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

The following discussion should be read together with the accompanying condensed consolidated financial statements and notes. In addition, the following discussion should be considered in light of a number of factors that affect the Company, the industry in which we operate and business generally. These factors are described in Exhibit 99 to this Quarterly Report.

Summary highlights of our third quarter 2001 results include:

•

Earnings per share reached $0.71, an increase of 31% from $0.54 per share reported in the third quarter of 2000 and up $0.03 per share, or 4%, sequentially over the second quarter of 2001.



•

Cash flows from operations were $1.48 billion for the nine months ended September 30, 2001, up $516 million, or 53%, year over year. When adjusted for the timing of quarterly Medicare premium cash receipts from the Centers for Medicare and Medicaid Services ("CMS"), formerly the Health Care Financing Administration, cash flows from operations increased 28% year over year.



•

Earnings from operations increased to $396 million in the third quarter, up $87 million, or 28%, over the prior year, and up $12 million, or 3%, sequentially over the second quarter of 2001.



•

Consolidated revenues increased $572 million, or 11%, over the third quarter of 2000 to $5.9 billion, reflecting strong and balanced growth across all business segments. On a same store basis, revenues increased $735 million, or 14%, year-over-year.



•

Consolidated operating margin improved 90 basis points year-over-year, reaching 6.7%.



•

We repurchased an additional 3.6 million shares of our common stock during the third quarter. Since the inception of our stock repurchase activities in November 1997, we have repurchased 109.1 million shares of our common stock.



•

Annualized return on equity reached 25.3% in the third quarter of 2001, up from 24.2% in the second quarter of 2001 and 19.8% a year ago.

(1)

Adjusted to exclude a net permanent tax benefit of $14 million, or $0.04 diluted net earnings per common share, related to the contribution of UnitedHealth Capital investments to the UnitedHealth Foundation in the first quarter of 2000.

(2)

Excludes AARP business.

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Results of Operations

Consolidated Financial Results

Revenues

Revenues are comprised of premium revenues associated with insured products, fees associated with management, administrative and consulting services, and investment and other income.

Consolidated revenues increased 11% year-over-year in the third quarter of 2001 to $5.9 billion, reflecting balanced growth across all business segments. On a same store basis, revenues increased $735 million, or 14%, year-over-year. The following is a discussion of 2001 consolidated revenue trends for each of our three revenue components.

Premium Revenues

Consolidated premium revenues totaled $5.2 billion in the third quarter of 2001, an increase of $417 million, or 9%, over the third quarter of 2000. On a same store basis, premium revenues increased 12% for the three month period ended September 30, 2001 and 14% for the nine month period ended September 30, 2001 over the comparable periods in 2000. These increases were primarily driven by average premium yield increases above 13% on UnitedHealthcare's commercial customer renewals.

Management Services Fees

Management services fees totaled $643 million and $1.8 billion, during the three and nine month periods ended September 30, 2001, respectively, representing increases of $142 million, or 28%, and $336 million, or 23%, over the comparable periods in 2000. The overall increase in management services fee revenues is primarily the result of record growth in Uniprise's multi-site customer base, growth in UnitedHealthcare's fee-based business, modest price increases on fee-based business, and growth in our Ingenix business.

Investment and Other Income

Investment and other income during the three and nine month periods ended September 30, 2001 totaled $69 million and $217 million, representing increases of $13 million and $49 million, respectively, over the comparable periods in 2000. For the three month period ended September 30, 2001, interest income decreased by $1 million from the comparable 2000 period due to lower interest rates. Net capital gains on sales of investments were $3 million in the three month period ended September 30, 2001 (including net expenses from contributions to the UnitedHealth Foundation) compared with $11 million of net capital losses in the comparable 2000 period. For the nine month period ended September 30, 2001, interest income increased by $17 million due to increased levels of cash and fixed income securities. Additionally, net capital gains on sales of investments were $6 million in the first nine months of 2001 compared with $26 million of net capital losses in the first nine months of 2000.

Medical Costs

The combination of our pricing and care coordination efforts is reflected in the medical care ratio (medical costs as a percentage of premium revenues).

Our consolidated medical care ratio for the three months ended September 30, 2001, excluding the AARP business, decreased ten basis points from 84.0% to 83.9% on a sequential basis. On a year-over-year basis, our medical care ratio, excluding AARP, remained at 83.9%. The relatively flat trend in our medical care ratio is attributable to commercial premium yield increases generally well-matched with underlying medical cost trends.

