                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    Form 10-Q
(Mark One)

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

For the quarterly period ended       March 31, 2001                                 

                                                         OR

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

For the transition period from _______________________ to __________________________

Commission File Number 1-10589


                               CII FINANCIAL, INC.
             (Exact name of registrant as specified in its charter)

               CALIFORNIA                                 95-4188244
      (State or other jurisdiction of                  (I.R.S. Employer
      incorporation or organization)                  Identification No.)


            2716 NORTH TENAYA WAY
                LAS VEGAS, NV                                89128
    (Address of principal executive offices)              (Zip Code)

                                 (702) 242-7040
              (Registrant's telephone number, including area code)

                                       N/A
 (Former name,former address and former fiscal year, if changed
  since last report)

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  

      As of May 1, 2001, there were 100 shares of common stock outstanding.









                      CII FINANCIAL, INC. AND SUBSIDIARIES
                                    FORM 10-Q
                    FOR THE THREE MONTHS ENDED MARCH 31, 2001

                                      INDEX



                                                                                                           Page No.


Part I - FINANCIAL INFORMATION

      Item l.     Financial Statements


                  Condensed Consolidated Balance Sheets -

                    March 31, 2001 and December 31, 2000.....................................................    3

                  Condensed Consolidated Statements of Operations -
                    three months ended March 31, 2001 and 2000...............................................    4

                  Condensed Consolidated Statements of Cash Flows -
                    three months ended March 31, 2001 and 2000...............................................    5

                  Notes to Condensed Consolidated Financial Statements.......................................    6

      Item 2.     Management's Discussion and Analysis of
                    Financial Condition and Results of Operations............................................    9

      Item 3.     Quantitative and Qualitative Disclosures
                    about Market Risk........................................................................   13



Part II - OTHER INFORMATION

      Item l.     Legal Proceedings..........................................................................   14

      Item 2.     Changes in Securities and Use of Proceeds..................................................   14

      Item 3.     Defaults Upon Senior Securities............................................................   14

      Item 4.     Submission of Matters to a Vote of Security Holders........................................   14

      Item 5.     Other Information..........................................................................   14

      Item 6.     Exhibits and Reports on Form 8-K...........................................................   14

Signatures...................................................................................................   15











                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                      CII FINANCIAL, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                        (In thousands, except share data)

                                                                                     March 31                December 31
                                                                                       2001                     2000

ASSETS
   Invested assets:
       Debt securities, available-for-sale, at fair value..................           $206,837                 $177,671
       Debt securities, held-to-maturity, at amortized cost ...............             13,684                   21,258
       Preferred stocks, at fair value.....................................              9,118                    5,130
       Mortgage loans on non-affiliated real estate........................             12,326                   12,362
                                                                                      --------                 --------
   Total invested assets...................................................            241,965                  216,421
                                                                                      --------                 --------

   Cash and cash equivalents...............................................              6,067                   28,666
    Reinsurance recoverable................................................            246,204                  247,205
    Premiums receivable (net of allowances of $1,384 and $1,449)...........             12,338                   11,785
    Investment income receivable...........................................              2,687                    2,712
    Deferred policy acquisition costs......................................              2,519                    2,015
    Deferred income taxes..................................................             17,497                   16,251
    Property and equipment, net............................................              3,709                    4,126
    Other assets...........................................................              2,636                    4,421
                                                                                      --------                 --------
TOTAL ASSETS...............................................................           $535,622                 $533,602
                                                                                      ========                 ========

LIABILITIES
    Reserve for loss and loss adjustment expenses..........................           $379,909                 $374,554
    Unearned premiums......................................................             16,500                   13,493
    Ceded reinsurance premiums payable.....................................              3,118                   11,073
    Convertible subordinated debentures....................................             47,059                   47,059
    Accounts payable and other accrued expenses............................             24,848                   24,071
                                                                                      --------                 --------
TOTAL LIABILITIES..........................................................            471,434                  470,250
                                                                                      --------                 --------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDER'S EQUITY
   Common stock, no par value, 1,000 shares
   authorized; 100 shares issued and outstanding...........................              3,604                    3,604
   Additional paid-in capital..............................................             64,450                   64,450
   Accumulated other comprehensive loss:
      Unrealized holding loss on available-for-sale investments ...........             (3,615)                  (4,535)
   Accumulated deficit.....................................................               (251)                    (167)
                                                                                      --------                 --------
TOTAL STOCKHOLDER'S EQUITY.................................................             64,188                   63,352
                                                                                      --------                 --------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY.................................           $535,622                 $533,602
                                                                                      ========                 ========


     See accompanying notes to condensed consolidated financial statements.





                      CII FINANCIAL, INC. AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                 (In thousands)


                                                                                                Three Months Ended March 31,
                                                                                              2001               2000

REVENUES
  Direct written premiums....................................................               $50,229             $47,937
  Changes in direct unearned premiums........................................                (3,006)             (3,503)
                                                                                            -------             -------

  Direct earned premiums.....................................................                47,223              44,434
  Less:  premiums ceded......................................................                 8,333              19,090
                                                                                            -------             -------

  Net earned premiums........................................................                38,890              25,344
  Net investment income......................................................                 4,110               3,607
  Net realized investment gains (losses).....................................                   385                (238)
                                                                                            -------             -------

Total revenues...............................................................                43,385              28,713
                                                                                            -------             -------

COSTS AND EXPENSES
  Direct loss and loss adjustment expenses...................................                49,307              51,067
  Reinsurance recoveries.....................................................               (16,938)            (34,427)
                                                                                            -------             -------

  Net loss and loss adjustment expenses......................................                32,369              16,640
  Policy acquisition costs...................................................                 6,261               4,318
  General, administrative and other..........................................                 3,732               4,028
  Interest expense...........................................................                   882                 940
                                                                                            -------             -------

Total costs and expenses.....................................................                43,244              25,926
                                                                                            -------             -------

INCOME BEFORE FEDERAL
INCOME TAX EXPENSE
AND EXTRAORDINARY GAIN.......................................................                   141               2,787

Federal income tax expense...................................................                   225               1,153
                                                                                            -------             -------

(LOSS) INCOME BEFORE EXTRAORDINARY GAIN                                                         (84)              1,634

Extraordinary gain from debt extinguishment
(net of income tax of $42)                                                                      -                    76
                                                                                            -------             -------

NET (LOSS) INCOME............................................................               $   (84)            $ 1,710
                                                                                            =======             =======


     See accompanying notes to condensed consolidated financial statements.






                      CII FINANCIAL, INC. AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

                                                                                       Three Months Ended March 31,
                                                                                           2001             2000
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net (loss) income...............................................................        $   (84)          $ 1,710
  Adjustments to reconcile net (loss) income to net
       cash provided by (used in) operating activities:
    Extraordinary gain............................................................                             (118)
    Depreciation and amortization.................................................            312               262
  Change in assets and liabilities................................................          1,201           (11,267)
                                                                                          -------           -------
Net cash provided by (used in) operating activities...............................          1,429            (9,413)
                                                                                          -------           -------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures, net.......................................................            136              (464)
  Changes in investments .........................................................        (24,164)            6,310
                                                                                          -------           -------
Net cash (used in) provided by investing activities...............................        (24,028)            5,846
                                                                                          -------           -------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Dividend to Sierra.............................................................                            (2,637)
  Repurchase of convertible subordinated debentures...............................            -                (355)
                                                                                          -------           -------
Net cash used in financing activities.............................................            -              (2,992)
                                                                                          -------           -------

NET CHANGE IN CASH AND CASH EQUIVALENTS...........................................        (22,599)           (6,559)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD..................................         28,666            16,833
                                                                                          -------           -------

CASH AND CASH EQUIVALENTS AT END OF PERIOD........................................        $ 6,067           $10,274
                                                                                          =======           =======


Supplemental Condensed Consolidated Disclosures of Cash Flows Information:

Cash paid during the period for interest (net of amount capitalized)..............        $   -             $ 1,909
                                                                                          =======           =======


     See accompanying notes to condensed consolidated financial statements.





                      CII FINANCIAL, INC. AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.   Basis of Presentation

     CII Financial,  Inc. ("CII Financial",  a workers'  compensation  insurance
     holding company,  together with its subsidiaries,  collectively referred to
     as the "Company") is a wholly owned  subsidiary of Sierra Health  Services,
     Inc.  ("Sierra"),  a  managed  health  care  organization.   The  Company's
     insurance  subsidiaries  consist of California  Indemnity Insurance Company
     ("California  Indemnity")  and its wholly  owned  subsidiaries,  Commercial
     Casualty  Insurance  Company,  CII Insurance  Company and Sierra  Insurance
     Company of Texas. The accompanying  unaudited financial  statements include
     the  consolidated  accounts  of  the  Company.  All  material  intercompany
     balances and transactions have been eliminated.  These statements have been
     prepared in conformity with accounting principles generally accepted in the
     United States of America and used in preparing the Company's annual audited
     consolidated financial statements but do not contain all of the information
     and  disclosures  that  would be  required  in a  complete  set of  audited
     financial statements.  They should,  therefore, be read in conjunction with
     the Company's audited  consolidated  financial statements and related notes
     thereto as of and for the years ended  December  31, 2000 and 1999.  In the
     opinion of management,  the accompanying  unaudited condensed  consolidated
     financial  statements  reflect all  adjustments,  consisting only of normal
     recurring  adjustments,  necessary for a fair presentation of the financial
     results for the interim periods presented.

2.  Comprehensive Income

    The following table presents comprehensive income for the periods indicated:

                                                                          Three Months Ended March 31

           (In thousands)                                                 2001                  2000

           Net (Loss) Income.........................                     $  (84)              $1,710
           Change in Accumulated Other
             Comprehensive Loss, Net of Tax..........                        920                3,052
                                                                           -----               ------

           Comprehensive Income......................                      $ 836               $4,762
                                                                           =====               ======

3.  Convertible Subordinated Debentures

     In September  1991, CII Financial  issued 7 1/2%  convertible  subordinated
     debentures.  As of March 31,  2001,  $47.1  million  in 7 1/2%  convertible
     subordinated   debentures  were   outstanding.   Interest  on  the  7  1/2%
     convertible  subordinated  debentures is due  semi-annually on March 15 and
     September 15, and they mature  September 15, 2001. Each $1,000 in principal
     is convertible into 25.382 shares of common stock of Sierra at a conversion
     price of $39.398  per share.  During the first  three  months of 2000,  the
     Company repurchased  $473,000 of debentures in the open market resulting in
     an  extraordinary  gain of $118,000 and a  corresponding  tax  provision of
     $42,000.

