**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**Forthe quarterly period ended September 30, 2003**

 

**OR**

 

**o****                                ****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom             to             **

 

**CommissionFile Number 001-13083**

 

**WELLPOINTHEALTH 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’stelephone 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  No  o

 

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

 

As of November 5, 2003, there wereapproximately 151,940,946 shares of Common Stock, $0.01 par value of theregistrant outstanding.

 

 

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**WellPoint Health Networks Inc.**

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

**Table of Contents**

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

 

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**PART I****. FINANCIAL INFORMATION**

 

ITEM 1.                 FinancialStatements

 

**WellPoint Health Networks Inc.**

Consolidated Balance Sheets

** **
| **(In thousands, except share data)**                                                                                                                         |   | **September  30,  2003** |       | **December  31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|--------|
|                                                                                                                                                          |   | **(Unaudited)**          |       |                    |   |
| ***ASSETS***                                                                                                                                                  |   |                     |       |                    |   |
| Current Assets:                                                                                                                                               |   |                     |       |                    |   |
| Cash and cash equivalents                                                                                                                                     |   | $                        | 1,086,063  |                    | $      | 1,355,616 |   |
| Investments - available-for-sale, at fair  value                                                                                                              |   | 6,647,958                |       | 5,282,887               |   |
| Receivables, net                                                                                                                                              |   | 1,494,378                |       | 1,223,232               |   |
| Deferred tax assets, net                                                                                                                                      |   | 344,735                  |       | 310,245                 |   |
| Other current assets                                                                                                                                          |   | 280,279                  |       | 208,711                 |   |
| Total Current Assets                                                                                                                                          |   | 9,853,413                |       | 8,380,691               |   |
| Property and equipment, net                                                                                                                                   |   | 418,002                  |       | 346,351                 |   |
| Intangible assets, net                                                                                                                                        |   | 964,660                  |       | 737,461                 |   |
| Goodwill, net                                                                                                                                                 |   | 2,180,349                |       | 1,691,771               |   |
| Long-term investments, at market value                                                                                                                        |   | 160,720                  |       | 134,274                 |   |
| Other non-current assets                                                                                                                                      |   | 296,135                  |       | 180,083                 |   |
| Total Assets                                                                                                                                                  |   | $                        | 13,873,279 |                    | $      | 11,470,631 |   |
|                                                                                                                                                          |   |                     |       |                    |   |
| ***LIABILITIES AND STOCKHOLDERS' EQUITY***                                                                                                                    |   |                     |       |                    |   |
| Current Liabilities:                                                                                                                                          |   |                     |       |                    |   |
| Medical claims payable                                                                                                                                        |   | $                        | 2,753,718  |                    | $      | 2,422,331 |   |
| Reserves for future policy benefits                                                                                                                           |   | 72,914                   |       | 68,907                  |   |
| Unearned premiums                                                                                                                                             |   | 606,917                  |       | 495,508                 |   |
| Accounts payable and accrued expenses                                                                                                                         |   | 1,280,534                |       | 1,144,662               |   |
| Experience rated and other refunds                                                                                                                            |   | 263,899                  |       | 251,743                 |   |
| Income taxes payable                                                                                                                                          |   | 151,136                  |       | 140,881                 |   |
| Security trades pending payable                                                                                                                               |   | 110,933                  |       | 428,851                 |   |
| Security lending payable                                                                                                                                      |   | 614,590                  |       | 197,453                 |   |
| Other current liabilities                                                                                                                                     |   | 721,826                  |       | 601,513                 |   |
| Total Current Liabilities                                                                                                                                     |   | 6,576,467                |       | 5,751,849               |   |
| Accrued postretirement benefits                                                                                                                               |   | 146,750                  |       | 123,042                 |   |
| Reserves for future policy benefits,  non-current                                                                                                             |   | 272,074                  |       | 214,328                 |   |
| Long-term debt                                                                                                                                                |   | 1,287,445                |       | 1,011,578               |   |
| Deferred tax liabilities                                                                                                                                      |   | 316,911                  |       | 187,020                 |   |
| Other non-current liabilities                                                                                                                                 |   | 242,321                  |       | 206,117                 |   |
| Total Liabilities                                                                                                                                             |   | 8,841,968                |       | 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, 157,006,322 and 149,748,101 issued at September 30, 2003  and December 31, 2002, respectively |   | 1,570                    |       | 1,497                   |   |
| Treasury stock, at cost, 5,890,449 and  2,697,958 shares at September 30, 2003 and December 31, 2002, respectively                                            |   | (415,592                 | )          | (173,842                | )      |
| Additional paid-in capital                                                                                                                                    |   | 2,373,255                |       | 1,812,004               |   |
| Retained earnings                                                                                                                                             |   | 2,978,995                |       | 2,315,254               |   |
| Accumulated other comprehensive income                                                                                                                        |   | 93,083                   |       | 21,784                  |   |
| Total Stockholders' Equity                                                                                                                                    |   | 5,031,311                |       | 3,976,697               |   |
| Total Liabilities and Stockholders' Equity                                                                                                                    |   | $                        | 13,873,279 |                    | $      | 11,470,631 |   |

 

See the accompanying notes to the Consolidated Financial Statements.

 

1

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**WellPoint Health Networks Inc.**

Consolidated Income Statements

(Unaudited)

 
|                                                             |   | **Quarter  Ended September 30,** |      | **Nine  Months Ended September 30,** |   |
|------------------------------------------------------------------|--------|----------------------------------|-----------|--------------------------------------|--------|
| **(In thousands, except earnings per share)**                    |   | **2003**                         |      | **2002**                             |   | **2003** |   | **2002** |   |
| Revenues:                                                        |   |                             |      |                                 |   |   |   |   |   |
| Premium revenue                                                  |   | $                                | 4,763,859 |                                 | $      | 4,183,949 |   | $ | 13,967,018 |   | $ | 11,907,702 |   |
| Management services and other revenue                            |   | 219,695                          |      | 213,407                              |   | 667,332 |   | 605,675 |   |
| Investment income                                                |   | 65,455                           |      | 117,769                              |   | 195,807 |   | 243,831 |   |
|                                                             |   | 5,049,009                        |      | 4,515,125                            |   | 14,830,157 |   | 12,757,208 |   |
| Operating Expenses:                                              |   |                             |      |                                 |   |   |   |   |   |
| Health care services and other benefits                          |   | 3,792,105                        |      | 3,420,328                            |   | 11,279,272 |   | 9,684,935 |   |
| Selling expense                                                  |   | 200,562                          |      | 175,612                              |   | 593,796 |   | 498,802 |   |
| General and administrative expense                               |   | 624,258                          |      | 539,950                              |   | 1,791,927 |   | 1,620,625 |   |
|                                                             |   | 4,616,925                        |      | 4,135,890                            |   | 13,664,995 |   | 11,804,362 |   |
| Operating Income                                                 |   | 432,084                          |      | 379,235                              |   | 1,165,162 |   | 952,846 |   |
| Interest expense                                                 |   | 12,645                           |      | 20,232                               |   | 38,108 |   | 55,786 |   |
| Other expense, net                                               |   | 9,074                            |      | 15,072                               |   | 20,724 |   | 39,973 |   |
| Income before Provision for Income Taxes  and Extraordinary Item |   | 410,365                          |      | 343,931                              |   | 1,106,330 |   | 857,087 |   |
| Provision for income taxes                                       |   | 164,146                          |      | 137,583                              |   | 442,589 |   | 342,934 |   |
| Income before Extraordinary Item                                 |   | 246,219                          |      | 206,348                              |   | 663,741 |   | 514,153 |   |
| Extraordinary Item:                                              |   |                             |      |                                 |   |   |   |   |   |
| Gain from negative goodwill on acquisition                       |   | —                           |      | 4,908                                |   | — |   | 8,950 |   |
| Net Income                                                       |   | $                                | 246,219   |                                 | $      | 211,256 |   | $ | 663,741 |   | $ | 523,103 |   |
|                                                             |   |                             |      |                                 |   |   |   |   |   |
| Earnings Per Share:                                              |   |                             |      |                                 |   |   |   |   |   |
| Income before Extraordinary Item                                 |   | $                                | 1.68      |                                 | $      | 1.42 |   | $ | 4.55 |   | $ | 3.59 |   |
| Extraordinary gain from negative goodwill  on acquisition        |   | —                           |      | 0.03                                 |   | — |   | 0.06 |   |
| Net Income                                                       |   | $                                | 1.68      |                                 | $      | 1.45 |   | $ | 4.55 |   | $ | 3.65 |   |
|                                                             |   |                             |      |                                 |   |   |   |   |   |
| Earnings Per Share Assuming Full Dilution:                       |   |                             |      |                                 |   |   |   |   |   |
| Income before Extraordinary Item                                 |   | $                                | 1.63      |                                 | $      | 1.35 |   | $ | 4.42 |   | $ | 3.42 |   |
| Extraordinary gain from negative goodwill  on acquisition        |   | —                           |      | 0.03                                 |   | — |   | 0.06 |   |
| Net Income                                                       |   | $                                | 1.63      |                                 | $      | 1.38 |   | $ | 4.42 |   | $ | 3.48 |   |
|                                                             |   |                             |      |                                 |   |   |   |   |   |
| Weighted Average Shares Outstanding                              |   | 146,626                          |      | 145,523                              |   | 145,987 |   | 143,178 |   |
| Fully Diluted Weighted Average Shares  Outstanding               |   | 150,845                          |      | 152,764                              |   | 150,084 |   | 150,421 |   |

 

See the 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** |       | **Common Stock** |             | **Additional  Paid - in  Capital** |       | **Retained  Earnings** |       | **Accumulated  Other  Comprehensive  Income** |   | **Total** |     |
|---------------------------------------------------------------------------------------------------------|--------|----------------------|------------|------------------|------------------|------------------------------------|------------|------------------------|------------|-----------------------------------------------|--------|-----------|----------|
|                                                                                                    |   |                 | **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                                                                 |   |                 |       |             |             |                               |       | (491                   | )          | 31,784                                        |   |      |     |   |   |   |   | 31,784 |   |
| Stock issued for employee stock option plans and stock purchase plans                                   |   |                 |       |             |             |                               |       | (2,365                 | )          | 158,015                                       |   | 41,488    |     |   |   |   |   | 199,503 |   |
| Stock repurchased, at cost                                                                              |   |                 |       |             |             |                               |       | 3,912                  |       | (268,565                                      | )      |      |     |   |   |   |   | (268,565 | ) |
| Net losses from treasury stock reissued                                                                 |   |                 |       |             |             |                               |       |                   |       |                                          |   | (84,532   | )        |   |   |   |   | (84,532 | ) |
| Stock and stock options issued in connection with acquisition of  Cobalt Corporation                    |   |                 |       | 7,258            |             | 73                                 |       |                   |       |                                          |   | 604,295   |     |   |   |   |   | 604,368 |   |
| Stock held by Subsidiaries                                                                              |   |                 |       |             |             |                               |       | 2,136                  |       | (162,984                                      | )      |      |     |   |   |   |   | (162,984 | ) |
| Comprehensive income                                                                                    |   |                 |       |             |             |                               |       |                   |       |                                          |   |      |     |   |   |   |   |   |   |
| Net income                                                                                              |   |                 |       |             |             |                               |       |                   |       |                                          |   |      |     | 663,741 |   |   |   | 663,741 |   |
| Treasury stock owned by subsidiary                                                                      |   |                 |       |             |             |                               |       |                   |       |                                          |   |      |     |   |   | (5,604 | ) | (5,604 | ) |
| Change in unrealized valuation adjustment on investment securities,  net of reclassification adjustment |   |                 |       |             |             |                               |       |                   |       |                                          |   |      |     |   |   | 76,903 |   | 76,903 |   |
| Total comprehensive income                                                                              |   |                 |       |             |             |                               |       |                   |       |                                          |   |      |     | 663,741 |   | 71,299 |   | 735,040 |   |
| Balance as of September 30, 2003                                                                        |   | $                    | —     |             | 157,006          |                               | $          | 1,570                  |       | 5,890                                         |   | $         | (415,592 | ) | $ | 2,373,255 |   | $ | 2,978,995 |   | $ | 93,083 |   | $ | 5,031,311 |   |

 

See the accompanying notes to the Consolidated Financial Statements.

