Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview
Results of Operations
Liquidity and Capital Resources
Recent Accounting Pronouncements
Interest Rate and Equity Price Sensitivity
Year 2000
Certain Factors That May Affect Future Operating Results or Our Stock Price

This Annual Report may contain forward-looking statements (see "Certain Factors That May Affect Future Operating Results or Stock Prices") within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve a number of risks and uncertainties. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully review and consider the various disclosures made in this report and in our other filings with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business.

OVERVIEW
We expect to generate a significant portion of our revenue from the sale of membership programs which include health and disability benefits. While product development has been ongoing for the past several years, we began revenue-generating activities in January 1999. Prior to that time, we were a development stage enterprise, which designed and test marketed various benefit combinations. To date, we have primarily focused on the distribution of our membership programs to bank customers and building recognition of our program brand. Christopher Reeve is featured prominently in our online, television and print marketing campaigns to build brand awareness. Our intent is to effect a substantial portion of our program distributions over the Internet.

We believe our consumer research and marketing efforts have given us valuable insight into the consumer perceptions and preferences regarding the value and limitations of prevailing insurance products. Accordingly, we believe that our programs are well positioned to address the needs of our targeted market segments. As of December 31, 1999, more than 105,000 members had enrolled in our programs.

Revenue is generated by payments for program benefits. The primary determinant of HealthExtras' revenue recognition is monthly program enrollment. In general, revenue is recognized based on the number of members enrolled in each reporting period multiplied by the applicable monthly fee for their specific membership program. The revenue recognized by HealthExtras includes the cost of the membership benefits, which are supplied by others, including the insurance components. Revenue from program payments received, and related direct expenses, are deferred to the extent that they are applicable to future periods or to any refund guarantee we offer for an initial 90-day period. As of December 31, 1999, initial revenue was deferred for approximately 40,000 program members. Direct expenses consist principally of bank marketing and processing fees and the cost of benefits provided to program members.

Direct expenses are a function of the level of membership during the period and the specific set of program features selected by members. The coverage obligations of our benefit suppliers and the related expense are determined monthly, as are the remaining direct expenses. HealthExtras has historically maintained a prepaid expense balance with respect to the insurance features of its programs. Where amounts are prepaid, direct expense is recognized based on the actual membership levels in each program. These prepaid amounts were $879,300 and $731,800 at December 31, 1998 and December 31, 1999, respectively. The carrying value of the prepayment is adjusted at the end of each quarter based on factors including enrollment levels in each product, enrollment trends, and the remaining portion of the unexpired prepayment period. In the event that a period of coverage was purchased in advance, and there were insufficient members to utilize the coverage, the value would expire and be expensed by HealthExtras without any related revenue. HealthExtras believes that current enrollment levels will allow the balance at December 31, 1999 to be fully utilized prior to expiration.

We have entered into three-year employment agreements with five of our officers. The annual base salaries under these arrangements range from $120,000 to $210,000, and one executive will be entitled to a bonus equal to one percent of our after-tax profits. Our minimum aggregate payments under these employment agreements are expected to be $837,000 annually.

Our limited history makes it difficult to evaluate our business and prospects. We have incurred substantial operating losses since our inception, and we intend to incur significant marketing and brand development expenses over the next several years. We anticipate that our operating losses will continue in the near term. There can be no assurance that we will generate significant revenues or profitability in the future.

