006. The transaction is subject to the approval of Ceres’ stockholders and the Ohio and Nebraska Departments of Insurance and other customary conditions, including regulatory approvals.

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

This discussion should be read in conjunction with our condensed consolidated financial statements, notes and tables included elsewhere in this report, as well as, the more detailedManagement’s Discussion and Analysis of Financial Condition and Results of Operations,or MD&A, contained in our ~~2004~~2005 Annual Report on Form 10-K. MD&A may contain forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, future performance involves risks and uncertainties, which may cause actual results to differ materially from those expressed in the forward-looking statements. See “Forward-Looking Statements” for further information.

Overview

Ceres Group, through its insurance subsidiaries, provides a wide array of health and life insurance products through two primary business segments. The Medical segment includes major medical health insurance for individuals, families, associations and small to mid-size businesses. The Senior segment includes senior health, life and annuity products for Americans age 55 and over. To help control medical costs Ceres also provides medical cost management services to its insureds.

Our insurance subsidiaries include Central Reserve Life Insurance Company, Provident American Life &and Health Insurance Company, United Benefit Life Insurance Company and Continental General Insurance Company. Central Reserve markets and sells both major medical health insurance to individuals, families, associations and small employer groups and senior products to Americans age 55 and over. Continental General markets and sells both major medical and senior health and life products to individuals, families, associations, and Americans age 55 and over. Provident American Life ~~previously~~ discontinued new medical sales activities and currently has approximately 200 active major medical certificate holders and 300 life policyholders. In June 2005, Provident American Life began marketing and selling a new portfolio of senior products. United Benefit Life ~~discontinued new sales activities in July 2000 and terminated all of its existing business at the end of 2001. United Benefit Life~~ has no active policyholders.

Recent Event

Critical Accounting Policies

Refer toCritical Accounting Policiesin our ~~2004~~2005 Annual Report on Form 10-K for information on accounting policies that we consider critical in preparing our consolidated financial statements. These policies include significant estimates made by management using information available at the time the estimates were made. However, these estimates could change materially if different information or assumptions were used.

1517

Quarter Ended ~~September 30, 2005~~March 31, 2006 Compared to Quarter Ended ~~September 30, 2004~~March 31, 2005


													Three			Three
	Three Months			Three Months			Increase						Months			Months			Increase
	Ended			Ended			(Decrease) from						Ended			Ended			(Decrease) from
	September 30,			September 30,			Previous Year						March 31,			March 31,			Previous Year
	2005			2004			Dollars			%			2006			2005			Dollars			%
	*(dollars in thousands, except per share amounts)*												*(dollars in thousands, except per share amounts)*
Premiums, net
Medical	$	54,244		$	60,097		$	(5,853	)		(9.7	)%	$	55,827		$	56,566		$	(739	)		(1.3	)%
Senior and other		51,662			46,182			5,480			11.9			55,367			50,070			5,297			10.6

Total premiums, net		105,906			106,279			(373	)		(0.4	)		111,194			106,636			4,558			4.3

Net investment income		6,753			6,285			468			7.4			6,974			6,083			891			14.6
Net realized gains		750			163			587			360.1
Net realized gains (losses)														109			(840	)		949			113.0
Fee and other income		3,970			4,800			(830	)		(17.3	)		4,627			4,588			39			0.9


		117,379			117,527			(148	)		(0.1	)
														122,904			116,467			6,437			5.5

Benefits, claims, losses and settlement expenses
Medical		39,095			44,468			(5,373	)		(12.1	)		40,058			38,920			1,138			2.9
Senior and other		41,574			34,494			7,080			20.5			41,419			38,486			2,933			7.6

Total benefits, claims, losses and settlement expenses		80,669			78,962			1,707			2.2			81,477			77,406			4,071			5.3

Selling, general and administrative expenses		33,292			34,528			(1,236	)		(3.6	)		35,323			32,512			2,811			8.6
Net (deferral) amortization and change in deferred acquisition costs and value of business acquired		(787	)		187			(974	)		(520.9	)
Net (deferral) amortization and change in acquisition costs and value of business acquired														(2,593	)		441			(3,034	)		(688.0	)
Interest expense and financing costs		178			169			9			5.3			159			175			(16	)		(9.1	)

		113,352			113,846			(494	)		(0.4	)
														114,366			110,534			3,832			3.5


Income before federal income taxes		4,027			3,681			346			9.4			8,538			5,933			2,605			43.9
Federal income tax expense (benefit)		597			(1,729	)		2,326			134.5

Federal income tax expense														2,996			1,084			1,912			176.4

Net income	$	3,430		$	5,410		$	(1,980	)		(36.6	)	$	5,542		$	4,849		$	693			14.3


Net income per share
Basic	$	0.10		$	0.16		$	(0.06	)		(37.5	)	$	0.17		$	0.14		$	0.03			21.4
Diluted		0.10			0.16			(0.06	)		(37.5	)		0.17			0.14			0.03			21.4

Medical loss ratio		72.1	%		74.0	%		¾			¾			71.8	%		68.8	%		—			—
Senior loss ratio		80.5	%		74.7	%		¾			¾			74.8	%		76.9	%		—			—
Overall loss ratio		76.2	%		74.3	%		¾			¾			73.3	%		72.6	%		—			—
Selling, general and administrative expense ratio		31.4	%		32.5	%		¾			¾			31.8	%		30.5	%		—			—

Net Premiums (net of reinsurance ceded)

For the quarter ended ~~September 30, 2005,~~March 31, 2006, total net premiums ~~decreased 0.4%~~increased 4.3% to ~~$105.9~~$111.2 million compared to ~~$106.3~~$106.6 million for the ~~third~~first quarter of ~~2004.~~2005.

Medical

Medical premiums for the quarter ended ~~September 30, 2005~~March 31, 2006 were ~~$54.2~~$55.8 million compared to ~~$60.1~~$56.6 million for the quarter ended ~~September 30, 2004,~~March 31, 2005, a decrease of ~~9.7%~~1.3%. The decrease in medical premiums was primarily the result of a ~~15.9%~~3.8% decrease in major medical certificates in force from ~~70,290~~63,582 at ~~September 30, 2004~~March 31, 2005 to ~~59,149~~61,171 at ~~September 30,~~March 31, 2006 due to continued high lapsation rates on renewal business partially offset by an increase in new business production and renewal rate increases.

Medical premiums increased 1.3% from the fourth quarter of 2005 due to ~~high lapse rates~~the significant increase in new business on ~~renewal business.~~

~~The decline~~the recently released Advantage product series. Due to the continued increase in ~~major medical premium moderated~~new sales, Medical segment premiums are still expected to increase approximately 5% in the third quarter of 2005 to 6% on an annualized basis. In the third quarter of 2005, we introduced our new Advantage Series of major medical products designed to offer customers a choice of benefit levels and prices.2006.

Senior and Other

Senior and other premiums increased ~~$5.5~~$5.3 million to ~~$51.7~~$55.4 million for the quarter ended ~~September 30, 2005~~March 31, 2006 compared to ~~$46.2~~$50.1 million for the same ~~period~~quarter in ~~2004.~~2005. This ~~11.9%~~10.6% increase in senior and other premiums was primarily the result of ~~a 15.3% increase in Medicare supplement premium due to new business production as well as~~ rate increases that were ~~filed in 2004 and~~ implemented in the first quarter of ~~2005. We expect~~2006. The increases were partially offset by higher shock lapse rates associated with the first quarter 2006 Medicare supplement rate increases.