 

3

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**WellPoint Health Networks Inc.**

ConsolidatedStatements of Cash Flows

(Unaudited)

 
|                                                                                                                        |   | **Nine  Months Ended September 30,** |      |
|-----------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|-----------|
| **(In thousands)**                                                                                                          |   | **2003**                             |      | **2002** |   |
| **Cash flows from operating activities:**                                                                                   |   |                                 |      |   |   |
| Income before extraordinary item                                                                                            |   | $                                    | 663,741   |   | $ | 514,153 |   |
| Adjustments to reconcile income before  extraordinary item to net cash provided by operating activities:                    |   |                                 |      |   |   |
| Depreciation and amortization, net of  accretion                                                                            |   | 123,132                              |      | 81,676 |   |
| Gain on sales of assets, net                                                                                                |   | (12,452                              | )         | (43,677 | ) |
| Benefit for deferred income taxes                                                                                           |   | (32,464                              | )         | (38,273 | ) |
| Amortization of deferred gain on sale of  building                                                                          |   | —                               |      | (3,320 | ) |
| Accretion of interest on zero coupon  convertible subordinated debentures, 6 3/8% Notes due 2012 and 6 3/8% Notes  due 2006 |   | 212                                  |      | 8,811 |   |
| (Increase) decrease in certain assets:                                                                                      |   |                                 |      |   |   |
| Receivables, net                                                                                                            |   | (232,086                             | )         | (82,145 | ) |
| Other current assets                                                                                                        |   | (57,186                              | )         | (15,865 | ) |
| Other non-current assets                                                                                                    |   | (6,194                               | )         | (40,240 | ) |
| Increase (decrease) in certain liabilities:                                                                                 |   |                                 |      |   |   |
| Medical claims payable                                                                                                      |   | 86,973                               |      | 222,990 |   |
| Reserves for future policy benefits                                                                                         |   | 10,931                               |      | 9,733 |   |
| Unearned premiums                                                                                                           |   | 220                                  |      | 14,944 |   |
| Accounts payable and accrued expenses                                                                                       |   | 77,747                               |      | 181,259 |   |
| Experience rated and other refunds                                                                                          |   | 10,475                               |      | (11,014 | ) |
| Income taxes payable                                                                                                        |   | 35,391                               |      | 28,861 |   |
| Other current liabilities                                                                                                   |   | 100,640                              |      | 116,108 |   |
| Accrued postretirement benefits                                                                                             |   | 5,106                                |      | 5,623 |   |
| Other non-current liabilities                                                                                               |   | 16,097                               |      | 4,521 |   |
| Net cash provided by operating activities                                                                                   |   | 790,283                              |      | 954,145 |   |
| **Cash flows from investing activities:**                                                                                   |   |                                 |      |   |   |
| Investments purchased                                                                                                       |   | (7,890,081                           | )         | (4,709,986 | ) |
| Proceeds from investments sold                                                                                              |   | 6,803,090                            |      | 3,908,255 |   |
| Property and equipment purchased                                                                                            |   | (101,645                             | )         | (75,442 | ) |
| Proceeds from property and equipment sold                                                                                   |   | 5,561                                |      | 5,786 |   |
| Acquisition of new businesses, net of cash  acquired                                                                        |   | (405,420                             | )         | (349,178 | ) |
| Net cash used in investing activities                                                                                       |   | (1,588,495                           | )         | (1,220,565 | ) |
| **Cash flows from financing activities:**                                                                                   |   |                                 |      |   |   |
| Net repayment of long-term debt under the  revolving credit facility                                                        |   | —                               |      | (235,000 | ) |
| Net borrowing of commercial paper                                                                                           |   | 274,620                              |      | 199,778 |   |
| 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                                                 |   | —                               |      | (18,913 | ) |
| Change in advances on securities lending  deposits                                                                          |   | 417,137                              |      | — |   |
| Proceeds from issuance of Common Stock                                                                                      |   | 105,467                              |      | 127,135 |   |
| Proceeds from sale of put options                                                                                           |   | —                               |      | 1,603 |   |
| Common Stock repurchased                                                                                                    |   | (268,565                             | )         | (165,453 | ) |
| Net cash provided by financing activities                                                                                   |   | 528,659                              |      | 258,055 |   |
| Net decrease in cash and cash equivalents                                                                                   |   | (269,553                             | )         | (8,365 | ) |
| Cash and cash equivalents at beginning of  period                                                                           |   | 1,355,616                            |      | 1,028,476 |   |
| Cash and cash equivalents at end of period                                                                                  |   | $                                    | 1,086,063 |   | $ | 1,020,111 |   |

 

See the accompanying notes to the Consolidated Financial Statements.

 

4

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**WellPoint Health Networks Inc.**

**Notes****to Consolidated Financial Statements**

**(Unaudited)**

 

**1.****              Organization**

 

WellPoint Health Networks Inc. (the “Company” or “WellPoint”) isone of the nation’s largest publicly traded managed health care companies.  As of September 30, 2003, WellPoint had approximately14.0 million medical members and approximately 44.7 million specialtymembers.  Through its subsidiaries, theCompany offers a broad spectrum of network-based managed care plans to thelarge 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, 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. With the acquisition of Cobalt Corporation,the Company now also offers workers’ compensation products and is currently thelargest Part A Medicare fiscal intermediary in the nation, processing claimsfor providers in all 50 states. The Company markets its products in Californiaprimarily under the name Blue Cross of California, in Georgia primarily underthe name Blue Cross Blue Shield of Georgia, in various parts of Missouri(including the greater St. Louis area) under the name Blue Cross & BlueShield of Missouri, in Wisconsin primarily under the name Blue Cross & BlueShield United of Wisconsin and in various parts of the country under the namesUNICARE or HealthLink. These products are marketed by the Company’s variousoperating subsidiaries throughout the United States. The Company’s customerbase is diversified, with extensive membership among large and small employergroups and individuals and in the Medicare and Medicaid markets.

 

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

 

The accompanying unaudited consolidated financial statements ofWellPoint have been prepared in accordance with accounting principles generallyaccepted in the United States of America (“GAAP”) and the rules and regulationsof the Securities and Exchange Commission (“SEC”) for interim financialreporting.  In accordance with the rulesand regulations of the SEC, certain footnotes or other financial informationhave been condensed or omitted if they substantially duplicate the disclosurescontained in the Company’s annual audited financial statements.  In the opinion of management, the interimfinancial statements reflect all material adjustments (which are of a normalrecurring nature) necessary for a fair statement of its financial position asof September 30, 2003, the results of its operations for the quarters and ninemonths ended September 30, 2003 and 2002, its changes in stockholders’ equityfor the nine months ended September 30, 2003 and its cash flows for the ninemonths ended September 30, 2003 and 2002. The results of operations for the interim periods presented are notnecessarily indicative of the operating results for the full year.  These unaudited consolidated financialstatements should be read together with the consolidated financial statementsand notes included in the Company’s annual report on Form 10-K for the yearended December 31, 2002. The Company has reclassified certain prior yearamounts in the

 

5

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accompanying unaudited consolidated financial statements to conform tothe 2003 presentation.

 

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

 

In April 2002, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 145, “Rescission of FASBStatements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections as of April 2002” (“SFAS No. 145”). With the rescission of FASBStatement No. 4, gains and losses from the extinguishment of debt should beclassified as extraordinary items only if they meet the criteria in APB OpinionNo. 30. The provisions of APB Opinion No. 30 distinguish between transactionsthat are part of an entity’s recurring operations and those that are unusual orinfrequent or that meet the criteria for classification as an extraordinaryitem. The provisions of SFAS No. 145 related to the rescission of FASBStatement No. 4 are required to be applied for fiscal years beginning after May15, 2002. The Company has determined that the extinguishment of debt under itsZero Coupon Convertible Subordinated Debentures, which were redeemed as ofOctober 28, 2002, does not meet the requirements of unusual or infrequent andtherefore would not be included as an extraordinary item with the rescission ofFASB Statement No. 4.  For the quarterended September 30, 2002, WellPoint reclassified an extraordinary loss of $4.2million, which included a tax benefit of $1.7 million, to interest expense. Forthe nine months ended September 30, 2002, WellPoint reclassified anextraordinary loss of $6.3 million, which included a tax benefit of $2.5million, to interest expense. The other provisions of SFAS No. 145 did not havea material impact on the Company’s consolidated financial statements.

 

In December 2002, the FASB amended the transition and disclosurerequirements of Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation” (“SFAS No. 123”), through theissuance of Statement of Financial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure” (“SFAS No. 148”). SFASNo. 148 amends the disclosures that a company is required to make in its annualand interim financial statements. These disclosures are required regardless ofwhether a company is using the intrinsic value method under APB Opinion No. 25,“Accounting for Stock Issued to Employees” or the fair value based method underSFAS No. 123 to account for its stock-based employee compensation. SFAS No. 148also provides alternative methods of transition for a voluntary change to thefair value based method of accounting for stock-based employee compensation.SFAS No. 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 andreporting for derivative instruments, including certain derivative instrumentsembedded in other contracts and hedging activities under Statement of FinancialAccounting Standards No. 133, “Accounting for Derivative Instruments andHedging Activities” (“SFAS No. 133”), through the issuance of Statement ofFinancial Accounting Standards No. 149, “Amendment of

 

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Statement 133 on Derivative Instruments and Hedging Activities” (“SFASNo. 149”). SFAS No. 149 is effective for contracts entered into or modifiedafter June 30, 2003 and for hedging relationships designated after June 30,2003. The adoption of SFAS No. 149 did not have a material impact on theCompany’s financial condition or results of operations.

 

In May 2003, the FASB issued Statement of Financial AccountingStandards No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity” (“SFAS No. 150”). SFAS No. 150modifies the accounting for certain financial instruments that, under previousguidance, issuers could account for as equity. SFAS No. 150 requires that thoseinstruments be classified as liabilities in statements of financial position.Most of the guidance in SFAS No. 150 is effective for all financial instrumentsentered into or modified after May 31, 2003 or otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003. Theadoption of SFAS No. 150 did not have a material impact on the Company’s financialcondition or results of operations.

 

**4.****              Acquisitions**

 

On September 24, 2003, the Company completed its merger, through itswholly owned subsidiary, Crossroads Acquisition Corp., with Cobalt Corporation(“Cobalt”), the parent company of Blue Cross & Blue Shield United ofWisconsin, which served approximately 675,000 medical members as of September30, 2003. The transaction was effective as of September 30, 2003 for accountingpurposes. Accordingly, the Consolidated Balance Sheet and membership data as ofSeptember 30, 2003 reflected the impact of the Cobalt transaction. However,Cobalt’s operating results for the quarter and nine months ended September 30,2003, were not included in the Consolidated Income Statement or ConsolidatedStatement of Cash Flows.

