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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003

OR

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

For the transition period from ______________ to _________________

COMMISSION FILE NUMBER 1-16477

COVENTRY HEALTH CARE, INC.

(Exact name of registrant as specified in its charter)

6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817
(Address of principal executive offices) (Zip Code)

(301) 581-0600
(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 þ No¨

     Indicate by check mark whether the registrant is an accelerated filer (as defined in the Securities Exchange Act of 1934 Rule 12b-2). Yes þ No¨

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

COVENTRY HEALTH CARE, INC.
FORM 10-Q
TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION
ITEM 1: Financial Statements

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

See accompanying notes to the condensed consolidated financial statements.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

See accompanying notes to the condensed consolidated financial statements.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See accompanying notes to the condensed consolidated financial statements.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

A.     BASIS OF PRESENTATION

        The condensed consolidated financial statements of Coventry Health Care, Inc. and subsidiaries (“Coventry” or the “Company”) contained in this report are unaudited but reflect all normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s most recent Annual Report on Form 10-K for the year ended December 31, 2002, filed with the Securities and Exchange Commission on March 24, 2003.

B.     SIGNIFICANT ACCOUNTING POLICIES

        The Company accounts for stock-based compensation to employees under Accounting Principles Board (“APB”) Opinion No. 25 – “Accounting for Stock Issued to Employees.” Until the accounting rules change, the Company does not currently expect to transition to the fair value method of accounting for stock-based compensation. Had compensation cost been determined consistent with Statement of Financial Accounting Standards (“SFAS”) No. 123 – “Accounting for Stock-Based Compensation,” the Company’s net earnings and earnings per share (“EPS”) would have been reduced to the following pro-forma amounts (in thousands, except per share data):

C.    ACQUISITIONS

      Effective February 1, 2003, the Company completed its acquisition of PersonalCare Health Management, Inc. (“PersonalCare”), in Champaign, Illinois. The acquisition was accounted for using the purchase method of accounting, and, accordingly, the operating results of PersonalCare have been included in the Company’s consolidated financial statements since the date of acquisition. The purchase price for PersonalCare was allocated to the assets, including identifiable intangible assets and liabilities based on estimated fair values. As of the acquisition date, PersonalCare had approximately 78,000 commercial members in Illinois.

D.     GOODWILL AND OTHER INTANGIBLE ASSETS

        Goodwill and other intangible assets consist of costs in excess of the fair value of the net tangible assets of subsidiaries or operations acquired through June 30, 2003.

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Goodwill

        As described in the Company’s segment disclosure, assets are not allocated to specific products, and, accordingly, goodwill can not be reported by segment. The changes in the carrying amount of goodwill for the six months ended June 30, 2003 are as follows (in thousands):

Other Intangible Assets

        The other intangible asset balances are as follows (in thousands):

        Other intangible asset amortization expense for quarters ended June 30, 2003 and 2002 was $0.6 million and $0.8 million, respectively, and $1.3 million and $1.6 million for the six months ended June 30, 2003 and 2002, respectively. Estimated intangible asset amortization expense is $2.4 million for the year ending December 31, 2003 and $2.2 million for the years ending December 31, 2004 through 2007. The weighted-average amortization period is approximately 12 years for other intangible assets.

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E.     SENIOR NOTES

        As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, on February 1, 2002, the Company completed a transaction to sell $175.0 million original 8.125% senior notes. As required under the terms of the senior notes, the Company made an interest payment of $7.1 million during the first quarter of 2003. The Company has complied with all covenants under the senior notes.

F.    CONTINGENCIES

Legal Proceedings

        In the normal course of business, the Company has been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through June 30, 2003 may result in the assertion of additional claims. The Company carries general liability insurance for each of the Company’s operations on a claims-made basis with varying deductibles for which the Company maintains reserves. The Company maintains general liability and professional liability insurance coverage in amounts that it believes is appropriate. The Company carries professional malpractice insurance through its captive subsidiary.

         The Company’s captive subsidiary provides up to $5 million in coverage for each event and up to $10 million in coverage for each event that is a class action. The captive has an aggregate policy limit of $20 million, which is an increase of $5 million from the prior year. On top of the captive’s per event limit of $5 million, the captive is co-insured with a commercial carrier for an additional $10 million. Each year the Company will re-evaluate the most cost effective method for insuring these types of claims.