Based on current new business production trends and slightly higher-than-expected lapse rates on our Medicare supplement business related to the 2006 rate increases, Senior segment premiums ~~in this segment~~are now expected to increase approximately ~~12% overall~~11% in ~~2005.~~

In June 2005, we introduced new Medicare supplement products through our Provident American Life subsidiary and began selling new senior life insurance plans. We also developed a career distribution channel to focus on marketing senior products of our Provident American Life and Continental General subsidiaries. We currently have appointed 18 regional sales managers and approximately 180 agents to focus specifically on marketing our senior product portfolio.

In addition, we have begun marketing Medicare Part D prescription drug plans through our relationship with Coventry Health Care, Inc., and its affiliates. We have sent introductory mailings to approximately 130,000 of our existing senior insureds. We plan to participate in 25% of the risk on all Part D policies sold by our agents. Part D policies will be effective January 1, 2006 and after.2006.

Other Revenues

Net investment income was ~~$6.8~~$7.0 million for the ~~third~~first quarter of 2006 compared to $6.1 million for the first quarter of 2005, ~~compared to $6.3 million for the third quarter of 2004,~~ an increase of ~~7.4%~~14.6%. The increase was attributable to an increase in the overall book yield of our fixed maturities portfolio caused by the increased interest rate environment and higher average invested balances. The book yield of our ~~investment~~fixed maturities portfolio at ~~September 30, 2005~~March 31, 2006 was ~~5.38%~~5.45%, compared to a book yield of ~~5.23%~~5.31% at ~~September 30, 2004.~~March 31, 2005. In addition, we reallocated our investment in convertible bond securities in the second quarter of 2005 to a higher yielding collateralized securities fund.

Net realized gains were $0.1 million for the first quarter of 2006 compared to net realized losses of $0.8 million for the ~~third~~first quarter of 2005. The first quarter of 2005 ~~compared to $0.2~~includes $1.2 million ~~for~~in unrealized losses on our trading portfolios, which were liquidated in the third quarter ~~of 2004. The $0.6 million increase was primarily attributable to a $0.2 million increase in realized gains on our available-for-sale investment portfolios and a $0.4~~

~~million increase in realized gains on our trading portfolios. The trading portfolios were liquidated in September~~ of 2005.

Fee and other income was ~~$4.0~~$4.6 million for the quarter ended ~~September 30, 2005 compared~~March 31, 2006 which was comparable to ~~$4.8 million for~~ the ~~same~~first quarter of ~~2004, a decrease of 17.3%. This decrease was primarily attributable to the decline in major medical policies and the associated policy fee income.~~2005.

Benefits, Claims, Losses and Settlement Expenses

Total benefits, claims, losses and settlement expenses increased to ~~$80.7~~$81.5 million for the quarter ended ~~September 30, 2005~~March 31, 2006 compared to ~~$79.0~~$77.4 million for the ~~third~~first quarter of ~~2004,~~2005, an increase of ~~2.2%~~5.3%.

Medical

Medical benefits, claims, losses and settlement expenses were ~~$39.1~~$40.1 million for the quarter ended ~~September 30, 2005~~March 31, 2006 compared to ~~$44.5~~$38.9 million for the ~~third~~first quarter of ~~2004, a decrease~~2005, an increase of ~~12.1%~~2.9%. ~~The decrease was primarily the result of a smaller volume of business in force.~~ In addition, the medical loss ratio was ~~72.1%~~71.8% for the quarter ended ~~September 30, 2005~~March 31, 2006 compared to ~~74.0%~~68.8% for the same ~~period in 2004.~~quarter of 2005. The ~~decrease in the medical~~first quarter 2006 loss ratio was primarily ~~due to favorable reserve development which was partially offset~~impacted by a strengthening of claim reserves and an ~~increased severity of claims.~~increase in January in-patient hospital stays. The loss ratio in the Medical segment is expected to be higher in the ~~fourth quarter~~balance of ~~2005 consistent with quarterly seasonality patterns experienced last year.~~2006 as insureds meet their initial co-pays and deductibles. We expect the loss ratio in ~~the Medical segment~~2006 to ~~be approximately 70 basis points higher for the full year 2005 than 2004.~~remain consistent with 2005.

Senior and Other

Senior and other benefits, claims, losses and settlement expenses were ~~$41.6~~$41.4 million for the quarter ended ~~September 30, 2005,~~March 31, 2006, compared to ~~$34.5~~$38.5 million in the ~~third~~first quarter of ~~2004.~~2005. The senior and other loss ratio was ~~80.5%~~74.8% for the ~~third~~first quarter of ~~2005~~2006 compared to ~~74.7%~~76.9% for the ~~third~~first quarter of ~~2004.~~2005. The ~~increase~~improvement in the loss ratio in the ~~third~~first quarter of ~~2005~~2006 was due primarily to ~~unfavorable~~favorable long-term care experience, in the third quarter of 2005, compared to favorable experience and development of long-term care reserves in the third quarter of 2004. The number of long-term care open claims increased approximately 4% during the quarter, resulting in a $1.6 millionpartially offset by an increase in ~~reserves. In addition,~~ the Medicare supplement loss ratio ~~increased~~ from ~~75.2%~~71.9% in the ~~third quarter of 2004 to 75.5% in the third~~first quarter of 2005 ~~reflecting $1.3 million~~to 74.0% in the first quarter of ~~adverse development of the June 30, 2005 claim reserves.~~2006. The Medicare supplement loss ratio is still expected to be approximately ~~74.0%~~72% for the full year ~~2005~~2006 compared to ~~71.9%~~73.8% for ~~2004. The overall loss ratio in this segment is expected to be approximately 78% in~~ 2005.

Other Expenses and Net Income

Selling, general and administrative expenses ~~decreased~~increased to ~~$33.3~~$35.3 million in the ~~third~~first quarter of 2006 compared to $32.5 million in the first quarter of 2005, ~~compared to $34.5~~an increase of $2.8 million ~~in the third quarter of 2004, a decrease of 3.6%~~or 8.6%. ~~Included in selling, general and administrative expenses in the third quarter of 2004~~The $2.8 million increase was a $3.3 million pre-tax charge related to the settlement of two California lawsuits against the company and its subsidiaries. These lawsuits related primarily to challenges to premium increases for California holders of major medical policies issued by United Benefit Life and Provident American Life.

~~Excluding this charge, other operating expenses increased by $0.6 million~~ primarily attributable to ~~an increase in regulatory fees due to routine regulatory exams by~~ the domiciliary states at both of our major insurance companies. In addition, commissions increased by $0.5 million due to an increase in the overall commissions rate attributable to higher first year premium and reinsurance allowances decreased by $1.0 million due to a lower volume of ceded premium.following:

	•		a $1.6 million increase in commissions due to an increase in the overall commissions rate attributable to higher first year premium;

	•		a $0.5 million increase in other operating expenses due primarily to an increase in salaries and benefits; and

	•		reduced reinsurance allowances of $0.7 million due to expected lapsation of closed blocks of reinsured business.

As a percentage of premium, selling, general and administrative expenses were ~~31.4%~~31.8% in the ~~third~~first quarter of ~~2005~~2006 compared to ~~32.5%~~30.5% in the ~~third~~first quarter of ~~2004, including the California lawsuit settlements.~~2005.