 

Under the terms of the transaction, total consideration paid to allholders of Cobalt common stock in the merger was approximately $427.5 millionin cash and approximately 7.3 million shares of WellPoint Common Stock (whichincluded approximately 2.1 million shares issued to affiliates) from newlyissued shares of WellPoint Common Stock. The total purchase price ofapproximately $884.9 million valued as of September 24, 2003 was used topurchase net assets with a fair value of approximately $271.6 million. Includedin the total purchase price was $12.1 million used to retire Cobalt’s existinglong-term debt at the time of acquisition. As a result of the acquisition ofCobalt, the Company incurred $1.5 million in expenses primarily related totransaction costs. Generally accepted accounting principles require that theseexpenses, which are not associated with the generation of future revenues andhave no future economic benefit, be reflected as assumed liabilities in theallocation of the purchase price to the net assets acquired. Goodwill and otherintangibles totaling $711.3 million includes $96.5 million of deferred taxliabilities relating to identified intangibles. With the adoption of Statementof Financial Accounting Standards No. 142, “Goodwill and Other IntangibleAssets” (“SFAS No. 142”), goodwill and other intangible assets with indefiniteuseful lives are no longer amortized, but instead are subject to impairmenttests. Identified intangibles with definite useful lives are being amortized ona straight-line basis or the timing of related cash flows depending upon theexpected amortization pattern over three to 23 years.  The purchase price allocation between

 

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goodwill and identifiable intangible assets was $470.0 million and$241.3 million, respectively. The entire goodwill amount of $470.0 million isnot deductible for tax purposes. The operating results for Cobalt will beincluded in WellPoint’s consolidated income statement for periods beginningOctober 1, 2003.

 

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 $17.2 million and $13.0 million, respectively. The operating results forGolden West are included in WellPoint’s consolidated income statement forperiods following the completion of the acquisition.

 

On April 30, 2002, the Company completed its acquisition of MethodistCare, Inc. (“MethodistCare”), which served over 70,000 members in the Houston,Texas and surrounding areas at the time of acquisition. This acquisition wasintended to enable UNICARE, WellPoint’s national operating unit, to expand itsproduct line by offering HMO and open-access products in the Gulf Coast andsurrounding 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 in the merger was approximately $379.1 million in cashand 16.5 million shares of WellPoint Common Stock. The Company issuedapproximately 11.1 million shares from treasury stock and the remaining 5.4million shares from newly issued shares of WellPoint Common Stock. The totalpurchase price of approximately $1,503.7 million was used to purchase netassets with a fair value of approximately $308.8 million. The operating resultsfor RightCHOICE are included in WellPoint’s consolidated income statementperiods following the completion of the acquisition.

 

In accordance with the requirements of Statement of FinancialAccounting Standards No. 141, “Business Combinations” (“SFAS No. 141”), thefollowing unaudited pro forma summary presents revenues, net income and pershare data of WellPoint as if the acquisitions of RightCHOICE, MethodistCare,Golden West and Cobalt had occurred on January 1, 2002.  The pro forma information includes theresults of operations for each acquired entity for the period prior to its acquisition,adjusted for interest expense on long-term debt incurred to fund

 

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the acquisitions, amortization of intangible assets with definiteuseful lives and the related income tax effects.

 

The pro forma financial information is presented for informationalpurposes only and may not be indicative of the results of operations had theCompany been a single entity during the quarters and nine months endedSeptember 30, 2003 and 2002, nor is it necessarily indicative of future resultsof operations. Pro forma earnings per share is based on 151.8 million and150.7 million weighted average shares for the quarters endedSeptember 30, 2003 and 2002, respectively. Pro forma earnings per shareassuming full dilution is based on 157.0 million and 158.9 millionweighted average shares for the quarters ended September 30, 2003 and2002, respectively. Pro forma earnings per share is based on 151.1 million and150.1 million weighted average shares for the nine months endedSeptember 30, 2003 and 2002, respectively. Pro forma earnings per shareassuming full dilution is based on 156.2 million and 158.5 millionweighted average shares for the nine months ended September 30, 2003 and2002, respectively.

 
|                                                                             |   | **Quarter  Ended********September  30,** |       | **Nine Months  Ended********September  30,** |       |
|----------------------------------------------------------------------------------|--------|------------------------------------------|------------|----------------------------------------------|------------|
| **(In thousands, except per share  amounts)**                                    |   | **2003**                                 |       | **2002**                                     |       | **2003** |   | **2002** |   |
|                                                                             |   |                                     |       |                                         |       |   |   |   |   |
| Revenues                                                                         |   | $                                        | 5,465,492  |                                         | $          | 4,912,229 |   | $ | 16,085,480 |   | $ | 14,094,414 |   |
| Adjusted Pro Forma Income from Continuing  Operations before Extraordinary Items |   | $                                        | 255,163    |                                         | $          | 212,388 |   | $ | 695,094 |   | $ | 528,063 |   |
| Adjusted Pro Forma Net Income                                                    |   | $                                        | 255,163    |                                         | $          | 212,388 |   | $ | 695,094 |   | $ | 543,004 |   |
|                                                                             |   |                                     |       |                                         |       |   |   |   |   |
| **Earnings Per Share:**                                                          |   |                                     |       |                                         |       |   |   |   |   |
| Adjusted Pro Forma Income from Continuing  Operations before Extraordinary Items |   | $                                        | 1.68       |                                         | $          | 1.41 |   | $ | 4.60 |   | $ | 3.52 |   |
| Adjusted Pro Forma Net Income                                                    |   | $                                        | 1.68       |                                         | $          | 1.41 |   | $ | 4.60 |   | $ | 3.62 |   |
|                                                                             |   |                                     |       |                                         |       |   |   |   |   |
| **Diluted Earnings  Per Share:**                                                 |   |                                     | ** ** |                                         | ** ** |   | ** ** |   | ** ** |
| Adjusted Pro Forma Income from Continuing  Operations before Extraordinary Items |   | $                                        | 1.63       |                                         | $          | 1.34 |   | $ | 4.45 |   | $ | 3.34 |   |
| Adjusted Pro Forma Net Income                                                    |   | $                                        | 1.63       |                                         | $          | 1.34 |   | $ | 4.45 |   | $ | 3.44 |   |

 

 

The adjusted pro forma net income for the nine months ended September30, 2002 includes Cobalt’s recognition of a net gain from discontinuedoperations of $6.0 million from its behavioral health and medical managementsubsidiary, on a pro forma basis, using WellPoint’s effective tax rate of40.0%. In addition included in net income for the nine months ended September30, 2002, was a net after-tax realized gain by Cobalt of $6.7 million, on a pro

 

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forma basis, using WellPoint’s effective tax rate of 40.0% on the saleof 4.4 million shares of American Medical Security Group, Inc. common stock.

 

**5.****              Goodwilland Other Intangible Assets**

 

The Company adopted SFAS No. 142 on January 1, 2002 and no longeramortizes goodwill and other intangible assets with indefinite useful lives. Inaccordance with SFAS No. 142, the Company completed the transitional evaluationof its goodwill and other intangible assets at January 1, 2002 and the annualevaluation at December 31, 2002, and determined that there was no impairmentloss.

 

The changes in the carrying amount of goodwill by reportable segmentare 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                                                             |   | 469,951          |      | 17,156        |   | 487,107          |   |
| Balance as of September 30, 2003                                                          |   | $                | 2,148,222 |          | $      | 32,127           |   | $ | 2,180,349 |   |

 

 

On September 24, 2003, WellPoint completed its merger with Cobalt, asdiscussed in Note 4.  As a result of theacquisition of Cobalt, the Company recorded $470.0 million of goodwill and$241.3 million of identifiable intangible assets as of September 30, 2003. Thevaluation process is not yet complete and, therefore, the allocation betweengoodwill and other intangible assets recorded as of September 30, 2003represents an estimate. The Company assumes no residual value for itsamortizable intangible assets.

 

The following table presents details of the acquired amortized andnon-amortized intangible assets of Cobalt at cost as of September 30, 2003:

 

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

 

On June 30, 2003, WellPoint completed its acquisition of Golden West,as discussed in Note 4.  As a result ofthe acquisition of Golden West, the Company recorded $17.2 million of goodwilland $13.0 million of identifiable intangible assets as of September 30, 2003.The valuation process is not yet complete and, therefore, the allocationbetween goodwill and other intangible assets recorded as of September 30, 2003represents an estimate. The Company assumes no residual value for itsamortizable intangible assets.

 

The following table presents details of the acquired amortized andnon-amortized intangible assets of Golden West at cost as of September 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 carrying value, accumulated amortization and net carryingvalue of other intangible assets as of September 30, 2003 and December 31, 2002were as follows:

 

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| **(In thousands)  As of September 30, 2003**           |   | **Gross  Carrying  Value** |      | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Amortizat-  ion Period  (in years)** |    |
|--------------------------------------------------------|--------|----------------------------|-----------|-------------------------------|--------|--------------------------|--------|----------------------------------------|---------|
| Amortized intangible assets:                           |   |                       |      |                          |   |                     |   |                                   |    |
| Provider relationships                                 |   | $                          | 33,424    |                          | $      | 4,979                    |   | $                                      | 28,445  |   | 10 to 25 |   |
| Customer contracts and related customer  relationships |   | 427,974                    |      | 98,519                        |   | 329,455                  |   | 1.5 to 20                              |    |
| Other                                                  |   | 21,968                     |      | 9,442                         |   | 12,526                   |   | 5 to 20                                |    |
| Total amortized intangible assets                      |   | 483,366                    |      | 112,940                       |   | 370,426                  |   |                                   |    |
|                                                   |   |                       |      |                          |   |                     |   |                                   |    |
| Non-amortized intangible assets:                       |   |                       |      |                          |   |                     |   |                                   |    |
| Provider relationships                                 |   | 17,674                     |      | 98                            |   | 17,576                   |   | Indefinite                             |    |
| Trade names and service marks                          |   | 579,300                    |      | 2,642                         |   | 576,658                  |   | Indefinite                             |    |
| Total non-amortized intangible assets                  |   | 596,974                    |      | 2,740                         |   | 594,234                  |   |                                   |    |
|                                                   |   |                       |      |                          |   |                     |   |                                   |    |
| Total other intangible assets                          |   | $                          | 1,080,340 |                          | $      | 115,680                  |   | $                                      | 964,660 |   |   |   |

 

 
| **(In thousands)  As of December 31, 2002**            |   | **Gross  Carrying  Value** |    | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Amortizat-  ion Period  (in years)** |    |
|--------------------------------------------------------|--------|----------------------------|---------|-------------------------------|--------|--------------------------|--------|----------------------------------------|---------|
| 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 quarter and nine months ended September 30, 2003, amortizationexpense relating to intangible assets was $9.3 million and $27.4 million,respectively. For the quarter and nine months ended September 30, 2002,amortization expense relating to intangible assets was $9.8 million and $28.2million, respectively. The following table presents the Company’s estimatedannual amortization expense for amortized intangible assets for each of theyears ending December 31, 2003, 2004, 2005, 2006 and 2007 (amounts inthousands). These estimates were calculated based on the gross carrying valueof amortized intangible assets as of September 30, 2003 using the applicableamortization period.

