CERES GROUP INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 COMMISSION FILE NUMBER 0-8483

CERES GROUP, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 34-1017531
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

17800 ROYALTON ROAD, CLEVELAND, OHIO 44136
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(Address of principal executive offices) (Zip Code)

(440) 572-2400
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(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, PAR VALUE $0.001 PER SHARE
------------------------------------------------
(Title of class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES [X] NO [ ]

The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant was approximately $51,909,387 computed based
on the closing price of $2.76 per share of the common stock on June 30, 2003.

The number of shares of common stock, par value $0.001 per share,
outstanding as of March 8, 2004 was 34,392,671.
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DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant's definitive proxy statement for the annual
meeting of stockholders to be held May 19, 2004 are incorporated by reference
into Part III of this Form 10-K.
- --------------------------------------------------------------------------------

As used in this Form 10-K, the terms "Company," "Ceres," "Registrant," "we,"
"us," and "our" mean Ceres Group, Inc. and its consolidated subsidiaries, taken
as a whole, unless the context indicates otherwise. Except as otherwise stated,
the information contained in this Form 10-K is as of December 31, 2003.

CERES GROUP, INC.
INDEX TO
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003

PART I

ITEM 1. BUSINESS

OVERVIEW

Ceres, through its insurance subsidiaries, provides a wide array of health
and life insurance products through two primary business segments. Our Senior
segment includes senior health, life and annuity products for Americans age 55
and over. The Medical segment includes catastrophic and comprehensive major
medical health insurance for individuals, families, association members, and
small to mid-size businesses. To help control medical costs, we also provide
medical cost management services to our insureds. Our nationwide distribution
channels include independent agents and our electronic distribution platform.

Ceres (known as Central Reserve Life Corporation prior to December 1998)
operated prior to 1998 primarily through its wholly-owned subsidiary, Central
Reserve Life Insurance Company. Central Reserve markets and sells major medical
health insurance to individuals, families, associations and small to mid-size
employer groups. In late 2003, Central Reserve began marketing and selling
senior health and life products.

In 1999, we acquired Continental General Insurance Company which markets
and sells both major medical and senior health and life products.

Also, in 1999, we acquired, through foreclosure, United Benefit Life
Insurance Company. All of United Benefit Life's business is reinsured to Central
Reserve and another unaffiliated reinsurance company. United Benefit Life
discontinued new sales activities in July 2000 and terminated all of its
existing business at the end of 2001.

In 1998, we acquired Provident American Life and Health Insurance Company.
Provident American Life also has discontinued new sales activities and currently
has approximately 1,300 active major medical policyholders (HealthEdge product).

In March 2003, we sold Pyramid Life Insurance Company, a company we
acquired in July 2000, for approximately $57.5 million in cash. Pyramid Life
primarily markets and sells senior products. Immediately prior to the closing of
the sale, Continental General acquired Pyramid Life's Kansas City building and
personal property and retained its employees. Continental General continued to
administer Pyramid Life's business out of the Kansas City location under a
transition services agreement until December 31, 2003. In addition, Continental
General reinsured a small block of certain life insurance policies of Pyramid
Life.

We also have various non-regulated subsidiaries that, through intercompany
arrangements, provide a variety of services to our insurance subsidiaries,
including personnel, administration, billing and collection, electronic
distribution, managed care and sales support services.

Our major medical operations are located in Strongsville (Cleveland), Ohio
(as well as our corporate offices) and Omaha, Nebraska, and our senior
operations are located in Mission (Kansas City), Kansas.

Our health and life insurance products protect individuals, families,
association members, and small to mid-size employer groups during the years up
to retirement, while our Medicare supplement, long-term care, other supplemental
products, and life and annuity products provide ongoing coverage for senior
Americans.

Our strategy is to:

- grow our historically profitable and predictable Senior segment;

- focus on the profitability of our Medical segment;

- promote electronic distribution for increased efficiency and agent
productivity; and

- reduce administrative costs.

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Our Senior segment continued to produce increasing earnings for 2003,
totaling $19.9 million in pre-tax profits for the year ended 2003 compared to
$14.9 million in 2002. Our Medical segment's pre-tax earnings improved to $8.9
million in 2003 compared to a pre-tax loss of $6.0 million in 2002.

We believe our focus on consistent and selective growth will lead to more
predictable earnings, enhanced profitability, and higher financial agency
ratings of our insurance subsidiaries. We believe that our strategies in the
Senior and Medical segments have proven effective in balancing our results.
Earnings in the Senior segment remain solid and the segment is now poised for
growth in 2004 and beyond. At the same time, we continue to target market in our
Medical segment to maintain stable earnings results in a challenging
environment.

OUR CORE BUSINESSES

SENIOR HEALTH, LIFE AND ANNUITY PRODUCTS. We continue to concentrate our
efforts on the Senior segment because we believe this market has the potential
for greater revenue growth and higher profit margins than our Medical segment.
Our strategy is to expand this segment by emphasizing competitive markets,
working with select distributors, exploring new marketing relationships, and
increasing our agent base. The products in this segment are designed
specifically for Americans age 55 and over, one of the country's fastest growing
age segments that is projected to increase to 103 million people by 2025. In
addition, the senior population controls 72% of the nation's wealth. Our senior
products supplement other programs, such as Medicare, and also include specialty
supplemental coverages and life insurance. According to the Centers for Medicare
and Medicaid Services (CMS), the number of Medicare enrollees, age 65 and over,
nearly doubled between 1966 and 2002, growing to 34.7 million from 19.1 million.
By 2007, the Medicare population is expected to exceed 44 million. Approximately
63.1% of individuals age 65 and over have private insurance along with Medicare.
To address this demand, we will continue to concentrate on our primary product,
Medicare supplement, and increase our market reach through new plan offerings
and portfolio refinements.

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

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

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BUSINESS STRATEGY

Principal elements of our business strategy include:

INCREASING SENIOR MARKET FOCUS. Because of favorable demographics and
higher profit potential in the Senior segment and with the strengthened
statutory capital at Continental General as a result of the sale of Pyramid Life
Insurance Company in March 2003, we intend to continue to focus our sales
efforts on this part of our business. We believe the senior market will continue
to produce more predictable earnings, particularly since these products are not
as sensitive to medical inflation as major medical products. We will be
concentrating more on our agent recruiting and a significant amount of our
product development efforts on the senior market. We also intend to transition
our major medical insureds into our senior products as they age. For the year
ended December 31, 2003, our Senior segment comprised 36% of our total net
premium revenues compared to 31% for 2002. One of our strategic objectives is to
balance our segments' revenue equally over the next two years. Our Senior
segment products are administered at our Kansas facility, which we believe has
superior and efficient technology and administration.