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On an absolute dollar basis, the increase of $360 million, or 9%, in medical costs in the third quarter of 2001 over the comparable prior year period is driven by a combination of medical cost inflation, benefit changes and product mix changes.

Operating Costs

Operating costs as a percentage of total revenues (the operating cost ratio) increased from 16.6% during the third quarter of 2000 to 17.1% during the third quarter of 2001. Excluding the results of our AARP Pharmacy Services program, which began operations on June 1, 2001, the operating cost ratio decreased to 16.0% for the three month period ended September 30, 2001. This decrease was driven primarily by productivity increases achieved through process improvements, technology deployment and cost reduction initiatives, and by further leveraging the fixed cost components of our infrastructure during a period of strong revenue growth.

On an absolute dollar basis, operating costs increased $120 million, or 13%, over the comparable period in 2000. This increase reflects additional costs to support the 11% increase in 2001 consolidated revenues as well as operating costs related to our new AARP Pharmacy Services program.

Depreciation and Amortization

Depreciation and amortization was $67 million and $62 million, and $195 million and $185 million, for the three and nine month periods ended September 30, 2001 and 2000, respectively. The increases resulted from a combination of increased levels of capital expenditures to support business growth and technology enhancements and amortization of goodwill and other intangible assets related to acquisitions.

Income Taxes

Our 2000 income tax provision includes nonrecurring tax benefits related to the contribution of UnitedHealth Capital investments to the UnitedHealth Foundation. Excluding non-recurring benefits, our effective income tax rate was 38.0% in 2001 and 37.5% in 2000.

Business Segments

The following summarizes the operating results of our business segments for the three and nine month periods ended September 30 (in millions):

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Health Care Services

The Health Care Services segment, comprised of UnitedHealthcare and Ovations, posted third quarter revenues of $5.2 billion, representing an increase of $466 million, or 10%, over the third quarter of 2000. On a same store basis, Health Care Services' revenues increased $604 million, or 13%, and $1.8 billion, or 14%, for the three and nine month periods ended September 30, 2001, respectively, over the comparable 2000 periods. The increases were primarily attributable to UnitedHealthcare's average net premium yield increases above 13% on renewing commercial business.

The Health Care Services segment contributed earnings from operations of $237 million and $696 million during the three and nine month periods ended September 30, 2001, representing increases of $50 million, or 27%, and $158 million, or 29%, over the comparable 2000 periods. The increases were primarily the result of revenue growth and stable gross margins on UnitedHealthcare's commercial business and operating cost efficiencies driven by process improvement, technology deployment and cost reduction initiatives.

UnitedHealthcare's commercial medical care ratio remained flat at 84.1% in the third quarter of 2001 compared to the third quarter of 2000. The relatively flat trend in the commercial medical care ratio is attributable to net premium yield increases generally well-matched with underlying medical costs. Commercial health plan premium rates are established based on anticipated benefit costs, including the effects of medical cost inflation, benefit changes and product mix.

UnitedHealthcare's year-over-year Medicare enrollment decreased 9% as a result of actions taken to better position this program for long-term success. Effective January 1, 2001, UnitedHealthcare withdrew its Medicare+Choice product from targeted counties affecting 56,000 individuals. In September 2001, UnitedHealthcare elected not to renew its Medicare+Choice contracts in 12 counties across the United States, effective January 1, 2002, affecting 57,000 individuals. Annual revenues for 2001 from the Medicare markets we are exiting, effective January 1, 2002, are expected to be approximately $370 million. These actions are expected to further reduce Medicare enrollment, but better position this program in the long term in terms of profitability relative to the cost of capital and required resource management. We will continue to evaluate the markets we serve and, where necessary, take actions that may result in further withdrawals of Medicare product offerings or reductions in membership, when and as permitted by our contracts with CMS. 

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The following table summarizes individuals served by UnitedHealthcare, by major market segment and funding arrangement, as of September 30 (in thousands):

(1)

Restated to exclude individuals served through UnitedHealthcare platforms located in Puerto Rico and Pacific Coast regions. As of December 31, 2000, UnitedHealthcare had substantially transitioned from these markets.

Uniprise

Uniprise's revenues for the three and nine month periods ended September 30, 2001 of $621 million and $1.8 billion increased by $67 million, or 12%, and $231 million, or 14%, over the comparable periods in 2000. Adjusted for the closure of the Medicare Part B servicing operations in October 2000, third quarter revenues increased by 18% on a year-over-year basis. This increase was driven primarily by record growth in Uniprise's large multi-site customer base, with a 21% increase in individuals served year-over-year. Uniprise served 8.0 million and 6.6 million individuals as of September 30, 2001 and 2000, respectively.