 

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| For year ending December 31, 2003 |   | $      | 41,145 |   |
|-----------------------------------|--------|--------|--------|--------|
| For year ending December 31, 2004 |   | 47,058 |   |
| For year ending December 31, 2005 |   | 43,678 |   |
| For year ending December 31, 2006 |   | 37,132 |   |
| For year ending December 31, 2007 |   | 32,442 |   |

 

**6.****              Long-TermDebt**

 

Thecarrying amount of the Company’s long-term indebtedness consisted of thefollowing:

 
| **(In  thousands)**      |   | **September 30,  2003** |      | **December 31,  2002** |   |
|--------------------------|--------|-------------------------|-----------|------------------------|--------|
|                     |   |                    |      |                   |   |
| 6 3/8*%* Notes due 2006  |   | $                       | 464,020   |                   | $      | 462,838 |   |
| 6 3/8*%* Notes due 2012  |   | 349,046                 |      | 348,982                |   |
| Commercial paper program |   | 474,379                 |      | 199,758                |   |
| Total long-term debt     |   | $                       | 1,287,445 |                   | $      | 1,011,578 |   |

 

*6 3/8% Notes due 2012*

 

On January 16, 2002, the Company issued $350.0 million aggregateprincipal amount at maturity of 6 3/8*%* Notes due January 15, 2012 (the “2012Notes”). Thenet proceeds 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 15 of eachyear commencing July 15, 2002. Interest is computed on the basis of a 360-dayyear of twelve 30-day months. At September 30, 2003 and December 31, 2002, theCompany had $349.0 million (based upon the principal amount of $350.0 millionless unamortized discount) of 2012 Notes outstanding. The related interestexpense and amortization of discount and issue costs for each of the quartersended September 30, 2003 and 2002 totaled $5.8 million and $5.9 million,respectively. The related interest expense and amortization of discount and issuecosts for the nine months ended September 30, 2003 and 2002 totaled $17.2million and $16.4 million, respectively.

 

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

 

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

 

On June 15, 2001, the Company issued $450.0 million aggregate principalamount at maturity of 6 3/8% Notes due June 15, 2006 (the“2006 Notes”). The net proceeds of this offering totaled approximately $449.0million. The net proceeds from the sale of the 2006 Notes were used forrepayment of indebtedness under the Company’s revolving credit facilities. The2006 Notes bear interest at a rate of 6 3/8% per annum,payable semi-annually in arrears on June 15 and December 15 of each yearcommencing December 15, 2001. Interest is computed on the basis of a 360-dayyear of twelve 30-day months. At September 30, 2003 and December 31, 2002, theCompany had $449.4 million and $449.3 million, respectively, (based upon theprincipal amount of $450.0 million less unamortized discount) of 2006 Notesoutstanding. The related interest expense and amortization of discount andissue costs for each of the quarters ended September 30, 2003 and 2002 was $7.4million and $7.6 million, respectively. The related interest expense andamortization of discount and issue costs for each of the nine-month periodsended September 30, 2003 and 2002 totaled $22.3 million and $22.5 million,respectively. The 2006 Notes may be redeemed, in whole or in part, at theCompany’s option at any time. The redemption price for any 2006 Notes redeemedwill be equal to the greater of the following amounts: 1) 100% of the principalamount of the 2006 Notes being redeemed on the redemption date; and 2) the sumof the present values of the remaining scheduled payments of principal andinterest on the 2006 Notes being redeemed on that redemption date (notincluding any portion of any payments of interest accrued to the redemptiondate) discounted to the redemption date on a semi-annual basis at the Treasuryrate as determined by the designated Reference Treasury Dealer (Salomon SmithBarney Inc. or UBS Warburg LLC or their respective successors), plus 25 basispoints. In each case, the redemption price will also include accrued and unpaidinterest on the 2006 Notes to the redemption date.

 

With the intention of reducing the interest expense associated with the2006 Notes, the Company, on January 15, 2002, entered into a $200.0 millionnotional amount interest rate swap agreement. The swap agreement is a contractto exchange a fixed 6 3/8% rate for a LIBOR-basedfloating rate. The swap agreement expires June 15, 2006. As of September 30,2003 and December 31, 2002, the Company recognized a liability adjustment, forthe change in the fair value of the interest rate swap agreement, of $14.6million and $13.6 million, respectively, related to the 2006 Notes. The Companyrecognized settlement income of $2.1 million and $1.7 million for the quartersended September 30, 2003 and 2002, respectively, from this interest rate swap,which offset the Company’s interest expense. For the nine months endedSeptember 30, 2003 and 2002, the Company recognized settlement income of $6.0million and $4.5 million, respectively from this interest rate swap, whichoffset the Company’s interest expense (see Note 7).

 

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

 

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*Revolving Credit**Facility*

 

Effective as of March 30, 2001, the Company entered into two unsecured revolving credit facilitiesallowing aggregate indebtedness of $1.0 billion in principal amount. Uponexecution of these facilities (collectively, the “revolving credit facility”),the Company terminated its prior $1.0 billion unsecured revolving facility.Borrowings under these facilities bear interest at rates determined byreference 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 of March 26, 2004may be converted into a one-year term loan at the option of the Company andwill bear interest at rates determined by reference to the bank’s base rate orLIBOR plus a margin determined by reference to the then-current rating of theCompany’s unsecured long-term debt by specified rating agencies, plus 0.125%until paid in full.

 

Loans under the $250.0 million facility are made on a committed basis.Loans under the $750.0 million facility are made on a committed basis orpursuant to an auction bid process. The $750.0 million facility also containssublimits for letters of credit and “swingline” loans. Each credit agreementrequires the Company to maintain certain financial ratios and containsrestrictive covenants, including restrictions on the incurrence of additionalindebtedness and the granting of certain liens, limitations on acquisitions andinvestments and limitations on changes in control. During the year endedDecember 31, 2002, the Company repaid the entire outstanding principal balanceunder the revolving credit facility. This repayment was funded in part by theCompany’s incurrence of indebtedness described below under the heading****“CommercialPaper Program.” As of September 30, 2003, the Company had no amountsoutstanding under the revolving credit facility.

 

*Zero Coupon Convertible SubordinatedDebentures*

 

On July 2, 1999, the Company issued $299.0 million aggregate principalamount at maturity of zero 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 trading day preceding the conversion date. The Debentures weresubordinated in right of payment to all existing and future seniorindebtedness. On October 6, 1999, the Board of

 

15

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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 $0.8 million and $2.3 million for the quarter and ninemonths ended September 30, 2002, respectively.

 

*Commercial Paper Program*

 

In April 2002, the Company commenced a commercial paper programproviding for the issuance of up to $1.0 billion in aggregate maturity value ofshort-term indebtedness(known generally as “commercial paper”). The commercial paper is being issuedby the Company without registration under the Securities Act of 1933, asamended (the “1933 Act”) in reliance upon the exemption from registrationcontained in Section 4(2) of the 1933 Act. The commercial paper is issued indenominations of $100,000 or integral multiples of $1,000 in excess thereof andwill bear such interest rates, if interest-bearing, or will be sold at suchdiscount from their face amounts, as agreed upon by the Company and the dealeror dealers acting in connection with the commercial paper program. Thecommercial paper may be issued with varying maturities up to a maximum of 270days from the date of issuance. As of September 30, 2003 and December 31, 2002,outstanding commercial paper totaled approximately $474.4 million and $199.8million, respectively. The average maturity for the commercial paper was 56.1days as of September 30, 2003 and 54.0 days as of December 31, 2002. Theweighted average yield on the outstanding commercial paper as of September 30,2003 and December 31, 2002 was 1.22% and 1.62%, respectively. The Companyintends to maintain commercial paper borrowings of at least the amountoutstanding at September 30, 2003 for more than one year. Accordingly, forfinancial reporting purposes, the commercial paper has been classified undernon-current liabilities in the accompanying Consolidated Balance Sheets. Underthe Company’s merger agreement with Anthem, Inc., however, the Company has agreedto repurchase, prior to the closing of the merger with Anthem, any outstandingcommercial paper issued by the Company or any of its subsidiaries.  The related interest expense for the quarterand nine months ended September 30, 2003 was $1.8 million and $4.4 million,respectively. The related interest expense for the quarter and nine monthsended September 30, 2002 was $1.0 million and $1.5 million, respectively.

 

*Debt Covenants*

 

The Company’s revolving credit facility requires the maintenance of certain financialratios and contains other restrictive covenants, including restrictions on theincurrence of additional indebtedness by subsidiaries and the granting ofcertain liens, limitations on acquisitions and

 

16

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investments and limitations on changes in control. As of September 30,2003 and December 31, 2002, the Company was in compliance with the requirementsin these agreements.

 

**7.****              HedgingActivities**

 

The Company maintains an interest rate risk management strategy thatuses derivative instruments to minimize significant, 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.

 

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

 

The Company uses interest rate swap agreements to manage interest rateexposures. The principal objective of such contracts is to minimize the risksand/or costs associated with financial and investing activities. The Companydoes not use derivative financial instruments for speculative purposes. The counterpartiesto these contractual arrangements are major financial institutions with whichthe Company also has other financial relationships. These counterparties exposethe Company to credit loss in the event of non-performance. However, theCompany does not anticipate non-performance by the other parties. As ofSeptember 30, 2003, the Company reported a derivative asset of $14.6 millionrelated to a fair value hedge. The cash flow hedges on the floating rate debtunder the revolving credit facility were terminated and settled in September2002 and are discussed in further detail below.

 

*Fair Value Hedges*

 

With the intention 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 expires June 15, 2006.For the quarters ended September 30, 2003 and 2002, the Company recognized $2.1million and $1.7 million, respectively, of income from this swap agreement,which was recorded as a reduction to interest expense. For the nine monthsended September 30, 2003 and 2002, the Company recognized $6.0 million and $4.5million, respectively, of income from this swap agreement, which was recordedas a reduction to interest expense. As of September 30, 2003 and December 31,2002, the Company recognized a derivative asset of $14.6 million and $13.6million, respectively, related to this swap agreement.

 

*Cash Flow Hedges*

 

The Company has entered into interest rate swap agreements to reducethe impact of changes in interest rates on its floating rate debt under itsrevolving credit facility. The swap

 

17

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agreements are contracts to exchange variable-rate for fixed-rateinterest payments without the exchange of the underlying notional amounts.During the nine months ended September 30, 2002, the Company recognized a netgain of approximately $137,000, as reported in the Company’s ConsolidatedIncome Statements, which represented the total ineffectiveness of all cash flowhedges during such period.

 

In September2002, 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 $8.0 millionand $7.8 million, respectively. Amortization of other comprehensive incomerelated to the terminated swaps on a pre-tax basis for the quarter and ninemonths ended September 30, 2003 totaled $2.3 million, or $1.3 million after-taxand $7.0 million, or $4.1 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 September 30, 2003 totaled $0.6million and $5.9 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 itsunrealized gain on an available-for-sale equity investment by entering into azero-cost equity collar. The Company’s intent was to limit any cash flow impactcaused by any downside price movement in the stock with its anticipated sale. Asa result, the Company designated the equity collar as a cash flow hedge.  The collar was created by combining apurchased put option with a written call option.  During June 2003, the Company terminated the equity collar and atthe settlement date the Company recorded a loss of $0.9 million on investmentsas the cost to terminate the equity collar.

 

**8.****              Stock-BasedCompensation**

 

At September30, 2003, the Company had three stock-based employee compensation plans: the1999 Stock Incentive Plan, the 2000 Employee Stock Option Plan and the EmployeeStock Purchase Plan.  The Companyaccounts for these plans under the recognition and measurement principles ofAPB Opinion No. 25, “Accounting for Stock Issued to Employees” and related FASBinterpretations.  Accordingly,compensation cost for stock options under existing plans is measured as theexcess, if any, of the quoted market price of the Company’s Common Stock at thedate of the grant over the amount an employee must pay to acquire the stock.  No stock-based employee compensation cost isreflected in net income related to stock options granted because options underthose plans had an exercise price equal to the market value of the

 

18

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underlying Common Stock on the date of grant.  Employee stock-based compensation included in reported net incomeincludes restricted stock awards being amortized over the award’s vestingperiod.

