**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For the quarterlyperiod ended June 30, 2003**

 

**OR**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from        to        **

 

**Commission FileNumber  001-13083**

 

**WELLPOINT HEALTH NETWORKS INC.**

(Exact name of registrant as specified in its charter)

 

| **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)                       |
|                                                                                                           |   |                             |
| Registrant’s telephone number, including area  code      **(818) 234-4000** |
|                                                                                                           |
| **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 reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.  Yes ý   Noo

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes ý   Noo

 

As of August 5, 2003, there wereapproximately 146,812,527 shares of Common Stock, $0.01 par value of the registrantoutstanding.

 

 

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**WellPoint Health Networks Inc.**

**Quarterly Report on Form 10-Q for the QuarterEnded June 30, 2003**

**Table of Contents**

 
| PART I. FINANCIAL INFORMATION |                               |
|-------------------------------|------------------------------------|
|                          |                               |   |   |
|                          | ITEM 1.  Financial Statements |   |
|                          |                               |   |   |
|                          |                               | Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 | 1 |
|                          |                               |   |   |
|                          |                               | Consolidated Income Statements for the Quarter and Six Months Ended  June 30, 2003 and 2002 | 2 |
|                          |                               |   |   |
|                          |                               | Consolidated Statement of Changes in Stockholders’ Equity for the Six  Months Ended June 30, 2003 | 3 |
|                          |                               |   |   |
|                          |                               | Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002 | 4 |
|                          |                               |   |   |
|                          |                               | Notes to Consolidated Financial Statements | 5 |
|                          |                               |   |   |
|                          |                               | Report of Independent Accountants | 28 |
|                          |                               |   |   |
|                          | ITEM 2.                            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 29 |
|                          |                               |   |   |
|                          | ITEM 3.                            | Quantitative and Qualitative Disclosures  About Market Risk | 61 |
|                          |                               |   |   |
|                          | ITEM 4.                            | Controls and Procedures | 63 |
|                          |                               |   |   |
| PART II. OTHER INFORMATION    |                               |
|                          |                               |   |   |
|                          | ITEM 1.                            | Legal Proceedings | 64 |
|                          |                               |   |   |
|                          | ITEM 4.                            | Submission of Matters to a Vote of Security  Holders | 64 |
|                          |                               |   |   |
|                          | ITEM 6.                            | Exhibits and Reports on Form 8-K | 64 |
|                          |                               |   |   |
| SIGNATURES                    | 65                                 |
|                          |                               |
| EXHIBIT  INDEX                | 66                                 |

 

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PART I.FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements

 

**WellPoint Health Networks Inc.**

Consolidated Balance Sheets

 
| **(In thousands, except share data)**                                                                                     |   | **June 30,  2003** |       | **December  31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|--------|
|                                                                                                                      |   | **(Unaudited)**    |       |                    |   |
| ***ASSETS***                                                                                                              |   |               |       |                    |   |
| Current Assets:                                                                                                           |   |               |       |                    |   |
| Cash and cash equivalents                                                                                                 |   | $                  | 1,378,068  |                    | $      | 1,355,616 |   |
| Investment securities, at market value                                                                                    |   | 6,395,622          |       | 5,282,887               |   |
| Receivables, net                                                                                                          |   | 1,367,685          |       | 1,223,232               |   |
| Deferred tax assets, net                                                                                                  |   | 274,200            |       | 310,245                 |   |
| Other current assets                                                                                                      |   | 249,792            |       | 208,711                 |   |
| Total Current Assets                                                                                                      |   | 9,665,367          |       | 8,380,691               |   |
| Property and equipment, net                                                                                               |   | 357,072            |       | 346,351                 |   |
| Intangible assets, net                                                                                                    |   | 732,332            |       | 737,461                 |   |
| Goodwill, net                                                                                                             |   | 1,710,292          |       | 1,691,771               |   |
| Long-term investments, at market value                                                                                    |   | 148,222            |       | 134,274                 |   |
| Other non-current assets                                                                                                  |   | 174,352            |       | 180,083                 |   |
| Total Assets                                                                                                              |   | $                  | 12,787,637 |                    | $      | 11,470,631 |   |
|                                                                                                                      |   |               |       |                    |   |
| ***LIABILITIES AND STOCKHOLDERS’ EQUITY***                                                                           |   |               |       |                    |   |
| Current Liabilities:                                                                                                      |   |               |       |                    |   |
| Medical claims payable                                                                                                    |   | $                  | 2,518,384  |                    | $      | 2,422,331 |   |
| Reserves for future policy benefits                                                                                       |   | 67,463             |       | 68,907                  |   |
| Unearned premiums                                                                                                         |   | 518,689            |       | 495,508                 |   |
| Accounts payable and accrued expenses                                                                                     |   | 1,130,390          |       | 1,144,662               |   |
| Experience rated and other refunds                                                                                        |   | 252,069            |       | 251,743                 |   |
| Income taxes payable                                                                                                      |   | 106,276            |       | 140,881                 |   |
| Security trades pending payable                                                                                           |   | 399,214            |       | 428,851                 |   |
| Security lending payable                                                                                                  |   | 778,296            |       | 197,453                 |   |
| Other current liabilities                                                                                                 |   | 702,967            |       | 601,513                 |   |
| Total Current Liabilities                                                                                                 |   | 6,473,748          |       | 5,751,849               |   |
| Accrued postretirement benefits                                                                                           |   | 126,722            |       | 123,042                 |   |
| Reserves for future policy benefits,  non-current                                                                         |   | 221,417            |       | 214,328                 |   |
| Long-term debt                                                                                                            |   | 1,163,539          |       | 1,011,578               |   |
| Deferred tax liabilities                                                                                                  |   | 189,097            |       | 187,020                 |   |
| Other non-current liabilities                                                                                             |   | 204,843            |       | 206,117                 |   |
| Total Liabilities                                                                                                         |   | 8,379,366          |       | 7,493,934               |   |
| 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, 149,748,101 issued at June 30, 2003 and December 31, 2002 |   | 1,497              |       | 1,497                   |   |
| Treasury stock, at cost, 3,292,530 and  2,697,958 shares at June 30, 2003 and December 31, 2002, respectively   |   | (215,275           | )          | (173,842                | )      |
| Additional paid-in capital                                                                                                |   | 1,779,751          |       | 1,812,004               |   |
| Retained earnings                                                                                                         |   | 2,732,776          |       | 2,315,254               |   |
| Accumulated other comprehensive income                                                                                    |   | 109,522            |       | 21,784                  |   |
| Total Stockholders’ Equity                                                                                           |   | 4,408,271          |       | 3,976,697               |   |
| Total Liabilities and Stockholders’ Equity                                                                           |   | $                  | 12,787,637 |                    | $      | 11,470,631 |   |

 

Seethe accompanying notes to 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)**                    |   | **2003**                    |      | **2002**                       |   | **2003** |   | **2002** |   |
| Revenues:                                                        |   |                        |      |                           |   |   |   |   |   |
| Premium revenue                                                  |   | $                           | 4,654,854 |                           | $      | 4,025,094 |   | $ | 9,203,159 |   | $ | 7,723,753 |   |
| Management services and other revenue                            |   | 221,466                     |      | 207,831                        |   | 447,637 |   | 392,268 |   |
| Investment income                                                |   | 64,037                      |      | 66,148                         |   | 130,352 |   | 126,062 |   |
|                                                             |   | 4,940,357                   |      | 4,299,073                      |   | 9,781,148 |   | 8,242,083 |   |
| Operating Expenses:                                              |   |                        |      |                           |   |   |   |   |   |
| Health care services and other benefits                          |   | 3,769,667                   |      | 3,282,003                      |   | 7,487,167 |   | 6,264,607 |   |
| Selling expense                                                  |   | 201,237                     |      | 167,465                        |   | 393,234 |   | 323,190 |   |
| General and administrative expense                               |   | 578,000                     |      | 538,586                        |   | 1,167,669 |   | 1,080,675 |   |
|                                                             |   | 4,548,904                   |      | 3,988,054                      |   | 9,048,070 |   | 7,668,472 |   |
| Operating Income                                                 |   | 391,453                     |      | 311,019                        |   | 733,078 |   | 573,611 |   |
| Interest expense                                                 |   | 12,689                      |      | 19,069                         |   | 25,463 |   | 35,554 |   |
| Other expense, net                                               |   | 4,646                       |      | 13,978                         |   | 11,650 |   | 24,901 |   |
| Income before Provision for Income Taxes  and Extraordinary Item |   | 374,118                     |      | 277,972                        |   | 695,965 |   | 513,156 |   |
| Provision for income taxes                                       |   | 149,649                     |      | 111,267                        |   | 278,443 |   | 205,351 |   |
| Income before Extraordinary Item                                 |   | 224,469                     |      | 166,705                        |   | 417,522 |   | 307,805 |   |
| Extraordinary Item:                                              |   |                        |      |                           |   |   |   |   |   |
| Gain from negative goodwill on acquisition                       |   | —                      |      | 4,042                          |   | — |   | 4,042 |   |
| Net Income                                                       |   | $                           | 224,469   |                           | $      | 170,747 |   | $ | 417,522 |   | $ | 311,847 |   |
|                                                             |   |                        |      |                           |   |   |   |   |   |
| Earnings Per Share:                                              |   |                        |      |                           |   |   |   |   |   |
| Income before Extraordinary Item                                 |   | $                           | 1.54      |                           | $      | 1.15 |   | $ | 2.87 |   | $ | 2.17 |   |
| Extraordinary gain from negative goodwill  on acquisition        |   | —                      |      | 0.03                           |   | — |   | 0.03 |   |
| Net Income                                                       |   | $                           | 1.54      |                           | $      | 1.18 |   | $ | 2.87 |   | $ | 2.20 |   |
|                                                             |   |                        |      |                           |   |   |   |   |   |
| Earnings Per Share Assuming Full Dilution:                       |   |                        |      |                           |   |   |   |   |   |
| Income before Extraordinary Item                                 |   | $                           | 1.49      |                           | $      | 1.09 |   | $ | 2.79 |   | $ | 2.07 |   |
| Extraordinary gain from negative goodwill  on acquisition        |   | —                      |      | 0.03                           |   | — |   | 0.03 |   |
| Net Income                                                       |   | $                           | 1.49      |                           | $      | 1.12 |   | $ | 2.79 |   | $ | 2.10 |   |
|                                                             |   |                        |      |                           |   |   |   |   |   |
| Weighted Average Shares Outstanding                              |   | 145,711                     |      | 144,852                        |   | 145,662 |   | 141,986 |   |
| Fully Diluted Weighted Average Shares  Outstanding               |   | 150,217                     |      | 152,566                        |   | 149,697 |   | 149,230 |   |

 

Seethe accompanying notes to the consolidated financial statements

 

2

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**WellPoint Health Networks Inc.**

Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited)

 
|                                                                                                    |   | **Preferred  Stock** |              |   |             |   |       |   |       |     |   | **Additional  Paid - in  Capital** |     | **Retained  Earnings** |   | **Accumulated********Other  Comprehensive  Income** |   | **Total** |      |
|---------------------------------------------------------------------------------------------------------|--------|----------------------|-------------------|--------|------------------|--------|------------|--------|------------|----------|--------|------------------------------------|----------|------------------------|--------|-----------------------------------------------------|--------|-----------|-----------|
|                                                                                                    |   |                 | **Common  Stock** |   |             |   |       |   |
|                                                                                                    |   |                 | **Issued**        |   | **In  Treasury** |   |       |   |       |     |
| **(In thousands)**                                                                                      |   |                 | **Shares**        |   | **Amount**       |   | **Shares** |   | **Amount** |     |   |                               |     |                   |
| Balance as of December 31, 2002                                                               |   | $                    | —            |   | 149,748          |   | $          | 1,497  |       | 2,698    |   | $                                  | (173,842 | )                      | $      | 1,812,004                                           |   | $         | 2,315,254 |   | $ | 21,784 |   | $ | 3,976,697 |   |
| Stock grants to employees and directors                                                                 |   |                 |              |   |             |   |       | (483   | )          | 31,266   |   |                               |     |                   |   |                                                |   | 31,266    |      |
| Stock issued for employee stock option plans and stock purchase plans                                   |   |                 |              |   |             |   |       | (1,834 | )          | 119,715  |   | 30,712                             |     |                   |   |                                                |   | 150,427   |      |
| Stock repurchased, at cost                                                                              |   |                 |              |   |             |   |       | 2,912  |       | (192,414 | )      |                               |     |                   |   |                                                |   | (192,414  | )         |
| Net losses from treasury stock reissued                                                                 |   |                 |              |   |             |   |       |   |       |     |   | (62,965                            | )        |                   |   |                                                |   | (62,965   | )         |
| Comprehensive income                                                                                    |   |                 |              |   |             |   |       |   |       |     |   |                               |     |                   |   |                                                |   |      |      |
| Net income                                                                                              |   |                 |              |   |             |   |       |   |       |     |   |                               |     | 417,522                |   |                                                |   | 417,522   |      |
| Other comprehensive income, net of tax                                                                  |   |                 |              |   |             |   |       |   |       |     |   |                               |     |                   |   |                                                |   |      |      |
| Change in unrealized valuation adjustment on investment securities,  net of reclassification adjustment |   |                 |              |   |             |   |       |   |       |     |   |                               |     |                   |   | 87,738                                              |   | 87,738    |      |
| Total comprehensive income                                                                              |   |                 |              |   |             |   |       |   |       |     |   |                               |     | 417,522                |   | 87,738                                              |   | 505,260   |      |
|                                                                                                    |   |                 |              |   |             |   |       |   |       |     |   |                               |     |                   |   |                                                |   |      |      |
| Balance as of June 30, 2003                                                                             |   | $                    | —            |   | 149,748          |   | $          | 1,497  |       | 3,293    |   | $                                  | (215,275 | )                      | $      | 1,779,751                                           |   | $         | 2,732,776 |   | $ | 109,522 |   | $ | 4,408,271 |   |

 

Seethe accompanying notes to the consolidated financial statements

 

3

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**WellPoint Health Networks Inc.**

Consolidated Statements ofCash Flows

(Unaudited) 

 
|                                                                                                                            |   | **Six Months  Ended June 30,** |      |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|-----------|
| **(In thousands)**                                                                                                              |   | **2003**                       |      | **2002** |   |
| **Cash flows from operating activities:**                                                                                       |   |                           |      |   |   |
| Income before extraordinary item                                                                                                |   | $                              | 417,522   |   | $ | 307,805 |   |
| Adjustments to reconcile income before  extraordinary item to net cash provided by operating activities:                        |   |                           |      |   |   |
| Depreciation and amortization, net of  accretion                                                                                |   | 79,468                         |      | 56,562 |   |
| (Gain) loss on sales of assets, net                                                                                             |   | (10,856                        | )         | 6,533 |   |
| Benefit for deferred income taxes                                                                                               |   | (16,137                        | )         | (58,548 | ) |
| Amortization of deferred gain on sale of  building                                                                              |   | —                         |      | (2,213 | ) |
| Accretion of interest on zero coupon  convertible subordinated debentures 6 *3*/8%  Notes due 2012 and 6 *3*/8%  Notes due 2006 |   | 140                            |      | 3,761 |   |
| (Increase) decrease in certain assets:                                                                                          |   |                           |      |   |   |
| Receivables, net                                                                                                                |   | (212,793                       | )         | (104,912 | ) |
| Other current assets                                                                                                            |   | (41,105                        | )         | (18,159 | ) |
| Other non-current assets                                                                                                        |   | 8,048                          |      | (24,187 | ) |
| Increase (decrease) in certain liabilities:                                                                                     |   |                           |      |   |   |
| Medical claims payable                                                                                                          |   | 95,865                         |      | 200,247 |   |
| Reserves for future policy benefits                                                                                             |   | 5,645                          |      | 12,029 |   |
| Unearned premiums                                                                                                               |   | 17,329                         |      | (24,479 | ) |
| Accounts payable and accrued expenses                                                                                           |   | (13,824                        | )         | 145,730 |   |
| Experience rated and other refunds                                                                                              |   | 326                            |      | 910 |   |
| Income taxes payable                                                                                                            |   | (11,191                        | )         | 18,137 |   |
| Other current liabilities                                                                                                       |   | 101,115                        |      | 62,497 |   |
| Accrued postretirement benefits                                                                                                 |   | 3,680                          |      | 4,249 |   |
| Other non-current liabilities                                                                                                   |   | (1,274                         | )         | 10,606 |   |
| Net cash provided by operating activities                                                                                       |   | 421,958                        |      | 596,568 |   |
| **Cash flows from investing activities:**                                                                                       |   |                           |      |   |   |
| Investments purchased                                                                                                           |   | (5,339,371                     | )         | (3,251,028 | ) |
| Proceeds from investments sold                                                                                                  |   | 4,394,694                      |      | 2,614,967 |   |
| Property and equipment purchased                                                                                                |   | (58,576                        | )         | (55,885 | ) |
| Proceeds from property and equipment sold                                                                                       |   | 5,306                          |      | 4,355 |   |
| Acquisition of new businesses, net of cash  acquired                                                                            |   | (27,708                        | )         | (347,616 | ) |
| Net cash used in investing activities                                                                                           |   | (1,025,655                     | )         | (1,035,207 | ) |
| **Cash flows from financing activities:**                                                                                       |   |                           |      |   |   |
| Net repayment of long-term debt under the  revolving credit facility                                                            |   | —                         |      | (235,000 | ) |
| Net borrowing of commercial paper                                                                                               |   | 149,504                        |      | 199,813 |   |
| Net borrowing of long-term debt under 6 *3*/8% Notes due 2012                                                                   |   | —                         |      | 348,905 |   |
| Cash paid on redemption of zero coupon  convertible subordinated debentures                                                     |   | —                         |      | (5,747 | ) |
| Change in advances on securities lending  deposits                                                                              |   | 580,843                        |      | — |   |
| Proceeds from issuance of Common Stock                                                                                          |   | 88,216                         |      | 107,162 |   |
| Common Stock repurchased                                                                                                        |   | (192,414                       | )         | (122,265 | ) |
| Net cash provided by financing activities                                                                                       |   | 626,149                        |      | 292,868 |   |
| Net increase (decrease) in cash and cash  equivalents                                                                           |   | 22,452                         |      | (145,771 | ) |
| Cash and cash equivalents at beginning of  period                                                                               |   | 1,355,616                      |      | 1,028,476 |   |
| Cash and cash equivalents at end of period                                                                                      |   | $                              | 1,378,068 |   | $ | 882,705 |   |

 

Seethe accompanying notes to the consolidated financial statements

 

4

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**WellPoint Health Networks Inc.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**1.****              Organization**

 

WellPointHealth Networks Inc. (the “Company” or “WellPoint”) is one of the nation’slargest publicly traded managed health care companies.  As of June 30, 2003, WellPoint hadapproximately 13.4 million medical members and approximately 49.4 millionspecialty members.  Through itssubsidiaries, the Company offers a broad spectrum of network-based managed careplans to the large and small employer, individual and senior markets.  The Company’s managed care plans includepreferred provider organizations (“PPOs”), health maintenance organizations(“HMOs”), point-of-service (“POS”) plans and other hybrid plans and traditionalindemnity plans.  In addition, theCompany offers managed care services, including underwriting, actuarialservices, network access, medical management and claims processing. The Companyalso provides a broad array of specialty and other products and servicesincluding pharmacy benefits management, dental, vision, life insurance,preventive care, disability insurance, behavioral health, COBRA and flexiblebenefits account administration.  TheCompany markets its products in California primarily under the name Blue Crossof California, in Georgia primarily under the name Blue Cross Blue Shield ofGeorgia, in various parts of Missouri (including the greater St. Louis area)under the name Blue Cross Blue Shield of Missouri and in various parts of thecountry under the name UNICARE or HealthLink. These products are marketed bythe Company’s various operating subsidiaries throughout the United States. TheCompany holds the exclusive right in California to market its products underthe Blue Cross name and mark and in Georgia and in 85 counties in Missouri(including the greater St. Louis area) to market its products under the BlueCross and Blue Shield names and marks. The Company’s customer base isdiversified, with extensive membership among large and small employer groupsand individuals and in the Medicare and Medicaid markets.

 

**2.****              Basisof Presentation**

 

Theaccompanying unaudited consolidated financial statements of WellPoint have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) and the rules and regulations of theSecurities 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, 2003, the results of its operations for the quarters and six monthsended June 30, 2003 and 2002, its changes in stockholders’ equity for the sixmonths ended June 30, 2003 and its cash flows for the six months ended June 30,2003 and 2002.  The results ofoperations for the interim periods presented are not necessarily indicative of theoperating results for the full year.  These unaudited consolidated financial statements should be readtogether with the consolidated financial statements and notes included in theCompany’s annual report on Form 10-K for the year ended December 31, 2002. TheCompany has reclassified certain prior year amounts in the accompanyingunaudited consolidated financial statements to conform to the 2003presentation.