         Coventry Health Care, Inc. is a defendant in the provider track in the Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, MDL No. 1334, styled in re: Humana, Inc., Charles B. Shane, MD, et al. vs. Humana, Inc., et al. This action was filed by a group of physicians as a class action against Coventry and twelve other companies in the managed care field. In its fourth amended complaint, the plaintiffs have alleged violations of the federal racketeering act, Racketeer Influenced and Corrupt Organizations (“RICO”), conspiracy to violate RICO and aiding and abetting a scheme to violate RICO. In addition to these RICO claims, the complaint includes counts for breach of contract, violations of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. Coventry has filed a motion to dismiss each of these claims because they fail to state a cause of action or, in the alternative, to compel arbitration pursuant to the arbitration provisions which exist in the Company’s physician contracts. The trial court has certified various subclasses of physicians; however, the Company was not subject to the class certification order because the motion to certify was filed before Coventry was joined as a defendant. The plaintiffs are currently pursuing class discovery against Coventry and will then file their motion for class certification as to Coventry. The defendants who were subject to the certification order filed an appeal to the 11th Circuit which has been granted. Although Coventry can not predict the outcome, management believes that the claims asserted in this lawsuit are without merit and the Company intends to defend its position.

Federal Employees Health Benefits Program

        The Company contracts with the Office of Personnel Management (“OPM”) to provide managed health care services under the Federal Employee Health Benefits Program (“FEHBP”). These contracts with the OPM and applicable government regulations establish premium rating arrangements for this program. The OPM conducts periodic audits of its contractors to, among other things, verify that the premiums established under its contracts are in compliance with the community rating and other requirements under FEHBP. The OPM may seek premium refunds or institute other sanctions against health plans that participate in the program.

         HealthAmerica Pennsylvania, Inc., the Company’s Pennsylvania HMO subsidiary, has received draft audit reports from the OPM that questioned approximately $31.1 million of subscription charges for contract years 1993 – 1999 that were paid to this subsidiary under the FEHBP. The reports recommend that if these amounts are deemed to be due, approximately $5.5 million in lost investment income charges should also be recovered with respect to such overcharges, with additional interest continuing to accrue until repayment of the overcharged amounts. This matter has also been referred to the Office of the U.S. Attorney for consideration of a possible civil action. The Company has responded to the OPM and the U.S. Attorney with respect to the amounts questioned during these audits and has provided additional information to support its positions. Although the Company can not predict the outcome of this matter, management believes, after consultation with legal counsel, that the ultimate resolution of this matter will not have a material adverse effect on the accompanying condensed consolidated financial statements.

G.    RESTRICTED STOCK AWARDS

        In the second quarter of 2003, the Company awarded 309,000 shares of restricted stock with varying vesting periods through May 2007. The fair value of the restricted shares, at the date of grant, is amortized over the vesting period. The restricted stock shares were granted at a weighted-average fair value of $43.33. The Company recorded compensation expense related to restricted stock grants, including restricted stock previously awarded in 2001 and 2002, of approximately $2.2 million and $1.4 million for the quarters ended June 30, 2003 and 2002, respectively, and $4.0 million and $2.1 million for the six months ended June 30, 2003 and 2002, respectively. The deferred portion of the restricted stock grants is $26.6 million at June 30, 2003 and $17.2 million at December 31, 2002.

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H.    SEGMENT INFORMATION

        The Company has three reportable segments: Commercial, Medicare and Medicaid products. The products are provided to a cross section of employer groups and individuals throughout the Company’s health plans. Commercial products include health maintenance organization (“HMO”), preferred provider organization (“PPO”), and point-of-service (“POS”) products. HMO products provide comprehensive health care benefits to members through a primary care physician. PPO and POS products permit members to participate in managed care but allow them the flexibility to utilize out-of-network providers in exchange for increased out-of-pocket costs. The Company provides comprehensive health benefits to members participating in Medicare and Medicaid programs and receives premium payments from federal and state governments.