     CII Financial  anticipated that it would not have readily available sources
     of cash to pay the 7 1/2%  convertible  subordinated  debentures  when they
     were  scheduled  to mature  in  September  2001 and  initiated  a  proposed
     exchange offer in December  2000. CII Financial  proposed to exchange the 7
     1/2% convertible subordinated debentures for new debentures and/or cash. To
     facilitate the exchange, CII Financial was able to obtain approval from the
     California  Department  of Insurance to receive an  extraordinary  dividend
     from California  Indemnity of $5.0 million and borrowed an additional $17.0
     million from Sierra.  On May 8, 2001,  CII Financial  announced that it had
     closed its tender and exchange offer on $42.1 million of its  outstanding 7
     1/2% convertible  subordinated  debentures.  CII Financial  purchased $27.1
     million in principal amount of 7 1/2% convertible  subordinated  debentures
     for $20.0  million in cash and issued  $15.0  million in new 9 1/2%  senior
     debentures, due September 15, 2004, in exchange for $15.0 million in 7 1/2%
     convertible  subordinated  debentures.  CII Financial has $5.0 million in 7
     1/2% convertible subordinated debentures due September 15, 2001 that remain
     outstanding.

     The new 9 1/2% senior  debentures pay interest,  which is due semi-annually
     on March 15 and  September 15 of each year,  commencing  on  September  15,
     2001. The new 9 1/2% senior  debentures  rank senior to  outstanding  notes
     payable from CII Financial to Sierra,  the 7 1/2% convertible  subordinated
     debentures  and CII  Financial's  guarantee  of Sierra's  revolving  credit
     facility. The new 9 1/2% senior debentures may be redeemed by CII Financial
     at any  time  at  premiums  starting  at 110%  and  declining  to 100%  for
     redemptions after April 1, 2004. In the event of a change in control of CII
     Financial,  the holders of these new 9 1/2% senior  debentures  may require
     that CII Financial repurchase them at the then applicable redemption price,
     plus accrued and unpaid interest.

4.  Segment Information

     For each of the periods presented the Company operated in a single business
     segment, workers' compensation insurance.

5.  Codification of Statutory Accounting Principles

     In March 1998, the National Association of Insurance  Commissioners adopted
     the Codification of Statutory Accounting Principles (the Codification). The
     Codification,  which is intended to standardize  regulatory  accounting and
     reporting to state insurance departments, became effective January 1, 2001.
     However, statutory accounting principles will continue to be established by
     individual state laws and permitted practices.  The insurance  subsidiaries
     were required to implement the Codification,  with certain applicable state
     modifications,  for  the  preparation  of  statutory  financial  statements
     effective January 1, 2001. The adoption of the Codification, as modified by
     the  applicable  state,  increased  the Company's  insurance  subsidiaries'
     statutory capital and surplus as of January 1, 2001, by approximately  $7.0
     million,   which  is  primarily  due  to  permitted  statutory   accounting
     principles  under the  Codification  regarding  income  taxes,  earned  but
     unbilled premiums and electronic data processing equipment.


6.  Recently Issued Accounting Standards

     The  Financial  Accounting  Standards  Board issued  Statement of Financial
     Accounting  Standards No. 133,  "Accounting for Derivative  Instruments and
     Hedging Activities" ("SFAS 133"), as amended, which is effective for fiscal
     years  beginning  after  June 15,  2000.  SFAS 133  establishes  additional
     accounting and reporting  standards for derivative  instruments and hedging
     activities.  SFAS 133 requires that an entity  recognize all derivatives as
     either assets or liabilities in the statement of financial  position.  This
     statement  also defines and allows  companies to apply hedge  accounting to
     its designated  derivatives under certain instances.  It also requires that
     all  derivatives  be marked to market on an  ongoing  basis.  This  applies
     whether the derivatives are  stand-alone  instruments,  such as warrants or
     interest-rate  swaps,  or  embedded  derivatives,   such  as  call  options
     contained in convertible debt investments.  Along with the derivatives,  in
     the case of qualifying  hedges,  the underlying hedged items are also to be
     marked to market.  These market value adjustments are to be included either
     in the income  statement or other  comprehensive  income,  depending on the
     nature of the hedged transaction.  The fair value of financial  instruments
     is  generally  determined  by  reference to market  values  resulting  from
     trading on a national securities exchange or in an over-the-counter market.
     In cases where  derivatives  relate to financial  instruments of non-public
     companies, or where quoted market prices are otherwise not available,  such
     as for derivative financial  instruments,  fair value is based on estimates
     using present  value or other  valuation  techniques.  The Company does not
     believe  that it has any  derivative  instruments  and  does  not  have any
     hedging activities.  The majority of the Company's  investments are held by
     insurance  companies,  which are  regulated as to the types of  investments
     they may hold.

7.  Commitments and Contingencies

     The Company's  insurance  subsidiaries are required to participate in state
     guaranty associations in all states in which they do business. The guaranty
     associations   assess  solvent  insurance   companies  to  fund  claims  of
     policyholders of insolvent insurance  companies.  Assessments are typically
     based on a percentage of direct premiums  written on a specific  line(s) of
     insurance in the calendar year previous to the assessment. The associations
     can assess 1% to 2% of premiums  written.  In California  and certain other
     states,  insurance  companies  are allowed to recoup the  assessments  from
     their  policyholders,  while other states allow an offset  against  premium
     taxes.

     In  California,   there  were  no  new  workers'   compensation   insurance
     assessments for insolvent companies between 1990 and 1999. In October 2000,
     the  Company  received a notice  from the  California  Insurance  Guarantee
     Association  of an  assessment  of $1.2 million of which  one-half was paid
     prior to December 31, 2000.  The  remainder is scheduled to be paid in June
     2001.   This   assessment  is  being  recouped  by   surcharging   workers'
     compensation  insurance  policies with effective dates on and after January
     1, 2001. The assessment was based on 1% of direct written premiums in 1999.
     Legislation  is  currently  pending  in  California  that  would  raise the
     assessment to 2% of written premiums.  Due to the current ability to recoup
     assessments  or reduce  premium  taxes,  the Company  does not believe that
     guaranty  association  assessments  will  materially  affect its  financial
     condition or results of operations.






                      CII FINANCIAL, INC. AND SUBSIDIARIES

ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS

The following  discussion and analysis  provides  information  which  management
believes  is relevant  for an  assessment  and  understanding  of the  Company's
consolidated  financial  condition  and results of  operations.  The  discussion
should  be  read  in  conjunction  with  the  Condensed  Consolidated  Financial
Statements and related Notes thereto. Any forward-looking  information contained
in this Management's  Discussion and Analysis of Financial Condition and Results
of Operations and any other sections of this Quarterly  Report on Form 10-Q that
is not historical fact is forward-looking and based on management's projections,
assumptions and estimates;  actual results may vary materially.  Forward-looking
statements  are  subject  to  certain  risks  and  uncertainties  that have been
discussed  in other  filings made by the Company and its parent,  Sierra  Health
Services, Inc.

Our operating  results are  primarily  the results of our workers'  compensation
insurance subsidiaries and consist of underwriting  profit/loss,  net investment
income, net realized  gains/losses,  other income/expense,  interest expense and
income taxes.

RESULTS OF OPERATIONS, THREE MONTHS ENDED MARCH 31, 2001, COMPARED TO THREE
MONTHS ENDED MARCH 31, 2000.

Income before taxes decreased by $2.6 million as a result of the following:

 o  $13.5 million increase in net earned premiums;
 o  $1.1 million increase in investment income, including realized gains/losses;
 o  $15.7 million increase in net loss and loss adjustment expenses;
 o  $1.9 million increase in policy acquisition costs; and
 o  $0.4 million decrease in general, administrative and other expenses.

Revenues are comprised of net earned  premiums,  net  investment  income and net
realized  gains/losses.  Total  revenues  increased  by 51% due  primarily  to a
reduction in premiums ceded to reinsurers. Direct written premiums increased due
to an overall increase in written premiums including a 29% composite increase in
premium rates for all states and a 12% increase in production growth.

Net earned  premiums  are the end result of direct  written  premiums,  plus the
change in unearned  premiums,  less  premiums  ceded to  reinsurers.  Our direct
written  premiums  increased by 5% due primarily to growth in Nevada,  Texas and
Colorado,  offset by a decrease in  California.  The  reduction in the amount of
premium ceded to reinsurers  increased  earned  premiums by 79%. The decrease in
ceded  reinsurance  premiums was primarily due to the  expiration and run-off of
our low level  reinsurance  agreement on June 30, 2000 along with new lower cost
reinsurance  agreements,  all of which reduced the  percentage of premiums being
ceded.

The following table reflects a comparison of direct written premiums, by state:

                                                    Three months ended March 31,
                                       2001       % of total             2000      % of total
                                                       (dollars in millions)
        California                      $36.0         71.6%             $37.7         78.5%
        Colorado                          4.6          9.1                3.8          7.9
        Nevada                            5.4         10.7                3.1          6.5
        Texas                             2.5          5.0                1.5          3.1
        Other States                      1.8          3.6                1.9          4.0
                                        -----        -----              -----        -----
           Total                        $50.3        100.0%             $48.0        100.0%
                                        =====        =====              =====        =====

As shown in the preceding  table, our largest premium state,  California,  had a
small decrease in written premiums. We obtained an average premium rate increase
on California  renewing policies of approximately 41% for the three months ended
March 31, 2001 and 36% for policies that renewed in the second half of 2000.

Premiums in force are an indicator of future  written  premium  trends.  Inforce
premiums are the total  estimated  annual premiums of all policies in force at a
point in time.  Total inforce  premiums  increased by 1% to $174.1  million on a
comparative  quarter  basis but have  dropped  by 9% from their peak in the last
twelve months, which was in August 2000. This decrease indicates a slowing trend
in premiums written, especially in California, due largely to business lost as a
result of the  premium  rate  increases  we have been  obtaining.  The number of
inforce  policies at March 31, 2001 has also dropped by 14% from its peak in the
last twelve months, which was also in August 2000.

The $0.5 million or 14% increase in net investment  income is due to an increase
in the average  invested  balance as less cash was required  for ceded  premiums
paid to reinsurers starting from the latter half of 2000.

We had net  realized  gains of $0.4 million  compared to net realized  losses of
$0.2  million  in  2000.  We  manage  our  investment  portfolio  with a view of
minimizing unplanned sales of our available-for-sale investments.