 

5

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**3.****              New AccountingPronouncements**

 

In April 2002,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64,Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002”(“SFAS No. 145”). With the rescission of FASB Statement No. 4, gains and lossesfrom the extinguishment of debt should be classified as extraordinary itemsonly if they meet the criteria in APB Opinion No. 30. The provisions of APBOpinion No. 30 distinguish between transactions that are part of an entity’srecurring operations and those that are unusual or infrequent or that meet thecriteria for classification as an extraordinary item. The provisions of SFASNo. 145 related to the rescission of FASB Statement No. 4 are required to beapplied for fiscal years beginning after May 15, 2002. The Company hasdetermined that the extinguishment of debt under its Zero Coupon ConvertibleSubordinated Debentures, which were redeemed as of October 28, 2002, does notmeet the requirements of unusual or infrequent and therefore would not beincluded as an extraordinary item with the rescission of FASB Statement No.4.  For the quarter and six months endedJune 30, 2002, WellPoint reclassified an extraordinary loss of $2.1 million,which included a tax benefit of $0.8 million, to interest expense. The Companydoes not believe the other provisions of SFAS No. 145 will have a materialeffect on its consolidated financial statements.

 

In December2002, the FASB amended the transition and disclosure requirements of Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” (“SFAS No. 123”), through the issuance of Statement of FinancialAccounting Standards No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure” (“SFAS No. 148”). SFAS No. 148 amendsthe disclosures that a company is required to make in its annual and interimfinancial statements. These disclosures are required regardless of whether acompany is using the intrinsic value method under APB Opinion No. 25, “Accountingfor Stock Issued to Employees” or the fair value based method under SFAS No.123 to account for its stock-based employee compensation. SFAS No. 148 alsoprovides alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation. SFASNo. 148 is effective for fiscal years ending after December 15, 2002. TheCompany plans to continue to account for stock-based employee compensationunder the intrinsic value-based method. The impact of the fair value-basedmethod on reported income is disclosed in Note 8.

 

In April 2003,the FASB amended and clarified financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and hedging activities under Statement of Financial AccountingStandards No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“SFAS No. 133”), through the issuance of Statement of FinancialAccounting Standards No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“SFAS No. 149”). SFAS No. 149 is effectivefor contracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003. The adoption of SFAS No. 149 isnot expected to have a material impact on the Company’s financial condition orresults of operations.

 

6

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In May 2003, theFASB issued Statement of Financial Accounting Standards No. 150, “Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity” (“SFAS No. 150”). SFAS No. 150 modifies the accounting for certainfinancial instruments that, under previous guidance, issuers could account foras equity. SFAS No. 150 requires that those instruments be classified asliabilities in statements of financial position. Most of the guidance in SFASNo. 150 is effective for all financial instruments entered into or modifiedafter May 31, 2003 or otherwise is effective at the beginning of the firstinterim period beginning after June 15, 2003. The adoption of SFAS No. 150 isnot expected to have a material impact on the Company’s financial condition orresults of operations.

 

**4.     Acquisitions**

 

On June 30, 2003, the Company completed the acquisition of Golden WestHealth Plan, Inc. (“Golden West”) for a purchase price of approximately $30.5million. Upon completion of the acquisition, Golden West had net assets with afair value of approximately $0.5 million and served more than 275,000 dentaland vision members. With the acquisition of Golden West, WellPoint servedapproximately 2.9 million dental members nationally as of June 30, 2003. Thepurchase price allocation between goodwill and identifiable intangible assetswas $17.1 million and $13.0 million, respectively. The operating results forGolden West will be included in WellPoint’s consolidated income statement forperiods following the completion of the acquisition.

 

On April 30, 2002,the Company completed its acquisition of Methodist Care, Inc. (“MethodistCare”), whichserved over 70,000 members in the Houston, Texas and surrounding areas at thetime of acquisition. This acquisition was intended to enable UNICARE,WellPoint’s national operating unit, to expand its product line by offering HMOand  open-access products in the GulfCoast and surrounding regions in Texas, including the greater Houston-Galvestonmetropolitan area. As a result of the acquisition, the Company recognized anextraordinary gain of $8.9 million, or $0.06 per share assuming full dilution,for the year ended December 31, 2002, due to an excess of the fair value of netassets over acquisition costs. The operating results for MethodistCare areincluded in WellPoint’s consolidated income statement for periods following thecompletion of the acquisition.

 

On January 31, 2002, WellPoint completed its merger, through its whollyowned subsidiary, RWP Acquisition Corp., with RightCHOICE Managed Care, Inc.(“RightCHOICE”), the parent company of Blue Cross and Blue Shield of Missouri,which served approximately 2.2 million medical members as of January 31, 2002.Under the terms of the transaction, total consideration paid to all holders ofRightCHOICE common stock and holders of employee stock options in the merger wasapproximately $379.1 million in cash and 16.5 million shares of WellPointCommon Stock. The Company issued approximately 11.1 million shares fromtreasury stock and the remaining 5.4 million shares from newly issued shares ofWellPoint Common Stock. The total purchase price of approximately $1,503.7million was used to purchase net assets with a fair value ofapproximately $308.8 million. The operating results for

 

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RightCHOICE areincluded in WellPoint’s consolidated income statement periods following thecompletion of the acquisition.

 

**5.     Goodwilland Other Intangible Assets**

 

The Companyadopted SFAS No. 142 on January 1, 2002 and no longer amortizes goodwill andother intangible assets with indefinite useful lives. In accordance with SFASNo. 142, the Company completed the transitional evaluation of its goodwill andother intangible assets at January 1, 2002 and the annual evaluation atDecember 31, 2002, and determined that there was no impairment loss.

 

The changes in thecarrying amount of goodwill by reportable segment are as follows:

 
| **(In thousands*****)***                                                                  |   | **Health  Care** |      | **Specialty** |   | **Consolidated** |   |
|-------------------------------------------------------------------------------------------|--------|------------------|-----------|---------------|--------|------------------|--------|
| Balance as of January 1, 2002                                                             |   | $                | 646,375   |          | $      | 14,971           |   | $ | 661,346 |   |
| Goodwill acquired during 2002                                                             |   | 1,074,322        |      | —        |   | 1,074,322        |   |
| Final allocation of Cerulean goodwill and acquired  intangibles                           |   | (47,361          | )         | —        |   | (47,361          | )      |
| Reclassification from other intangible assets, net  of accumulated amortization of $2,005 |   | 3,464            |      | —        |   | 3,464            |   |
| Balance as of December 31, 2002                                                           |   | 1,676,800        |      | 14,971        |   | 1,691,771        |   |
| Final purchase accounting adjustments for  RightCHOICE goodwill                           |   | 1,471            |      |          |   | 1,471            |   |
| Goodwill acquired during 2003                                                             |   | —           |      | 17,050        |   | 17,050           |   |
| Balance as of June 30, 2003                                                               |   | $                | 1,678,271 |          | $      | 32,021           |   | $ | 1,710,292 |   |

 

On June 30, 2003,WellPoint completed its acquisition of Golden West, as discussed in Note4.  As a result of the acquisition ofGolden West, the Company recorded $17.1 million of goodwill and $13.0 millionof identifiable intangible assets as of June 30, 2003. The valuation process isnot yet complete and, therefore, the allocation between goodwill and otherintangible assets recorded as of June 30, 2003 represents an estimate. TheCompany assumes no residual value for its amortizable intangible assets.

 

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The followingtable presents details of the acquired amortized and non-amortized intangibleassets of Golden West at cost as of June 30, 2003:

 
| **(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 |                          |   |                                             |   |   |

 

The gross carryingvalue, accumulated amortization and net carrying value of other intangibleassets as of June 30, 2003 and December 31, 2002 were as follows:

 
| **(In thousands) **                               | ** ** | **Gross   Carrying   Value** |    | **Accumulated  Amortization** |   | **Net   Carrying   Value** |   | **Amortizat-  ion Period  (in years)** |    |
|--------------------------------------------------------|------------|------------------------------|---------|------------------------------------|--------|----------------------------|--------|----------------------------------------|---------|
| **As of June 30, 2003**                                |
| Amortized intangible assets:                           |       |                         |    |                               |   |                       |   |                                   |    |
| Provider relationships                                 |       | $                            | 29,974  |                               | $      | 4,610                      |   | $                                      | 25,364  |   | 10 to 25 |   |
| Customer contracts and related customer  relationships |       | 357,699                      |    | 90,143                             |   | 267,556                    |   | 1.5 to 20                              |    |
| Other                                                  |       | 21,967                       |    | 8,937                              |   | 13,030                     |   | 5 to 20                                |    |
| Total amortized intangible assets                      |       | 409,640                      |    | 103,690                            |   | 305,950                    |   |                                   |    |
|                                                   |       |                         |    |                               |   |                       |   |                                   |    |
| Non-amortized intangible assets:                       |       |                         |    |                               |   |                       |   |                                   |    |
| Provider relationships                                 |       | 17,122                       |    | 98                                 |   | 17,024                     |   | Indefinite                             |    |
| Trade names and service marks                          |       | 412,000                      |    | 2,642                              |   | 409,358                    |   | Indefinite                             |    |
| Total non-amortized intangible assets                  |       | 429,122                      |    | 2,740                              |   | 426,382                    |   |                                   |    |
|                                                   |       |                         |    |                               |   |                       |   |                                   |    |
| Total other intangible assets                          |       | $                            | 838,762 |                               | $      | 106,430                    |   | $                                      | 732,332 |   |   |   |

 

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| **(In thousands) **                               |   | **Gross   Carrying   Value** |    | **Accumulated  Amortization** |   | **Net  Carrying Value** |   | **Amortizat-  ion Period  (in years)** |    |
|--------------------------------------------------------|--------|------------------------------|---------|-------------------------------|--------|-------------------------|--------|----------------------------------------|---------|
| **As of December 31, 2002**                            |   |                         |    |                          |   |
| Amortized intangible assets:                           |   |                         |    |                          |   |                    |   |                                   |    |
| Provider relationships                                 |   | $                            | 29,974  |                          | $      | 3,871                   |   | $                                      | 26,103  |   | 10 to 25 |   |
| Customer contracts and related customer  relationships |   | 352,699                      |    | 73,761                        |   | 278,938                 |   | 1.5 to 20                              |    |
| Other                                                  |   | 21,967                       |    | 7,929                         |   | 14,038                  |   | 5 to 20                                |    |
| Total amortized intangible assets                      |   | 404,640                      |    | 85,561                        |   | 319,079                 |   |                                   |    |
|                                                   |   |                         |    |                          |   |                    |   |                                   |    |
| Non-amortized intangible assets:                       |   |                         |    |                          |   |                    |   |                                   |    |
| Provider relationships                                 |   | 17,122                       |    | 98                            |   | 17,024                  |   | Indefinite                             |    |
| Trade names and service marks                          |   | 404,000                      |    | 2,642                         |   | 401,358                 |   | Indefinite                             |    |
| Total non-amortized intangible assets                  |   | 421,122                      |    | 2,740                         |   | 418,382                 |   |                                   |    |
|                                                   |   |                         |    |                          |   |                    |   |                                   |    |
| Total other intangible assets                          |   | $                            | 825,762 |                          | $      | 88,301                  |   | $                                      | 737,461 |   |   |   |

 

For the quarterand six months ended June 30, 2003, amortization expense relating to intangibleassets was $9.0 million and $18.1 million, respectively. For the quarter andsix months ended June 30, 2002, amortization expense relating to intangibleassets was $9.6 million and $18.4 million, respectively. The following tablepresents the Company’s estimated annual amortization expense for amortizedintangible assets for each of the years ending December 31, 2003, 2004, 2005,2006 and 2007 (amounts in thousands). These estimates were calculated based onthe gross carrying value of amortized intangible assets as of June 30, 2003using the applicable amortization period.

 
| For year ending December 31, 2003 |   | $      | 36,595 |   |
|-----------------------------------|--------|--------|--------|--------|
| For year ending December 31, 2004 |   | 34,489 |   |
| For year ending December 31, 2005 |   | 32,257 |   |
| For year ending December 31, 2006 |   | 27,868 |   |
| For year ending December 31, 2007 |   | 24,907 |   |

 

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**6.     Long-TermDebt**

 

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

 
| **(In  thousands)**      |   | **June 30,  2003** |      | **December 31,  2002** |   |
|--------------------------|--------|--------------------|-----------|------------------------|--------|
|                     |   |               |      |                   |   |
| 6 3/8% Notes due 2006    |   | $                  | 465,252   |                   | $      | 462,838 |   |
| 6 3/8% Notes due 2012    |   | 349,025            |      | 348,982                |   |
| Commercial paper program |   | 349,262            |      | 199,758                |   |
| Total long-term debt     |   | $                  | 1,163,539 |                   | $      | 1,011,578 |   |

 

*6**3/8%Notes due 2012*

 

On January 16,2002, the Company issued $350.0 million aggregate principal amount at maturityof 6 3/8% Notes due January 15, 2012 (the “2012 Notes”). The netproceeds of this offering totaled approximately $348.9 million. The netproceeds from the sale of the 2012 Notes were used to partially finance theRightCHOICE merger discussed in Note 4. The 2012 Notes bear interest at a rateof 6 3/8% per annum, payable semi-annually in arrears on January 15 and July 15of each year commencing July 15, 2002. Interest is computed on the basis of a360-day year of twelve 30-day months. At June 30, 2003 andDecember 31, 2002, the Company had $349.0 million (based upon theprincipal amount of $350.0 million less unamortized discount) of 2012 Notesoutstanding. The related interest expense and amortization of discount andissue costs for each of the quarters ended June 30, 2003 and 2002 totaled $5.7million. The related interest expense and amortization of discount and issuecosts for the six months ended June 30, 2003 and 2002 totaled $11.4 million and$10.5 million, respectively.

 

The 2012 Notesmay be redeemed, in whole or in part, at the Company’s option at any time. Theredemption price for any 2012 Notes redeemed will be equal to the greater ofthe following amounts: 1) 100% of the principal amount of the 2012 Notes beingredeemed on the redemption date; and 2) the sum of the present values of theremaining scheduled payments of principal and interest on the 2012 Notes beingredeemed on that redemption date (not including any portion of any payments ofinterest accrued to the redemption date) discounted to the redemption date on asemiannual basis at the Treasury rate as determined by the Reference TreasuryDealer (J.P. Morgan Securities Inc. or Deutsche Banc Alex Brown or theirrespective successors), plus 25 basis points. In each case, the redemptionprice will also include accrued and unpaid interest on the 2012 Notes to theredemption date.

 

*6**3/8%Notes due 2006*

 

On June 15,2001, the Company issued $450.0 million aggregate principal amount at maturityof 6 3/8% Notes due June 15, 2006 (the “2006 Notes”). The net proceeds of thisoffering totaled approximately $449.0 million. The net proceeds from the saleof the 2006 Notes were used for repayment of indebtedness under the Company’srevolving credit facilities. The 2006 Notes

 

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bear interestat a rate of 6 3/8% per annum, payable semi-annually in arrears on June 15 andDecember 15 of each year commencing December 15, 2001. Interest is computed onthe basis of a 360-day year of twelve 30-day months. At June 30, 2003 andDecember 31, 2002, the Company had $449.4 million and $449.3 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, 2003 and 2002 was $7.5 million. The related interest expense andamortization of discount and issue costs for each of the six-month periodsended June 30, 2003 and 2002 totaled $14.9 million. The 2006 Notes may beredeemed, in whole or in part, at the Company’s option at any time. Theredemption price for any 2006 Notes redeemed will be equal to the greater ofthe following amounts: 1) 100% of the principal amount of the 2006 Notes beingredeemed on the redemption date; and 2) the sum of the present values of theremaining scheduled payments of principal and interest on the 2006 Notes beingredeemed on that redemption date (not including any portion of any payments ofinterest accrued to the redemption date) discounted to the redemption date on asemi-annual basis at the Treasury rate as determined by the designatedReference Treasury Dealer (Salomon Smith Barney Inc. or UBS Warburg LLC ortheir respective successors), plus 25 basis points. In each case, theredemption price will also include accrued and unpaid interest on the 2006Notes to the redemption date.

 

With theintention of reducing the interest expense associated with the 2006 Notes, theCompany, on January 15, 2002, entered into a $200.0 million notional amountinterest rate swap agreement. The swap agreement is a contract to exchange afixed 6 3/8% rate for a LIBOR-based floating rate. The swap agreement expiresJune 15, 2006. As of June 30, 2003 and December 31, 2002, the Companyrecognized a liability adjustment, for the change in the fair value of theinterest rate swap agreement, of $15.9 million and $13.6 million, respectively,related to the 2006 Notes. The Company recognized settlement income of $2.0million and $1.8 million for the quarters ended June 30, 2003 and 2002,respectively, from this interest rate swap, which offset the Company’s interestexpense. For the six months ended June 30, 2003 and 2002, the Companyrecognized settlement income of $3.9 million and $2.8 million, respectivelyfrom this interest rate swap (see Note 7).

 

The 2012 and2006 Notes are unsecured obligations and rank equally with all of the Company’sexisting and future senior unsecured indebtedness. All existing and futureliabilities of the Company’s subsidiaries are and will be effectively senior tothe 2012 and 2006 Notes. The indenture governing the 2012 and 2006 Notescontains a covenant that limits the ability of the Company and its subsidiariesto create liens on any of their property or assets to secure certainindebtedness without also securing the indebtedness under the 2012 and 2006Notes.

 

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*RevolvingCredit Facility*

 

Effective as ofMarch 30, 2001, the Company entered into two unsecured revolving creditfacilities allowing aggregate indebtedness of $1.0 billion in principal amount.Upon execution of these facilities (collectively, the “revolving creditfacility”), the Company terminated its prior $1.0 billion unsecured revolvingfacility. Borrowings under these facilities bear interest at rates determinedby reference to the bank’s base rate or London InterBank Offered Rate (“LIBOR”)plus a margin determined by reference to the then-current rating of theCompany’s unsecured long-term debt by specified rating agencies. A facility feebased on the facility amount, regardless of utilization, is payable quarterly.The facility fee rate is also determined by the senior unsecured long-term debtratings by specified rating agencies. One facility, which provides forborrowings not to exceed $750.0 million at any time outstanding, expires as ofMarch 30, 2006, although it may be extended for up to two additional one-yearperiods under certain circumstances. The other facility, which provides forborrowings not to exceed $250.0 million at any time outstanding, expires onMarch 26, 2004. Any amount outstanding under this facility as ofMarch 26, 2004 may be converted into a one-year term loan at theoption of the Company and will bear interest at rates determined by referenceto the bank’s base rate or LIBOR plus a margin determined by reference to thethen-current rating of the Company’s unsecured long-term debt by specifiedrating agencies, plus 0.125% until paid in full.

 

Loans under the$250.0 million facility are made on a committed basis. Loans under the $750.0million facility are made on a committed basis or pursuant to an auction bidprocess. The $750.0 million facility also contains sublimits for letters ofcredit and “swingline” loans. Each credit agreement requires the Company tomaintain certain financial ratios and contains restrictive covenants, includingrestrictions on the incurrence of additional indebtedness and the granting ofcertain liens, limitations on acquisitions and investments and limitations onchanges in control. During the year ended December 31, 2002, the Company repaidthe entire outstanding principal balance under the revolving credit facility.This repayment was funded in part by the Company’s incurrence of indebtednessdescribed below under the heading****“Commercial Paper Program.” As of June 30,2003, the Company had no amounts outstanding under the revolving creditfacility.

# * *

*ZeroCoupon Convertible Subordinated Debentures*

 

On July 2, 1999,the Company issued $299.0 million aggregate principal amount at maturity ofzero coupon convertible subordinated debentures due 2019 (the “Debentures”).The proceeds totaled approximately $200.8 million. The Debentures accretedinterest at a yield to maturity of 2.0% per year compounded semi-annually.Holders had the option to convert the Debentures into the Company’s CommonStock at any time prior to maturity at a rate of 13.594 shares per $1,000principal amount at maturity. In lieu of delivering shares of Common Stock uponconversion of any Debentures, the Company had the option to pay cash for theDebentures in an amount equal to the last reported sales price of its CommonStock on the

 

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trading daypreceding the conversion date. The Debentures were subordinated in right ofpayment to all existing and future senior indebtedness. On October 6, 1999, theBoard of Directors authorized the repurchase of some or all of the Company’sDebentures for cash. The Company did not repurchase any Debentures during theyear ended December 31, 2001. During 2002, all of the outstanding Debentureswere either redeemed by the Company or converted. Accreted interest related tothe Debentures was $0.7 million and $1.5 million for the quarter and six monthsended June 30, 2002, respectively.

* *

*CommercialPaper Program*

 

In April 2002, theCompany commenced a commercial paper program providing for the issuance of upto $1.0 billion in aggregate maturity value of short-term indebtedness (knowngenerally as “commercial paper”). The commercial paper is being issued by theCompany without registration under the Securities Act of 1933, as amended (the“1933 Act”) in reliance upon the exemption from registration contained inSection 4(2) of the 1933 Act. The commercial paper is issued in denominationsof $100,000 or integral multiples of $1,000 in excess thereof and will bearsuch interest rates, if interest-bearing, or will be sold at such discount fromtheir face amounts, as agreed upon by the Company and the dealer or dealersacting in connection with the commercial paper program. The commercial papermay be issued with varying maturities up to a maximum of 270 days from the dateof issuance. As of June 30, 2003 and December 31, 2002, outstanding commercialpaper totaled approximately $349.3 million and $199.8 million, respectively.The average maturity for the commercial paper was 30.5 days as of June 30, 2003and 54.0 days as of December 31, 2002. The weighted average yield on theoutstanding commercial paper as of June 30, 2003 and December 31, 2002 was1.27% and 1.62%, respectively. The Company intends to maintain commercial paperborrowings of at least the amount outstanding at June 30, 2003 for more thanone year. Accordingly, for financial reporting purposes, the commercial paperhas been classified under non-current liabilities in the accompanyingConsolidated Balance Sheets. The related interest expense for the quarter andsix months ended June 30, 2003 was $1.5 million and $2.6 million, respectively.The related interest expense for the quarter and six months ended June 30, 2002was $0.5 million.