The net ~~(deferral)~~ amortization and change in deferred acquisition costs (DAC) and value of business acquired (VOBA) resulted in a net deferral of ~~$0.8~~$2.6 million infor the ~~third~~first quarter of ~~2005~~2006 compared to net amortization of ~~$0.2~~$0.4 million for the ~~third~~first quarter of ~~2004. The~~2005.

In the Senior segment, the DAC asset increased by $2.3 million in the first quarter of 2006 compared to $1.5 million for the same period in 2005 attributable to an increase in Medicare supplement new business ~~production resulted~~production. In the Medical segment, the DAC asset increased $1.1 million in the first quarter of 2006 compared to a decrease of $1.3 million in the first quarter of 2005. The higher level of costs capitalized was attributable to a significant increase in new sales in the ~~third quarter of 2005 compared to the same period a year ago.~~Medical segment.

Interest expense and financing costs were $0.2 million for the ~~third~~first quarter of ~~2005~~2006 which was comparable to the ~~third~~first quarter of ~~2004. The higher effective interest rate on our bank credit facility in the quarter was offset by the lower level of outstanding debt.~~2005.

Income before federal income taxes was ~~$4.0~~$8.5 million for the ~~third~~first quarter of ~~2005,~~2006, compared to ~~$3.7~~$5.9 million for the same period in ~~2004. The third quarter of 2004 included a $3.3 million pre-tax charge related to the settlement of the California lawsuits.~~2005.

A federal income tax expense of ~~$0.6~~$3.0 million was recorded for the ~~third~~first quarter of 2006. This compares to a federal income tax expense of $1.1 million for the first quarter of 2005, which included a ~~$0.8~~$1.0 million ~~reduction~~ ($0.02 per share) to the federal income tax contingency reserve due to elimination of tax contingencies associated with the closed tax years. In the third quarter of 2004, a federal income tax benefit of $1.7 million was recorded, which included a $3.0 million reduction ($0.09 per share) to the deferred tax valuation allowance. During the third quarter of 2004, we evaluated our valuation allowance for deferred taxes and determined that no valuation allowance was required due to the continued profitability of the company and the projection of a continued pattern of taxable income in future periods sufficient to utilize these net operating losses. The effective tax rate for the third quarter of 2005 was 14.8% of the income before federal income taxes.

~~Net income was $3.4 million, or $0.10 per diluted share, for the third quarter of 2005, compared to $5.4 million, or $0.16 per diluted share for the third quarter of 2004.~~

~~Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004~~

Nine Months Nine Months Increase
Ended Ended (Decrease) from
September 30, September 30, Previous Year
2005 2004 Dollars %
(dollars in thousands, except per share amounts)
Premiums, net
Medical $ 165,917 $ 187,989 $ (22,072 ) (11.7 )%
Senior and other 152,533 134,698 17,835 13.2

Total premiums, net 318,450 322,687 (4,237 ) (1.3 )

Net investment income 19,634 19,234 400 2.1
Net realized gains 646 401 245 61.1
Fee and other income 12,721 14,663 (1,942 ) (13.2 )

351,451 356,985 (5,534 ) (1.6 )

Benefits, claims, losses and settlement expenses
Medical 116,431 131,167 (14,736 ) (11.2 )
Senior and other 120,027 101,802 18,225 17.9

Total benefits, claims, losses and settlement expenses 236,458 232,969 3,489 1.5

Selling, general and administrative expenses 97,613 101,102 (3,489 ) (3.5 )
Net (deferral) amortization and change in deferred acquisition costs and value of business acquired (320 ) 4,626 (4,946 ) (106.9 )
Interest expense and financing costs 533 507 26 5.1

334,284 339,204 (4,920 ) (1.5 )

Income before federal income taxes 17,167 17,781 (614 ) (3.5 )
Federal income tax expense 4,216 1,305 2,911 223.1

Net income
$ 12,951 $ 16,476 $ (3,525 ) (21.4 )

Net income per share

Basic $ 0.38 $ 0.48 $ (0.10 ) (20.8 )
Diluted 0.37 0.47 (0.10 ) (21.3 )

Medical loss ratio
70.2 % 69.8 % ¾ ¾
Senior loss ratio
78.7 % 75.6 % ¾ ¾
Overall loss ratio
74.3 % 72.2 % ¾ ¾
Selling, general and administrative expense ratio
30.7 % 31.3 % ¾ ¾

~~Net Premiums (net of reinsurance ceded)~~

~~For the nine months ended September 30, 2005, total net premiums decreased 1.3% to $318.5 million, compared to $322.7 million for the same period in 2004.~~

~~Medical~~

Medical premiums for the nine months ended September 30, 2005 were $165.9 million, compared to $188.0 million for the nine months ended September 30, 2004, a decrease of 11.7%. The decrease in medical premiums was primarily the result of a 15.9% decrease in major medical certificates in force from 70,290 at September 30, 2004 to 59,149 at September 30, 2005 due to high lapse rates on renewal business.

The decline in major medical premium moderated in the third quarter of 2005 to 6% on an annualized basis. In the third quarter of 2005, we introduced our new Advantage Series of major medical products designed to offer customers a choice of benefit levels and prices. We now expect the decline in medical premiums to moderate for 2005 to approximately 3% on an annualized basis as the level of new business production approaches the level of business that is lapsing.

~~Senior and Other~~

Senior and other premiums increased $17.8 million to $152.5 million for the nine months ended September 30, 2005 compared to $134.7 million for the same period in 2004. This 13.2% increase in senior and other premiums was primarily the result of an 18.6% increase in Medicare supplement premium due to new business production as well as rate increases that were filed in 2004 and implemented in the first quarter of 2005. We expect premiums in this segment to increase approximately 12% overall in 2005.

~~Other Revenues~~

Net investment income was $19.6 million for the first nine months of 2005, compared to $19.2 million for the first nine months of 2004, an increase of 2.1%. The book yield of our investment portfolio at September 30, 2005 was 5.38% compared to a book yield of 5.23% at September 30, 2004.

Net realized gains were $0.6 million for the first nine months of 2005, compared to $0.4 million for the first nine months of 2004. The $0.2 million increase was primarily attributable to a $0.9 million increase in realized gains on our available-for-sale portfolios in the first nine months of 2005 offset by a $0.7 million realized loss on our trading portfolios. The trading portfolios were liquidated in September of 2005.

Fee and other income was $12.7 million for the nine months ended September 30, 2005, compared to $14.7 million for the same period in 2004, a decrease of 13.2%. This decrease was primarily attributable to the decline in major medical policies and the associated policy fee income.

~~Benefits, Claims, Losses and Settlement Expenses~~

Total benefits, claims, losses and settlement expenses increased to $236.5 million for the nine months ended September 30, 2005, compared to $233.0 million for the first nine months of 2004, an increase of 1.5%.

~~Medical~~

Medical benefits, claims, losses and settlement expenses were $116.4 million for the nine months ended September 30, 2005, compared to $131.2 million for the same period in 2004, a decrease of 11.2%. The decrease was primarily the result of a smaller volume of business in force. In addition, the medical loss ratio was 70.2% for the nine months ended September 30, 2005 compared to 69.8% for the same period in 2004. The loss ratio in the Medical segment is expected to be higher in the fourth quarter of 2005 consistent with quarterly seasonality patterns experienced last year. We expect the loss ratio in the Medical segment to be approximately 70 basis points higher for the full year 2005 than 2004.

