**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterly period ended June 30,2004**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from           to          **

 

**Commission File Number  001-13083**

 

**WELLPOINT HEALTH NETWORKS INC.**

(Exact name of registrant as specified in itscharter)

 
| **Delaware**                                                                        |   | **95-4635504**                    |
|-------------------------------------------------------------------------------------|--------|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |   | (IRS Employer Identification No.) |
|                                                                                |   |                              |
| **1 WellPoint Way, Thousand Oaks,  California**                                     |   | **91362**                         |
| (Address of principal executive offices)                                            |   | (Zip Code)                        |
|                                                                                |   |                              |
| **(818) 234-4000**                                                                  |
| (Registrant’s telephone number, including  area code)                          |
|                                                                                |   |                              |
| **Not Applicable**                                                                  |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý  No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act of 1934).  Yes  ý  No  o

 

As of August 4, 2004, there were approximately 157,061,965 sharesof Common Stock, $0.01 par value of the registrant outstanding.

 

 

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**WellPoint Health Networks Inc.**

**Quarterly Report on Form 10-Q for the QuarterEnded June 30, 2004**

**Table of Contents**

 
| PART I.  FINANCIAL INFORMATION                                                                         |                                                                                        |
|-------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                                                                                        |                                                                                        |   |
| ITEM 1.                                                                                                     | Financial  Statements                                                                       |   |
|                                                                                                        |                                                                                        |   |
| Consolidated Balance Sheets as of June 30, 2004 and  December 31, 2003                            | 1                                                                                           |
|                                                                                                        |                                                                                        |   |
| Consolidated Income Statements for the Quarters and Six Months Ended  June 30, 2004 and 2003           | 2                                                                                           |
|                                                                                                        |                                                                                        |   |
| Consolidated Statement of Changes in  Stockholders’ Equity for the Six Months Ended June 30, 2004 | 3                                                                                           |
|                                                                                                        |                                                                                        |   |
| Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2004 and 2003                 | 4                                                                                           |
|                                                                                                        |                                                                                        |   |
| Notes to Consolidated Financial Statements                                                                  | 5                                                                                           |
|                                                                                                        |                                                                                        |   |
| Report of Independent Registered Public  Accounting Firm                                                    | 31                                                                                          |
|                                                                                                        |                                                                                        |   |
| ITEM 2.                                                                                                     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 32 |
|                                                                                                        |                                                                                        |   |
| ITEM 3.                                                                                                     | Quantitative  and Qualitative Disclosures About Market Risk                                 | 72 |
|                                                                                                        |                                                                                        |   |
| ITEM 4.                                                                                                     | Controls  and Procedures                                                                    | 74 |
|                                                                                                        |                                                                                        |   |
| PART  II.  OTHER INFORMATION                                                                           |                                                                                        |
|                                                                                                        |                                                                                        |   |
| ITEM 1.                                                                                                     | Legal  Proceedings                                                                          | 75 |
|                                                                                                        |                                                                                        |   |
| ITEM 2.                                                                                                     | Changes  in Securities, Use of Proceeds and Issuer Purchases of Equity Securities           | 76 |
|                                                                                                        |                                                                                        |   |
| ITEM 4.                                                                                                     | Submission  of Matters to a Vote of Security Holders                                        | 77 |
|                                                                                                        |                                                                                        |   |
| ITEM 6.                                                                                                     | Exhibits  and Reports on Form 8-K                                                           | 78 |
|                                                                                                        |                                                                                        |   |
| SIGNATURES                                                                                                  | 79                                                                                          |
|                                                                                                        |                                                                                        |   |
| EXHIBIT  INDEX                                                                                              | 80                                                                                          |

 

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PART I.FINANCIAL INFORMATION

 

ITEM 1.                             FinancialStatements

 

**WellPointHealth Networks Inc.**

Consolidated Balance Sheets

 
| **(In thousands, except share  data)**                                                                                                                             | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| ***ASSETS***                                                                                                                                                       |       |                    |       |                        |       |
| Current Assets:                                                                                                                                                    |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                          |       | $                       | 956,711    |                        | $          | 1,030,327 |   |
| Investments - available-for-sale, at fair value                                                                                                                    |       | 6,844,321               |       | 6,726,802                   |       |
| Securities lending collateral                                                                                                                                      |       | 846,991                 |       | 914,173                     |       |
| Receivables, net                                                                                                                                                   |       | 1,522,361               |       | 1,356,107                   |       |
| Deferred tax assets, net                                                                                                                                           |       | 385,751                 |       | 355,110                     |       |
| Other current assets                                                                                                                                               |       | 359,356                 |       | 258,588                     |       |
| Total Current Assets                                                                                                                                               |       | 10,915,491              |       | 10,641,107                  |       |
| Property and equipment, net                                                                                                                                        |       | 463,090                 |       | 441,936                     |       |
| Intangible assets, net                                                                                                                                             |       | 927,440                 |       | 950,954                     |       |
| Goodwill, net                                                                                                                                                      |       | 2,295,651               |       | 2,321,208                   |       |
| Long-term investments, at market value                                                                                                                             |       | 196,812                 |       | 161,784                     |       |
| Other non-current assets                                                                                                                                           |       | 254,996                 |       | 271,689                     |       |
| Total Assets                                                                                                                                                       |       | $                       | 15,053,480 |                        | $          | 14,788,678 |   |
|                                                                                                                                                               |       |                    |       |                        |       |
| ***LIABILITIES AND  STOCKHOLDERS’ EQUITY***                                                                                                                   |       |                    |       |                        |       |
| Current Liabilities:                                                                                                                                               |       |                    |       |                        |       |
| Medical claims payable                                                                                                                                             |       | $                       | 2,649,916  |                        | $          | 2,747,074 |   |
| Reserves for future policy benefits                                                                                                                                |       | 108,337                 |       | 129,135                     |       |
| Unearned premiums                                                                                                                                                  |       | 690,965                 |       | 629,831                     |       |
| Accounts payable and accrued expenses                                                                                                                              |       | 1,398,428               |       | 1,411,391                   |       |
| Experience rated and other refunds                                                                                                                                 |       | 255,226                 |       | 267,382                     |       |
| Income taxes payable                                                                                                                                               |       | 187,389                 |       | 241,979                     |       |
| Security trades pending payable                                                                                                                                    |       | 146,006                 |       | 27,456                      |       |
| Securities lending payable                                                                                                                                         |       | 846,991                 |       | 914,173                     |       |
| Other current liabilities                                                                                                                                          |       | 731,520                 |       | 712,273                     |       |
| Total Current Liabilities                                                                                                                                          |       | 7,014,778               |       | 7,080,694                   |       |
| Accrued postretirement benefits                                                                                                                                    |       | 155,331                 |       | 152,738                     |       |
| Reserves for future policy benefits, non-current                                                                                                                   |       | 313,825                 |       | 288,197                     |       |
| Long-term debt                                                                                                                                                     |       | 803,294                 |       | 1,238,267                   |       |
| Deferred tax liabilities                                                                                                                                           |       | 325,918                 |       | 370,737                     |       |
| Other non-current liabilities                                                                                                                                      |       | 223,789                 |       | 228,096                     |       |
| Total Liabilities                                                                                                                                                  |       | 8,836,935               |       | 9,358,729                   |       |
| Stockholders’ Equity:                                                                                                                                         |       |                    |       |                        |       |
| Preferred Stock - $0.01 par value, 50,000,000 shares authorized, none  issued and outstanding                                                                      |       | —                  |       | —                      |       |
| Common Stock - $0.01 par value, 300,000,000 shares authorized,  159,202,083 and 157,006,322 issued at June 30, 2004 and  December 31, 2003, respectively |       | 1,592                   |       | 1,570                       |       |
| Treasury stock, at cost, 2,171,017 and 4,248,172 shares at  June 30, 2004 and December 31, 2003, respectively                                            |       | (164,726                | )          | (298,049                    | )          |
| Additional paid-in capital                                                                                                                                         |       | 2,447,130               |       | 2,348,506                   |       |
| Retained earnings                                                                                                                                                  |       | 3,845,639               |       | 3,250,483                   |       |
| Accumulated other comprehensive income                                                                                                                             |       | 86,910                  |       | 127,439                     |       |
| Total Stockholders’ Equity                                                                                                                                    |       | 6,216,545               |       | 5,429,949                   |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                    |       | $                       | 15,053,480 |                        | $          | 14,788,678 |   |

 

See the accompanying notesto the Consolidated Financial Statements.

 

1

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**WellPoint Health Networks Inc.**

ConsolidatedIncome Statements

(Unaudited)

 
| ** **                                        | ** ** | **Quarter  Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| **(In thousands, except earnings  per share)**    | ** ** | **2004**                         | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                         |       |                             |       |                                |       |   |   |   |   |
| Premium revenue                                   |       | $                                | 5,407,984  |                                | $          | 4,654,854 |   | $ | 10,664,287 |   | $ | 9,203,159 |   |
| Management services and other revenue             |       | 303,901                          |       | 221,466                             |       | 610,077 |   | 447,637 |   |
| Investment income                                 |       | 68,532                           |       | 64,037                              |       | 152,193 |   | 130,352 |   |
|                                              |       | 5,780,417                        |       | 4,940,357                           |       | 11,426,557 |   | 9,781,148 |   |
| Operating Expenses:                               |       |                             |       |                                |       |   |   |   |   |
| Health care services and other benefits           |       | 4,364,370                        |       | 3,769,667                           |       | 8,551,721 |   | 7,487,167 |   |
| Selling expense                                   |       | 223,400                          |       | 201,237                             |       | 440,522 |   | 393,234 |   |
| General and administrative expense                |       | 670,010                          |       | 578,000                             |       | 1,395,733 |   | 1,167,669 |   |
|                                              |       | 5,257,780                        |       | 4,548,904                           |       | 10,387,976 |   | 9,048,070 |   |
| Operating Income                                  |       | 522,637                          |       | 391,453                             |       | 1,038,581 |   | 733,078 |   |
| Interest expense                                  |       | 12,967                           |       | 12,689                              |       | 25,210 |   | 25,463 |   |
| Other expense, net                                |       | 9,778                            |       | 4,646                               |       | 21,444 |   | 11,650 |   |
| Income before Provision for Income Taxes          |       | 499,892                          |       | 374,118                             |       | 991,927 |   | 695,965 |   |
| Provision for income taxes                        |       | 199,957                          |       | 149,649                             |       | 396,771 |   | 278,443 |   |
| Net Income                                        |       | $                                | 299,935    |                                | $          | 224,469 |   | $ | 595,156 |   | $ | 417,522 |   |
|                                              |       |                             |       |                                |       |   |   |   |   |
| Earnings Per Share                                |       | $                                | 1.92       |                                | $          | 1.54 |   | $ | 3.84 |   | $ | 2.87 |   |
|                                              |       |                             |       |                                |       |   |   |   |   |
| Earnings Per Share Assuming Full Dilution         |       | $                                | 1.86       |                                | $          | 1.49 |   | $ | 3.71 |   | $ | 2.79 |   |
|                                              |       |                             |       |                                |       |   |   |   |   |
| Weighted Average Shares Outstanding               |       | 155,823                          |       | 145,711                             |       | 154,881 |   | 145,662 |   |
|                                              |       |                             |       |                                |       |   |   |   |   |
| Fully Diluted Weighted Average Shares Outstanding |       | 161,163                          |       | 150,217                             |       | 160,280 |   | 149,697 |   |

 

Seethe accompanying notes to the Consolidated Financial Statements.

 

2

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**WellPoint Health Networks Inc.**

Consolidated Statement ofChanges in Stockholders’ Equity

(Unaudited)

 
| ** **                                                                                               | ** ** | ** **    | ** ** | **Common  Stock** | ** ** | **Additional**   | ** ** | ** **  | ** ** | **Accumulated  Other** | ** ** | ** **        | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------|------------|-------------------|------------|------------------|------------|-------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                               | ** ** | **Preferred** | ** ** | **Issued**        | ** ** | **In  Treasury** | ** ** | **Paid-in** | ** ** | **Retained**           | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| **(In thousands)**                                                                                       | ** ** | **Stock**     | ** ** | **Shares**        | ** ** | **Amount**       | ** ** | **Shares**  | ** ** | **Amount**             | ** ** | **Capital**       | ** ** | **Earnings** | ** ** | **Income** | ** ** | **Total** | ** ** |
| Balance  as of December 31, 2003                                                                    |       | $             | —     |              | 157,006    |             | $          | 1,570       |       | 4,248                  |       | $                 | (298,049   | ) | $ | 2,348,506 |   | $ | 3,250,483 |   | $ | 127,439 |   | $ | 5,429,949 |   |
| Stock  grants to employees and directors                                                                 |       |          |       | 526               |       | 5                |       | (514        | )          | 33,119                 |       | 18,527            |       |   |   |   |   | 51,651 |   |
| Stock  issued for employee stock option plans and stock purchase plans                                   |       |          |       | 1,670             |       | 17               |       | (1,563      | )          | 100,204                |       | 115,058           |       |   |   |   |   | 215,279 |   |
| Net  losses from treasury stock reissued                                                                 |       |          |       |              |       |             |       |        |       |                   |       | (34,961           | )          |   |   |   |   | (34,961 | ) |
| Comprehensive  income                                                                                    |       |          |       |              |       |             |       |        |       |                   |       |              |       |   |   |   |   |   |   |
| Net  income                                                                                              |       |          |       |              |       |             |       |        |       |                   |       |              |       | 595,156 |   |   |   | 595,156 |   |
| Other  comprehensive income, net of tax                                                                  |       |          |       |              |       |             |       |        |       |                   |       |              |       |   |   |   |   |   |   |
| Change  in unrealized valuation adjustment on investment securities, net of  reclassification adjustment |       |          |       |              |       |             |       |        |       |                   |       |              |       |   |   | (40,529 | ) | (40,529 | ) |
| Total  comprehensive income                                                                              |       |          |       |              |       |             |       |        |       |                   |       |              |       | 595,156 |   | (40,529 | ) | 554,627 |   |
|                                                                                                     |       |          |       |              |       |             |       |        |       |                   |       |              |       |   |   |   |   |   |   |
| Balance  as of June 30, 2004                                                                        |       | $             | —     |              | 159,202    |             | $          | 1,592       |       | 2,171                  |       | $                 | (164,726   | ) | $ | 2,447,130 |   | $ | 3,845,639 |   | $ | 86,910 |   | $ | 6,216,545 |   |

 

Seethe accompanying notes to the Consolidated Financial Statements.

 

3

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**WellPoint Health Networks Inc.**

Consolidated Statements of Cash Flows

(Unaudited)

 
| ** **                                                                                   | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(In  thousands)**                                                                          | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| **Cash flows from  operating activities:**                                                   |       |                               |       |   |   |
| Net income                                                                                   |       | $                                  | 595,156    |   | $ | 417,522 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:           |       |                               |       |   |   |
| Depreciation and amortization, net of  accretion                                             |       | 103,370                            |       | 79,468 |   |
| Gain on sales of assets, net                                                                 |       | (15,371                            | )          | (10,856 | ) |
| Benefit for deferred income taxes                                                            |       | (22,240                            | )          | (16,137 | ) |
| Amortization of deferred gain on sale of  building                                           |       | (261                               | )          | — |   |
| Accretion of interest on 6 3/8% Notes due  2012 and 6 3/8% Notes due 2006                    |       | 149                                |       | 140 |   |
| (Increase) decrease  in certain assets, net of effect of  businesses acquired and sold: |       |                               |       |   |   |
| Receivables, net                                                                             |       | (136,962                           | )          | (212,793 | ) |
| Other current assets                                                                         |       | (81,376                            | )          | (41,105 | ) |
| Other non-current assets                                                                     |       | 6,782                              |       | 8,048 |   |
| Increase (decrease) in certain liabilities,  net of effect of businesses acquired and sold:  |       |                               |       |   |   |
| Medical claims payable                                                                       |       | (97,172                            | )          | 95,865 |   |
| Reserves for future policy benefits                                                          |       | 4,830                              |       | 5,645 |   |
| Unearned premiums                                                                            |       | 61,134                             |       | 17,329 |   |
| Accounts payable and accrued expenses                                                        |       | 17,685                             |       | (13,824 | ) |
| Experience rated and other refunds                                                           |       | (12,156                            | )          | 326 |   |
| Income taxes payable                                                                         |       | 76,445                             |       | (11,191 | ) |
| Other current liabilities                                                                    |       | 33,544                             |       | 101,115 |   |
| Accrued postretirement benefits                                                              |       | 2,593                              |       | 3,680 |   |
| Other non-current liabilities                                                                |       | (4,056                             | )          | (1,274 | ) |
| Net cash provided by operating activities                                                    |       | 532,094                            |       | 421,958 |   |
| **Cash flows from  investing activities:**                                                   |       |                               |       |   |   |
| Investments purchased                                                                        |       | (3,539,781                         | )          | (5,339,371 | ) |
| Proceeds from investments sold and matured                                                   |       | 3,467,193                          |       | 4,394,694 |   |
| Property and equipment purchased                                                             |       | (112,093                           | )          | (58,576 | ) |
| Proceeds from property and equipment sold                                                    |       | 36,126                             |       | 5,306 |   |
| Acquisition of new businesses, net of cash  acquired                                         |       | —                             |       | (27,708 | ) |
| Additional cash used for prior period  acquisitions                                          |       | (13,116                            | )          | — |   |
| Proceeds from sale of business, net of cash  sold                                            |       | 1,262                              |       | — |   |
| Net cash used in investing activities                                                        |       | (160,409                           | )          | (1,025,655 | ) |
| **Cash flows from  financing activities:**                                                   |       |                               |       |   |   |
| Net (repayment) borrowing of commercial  paper                                               |       | (429,833                           | )          | 149,504 |   |
| Proceeds from termination of interest rate  swap on 6 3/8% Notes due 2006                    |       | 4,633                              |       | — |   |
| Change in advances on securities lending  payable                                            |       | (67,182                            | )          | 580,843 |   |
| Proceeds from issuance of Common Stock                                                       |       | 47,081                             |       | 88,216 |   |
| Common Stock repurchased                                                                     |       | —                             |       | (192,414 | ) |
| Net cash (used) provided by financing  activities                                            |       | (445,301                           | )          | 626,149 |   |
| Net (decrease) increase in cash and cash  equivalents                                        |       | (73,616                            | )          | 22,452 |   |
| Cash and cash equivalents at beginning of  period                                            |       | 1,030,327                          |       | 1,355,616 |   |
| Cash and cash equivalents at end of period                                                   |       | $                                  | 956,711    |   | $ | 1,378,068 |   |

 

See the accompanying notes to theConsolidated Financial Statements.

 

4

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**WellPoint Health Networks Inc.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**1.****              Organization**

 

WellPoint Health Networks Inc. (the “Company” or “WellPoint”) isone of the nation’s largest publicly traded managed health care companies. Asof June 30, 2004, WellPoint had approximately 15.5 million medicalmembers (including approximately 1.3 million BlueCard “host” members) andapproximately 46.2 million specialty members. Host members are generallymembers who reside in a state in which a WellPoint subsidiary is the Blue Crossand/or Blue Shield licensee and who are covered under an employer-sponsoredhealth plan issued by a non-WellPoint controlled Blue Cross and/or Blue Shieldlicensee. Through its subsidiaries, the Company offers a broad spectrum ofnetwork-based managed care plans to the large and small employer, individual,Medicaid and senior markets. The Company’s managed care plans include preferredprovider organizations (“PPOs”), health maintenance organizations (“HMOs”),point-of-service (“POS”) plans, other hybrid plans and traditional indemnityplans. In addition, the Company offers managed care services, includingunderwriting, actuarial services, network access, medical management and claimsprocessing. The Company also provides a broad array of specialty and otherproducts and services including pharmacy benefits management, dental, vision,life insurance, preventive care, disability insurance, behavioral health, COBRAand flexible benefits account administration. With its recent acquisition ofCobalt Corporation, the Company now also offers workers’ compensation insuranceproducts and is currently the largest Medicare Part A fiscal intermediaryin the nation, processing claims for providers in all 50 states. The Companymarkets its products in California primarily under the name Blue Cross ofCalifornia, in Georgia primarily under the name Blue Cross Blue Shield ofGeorgia, in most parts of Missouri (except Kansas City and surroundingcounties) primarily under the name Blue Cross Blue Shield of Missouri, inWisconsin primarily under the names Blue Cross Blue Shield of Wisconsin andCompcareBlue and in various parts of the country under the names UNICARE andHealthLink. These products are marketed by the Company’s various operatingsubsidiaries throughout the United States. The Company’s customer base isdiversified, with extensive membership among large and small employer groupsand individuals and in the Medicare and Medicaid markets.

 

**2.****              Basis ofPresentation**

 

The accompanying unaudited consolidated financial statements ofWellPoint have been prepared in accordance with accounting principles generallyaccepted in the United States of America (“GAAP”) and the rules and regulationsof the Securities and Exchange Commission (“SEC”) for interim financialreporting.  In accordance with the rulesand regulations of the SEC, certain footnotes or other financial informationhave been condensed or omitted if they substantially duplicate the disclosurescontained in the Company’s annual audited financial statements.  In the opinion of management, the interimfinancial statements reflect all material adjustments (which are of a normalrecurring nature) necessary for a fair statement of its financial position asof June 30, 2004, the results of its operations for the quarters and sixmonths ended June 30, 2004 and 2003, its changes in stockholders’ equityfor the six months ended June 30, 2004 and its cash flows for the sixmonths ended June 30, 2004 and 2003. The results of operations for the interim periods presented are notnecessarily indicative of the operating results for the full year.  These unaudited consolidated financialstatements should be read together with the consolidated financial statementsand notes included in the Company’s annual report on Form 10-K for the yearended December 31, 2003. The Company has

 

5

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reclassified certain prior year amounts in the accompanying unauditedconsolidated financial statements to conform to the 2004 presentation.

 

**3.****              Stock-BasedCompensation**

 

At June 30, 2004, the Company had three stock-based employeecompensation plans: the 1999 Stock Incentive Plan, the 2000 Employee StockOption Plan and the Employee Stock Purchase Plan. The Company accounts forthese plans under the recognition and measurement principles of APB Opinion No.25, “Accounting for Stock Issued to Employees” and related FASBinterpretations. Accordingly, compensation cost for stock options underexisting plans is measured as the excess, if any, of the quoted market price ofthe Company’s Common Stock at the date of the grant over the amount an employeemust pay to acquire the stock. No stock-based employee compensation cost isreflected in net income related to stock options granted because optionsgranted under those plans had an exercise price equal to the market value ofthe underlying Common Stock on the date of grant. In addition, no compensationexpense is recorded for purchases under the Employee Stock Purchase Plan inaccordance with APB No. 25.

 

Employee stock-based compensation included in reported net incomeincludes restricted stock awards being amortized over the award’s vestingperiod. The vesting period is generally three years from the date of the grant.During the six months ended June 30, 2004, 565,000 restricted shares ofCompany Common Stock with purchase prices below current fair market value weregranted to employees of the Company with a fair value at the date of grant of$57.6 million. During the quarter and six months ended June 30, 2004, theCompany recorded approximately $4.8 million and $9.1 million, respectively, invested stock-based compensation. During the quarter and six months endedJune 30, 2003, the Company recorded approximately $0.2 million and $0.9million, respectively, in vested stock-based compensation. As of June 30,2004, total unearned compensation from all non-vested stock awards totaled$49.6 million.

 

The following table illustrates the pro forma effect on net income andearnings per share if the Company had applied the fair value recognitionprovisions of Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” as amended by Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure,” for the quarters and six months ended June 30, 2004 and 2003.

 

6

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| ** **                                                                                                                                       | ** ** | **Quarter Ended********June 30,** | ** ** | **Six Months Ended********June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------|------------|
| **(In  millions, except per share amounts)**                                                                                                     | ** ** | **2004**                               | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                             |       |                                   |       |                                      |       |   |   |   |   |
| Net income—as reported                                                                                                                      |       | $                                      | 299.9      |                                      | $          | 224.5 |   | $ | 595.1 |   | $ | 417.5 |   |
| Add: Stock—based employee compensation  expense included in reported net income, net of related tax effects                                 |       | 2.9                                    |       | 0.1                                       |       | 5.5 |   | 0.5 |   |
| Less: Total stock—based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |       | (31.9                                  | )          | (18.2                                     | )          | (61.5 | ) | (35.4 | ) |
| Net income—pro forma                                                                                                                        |       | $                                      | 270.9      |                                      | $          | 206.4 |   | $ | 539.1 |   | $ | 382.6 |   |
|                                                                                                                                             |       |                                   |       |                                      |       |   |   |   |   |
| Earnings per share—as reported                                                                                                              |       | $                                      | 1.92       |                                      | $          | 1.54 |   | $ | 3.84 |   | $ | 2.87 |   |
| Earnings per share—pro forma                                                                                                                |       | $                                      | 1.74       |                                      | $          | 1.42 |   | $ | 3.48 |   | $ | 2.63 |   |
| Earnings per share assuming full  dilution—as reported                                                                                      |       | $                                      | 1.86       |                                      | $          | 1.49 |   | $ | 3.71 |   | $ | 2.79 |   |
| Earnings per share assuming full  dilution—pro forma                                                                                        |       | $                                      | 1.68       |                                      | $          | 1.37 |   | $ | 3.36 |   | $ | 2.56 |   |

 

The above pro forma disclosures may not be representative of theeffects on reported pro forma net income for future years.

 

**4.****              SupplementalSignificant Accounting Policies**

 

*Principles of Consolidation*

 

Allof the Company’s majority owned subsidiaries, including the Company’s 51%interest in a community health partnership network, are accounted for under theconsolidation method of accounting as required under Statement of FinancialAccounting Standards No. 94, “Consolidation of All Majority-Owned Subsidiaries”(“SFAS No. 94”).  Joint ventures in whichthe Company owns a 50% interest are recorded under the equity method ofaccounting as required by SFAS No. 94. Other investments in which the Company owns less than 50% of the votingstock are recorded in accordance with Accounting Principles Board No. 18, “TheEquity Method of Accounting for Investments in Common Stock” (“APB No.18”).  The Company maintains certaininvestments in enterprises in which the Company owns less than 20% of thevoting stock that are accounted for under the equity method of accounting as aresult of the Company’s ability to exert significant influence over theoperating and financial policies of the enterprise, as defined in APB No. 18.

 

*Investments*

 

TheCompany and certain of its subsidiaries participate in securities lendingprograms whereby the loaned marketable securities in the Company’s portfolioare transferred to borrowers (generally independent brokers or dealers)approved by the Company based on, among other things, their creditworthiness inexchange for collateral initially equal to at least

 

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102%of the value of the securities on loan and is thereafter maintained at aminimum of 100% of the market value of the securities loaned.  The market value of the securities on loan toeach borrower is monitored daily and the borrower is required to deliveradditional collateral if the market value of the collateral falls below 100% ofthe market value of the securities on loan. Under the guidance provided inStatement of Financial Accounting Standards No. 140, “Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities,” theCompany recognizes the collateral as an asset under “securities lendingcollateral” on its balance sheet and the Company records a correspondingliability for the obligation to return the collateral to the borrower under“securities lending payable.”