 

*DebtCovenants*

 

The Company’s revolvingcredit facility requires the maintenance of certain financial ratios andcontains other restrictive covenants, including restrictions on the incurrenceof additional indebtedness by subsidiaries and the granting of certain liens,limitations on acquisitions and investments and limitations on changes incontrol. As of June 30, 2003 and December 31, 2002, the Company was incompliance with the requirements in these agreements.

 

 

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**7.     Hedging Activities**

 

The Companymaintains an interest rate risk management strategy that uses derivativeinstruments to minimize significant, unanticipated earnings fluctuations causedby interest rate volatility. The Company’s goal is to maintain a balancebetween fixed and floating interest rates on its long-term debt.

 

By usingderivative financial instruments to hedge exposures to changes in interestrates, the Company exposes itself to credit risk and market risk. Market riskis the adverse effect on the value of a financial instrument that results froma change in interest rates. The Company manages exposure to market riskassociated with interest rate contracts by establishing and monitoringparameters that limit the types and degree of market risk that may be undertaken.

 

The Company usesinterest rate swap agreements to manage interest rate exposures. The principalobjective of such contracts is to minimize the risks and/or costs associatedwith financial and investing activities. The Company does not use derivativefinancial instruments for speculative purposes. The counterparties to thesecontractual arrangements are major financial institutions with which theCompany also has other financial relationships. These counterparties expose theCompany to credit loss in the event of non-performance. However, the Companydoes not anticipate non-performance by the other parties. As of June 30, 2003,the Company reported a derivative asset of $15.9 million related to a fairvalue hedge. The cash flow hedges on the floating rate debt under the revolvingcredit facility were terminated and settled in September 2002 and are discussedin further detail below.

 

*FairValue Hedges*

 

With the intentionof reducing the interest expense associated with the 2006 Notes, the Company,on January 15, 2002, entered into a $200.0 million notional amount interestrate swap agreement. The swap agreement is a contract to exchange a fixed 6 *3*/8% rate for aLIBOR-based floating rate. The swap agreement expires June 15, 2006. For thequarters ended June 30, 2003 and 2002, the Company recognized $2.0 million and$1.8 million, respectively, of income from this swap agreement, which wasrecorded as a reduction to interest expense. For the six months ended June 30,2003 and 2002, the Company recognized $3.9 million and $2.8 million,respectively, of income from this swap agreement, which was recorded as areduction to interest expense. As of June 30, 2003 and December 31, 2002, theCompany recognized a derivative asset of $15.9 million and $13.6 million, respectively,related to this swap agreement.

 

*CashFlow Hedges*

 

The Company hasentered into interest rate swap agreements to reduce the impact of changes ininterest rates on its floating rate debt under its revolving credit facility.The swap agreements are contracts to exchange variable-rate for fixed-rateinterest payments without the exchange of the underlying notional amounts.During the six months ended June 30, 2002, the

 

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Company recognizeda net loss of approximately $8,000, as reported in the Company’s ConsolidatedIncome Statements, which represented the total ineffectiveness of all cash flowhedges during such period.

 

In September 2002,the Company terminated and settled its $150.0 million and $50.0 millionnotional amount interest rate swap agreements with original expiration dates ofOctober 17, 2003 and October 17, 2006, respectively. At termination, theCompany paid $17.6 million, of which $1.8 million was accrued interest and theremaining $15.8 million represented the fair value of the swap agreements atthe time of termination. The fair value of the swap agreements was reflected inaccumulated other comprehensive income and will be amortized as a reduction toinvestment 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, at termination, were $8.0million and $7.8 million, respectively. Amortization of other comprehensiveincome related to the terminated swaps on a pre-tax basis for the quarter andsix months ended June 30, 2003 totaled $2.3 million, or $1.4 million after-taxand $4.7 million, or $2.8 million after-tax, respectively. The unamortizedamounts in other comprehensive income related to the $150.0 million and $50.0million notional amount swap agreements as of June 30, 2003 totaled $2.5million and $6.3 million, respectively. The unamortized pre-tax amounts inother comprehensive income related to the $150.0 million and $50.0 millionnotional amount swap agreements as of December 31, 2002 totaled $6.2 millionand $7.3 million, respectively.

 

In December 2002,the Company decided to hedge a portion of its unrealized gain on anavailable-for-sale equity investment by entering into a zero-cost equitycollar. The Company’s intent was to limit any cash flow impact caused by anydownside price movement in the stock with its anticipated sale. As a result,the Company  designated the equitycollar as a cash flow hedge. The collar was created by combining a purchasedput option with a written call option. During June 2003, the Company terminatedthe equity collar and at the settlement date the Company recorded a loss of$0.9 million on investments as the cost to terminate the equity collar.

 

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**8.     Stock-Based Compensation**

 

At June 30, 2003,the Company had three stock-based employee compensation plans: the 1999 StockIncentive Plan, the 2000 Employee Stock Option Plan and the Employee StockPurchase Plan. The Company accounts for these plans under the recognition andmeasurement principles of APB Opinion No. 25, “Accounting for Stock Issued toEmployees” and related FASB interpretations. Accordingly, compensation cost forstock options under existing plans is measured as the excess, if any, of thequoted market price of the Company’s Common Stock at the date of the grant overthe amount an employee must pay to acquire the stock. No stock-based employeecompensation cost is reflected in net income related to stock options grantedbecause options under those plans had an exercise price equal to the marketvalue of the underlying Common Stock on the date of grant. Employee stock-basedcompensation included in reported net income includes restricted stock awardsbeing amortized over the award’s vesting period.

 

The followingtable illustrates the pro forma effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” as amended by Statement of Financial Accounting Standards No.148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” forthe quarters and six months ended June 30, 2003 and 2002.

 
|                                                                                                                                        |   | **Quarter  Ended  June 30,** |   | **Six Months  Ended********June 30,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|---------------------------------------|--------|
| **(In millions, except per share amounts)**                                                                                                 |   | **2003**                     |   | **2002**                              |   | **2003** |   | **2002** |   |
|                                                                                                                                        |   |                         |   |                                  |   |   |   |   |   |
| Net income—as reported                                                                                                                 |   | $                            | 224.5  |                                  | $      | 170.7 |   | $ | 417.5 |   | $ | 311.8 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                 |   | 0.1                          |   | 0.6                                   |   | 0.5 |   | 1.7 |   |
| Less: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (18.2                        | )      | (14.1                                 | )      | (35.4 | ) | (27.6 | ) |
| Net income—pro forma                                                                                                                   |   | $                            | 206.4  |                                  | $      | 157.2 |   | $ | 382.6 |   | $ | 285.9 |   |
|                                                                                                                                        |   |                         |   |                                  |   |   |   |   |   |
| Earnings per share—as reported                                                                                                         |   | $                            | 1.54   |                                  | $      | 1.18 |   | $ | 2.87 |   | $ | 2.20 |   |
| Earnings per share—pro forma                                                                                                           |   | $                            | 1.42   |                                  | $      | 1.09 |   | $ | 2.63 |   | $ | 2.01 |   |
| Earnings per share assuming full  dilution—as reported                                                                                 |   | $                            | 1.49   |                                  | $      | 1.12 |   | $ | 2.79 |   | $ | 2.10 |   |
| Earnings per share assuming full  dilution—pro forma                                                                                   |   | $                            | 1.37   |                                  | $      | 1.03 |   | $ | 2.56 |   | $ | 1.92 |   |

 

The above proforma disclosures may not be representative of the effects on reported proforma net income for future years.

 

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**9.     EarningsPer Share**

 

The following isan illustration of the dilutive effect of the Company’s potential Common Stockon earnings per share (“EPS”). For the quarters ended June 30, 2003 and 2002,there were outstanding stock options to purchase approximately 410,248 and479,621 shares of Common Stock, respectively, for which the exercise price wasgreater than the average market per share price of Common Stock. For the six months ended June30, 2003 and 2002, there were outstanding stock options to purchaseapproximately 523,318 and 511,121 shares of Common Stock, respectively, forwhich the exercise price was greater than the average market per share price ofCommon Stock. Since the effect of these options was antidilutive, they havebeen excluded from the computation of the diluted earnings per share below.

 
| **(In thousands, except per share data)**                                        |     | **Quarter  Ended   June 30,** |     | **Six Months  Ended  June 30,** |     |
|----------------------------------------------------------------------------------|----------|-------------------------------|----------|---------------------------------|----------|
|                                                                             | **2003** |                          | **2002** |                            | **2003** |   | **2002** |   |
|                                                                             |     |                          |     |                            |     |   |   |   |   |
| **Basic Earnings Per Share Calculation:**                                        |     |                          |     |                            |     |   |   |   |   |
| **Numerator**                                                                    |     |                          |     |                            |     |   |   |   |   |
| Income before extraordinary items                                                |     | $                             | 224,469  |                            | $        | 166,705 |   | $ | 417,522 |   | $ | 307,805 |   |
| Extraordinary gain from negative goodwill on acquisition                         |     | —                        |     | 4,042                           |     | — |   | 4,042 |   |
| Net Income                                                                       |     | $                             | 224,469  |                            | $        | 170,747 |   | $ | 417,522 |   | $ | 311,847 |   |
|                                                                             |     |                          |     |                            |     |   |   |   |   |
| **Denominator**                                                                  |     |                          |     |                            |     |   |   |   |   |
| Weighted average shares outstanding                                              |     | 145,711                       |     | 144,852                         |     | 145,662 |   | 141,986 |   |
|                                                                             |     |                          |     |                            |     |   |   |   |   |
| **Earnings Per Share**                                                           |     |                          |     |                            |     |   |   |   |   |
| Income before extraordinary items                                                |     | $                             | 1.54     |                            | $        | 1.15 |   | $ | 2.87 |   | $ | 2.17 |   |
| Extraordinary gain from negative goodwill on acquisition                         |     | —                        |     | 0.03                            |     | — |   | 0.03 |   |
| Net Income                                                                       |     | $                             | 1.54     |                            | $        | 1.18 |   | $ | 2.87 |   | $ | 2.20 |   |
|                                                                             |     |                          |     |                            |     |   |   |   |   |
| **Earnings Per Share Assuming Full Dilution  Calculation:**                      |     |                          |     |                            |     |   |   |   |   |
| **Numerator**                                                                    |     |                          |     |                            |     |   |   |   |   |
| Income before extraordinary items                                                |     | $                             | 224,469  |                            | $        | 166,705 |   | $ | 417,522 |   | $ | 307,805 |   |
| Interest expense on zero coupon convertible subordinated debentures,  net of tax |     | —                        |     | 483                             |     | — |   | 966 |   |
| Adjusted income before extraordinary items                                       |     | 224,469                       |     | 167,188                         |     | 417,522 |   | 308,771 |   |
| Extraordinary gain from negative goodwill on acquisition                         |     | —                        |     | 4,042                           |     | — |   | 4,042 |   |
| Adjusted Net Income                                                              |     | $                             | 224,469  |                            | $        | 171,230 |   | $ | 417,522 |   | $ | 312,813 |   |
|                                                                             |     |                          |     |                            |     |   |   |   |   |
| **Denominator**                                                                  |     |                          |     |                            |     |   |   |   |   |
| Weighted average shares outstanding                                              |     | 145,711                       |     | 144,852                         |     | 145,662 |   | 141,986 |   |
| Net effect of dilutive stock options                                             |     | 4,506                         |     | 4,758                           |     | 4,035 |   | 4,284 |   |
| Assumed conversion of zero coupon convertible subordinated debentures            |     | —                        |     | 2,956                           |     | — |   | 2,960 |   |
| Fully diluted weighted average shares outstanding                                |     | 150,217                       |     | 152,566                         |     | 149,697 |   | 149,230 |   |
|                                                                             |     |                          |     |                            |     |   |   |   |   |
| **Earnings Per Share Assuming Full Dilution**                                    |     |                          |     |                            |     |   |   |   |   |
| Income before extraordinary items                                                |     | $                             | 1.49     |                            | $        | 1.09 |   | $ | 2.79 |   | $ | 2.07 |   |
| Extraordinary gain from negative goodwill on acquisition                         |     | —                        |     | 0.03                            |     | — |   | 0.03 |   |
| Net Income                                                                       |     | $                             | 1.49     |                            | $        | 1.12 |   | $ | 2.79 |   | $ | 2.10 |   |

 

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**10.  Comprehensive Income**

 

The following summarizescomprehensive income (loss) reclassification adjustments for the six monthsended June 30, 2003 and 2002:

 
| **(In thousands)**                                                                                                                      |     | **Six Months  Ended June 30,** |     |
|-----------------------------------------------------------------------------------------------------------------------------------------|----------|--------------------------------|----------|
|                                                                                                                                    | **2003** |                           | **2002** |   |
|                                                                                                                                    |     |                           |     |   |   |
| Investment Securities:                                                                                                                  |     |                           |     |   |   |
| Net holding gain (loss) on investment securities  arising during the period, net of tax (expense) benefit of  $(56,445) and $9,394 |     | $                              | 83,505   |   | $ | (14,364 | ) |
| Reclassification adjustment for realized  gain on investment securities, net of tax expense of $2,751 and $3,607                        |     | 4,233                          |     | 5,410 |   |
|                                                                                                                                    |     | 87,738                         |     | (8,954 | ) |
| Cash Flow Hedges:                                                                                                                       |     |                           |     |   |   |
| Holding gain related to swap transactions,  net of tax expense of $111                                                                  |     | —                         |     | 160 |   |
|                                                                                                                                    |     |                           |     |   |   |
| Net gain (loss) recognized in other  comprehensive income, net of tax (expense) benefit of $(59,196) and $5,676                         |     | $                              | 87,738   |   | $ | (8,794 | ) |

 

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**11.  BusinessSegment Information**

 

As a result of theJanuary 31, 2002 acquisition of RightCHOICE, the organizational structure ofthe Company changed effective February 1, 2002. As a result of these changes,the Company has the following two reportable segments: Health Care andSpecialty. The Health Care segment is an aggregation of four operatingsegments: California, Central, Georgia and Senior/State-Sponsored programs.These Health Care operating segments all have similar characteristics and meetthe following five aggregation criteria as defined under paragraph 17 ofStatement of Financial Accounting Standards No. 131, “Disclosures AboutSegments of an Enterprise and Related Information” (“SFAS No. 131”):

 

(1)          Alloperating segments provide similar health care products to similar customertypes. WellPoint generally markets the same health care products across thecountry for each of its customer groups.

 

(2)          Theproduction processes are substantially similar for all operating segments asthey support similar customer groups and products.

 

(3)          Eachoperating segment has the same class of customers, primarily large employergroups and individual and small employer groups.

 

(4)          Eachoperating segment has similar distribution channels that are used for each ofthe customer types. Large employer group products are distributed primarilythrough health care consultants and brokers, while individual and small groupproducts are distributed through agents or through captive sales forces. Thesemethods are similar across geographies.

 

(5)          Thehealth care industry is highly regulated at both the federal and state levels.All of the geographies must comply with the same federal regulations. Whileeach state’s laws are in some respects unique, many states have similar lawsand regulations applicable to managed 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’schief operating decision maker (Chief Executive Officer) reviews the results ofoperations on a regular basis and holds each Division President accountable forhis or her segment’s operating results. These operating segments comprising theHealth Care segment provide a broad spectrum of network-based health plans,including PPOs, HMOs, POS plans, other hybrid plans and traditional indemnityproducts, to large and small employers and individuals as well as other healthcare-related products, such as vision, preventive care, COBRA and flexiblebenefits account administration. The Specialty business is maintained as aseparate segment providing an array of specialty products, including pharmacybenefits management, dental, life insurance, disability insurance, behavioralhealth and workers’ compensation managed care services. Amounts under theheading “Corporate and Other” include net investment income, general andadministrative expense and interest expense not allocable to the reportablesegments. Also

 

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included in Corporate and Other are the operating results from theCompany’s captive general insurance agency, which has not met the quantitativethresholds for an operating segment under SFAS No. 131. The operating resultsfor the Company’s captive general insurance agency were previously reported inthe Health Care segment for the quarter and six months ended June 30, 2002, buthave been reclassified to Corporate and Other to conform to the 2003presentation.

 

The accountingpolicies of the segments are consistent with generally accepted accountingprinciples in the United States. The following tables present segmentinformation for the Health Care and Specialty segments for the quarter and sixmonths ended June 30, 2003 and 2002, respectively. The amounts for the quarterand six months ended June 30, 2002 reflect a new method of cost allocation asreviewed by the chief operating decision maker effective January 1, 2003.  As a result of this change, the net incomefor the Health Care segment decreased by $14.8 million while the Specialtysegment increased by $14.8 million for the quarter ended June 30, 2002. For thesix months ended June 30, 2002, net income for the Health Care segmentdecreased by $29.0 million while the Specialty segment increased by $29.0million.

 

In addition, theoperating results by segment for the quarter and six months ended June 30, 2002have been reclassified to conform to a 2003 change in a segment manager’sresponsibility.  For the quarter endedJune 30, 2002, this change resulted in a $1.3 million increase in managementservices and other revenue for the Health Care segment with a corresponding decrease in theSpecialty segment. For the quarter ended June 30, 2002, net income increased by$0.2 million for the Health Care segment, $0.4 million for the Corporate andOther segments while decreasing by $0.6 million for the Specialty segment.  For the six months ended June 30, 2002, netincome decreased by $0.8 million for the Health Care segment while theCorporate and Other segments increased by $0.8 million, respectively.

 

Intersegmentrevenues include internal pharmaceutical sales by the Company’s mail orderpharmacy to the Health Care segment’s members, utilization review fees(primarily related to behavioral health services) and claims and rebateprocessing fees recognized by the Specialty segment for pharmacy benefitmanagement services provided to the Health Care segment. For the quarter andsix 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 $21.2million and $42.8 million, respectively. For the quarter and six months endedJune 30, 2002, pharmaceutical sales totaled $60.6 million and $121.2 million,respectively.  Utilization review feesand claims and rebate processing fees for the quarter and six months endedJune 30, 2002 were not separately identified; estimating such feeswould be impractical. All intersegment transactions are eliminated inconsolidation under the caption “Corporate and Other.”

 

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**Quarter Ended June 30, 2003**

 
| **(In thousands)**                    |   | **HealthCare** |      | **Specialty** |   | **Corporateand 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 |   |

 

**Quarter Ended June 30, 2002**

 
| **(In  thousands)**                   |   | **HealthCare** |      | **Specialty** |   | **Corporateand Other** |   | **Consolidated** |   |
|---------------------------------------|--------|----------------|-----------|---------------|--------|------------------------|--------|------------------|--------|
|                                  |   |           |      |          |   |                   |   |             |   |
| Premium revenue                       |   | $              | 3,898,013 |          | $      | 127,081                |   | $                | — |   | $ | 4,025,094 |   |
| Management services and other revenue |   | 171,551        |      | 36,280        |   | —                 |   | 207,831          |   |
| Total revenue from external customers |   | 4,069,564      |      | 163,361       |   | —                 |   | 4,232,925        |   |
| Intersegment revenues                 |   | —         |      | 60,628        |   | (60,628                | )      | —           |   |
|                                  |   |           |      |          |   |                   |   |             |   |
| Segment net income (loss)             |   | $              | 152,092   |          | $      | 19,450                 |   | $                | (795   | ) | $ | 170,747 |   |

 

**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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**Six Months Ended June 30, 2002**

 
| **(In  thousands)**                   |   | **Health  Care** |      | **Specialty** |   | **Corporate  and Other** |   | **Consolidated** |   |
|---------------------------------------|--------|------------------|-----------|---------------|--------|--------------------------|--------|------------------|--------|
|                                  |   |             |      |          |   |                     |   |             |   |
| Premium revenue                       |   | $                | 7,473,738 |          | $      | 250,015                  |   | $                | — |   | $ | 7,723,753 |   |
| Management services and other revenue |   | 323,956          |      | 68,312        |   | —                   |   | 392,268          |   |
| Total revenue from external customers |   | 7,797,694        |      | 318,327       |   | —                   |   | 8,116,021        |   |
| Intersegment revenues                 |   | —           |      | 121,241       |   | (121,241                 | )      | —           |   |
|                                  |   |             |      |          |   |                     |   |             |   |
| Segment net income (loss)             |   | $                | 282,495   |          | $      | 38,507                   |   | $                | (9,155 | ) | $ | 311,847 |   |

 

**12.  RelatedParty 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 improve the health andwell-being of individuals in the communities served by the Company and itssubsidiaries. The Foundation’s Board of Directors is comprised solely ofpersons who are also officers of the Company. For the quarter and six monthsended June 30, 2003, the Company committed and contributed $10.0million and $20.0 million, respectively, to the Foundation. For the quarter andsix months ended June 30, 2002, the Company contributed or committed tocontribute $15.0 million and $30.0 million, respectively, to the Foundation. Asof June 30, 2003 and December 31, 2002, the Company did not have anyoutstanding commitments payable to the Foundation. The Company currently has nolegal obligations for any future commitments to the Foundation.