~~Senior and Other~~

Senior and other benefits, claims, losses and settlement expenses were $120.0 million for the nine months ended September 30, 2005, compared to $101.8 million for the same period in 2004. The senior and other loss ratio was 78.7% for the first nine months of 2005, compared to 75.6% for the same period in 2004. This increase was primarily due to an increase in the Medicare supplement loss ratio from 72.3% in the first nine months of 2004 to 75.0% in the first nine months of 2005, as well as unfavorable long-term care experience in the third quarter of 2005. The Medicare supplement loss ratio is expected to be 71.1% in the fourth quarter of the year consistent with the historical seasonality of this product. For the full year 2005, the Medicare supplement loss ratio is now expected to be approximately 74.0% compared to 71.9% for 2004. The overall loss ratio in this segment is expected to be approximately 78% in 2005.

~~Other Expenses and Net Income~~

Selling, general and administrative expenses decreased to $97.6 million in the first nine months of 2005, compared to $101.1 million for the same period in 2004, a decrease of 3.5%. Included in selling, general and administrative expenses in the first nine months of 2004, was a $3.3 million pre-tax charge related to the settlement of two California lawsuits against the company and its subsidiaries. These lawsuits related primarily to challenges to premium increases for California holders of major medical policies issued by United Benefit Life and

~~Provident American Life. Excluding this charge, other operating expenses decreased $4.0 million attributable to the following:~~

	•		~~a decrease in consulting expenses of approximately $1.0 million related to bringing our Cleveland data processing and programming back in-house from a third party vendor in the first half of 2004;~~

	•		~~a decrease in fees charged by third party administrators for claims processing and other administrative services due to a decline in medical business in force;~~

	•		~~a decrease in legal fees;~~

	•		~~a decrease in salaries and benefits due to a reduced workforce;~~

~~which was partially offset by an increase in regulatory fees due to routine regulatory exams by the domiciliary states of both of our major insurance companies.~~

The $4.0 million decrease in other operating expenses was partially offset by an increase in commissions of $1.3 million due to an increase in the overall commission rate attributable to higher first year premium and reduced reinsurance allowances of $2.4 million due to a lower volume of ceded premium. As a percentage of premium, selling, general and administrative expenses were 30.7% in the first nine months of 2005 compared to 31.3% in the first nine months of 2004, including the California litigation settlements.

The net (deferral) amortization and change in deferred acquisition costs (DAC) and value of business acquired (VOBA) resulted in a net deferral of $0.3 million for the first nine months of 2005, compared to net amortization of $4.6 million for the first nine months of 2004. In the Senior segment, the DAC asset increased by $5.5 million in the first nine months of 2005 compared to $3.3 million for the same period in 2004. The increase was primarily due to a higher level of costs capitalized due to an increase in Medicare supplement business. The decline in the DAC asset in the Medical segment was $3.4 million in the first nine months of 2005 compared to $6.3 million in the first nine months of 2004. Higher lapse rates on new and existing medical business caused a higher-than-expected increase in the level of DAC amortization in 2004.

~~Interest expense and financing costs were $0.5 million in the first nine months of 2005, which was comparable to the first nine months of 2004.~~

Income before federal income taxes was $17.2 million for the first nine months of 2005, compared to $17.8 million for the same period in 2004. The first nine months of 2004 included a $3.3 million pre-tax charge related to the settlement of the California lawsuits.

~~A federal income tax expense of $4.2 million was recorded for the first nine months of 2005, which included a $1.8 million ($0.05~~0.03 per share) federal income tax benefit related to the reduction of federal income tax reserves associated with the elimination of our untaxed policyholder surplus account exposure and recently closed tax years. In the first nine months of 2004, a federal income tax expense of $1.3 million was recorded, which included a $5.0 million reduction in the deferred tax valuation allowance. As a result of our continued profitability, a projection of continued taxable income in future periods, and the corresponding utilization of the

~~net operating loss (NOL) carryforwards against 2004 taxable income, the deferred tax valuation allowance was reduced by $5.0 million, or $0.14 per share, in the first nine months of 2004.~~exposure. The effective tax rate ~~including the $1.8 million reduction of federal income tax reserves,~~ was ~~24.6%~~35.1% of the income before federal income taxes for the first ~~nine months~~quarter of ~~2005.~~2006. The effective tax rate for the first ~~nine months~~quarter of ~~2004,~~2005, including the ~~$5.0 million~~ reduction ~~to the deferred~~of federal income tax ~~valuation allowance,~~reserves, was ~~7.3%~~18.3% of the income before federal income taxes.

Net income was ~~$13.0~~$5.5 million, or ~~$0.37~~$0.17 per ~~diluted~~ share, for the first ~~nine months~~quarter of ~~2005,~~2006, compared to ~~$16.5~~$4.8 million, or ~~$0.47~~$0.14 per ~~diluted~~ share for the first ~~nine months~~quarter of ~~2004.~~2005.

Liquidity and Capital Resources

Liquidity is our ability to generate adequate amounts of cash to meet our financial commitments. Our major needs for cash are to enable our insurance subsidiaries to pay claims and expenses as they come due and for Ceres to pay interest on, and to repay principal of, its indebtedness. The primary sources of cash are premiums, investment income, fee income, equity and debt financings, and reimbursements from reinsurers. Payments consist of current claim payments to insureds, medical cost management expenses, operating expenses such as rent, salaries, employee benefits, commissions, taxes, and interest on debts. Net cash provided by operating activities for the period ended ~~September 30, 2005~~March 31, 2006 was ~~$38.0~~$7.5 million compared to ~~$3.2~~$8.3 million at ~~September 30, 2004.~~March 31, 2005. Cash provided by operating activities ~~increased~~decreased compared to the first ~~nine months~~quarter of ~~2004 primarily~~2005 due to $1.8 million in federal income tax payments to the ~~result~~Internal Revenue Service in the first quarter of ~~the following:~~

	•		~~the prior year period~~2006 and an increase in major medical claim payments. The first quarter of 2005 included ~~a significant reduction in our major medical claim reserves due to our declining block of major medical business in force and the decline in our claim inventory; and~~

	•		an increase of operating cash flows of approximately $22.8 million due to the liquidation of the trading investment portfolios in September of 2005. The proceeds from the liquidation of the trading investment portfolios will be re-invested in the fourth quarter of 2005.

~~The increases previously mentioned were partially offset by~~ the payment of the California litigation ~~settlements in the first quarter of 2005.~~settlements.

Assets decreased to ~~$765.4~~$769.8 million at ~~September 30, 2005~~March 31, 2006 from ~~$766.0~~$771.0 million at December 31, ~~2004, a decrease of 0.1%.~~2005. Assets of ~~$470.0~~$491.2 million, or ~~61.4%~~63.8% of the total assets, were in investments at ~~September 30, 2005.~~March 31, 2006. Fixed maturities, our primary ~~investments,~~investment, were ~~$431.5~~$448.4 million, or ~~91.8%~~91.3% of total investments, at ~~September 30, 2005~~March 31, 2006 compared to ~~$474.6~~$447.5 million ~~or 95.9% of total investments,~~ at December 31, ~~2004.~~2005. Other investments consist of equity securities, an investment in a limited partnership, and policy loans and mortgage loans. During the second quarter of 2005, we invested approximately $20.0 million in a collateralized securities fund which invests in asset-backed and mortgage-backed securities. This fund invests a minimum of 80% of its total assets in investment-grade securities. The shares in the fund are classified as equity securities available-for-sale at September 30, 2005.