 

The following table illustrates the pro forma effect on net income andearnings per share if the Company had applied the fair value recognitionprovisions of Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation” as amended by Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure,” for the quarters and nine months ended September 30, 2003 and2002.

 
|                                                                                                                                        |   | **Quarter  Ended********September  30,** |   | **Nine Months  Ended********September  30,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------------|--------|
| **(In millions, except per share amounts)**                                                                                                 |   | **2003**                                 |   | **2002**                                     |   | **2003** |   | **2002** |   |
|                                                                                                                                        |   |                                     |   |                                         |   |   |   |   |   |
| Net income—as reported                                                                                                                 |   | $                                        | 246.2  |                                         | $      | 211.3 |   | $ | 663.7 |   | $ | 523.1 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                 |   | —                                   |   | —                                       |   | 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 |   | (18.0                                    | )      | (14.4                                        | )      | (53.4 | ) | (42.0 | ) |
| Net income—pro forma                                                                                                                   |   | $                                        | 228.2  |                                         | $      | 196.9 |   | $ | 610.8 |   | $ | 482.8 |   |
|                                                                                                                                        |   |                                     |   |                                         |   |   |   |   |   |
| Earnings per share—as reported                                                                                                         |   | $                                        | 1.68   |                                         | $      | 1.45 |   | $ | 4.55 |   | $ | 3.65 |   |
| Earnings per share—pro forma                                                                                                           |   | $                                        | 1.56   |                                         | $      | 1.35 |   | $ | 4.18 |   | $ | 3.37 |   |
| Earnings per share assuming full  dilution—as reported                                                                                 |   | $                                        | 1.63   |                                         | $      | 1.38 |   | $ | 4.42 |   | $ | 3.48 |   |
| Earnings per share assuming full  dilution—pro forma                                                                                   |   | $                                        | 1.51   |                                         | $      | 1.29 |   | $ | 4.07 |   | $ | 3.21 |   |

 

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

 

**9.****              EarningsPer Share**

 

The following is an illustration of the dilutive effect of theCompany’s potential Common Stock on earnings per share (“EPS”).  Outstanding stock options for which the exercise price wasgreater than the average market per share price of Common Stock were as follows: 633,522 and 550,194 for the quarters endedSeptember 30, 2003 and 2002, respectively, and 1,097,071 and 861,228 for thenine months ended September 30, 2003 and 2002, respectively.  Since the effect of these options wasantidilutive, they have been excluded from the computation of the dilutedearnings per share below.

 

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|                                                                             |   | **Quarter  Ended  September 30,** |    | **Nine  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------|--------|-----------------------------------|---------|---------------------------------------|--------|
| **(In thousands, except per share data)**                                        |   | **2003**                          |    | **2002**                              |   | **2003** |   | **2002** |   |
| **Basic Earnings Per Share  Calculation:**                                       |   |                              |    |                                  |   |   |   |   |   |
| **Numerator**                                                                    |   |                              |    |                                  |   |   |   |   |   |
| Income before extraordinary items                                                |   | $                                 | 246,219 |                                  | $      | 206,348 |   | $ | 663,741 |   | $ | 514,153 |   |
| Extraordinary gain from negative goodwill on  acquisition                        |   | —                            |    | 4,908                                 |   | — |   | 8,950 |   |
| Net Income                                                                       |   | $                                 | 246,219 |                                  | $      | 211,256 |   | $ | 663,741 |   | $ | 523,103 |   |
|                                                                             |   |                              |    |                                  |   |   |   |   |   |
| **Denominator**                                                                  |   |                              |    |                                  |   |   |   |   |   |
| Weighted average shares outstanding                                              |   | 146,626                           |    | 145,523                               |   | 145,987 |   | 143,178 |   |
|                                                                             |   |                              |    |                                  |   |   |   |   |   |
| **Earnings Per Share**                                                           |   |                              |    |                                  |   |   |   |   |   |
| Income before extraordinary items                                                |   | $                                 | 1.68    |                                  | $      | 1.42 |   | $ | 4.55 |   | $ | 3.59 |   |
| Extraordinary gain from negative goodwill on  acquisition                        |   | —                            |    | 0.03                                  |   | — |   | 0.06 |   |
| Net Income                                                                       |   | $                                 | 1.68    |                                  | $      | 1.45 |   | $ | 4.55 |   | $ | 3.65 |   |
|                                                                             |   |                              |    |                                  |   |   |   |   |   |
| **Earnings Per Share Assuming Full  Dilution Calculation:**                      |   |                              |    |                                  |   |   |   |   |   |
| **Numerator**                                                                    |   |                              |    |                                  |   |   |   |   |   |
| Income before extraordinary items                                                |   | $                                 | 246,219 |                                  | $      | 206,348 |   | $ | 663,741 |   | $ | 514,153 |   |
| Interest expense on zero coupon convertible  subordinated debentures, net of tax |   | —                            |    | 472                                   |   | — |   | 1,438 |   |
| Adjusted income before extraordinary items                                       |   | 246,219                           |    | 206,820                               |   | 663,741 |   | 515,591 |   |
| Extraordinary gain from negative goodwill on  acquisition                        |   | —                            |    | 4,908                                 |   | — |   | 8,950 |   |
| Adjusted Net Income                                                              |   | $                                 | 246,219 |                                  | $      | 211,728 |   | $ | 663,741 |   | $ | 524,541 |   |
|                                                                             |   |                              |    |                                  |   |   |   |   |   |
| **Denominator**                                                                  |   |                              |    |                                  |   |   |   |   |   |
| Weighted average shares outstanding                                              |   | 146,626                           |    | 145,523                               |   | 145,987 |   | 143,178 |   |
| Net effect of dilutive stock options                                             |   | 4,219                             |    | 4,473                                 |   | 4,097 |   | 4,348 |   |
| Assumed conversion of zero coupon convertible  subordinated debentures           |   |                              |    | 2,768                                 |   |   |   | 2,895 |   |
| Fully diluted weighted average shares outstanding                                |   | 150,845                           |    | 152,764                               |   | 150,084 |   | 150,421 |   |
|                                                                             |   |                              |    |                                  |   |   |   |   |   |
| **Earnings Per Share Assuming Full  Dilution**                                   |   |                              |    |                                  |   |   |   |   |   |
| Income before extraordinary items                                                |   | $                                 | 1.63    |                                  | $      | 1.35 |   | $ | 4.42 |   | $ | 3.42 |   |
| Extraordinary gain from negative goodwill on  acquisition                        |   | —                            |    | 0.03                                  |   | — |   | 0.06 |   |
| Net Income                                                                       |   | $                                 | 1.63    |                                  | $      | 1.38 |   | $ | 4.42 |   | $ | 3.48 |   |

 

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**10**.       **Comprehensive Income**

 

The following summarizes comprehensive income (loss) reclassification adjustments for thenine months ended September 30, 2003 and 2002:

 
|                                                                                                                                     |   | **Nine  Months Ended  September 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
| **(In thousands)**                                                                                                                       |   | **2003**                              |   | **2002** |   |
|                                                                                                                                     |   |                                  |   |   |   |
| Investment Securities:                                                                                                                   |   |                                  |   |   |   |
| Net holding gain (loss) on investment  securities arising during the period, net of tax (expense) benefit of  $(45,840) and $38,977 |   | $                                     | 66,153 |   | $ | (50,088 | ) |
| Reclassification adjustment for realized  gain on investment securities, net of tax expense of $3,430 and $25,406                        |   | 5,146                                 |   | 38,109 |   |
|                                                                                                                                     |   | 71,299                                |   | (11,979 | ) |
|                                                                                                                                     |   |                                  |   |   |   |
| Cash Flow Hedges:                                                                                                                        |   |                                  |   |   |   |
| Holding loss related to swap transactions,  net of tax benefit of $692                                                                   |   | —                                |   | (1,000 | ) |
|                                                                                                                                     |   |                                  |   |   |   |
| Net gain (loss) recognized in other  comprehensive income, net of tax (expense) benefit of $(49,270) and $14,263                         |   | $                                     | 71,299 |   | $ | (12,979 | ) |

 

 

**11.****       BusinessSegment Information**

 

As a result of the January 31, 2002 acquisition of RightCHOICE, theorganizational structure of the Company changed effective February 1,2002.  As a result of these changes, theCompany has the following two reportable segments: Health Care andSpecialty.  The Health Care segment isan aggregation of four operating segments: California, Central, Georgia andSenior/State-Sponsored Programs.  TheseHealth Care operating segments all have similar characteristics and meet thefollowing five aggregation criteria as defined under paragraph 17 of Statementof Financial Accounting Standards No. 131, “Disclosures About Segments of anEnterprise and Related Information” (“SFAS No. 131”):

 

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

 

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

 

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

 

(4)          Each operating segment has similardistribution channels that are used for each of the customer types.  Large employer group products aredistributed primarily through health care consultants and brokers, whileindividual and small group products are distributed through agents or throughcaptive sales forces.  These methods aresimilar across geographies.

 

(5)          The health care industry is highly regulatedat both the federal and state levels. All of the geographies must comply with the same federalregulations.  While each state’s lawsare in some respects unique, many states have similar laws and regulationsapplicable 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’s chiefoperating 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 the Health Care segment provide abroad spectrum of network-based health plans, including PPOs, HMOs, POS plans,other hybrid plans and traditional indemnity products, to large and smallemployers and individuals as well as other health care-related products, suchas vision, preventive care, COBRA and flexible benefits accountadministration.  The Specialty businessis maintained as a separate segment providing an array of specialty products,including pharmacy benefits management, dental, life insurance, disabilityinsurance, behavioral health and workers’ compensation managed careservices.  Amounts under the heading“Corporate and Other” include net investment income, general and administrativeexpense and interest expense not allocable to the reportable segments.  Also included in Corporate and Other are theoperating results from the Company’s captive general insurance agency, whichhas not met the quantitative thresholds for an operating segment under SFAS No.131.  The operating results for theCompany’s captive general insurance agency were previously reported in theHealth Care segment for the quarter and nine months ended September 30, 2002, buthave been reclassified to Corporate and Other to conform to the 2003presentation.

 

The accounting policies of the segments are consistent with generallyaccepted accounting principles in the United States.  The following tables present segment information for the HealthCare and Specialty segments for the quarters and nine months ended September30, 2003 and 2002, respectively.  Theamounts for the quarter and nine months ended September 30, 2002 reflect a newmethod of cost allocation as reviewed by the chief operating decision makereffective January 1, 2003.  As a resultof this change, the net income for the Health Care segment decreased by $13.9million while the Specialty segment increased by $13.9 million

 

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for the quarter ended September 30, 2002.  For the nine months ended September 30, 2002, net income for theHealth Care segment decreased by $42.9 million while the Specialty segmentincreased by $42.9 million.

 

In addition, the operating results by segment for the quarter and ninemonths ended September 30, 2002 have been reclassified to conform to a 2003change in a segment manager’s responsibility. For the quarter and nine months ended September 30, 2002, net incomedecreased by $0.6 million for the Health Care segment while the Corporate andOther segments increased by $0.6 million. For the nine months ended September 30, 2002, net income decreased by$1.4 million for the Health Care segment while the Corporate and Other segmentsincreased by $1.4 million.