 

**13.  Contingencies**

 

From time to time,the Company and certain of its subsidiaries are parties to various legalproceedings, many of which involve claims for coverage encountered in theordinary course of business. The Company, like HMOs and health insurersgenerally, excludes certain health care services from coverage under its HMO,PPO and other plans. The Company is, in its ordinary course of business, subjectto the claims of its enrollees arising out of decisions to restrict treatmentor reimbursement for certain services. The loss of even one such claim, if itresults in a significant punitive damage award, could have a material adverseeffect on the Company. In addition, the risk of potential liability underpunitive damage theories may increase significantly the difficulty of obtainingreasonable settlements of coverage claims.

 

In June 2000, theCalifornia Medical Association filed a lawsuit in U.S. district court in SanFrancisco against Blue Cross of California (“BCC”). The lawsuit alleges thatBCC violated theRacketeer Influenced and Corrupt Organizations Act (“RICO”) through variousmisrepresentations to and inappropriate actions against health care providers.In late 1999, a

 

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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. In August2000, the Company was added as a party to*Shane v. Humana*, *et al*.,a class-action lawsuit brought on behalf of health care providers nationwide.In addition to the RICO claims brought in the California Medical Associationlawsuit, this lawsuit also alleges violations of the Employee Retirement IncomeSecurity Act of 1974, as amended (“ERISA”), federal and state “prompt pay”regulations and certain common law claims. In October 2000, the federalJudicial Panel on Multidistrict Litigation issued an order consolidating theCalifornia Medical Association lawsuit, the *Shane*lawsuit and various other pending managed care class-action lawsuits againstother companies before District Court Judge Federico Moreno in the SouthernDistrict of Florida for purposes of the pretrial proceedings. In March 2001,Judge Moreno dismissed the plaintiffs’ claims based on violation of RICO,although the dismissal was made without prejudice to the plaintiffs’ ability tosubsequently refile their claims. Judge Moreno also dismissed, with prejudice,the plaintiffs’ federal prompt pay law claims. On March 26, 2001, theCalifornia Medical Association filed an amended complaint in its lawsuit,alleging, among other things, revised RICO claims and violations of Californialaw. On May 9, 2001, Judge Moreno issued an order requiring that all discoveryin the litigation be completed by December 2001, with the exception ofdiscovery related 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 Appeals panel issuedan opinion affirming Judge Moreno’s earlier action with respect to the motionto compel arbitration. The Company filed a motion requesting a rehearing of thematter before the entire 11th Circuit Court of Appeals, which motion was deniedby the 11th Circuit Court of Appeals in June 2002. On July 29, 2002, JudgeMoreno issued an order providing that discovery in the case would be allowed tore-commence on September 30, 2002. On September 26, 2002, Judge Moreno issuedan additional order certifying a nationwide class of physicians in the *Shane* matter, setting a trial date in May2003 and ordering the parties to participate in non-binding mediation. InOctober 2002, the Company filed a motion with the 11th Circuit Court of Appealsseeking to appeal Judge Moreno’s class-certification order. The 11thCircuit has scheduled a hearing for September 11, 2003 on the Company’s motion.A mediator has been appointed by Judge Moreno and the parties are currentlyconducting court-ordered mediation.

 

In March 2002, theAmerican Dental Association and three individual dentists filed a lawsuit inU.S. district court in Chicago against the Company and BCC. This lawsuitalleges that WellPoint and BCC engaged in conduct that constituted a breach ofcontract under ERISA, trade libel and tortious interference with contractualrelations and existing and prospective business expectancies. The lawsuit seeksclass-action status. The Company filed a motion (which was granted in July2002) with the federal Judicial Panel on Multidistrict Litigation requestingthat the proceedings in this case be consolidated with a similar action brought

 

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against othermanaged care companies that has been consolidated with the *Shane* lawsuit.

 

In May 2003, alawsuit entitled *Thomas, et al. v. BlueCross and Blue Shield Association*, *etal.*was filed in the U.S. District Court in the Southern District ofFlorida. The attorneys representing the plaintiffs in the lawsuit are primarilythe attorneys representing the plaintiffs in the *Shane*litigation described above. The defendants in *Thomas*are the Company, the Blue Cross andBlue Shield Association and all of the other current Blue Cross and Blue Shieldlicensees. The lawsuit alleges that each of the defendants engaged in similaractivities and conduct as that alleged in the *Shane*litigation. The Company currently anticipates that the *Thomas*litigation will be consolidatedwith the *Shane*litigation.

 

In July 2001, twoindividual physicians seeking to represent a class of physicians, hospitals andother providers brought suit in the Circuit Court of Madison County, Illinoisagainst HealthLink, Inc., which is now a subsidiary of the Company as a resultof the acquisition of RightCHOICE. The physicians allege that HealthLinkbreached the contracts with these physicians by engaging in the practices of“bundling” and “down-coding” in its processing and payment of provider claims.The relief sought includes an injunction against these practices and damages inan unspecified amount. This litigation was dismissed without prejudice at therequest of the plaintiffs in February 2003. A similar lawsuit was brought byphysicians (including one of the physicians in the case described above) in thesame court in Madison County, Illinois, on behalf of a nationwide class ofproviders who contract with Blue Cross and Blue Shield plans against the BlueCross and Blue Shield Association and another Blue Cross Blue Shield plan. Thecomplaint recites that it is brought against those entities and their “unnamedsubsidiaries, licensees, and affiliates,” listing a large number of Blue Crossand Blue Shield plans, including “Alliance Blue Cross Blue Shield of Missouri.”The plaintiffs also allege that the plans have systematically engaged inpractices known as “short paying,” “bundling” and “down-coding” in their processingand payment of subscriber claims. Blue Cross Blue Shield of Missouri has notbeen formally named or served as a defendant in this lawsuit. The Blue Crossand Blue Shield Association was dismissed as a defendant in this lawsuit inAugust 2002.

 

On March 26, 2003,a lawsuit entitled *Irwin v. AdvancePCS, etal.* was filed in the California Superior Court in Alameda County,California.  WellPoint and certain ofits wholly owned subsidiaries are named as defendants in the lawsuit.  The complaint alleges that the defendantsviolated California Business and Professions Code Section 17200 by engaging inunfair, fraudulent and unlawful business practices.  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, suchas negotiating discounts in prices of drugs from pharmacies and negotiatingrebates from drug manufacturers and retaining such discounts and rebates fortheir own benefit.  The complaint alsoalleges that drugs are included in formularies in exchange for rebates and thatthe defendants charge patient co-payments that exceed the actual cost ofgeneric drugs.

 

25

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Prior to theCompany’s acquisition of the Group Benefits Operations of John Hancock MutualLife Insurance Company (“John Hancock”), John Hancock entered into a number ofreinsurance arrangements with respect to personal accident insurance and theoccupational accident component of workers’ compensation insurance, a portionof which was originated through a pool managed by Unicover Managers, Inc. Underthese arrangements, John Hancock assumed risks as a reinsurer and transferredcertain of such risks to other companies. These arrangements have become thesubject of disputes, including a number of legal proceedings to which JohnHancock is a party. The Company believes that it has a number of defenses toavoid any ultimate liability with respect to these matters and believes thatsuch liabilities were not transferred to the Company as part of the GBOacquisition. However, if the Company were to become subject to suchliabilities, the Company could suffer losses that might have a material adverseeffect on its financial condition, results of operations or cash flows.

 

The financial andoperational impact that these and other evolving theories of recovery will haveon the managed care industry generally, or the Company in particular, is atpresent unknown. Certain of such legal proceedings are or may be covered underinsurance policies or indemnification agreements. Based upon informationpresently available, the Company believes that the final outcome of all suchproceedings should not have a material adverse effect on the Company’s resultsof operations, cash flows or financial condition.

 

The Company andits subsidiaries are party to a variety of agreements entered into in theordinary course of business that contain standard indemnity provisionsobligating the Company or such subsidiary to indemnify third parties forcertain 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 indemnity provisions cannot be estimated because the amount ofcosts and expenses that may be incurred by the indemnified parties is unknown.

 

In connection withthe formation of a joint venture providing Medicaid services in Puerto Rico in2000, the Company agreed under certain circumstances to provide additionalfunds to the joint-venture entity. The Company agreed that it would make acapital contribution to the joint venture of up to 80% of any amount necessaryto increase the entity’s capital to meet minimum regulatory capitalrequirements if (i) applicable law or regulation requires an increase in theentity’s capital and the entity does not then have capital sufficient to meetthe increased requirement or (ii) the entity’s medical care ratio is 100% orgreater during any 180-day period and the entity does not then meet statutorycapital requirements under the Puerto Rico Insurance Code. The amount of thisguarantee will not exceed 80% of the amount necessary to provide the entitywith a 12 to 1 premium-to-capital ratio. As of June 30, 2003, the Company’sestimated maximum potential liability pursuant to this guarantee was $26.2million. Since the formation of the joint venture in 2000, the Company has notbeen required to make any payments under this guarantee and the Company doesnot currently expect that any such

 

26

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payments will bemade.

 

**14.  PendingAcquisition**

 

On June 3, 2003,WellPoint entered into a definitive agreement with Cobalt Corporation(“Cobalt”) to merge.  Based on theclosing price of WellPoint’s common stock on June 3, 2003, the transaction wasvalued at approximately $906 million on a fully diluted basis or $20.50 pershare for Cobalt common stock. Upon completion of this transaction, Cobalt willmerge with a wholly owned subsidiary of WellPoint. Cobalt, a publicly tradedcompany, 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 state of Wisconsin. As of June 30, 2003, Cobalt servedapproximately 785,000 medical members. Headquartered in Milwaukee, Wisconsin,Cobalt, along with its subsidiaries, offers a diverse portfolio ofcomplementary insurance, managed care products and administrative services toemployer, individual, insurer and government customers. The transaction is intended to be tax-freewith respect to the WellPoint stock to be received in the transaction by Cobaltshareholders. The consideration to be received by the shareholders of Cobaltwill be comprised of $10.25 in cash and WellPoint stock at a fixed exchangeratio of 0.1233 of a share of WellPoint stock for each share of Cobalt stock(valued at $10.25 per share at the market close on June 3, 2003). The exchangeratio will be adjusted if WellPoint’s stock price falls below $70.97, so thatCobalt shareholders receive no less than $8.75 per share in stock considerationand no less than $19.00 per share in stock and cash consideration.

 

The transaction is subject to customary closing conditions, includingapproval of Cobalt’s shareholders and various regulatory and third partyconsents. The Company currently expects the transaction to close by the end of2003.

 

27

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Report of IndependentAccountants

 

 

To theStockholders and Board of Directors of

WellPoint HealthNetworks Inc.

 

We have reviewed the accompanying consolidated balance sheet of WellPointHealth Networks Inc. and its subsidiaries (the “Company”) as of June 30, 2003,and the related consolidated income statements for each of the three-month andsix-month periods ended June 30, 2003 and 2002, and the related consolidatedstatement of changes in stockholders’ equity for the six-month period endedJune 30, 2003 and the consolidated statements of cash flows for the six-monthperiods ended June 30, 2003 and 2002. These interim financial statements are the responsibility of theCompany’s management.

 

We conducted our review in accordance with standards established by theAmerican Institute of Certified Public Accountants.  A review of interim financial information consists principally ofapplying analytical procedures and making inquiries of persons responsible forfinancial and accounting matters.  It issubstantially less in scope than an audit conducted in accordance withgenerally accepted auditing standards, the objective of which is the expressionof an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications thatshould be made to the accompanying consolidated interim financial statementsfor them to be in conformity with accounting principles generally accepted inthe United States of America.

 

We previously audited in accordance with auditing standards generallyaccepted in the United States of America, the consolidated balance sheet as ofDecember 31, 2002, and the related consolidated income statement andconsolidated changes in stockholders’ equity, and cash flows for the year thenended (not presented herein), and in our report dated January 31, 2003 exceptNote 24 as to which the date is March 5, 2003, we expressed an unqualifiedopinion on those consolidated financial statements.  Our report included an explanatory paragraph, that effectiveJanuary 1, 2002, the Company adopted Statement of Financial AccountingStandards No. 142, *Goodwill and OtherIntangible Assets*. Accordingly, the Company ceased amortizing goodwill and indefinite-livedintangible assets as of January 1, 2002. In our opinion, the information set forth in the accompanyingconsolidated balance sheet information as of December 31, 2002, is fairlystated in all material respects in relation to the consolidated balance sheetfrom which it has been derived.

 

 
| /s/  PricewaterhouseCoopers LLP |   |
|---------------------------------|--------|
|                            |
| PricewaterhouseCoopers  LLP     |
| Los Angeles,  California        |
| July 21, 2003                   |

 

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ITEM 2.     Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

 

This discussioncontains forward-looking statements, which involve risks anduncertainties.  The Company’s actualresults may differ materially from those anticipated in these forward-lookingstatements as a result of certain factors including, but not limited to, thoseset forth under “Factors That May Affect Future Results of Operations.”

 

***General***

 

The Company is oneof the nation’s largest publicly traded managed health care companies. As ofJune 30, 2003, WellPoint had approximately 13.4 million medical members andapproximately 49.4 million specialty members. Through its subsidiaries, theCompany offers a broad spectrum of network-based managed care plans to thelarge and small employer, individual, Medicaid and senior markets. TheCompany’s managed care plans include PPOs, HMOs, POS plans and other hybridplans and traditional indemnity products. In addition, the Company offersmanaged care services, including underwriting, actuarial services, networkaccess, medical management and claims processing. The Company also provides abroad array of specialty and other products, including pharmacy benefitsmanagement, dental, vision, life insurance, preventive care, disabilityinsurance, behavioral health, COBRA and flexible benefits accountadministration. The Company markets its products in California primarily underthe name Blue Cross of California, in Georgia primarily under the name BlueCross Blue Shield of Georgia, in various parts of Missouri (including thegreater St. Louis area) under the name Blue Cross Blue Shield of Missouri andin various parts of the country under the name UNICARE or HealthLink. TheCompany holds the exclusive right in California to market its products underthe Blue Cross name and mark and in Georgia and in 85 counties in Missouri (includingthe greater St. Louis area) to market its products under the Blue Cross andBlue Shield names and marks.

 

*Acquisition ofGolden West*

 

On June 30, 2003,the Company completed its acquisition of Golden West (see Note 4 to theConsolidated Financial Statements), which served over 275,000 dental and visionmembers at the time of acquisition.

 

*Acquisition ofMethodistCare*

 

On April 30, 2002,the Company completed its acquisition of MethodistCare (see Note 4 to theConsolidated Financial Statements), which served over 70,000 members inHouston, Texas and surrounding areas at the time of acquisition.

 

*Acquisition ofRightCHOICE*

# * *

On January 31,2002, the Company completed this transaction, pursuant to which RightCHOICEbecame a wholly owned subsidiary of the Company (see Note 4 to the ConsolidatedFinancial Statements). At closing, the acquisition was valued at approximately$1.5 billion, which was paid with $379.1 million in cash and approximately 16.5million

 

29

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shares ofWellPoint Common Stock. RightCHOICE, through its HealthLink subsidiary, alsoprovides network rental, administrative services, workers’ compensation managedcare services and other non-underwritten health benefit programs. As of January31, 2002, RightCHOICE served approximately 2.2 million medical members inMissouri, Arkansas, Illinois, Indiana, Iowa, Kentucky and West Virginia.RightCHOICE has historically experienced a higher general and administrativeexpense ratio than the Company’s core businesses due to its higherconcentration of administrative services business.

 

*CareFirst Merger Agreement*

 

In November 2001,WellPoint entered into a merger agreement with CareFirst, Inc., which agreementwas amended in January 2003. CareFirst has the exclusive right to use the BlueCross and Blue Shield names and marks in Maryland, Delaware and the District ofColumbia. Under the amended merger agreement, CareFirst would have become asubsidiary of WellPoint.  Theconsummation of the CareFirst transaction was subject to a number ofconditions, 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, the Maryland insurance commissioner issued an orderdisapproving this conversion.  In August2003, the Company received a notice from CareFirst electing to terminate theamended merger agreement in accordance with its terms.

 

In August 2003, the Companyreceived a Grand Jury subpoena from the United States Attorney's office in theDistrict of Maryland requesting various documents relating to the CareFirsttransaction.  The Company intends torespond to the request and cooperate fully with the United States Attorney.  The Company has no reason to believe it is atarget of the proceedings.

 

*PendingAcquisition of Cobalt*

 

On June 3, 2003,WellPoint entered into a definitive agreement with Cobalt Corporation(“Cobalt”) to merge.  Based on theclosing price of WellPoint’s common stock on June 3, 2003, the transaction wasvalued at approximately $906 million on a fully diluted basis or $20.50 pershare for Cobalt common stock. Upon completion of this transaction, Cobalt willmerge with a wholly owned subsidiary of WellPoint. Cobalt, a publicly tradedcompany, 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 state of Wisconsin. As of June 30, 2003, Cobalt servedapproximately 785,000 medical members. Headquartered in Milwaukee, Wisconsin,Cobalt, along with its subsidiaries, offers a diverse portfolio ofcomplementary insurance, managed care products and administrative services toemployer, individual, insurer and government customers. The transaction is intended to be tax-freewith respect to the WellPoint stock to be received in the transaction by Cobaltshareholders. The consideration to be received by the shareholders of Cobaltwill be comprised of $10.25 in cash and WellPoint stock at a fixed exchangeratio of 0.1233 of a share of WellPoint stock for each share of Cobalt stock(valued at $10.25 per share at the market close on June 3, 2003). The exchangeratio will be adjusted if WellPoint’s stock price falls below $70.97, so thatCobalt shareholders receive no less than $8.75 per share in stock considerationand no less than $19.00 per share in stock and cash consideration.

 

The transaction is subject to customary closing conditions, includingapproval of Cobalt’s shareholders and various regulatory and third partyconsents. The Company currently expects the transaction to close by the end of2003.

 

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*National Expansion and Other RecentDevelopments*

 

In an effort topursue the expansion of the Company’s business outside the state of California,the Company acquired two businesses in 1996 and 1997, the Life and HealthBenefits Management Division of Massachusetts Mutual Life Insurance Company andthe Group Benefits Operations (the “GBO”) of John Hancock Mutual Life InsuranceCompany. The acquisitions of Rush Prudential Health Plans and a mail-orderpharmacy, which now does business as PrecisionRx, in 2000, the acquisition ofCerulean Companies, Inc. in 2001, and the acquisitions of RightCHOICE andMethodistCare in 2002 were also components of this expansion strategy. In June2003, the Company entered into a definitive agreement to merge with Cobalt,which will further expand the Company’s business in the Midwest region.

 

As a result ofthese acquisitions, the Company has significantly expanded its operationsoutside of California. In order to integrate its acquired businesses andimplement its regional expansion strategy, the Company will need to developsatisfactory networks of hospitals, physicians and other health care serviceproviders, develop distribution channels for its products and successfullyconvert acquired books of business to the Company’s existing informationsystems, which will require continued investments by the Company.

 

In response torising medical and pharmacy costs, the Company has from time to timeimplemented premium increases with respect to certain of its products. TheCompany will continue to evaluate the need for further premium increases, plandesign changes and other appropriate actions in the future in order to maintainor restore profit margins. There can be no assurances, however, that theCompany will be able to take subsequent pricing or other actions or that anyactions previously taken or implemented in the future will be successful inaddressing any concerns that may arise with respect to the performance ofcertain businesses.

 

## *Legislation*

 

Federal legislation enactedduring the last several years seeks, among other things, to ensure theportability of health coverage and mandates minimum maternity hospital stays.California legislation enacted since 1999, among other things, establishes anexplicit duty on managed care entities to exercise ordinary care in arrangingfor the provision of medically necessary health care services and establishes asystem of independent medical review. In 1997, Texas adopted legislationpurporting to make managed care organizations such as the Company liable fortheir failure to exercise ordinary care when making health care treatmentdecisions. Similar legislation has also been enacted in Georgia. These andother proposed measures may have the effect of dramatically altering theregulation of health care and of increasing the Company’s medical care ratioand administrative costs or decreasing the affordability of the Company’sproducts.

 

31

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***Consolidated Results of Operations***

 

The Company’srevenues are primarily generated from premiums earned for risk-based healthcare and specialty services provided to its members; fees for administrativeservices, including claims processing and access to provider networks forself-insured employers; and investment income. Operating expenses includehealth care services and other benefits expenses, consisting primarily ofpayments 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’sconsolidated results of operations for the six months ended June 30, 2003include its acquired operations of RightCHOICE for the entire six months, whileoperating results for the six months ended June 30, 2002 include the results ofRightCHOICE from January 31, 2002, the date of acquisition.