Losses and Loss Adjustment  Expenses,  or LAE, increased by approximately
$15.7 million due to the following:

     o    Approximately  $8.1  million of the increase is related to our premium
          growth.

     o    We recorded  $1.6  million of net adverse loss  development  for prior
          accident years,  primarily 1996 to 2000,  compared to net adverse loss
          development of $1.5 million  recorded in 2000,  primarily for accident
          years 1996 to 1999. The net adverse  development  recorded was largely
          attributable  to  higher  costs  per  claim,  or  claim  severity,  in
          California.  Our average cost per claim has increased  each year since
          1995 and the  majority of our claims occur in  California.  The entire
          California workers'  compensation industry has been adversely affected
          by higher claim  severity.  According  to a published  estimate by the
          California  Workers'  Compensation  Insurance Rating Bureau in January
          2001,  the average  ultimate  loss per  indemnity  claim in California
          increased 62% from  accident year 1995 to accident year 1999.  Factors
          influencing this increase include rising average temporary  disability
          costs,  the  increase  in the  number  of major  permanent  disability
          claims,  medical  inflation  and adverse  court  decisions  related to
          medical control of claimant's treatment. Higher claim severity has had
          a  negative  impact on the  entire  California  workers'  compensation
          industry.

     o    We  established a higher loss and LAE ratio for the 2001 accident year
          compared to prior years experience,  which has resulted in an increase
          of approximately $7.5 million.  The majority of the increase is due to
          the  termination  of the low level  reinsurance  agreement on June 30,
          2000,  which results in a higher risk  exposure on policies  effective
          after that date and a higher  amount of net incurred  loss and LAE. In
          addition,  in light of the net adverse  loss  development  we recorded
          during  2000,  we believed it prudent to establish  the 2001  accident
          year reserves at a higher rate.

Under our low level reinsurance agreement,  we reinsure 30% of the first $10,000
of each  claim,  75% of the next  $40,000  and 100% of the  next  $450,000.  The
maximum  net loss  retained  on any one claim  ceded  under  this  agreement  is
$17,000.  This  agreement  covered  all  policies  in force at July 1,  1998 and
continued  until June 30, 2000, when we executed an option to extend coverage to
all policies in force as of June 30, 2000.  For policies  effective from July 1,
2000,  we  obtained  excess of loss  reinsurance  for 100% of the  losses  above
$250,000  and less than  $500,000.  We already  had an  existing  excess of loss
reinsurance agreement that covered 100% of the losses above $500,000.

As a  percentage  of net  earned  premiums,  the loss and LAE  ratio  was  83.2%
compared to 65.7% for 2000.  The increase is primarily due to the  expiration of
the low level reinsurance  agreement which is resulting in a higher loss and LAE
ratio on policies effective after June 30, 2000.

Policy  Acquisition  Costs are those expenses that are directly  related to, and
vary  with,   written  premiums.   Examples  of  policy  acquisition  costs  are
commissions and allowances paid to agents and brokers, premium taxes, boards and
bureau fees and certain operating expenses primarily related to our underwriting
and  marketing  departments.  The increase in policy  acquisition  costs of $1.9
million is primarily attributable to the increase in net earned premiums.  Other
underwriting expenses decreased by $0.2 million due to lower personnel costs and
efforts  to  control  administrative  expenses.  As a  percentage  of net earned
premiums,  the underwriting expense ratio, including  policyholders'  dividends,
was 25.7% in 2001  compared  to 32.9% in 2000.  The  improvement  in the expense
ratio was due in part to higher net  earned  premiums,  which  provides a larger
base to spread our fixed costs,  smaller growth in personnel  expenses and lower
agents' commissions and allowances.

General,  Administrative and Other Expenses include other underwriting  expenses
of $3.7 million compared to $4.0 million in 2000 and policyholders' dividends of
$0.6  million   compared  to  $0.3   million  in  2000.   The  majority  of  the
policyholders'  dividends  are for Nevada  participating  policies and represent
1.6% of 2001 net earned premiums compared to 1.2% of 2000 net earned premiums.

Interest Expense  decreased by $58,000 or 6% during the period due to a decrease
in the balance of outstanding debentures.

The Combined  Ratio is a measurement of  underwriting  profit or loss and is the
sum of the loss and LAE ratio,  underwriting  expense  ratio and  policyholders'
dividend  ratio. A combined  ratio of less than 100%  indicates an  underwriting
profit. Our combined ratio was 108.9% compared to 98.6% for the first quarter of
2000.  The  increase  was  primarily  due to a higher loss and LAE ratio of 17.5
percentage  points and  policyholders'  dividend ratio increase of .4 percentage
points and was offset by a decrease  in the  underwriting  expense  ratio of 7.6
percentage  points.  The increase in the loss and LAE ratio was primarily due to
the run off of the low level  reinsurance  which is resulting  in our  retaining
more of the incurred losses. The reduction in the underwriting expense ratio was
primarily due to higher retained net earned premiums.

Provision for Income Taxes was recorded at $0.2 million compared to $1.2 million
in 2000.  The effective tax rate was 159.6% for 2001 compared to 41.4% for 2000.
The increase in the  effective tax rate for 2001 is a result of the inability of
CII  Financial  to realize  all of the tax  benefit of its losses  under the tax
sharing  agreement  with Sierra and the  proportion of the loss of CII Financial
related to its subsidiaries' income.  Excluding CII Financial, the effective tax
rate for the quarter was 29.8%.

For the three  months  ended March 31, 2001 and 2000,  the Company  maintained a
valuation  allowance  on deferred  tax assets of $11.3  million for each period.
Under the tax sharing agreement  valuation  allowances have been established for
the net  deferred  tax asset of CII  Financial  as they can only  utilize  these
benefits to the extent of separate return income.

LIQUIDITY AND CAPITAL RESOURCES

Debentures  In  September  1991,  CII  Financial  issued 7 1/2%  convertible
subordinated  debentures.  As  of  March  31,  2001,  $47.1  million  in 7  1/2%
convertible  subordinated  debentures were  outstanding.  Interest on the 7 1/2%
convertible  subordinated  debentures  is  due  semi-annually  on  March  15 and
September 15, and they mature  September  15, 2001.  Each $1,000 in principal is
convertible  into 25.382 shares of common stock of Sierra at a conversion  price
of $39.398  per share.  During the first  three  months of 2000,  CII  Financial
repurchased   $473,000  of  debentures  in  the  open  market  resulting  in  an
extraordinary gain of $118,000 and a corresponding tax provision of $42,000.

CII Financial  anticipated that it would not have readily  available  sources of
cash  to pay the 7 1/2%  convertible  subordinated  debentures  when  they  were
scheduled to mature in September 2001 and initiated a proposed exchange offer in
December  2000.  CII  Financial  offered  to  exchange  the 7  1/2%  convertible
subordinated  debentures for new  debentures  and/or cash. To make the exchange,
CII Financial  was able to obtain  approval  from the  California  Department of
Insurance to receive an extraordinary dividend from California Indemnity, one of
its insurance  subsidiaries,  of $5.0 million and borrowed an  additional  $17.0
million from Sierra. On May 8, 2001, CII Financial  announced that it had closed
its  tender  and  exchange  offer on $42.1  million  of its  outstanding  7 1/2%
convertible  subordinated  debentures.  CII Financial purchased $27.1 million in
principal amount of 7 1/2% convertible subordinated debentures for $20.0 million
in cash and issued $15.0 million in new 9 1/2% senior debentures,  due September
15,  2004,  in exchange  for $15.0  million in 7 1/2%  convertible  subordinated
debentures.  CII Financial has $5.0 million in 7 1/2%  convertible  subordinated
debentures due September 15, 2001 that remain outstanding as of May 8, 2001.

The new 9 1/2% senior  debentures pay interest,  which is due  semi-annually  on
March 15 and September 15 of each year,  commencing  on September 15, 2001.  The
new 9 1/2% senior  debentures rank senior to outstanding  notes payable from CII
Financial to Sierra,  the 7 1/2%  convertible  subordinated  debentures  and CII
Financial's  guarantee of Sierra's  revolving  credit  facility.  The new 9 1/2%
senior  debentures  may be  redeemed  by CII  Financial  at any time at  defined
premiums  starting at 110% and declining to 100% for redemptions  after April 1,
2004. In the event of a change in control of CII Financial, the holders of these
new 9 1/2% senior  debentures  may require that we  repurchase  them at the then
applicable redemption price, plus accrued and unpaid interest.

Other
Our insurance  subsidiaries require liquidity to pay policy claims and benefits,
for operating  expenses,  income taxes and to purchase  fixed assets to maintain
and enhance their operations.  The source of our insurance  subsidiaries'  funds
come from the premiums we collect,  the  investment  income we earn and receipts
from our reinsurers. The liquidity needs of our non-insurance operations,  which
are  essentially  the holding  company,  CII Financial,  are  substantially  all
related to the servicing of interest  payments on the debentures and the payment
of the debentures at maturity.

Our insurance  subsidiaries are required to maintain sufficient liquid assets to
pay claims and other  policy  obligations.  Workers'  compensation  insurance is
referred to a "long-tail"  business because of the length of time that typically
occurs  between when the premium is collected and when a claim is fully paid and
settled due to  life-time  benefits  that could be  provided to a claimant.  The
excess of premiums  collected  over claims and expenses paid are invested  until
needed.  State  regulations  dictate the kinds of investments we can have and we
try to match the maturity of our investments with expected future cash needs.

Our significant short-term  non-insurance  liquidity need is for interest on the
debentures and the repayment of the approximately  $5.0 million in outstanding 7
1/2% convertible subordinated debentures, which are due on September 15, 2001 as
discussed  above.  Our new 9 1/2%  senior  debentures  represent  our  long-term
non-insurance  liquidity  needs.  We expect  to  service  the new 9 1/2%  senior
debentures from future cash flows, primarily from dividends that will be paid by
our  insurance  subsidiaries  from their future  earnings.

CII  Financial  is a  holding  company  and its  only  significant  asset is its
investment in California  Indemnity  Insurance  Company.  Of the $6.1 million in
cash and cash equivalents held at March 31, 2001, $5.3 million is designated for
use only by the regulated insurance companies. CII Financial has limited sources
of cash and is  dependent  upon  dividends  paid by  California  Indemnity.  The
payment of stockholders'  dividends by California  Indemnity is regulated by the
California  Insurance  Code and, at a minimum,  requires a 10 business day prior
notice to the California Department of Insurance.  If a payment of a dividend or
distribution  whose fair market value,  together with that of other dividends or
distributions  made within the  preceding 12 months,  exceeds the greater of ten
percent of the insurer's  surplus or its net income for the preceding  year end,
then  the  insurance  commissioner  has up to 30  days  to  disapprove  it.  The
California  Insurance  Department  will not allow a  payment  of a  dividend  or
distribution  if  it  will  cause  an  insurer's  policyholders'  surplus  to be
unreasonable  in relation to the insurer's  liabilities  and the adequacy of the
insurer's  financial  needs.  In making this  determination,  the  Department of
Insurance considers a variety of factors including, but not limited to, the size
of the insurer,  the amount,  type and geographic  concentration of insurance it
writes,  the  quality of its  assets and  reinsurance  programs,  and  operating
trends.