FOCUSING ON PROFITABILITY IN THE MAJOR MEDICAL MARKET. While historically
the Medical segment has been the largest percentage of our revenue, we, like all
health insurance companies, continue to face challenges in this marketplace due
to higher expenses resulting from escalating healthcare and prescription drug
costs. However, we believe that the programs that we have put into place over
the last two years have lessened the inflationary impact. These programs
include:

- target marketing with select distributors in select states with the
greatest potential for profitability;

- selective products that shift some of the control over routine,
discretionary healthcare costs to the consumer;

- rate adjustments;

- cancellation of unprofitable blocks of business in certain states;

- proactive medical cost management; and

- lowered administrative and sales expenses.

Our selective marketing approach has enabled us to serve the demand for
health insurance products while remaining profitable. In addition, we have
improved our underwriting practices.

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

Our 2004 marketing strategy will continue to focus on a reduced number of
geographic locations which have historically produced favorable underwriting
results. We expect increased production levels in 2004 and the decline in major
medical premium to moderate to 10-15%.

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

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

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

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REDUCING ADMINISTRATIVE COSTS. We are committed to reducing administrative
costs through increases in efficiency, streamlined procedures, and consolidation
of operations and services. Our areas of focus include reductions in facility
management costs, printing and supply costs, travel expenses, consolidation of
corporate services, such as accounting, marketing, and distribution, and the
utilization of new electronic technology. We expect to improve our efficiency
and service as we move closer to a paperless environment. Our agency Internet
software system program provides direct online communication for our agents to
check the status of business they submit via their computers 24 hours a day.

We review expense variances to budgets on a monthly basis and make needed
adjustments. If cost effective, we outsource certain functions to independent
third parties. We currently outsource all information and telephone systems at
our Cleveland headquarters. On March 31, 2004, this outsourcing agreement
terminates and we will perform this function internally beginning April 1, 2004.
We also currently outsource claims processing for our Central Reserve Life Ohio
insureds, and claims processing and other administrative services for the
American Chambers Life Insurance Company business and for our insurance
subsidiaries, Provident American Life and United Benefit Life. We believe this
outsourcing offers us the following advantages:

- predictable operational, administrative and systems costs;

- variable expenses based upon volume of business;

- efficiency and economies of scale; and

- system consolidation and integration.

We expect to continue streamlining operations and reducing our general and
administrative expenses through efficiency improvements and elimination of
functions that do not support our core businesses.

PRODUCTS AND SERVICES

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

MAJOR MEDICAL. Our major medical products include catastrophic,
comprehensive, and basic coverage options from PPO benefit plans to traditional
indemnity health insurance plans. Currently, we market only PPO plans. Some of
our major medical plans can also be configured as health savings account plans.

Because our PPO products provide for healthcare delivery at lower premium
costs than traditional indemnity plans, we emphasize our PPO products and
encourage our insureds to purchase them or convert from traditional indemnity
health insurance. Our medical networks provide favorable rates and include other
cost control measures to save money for our insureds.

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

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

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

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

SMALL GROUP PRODUCTS. Our Professional Multi-Option (PMO) product is a
comprehensive major medical plan offered to our small business customers. In
addition, we offer small to mid-size businesses with 2-100 employees our
Partnership Plan, a major medical product in which we share the medical cost
risk with the employer. This alternate funding mechanism allows the employer to
limit expense and risk by self-insuring part of the coverage. This product can
produce a year-end refund or carryover feature for low claims experience that is
attractive to businesses with healthy employees. The savings generated with this
plan can be used to provide other employee benefits.

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

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

SENIOR LIFE INSURANCE AND ANNUITIES. Our life insurance and annuity
products include lower face amount life insurance policies offering coverages up
to $50,000 and annuity plans with first-year bonus interest or interest rate
guarantees.

MEDICAL COST MANAGEMENT. We focus on reducing medical costs for our
insureds by actively managing medical inflation and utilization rate costs.
National health expenditures have grown from $1,872 per capita in 1986 to $4,177
per capita in 1999 and are projected to increase to $9,216 per capita in 2010,
according to statistics compiled by CMS. Several factors have contributed to the
dramatic increase in healthcare expenditures, including increased costs and
utilization of high-technology diagnostic testing and treatments, the rising
cost of malpractice insurance, higher operating costs for hospitals and
physicians, changes in federal and state healthcare regulations, increased
utilization and cost of pharmaceuticals, and the aging of the population.

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

- shifting to the consumer a greater portion of risk with higher deductible
plans and lower premiums;

- focusing our business with national and regional PPOs with superior
pricing and management of costs;

- use of a "Centers of Excellence" network providing our insureds access to
transplant and other necessary high-risk procedures at approximately 75
renowned medical institutions that have the staff, experience and volume
of patients to produce higher recovery rates while offering discounted
costs;

- a multiple benefit level pharmacy coverage to promote use of lower cost
drugs when possible;

- screening techniques to identify and move high-cost and high-risk
insureds as early as possible into case management programs to enhance
treatment programs and lower the long-term total medical expenses;

- a program to detect fraud and abuse by medical providers, policyholders
or agents;

- medical protocol use to avoid claims for unnecessary procedures;

- claims cost negotiation for long-term care expenses;

- product design geared to encourage use of PPOs; and
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- enhanced communication to insureds on the features and benefits of these
programs, emphasizing how they can reduce their total healthcare costs.

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

Our care coordination program provides our insureds with 24-hour access to
medical information, case management early intervention programs and non-network
negotiation processes to lower medical expenses, as well as additional services
to help them extend and maximize insurance benefits.

MARKETING AND SALES

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

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

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

1. SENIOR BROKERAGE. These Continental General agents target Americans age
55 and over with a comprehensive product line.

2. SENIOR CAREER. This channel is comprised of an independent marketing
organization that exclusively markets a new line of senior products for
Central Reserve that was rolled out in December 2003.

3. MEDICAL CAREER. This channel is comprised of well-established marketing
organizations that primarily market both Central Reserve and Continental
General health insurance and supplemental health insurance. Some of this
business is sold through electronic platforms.

4. MEDICAL BROKERAGE. Our Central Reserve brokerage agents concentrate on
individuals, families, associations, and small business owners. The
product portfolio includes catastrophic medical coverage, individual
medical plans, small group medical plans, health savings account plans,
basic medical coverage, short-term major medical, life insurance and
annuities. These agents may represent multiple insurance carriers.

5. QQLINK ELECTRONIC DISTRIBUTION. QQLink is our fully transactional online
platform for Continental General's major medical and senior life and
health products. QQLink, founded in late 2000, combines a traditional
agent distribution system with direct online sales of insurance.
Consumers are able to review and receive premium quotes and apply for
insurance online. QQLink is 99% owned by Ceres with the remaining 1%
owned by three of our agents. The majority of Continental General's
major medical business was sold through QQLink in 2003.