 

The followingtable sets forth selected operating ratios. The medical care ratio for health care services and other benefits isshown as a percentage of premium revenue. All other ratios are shown as a percentage of premium revenue andmanagement services revenue combined.

 
|                                                         |   | **Quarter  Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------------|--------|------------------------------|--------|---------------------------------|--------|
|                                                         |   | **2003**                     |   | **2002**                        |   | **2003** |   | **2002** |   |
| Operating Revenues:                                          |   |                         |   |                            |   |   |   |   |   |
| Premium revenue                                              |   | 95.5                         | %      | 95.1                            | %      | 95.4 | % | 95.2 | % |
| Management services and other revenue                        |   | 4.5                          | %      | 4.9                             | %      | 4.6 | % | 4.8 | % |
|                                                         |   | 100.0                        | %      | 100.0                           | %      | 100.0 | % | 100.0 | % |
| Operating Expenses:                                          |   |                         |   |                            |   |   |   |   |   |
| Health care services and other benefits (medical care ratio) |   | 81.0                         | %      | 81.5                            | %      | 81.4 | % | 81.1 | % |
| Selling expense                                              |   | 4.1                          | %      | 4.0                             | %      | 4.1 | % | 4.0 | % |
| General and administrative expense                           |   | 11.9                         | %      | 12.7                            | %      | 12.1 | % | 13.3 | % |

 

 

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***Membership***

 

The following table sets forthmembership data and the percent change in membership:  

 
|                                 |   | **June 30,**   |       | **Percent  Change** |       |
|--------------------------------------|--------|----------------|------------|---------------------|------------|
| **Medical Membership  (a)(b)(c)(d)** |   | **2003 (e)**   |       | **2002 (e)**        |       |   |
| **California**                       |   |           |       |                |       |   |   |
| Large Group                          |   | 4,788,890      |       | 4,490,864           |       | 6.6 | % |
| Individual and Small Group           |   | 1,626,412      |       | 1,607,429           |       | 1.2 | % |
| Senior                               |   | 248,127        |       | 237,505             |       | 4.5 | % |
| Total California                     |   | 6,663,429      |       | 6,335,798           |       | 5.2 | % |
| **Georgia**                          |   |           |       |                |       |   |   |
| Large Group                          |   | 1,642,594      |       | 1,583,617           |       | 3.7 | % |
| Individual and Small Group           |   | 466,909        |       | 391,211             |       | 19.3 | % |
| Senior                               |   | 69,154         |       | 70,396              |       | -1.8 | % |
| Total Georgia                        |   | 2,178,657      |       | 2,045,224           |       | 6.5 | % |
|                                 |   |           |       |                |       |   |   |
| **Central Region (f)**               |   |           |       |                |       |   |   |
| **Missouri**                         |   |           |       |                |       |   |   |
| Large Group                          |   | 1,259,211      |       | 1,272,057           |       | -1.0 | % |
| Individual and Small Group           |   | 240,480        |       | 232,340             |       | 3.5 | % |
| Senior                               |   | 41,239         |       | 43,056              |       | -4.2 | % |
| Total Missouri                       |   | 1,540,930      |       | 1,547,453           |       | -0.4 | % |
| **Illinois**                         |   |           |       |                |       |   |   |
| Large Group                          |   | 596,577        |       | 769,750             |       | -22.5 | % |
| Individual and Small Group           |   | 115,330        |       | 120,832             |       | -4.6 | % |
| Senior                               |   | 12,401         |       | 12,589              |       | -1.5 | % |
| Total Illinois                       |   | 724,308        |       | 903,171             |       | -19.8 | % |
| **Texas**                            |   |           |       |                |       |   |   |
| Large Group                          |   | 287,875        |       | 373,150             |       | -22.9 | % |
| Individual and Small Group           |   | 194,829        |       | 196,291             |       | -0.7 | % |
| Senior                               |   | 2,710          |       | 521                 |       | 420.2 | % |
| Total Texas                          |   | 485,414        |       | 569,962             |       | -14.8 | % |
| **Other States**                     |   |           |       |                |       |   |   |
| Large Group                          |   | 1,657,265      |       | 1,526,765           |       | 8.5 | % |
| Individual and Small Group           |   | 101,578        |       | 92,088              |       | 10.3 | % |
| Senior                               |   | 26,217         |       | 21,907              |       | 19.7 | % |
| Total Other States                   |   | 1,785,060      |       | 1,640,760           |       | 8.8 | % |
| **Total Medical  Membership**        |   | **13,377,798** | ** ** | **13,042,368**      |       | 2.6 | % |
|                                 |   |           |       |                |       |   |   |
| **ASO Membership (g)**               |   |           | ** ** |                | ** ** |   | ** ** |
| California                           |   | 1,581,804      |       | 1,444,984           |       | 9.5 | % |
| Georgia                              |   | 860,378        |       | 875,547             |       | -1.7 | % |
| Central Region                       |   | 2,640,156      |       | 2,802,028           |       | -5.8 | % |
| **Total ASO Membership**             |   | **5,082,338**  | ** ** | **5,122,559**       |       | -0.8 | % |
|                                 |   |           | ** ** |                | ** ** |   | ** ** |
| **Risk Membership**                  |   |           | ** ** |                | ** ** |   | ** ** |
| California                           |   | 5,081,625      |       | 4,890,814           |       | 3.9 | % |
| Georgia                              |   | 1,318,279      |       | 1,169,677           |       | 12.7 | % |
| Central Region                       |   | 1,895,556      |       | 1,859,318           |       | 1.9 | % |
| **Total Risk Membership**            |   | **8,295,460**  | ** ** | **7,919,809**       |       | 4.7 | % |
| **Total Medical Membership**         |   | **13,377,798** | ** ** | **13,042,368**      |       | 2.6 | % |

 

33

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|                              |   | **June 30,** |   | **Percent  Change** |   |
|-----------------------------------|--------|--------------|--------|---------------------|--------|
| **State-Sponsored  Programs (h)** |   | **2003**     |   | **2002**            |   |   |
| Medi-Cal/Medicaid                 |   |         |   |                |   |   |   |
| California                        |   | 836,788      |   | 783,139             |   | 6.9 | % |
| Virginia                          |   | 44,187       |   | 38,083              |   | 16.0 | % |
| Puerto Rico                       |   | 269,918      |   | 209,827             |   | 28.6 | % |
| Other                             |   | 98,008       |   | 62,893              |   | 55.8 | % |
| Total                             |   | 1,248,901    |   | 1,093,942           |   | 14.2 | % |
|                              |   |         |   |                |   |   |   |
| Healthy Families                  |   | 271,316      |   | 229,721             |   | 18.1 | % |
|                              |   |         |   |                |   |   |   |
| MRMIP / AIM / IHRP                |   | 18,396       |   | 17,938              |   | 2.6 | % |
|                              |   |         |   |                |   |   |   |
| California Kids                   |   | 20,122       |   | 19,287              |   | 4.3 | % |
| Total                             |   | 1,558,735    |   | 1,360,888           |   | 14.5 | % |

 

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(a)                                  Membershipnumbers are approximate and include some estimates based upon the number ofcontracts at the relevant date and an actuarial estimate of the number ofmembers represented by the contract.

(b)                                 Classificationbetween states for employer groups is determined by the zip code of thesubscriber.

(c)                                  Medicalmembership includes management services and network services members, which areprimarily included in the Large Group for each respective state.

(d)                                 Seniormembership includes members covered under both Medicare risk and Medicaresupplement products.

(e)                                  Membershipnumbers as of June 30, 2003 and June 30, 2002 have been adjusted from thenumbers previously reported in the Company's current report on Form 8-K datedJuly 22, 2003. The membership data has been reclassified to reflect thezip code of the subscriber of HealthLink's commercial insurer accounts.  These members were previously included inthe commercial insurers’ or employers' state of domicile. 

(f)                                    CentralRegion - Large Group membership includes network access services members,primarily from HealthLink, of 1,385,622 and 1,405,499 as of June 30, 2003 andJune 30, 2002, respectively.

(g)                                 ASOMembership represents members for which the Company provides administrativeservices only and does not assume full insurance risk.

(h)                                 Medi-Calmembership is included in California - Large Group.  Medicaid membership for Virginia, Puerto Rico and Other areincluded in Other States - Large Group. Healthy Families, MRMIP (Major Risk Medical Insurance Program) /AIM(Access for Infants and Mothers) / IHRP (Interim High Risk Program) andCalifornia Kids membership is included in California - Large Group.

 

***Specialty Membership***

*** ***
|                         |   | **June 30,** |   | **Percent  Change** |   |
|------------------------------|--------|--------------|--------|---------------------|--------|
|                         |   | **2003**     |   | **2002**            |   |   |
|                         |   |         |   |                |   |   |   |
| Pharmacy Benefits Management |   | 35,980,533   |   | 32,912,985          |   | 9.3 | % |
| Dental                       |   | 2,880,224    |   | 2,704,078           |   | 6.5 | % |
| Life                         |   | 2,810,903    |   | 2,366,670           |   | 18.8 | % |
| Disability                   |   | 499,970      |   | 517,811             |   | -3.4 | % |
| Behavioral Health            |   | 7,262,131    |   | 6,813,440           |   | 6.6 | % |

 

 

34

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***Comparison of Results of Operations for the Quarter EndedJune 30, 2003 to the Quarter Ended June 30, 2002***

* *

As a result of theJanuary 31, 2002 acquisition of RightCHOICE, the organizational structure ofthe Company changed effective February 1, 2002. As a result of these changes,the Company has the following two reportable segments: Health Care andSpecialty. (See Note 11 to the Consolidated Financial Statements for furtherdiscussion.) The Health Care segment provides a broad spectrum of network-basedhealth plans, including PPOs, HMOs, POS plans, other hybrid plans and traditionalindemnity products, to large and small employers and individuals as well asother health care-related products, such as vision, preventive care, COBRA, andflexible benefits account administration. The Specialty business is maintainedas a separate segment providing an array of specialty products, includingpharmacy benefits management, dental, life insurance, disability insurance,behavioral health and workers’ compensation managed care services.

 

The followingtable depicts premium revenue by reportable segment: 

 
|                |   | **Quarter Ended June 30,** |      |
|---------------------|--------|----------------------------|-----------|
| **(In  thousands)** |   | **2003**                   |      | **2002** |   |
| Health Care         |   | $                          | 4,519,126 |   | $ | 3,898,013 |   |
| Specialty           |   | 135,728                    |      | 127,081 |   |
| Consolidated        |   | $                          | 4,654,854 |   | $ | 4,025,094 |   |

 

Premium revenue increased 15.6%, or $629.8 million, to $4,654.9 millionfor the quarter ended June 30, 2003 from $4,025.1 million for the quarterended June 30, 2002.  This growthoccurred across all regions of the Health Care segment, but was more pronouncedin the California and Georgia regions of the Health Care segment. In additionto an increase in insured member months of 5.9%, the increase in premiumrevenue was also due to the implementation of premium increases across allregions of the Health Care segment.

 

The followingtable depicts management services and other revenue by reportable segment: 

 
|                |   | **Quarter Ended June 30,** |    |
|---------------------|--------|----------------------------|---------|
| **(In  thousands)** |   | **2003**                   |    | **2002** |   |
| Health Care         |   | $                          | 186,551 |   | $ | 171,551 |   |
| Specialty           |   | 34,253                     |    | 36,280 |   |
| Corporate and Other |   | 662                        |    | — |   |
| Consolidated        |   | $                          | 221,466 |   | $ | 207,831 |   |

 

Management services and other revenue increased 6.6%, or$13.7 million, to $221.5 million for the quarter ended June 30, 2003from $207.8 million for the quarter ended June 30, 2002. The increases wereprimarily due to an increase in management services revenue from the Californiaand Georgia regions of $13.2 million and $7.4 million, respectively. Theincrease in the California region resulted from an increase in administrativeservices member months of 9.4% and a 15.8% increase in the administrativeservices per member per month rate. The increase in the Georgia region resultedfrom an 18.2% increase in the administrative services per member per

 

35

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month rate. These increases were offset by a decrease in the CentralRegion of $5.7 million. The decrease in the Central Region resulted from adecrease of 6.3% member months in the Company’s administrative servicesbusiness. In addition, management services revenue in the Specialty segmentdecreased by $2.0 million, which was primarily attributable to a decrease inpharmacy benefit management services revenues from non-affiliated clients.

 

Investment income was $64.0 million for the quarter ended June 30,2003, compared to $66.1 million for the quarter ended June 30, 2002, adecrease of $2.1 million or 3.2%.  Thedecrease was primarily due to lower investment yields and an increase intax-exempt bond holdings.

 

The followingtable depicts health care services and other benefits expense by reportablesegment: 

 
|               |   | **Quarter Ended June 30,** |      |
|--------------------|--------|----------------------------|-----------|
| **(In thousands)** |   | **2003**                   |      | **2002** |   |
| Health Care        |   | $                          | 3,687,744 |   | $ | 3,189,369 |   |
| Specialty          |   | 81,923                     |      | 92,634 |   |
| Consolidated       |   | $                          | 3,769,667 |   | $ | 3,282,003 |   |

 

Health careservices and other benefits expense increased 14.9%, or $487.7 million, to$3,769.7 million for the quarter ended June 30, 2003 from$3,282.0 million for the quarter ended June 30, 2002. The Company’smedical care ratio was 81.0% for the quarter ended June 30, 2003 compared to81.5% for the quarter ended June 30, 2002. The medical care ratio attributableto the Health Care segment was 81.6% for the quarter ended June 30, 2003,compared to 81.8% for the quarter ended June 30, 2002.  The medical care ratio attributable to theSpecialty segment was 60.4% for the quarter ended June 30, 2003 compared to72.9% for the quarter ended June 30, 2002. Health care services and otherbenefits expense and medical care ratio information is provided for eachsegment so investors can compare the performance of each segment to the othersegment and to the Company as a whole.

 

The Company’smedical care ratio attributable to the Health Care segment decreased slightlyfrom 81.8% for the quarter ended June 30, 2002 to 81.6% for the quarter endedJune 30, 2003, primarily due to price increases in all regions and lapses inaccounts with higher-than-average medical care ratios.  The medical care ratio for the Specialtysegment decreased to 60.4% for the quarter ended June 30, 2003 from 72.9% forthe same quarter in 2002. The improvement in the medical care ratio wasattributable to favorable claims trends for dental, life and disabilityproducts. The health care services and other benefits expense includes anestimate of claims incurred during the period that have not been reported tothe Company.  This estimate isactuarially determined based on a variety of factors and is inherently subjectto a number of highly variable circumstances. Consequently, the actual results could differ materially from the amountrecorded in the consolidated financial statements. See “Critical Accounting Policies”for a discussion of this item and its potential effect on the Company’sreported results of operations.

 

36

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Selling expense consists ofcommissions paid to outside brokers and agents representing the Company.  The selling expense ratio increased slightlyfrom 4.0% for the quarter ended June 30, 2002 to 4.1% for the quarter endedJune 30, 2003.

 

The general and administrativeexpense ratio decreased to 11.9% for the quarter ended June 30, 2003 from 12.7%for the quarter ended June 30, 2002. The decrease in the general andadministrative expense ratio resulted from administrative efficiencies fromtechnology investments and systems convergence efforts and fixed administrativecosts spread over a larger membership base. 

 

Interest expense decreased$6.4 million to $12.7 million for the quarter ended June 30, 2003,compared to $19.1 million for the quarter ended June 30, 2002.  The decrease in interest expense wasprimarily due to the reduction in the weighted average interest rate (whichincludes fees associated with the Company’s borrowings and interest rate swapagreements) for the quarter ended June 30, 2003 of 4.4%, compared to 5.9% forthe quarter ended June 30, 2002.

 

Other expense, net decreased$9.4 million to $4.6 million for the quarter ended June 30, 2003,compared to $14.0 million for the quarter ended June 30, 2002.  Prior to 2003, results of the Company’sinsurance general agency subsidiary were reported on a “net basis” in otherexpense, net.  For the quarter endedJune 30, 2003, the results have been recorded on a “gross basis,” with externalrevenue reported in management services and other revenue, commissions reportedin selling expense and other costs reported in general and administrativeexpense.  The impact of this change is areduction of $4.4 million in other expense, net for the quarter ended June 30,2003. In addition, the decrease also resulted from lower losses on disposal offixed assets of approximately $3.0 million.

 

The Company’s net income forthe quarter ended June 30, 2003 was $224.5 million, compared to$170.7 million for the quarter ended June 30, 2002.  Net income for the quarter ended June 30,2002 of $170.7 million also included an extraordinary gain of $4.0 million, or$0.03 per basic and diluted share.  Theextraordinary gain was related to the acquisition of MethodistCare, resultingfrom an excess of the fair value of net assets over acquisition costs.  Earnings per share totaled $1.54 and $1.18for the quarters ended June 30, 2003 and 2002, respectively.  Earnings per share assuming full dilutiontotaled $1.49 and $1.12 for the quarters ended June 30, 2003 and 2002,respectively.

 

Earnings per share for thequarter ended June 30, 2003 is based upon weighted average shares outstandingof 145.7 million shares, excluding potential common stock, and150.2 million shares, assuming full dilution.  Earnings per share for the quarter ended June 30, 2002 is basedupon 144.9 million shares, excluding potential common stock, and152.6 million shares, assuming full dilution.  The decrease in weighted average shares outstanding assuming fulldilution primarily resulted from the redemption of the Company’s Zero CouponConvertible Subordinated Debentures. 

 

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***Comparisonof Results of Operations for the Six Months Ended June 30, 2003 to the SixMonths Ended June 30, 2002***

 

The operating results for thesix months ended June 30, 2003 compared to the six months ended June 30, 2002were impacted by the RightCHOICE acquisition, which was consummated on January31, 2002.  Specifically, the Company’soperating results for the six months ended June 30, 2003 include six months ofoperating results attributable to the acquired RightCHOICE business, whereasthe Company’s operating results for the six months ended June 30, 2002 includeonly five months (February 1, 2002 through June 30, 2002) of operating resultsattributable to the acquired RightCHOICE business.  In order to provide a more meaningful comparison of the Company’sresults of operations for the six months of 2003 versus the first six months of2002, the following discussion presents financial measures that excludeoperating results attributable to the acquired RightCHOICE business for themonth of January 2003, which we refer to as “Same-Store.” The Company also usesSame-Store measures for purposes of reporting comparative financial results toits Board of Directors.

 

The following table depictspremium revenue by reportable segment: 

 
| **(In  thousands)** |   | **Six Months Ended  June 30, 2003** |      | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Six Months Ended  June 30, 2003  (Same-Store)** |   | **Six Months  Ended  June 30, 2002** |      |
|---------------------|--------|-------------------------------------|-----------|----------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|--------------------------------------|-----------|
| Health Care         |   | $                                   | 8,936,591 |                                                                             | $      | 109,386                                           |   | $                                    | 8,827,205 |   | $ | 7,473,738 |   |
| Specialty           |   | 266,568                             |      | 673                                                                              |   | 265,895                                           |   | 250,015                              |      |
| Consolidated        |   | $                                   | 9,203,159 |                                                                             | $      | 110,059                                           |   | $                                    | 9,093,100 |   | $ | 7,723,753 |   |

 

Premium revenue increased19.2%, or $1,479.4 million, to $9,203.2 million for the six months ended June30, 2003 from $7,723.8 million for the six months ended June 30,2002.  Excluding premium revenueattributable to the acquired RightCHOICE business of $110.1 million for themonth of January 2003, premium revenue increased $1,369.3 million or17.7%.  Excluding insured membershipattributable to the acquired RightCHOICE business for the month of January2003, insured member months increased approximately 6.0% for the six monthsended June 30, 2003 compared to the six months ended June 30, 2002. This growthin premium revenue occurred across all regions of the Health Care segment, butwas more pronounced in the California region due mainly to an increase ininsured member months and the implementation of premium increases.

 

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The following table depictsmanagement services and other revenue by reportable segment: 

 
| **(In  thousands)** |   | **Six Months Ended  June 30, 2003** |    | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Six Months Ended  June 30, 2003  (Same-Store)** |   | **Six Months  Ended  June 30, 2002** |    |
|---------------------|--------|-------------------------------------|---------|----------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|--------------------------------------|---------|
| Health Care         |   | $                                   | 375,085 |                                                                             | $      | 13,288                                            |   | $                                    | 361,797 |   | $ | 323,956 |   |
| Specialty           |   | 71,220                              |    | 173                                                                              |   | 71,047                                            |   | 68,312                               |    |
| Corporate and Other |   | 1,332                               |    | —                                                                           |   | 1,332                                             |   | —                               |    |
| Consolidated        |   | $                                   | 447,637 |                                                                             | $      | 13,461                                            |   | $                                    | 434,176 |   | $ | 392,268 |   |

 

Management services and otherrevenue increased 14.1%, or $55.3 million, to $447.6 million for thesix months ended June 30, 2003 from $392.3 million for the six monthsended June 30, 2002. Excluding management services and other revenue attributableto the acquired RightCHOICE business of $13.5 million for the month of January2003, management services and other revenue increased $41.8 million or10.7%.  Excluding the RightCHOICEacquisition, the increase in the Health Care segment was primarily due to anincrease in management services revenue from the California and Georgia regionsof $28.6 million and $17.7 million, respectively. The increase in theCalifornia region resulted from an increase in administrative services membermonths of 9.3% and an 18.7% increase in the administrative services per memberper month rate. The increase in the Georgia region resulted from a 22.5%increase in the administrative services per member per month rate. Theseincreases were offset by a decrease in the Central Region of $8.7 million. Thedecrease in the Central Region resulted from a decrease of 5.9% member monthsin the Company’s administrative services business.