        The Company evaluates the performance of its operating segments and allocates resources based on gross margin. Assets are not allocated to specific products and, accordingly, can not be reported by segment. The following tables summarize the Company’s reportable segments through gross margin and include a medical loss ratio (“MLR”) calculation:

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I.    COMPREHENSIVE INCOME

        Comprehensive income for the quarters and six months ended June 30, 2003 and 2002 was as follows (in thousands):

    J.        SUBSEQUENT EVENTS

         On July 9, 2003, the Company announced that it had signed a definitive agreement to acquire Altius Health Plans Inc. (“Altius”), a Utah-based commercial-only health plan. Altius has total membership of approximately 160,000 consisting of 116,000 risk and 44,000 non-risk members. The transaction is expected to close late in the third quarter of 2003, subject to closing conditions, regulatory and other customary approvals.

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

Quarters and Six Months Ended June 30, 2003 and 2002

        The statements contained in this Form 10-Q that are not historical are forward-looking statements, made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which are subject to risks and uncertainties. Forward-looking statements, which are based on assumptions and estimates and describe our future plans, strategies and expectations, are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “intend,” “seek,” or similar expressions. These forward-looking statements include all statements that are not statements of historical fact as well as those regarding our intent, belief or expectations including, but not limited to, the discussions of our operating and growth strategy, projections of revenue, income or loss and future operations. These forward-looking statements may be affected by a number of factors, including, but not limited to, the “Risk Factors” contained in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2002. Actual operations and results may differ materially from those expressed in this Form 10-Q.

        Unless this Form 10-Q indicates otherwise or the context otherwise requires, the terms “we,” “our,” “our Company,” “the Company” or “us” as used in this Form 10-Q refer to Coventry Health Care, Inc. and its subsidiaries.

        The following discussion and analysis relates to our financial condition and results of operations for the quarters ended and six months ended June 30, 2003 and 2002. This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and other information presented herein as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2002 filed on March 24, 2003, including the critical accounting policies discussed therein. Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports, and recent press releases can be found, within one week of being filed with or furnished to the Securities and Exchange Commission and free of charge, on the Internet at www.cvty.com.

General Overview

         We are a leading publicly traded managed health care company with approximately 2.2 million members, excluding our network rental members, as of June 30, 2003. We operate health plans under the names Coventry Health Care, Coventry Health and Life, Carelink Health Plans, Group Health Plan, HealthAmerica, HealthAssurance, HealthCare USA, PersonalCare, Southern Health and WellPath. We operate a diversified portfolio of local market health plans serving 13 markets, primarily in the Mid-Atlantic, Midwest and Southeast regions. Our health plans generally are located in small to mid-sized metropolitan areas.

         We offer employer groups a broad range of commercial managed care products that vary with respect to the level of benefits provided, the costs paid by employers and members and our members’ access to providers without referral or preauthorization requirements. We offer underwritten or “risk” products, including health maintenance organizations (“HMO”s), preferred provider organizations (“PPO”s) and point of service (“POS”) plans. In addition, we offer defined contribution health plans. Our risk products also include state-sponsored managed Medicaid programs and Medicare+Choice programs in selected markets where we believe we can achieve profitable growth based upon favorable reimbursement levels, provider costs and regulatory climates. For our risk products, we receive premiums in exchange for assuming underwriting risks and performing sales, marketing and administrative functions. We also offer “non-risk” products to employer groups that self-insure employee health benefits. The management services we provide typically include provider contracting, claims processing, utilization review and quality assurance. For our non-risk products, we receive fees for access to our provider networks and the management services we provide, but we do not generally assume any underwriting risk for these products. In addition, we offer a product where we rent our network of providers (“network rental members”) to other managed care plans or self-insured employers and assume no underwriting risk and provide no management services.

Revenues

        We generate operating revenues from managed care premiums and management services. Our managed care premiums are derived from our commercial risk products and our government programs. Our commercial managed care premium revenues are comprised of premiums from our commercial HMO products and flexible provider products, including PPO and POS products for which we assume full underwriting risk. Premiums for such commercial PPO and POS products are typically lower than HMO premiums due to medical underwriting and higher deductibles and co-payments that are required of the PPO and POS members. Premium rates for Commercial HMO, POS and PPO products are reviewed by various state agencies based on rate filings. In response to this regulatory review, we may have to modify or revise our rate filings in order to obtain the required regulatory approvals. While these modifications have not been material in the past, no assurance can be given that future rate filings will be approved in the same fashion. We provide comprehensive health benefits to members participating in government programs and receive premium payments from federal and state governments. Premium rates for the Medicaid and Medicare+Choice products are established by governmental regulatory agencies and may be reduced by regulatory action.