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RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998

HealthExtras incurred an operating loss of $11.5 million for the year ended December 31, 1999. Revenue of $5.3 million consisted of annual program member payments earned during the period. Cash collections for program subscriptions through December 31, 1999 totaled $10.5 million. There was no revenue in 1998. Operating expenses for the year ended December 31, 1999 totaled $16.4 million. Direct expenses of $3.1 million consisted of the cost of obtaining the benefits included in our programs, and marketing and other fees payable to our distribution partners. These direct expenses represented 19% of operating expenses for that period. For the year ended December 31, 1999, HealthExtras incurred $10.3 million in product development and marketing expenses, or 63% of total operating expenses, $4.3 million of which was incurred for the continuing creative development of promotional and sales materials, including television and print advertisements, and $1.1 million of which was product endorsement costs. Media production expenses totaled $5.1 million for print and Internet advertisement production and distribution. Market research expenses were $380,000. General and administrative expenses for that period totaled $3.0 million or 18% of total operating expenses. These expenses included $1.7 million in compensation and benefits and $205,000 in professional services. Total operating expenses for the twelve months ended December 31, 1998 were $6.5 million. In 1998, total product development and marketing expenses were $4.9 million, representing 75% of total operating expenses. These expenses included $2.4 million for media development, consisting of $1.0 million in product endorsement costs, $631,000 in business partner marketing materials, $133,000 in test-marketing costs and approximately $650,000 in pre-production creative costs. Production-related expenses in 1998 totaled $1.1 million, of which $765,000 was in print advertisements and fulfillment materials and $330,000 was for the production of television and radio promotions. Also in 1998, $626,000 was devoted to market research and product development consulting. Additional costs of $237,000 of compensation expense, $324,000 in travel expense, and $220,000 of other costs were incurred as product development and marketing expenses. General and administrative expenses for the same period totaled $1.6 million, approximately 25% of total operating costs, and included approximately $630,000 in compensation and $224,000 in professional and consulting fees.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

Total operating expenses for the year ended December 31, 1998 were $6.5 million compared to $4.7 million for 1997. This difference was largely attributable to a $1.6 million increase in product development and marketing expenses, reflecting the implementation of marketing agreements, initial focus groups and product evaluation. In 1997, product development and marketing expenses included $674,000 for media development and $976,000 in market research and product development consulting. Other costs for 1997 totaled approximately $1,730,000, of which $513,000 was in compensation expense, $555,000 was in travel expenses and approximately $660,000 was in other product and media development costs. In 1998, product development and marketing expenses included $2.4 million for media development, consisting of $1.0 million in product endorsement costs, $631,000 in business partner marketing materials, $133,000 in test-marketing costs and approximately $650,000 in pre-production creative costs. Production-related expenses in 1998 totaled $1.1 million, of which $765,000 was in print advertisements and fulfillment materials and $330,000 was for the production of television and radio promotions. Also in 1998, $626,000 was devoted to market research and product development consulting. Additional costs of $237,000 of compensation expense, $324,000 in travel expense, and $220,000 of other costs were incurred as product development and marketing expenses. General and administrative expenses were largely unchanged from year to year. In 1997, these expenses included approximately $330,000 in compensation and $541,000 in professional and consulting fees. In 1998, these expenses included approximately $630,000 in compensation and $224,000 in professional and consulting fees. Net other income decreased from $589,000 for the year ended December 31, 1997 to a net expense of $100 for the year ended December 31, 1998. This decrease reflected a reduction in realized securities trading gains. Interest expense decreased from a net expense of $555,000 for the year ended December 31, 1997 to $110,000 for the year ended December 31, 1998, as more liquid assets were invested in interest-bearing instruments.

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LIQUIDITY AND CAPITAL RESOURCES
Our operations since inception were funded primarily through capital investments, advances from the Chairman of the Board of the Company and borrowings under a line of credit. In December 1999, we completed the sale to the public of 5,500,000 shares of the Company's common stock and received proceeds (net of underwriting commissions and expenses of $5.6 million) of approximately $54.9 million. As of December 31, 1999, we had $47.0 million in cash and cash equivalents, $45.2 in working capital and no debt.

The primary commitment of our capital resources is to fund expenditures relating to marketing and brand development we intend to incur over the next several years and to fund the operating losses we anticipate in the near term.

We currently anticipate our available cash resources will be sufficient to meet our presently anticipated working capital, capital expenditures and business expansion requirements for approximately the next 24 months. There can be no assurance that we will not require additional capital prior to the expiration of that 24-month period. Even if such funds are not required, we may seek additional equity or debt financing. We cannot assure you that such financing will be available on acceptable terms, if at all, or that such financing will not be dilutive to our stockholders.