 

*Receivables, net*

 

A Company subsidiary (the “PBM”) operates as apharmacy benefit manager under the trade name WellPoint PharmacyManagement.  The PBM contracts withpharmaceutical manufacturers, some of whom provide rebates based on use of themanufacturers’ products by the PBM’s affiliated and non-affiliatedclients.  The Company accrues rebates receivableon a monthly basis based on the terms of the applicable contracts, historicaldata and current estimates.  The PBMbills these rebates to the manufacturers on a quarterly basis.  The Company records rebates attributable toaffiliated clients as a reduction to “health care services and otherbenefits.”  Rebates attributable tonon-affiliated clients are accrued as rebates receivable and a correspondingpayable for the amounts of the rebates to be remitted to non-affiliated clientsin accordance with their contracts is also recorded.  The Company generally receives rebatesbetween two to five months after billing.

 

**5.****              New Accounting****Pronouncements**

 

In December 2003, the FASB issuedStatement of Financial Accounting Standards No. 132 (revised 2003), “Employers’Disclosures about Pensions and Other Postretirement Benefits - an amendment ofFASB Statements No. 87, 88, and 106” (“SFAS No. 132R”). SFASNo. 132R retains the disclosure requirements contained in FASB StatementNo. 132, “Employers’ Disclosures about Pensions and Other PostretirementBenefits” (“SFAS No. 132”), and also requires additional disclosures tothose in the original SFAS No. 132 that a company is required to make inits annual and interim financial statements. Except as noted, disclosuresrequired by SFAS No. 132R are effective for financial statements withfiscal years ending after December 15, 2003. The disclosure of estimatedfuture benefit payments required by SFAS No. 132R is effective for fiscalyears ending after June 15, 2004. The adoption of SFAS No. 132R didnot have a material effect on the consolidated financial statements of theCompany.

 

On December 8, 2003, the Medicare Prescription Drug, Improvementand Modernization Act of 2003 (“MMA”) was signed into law. MMA introduced avoluntary Medicare Part D prescription drug benefit and created a new 28%federal subsidy for the sponsors of postretirement prescription drug benefitsthat are at least actuarially equivalent to the new Medicare Part Dbenefit. The Company has determined that it qualifies for the subsidy underMMA. In May 2004, the FASB issued FASB Staff Position No. FAS 106-2,“Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003” (“FSP FAS 106-2”). UnderFSP FAS 106-2, sponsors must consider the two new features of MMA inmeasuring the accumulated postretirement benefit obligation (“APBO”) and netperiodic postretirement benefit cost. In accordance with FSP FAS 106-2,the Company made a one-time election to recognize the impact of MMA as ofDecember 31, 2003. Accordingly, any measures of the APBO and net periodicpostretirement benefit cost in the Company’s Consolidated Financial Statementsand the related footnotes for the year ended December 31, 2003 includedthe effects of MMA. The impact of the adoption of the FSP FAS 106-2 on theCompany’s Consolidated Financial Statements as of December 31, 2003 resulted ina reduction in the APBO of $7.9 million. The reduction in the 2004 net periodicpostretirement benefit cost for the quarter and six months ended June 30, 2004was $0.3 million and $0.6 million, respectively.

 

8

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**6.****              Acquisitions**

 

On October 31, 2003, the Company completed its acquisition of HealthCore, Inc. (“Health Core”). Health Core currently provides outcomes researchservices to health plans and pharmaceutical organizations. The purchase priceand related acquisition costs of approximately $4.1 million plus anadditional $3.5 million in scheduled future payments over the next three yearsexceeded the estimated fair value of net assets acquired by $6.4 million.Under the purchase method of accounting, the Company assigned this amount togoodwill.  In addition, the terms of thetransaction include a provision for additional contingent payments of up to$5.5 million based on Health Core achieving certain financial performancetargets during 2005, 2006 and 2007. The final amount of goodwill may increaseas a result of these contingent payments. The operating results for Health Coreare included in WellPoint’s consolidated income statements for periodsfollowing the completion of the acquisition.

 

On September 24, 2003, the Company completed its acquisition ofCobalt, the parent company of Blue Cross Blue Shield of Wisconsin. Cobaltserved approximately 675,000 medical members (excluding BlueCard “host”members) as of September 30, 2003. The transaction was effective as ofSeptember 30, 2003 for accounting purposes. The operating results forCobalt are included in WellPoint’s consolidated income statement for periodsfollowing September 30, 2003. Under the terms of the transaction, totalconsideration paid to all holders of Cobalt common stock in the merger wasapproximately $427.5 million in cash and approximately 7.3 millionnewly issued shares of WellPoint Common Stock (which included approximately2.1 million shares issued to affiliates). The total purchase price ofapproximately $884.9 million valued as of September 24, 2003 was usedto purchase net assets with a fair value of approximately $251.0 million.Included in the total purchase price was $12.1 million used to retireCobalt’s existing long-term debt at the time of acquisition. As a result of theacquisition of Cobalt, the Company incurred $37.1 million in expenses,primarily related to transaction costs. Generally accepted accountingprinciples require that these expenses, which are not associated with thegeneration of future revenues and have no future economic benefit, be reflectedas assumed liabilities in the allocation of the purchase price to the netassets acquired. Estimated goodwill and other intangibles totaling$820.0 million includes $96.5 million of deferred tax liabilitiesrelating to identified intangibles. Identified

 

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intangibles with definite useful lives are being amortized on astraight-line basis or the timing of related cash flows depending upon theexpected amortization pattern over three to 23 years. The valuation of certainassets and liabilities and the implementation of the integration plan are notyet complete and, therefore, the allocation between goodwill and intangibleassets recorded as of June 30, 2004 represents an estimate. As a result,the useful lives and method of amortization are only preliminary estimates. Thecurrent estimated purchase price allocation between goodwill and identifiableintangible assets is $578.7 million and $241.3 million, respectively.The entire estimated goodwill amount of $578.7 million is not deductiblefor tax purposes.

 

On June 30, 2003, the Company completed its acquisition of GoldenWest Health Plan, Inc. (“Golden West”) for a purchase price ofapproximately $30.4 million. Upon completion of the acquisition, GoldenWest had net assets with a fair value of approximately $0.4 million andserved more than 275,000 dental and vision members. As a result of theacquisition of Golden West, the Company incurred $0.4 million in expensesprimarily related to transaction costs. The estimated purchase price allocationbetween goodwill and identifiable intangible assets was $17.3 million and$13.0 million, respectively. The operating results for Golden West areincluded in WellPoint’s consolidated income statements for periods followingthe completion of the acquisition.

 

**7.****              Goodwilland Other Intangible Assets**

 

In accordance with SFAS No. 142, the Company completed the annualevaluation of its goodwill and other intangible assets at December 31,2003, and determined that there was no impairment loss.

 

The changes in the carrying amount of goodwill by reportable segmentare as follows:

 
| **(In  thousands)**                                                  | ** ** | **Health  Care** | ** ** | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|------------------|------------|---------------|------------|--------------------------|------------|------------------|------------|
| Balance as of January 1, 2003                                   |       | $                | 1,676,800  |          | $          | 14,971                   |       | $                | —     |   | $ | 1,691,771 |   |
| Goodwill acquired during 2003                                        |       | 607,826          |       | 17,248        |       | 2,892                    |       | 627,966          |       |
| Final purchase accounting adjustments  for RightCHOICE goodwill |       | 1,471            |       | —        |       | —                   |       | 1,471            |       |
| Balance as of December 31, 2003                                 |       | 2,286,097        |       | 32,219        |       | 2,892                    |       | 2,321,208        |       |
| Purchase accounting adjustments for Cobalt goodwill                  |       | (29,118          | )          | —        |       | —                   |       | (29,118          | )          |
| Other goodwill adjustments                                           |       | —           |       | 46            |       | 3,515                    |       | 3,561            |       |
| Balance as of June 30, 2004                                     |       | $                | 2,256,979  |          | $          | 32,265                   |       | $                | 6,407      |   | $ | 2,295,651 |   |

 

On October 31, 2003, WellPoint completed its acquisition of HealthCore, as discussed in Note 6. As a result of the acquisition of HealthCore, the Company recorded $6.4 million of goodwill as of June 30,2004.

 

On September 24, 2003, WellPoint completed its acquisition ofCobalt, as discussed in Note 6. As a result of the acquisition of Cobalt,the Company recorded $578.7 million of goodwill and

 

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$241.3 million of identifiable intangible assets as ofJune 30, 2004. The valuation process is not yet complete and, therefore,the allocation between goodwill and other intangible assets recorded as ofJune 30, 2004 represents an estimate. The Company assumes no residualvalue for its amortizable intangible assets. The following table presentsdetails of the acquired amortized and non-amortized intangible assets of Cobaltat cost as of June 30, 2004.

 
| **(In  thousands)**                                    | ** ** | **Gross  Carrying  Value** | ** ** | **Useful  Life  (in years)** | ** ** | **Weighted  Average  Useful Life  (in years)** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|------------------------------|------------|------------------------------------------------|------------|
| Amortized intangible assets:                           |       |                       |       |                         |       |                                           |       |
| Provider relationships                                 |       | $                          | 3,450      |                         | 11 to 23   |                                           | 16.7       |   |
| Customer contracts and related customer  relationships |       | 70,000                     |       | 3 to 16                      |       | 9.0                                            |       |
| Total amortized intangible assets                      |       | 73,450                     |       |                         |       | 9.4                                            |       |
|                                                   |       |                       |       |                         |       |                                           |       |
| Non-amortized intangible assets:                       |       |                       |       |                         |       |                                           |       |
| Provider relationships                                 |       | 552                        |       | Indefinite                   |       | Indefinite                                     |       |
| Trade names and service marks                          |       | 167,300                    |       | Indefinite                   |       | Indefinite                                     |       |
| Total non-amortized intangible assets                  |       | 167,852                    |       |                         |       |                                           |       |
|                                                   |       |                       |       |                         |       |                                           |       |
| Total other intangible assets                          |       | $                          | 241,302    |                         |       |                                           |       |   |

 

On June 30, 2003, WellPoint completed its acquisition of GoldenWest, as discussed in Note 6. As a result of the acquisition of GoldenWest, the Company recorded $17.3 million of goodwill and$13.0 million of identifiable intangible assets as of June 30, 2004.The Company assumes no residual value for its amortizable intangible assets.The following table presents details of the acquired amortized andnon-amortized intangible assets of Golden West at cost as of June 30,2004.

 
| **(In  thousands)**                                    | ** ** | **Gross  Carrying  Value** | ** ** | **Useful  Life  (in years)** | ** ** | **Weighted  Average  Useful Life  (in years)** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|------------------------------|------------|------------------------------------------------|------------|
| Amortized intangible assets:                           |       |                       |       |                         |       |                                           |       |
| Customer contracts and related customer  relationships |       | $                          | 5,000      |                         | 12         |                                           | 12.0       |   |
| Total amortized intangible assets                      |       | 5,000                      |       |                         |       |                                           |       |
|                                                   |       |                       |       |                         |       |                                           |       |
| Non-amortized intangible assets:                       |       |                       |       |                         |       |                                           |       |
| Trade names and service marks                          |       | 8,000                      |       | Indefinite                   |       | Indefinite                                     |       |
| Total non-amortized intangible assets                  |       | 8,000                      |       |                         |       |                                           |       |
|                                                   |       |                       |       |                         |       |                                           |       |
| Total other intangible assets                          |       | $                          | 13,000     |                         |       |                                           |       |   |

 

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The gross carrying value, accumulated amortization and net carryingvalue of other intangible assets of the Company as of June 30, 2004 andDecember 31, 2003 were as follows:

 
| **(In  thousands)  As of June 30, 2004**          | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Value** | ** ** | **Amortizat-  ion Period  (in years)** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Amortized intangible assets:                           |       |                       |       |                          |       |                     |       |                                   |       |
| Provider relationships                                 |       | $                          | 33,424     |                          | $          | 6,187                    |       | $                                      | 27,237     |   | 10 to 25 |   |
| Customer contracts and related customer  relationships |       | 427,974                    |       | 133,019                       |       | 294,955                  |       | 1.5 to 20                              |       |
| Other                                                  |       | 21,968                     |       | 10,954                        |       | 11,014                   |       | 5 to 20                                |       |
| Total amortized intangible assets                      |       | 483,366                    |       | 150,160                       |       | 333,206                  |       |                                   |       |
|                                                   |       |                       |       |                          |       |                     |       |                                   |       |
| Non-amortized intangible assets:                       |       |                       |       |                          |       |                     |       |                                   |       |
| Provider relationships                                 |       | 17,674                     |       | 98                            |       | 17,576                   |       | Indefinite                             |       |
| Trade names and service marks                          |       | 579,300                    |       | 2,642                         |       | 576,658                  |       | Indefinite                             |       |
| Total non-amortized intangible assets                  |       | 596,974                    |       | 2,740                         |       | 594,234                  |       |                                   |       |
|                                                   |       |                       |       |                          |       |                     |       |                                   |       |
| Total other intangible assets                          |       | $                          | 1,080,340  |                          | $          | 152,900                  |       | $                                      | 927,440    |   |   |   |

 
| **(In thousands)  As of December 31, 2003**       | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Value** | ** ** | **Amortizat-  ion Period  (in years)** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Amortized intangible assets:                           |       |                       |       |                          |       |                     |       |                                   |       |
| Provider relationships                                 |       | $                          | 33,424     |                          | $          | 5,349                    |       | $                                      | 28,075     |   | 10 to 25 |   |
| Customer contracts and related customer  relationships |       | 427,974                    |       | 111,351                       |       | 316,623                  |       | 1.5 to 20                              |       |
| Other                                                  |       | 21,968                     |       | 9,946                         |       | 12,022                   |       | 5 to 20                                |       |
| Total amortized intangible assets                      |       | 483,366                    |       | 126,646                       |       | 356,720                  |       |                                   |       |
|                                                   |       |                       |       |                          |       |                     |       |                                   |       |
| Non-amortized intangible assets:                       |       |                       |       |                          |       |                     |       |                                   |       |
| Provider relationships                                 |       | 17,674                     |       | 98                            |       | 17,576                   |       | Indefinite                             |       |
| Trade names and service marks                          |       | 579,300                    |       | 2,642                         |       | 576,658                  |       | Indefinite                             |       |
| Total non-amortized intangible assets                  |       | 596,974                    |       | 2,740                         |       | 594,234                  |       |                                   |       |
|                                                   |       |                       |       |                          |       |                     |       |                                   |       |
| Total other intangible assets                          |       | $                          | 1,080,340  |                          | $          | 129,386                  |       | $                                      | 950,954    |   |   |   |

 

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For the quarters ended June 30, 2004 and 2003, amortizationexpense relating to intangible assets was $11.7 million and $9.0 million,respectively. For the six months ended June 30, 2004 and 2003,amortization expense relating to intangible assets was $23.5 million and $18.1million, respectively. The following table presents the Company’s estimatedannual amortization expense for amortized intangible assets for each of theyears ending December 31, 2004, 2005, 2006, 2007 and 2008 (amounts inthousands). These estimates were calculated based on the gross carrying valueof amortized intangible assets as of June 30, 2004 using the applicableamortization period.

 
| For year ending December 31, 2004 |   | $      | 47,028 |   |
|----------------------------------------|--------|--------|--------|--------|
| For year ending December 31, 2005 |   | 43,648 |   |
| For year ending December 31, 2006 |   | 37,102 |   |
| For year ending December 31, 2007 |   | 32,412 |   |
| For year ending December 31, 2008 |   | 28,945 |   |

 

**8.****              PensionBenefits**

 

The Company maintains three non-contributory defined benefit pension plans.The Restated Employees’ Retirement Plan of Blue Cross of California (the “BCCPlan”) covers employees of a collective bargaining unit. The WellPoint HealthNetworks Inc. Pension Accumulation Plan (the “WellPoint Pension Plan”),which was established on January 1, 1987, covers all eligible employees(employees covered under a collective bargaining agreement participate if theterms of the collective bargaining agreement provides for such participation)meeting certain age and service requirements. In addition, with the completionof the acquisition of Cobalt, WellPoint became the sponsor of Cobalt’s UGSPension Plan (“UGS Plan”). The UGS Plan provides retirement benefits to coveredemployees based primarily on compensation and years of service. Plan assets areinvested primarily in pooled income funds. The Company’s policy is to fund itsplans according to the requirements of the Employee Retirement Income SecurityAct of 1974, as amended, and applicable income tax regulations. The Companyuses the projected unit credit method of cost determination. InOctober 2003, the Company amended the WellPoint Pension Plan effectiveJanuary 1, 2004. Beginning January 1, 2004, employees who are of age50 and over, with combined age and service totaling 65 or higher as ofDecember 31, 2003, will continue to earn future contributions under theWellPoint Pension Plan based on eligible compensation. For other employees, thefunds in their pension account earned through December 31, 2003 willcontinue to accrue interest. However, there will be no additional contributionsbased on the employee’s earnings after December 31, 2003. Once theemployee becomes vested (after five years of service), the employee will beeligible to receive a benefit from the WellPoint Pension Plan at retirement ortermination based on his or her account balance as of December 31, 2003plus accrued interest. Employees hired after December 31, 2003 will not beeligible to participate in the WellPoint Pension Plan.

 

Estimated net periodic pension expense for the Company’s definedbenefit pension plans included the following components:

 

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| ** **                                       | ** ** | **Quarter  Ended June 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| **(In thousands)**                               | ** ** | **2004**                         | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Service cost—benefits earned                |       | $                                | 1,809      |   | $ | 4,888 |   |
| Interest cost on projected benefits  obligations |       | 7,732                            |       | 4,910 |   |
| Expected return on plan assets                   |       | (8,411                           | )          | (4,902 | ) |
| Amortization of prior service cost               |       | 29                               |       | 24 |   |
| Recognized net actuarial loss                    |       | 2,308                            |       | 2,206 |   |
| Curtailment charge                               |       | —                           |       | 310 |   |
| Net periodic pension expense                     |       | $                                | 3,467      |   | $ | 7,436 |   |

 
| ** **                                       | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|
| **(In  thousands)**                              | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Service cost—benefits earned                |       | $                                  | 3,702      |   | $ | 9,776 |   |
| Interest cost on projected benefits  obligations |       | 13,414                             |       | 9,820 |   |
| Expected return on plan assets                   |       | (15,373                            | )          | (9,804 | ) |
| Amortization of prior service cost               |       | 48                                 |       | 48 |   |
| Recognized net actuarial loss                    |       | 4,005                              |       | 4,412 |   |
| Curtailment charge                               |       | —                             |       | 620 |   |
| Net periodic pension expense                     |       | $                                  | 5,796      |   | $ | 14,872 |   |

 

Based on the funded status of all of WellPoint’s pension plans, during2004 the Company expects to contribute approximately $14.0 million and $0.6million to the WellPoint Pension Plan and BCC Plan, respectively. Nocontributions are projected to be made for the UGS Plan during 2004. During thesix months ended June 30, 2004, $5.1 million in contributions were made toWellPoint’s pension plans.

 

**9.****              Long-Term Debt**

 

The carrying amount of the Company’s long-term indebtedness consistedof the following:

 
| **(In thousands)**       | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                     |       |                    |       |                        |       |
| 6 3/8*%* Notes due 2006  |       | $                       | 454,191    |                        | $          | 459,366 |   |
| 6 3/8*%* Notes due 2012  |       | 349,103                 |       | 349,068                     |       |
| Commercial paper program |       | —                  |       | 429,833                     |       |
| Total long-term debt     |       | $                       | 803,294    |                        | $          | 1,238,267 |   |

 

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*6 3/8% Notes due 2012*

 

On January 16, 2002, the Company issued $350.0 millionaggregate principal amount at maturity of 6 3/8% Notes due January 15,2012 (the “2012 Notes”). The net proceeds of this offering totaledapproximately $348.9 million. The 2012 Notes bear interest at a rate of 63/8% per annum, payable semi-annually in arrears on January 15 andJuly 15 of each year commencing July 15, 2002. Interest is computedon the basis of a 360-day year of twelve 30-day months. At June 30, 2004and December 31, 2003, the Company had $349.1 million, (based uponthe principal amount of $350.0 million less unamortized discount) of 2012Notes outstanding. The related interest expense and amortization of discountand issue costs for each of the quarters ended June 30, 2004 and 2003 totaled$5.7 million. The related interest expense and amortization of discountand issue costs for each of the six months ended June 30, 2004 and 2003totaled $11.4 million.

 

The 2012 Notes may be redeemed, in whole or in part, at the Company’soption at any time. The redemption price for any 2012 Notes redeemed will beequal to the greater of the following amounts: 1) 100% of the principalamount of the 2012 Notes being redeemed on the redemption date; or 2) thesum of the present values of the remaining scheduled payments of principal andinterest on the 2012 Notes being redeemed on that redemption date (notincluding any portion of any payments of interest accrued to the redemptiondate) discounted to the redemption date on a semi-annual basis at the Treasuryrate as determined by the Reference Treasury Dealer (J.P. MorganSecurities Inc. or Deutsche Banc Alex Brown or their respectivesuccessors), plus 25 basis points. In each case, the redemption price will alsoinclude accrued and unpaid interest on the 2012 Notes to the redemption date.

 

*6 3/8% Notes due 2006*

 

On June 15, 2001, the Company issued $450.0 million aggregateprincipal amount at maturity of 6 3/8% Notes due June 15, 2006 (the “2006Notes”). The net proceeds of this offering totaled approximately$449.0 million. The net proceeds from the sale of the 2006 Notes were usedfor repayment of indebtedness under the Company’s revolving credit facilities.The 2006 Notes bear interest at a rate of 6 3/8% per annum, payablesemi-annually in arrears on June 15 and December 15 of each yearcommencing December 15, 2001. Interest is computed on the basis of a360-day year of twelve 30-day months. At June 30, 2004 andDecember 31, 2003, the Company had $449.6 million and $449.5 million,respectively, (based upon the principal amount of $450.0 million lessunamortized discount) of 2006 Notes outstanding. The related interest expenseand amortization of discount and issue costs for each of the quarters endedJune 30, 2004 and 2003 was $7.5 million. The related interest expense andamortization of discount and issue costs for each of the six months endedJune 30, 2004 and 2003 was $14.9 million.

 

The 2006 Notes may be redeemed, in whole or in part, at the Company’soption at any time. The redemption price for any 2006 Notes redeemed will beequal to the greater of the following amounts: 1) 100% of the principalamount of the 2006 Notes being redeemed on the redemption date; or 2) thesum of the present values of the remaining scheduled payments of

 

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principal and interest on the 2006 Notes being redeemed on thatredemption date (not including any portion of any payments of interest accruedto the redemption date) discounted to the redemption date on a semi-annual basisat the Treasury rate as determined by the designated Reference Treasury Dealer(Salomon Smith Barney Inc. or UBS Warburg LLC or their respectivesuccessors), plus 25 basis points. In each case, the redemption price will alsoinclude accrued and unpaid interest on the 2006 Notes to the redemption date.

 

With the intention of reducing the interest expense associated with the2006 Notes, the Company, on January 15, 2002, entered into a$200.0 million notional amount interest rate swap agreement. The swap agreementis a contract to exchange a fixed 6 3/8% rate for a floating rate based on theLondon InterBank Offered Rate (“LIBOR”). In anticipation of the completion ofthe pending merger with Anthem, Inc. (“Anthem”), in June 2004 the Companyterminated this interest rate swap agreement and received proceeds of $4.6million. No gain was recognized under this transaction since the accountingadjustment to the carrying amount of the 2006 Notes of $4.6 million is treatedas a premium and will be amortized as a reduction to interest expense over theremaining life of the 2006 Notes (through June 15, 2006). Prior to thetermination of the interest rate swap agreement, the Company recognizedsettlement income of $1.0 million and $2.0 million, respectively, for thequarters ended June 30, 2004 and 2003, which offset the Company’s interestexpense for these periods. For the six months ended June 30, 2004 and2003, the Company recognized settlement income of $2.9 million and $3.9million, respectively, from this interest rate swap agreement (seeNote 10).

 

The 2012 and 2006 Notes are unsecured obligations and rank equally withall of the Company’s existing and future senior unsecured indebtedness. Allexisting and future liabilities of the Company’s subsidiaries are and will beeffectively senior to the 2012 and 2006 Notes. The indenture governing the 2012and 2006 Notes contains a covenant that limits the ability of the Company andits subsidiaries to create liens on any of their property or assets to securecertain indebtedness without also securing the indebtedness under the 2012 and2006 Notes.

 

*Revolving Credit Facility*

 

Effective as of March 30, 2001, the Company entered into twounsecured revolving credit facilities allowing aggregate indebtedness of$1.0 billion in principal amount. Borrowings under these facilities (whichare generally referred to collectively as the Company’s “revolving creditfacility”) bear interest at rates determined by reference to the bank’s baserate or LIBOR plus a margin determined by reference to the then-current ratingof the Company’s unsecured long-term debt by specified rating agencies. Afacility fee based on the facility amount, regardless of utilization, ispayable quarterly. The facility fee rate is also determined by the senior unsecuredlong-term debt ratings by specified rating agencies. One facility, whichprovides for borrowings not to exceed $750.0 million at any timeoutstanding, expires on March 30, 2006, although it may be extended for upto two additional one-

 

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year periods under certain circumstances. The other facility, whichprovides for borrowings not to exceed $250.0 million at any timeoutstanding, expires on March 25, 2005. Any amount outstanding under thisfacility as of March 25, 2005 may be converted into a one-year term loanat the option of the Company and will bear interest at rates determined byreference to the bank’s base rate or LIBOR plus a margin determined byreference to the then-current rating of the Company’s unsecured long-term debtby specified rating agencies, plus 0.125% until paid in full.

 

Loans under the $250.0 million facility are made on a committedbasis. Loans under the $750.0 million facility are made on a committedbasis or pursuant to an auction bid process. The $750.0 million facilityalso contains sublimits for letters of credit and “swingline” loans. Eachcredit agreement requires the Company to maintain certain financial ratios andcontains restrictive covenants, including restrictions on the incurrence ofadditional indebtedness and the granting of certain liens, limitations onacquisitions and investments and limitations on changes in control. As ofJune 30, 2004 and December 31, 2003, the Company had no amountsoutstanding under the revolving credit facility.