        Our management services revenues result from operations in which our health plans provide administrative and other services to self-insured employers and to employer group beneficiaries that have elected HMO coverage. We receive an administrative fee for these services, but do not assume underwriting risk. Certain of our management services contracts include performance and utilization management standards that if not met may cause us to incur penalties. In addition, we offer a PPO product to other third party payors, under which we provide rental of and access to our PPO network, claims repricing and utilization review, and do not assume underwriting risk.

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Expenses

        Our primary operating expenses consist of medical costs; selling, general and administrative expense; and depreciation and amortization expense. Our medical costs include medical claims paid under contractual relationships with a wide variety of providers and capitation payments. Medical costs also include an estimate for claims incurred but not reported (“IBNR”).

        In determining our IBNR liabilities, we employ standard actuarial reserve methods that are specific to each market’s membership, product characteristics, geographic territories and provider network. We also consider utilization frequency and unit costs of inpatient, outpatient, pharmacy and other medical expenses, as well as the rate of claims submissions, claim payment backlogs and the timing of provider reimbursements. Estimates are reviewed by our underwriting, finance and accounting personnel and other appropriate health plan and corporate personnel. Changes in assumptions for medical costs caused by changes in actual experience, changes in the delivery system, changes in pricing due to ancillary capitation and fluctuations in the claims submissions or backlog could cause these estimates to be revised in the near term. We continually monitor and review our IBNR reserves, and as actual payments are made or accruals adjusted, reflect these differences in current operations. Medical costs are affected by a variety of factors, including the severity and frequency of claims. These factors are difficult to predict and may not be entirely within our control. We continually refine our actuarial practices to incorporate new cost events and trends.

Membership

        The following tables show our total risk and non-risk members as of June 30, 2003 and 2002.

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        Total membership, excluding network rental membership of  739,000, increased by 11.9% from the prior year’s second quarter. The increase is attributable to the acquisition of PersonalCare (Illinois) in the first quarter of 2003 and Mid-America (Kansas) in the fourth quarter of 2002 and organic growth. Medicaid membership increased due to an expansion into additional counties and the withdrawal of a competitor in our Missouri market and due to the introduction of a new product in our Pennsylvania market, offset by our exit from the Delaware Medicaid business representing approximately 43,000 members. Non-risk membership increased as a result of the Mid-America acquisition mentioned above and from additional organic membership obtained in our Missouri market.

Completed and Subsequent Acquisitions

         Effective February 1, 2003, we completed our acquisition of PersonalCare Health Management, Inc. (“PersonalCare”), in Champaign, Illinois.  The acquisition was accounted for using the purchase method of accounting and, accordingly, the operating results of PersonalCare have been included in our condensed consolidated financial statements since the date of acquisition. The purchase price for PersonalCare was allocated to the assets, including identifiable intangible assets and liabilities based on estimated fair values. As of the acquisition date, PersonalCare had approximately 78,000 commercial members in Illinois.

         On July 9, 2003, we announced that we had signed a definitive agreement to acquire Altius Health Plans Inc. (“Altius”). Altius is a privately-owned, Utah-based commercial-only health plan with total membership of approximately 160,000 consisting of 116,000 risk and 44,000 non-risk members.  The transaction is expected to close late in the third quarter of 2003, subject to closing conditions, regulatory and other customary approvals.

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Results of Operations

         The following summary table is provided to facilitate a more meaningful discussion regarding the comparison of our operations for the quarters and six months ended June 30, 2003 and 2002 (in thousands, except percentages).

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         Quarters Ended June 30, 2003 and 2002

         Managed care premium revenue increased from the prior year’s second quarter as a result of rate increases on renewals that occurred throughout all markets, organic membership growth, and acquisitions. Commercial yields increased by an average of 13.0% over second quarter 2002 on a per member per month (“PMPM”) basis, to $204.83 PMPM. We expect commercial rate increases on renewals to be in the range of 13% to 15% for the remainder of 2003. Medicare yields increased by an average of 5.9% over second quarter 2002 on a PMPM basis as a result of changes being made to rate structures, as well as changes in demographics.

         Management services revenue increased from the prior year’s second quarter due to the increase in non-risk membership discussed above.