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RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement on Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." We will be required to adopt SFAS No. 133 for the quarter ending March 31, 2001. Because we do not currently hold any derivative financial instruments and do not expect to engage in hedging activities, adoption of SFAS No. 133 is expected to have no material impact on our financial condition or results of operations. In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Software for Internal Use," which provides guidance on accounting for the cost of computer software developed or obtained for internal use. We have adopted this statement of position for the year ended December 31, 1999. The adoption did not have a material impact on our financial statements for the year ended December 31, 1999.

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INTEREST RATE AND EQUITY PRICE SENSITIVITY
We are subject to interest rate risk on our short-term investments and equity price risk in our marketable securities. We have determined that a 10% move in the current weighted average interest rate of our short-term investments and/or a 10% move in the weighted average market price of our marketable securities would not have a material effect in our financial position, results of operations and cash flows in the next year.

YEAR 2000
To date, we have not experienced any significant adverse effect related to the Year 2000 issue. Due to our recent founding, we developed our systems and technology in light of the Year 2000 problem, as opposed to many older systems designed before this problem was known. On June 15, 1999, we completed our review and testing of Year 2000 compliance for all of our internally developed software, which include substantially all of the systems for the operation of our website, customer interaction and transaction systems and our security, monitoring and back-up capabilities. On May 31, 1999, we completed our assessment of the Year 2000 readiness of our third party supplied software and hardware, and of our vendors. During the assessment phase, we identified those vendors critical to us, and received certifications of Year 2000 compliance or a readiness disclosure statement from them. Testing was completed in the fourth quarter of 1999. While we have not experienced any significant adverse effects to date, there can be no assurance that currently unidentified Year 2000 issues, if any, will not arise and that these issues will not have a material adverse effect on us.

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CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS OR STOCK PRICES

FACTORS RELATED TO OUR BUSINESS

Because we have a limited operating history, our business prospects are subject to a great deal of uncertainty.

While our product development efforts have been ongoing for the past two years, we only began revenue-generating activities in January 1999. This limited history of operating our business means that our business prospects are subject to a great deal of uncertainty and risks.

We have not been profitable and may not become profitable in the future.

We have incurred operating losses since our inception. Because we plan to continue to significantly increase our operating expenses in an attempt to increase our member base, we will need to generate significantly higher revenues to achieve profitability. Even if we achieve profitability, we may not be able to maintain profitability in the future. In addition, as our business model evolves, we expect to introduce a number of new products and services that may or may not be profitable for us.

Our future profitability is dependent, to a significant extent, upon increased consumer demand for additional products, which we are in the process of developing or may develop in the future.

Most of our revenue currently is derived from members purchasing membership programs which include disability benefits. We believe our future profitability is dependent upon achieving substantial increases in sales of our programs, including those providing excess health insurance coverage and other benefits we are developing or may develop in the future. To the extent these products include insurance features, they generally will require regulatory approvals. If we do not achieve these increased sales, we may never achieve profitability.

If the sale of our membership programs over the Internet does not achieve widespread consumer acceptance, we may never achieve profitability.

To date, we primarily have promoted our membership programs through mailings to credit card or other customers of banks. However, we intend to significantly increase the distribution of our programs over the Internet. Thus, our future profitability is dependent in large part on our ability to achieve widespread consumer acceptance of purchasing our programs over the Internet. The development of an online market for programs, such as those we offer, has only recently begun, is rapidly evolving and likely will be characterized by an increasing number of market entrants. Therefore, there is significant uncertainty with respect to the viability and growth potential of this market.

There can be no assurance that an online market for our programs will develop or that consumers will significantly increase their use of the Internet for obtaining the types of products and services included in the programs that we sell. If an online market for these products fails to develop, or develops more slowly than we expect, or if our programs do not achieve widespread market acceptance, the prospects for our achieving profitable operations will be significantly reduced.