MARKETING SUPPORT. We compete with other insurance companies and other
sales operations for our agents. In addition, we compete with other companies
that our independent agents represent. Our marketing systems concentrate on
broad product portfolios and sales support to agents. Our strategy is to provide
the tools and resources needed by the sales force, so that our agents can devote
their time to selling.

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

- competitive products and commission structures;

- advanced commissions on select products for agents who qualify;

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- ongoing product development;

- special incentive awards to new agents;

- website development for participating QQLink agents;

- training seminars to introduce new products and sales material for our
agents; and

- consistent agent communication and quality sales materials.

CUSTOMER BASE

We had approximately 250,000 group certificates and individual policies in
force as of December 31, 2003, representing approximately 343,000 insureds. Each
group certificate represents an insured and any spouse, children and other
dependents. The following table reflects the breakdown by product of the group
certificates and individual policies for the years ended December 31, 2003 and
2002.

Because of the Health Insurance Portability and Accountability Act of 1996
(HIPAA) and state regulatory restrictions, we place greater emphasis on the sale
of individual and association major medical products. For 2003, our major
medical certificates included 67% for individual and association products and
33% for small group products, which were consistent with levels experienced in
2002.

The geographic distribution of direct and assumed premiums, before
reinsurance ceded, on a statutory basis of all of our subsidiaries in 2003 and
2002 is presented in the table below. The presentation on a statutory basis
differs from accounting principles generally accepted in the United States of
America (GAAP) in that our fee income and annuity considerations are considered
premiums for statutory purposes. Effective March 31, 2003, Continental General
entered into a reinsurance agreement with Pyramid Life under which Continental
General reinsured on a 100% coinsurance basis and, to the extent policyholders
consent or are deemed to consent thereto, on an assumption reinsurance basis,
certain interest sensitive whole-life policies. The policy liabilities assumed
by Continental General of $12.2 million were reported as assumed premiums for
statutory purposes. The 2003 statutory premiums presented in the table below
exclude the $12.2 million in policy liabilities assumed from Pyramid Life.

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PRICING AND UNDERWRITING

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

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

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

Our profitability depends on our ability to adequately increase rates for
both new business and at renewal. We have implemented procedures that permit us
to apply to regulatory authorities for corrective rate actions on a timely basis
with respect to both new business rates and the current market rates. This
allows us to analyze whether these rates sufficiently cover benefits, expenses
and commissions. For renewal business, we analyze our loss ratios and compare
them to our target loss ratios. When this analysis is complete, we immediately
implement any necessary corrective action, including rate increases.

8

CLAIMS

All claims for policy benefits are currently either processed by our Claims
Department or outsourced to third party administrators. We currently outsource
claims processing for our Central Reserve Ohio insureds and claims processing
and other administrative services for the Chambers and Provident American Life's
HealthEdge business to a third party vendor. We also outsource claims processing
for the run-off business of Provident American Life and United Benefit Life to a
third party vendor.

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

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

SYSTEMS

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

Our business depends significantly on effective information systems. We
have many different information systems for our various businesses, including
the use of our third party vendors' systems. Our information systems require an
ongoing commitment of significant capital and human resources to maintain and
enhance existing systems and develop new systems or relationships with third
party vendors in order to keep pace with continuing changes in information
processing technology, evolving industry and regulatory standards, and changing
customer preferences. Prior to 2004, a significant portion of our support
systems was obtained from third party vendors.

Pursuant to an administrative services agreement with a third party vendor
that terminates on March 31, 2004, we outsourced all information and telephone
systems at our Cleveland headquarters. We also outsource administration of some
blocks of business to third party vendors. We receive regular reports from our
third party vendors that enable us to closely monitor our business on their
systems.

INVESTMENTS

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

At December 31, 2003, approximately 98.9% of our invested assets were fixed
maturity securities. At December 31, 2003, 96.0% of our fixed maturity
securities were of investment grade quality with 84.0% in securities rated A or
better (typically National Association of Insurance Commissioners (NAIC) I) and
12.0% in securities rated BBB (typically NAIC II). We do not invest in
derivatives, such as futures, forwards, swaps, option contracts or other
financial instruments with similar characteristics.

At December 31, 2003, the fair value of our investments in mortgage-backed
securities totaled $162.3 million, or 33.5% of total invested assets. We
minimize the credit risk of our mortgage-backed securities by holding primarily
issues of U.S. Government agencies or high-quality non-agency issuers rated

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AA or better. Among the agency mortgage-backed securities, which comprises 19.7%
of the portfolio, the securities are comprised of pass-through securities and
planned amortization class collateralized mortgage obligations. The pass-through
securities primarily are invested in current market coupons that should exhibit
only moderate prepayments in a declining interest rate environment, while the
planned amortization class collateralized mortgage obligations provide strong
average life protection over a wide range of interest rates. The non-agency
mortgage-backed securities, which represent 13.8% of the portfolio, consist of
commercial and jumbo residential mortgage securities. The commercial
mortgage-backed securities provide very strong prepayment protection through
lockout and yield maintenance provisions, while the residential mortgage-backed
securities are concentrated in non-accelerating securities that have several
years of principal lockout provisions.

The amortized cost and estimated fair value of invested assets as of
December 31, 2003, were as follows:

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

RESERVES

We establish and report liabilities or reserves on our balance sheet for
unpaid healthcare costs by estimating the ultimate cost of incurred claims that
have not yet been reported to us by our policyholders or their providers and
reported claims that we have not yet paid. Since these reserves represent our
estimates, the process requires a degree of judgment. Reserves are established
according to Actuarial Standards of Practice and generally accepted actuarial
principles and are based on a number of factors, including experience derived
from historical claims payments and actuarial assumptions to arrive at loss
development factors.

Such assumptions and other factors include:

- healthcare cost trends;

- the incidence of incurred claims;

- the extent to which all claims have been reported; and

- internal claims processing changes.

Due to the variability inherent in these estimates, reserves are sensitive to
changes in medical claims payment patterns and changes in medical cost trends. A
deterioration or improvement of the medical cost trend or changes in claims
payment patterns from the trends and patterns assumed in estimating reserves
would trigger a change.

10

The majority of Central Reserve's, Provident American Life's and United
Benefit Life's reserves and liabilities for claims are for the health insurance
business. The majority of Continental General's reserves and liabilities for
claims are for the life and annuity and long-term care business due to the long
duration nature of these productions. For our individual and group accident and
health business, we establish an active life reserve plus a liability for due
and unpaid claims, claims in course of settlement and incurred but not yet
reported claims, as well as a reserve for the present value of amounts not yet
due on claims. These reserves and liabilities are also impacted by many factors,
such as economic and social conditions, inflation, hospital and pharmaceutical
costs, changes in doctrines of legal liability and damage awards for pain and
suffering. Therefore, the reserves and liabilities established are necessarily
based on estimates and prior years' experience.