 

Intersegment revenues include internal pharmaceutical sales by theCompany’s mail order pharmacy to the Health Care segment’s members, utilizationreview fees (primarily related to behavioral health services) and claims andrebate processing fees recognized by the Specialty segment for pharmacy benefitmanagement services provided to the Health Care segment.  For the quarter and nine months endedSeptember 30, 2003, pharmaceutical sales totaled $105.6 million and $304.4million, respectively, and utilization review fees and claims and rebateprocessing fees totaled $20.6 million and $63.4 million, respectively.  For the quarter and nine months endedSeptember 30, 2002, pharmaceutical sales totaled $73.6 million and $194.8million, respectively.  Utilizationreview fees and claims and rebate processing fees for the quarter and ninemonths ended September 30, 2002 were not separately identified; estimating suchfees would be impractical.  Allintersegment transactions are eliminated in consolidation under the caption“Corporate and Other.”

 

As of September 30, 2003, the Cobalt acquisition added $1,076.7 millionin assets, of which $507.4 million is apportioned to the Health Care segment,$252.1 million to the Specialty segment and $317.2 million to the Corporate andOther segment.

 

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**Quarter Ended September****30, 2003**

 
| **(In  thousands)**                    |   | **Health  Care** |      | **Specialty** |   | **Corporate  and Other** |   | **Consolidated** |   |
|----------------------------------------|--------|------------------|-----------|---------------|--------|--------------------------|--------|------------------|--------|
|                                   |   |             |      |          |   |                     |   |             |   |
| Premium  revenue                       |   | $                | 4,622,614 |          | $      | 141,245                  |   | $                | — |   | $ | 4,763,859 |   |
| Management  services and other revenue |   | 187,363          |      | 31,376        |   | 956                      |   | 219,695          |   |
| Total  revenue from external customers |   | 4,809,977        |      | 172,621       |   | 956                      |   | 4,983,554        |   |
|                                   |   |             |      |          |   |                     |   |             |   |
| Intersegment  revenues                 |   | —           |      | 126,255       |   | (126,255                 | )      | —           |   |
|                                   |   |             |      |          |   |                     |   |             |   |
| Segment  net income (loss)             |   | $                | 224,031   |          | $      | 27,129                   |   | $                | (4,941 | ) | $ | 246,219 |   |

 

**Quarter Ended September 30, 2002**

 
| **(In thousands)**                    |   | **Health  Care** |      | **Specialty** |   | **Corporate  and Other** |   | **Consolidated** |   |
|---------------------------------------|--------|------------------|-----------|---------------|--------|--------------------------|--------|------------------|--------|
|                                  |   |             |      |          |   |                     |   |             |   |
| Premium revenue                       |   | $                | 4,059,121 |          | $      | 124,828                  |   | $                | — |   | $ | 4,183,949 |   |
| Management services and other revenue |   | 179,582          |      | 33,825        |   | —                   |   | 213,407          |   |
| Total revenue from external customers |   | 4,238,703        |      | 158,653       |   | —                   |   | 4,397,356        |   |
|                                  |   |             |      |          |   |                     |   |             |   |
| Intersegment revenues                 |   | —           |      | 73,572        |   | (73,572                  | )      | —           |   |
|                                  |   |             |      |          |   |                     |   |             |   |
| Segment net income                    |   | $                | 156,769   |          | $      | 20,660                   |   | $                | 33,827 |   | $ | 211,256 |   |

 

**Nine Months Ended September 30, 2003**

 
| **(In thousands)**                    |   | **Health  Care** |       | **Specialty** |   | **Corporate  and Other** |   | **Consolidated** |    |
|---------------------------------------|--------|------------------|------------|---------------|--------|--------------------------|--------|------------------|---------|
|                                  |   |             |       |          |   |                     |   |             |    |
| Premium revenue                       |   | $                | 13,559,205 |          | $      | 407,813                  |   | $                | —  |   | $ | 13,967,018 |   |
| Management services and other revenue |   | 562,448          |       | 102,596       |   | 2,288                    |   | 667,332          |    |
| Total revenue from external customers |   | 14,121,653       |       | 510,409       |   | 2,288                    |   | 14,634,350       |    |
|                                  |   |             |       |          |   |                     |   |             |    |
| Intersegment revenues                 |   | —           |       | 367,780       |   | (367,780                 | )      | —           |    |
|                                  |   |             |       |          |   |                     |   |             |    |
| Segment net income (loss)             |   | $                | 595,145    |          | $      | 92,149                   |   | $                | (23,553 | ) | $ | 663,741 |   |

 

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**Nine Months Ended September 30, 2002**

 
| **(In thousands)**                    |   | **Health  Care** |       | **Specialty** |   | **Corporate  and Other** |   | **Consolidated** |   |
|---------------------------------------|--------|------------------|------------|---------------|--------|--------------------------|--------|------------------|--------|
|                                  |   |             |       |          |   |                     |   |             |   |
| Premium revenue                       |   | $                | 11,532,859 |          | $      | 374,843                  |   | $                | — |   | $ | 11,907,702 |   |
| Management services and other revenue |   | 503,538          |       | 102,137       |   | —                   |   | 605,675          |   |
| Total revenue from external customers |   | 12,036,397       |       | 476,980       |   | —                   |   | 12,513,377       |   |
|                                  |   |             |       |          |   |                     |   |             |   |
| Intersegment revenues                 |   | —           |       | 194,813       |   | (194,813                 | )      | —           |   |
|                                  |   |             |       |          |   |                     |   |             |   |
| Segment net income                    |   | $                | 439,264    |          | $      | 59,167                   |   | $                | 24,672 |   | $ | 523,103 |   |

 

**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 ofDirectors is comprised solely of persons who are also officers of theCompany.  For the quarter and ninemonths ended September 30, 2003, the Company committed and contributed $10.0million and $30.0 million, respectively, to the Foundation.  For the quarter and nine months endedSeptember 30, 2002, the Company contributed or committed to contribute $15.0million and $45.0 million, respectively, to the Foundation.  As of September 30, 2003 and December 31,2002, the Company did not have any outstanding commitments payable to theFoundation.  The Company currently hasno legal obligations for any future commitments to the Foundation.

 

**13.****       Contingencies**

 

From time to time, the Company and certain of its subsidiaries areparties to various legal proceedings, many of which involve claims for coverageencountered in the ordinary course of business.  The Company, like HMOs and health insurers generally, excludescertain health care services from coverage under its HMO, PPO and other plans.  The Company is, in its ordinary course ofbusiness, subject to the claims of its enrollees arising out of decisions torestrict treatment or reimbursement for certain services.  The loss of even one such claim, if itresults in a significant punitive damage award, could have a material adverseeffect on the Company.  In addition, therisk of potential liability under punitive damage theories may increasesignificantly the difficulty of obtaining reasonable settlements of coverageclaims.

 

In June 2000, the California Medical Association filed a lawsuit inU.S.  district court in San Franciscoagainst Blue Cross of California (“BCC”). The lawsuit alleges that BCC violated the Racketeer Influenced andCorrupt Organizations Act (“RICO”) through various misrepresentations to andinappropriate actions against health care providers.  In late 1999, a number of class-action lawsuits were broughtagainst several of the Company’s competitors alleging, among other things,various misrepresentations regarding their health plans and

 

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breaches of fiduciary obligations 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 claims brought in the California MedicalAssociation lawsuit, this lawsuit also alleges violations of the EmployeeRetirement Income Security Act of 1974, as amended (“ERISA”), federal and state“prompt pay” regulations and certain common law claims.  In October 2000, the federal Judicial Panelon Multidistrict Litigation issued an order consolidating the CaliforniaMedical 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 theplaintiffs’ claims based on violation of RICO, although the dismissal was madewithout prejudice to the plaintiffs’ ability to subsequently refile theirclaims.  Judge Moreno also dismissed,with prejudice, the plaintiffs’ federal prompt pay law claims.  On March 26, 2001, the California MedicalAssociation filed an amended complaint in its lawsuit, alleging, among otherthings, revised RICO claims and violations of California law.  On May 9, 2001, Judge Moreno issued an orderrequiring that all discovery in the litigation be completed by December 2001, withthe exception of discovery related to expert witnesses, which was to becompleted by March 15, 2002.  In June2001, the federal Court of Appeals for the 11th Circuit issued a stay of JudgeMoreno’s discovery order, pending a hearing before the Court of Appeals on theCompany’s appeal of its motion to compel arbitration (which had earlier beengranted in part and denied in part by Judge Moreno).  The hearing was held in January 2002 and, in March 2002, theCourt of Appeals panel issued an opinion affirming Judge Moreno’s earlieraction with respect to the motion to compel arbitration.  The Company filed a motion requesting arehearing of the matter before the entire 11th Circuit Court of Appeals, whichmotion was denied by the 11th Circuit Court of Appeals in June 2002.  On July 29, 2002, Judge Moreno issued anorder providing that discovery in the case would be allowed to re-commence onSeptember 30, 2002.  On September 26,2002, Judge Moreno issued an additional order certifying a nationwide class ofphysicians in the *Shane* matter,setting a trial date in May 2003 and ordering the parties to participate innon-binding mediation.  In October 2002,the Company filed a motion with the 11th Circuit Court of Appeals seeking toappeal Judge Moreno’s class-certification order.  The 11th Circuit held a hearing on September 11, 2003on the Company’s motion.  A mediator hasbeen appointed by Judge Moreno and the parties are currently conductingcourt-ordered mediation.

 

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

 

InMay 2003, a lawsuit entitled *Thomas, et al.v. Blue Cross and Blue Shield Association*, *et al.*was filed in the U.S. DistrictCourt in the Southern District of Florida. The attorneys

 

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representingthe plaintiffs in the lawsuit are primarily the attorneys representing theplaintiffs in the *Shane*litigationdescribed 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 thateach of the defendants engaged in similar activities and conduct as that allegedin the *Shane*litigation.

 

In July 2001, two individual physicians seeking to represent a class ofphysicians, hospitals and other providers brought suit in the Circuit Court ofMadison County, Illinois against HealthLink, Inc., which is now a subsidiary ofthe Company as a result of 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 injunctionagainst these practices and damages in an unspecified amount.  This litigation was dismissed withoutprejudice at the request of the plaintiffs in February 2003.  A similar lawsuit was brought by physicians(including one of the physicians in the case described above) in the same courtin Madison County, Illinois, on behalf of a nationwide class of providers whocontract with Blue Cross and Blue Shield plans against the Blue Cross and BlueShield Association and another Blue Cross Blue Shield plan.  The complaint recites that it is broughtagainst those entities and their “unnamed subsidiaries, licensees, andaffiliates,” listing a large number of Blue Cross and Blue Shield plans,including “Alliance Blue Cross Blue Shield of Missouri.” The plaintiffs alsoallege that the plans have systematically engaged in practices known as “shortpaying,” “bundling” and “down-coding” in their processing and payment ofsubscriber claims.  Blue Cross BlueShield of Missouri has not been formally named or served as a defendant in thislawsuit.  The Blue Cross and Blue ShieldAssociation was dismissed 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 inexchange for rebates and that the defendants charge patient co-payments thatexceed the actual cost of generic drugs.

 

Inearly 2003, a lawsuit entitled *Knecht v. Cigna, et al.* was filed in U.S.District Court in Oregon.  This litigationhas subsequently been transferred to Judge Moreno of the U.S. District Courtfor the Southern District of Florida. This litigation is a putative class action lawsuit on behalf ofchiropractors in the western United States. The Company is a named defendant in the lawsuit.  The lawsuit alleges that each of thedefendants engaged in similar activities and conduct as that alleged in the *Shane*litigation.