If we lose one or more of our marketing relationships, our access to potential customers would decline and sales and revenues would suffer.

A substantial majority of all of our programs sold to date have been through mailings sent by banks to their credit card and other customers.If we lose one or more of our marketing relationships with credit card issuers and are unable to replace those relationships with other marketing outlets, our access to potential customers would decline and sales and revenues would suffer.

If we are not able to achieve a high level of brand recognition and consumer demand for our programs, we will not achieve the level of revenues we need to be profitable

There are a growing number of websites that offer consumers access to information regarding insurance coverage alternatives and product pricing. Our programs may be considered to compete with these and other distribution channels for insurance products. We believe that broader recognition of the HealthExtras brand and increased consumer demand for our programs are essential to our future success. To attempt to achieve that recognition and demand, we intend to continue to pursue an aggressive brand-enhancement strategy consisting of our traditional print advertising, as well as national radio and television advertising, online marketing and promotional efforts. This effort will require significantly greater expenditures than we have been able to make to date. If these expenditures do not result in a sufficient increase in revenues, we will not achieve profitability.

The loss of our relationship with Christopher Reeve to promote our programs could significantly impair our brand recognition and, thus, our ability to sell our programs.

Our agreement for Christopher Reeve to promote our programs currently expires in July 2002. The loss of the Christopher Reeve identification with our programs, upon termination of our contract or otherwise, could significantly reduce our ability to sell our programs.

If we lose our relationships with our benefit providers, we could have difficulty meeting demand for the products and services included in the programs we sell.

We are dependent on the providers of benefits included in our programs. These benefits are provided pursuant to arrangements with Reliance National, Chubb & Son and others that may be terminated on relatively short notice.If we lose these relationships and are unable to replace them quickly and cost effectively, we would not be able to satisfy consumer demand for our programs.

We may experience significant fluctuations in our quarterly results of operations which will make it difficult for investors to make reliable period-to-period comparisons and may contribute to volatility in our stock price.

Our quarterly expenses have fluctuated significantly in the past, and we expect our quarterly revenues and expenses to continue to fluctuate significantly in the future. The causes for fluctuations could include, among other factors:

We believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and not good indicators of our future performance. Due to the above-mentioned and other factors, it is possible that in one or more future quarters our operating results will fall below the expectations of securities analysts and investors. If this happens, the trading price of our common stock would likely decrease.

If we do not manage our growth effectively, we will not be able to operate profitably.

We only began offering our programs this year, and we have been expanding our operations rapidly. Our growth strategy, if successful, will result in further expansion. We can achieve profitable operation, however, only if we are able to manage our growth effectively. Our growth in operations has placed significant demands on our management and other resources, which is likely to continue. Under these conditions, it is important for us to retain our existing management and to attract, hire and retain additional highly skilled and motivated officers, managers and employees and improve existing systems and/or implement new systems.

We may not be successful in managing or expanding our operations or maintaining adequate management, financial and operating systems and controls.

If the providers of the benefits included in our programs fail to provide those benefits, we could become subject to liability claims by our program members.

We arrange for the provision by others of the benefits included in our member programs. If the firms with which we have contracted to provide those benefits fail to provide them as required, or are negligent or otherwise culpable in providing them, we could become involved in any resulting claim or litigation.

FACTORS RELATED TO REGULATION

If we fail to comply with all of the various and complex laws and regulations governing our business, we could be subject to fines, additional licensing requirements or the inability to market in particular jurisdictions.