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

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

We may from time to time need to increase or decrease our claims reserves
significantly in excess of our initial estimates and any adjustments would be
reflected in our earnings. An inadequate estimate in reserves could have a
material adverse impact on our business, financial condition and results of
operations. For more information, please see "Critical Accounting Policies" on
page 21.

REINSURANCE

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

Under quota share reinsurance, the reinsurer assumes or cedes an agreed
percentage of certain risks insured by the ceding insurer and shares premium
revenue and losses proportionately. When we cede business to others, reinsurance
does not discharge us from our primary liability to our insureds. However, 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.

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

A significant portion of our risks are reinsured with a single reinsurance
company, Hannover Life Reassurance Company of America, a health and life
reinsurance company. In 2003, Hannover accounted for 93.8% of the total premiums
ceded by our subsidiaries. Hannover has entered into reinsurance agreements with
several of our subsidiaries, including Central Reserve, Provident American Life,
United Benefit Life and Continental General. Our reinsurance agreements with
Hannover are not cancelable or terminable by Hannover. In recent years, we have
reduced our reliance on reinsurance. Our arrangements are generally for closed
blocks of business, which means that Hannover is not reinsuring any new sales or
business of any of our subsidiaries under these reinsurance agreements.

11

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

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

The total premiums ceded by our subsidiaries in 2003 to unaffiliated
reinsurers amounted to $93.1 million, of which Hannover represented
approximately 93.8%. Our gross reinsurance receivables from unaffiliated
reinsurers amounted to $143.4 million as of December 31, 2003, of which
approximately 98.3% was attributable to Hannover.

Hannover is a subsidiary of Hannover Rueckversicherungs, a German
corporation, which had assets of $35.2 billion and total stockholders' equity of
$1.8 billion at December 31, 2002. Moody's has assigned Hannover
Rueckversicherungs a financial strength rating of Baa1 (adequate). Hannover and
Hannover Rueckversicherungs each have an A (excellent) rating from A.M. Best
Company, Inc. In addition, Hannover Rueckversicherungs has a financial strength
rating of AA- (very strong) from Standard & Poor's. Hannover's failure to pay
our claims in full or on a timely basis could have a material adverse effect on
our business, financial condition and results of operations.

For ordinary and group life claims, Continental General's maximum retention
is $125,000 and Central Reserve's maximum retention is $50,000 with no retention
maintained over age 70. For accident and health claims, maximum retention on
individual claims is $500,000. For a complete discussion of our material
reinsurance agreements, including recent reinsurance agreements, see Note L.
Reinsurance Arrangements to our audited consolidated financial statements.

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

COMPETITION

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

We face additional competition due to a trend among healthcare providers
and insurance companies to combine and form networks in order to contract
directly with small businesses and other prospective customers to provide
healthcare services. In addition, because many of our products are marketed
through

12

independent agents, most of which represent more than one company, we compete
with other companies for the marketing focus of each agent.

RATINGS

Our ratings assigned by A.M. Best Company, Inc. and other nationally
recognized rating agencies are important in evaluating our competitive position.
A.M. Best ratings are based on an analysis of the financial condition of the
companies rated. A.M. Best ratings are primarily based upon factors of concern
to policyholders and insurance agents. In January 2003, the A.M. Best ratings of
our insurance subsidiaries were affirmed. Central Reserve's rating is a B
(fair). Continental General's rating is a B+ (very good). Provident American
Life's and United Benefit Life's ratings for 2001 were affirmed NR-3 (rating
procedure inapplicable). This rating is defined by A.M. Best to mean that normal
rating procedures do not apply due to unique or unusual business features.
Provident American Life and United Benefit Life fall into this category because,
due to reinsurance, they both retain only a small portion of their gross
premiums.

In April 2003, Fitch upgraded Central Reserve's rating to BBB- (good credit
quality) and affirmed Continental General's BBB (good credit quality) financial
strength rating.

In light of the statutory capitalization and strengthened balance sheet
from the sale of Pyramid Life, reduced holding company leverage and improved
operating performance in 2003, we are hopeful that the major rating agencies
will give favorable consideration to our financial ratings in 2004.

GOVERNMENT REGULATION

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

INSURANCE REGULATION. We are subject to regulation and supervision by
state insurance regulatory agencies. This regulation is primarily intended to
protect insureds rather than investors. These regulatory bodies have broad
administrative powers relating to standards of solvency, which must be met on a
continuing basis, granting and revoking of licenses, licensing of agents,
approval of policy forms, approval of rate increases, maintenance of adequate
reserves, claims payment practices, form and content of financial statements,
types of investments permitted, issuance and sale of stock, payment of
dividends, and other matters pertaining to insurance. We are required to file
detailed annual statements with the state insurance regulatory bodies and are
subject to periodic examination. The most recent completed regulatory
examination for Central Reserve, Provident American Life and United Benefit Life
was performed by the State of Ohio as of December 31, 1999. For Continental
General, the most recent examination was performed by the State of Nebraska as
of December 31, 2001. State insurance departments also periodically conduct
market conduct examinations of our insurance subsidiaries.

Although many states' insurance laws and regulations are based on models
developed by the NAIC and are therefore similar, variations among the laws and
regulations of different states are common. The National Association of
Insurance Commissioners (NAIC) is a voluntary association of all of the state
insurance commissioners in the United States. The primary function of the NAIC
is to develop model laws on key insurance regulatory issues that can be used as
guidelines for individual states in adopting or enacting insurance legislation.
While the NAIC model laws are accorded substantial deference within the
insurance industry, these laws are not binding on insurance companies unless
adopted by a state, and variation from the model laws within the state is
common.
13

The NAIC revised the Accounting Practices and Procedures Manual in a
process referred to as Codification. The revised manual was effective January 1,
2001. The domiciliary states of Ceres and its insurance subsidiaries have
adopted the provisions of the revised manual. The revised manual has changed, to
some extent, prescribed statutory accounting practices and has resulted in
changes to the accounting practices that our insurance subsidiaries use to
prepare their statutory-basis financial statements. The impact of these changes
to statutory-basis capital and surplus of the insurance subsidiaries was not
significant.

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

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

- The "Company Action Level" is triggered if a company's total adjusted
capital is less than 200%, but greater than or equal to 150% of its
risk-based capital. At the "Company Action Level," a company must submit
a comprehensive plan to the regulatory authority that discusses proposed
corrective actions to improve its capital position. A company whose total
adjusted capital is between 250% and 200% of its risk-based capital is
subject to a trend test. The trend test calculates the greater of any
decrease in the margin (i.e., the amount in dollars by which a company's
adjusted capital exceeds its risk-based capital) between the current year
and the prior year and between the current year and the average of the
past three years, and assumes that the decrease could occur again in the
coming year. If a similar decrease in margin in the coming year would
result in a risk-based capital ratio of less than 190%, then "Company
Action Level" regulatory action would be triggered.