         Medical costs increased from the prior year’s second quarter due to acquisitions, organic membership growth and medical trend.

         Our total medical loss ratio (medical costs as a percentage of managed care premiums) for all products improved 2.3% from the prior year’s second quarter to 80.9%. This favorable change was attributable mostly to our commercial business, which improved from 82.7% to 80.0% as a result of the commercial rate increases mentioned above outpacing commercial medical trend.

         Selling, general and administrative expense increased from the prior year’s second quarter primarily due to increased costs associated with acquisitions and an increase in broker commissions. Broker commissions have increased due to the growth in both membership and in premium yields. As a percentage of revenue, selling, general and administrative expense decreased by 0.3%.

         Other income increased from the prior year’s second quarter due an increase in interest income as a result of a larger investment portfolio in 2003 and due to a change in value of our only investment classified as derivative in nature. The prior year’s second quarter reported a loss from that derivative compared to a gain in the current quarter. This derivative investment was sold during the current quarter.

        Our provision for income taxes increased from the prior year’s second quarter due to an increase in earnings before taxes and due to an increase in the effective tax rate. The effective tax rate was 36.0% and 35.5% for the quarters ended June 30, 2003 and 2002, respectively. This increase in the tax rate is the result of our increased profitability.

         Six Months Ended June 30, 2003 and 2002

         Managed care premium revenue for the six months ended June 30, 2003 increased from the corresponding period of 2002 as a result of rate increases on renewals that occurred throughout all markets, organic membership growth, and acquisitions. Commercial yields increased by an average of 12.8% over the 2002 period on a PMPM basis, to $202.86 PMPM. Medicare yields increased by an average of 5.7% over the 2002 period on a PMPM basis as a result of changes being made to rate structures, as well as changes in demographics.

        Management services revenue increased from the six months ended June 30, 2002 due to the increase in non-risk membership discussed above.

        Medical costs increased from the six months ended June 30, 2002 due to acquisitions, organic membership growth and medical trend.

        Our medical loss ratio improved 2.1% from the six months ended June 30, 2002 to 81.7%. This favorable change was attributable mostly to our commercial business, which improved from 83.4% to 80.5% as a result of the commercial rate increases mentioned above outpacing commercial medical trend.

         Selling, general and administrative expense increased from the six months ended June 30, 2002 primarily due to increased costs associated with acquisitions and an increase in broker commissions. Broker commissions have increased due to the growth in both membership and in premium yields. As a percentage of revenue, selling, general and administrative expense decreased by 0.2%.

        Senior notes interest expense has increased in 2003. Due to the issuance of the notes on February 1, 2002, the prior year’s period represented five months of interest compared to six months in 2003.

        Other income increased from the prior year’s corresponding period due to an increase in interest income as a result of a larger investment portfolio in 2003 and due to an increase in value of our only investment classified as derivative in nature. The prior year’s six-month period reported a loss from that derivative compared to a gain in the current six-month period. This derivative investment was sold during the current quarter.

        Our provision for income taxes increased from the prior year’s six months due to an increase in earnings before taxes.

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Liquidity and Capital Resources

          Consolidated

        Our total cash and investments, consisting of cash and cash equivalents and short-term and long-term investments, but excluding deposits of $22.3 million restricted under state regulations, increased to $1.3 billion at June 30, 2003 from $1.1 billion at December 31, 2002.

        We have classified all of our investments as available-for-sale. Our investments at June 30, 2003 mature according to their contractual terms, as follows, in thousands (actual maturities may differ because of call or prepayment rights):

         Net cash provided by operating activities for the six months ended June 30, 2003 increased over the prior year due to an increase in net earnings, an increase in receipts of provider and other medical receivables and an increase in deferred revenue. Cash flows used for investing activities for the six months ended June 30, 2003 decreased due to an increase in the proceeds from sales of investments offset by an increase in the amount paid for acquisitions, net of cash acquired. The PersonalCare acquisition completed in the first quarter of 2003 was larger than the New Alliance acquisition completed in the second quarter of 2002. Cash flows from financing activities for the six months ended June 30, 2003 increased over the prior year, primarily due to the repurchase of shares of our common stock and a warrant, offset by proceeds from the issuance of our senior notes in 2002.