Complex laws, rules and regulations of each of the 50 states and the District of Columbia pertaining to insurance impose strict and substantial requirements on insurance coverage sold to consumers and businesses. Compliance with these laws, rules and regulations can be arduous and imposes significant costs. The underwriter of the insurance benefits included in HealthExtras programs is responsible for obtaining and maintaining regulatory approvals for those benefits. If the appropriate regulatory approvals for the insurance benefits included in our programs are not maintained, we would have to stop including those benefits. An independent licensed insurance agency is responsible for the solicitation of insurance benefits involved in HealthExtras programs. Each jurisdiction's insurance regulator typically has the power, among other things, to:

State insurance laws and regulations are complex and broad in scope and are subject to periodic modification as well as differing interpretations. There can be no assurance that insurance regulatory authorities in one or more states will not determine that the nature of our business requires us to be licensed under applicable insurance laws. A determination to that effect or that we or our business partners are not in compliance with applicable regulations could result in fines, additional licensing requirements or inability to market our programs in particular jurisdictions. Such penalties could significantly increase our general operating expenses and harm our business. In addition, even if the allegations in any regulatory or legal action against us turn out to be false, negative publicity relating to any such allegation could result in a loss of consumer confidence and significant damage to our brand. We believe that because many consumers and insurance companies are not yet comfortable with the concept of purchasing insurance online, the publicity relating to any such regulatory or legal issues could significantly reduce sales of our programs.

Regulation of the sale of insurance over the Internet and of electronic commerce generally is unsettled, and future laws, regulations and interpretations could hinder our ability to offer programs over the Internet.

The distribution of our programs including an insurance component over the Internet subjects us to additional risk as most insurance laws and regulations have not been modified to clarify or amend their application to Internet transactions. Currently, many state insurance regulators and legislators are exploring the need for specific regulation of insurance sales over the Internet. Such regulation could dampen the growth of the Internet as a means of providing insurance services. Moreover, the application of laws governing general commerce on the Internet remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing insurance, intellectual property, privacy and taxation apply to the Internet. In addition, the growth and development of the market for electronic commerce may prompt calls for more stringent consumer protection laws and regulations that may impose additional burdens on companies conducting business over the Internet. Any new laws or regulations or new interpretations of existing laws or regulations relating to the Internet could hinder our ability to offer programs over the Internet.

We could be subject to legal liability based upon the information on our website.

Our members may rely upon the information published on our website regarding insurance coverage, exclusions, limitations and ratings, and the other benefits included in our programs. To the extent that the information we provide is not accurate, we could be liable for damages. These types of claims could be time-consuming and expensive to defend, divert management's attention, and could cause consumers to lose confidence in our service. As a result, these types of claims, whether or not successful, could harm our business.

FACTORS RELATED TO THE INTERNET AND ELECTRONIC COMMERCE

If we experience failures of, or capacity constraints in, our systems or the systems of third parties on which we rely, sales of our programs likely would be reduced and our reputation could be damaged.

We use both internally developed and third party systems to operate the Internet aspects of our business. If the number of users of our service increases substantially, we will need to significantly expand and upgrade our technology, transaction processing systems and network infrastructure. We do not know whether we will be able to accurately project the rate or timing of any increases, or expand and upgrade our systems and infrastructure to accommodate any increases in a timely manner. Our ability to facilitate transactions successfully and provide high quality customer service also depends on the efficient and uninterrupted operation of our computer and communications hardware systems. Our service has experienced periodic system interruptions, and it is likely that these interruptions will continue to occur from time to time. Additionally, our systems and operations are vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, acts of vandalism and similar events. We may not carry sufficient business interruption insurance to compensate for losses that could occur. Any system failure that causes an interruption in service or decreases the responsiveness of our service would impair our revenue-generating capabilities, and could damage our reputation and our brand name.

If we are unable to safeguard the security and privacy of our program members' information, our reputation would be damaged and we could be subject to litigation and liability.

A significant barrier to electronic commerce and online communications has been the need for secure transmission of confidential information over the Internet. Our ability to secure the transmission of confidential information over the Internet is essential in maintaining consumer confidence in our service. In addition, because we handle confidential and sensitive information about our program members, any security breaches would damage our reputation and could expose us to litigation and liability. We cannot guarantee that our systems will prevent security breaches.