 

*Commercial Paper Program*

 

In April 2002, the Company commenced a commercial paper programproviding for the issuance of up to $1.0 billion in aggregate maturityvalue of short-term indebtedness (known generally as “commercial paper”). Thecommercial paper is being issued by the Company without registration under theSecurities Act of 1933, as amended (the “1933 Act”) in reliance upon theexemption from registration contained in Section 4(2) of the 1933 Act. Thecommercial paper is issued in denominations of $100,000 or integral multiplesof $1,000 in excess thereof and will bear such interest rates, ifinterest-bearing, or will be sold at such discount from their face amounts, asagreed upon by the Company and the dealer or dealers acting in connection withthe commercial paper program. The commercial paper may be issued with varyingmaturities up to a maximum of 270 days from the date of issuance.

 

Asof December 31, 2003, outstanding commercial paper totaled approximately$429.8 million. The average maturity for the commercial paper was43 days as of December 31, 2003. The weighted average yield on theoutstanding commercial paper as of December 31, 2003 was 1.25%. TheCompany’s intent was to maintain commercial paper borrowings of at least theamount outstanding at December 31, 2003 for more than one year. Statementof Financial Accounting Standards No. 6, “Classification of Short-TermObligations Expected to Be Refinanced” (“SFAS No. 6”) provides that a companymay classify a short-term obligation as a long-term liability if the companyintends to refinance the short-term obligation on a long-term basis and if thecompany has the ability to consummate such refinancing on a long-termbasis.  SFAS No. 6 states thatrefinancing a short-term obligation on a long-term basis means either replacingit with a long-term obligation or replacing it with short-term obligations foran uninterrupted period extending beyond one year from the date of a company’sbalance sheet.  SFAS No. 6 further statesthat the company’s ability to consummate a refinancing is demonstrated where(i) the company has entered into a financing agreement that does not expirewithin the year following the applicable balance sheet date, (ii) the financingagreement is not cancelable (and the obligations incurred thereunder are notcallable) during such period except as a result of noncompliance, (iii) thereis no violation of the financing agreement on the applicable balance sheet dateor prior to issuance of such

 

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balancesheet, and (iv) the company expects the financing parties to be financiallycapable of honoring the agreement.

 

Management believes that the Company has met the SFAS No. 6requirements for its commercial paper borrowings as of December 31, 2003to be classified as a long-term liability because the Company’s practice andintent since the inception of the commercial paper program in April 2002has been to replace the short-term commercial paper outstanding at expirationwith additional short-term commercial paper for an uninterrupted periodextending for more than one year or with borrowings under the Company’s creditfacilities. Regarding the Company’s ability to consummate the refinancing, (i)the commercial paper and credit facility agreements will not expire prior toDecember 31, 2004, (ii) the commercial paper and credit facilityagreements are not cancelable (and the obligations incurred thereunder are notcallable) prior to December 31, 2004 unless the Company has defaulted,(iii) there was no violation under the commercial paper and credit facilityagreements during the relevant period, and (iv) the financing entities underthe commercial paper and credit facility agreements are institutions that mustmeet certain criteria selected by the Company and the Company expects all suchfinancing entities to be financially capable of honoring their commitmentsunder the commercial paper and credit facility agreements. Accordingly, forfinancial reporting purposes, the Company classified its outstanding commercialpaper balance under non-current liabilities in the Company’s ConsolidatedBalance Sheet at December 31, 2003. The related interest expense for thequarters ended June 30, 2004 and 2003 was $1.0 million and$1.5 million, respectively. The related interest expense for the sixmonths ended June 30, 2004 and 2003 was $2.3 million and$2.6 million, respectively.

 

TheCompany is currently subject to a pending merger with Anthem, Inc.  Under the merger agreement with Anthem, theCompany is obligated to repurchase or otherwise retire any outstandingcommercial paper prior to the closing of the merger.  In June 2004, in anticipation of themerger closing, the Company repaid the entire outstanding balance under thecommercial paper program.

 

*Debt Covenants*

 

The Company’s revolving credit facility requires the maintenance ofcertain financial ratios and contains other restrictive covenants, includingrestrictions on the incurrence of additional indebtedness by subsidiaries andthe granting of certain liens, limitations on acquisitions and investments andlimitations on changes in control. As of June 30, 2004 andDecember 31, 2003, the Company was in compliance with the requirements inthese agreements.

 

**10.****      ****Hedging Activities**

 

The Company maintains an interest rate risk management strategy thatuses derivative instruments to minimize significant, unanticipated earningsfluctuations caused by interest rate volatility. The Company’s goal is tomaintain a balance between fixed and floating interest rates on its long-termdebt.

 

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By using derivative financial instruments to hedge exposures to changesin interest rates, the Company exposes itself to credit risk and market risk.Market risk is the adverse effect on the value of a financial instrument thatresults from a change in interest rates. The Company manages exposure to marketrisk associated with interest rate contracts by establishing and monitoringparameters that limit the types and degree of market risk that may beundertaken.

 

The Company uses interest rate swap agreements to manage interest rateexposures. The principal objective of such contracts is to minimize the risksand/or costs associated with financial and investing activities. The Companydoes not use derivative financial instruments for speculative purposes. Thecounterparties to these contractual arrangements are major financialinstitutions with which the Company also has other financial relationships.These counterparties expose the Company to credit loss in the event ofnon-performance. However, the Company does not anticipate non-performance bythe other parties. As of December 31, 2003, the Company reported aderivative asset of $9.9 million on an interest rate swap agreement thatthe company designated as a fair value hedge on its 2006 Notes. InJune 2004, the Company terminated this interest rate swap agreement andreceived proceeds of $4.6 million (see further discussion below). As of June 30,2004, the Company was not party to any effective interest rate swap agreements.

 

*Fair Value Hedges*

 

With the intention of reducing the interest expense associated with the2006 Notes, the Company, on January 15, 2002, entered into a$200.0 million notional amount interest rate swap agreement. The swapagreement is a contract to exchange a fixed 6 3/8% rate for a LIBOR-basedfloating rate. The swap agreement expires June 15, 2006. As discussedabove, in anticipation of the completion of the pending merger with Anthem, inJune 2004 the Company terminated this interest rate swap agreement andreceived proceeds of $4.6 million. No gain was recognized under thistransaction since the accounting adjustment to the carrying amount of the 2006Notes of $4.6 million is treated as a premium and will be amortized as areduction to interest expense over the remaining life of the 2006 Notes(through June 15, 2006). Prior to the termination of the interest rateswap agreement, the Company recognized settlement income of $1.0 million and$2.0 million, respectively, for the quarters ended June 30, 2004 and 2003,which offset the Company’s interest expense for these periods. For the sixmonths ended June 30, 2004 and 2003, the Company recognized settlementincome of $2.9 million and $3.9 million, respectively.

 

*Cash Flow Hedges*

 

The Company has entered into interest rate swap agreements to reducethe impact of changes in interest rates on its floating rate debt under itsrevolving credit facility. The swap agreements were contracts to exchangevariable-rate for fixed-rate interest payments without the exchange of theunderlying notional amounts.

 

In September 2002, the Company terminated and settled its$150.0 million and $50.0 million notional amount interest rate swapagreements with original expiration dates of October 17, 2003 andOctober 17,

 

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2006, respectively. At termination, the Company paid$17.6 million, of which $1.8 million was accrued interest and theremaining $15.8 million represented the fair value of the swap agreementsat the time of termination. The fair value of the swap agreements was reflectedin accumulated other comprehensive income and will be amortized as a reductionto investment income on a straight-line basis over the shorter of the originalexpiration dates of the interest rate swap agreements or the expected cashflows of the commercial paper program. The fair value of the$150.0 million and $50.0 million notional amount swap agreements, attermination, were $8.0 million and $7.8 million, respectively.Amortization of other comprehensive income related to the terminated swaps on apre-tax basis for the quarters ended June 30, 2004 and 2003 totaled $0.5million and $2.3 million, respectively, and $0.3 million and $1.4 million on anafter-tax basis for the same periods, respectively. Amortization of othercomprehensive income related to the terminated swaps on a pre-tax basis for thesix months ended June 30, 2004 and 2003 totaled $1.0 million and $4.7 million,respectively, and $0.6 million and $2.8 million on an after-tax basis for thesame periods, respectively.

 

For the year ended December 31, 2003, the fair value of the$150.0 million notional amount swap agreement in other comprehensiveincome was fully amortized. The unamortized pre-tax amount in othercomprehensive income related to the $50.0 million notional amount swapagreement as of June 30, 2004 and December 31, 2003 totaled$4.4 million and $5.4 million, respectively.

 

**11**.       **Earnings Per Share**

 

The following is an illustration of the dilutive effect of theCompany’s potential Common Stock on earnings per share. Outstanding stockoptions for which the exercise price was greater than the average market pershare price of Common Stock were 75,000 and 410,000 for the quarters endedJune 30, 2004 and 2003, respectively, and 1,114,000 and 523,000 for thesix months ended June 30, 2004 and 2003, respectively. Since the effect ofthese options was antidilutive, they have been excluded from the computation ofthe diluted earnings per share below.

 
| ** **                                        | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| **(In  thousands, except per share data)**        | ** ** | **2004**                         | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Numerator**                                     |       |                             |       |                                |       |   |   |   |   |
| Net Income                                        |       | $                                | 299,935    |                                | $          | 224,469 |   | $ | 595,156 |   | $ | 417,522 |   |
|                                              |       |                             |       |                                |       |   |   |   |   |
| **Denominator**                                   |       |                             |       |                                |       |   |   |   |   |
| Weighted average shares outstanding               |       | 155,823                          |       | 145,711                             |       | 154,881 |   | 145,662 |   |
| Net effect of dilutive stock options              |       | 5,340                            |       | 4,506                               |       | 5,399 |   | 4,035 |   |
| Fully-diluted weighted average shares outstanding |       | 161,163                          |       | 150,217                             |       | 160,280 |   | 149,697 |   |
|                                              |       |                             |       |                                |       |   |   |   |   |
| Earnings Per Share                                |       | $                                | 1.92       |                                | $          | 1.54 |   | $ | 3.84 |   | $ | 2.87 |   |
| Earnings Per Share Assuming Full Dilution         |       | $                                | 1.86       |                                | $          | 1.49 |   | $ | 3.71 |   | $ | 2.79 |   |

 

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**12**.       **Comprehensive Income**

 

The following summarizes comprehensive (loss) incomereclassification adjustments for the six months ended June 30, 2004 and2003:

 
| ** **                                                                                                                          | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| **(In  thousands)**                                                                                                                 | ** ** | **2004**                            | ** ** | **2003** | ** ** |
|                                                                                                                                |       |                                |       |   |   |
| Investment Securities:                                                                                                              |       |                                |       |   |   |
| Net holding (loss) gain on investment  securities arising during the period, net of tax benefit (expense) of $29,680  and $(56,445) |       | $                                   | (50,553    | ) | $ | 83,505 |   |
| Reclassification adjustment for realized  gain on investment securities, net of tax expense of $6,682 and $2,751                    |       | 10,024                              |       | 4,233 |   |
| Net (loss) gain recognized in other  comprehensive income, net of tax benefit (expense) of $22,998 and $(59,196)                    |       | $                                   | (40,529    | ) | $ | 87,738 |   |

 

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**13.****       Business SegmentInformation**

 

The Company maintains the following two reportable segments: HealthCare and Specialty. The Health Care segment, prior to the acquisition ofCobalt, was an aggregation of four operating segments: California, Central,Georgia and Senior/State-Sponsored Programs. With the acquisition of Cobalt onSeptember 24, 2003, the Health Care segment increased to five operatingsegments with the addition of the Wisconsin region. These Health Care operatingsegments all have similar characteristics and meet the following fiveaggregation criteria as defined under paragraph 17 of Statement ofFinancial Accounting Standards No. 131, “Disclosures About Segments of anEnterprise and Related Information” (“SFAS No. 131”):

 

(1)          All operating segments provide similar healthcare products to similar customer types. WellPoint generally markets the samehealth care products across the country for each of its customer groups.

 

(2)          The production processes are substantiallysimilar for all operating segments as they support similar customer groups andproducts.

 

(3)          Each operating segment has the same class ofcustomers, primarily large employer groups and individual and small employergroups.

 

(4)          Each operating segment has similardistribution channels that are used for each of the customer types. Largeemployer group products are distributed primarily through health careconsultants and brokers, while individual and small group products aredistributed through agents or through captive sales forces. These methods aresimilar across geographies.

 

(5) The health care industry is highlyregulated at both the federal and state levels. All of the geographies mustcomply with the same federal regulations. While each state’s laws are in somerespects unique, many states have similar laws and regulations applicable tomanaged care and insurance companies.

 

The Company’s focus on regional concentration allows management tounderstand and meet customer needs while effectively managing the coststructure. The Company’s chief operating decision maker (Chief ExecutiveOfficer) reviews the results of operations on a regular basis and holds eachDivision President accountable for his or her segment’s operating results.These operating segments composing the Health Care segment provide a broadspectrum of network-based health plans, including PPOs, HMOs, POS plans, otherhybrid plans and traditional indemnity plans, to large and small employers andindividuals as well as other health care-related products, such as vision,preventive care, COBRA and flexible benefits account administration. TheSpecialty business is maintained as a separate segment providing an array ofspecialty products, including pharmacy benefits management, dental, lifeinsurance, disability insurance, behavioral health, workers’ compensationinsurance products and workers’ compensation managed care services. Amountsunder the heading “Corporate and Other” include net investment income, generaland administrative expense and interest

 

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expense not allocable to the reportable segments. Also included inCorporate and Other are the operating results from the Company’s captivegeneral insurance agency and other non-core strategic businesses, which havenot met the quantitative thresholds for an operating segment under SFASNo. 131.

 

The accounting policies of the segments are consistent with generallyaccepted accounting principles in the United States. The following tablespresent segment information for the Health Care and Specialty segments for thequarters and six months ended June 30, 2004 and 2003.

 

Intersegment revenues include internal pharmaceutical sales by theCompany’s mail order pharmacy to the Health Care segment’s members, utilizationreview fees (primarily related to behavioral health services) and claims andrebate processing fees recognized by the Specialty segment for pharmacy benefitmanagement services provided to the Health Care segment. For the quarter andsix months ended June 30, 2004, pharmaceutical sales totaled$120.0 million and $232.0 million, respectively, and utilization reviewfees and claims and rebate processing fees totaled $23.7 million and $47.0million, respectively. For the quarter and six months ended June 30, 2003,pharmaceutical sales totaled $105.7 million and $198.8 million, respectively,and utilization review fees and claims and rebate processing fees totaled$21.2 million and $42.8 million, respectively. All intersegmenttransactions are eliminated in consolidation under the caption “Corporate andOther.”

 

**Quarter Ended June 30, 2004**

 
| **(In thousands)**                     | ** ** | **Health  Care** | ** ** | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|----------------------------------------|------------|------------------|------------|---------------|------------|--------------------------|------------|------------------|------------|
| Premium  revenue                       |       | $                | 5,222,405  |          | $          | 185,579                  |       | $                | —     |   | $ | 5,407,984 |   |
| Management  services and other revenue |       | 251,061          |       | 49,803        |       | 3,037                    |       | 303,901          |       |
| Total  revenue from external customers |       | 5,473,466        |       | 235,382       |       | 3,037                    |       | 5,711,885        |       |
| Intersegment  revenues                 |       | —           |       | 143,727       |       | (143,727                 | )          | —           |       |
|                                   |       |             |       |          |       |                     |       |             |       |
| Segment  net income (loss)             |       | $                | 256,472    |          | $          | 43,883                   |       | $                | (420       | ) | $ | 299,935 |   |

 

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**Quarter Ended June 30, 2003**

 
| **(In  thousands)**                    | ** ** | **Health  Care** | ** ** | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|----------------------------------------|------------|------------------|------------|---------------|------------|--------------------------|------------|------------------|------------|
| Premium  revenue                       |       | $                | 4,519,126  |          | $          | 135,728                  |       | $                | —     |   | $ | 4,654,854 |   |
| Management  services and other revenue |       | 186,551          |       | 34,253        |       | 662                      |       | 221,466          |       |
| Total  revenue from external customers |       | 4,705,677        |       | 169,981       |       | 662                      |       | 4,876,320        |       |
| Intersegment  revenues                 |       | —           |       | 126,858       |       | (126,858                 | )          | —           |       |
|                                   |       |             |       |          |       |                     |       |             |       |
| Segment  net income (loss)             |       | $                | 198,074    |          | $          | 33,312                   |       | $                | (6,917     | ) | $ | 224,469 |   |

 

**Six Months Ended June 30, 2004**

 
| **(In thousands)**                     | ** ** | **Health  Care** | ** ** | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|----------------------------------------|------------|------------------|------------|---------------|------------|--------------------------|------------|------------------|------------|
| Premium  revenue                       |       | $                | 10,295,136 |          | $          | 369,151                  |       | $                | —     |   | $ | 10,664,287 |   |
| Management  services and other revenue |       | 505,974          |       | 98,696        |       | 5,407                    |       | 610,077          |       |
| Total  revenue from external customers |       | 10,801,110       |       | 467,847       |       | 5,407                    |       | 11,274,364       |       |
| Intersegment  revenues                 |       | —           |       | 279,048       |       | (279,048                 | )          | —           |       |
|                                   |       |             |       |          |       |                     |       |             |       |
| Segment  net income                    |       | $                | 510,817    |          | $          | 78,883                   |       | $                | 5,456      |   | $ | 595,156 |   |

 

**Six Months Ended June 30, 2003**

 
| **(In thousands)**                     | ** ** | **Health  Care** | ** ** | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|----------------------------------------|------------|------------------|------------|---------------|------------|--------------------------|------------|------------------|------------|
| Premium  revenue                       |       | $                | 8,936,591  |          | $          | 266,568                  |       | $                | —     |   | $ | 9,203,159 |   |
| Management  services and other revenue |       | 375,085          |       | 71,220        |       | 1,332                    |       | 447,637          |       |
| Total  revenue from external customers |       | 9,311,676        |       | 337,788       |       | 1,332                    |       | 9,650,796        |       |
| Intersegment  revenues                 |       | —           |       | 241,525       |       | (241,525                 | )          | —           |       |
|                                   |       |             |       |          |       |                     |       |             |       |
| Segment  net income (loss)             |       | $                | 371,114    |          | $          | 65,020                   |       | $                | (18,612    | ) | $ | 417,522 |   |

 

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**14. Related Party Transactions**

 

In December 2000, the Company formed the WellPoint Foundation (the“Foundation”), a non-profit organization exempt from federal taxation underSection 501(c)(3) of the Internal Revenue Code.  The purpose of the Foundation is to improvethe health and well-being of individuals in the communities served by theCompany and its subsidiaries. The Foundation’s Board of Directors is composedsolely of persons who are also officers of the Company. No commitments andcontributions were made to the Foundation during the quarter endedJune 30, 2004. For the six months ended June 30, 2004, the Companycommitted and contributed $15.0 million to the Foundation.  For the quarter and six months endedJune 30, 2003, the Company committed and contributed $10.0 million and$20.0 million, respectively, to the Foundation. As of June 30, 2004 andDecember 31, 2003, the Company did not have any outstanding commitmentspayable to the Foundation. The Company currently has no legal obligations forany future commitments to the Foundation.

 

**15.****       Contingencies**

 

From time to time, the Company and certain of its subsidiaries areparties to various legal proceedings, many of which involve claims for coverageencountered in the ordinary course of business. The Company, like HMOs andhealth insurers generally, excludes certain health care services from coverageunder its HMO, PPO and other plans. The Company is, in its ordinary course ofbusiness, subject to the claims of its enrollees arising out of decisions torestrict treatment or reimbursement for certain services. The loss of even onesuch claim, if it results in a significant punitive damage award, could have amaterial adverse effect on the Company. In addition, the risk of potentialliability under punitive damage theories may increase significantly thedifficulty of obtaining reasonable settlements of coverage claims.

 

In May 2000, the California Medical Association filed a lawsuit inU.S. district court in San Francisco against BCC. The lawsuit alleges that BCCviolated the Racketeer Influenced and Corrupt Organizations Act (“RICO”)through various misrepresentations to and inappropriate actions against healthcare providers. In late 1999, a number of class-action lawsuits were broughtagainst several of the Company’s competitors alleging, among other things,various misrepresentations regarding their health plans and breaches offiduciary obligations to health plan members. In August 2000, the Companywas added as a party to *Shane v. Humana, et al.*,a class-action lawsuit brought on behalf of health care providers nationwide. Inaddition to the RICO claims brought in the California Medical Associationlawsuit, this lawsuit also alleges violations of ERISA, federal and state“prompt pay” regulations and certain common law claims. In October 2000,the federal Judicial Panel on Multidistrict Litigation issued an orderconsolidating the California Medical Association lawsuit, the *Shane* lawsuit and various other pending managed careclass-action lawsuits against other companies before District Court JudgeFederico Moreno in the Southern District of Florida for purposes of thepretrial proceedings. In March 2001, Judge Moreno dismissed theplaintiffs’ claims based on violation of RICO, although the dismissal was madewithout prejudice to the plaintiffs’ ability to subsequently refile theirclaims. Judge Moreno also dismissed, with prejudice, the plaintiffs’ federalprompt pay law claims. On March 26, 2001, the plaintiffs filed an amendedcomplaint

 

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in its lawsuit, alleging, among other things, revised RICO claims andviolations of California law. On May 3, 2001, the defendants filed a motion todismiss this amended complaint. On May 9, 2001, Judge Moreno issued anorder requiring that all discovery in the litigation be completed by December 2001,with the exception of discovery related to expert witnesses, which was to becompleted by March 15, 2002. In June 2001, the federal Court ofAppeals for the 11th Circuit issued a stay of Judge Moreno’s discovery order,pending a hearing before the Court of Appeals on the Company’s appeal of itsmotion to compel arbitration (which had earlier been granted in part and deniedin part by Judge Moreno). The hearing was held in January 2002 and, inMarch 2002, the Court of Appeals panel issued an opinion affirming JudgeMoreno’s earlier action with respect to the motion to compel arbitration. TheCompany filed a motion requesting a rehearing of the matter before the entire11th Circuit Court of Appeals, which motion was denied by the 11th Circuit Courtof Appeals in June 2002. On July 29, 2002, Judge Moreno issued anorder providing that discovery in the case would be allowed to re-commence onSeptember 30, 2002. On September 26, 2002, Judge Moreno issued anadditional order certifying a nationwide class of physicians in the *Shane* matter, setting a trial date in May 2003 andordering the parties to participate in non-binding mediation. InOctober 2002, the defendants, among other things, moved to compelarbitration of most claims (which motion was granted in part inSeptember 2003). In October 2002, the Company also filed a motionwith the 11th Circuit Court of Appeals seeking to appeal Judge Moreno’sclass-certification order. The motion was granted. The 11th Circuit heard oralargument on September 11, 2003 on the Company’s appeal. A mediator hasbeen appointed by Judge Moreno and the parties are currently conductingcourt-ordered mediation. On April 30, 2004, Judge Moreno set a newtrial date in March 2005 and extended the deadline for expert discovery toSeptember 29, 2004, which may be further extended.

 

In March 2002, the American Dental Association and threeindividual dentists filed a lawsuit in U.S. district court in Chicago againstthe Company and BCC. This lawsuit alleges that WellPoint and BCC engaged inconduct that constituted a breach of contract under ERISA, trade libel andtortious interference with contractual relations and existing and prospectivebusiness expectancies. The lawsuit seeks class-action status. The Company fileda motion (which was granted in July 2002) with the federal Judicial Panelon Multidistrict Litigation requesting that the proceedings in this case beconsolidated with a similar action brought against other managed care companiesthat has been consolidated with the *Shane* lawsuit.The case is currently stayed.

 

In May 2003, a lawsuit entitled *Thomas, etal. v. Blue Cross and Blue Shield Association, et al*. was filed inthe U.S. District Court in the Southern District of Florida. The attorneysrepresenting the plaintiffs in the lawsuit are primarily the attorneysrepresenting the plaintiffs in the *Shane*litigation described above. The defendants in *Thomas*are the Company’s Blue Cross and Blue Shield-licensed subsidiaries, the BCBSAand all of the other current Blue Cross and Blue Shield licensees. The lawsuitalleges that each of the defendants engaged in similar activities and conductas that alleged in the *Shane*litigation. The case has been assigned to Judge Moreno. The defendants havemoved to compel arbitration and to dismiss the complaint. Class-certificationdiscovery has been initiated and is on-going. The deadline forclass-certification discovery is December 31, 2004.

 

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On March 26, 2003, a lawsuit entitled *Irwin v.AdvancePCS, et al*. was filed in the California Superior Court inAlameda County, California. WellPoint and certain of its wholly ownedsubsidiaries are named as defendants in the lawsuit. The complaint alleges thatthe defendants violated California Business and Professions CodeSection 17200 by engaging in unfair, fraudulent and unlawful businesspractices. The complaint alleges, among other things, that pharmacy benefitmanagement companies (such as the Company’s subsidiary that does business underthe tradename WellPoint Pharmacy Management) engage in unfair practices such asnegotiating discounts in prices of drugs from pharmacies and negotiatingrebates from drug manufacturers and retaining such discounts and rebates fortheir own benefit. The complaint also alleges that drugs are included informularies in exchange for rebates and that the defendants charge patientco-payments that exceed the actual cost of generic drugs.

 

In early 2003, a lawsuit entitled *Knecht v. Cigna, et al.*was filed in U.S. District Court in Oregon. This litigation has subsequentlybeen transferred to Judge Moreno of the U.S. District Court for the SouthernDistrict of Florida. This litigation is a putative class action lawsuit onbehalf of chiropractors in the western United States. The Company is a nameddefendant in the lawsuit. The lawsuit alleges that each of the defendantsengaged in similar activities and conduct as that alleged in the *Shane* litigation. The case is currently stayed.

 

In October 2003, a lawsuit entitled *Solomon, etal. v. Cigna, et al.* was filed in the U.S. District Court in theSouthern District in Florida. The Company is a named defendant in this lawsuit.This lawsuit is also a putative class action brought on behalf ofchiropractors, podiatrists and certain other types of health care practitionersnationwide. This lawsuit also alleges that the defendants engaged in similaractivities and conduct as that alleged in the *Shane*litigation. On December 15, 2003, this lawsuit was transferred to JudgeMoreno, and the case was consolidated with the *Knecht*lawsuit for pre-trial purposes. Both of these cases are currently stayed. InDecember 2003, the plaintiffs in *Solomon, et al. v. Cigna,et al.* filed a similar lawsuit against the Company, the Company’sBlue Cross and Blue Shield-licensed subsidiaries, the BCBSA and all of theother current Blue Cross and Blue Shield licensees. The lawsuit is entitled *Solomon, et al. v. Blue Cross and Blue Shield Association, et al.*and was filed in the U.S. District Court in the Southern District in Florida.On January 7, 2004, this lawsuit was transferred to Judge Moreno.  On March 9, 2004, Judge Moreno issued anorder restoring this case to the active docket and placing it on a coordinatedtrack with the *Thomas* lawsuit.

 

The financial and operational impact that these and other evolvingtheories of recovery will have on the managed care industry generally, or theCompany in particular, is at present unknown.