In  addition,  California  law  provides  that an insurer may not pay a dividend
without the prior approval of the state insurance commissioner to the extent the
cumulative  amount of dividends or distributions  paid or proposed to be paid in
any year exceeds the amount shown as unassigned funds (reduced by any unrealized
gains  included in such amount) on the insurer's  statutory  statement as of the
previous December 31. As of December 31, 2000,  California  Indemnity,  which is
our only direct  insurance  subsidiary,  had  unassigned  funds of $174,000 from
which it could pay a dividend  without prior  approval.  As noted above, to make
the  exchange  offer  for  the  outstanding  7  1/2%  convertible   subordinated
debentures,   California   Indemnity   received  approval  from  the  California
Department of Insurance and paid an  extraordinary  dividend to CII Financial of
$5.0 million in early May 2001. The payment of any future dividend by California
Indemnity in calendar  year 2001 will require prior  approval by the  California
Department of Insurance.

Under the terms of Sierra's revolving credit facility,  capital contributions by
Sierra to us that we use to repay the 7 1/2% convertible subordinated debentures
may require  Sierra to reduce  permanently  an equal  amount of the  outstanding
balance of its credit facility commitment.  Our affiliates have no obligation to
make loans or other  payments  to us to pay the  principal  amount of the 7 1/2%
convertible  subordinated debentures when they mature.  Accordingly,  we may not
have the cash resources  required to repay the 7 1/2%  convertible  subordinated
debentures  when they become  due.  We are  currently  analyzing  our  available
alternatives with respect to the payment of the 7 1/2% convertible  subordinated
debentures.

Cash Flows
We had positive cash flows from operating activities of $1.4 million compared to
negative cash flows of $9.4 million for 2000. Our positive cash flow in 2001 was
largely due to the run-off of the low level  reinsurance  agreement.  Ceded paid
losses now  exceed  ceded  premiums  under the  contract  and result in net cash
received from the  reinsurer.  In addition,  the growth in premium  revenues has
resulted in an increase in loss and LAE reserves and in unearned  premiums.  Our
negative  cash flow for 2000 was  primarily  due to the effects of the low level
reinsurance  agreement  whereby  premiums ceded  exceeded ceded paid losses.  In
addition,  an  increase  in  reinsurance   recoverable  and  mortgage  loans  on
non-affiliated  real estate was partially  offset by an increase in loss and LAE
reserves.

Our net cash used in investing  activities  was $24.0  million  compared to cash
provided by investing  activities  of $5.9 million for 2000.  As a result of the
run-off of the low level reinsurance  agreement,  we had more funds available to
invest in 2001. Due to the negative cash flows from  operations  during 2000, we
had to sell some of our  investments,  which resulted in net realized  losses of
$0.2 million.

No cash was used for  financing  activities  in 2001 compared to $3.0 million in
2000 for the repurchase of outstanding debentures of $0.4 million and a dividend
of $2.6 million paid to Sierra.


ITEM 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As  of  March  31,  2001,  unrealized  holding  losses  on  available  for  sale
investments have decreased by $0.9 million since December 31, 2000 due primarily
to a decrease in interest  rates,  and thus,  an increase in the market value of
bonds. We believe that changes in market interest rates, resulting in unrealized
holding gains or losses, should not have a material impact on future earnings or
cash  flows as it is  unlikely  that we would  need or choose  to  substantially
liquidate our investment portfolio.





                           PART II - OTHER INFORMATION


ITEM 1.       LEGAL PROCEEDINGS

We are subject to various claims and other  litigation in the ordinary course of
business.  Such  litigation  includes  workers'  compensation  claims by injured
workers and by providers  for payment for medical  services  rendered to injured
workers. In the opinion of management,  the ultimate resolution of these pending
legal  proceedings  should not have a material  adverse  effect on our financial
condition.


ITEM 2.       CHANGES IN SECURITIES AND USE OF PROCEEDS

              None

ITEM 3.       DEFAULTS UPON SENIOR SECURITIES

               None

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

               None

ITEM 5.       OTHER INFORMATION

              None

ITEM 6.       EXHIBITS AND REPORTS ON FORM 8-K

              (a)   Exhibits - None

              (b)   Reports on Form 8-K

                    Current  Report on Form 8-K,  filed May 16,  2001,  with the
                    Securities  and Exchange  Commission in connection  with CII
                    Financial's debenture exchange offer.







                                   SIGNATURES

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



                                  CII FINANCIAL, INC.
                                     (Registrant)



Date:  June 18, 2001               /S/ JOHN F. OKITA      
                                  JOHN F. OKITA
                                  Chief Financial Officer
                                  (Principal Financial and Accounting Officer)

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    Form 10-Q
(Mark One)

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

For the quarterly period ended       June 30, 2001                              

                                       OR

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

For the transition period from _______________________ to ______________________

Commission File Number 1-10589


                               CII FINANCIAL, INC.
             (Exact name of registrant as specified in its charter)

                        CALIFORNIA                      95-4188244
              (State or other jurisdiction of           (I.R.S. Employer
              incorporation or organization)           Identification No.)


                   2716 NORTH TENAYA WAY
                       LAS VEGAS, NV                      89128
         (Address of principal executive offices)       (Zip Code)

                                 (702) 242-7040
              (Registrant's telephone number, including area code)

                                       N/A
      (Former name, former address and former fiscal year, if changed since
                                  last report)

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 --- ---

    As of August 1, 2001, there were 100 shares of common stock outstanding.









                      CII FINANCIAL, INC. AND SUBSIDIARIES
                                    FORM 10-Q
                     FOR THE SIX MONTHS ENDED JUNE 30, 2001

                                      INDEX
                                                                                                           Page No.


Part I - FINANCIAL INFORMATION

      Item l.     Financial Statements

                  Condensed Consolidated Balance Sheets -
                    June 30, 2001 and December 31, 2000......................................................    3

                  Condensed Consolidated Statements of Operations -
                    three and six months ended June 30, 2001 and 2000........................................    4

                  Condensed Consolidated Statements of Cash Flows -
                    six months ended June 30, 2001 and 2000..................................................    5

                  Notes to Condensed Consolidated Financial Statements.......................................    6

      Item 2.     Management's Discussion and Analysis of
                    Financial Condition and Results of Operations............................................   10

      Item 3.     Quantitative and Qualitative Disclosures
                    about Market Risk........................................................................   16



Part II - OTHER INFORMATION

      Item l.     Legal Proceedings..........................................................................   17

      Item 2.     Changes in Securities and Use of Proceeds..................................................   17

      Item 3.     Defaults Upon Senior Securities............................................................   17

      Item 4.     Submission of Matters to a Vote of Security Holders........................................   17

      Item 5.     Other Information..........................................................................   17

      Item 6.     Exhibits and Reports on Form 8-K...........................................................   17

Signatures...................................................................................................   18










                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                      CII FINANCIAL, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                        (In thousands, except share data)

                                                                                      June 30                December 31
                                                                                       2001                     2000

                                                                                   (Unaudited)
ASSETS
   Invested assets:
       Debt securities, available-for-sale, at fair value..................           $184,625                 $177,671
       Debt securities, held-to-maturity, at amortized cost ...............             13,767                   21,258
       Preferred stocks, at fair value.....................................              3,040                    5,130
       Mortgage loans on non-affiliated real estate........................             12,247                   12,362
                                                                                      --------                 --------
   Total invested assets...................................................            213,679                  216,421
                                                                                      --------                 --------

   Cash and cash equivalents...............................................             25,861                   28,666
    Reinsurance recoverable................................................            257,760                  247,205
    Premiums receivable (net of allowances of $1,450 and $1,449)...........             10,711                   11,785
    Note receivable affiliate (Note 8).....................................              7,607
    Deferred income taxes..................................................             16,515                   16,251
    Property and equipment, net............................................              4,019                    4,126
    Other assets...........................................................              8,158                    9,148
                                                                                      --------                 --------
TOTAL ASSETS...............................................................           $544,310                 $533,602
                                                                                      ========                 ========

LIABILITIES
    Reserve for loss and loss adjustment expenses..........................           $399,059                 $374,554
    Unearned premiums......................................................             16,489                   13,493
    Ceded reinsurance premiums payable.....................................                327                   11,073
    Debentures (Note 3)....................................................             24,835                   47,059
    Notes payable affiliate (Note 8).......................................             17,257
    Accounts payable and other accrued expenses............................             22,592                   24,071
                                                                                      --------                 --------
TOTAL LIABILITIES..........................................................            480,559                  470,250
                                                                                      --------                 --------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDER'S EQUITY
   Common stock, no par value, 1,000 shares
   authorized; 100 shares issued and outstanding...........................              3,604                    3,604
   Additional paid-in capital..............................................             64,450                   64,450
   Accumulated other comprehensive loss:
      Unrealized holding loss on available-for-sale investments ...........             (5,763)                  (4,535)
   Retained Earnings (accumulated deficit).................................              1,460                     (167)
                                                                                      --------                 --------
TOTAL STOCKHOLDER'S EQUITY.................................................             63,751                   63,352
                                                                                      --------                 --------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY.................................           $544,310                 $533,602
                                                                                      ========                 ========


     See accompanying notes to condensed consolidated financial statements.