Approximately ~~94.6%~~95.5% of our fixed maturities available-for-sale were of investment grade quality at ~~September 30, 2005.~~March 31, 2006. In addition to the fixed maturities, we also had ~~$46.8~~$25.3 million in cash and cash equivalents of which ~~$5.5~~$5.7 million was restricted at ~~September 30, 2005.~~March 31, 2006.

2522

The total reinsurance receivable was ~~$134.2~~$127.5 million at ~~September 30, 2005.~~March 31, 2006. Of this amount, ~~$132.0~~$124.7 million represents reserves held by our reinsurers under our various reinsurance treaties in place. Hannover holds substantially all of these reserves.

The total policy liabilities and benefits accrued were ~~89.7%~~89.8% of the total liabilities at ~~September 30, 2005~~March 31, 2006 compared to ~~87.3%~~89.5% at December 31, ~~2004.~~2005.

Credit Agreement. At ~~September 30, 2005,~~March 31, 2006, our credit facility ~~as amended,~~ consisted of a ~~$2.3~~$1.6 million term loan A and a ~~$6.0~~$4.6 million term loan B with National City Bank. The term loan A has remaining quarterly principal payments of ~~$250,000 through December 2005,~~ $375,000 through December 2006, and a payment of $500,000 on March 1, 2007. The ~~$6.0 million~~ term loan B has remaining quarterly principal payments of ~~$687,500 through March 2006,~~ $375,000 through December 2006, $562,500 through December 2007, and a payment of $1,250,000 inon March 1, 2008.

Both term loans bear interest at floating rates, based on either Prime or LIBOR, plus applicable spreads. Under Prime rate borrowings, the interest rate for term loan A and term loan B will be the Prime interest rate plus 0.50% and ~~1.25%~~1.0%, respectively. Under Eurodollar borrowings, the interest rate for term loan A and term loan B will be LIBOR plus 3.25% and ~~4.00%~~3.75%, respectively. At ~~September 30, 2005,~~March 31, 2006, the interest rate on our term loan A balance of ~~$2.3~~$1.6 million was ~~7.125%~~8.06% per annum and on our ~~$6.0~~$4.6 million term loan B was ~~7.625%~~8.56% per annum.

The credit agreement contains various covenants including financial covenants relating to leverage, fixed charge coverage, risk-based capital of regulated insurance subsidiaries, and tangible net worth. It also has a number of affirmative and negative covenants, including limitations relating to indebtedness, liens, mergers, purchases and sales of assets, investments, dividends, and stock repurchases. At ~~September 30, 2005,~~March 31, 2006, we were in compliance with these covenants.

Off-Balance Sheet Arrangements.We do not have transactions or relationships with variable interest entities, and we do not have any off-balance sheet financing other than normal operating leases.

2623

Contractual ~~Obligations.~~Obligations.The following schedule summarizes current and future contractual obligations as of ~~September 30, 2005:~~March 31, 2006:


	Payments Due by Year										Payments Due by Year
			Less than										Less than						After 5
Contractual Obligations	Total		1 year		1-3 years		4-5 years		After 5 years		Total		1 year		1-3 years		4-5 years		years
	*(dollars in thousands)*										*(dollars in thousands)*
Long-term debt	$	8,250	$	3,500	$	4,750	$	—	$	—	$	6,250	$	3,313	$	2,937	$	—	$	—

Long-term debt interest (1)		837		512		325		—		—		616		437		179		—		—

Operating leases		23,371		2,770		4,683		3,911		12,007		22,149		2,665		4,506		3,947		11,031

Unfunded/callable investment commitments (2)		12,535		12,535		—		—		—		10,000		10,000		—		—		—

Deposit and investment contracts (3)		238,644		21,230		38,595		32,387		146,432		237,937		21,329		37,003		33,289		146,316

Other policy claims and benefits payable		100,771		70,481		18,727		6,485		5,078

Other policy claims and benefits payable (4)												101,583		71,418		17,447		6,463		6,255

Total contractual obligations	$	384,408	$	111,028	$	67,080	$	42,783	$	163,517	$	378,535	$	109,162	$	62,072	$	43,699	$	163,602

In December 2003, we committed to invest $5.0 million in a limited partnership, NYLIM-GCR Fund I-2002, L.P. Investments by this partnership are expected to consist primarily of a diversified pool of subordinated real estate mezzanine debt and sub-tranche loans with an expected concentration in office assets located in major metropolitan areas. These capital commitments can be called by the partnership at any time during the commitment period to fund working capital needs or to purchase new investments. Once the commitment period expires, we are under no obligation to fund the remaining unfunded commitment, but may elect to do so. During the first nine months of 2005, the partnership made capital calls on our limited partnership commitment of $0.6 million and made returns of capital totaling $1.1 million from the proceeds received from partial debt repayments. The partnership reserves the right to recall capital returned as a result of loan repayments for the remainder of the commitment period. At September 30, 2005, we had outstanding unfunded and callable capital commitments totaling $1.3 million related to this limited partnership.

period to fund working capital needs or to purchase new investments. Once the commitment period expires, we are under no obligation to fund the remaining unfunded commitment, but may elect to do so. The partnership has not made any capital calls on our $10.0 million commitment. Therefore, at ~~September 30, 2005,~~March 31, 2006, we had outstanding unfunded and callable capital commitments totaling $10.0 million related to this limited partnership.

In ~~September 2005,~~addition, we committed to invest ~~$2.0~~$5.0 million ~~or 10.5% of~~in the ~~total trust, to a~~aggregate, in two commercial mortgage loan ~~trust.~~trusts in 2005. The ~~trust, when fully funded, will be comprised of 14 small balance commercial mortgage loans in nine states. At September 30, 2005, we had~~ outstanding unfunded ~~commitments totaling $1.3~~commitment of $2.0 million ~~related to this commercial mortgage loan trust.~~at December 31, 2005 was funded in the first quarter of 2006.

We believe that cash flow from operating activities will be sufficient to meet the currently anticipated operating and capital expenditure requirements of our subsidiaries over the next 12 months. Funds to meet our debt obligations are generated from fee income from our non-regulated subsidiaries. Our ability to make scheduled payments of the principal and interest on our indebtedness depends on our future performance and the future performance of our non-regulated subsidiaries, which are subject to economic, financial, competitive and other factors beyond our control. Fee income is derived from fees charged primarily on our major medical business. ~~As that business continues to decline, fee income will decline.~~

Dividends from our regulated insurance subsidiaries are subject to, and limited by, state insurance regulations. In ~~2005,~~2006, Continental General could pay a dividend to Ceres ~~Group, the parent company,~~ of up to ~~$10.3~~$6.2 million without prior approval of ~~the~~its state regulator. ~~In 2005,~~However, in 2006, Central Reserve iswould be prohibited from paying any dividends without prior approval of its state regulator due to its statutory level of unassigned surplus. However, on February 24, 2005, Central Reserve received approval from the Ohio Department of Insurance to pay an extraordinary dividend of $12.0 million to Ceres Group. On May 4, 2005, Central Reserve paid Ceres Group a dividend of $10.0 million, which was used for the stock repurchase program.