 

Prior to the Company’s acquisition of the GBO, John Hancock Mutual LifeInsurance Company (“John Hancock”) entered into a number of reinsurancearrangements with respect to personal accident insurance and the occupationalaccident component of workers’ compensation insurance, a portion of which wasoriginated through a pool managed by Unicover Managers, Inc. Under thesearrangements, John Hancock assumed risks as a

 

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reinsurer and transferred certain of such risks to other companies.These arrangements have become the subject of disputes, including a number oflegal proceedings to which John Hancock is a party. The Company is currently inarbitration with John Hancock regarding these arrangements. The Companybelieves that it has a number of defenses to avoid any ultimate liability withrespect to these matters and believes that such liabilities were nottransferred to the Company as part of the GBO acquisition. However, if theCompany were to become subject to such liabilities, the Company could sufferlosses that might have a material adverse effect on its financial condition,results of operations or cash flows.

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors. The lawsuit, which is entitled *Abrams v.WellPoint Health Networks Inc., et al.*, alleges that theCompany’s directors breached their fiduciary duties to stockholders byapproving an Agreement and Plan of Merger with Anthem while in possession ofnon-public information regarding the Company’s financial results for the thirdquarter of 2003. The lawsuit seeks to enjoin the Company from consummating themerger with Anthem, unless the Company adopts and implements a process forobtaining the highest possible price for stockholders, and to rescind any termsof the Agreement and Plan of Merger that have already been implemented.  On May 7, 2004, WellPoint and the plaintiffsigned a memorandum of understanding regarding a potential settlement of theaction.  The potential settlementcontemplated by the memorandum of understanding involves WellPoint agreeing toprovide certain additional disclosures on several matters in the joint proxystatement/prospectus sent to WellPoint’s stockholders beyond those contained inthe preliminary proxy statement/prospectus. The settlement would also provide for the payment by WellPoint of $2.25million to the plaintiff’s counsel for fees and costs (subject to courtapproval).  No part of the settlementcosts will be paid by the WellPoint directors individually.  The settlement would not involve anyadmissions of breaches of fiduciary duty or other wrongdoing by WellPoint orany of its directors.  The settlement andpayment of the plaintiff’s counsel fees would be conditioned upon, among otherthings, completion of the merger.  Anyfinal settlement agreement signed by the parties must be approved by theSuperior Court judge assigned to the matter. While WellPoint expects to diligently negotiate the terms of a finalsettlement agreement, there can be no assurances that a settlement agreementwill be signed.

 

Certain of such legal proceedings are or may be covered under insurancepolicies or indemnification agreements. Based upon information presentlyavailable, the Company believes that the final outcome of all such proceedingsshould not have a material adverse effect on the Company’s results ofoperations, cash flows or financial condition.

 

The Company and its subsidiaries are party to a variety of agreementsentered into in the ordinary course of business that contain standard indemnityprovisions obligating the Company or such subsidiary to indemnify third partiesfor certain costs and expenses incurred by such parties in connection with suchagreements. These agreements include, for example, vendor contracts,underwriting and loan agreements, consulting agreements and agreements forother services, such as custodial arrangements with respect to certain of theCompany’s assets. The maximum amount of potential future payments pursuant tothese standard

 

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indemnity provisions cannot be estimated because the amount of costsand expenses that may be incurred by the indemnified parties is unknown.

 

In connection with the formation in 2000 of a joint venture providingMedicaid services in Puerto Rico, the Company agreed under certaincircumstances to provide additional funds to the joint-venture entity. TheCompany agreed that it would make a capital contribution to the joint ventureof up to 80% of any amount necessary to increase the entity’s capital to meetminimum regulatory capital requirements if (i) applicable law orregulation requires an increase in the entity’s capital and the entity does notthen have capital sufficient to meet the increased requirement or (ii) theentity’s medical care ratio is 100% or greater during any 180-day period andthe entity does not then meet statutory capital requirements under the PuertoRico Insurance Code. The amount of this guarantee will not exceed 80% of theamount necessary to provide the entity with a 12 to 1 premium-to-capital ratio.As of June 30, 2004, the Company’s maximum potential liability pursuant to thisguarantee was $26.9 million. Since the formation of the joint venture in 2000,the Company has not been required to make any payments under this guarantee andthe Company does not currently expect that any such payments will be made.

 

As partial consideration for the Company’s acquisition of Health Core(see Note 6), the Company agreed to make contingent payments of up to $5.5million based on Health Core achieving certain financial performance targetsduring 2005, 2006 and 2007.

 

On June 9, 2004, the Company agreed to pay up to $2 million per yearfor up to four years to a laboratory service provider if certain of theCompany’s subsidiaries enter into contracts to obtain services from suchprovider and the volume of laboratory service expenditures under thosecontracts for the years 2005, 2006, 2007 and 2008 do not exceed specifiedtargets.

 

In connection with an investment in July 2004 in a joint venture todevelop and operate a well-being center in California, the Company may berequired to make an additional capital contribution of up to $18 million duringthe first three years that the well-being center is in operation if cash flowsand occupancy rates do not exceed specified targets.  It is currently anticipated that constructionof the California well-being center will be completed in December 2005.

 

On July 15, 2004, the Company agreed to guarantee up to $37 million ofdebt incurred by an unaffiliated entity to partially finance the purchase of ahospital.  The maximum amount of theguaranty may be reduced after September 30, 2006 as determined by reference tothe leverage ratio (as defined in the guaranty) of the unaffiliatedentity.  The guaranty also provides forfull payment of all obligations under the guaranty to become immediately dueand payable under specified circumstances, including (i) upon the failure bythe unaffiliated entity or the Company to cure any payment default under thesubject loan to the unaffiliated entity within 10 days after written notice tothe unaffiliated entity and the Company and (ii) upon 10 days after writtennotice to the Company that the unaffiliated entity has become subject to abankruptcy or insolvency proceeding.  Inconnection with the guaranty, the unaffiliated entity and the Company enteredinto a reimbursement agreement pursuant to which the unaffiliated entity agreedto reimburse the Company upon demand for any amounts paid by the Company underthe guaranty.  The obligations of theunaffiliated entity under the reimbursement agreement are secured by a secondlien on certain real estate collateral. In addition, the parent company of the unaffiliated entity has provideda guaranty in favor of the Company guaranteeing the obligations of theunaffiliated entity under the reimbursement agreement.

 

**16. Pending Merger With Anthem**

 

On October 26, 2003, WellPoint entered into a merger agreementwith Anthem, Inc. (“Anthem”). The consideration to be received by thestockholders of WellPoint will be composed of $23.80 in cash and one share ofAnthem common stock per share of WellPoint Common Stock. Based on the closingprice of Anthem’s common stock on October 24, 2003, the transaction wasvalued at approximately $16.4 billion. Upon completion of thistransaction, WellPoint will merge into a wholly owned subsidiary of Anthem andAnthem will change its name to WellPoint, Inc. Anthem, a publicly tradedcompany, is an independent licensee of the Blue Cross and Blue ShieldAssociation and holds the exclusive right to use the Blue Cross

 

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and Blue Shield names and marks in the states of Indiana, Kentucky,Ohio, Connecticut, New Hampshire, Colorado, Nevada, Maine and Virginia,excluding the immediate suburbs of Washington D.C. As of June 30, 2004,Anthem provided health care benefits to more than 12.6 million medicalmembers, which includes BlueCard “host” members. Headquartered in Indianapolis,Indiana, Anthem, along with its subsidiaries, offers a diverse portfolio ofcomplementary health and group life insurance, managed care products, pharmacybenefit management and government health program administration. The transactionis subject to customary closing conditions, including, among other things,approval of WellPoint’s and Anthem’s shareholders and various regulatoryagencies. At separate meetings held on June 28, 2004, the Company’s andAnthem’s stockholders approved the transaction. On July 23, 2004, the California Department of Insurance (the“DOI”) announced that it was disapproving Anthem’s application (known as a“Form A”) to acquire control of the Company’s subsidiary, BC Life & HealthInsurance Company, in connection with the transaction.  The DOI’s approval was the final regulatoryapproval necessary to complete the merger. On August 3, 2004, Anthem filed a petition for writ of mandate inthe Superior Court of Los Angeles County, California, challenging the DOI’sdenial and asking the court to overturn the DOI’s decision.  There can be no assurances regarding theoutcome of this lawsuit. It is not currently known when the transaction willclose or if the parties will obtain all approvals necessary to complete themerger.

 

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Report ofIndependent Registered Public Accounting Firm

 

Tothe Stockholders and Board of Directors of

WellPointHealth Networks Inc.

 

We have reviewed the accompanying consolidated balancesheet of WellPoint Health Networks Inc. and its subsidiaries as ofJune 30, 2004, and the related consolidated income statements for each ofthe three-month and six-month periods ended June 30, 2004 and 2003, andthe related consolidated statement of changes in stockholders’ equity for thesix-month period ended June 30, 2004 and the consolidated statements ofcash flows for the six-month periods ended June 30, 2004 and 2003.  These interim financial statements are theresponsibility of the Company’s management.

 

We conducted our review in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  A review of interim financialinformation consists principally of applying analytical procedures and makinginquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than anaudit conducted in accordance with the standards of the Public CompanyAccounting Oversight Board, the objective of which is the expression of anopinion regarding the financial statements taken as a whole.  Accordingly, we do not express such anopinion.

 

Based on our review, we are not aware of anymaterial modifications that should be made to the accompanying consolidatedinterim financial statements for them to be in conformity with accountingprinciples generally accepted in the United States of America.

 

We previously audited in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheet as of December 31, 2003, and the relatedconsolidated income statement and consolidated changes in stockholders’ equity,and of cash flows for the year then ended (not presented herein), and in ourreport dated January 27, 2004 we expressed an unqualified opinion on thoseconsolidated financial statements.  Our report included an explanatory paragraph,that effective January 1, 2002, the Company adopted Statement of FinancialAccounting Standards No. 142, *Goodwill andOther Intangible Assets*. Accordingly, the Company ceased amortizing goodwill and indefinite-livedintangible assets as of January 1, 2002. Additionally, effective January 1, 2003, the Company adoptedStatement of Financial Accounting Standards No. 145, *Rescissionof FASB No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections. *Accordingly,the Company reclassified an extraordinary loss related to the extinguishment ofdebt to interest expense for the year ended December 31, 2002.  In our opinion, the informationset forth in the accompanying consolidated balance sheet information as ofDecember 31, 2003 is fairly stated in all material respects in relation tothe consolidated balance sheet from which it has been derived.

 

 
| /s/  PricewaterhouseCoopers LLP                                                 |   |
|---------------------------------------------------------------------------------|--------|
|                                                                            |
| PricewaterhouseCoopers LLP                                                      |
| Los  Angeles, California                                                        |
| July 23, 2004, except Note 16 as to which the  date is August 3, 2004 |

 

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ITEM 2.                             Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

This discussion contains forward-looking statements, which involverisks and uncertainties.  The Company’sactual results may differ materially from those anticipated in theseforward-looking statements as a result of certain factors including, but notlimited to, those set forth under “Factors That May Affect Future Results ofOperations.”

 

***General***

 

The Company is one of the nation’s largest publicly traded managedhealth care companies. As of June 30, 2004, WellPoint had approximately15.5 million medical members (including approximately 1.3 millionBlueCard “host” members) and approximately 46.2 million specialty members.Through its subsidiaries, the Company offers a broad spectrum of network-basedmanaged care plans to the large and small employer, individual, Medicaid andsenior markets. The Company’s managed care plans include PPOs, HMOs, POS plans,other hybrid plans and traditional indemnity plans. In addition, the Companyoffers managed care services, including underwriting, actuarial services,network access, medical management and claims processing. The Company alsoprovides a broad array of specialty and other products and services, includingpharmacy benefits management, dental, vision, life insurance, preventive care,disability insurance, behavioral health, COBRA and flexible benefits accountadministration. With its recent acquisition of Cobalt Corporation (“Cobalt”),the Company now also offers workers’ compensation insurance products and iscurrently the largest Medicare Part A fiscal intermediary in the nation,processing claims for providers in all 50 states. The Company markets itsproducts in California primarily under the name Blue Cross of California, inGeorgia primarily under the name Blue Cross Blue Shield of Georgia, in most partsof Missouri (except Kansas City and surrounding counties) primarily under thename Blue Cross Blue Shield of Missouri, in Wisconsin primarily under the namesBlue Cross Blue Shield of Wisconsin and CompcareBlue and in various parts ofthe country under the names UNICARE and HealthLink.

 

*Acquisition of Cobalt*

 

On September 24, 2003, the Company completed its acquisition ofCobalt (see Note 6 to the Consolidated Financial Statements). At closing,the acquisition was valued at approximately $884.9 million, which was paidwith $439.6 million in cash and approximately 7.3 million shares ofWellPoint Common Stock, of which approximately 2.1 million shares wereissued to affiliates of WellPoint. As of September 30, 2003, Cobalt servedapproximately 675,000 medical members and offered a diverse portfolio ofcomplementary insurance, managed care products and administrative services toemployer, individual, insurer and government customers. The Cobalt merger waseffective as of September 30, 2003 for accounting purposes.

 

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*Acquisition of Golden West*

 

On June 30, 2003, the Company completed its acquisition of GoldenWest (see Note 6 to the Consolidated Financial Statements), which servedover 275,000 dental and vision members, primarily in California, at the time ofacquisition.

 

*Pending Merger With Anthem*

 

On October 26, 2003, WellPoint enteredinto a merger agreement with Anthem, Inc. (“Anthem”). The consideration tobe received by the stockholders of WellPoint will be composed of $23.80 in cashand one share of Anthem common stock per share of WellPoint Common Stock. Basedon the closing price of Anthem’s common stock on October 24, 2003, thetransaction was valued at approximately $16.4 billion. Upon completion ofthis transaction, WellPoint will merge into a wholly owned subsidiary of Anthemand Anthem will change its name to WellPoint, Inc. Anthem, a publiclytraded company, is an independent licensee of the Blue Cross and Blue ShieldAssociation and holds the exclusive right to use the Blue Cross and Blue Shieldnames and marks in the states of Indiana, Kentucky, Ohio, Connecticut, NewHampshire, Colorado, Nevada, Maine and Virginia, excluding the immediatesuburbs of Washington D.C. As of June 30, 2004, Anthem provided healthcare benefits to more than 12.6 million medical members, which includesBlueCard “host” members. Headquartered in Indianapolis, Indiana, Anthem, alongwith its subsidiaries, offers a diverse portfolio of complementary health andgroup life insurance, managed care products, pharmacy benefit management andgovernment health program administration.

 

The transaction is subject to customaryclosing conditions, including, among other things, approval of WellPoint’s andAnthem’s shareholders, various regulatory agencies and the Blue Cross and BlueShield Association.

 

In connection with obtaining the approval ofWellPoint’s and Anthem’s stockholders for the proposed merger, Anthem filed afinal registration statement, including a definitive joint proxystatement/prospectus constituting a part thereof on May 11, 2004. Atseparate meetings held on June 28, 2004, the Company’s and Anthem’sstockholders approved the transaction.

 

WellPoint and Anthem have made appropriate filingsand applications with insurance and HMO regulators in California, Delaware,Georgia, Illinois, Missouri, Oklahoma, Puerto Rico, Texas, Virginia, WestVirginia and Wisconsin. Pursuant to applicable insurance and HMO laws andregulations, and before the merger may be consummated, the insurancecommissioner and, where applicable, HMO regulator, must review and approve theacquisition of control of the insurance company or HMO subsidiary domiciled inits respective jurisdiction. In addition to the filings with and approvals fromthe domiciliary insurance and HMO regulators, pre-acquisition notifications ofthe merger under state insurance antitrust laws and regulations will berequired in certain states in which insurance company or HMO subsidiaries ofboth WellPoint and Anthem operate. On July 23,2004, the California Department of Insurance (the “DOI”) announced that it wasdisapproving Anthem’s application (known as a “Form A”) to acquire control ofthe Company’s subsidiary, BC Life & Health Insurance Company, in connectionwith the transaction.  The DOI’s approvalwas the final regulatory approval necessary to complete the merger.  On August 3, 2004, Anthem filed a

 

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petitionfor writ of mandate in the Superior Court of Los Angeles County, California,challenging the DOI’s denial and asking the court to overturn the DOI’sdecision.  There can be no assurancesregarding the outcome of this lawsuit.

 

The Blue Cross and Blue Shield Associationmust approve the transfer to Anthem of WellPoint’s licenses to use the BlueCross and Blue Shield names and marks in WellPoint’s geographical territories.Anthem and WellPoint have submitted a joint application requesting that, inconnection with the completion of the merger, the Blue Cross and Blue ShieldAssociation grant to Anthem the licenses for the WellPoint service area. TheBlue Cross and Blue Shield Association unanimously approved this application onMarch 18, 2004.

 

The Hart-Scott-Rodino Antitrust ImprovementsAct of 1976, as amended, and the rules and regulations thereunder provide thatthe merger may not be completed until pre-merger notification filings have beenmade with the Federal Trade Commission, and the Antitrust Division of the U.S.Department of Justice, and the specified waiting period thereunder has expiredor is terminated. Even after the waiting period expires or is terminated, theDepartment of Justice and the Federal Trade Commission will have the authorityto challenge the merger on antitrust grounds before or after the merger iscompleted. Each of Anthem and WellPoint filed a notification and report formfor the merger with the Federal Trade Commission and the Department of Justicein January 2004 and the waiting period expired on February 26, 2004.

 

Following the merger, WellPoint stockholderswill become shareholders of Anthem. In addition, in the merger agreement, amongother things, WellPoint has agreed that Anthem will have its corporateheadquarters and principal executive offices in Indianapolis, Indiana and thatAnthem’s name will be changed to WellPoint, Inc. WellPoint and Anthem havealso agreed to file an application to have the common stock of Anthem listed onthe New York Stock Exchange under the ticker symbol “WLP.”

 

After the merger, the board of directors of Anthemwill have 19 members, consisting of 11 current members of Anthem’s board ofdirectors designated by Anthem (including Larry C. Glasscock) and eight currentmembers of WellPoint’s board of directors designated by WellPoint (includingLeonard D. Schaeffer). Also after the merger, Leonard D. Schaeffer of WellPointwill be Chairman of the Board of Directors of Anthem and Larry C. Glasscock ofAnthem will be the President and Chief Executive Officer and a director ofAnthem. By the second anniversary of the completion of the merger, Leonard D.Schaeffer will retire as Chairman and as a director of Anthem and Larry C.Glasscock will succeed him as Chairman.

 

Either WellPoint or Anthem may terminate themerger agreement, even after the requisite shareholder approvals have beenreceived, if the merger has not been completed by November 30, 2004, andeither of them may also terminate the merger agreement in certain othercircumstances specified in the merger agreement. It is not currently known whenthe transation will close or if the parties will obtain all approvals necessaryto complete the merger.

 

*CareFirst Merger Agreement*

 

In November 2001, WellPoint entered intoa merger agreement with CareFirst, Inc. (“CareFirst”), which agreement wasamended in January 2003. CareFirst has the exclusive right to use the BlueCross and Blue Shield names and marks in Maryland, Delaware, the District ofColumbia and certain counties in Northern Virginia. Under the amended mergeragreement, CareFirst would have become a subsidiary of WellPoint. Theconsummation of the

 

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CareFirst transaction was subject to a numberof conditions, including the approval of the insurance regulators in Maryland,Delaware and the District of Columbia for the conversion of CareFirst from anon-profit corporation to a for-profit entity. On March 5, 2003, theMaryland insurance commissioner issued an order disapproving this conversion.In August 2003, the Company received a notice from CareFirst electing toterminate the amended merger agreement in accordance with its terms.

 

In August 2003, the Company received aGrand Jury subpoena from the United States Attorney’s office in the District ofMaryland requesting various documents relating to the CareFirst transaction.The Company has responded to the request and intends to cooperate fully withthe United States Attorney’s office. The Company has no reason to believe it isa target of the proceedings.

 

*National Expansion and Other Recent Developments*

 

In an effort to pursue the expansion of the Company’s business outsidethe state of California, the Company acquired two businesses in 1996 and 1997,the Life and Health Benefits Management Division of Massachusetts Mutual LifeInsurance Company and the Group Benefits Operations (the “GBO”) of John HancockMutual Life Insurance Company. The acquisitions of Rush Prudential Health Plansand a mail-order pharmacy, which now does business as PrecisionRx, in 2000, theacquisition of Cerulean Companies, Inc. in 2001, the acquisitions ofRightCHOICE and MethodistCare in 2002 and the acquisition of Cobalt in 2003were also components of this expansion strategy.

 

As a result of these acquisitions, the Company has significantlyexpanded its operations outside of California. In order to integrate itsacquired businesses and implement its regional expansion strategy, the Companywill need to develop satisfactory networks of hospitals, physicians and otherhealth care service providers, develop distribution channels for its productsand successfully convert acquired books of business to the Company’s existinginformation systems, which will require continued investments by the Company.

 

In response to rising medical and pharmacy costs, the Company has fromtime to time implemented premium increases with respect to certain of itsproducts. The Company will continue to evaluate the need for further premiumincreases, plan design changes and other appropriate actions in the future inorder to maintain or restore profit margins. There can be no assurances,however, that the Company will be able to take subsequent pricing or otheractions or that any actions previously taken or implemented in the future willbe successful in addressing any concerns that may arise with respect to theperformance of certain businesses.

 

## *Legislation*

##  

Federal legislation enacted during the last several years seeks, amongother things, to ensure the portability of health coverage and mandates minimummaternity hospital stays. California legislation enacted since 1999, amongother things, establishes an explicit duty on managed care entities to exerciseordinary care in arranging for the provision of medically necessary health careservices and establishes a system of independent medical review. In 1997, Texasadopted legislation purporting to make managed care organizations such as theCompany liable for their failure to exercise ordinary care when making healthcare treatment decisions.

 

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Similar legislation has also been enacted in Georgia. These and otherproposed measures may have the effect of dramatically altering the regulationof health care and of increasing the Company’s medical care ratio andadministrative costs or decreasing the affordability of the Company’s products.

 

***Consolidated Results of Operations***

 

The Company’s revenues are primarily generated from premiums earned forrisk-based health care and specialty services provided to its members; fees foradministrative services, including claims processing and access to providernetworks for self-insured employers; and investment income. Operating expensesinclude health care services and other benefits expenses, consisting primarilyof payments for physicians, hospitals and other providers for health care andspecialty products claims; selling expenses for broker and agent commissions;general and administrative expenses; interest expense; depreciation andamortization expense; and income taxes.

 

The Company’s consolidated results of operations for the quarter endedJune 30, 2004 include its acquired operations of Cobalt for the entirethree months, while operating results for the quarter ended June 30, 2003do not include any acquired operations of Cobalt. On September 24, 2003,the Company completed its acquisition of Cobalt. The Cobalt merger waseffective as of September 30, 2003 for accounting purposes.

 

The following table sets forth selected operating ratios.  The medical care ratio for health careservices and other benefits is shown as a percentage of premium revenue.  All other ratios are shown as a percentage ofpremium revenue and management services and other revenue combined.

 
| ** **                                                    | ** ** | **Quarter  Ended  June 30,** | ** ** | **Six  Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                          | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Operating  Revenues:                                          |       |                              |       |                                 |       |   |   |   |   |
| Premium  revenue                                              |       | 94.7                              | %          | 95.5                                 | %          | 94.6 | % | 95.4 | % |
| Management  services and other revenue                        |       | 5.3                               | %          | 4.5                                  | %          | 5.4 | % | 4.6 | % |
|                                                          |       | 100.0                             | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Operating  Expenses:                                          |       |                              |       |                                 |       |   |   |   |   |
| Health  care services and other benefits (medical care ratio) |       | 80.7                              | %          | 81.0                                 | %          | 80.2 | % | 81.4 | % |
| Selling  expense                                              |       | 3.9                               | %          | 4.1                                  | %          | 3.9 | % | 4.1 | % |
| General  and administrative expense                           |       | 11.7                              | %          | 11.9                                 | %          | 12.4 | % | 12.1 | % |

 

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***Membership***

 

The following table sets forth membership data and the percent changein membership:

 

***Medical Membership (a)(b)(c)(d)***

 
| ** **                                                    | ** ** | **June 30,** | ** ** | **Percent**    | ** ** |
|---------------------------------------------------------------|------------|-------------------|------------|----------------|------------|
| ** **                                                    | ** ** | **2004**          | ** ** | **2003 (e)**   | ** ** | **Change** | ** ** |
| **California**                                                |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 4,785,737         |       | 4,788,890      |       | -0.1 | % |
| Individual  and Small Group                                   |       | 1,658,805         |       | 1,626,412      |       | 2.0 | % |
| Senior                                                        |       | 244,132           |       | 248,127        |       | -1.6 | % |
| Total  California                                             |       | 6,688,674         |       | 6,663,429      |       | 0.4 | % |
| **Georgia**                                                   |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 1,658,383         |       | 1,642,594      |       | 1.0 | % |
| Individual  and Small Group                                   |       | 520,578           |       | 466,909        |       | 11.5 | % |
| Senior                                                        |       | 55,220            |       | 69,154         |       | -20.1 | % |
| Total  Georgia                                                |       | 2,234,181         |       | 2,178,657      |       | 2.5 | % |
|                                                          |       |              |       |           |       |   |   |
| **Central Region (f)**                                        |       |              |       |           |       |   |   |
| **Missouri**                                                  |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 1,177,699         |       | 1,259,211      |       | -6.5 | % |
| Individual  and Small Group                                   |       | 242,395           |       | 240,480        |       | 0.8 | % |
| Senior                                                        |       | 40,370            |       | 41,239         |       | -2.1 | % |
| Total  Missouri                                               |       | 1,460,464         |       | 1,540,930      |       | -5.2 | % |
| **Illinois**                                                  |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 575,904           |       | 596,577        |       | -3.5 | % |
| Individual  and Small Group                                   |       | 134,261           |       | 115,330        |       | 16.4 | % |
| Senior                                                        |       | 13,162            |       | 12,401         |       | 6.1 | % |
| Total  Illinois                                               |       | 723,327           |       | 724,308        |       | -0.1 | % |
| **Texas**                                                     |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 266,537           |       | 287,875        |       | -7.4 | % |
| Individual  and Small Group                                   |       | 210,503           |       | 194,829        |       | 8.0 | % |
| Senior                                                        |       | 9,288             |       | 2,710          |       | N/A |   |
| Total  Texas                                                  |       | 486,328           |       | 485,414        |       | 0.2 | % |
| **Other States**                                              |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 1,894,992         |       | 1,632,267      |       | 16.1 | % |
| Individual  and Small Group                                   |       | 107,156           |       | 100,653        |       | 6.5 | % |
| Senior                                                        |       | 34,638            |       | 26,056         |       | 32.9 | % |
| Total  Other States                                           |       | 2,036,786         |       | 1,758,976      |       | 15.8 | % |
| **Wisconsin**                                                 |       |              |       |           |       |   |   |
| Large  Group                                                  |       | 409,412           |       | 24,998         |       | N/A |   |
| Individual  and Small Group                                   |       | 106,612           |       | 925            |       | N/A |   |
| Senior                                                        |       | 53,035            |       | 161            |       | N/A |   |
| Total  Wisconsin                                              |       | 569,059           |       | 26,084         |       | N/A |   |
| **Total Medical Members Excluding BlueCard Host Members (g)** | ** ** | **14,198,819**    | ** ** | **13,377,798** |       | 6.1 | % |
| **Total BlueCard Host Members (h)**                           |       | 1,269,000         |       | 743,897        |       | 70.6 | % |
| **Total Medical Members**                                     | ** ** | **15,467,819**    | ** ** | **14,121,695** |       | 9.5 | % |

 

37

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| ** **                | ** ** | **June 30,** | ** ** | **Percent**   | ** ** |
|---------------------------|------------|-------------------|------------|---------------|------------|
| ** **                | ** ** | **2004**          | ** ** | **2003  (e)** | ** ** | **Change** | ** ** |
| ***ASO Membership (i)***  | ** ** | ** **        | ** ** | ** **    | ** ** | ** ** | ** ** |
| California                |       | 1,621,626         |       | 1,581,804     |       | 2.5 | % |
| Georgia                   |       | 867,091           |       | 860,378       |       | 0.8 | % |
| Central  Region (f)       |       | 2,785,785         |       | 2,623,083     |       | 6.2 | % |
| Wisconsin                 |       | 181,635           |       | 17,073        |       | N/A |   |
| BlueCard  Host Members    |       | 1,269,000         |       | 743,897       |       | 70.6 | % |
| Total  ASO Membership     |       | 6,725,137         |       | 5,826,235     |       | 15.4 | % |
|                      |       |              |       |          |       |   |   |
| ***Risk Membership***     |       |              |       |          |       |   |   |
| California                |       | 5,067,048         |       | 5,081,625     |       | -0.3 | % |
| Georgia                   |       | 1,367,090         |       | 1,318,279     |       | 3.7 | % |
| Central  Region           |       | 1,921,120         |       | 1,886,545     |       | 1.8 | % |
| Wisconsin                 |       | 387,424           |       | 9,011         |       | N/A |   |
| Total  Risk Membership    |       | 8,742,682         |       | 8,295,460     |       | 5.4 | % |
| Total  Medical Membership |       | 15,467,819        |       | 14,121,695    |       | 9.5 | % |

 

***State-Sponsored Programs (j)***

 
| ** **          | ** ** | **June 30,** | ** ** | **Percent** | ** ** |
|---------------------|------------|-------------------|------------|-------------|------------|
| ** **          | ** ** | **2004**          | ** ** | **2003**    | ** ** | **Change** | ** ** |
| Medi-Cal/Medicaid   |       |              |       |        |       |   |   |
| California          |       | 837,210           |       | 836,788     |       | 0.1 | % |
| Virginia            |       | 53,355            |       | 44,187      |       | 20.7 | % |
| Puerto  Rico        |       | 255,424           |       | 269,918     |       | -5.4 | % |
| Other               |       | 60,616            |       | 98,008      |       | -38.2 | % |
| Total               |       | 1,206,605         |       | 1,248,901   |       | -3.4 | % |
| Healthy  Families   |       | 267,443           |       | 271,316     |       | -1.4 | % |
| MRMIP  / AIM / IHRP |       | 14,237            |       | 18,396      |       | -22.6 | % |
| California  Kids    |       | 11,880            |       | 20,122      |       | -41.0 | % |
| Total               |       | 1,500,165         |       | 1,558,735   |       | -3.8 | % |

 

----

(a)          Membership numbers are approximate andinclude some estimates based upon the number of contracts at the relevant dateand an actuarial estimate of the number of members represented by the contract.