 

Investment income was $130.3million for the six months ended June 30, 2003, compared to $126.0 millionfor the six months ended June 30, 2002, an increase of $4.3 million or 3.4%.The increase was primarily due to net realized gains for the six months endedJune 30, 2003 of $7.0 million as compared to net realized losses for the sixmonths ended June 30, 2002 of $1.4 million. Excluding net realized gains andlosses, investment income for the six months ended June 30, 2003 and 2002 was$123.3 million and $127.4 million, respectively. The $4.1 million decline wasdue to lower investment yields on higher average fixed maturity investmentbalances. The Company believes the disclosure of investment income excludingrealized gains or losses is useful to investors because this measurement allowsmanagement and investors to analyze the performance of the fixed-income portionof the Company’s investment portfolio.

 

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The following table depictshealth care services and other benefits expense by reportable segment: 

 
| **(In  thousands)** |   | **Six Months Ended  June 30, 2003** |      | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Six Months Ended  June 30, 2003  (Same-Store)** |   | **Six Months  Ended  June 30, 2002** |      |
|---------------------|--------|-------------------------------------|-----------|----------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|--------------------------------------|-----------|
| Health Care         |   | $                                   | 7,322,601 |                                                                             | $      | 85,730                                            |   | $                                    | 7,236,871 |   | $ | 6,086,405 |   |
| Specialty           |   | 164,566                             |      | 334                                                                              |   | 164,232                                           |   | 178,202                              |      |
| Consolidated        |   | $                                   | 7,487,167 |                                                                             | $      | 86,064                                            |   | $                                    | 7,401,103 |   | $ | 6,264,607 |   |

 

Health care services and otherbenefits expense increased 19.5%, or $1,222.6 million, to$7,487.2 million for the six months ended June 30, 2003 from$6,264.6 million for the six months ended June 30, 2002. Excluding healthcare services and other benefits expense attributable to the acquiredRightCHOICE business of $86.1 million for the month of January 2003, healthcare services and other benefits expense increased $1,136.5 million or 18.1%,slightly more than the increase in premium revenue of 17.7%.

 

The Company’s medical careratio was 81.4% for the six months ended June 30, 2003 compared to 81.1% forthe six months ended June 30, 2002. The medical care ratio attributable to theHealth Care segment was 81.9% for the six months ended June 30, 2003, comparedto 81.4% for the six months ended June 30, 2002. The medical care ratioattributable to the Specialty segment was 61.7% for the six months ended June30, 2003 compared to 71.3% for the six months ended June 30, 2002. 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 $109.4 million and health care services and other benefits expenseof $85.7 million attributable to the acquired RightCHOICE business with respectto the Health Care segment for the month of January 2003, the Company’s medicalcare ratio attributable to the Health Care segment for the six months endedJune 30, 2003 increased to 82.0% compared to 81.4% for the six months endedJune 30, 2002, primarily due to higher health care services expense per memberper month, primarily in the California region of the Health Care segment. Thehealth care services and other benefits expense includes an estimate of claimsincurred during 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.

 

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The selling expense ratioincreased slightly from 4.0% for the six months ended June 30, 2002 to 4.1% forthe six months ended June 30, 2003. Excluding selling expense of $4.7 millionand combined premium revenue and management services and other revenue of$123.5 million attributable to the acquired RightCHOICE business for the monthof January 2003, the Company’s selling expense ratio remained unchanged at 4.0%for the six months ended June 30, 2002 and 4.1% for the six months ended June30, 2003.

 

The general and administrativeexpense ratio decreased to 12.1% for the six months ended June 30, 2003 from13.3% for the six months ended June 30, 2002. Excluding general andadministrative expense of $19.5 million and combined premium revenue andmanagement services and other revenue of $123.5 million attributable to theacquired RightCHOICE business for the month of January 2003, the Company’sgeneral and administrative expense ratio would have remained unchanged at 12.1%for the six months ended June 30, 2003 compared to 13.3% for the six monthsended June 30, 2002. 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.

 

Interest expense decreased$10.1 million to $25.5 million for the six months ended June 30, 2003,compared to $35.6 million for the six months ended June 30, 2002.  The decrease in interest expense wasprimarily due to the reduction in the weighted average interest rate (whichincludes fees associated with the Company’s borrowings and interest rate swapagreements) for the six months ended June 30, 2003 of 4.4%, compared to 5.9%for the six months ended June 30, 2002.

 

Other expense, net decreased$13.3 million to $11.6 million for the six months ended June 30,2003, compared to $24.9 million for the six months ended June 30, 2002.  Prior to 2003, results of the Company’sinsurance general agency subsidiary were reported on a “net basis” in otherexpense, net.  For the six months endedJune 30, 2003, the results have been recorded on a “gross basis,” with externalrevenue reported in management services and other revenue, commissions reportedin selling expense and other costs reported in general and administrativeexpense.  The impact of this change is areduction of $8.2 million in other expense, net for the six months ended June30, 2003.  In addition, the decreasealso resulted from lower losses on disposal of fixed assets of approximately$4.2 million.

 

The Company’s net income forthe six months ended June 30, 2003 was $417.5 million, compared to$311.8 million for the six months ended June 30, 2002.  Net income for the six months ended June 30,2002 of $311.8 million also included an extraordinary gain of $4.0 million, or$0.03 per basic and diluted share. The extraordinary gain was related to theacquisition of MethodistCare, resulting from an excess of the fair value of netassets over acquisition costs. Earnings per share totaled $2.87 and $2.20 forthe six months ended June 30, 2003 and 2002, respectively.  Earnings per share assuming full dilutiontotaled $2.79 and $2.10 for the six months ended June 30, 2003 and 2002,respectively.

 

Earnings per share for the sixmonths ended June 30, 2003 is based upon weighted average shares outstanding of145.7 million shares, excluding potential common stock, and 149.7 millionshares, assuming full dilution. Earnings per share for the six months ended June 30, 2002 is based upon 

 

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142.0 million shares, excludingpotential common stock, and 149.2 million shares, assuming fulldilution.  The increase in weightedaverage shares outstanding primarily resulted from the issuance of sharesrelated to the RightCHOICE acquisition and the Company’s employee stock option andpurchase plans. The slight increase in weighted average shares outstandingassuming full dilution primarily resulted from the issuance of shares relatedto the RightCHOICE acquisition and the Company’s employee stock option andpurchase plans offset by the decrease resulting from the redemption of theCompany’s Zero Coupon Convertible Subordinated Debentures.

 

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***Financial Condition***

 

The Company’s consolidatedassets increased by $1,317.0 million, or 11.5%, to $12,787.6 million as of June30, 2003 from $11,470.6 million as of December 31, 2002. The increase in totalassets was primarily due to growth in cash and investments of $1,149.1 millionas a result of operating cash flows attributable to net income and an increasein advances on security lending deposits. The increase in cash and investmentswas partially offset by timing of the receipts of receivables and tax paymentsmade in the second quarter of 2003. Cash and investments totaled $7.9 billion asof June 30, 2003, or 61.9% of total assets.

 

Overall claims liabilities,which is comprised of medical claims payable and reserves for future policybenefits, increased $101.7 million, or 3.8%, to $2,807.3 million as of June 30,2003 from $2,705.6 million as of December 31, 2002. This increase was due togrowth in medical members of 154,000 and an increase in per member per monthmedical claim expense during the six months ended June 30, 2003. See “CriticalAccounting Policies” for a discussion of medical claims payable and reservesfor future policy benefits. As of June 30, 2003, the Company’s long-termindebtedness was $1,163.5 million, of which $465.2 million was related to theCompany’s 6 3/8% Notes due 2006 (which includes a fairvalue adjustment of $15.9 million), $349.0 million was related to the Company’s6 3/8% Notes due 2012 and $349.3 million was related tothe commercial paper program. The 6 3/8% Notes due 2012,with an aggregate principal amount at maturity of $350.0 million, were issuedto partially finance the RightCHOICE acquisition. The Company’s revolvingcredit facility indebtedness of $235.0 million at December 31, 2001 was repaidduring the year ended December 31, 2002, with $200.0 million obtained throughthe commercial paper program and operating cash of $35.0 million. In the firstquarter of 2003, the Company issued an additional $149.9 million in commercialpaper (net of repayments made during the quarter) to repurchase Common Stock ofthe Company. (See Note 6 to the Consolidated Financial Statements.)

 

Stockholders’ equity totaled$4,408.3 million as of June 30, 2003, an increase of $431.6 million from$3,976.7 million as of December 31, 2002. The increase was primarily due to netincome of $417.5 million for the six months ended June 30, 2003 and a netincrease of $181.5 million from the reissuance of treasury stock related to theCompany’s employee 401(k) plan, stock option and stock purchase plans and $87.7million net unrealized gain from investment securities, net of taxes. Partiallyoffsetting these increases were the repurchase of 2.9 million shares of theCompany’s Common Stock for $192.4 million, and net losses from the reissuanceof treasury stock of $63.0 million.

 

***Liquidity and Capital Resources***

 

As of June 30, 2003, consolidatedcash and investments were $7.9 billion, of which $1.4 billion was in cash andcash equivalents. The Company’s primary sources of cash are premium andmanagement services revenues and investment income.  The Company’s primary uses of cash include health care claims andother benefits, capitation payments, income taxes, repayment of long-term debt,interest expense, broker and agent commissions, administrative expenses, CommonStock repurchases and capital expenditures. In addition to the foregoing,

 

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other uses of cash includeprovider network and systems development costs and costs associated with theintegration of acquired businesses.

 

The Company generally receivespremium revenue in advance of anticipated claims for related health careservices and other benefits.  TheCompany’s investment policies are designed to provide safety and preservationof capital, sufficient liquidity to meet cash flow needs, the integration ofinvestment strategy with the business operations and objectives of the Company,and attainment of a competitive after-tax total return.

 

The Company’s strategy forachieving its investment goals is broad diversification of its investments,both across and within asset classes. As of June 30, 2003, the Company’s investment portfolio consistedprimarily of investment grade fixed-income securities.  The Company’s portfolio also included largecapitalization and small capitalization domestic equities, foreign equities,tax-exempt municipal bonds and a small amount of non-investment grade debtsecurities.  The fixed-income assetsinclude both short and long-duration securities with an attempt to match theCompany’s funding needs.  The Company’sinvestment policy contains limitations regarding concentration in individualsecurities and industries and generally prohibits speculative and leveragedinvestments.  Cash and investmentbalances maintained by the Company are sufficient to meet applicable regulatoryfinancial stability and net worth requirements, including license requirementsof the Blue Cross and Blue Shield Association.

 

Cash flow provided by operatingactivities was $422.0 million for the six months ended June 30, 2003,compared with $596.6 million for the six months ended June 30, 2002.  Cash flow provided by operations for the sixmonths ended June 30, 2003 was due primarily to net income of$417.5 million, an increase in medical claims payable of $95.9 million dueto membership growth and higher health care expenses per member per month andan increase in other current liabilities of $101.1 million due to timing ofpharmaceutical drug and pharmacy rebate payments, an increase in life insurancepolicy settlement options accrual and timing of other accruals related tonormal operations. Partially offsetting these increases was an increase inreceivables, net of  $212.8 million dueto timing of cash receipts.

 

Net cash used in investingactivities for the six months ended June 30, 2003 totaled$1,025.7 million, compared with $1,035.2 million for the six monthsended June 30, 2002.  The cash used inthe first six months of 2003 was primarily attributable to the purchase ofinvestments of $5.3 billion, the purchase of property and equipment, net ofsales proceeds, of $53.3 million and the acquisition of Golden West, net ofcash acquired, for $27.7 million, which were partially offset by proceeds frominvestments sold of $4.4 billion.

 

Net cash provided by financingactivities totaled $626.1 million in the first six months of 2003 comparedwith $292.9 million for the six months ended June 30, 2002.  The net cash provided in the first sixmonths of 2003 was primarily attributable to additional advances on securitieslending deposits of $580.8 million, additional debt of $149.5 million incurredto partially finance the $192.4 million repurchase of Company Common Stock, andthe receipt of proceeds from the issuance of Common Stock related to theCompany’s employee stock option plans of $88.2 million.

 

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Effective March 30, 2001, theCompany entered into two new unsecured revolving credit facilities allowingaggregate indebtedness of $1.0 billion in principal amount. Upon execution ofthese facilities, the Company terminated its prior $1.0 billion unsecuredrevolving facility. Borrowings under these facilities (which are generallyreferred to collectively in this quarterly report on Form 10-Q as the Company’s“revolving credit facility”) bear interest at rates determined by reference tothe bank’s base rate or to the London InterBank Offered Rate (“LIBOR”) plus amargin determined by reference to the then-current rating of the Company’ssenior unsecured long-term debt by specified rating agencies. One facility,which provides for borrowings not to exceed $750.0 million at any timeoutstanding, expires as of March 30, 2006, although it may be extended for upto two additional one-year periods under certain circumstances. The otherfacility, which provides for borrowings not to exceed $250.0 million at anytime outstanding, expires on March 26, 2004. Any amount outstanding under thisfacility as of March 26, 2004 may be converted into a one-year term loan at theoption of the Company and will bear interest at rates determined by referenceto the bank’s base rate or LIBOR plus a margin determined by reference to thethen-current rating of the Company’s unsecured long-term debt by specifiedrating agencies, plus 0.125% until paid in full. Loans under the $250.0 millionfacility are made on a committed basis. Loans under the $750.0 million facilityare made on a committed basis or pursuant to an auction bid process. The $750.0million facility also contains sublimits for letters of credit and “swingline”loans. Each credit agreement requires the Company to maintain certain financialratios and contains restrictive covenants, including restrictions on theincurrence of additional indebtedness and the granting of certain liens,limitations on acquisitions and investments and limitations on changes incontrol (see Note 6 to the Consolidated Financial Statements). As of June 30,2003 and December 31, 2002, there were no amounts outstanding under therevolving credit facility.

 

In April 2002, the Companycommenced a commercial paper program providing for the issuance of up to $1.0billion in aggregate maturity value of short-term indebtedness (known generallyas “commercial paper”). The commercial paper is being issued by the Companywithout registration under the Securities Act of 1933, as amended (the “1933 Act”)in reliance upon the exemption from registration contained in Section 4(2) ofthe 1933 Act. The commercial paper is issued in denominations of $100,000 orintegral multiples of $1,000 in excess thereof and will bear such interestrates, if interest-bearing, or will be sold at such discount from their faceamounts, as agreed upon by the Company and the dealer or dealers acting inconnection with the commercial paper program. The commercial paper may beissued with varying maturities up to a maximum of 270 days from the date ofissuance. The commercial paper ranks equally with all other unsecured andunsubordinated indebtedness of the Company. As of June 30, 2003 and December31, 2002, the outstanding commercial paper borrowings totaled $349.3 millionand $199.8 million, respectively, with various maturity dates and had interestrates ranging from 1.20% to 1.48% as of June 30, 2003 and interest ratesranging from 1.60% to 1.65% as of December 31, 2002. The weighted average yieldon the outstanding commercial paper as of June 30, 2003 and December 31, 2002was 1.27% and 1.62%, respectively. The Company intends to maintain commercialpaper borrowings of at least the amount outstanding at June 30, 2003 for morethan one year. Accordingly, for financial reporting purposes, the commercialpaper has been classified under non-current liabilities in the ConsolidatedFinancial Statements.

 

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In anticipation of thecompletion of the RightCHOICE acquisition on January 31, 2002, the Company onJanuary 16, 2002 issued $350.0 million aggregate principal amount at maturityof 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 6 3/8%per annum, payable semi-annually in arrears on January 15 and July 15 of eachyear commencing July 15, 2002. Interest is computed on the basis of a 360-dayyear of twelve 30-day months.

 

The 2012 Notes may be redeemed,in whole or in part, at the Company’s option at any time. The redemption pricefor any 2012 Notes redeemed will be equal to the greater of the followingamounts: 1) 100% of the principal amount of the 2012 Notes being redeemed onthe redemption date; and 2) the sum of the present values of the remainingscheduled payments of principal and interest on the 2012 Notes being redeemedon that redemption date (not including any portion of any payments of interestaccrued to the redemption date) discounted to the redemption date on asemiannual basis at the Treasury rate as determined by the Reference TreasuryDealer (J.P. Morgan Securities Inc. or Deutsche Banc Alex Brown or theirrespective successors), plus 25 basis points. In each case, the redemptionprice will also include accrued and unpaid interest on the 2012 Notes to theredemption date.

 

On June 15, 2001, the Companyissued $450.0 million aggregate principal amount at maturity of 6 3/8%Notes due June 15, 2006 (the “2006 Notes”). The net proceeds of this offeringtotaled approximately $449.0 million. The net proceeds from the sale of the2006 Notes were used to repay indebtedness under the Company’s revolving creditfacilities. The 2006 Notes bear interest at a rate of 6 3/8%per annum, payable semi-annually in arrears on June 15 and December 15 of eachyear commencing December 15, 2001. Interest is computed on the basis of a360-day year of twelve 30-day months.

 

The 2006 Notes may be redeemed,in whole or in part, at the Company’s option at any time. The redemption pricefor any 2006 Notes redeemed will be equal to the greater of the followingamounts: 1) 100% of the principal amount of the 2006 Notes being redeemed onthe redemption date; and 2) the sum of the present values of the remainingscheduled payments of principal and interest on the 2006 Notes being redeemedon that redemption date (not including any portion of any payments of interestaccrued to the redemption date) discounted to the redemption date on asemi-annual basis at the Treasury rate as determined by the designatedReference Treasury Dealer (Salomon Smith Barney Inc. or UBS Warburg LLC ortheir respective successors), plus 25 basis points. In each case, theredemption price will also include accrued and unpaid interest on the 2006Notes to the redemption date.

 

The 2006 and 2012 Notes areunsecured obligations and rank equally with all of the Company’s existing andfuture senior unsecured indebtedness. All existing and future liabilities ofthe Company’s subsidiaries are and will be effectively senior to the 2006 and2012 Notes. The indenture governing the 2006 and 2012 Notes contains a covenantthat limits the ability of the Company and its subsidiaries to create liens onany of their property or assets to secure certain indebtedness without alsosecuring the indebtedness under the 2006 and 2012 Notes.

 

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On October 2, 2002, the Companyannounced that it had elected to redeem the Debentures as of October 28, 2002.Substantially all of the Debentures were tendered for conversion into theCompany’s Common Stock prior to the redemption date. Approximately $50,000principal amount at maturity of the Debentures were settled in cash. Thisconversion did not have an extraordinary income statement impact. (See Note 6to the Consolidated Financial Statements.) Prior to the Company’s announcementof its election to redeem the Debentures, Debentureholders in 2002 converted$18.0 million in aggregate principal amount at maturity of the Company’sDebentures with a carrying value (including accreted interest) of $12.6million. In lieu of delivering shares of Common Stock upon conversion of theseDebentures, the Company elected to pay cash of $18.9 million, which resulted inan extraordinary after-tax loss of $3.8 million, as shown on the Company’sConsolidated Income Statements for the year ended December 31, 2002. Inaccordance with SFAS No. 145 which was effective for fiscal years beginningafter May 15, 2002, the Company had determined that the extinguishmentof debt under its Zero Coupon Convertible Subordinated Debentures, which wereredeemed as of October 28, 2002, did not meet the requirements ofunusual or infrequent and therefore would not be included as an extraordinaryitem with the rescission of FASB Statement No. 4. For the quarter and sixmonths ended June 30, 2002, WellPoint reclassified an extraordinary loss of$2.1 million, which included a tax benefit of $0.8 million, to interestexpense.

 

As a part of a hedging strategyto limit its exposure to variable interest rate increases, the Company has fromtime to time entered into interest rate swap agreements in order to reduce thevolatility of interest expense resulting from changes in interest rates on itsvariable rate debt. The swap agreements were contracts to exchangevariable-rate interest payments (weighted average rate for the year endedDecember 31, 2002 of 2.25%) for fixed-rate interest payments(weighted average rate for the year ended December 31, 2002 of 7.08%) withoutthe exchange of the underlying notional amounts. The Company had entered into$200.0 million of fixed-rate swap agreements, which consisted of a $150.0million notional amount swap agreement at 6.99% maturing on October 17, 2003and a $50.0 million notional amount swap agreement at 7.06% maturing on October17, 2006. In September 2002, the Company terminated these two fixed-rate swapagreements with an aggregate cash settlement of $17.6 million, of which $1.8million was accrued interest and the remaining $15.8 million represented the fairvalue of the swap agreements at the time of termination and is being amortizedover the term of the original swap agreements. As of June 30, 2003, theremaining balance of the swap agreements was $8.8 million. (See Note 7 to theConsolidated Financial Statements.)

 

In order to reduce the interestexpense associated with the 2006 Notes, the Company, on January 15, 2002,entered into a $200.0 million notional amount interest rate swap agreement,which matures on June 15, 2006. The swap agreement is a contract to exchange afixed 6 3/8% rate for a LIBOR-based floating rate(weighted average variable rate of 2.53% for the six months ended June 30,2003).