If our non-regulated subsidiaries do not generate sufficient fee income or we are unable to take dividends from our insurance subsidiaries to service all of our debt obligations, there may be a material adverse effect on our business, financial condition and results of operations, and a significant adverse effect on the market value of our common stock. In addition, if needed, additional financing may not be available on terms favorable to us or at all.

Financial Information about Industry Segments

We have three segments: Medical, which includes catastrophic and comprehensive major medical plans; Senior and Other, which includes Medicare supplement, long-term care, dental, life insurance and annuities; and Corporate and Other, which includes interest income, interest expense, and corporate expenses of the parent company. See Note H.G. Operating Segments, to our Condensed Consolidated Financial Statements for further information.

~~Market Risk and Management Policies~~

~~The following is a description of certain risks facing health and life insurers and how we mitigate those risks:~~

~~Inadequate Pricing Risk~~is the risk that the premium charged for insurance and insurance related products is insufficient to cover the costs associated with the distribution of such products, including benefits, claims and losses, settlement expenses, acquisition expenses and other corporate expenses. We utilize a variety of actuarial and qualitative methods to set our pricing levels. Any negative fluctuation from our estimates of the effect of continued medical inflation and high benefit utilization could have a material adverse impact on our results of operations.

~~Legal/Regulatory Risk~~is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. For example, regulatory initiatives designed to reduce insurer profits or otherwise affecting the industry in which the insurer operates, new legal theories or insurance company insolvencies through guaranty fund assessments, may create costs for the insurer beyond those recorded in the financial statements. We attempt to mitigate this risk by offering a wide range of products and by operating in many states, thus reducing our exposure to any single product and by employing underwriting practices that identify and minimize the adverse impact of this risk.

In addition, insurance companies are subject to extensive federal and state regulation and compliance with these regulations could increase the insurance companies’ operating costs. In some circumstances, failure to comply with certain insurance regulations could subject an insurance company to regulatory actions by such insurance company’s state of domicile. For example, states have statutory risk-based capital (RBC) requirements for health and other insurance companies based on the RBC Model Act. These RBC requirements are intended to assess the capital adequacy of life and health insurers, taking into account the risk characteristics of an issuer’s investments and products. 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 provide for four different levels of regulatory attention depending on the ratio of an insurance company’s total adjusted capital (defined as the total of its statutory capital, surplus and asset valuation reserve) to its risk-based capital. As of December 31, 2004, our risk-based capital levels for each of our insurance subsidiaries exceeded the levels required by regulatory authorities.

~~Investment Impairment Risk~~is the risk that all amounts due (both principal and interest) on our fixed maturity investments will not be collected according to the investment’s contractual terms. We attempt to minimize this risk by adhering to a conservative investment strategy. With the exception of short-term investments and securities on deposit with various state regulators, investment responsibilities have been delegated to external investment managers within the investment parameters established by us.

Our external investment managers prepare a monthly investment surveillance list to analyze our fixed maturity portfolio for potential other-than-temporary impairment. The following factors are reviewed for inclusion on our surveillance list:

	•		~~debt downgrades or other events that adversely affects an investee’s access to, or cost of, financing;~~

	•		~~negative economic factors and conditions specific to the issuer’s industry;~~

	•		~~adverse changes in the regulatory environment specific to the issuer’s industry;~~

	•		~~all spread changes exceeding 50 basis points; or~~

	•		~~corporate bond prices that move more than 10% over the past week, 20% over the past month, or 30% over the past three months.~~

~~We evaluate our investment policies consistent with SFAS No. 115,~~~~Accounting for Certain Investments in Debt and Equity Securities.~~Investments in fixed maturities and equity securities are designated at purchase as held-to-maturity, available-for-sale or trading. Available-for-sale investments are carried at fair value, with unrealized holding gains and losses reported in accumulated other comprehensive income (loss), net of deferred federal income taxes. Trading securities are stated at fair value and are bought and held principally for the purpose of selling them in the near term. Unrealized holding gains and losses related to trading securities are included in our Consolidated Statements of Operations as part of net realized gains (losses). If management believes a decline in the value of a particular available-for-sale investment is temporary, the decline is reported as an unrealized capital loss in stockholders’ equity, and if the decline is “other-than-temporary,” the carrying value of the investment is written down and a realized capital loss is reported in the Consolidated Statements of Operations. As of September 30, 2005, we had gross unrealized losses on individual available-for-sale investments of $4.0 million compared to $1.6 million at December 31, 2004. There were 21 securities that were in a continuous unrealized loss position for twelve months or longer with unrealized losses totaling $1.2 million at September 30, 2005, compared to 13 securities with unrealized losses totaling $0.9 million at December 31, 2004. None of our investments are delinquent or in payment default and there are no conditions present that indicate a high probability that all amounts will not be collected. Based on our evaluation along with that of our external investment managers, there were no investments in an unrealized loss position that had experienced a decline in market value that was considered by us to be significant and other-than-temporary at September 30, 2005.

~~Credit Risk~~~~is the risk that parties, including reinsurers that have obligations to us, will not pay or perform. We attempt to minimize this risk by maintaining sound reinsurance and credit collection policies.~~

~~Interest Rate Risk~~is the risk that interest rates will change and cause a decrease in the value of an insurer’s investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation if we attempt to mitigate this risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of our assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, we would have to sell assets prior to

maturity and recognize a gain or loss. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of stockholders’ equity is estimated to be $11.8 million after-tax at September 30, 2005. This amount represents approximately 5.8% of our stockholders’ equity at that date.

We also have long-term debt that bears interest at variable rates. Therefore, our results of operations would be affected by interest rate changes. We do not expect a significant rate change in the near future that would have a material effect on our near-term results of operations.

~~Seasonality~~is the risk of fluctuations of revenues and operating results. Historically, our revenues and operating results during each fiscal year have varied from quarter to quarter and are expected to continue to fluctuate in the future. These fluctuations have been due to a number of factors, including higher benefit utilization by our insureds during the winter months and the use of deductibles. More specifically, our Senior segment’s seasonality is the opposite of our Medical segment’s, meaning that earnings in the Senior segment are generally lower in the first quarter and higher later in the year. This is mainly a factor of our Medicare Supplement products that pay the Medicare deductible for our insureds generally during the early months of the year.

~~Impact of Inflation~~

~~Inflation rates impact our financial condition and operating results in several areas. Changes in inflation rates impact the market value of the investment portfolio and yields on new investments.~~

Inflation has had an impact on claim costs and overall operating costs and although it has been lower in the last few years, hospital and medical costs have still increased at a higher rate than general inflation, especially prescription drug costs. New, more expensive and wider use of pharmaceuticals is inflating health care costs. We will continue to establish premium rates in accordance with trends in hospital and medical costs along with concentrating on various cost containment programs. However, there can be no assurance that these efforts by us will fully offset the impact of inflation or that premiums will equal or exceed increasing healthcare costs.

~~Forward-Looking Statements~~

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us.