(b)         Classification between states for employergroups is determined by the zip code of the subscriber.

(c)          Medical membership includes managementservices and network services members, which are primarily included in LargeGroup for each state.

(d)         Senior membership includes members coveredunder both Medicare risk and Medicare supplement products.

(e)          Membership numbers as of June 30, 2003have been reclassified to reflect the zip code of the subscriber ofHealthLink’s commercial insurer accounts. These members were previouslyincluded in the commercial insurers’ state of domicile. As of June 30,2003, Missouri and Illinois members would have been higher by 14,079 and25,631, respectively, while Georgia, Texas and Other States would have beenlower by 514, 5,870 and 33,326, respectively.

(f)            Central Region - Large Group membershipincludes network access services members, primarily from HealthLink, of1,286,972 and 1,385,823 as of June 30, 2004 and June 30, 2003,respectively. As of December 31, 2003, the Company revised its methodologyof calculating the number of medical members represented by each subscribercontract within the Company’s rental networks and a Missouri joint venture. Theweighted average factor changed from approximately 2.4 members to 2.1 membersper subscriber. The impact of this change as of each quarter end during theyear ended December 31, 2003 is to reduce membership as follows:

 

| **As of**               | ** ** | **Illinois** | ** ** | **Missouri** | ** ** | **Other  States** | ** ** | **Total** | ** ** |
|-------------------------|------------|--------------|------------|--------------|------------|-------------------|------------|-----------|------------|
|                    |       |         |       |         |       |              |       |      |       |
| March 31, 2003     |       | 35,999       |       | 111,008      |       | 15,314            |       | 162,321   |       |
| June 30, 2003      |       | 35,083       |       | 108,097      |       | 14,925            |       | 158,105   |       |
| September 30, 2003 |       | 34,990       |       | 104,614      |       | 14,885            |       | 154,489   |       |
| December 31, 2003  |       | 34,377       |       | 103,013      |       | 14,624            |       | 152,014   |       |

 

Membership data as of June 30, 2003 shown in the MedicalMembership table have not been revised to reflect this change in methodology.

 

(g)         Total medical members as of June 30, 2004include 662,705 medical members from the Cobalt acquisition.

 

38

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(h)         The Company has revised its medical membershipcounting methodology to include estimated “host” members using the nationalBlueCard program. Host members are generally members who reside in a state inwhich a WellPoint subsidiary is the Blue Cross and/or Blue Shield licensee andwho are covered under an employer-sponsored health plan issued by anon-WellPoint controlled Blue Cross and/or Blue Shield licensee. Host membersare computed using, among other things, an estimate of the average number ofBlueCard claims received per member per month. Total BlueCard host members asof each quarter end during the year ended December 31, 2003 were asfollows:

 

| **As of**               | ** ** | **BlueCard  Host********Members** | ** ** |
|-------------------------|------------|-----------------------------------|------------|
|                    |       |                              |       |
| March 31, 2003     |       | 748,490                           |       |
| June 30, 2003      |       | 743,897                           |       |
| September 30, 2003 |       | 1,009,900                         |       |
| December 31, 2003  |       | 1,002,113                         |       |

 

Membership data shown in the Medical Membership table reflect thischange in methodology.

 

(i)             ASO Membership represents members forwhich the Company provides administrative services only and does not assumefull insurance risk.

(j)             Medi-Cal (the California Medicaid program)membership is included in California - Large Group.  Medicaid membership for Virginia, Puerto Ricoand Other are included in Other States - Large Group.  Healthy Families, MRMIP (Major Risk MedicalInsurance Program) / AIM (Access for Infants and Mothers) / IHRP (Interim HighRisk Program) and California Kids membership are included in California – LargeGroup.

 

***Specialty Membership***

 
| ** **                   | ** ** | **June 30,** | ** ** | **Percent** | ** ** |
|------------------------------|------------|-------------------|------------|-------------|------------|
| ** **                   | ** ** | **2004 (A)**      | ** ** | **2003**    | ** ** | **Change** | ** ** |
| Pharmacy Benefits Management |       | 31,521,156        |       | 35,980,533  |       | -12.4 | % |
| Dental                       |       | 3,243,208         |       | 2,880,224   |       | 12.6 | % |
| Life                         |       | 3,056,673         |       | 2,810,903   |       | 8.7 | % |
| Disability                   |       | 565,135           |       | 499,970     |       | 13.0 | % |
| Behavioral Health (B)        |       | 7,832,916         |       | 7,262,131   |       | 7.9 | % |
| Total                        |       | 46,219,088        |       | 49,433,761  |       | -6.5 | % |

 

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(A)      Specialty membership as of June 30, 2004includes 639,229 specialty members from the Cobalt acquisition.

 

(B)        Effective as of January 1, 2004, the Companybegan including HealthLink members who receive certain behavioral healthservices in its behavioral health membership. As of June 30, 2004, theCompany had approximately 529,000 such members.

 

39

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***Comparison ofResults of Operations for the Quarter Ended June 30, 2004 to the QuarterEnded June 30, 2003***

 

The Company maintains the following two reportable segments: HealthCare and Specialty. (See Note 13 to the Consolidated Financial Statementsfor further discussion.) The Health Care segment provides a broad spectrum ofnetwork-based health plans, including PPOs, HMOs, POS plans, other hybrid plansand traditional indemnity plans, to large and small employers and individualsas well as other health care-related products, such as vision, preventive care,COBRA and flexible benefits account administration. The Specialty business ismaintained as a separate segment providing an array of specialty products,including pharmacy benefits management, dental, life insurance, disabilityinsurance, behavioral health, workers’ compensation insurance products andworkers’ compensation managed care services.

 

The operating results for the quarter ended June 30, 2004 comparedto the quarter ended June 30, 2003 were affected by the Cobaltacquisition, which was effective as of September 30, 2003 for accountingpurposes. Specifically, the Company’s operating results for the quarter endedJune 30, 2004 included three months of operating results from the Cobaltacquisition whereas the Company’s operating results for the quarter endedJune 30, 2003 did not include any operating results from the acquiredCobalt business. In order to provide a more meaningful comparison of theCompany’s results of operations for the quarter ended June 30, 2004 versusthe quarter ended June 30, 2003, the following discussion presentsfinancial measures that exclude operating results attributable to the acquiredCobalt business for the quarter ended June 30, 2004, which we refer to as“Same-Store.” The Company also uses Same-Store measures for purposes ofreporting comparative financial results to its Board of Directors.

 

The following table depicts premium revenue by reportable segment:

 
| **(In thousands)** | ** ** | **Quarter Ended****June 30, 2004** | ** ** | **Less: Acquired  Cobalt Business for  the Quarter Ended  June 30, 2004** | ** ** | **Quarter Ended****June 30, 2004  (Same-Store)** | ** ** | **Quarter Ended****June 30, 2003** | ** ** |
|--------------------|------------|-----------------------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------|------------|
| Health Care        |       | $                                       | 5,222,405  |                                                                           | $          | 300,700                                               |       | $                                       | 4,921,705  |   | $ | 4,519,126 |   |
| Specialty          |       | 185,579                                 |       | 39,068                                                                         |       | 146,511                                               |       | 135,728                                 |       |
| Consolidated       |       | $                                       | 5,407,984  |                                                                           | $          | 339,768                                               |       | $                                       | 5,068,216  |   | $ | 4,654,854 |   |

 

Premium revenue increased 16.2%, or $ 753.1 million, to $5,408.0million for the quarter ended June 30, 2004 from $4,654.9 million forthe quarter ended June 30, 2003. Excluding premium revenue attributable to the acquired Cobalt businessof $339.8 million for the quarter ended June 30, 2004, premium revenueincreased $413.3 million or 8.9% on a Same-Store basis from the quarter endedJune 30, 2003. Insured member months increased 4.9% for the quarter endedJune 30, 2004 compared to the quarter ended June 30, 2003. Excluding insuredmember months attributable to the acquired Cobalt business for the quarterended June 30, 2004, insured member months increased by approximately 0.3%for the quarter ended June 30, 2004 compared to the quarter endedJune 30, 2003. The growth in premium revenue for the quarter ended June30, 2004 occurred across all regions of the Health Care segment, and was mainlyattributable to increases in the per member per month rate of 12.2% in theCalifornia region and 8.7% in the Georgia region.

 

40

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The following table depicts management services and other revenue byreportable segment:

 
| **(In thousands)**   | ** ** | **Quarter  Ended****June 30, 2004** | ** ** | **Less:  Acquired  Cobalt Business for  the Quarter Ended  June 30, 2004** | ** ** | **Quarter  Ended****June 30, 2004  (Same-Store)** | ** ** | **Quarter  Ended  June 30, 2003** | ** ** |
|----------------------|------------|------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------|------------|
| Health Care          |       | $                                        | 251,061    |                                                                            | $          | 49,489                                                 |       | $                                      | 201,572    |   | $ | 186,551 |   |
| Specialty            |       | 49,803                                   |       | 615                                                                             |       | 49,188                                                 |       | 34,253                                 |       |
| Corporate and  Other |       | 3,037                                    |       | 29                                                                              |       | 3,008                                                  |       | 662                                    |       |
| Consolidated         |       | $                                        | 303,901    |                                                                            | $          | 50,133                                                 |       | $                                      | 253,768    |   | $ | 221,466 |   |

 

Management services and other revenue increased 37.2%, or$82.4 million, to $303.9 million for the quarter ended June 30,2004 from $221.5 million for the quarter June 30, 2003. Excludingmanagement services and other revenue attributable to the acquired Cobaltbusiness of $50.1 million for the quarter ended June 30, 2004, managementservices and other revenue increased $32.3 million, or 14.6%, from the quarterended June 30, 2003. The increase was primarily due to an increase inmanagement services revenue from the Georgia region of the Health Care segmentof $14.3 million, the California region of the Health Care segment of $3.3million and the Specialty segment of $14.9 million. The increase in the Georgiaregion resulted primarily from an increase in administrative services membermonths of 16.9% and an increase of 7.9% in the administrative services permember per month rate. The increase in the California region resulted from anincrease of 5.8% in administrative services member months.  The increase in the Specialty segment’smanagement services revenue was primarily attributable to an increase inpharmacy benefit management services revenues from non-affiliated clients.  These increases were offset by a decrease inmanagement services revenue from the Central Region of $2.5 million. Thedecrease in the Central Region resulted primarily from lower administrativeservices membership, partially offset by an increase in the administrativeservices per member per month rate.

 

Investment income was $68.5 million for the quarter ended June 30,2004, compared to $64.0 million for the quarter ended June 30, 2003,an increase of $4.5 million or 7.0%. The increase was primarily due to anincrease in gross investment income of $5.8 million as a result of higheraverage investment balances, which were due partially to the Cobaltacquisition.  The increase was partiallyoffset by net realized gains of $0.1 million for the quarter endedJune 30, 2004 (as compared to net realized gains for the quarter endedJune 30, 2003 of $0.8 million) and an increase in investment expense of$0.7 million.

 

41

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The following table depicts health care services and other benefitsexpense by reportable segment:

 
| **(In thousands)** | ** ** | **Quarter Ended****June 30, 2004** | ** ** | **Less: Acquired  Cobalt Business for  the Quarter Ended  June 30, 2004** | ** ** | **Quarter Ended****June 30, 2004  (Same-Store)** | ** ** | **Quarter Ended****June 30, 2003** | ** ** |
|--------------------|------------|-----------------------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------|------------|
| Health Care        |       | $                                       | 4,245,816  |                                                                           | $          | 249,625                                               |       | $                                       | 3,996,191  |   | $ | 3,687,744 |   |
| Specialty          |       | 118,554                                 |       | 26,518                                                                         |       | 92,036                                                |       | 81,923                                  |       |
| Consolidated       |       | $                                       | 4,364,370  |                                                                           | $          | 276,143                                               |       | $                                       | 4,088,227  |   | $ | 3,769,667 |   |

 

Health care services and other benefits expense increased 15.8%, or$594.7 million, to $4,364.4 million for the quarter endedJune 30, 2004 from $3,769.7 million for the quarter endedJune 30, 2003. The Company’s medical care ratio was 80.7% for the quarterended June 30, 2004, compared to 81.0% for the quarter ended June 30,2003. Excluding health care services and other benefits expense attributable tothe acquired Cobalt business of $276.1 million for the quarter ended June 30,2004, health care services and other benefits expense increased $318.6 million,or 8.5%, slightly lower than the increase in premium revenue.

 

The Company’s medical care ratio was 80.7% for the quarter ended June30, 2004, compared to 81.0% for the quarter ended June 30, 2003. The Company’smedical care ratio attributable to the Health Care segment decreased from 81.6%for the quarter ended June 30, 2003 to 81.3% for the quarter endedJune 30, 2004, primarily due to price increases in all regions and lapsesin accounts with higher-than-average medical care ratios.  The medical care ratio for the Specialtysegment increased to 63.9% for the quarter ended June 30, 2004 from 60.4%for the same quarter in 2003. The increase in the Specialty medical ratio wasprimarily attributable to higher claims trends for dental products. Health careservices and other benefits expense and medical care ratio information isprovided for each segment so investors can compare the performance of eachsegment to the other segment and to the Company as a whole. Excluding premiumrevenue of $300.7 million and health care services and other benefits expenseof $249.6 million attributable to the acquired Cobalt business with respect tothe Health Care segment for the quarter ended June 30, 2004, the Company’smedical care ratio attributable to the Health Care segment for the quarterended June 30, 2004 decreased to 81.2%, compared to 81.6% for the quarter endedJune 30, 2003.  This decrease occurredacross all regions in the Health Care segment. The health care services andother benefits expense included an estimate of claims incurred during theperiod that have not been reported to the Company.  This estimate is actuarially determined basedon a variety of factors and is inherently subject to a number of highlyvariable circumstances.  Consequently,the actual results could differ materially from the amount recorded in theConsolidated Financial Statements. See “Critical Accounting Policies” for adiscussion of this item and its potential effect on the Company’s reportedresults of operations.

 

Selling expense consists of commissions paid to outside brokers andagents representing the Company.  Theselling expense ratio decreased from 4.1% for the quarter ended June 30,2003 to 3.9% for the quarter ended June 30, 2004. The acquired Cobaltbusiness experienced a lower selling expense ratio due primarily to its higherpercentage of large employer group business that maintained a selling expenseratio of less than 1%. Excluding selling expense of $6.6 million and combinedpremium revenue and management services and other revenue of $389.9 millionattributable to the acquired Cobalt business for the quarter endedJune 30, 2004, the selling expense ratio remained unchanged at 4.1% foreach of the quarters ended June 30, 2004 and 2003.

 

42

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The general and administrative expense ratio decreased slightly to11.7% for the quarter ended June 30, 2004 from 11.9% for the quarter endedJune 30, 2003. The decrease in the general and administrative expenseratio resulted from administrative efficiencies from technology investments andsystems convergence efforts and fixed administrative costs spread over a largermembership base. The acquired Cobalt business had a higher general andadministrative expense ratio of 20.3% during the quarter ended June 30,2004. The acquired Cobalt business has historically had a higher administrativeexpense ratio due to its Medicare processing business, which has a general andadministrative expense ratio of approximately 98%, and the balance of its businessis weighted more towards non-insured business, which tends to have a highergeneral and administrative expense ratio than insured business. Excludinggeneral and administrative expense of $79.2 million and combined premiumrevenue and management services and other revenue of $389.9 millionattributable to the acquired Cobalt business for the quarter endedJune 30, 2004, general and administrative expense decreased from 11.9% forthe quarter ended June 30, 2003 to 11.1% for the quarter ended June 30,2004.

 

Interest expense increased $0.3 million to $13.0 million forthe quarter ended June 30, 2004, compared to $12.7 million for the quarterended June 30, 2003.  The increasein interest expense was primarily due to a reduction in interest incomeassociated with the Company’s interest rate swap agreement, which serves toreduce interest expense on the Company’s 2006 Notes, partially offset by adecrease in interest expense on commercial paper due to repayment of thebalance in mid-June 2004.

 

Other expense, net increased $5.2 million to $9.8 million forthe quarter ended June 30, 2004, compared to $4.6 million for the quarterended June 30, 2003. The increase was primarily due to additionalamortization of intangibles attributable to the Cobalt and Golden West acquisitionsof $3.3 million during the quarter ended June 30, 2004.

 

The Company’s net income for the quarter ended June 30, 2004 was$299.9 million, compared to $224.5 million for the quarter endedJune 30, 2003. Earnings per share totaled $1.92 and $1.54 for the quartersended June 30, 2004 and 2003, respectively.  Earnings per share assuming full dilutiontotaled $1.86 and $1.49 for the quarters ended June 30, 2004 and 2003,respectively.

 

Earnings per share for the quarter ended June 30, 2004 is basedupon weighted average shares outstanding of 155.8 million shares, excludingpotential common stock, and 161.2 million shares, assuming fulldilution.  Earnings per share for thequarter ended June 30, 2003 is based upon 145.7 million shares, excludingpotential common stock, and 150.2 million shares, assuming fulldilution.  The increase in weightedaverage shares outstanding primarily resulted from the issuance of sharesrelated to the Cobalt acquisition and the Company’s employee stock option andstock purchase plans.  The increase inweighted average shares outstanding assuming full dilution primarily resultedfrom the issuance of shares related to the Cobalt acquisition and the Company’sstock option and stock purchase plans.

 

43

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The operating results for the six months ended June 30, 2004compared to the six months ended June 30, 2003 were affected by the Cobaltacquisition, which was effective as of September 30, 2003 for accountingpurposes. Specifically, the Company’s operating results for the six monthsended June 30, 2004 included six months of operating results from theCobalt acquisition, whereas the Company’s operating results for the six monthsended June 30, 2003 did not include any operating results from theacquired Cobalt business. In order to provide a more meaningful comparison ofthe Company’s results of operations for the six months ended June 30, 2004versus the six months ended June 30, 2003, the following discussionpresents financial measures that exclude operating results attributable to theacquired Cobalt business for the six months ended June 30, 2004, which werefer to as “Same-Store.” The Company also uses Same-Store measures forpurposes of reporting comparative financial results to its Board of Directors.

 

The following table depicts premium revenue by reportable segment:

 
| **(In thousands)** | ** ** | **Six Months Ended****June 30, 2004** | ** ** | **Less: Acquired  Cobalt Business for  the Six Months  Ended June 30,  2004** | ** ** | **Six Months Ended****June 30, 2004  (Same-Store)** | ** ** | **Six Months  Ended****June 30, 2003** | ** ** |
|--------------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------|------------|
| Health Care        |       | $                                          | 10,295,136 |                                                                               | $          | 598,944                                                  |       | $                                           | 9,696,192  |   | $ | 8,936,591 |   |
| Specialty          |       | 369,151                                    |       | 77,977                                                                             |       | 291,174                                                  |       | 266,568                                     |       |
| Consolidated       |       | $                                          | 10,664,287 |                                                                               | $          | 676,921                                                  |       | $                                           | 9,987,366  |   | $ | 9,203,159 |   |

 

Premium revenue increased 15.9%, or $1,461.1 million, to $10,664.3million for the six months ended June 30, 2004 from $9,203.2 millionfor the six months ended June 30, 2003. Excluding premium revenue attributable to the acquired Cobalt businessof $676.9 million for the six months ended June 30, 2004, premium revenueincreased $784.2 million, or 8.5%. Including membership attributable to the acquired Cobalt business,insured member months increased by 4.8% for the six months ended June 30,2004 compared to the six months ended June 30, 2003. Excluding insuredmembership attributable to the acquired Cobalt business for the first sixmonths of 2004, insured member months decreased by approximately 0.1% for thesix months ended June 30, 2004 compared to the six months ended June 30,2003. The growth in premium revenue for the six months ended June 30, 2004occurred across all regions of the Health Care segment, but was more pronouncedin the California and Georgia regions due mainly to the implementation ofpremium increases of 12.3% in California and to an increase in insured membermonths of 5.2% and the implementation of premium increases of 8.1% in Georgia.

 

44

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The following table depicts management services and other revenue byreportable segment:

 
| **(In thousands)**   | ** ** | **Six Months Ended****June 30, 2004** | ** ** | **Less: Acquired  Cobalt Business for  the Six Months  Ended June 30,  2004** | ** ** | **Six Months Ended****June 30, 2004  (Same-Store)** | ** ** | **Six Months  Ended****June 30, 2003** | ** ** |
|----------------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------|------------|
| Health Care          |       | $                                          | 505,974    |                                                                               | $          | 98,325                                                   |       | $                                           | 407,649    |   | $ | 375,085 |   |
| Specialty            |       | 98,696                                     |       | 2,992                                                                              |       | 95,704                                                   |       | 71,220                                      |       |
| Corporate and  Other |       | 5,407                                      |       | 29                                                                                 |       | 5,378                                                    |       | 1,332                                       |       |
| Consolidated         |       | $                                          | 610,077    |                                                                               | $          | 101,346                                                  |       | $                                           | 508,731    |   | $ | 447,637 |   |

 

Management services and other revenue increased 36.3%, or$162.5 million, to $610.1 million for the six months endedJune 30, 2004 from $447.6 million for the six months endedJune 30, 2003. Excluding management services and other revenueattributable to the acquired Cobalt business of $101.3 million for the sixmonths ended June 30, 2004, management services and other revenueincreased $61.2 million, or 13.7%.  Theincrease in management services and other revenue on a Same-Store basis in theHealth Care segment was primarily due to an increase in management servicesrevenue from the Georgia and California regions of $27.2 million and $10.4million, respectively. The increase in the Georgia region resulted from a 15.9%increase in administrative services member months and an 8.0% increase in theadministrative services per member per month rate. The increase in theCalifornia region resulted from an increase in administrative services membermonths of 5.8% and a 2.4% increase in the administrative services per memberper month rate. These increases were partially offset by a decrease inmanagement services revenue in the Central Region of $4.8 million. The decreasein the Central Region resulted from a decrease of 9.9% member months in theCompany’s administrative services business, which was partially offset by permember per month increases in rates of 7.1% in its administrative servicesbusiness.  Additionally, the Specialtysegment experienced a $24.5 million increase in management services revenue,primarily attributable to an increase in pharmacy benefit management servicesrevenues from non-affiliated clients.

 

Investment income was $152.2 million for the six months endedJune 30, 2004, compared to $130.3 million for the six months endedJune 30, 2003, an increase of $21.9 million or 16.8%. The increase wasprimarily due to a $14.2 million increase in gross investment income and netrealized gains for the six months ended June 30, 2004 of $16.7 million, ascompared to net realized gains for the six months ended June 30, 2003 of$7.0 million. Excluding net realized gains and losses, investment income forthe six months ended June 30, 2004 and 2003 was $135.5 million and $123.3million, respectively. The increase in gross investment income was due tohigher average fixed maturity investment balances, which were partially due to theCobalt acquisition. The Company believes the disclosure of investment incomeexcluding realized gains or losses is useful to investors because thismeasurement allows management and investors to analyze the performance of thefixed-income portion of the Company’s investment portfolio.