 

Certain of the Company’ssubsidiaries are required to maintain minimum capital requirements prescribed byvarious regulatory agencies, including the California Department of ManagedHealth Care and the Departments of Insurance in various states, includingGeorgia, Missouri and Delaware. As of June 30, 2003 (or the most recent datewith respect to which compliance

 

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is required), thosesubsidiaries of the Company were in compliance with all minimum capitalrequirements.

 

The Company believes that cashflow generated by operations and its cash and investment balances, supplementedby the Company’s ability to borrow under its existing revolving creditfacility, commercial paper program or through public or private financingsources, will be sufficient to fund continuing operations and expected capitalrequirements for the foreseeable future.

 

***Critical Accounting Policies***

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresthe Company’s management to make a variety of estimates and assumptions. Theseestimates and assumptions affect, among other things, the reported amounts ofassets and liabilities, the disclosure of contingent liabilities and thereported amounts of revenues and expenses. Actual results could differ from theamounts previously estimated, which were based on the information available atthe time the estimates were made.

 

The critical accountingpolicies described below are those that the Company believes are important tothe portrayal of the Company’s financial condition and results of operations,and which require management to make difficult, subjective and/or complexjudgments. Critical accounting policies cover accounting matters that areinherently uncertain because the future resolution of such matters is unknown.The Company believes that critical accounting policies include medical claimspayable, reserves for future policy benefits, goodwill and other intangibleassets and investments.

 

*Medical Claims Payable*

 

Medical claims payableincludes claims in process as well as provisions for the estimate of incurredbut not reported claims (“IBNR”) and provisions for disputed claimsobligations.  As of June 30, 2003,approximately 90% of the Company’s medical claims payable consisted of IBNR andclaims in process.   Such estimates aredeveloped using actuarial principles and assumptions that consider, among otherthings, contractual requirements, historical utilization trends and paymentpatterns, benefits changes, medical inflation, product mix, seasonality,membership and other relevant factors. In developing IBNR, the Company applies different estimation methodsdepending on the period for which incurred claims are being estimated.  For the most recent four months, theincurred claims are estimated from the trend analysis based on per member permonth claims trends developed from the experience in preceding months.  For periods prior to the most recent fourmonths, the key assumption used in developing the Company’s IBNR is that thecompletion factor pattern remains consistent over a rolling 12-monthperiod.  The completion factor is anactuarial estimate, based upon historical experience, of the percentage ofclaims incurred during a given period that have been adjudicated by the Companyas of the date of estimation.  Thisapproach is consistently applied to each period presented.

 

The completion factorsand claims per member per month trend factor are the most significant factorsused in estimating the Company’s IBNR. The following table illustrates the sensitivity of these factors using June30, 2003 data and the estimated potential impact on the Company’s operatingresults caused by these factors:

 

 
| **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                                 | )%     | $                                                 | 270,000,000 |                               | (3 | )% | $ | (13,000,000 | ) |
| (2                                 | )%     | 175,000,000                                       |        | (2                                 | )% | (8,000,000 | ) |
| (1                                 | )%     | 85,000,000                                        |        | (1                                 | )% | (4,000,000 | ) |
| 1                                  | %      | (81,000,000                                       | )           | 1                                  | % | 4,000,000 |   |
| 2                                  | %      | (158,000,000                                      | )           | 2                                  | % | 8,000,000 |   |
| 3                                  | %      | (232,000,000                                      | )           | 3                                  | % | 12,000,000 |   |
|                                    |        |                                                   |             |                                    |  |  |  |  |  |  |  |

 

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(a)    Reflects estimated potential changes inmedical claims payable caused by changes in completion factors in each of themost recent four months.  

(b)    Reflects estimated potential changes inmedical claims payable caused by changes in annualized claims trend used forthe estimation of per member per month claims for the most recent fourmonths.  

 

In addition, assuming ahypothetical 1% difference between the Company’s June 30, 2003 estimated claimsliability and the actual claims incurred, net income for the three months endedJune 30, 2003 would increase or decrease by $15.1 million, while diluted netincome per share would increase or decrease by $0.10 per share.  

 

Other relevant factorsinclude exceptionalsituations that might require judgmental adjustments in setting the outstandingreserves, such as system conversions, processing interruptions, environmentalchanges or other factors.  None of thesefactors had a material impact on the development of the Company’s claimspayable estimates during any of the periods in this Form 10-Q. All ofthese 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 itsbest estimate of medical claims payable, the Company consistently applies theprinciples and assumptions listed above from year to year, while also givingdue consideration to the potential variability of these factors. Becausemedical claims payable includes various actuarially developed estimates, theCompany's actual health care services expense may be more or less than theCompany's previously developed estimates. Claim processing expenses are alsoaccrued based on an estimate of expenses necessary to process such claims. Suchreserves are continually monitored and reviewed, with any adjustments reflectedin current operations. 

 

The table below providesa reconciliation of changes in medical claims payable as of December 31, 2002,2001 and 2000 during the immediately following six months period:

 
|                                                                |   |   | **Six Months Ended June 30,** |      |
|---------------------------------------------------------------------|--------|--------|-------------------------------|-----------|
| *(In thousands)*                                                    |   |   | **2003**                      |      | **2002** |   | **2001** |   |
|                                                                |   |   |                          |      |   |   |   |   |
| Medical claims payable as of January 1                              |   |   | $                             | 2,422,331 |   | $ | 1,934,620 |   | $ | 1,566,569 |   |
|                                                                |   |   |                          |      |   |   |   |   |
| Medical claims reserves from businesses  acquired during the period |   |   | 188                           |      | 177,836 |   | 258,375 |   |
|                                                                |   |   |                          |      |   |   |   |   |
| Health care claim expenses incurred during  period:                 |   |   |                          |      |   |   |   |   |
| Related to current year                                             |   |   | 7,676,702                     |      | 6,454,580 |   | 4,435,551 |   |
| Related to prior years                                              |   |   | (339,250                      | )         | (339,295 | ) | (233,969 | ) |
| Total Incurred                                                      |   |   | 7,337,452                     |      | 6,115,285 |   | 4,201,582 |   |
|                                                                |   |   |                          |      |   |   |   |   |
| Health care services payments during  period:                       |   |   |                          |      |   |   |   |   |
| Related to current year                                             |   |   | 5,727,790                     |      | 4,820,689 |   | 3,319,217 |   |
| Related to prior years                                              |   |   | 1,513,797                     |      | 1,094,349 |   | 900,007 |   |
| Total Payments                                                      |   |   | 7,241,587                     |      | 5,915,038 |   | 4,219,224 |   |
|                                                                |   |   |                          |      |   |   |   |   |
| Medical claims payable as of June 30                                |   |   | $                             | 2,518,384 |   | $ | 2,312,703 |   | $ | 1,807,302 |   |

 

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 Because medical claims payable includes various actuariallydeveloped estimates, the Company's actual health care services experience maybe more or less than the Company's previously developed estimates. As shown inthe table above, for the six months ended June 30, 2003, 2002 and 2001, theamount shown on the line labeled "Health care services expenses incurredduring period: Related to prior years" is negative, meaning that theCompany's actual health care services experience related to prior years wereless than the estimates previously made by the Company.  This favorable development was primarilyrelated to prior years claims settled for amounts less than the originalestimate for IBNR.  Actuarial standardsof practice, which the Company consistently follows in developing its bestpoint estimate as reflected in the financial statements, generally require theactuarially developed health care 

claims estimates to coverobligations 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 an estimate that satisfies the actuarial standards ofpractice.  Adjustments of prior-yearestimates may result in additional health care services expenses or, as theCompany experienced during each of the last three years, a reduction in healthcare services expenses in the period an adjustment is made.   

 

Health care claims are usuallydescribed as having a “short tail,” which means that they are generally paidwithin a few months of the member receiving service from the physician or otherhealth 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 2002 estimate ofmedical claims payable will be known during 2003.

 

Capitation costs representmonthly fees paid one month in advance to physicians, certain other medicalservice providers and hospitals in the Company's HMO networks as retainers forproviding continuing medical care. The Company maintains various programs thatprovide incentives to physicians, certain other medical service providers andhospitals participating in its HMO networks through the use of risk-sharingagreements and other programs. Payments under such agreements are made based onthe providers' performance in controlling health care costs while providingquality health care. Expenses related to these programs, which are based inpart on estimates, are recorded in the period in which the related services arerendered. The Company believes that its reserves for medical claims payable areadequate to satisfy its ultimate claim liability. However, these estimates areinherently subject to a number of highly variable circumstances. Consequently,the actual results could differ materially from the amount recorded in theconsolidated financial statements.

 

Health care services and otherbenefits expense includes the costs of health care services, capitationexpenses and expenses related to risk-sharing agreements with participatingphysicians, medical groups and hospitals and incurred losses on the Company'sdisability and life products. The costs of health care services are accrued asservices are rendered, including an estimate for claims incurred but not yetreported.

 

For many of the Company's HMOplans (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 professionalcapitation arrangements, 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 capitation arrangements,the health care provider does not assume the risk of the member's utilizationof any hospital-based services. The second type is the so-called"global" capitation arrangement. Under global capitationarrangements, the Company also pays the health care provider, such as aparticipating medical group, a fixed amount per member per month. However,under global capitation arrangements, the health care provider generallyassumes the risk of the member's utilization of all health care services(subject to certain limited exceptions and state regulatory requirements). Asof June 30, 2003 and December 31, 2002, the Company had approximately eight and10 global capitation arrangements, respectively, covering approximately 165,000and 179,000 members, respectively. In addition, one of the Company'ssubsidiaries owns a 51% equity interest in a community health partnershipnetwork (the "CHPN") operating in the greater Atlanta area. The CHPNis a locally based equity venture between the Company's subsidiary and localphysician and hospital groups. The Company's subsidiary has entered into aglobal arrangement with the CHPN. As of June 30, 2003 and December 31, 2002,approximately 563,000 and 535,000 members, respectively, were covered by thisarrangement.

 

For the quarters ended June 30,2003 and 2002, the Company's capitation expenses of $380.5 million and $379.8million, represented 10.1% and 11.6%, respectively, of the Company's totalhealth care services and other benefits expense. For the six months ended June30, 2003 and 2002, the Company's capitation expenses of $774.2 million and$748.7 million, represented 10.3% and 12.0%, respectively, of the Company'stotal health care services and other benefits expense. As of June 30, 2003 andDecember 31, 2002, the Company's capitation expenses payable of $101.2 millionand $137.0 million represented 4.0% and 5.7%, respectively, of the Company'stotal medical claims payable.

 

The Company's future results ofoperations will depend in part on its ability to predict and control healthcare costs through underwriting criteria, medical management, product designand negotiation of favorable provider and hospital contracts. The Company'sability to contain such costs may be adversely affected by changes inutilization rates, demographic characteristics, the regulatory environment,health care practices, inflation, new technologies, clusters of high-costcases, continued consolidation of physician, hospital and other providergroups, acts of terrorism and bioterrorism or other catastrophes, including warand numerous other factors. The inability to mitigate any or all of theabove-listed or other factors may adversely affect the Company's futureprofitability.    

 

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*Reserves for Future Policy Benefits*

 

The estimate of reserves forfuture policy benefits relates to life and disability insurance policieswritten in connection with health care contracts. Reserves for future lifebenefit coverage are based on projections of past experience. Reserves forfuture policy and contract benefits for certain long-term disability productsand group paid-up life products are based upon interest, mortality andmorbidity assumptions from published actuarial tables, modified based upon theCompany’s experience. Reserves are continually monitored and reviewed, and assettlements are made or reserves adjusted, differences are reflected in currentoperations. The current portion of reserves for future policy benefits relatesto the portion of such reserves that the Company expects to pay within oneyear. The Company believes that its reserves for future policy benefits areadequate to satisfy its ultimate benefit liability. However, these estimatesare inherently subject to a number of highly variable circumstances.Consequently, the actual results could differ materially from the amountrecorded in the consolidated financial statements. As of June 30, 2003 andDecember 31, 2002, the reserves for future policy benefits were $288.9 millionand $283.2 million, respectively.

 

*Intangible Assets and Goodwill*

 

The Company has made severalacquisitions in the past several years that included a significant amount ofgoodwill and other intangible assets. Under generally accepted accountingprinciples in effect through December 31, 2001, these assets were amortizedover their useful lives, and were tested periodically to determine if they wererecoverable from operating earnings on an undiscounted basis over their usefullives.

 

In June 2001, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 141, “Business Combinations” (“SFAS No. 141”) and Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No.142”). SFAS No. 141 requires that all business combinations initiated afterJune 30, 2001 be accounted for using the purchase method. The provisions ofSFAS No. 141 also apply to all business combinations consummated after June 30,2001. SFAS No. 142, which became effective for fiscal years beginning afterDecember 15, 2001, eliminates amortization of goodwill and other intangibleassets with indefinite useful lives. Rather, these assets are subject toimpairment tests at least annually. The Company is required to make estimatesof fair value and apply certain assumptions, such as a discount factor inapplying these annual impairment tests. Such estimates could producesignificantly different results if other

 

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assumptions, which could alsobe considered reasonable, were to be used. Intangible assets with definiteuseful lives are being amortized using a straight-line basis or the timing ofrelated cash flows over periods ranging from five to 25 years. An intangibleasset subject to amortization must be reviewed for impairment pursuant toStatement of Financial Accounting Standards No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.”

 

The Company adopted SFAS No.142 on January 1, 2002 and, accordingly, no longer amortizes goodwill and otherintangible assets with indefinite useful lives. In accordance with SFAS No.142, the Company completed the transitional evaluation of its goodwill andother intangible assets at January 1, 2002 and the annual evaluation at December31, 2002, and determined that there was no impairment loss. As of June 30, 2003and December 31, 2002, total goodwill and other intangible assets were $2.4billion. (See Note 5 to the Consolidated Financial Statements for furtherdiscussion of the Company’s goodwill and other intangible assets.)

 

*Investments*

 

As of June 30, 2003, theCompany’s investment securities at market value, totaled $6.4 billion, of which89.1% was invested in fixed-income securities and the remaining 10.9% wasinvested in equity securities. As of December 31, 2002, the Company’sinvestment securities at market value totaled $5.3 billion, of which 89.6% wasinvested in fixed-income securities and the remaining 10.4% was invested inequity securities. These investment securities are generally used to supportcurrent operations and, accordingly, have been classified as current assets.The Company’s long-term investments as of June 30, 2003 andDecember 31, 2002 were $148.2 million and $134.3 million,respectively, and consisted primarily of restricted assets, certain equitiesand other investments. Total current and long-term investments comprised 51.3%and 47.2% of total assets as of June 30, 2003 and December 31, 2002,respectively.

 

With the majority ofinvestments in fixed-income securities, the Company maintains an investmentportfolio that is primarily structured to maximize investment income whilepreserving the principal asset base and provide a source of liquidity foroperating needs. The Company records investment income when earned, andrealized gains or losses when sold, as determined using the first-in-first-outmethod.

 

The Company regularly evaluatesthe appropriateness of investments relative to its internal investmentguidelines. The Company operates within these guidelines by maintaining awell-diversified portfolio, both across and within asset classes. The Companyhas from time to time retained an independent consultant to advise the Companyon the appropriateness of its investment policy. The Company performs a quarterlyevaluation of its investment securities, using both quantitative andqualitative factors to determine whether a decline in investment value isother-than-temporary. When a decline in an investment’s fair value isdetermined to be other-than-temporary, a loss is recorded against investmentincome. When determining whether a decline in an investment’s fair value isother-than-temporary, the Company considers the extent and duration to which asecurity’s market value has been less than its cost, the financial conditionand future earnings potential of the issuer, recommendations and opinions fromoutside investment managers and the current economic environment. For the

 

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* *

quarters ended June 30, 2003and 2002, the Company recorded investment losses that the Company believed tobe other-than-temporary of approximately $5.4 million and $17.4 million,respectively. For the six months ended June 30, 2003 and 2002, the Companyrecorded investment losses that the Company believed to be other-than-temporaryof approximately $29.3 million and $19.6 million, respectively. The Companybelieves that it has performed an adequate review for impairment of theinvestment portfolio and that investments are carried at fair value. Changingeconomic and market conditions in the future, however, may cause the Company toreassess its judgment regarding impairment, which could result in realizedlosses relating to other-than-temporary declines being charged against futureincome.

 

As of June 30, 2003 andDecember 31, 2002, net unrealized gains from the Company’s fixed-incomesecurities totaled $204.7 million and $184.5 million, respectively, primarilyresulting from a general decrease in interest rates. The Company had a netunrealized gain in its equity securities portfolio as of June 30, 2003 of $73.6million and a net unrealized loss of $49.5 million as of December 31, 2002. TheCompany believes that these fluctuations are temporary as a result of currentmarket conditions.

 

***FactorsThat May Affect Future Results of Operations***

 

Certain statements containedherein, such as statements concerning potential or future medical care ratios,pending acquisitions and other statements regarding matters that are nothistorical facts, are forward-looking statements (as such term is defined inthe Securities Exchange Act of 1934, as amended). Such statements involve anumber of risks and uncertainties that could cause actual results to differmaterially from those projected. Factors that could cause actual results todiffer materially from those projected include, but are not limited to, thosediscussed below and those discussed from time to time in the Company’s variousfilings with the Securities and Exchange Commission.

 

The Company’s operations aresubject to substantial 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. 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.

 

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In connection with theRightCHOICE and Cerulean transactions, the Company incurred significantadditional indebtedness to fund the cash payments made to the acquiredcompanies’ stockholders. In addition, the Company may incur additionalindebtedness to fund the Cobalt transaction or other potential futureacquisitions. This existing or new indebtedness may result in a significantpercentage of the Company’s cash flow being applied to the payment of interest,and there can be no assurance that the Company’s operations will generatesufficient future cash flow to service this indebtedness. The Company’s currentindebtedness, as well as any indebtedness that the Company may incur in thefuture (such as indebtedness incurred to fund repurchases of its Common Stockor to fund potential future acquisitions), may adversely affect the Company’sability to finance its operations and could limit the Company’s ability topursue business opportunities that may be in the best interests of the Companyand its stockholders.

 

As part of the Company’sbusiness strategy, the Company has acquired substantial operations in newgeographic markets over the last seven years. These businesses, some of whichinclude substantial indemnity-based insurance operations, have experiencedvarying profitability or losses in recent periods. Since the relevant dates ofacquisition of Cerulean, RightCHOICE and MethodistCare, the Company hascontinued to work extensively on the integration of these businesses. However,there can be no assurances regarding the ultimate success of the Company’sintegration efforts or regarding the ability of the Company to maintain orimprove the results of operations of the acquired businesses. The Company hasincurred and will, among other things, need to continue to incur considerableexpenditures for provider networks, distribution channels and informationsystems in addition to the costs associated with the integration of theseacquisitions. The integration of these complex businesses may result in, amongother things, temporary increases in claims inventory or other service-relatedissues that may negatively affect the Company’s relationship with its customersand contribute to increased attrition of such customers. The Company’s resultsof operations could be adversely affected in the event that the Companyexperiences such problems or is otherwise unable to implement fully itsexpansion strategy.

 

The Company and certain of itssubsidiaries are subject to capital surplus requirements by the CaliforniaDepartment of Managed Health Care, the California, Delaware, Georgia andMissouri Departments of Insurance, various other state Departments of Insuranceand the Blue Cross and Blue Shield Association. Although the Company believesthat it is 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 Companyand certain of its subsidiaries are parties to various legal proceedings, manyof which involve claims for coverage encountered in the ordinary course ofbusiness. The Company, like HMOs and health insurers generally, excludescertain health care services from coverage under its HMO, PPO and other plans.The Company is, in its ordinary course of business, subject to the claims ofits enrollees arising out of decisions to restrict treatment or reimbursementfor certain services. The loss of even one such claim, if it results in asignificant punitive damage award, could have a material adverse effect on theCompany. In addition, the risk of potential liability under punitive damagetheories may increase significantly the difficulty of obtaining reasonablesettlements of coverage claims.