                      CII FINANCIAL, INC. AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                 (In thousands)

                                   (Unaudited)


                                                               Three Months Ended June 30,                Six Months Ended June 30,

                                                                 2001                2000                   2001             2000

REVENUES
  Direct written premiums...............................         $45,240            $ 48,527                $95,469         $96,464
  Changes in direct unearned premiums...................              10                  31                 (2,996)         (3,472)
                                                                 -------            --------                -------         -------

  Direct earned premiums................................          45,250              48,558                 92,473          92,992
  Less:  premiums ceded.................................           2,766              21,215                 11,099          40,305
                                                                 -------            --------                -------         -------

  Net earned premiums...................................          42,484              27,343                 81,374          52,687
  Net investment income.................................           3,901               3,723                  8,011           7,330
  Net realized investment (losses) gains................             (53)               (151)                   332            (389)
                                                                 -------            --------                -------         -------

Total revenues..........................................          46,332              30,915                 89,717          59,628
                                                                 -------            --------                -------         -------

COSTS AND EXPENSES
  Direct loss and loss adjustment expenses..............          64,567              84,060                113,874         135,127
  Reinsurance recoveries................................         (30,645)            (46,983)               (47,583)        (81,410)
                                                                 -------            --------                -------         -------

  Net loss and loss adjustment expenses.................          33,922              37,077                 66,291          53,717
  Policy acquisition costs..............................           7,148               3,773                 13,409           8,091
  General, administrative and other.....................           3,079               7,216                  6,811          11,244
  Interest expense......................................             603                 902                  1,485           1,842
                                                                 -------            --------                -------         -------

Total costs and expenses................................          44,752              48,968                 87,996          74,894
                                                                 -------            --------                -------         -------

INCOME (LOSS) BEFORE FEDERAL
INCOME TAX EXPENSE
AND EXTRAORDINARY GAIN..................................           1,580             (18,053)                 1,721         (15,266)

Federal income tax expense (benefit)....................             332              (6,503)                   557          (5,350)
                                                                 -------            --------                -------         -------

INCOME (LOSS) BEFORE
   EXTRAORDINARY GAIN...................................           1,248             (11,550)                 1,164          (9,916)

Extraordinary gain from debt extinguishment
(net of income tax of $249, $260, $249, $302)...........             463                 485                    463             561
                                                                 -------            --------                -------         -------

NET INCOME (LOSS).......................................         $ 1,711            $(11,065)              $  1,627         $(9,355)
                                                                 =======            ========               ========         =======


     See accompanying notes to condensed consolidated financial statements.






                      CII FINANCIAL, INC. AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

                                   (Unaudited)

                                                                                         Six Months Ended June 30,

                                                                                           2001             2000

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)...............................................................        $ 1,627          $ (9,355)
  Adjustments to reconcile net income (loss) to net
       cash provided by (used in) operating activities:
    Extraordinary gain............................................................           (712)             (863)
    Depreciation and amortization.................................................            599               780
    Provision for asset impairment................................................                            3,000
Change in assets and liabilities:
    Reinsurance recoverable.......................................................        (10,555)          (59,059)
    Reserve for loss and loss adjustment expense..................................         24,505            65,624
    Ceded reinsurance premiums payable............................................        (10,746)              128
    Change in other assets and liabilities........................................          2,496           (10,178)
                                                                                          -------          --------
Net cash provided by (used in) operating activities...............................          7,214            (9,923)
                                                                                          -------          --------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures, net.......................................................           (452)             (615)
  Changes in investments .........................................................          2,446             8,066
  Note receivable affiliate.......................................................         (7,500)
                                                                                          -------          --------
Net cash (used in) provided by investing activities...............................         (5,506)            7,451
                                                                                          -------          --------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Dividend to Sierra..............................................................                           (2,637)
  Repurchase of convertible subordinated debentures...............................        (21,513)           (2,167)
  Notes payable affiliate.........................................................         17,000
                                                                                          -------          --------
Net cash used in financing activities.............................................         (4,513)           (4,804)
                                                                                          -------          --------

NET DECREASE IN CASH AND CASH EQUIVALENTS.........................................         (2,805)           (7,276)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD..................................         28,666            16,833
                                                                                          -------          --------

CASH AND CASH EQUIVALENTS AT END OF PERIOD........................................        $25,861          $  9,557
                                                                                          =======          ========



                                                                                         Six Months Ended June 30,

                                                                                           2001             2000

Supplemental Condensed Consolidated Disclosures of Cash Flows Information:

Cash paid during the period for interest (net of amount capitalized)..............        $  2,478         $  1,937

Non-cash Investing and Financing Activities:
     Debentures exchanged.........................................................          19,692



     See accompanying notes to condensed consolidated financial statements.





                      CII FINANCIAL, INC. AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.   Basis of Presentation

     CII Financial,  Inc. ("CII Financial",  a workers'  compensation  insurance
     holding company,  together with its subsidiaries,  collectively referred to
     as the "Company") is a wholly owned  subsidiary of Sierra Health  Services,
     Inc.  ("Sierra"),  a  managed  health  care  organization.   The  Company's
     insurance  subsidiaries  consist of California  Indemnity Insurance Company
     ("California  Indemnity")  and its wholly  owned  subsidiaries,  Commercial
     Casualty  Insurance  Company,  CII Insurance  Company and Sierra  Insurance
     Company of Texas. The accompanying  unaudited financial  statements include
     the  consolidated  accounts  of  the  Company.  All  material  intercompany
     balances and transactions have been eliminated.  These statements have been
     prepared in conformity with accounting principles generally accepted in the
     United States of America and used in preparing the Company's annual audited
     consolidated financial statements but do not contain all of the information
     and  disclosures  that  would be  required  in a  complete  set of  audited
     financial statements.  They should,  therefore, be read in conjunction with
     the Company's audited  consolidated  financial statements and related notes
     thereto as of and for the years ended  December  31, 2000 and 1999.  In the
     opinion of management,  the accompanying  unaudited condensed  consolidated
     financial  statements  reflect all  adjustments,  consisting only of normal
     recurring  adjustments,  necessary for a fair presentation of the financial
     results for the interim periods presented.

2.   Comprehensive Income

    The following table presents comprehensive income for the periods indicated:

                                                                           Six Months Ended June 30,


               (In thousands)                                             2001                  2000

           Net Income (Loss).........................                    $ 1,627              $(9,355)
           Change in Accumulated Other
             Comprehensive (Loss)
             Income, Net of Tax......................                     (1,228)               2,702
                                                                         -------              -------

           Comprehensive Income (Loss)...............                    $   399              $(6,653)
                                                                         =======              =======

3.   Debentures

     In September  1991, CII Financial  issued 7 1/2%  convertible  subordinated
     debentures  (the  "Subordinated  Debentures")  of  which  $47,059,000  were
     outstanding at March 31, 2001.  Interest on the Subordinated  Debentures is
     due  semi-annually  on March 15 and September 15, and they mature September
     15, 2001.  Each $1,000 in principal is  convertible  into 25.382  shares of
     common stock of Sierra at a conversion  price of $39.398 per share.  During
     the first six months of 2000,  the Company  repurchased  $3,031,000  of the
     Subordinated  Debentures in the open market  resulting in an  extraordinary
     gain of $863,000 and a corresponding tax provision of $302,000.

     In  December  2000,  CII  Financial  commenced  an  offer to  exchange  the
     Subordinated  Debentures for cash and/or new debentures.  To facilitate the
     exchange,  CII Financial  borrowed $17.0 million from Sierra and California
     Indemnity  was able to obtain  approval from the  California  Department of
     Insurance  to  pay  an  extraordinary  dividend  of  $5.0  million  to  CII
     Financial. On May 7, 2001, CII Financial closed its exchange offer on $42.1
     million of its outstanding Subordinated Debentures. CII Financial purchased
     $27.1  million in principal  amount of  Subordinated  Debentures  for $20.0
     million in cash and issued $15.0  million in new 9 1/2% senior  debentures,
     due  September  15,  2004,  in exchange for $15.0  million in  Subordinated
     Debentures.  CII Financial has $5.0 million in Subordinated Debentures that
     remain outstanding.

     The exchange offer proposed  concessions by the holders of the Subordinated
     Debentures, including extending the maturity and accepting an interest rate
     that may have been lower than what CII  Financial  could have obtained from
     other lenders. In accordance with accounting  principles generally accepted
     in the United  States of  America,  the  exchange  of the new 9 1/2% senior
     debentures for the Subordinated Debentures is treated as a restructuring of
     debt. Additionally, the Subordinated Debentures are considered to represent
     one payable, even though there are many debenture holders. Although some of
     the debenture holders exchanged the Subordinated  Debentures for cash, some
     exchanged them for new 9 1/2% senior debentures and others a combination of
     the two,  this does not change the  substance  of the  transaction  for CII
     Financial;   accordingly,  the  exchange  is  considered  to  be  a  single
     transaction.

     In the transaction,  total future cash payments (interest and principal) on
     the remaining Subordinated  Debentures and the new 9 1/2% senior debentures
     are less than the balance of the Subordinated Debentures at the time of the
     exchange less the cash consideration given in the exchange.  Accordingly, a
     gain on  restructuring  was  recognized for the difference and the carrying
     amount  of the  remaining  Subordinated  Debentures  and new 9 1/2%  senior
     debentures  is the total  future  cash  payments on the  debentures.  Costs
     incurred in  connection  with the exchange  were used to offset the gain on
     restructuring.  All future cash payments  related to the debentures will be
     reductions  of the carrying  amount of the  debentures  therefore no future
     interest  expense will be recognized for the  debentures.  The  transaction
     resulted in an  extraordinary  gain of  $712,000  and a  corresponding  tax
     provision of $249,000.

     The new 9 1/2% senior  debentures pay interest,  which is due semi-annually
     on March 15 and  September 15 of each year,  commencing  on  September  15,
     2001. The new 9 1/2% senior  debentures  rank senior to  outstanding  notes
     payable from CII Financial to Sierra, the remaining Subordinated Debentures
     and CII Financial's  guarantee of Sierra's  revolving credit facility.  The
     new 9 1/2% senior  debentures  may be redeemed by CII Financial at any time
     at premiums  starting at 110% and declining to 100% for  redemptions  after
     April 1, 2004.  In the event of a change in control of CII  Financial,  the
     holders  of  these  new 9 1/2%  senior  debentures  may  require  that  CII
     Financial  repurchase them at the then applicable  redemption  price,  plus
     accrued and unpaid interest.

4.   Segment Information

     For  each of the  periods  presented,  the  Company  operated  in a  single
     business segment, workers' compensation insurance.

5.   Codification of Statutory Accounting Principles

     In March 1998, the National Association of Insurance  Commissioners adopted
     the Codification of Statutory Accounting  Principles ("the  Codification").
     The Codification,  which is intended to standardize  regulatory  accounting
     and reporting to state insurance  departments,  became effective January 1,
     2001.  However,   statutory  accounting  principles  will  continue  to  be
     established by individual state laws and permitted practices. The insurance
     subsidiaries  were  required to implement  the  Codification,  with certain
     applicable state modifications,  for the preparation of statutory financial
     statements effective January 1, 2001. The adoption of the Codification,  as
     modified  by  the  applicable  state,  increased  the  Company's  insurance
     subsidiaries'  statutory  capital  and  surplus as of  January 1, 2001,  by
     approximately $7.0 million,  which is primarily due to prescribed statutory
     accounting principles under the Codification regarding income taxes, earned
     but unbilled premiums and electronic data processing equipment.