        Our investment guidelines emphasize investment grade fixed income instruments in order to provide liquidity to meet future payment obligations and minimize the risk of principal. The fixed income portfolio includes government and corporate securities with an average quality rating of “AA+” and an average contractual maturity of 3.9 years as of June 30, 2003. We believe that since our long-term investments are available-for-sale, the amount of such investments should be added to current assets when assessing our working capital and liquidity. On such basis, current assets plus long-term investments available-for-sale less current liabilities increased to $627.0 million at June 30, 2003 from $498.0 million at December 31, 2002.

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         Health Plans

        Our HMOs, our insurance company subsidiary, Coventry Health and Life Insurance Company (“CH&L”), and our captive subsidiary, CHC Risk Retention Group, Inc. (“CRRG”) are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the parent may receive from its HMOs, CH&L and CRRG. During the six months ended June 30, 2003, the parent collected $55.0 million in dividends from our subsidiaries subject to such regulatory restrictions.

        The majority of states in which we operate health plans have adopted a risk-based capital (“RBC”) policy that recommends the health plans maintain statutory reserves at or above the ‘Company Action Level’ which is currently equal to 200% of their RBC (250% for CH&L). Although not all states have adopted the RBC policy, we maintain all of our health plans at this standard. The total surplus in excess of 200% for all of our HMO subsidiaries was approximately $189.9 million at June 30, 2003, up from $155.8 million at December 31, 2002. These total statutory reserves for our HMO subsidiaries, as a percentage of RBC, was 351% and 331% as of June 30, 2003 and December 31, 2002, respectively. The increase is primarily due to current year earnings from our HMO subsidiaries offset by dividends paid to the parent.

        CH&L had surplus in excess of 250% of RBC of approximately $36.4 million and $24.1 million at June 30, 2003 and December 31, 2002, respectively. The total statutory reserve for CH&L, as a percentage of RBC, was 792% and 609% as of June 30, 2003 and December 31, 2002, respectively. The increase is primarily due to income from the first six months of 2003.

        CRRG had surplus in excess of 200% of RBC of approximately $1.3 million and $1.2 million at June 30, 2003 and December 31, 2002, respectively. The total statutory reserve for CRRG, as a percentage of RBC, was 336% and 325% as of June 30, 2003 and December 31, 2002, respectively.

        Excluding funds held by entities subject to regulation, we had cash and investments of approximately $156.6 million and $86.7 million at June 30, 2003 and December 31, 2002, respectively. The increase in non-regulated cash and investments is primarily a result of dividends received from subsidiaries mentioned above and ordinary operating activities offset by a payment for an acquisition. During the six months ended June 30, 2003, we did not make any capital contributions to our regulated subsidiaries.

         Other

        Projected capital investments in 2003 of approximately $13.7 million consist primarily of computer hardware, software and related equipment costs associated with the development and implementation of improved operational and communications systems. As of June 30, 2003, approximately $5.2 million has been spent.

        The United States Department of Health and Human Services has issued rules, as mandated by the Health Insurance Portability and Accountability Act of 1996, which, among other things, impose security and privacy requirements with respect to individually identifiable patient data, including a member’s transactions with health care providers and payors, as well as requirements for the standardization of certain electronic transaction code sets and provider identifiers. We have spent approximately $2.1 million on compliance matters for the six months ended June 30, 2003. We anticipate spending approximately $5.5 million in 2003, of which approximately $1.1 million will be capitalized, related to improved functionality of our electronic transaction code sets, improved provider identifier standards, and improved security and patient information privacy standards.

        Management believes that our cash flows generated from operations, cash and investments, and excess funds in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures, and debt interest costs at least through December 31, 2003.

Legal Proceedings

        In the normal course of business, we have been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through June 30, 2003 may result in the assertion of additional claims. We carry general liability insurance for each of our operations on a claims-made basis with varying deductibles for which we maintain reserves. We maintain general liability and professional liability insurance coverage in amounts that we believe is appropriate. We carry professional malpractice insurance through our captive subsidiary.

         Our captive subsidiary provides up to $5 million in coverage for each event and up to $10 million in coverage for each event that is a class action. The captive has an aggregate policy limit of $20 million, which is an increase of $5 million from the prior year. On top of the captive’s per event limit of $5 million, the captive is co-insured with a commercial carrier for an additional $10 million. Each year we will re-evaluate the most cost effective method for insuring these types of claims.