~~differ materially and adversely from those in the forward-looking statements, including those risks outlined above in “Market Risk and Management Policies,” and the following:~~

	•		~~our ability to accurately predict loss ratios and improvement in our business;~~

	•		~~business conditions and competition in the healthcare industry;~~

	•		~~our ability to successfully implement our business plans, including our growth strategy;~~

	•		unforeseen losses with respect to loss and settlement expense reserves for unreported and reported claims or adverse changes in persistency or profitability of insurance contracts that would accelerate the amortization of our deferred acquisition costs;

	•		~~our ability to institute necessary increases in premium rates; our ability to develop, market, distribute and administer competitive products and services in a timely, cost-effective manner;~~

	•		~~rising healthcare costs, especially prescription drug costs and rising utilization rates;~~

	•		changes or developments in healthcare reform and other regulatory issues, including Medicare reform and the Health Insurance Portability and Accountability Act of 1996 and increased privacy and security regulation, and changes in laws and regulations in key states in which we operate, could increase our costs, cause us to discontinue marketing products in certain states or cause us to change our business or operations significantly;

	•		~~changing regulations of corporate governance and public disclosure that has increased both our costs and the risk of non-compliance, including Section 404 of the Sarbanes-Oxley Act of 2002;~~

	•		~~the risk of material adverse outcomes in litigation and related matters;~~

	•		~~our ability to meet risk-based or statutory capital requirements and the outcome of our efforts to meet these capital requirements;~~

	•		~~our ability to continue to meet the terms of our debt obligations under our credit agreement, as amended, which contains a number of significant financial and other covenants;~~

	•		the adequacy of funds, including fee income, received from our non-regulated subsidiaries, and the restrictions on our insurance subsidiaries’ ability to pay dividends to Ceres, to meet our debt obligations;

	•		~~failure (including material weaknesses) of our information and administration systems;~~

	•		~~our financial and claims paying ratings, including any potential downgrades;~~

	•		~~our ability to maintain our current PPO network arrangements;~~

	•		~~dependence on senior management and key personnel;~~

	•		~~the performance of others on whom we rely for insurance and reinsurance, particularly Hannover Life Reassurance Company of America upon whom we have relied for substantially all of our reinsurance;~~

	•		~~the risk of selling investments to meet liquidity requirements;~~

	•		~~our ability to obtain additional debt or equity financing on terms favorable to us to facilitate our long-term growth;~~

	•		~~the risk that issuers of securities owned by Ceres will default or that other parties will not pay or perform;~~

	•		~~the performance of others on whom we rely for administrative and operations services;~~

	•		~~changes in accounting and reporting practices;~~

	•		~~the failure to successfully manage our operations and integrate future acquisitions, if any, including the failure to achieve cost savings;~~

	•		~~payments to state assessment funds;~~

	•		~~changes in tax laws; and~~

	•		~~our ability to fully collect all agent advances.~~

The factors listed above should not be construed as exhaustive. We undertake no obligation to publicly release the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

New Accounting Pronouncements

See Note A. Summary of Business and Significant Accounting Policies, to our condensed consolidated financial statements for a discussion of recently issued ~~accounting standards.~~Accounting Standards.

3325

Item 3. Quantitative and Qualitative ~~Disclosures~~Disclosure about Market Risk

~~The information called~~As of March 31, 2006, we had gross unrealized losses on individual available-for-sale investments of $10.5 million compared to $6.3 million at December 31, 2005. There were 42 securities that were in a continuous unrealized loss position for twelve months or longer with unrealized losses totaling $3.3 million at March 31, 2006, compared to 36 securities with unrealized losses totaling $2.0 million at December 31, 2005. None of our investments are delinquent or in payment default and there are no conditions present that indicate a high probability that all amounts will not be collected. Based on our evaluation along with that of our external investment managers, there were no investments in an unrealized loss position that had experienced a decline in market value that was considered by us to be significant and other-than-temporary at March 31, 2006.

Interest rate risk is the risk that interest rates will change and cause a decrease in the value of an insurer’s investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation if we attempt to mitigate this ~~item~~risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of our assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, we would have to sell assets prior to maturity and recognize a gain or loss. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical decline in fair value of stockholders’ equity is ~~provided under the caption “Market Risk and Management Policies” under~~estimated to be $10.2 million after-tax at March 31, 2006. This amount represents approximately 5.0% of our stockholders’ equity at that date.

See also Part II Item 21A. – ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations.~~“Risk Factors.”

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures.We carried out an evaluation, under the supervision and with the participation of our President and Chief Executive Officer along with our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of ~~September 30, 2005.~~March 31, 2006. Based upon that evaluation, our President and Chief Executive Officer along with our Chief Financial Officer concluded that our disclosure controls and procedures are effective and designed to ensure that material information relating to us and our consolidated subsidiaries in the reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in internal control.There have been no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

3426

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The nature of our business subjects us to a variety of legal actions ~~(including class actions)~~ and claims relating to such things as denial of healthcare benefits, premium rate increases, termination of coverage, claims administration ~~our relationship with the associations that market our products,~~ and alleged violations of state and federal statutes.

WeIn addition, we are involved in various other legal and regulatory actions occurring in the normal course of business that could result in significant liabilities and costs. Based on current information, including consultation with outside counsel, we believe that any ultimate liability that may arise from any of these other actions would not materially affect our consolidated financial position or results of operations. However, we cannot predict with certainty the outcome of any of these actions against us or the potential costs involved. Our evaluation of the likely impact of any of these actions could change in the future and an unfavorable outcome in any case could have a material adverse effect on our consolidated financial position, results of operations or cash flows of a future period.

Item 1A. Risk Factors

The Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2005 as filed with the SEC on March 16, 2006 have not materially changed with the exception of the addition of the first risk factor related to the proposed merger. Some of the risks which may be relevant to us could include:

	•		failure to obtain stockholder approval or the failure to satisfy other closing conditions, including regulatory approval, with respect to the proposed merger;

	•		failure to accurately predict health care costs when pricing our products and establishing our liabilities for future policy benefits and claim liabilities could have a significant impact on our business and results of operations;

	•		we may lose business to competitors offering products similar to ours at lower prices;

	•		our profitability depends in large part on our ability to accurately predict and effectively manage rising health care costs, and accurately predict loss ratios, persistency, and the performance of and improvements in our business, as well as implement necessary increases in premium rates;

	•		changes in government regulation may affect our profitability, increase our costs of compliance or cause us to discontinue marketing certain products or marketing in certain states;

	•		we are subject to a variety of legal actions relating to our business operations, including claims related to the denial of benefits, which may result in financial losses or harm our reputation;

	•		changes in the relationship with the associations that make available our health insurance products to their members and/or changes in laws and regulations governing “association group” insurance could have a material adverse effect on our business, financial

			condition and results of operations;
	•		our profitability may be adversely affected if we are unable to maintain our current preferred provider organization (PPO) arrangements and to enter into other appropriate arrangements;

	•		our success depends on our ability to develop, market, distribute and administer profitable and competitive products and services in a timely, cost-effective manner;

	•		a failure of our information systems to provide timely and accurate information could adversely affect our business and results of operations;

	•		failure by our reinsurers to timely and fully meet their obligations under our reinsurance agreements could have an adverse effect on our profitability and financial conditions;

	•		our insurance subsidiaries are subject to risk-based or statutory capital requirements and our failure to meet these standards could subject us to regulatory actions;

	•		a decline in our financial agency ratings could adversely affect our operations;

	•		our investment portfolio involves risks, including risks inherent with ownership of bonds and risks associated with rising interest rates;

	•		applicable laws restrict the acquisition of more than 10% of our outstanding voting securities;

	•		changing regulations of corporate governance and public disclosure that has increased both our costs and the risk of non-compliance, including Section 404 of the Sarbanes-Oxley Act of 2002;

	•		our dependence on senior management and key personnel;

	•		our ability to continue to meet the terms of our debt obligations under our credit agreement, as amended, which contains a number of significant financial and other covenants;

	•		the adequacy of funds, including fee income, received from our non-regulated subsidiaries, and the restrictions on our insurance subsidiaries’ ability to pay dividends to Ceres, to meet our debt obligations;

	•		the performance of others on whom we rely for administrative and operations services;

	•		changes in accounting and reporting practices;

	•		payments to state assessment funds;

	•		changes in tax laws; and

	•		our ability to fully collect all agent advances.