6.   Recently Issued Accounting Standards

     In July 2001, the Financial  Accounting  Standards  Board  ("FASB")  issued
     Statement   of   Financial   Accounting   Standards   No.  141,   "Business
     Combinations"  ("SFAS  141").  SFAS 141  requires  the  purchase  method of
     accounting  for  business  combinations  initiated  after June 30, 2001 and
     eliminates the  pooling-of-interests  method. The Company believes that the
     adoption of SFAS 141 will not have any impact on its financial statements.

     In July 2001, the FASB issued Statement of Financial  Accounting  Standards
     No. 142  "Goodwill and Other  Intangible  Assets"  ("SFAS  142"),  which is
     effective  January 1, 2002.  SFAS 142  requires,  among other  things,  the
     discontinuance of goodwill amortization. In addition, the standard includes
     provisions  for  the   reclassification   of  certain  existing  recognized
     intangibles  as  goodwill,  reassessment  of the useful  lives of  existing
     recognized  intangibles,  reclassification  of certain  intangibles  out of
     previously  reported goodwill and the identification of reporting units for
     purposes of assessing  potential future  impairments of goodwill.  SFAS 142
     also requires companies to complete a transitional goodwill impairment test
     six  months  from  the  date of  adoption.  The  Company  does not have any
     goodwill or other  significant  intangible  assets and believes  that there
     will not be any material impact from SFAS 142 on its financial position and
     results of operations.

7.   Commitments and Contingencies

     The Company's  insurance  subsidiaries are required to participate in state
     guaranty associations in all states in which they do business. The guaranty
     associations   assess  solvent  insurance   companies  to  fund  claims  of
     policyholders of insolvent insurance  companies.  Assessments are typically
     based on a percentage of direct premiums  written on a specific  line(s) of
     insurance in the calendar year previous to the assessment. The associations
     can assess 1% to 2% of premiums  written.  In California  and certain other
     states,  insurance  companies  are allowed to recoup the  assessments  from
     their  policyholders,  while other states allow an offset  against  premium
     taxes.

     In  California,   there  were  no  new  workers'   compensation   insurance
     assessments for insolvent companies between 1990 and 1999. In October 2000,
     the  Company  received a notice  from the  California  Insurance  Guarantee
     Association  of an  assessment  of $1.2 million of which  one-half was paid
     prior to December 31, 2000 and the  remainder  was paid in June 2001.  This
     assessment is being recouped by surcharging workers' compensation insurance
     policies with effective  dates on and after January 1, 2001. The assessment
     was  based  on 1% of  direct  written  premiums  in  1999.  Legislation  is
     currently  pending in California  that would raise the  assessment to 2% of
     written  premiums.  Due to the  current  ability to recoup  assessments  or
     reduce  premium   taxes,   the  Company  does  not  believe  that  guaranty
     association  assessments will materially affect its financial  condition or
     results of operations.

8.   Note Receivable and Notes Payable to Affiliate

     In connection with the exchange offer on the  Subordinated  Debentures (see
     Note 3),  California  Indemnity  lent Sierra $7.5  million.  The loan bears
     interest at 8.5%,  which is due  semi-annually on March 31 and September 30
     of each year,  commencing September 30, 2001. All outstanding principal and
     accrued  interest is due on September 30, 2004.  The loan is secured by the
     common stock of Sierra Health and Life Insurance Company ("SHL"),  a wholly
     owned  subsidiary  of  Sierra,  equal  to  120%  of  the  principal  amount
     outstanding.  At June  30,  2001,  SHL had  total  equity,  on a  statutory
     accounting basis, of approximately  $13.3 million. As an additional part of
     the exchange offer transaction,  Sierra lent CII Financial $15.0 million as
     well as an  additional  $2.0  million  to enable CII  Financial  to pay the
     accrued interest on the  Subordinated  Debentures due on March 15, 2001 and
     other  operating  expenses.  Each of the loans are demand notes payable and
     bear interest at 9.5%, which is due semi-annually on March 15 and September
     15 of each year,  commencing September 15, 2001. The notes are subordinated
     to the  new 9 1/2%  senior  debentures  and  CII  Financial's  guaranty  of
     Sierra's  credit  facility but are senior to the  Subordinated  Debentures,
     which mature in September 2001.






                      CII FINANCIAL, INC. AND SUBSIDIARIES

ITEM 2. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

The following  discussion and analysis  provides  information  which  management
believes is relevant for an assessment  and  understanding  of our  consolidated
financial condition and results of operations.  The discussion should be read in
conjunction  with the Condensed  Consolidated  Financial  Statements and related
Notes thereto.  Any information  contained in this  Management's  Discussion and
Analysis of Financial Condition and Results of Operations and any other sections
of  this  Quarterly  Report  on  Form  10-Q  that  is  not  historical  fact  is
forward-looking  and is  based  on  management's  projections,  assumptions  and
estimates;  actual results may vary materially.  Forward-looking  statements are
subject to certain  risks and  uncertainties  that have been  discussed in other
filings made by the Company and its parent, Sierra Health Services, Inc.

Our operating  results are  primarily  the results of our workers'  compensation
insurance subsidiaries and consist of underwriting  profit/loss,  net investment
income, net realized  gains/losses,  other income/expense,  interest expense and
income taxes.

RESULTS OF  OPERATIONS,  THREE  MONTHS  ENDED JUNE 30,  2001,  COMPARED TO THREE
MONTHS ENDED JUNE 30, 2000.

Income before taxes increased by $19.6 million as a result of the following:

     o $15.1 million increase in net earned premiums;

     o  $.3  million   increase  in  investment   income,   including   realized
        gains/losses;

     o $3.2 million decrease in net loss and loss adjustment expenses;

     o $3.4 million increase in policy acquisition costs;

     o $4.1 million decrease in general, administrative and other expenses; and

     o $.3 million decrease in interest expense.


Revenues are comprised of net earned  premiums,  net  investment  income and net
realized  gains/losses.  Total  revenue  increased  by 50%  due  primarily  to a
reduction in premiums ceded to reinsurers.  Reflected in the 2001 direct written
premiums is a 29% decrease in production and a 32% composite increase in premium
rates for all states.

Net earned  premiums  are the end result of direct  written  premiums,  plus the
change in unearned  premiums,  less  premiums  ceded to  reinsurers.  Our direct
written premiums  decreased by 6.8% due primarily to a decline in our California
business offset by growth in Nevada,  Texas and Colorado.  Offsetting this was a
reduction in the amount of premium ceded to reinsurers  which  increased  earned
premium  by $18.4  million.  The  decrease  in ceded  reinsurance  premiums  was
primarily  due to the  expiration  and  run-off  of our  low  level  reinsurance
agreement on June 30, 2000 along with new lower cost reinsurance agreements, all
of which reduced the percentage of premiums being ceded.

The following table reflects a comparison of direct written premiums, by state:

                                                Three months ended June 30,
                                       2001       % of total      2000      % of total
                                                   (dollars in millions)
        California                      $33.4         73.7%        $38.0         78.4%
        Colorado                          4.4          9.7           4.1          8.5
        Nevada                            3.6          7.9           2.4          4.9
        Texas                             2.4          5.3           2.0          4.1
        Other States                      1.4          3.4           2.0          4.1
                                        -----        -----         -----        -----
           Total                        $45.2        100.0%        $48.5        100.0%
                                        =====        =====         =====        =====


As shown in the preceding  table, our largest premium state,  California,  had a
12.1% decrease in written premiums. However, we obtained an average premium rate
increase on California  renewing  policies of approximately  39% for the quarter
ended June 30, 2001.

Premiums in force are an indicator of future  written  premium  trends.  Inforce
premiums are the total  estimated  annual premiums of all policies in force at a
point in time.  Total inforce  premiums have decreased by 8.8% to $168.6 million
from the same period last year and have  dropped by 11.4% from their peak in the
last twelve  months,  which was August 2000.  This decrease  indicates a slowing
trend in premiums  written,  especially in  California,  due largely to business
lost as a result of premium rate increases we have been obtaining. The number of
inforce policies at June 30, 2001 has also dropped by 21.8% from its peak in the
last twelve months, which was also August 2000.

The $.2 million or 4.8% increase in net investment  income is due to an increase
in the average  invested  asset balance as we are retaining more of the premiums
and receiving  monthly  payments from our reinsurers  that started at the end of
2000.

We had net  realized  losses of $53,000 in the second  quarter  compared  to net
realized  losses of $151,000 in the second  quarter  2000.  We try to manage our
investment  portfolio  to  minimize  unplanned  sales of our  available-for-sale
investments.

Net losses and loss adjustment expenses, or LAE, decreased by approximately $3.2
million due to the following:

     o    We  booked  approximately  $9.9  million  in  additional  loss and LAE
          related to the  increase in net earned  premiums  in 2001  compared to
          2000.

     o    In the second quarter of 2001, we recorded $4.2 million of net adverse
          loss  development  for prior  accident  years,  primarily for accident
          years 1996 to 1998,  compared to net adverse loss development of $19.2
          million recorded in the second quarter of 2000, primarily for accident
          years 1996 to 1999. The net adverse  development  recorded was largely
          attributable  to  higher  costs  per  claim,  or  claim  severity,  in
          California.  Higher claim  severity  has had a negative  impact on the
          entire California workers' compensation industry.

     o    We established a higher loss and LAE ratio for the 2001 accident year,
          which has resulted in an increase of approximately  $1.9 million.  The
          majority of the  increase is due to the  termination  of the low level
          reinsurance agreement on June 30, 2000, which results in a higher risk
          exposure on policies  effective after that date and a higher amount of
          net incurred loss and LAE.

The net adverse loss  development  on prior  accident years included those years
that were covered by our low level  reinsurance  agreement.  This resulted in an
increase,  net of paid recoveries,  in the amount of reinsurance  recoverable of
$11.6 million in 2001 and $44.4 million in 2000.

Under our low level reinsurance agreement, we reinsured 30% of the first $10,000
of each  claim,  75% of the next  $40,000  and 100% of the  next  $450,000.  The
maximum  net loss  retained  on any one claim  ceded  under this  agreement  was
$17,000.  This  agreement  covered  all  policies  in force at July 1,  1998 and
continued  until June 30, 2000, when we executed an option to extend coverage to
all policies in force as of June 30, 2000.  For policies  effective from July 1,
2000,  we  obtained  excess of loss  reinsurance  for 100% of the  losses  above
$250,000  and less than  $500,000.  We already  had an  existing  excess of loss
reinsurance agreement that covered 100% of the losses above $500,000.