 

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InOctober 2003, a lawsuit entitled *Solomon, et al. v. Cigna, et al.* was filedin the U.S. District Court in the Southern District in Florida.  The Company is a named defendant in thislawsuit, although the Company has not yet been served.  This lawsuit is also a putative class actionbrought on behalf of chiropractors, podiatrists and certain other types ofhealth care practitioners nationwide. This lawsuit also alleges that the defendants engaged in similaractivities and conduct as that alleged in the *Shane* litigation.

 

Prior to the Company’s acquisition of the Group Benefits Operations ofJohn Hancock Mutual Life Insurance Company (“John Hancock”), John Hancockentered into a number of reinsurance arrangements with respect to personalaccident 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 havebecome the subject of disputes, including a number of legal proceedings towhich John Hancock is a party.  TheCompany believes that it has a number of defenses to avoid any ultimateliability with respect to these matters and believes that such liabilities werenot transferred to the Company as part of the GBO acquisition.  However, if the Company were to becomesubject to such liabilities, the Company could suffer losses that might have amaterial adverse effect on its financial condition, results of operations orcash flows.

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors.  The lawsuit, whichis entitled *Abramsv. WellPoint Health Networks Inc., et al*., alleges that theCompany’s directors breached their fiduciary duties to stockholders byapproving an Agreement and Plan of Merger with Anthem, Inc. while in possessionof non-public information regarding the Company’s financial results for thethird quarter of 2003.  The lawsuitseeks to enjoin the Company from consummating the merger with Anthem, Inc.,unless the Company adopts and implements a process for obtaining the highestpossible price for stockholders, and to rescind any terms of the Agreement andPlan of Merger that have already been implemented.

 

The financial and operational impact that these and other evolvingtheories of recovery will have on the managed care industry generally, or theCompany in particular, is at present unknown. Certain of such legal proceedings are or may be covered under insurancepolicies or indemnification agreements. Based upon information presently available, the Company believes thatthe final outcome of all such proceedings should not have a material adverseeffect on the Company’s results of operations, cash flows or financialcondition.

 

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

 

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

 

In connection with the formation of a joint venture providing Medicaidservices in Puerto Rico in 2000, the Company agreed under certain circumstancesto provide additional funds 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 this guarantee will not exceed80% of the amount necessary to provide the entity with a 12 to 1premium-to-capital ratio.  As ofSeptember 30, 2003, the Company’s estimated maximum potential liabilitypursuant to this guarantee was $26.7 million. 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 payments will be made.

 

**14.****       PendingMerger with Anthem**

 

On October 26, 2003, WellPoint entered into a definitive agreement tomerge with Anthem, Inc. (“Anthem”).  The consideration to be received by theshareholders of WellPoint will be comprised of $23.80 in cash and one share ofAnthem common stock per share of WellPoint Common Stock.  Based on the closing price ofAnthem’s common stock on October 24, 2003, the transaction was valued atapproximately $16.4 billion.  Uponcompletion of this transaction, WellPoint will merge into a wholly ownedsubsidiary of Anthem and Anthem will change its name to WellPoint, Inc. Anthem,a publicly traded company, is an independent licensee of the Blue Cross andBlue Shield Association and holds the exclusive right to use the Blue Cross andBlue Shield names and marks in the states of Indiana, Kentucky, Ohio,Connecticut, New Hampshire, Colorado, Nevada, Maine, and Virginia, excludingthe immediate suburbs of Washington D.C. As of September 30, 2003, Anthem provided health care benefits to morethan 11.8 million members and specialty benefits to 12.1 million members.  Headquartered in Indianapolis, Indiana,Anthem, along with its subsidiaries, offers a diverse portfolio ofcomplementary health and group life insurance, managed care products, pharmacybenefit management and government health program administration.

 

Thetransaction is subject to customary closing conditions, including, among otherthings, approval of WellPoint’s shareholders and various regulatoryagencies.  The Company currently expectsthe transaction to close by mid-2004.

 

**15.****       SubsequentEvents**

 

In October 2003, the Company amended its 401(k) Retirement Savings Plan(the “401(k) Plan”) and Pension Accumulation Plan (the “Pension Plan”)effective January 1, 2004.

 

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Generally, employees (excluding temporary employees working less than1,000 hours and leased employees) over 18 years of age are eligible toparticipate in the 401(k) Plan if they meet certain length of servicerequirements.  Under this plan,employees may contribute a percentage of their pre-tax earnings to the 401(k)Plan.  After one year of service,employee contributions up to 6% of eligible compensation are matched by anemployer contribution in cash equal to 75% of the employee’s contribution.  The matching percentage is higher forcertain longer-service employees. Matching contributions are immediately vested.  Effective January 1, 2004, after one year of service, the Companywill match 100% of the first 6% of eligible compensation employees contributeto the 401(k) Plan.

 

The Pension Plan was established on January 1, 1987 and covers alleligible employees (including employees covered under a collective bargainingagreement participate if the terms of the collective bargaining agreementpermit) meeting certain age and service requirements.  Beginning January 1, 2004, employees who are of age 50 and over,with combined age and service totaling 65 or higher as of December 31, 2003,will continue to earn future contributions based on compensation under thePension Plan.  For other employees, thefunds in their pension account earned through December 31, 2003 will continueto accrue interest.  However, there willbe no additional contributions based on the employee’s earnings after December31, 2003.  Once the employee becomesvested (after five years of service) the employee will be eligible to receive abenefit from the Pension Plan at retirement or termination based on his or heraccount balance as of December 31, 2003 plus accrued interest.  Employees hired after December 31, 2003 willnot be eligible to participate in the Pension Plan.

 

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Report of IndependentAccountants

 

 

To the Stockholders and Board of Directors ofWellPoint Health Networks Inc.

 

We have reviewed the accompanyingconsolidated balance sheet of WellPoint Health Networks Inc.  and its subsidiaries (the “Company”) as ofSeptember 30, 2003, and the related consolidated income statements for each ofthe three-month and nine-month periods ended September 30, 2003 and 2002, andthe related consolidated statement of changes in stockholders’ equity for thenine-month period ended September 30, 2003 and the consolidated statements ofcash flows for the nine-month periods ended September 30, 2003 and 2002.  These interim financial statements are theresponsibility of the Company’s management.

 

We conducted our review in accordance withstandards established by the American Institute of Certified PublicAccountants.  A review of interimfinancial information consists principally of applying analytical proceduresand making inquiries of persons responsible for financial and accountingmatters.  It is substantially less inscope than an audit conducted in accordance with generally accepted auditingstandards, the objective of which is the expression of an opinion regarding thefinancial statements taken as a whole. Accordingly, we do not express such an opinion.

 

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

 

We previously audited in accordance withauditing standards generally accepted in the United States of America, theconsolidated balance sheet as of December 31, 2002, and the relatedconsolidated income statement and consolidated changes in stockholders’ equity,and cash flows for the year then ended (not presented herein), and in ourreport dated January 31, 2003 except Note 24 as to which the date is March 5,2003, we expressed an unqualified opinion on those consolidated financialstatements.  Our report included anexplanatory paragraph, that effective January 1, 2002, the Company adoptedStatement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*.  Accordingly, the Company ceased amortizinggoodwill and indefinite-lived intangible assets as of January 1, 2002.  In our opinion, the information set forth inthe accompanying consolidated balance sheet information as of December 31,2002, is fairly stated in all material respects in relation to the consolidatedbalance sheet from which it has been derived.

 

 
| /s/  PricewaterhouseCoopers LLP |   |
|---------------------------------|--------|
|                            |
| PricewaterhouseCoopers  LLP     |
| Los Angeles,  California        |
| October 26,  2003               |

 

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

 

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

 

***General***

 

The Company is one of the nation’s largest publicly traded managed healthcare companies.  As of September 30,2003, WellPoint had approximately 14.0 million medical members andapproximately 44.7 million specialty members. Through its subsidiaries, the Company offers a broad spectrum ofnetwork-based managed care plans to the large and small employer, individual,Medicaid and senior markets.  TheCompany’s managed care plans include PPOs, HMOs, POS plans, other hybrid plansand traditional indemnity products.  Inaddition, the Company offers managed care services, including underwriting,actuarial services, network access, medical management and claimsprocessing.  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.  With the acquisition ofCobalt Corporation (“Cobalt”), the Company now also offers workers’compensation products and is currently the largest Medicare Part A fiscalintermediary in the nation, processing claims for providers in all 50states.  The Company markets itsproducts in California primarily under the name Blue Cross of California, inGeorgia primarily under the name Blue Cross Blue Shield of Georgia, in variousparts of Missouri (including the greater St. Louis area) under the name BlueCross & Blue Shield of Missouri, in Wisconsin primarily under the name BlueCross & Blue Shield United of Wisconsin and in various parts of the countryunder the names UNICARE or HealthLink.

 

*Acquisition of Cobalt*

 

On September 24, 2003, the Company completed its acquisition of Cobalt(see Note 4 to the Consolidated Financial Statements).  At closing, the acquisition was valued atapproximately $884.9 million, which was paid with $439.6 million in cash andapproximately 7.3 million shares of WellPoint Common Stock, of whichapproximately 2.1 million shares were issued to affiliates of WellPoint.  As of September 30, 2003, Cobalt served approximately675,000 medical members offering a diverse portfolio of complementaryinsurance, managed care products and administrative services to employer,individual, insurer and government customers. Cobalt 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.

 

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*Acquisition of Golden West*

 

On June 30, 2003, the Company completed its acquisition of Golden West(see Note 4 to the Consolidated Financial Statements), which served over275,000 dental and vision members at the time of acquisition.

 

*Acquisition of MethodistCare*

 

On April 30, 2002, the Company completed its acquisition ofMethodistCare (see Note 4 to the Consolidated Financial Statements), whichserved over 70,000 members in Houston, Texas and surrounding areas at the timeof acquisition.

 

*Acquisition of RightCHOICE*

 

On January 31, 2002, the Company completed this transaction, pursuantto which RightCHOICE became a wholly owned subsidiary of the Company (see Note4 to the Consolidated Financial Statements). At closing, the acquisition was valued at approximately $1.5 billion,which was paid with $379.1 million in cash and approximately 16.5 millionshares of WellPoint Common Stock. RightCHOICE, through its HealthLink subsidiary, also provides networkrental, administrative services, workers’ compensation managed care servicesand other non-underwritten health benefit programs.  As of January 31, 2002, RightCHOICE served approximately 2.2million medical members in Missouri, Arkansas, Illinois, Indiana, Iowa,Kentucky and West Virginia.  RightCHOICEhas historically experienced a higher general and administrative expense ratiothan the Company’s core businesses due to its higher concentration ofadministrative services business.

 

*Pending Merger with Anthem*

 

On October 26, 2003, WellPoint entered into a definitive agreement tomerge with Anthem, Inc. (“Anthem”).  The consideration to be received by thestockholders of WellPoint will be comprised of $23.80 in cash and one share ofAnthem common stock per share of WellPoint Common Stock.  Based on the closing price ofAnthem’s common stock on October 24, 2003, the transaction was valued atapproximately $16.4 billion.  Uponcompletion of this transaction, WellPoint will merge into a wholly ownedsubsidiary of Anthem and Anthem will change its name to WellPoint, Inc.  Anthem, a publicly traded company, is anindependent licensee of the Blue Cross and Blue Shield Association and holdsthe exclusive right to use the Blue Cross and Blue Shield names and marks inthe states of Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Colorado,Nevada, Maine, and Virginia, excluding the immediate suburbs of Washington D.C.  As of September 30, 2003, Anthem providedhealth care benefits to more than 11.8 million members and specialty benefitsto 12.1 million members.  Headquarteredin Indianapolis, Indiana, Anthem, along with its subsidiaries, offers a diverseportfolio of complementary health and group life insurance, managed careproducts, pharmacy benefit management and government health programadministration.