 

45

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The following table depicts health careservices and other benefits expense by reportable segment:

 
| **(In thousands)** | ** ** | **Six Months Ended****June 30, 2004** | ** ** | **Less: Acquired  Cobalt Business  for the Six Months  Ended June 30,  2004** | ** ** | **Six Months Ended****June 30, 2004  (Same-Store)** | ** ** | **Six Months  Ended****June 30, 2003** | ** ** |
|--------------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------|------------|
| Health Care        |       | $                                          | 8,307,168  |                                                                               | $          | 505,455                                                  |       | $                                           | 7,801,713  |   | $ | 7,322,601 |   |
| Specialty          |       | 244,553                                    |       | 55,977                                                                             |       | 188,576                                                  |       | 164,566                                     |       |
| Consolidated       |       | $                                          | 8,551,721  |                                                                               | $          | 561,432                                                  |       | $                                           | 7,990,289  |   | $ | 7,487,167 |   |

 

Health care services and other benefits expense increased 14.2%, or$1,064.5 million, to $8,551.7 million for the six months endedJune 30, 2004 from $7,487.2 million for the six months endedJune 30, 2003. Excluding health care services and other benefits expenseattributable to the acquired Cobalt business of $561.4 million for the sixmonths ended June 30, 2004, health care services and other benefitsexpense increased $503.1 million or 6.7%.

 

The Company’s medical care ratio was 80.2% for the six months endedJune 30, 2004 compared to 81.4% for the six months ended June 30,2003. The medical care ratio attributable to the Health Care segment was 80.7%for the six months ended June 30, 2004, compared to 81.9% for the sixmonths ended June 30, 2003. The medical care ratio attributable to theSpecialty segment was 66.3% for the six months ended June 30, 2004compared to 61.7% for the six months ended June 30, 2003. The increase inthe Specialty medical care ratio was attributable to higher claims trends forlife insurance and dental products. Health care services and other benefitsexpense and medical care ratio information is provided for each segment soinvestors can compare the performance of each segment to the other segment andto the Company as a whole. Excluding premium revenue of $598.9 million andhealth care services and other benefits expense of $505.5 million attributableto the acquired Cobalt business with respect to the Health Care segment for thesix months ended June 30, 2004, the Company’s medical care ratioattributable to the Health Care segment for the six months ended June 30,2004 decreased to 80.5% compared to 81.9% for the six months endedJune 30, 2003, primarily due to price increases in all regions and lapsesin accounts with higher-than-average medical care ratios. The health careservices and other benefits expense includes an estimate of claims incurredduring the period that have not been reported to the Company.  This estimate is actuarially determined basedon a variety of factors and is inherently subject to a number of highlyvariable circumstances.  Consequently,the actual results could differ materially from the amount recorded in theconsolidated financial statements. See “Critical Accounting Policies” for adiscussion of this item and its potential effect on the Company’s reportedresults of operations.

 

The selling expense ratio decreased slightly from 4.1% for the sixmonths ended June 30, 2003 to 3.9% for the six months ended June 30,2004. Excluding selling expense of $12.9 million and combined premium revenueand management services and other revenue of $778.3 million attributable to theacquired Cobalt business for the six months ended June 30, 2004, the

 

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Company’s selling expense ratio remained unchanged at 4.1% for the sixmonths ended June 30, 2004 and the six months ended June 30, 2003.

 

The general and administrative expense ratio increased to 12.4% for thesix months ended June 30, 2004 from 12.1% for the six months endedJune 30, 2003. Excluding general and administrative expense of $163.3million and combined premium revenue and management services and other revenueof $778.3 million attributable to the acquired Cobalt business for the sixmonths ended June 30, 2004, the Company’s general and administrativeexpense ratio would have decreased to 11.7% for the six months endedJune 30, 2004 compared to 12.1% for the six months ended June 30, 2003.The decrease in the general and administrative expense ratio resulted fromadministrative efficiencies from technology investments and systems convergenceefforts and fixed administrative costs spread over a larger membership base.

 

Interest expense decreased slightly by $0.3 million to$25.2 million for the six months ended June 30, 2004, compared to$25.5 million for the six months ended June 30, 2003.  The decrease in interest expense wasprimarily due to the reduction in the balance of commercial paper borrowings duringthe first six months of 2004 compared to the first six months of 2003,partially offset by interest expense associated with the Company’s interestrate swap agreement.

 

Other expense, net increased $9.8 million to $21.4 millionfor the six months ended June 30, 2004, compared to $11.6 million for thesix months ended June 30, 2003.  Theincrease was primarily attributable to an increase in amortization ofintangibles of $6.6 million related to the Company’s acquisitions of Cobalt andGolden West.

 

The Company’s net income for the six months ended June 30, 2004was $595.1 million, compared to $417.5 million for the six monthsended June 30, 2003.  Earnings pershare totaled $3.84 and $2.87 for the six months ended June 30, 2004 and2003, respectively.  Earnings per shareassuming full dilution totaled $3.71 and $2.79 for the six months endedJune 30, 2004 and 2003, respectively.

 

Earnings per share for the six months ended June 30, 2004 is basedupon weighted average shares outstanding of 154.9 million shares, excludingpotential common stock, and 160.3 million shares, assuming fulldilution.  Earnings per share for the sixmonths ended June 30, 2003 is based upon 145.7 million shares, excludingpotential common stock, and 149.7 million shares, assuming fulldilution.  The increase in weightedaverage shares outstanding primarily resulted from the issuance of sharesrelated to the Cobalt acquisition and the Company’s employee stock option andstock purchase plans. The increase in weighted average shares outstandingassuming full dilution primarily resulted from the issuance of shares relatedto the Cobalt acquisition and the Company’s employee stock option and stockpurchase plans.

 

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***Financial Condition***

 

The Company’s consolidated assets increasedby $264.8 million, or 1.8%, to $15,053.5 million as of June 30, 2004 from$14,788.7 million as of December 31, 2003. The increase in total assetswas primarily due to growth in cash and investments of $78.9 million as aresult of operating cash flows attributable to net income, net of commercialpaper repayments. Also contributing to the increase in consolidated assets wasan increase in receivables, net of $166.3 million. Cash and investments totaled$8.0 billion as of June 30, 2004, or 53.1% of total assets.

 

Overall claims liabilities, which is composed of medical claims payableand reserves for future policy benefits, decreased $92.3 million, or 2.9%, to$3,072.1 million as of June 30, 2004 from $3,164.4 million as ofDecember 31, 2003. The decrease was due primarily to faster average claimspayments and provider incentive payments that were accrued as ofDecember 31, 2003 and paid during the six months ended June 30, 2004. See“Critical Accounting Policies” for a discussion of medical claims payable andreserves for future policy benefits. As of June 30, 2004, the Company’slong-term indebtedness was $803.3 million, of which $454.2 million was relatedto the Company’s 6 3/8% Notes due 2006 (which includes afair value adjustment of $4.6 million) and $349.1 million was related to theCompany’s 6 3/8% Notes due 2012. The 6 3/8%Notes due 2012, with an aggregate principal amount at maturity of $350.0million, were issued to partially finance the RightCHOICE acquisition. Duringthe year ended December 31, 2003, the Company issued an additional $104.7million in commercial paper (net of repayments made during the year) torepurchase Common Stock of the Company. In the third quarter of 2003, theCompany also issued an additional $125.1 million in commercial paper primarilyto partially finance the acquisition of Cobalt. In anticipation of the completion of its pending merger with Anthem,Inc., the Company repurchased its entire balance of commercial paperoutstanding during the quarter ending June 30, 2004 (see “Liquidity andCapital Resources” below for a discussion of the potential repurchase of theCompany’s commercial paper as a result of the Company’s pending merger withAnthem, Inc.).

 

Stockholders’ equity totaled $6,216.5 millionas of June 30, 2004, an increase of $786.6 million from $5,429.9 millionas of December 31, 2003. The increase was primarily due to net income of$595.1 million for the six months ended June 30, 2004 and a net increaseof $266.8 million from the issuance of new Common Stock and the reissuance oftreasury stock related to stock grants under the Company’s employee 401(k)plan, stock option and stock purchase plans. Partially offsetting theseincreases were a decrease in net unrealized gains from investment securities of$40.5 million and net losses from the reissuance of treasury stock of $34.9million.  During the six monthsended June 30, 2004, the Company granted 565,000 restricted shares of CompanyCommon Stock, which are subject to vesting. As of June 30, 2004, total unearnedcompensation from all unvested stock awards totaled $49.6 million, which has noimpact to stockholders’ equity since the Company recorded an increase toadditional paid-in-capital of the same amount.

 

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***Liquidity and Capital Resources***

 

As of June 30, 2004, consolidated cash and investments were $8.0billion, of which $1.0 billion were in cash and cash equivalents. The Company’sprimary sources of cash are premium and management services revenues andinvestment income.  The Company’s primaryuses of cash include health care claims and other benefits, capitationpayments, income taxes, repayment of long-term debt, interest expense, brokerand agent commissions, administrative expenses, Common Stock repurchases andcapital expenditures.  In addition to theforegoing, other uses of cash include provider network and systems developmentcosts and costs associated with the integration of acquired businesses.

 

The Company generally receives premium revenue in advance ofanticipated claims for related health care services and other benefits.  The Company’s investment policies aredesigned to provide safety and preservation of capital, sufficient liquidity tomeet cash flow needs, the integration of investmentstrategy with the business operations and objectives of the Company, andattainment of a competitive after-tax total return.

 

The Company’s strategy for achieving its investment goals is broaddiversification of its investments, both across and within asset classes.  As of June 30, 2004, the Company’sinvestment portfolio consisted primarily of investment grade fixed-incomesecurities.  The Company’s portfolio alsoincluded large capitalization and small capitalization domestic equities,foreign equities, tax-exempt municipal bonds and a small amount ofnon-investment grade debt securities. The fixed-income assets include both short and long-duration securitieswith an attempt to match the Company’s funding needs.  The Company’s investment policy containslimitations regarding concentration in individual securities and industries andgenerally prohibits speculative and leveraged investments.  Cash and investment balances maintained bythe Company are sufficient to meet applicable regulatory financial stabilityand net worth requirements, including license requirements of the Blue Crossand Blue Shield Association.

 

Net cash provided by operating activities was $532.1 million forthe six months ended June 30, 2004, compared with $422.0 million for thesix months ended June 30, 2003.  Netcash provided by operations for the six months ended June 30, 2004 was dueprimarily to net income of $595.1 million and an adjustment for non-cashdepreciation and amortization of $103.4 million.  Partially offsetting these increases were adecrease in medical claims payable of $97.2 million, primarily due to fasteraverage claims payments and provider incentive payments that were accrued as ofDecember 31, 2003, and an increase in “receivables, net” of $137.0 milliondue to the timing of cash receipts of certain receivables.

 

Net cash used in investing activities for the six months endedJune 30, 2004 totaled $160.4 million, compared with$1,025.7 million for the six months ended June 30, 2003.  The cash used in the first six months of 2004was primarily attributable to the purchase of investments of $3,539.8 millionand the purchase of property and equipment, net of sales proceeds, of $76.0million, which were partially offset by proceeds from investments sold of$3,467.2 million.

 

Net cash used in financing activities totaled $445.3 million forthe six months ended June 30, 2004, compared with $626.1 million providedfor the six months ended June 30, 2003. The net

 

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cash used in the six months ended June 30, 2004 was primarilyattributable to the repurchase of the Company’s commercial paper of $429.8million in anticipation of the completion of its pending merger with Anthem,Inc. and a decrease in securities lending payable of $67.2 million, offset bythe receipt of proceeds from the issuance of Common Stock related to theCompany’s employee stock option plans of $47.1 million.

 

Effective March 30, 2001, the Company entered into two unsecuredrevolving credit facilities allowing aggregate indebtedness of $1.0 billion inprincipal amount. Borrowings under these facilities (which are generallyreferred to collectively as the Company’s “revolving credit facility”) bearinterest at rates determined by reference to the bank’s base rate or to theLondon InterBank Offered Rate (“LIBOR”) plus a margin determined by referenceto the then-current rating of the Company’s senior unsecured long-term debt byspecified rating agencies. One facility, which provides for borrowings not toexceed $750.0 million at any time outstanding, expires as of March 30,2006, although it may be extended for up to two additional one-year periodsunder certain circumstances. The other facility, which provides for borrowingsnot to exceed $250.0 million at any time outstanding, expires on March 25,2005. Any amount outstanding under this facility as of March 25, 2005 maybe converted into a one-year term loan at the option of the Company and willbear interest at rates determined by reference to the bank’s base rate or LIBORplus a margin determined by reference to the then-current rating of theCompany’s unsecured long-term debt by specified rating agencies, plus 0.125%until paid in full. Loans under the $250.0 million facility are made on acommitted basis. Loans under the $750.0 million facility are made on acommitted basis or pursuant to an auction bid process. The $750.0 millionfacility also contains sublimits for letters of credit and “swingline” loans.Each credit agreement requires the Company to maintain certain financial ratiosand contains restrictive covenants, including restrictions on the incurrence ofadditional indebtedness and the granting of certain liens, limitations onacquisitions and investments and limitations on changes in control (see Note 9to the Consolidated Financial Statements). As of June 30, 2004 andDecember 31, 2003, there were no amounts outstanding under the revolvingcredit facility.

 

In April 2002, the Company commenced acommercial paper program providing for the issuance of up to $1.0 billion inaggregate maturity value of short-term indebtedness (known generally as“commercial paper”). The commercial paper is being issued by the Companywithout registration under the Securities Act of 1933, as amended (the “1933Act”) in reliance upon the exemption from registration contained inSection 4(2) of the 1933 Act. The commercial paper is issued indenominations of $100,000 or integral multiples of $1,000 in excess thereof andwill bear such interest rates, if interest-bearing, or will be sold at suchdiscount from their face amounts, as agreed upon by the Company and the dealeror dealers acting in connection with the commercial paper program. Thecommercial paper may be issued with varying maturities up to a maximum of 270days from the date of issuance. The commercial paper ranks equally with allother unsecured and unsubordinated indebtedness of the Company. As ofDecember 31, 2003, the outstanding commercial paper borrowings totaled$429.8 million, with various maturity dates, and had interest rates rangingfrom 1.10% to 1.27%. The weighted average yield on the outstanding commercialpaper as of December 31, 2003 was 1.25%.

 

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The Company is currently subject to a pending merger with Anthem,Inc.  Under the merger agreement withAnthem, the Company is obligated to repurchase or otherwise retire anyoutstanding commercial paper prior to the closing of the merger.  In June 2004, in anticipation of the mergerclosing, the Company repaid the entire outstanding balance under the commercialpaper program.  (SeeNote 9 to the Consolidated Financial Statements.)

 

In anticipation of the completion of the RightCHOICE acquisition onJanuary 31, 2002, the Company on January 16, 2002 issued $350.0million aggregate principal amount at maturity of 6 3/8*%* Notes due January 15, 2012 (the“2012 Notes”). The net proceeds of this offering totaled approximately $348.9million. The 2012 Notes bear interest at a rate of 6 3/8*%* per annum, payable semi-annually inarrears on January 15 and July 15 of each year commencingJuly 15, 2002. Interest is computed on the basis of a 360-day year oftwelve 30-day months.

 

The 2012 Notes may be redeemed, in whole or in part, at the Company’soption at any time. The redemption price for any 2012 Notes redeemed will beequal to the greater of the following amounts: 1) 100% of the principal amountof the 2012 Notes being redeemed on the redemption date; or 2) the sum of thepresent values of the remaining scheduled payments of principal and interest onthe 2012 Notes being redeemed on that redemption date (not including anyportion of any payments of interest accrued to the redemption date) discountedto the redemption date on a semi-annual basis at the Treasury rate asdetermined by the Reference Treasury Dealer (J.P. Morgan Securities Inc. orDeutsche Banc Alex Brown or their respective successors), plus 25 basis points.In each case, the redemption price will also include accrued and unpaid intereston the 2012 Notes to the redemption date.

 

On June 15, 2001, the Company issued $450.0 million aggregateprincipal amount at maturity of 6 3/8*%* Notes due June 15, 2006 (the “2006Notes”). The net proceeds of this offering totaled approximately $449.0million. The net proceeds from the sale of the 2006 Notes were used to

 

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repay indebtedness under theCompany’s revolving credit facilities. The 2006 Notes bear interest at a rateof 6 3/8*%*per annum, payable semi-annually in arrears on June 15 andDecember 15 of each year commencing December 15, 2001. Interest iscomputed on the basis of a 360-day year of twelve 30-day months.

 

The 2006 Notes may be redeemed, in whole or in part, at the Company’soption at any time. The redemption price for any 2006 Notes redeemed will beequal to the greater of the following amounts: 1) 100% of the principal amountof the 2006 Notes being redeemed on the redemption date; or 2) the sum of thepresent values of the remaining scheduled payments of principal and interest onthe 2006 Notes being redeemed on that redemption date (not including anyportion of any payments of interest accrued to the redemption date) discountedto the redemption date on a semi-annual basis at the Treasury rate asdetermined by the designated Reference Treasury Dealer (Salomon Smith BarneyInc. or UBS Warburg LLC or their respective successors), plus 25 basis points.In each case, the redemption price will also include accrued and unpaidinterest on the 2006 Notes to the redemption date.

 

The 2006 and 2012 Notes are unsecured obligations and rank equally withall of the Company’s existing and future senior unsecured indebtedness. Allexisting and future liabilities of the Company’s subsidiaries are and will beeffectively senior to the 2006 and 2012 Notes. The indenture governing the 2006and 2012 Notes contains a covenant that limits the ability of the Company andits subsidiaries to create liens on any of their property or assets to securecertain indebtedness without also securing the indebtedness under the 2006 and2012 Notes.

 

As a part of a hedging strategy to limit its exposure to variableinterest rate increases, the Company has from time to time entered intointerest rate swap agreements in order to reduce the volatility of interestexpense resulting from changes in interest rates on its variable rate debt. Theswap agreements were contracts to exchange variable-rate interest payments(weighted average rate for the year ended December 31, 2002 of 2.25%) forfixed-rate interest payments (weighted average rate for the year endedDecember 31, 2002 of 7.08%) without the exchange of the underlyingnotional amounts. The Company had entered into $200.0 million of fixed-rateswap agreements, which consisted of a $150.0 million notional amount swapagreement at 6.99% maturing on October 17, 2003 and a $50.0 millionnotional amount swap agreement at 7.06% maturing on October 17, 2006. InSeptember 2002, the Company terminated these two fixed-rate swap agreementswith an aggregate cash settlement of $17.6 million, of which $1.8 million wasaccrued interest and the remaining $15.8 million represented the fair value ofthe swap agreements at the time of termination and is being amortized over theterm of the original swap agreements. As of June 30, 2004, the remainingbalance to be amortized was $4.4 million. (See Note 10 to theConsolidated Financial Statements.)

 

In order to reduce the interest expense associated with the 2006 Notes,the Company, on January 15, 2002, entered into a $200.0 million notionalamount interest rate swap agreement, which matures on June 15, 2006. Theswap agreement is a contract to exchange a fixed 6 3/8%rate for a LIBOR-based floating rate (weighted average variable rate of 3.15% and2.53% for the six months ended June 30, 2004 and 2003, respectively).  In anticipation of the completion

 

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of the Company’s pending merger with Anthem, in June 2004 theCompany terminated this swap agreement with an aggregate cash settlement of$4.6 million, which is being amortized over the remaining term of the 2006Notes. (See Note 10 to the Consolidated Financial Statements.)

 

Certain of the Company’s subsidiaries arerequired to maintain minimum capital requirements prescribed by variousregulatory agencies, including the California Department of Managed Health Careand the Departments of Insurance in various states, including Georgia,Missouri, Wisconsin and Delaware. As of June 30, 2004 (or the most recentdate with respect to which compliance is required), those subsidiaries of theCompany were in compliance with all minimum capital requirements.

 

The Company believes that cash flow generatedby operations and its cash and investment balances, supplemented by theCompany’s ability to borrow under its existing revolving credit facility,commercial paper program or through public or private financing sources, willbe sufficient to fund continuing operations and expected capital requirementsfor the foreseeable future.

 

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**Critical Accounting Policies**

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires the Company’s management to make avariety of estimates and assumptions. These estimates and assumptions affect,among other things, the reported amounts of assets and liabilities, thedisclosure of contingent liabilities and the reported amounts of revenues andexpenses. Actual results could differ from the amounts previously estimated,which were based on the information available at the time the estimates weremade.

 

The critical accounting policies described below are those that theCompany believes are important to the portrayal of the Company’s financialcondition and results of operations, and which require management to makedifficult, subjective or complex judgments. Critical accounting policies coveraccounting matters that are inherently uncertain because the future resolutionof such matters is unknown. The Company believes that critical accountingpolicies include medical claims payable, reserves for future policy benefits,goodwill and other intangible assets and investments.

 

*Medical Claims Payable*

 

Medical claims payable includes claims in process as well as provisionsfor the estimate of incurred but not reported claims (“IBNR”) and provisionsfor disputed claims obligations.  As ofJune 30, 2004, approximately 89% of the Company’s medical claims payableconsisted of IBNR and claims in process. Such estimates are developed usingactuarial principles and assumptions that consider, among other things,contractual requirements, historical utilization trends and payment patterns,benefits changes, medical inflation, product mix, seasonality, membership andother relevant factors.  In developingIBNR, the Company applies different estimation methods depending on the periodfor which incurred claims are being estimated. For the most recent four months, the incurred claims are estimated fromthe trend analysis based on per member per month claims trends developed fromthe experience in preceding months.  Forperiods prior to the most recent four months, the key assumption used indeveloping the Company’s IBNR is that the completion factor pattern remainsconsistent over a rolling 12-month period. The completion factor is an actuarial estimate, based upon historicalexperience, of the percentage of claims incurred during a given period thathave been adjudicated by the Company as of the date of estimation.  This approach is consistently applied to eachperiod presented.

 

The completion factors and claims per member per month trend factor arethe most significant factors used in estimating the Company’s IBNR.  The following table illustrates the sensitivityof these factors using June 30, 2004 data and the estimated potentialimpact on the Company’s operating results caused by these factors:

 

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| **Completion Factor (a):**          | ** ** | **Claims Trend Factor (b):**                         | ** **  |
|-------------------------------------|------------|------------------------------------------------------|-------------|
| **(Decrease)  Increase in  Factor** | ** ** | **Increase  (Decrease) in  Medical Claims  Payable** | ** **  | **(Decrease)  Increase in  Factor** | ** ** | **Increase  (Decrease) in  Medical Claims  Payable** | ** ** |
|                                |       |                                                 |        |   |   |   |   |
| (3)%                                |       | $                                                    | 314,000,000 |   | (3)% |   | $ | (12,000,000 | ) |
| (2)%                                |       | 204,000,000                                          |        | (2)% |   | (8,000,000 | ) |
| (1)%                                |       | 99,000,000                                           |        | (1)% |   | (4,000,000 | ) |
| 1%                                  |       | (94,000,000                                          | )           | 1% |   | 4,000,000 |   |
| 2%                                  |       | (184,000,000                                         | )           | 2% |   | 8,000,000 |   |
| 3%                                  |       | (270,000,000                                         | )           | 3% |   | 12,000,000 |   |
|                                     |            |                                                      |             |  |  |  |  |  |  |

 

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(a)          Reflectsestimated potential changes in medical claims payable caused by changes incompletion factors in each of the most recent four months.

(b)         Reflectsestimated potential changes in medical claims payable caused by changes inannualized claims trend used for the estimation of per member per month claimsfor the most recent four months.

 

In addition, assuming a hypothetical 1% difference betweenthe Company’s June 30, 2004 estimated claims liability and theactual claims incurred, net income for the quarter ended June 30, 2004would increase or decrease by $15.9 million, while diluted net income per sharewould increase or decrease by $0.10 per share.

 

Other relevant factors include exceptional situations that mightrequire judgmental adjustments in setting the outstanding reserves, such assystem conversions, processing interruptions, environmental changes or otherfactors.  None of these factors had amaterial impact on the development of the Company’s claims payable estimatesduring any of the periods presented in this quarterly report on Form 10-Q. Allof these factors are used in estimating IBNR and are important to the Company’sreserve methodology in trending the claims per member per month for purposes ofestimating the reserves for the most recent four months.

 

In developing its best estimate of medical claims payable, the Companyconsistently applies the principles and assumptions listed above from year toyear, while also giving due consideration to the potential variability of thesefactors. Because medical claims payable includes various actuarially developedestimates, the Company’s actual health care services expense may be more orless than the Company’s previously developed estimates. Claim processingexpenses are also accrued based on an estimate of expenses necessary to processsuch claims. Such reserves are continually monitored and reviewed, with anyadjustments reflected in current operations.

 

The table below provides a reconciliation of changes in medical claimspayable as of December 31, 2003, 2002 and 2001 during the immediatelyfollowing six-month period:

 

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| ** **                                                          | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------|------------|
| **(In thousands)**                                                  | ** ** | **2004**                           | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                |       |                               |       |   |   |   |   |
| Medical claims payable as of January 1                         |       | $                                  | 2,747,074  |   | $ | 2,422,331 |   | $ | 1,934,620 |   |
|                                                                |       |                               |       |   |   |   |   |
| Medical claims reserves from businesses acquired  during the period |       | —                             |       | 188 |   | 177,836 |   |
|                                                                |       |                               |       |   |   |   |   |
| Health care claim expenses incurred during period:                  |       |                               |       |   |   |   |   |
| Related to current year                                             |       | 8,606,540                          |       | 7,676,702 |   | 6,454,580 |   |
| Related to prior years                                              |       | (241,639                           | )          | (339,250 | ) | (339,295 | ) |
| Total Incurred                                                      |       | 8,364,901                          |       | 7,337,452 |   | 6,115,285 |   |
|                                                                |       |                               |       |   |   |   |   |
| Health care services payments during period:                        |       |                               |       |   |   |   |   |
| Related to current year                                             |       | 6,587,644                          |       | 5,727,790 |   | 4,820,689 |   |
| Related to prior years                                              |       | 1,874,415                          |       | 1,513,797 |   | 1,094,349 |   |
| Total Payments                                                      |       | 8,462,059                          |       | 7,241,587 |   | 5,915,038 |   |
|                                                                |       |                               |       |   |   |   |   |
| Medical claims payable as of June 30                           |       | $                                  | 2,649,916  |   | $ | 2,518,384 |   | $ | 2,312,703 |   |

 

As shown in the table above, for each of the six-month periods endedJune 30, 2004, 2003 and 2002, the amount shown on the line labeled “Healthcare services expenses incurred during period: Related to prior years” isnegative, meaning that the Company’s actual health care services experiencerelated to prior years was less than the estimates previously made by theCompany.  This favorable development wasprimarily due to prior-years’ claims being settled for amounts less than theoriginal estimate for IBNR.  Themagnitude of favorable development for the six months ended June 30, 2004 isless than that experienced in the first six months of June 30, 2003 and 2002due to negative development in certain identifiable reserves established as ofDecember 31, 2003. Based on claim payments through the first six months of2004, the Company experienced actual flu-related claims in 2003 that were $32million more than the amount accrued as of December 31, 2003. During the sixmonths ended June 30, 2004, an existing litigation reserve as of December 31,2003 was also increased by $9 million based on new information. Additionally,the accrual as of December 31, 2003 for a Company program to provide desktopcomputers and handheld devices to selected network physicians was increased by$2 million to include physicians primarily serving the Medicaid market.  Finally, the Company believes that thefavorable development was negatively affected by new transaction code setsunder HIPAA becoming effective in October 2003, which may have contributed to aslowdown in the submission of claims during the remainder of 2003. Actuarialstandards of practice, which the Company consistently follows in developing itsbest point estimate as reflected in the Consolidated Financial Statements,generally require that the actuarially developed health care claims estimatescover obligations under an assumption of moderately adverse conditions.  Adverse conditions are situations in whichthe actual claims are expected to be higher than the otherwise estimated valueof such claims at the time of the estimate. Therefore, in many situations, the claims amount actually experiencedwill be less than the estimate that satisfies the actuarial standards ofpractice.  Adjustments of prior-yearestimates may result in additional health care claim expenses or, as theCompany experienced during each of the last three years, a reduction in healthcare claim expenses in the period an adjustment is made.