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        We are a defendant in the provider track in the Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, MDL No. 1334, styled in re: Humana, Inc., Charles B. Shane, MD, et al. vs. Humana, Inc., et al. This action was filed by a group of physicians as a class action against us and twelve other companies in the managed care field. In its fourth amended complaint, the plaintiffs have alleged violations of RICO, conspiracy to violate RICO and aiding and abetting a scheme to violate RICO. In addition to these RICO claims, the complaint includes counts for breach of contract, violations of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. We have filed a motion to dismiss each of these claims because they fail to state a cause of action or, in the alternative, to compel arbitration pursuant to the arbitration provisions which exist in our physician contracts. The trial court has certified various subclasses of physicians; however, we were not subject to the class certification order because the motion to certify was filed before we were joined as a defendant. The plaintiffs are currently pursuing class discovery against us and will then file their motion for class certification as to us. The defendants who were subject to the certification order have filed an appeal with the 11^th Circuit Court of Appeals which has been granted. Although we can not predict the outcome, we believe that the claims asserted in this lawsuit are without merit and we intend to defend our position.

Legislation and Regulation

        As a publicly traded managed health care company, we are subject to extensive government regulation of our products and services. The laws and regulations affecting our industry generally give state and federal regulatory authorities broad discretion in their exercise of supervisory, regulatory and administrative powers. These laws and regulations are intended primarily for the benefit of the members of the health plans. Managed care laws and regulations vary significantly from jurisdiction to jurisdiction and changes are frequently considered and implemented. Although the provisions of any legislation adopted at the state or federal level can not be accurately predicted at this time, management believes that the ultimate outcome of currently proposed legislation would not have a material adverse effect on our results of operations in the short-term.

        Our industry is heavily regulated and the laws and rules governing the industry and interpretations of those laws and rules are subject to frequent change. Existing or future laws could have significant effect on our operations.

Federal Employees Health Benefits Program

        We contract with the Office of Personnel Management (“OPM”) to provide managed health care services under the Federal Employee Health Benefits Program (“FEHBP”). These contracts with the OPM and applicable government regulations establish premium rating arrangements for this program. The OPM conducts periodic audits of its contractors to, among other things, verify that the premiums established under its contracts are in compliance with the community rating and other requirements under FEHBP. The OPM may seek premium refunds or institute other sanctions against health plans that participate in the program.

        HealthAmerica Pennsylvania, Inc., our Pennsylvania HMO subsidiary, has received draft audit reports from the OPM that questioned approximately $31.1 million of subscription charges for contract years 1993 – 1999 that were paid to this subsidiary under the FEHBP. The reports recommend that if these amounts are deemed to be due, approximately $5.5 million in lost investment income charges should also be recovered with respect to such overcharges, with additional interest continuing to accrue until repayment of the overcharged amounts. This matter has also been referred to the Office of the U.S. Attorney for consideration of a possible civil action. We have responded to the OPM and the U.S. Attorney with respect to the amounts questioned during these audits and have provided additional information to support our positions. Although we can not predict the outcome of this matter, management believes, after consultation with legal counsel, that the ultimate resolution of this matter will not have a material adverse effect on the accompanying financial statements.

ITEM 3: Quantitative and Qualitative Disclosures of Market Risk

        Under an investment policy approved by our Board of Directors, we invest primarily in marketable U.S. Government and agency, state, municipal, mortgage-backed and asset-backed securities and corporate debt obligations that are investment grade. The investment policy specifically prohibits investments in any equities or in corporate debt obligations that are below investment grade. We have classified all of our investments as available-for-sale. We are exposed to certain market risks including interest rate risk and credit risk.

        We have established policies and procedures to manage our exposure to changes in the fair value of our investments. Our policies include an emphasis on credit quality and the management of our portfolio’s duration, profile and security mix. We believe our investment portfolio is diversified and currently expect no material loss to result from the failure to perform by the issuers of the debt securities we hold. The mortgage-backed securities are insured by several associations, including Government National Mortgage Administration and Federal National Mortgage Administration.

        Investments are evaluated on at least a quarterly basis to determine if declines in value are other-than-temporary. In making that determination, all available evidence relating to the realizable value of a security is considered. Debt securities with declines in value below cost due to market conditions or industry-specific events where we intend and have the ability to hold the investment for a period of time sufficient to allow a market recovery, are not assumed to be other-than-temporary.