For the three and nine month periods ended September 30, 2001, Uniprise's earnings from operations grew by $19 million, or 25%, and $64 million, or 30%, respectively, over the comparable 2000 periods. These increases were due to increased revenues and improved operating margins of approximately 15% in 2001 from approximately 13% in the comparable prior year period. As revenues have increased, Uniprise has expanded its operating margin by improving productivity through process improvement initiatives, increased deployment of technology and by further leveraging the fixed cost components of its infrastructure.

Specialized Care Services

For the three and nine month periods ended September 30, 2001, Specialized Care Services' revenues of $312 million and $928 million increased $69 million, or 28%, and $218 million, or 31%, over the comparable periods in 2000. These increases were driven primarily by an increase in the number of individuals served by United Behavioral Health, our mental health benefit business. For the three and nine month periods ended September 30, 2001, earnings from operations increased by $9 million, or 20%, and $32 million, or 25%, respectively, compared with the comparable 2000 periods. Specialized Care Services' operating margin was 17.3% for the third quarter of 2001, compared with 18.5% in the third quarter of 2000. The slight decrease in operating margin is the result of shifting product mix, with a larger percentage of revenues coming from premium-based products which typically generate lower percentage operating margins than fee-based offerings.

Ingenix

For the three and nine month periods ended September 30, 2001, Ingenix's revenues increased $10 million, or 10%, and $52 million, or 20%, over the comparable periods in 2000 as a result of growth in both the

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health information and pharmaceutical services businesses. Earnings from operations increased by $3 million and $10 million over the prior year three and nine month periods, respectively, as a result of revenue growth and improved productivity. Ingenix typically generates higher revenues and operating margins in the second half of the year due to seasonally strong demand for higher margin software and information content products.

Corporate and Eliminations

Corporate includes the company-wide costs associated with core process improvement initiatives, net expenses from charitable contributions to the UnitedHealth Foundation and eliminations of intersegment transactions.

Operational Realignment and Other Charges

In conjunction with our operational realignment initiatives, we developed and, in the second quarter of 1998, approved the Plan to implement our operational realignment. We recognized corresponding charges to operations of $725 million in the second quarter of 1998, which reflected the estimated costs to be incurred under the Plan. The charges included costs associated with asset impairments; employee terminations; disposing of or discontinuing business units, product lines and contracts; and consolidating and eliminating certain claim processing operations and associated real estate obligations. Activities associated with the Plan will result in the reduction of approximately 5,100 positions, affecting approximately 5,800 people in various locations. Through September 30, 2001, we have eliminated approximately 4,900 positions, affecting approximately 5,400 people, pursuant to the Plan. The remaining positions are expected to be eliminated during the remainder of 2001.

As of December 31, 2000, we had substantially completed all planned business dispositions and market exits and, accordingly, our 2001 financial statements do not include the operating results of exited businesses or markets. For the three and nine month periods ended September 30, 2000, our accompanying Condensed Consolidated Statement of Operations includes $86 million and $283 million of revenues and $4 million and $3 million of earnings from operations, respectively, from businesses disposed of and markets exited in connection with the operational realignment.

The operational realignment and other charges do not cover certain aspects of the Plan, including new information systems, data conversions, process re-engineering, temporary duplicate staffing costs as we consolidate processing centers, and employee relocation and training. These costs are expensed as incurred or capitalized, as appropriate. During the three and nine month periods ended September 30, 2001, we incurred expenses of approximately $3 million and $19 million, respectively, related to these activities compared to $16 million and $46 million for the comparable periods in 2000. We expect to complete these activities in 2001. Based on current facts and circumstances, we believe our remaining accrued liability for realignment initiatives of $21 million is adequate to cover the costs to be incurred in executing the remainder of the Plan.

Financial Condition and Liquidity at September 30, 2001

During the first nine months of 2001, we generated cash from operations of $1.48 billion, an increase of $516 million, or 53%, over 2000. The increase in operating cash flows resulted from an increase of $150 million in net income excluding depreciation and amortization expense, net working capital improvements of approximately $157 million, $194 million related to the timing of quarterly Medicare premium cash receipts from CMS, and $15 million related to income tax benefits resulting from employee stock option exercises.