 

Health care claims are usually described as having a “short tail,”which means that they are generally paid within a few months of the memberreceiving service from the physician or other health care provider.  Based on the Company’s historical claimpayment patterns, less than 5% of the medical claims payable as of the end ofany given year is outstanding at the end of the following year. Managementexpects that substantially all of the development of the estimate of medicalclaims payable as of December 31, 2003 will be known by the end of 2004.

 

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Capitation costs represent monthly fees paid one month in advance tophysicians, certain other medical service providers and hospitals in theCompany’s HMO networks as retainers for providing continuing medical care. TheCompany maintains various programs that provide incentives to physicians,certain other medical service providers and hospitals participating in its HMOnetworks through the use of risk-sharing agreements and other programs.Payments under such agreements are made based on the providers’ performance inmanaging health care costs while providing quality health care. Expensesrelated to these programs, which are based in part on estimates, are recordedin the period in which the related services are rendered. The Company believesthat its reserves for medical claims payable are adequate to satisfy itsultimate claim liability. However, these estimates are inherently subject to anumber of highly variable circumstances. Consequently, the actual results coulddiffer materially from the amount recorded in the Consolidated FinancialStatements.

 

Health care services and other benefitsexpense includes the costs of health care services, capitation expenses andexpenses related to risk-sharing agreements with participating physicians,medical groups and hospitals and incurred losses on the Company’s disabilityand life products. The costs of health care services are accrued as servicesare rendered, including an estimate for claims incurred but not yet reported.

 

For many of the Company’s HMO plans(including substantially all of its California HMO plans), the Companycontracts with physicians, hospitals and other health care providers throughcapitation fee arrangements as a means to manage health care costs. The Companyhas two general types of capitation arrangements. The predominant type is theso-called “professional” capitation arrangement. Under professional capitationarrangements, the Company pays the health care provider, such as aparticipating medical group, a fixed amount per member per month, and thehealth care provider assumes the risk of the member’s utilization of certainspecified health care services. Typically, under professional capitationarrangements, the health care provider does not assume the risk of the member’sutilization of any hospital-based services. The second type is the so-called“global” capitation arrangement. Under global capitation arrangements, theCompany also pays the health care provider, such as a participating medicalgroup, a fixed amount per member per month. However, under global capitationarrangements, the health care provider generally assumes the risk of themember’s utilization of all health care services (subject to certain limitedexceptions and state regulatory requirements). The Company had approximatelynine and eight global capitation arrangements as of June 30, 2004 andDecember 31, 2003, respectively, covering approximately 165,000 and161,000 members, respectively. In addition, one of the Company’s subsidiariesowns a 51% equity interest in a community health partnership network (the“CHPN”) operating in the greater Atlanta area. The CHPN is a locally based equityventure between the Company’s subsidiary and a local physician group. TheCompany’s subsidiary has entered into a global capitation arrangement with theCHPN. As of June 30, 2004 and December 31, 2003, approximately544,000 and 560,000 members, respectively, were covered by thisarrangement.  The Company’s investment inthe CHPN is accounted for using the consolidation method of accounting asrequired under Statement of Financial Accounting Standards No. 94, “Consolidationof All Majority-Owned Subsidiaries.”

 

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For the quarters ended June 30, 2004 and 2003, the Company’scapitation expenses of $423.2 million and $380.5 million represented 9.7% and10.1%, respectively, of the Company’s total health care services and otherbenefits expense. For the six months ended June 30, 2004 and 2003, theCompany’s capitation expenses of $851.4 million and $774.2 million, represented10.0% and 10.3%, respectively, of the Company’s total health care services andother benefits expense.  As ofJune 30, 2004 and December 31, 2003, the Company’s capitationexpenses payable of $114.2 million and $145.9 million represented 4.3% and5.3%, respectively, of the Company’s total medical claims payable.

 

The Company’s future results of operations will depend in part on itsability to predict and manage health care costs through underwriting criteria,medical management, product design and negotiation of favorable provider andhospital contracts. The Company’s ability to contain such costs may beadversely affected by changes in utilization rates, demographiccharacteristics, the regulatory environment, health care practices, inflation,new technologies, clusters of high-cost cases, continued consolidation ofphysician, hospital and other provider groups, acts of terrorism andbioterrorism or other catastrophes, including war and numerous other factors.The Company’s inability to mitigate any or all of the above-listed or otherfactors may adversely affect the Company’s future profitability.

 

## *Reserves forFuture Policy Benefits*

##  

The estimate of reserves for future policy benefits relates to life anddisability insurance policies written in connection with health care contracts.Reserves for future life benefit coverage are based on projections of pastexperience. Reserves for future policy and contract benefits for certainlong-term disability products and group paid-up life products are based uponinterest, mortality and morbidity assumptions from published actuarial tables,modified based upon the Company’s experience. Reserves are continuallymonitored and reviewed, and as settlements are made or reserves adjusted,differences are reflected in current operations. The current portion ofreserves for future policy benefits relates to the portion of such reservesthat the Company expects to pay within one year. The Company believes that itsreserves for future policy benefits are adequate to satisfy its ultimatebenefit liability. However, these estimates are inherently subject to a numberof highly variable circumstances. Consequently, the actual results could differmaterially from the amount recorded in the consolidated financial statements.As of June 30, 2004 and December 31, 2003, the reserves for futurepolicy benefits were $422.2 million and $417.3 million, respectively.

 

## *IntangibleAssets and Goodwill*

##  

The Company has made several acquisitions in the past several yearsthat included a significant amount of goodwill and other intangible assets.Under generally accepted accounting principles in effect throughDecember 31, 2001, these assets were amortized over their useful lives andwere tested periodically to determine if they were recoverable from operatingearnings on an undiscounted basis over their useful lives.

 

The Company is required to make estimates of fair value and applycertain assumptions, such as a discount factor in applying these annualimpairment tests. Such estimates could produce

 

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significantly different results if otherassumptions, which could also be considered reasonable, were to be used.Intangible assets with definite useful lives are being amortized using astraight-line basis or the timing of related cash flows over periods rangingfrom 1.5 to 25 years. An intangible asset subject to amortization must bereviewed for impairment pursuant to Statement of Financial Accounting StandardsNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

In accordance with SFAS No. 142, the Company completed the annualevaluation of its goodwill and other intangible assets at December 31,2003 and determined that there was no impairment loss. Goodwill and otherintangible assets totaled $3.2 billion as of June 30, 2004 and $3.3billion as of December 31, 2003. (See Note 7 to the ConsolidatedFinancial Statements for further discussion of the Company’s goodwill and otherintangible assets.)

 

## *Investments*

##  

As of June 30, 2004, the Company’s current investment securitiesat fair value, totaled $6.8 billion, of which 86.5% was invested infixed-income securities and the remaining 13.5% was invested in equitysecurities. As of December 31, 2003, the Company’s current investmentsecurities at fair value totaled $6.7 billion, of which 87.6% was invested infixed-income securities and the remaining 12.4% was invested in equitysecurities. These investment securities are generally used to support currentoperations and, accordingly, have been classified as current assets. TheCompany’s long-term investments as of June 30, 2004 and December 31,2003 were $196.8 million and $161.8 million, respectively, and consistedprimarily of restricted assets, certain equities and other investments. Total current and long-term investments at fair value, comprised46.8% and 46.6% of total assets as of June 30, 2004 and December 31,2003, respectively.

 

With the majority of investments in fixed-income securities, theCompany maintains an investment portfolio that is primarily structured tomaximize total return while preserving the principal asset base and provide asource of liquidity for operating needs. The Company records investment incomewhen earned, and realized gains or losses when sold, as determined using thefirst-in-first-out method.

 

The Company regularly evaluates the appropriateness of investmentsrelative to its internal investment guidelines. The Company operates withinthese guidelines by maintaining a well-diversified portfolio, both across andwithin asset classes. The Company has from time to time retained an independentconsultant to advise the Company on the appropriateness of its investmentpolicy. The Company performs a quarterly evaluation of its investmentsecurities, using both quantitative and qualitative factors to determinewhether a decline in investment value is other-than-temporary. When a declinein an investment’s fair value is determined to be other-than-temporary, a lossis recorded against investment income. When determining whether a decline in aninvestment’s fair value is other-than-temporary, the Company considers theextent and duration to which a security’s market value has been less than itscost, the financial condition and future earnings potential of the issuer,recommendations and opinions from outside investment managers and the currenteconomic environment. For the quarters ended June 30, 2004 and 2003, theCompany recorded investment losses that the

 

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Company believed to be other-than-temporary of $0.1 million and $5.4million, respectively. For the six months ended June 30, 2004 and 2003,the Company recorded investment losses that the Company believes to beother-than-temporary of $0.2 million and $29.3 million, respectively.  The Company believes that it has performed anadequate review for impairment of the investment portfolio and that investmentsare carried at fair value. Changing economic and market conditions in thefuture, however, may cause the Company to reassess its judgment regardingimpairment, which could result in realized losses relating toother-than-temporary declines being charged against future income.

 

As of June 30, 2004 and December 31, 2003, net unrealizedgains from the Company’s fixed-income securities totaled $5.6 million and$131.6 million, respectively, primarily resulting from a general increase ininterest rates during the quarter ended June 30, 2004, compared to ageneral decrease in interest rates in 2003. The Company had a net unrealizedgain in its equity securities portfolio as of June 30, 2004 andDecember 31, 2003 of $222.5 million and $157.2 million, respectively. TheCompany believes that these fluctuations are temporary as a result of currentmarket conditions.

 

The following table illustrates the gross unrealized losses included inthe Company’s investment portfolio aggregated by investment category. The tablealso illustrates the length of time the securities have been in an unrealizedloss position as of June 30, 2004.

 
| ** **                          | ** ** | **June 30, 2004********Gross Unrealized Losses** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------|------------|
|                                |       | **Months in Unrealized  Loss Position**               |       |   |   |
| ** **                          | ** ** | **Less than********12 months**                        | ** ** | **12 months********or more** | ** ** | **Total** | ** ** |
| ** **                          | ** ** | **(In thousands)**                                    | ** ** |
|                                |       |                                                  |       |   |   |   |   |
| U.S. Treasury and agency securities |       | $                                                     | 12,916     |   | $ | 23 |   | $ | 12,939 |   |
| Municipal securities                |       | 13,867                                                |       | 2,602 |   | 16,469 |   |
| Mortgage-backed securities          |       | 15,517                                                |       | 1,523 |   | 17,040 |   |
| Corporate and other securities      |       | 24,804                                                |       | 2,393 |   | 27,197 |   |
| Total debt securities               |       | 67,104                                                |       | 6,541 |   | 73,645 |   |
| Equity and other investments        |       | 1,357                                                 |       | 331 |   | 1,688 |   |
| Total investment securities         |       | $                                                     | 68,461     |   | $ | 6,872 |   | $ | 75,333 |   |

 

TheCompany and certain of its subsidiaries participate in securities lendingprograms whereby the loaned marketable securities in the Company’s portfolioare transferred to borrowers (generally independent brokers or dealers)approved by the Company based on, among other things, their creditworthiness inexchange for collateral initially equal to at least

 

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102%of the value of the securities on loan and is thereafter maintained at aminimum of 100% of the market value of the securities loaned.  The market value of the securities on loan toeach borrower is monitored daily and the borrower is required to deliveradditional collateral if the market value of the collateral falls below 100% ofthe market value of the securities on loan.

 

Under the guidance provided in Statement of Financial AccountingStandards No. 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities,” the Company recognizes the collateral asan asset under “securities lending collateral” on its balance sheet and theCompany records a corresponding liability for the obligation to return thecollateral to the borrower under “securities lending payable.”

 

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***Factors That May Affect Future Results ofOperations***

 

Certain statements contained in “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” such as statementsconcerning the Company’s geographic expansion and other business strategies,the effect of recent health care reform legislation, changes in the competitiveenvironment and small group membership growth and other statements containedherein regarding matters that are not historical facts, are forward-lookingstatements (as such term is defined in the Securities Exchange Act of 1934, asamended). Such statements involve a number of risks and uncertainties that maycause actual results to differ from those projected. Factors that could causeactual results to differ materially include, but are not limited to, thosediscussed below. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof.

 

Completion of the Company’s pending merger with Anthem is contingentupon, among other things, receipt of applicable regulatory approvals. OnJuly 23, 2004, the California Department of Insurance (the “DOI”)announced that it was disapproving Anthem’s application (known as a “Form A”)to acquire control of the Company’s subsidiary, BC Life & Health InsuranceCompany, in connection with the transaction. The DOI’s approval was the finalregulatory approval necessary to complete the merger.  On August 3, 2004, Anthem filed apetition for writ of mandate in the Superior Court of Los Angeles County,California, challenging the DOI’s denial and asking the court to overturn theDOI’s decision. There can be no assurances regarding the outcome of thislawsuit.  If the merger is not completedby November 30, 2004, either WellPoint or Anthem may terminate the mergeragreement. It is notcurrently known when the transaction will close or if the parties will obtainall approvals necessary to complete the merger. Broad latitude in administeringthe applicable regulations is given to the federal and state agencies fromwhich WellPoint and Anthem must seek approvals. There can be no assurance thatthe companies will obtain these approvals or be able to successfully challengethe California Department of Insurance disapproval. As a condition to approvalof the transaction, regulatory agencies may seek to impose requirements orlimitations or costs on the way that the combined company conducts businessafter consummation of the transaction. If the Company or Anthem were to agreeto any material requirements or limitations in order to obtain any necessaryapprovals, such requirements or limitations or additional costs could adverselyaffect the combined company’s ability to integrate the operations of theCompany with those of Anthem, and could result in a material adverse effect onthe combined company’s revenues or results of operations. In addition,achieving the anticipated benefits of the merger will depend in part uponwhether the two companies integrate their businesses in an efficient andeffective manner. Because of the complex nature of the integration process,WellPoint cannot provide any assurances regarding the ultimate success of theseintegration activities.

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors. The lawsuit, which is entitled *Abrams v.WellPoint Health Networks Inc., et al.*, alleges that theCompany’s directors breached their fiduciary duties to stockholders byapproving an Agreement and Plan of Merger with Anthem while in possession ofnon-public information regarding the Company’s financial results for the thirdquarter of 2003. The lawsuit seeks to enjoin the Company from consummating themerger with Anthem, unless the Company adopts and implements a process forobtaining the highest possible price for stockholders, and to rescind any termsof the Agreement and Plan of Merger that have already been implemented.  On May

 

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7, 2004, WellPoint and the plaintiff signed a memorandum ofunderstanding regarding a potential settlement of the action.  The potential settlement contemplated by thememorandum of understanding involves WellPoint agreeing to provide certainadditional disclosures on several matters in the joint proxystatement/prospectus sent to WellPoint’s stockholders beyond those contained inthe preliminary proxy statement/prospectus. The settlement would also provide for the payment by WellPoint of $2.25million to the plaintiff’s counsel for fees and costs (subject to courtapproval).  No part of the settlementcosts will be paid by the WellPoint directors individually.  The settlement would not involve anyadmissions of breaches of fiduciary duty or other wrongdoing by WellPoint orany of its directors.  The settlement andpayment of the plaintiff’s counsel fees would be conditioned upon, among otherthings, completion of the merger.  Any finalsettlement agreement signed by the parties must be approved by the SuperiorCourt judge assigned to the matter. While WellPoint expects to diligently negotiate the terms of a finalsettlement agreement, there can be no assurances that a settlement agreementwill be signed.

 

The Company’s operations are subject tosubstantial regulation by federal, state and local agencies in alljurisdictions in which the Company operates. Many of these agencies haveincreased their scrutiny of managed health care companies in recent periods orare expected to increase their scrutiny as newly passed legislation becomeseffective. From time to time, the Company and its subsidiaries receive requestsfor information from regulatory agencies or are notified that such agencies areconducting reviews, investigations or other proceedings with respect to certainof the Company’s activities. The Company also provides insurance products toMedicare and Medicaid beneficiaries in various states, including to Medi-Calbeneficiaries in various California counties under contracts with theCalifornia Department of Health Services (or delegated local agencies), andprovides administrative services to the Centers for Medicare and MedicaidServices in various capacities (including serving as the largest MedicarePart A fiscal intermediary). There can be no assurance that acting as agovernment contractor in these circumstances will not increase the risk ofheightened scrutiny by such government agencies or that such scrutiny will nothave a material adverse effect on the Company, either through negativepublicity about the Company or through an adverse impact on the Company’sresults of operations. In addition, profitability from this business may beadversely affected by inadequate premium rate increases due to governmentalbudgetary issues. Future actions by any regulatory agencies may have a materialadverse effect on the Company’s business.

 

In connection with the RightCHOICE, Ceruleanand Cobalt transactions, the Company incurred significant additionalindebtedness to fund the cash payments made to the acquired companies’stockholders. In addition, the Company may incur additional indebtedness tofund potential future acquisitions. This existing or new indebtedness mayresult in a significant percentage of the Company’s cash flow being applied tothe payment of interest, and there can be no assurance that the Company’soperations will generate sufficient future cash flow to service thisindebtedness. The Company’s current indebtedness, as well as any indebtednessthat the Company may incur in the future (such as indebtedness incurred to fundrepurchases of its Common Stock or to fund potential future acquisitions), mayadversely affect the Company’s ability to finance its operations and couldlimit the Company’s ability to pursue business opportunities that may be in thebest interests of the Company and its stockholders.

 

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As part of the Company’s business strategy,the Company has acquired substantial operations in new geographic markets overthe last seven years. These businesses, some of which include substantialindemnity-based insurance operations, have experienced varying profitability orlosses in recent periods. Since the relevant dates of acquisition of Cerulean,RightCHOICE, MethodistCare and Cobalt, the Company has continued to workextensively on the integration of these businesses. However, there can be noassurances regarding the ultimate success of the Company’s integration effortsor regarding the ability of the Company to maintain or improve the results ofoperations of the acquired businesses. The Company has incurred and will, amongother things, need to continue to incur considerable expenditures for providernetworks, distribution channels and information systems in addition to thecosts associated with the integration of these acquisitions. The integration ofthese complex businesses may result in, among other things, temporary increasesin claims inventory or other service-related issues that may negatively affectthe Company’s relationship with its customers and contribute to increasedattrition of such customers. The Company’s results of operations could beadversely affected in the event that the Company experiences such problems oris otherwise unable to implement fully its expansion strategy.

 

The Company and certain of its subsidiariesare subject to capital surplus requirements by the California Department ofManaged Health Care, the California, Delaware, Georgia, Missouri and WisconsinDepartments of Insurance, various other state Departments of Insurance and theBlue Cross and Blue Shield Association. Although the Company believes that itis currently in compliance in all material respects with all applicablerequirements, there can be no assurances that applicable requirements will notbe increased in the future.

 

From time to time, the Company and certain ofits subsidiaries are parties to various legal proceedings, many of whichinvolve claims for coverage encountered in the ordinary course of business. TheCompany, like HMOs and health insurers generally, excludes certain health careservices from coverage under its HMO, PPO and other plans. The Company is, inits ordinary course of business, subject to the claims of its enrollees arisingout of decisions to restrict treatment or reimbursement for certain services.The loss of even one such claim, if it results in a significant punitive damageaward, could have a material adverse effect on the Company. In addition, therisk of potential liability under punitive damage theories may increasesignificantly the difficulty of obtaining reasonable settlements of coverageclaims.

 

In May 2000, the California MedicalAssociation filed a lawsuit in U.S. district court in San Francisco againstBCC. The lawsuit alleges that BCC violated the Racketeer Influenced and CorruptOrganizations Act (“RICO”) through various misrepresentations to andinappropriate actions against health care providers. In late 1999, a number ofclass-action lawsuits were brought against several of the Company’s competitorsalleging, among other things, various misrepresentations regarding their healthplans and breaches of fiduciary obligations to health plan members. InAugust 2000, the Company was added as a party to *Shane v.Humana, et al.*, a class-action lawsuit brought on behalf of healthcare providers nationwide. In addition to the RICO claims brought in theCalifornia Medical Association lawsuit, this lawsuit also alleges violations ofERISA, federal and state “prompt pay” regulations and certain common lawclaims. In October 2000, the federal Judicial Panel on MultidistrictLitigation issued an order

 

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consolidating the California Medical Association lawsuit,the *Shane* lawsuit and various other pendingmanaged care class-action lawsuits against other companies before DistrictCourt Judge Federico Moreno in the Southern District of Florida for purposes ofthe pretrial proceedings. In March 2001, Judge Moreno dismissed theplaintiffs’ claims based on violation of RICO, although the dismissal was madewithout prejudice to the plaintiffs’ ability to subsequently refile theirclaims. Judge Moreno also dismissed, with prejudice, the plaintiffs’ federalprompt pay law claims. On March 26, 2001, the plaintiffs filed an amendedcomplaint in its lawsuit, alleging, among other things, revised RICO claims andviolations of California law. On May 3, 2001, the defendants filed amotion to dismiss this amended complaint. On May 9, 2001, Judge Morenoissued an order requiring that all discovery in thelitigation be completed by December 2001, with the exception of discoveryrelated to expert witnesses, which was to be completed by March 15, 2002.In June 2001, the federal Court of Appeals for the 11th Circuit issued astay of Judge Moreno’s discovery order, pending a hearing before the Court ofAppeals on the Company’s appeal of its motion to compel arbitration (which hadearlier been granted in part and denied in part by Judge Moreno). The hearingwas held in January 2002 and, in March 2002, the Court of Appealspanel issued an opinion affirming Judge Moreno’s earlier action with respect tothe motion to compel arbitration. The Company filed a motion requesting arehearing of the matter before the entire 11th Circuit Court of Appeals, whichmotion was denied by the 11th Circuit Court of Appeals in June 2002. OnJuly 29, 2002, Judge Moreno issued an order providing that discovery inthe case would be allowed to re-commence on September 30, 2002. OnSeptember 26, 2002, Judge Moreno issued an additional order certifying anationwide class of physicians in the *Shane* matter,setting a trial date in May 2003 and ordering the parties to participatein non-binding mediation. In October 2002, the defendants, among otherthings, moved to compel arbitration of most claims (which motion was granted inpart in September 2003). In October 2002, the Company also filed amotion with the 11th Circuit Court of Appeals seeking to appeal Judge Moreno’sclass-certification order. The motion was granted. The 11th Circuit heard oralargument on September 11, 2003 on the Company’s appeal. A mediator hasbeen appointed by Judge Moreno and the parties are currently conductingcourt-ordered mediation. On April 30, 2004, Judge Moreno set a new trialdate in March 2005 and extended the deadline for expert discovery toSeptember 29, 2004, which may be further extended.

 

In March 2002, the American DentalAssociation and three individual dentists filed a lawsuit in U.S. districtcourt in Chicago against the Company and BCC. This lawsuit alleges thatWellPoint and BCC engaged in conduct that constituted a breach of contractunder ERISA, trade libel and tortious interference with contractual relationsand existing and prospective business expectancies. The lawsuit seeks class-actionstatus. The Company filed a motion (which was granted in July 2002) withthe federal Judicial Panel on Multidistrict Litigation requesting that theproceedings in this case be consolidated with a similar action brought againstother managed care companies that has been consolidated with the *Shane* lawsuit. The case is currently stayed.

 

In May 2003, a lawsuit entitled *Thomas, et al. v. Blue Cross and Blue Shield Association, et al.*was filed in the U.S. District Court in the Southern District of Florida. Theattorneys representing the plaintiffs in the lawsuit are primarily theattorneys representing the plaintiffs in the *Shane*litigation described above. The defendants in *Thomas*are the Company’s Blue

 

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Cross and BlueShield-licensed subsidiaries, the BCBSA and all of the other current Blue Crossand Blue Shield licensees. The lawsuit alleges that each of the defendants engaged in similaractivities and conduct as that alleged in the *Shane*litigation. The case has been assigned to Judge Moreno. The defendants havemoved to compel arbitration and to dismiss the complaint. Class-certificationdiscovery has been initiated and is on-going. The deadline forclass-certification discovery is December 31, 2004.

 

On March 26, 2003, a lawsuit entitled *Irwin v. AdvancePCS, et al.* wasfiled in the California Superior Court in Alameda County, California. WellPointand certain of its wholly owned subsidiaries are named as defendants in thelawsuit. The complaint alleges that the defendants violated California Businessand Professions Code Section 17200 by engaging in unfair, fraudulent andunlawful business practices. The complaint alleges, among other things, thatpharmacy benefit management companies (such as the Company’s subsidiary thatdoes business under the tradename WellPoint Pharmacy Management) engage inunfair practices such as negotiating discounts in prices of drugs frompharmacies and negotiating rebates from drug manufacturers and retaining suchdiscounts and rebates for their own benefit. The complaint also alleges thatdrugs are included in formularies in exchange for rebates and that thedefendants charge patient co-payments that exceed the actual cost of genericdrugs.

 

In early 2003, a lawsuit entitled *Knecht v. Cigna, et al.* was filedin U.S. District Court in Oregon. This litigation has subsequently beentransferred to Judge Moreno of the U.S. District Court for the SouthernDistrict of Florida. This litigation is a putative class action lawsuit on behalfof chiropractors in the western United States. The Company is a named defendantin the lawsuit. The lawsuit alleges that each of the defendants engaged insimilar activities and conduct as that alleged in the *Shane*litigation. The case is currently stayed.