- The "Regulatory Action Level" is triggered if a company's total adjusted
capital is less than 150%, but greater than or equal to 100% of its
risk-based capital. At the "Regulatory Action Level," the regulatory
authority will perform a special examination of the company and issue an
order specifying corrective actions that must be followed.

- The "Authorized Control Level" is triggered if a company's total adjusted
capital is less than 100%, but greater than or equal to 70% of its
risk-based capital, at which level the regulatory authority may take any
action it deems necessary, including placing the company under regulatory
control.

- The "Mandatory Control Level" is triggered if a company's total adjusted
capital is less than 70% of its risk-based capital, at which level the
regulatory authority is mandated to place the company under its control.

We calculated the risk-based capital for our insurance subsidiaries as of
December 31, 2003, using the applicable RBC formula. Based on these
calculations, our risk-based capital levels for each of our subsidiaries
exceeded the levels required by regulatory authorities.

Dividends paid by our insurance subsidiaries to Ceres are limited by state
insurance regulations. The insurance regulator in the insurer's state of
domicile may disapprove any dividend which, together with other dividends paid
by an insurance company in the prior 12 months, exceeds the regulatory maximum
as computed for the insurance company based on its statutory surplus and net
income. In 2003, none of our direct insurance subsidiaries (Central Reserve and
Continental General) could pay a dividend to Ceres without the prior approval of
their respective state insurance regulators as a result of their respective
statutory levels of
14

unassigned surplus at December 31, 2002. In 2004, Continental General could pay
a dividend to Ceres Group, the parent company, of up to $6.0 million without
prior approval of the state regulator. Central Reserve is prohibited from paying
any dividends without prior approval of its state regulator due to its statutory
level of unassigned surplus.

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

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

HEALTHCARE REGULATION AND REFORM. Government regulation and reform of the
healthcare industry also affects the manner in which we conduct our business.
The Gramm-Leach-Bliley Act mandated restrictions on the disclosure and
safeguarding of our insureds' financial information. The USA Patriot Act placed
new federal compliance requirements relating to anti-money laundering, customer
identification and information sharing. The Department of Labor regulations
affected the timeframes for making a decision on claims submitted by those
insured by an employer sponsored plan.

HIPAA has mandated the adoption of extensive standards for the use and
disclosure of health information. HIPAA has also mandated the adoption of
standards for the exchange of electronic health information in an effort to
encourage overall administrative simplification and enhance the effectiveness
and the efficiency of the healthcare industry. We have developed, and continue
to enhance, electronic data interface (EDI) systems and relationships relating
to our claim adjudication operations. These electronic processes increase the
efficiencies in the service provided to our customers.

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

There continues to be diverse legislative and regulatory initiatives at
both the federal and state levels to affect aspects of the nation's health care
system. On December 8, 2003, President Bush signed into law the Medicare
Prescription Drug Improvement and Modernization Act of 2003, or DIMA. DIMA makes
many significant changes to the Medicare fee-for-service and Medicare+Choice
programs, as well as other changes to the commercial health insurance
marketplace. Most significantly, DIMA creates a prescription drug benefit for
Medicare beneficiaries, establishes a new Medicare Advantage program to replace
the Medicare+Choice program, and enacts health savings accounts (HSAs) for
non-Medicare eligible individuals and groups. The effects of DIMA on our
business, including any impact on our future prospects, are still unknown. We
will continue to assess the impact, if any, of DIMA and any other new or
proposed Medicare legislation.

In addition to federal regulation and reform, many states have enacted, or
are considering, various healthcare reform statutes. These reforms relate to,
among other things, managed care practices, prompt pay payment practices, and
mandated benefits. Most states have also enacted patient confidentiality laws
that prohibit the disclosure of confidential information. As with all areas of
legislation, the federal regulations establish minimum standards and preempt
conflicting state laws that are less restrictive but will allow state laws that
are more restrictive. These laws or regulations may limit our operations and
hinder our ability to effectively manage utilization and costs. We are unable to
predict what state reforms will be enacted or how they would affect our
business.

15

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

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

For several years, Congress and various states have been considering some
form of the "Patients' Bill of Rights." This legislation, if enacted, is
designed to provide, among other things, consumers more freedom of choice in the
selection of doctors, facilities, and treatments. Although the bill was
originally conceived to regulate HMOs, it affects all facets of the nation's
healthcare organizations and indemnity insurance plans. These changes are
expected to result in higher total medical costs, which could encourage more
partnerships and associations between medical providers and insurers to control
costs, more community-based health organizations, and greater use of higher
deductibles to lower insurance costs and reduce administrative expenses of
smaller claims.

Statutory and regulatory changes may also significantly alter our ability
to manage pharmaceutical costs through restricted formularies of products
available to our insureds.

E-COMMERCE REGULATION. We may be subject to additional federal and state
statutes and regulations in connection with our changing product strategy, which
includes Internet services and products. On an increasingly frequent basis,
federal and state legislators are proposing laws and regulations that apply to
Internet based commerce and communications. Areas being affected by this
regulation include user privacy, pricing, content, taxation, copyright
protection, distribution and quality of products, and services. To the extent
that our products and services would be subject to these laws and regulations,
the sale of our products and our business could be harmed.

EMPLOYEES

We had approximately 733 employees at December 31, 2003. We consider our
employee relations to be good. Our agents are independent contractors and not
employees.

AVAILABLE INFORMATION

Ceres Group, Inc. is a Delaware corporation. Our principal executive
offices are located at 17800 Royalton Road, Cleveland, Ohio 44136 and our
telephone number at that address is (440) 572-2400.

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange

16

Act of 1934 are available free of charge through the Company's website at
http://www.ceresgp.com as soon as reasonably practicable after we electronically
file such reports with the Securities and Exchange Commission.

We have adopted a code of corporate conduct for our directors, officers and
employees, known as the Code of Conduct and Ethics. The Code is available on our
website at http://www.ceresgp.com or you may request a free copy of the Code of
Conduct and Ethics from:

Ceres Group, Inc.
Attention: Investor Relations
17800 Royalton Road
Cleveland, Ohio 44136
(440) 572-2400

ITEM 2. PROPERTIES

OWNED PROPERTIES (OFFICE SPACE)

- ---------------

(1) Immediately prior to the closing of the Pyramid Life sale, Continental
General acquired Pyramid Life's building in Kansas. See Note E. Discontinued
Operations for further information.