We maintained a strong financial condition and liquidity position, with cash and investments of $5.6 billion at September 30, 2001. Total cash and investments increased by $516 million since December 31, 2000, primarily resulting from strong cash flows from operations partially offset by common stock repurchases.

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As further described under "Regulatory Capital and Dividend Restrictions," many of our subsidiaries are subject to various government regulations. At September 30, 2001, $613 million of our $5.6 billion of cash and investments was held by non-regulated subsidiaries. Of this amount, $402 million was available for general corporate use, including acquisitions and share repurchases. The remaining $211 million consists of public and non-public equity securities primarily held by UnitedHealth Capital, our venture and development capital business. Our operating cash flows and financing capability also provide us with funds, as needed, for general corporate use.

As of September 30, 2001, we had $640 million of commercial paper outstanding, with interest rates ranging from 2.6% to 3.8%. We have credit arrangements supporting our commercial paper program with an aggregate capacity of $900 million. These credit arrangements are composed of a $450 million revolving facility expiring in July 2005, and a $450 million, 364-day facility expiring in July 2002. We also have the capacity to issue approximately $200 million of extendible commercial notes ("ECNs"). At September 30, 2001, we had no amounts outstanding under our credit facilities or ECNs.

In November 2001, we retired a $150 million two-year floating rate note and issued $100 million of floating rate notes due November 2003 and $150 million of floating rate notes due November 2004.

Our debt arrangements and credit facilities contain various covenants, the most restrictive of which place limitations on secured and unsecured borrowings and require us to exceed minimum interest coverage levels. We are in compliance with the requirements of all debt covenants. Our senior debt is rated "A" by Standard & Poor's and Fitch and "A3" by Moody's. Our commercial paper and ECN programs are rated "A-1" by Standard & Poor's, "F-1" by Fitch, and "P-2" by Moody's.

The remaining aggregate issuing capacity of all securities covered by shelf registration statements for common stock, preferred stock, debt securities and other securities is $850 million. We may publicly offer such securities from time to time at prices and terms to be determined at the time of offering.

Under our board of directors' authorization, we are operating a common stock repurchase program. Repurchases may be made from time to time at prevailing prices, subject to certain restrictions on volume, pricing and timing. During the first nine months of 2001, we repurchased 16.2 million shares at an aggregate cost of $945 million. Through September 30, 2001, we had repurchased approximately 109.1 million shares for an aggregate cost of $3.6 billion since the inception of the program in November of 1997. As of September 30, 2001, we have board of directors' authorization to purchase up to an additional 12.1 million shares of our common stock.

We expect our available cash and investment resources, operating cash flows and financing capability will be sufficient to meet our current operating requirements and other corporate development initiatives. A substantial portion of our long-term investments (approximately $3.8 billion as of September 30, 2001) is classified as available for sale. Subject to the previously described regulations, these investments may be used to fund working capital or for other purposes.

Currently, we do not have any other material definitive commitments that require cash resources; however, we continually evaluate opportunities to expand our operations. This includes internal development of new products and programs and may include acquisitions.

Regulatory Capital and Dividend Restrictions

Our operations are conducted through our wholly-owned subsidiaries, which include health maintenance organizations and insurance companies. These companies are subject to state regulations that, among other things, may require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing and amount of dividends and other distributions that may be paid to their respective parent companies. Generally, the amount of dividend distributions that may be paid by our regulated subsidiaries, without prior approval by state regulatory authorities, is limited based on the entity's level of statutory net income and statutory capital and surplus.

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The National Association of Insurance Commissioners has developed minimum capitalization guidelines for health maintenance organizations, subject to state-by-state adoption. Most states have adopted these rules. We do not expect that further state adoptions or implementations will require us to make significant incremental investments of general corporate resources into regulated subsidiaries.

Inflation

The national health care cost inflation rate significantly exceeds the general inflation rate. We use various strategies to mitigate the effects of health care cost inflation including setting commercial premiums based on anticipated health care costs and coordinating care with various physicians and other health care providers. Through contracts with physicians and other health care providers, our health plans emphasize preventive health care, appropriate use of specialty and hospital services, education and closing gaps in care.

We believe our strategies mitigate the impact of health care cost inflation on our operating results. However, other factors such as competitive pressures, new health care and pharmaceutical product introductions, demands from physicians and other health care providers and consumers, applicable regulations or other factors may affect our ability to control the impact of health care cost increases.