As a percentage of net earned premiums, the loss and LAE ratio was 79.9% for the
quarter  ended June 30, 2001  compared to 135.6% for the quarter  ended June 30,
2000.  The decrease is  primarily  due to the prior year  development  booked in
2000.

Policy  acquisition  costs are those expenses that are directly  related to, and
vary  with,   written  premiums.   Examples  of  policy  acquisition  costs  are
commissions and allowances paid to agents and brokers, premium taxes, boards and
bureau fees and certain operating expenses primarily related to our underwriting
and  marketing  departments.  The increase in policy  acquisition  costs of $3.4
million  in  2001 is  primarily  attributable  to the  run off of the low  level
reinsurance treaty, whereby we are ceding less commission to our reinsurer.

General,  administrative and other expenses include other underwriting  expenses
of $2.7  million in 2001  compared  to $6.6  million in 2000 and  policyholders'
dividends of $.4 million in 2001 compared to $.6 million in 2000. Policyholders'
dividends, which primarily include Nevada participating policies,  represent .9%
of 2001 net earned premiums  compared to 2.2% of 2000 net earned  premiums.  The
decrease of $3.9 million in other underwriting expenses in 2001 is primarily due
to an  asset  impairment  charge  in  2000 of $3.0  million  as well as  expense
reduction  initiatives which reduced  personnel and related expenses.  The asset
impairment  charge was for the write-off of capitalized  costs on an information
system  software  project  that was  canceled  because  the vendor was unable to
fulfill its contractual obligations.

The  underwriting  expense ratio,  which includes policy  acquisition  costs and
other underwriting expenses as a percentage of net earned premiums, was 23.1% in
2001 compared to 27.0% in 2000. The  improvement in the expense ratio was due in
part to higher net earned  premiums,  which provides a larger base to spread our
fixed costs, a reduction in personnel expenses and lower agents' commissions and
allowances.

Interest expense  decreased by $.3 million or 33.2% during the period due to the
exchange  offer for the CII  Financial,  Inc.  7 1/2%  Convertible  Subordinated
Debentures  (the  "Subordinated  Debentures")  that closed on May 7, 2001.  As a
result of the restructuring of the Subordinated Debentures,  all future interest
payments after the closing on both the remaining Subordinated Debentures and the
new 9 1/2% senior  debentures  will be reductions of the carrying  amount of the
debentures and no further interest  expense will be recorded.  See Note 3 of the
Notes to Condensed Consolidated Financial Statements.

The combined  ratio is a measurement of  underwriting  profit or loss and is the
sum of the loss and LAE ratio,  underwriting  expense  ratio and  policyholders'
dividend  ratio. A combined  ratio of less than 100%  indicates an  underwriting
profit.  Our combined ratio was 103.9% compared to 164.8% for the second quarter
of 2000.  The decrease was  primarily  due to a lower loss and LAE ratio of 55.7
percentage points in addition to a decrease in the underwriting expense ratio of
3.9 percentage points and a decrease in the policyholders' dividend ratio of 1.3
percentage points. The decrease in the loss and LAE ratio was primarily due to a
decrease of $15.0 million in the amount of adverse  prior year loss  development
recorded in 2001  compared to 2000,  offset by an increase in the 2001  accident
year loss ratio due to the run off of the low level  reinsurance.  The reduction
in the  underwriting  expense ratio was  primarily  due to the asset  impairment
charge  recorded in 2000 and higher  retained  net earned  premiums  and expense
reduction initiatives taken by the Company.

Provision for income taxes was recorded at $.3 million  compared to a benefit of
$6.5 million in 2000 with an effective  tax rate of 21.0%  compared to 36.0% for
2000. The decrease in the effective tax rate for 2001 is due to the reduction of
previously established tax valuation allowances.

RESULTS OF  OPERATIONS,  SIX MONTHS ENDED JUNE 30, 2001,  COMPARED TO SIX MONTHS
ENDED JUNE 30, 2000.

Income before taxes increased by $17.0 million as a result of the following:

     o    $28.7 million increase in net earned premiums;

     o    $1.4  million  increase  in  investment  income,   including  realized
          gains/losses;

     o    $12.6 million increase in net loss and loss adjustment expenses;

     o    $5.3 million increase in policy acquisition costs;

     o    $4.4 million decrease in general,  administrative  and other expenses;
          and

     o    $.4 million decrease in interest expense.

Revenues are comprised of net earned  premiums,  net  investment  income and net
realized  gains/losses.  Total  revenue  increased  by 50%  due  primarily  to a
reduction in premiums ceded to reinsurers.  Reflected in the 2001 direct written
premiums is a 25% decrease in production and a 33% composite increase in premium
rates for all states.

Net earned  premiums  are the end result of direct  written  premiums,  plus the
change in unearned  premiums,  less  premiums  ceded to  reinsurers.  Our direct
written  premiums  decreased by 1% due primarily to a decline in our  California
business  offset by growth in Nevada,  Texas and Colorado.  The reduction in the
amount of premium ceded to reinsurers increased earned premium by $29.2 million.
The decrease in ceded  reinsurance  premiums was primarily due to the expiration
and run-off of our low level  reinsurance  agreement on June 30, 2000 along with
new lower cost  reinsurance  agreements,  all of which reduced the percentage of
premiums being ceded.

The following table reflects a comparison of direct written premiums, by state:

                                                 Six months ended June 30,
                                       2001       % of total      2000      % of total
                                                   (dollars in millions)
        California                      $69.4         72.6%        $75.7         78.4%
        Colorado                          9.0          9.4           7.9          8.2
        Nevada                            9.0          9.4           5.5          5.7
        Texas                             4.9          5.1           3.5          3.6
        Other States                      3.2          3.5           3.9          4.1
                                        -----        -----         -----        -----
           Total                        $95.5        100.0%        $96.5        100.0%
                                        =====        =====         =====        =====

As shown in the preceding table, our largest premium state,  California,  had an
7.7% decrease in written premiums.  We obtained an average premium rate increase
on California  renewing  policies of approximately  41% for the six months ended
June 30,  2001 and 36% for  policies  that  renewed in the second  half of 2000.
However, the production of new and renewal business is decreasing because of our
higher premium rates.

The $.7 million or 9% increase in net investment income is due to an increase in
the average invested asset balance as we are receiving monthly payments from our
reinsurers that started at the end of 2000.

We had net realized gains of $.3 million  compared to net realized losses of $.4
million in 2000. We try to manage our investment portfolio to minimize unplanned
sales of our available-for-sale investments.

Net losses and loss  adjustment  expenses,  or LAE,  increased by  approximately
$12.6 million due to the following:

     o    We booked  approximately  $18.0 million in  additional  losses and LAE
          related to the  increase in net earned  premiums  in 2001  compared to
          2000.

     o    In 2001, we recorded $5.8 million of net adverse loss  development for
          prior accident years,  primarily 1996 to 1998, compared to net adverse
          loss  development  of $20.7  million  recorded in 2000,  primarily for
          accident years 1996 to 1999. The net adverse development  recorded was
          largely attributable to higher costs per claim, or claim severity,  in
          California.  Higher claim  severity  has had a negative  impact on the
          entire California workers' compensation industry.

     o    We established a higher loss and LAE ratio for the 2001 accident year,
          which has resulted in an increase of approximately  $9.5 million.  The
          majority of the  increase is due to the  termination  of the low level
          reinsurance agreement on June 30, 2000, which results in a higher risk
          exposure on policies  effective after that date and a higher amount of
          net incurred loss and LAE.

The net adverse loss  development  on prior  accident years included those years
that were covered by our low level  reinsurance  agreement.  This resulted in an
increase,  net of paid recoveries,  in the amount of reinsurance  recoverable of
$10.6 million in 2001 and $59.1 million in 2000.

Under our low level reinsurance agreement, we reinsured 30% of the first $10,000
of each  claim,  75% of the next  $40,000  and 100% of the  next  $450,000.  The
maximum  net loss  retained  on any one claim  ceded  under this  agreement  was
$17,000.  This  agreement  covered  all  policies  in force at July 1,  1998 and
continued  until June 30, 2000, when we executed an option to extend coverage to
all policies in force as of June 30, 2000.  For policies  effective from July 1,
2000,  we  obtained  excess of loss  reinsurance  for 100% of the  losses  above
$250,000  and less than  $500,000.  We already  had an  existing  excess of loss
reinsurance agreement that covered 100% of the losses above $500,000.

As a  percentage  of net  earned  premiums,  the loss and LAE  ratio  was  81.5%
compared to 101.9% for 2000.  The  decrease is  primarily  due to the prior year
development booked in 2000 offset by the expiration of the low level reinsurance
agreement for policies effective after June 30, 2000.

Policy  acquisition  costs are those expenses that are directly  related to, and
vary  with,   written  premiums.   Examples  of  policy  acquisition  costs  are
commissions and allowances paid to agents and brokers, premium taxes, boards and
bureau fees and certain operating expenses primarily related to our underwriting
and  marketing  departments.  The increase in policy  acquisition  costs of $5.3
million  in  2001 is  primarily  attributable  to the  run off of the low  level
reinsurance treaty, whereby we are ceding less commission to our reinsurer.

General,  administrative and other expenses include other underwriting  expenses
of $5.7  million in 2001  compared to $10.3  million in 2000 and  policyholders'
dividends   of  $1.1   million  in  2001   compared  to  $.9  million  in  2000.
Policyholders' dividends, which primarily include Nevada participating policies,
represent 1.3% of 2001 net earned  premiums  compared to 1.7% of 2000 net earned
premiums. The decrease of $4.6 million in other underwriting expenses in 2001 is
primarily due to an asset  impairment  charge of $3.0 million in 2000 as well as
expense reduction initiatives, which reduced personnel and related expenses. The
asset  impairment  charge  was for the  write-off  of  capitalized  costs  on an
information  system  software  project that was canceled  because the vendor was
unable to fulfill its contractual obligations.

The  underwriting  expense ratio,  which includes policy  acquisition  costs and
other underwriting expenses as a percentage of net earned premiums, was 23.5% in
2001 compared to 29.3% in 2000. The  improvement in the expense ratio was due in
part to higher net earned  premiums,  which provides a larger base to spread our
fixed costs, a reduction in personnel expenses and lower agents' commissions and
allowances.

Interest expense  decreased by $.3 million or 19.4% during the period due to the
exchange offer for the Subordinated  Debentures that closed on May 7, 2001. As a
result of the restructuring of the Subordinated Debentures,  all future interest
payments on both the remaining Subordinated Debentures and the new 9 1/2% senior
debentures  after the closing will be reductions  of the carrying  amount of the
debentures and no further interest  expense will be recorded.  See Note 3 of the
Notes to Condensed Consolidated Financial Statements.