LEASED PROPERTIES (OFFICE SPACE)

ITEM 3. 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 denials of
healthcare benefits, premium rate increases, termination of coverage, claims
administration and violations of state statutes. We are involved in various
legal and regulatory actions occurring in the normal course of business, which
could result in significant liabilities and costs. Based on current information,
including consultation with outside counsel, we believe any ultimate liability
that may arise from these actions would not materially affect our consolidated
financial position or results of operations. However, we cannot predict with
certainty the outcome of lawsuits against the Company or the potential costs
involved. Our evaluation of the likely impact of these actions could change in
the future and an unfavorable outcome could have a material adverse effect on
our consolidated financial position, results of operations or cash flows of a
future period.

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

None.

17

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock trades on the Nasdaq National Market under the symbol
CERG. The following table shows the high and low closing prices of our common
stock for the quarters listed. These prices were taken from the Nasdaq Monthly
Statistical Reports. On March 9, 2004, our common stock closed at $6.70 per
share.

As of March 1, 2004, we had an estimated 2,073 record holders.

We have not paid any cash dividends on our common stock since the end of
1996, and we do not anticipate paying any dividends in the foreseeable future.
Our new credit agreement with National City Bank, dated December 23, 2003,
contains financial and other covenants that, among other matters, limit the
payment of cash dividends on our common stock. For more information on our
credit agreement, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."

Dividends paid by our insurance subsidiaries to us are limited by state
insurance regulations. The insurance regulator in the insurer's state of
domicile may disapprove any dividend which, together with other dividends paid
by an insurance company in the prior 12 months, exceeds the regulatory maximum
as computed for the insurance company based on its statutory surplus and net
income. In 2003, none of our direct insurance subsidiaries (Central Reserve and
Continental General) could pay a dividend to Ceres without the prior approval of
their respective state insurance regulators as a result of their respective
statutory levels of unassigned surplus at December 31, 2002. In 2004,
Continental General could pay a dividend to Ceres Group, the parent company, of
up to $6.0 million without prior approval of the state regulator. Central
Reserve is prohibited from paying any dividends without prior approval of its
state regulator due to its statutory level of unassigned surplus.

18

ITEM 6. SELECTED FINANCIAL DATA

The selected audited consolidated financial data presented below as of and
for each of the five years ended December 31, 2003, 2002, 2001, 2000 and 1999
have been derived from our audited consolidated financial statements. However,
financial data for 2001 and 2000 was reclassified to reflect the sale of Pyramid
Life. See Note E. Discontinued Operations to our audited consolidated financial
statements for further information. The acquisitions of Provident American Life
and Continental General occurred on December 31, 1998 and February 17, 1999,
respectively. Results for United Benefit Life are included from August 1, 1998
to July 20, 1999 under a reinsurance agreement and thereafter as an acquired
entity. The financial information for the year ended December 31, 1999 includes
the operations of Continental General since February 1, 1999 and for Provident
American Life and United Benefit Life (through reinsurance) for the entire
period. The financial information for the years ended December 31, 2003, 2002,
2001, and 2000 includes the operations of all our subsidiaries for the entire
year except for Pyramid Life. Pyramid Life, which is presented separately as
discontinued operations, was acquired on July 26, 2000 and sold on March 31,
2003. The data for 2003, 2002, and 2001 should be read in conjunction with the
more detailed information contained in the audited consolidated financial
statements and accompanying notes, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and other financial information
included elsewhere in this filing.

- ---------------

(1) Effective March 31, 2003, Continental General sold its subsidiary, Pyramid
Life Insurance Company, to Pennsylvania Life Insurance Company, a subsidiary
of Universal American Financial Corp., for approximately $57.5 million in
cash. See Note E. Discontinued Operations to our audited consolidated
financial statements for further information.

(2) The exercise of options and warrants is not assumed when a loss from
operations is reported and the result would be antidilutive.

(3) We received proceeds from a December 2001 public offering and private
placement offerings in 2000 and 1999. For more information, see Note B.
Equity Transactions to our audited consolidated financial statements.

(4) "Accumulated other comprehensive income" relates primarily to the net
unrealized gain (loss) on available-for-sale securities.

20

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

This discussion should be read in conjunction with the audited consolidated
financial statements, notes, and tables included elsewhere in this report.
Management's discussion and analysis contains 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."

OVERVIEW

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

Our insurance subsidiaries include Central Reserve Life Insurance Company,
Provident American Life & Health Insurance Company, United Benefit Life
Insurance Company and Continental General Insurance Company. Central Reserve
markets and sells major medical health insurance to individuals, families,
associations, and small employer groups and, in late 2003, began marketing and
selling senior products. Continental General markets and sells both major
medical and senior health and life products to individuals, families,
associations and Americans age 55 and over. 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 and its business
was substantially wound down at December 31, 2003. Provident American Life also
has discontinued new sales activities and currently has approximately 1,300
active policyholders.

Effective March 31, 2003, Ceres sold its subsidiary, Pyramid Life Insurance
Company to Pennsylvania Life Insurance Company, a subsidiary of Universal
American Financial Corp., for approximately $57.5 million in cash. For more
information on the Pyramid Life sale, see Note E. Discontinued Operations to our
audited consolidated financial statements.

CRITICAL ACCOUNTING POLICIES

Management has identified the following items that represent our most
sensitive and subjective accounting estimates that have or could have a material
impact on our financial statements. These estimates required management to make
assumptions about matters that were highly uncertain at the time the estimates
were made. Changes to these estimates occur from period to period and may have a
material impact on our consolidated financial statements in the period in which
they are made. Management has discussed the development, selection and
disclosure of these estimates with our Audit Committee.

LIABILITIES FOR OTHER POLICY CLAIMS AND BENEFITS PAYABLE. The most
significant accounting estimate in our audited consolidated financial statements
is our liability for other policy claims and benefits payable.

We recognize claim costs in the period the service was provided to our
insureds. However, claim costs incurred in a particular period are not known
with certainty until after we receive, process and pay the claim. The receipt
and payment date of claims may lag significantly from the date the service was
provided. Consequently, we must estimate our liabilities for claims that are
incurred but not yet reported.

Liabilities for unpaid claims are based on an estimation process that is
complex and uses information obtained from both company specific and industry
data, as well as general economic information. These estimates are developed
using actuarial methods based upon historical data for payment patterns, medical
inflation, product mix, seasonality, utilization of health care services, and
other relevant factors. The amount recorded for unpaid claims liabilities is
sensitive to judgments and assumptions made in the estimation process. The most
significant assumptions used in the estimation process include determining
utilization and inflation trends, the expected consistency in the frequency and
severity of claims incurred but not yet reported,

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changes in the timing of claims submission patterns from providers, changes in
our speed of processing claims, and expected costs to settle unpaid claims.

Actual conditions could differ from those assumed in the estimation
process. Due to the uncertainties associated with the factors used in these
assumptions, materially different amounts could be reported in our statement of
operations for a particular period under different conditions or using different
assumptions. As is common in the health insurance industry, we believe that
actual results may vary within a reasonable range of possible outcomes.
Management believes that our reasonable range of actual outcomes may vary up to
10% to 15% of the total liabilities for other policy claims and benefits payable
recorded at the end of a period.