The risks listed above should not be construed as exhaustive.

Forward-Looking Statements

In particular, forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “continue” or similar words. In light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements in this report should not be considered as a representation by us or any other person that our objectives or plans will be achieved. Numerous factors could cause our actual results to differ materially and adversely from those in the forward-looking statements, including those risks outlined above in “Risk Factors.” We undertake no obligation to publicly release the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

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

The following is a summary of stock repurchases, pursuant to our previously-announced stock repurchase program, for the third quarter of 2005. See Note I. Treasury Stock, to our Condensed Consolidated Financial Statements for further information.None.

Issuer Purchases of Equity Securities
(c) Total
Number of
Shares
Purchased as (d) Approximate
Part of Dollar Value of
(a) Total Publicly Shares that may
Number of (b) Average Announced yet be Purchased
Shares Price Paid Plan or Under the Plan
Period Repurchased Per Share Program or Program (1)
July 1 – July 31 ¾ ¾ ¾ $ 8,286,000
August 1 – August 31 107,342 $ 6.01 107,342 $ 7,642,000
September 1 – September 30 1,255,777 $ 5.88 1,255,777 $ 255,000

Total
1,363,119 $ 5.89 1,363,119


~~(1)~~		On May 4, 2005, our Board of Directors authorized the repurchase of up to $10 million of our outstanding common stock in the open market or in private transactions. During the third quarter of 2005, we repurchased 363,119 shares in open market transactions at an average price per share of $5.81 and 1,000,000 shares in a private transaction at a price per share of $5.92. We completed the authorized $10 million stock repurchase program in October 2005.


			Page
Part I.	Financial Information

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets – ~~September 30, 2005~~March 31, 2006 (Unaudited) and December 31, ~~2004~~2005			1

	Condensed Consolidated Statements of Operations – Three ~~and nine~~ months ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~ (Unaudited)			2

	Condensed Consolidated Statement of Stockholders’ Equity – ~~Nine~~Three months ended ~~September 30, 2005~~March 31, 2006 (Unaudited)			3

	Condensed Consolidated Statements of ~~Cash Flows~~Comprehensive Income – ~~Nine~~Three months ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~ (Unaudited)			4

	~~Notes to~~ Condensed Consolidated ~~Financial~~ Statements of Cash Flows – ~~September 30,~~Three months ended March 31, 2006 and 2005 (Unaudited)			5

Notes to Condensed Consolidated Financial Statements – March 31, 2006 (Unaudited)		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			1517

Item 3.	Quantitative and Qualitative ~~Disclosures~~Disclosure about Market Risk			3426

Item 4.	Controls and Procedures			3426

Part II.	Other Information

Item 1. Legal Proceedings		27

Item 1.1A. Risk Factors	~~Legal Proceedings~~			3527

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds			3529

Item 3.	Defaults Upon Senior Securities			3629

Item 4.	Submission of Matters to a Vote of Security Holders			3629

Item 5.	Other Information			3629

Item 6. Exhibits	~~Exhibits~~			3629

Signatures		3730
EX-31.1 ~~302~~ CEO Certification Pursuant to Section 302
EX-31.2 ~~302~~ CFO Certification Pursuant to Section 302
EX-32 ~~906 CEO & CFO Certifications~~Certification Pursuant to 18 U.S.C. Section 1350

	31.1		CEO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2		CFO certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	32		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	CERES GROUP, INC.
Date: ~~November 9, 2005~~May 10, 2006	By:	/s/ David I. Vickers
		David I. Vickers
		Executive Vice President and Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer)


~~(1)~~		~~Net of reclassification adjustments. See Note D. Comprehensive Income (Loss) for further information.~~

	•		Medical – includes catastrophic and comprehensive major medical plans;

	•		Senior and Other – includes Medicare supplement, long-term care, dental, life insurance and annuities; and

	•		Corporate and Other – includes primarily interest income, interest expense, and corporate expenses of the holding company.


	Nine Months			Nine Months			Increase
	Ended			Ended			(Decrease) from
	September 30,			September 30,			Previous Year
	2005			2004			Dollars			%
	*(dollars in thousands, except per share amounts)*
Premiums, net
Medical	$	165,917		$	187,989		$	(22,072	)		(11.7	)%
Senior and other		152,533			134,698			17,835			13.2

Total premiums, net		318,450			322,687			(4,237	)		(1.3	)

Net investment income		19,634			19,234			400			2.1
Net realized gains		646			401			245			61.1
Fee and other income		12,721			14,663			(1,942	)		(13.2	)


		351,451			356,985			(5,534	)		(1.6	)


Benefits, claims, losses and settlement expenses
Medical		116,431			131,167			(14,736	)		(11.2	)
Senior and other		120,027			101,802			18,225			17.9

Total benefits, claims, losses and settlement expenses		236,458			232,969			3,489			1.5

Selling, general and administrative expenses		97,613			101,102			(3,489	)		(3.5	)
Net (deferral) amortization and change in deferred acquisition costs and value of business acquired		(320	)		4,626			(4,946	)		(106.9	)
Interest expense and financing costs		533			507			26			5.1

		334,284			339,204			(4,920	)		(1.5	)


Income before federal income taxes		17,167			17,781			(614	)		(3.5	)
Federal income tax expense		4,216			1,305			2,911			223.1

Net income	$	12,951		$	16,476		$	(3,525	)		(21.4	)


Net income per share
Basic	$	0.38		$	0.48		$	(0.10	)		(20.8	)
Diluted		0.37			0.47			(0.10	)		(21.3	)

Medical loss ratio		70.2	%		69.8	%		¾			¾
Senior loss ratio		78.7	%		75.6	%		¾			¾
Overall loss ratio		74.3	%		72.2	%		¾			¾
Selling, general and administrative expense ratio		30.7	%		31.3	%		¾			¾


(1)		The interest associated with our variable-rate term loans is based upon interest rates in effect at ~~September 30, 2005.~~March 31, 2006. The contractual amounts to be paid on variable-rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.

(2)		Represents estimated timing for fulfilling unfunded and callable capital commitments for ~~investments~~an investment in ~~two~~a limited ~~partnerships and a commercial mortgage trust.~~partnership. Outstanding commitments are included in payments due in less than one year since the timing of funding these commitments cannot be reasonably estimated.

(3)		Estimated payments required under interest sensitive life and annuity contracts. The actual payments could vary based on changes in assumed crediting rates, persistency, and mortality levels.

(4)		Includes claims and benefits payable on our major medical, Medicare supplement, long-term care and other health care products.