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        Temporary declines in value of investments classified as available-for-sale are netted with unrealized gains and reported as a net amount in a separate component of stockholders’ equity. A decline in fair value below amortized cost that is judged to be other-than-temporary is accounted for as a realized loss and the write down is included in earnings. Realized gains and losses on the sale of investments are determined on a specific identification basis.

        No material changes have occurred in our exposures to market risk since the date of our Annual Report on Form 10-K for the fiscal year ended December 31, 2002.

        Our projections of hypothetical net losses in fair value of our market rate sensitive instruments, should potential changes in market rates occur, are presented below. The projection is based on a duration model, which tests hypothetical changes in interest rates of positive and negative 100, 200 and 300 basis points. The model excludes cash, and assumes instantaneous changes in interest rates. While we believe that the potential market rate change is reasonably possible, actual results may differ.

ITEM 4: Controls and Procedures

        We have performed an evaluation as of the end of the period covered by this report, under the supervision and with the participation of our Chief Executive Officer and 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)). Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. 

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PART II. OTHER INFORMATION

ITEM 1: Legal Proceedings

        In the normal course of business, we have been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through June 30, 2003 may result in the assertion of additional claims. We carry general liability insurance for each of our operations on a claims-made basis with varying deductibles for which we maintain reserves. We maintain general liability and professional liability insurance coverage in amounts that we believe is appropriate. We carry professional malpractice insurance through our captive subsidiary.

         Our captive subsidiary provides up to $5 million in coverage for each event and up to $10 million in coverage for each event that is a class action. The captive has an aggregate policy limit of $20 million, which is an increase of $5 million from the prior year. On top of the captive’s per event limit of $5 million, the captive is co-insured with a commercial carrier for an additional $10 million. Each year we will re-evaluate the most cost effective method for insuring these types of claims.

        We are a defendant in the provider track in the Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, MDL No. 1334, styled in re: Humana, Inc., Charles B. Shane, MD, et al. vs. Humana, Inc., et al. This action was filed by a group of physicians as a class action against us and twelve other companies in the managed care field. In its fourth amended complaint, the plaintiffs have alleged violations of RICO, conspiracy to violate RICO and aiding and abetting a scheme to violate RICO. In addition to these RICO claims, the complaint includes counts for breach of contract, violations of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. We have filed a motion to dismiss each of these claims because they fail to state a cause of action or, in the alternative, to compel arbitration pursuant to the arbitration provisions which exist in our physician contracts. The trial court has certified various subclasses of physicians; however, we were not subject to the class certification order because the motion to certify was filed before we were joined as a defendant. The plaintiffs are currently pursuing class discovery against us and will then file their motion for class certification as to us. The defendants who were subject to the certification order have filed an appeal with the 11^th Circuit Court of Appeals which has been granted. Although we can not predict the outcome, we believe that the claims asserted in this lawsuit are without merit and we intend to defend our position.

ITEMS 2 and 3: Not Applicable

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

        We held our Annual Meeting of Shareholders on June 5, 2003. An aggregate of 54,450,226 shares of Common Stock, or 92.34% of the Company’s outstanding shares, were represented at the meeting either in person or by proxy and, accordingly, the meeting was duly constituted. The following proposals were adopted by a majority of the shares voting for each proposal as follows:

         Proposal One:  To elect Class III Directors to serve until the annual meeting of shareholders in 2006:

         Proposal Two:  To approve certain amendments to the Amended and Restated 1998 Stock Incentive Plan.

         Proposal Three:  Ratification of Ernst & Young, LLP as the Company’s Independent Auditors.

ITEM 5: Not applicable

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ITEM 6: Exhibits and Reports on Form 8-K

(a)     Exhibit Listing

(b)    Reports on Form 8-K

        In connection with news release regarding our results of operations for the quarter ended March 31, 2003 and our financial condition as of the period then ended, we filed a current report on Form 8-K with the Securities and Exchange Commission on April 29, 2003.

        In connection with Moody’s confirmation of our ratings (senior unsecured notes at Ba3) and revision of our outlook to positive, we filed a current report on Form 8-K with the Securities and Exchange Commission on June 16, 2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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INDEX TO EXHIBITS

Reg. S-K: Item 601

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