Note K. Liabilities for Other Policy Claims and Benefits Payable to our
audited consolidated financial statements provides historical information
regarding the accrual and payment of our unpaid claims liability. Components of
the total incurred claims for each year include amounts accrued for current year
estimated claims expense, as well as adjustments to prior year estimated
accruals.

Management considered the volatile claims experience in recent periods when
it established its liabilities for unpaid claims at December 31, 2003.
Management believes that the recorded liabilities for unpaid claims at December
31, 2003 is within a reasonable range of outcomes. Management closely monitors
and evaluates developments and emerging trends in claims costs to determine the
reasonableness of judgments made. A retrospective test is performed on prior
period claims liabilities and, as adjustments to the liabilities become
necessary, the adjustments are reflected in current operations. Management
believes that the amount of medical and other benefits payable is adequate to
cover our liabilities for unpaid claims as of December 31, 2003.

DEFERRED ACQUISITION COSTS. In connection with the sale of our insurance
policies, we defer and amortize a portion of the policy acquisition costs over
the related premium paying periods of the life of the policy. These costs
include certain excess policy acquisition costs associated with issuing an
insurance policy, including commissions and underwriting, all of which vary with
and are primarily related to the production of new business. The amortization of
deferred acquisition costs is determined using the same projected actuarial
assumptions used in computing policy reserves. Deferred acquisition costs
associated with traditional life and accident and health contracts are charged
to expense over the premium-paying period or as premiums are earned over the
life of the contract. Deferred acquisition costs associated with
interest-sensitive life and annuity products are charged to expense over the
estimated duration of the policies in relation to the present value of the
estimated gross profits from surrender charges and investments, mortality, and
expense margins.

We evaluate the recoverability of our deferred acquisition costs on a
quarterly basis. The recoverability of our deferred acquisition costs is
sensitive to judgments and assumptions made in projecting future cash flows on
our various blocks of business. The most significant assumptions are claim cost
trends, magnitude of rate increases, lapsation and persistency, and mortality.

During 2002 and 2001, we wrote-off $4.2 million and $6.7 million,
respectively, of deferred acquisition costs associated with certain of our major
medical business due to the continuing unprofitability of terminated blocks of
business.

Management believes the amount of deferred acquisition costs as of December
31, 2003 is recoverable.

OTHER ACCOUNTING POLICIES AND INSURANCE BUSINESS FACTORS

Our results of operations are affected by the following accounting and
insurance business factors:

GOODWILL AND OTHER INTANGIBLE ASSETS. Goodwill represents the excess of
purchase price over the fair value of tangible and identifiable intangible net
assets acquired. At December 31, 2003, goodwill was $10.7 million and
represented approximately 1.4% of our total assets. Additionally, other
intangible assets represent purchased assets that also lack physical substance
but can be distinguished from goodwill because of other legal rights or because
the asset is capable of being sold or exchanged either on its own or in
combination with a related contract asset or liability. At December 31, 2003,
our other intangible assets consisted of $3.4 million in licenses, or 0.4% of
our total assets.

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Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets issued by the
Financial Accounting Standards Board (FASB), which provides that goodwill and
intangibles with indefinite useful lives should not be amortized but instead be
tested for impairment annually at the reporting unit level. In accordance with
SFAS No. 142, we completed a transitional goodwill impairment test, which
indicated that an impairment loss against our goodwill and other intangible
assets was not required. Goodwill and intangibles with indefinite useful lives
are tested for impairment on an annual basis and more often if indications of
impairment exist. The estimated fair value of goodwill of a reporting unit is
determined by applying the appropriate discount rates to estimated future cash
flows for the reporting unit. The estimated fair value of licenses was
determined by independent appraisals. The results of our analysis indicated that
no reduction of goodwill was required. A slight reduction of $0.1 million was
made to the carrying value of licenses in 2003 due to the cancellation of
business in certain unprofitable states.

LONG-LIVED ASSETS. Property and intangible assets are reviewed for
possible impairment when events indicate that the carrying amount of an asset
may not be recoverable. Assumptions and estimates used in the evaluation of
impairment may affect the carrying value of long-lived assets, which could
result in impairment charges in future periods. Depreciation and amortization
policies reflect judgments on the estimated useful lives of assets.

REVENUE RECOGNITION. Life insurance premiums are recognized as revenue
when they become due. Health premiums are recognized as revenue over the terms
of the policies. Amounts received from interest sensitive contracts, principally
universal life and annuity products, are not reflected in premium revenue;
rather, such amounts are accounted for as deposits with the related liabilities
included in future policy benefits, losses and claims.

VALUE OF BUSINESS ACQUIRED. A portion of the purchase price paid for
Continental General Corporation was allocated to the value of business acquired
based on the actuarially determined present value of the expected pre-tax future
profits from the business assuming a discount rate of 15.0%. Interest is accrued
on the balance annually at a rate consistent with the rate credited on the
acquired policies on the acquisition date, which ranges from 4.0% to 8.75%.
Recoverability of the value of business acquired is evaluated periodically by
comparing the current estimate of the present value of expected pre-tax future
profits to the unamortized asset balance. If the current estimate is less than
the existing asset balance, the difference would be charged to expense, and if
the current estimate is higher than the existing asset balance, the difference
will emerge into profits as earned.

For accident and health and ordinary life business, the value of business
acquired is amortized over the estimated life of the in force business using
assumptions consistent with those in computing reserves. Interest of 6.5% for
Continental General is credited to the unamortized balance. For interest
sensitive products such as universal life and deferred annuities, the value of
business acquired is amortized over the expected profit stream of the in force
business. The expected profit stream is based upon actuarial assumptions as to
mortality, lapses and expenses. Earned interest was assumed to be 6.0% for
Continental General, the market rate at the time of acquisition.

THE NUMBER OF YEARS A POLICY HAS BEEN IN EFFECT. Claims costs tend to be
higher on policies that have been in force for a longer period of time. As the
policy ages, it is more likely that the insured will need services covered by
the policy. However, generally, the longer the policy is in effect, the more
premium we will receive for major medical and Medicare supplement policies. For
other health, life and annuity policies/contracts, reserve liabilities are
established for policy benefits expected to be paid for in future years.

LAPSATION AND PERSISTENCY. Other factors that affect our results of
operations are lapsation and persistency, both of which relate to the renewal of
insurance policies and certificates in force. Lapsation is the termination of a
policy for nonrenewal and, pursuant to our practice, is automatic if and when
premiums become more than 31 days overdue. However, policies may be reinstated,
if approved, within six months after the policy lapses. Persistency represents
the percentage of total certificates in force at the end of a period less any
newly-issued certificates divided by the total certificates in force at the
beginning of the period.