The combined  ratio is a measurement of  underwriting  profit or loss and is the
sum of the loss and LAE ratio,  underwriting  expense  ratio and  policyholders'
dividend  ratio. A combined  ratio of less than 100%  indicates an  underwriting
profit.  Our  combined  ratio was  106.3%  compared  to 132.9% for the first six
months of 2000.  The decrease was primarily due to a lower loss and LAE ratio of
20.4 percentage  points as well as a decrease in the underwriting  expense ratio
of 5.8 percentage points and a decrease in the policyholders'  dividend ratio of
 .4 percentage  points.  The decrease in the loss and LAE ratio was primarily due
to $20.7  million  in  adverse  prior  year loss  development  recorded  in 2001
compared to 2000, offset by an increase in the 2001 accident year loss ratio due
to the run off of the low level  reinsurance.  The reduction in the underwriting
expense ratio was primarily due to the asset impairment  charge recorded in 2000
and higher retained net earned premiums and expense reduction  initiatives taken
by the Company.

Provision for income taxes was recorded at $.6 million  compared to a benefit of
$5.4 million in 2000 with an effective  tax rate of 32.4%  compared to 35.1% for
2000. The decrease in the effective tax rate for 2001 is due to the reduction of
previously established tax valuation allowances.

LIQUIDITY AND CAPITAL RESOURCES

Debentures

In  September  1991,  CII  Financial  issued  7  1/2%  convertible  subordinated
debentures (the "Subordinated  Debenture") of which $47,059,000 were outstanding
at March  31,  2001.  The  Subordinated  Debentures  were  neither  assumed  nor
guaranteed by Sierra and were  subordinated  to Sierra's  credit  facility debt.
Interest on the  Subordinated  Debentures is due  semi-annually  on March 15 and
September 15, and they mature  September  15, 2001.  Each $1,000 in principal is
convertible  into 25.382 shares of common stock of Sierra at a conversion  price
of $39.398 per share.

CII Financial  anticipated that it would not have readily  available  sources of
cash to pay the  Subordinated  Debentures  when they were scheduled to mature in
September  2001 and initiated a proposed  exchange  offer in December  2000. CII
Financial  offered to exchange new debentures  and/or cash for the  Subordinated
Debentures.  To facilitate the exchange,  CII Financial  received loans of $17.0
million from Sierra and California  Indemnity  Insurance Company, a wholly owned
subsidiary of CII  Financial,  was able to obtain  approval from the  California
Department of Insurance to pay an extraordinary  dividend of $5.0 million to CII
Financial.  On May 7, 2001,  CII  Financial  closed its exchange  offer on $42.1
million of its  outstanding  Subordinated  Debentures.  CII Financial  purchased
$27.1 million in principal  amount of Subordinated  Debentures for $20.0 million
in cash and issued $15.0 million in new 9 1/2% senior debentures,  due September
15,  2004,  in  exchange  for $15.0  million  in  Subordinated  Debentures.  The
transaction  resulted in an  extraordinary  gain of $712,000 and a corresponding
tax  provision  of $249,000.  See Note 3 of the Notes to Condensed  Consolidated
Financial  Statements  for an  explanation  of the  accounting  treatment of the
transaction.  CII Financial  has $5.0 million in  Subordinated  Debentures  that
remain outstanding and is exploring alternatives to address the maturity of this
debt that is due September 15, 2001.

The new 9 1/2% senior  debentures pay interest,  which is due  semi-annually  on
March 15 and September 15 of each year,  commencing  on September 15, 2001.  The
new 9 1/2% senior  debentures rank senior to outstanding  notes payable from CII
Financial to Sierra, the remaining  Subordinated  Debentures and CII Financial's
guarantee  of  Sierra's  revolving  credit  facility.  The  new  9  1/2%  senior
debentures may be redeemed by CII Financial at any time at premiums  starting at
110% and declining to 100% for redemptions  after April 1, 2004. In the event of
a change in control of CII  Financial,  the  holders of these new 9 1/2%  senior
debentures may require that CII Financial repurchase them at the then applicable
redemption  price,  plus accrued and unpaid interest.  CII Financial  expects to
service the new 9 1/2% senior debentures from future cash flows,  primarily from
dividends  that will be paid by its  insurance  subsidiaries  from their  future
earnings.

Other

Our insurance  subsidiaries require liquidity to pay policy claims and benefits,
for operating  expenses,  income taxes and to purchase  fixed assets to maintain
and enhance their operations.  The source of our insurance  subsidiaries'  funds
come  from the  premiums  they  collect,  the  investment  income  they earn and
receipts from their reinsurers.  The liquidity requirements of our non-insurance
operations,  which are  essentially  the holding  company,  CII  Financial,  are
substantially  all  related  to  the  servicing  of  interest  payments  on  the
debentures and the payment of the debentures at maturity.

Our insurance  subsidiaries are required to maintain sufficient liquid assets to
pay claims and other  policy  obligations.  Workers'  compensation  insurance is
referred  to as a  "long-tail"  business  because  of the  length  of time  that
typically occurs between when the premium is collected and when a claim is fully
paid and settled due to life-time benefits that could be provided to a claimant.
The excess of premiums  collected  over claims and  expenses  paid are  invested
until needed. State regulations dictate the kinds of investments we can have and
we try to match the maturity of our investments with expected future cash needs.

CII  Financial  is a  holding  company  and its  only  significant  asset is its
investment in California  Indemnity  Insurance Company.  Of the $25.9 million in
cash and cash equivalents held at June 30, 2001, $25.0 million is designated for
use only by the regulated insurance companies. CII Financial has limited sources
of cash and is  dependent  upon  dividends  paid by  California  Indemnity.  The
payment of stockholders'  dividends by California  Indemnity is regulated by the
California  Insurance  Code and, at a minimum,  requires a 10 business day prior
notice to the California Department of Insurance.  If a payment of a dividend or
distribution  whose fair market value,  together with that of other dividends or
distributions  made within the  preceding 12 months,  exceeds the greater of ten
percent of the insurer's  surplus or its net income for the preceding  year end,
then  the  insurance  commissioner  has up to 30  days  to  disapprove  it.  The
California  Department  of  Insurance  will not allow a payment of a dividend or
distribution  if  it  will  cause  an  insurer's  policyholders'  surplus  to be
unreasonable  in relation to the insurer's  liabilities  and the adequacy of the
insurer's  financial  needs.  In  making  this  determination,   the  California
Department  of  Insurance  considers  a variety  of factors  including,  but not
limited  to,  the  size  of  the  insurer,   the  amount,  type  and  geographic
concentration of insurance it writes,  the quality of its assets and reinsurance
programs, and operating trends.

In  addition,  California  law  provides  that an insurer may not pay a dividend
without the prior approval of the state insurance commissioner to the extent the
cumulative  amount of dividends or distributions  paid or proposed to be paid in
any year exceeds the amount shown as unassigned funds (reduced by any unrealized
gains  included in such amount) on the insurer's  statutory  statement as of the
previous December 31. As of December 31, 2000,  California  Indemnity,  which is
our only direct  insurance  subsidiary,  had  unassigned  funds of $174,000 from
which it could pay a dividend  without prior  approval.  As noted above, to make
the  exchange  offer for the  outstanding  Subordinated  Debentures,  California
Indemnity received approval from the California Department of Insurance and paid
an  extraordinary  dividend to CII  Financial of $5.0 million in early May 2001.
The payment of any future dividend by California Indemnity in calendar year 2001
will require prior approval by the California Department of Insurance.

Under the terms of Sierra's revolving credit facility,  capital contributions by
Sierra  to us that are used to repay the  Subordinated  Debentures  may  require
Sierra to reduce  permanently an equal amount of the outstanding  balance of its
credit facility commitment.

Cash Flows

We had positive  cash flows from  operating  activities  of $7.2 million in 2001
compared to negative cash flows of $9.9 million for 2000. Our positive cash flow
in 2001 was largely due to the run-off of the low level  reinsurance  agreement.
Ceded paid losses now exceed ceded premiums under the contract and result in net
cash received from the reinsurer.  In addition,  the growth in premium  revenues
has resulted in an increase in loss and LAE  reserves and in unearned  premiums.
Our  negative  cash  flow  for 2000  was  primarily  due to the net loss for the
period.

Our net cash used in  investing  activities  was $5.5  million  compared to cash
provided by investing  activities  of $7.5 million for 2000.  The primary use of
cash  for  investing  activities  in 2001  was a loan to  Sierra  by  California
Indemnity of $7.5 million in conjunction with the debenture  exchange offer. Due
to the negative  cash flows from  operations  during  2000,  we sold some of our
investments which resulted in positive cash from investments of $8.1 million.

We used $4.5 million in cash for  financing  activities in 2001 compared to $4.8
million in 2000. The debenture  exchange offer used $21.5 million in cash, which
was offset by loans from  Sierra of $17.0  million.  During  2000,  we used $2.2
million to repurchase outstanding debentures and paid a dividend of $2.6 million
to Sierra.


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Unrealized  holding losses on available for sale  investments  have increased by
$1,228,000  since  December  31, 2000 due  primarily to a decrease in the market
value of bonds. We believe that changes in market  interest rates,  resulting in
unrealized holding gains or losses,  should not have a material impact on future
earnings  or cash  flows as it is  unlikely  that we  would  need or  choose  to
substantially liquidate our investment portfolio.





                           PART II - OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS

We are subject to various claims and other  litigation in the ordinary course of
business.  Such  litigation  includes  workers'  compensation  claims by injured
workers and by providers  for payment for medical  services  rendered to injured
workers. In the opinion of management,  the ultimate resolution of these pending
legal  proceedings  should not have a material  adverse  effect on our financial
condition.


ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

        None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

        None

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

        None

ITEM 5. OTHER INFORMATION

        None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

        (a)     Exhibits - None

        (b)     Reports on Form 8-K

               Current  Report  on Form  8-K,  filed  May  16,  2001,  with  the
               Securities  and  Exchange   Commission  in  connection  with  CII
               Financial's debenture exchange offer.







                                   SIGNATURES

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



                                    CII FINANCIAL, INC.
                                        (Registrant)



Date:  August 14, 2001              /S/ JOHN F. OKITA         
                                    JOHN F. OKITA
                                    Chief Financial Officer
                                    (Principal Financial and Accounting Officer)

Filing Compare · CII FINANCIAL INC