 

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In June 2000, the CaliforniaMedical Association filed a lawsuit in U.S. district court in San Franciscoagainst Blue Cross of California (“BCC”). The lawsuit alleges that BCC violatedthe Racketeer Influenced and Corrupt Organizations Act (“RICO”) through variousmisrepresentations to and inappropriate actions against health care providers.In late 1999, a number of class-action lawsuits were brought against several ofthe Company’s competitors alleging, among other things, variousmisrepresentations regarding their health plans and breaches of fiduciaryobligations to health plan members. In August 2000, the Company was added as aparty to *Shane v. Humana*, *et al*., a class-action lawsuit brought onbehalf of health care providers nationwide. In addition to the RICO claimsbrought in the California Medical Association lawsuit, this lawsuit alsoalleges violations of the Employee Retirement Income Security Act of 1974, asamended (“ERISA”), federal and state “prompt pay” regulations and certaincommon law claims. In October 2000, the federal Judicial Panel on MultidistrictLitigation issued an order consolidating the California Medical Associationlawsuit, the *Shane* lawsuit andvarious other pending managed care class-action lawsuits against othercompanies before District Court Judge Federico Moreno in the Southern Districtof Florida for purposes of the pretrial proceedings. In March 2001, JudgeMoreno dismissed the plaintiffs’ claims based on violation of RICO, althoughthe dismissal was made without prejudice to the plaintiffs’ ability tosubsequently refile their claims. Judge Moreno also dismissed, with prejudice,the plaintiffs’ federal prompt pay law claims. On March 26, 2001, theCalifornia Medical Association filed an amended complaint in its lawsuit,alleging, among other things, revised RICO claims and violations of Californialaw. On May 9, 2001, Judge Moreno issued an order requiring that all discoveryin the litigation be completed by December 2001, with the exception ofdiscovery related 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 Appeals panel issuedan opinion affirming Judge Moreno’s earlier action with respect to the motionto compel arbitration. The Company filed a motion requesting a rehearing of thematter before the entire 11th Circuit Court of Appeals, which motion was deniedby the 11th Circuit Court of Appeals in June 2002. On July 29, 2002, JudgeMoreno issued an order providing that discovery in the case would be allowed tore-commence on September 30, 2002. On September 26, 2002, Judge Moreno issuedan additional order certifying a nationwide class of physicians in the *Shane* matter, setting a trial date in May2003 and ordering the parties to participate in non-binding mediation. InOctober 2002, the Company filed a motion with the 11th Circuit Court of Appealsseeking to appeal Judge Moreno’s class-certification order. The 11th Circuithas scheduled a hearing for September 11, 2003 on the Company’s motion. Amediator has been appointed by Judge Moreno and the parties are currentlyconducting court-ordered mediation.

 

In March 2002, the AmericanDental Association and three individual dentists filed a lawsuit in U.S.district court in Chicago against the Company and BCC. This lawsuit allegesthat WellPoint 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 seeksclass-action status. The Company filed a motion (which was granted in July2002) with the federal Judicial Panel on Multidistrict Litigation

 

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requesting that the proceedingsin this case be consolidated with a similar action brought against othermanaged care companies that has been consolidated with the *Shane* lawsuit.

 

In May 2003, a lawsuit entitled *Thomas, et al. v. Blue Cross and Blue ShieldAssociation*, *et al.*wasfiled 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, the Blue Cross andBlue Shield Association and all of the other current Blue Cross and Blue Shieldlicensees. The lawsuit alleges that each of the defendants engaged in similaractivities and conduct as that alleged in the *Shane*litigation. The Company currently anticipates that the *Thomas*litigation will be consolidatedwith the *Shane*litigation.

 

In July 2001, two individual physiciansseeking to represent a class of physicians, hospitals and other providersbrought suit in the Circuit Court of Madison County, Illinois againstHealthLink, Inc., which is now a subsidiary of the Company as a result of theacquisition of RightCHOICE. The physicians allege that HealthLink breached thecontracts with these physicians by engaging in the practices of “bundling” and“down-coding” in its processing and payment of provider claims. The reliefsought includes an injunction against these practices and damages in anunspecified amount. This litigation was dismissed without prejudice at therequest of the plaintiffs in February 2003. A similar lawsuit was brought by physicians (including one of the physiciansin the case described above) in the same court in Madison County, Illinois, onbehalf of a nationwide class of providers who contract with Blue Cross and BlueShield plans against the Blue Cross and Blue Shield Association and anotherBlue Cross Blue Shield plan. The complaint recites that it is brought againstthose entities and their “unnamed subsidiaries, licensees, and affiliates,”listing a large number of Blue Cross and Blue Shield plans, including “AllianceBlue Cross Blue Shield of Missouri.” The plaintiffs also allege that the planshave systematically engaged in practices known as “short paying,” “bundling”and “down-coding” in their processing and payment of subscriber claims. BlueCross Blue Shield of Missouri has not been formally named or served as adefendant in this lawsuit. The Blue Cross and Blue Shield Association wasdismissed as a defendant in this lawsuit in August 2002.

 

On March 26, 2003, a lawsuit entitled *Irwinv. AdvancePCS, et al.* was filed in the California Superior Court inAlameda County, California.  WellPointand certain of its wholly owned subsidiaries are named as defendants in thelawsuit.  The complaint alleges that thedefendants violated California Business and Professions Code Section 17200 byengaging in unfair, fraudulent and unlawful business practices.  The complaint alleges, among other things,that pharmacy benefit management companies (such as the Company’s subsidiarythat does 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 that drugs are included in formularies in exchangefor rebates and that the defendants charge patient co-payments that exceed theactual cost of generic drugs.

 

The Company’s future resultswill depend in part on its ability to accurately predict health care costs andto control future health care costs through product and benefit design, underwriting

 

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criteria, medical managementand negotiation of favorable provider contracts. Changes in utilization rates,demographic characteristics, the regulatory environment and health carepractices, inflation, new pharmaceuticals/technologies, clusters of high-costcases and numerous other factors are beyond the control of any health planprovider and may adversely affect the Company’s ability to predict and controlhealth care costs and claims, as well as the Company’s financial condition,results of operations or cash flows. Periodic renegotiations of hospital andother provider contracts, coupled with continued consolidation of physician,hospital and other provider groups, may result in increased health care costsand limit the Company’s ability to negotiate favorable rates. In recent years,large physician practice management companies have experienced extremefinancial difficulties, including bankruptcy, which may subject the Company toincreased credit risk related to provider groups and cause the Company to incurduplicative health care services expense. Additionally, the Company facescompetitive pressure to contain premium prices. Fiscal concerns regarding thecontinued viability of government-sponsored programs such as Medicare andMedicaid may cause decreasing reimbursement rates for these programs. Anylimitation on the Company’s ability to increase or maintain its premium levels,design products, implement underwriting criteria or negotiate competitiveprovider contracts may adversely affect the Company’s financial condition orresults of operations.

 

Managed care organizations,both inside and outside California, operate in a highly competitive environmentthat has undergone 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 theservices of independent agents and brokers in the marketing of its health careplans, particularly with respect to individuals, seniors and small employergroup members. Such independent agents and brokers are typically notexclusively dedicated to the Company and may frequently also market health careplans of the Company’s competitors. The Company faces intense competition forthe services and allegiance of independent agents and brokers.

 

As a result of the Company’sacquisitions, the Company operates on a select geographic basis nationally andoffers a spectrum of health care and specialty products through variousrisk-sharing arrangements. The Company’s health care products include a varietyof managed care offerings as well as traditional fee-for-service coverage. Withrespect to product type, fee-for-service products are generally less profitablethan managed care products. A component of the Company’s expansion strategy isto transition over time the traditional insurance members of the Company’sacquired businesses to more managed care products.

 

With respect to therisk-sharing nature of products, managed care products that involve greaterpotential risk to the Company generally tend to be more profitable thanmanagement services products and those managed care products where the Companyis able to shift risks to 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

 

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unwilling to bear greaterliability 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 theCompany’s results of operations and on the continued merits of the Company’sgeographic expansion strategy.

 

One of the Company’s whollyowned subsidiaries operates as a pharmacy benefit manager (“PBM”) under thetrade name WellPoint Pharmacy Management. The PBM industry faces a number ofrisks and uncertainties in addition to those facing the Company’s core healthplan business. Such risks and uncertainties include the application of federaland state anti-remuneration laws (generally known as “anti-kickback” laws),whether PBMs operate as fiduciaries under the Employee Retirement IncomeSecurity Act of 1974 (“ERISA”) and are in compliance with their fiduciary obligationsunder ERISA in connection with the development and implementation of items suchas formularies, preferred drug listings and therapeutic intervention programs,and potential liability regarding the use of patient-identifiable medicalinformation. In addition, a number of federal and state legislative proposalsare being considered that could affect a variety of PBM industry practices,such as the receipt of rebates from pharmaceutical manufacturers. The Companybelieves that its PBM business is currently being conducted in compliance inall material respects with applicable legal requirements. However, there can beno assurance that the Company’s PBM business will not be subject to challengeunder various laws and regulations, or that any such challenge will not have amaterial adverse effect upon the Company’s results of operations or financialcondition. In addition, future legislative enactments affecting the PBMindustry could have a material adverse effect upon the Company’s results ofoperations and financial condition.

 

Substantially all of theCompany’s investment assets are in interest-yielding debt securities of varyingmaturities or equity securities. The value of fixed-income securities is highlysensitive to fluctuations in short- and long-term interest rates, with thevalue decreasing as such rates increase and increasing as such rates decrease.In addition, the value of equity securities can fluctuate significantly withchanges in market conditions. Changes in the value of the Company’s investmentassets, as a result of interest rate fluctuations, can affect the Company’sresults of operations and stockholders’ equity. There can be no assurances thatinterest rate fluctuations will not have a material adverse effect on theresults of operations or financial condition of the Company.

 

The Company’s operations aredependent on retaining existing employees, attracting additional qualifiedemployees and achieving productivity gains from the Company’s investment intechnology. The Company faces intense competition for qualified informationtechnology personnel and other skilled professionals. There can be noassurances that an inability to retain

 

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existing employees or attractadditional employees will not have a material adverse effect on the Company’sresults of operations.

 

Prior to the Company’sacquisition of the GBO, John Hancock Mutual Life Insurance Company (“JohnHancock”) entered into a number of reinsurance arrangements with respect topersonal accident insurance and the occupational accident component of workers’compensation insurance, a portion of which was originated through a poolmanaged by Unicover Managers, Inc. Under these arrangements, John Hancockassumed risks as a reinsurer and transferred certain of such risks to othercompanies. These arrangements have become the subject of disputes, including anumber of legal proceedings to which John Hancock is a party. 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 whollyowned subsidiary 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 which 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 maintainsprofessional liability and errors and omissions liability insurance, there canbe no assurances that the coverage limits under such insurance programs will beadequate to protect against future claims or that the Company will be able tomaintain insurance on acceptable terms in the future.

 

Following the terrorist attacksof September 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 ofthe Company’s wholly owned subsidiaries acting as a pharmacy benefit managementbusiness under the trade name WellPoint Pharmacy Management received twoadministrative subpoenas duces tecum issued by the U.S. Attorney’s Office inBoston Massachusetts. The Company does not believe that its pharmacy benefitmanagement business is presently a target of investigation by the U.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

 

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material respects with all lawsand regulations applicable to the pharmacy benefit management business.

 

As a result of the generalnationwide economic downturn, many states are currently experiencing budgetdeficits. State legislators are exploring a variety of alternatives to addressthis situation. In order to address the budget shortfalls, various states maypropose reductions in payments received by Medicaid managed care providers suchas the Company. Alternatively, state legislators may seek to impose greaterstate taxes. 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.

 

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***Review by Independent Accountants***

 

With respect to the unauditedconsolidated financial information of WellPoint Health Networks Inc. for thethree-month and six-month periods ended June 30, 2003 and 2002,PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) reported that they haveapplied limited procedures in accordance with professional standards for areview of such information.  However,their separate report dated July 21, 2003 appearing herein states that they didnot audit and they do not express an opinion on that unaudited consolidatedfinancial information.  Accordingly, thedegree of reliance on their report on such information should be restricted inlight of the limited nature of the review procedures applied.  PricewaterhouseCoopers is not subject to theliability provisions of Section 11 of the Securities Act of 1933 for theirreport on the unaudited consolidated financial information because that reportis not a “report” or a “part” of the registration statement prepared orcertified by PricewaterhouseCoopers within the meaning of Sections 7 and 11 ofthe Act.

 

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ITEM 3.  Quantitativeand Qualitative Disclosures About Market Risk

 

The Company regularly evaluatesits asset and liability interest rate risks, as well as the appropriateness ofinvestments, relative to its internal investment guidelines. The Companyoperates within these guidelines by maintaining a well-diversified portfolio,both across and within asset classes. The Company has from time to timeretained an independent consultant to advise the Company on the appropriatenessof its investment policy.

 

Asset interest rate risk ismanaged within a duration band tied to the Company’s liability interest raterisk. Credit risk is managed by maintaining high average quality ratings and awell-diversified portfolio.

 

The Company’s use of derivativeinstruments is generally limited to hedging purposes and has principallyconsisted of forward exchange contracts and interest rate swaps. The Company’sinvestment policy prohibits the use of derivatives for leveraging purposes aswell as the creation of risk exposures not otherwise allowed within the policy.

 

From time to time, the Companyhas entered into interest rate swap agreements primarily to minimizesignificant, unanticipated earnings fluctuations caused by interest ratevolatility. The Company’s goal is to maintain a balance between fixed andfloating interest rates on its long-term debt. The Company believes that thisallows it to better anticipate its interest payments while helping to managethe asset-liability relationship.

 

*Interest Rate Risk*

 

The Company is exposed tomarket rate risks associated with its investments and borrowings. Market riskrepresents the risk of loss in value of a financial instrument resulting fromchanges in interest rates and equity prices.

 

As of June 30, 2003, theCompany’s investment securities at market value, totaled $6.4 billion, of which89.1% was invested in fixed-income securities and the remaining 10.9% wasinvested in equity securities. The Company has evaluated the net impact to thefair value of its fixed-income investments from a hypothetical change in allinterest 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, 2003 are shown in the table below. The table alsoshows the change in valuation of the $200.0 million notional amount 6 3/8%fixed for LIBOR-based floating interest rate swap agreement as of June 30,2003.

 

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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                    |   | $                                                                | (164.9     | ) | $ | (345.1 | ) | $ | (532.6 | ) |
| Valuation of Interest Rate Swap Agreement |   | (5.0                                                             | )          | (9.9 | ) | (14.5 | ) |
|                                      |   | $                                                                | (169.9     | ) | $ | (355.0 | ) | $ | (547.1 | ) |

 

The Company believes that aninterest rate shift in a 12-month period of 100 bp represents a moderatelyadverse outcome, while a 200 bp shift is significantly adverse and a 300 bpshift is unlikely given historical precedents. Although the Company holds itsbonds as “available for sale” for purposes of Statement of Financial AccountingStandards No. 115, “Accounting for Certain Investments in Debt and EquitySecurities,” the Company’s cash flows and the short duration of its investmentportfolio should allow it to hold securities to maturity, thereby avoiding therecognition of losses should interest rates rise significantly.

 

*Interest Rate Swap Agreements*

 

On January 15, 2002, theCompany entered into a $200.0 million notional amount interest rate swapagreement with respect to its 2006 Notes. The swap agreement is a contract toexchange a fixed 6 3/8% rate for a LIBOR-based floatingrate. For the six months ended June 30, 2003 and 2002, the Company recognizedsettlement income of $3.9 million and $2.8 million from this swap agreement.(See Note 6 to the Consolidated Financial Statements.)

 

The Company has from time totime entered into additional interest rate swap agreements in order to reducethe volatility of interest expense resulting from changes in interest rates. Asof December 31, 2001, the Company had entered into $200.0 million of floatingto fixed-rate swap agreements, which consisted of a $150.0 million notionalamount swap agreement at 6.99% and a $50.0 million notional amount swapagreement at 7.06%. As of December 31, 2001, the Company also had $235.0million of LIBOR-based floating rate debt outstanding. In September 2002, theCompany terminated these two fixed-rate swap agreements with an aggregate cashsettlement of $17.6 million, of which $1.8 million was accrued interest and theremaining $15.8 million represented the fair value of the swap agreements atthe time of termination and is being amortized over the term of the originalswap agreements. As of June 30, 2003, the remaining balance of the swapagreements was $8.8 million. (See Note 7 to the Consolidated FinancialStatements for further discussion.)

 

*Equity Price Risk*

 

As of June 30, 2003, theCompany’s equity securities were comprised primarily of domestic stocks.Assuming an immediate decrease of 10% in market value, as of June 30, 2003, thehypothetical pre-tax loss in fair value of stockholders’ equity is estimated tobe approximately $69.5 million.

 

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ITEM 4.  Controlsand Procedures

 

The Company maintains “disclosurecontrols and procedures,” as such term is defined under Rule 13a-14(c) of therules and regulations under the Securities Exchange Act of 1934, as amended(the “Exchange Act”).  These disclosurecontrols and procedures are designed to ensure that information required to bedisclosed in the Company’s Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission (the “SEC”), and that such informationis accumulated and communicated to the Company’s management, including itsChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosures.  As of June 30, 2003, 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 disclosure controlsand procedures. Based upon their evaluation, the Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures were effective in ensuring that material information relating to theCompany is made known to the Chief Executive Officer and Chief FinancialOfficer by others within the Company during the period in which this quarterlyreport on Form 10-Q was being prepared.

 

There have been no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect these controls subsequent to the date the Companycompleted its evaluation.

 

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PART II.        OTHERINFORMATION

 

ITEM 1.          LegalProceedings

 

See “Factors That May Affect Future Results of Operations” for adiscussion of various pending legal matters involving the Company and itssubsidiaries. The Company’s annual report on Form 10-K for the year endedDecember 31, 2002 also contains a discussion of various pending legal matters.

 

ITEM 4.          Submission of Matters to a Vote ofSecurity Holders

 

OnMay 13, 2003, the annual meeting of stockholders of the Company was held. The agenda items for suchmeeting are shown below along with the vote of the Company’s Common Stock withrespect to such agenda items.

 

1.               Election of three Class I Directors toserve until the 2006 Annual Meeting of Stockholders and one Class IIIdirector to serve until the 2005 Annual Meeting of Stockholders; or in eachcase until the election of their successors.

 
| **Class I Nominees:** |   |                                                                             |
|----------------------------|--------|----------------------------------------------------------------------------------|
| Nominee:                   |   | Roger E. Birk  Votes FOR: 117,267,128  Votes WITHHELD AUTHORITY: 8,877,740       |
| Nominee:                   |   | Sheila P. Burke  Votes FOR: 118,701,991Votes WITHHELD AUTHORITY:  7,442,877      |
| Nominee:                   |   | Elizabeth A. Sanders  Votes FOR: 118,144,859Votes WITHHELD AUTHORITY:  8,000,009 |

 
| **Class III Nominee:** |   |                                                                        |
|-----------------------------|--------|-----------------------------------------------------------------------------|
| Nominee:                    |   | Ramiro G. Peru  Votes FOR: 124,218,547  Votes WITHHELD AUTHORITY: 1,926,321 |

 

Theterms of William H. T. Bush, Julie A. Hill, Warren Y. Jobe, Jane G. Pisano andLeonard D. Schaeffer continued after the meeting.

 

2.              Ratification of the selection ofPricewaterhouseCoopers LLP as the Company’s independent public accountants forthe fiscal year ending December 31, 2003.

 
| Votes FOR:        |   | 118,396,802 |
|-------------------|--------|-------------|
| Votes AGAINST:    |   | 7,668,081   |
| Votes: ABSTAIN:   |   | 79,985      |
| Broker non-votes: |   | 0           |

 

ITEM 6.        Exhibits and Reports on Form 8-K

 
| (a)    |   | Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   | See Exhibit  Index.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| (b)    |   | Reports on  Form 8-K                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   | On April 23,  2003, the Company furnished a current report on Form 8-K dated April 23,  2003, which attached a copy of the Company’s press release dated April 23,  2003 regarding the Company’s earnings for the quarter ended  March 31, 2003.                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   | On May 7,  2003, the Company furnished a current report on Form 8-K dated May 1, 2003,  which attached the text of certain information provided and to be provided by  the Company during various investor conferences.                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   | On June 4,  2003, the Company furnished a current report on Form 8-K dated May 28, 2003,  which attached the text of certain information provided by the Company at its  annual investor conference held on May 28, 2003 and indicated that the  Company may provide the same information at future investor conferences.                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   | The  information furnished pursuant to the current reports on Form 8-K described  above was intended to be furnished under Item 12 of the Form 8-K and is not  to be considered “filed” under the Securities Exchange Act of 1934, as  amended, nor shall it be incorporated by reference into this filing or future  filings by the Company under the Securities Act of 1933, as amended or under  the Securities Exchange Act of 1934, as amended, unless the Company expressly  sets forth 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 ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                   |   | **WELLPOINT HEALTH NETWORKS INC.**

                             Registrant

  |
|------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                   |   |                                                                                                                                                                                                                                 |   |
|                   |   |                                                                                                                                                                                                                                 |   |
| Date: August  14, 2003 |   | By:                                                                                                                                                                                                                             | /s/ LEONARD  D. SCHAEFFER |
|                   |   | Leonard D.  Schaeffer                                                                                                                                                                                                                |
|                   |   | Chairman of  the Board of Directors  and Chief Executive Officer                                                                                                                                                                     |

 

 

 
| Date: August  14, 2003 |   | By:                                               | /s/ DAVID C.  COLBY |
|------------------------|--------|--------------------------------------------------------|---------------------|
|                   |   | David C.  Colby                                        |
|                   |   | Executive  Vice President  and Chief Financial Officer |

 

 

 
| Date: August  14, 2003 |   | By:                           | /s/ KENNETH  C. ZUREK |
|------------------------|--------|------------------------------------|-----------------------|
|                   |   | Kenneth C.  Zurek                  |
|                   |   | Senior Vice  President, Controller |
|                   |   | and Taxation                       |

 

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**EXHIBITINDEX**

** **
| **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                |   | Amended and Restated  Agreement and Plan of Merger dated as of November 29, 2000 by and among  Cerulean Companies, Inc., the Registrant and Water Polo Acquisition Corp.,  incorporated by reference to Exhibit 2.01 to the Registrant’s Current Report  on Form 8-K dated March 15, 2001.                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 2.03                |   | 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).                                                     |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 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. 333-90701).                                                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 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.                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 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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