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Policies renew or lapse for a variety of reasons, due both to internal and
external causes. We believe that our efforts to address any concerns or
questions of our insureds in an expedient fashion help to ensure ongoing policy
renewal. We work closely with our licensed agents, who play an integral role in
obtaining policy renewals and communicating with our insureds.

EXTERNAL FACTORS ALSO CONTRIBUTE TO POLICY RENEWAL OR LAPSATION. Economic
cycles can influence an insured's ability to continue to pay insurance premiums
when due.

Lapsation and persistency may positively or adversely impact future
earnings. Higher persistency generally results in higher renewal premium.
However, higher persistency may lead to increased claims in future periods.
Additionally, increased lapsation can result in reduced premium collection,
accelerated amortization of deferred acquisition cost, and antiselection of
higher-risk insureds.

REINSURANCE. Consistent with the general practice of the insurance
industry, we reinsure portions of the coverage 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. For more information on
Hannover, see "Business -- Reinsurance -- Existing Arrangements." We also have
assumed risk on a "quota share" basis from other insurance companies. Our
results of operations are presented net of reinsurance.

LIABILITIES FOR LITIGATION. We are involved in various litigation and
regulatory actions. Such actions typically involve disputes over policy coverage
and benefits, but may also relate to premium rates, agent and employment related
issues, regulatory compliance and market conduct, contractual relationships, and
other matters. These disputes are resolved by settlement, dismissal or upon a
decision rendered by a judge, jury or regulatory official.

In determining the amount to be recorded as a litigation reserve, judgments
are generally made by management, in consultation with legal counsel and other
experts both within and outside the Company, on a case-by-case basis based on
the facts and the merits of the case, the general litigation and regulatory
environment of the originating state, our past experience with outcomes of cases
in particular jurisdictions, historical results of similar cases and other
relevant factors. We closely monitor and evaluate developments and emerging
facts of each case to determine the reasonableness of judgments and assumptions
on which litigation reserves are based. Such assumptions relate to matters that
are highly uncertain. Estimates could be made based on other reasonable
assumptions or judgments that would differ materially from those estimates
recorded. We will accrue a liability if the likelihood of an adverse outcome is
probable and the amount is estimable. We will not accrue a liability if either
the likelihood of an adverse outcome is only reasonably possible or an estimate
is not determinable. Our evaluation of the likely outcome of these actions and
the resulting estimate of the potential liability are subject to periodic
adjustments that may have a material impact on our financial condition and
results of operations of a future period.

Inherent uncertainties surround legal proceedings and actual results could
differ materially from those assumed in estimating the liabilities. The
possibility exists that a decision could be rendered against us, and, in some
circumstances, include punitive or other damage awards in excess of amounts
reserved, that may have a material impact on our financial condition, results of
operations or cash flows, of a future period.

INSURANCE. We use a combination of insurance and self-insurance for a
number of our risks including property, general liability, directors' and
officers' liability, workers' compensation, vehicle liability, and
employee-related healthcare benefits. Liabilities associated with the risks that
are retained are estimated by considering various historical trends and
forward-looking assumptions. The estimated accruals for these liabilities could
be significantly affected if future occurrences and claims differ from these
assumptions and historical trends. Over the past couple of years, increases in
the cost and availability of commercial insurance

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as a result of significant changes in the insurance market have impacted our
insurance coverages. We have renewed most of our insurance policies for 2004,
although with increased exposure to losses. Other policies are up for renewal in
mid-2004. We may not be successful in obtaining coverage on terms favorable to
us or at all.

RESULTS OF OPERATIONS

We have three reportable segments:

- 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.

All of our acquisitions were accounted for using the purchase method of
accounting. Results for United Benefit Life are included from August 1, 1998 to
July 20, 1999 under a reinsurance agreement and thereafter as an acquired
entity. The financial information for the year ended December 31, 1999 includes
the operations of Continental General since February 1, 1999 and of Provident
American Life for the entire year. The financial information for the years ended
December 31, 2003, 2002 and 2001, includes the operations of all our
subsidiaries for the entire period with the exception of Pyramid Life.

DISCONTINUED OPERATIONS. On March 31, 2003, we sold our indirect
subsidiary, Pyramid Life Insurance Company, to the Pennsylvania Life Insurance
Company, a subsidiary of Universal American Financial Corp., for approximately
$57.5 million in cash. Consistent with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, Pyramid Life was classified as held
for sale as of December 31, 2002, and was measured at its fair value less costs
to sell. Therefore, the financial information for the years ended December 31,
2003, 2002 and 2001 excludes the operations of Pyramid Life for all periods
presented and the $13.8 million loss from the sale, net of taxes and expenses
incurred (except where specifically noted). Financial data for 2001 was
reclassified to reflect the sale of Pyramid Life. The net assets, results of
operations, and cash flows of Pyramid Life have been reported separately as
discontinued operations of a subsidiary in our audited consolidated financial
statements for all periods presented. See Note E. Discontinued Operations to our
audited consolidated financial statements for further information.

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2003 COMPARED TO 2002

- ---------------

N/M = not meaningful

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NET PREMIUMS (NET OF REINSURANCE CEDED)

For the year ended December 31, 2003, total net premiums were $478.3
million, a decrease of 11.4%, from $540.1 million for 2002.

MEDICAL

Medical premiums for 2003 were $305.4 million compared to $370.0 million
for 2002, a decrease of 17.5%. The change in medical premiums was primarily the
result of the following:

- a 34.0% decrease in major medical certificates in force from 127,463 at
December 31, 2002 to 84,167 at December 31, 2003 due to exiting certain
unprofitable states and higher lapsation rates. Rate increases
implemented in excess of claim trend on certain unprofitable blocks
caused higher lapsation rates in 2003.

- a 58.3% decline in new business production from $89.2 million in
annualized premium in 2002 to $37.2 million in 2003. We discontinued
Continental General major medical brokerage sales in 2003 due to adverse
claim experience, which accounted for $18.0 million of the decreased
production levels. In addition, Continental General did not write major
medical business in Florida for half of 2003, due to capital constraints.
Florida accounted for approximately 19% of our major medical production
in 2002. Continental General is currently writing major medical business
in Florida.

- renewal premium increases averaging between 25-30% prior to any benefit
downgrades or deductible changes.

- a decline in the percentage of business ceded from 15.3% in 2002 to 13.5%
in 2003.

Our 2004 marketing strategy will continue to focus on a reduced number of
geographic locations which have historically produced favorable underwriting
results. We expect increased production levels in 2004 and the decline in major
medical premium to moderate to 10-15%.

SENIOR AND OTHER

Senior and other premiums were $172.9 million for 2003 compared to $170.1
million for 2002, an increase of 1.6%. The change in seni