 

In October 2003, a lawsuit entitled *Solomon, et al. v. Cigna, et al.*was filed in the U.S. District Court in the Southern District in Florida. TheCompany is a named defendant in this lawsuit. This lawsuit is also a putativeclass action brought on behalf of chiropractors, podiatrists and certain othertypes of health care practitioners nationwide. This lawsuit also alleges thatthe defendants engaged in similar activities and conduct as that alleged in the*Shane* litigation. On December 15,2003, this lawsuit was transferred to Judge Moreno, and the case wasconsolidated with the *Knecht* lawsuitfor pre-trial purposes. Both of these cases are currently stayed. InDecember 2003, the plaintiffs in *Solomon, et al. v. Cigna,et al.* filed a similar lawsuit against the Company, the Company’sBlue Cross and Blue Shield-licensed subsidiaries, the BCBSA and all of theother current Blue Cross and Blue Shield licensees. The lawsuit is entitled *Solomon, et al. v. Blue Cross and Blue Shield Association, et al.*and was filed in the U.S. District Court in the Southern District in Florida.On January 7, 2004, this lawsuit was transferred to Judge Moreno. OnMarch 9, 2004, Judge Moreno issued an order restoring this case to theactive docket and placing it on a coordinated track with the *Thomas* lawsuit.

 

The financial and operational impact thatthese and other evolving theories of recovery will have on the managed careindustry generally, or the Company in particular, is at present unknown.

 

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The Company’s future results will depend inpart on its ability to accurately predict health care costs and to managefuture health care costs through product and benefit design, underwritingcriteria, medical management and negotiation of favorable provider contracts.Changes in utilization rates, demographic characteristics, the regulatoryenvironment and health care practices, inflation, newpharmaceuticals/technologies, clusters of high-cost cases and numerous otherfactors are beyond the control of any health plan provider and may adverselyaffect the Company’s ability to predict and control health care costs andclaims, as well as the Company’s financial condition, results of operations orcash flows. Periodic renegotiations of hospital and other provider contracts,coupled with continued consolidation of physician, hospital and other providergroups, may result in increased health care costs and limit the Company’sability to negotiate favorable rates. In recent years, large physician practicemanagement companies have experienced extreme financial difficulties, includingbankruptcy, which may subject the Company to increased credit risk related toprovider groups and cause the Company to incur duplicative health care servicesexpense. Additionally, the Company faces competitive pressure to containpremium prices. Fiscal concerns regarding the continued viability ofgovernment-sponsored programs such as Medicare and Medicaid may causedecreasing reimbursement rates for these programs. Any limitation on theCompany’s ability to increase or maintain its premium levels, design products,implement underwriting criteria or negotiate competitive provider contracts mayadversely affect the Company’s financial condition or results of operations.

 

Managed care organizations, both inside andoutside California, operate in a highly competitive environment that hasundergone significant change in recent years as a result of businessconsolidations, new strategic alliances, aggressive marketing practices bycompetitors and other market pressures. Additional increases in competition(including competition from market entrants offering Internet-based productsand services) could adversely affect the Company’s financial condition, cashflows or results of operations.

 

The Company is dependent on the services ofindependent agents and brokers in the marketing of its health care plans,particularly with respect to individuals, seniors and small employer groupmembers. Such independent agents and brokers are typically not exclusivelydedicated to the Company and may frequently also market health care plans ofthe Company’s competitors. The Company faces intense competition for theservices and allegiance of independent agents and brokers.

 

As a result of the Company’s acquisitions,the Company operates on a select geographic basis nationally and offers aspectrum of health care and specialty products through various risk-sharingarrangements. The Company’s health care products include a variety of managed careofferings as well as traditional fee-for-service coverage. With respect toproduct type, fee-for-service products are generally less profitable thanmanaged care products. A component of the Company’s expansion strategy is totransition over time the traditional insurance members of the Company’sacquired businesses to more managed care products.

 

With respect to the risk-sharing nature ofproducts, managed care products that involve greater potential risk to theCompany generally tend to be more profitable than management services productsand those managed care products where the Company is able to shift risks to

 

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employer groups. Individuals and small employergroups are more likely to purchase the Company’s higher-risk managed careproducts because such purchasers are generally unable or unwilling to beargreater liability for health care expenditures. Typically, government-sponsoredprograms involve the Company’s higher-risk managed care products. Over the pastfew years, the Company has experienced a slight decline in margins in itshigher-risk managed care products and to a lesser extent on its lower-riskmanaged care and management services products. This decline is primarilyattributable to product mix change, product design, competitive pressure andgreater regulatory restrictions applicable to the small employer group market.From time to time, the Company has implemented price increases in certain ofits managed care businesses. While these price increases are intended toimprove profitability, there can be no assurance that this will occur.Subsequent unfavorable changes in the relative profitability between theCompany’s various products could have a material adverse effect on the Company’sresults of operations and on the continued merits of the Company’s geographicexpansion strategy.

 

One of the Company’s wholly ownedsubsidiaries operates as a pharmacy benefit manager (“PBM”) under the tradename WellPoint Pharmacy Management. The PBM industry faces a number of risksand uncertainties in addition to those facing the Company’s core health planbusiness. Such risks and uncertainties include the application of federal andstate anti-remuneration laws (generally known as “anti-kickback” laws), whetherPBMs operate as fiduciaries under the Employee Retirement Income SecurityAct of 1974 (“ERISA”) and are in compliance with their obligations under ERISAor other laws in connection with the development and implementation of itemssuch as formularies, preferred drug listings and therapeutic interventionprograms, and potential liability regarding the use of patient-identifiablemedical information. In addition, a number of federal and state legislativeproposals are being considered that could affect a variety of PBM industrypractices, such as the receipt of rebates from pharmaceutical manufacturers.The Company believes that its PBM business is currently being conducted incompliance in all material respects with applicable legal requirements. However,there can be no assurance that the Company’s PBM business will not be subjectto challenge under various laws and regulations, or that any such challengewill not have a material adverse effect upon the Company’s results ofoperations or financial condition. In addition, future legislative enactmentsaffecting the PBM industry could have a material adverse effect upon theCompany’s results of operations and financial condition.

 

Substantially all of the Company’s investmentassets are in interest-yielding debt securities of varying maturities or equitysecurities. The value of fixed-income securities is highly sensitive tofluctuations in short- and long-term interest rates, with the value decreasingas such rates increase and increasing as such rates decrease. In addition, thevalue of equity securities can fluctuate significantly with changes in marketconditions. Changes in the value of the Company’s investment assets, as aresult of interest rate fluctuations, can affect the Company’s results of operationsand stockholders’ equity. There can be no assurances that interest ratefluctuations will not have a material adverse effect on the results ofoperations or financial condition of the Company.

 

The Company’s operations are dependent onretaining existing employees, attracting additional qualified employees andachieving productivity gains from the Company’s investment in

 

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technology. The Company faces intense competition forqualified information technology personnel and other skilled professionals.There can be no assurances that an inability to retain existing employees orattract additional employees will not have a material adverse effect on theCompany’s results of operations.

 

Prior to the Company’s acquisition of theGBO, John Hancock Mutual Life Insurance Company (“John Hancock”) entered into anumber of reinsurance arrangements with respect to personal accident insuranceand the occupational accident component of workers’ compensation insurance, aportion of which was originated through a pool managed by UnicoverManagers, Inc. Under these arrangements, John Hancock assumed risks as areinsurer and transferred certain of such risks to other companies. Thesearrangements have become the subject of disputes, including a number of legalproceedings to which John Hancock is a party. The Company is currently inarbitration with John Hancock regarding these arrangements. The Companybelieves that it has a number of defenses to avoid any ultimate liability withrespect to these matters and believes that such liabilities were nottransferred to the Company as part of the GBO acquisition. However, if theCompany were to become subject to such liabilities, the Company could sufferlosses that might have a material adverse effect on its financial condition,results of operations or cash flows.

 

In December 2000, a wholly ownedsubsidiary of the Company completed its acquisition of certain mail orderpharmaceutical service assets and now conducts business as a mail orderpharmacy. The pharmacy business is subject to extensive federal, state andlocal regulations that are in many instances different from those under whichthe Company’s core health plan business currently operates. The failure toproperly adhere to these and other applicable regulations could result in theimposition of civil and criminal penalties, which could adversely affect theCompany’s results of operations or financial condition. In addition, pharmaciesare exposed to risks inherent in the packaging and distribution ofpharmaceuticals and other health care products. Although the Company currentlymaintains and intends to continue to maintain professional liability and errorsand omissions liability insurance, there can be no assurances that the coveragelimits under such insurance programs will be adequate to protect against futureclaims or that the Company will be able to maintain insurance on acceptableterms in the future.

 

Following the terrorist attacks ofSeptember 11, 2001, there have been various incidents of suspectedbioterrorist activity in the United States. To date, these incidents haveresulted in related isolated incidents of illness and death. However, federaland state law enforcement officials have issued public warnings aboutadditional potential terrorist activity involving biological and other weapons.If the United States were to experience more widespread bioterrorist or otherattacks, the Company’s covered medical expenses could rise and the Companycould experience a material adverse effect on its results of operations,financial condition and cash flow.

 

In April and May 2002, one of the Company’s wholly owned subsidiaries acting as a pharmacybenefit management business under the trade name WellPoint Pharmacy Managementreceived two administrative subpoenas duces tecum issued by the U.S. Attorney’sOffice in Boston Massachusetts. The Company does not believe that its pharmacybenefit management business

 

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is presently a target of investigation by theU.S. Attorney. The subpoenas appear to focus primarily on WellPoint PharmacyManagement’s relationship with TAP Pharmaceuticals, including TAP’s drugsLupron and Prevacid. The Company has responded to the subpoenas by producingcertain requested documents. The Company believes that it is in compliance inall material respects with all laws and regulations applicable to the pharmacybenefit management business.

 

As a result of the general nationwideeconomic downturn, many states are currently experiencing budget deficits.State legislators are exploring a variety of alternatives to address thissituation. In order to address the budget shortfalls, various states maypropose reductions in payments received by Medicaid managed care providers suchas the Company. For instance, the California Legislature in 2003 enactedlegislation reducing rates paid for Medi-Cal (California’s Medicaid program)coverage. Alternatively, state legislators may seek to impose greater statetaxes. Any significant reduction in payments received by the Company inconnection with its Medicaid managed care business could have a materialadverse effect on the Company’s results of operations or financial condition.Additionally, any increase in state taxes could prolong or exacerbate thecurrent economic downturn, which could in turn have a material adverse effecton the Company’s results of operations or financial condition. Budget cutbackscould also result in reduced employment levels in public sector accounts forwhich the Company provides insured or administrative services products or couldresult in public sector accounts switching from insured products toadministrative services products.

 

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***Review byIndependent Registered Public Accounting Firm***

 

With respect to the unaudited consolidated financial information ofWellPoint Health Networks Inc. for the three-month and six-month periods endedJune 30, 2004 and 2003, PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”)reported that they have applied limited procedures in accordance withprofessional standards for a review of such information.  However, their separate report datedJuly 23, 2004, except Note 16 as to which the date is August 3, 2004,appearing herein states that they did not audit and they do not express anopinion on that unaudited consolidated financial information.  Accordingly, the degree of reliance on theirreport on such information should be restricted in light of the limited natureof the review procedures applied. PricewaterhouseCoopers is not subject to the liability provisions ofSection 11 of the Securities Act of 1933 for their report on the unauditedconsolidated financial information because that report is not a “report” or a“part” of the registration statement prepared or certified byPricewaterhouseCoopers within the meaning of Sections 7 and 11 of the Act.

 

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ITEM 3.     Quantitative and Qualitative Disclosures About Market Risk

 

The Company regularly evaluates its asset and liability interest raterisks, as well as the appropriateness of investments, relative to its internalinvestment guidelines. The Company operates within these guidelines bymaintaining a well-diversified portfolio, both across and within asset classes.The Company has from time to time retained an independent consultant to advisethe Company on the appropriateness of its investment policy.

 

Asset interest rate risk is managed within a duration band tied to theCompany’s liability interest rate risk. Credit risk is managed by maintaininghigh average quality ratings and a well-diversified portfolio.

 

The Company’s use of derivative instruments is generally limited tohedging purposes and has principally consisted of forward exchange contractsand interest rate swaps. The Company’s investment policy prohibits the use ofderivatives for leveraging purposes as well as the creation of risk exposuresnot otherwise allowed within the policy.

 

From time to time, the Company has entered into interest rate swapagreements primarily to minimize significant, unanticipated earningsfluctuations caused by interest rate volatility. The Company’s goal is tomaintain a balance between fixed and floating interest rates on its long-termdebt. The Company believes that this allows it to better anticipate itsinterest payments while helping to manage the asset-liability relationship.

 

# *Interest Rate Risk*

# * *

The Company is exposed to market rate risks associated with itsinvestments and borrowings. Market risk represents the risk of loss in value ofa financial instrument resulting from changes in interest rates and equityprices.

 

As of June 30, 2004, the Company’s current investment securitiesat fair value, totaled $6.8 billion, of which 86.5% was invested infixed-income securities and the remaining 13.5% was invested in equitysecurities. The Company has evaluated the pre-tax net impact to the fair valueof its fixed-income investments over a 12-month period from a hypothetical changein all interest rates of 100, 200 and 300 basis points (“bp”). In doing so,optionality was addressed through Monte Carlo simulation of the price behaviorof securities with embedded options. In addressing prepayments onmortgage-backed securities, the model follows the normal market practice ofestimating a non-interest rate sensitive component (primarily related torelocations) and an interest-sensitive component (primarily related torefinancings) separately. The model is based on statistical techniques appliedto historical prepayment and market data, and then incorporates forward-lookingmortgage market research and judgments about future prepayment behavior.Changes in the fair value of the investment portfolio, net of tax, arereflected in the balance sheet through stockholders’ equity. The results ofthis analysis as of June 30, 2004 are shown in the table below.

 

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| ** **             | ** ** | **Decrease in fair value********given an interest rate increase of:** | ** ** |
|------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **             | ** ** | **100 bp**                                                            | ** ** | **200 bp** | ** ** | **300 bp** | ** ** |
| ** **             | ** ** | **(In millions)**                                                     | ** ** |
|                   |       |                                                                  |       |   |   |   |   |
| Fixed Income Portfolio |       | $                                                                     | (198.6     | ) | $ | (394.5 | ) | $ | (584.2 | ) |
|                        |            |                                                                       |            |  |  |  |  |  |  |  |

 

The Company believes that an interest rate shift in a 12-month periodof 100 bp represents a moderately adverse outcome, while a 200 bp shift issignificantly adverse and a 300 bp shift is unlikely given historicalprecedents. Although the Company holds its bonds as “available for sale” forpurposes of Statement of Financial Accounting Standards No. 115, “Accountingfor Certain Investments in Debt and Equity Securities,” the Company’s cashflows and the short duration of its investment portfolio should allow it tohold securities to maturity, thereby avoiding the recognition of losses shouldinterest rates rise significantly.

 

# *Interest Rate Swap Agreements*

# * *

On January 15, 2002, the Company entered into a $200.0 millionnotional amount interest rate swap agreement with respect to its 2006 Notes.The swap agreement is a contract to exchange a fixed 6 3/8*%* rate for a LIBOR-based floating rate.The swap agreement expires June 15, 2006. In anticipation of thecompletion of the pending merger with Anthem, in June 2004 the Companyterminated this interest rate swap agreement and received proceeds of $4.6million. No gain was recognized under this transaction since the accountingadjustment to the carrying amount of the 2006 Notes of $4.6 million is treatedas a premium and will be amortized as a reduction to interest expense over theremaining life of the 2006 Notes (through June 15, 2006). (See Note 10 to the Consolidated Financial Statements.)

 

The Company has from time to time entered into additional interest rateswap agreements in order to reduce the volatility of interest expense resultingfrom changes in interest rates. As of December 31, 2001, the Company hadentered into $200.0 million of floating to fixed-rate swap agreements, whichconsisted of a $150.0 million notional amount swap agreement at 6.99% and a$50.0 million notional amount swap agreement at 7.06%. As of December 31,2001, the Company also had $235.0 million of LIBOR-based floating rate debtoutstanding. In September 2002, the Company terminated these twofixed-rate swap agreements with an aggregate cash settlement of $17.6 million,of which $1.8 million was accrued interest and the remaining $15.8 millionrepresented the fair value of the swap agreements at the time of terminationand is being amortized over the term of the original swap agreements. As ofJune 30, 2004, the remaining balance to be amortized was $4.4 million.(See Note 10 to the Consolidated Financial Statements for further discussion.)

 

# *Equity Price Risk*

# * *

As of June 30, 2004, the Company’s equity securities were composedprimarily of domestic stocks. Assuming an immediate decrease of 10% in marketvalue, as of June 30, 2004, the hypothetical pre-tax loss in fair value ofstockholders’ equity is estimated to be approximately $92.4 million.

 

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ITEM 4.     Controlsand Procedures

 

The Company maintains “disclosure controls and procedures,” as suchterm is defined in Rules 13a-15(e) and 15d-15(e) of the rules and regulationsunder the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  These disclosure controls andprocedures are designed to ensure that information required to be disclosed inthe Company’s Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the rules and forms of theSecurities and Exchange Commission (the “SEC”), and that such information isaccumulated and communicated to the Company’s management, including its ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosures. As of June 30, 2004, the Company has carried out an evaluationunder the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures. Based upon their evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures were effective in ensuring that material informationrelating to the Company is made known to the Chief Executive Officer and ChiefFinancial Officer by others within the Company during the period in which thisquarterly report on Form 10-Q was being prepared.

 

There has been no change in the Company’s internal control overfinancial reporting during the period covered by this quarterly report on Form10-Q that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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PART II.                         OTHERINFORMATION

 

ITEM 1.     Legal Proceedings

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors. The lawsuit, which is entitled *Abrams v.WellPoint Health Networks Inc., et al.*, alleges that theCompany’s directors breached their fiduciary duties to stockholders byapproving an Agreement and Plan of Merger with Anthem while in possession ofnon-public information regarding the Company’s financial results for the thirdquarter of 2003. The lawsuit seeks to enjoin the Company from consummating themerger with Anthem, unless the Company adopts and implements a process forobtaining the highest possible price for stockholders, and to rescind any termsof the Agreement and Plan of Merger that have already been implemented.  On May 7, 2004, WellPoint and the plaintiffsigned a memorandum of understanding regarding a potential settlement of theaction.  The potential settlementcontemplated by the memorandum of understanding involves WellPoint agreeing toprovide certain additional disclosures on several matters in the joint proxystatement/prospectus sent to WellPoint’s stockholders beyond those contained inthe preliminary proxy statement/prospectus. The settlement would also provide for the payment by WellPoint of $2.25million to the plaintiff’s counsel for fees and costs (subject to courtapproval).  No part of the settlementcosts will be paid by the WellPoint directors individually.  The settlement would not involve any admissionsof breaches of fiduciary duty or other wrongdoing by WellPoint or any of itsdirectors.  The settlement and payment ofthe plaintiff’s counsel fees would be conditioned upon, among other things,completion of the merger.  Any finalsettlement agreement signed by the parties must be approved by the SuperiorCourt judge assigned to the matter. While WellPoint expects to diligently negotiate the terms of a finalsettlement agreement, there can be no assurances that a settlement agreementwill be signed.

 

See “Factors That May Affect Future Results of Operations” for adiscussion of additional various pending legal matters involving the Companyand its subsidiaries. The Company’s annual report on Form 10-K for the yearended December 31, 2003, as amended by Amendment No. 1 on Form 10-K/A,also contains a discussion of various pending legal matters.

 

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ITEM 2.   Changes inSecurities, Use of Proceeds and Issuer Purchases of Equity Securities 

 

During the quarter ended June 30, 2004, the Company had oneoutstanding stock repurchase program. The Company’s stock repurchase program isprimarily intended to reduce the dilutive effect of its employee stock optionand stock purchase plans. The amount the Company spends and the number ofshares repurchased varies based on a variety of factors, including employeestock option grants and the stock price.

 

A summary of the Company’s repurchase activity for the quarter endedJune 30, 2004 is as follows:

 
| ** **                         | ** ** | **Total Number of  Shares Purchased  (1)** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced  Program (2)** | ** ** | **Maximum  Number of  Shares that May  Yet Be  Purchased  Under the  Program** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| April 1 –  April 30 |       | —                                     |       | $                                 | —     |                                                                               | —     |                                                                           | 6,198,400  |   |
| May 1 – May 31                |       | —                                     |       | $                                 | —     |                                                                               | —     |                                                                           | 6,198,400  |   |
| June 1 –  June 30   |       | 942,493                                    |       | $                                 | 111.54     |                                                                               | —     |                                                                           | 6,198,400  |   |
| Total                              |       | 942,493                                    |       | $                                 | 111.54     |                                                                               | —     |                                                                           |       |   |

 

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(1)          All shares purchased during the quarter endedJune 30, 2004 were due to shares delivered to or withheld by the Companyin connection with stock-for-stock stock option exercises and employee payrolltax withholding upon exercise of stock options and vesting of restricted stock.Stock grants to employees and directors and stock issued for stock option plansand stock purchase plans in the Consolidated Statement of Changes inStockholders’ Equity are shown net of these shares purchased.

 

(2)          The board of directors of the Company haspreviously authorized the Company to repurchase up to 35.5 million shares ofthe Company’s Common Stock.

 

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ITEM 4.    Submissionof Matters to a Vote of Security Holders

 

On June 28, 2004, aspecial meeting of stockholders of the Company was held. The agenda item forsuch meeting is shown below, together with the vote of the Company’s CommonStock with respect to such agenda item.

 

1.               Proposal to adopt the Amendedand Restated Agreement and Plan of Merger, effective as of October 26,2003, among Anthem, Inc., Anthem Holding Corp. and the Company.

 
| Votes FOR:        |   | 114,239,790 |   |
|-------------------|--------|-------------|--------|
| Votes AGAINST:    |   | 2,690,681   |   |
| Votes ABSTAIN:    |   | 1,237,934   |   |
| Broker non-votes: |   | 0           |   |

 

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ITEM 6.  Exhibits andReports on Form 8-K

 

(a)          Exhibits

 

See Exhibit Index.

 

(b)         Reportson Form 8-K

 

On April 22, 2004, the Company furnished a current report on Form8-K dated April 21, 2004, which attached a copy of the Company’s pressrelease dated April 21, 2004 regarding the Company’s earnings for thequarter ended March 31, 2004.

 

On May 6, 2004, the Company furnished a current report on Form 8-Kdated May 6, 2004, which attached the text of certain information provided andto be provided by the Company during various investor conferences.

 

Theinformation furnished pursuant to the current reports on Form 8-K describedabove was intended to be furnished under Item 12 of the Form 8-K and is not tobe considered “filed” under the Securities Exchange Act of 1934, as amended,nor shall it be incorporated by reference into this filing or future filings bythe Company under the Securities Act of 1933, as amended or under theSecurities Exchange Act of 1934, as amended, unless the Company expressly setsforth in such future filing that such information is to be considered “filed”or incorporated by reference therein.

 

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**SIGNATURES**

 

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

 

 
|                      | **WELLPOINT HEALTH NETWORKS INC.** |
|---------------------------|------------------------------------|
|                      | Registrant                         |
|                      |                               |
|                      |                               |
| Date: August 9, 2004 | By:                                | /s/ LEONARD D. SCHAEFFER |   |
|                      | Leonard D. Schaeffer               |
|                      | Chairman of the Board of Directors |
|                      | and Chief Executive Officer        |
|                      |                               |
|                      |                               |
| Date: August 9, 2004 | By:                                | /s/ DAVID C. COLBY |   |
|                      | David C. Colby                     |
|                      | Executive Vice President           |
|                      | and Chief Financial Officer        |
|                      |                               |
|                      |                               |
| Date: August 9, 2004 | By:                                | /s/ KENNETH C. ZUREK |   |
|                      | Kenneth C. Zurek                   |
|                      | Senior Vice President, Controller  |
|                      | and Taxation                       |
|                           |                                    |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                                                                                                                                                                                |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.01                |       | Amended and Restated  Recapitalization Agreement dated as of March 31, 1995 by and among the  Registrant, Blue Cross of California, Western Health Partnerships and Western  Foundation for Health Improvement, incorporated by reference to Exhibit 2.1  to the Registrant’s Registration Statement on Form S-4 dated  April 8, 1996. |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 2.02                |       | Agreement and Plan of  Merger dated as of October 17, 2001 by and among the Registrant,  RightCHOICE Managed Care, Inc. and RWP Acquisition Corp., incorporated  by reference to Exhibit 2.1 to the Registrant’s Registration Statement on Form S-4 (Registration No.  333-73382).                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 2.03                |       | Amended and Restated  Agreement and Plan of Merger effective as of October 26, 2003 among  Anthem, Inc., Anthem Holding Corp. and the Registrant, incorporated by  reference to Appendix A to the Registration Statement on Form S-4  (Registration No. 333-110830) filed by Anthem, Inc.                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 3.01                |       | Restated Certificate of  Incorporation of the Registrant, incorporated by reference to Exhibit 3.1 to  the Registrant’s Current Report on Form 8-K dated August 4, 1997  (File No. 001-13083).                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 3.02                |       | Bylaws of the Registrant,  incorporated by reference to Exhibit 4.2 to the Registrant’s Registration  Statement on Form S-8 (Registration No. 333-112933).                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.01                |       | Specimen of Common Stock  certificate of the Registrant, incorporated by reference to Exhibit 4.01 to  the Registrant’s Annual Report on Form 10-K for the year ended  December 31, 2002.                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.02                |       | Restated Certificate of  Incorporation of the Registrant (included in Exhibit 3.01).                                                                                                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.03                |       | Bylaws of the Registrant  (included in Exhibit 3.02).                                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.04                |       | Amended and Restated  Indenture dated as of June 8, 2001 by and between the Registrant and the  Bank of New York, as trustee, incorporated by reference to Exhibit 4.3 to the  Registrant’s Current Report on Form 8-K dated June 7, 2001.                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.05                |       | Form of Note  evidencing the Registrant’s 6 3 / 8% Notes due 2006, incorporated  by reference to Exhibit 4.1 to the Registrant’s Current Report on  Form 8-K dated June 12, 2001.                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 4.06                |       | Form of Note  evidencing the Registrant’s 6 3 / 8% Notes due 2012, incorporated  by reference to Exhibit 4.1 to the Registrant’s Current Report on  Form 8-K dated January 11, 2002.                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 10.01*              |       | Amendment  to the WellPoint 401(k) Retirement Savings Plan executed on July 9,  2004.                                                                                                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 10.02*              |       | Amendment  dated June 28, 2004 to the WellPoint Health Networks Inc. 1999 Executive  Officer Annual Incentive Plan.                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 10.03*              |       | Amendment  dated June 28, 2004 to the WellPoint Health Networks Inc. Management Bonus  Plan.                                                                                                                                                                                                                                                               |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 15.01               |       | Letter on unaudited  interim financial information.                                                                                                                                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 31.01               |       | Certifications.                                                                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 32.01               |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                       |
| 32.02               |       | Certification of Chief Financial  Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                                         |

 

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* Management contract or compensatory plan or arrangement

 

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