 

Thetransaction is subject to customary closing conditions, including, among otherthings, approval of WellPoint’s shareholders and various regulatoryagencies.  The Company currently expectsthe transaction to close by mid-2004.

 

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*CareFirst Merger Agreement*

 

In November 2001, WellPoint entered into a merger agreement withCareFirst, Inc., which agreement was amended in January 2003.  CareFirst has the exclusive right to use theBlue Cross and Blue Shield names and marks in Maryland, Delaware and theDistrict of Columbia.  Under the amendedmerger agreement, CareFirst would have become a subsidiary of WellPoint.  The consummation of the CareFirsttransaction was subject to a number of conditions, including the approval ofthe insurance regulators in Maryland, Delaware and the District of Columbia forthe conversion of CareFirst from a non-profit corporation to a for-profitentity.  On March 5, 2003, the Marylandinsurance commissioner issued an order disapproving this conversion.  In August 2003, the Company received anotice from CareFirst electing to terminate the amended merger agreement inaccordance with its terms.

 

In August 2003, the Company received a Grand Jury subpoena from theUnited States Attorney’s office in the District of Maryland requesting variousdocuments relating to the CareFirst transaction.  The Company has responded to the request and intends to cooperatefully with the United States Attorney. The Company has no reason to believe it is a target of the proceedings.

 

*National Expansion and Other Recent Developments*

 

In an effort to pursue the expansion of the Company’s business outsidethe state of California, the Company acquired two businesses in 1996 and 1997,the Life and Health Benefits Management Division of Massachusetts Mutual LifeInsurance Company and the Group Benefits Operations (the “GBO”) of John HancockMutual Life Insurance Company.  Theacquisitions of Rush Prudential Health Plans and a mail-order pharmacy, whichnow does business as PrecisionRx, in 2000, the acquisition of CeruleanCompanies, Inc. in 2001, the acquisitions of RightCHOICE and MethodistCare in2002 and Cobalt in 2003 were also components of this expansion strategy.

 

As a result of these acquisitions, the Company has significantlyexpanded its operations outside of California. In order to integrate its acquired businesses and implement its regionalexpansion strategy, the Company will need to develop satisfactory networks ofhospitals, physicians and other health care service providers, developdistribution channels for its products and successfully convert acquired books ofbusiness to the Company’s existing information systems, which will requirecontinued investments by the Company.

 

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

 

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*Legislation*

 

Federal legislation enacted during the last several years seeks, amongother things, to ensure the portability of health coverage and mandates minimummaternity hospital stays.  Californialegislation enacted since 1999, among other things, establishes an explicitduty on managed care entities to exercise ordinary care in arranging for theprovision of medically necessary health care services and establishes a systemof independent medical review.  In 1997,Texas adopted legislation purporting to make managed care organizations such asthe Company liable for their failure to exercise ordinary care when makinghealth care treatment decisions. Similar legislation has also been enacted in Georgia.  These and other proposed measures may havethe effect of dramatically altering the regulation of health care and ofincreasing the Company’s medical care ratio and administrative costs ordecreasing the affordability of the Company’s products.

 

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***Consolidated Resultsof Operations***

 

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

 

The Company’s consolidated results of operations for the nine monthsended September 30, 2003 include its acquired operations of RightCHOICE for theentire nine months, while operating results for the nine months ended September30, 2002 include the results of RightCHOICE from January 31, 2002, the date ofacquisition.  Although the Company’sconsolidated results of operations for the three months ended September 30,2003 include its acquired operations of Golden West from June 30, 2003, thedate of acquisition; its impact to the consolidated results of operations wasimmaterial and will not be separately discussed in the management’s discussionand analysis of financial condition and results of operations.  On September 24, 2003, the Company completedits acquisition of Cobalt Corporation. The Cobalt merger was effective as of September 30, 2003 for accountingpurposes.  Accordingly, the impact ofthe Cobalt transaction has been reflected on the Company’s Consolidated BalanceSheet and end-of-period membership data at September 30, 2003, but Cobalt’soperating results are not included in the Company’s Consolidated IncomeStatements for the quarter and nine months ended September 30, 2003 oroperating cash flows in the Consolidated Statement of Cash Flows for the ninemonths ended September 30, 2003.

 

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

 
|                                                          |   | **Quarter  Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|---------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------------|--------|
|                                                          |   | **2003**                          |   | **2002**                              |   | **2003** |   | **2002** |   |
| Operating Revenues:                                           |   |                              |   |                                  |   |   |   |   |   |
| Premium revenue                                               |   | 95.6                              | %      | 95.1                                  | %      | 95.4 | % | 95.2 | % |
| Management services and other revenue                         |   | 4.4                               | %      | 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) |   | 79.6                              | %      | 81.7                                  | %      | 80.8 | % | 81.3 | % |
| Selling expense                                               |   | 4.0                               | %      | 4.0                                   | %      | 4.1 | % | 4.0 | % |
| General and administrative expense                            |   | 12.5                              | %      | 12.3                                  | %      | 12.2 | % | 13.0 | % |

 

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***Membership***

 

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

*** ***
|                                  |   | **September 30,** |       | **Percent  Change** |   |
|---------------------------------------|--------|-------------------|------------|---------------------|--------|
| ***Medical Membership (a)(b)(c)(d)*** |   | **2003 (e)**      |       | **2002 (f)**        |   |   |
| **California**                        |   |              |       |                |   |   |   |
| Large Group                           |   | 4,782,677         |       | 4,596,329           |   | 4.1 | % |
| Individual and Small Group            |   | 1,613,065         |       | 1,597,480           |   | 1.0 | % |
| Senior                                |   | 250,760           |       | 241,420             |   | 3.9 | % |
| Total California                      |   | 6,646,502         |       | 6,435,229           |   | 3.3 | % |
| **Georgia**                           |   |              |       |                |   |   |   |
| Large Group                           |   | 1,620,886         |       | 1,603,943           |   | 1.1 | % |
| Individual and Small Group            |   | 480,572           |       | 409,580             |   | 17.3 | % |
| Senior                                |   | 69,205            |       | 69,819              |   | -0.9 | % |
| Total Georgia                         |   | 2,170,663         |       | 2,083,342           |   | 4.2 | % |
|                                  |   |              |       |                |   |   |   |
| **Central Region (g)**                |   |              |       |                |   |   |   |
| **Missouri**                          |   |              |       |                |   |   |   |
| Large Group                           |   | 1,244,375         |       | 1,247,436           |   | -0.2 | % |
| Individual and Small Group            |   | 242,888           |       | 228,245             |   | 6.4 | % |
| Senior                                |   | 41,080            |       | 42,634              |   | -3.6 | % |
| Total Missouri                        |   | 1,528,343         |       | 1,518,315           |   | 0.7 | % |
| **Illinois**                          |   |              |       |                |   |   |   |
| Large Group                           |   | 608,459           |       | 624,339             |   | -2.5 | % |
| Individual and Small Group            |   | 119,298           |       | 122,337             |   | -2.5 | % |
| Senior                                |   | 12,936            |       | 12,584              |   | 2.8 | % |
| Total Illinois                        |   | 740,693           |       | 759,260             |   | -2.4 | % |
| **Texas**                             |   |              |       |                |   |   |   |
| Large Group                           |   | 288,259           |       | 361,279             |   | -20.2 | % |
| Individual and Small Group            |   | 199,994           |       | 192,124             |   | 4.1 | % |
| Senior                                |   | 4,733             |       | 519                 |   | 811.9 | % |
| Total Texas                           |   | 492,986           |       | 553,922             |   | -11.0 | % |
| **Other States**                      |   |              |       |                |   |   |   |
| Large Group                           |   | 1,729,667         |       | 1,562,150           |   | 10.7 | % |
| Individual and Small Group            |   | 103,226           |       | 94,609              |   | 9.1 | % |
| Senior                                |   | 29,536            |       | 23,123              |   | 27.7 | % |
| Total Other States                    |   | 1,862,429         |       | 1,679,882           |   | 10.9 | % |
| **Wisconsin**                         |   |              |       |                |   |   |   |
| Large Group                           |   | 429,806           |       | 20,841              |   | N/A |   |
| Individual and Small Group            |   | 108,194           |       | 934                 |   | N/A |   |
| Senior                                |   | 53,048            |       | 66                  |   | N/A |   |
| Total Wisconsin                       |   | 591,048           |       | 21,841              |   | N/A |   |
| **Total Medical  Membership**         |   | **14,032,664**    | ** ** | **13,051,791**      |   | 7.5 | % |

 

37

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|                     |   | **September 30,** |   | **Percent  Change** |   |
|--------------------------|--------|-------------------|--------|---------------------|--------|
| ***ASO Membership (h)*** |   | **2003 (e)**      |   | **2002 (f)**        |   |   |
|                     |   |              |   |                |   |   |   |
| California               |   | 1,614,235         |   | 1,465,397           |   | 10.2 | % |
| Georgia                  |   | 831,464           |   | 868,493             |   | -4.3 | % |
| Central Region           |   | 2,705,333         |   | 2,665,045           |   | 1.5 | % |
| Wisconsin                |   | 165,249           |   | 13,304              |   | N/A |   |
| Total ASO Membership     |   | 5,316,281         |   | 5,012,239           |   | 6.1 | % |
|                     |   |              |   |                |   |   |   |
| ***Risk Membership***    |   |              |   |                |   |   |   |
|                     |   |              |   |                |   |   |   |
| California               |   | 5,032,267         |   | 4,969,832           |   | 1.3 | % |
| Georgia                  |   | 1,339,199         |   | 1,214,849           |   | 10.2 | % |
| Central Region           |   | 1,919,118         |   | 1,846,334           |   | 3.9 | % |
| Wisconsin                |   | 425,799           |   | 8,537               |   | N/A |   |
| Total Risk Membership    |   | 8,716,383         |   | 8,039,552           |   | 8.4 | % |
|                     |   |              |   |                |   |   |   |
| Total Medical Membership |   | 14,032,664        |   | 13,051,791          |   | 7.5 | % |

 
|                                |   | **September  30,** |   | **Percent  Change** |   |
|-------------------------------------|--------|--------------------|--------|---------------------|--------|
| ***State-Sponsored  Programs (i)*** |   | **2003**           |   | **2002**            |   |   |
| Medi-Cal/Medicaid                   |   |               |   |                |   |   |   |
| California                          |   | 839,674            |   | 811,455             |   | 3.5 | % |
| Virginia                            |   | 46,336             |   | 36,039              |   | 28.6 | % |
| Puerto Rico                         |   | 265,614            |   | 288,951             |   | -8.1 | % |
| Other                               |   | 101,567            |   | 68,889              |   | 47.4 | % |
| Total                               |   | 1,253,191          |   | 1,205,334           |   | 4.0 | % |
|                                |   |               |   |                |   |   |   |
| Healthy Families                    |   | 271,095            |   | 244,467             |   | 10.9 | % |
| MRMIP / AIM / IHRP                  |   | 12,094             |   | 17,910              |   | -32.5 | % |
| California Kids                     |   | 16,373             |   | 19,300              |   | -15.2 | % |
| Total                               |   | 1,552,753          |   | 1,487,011           |   | 4.4 | % |

 

 

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

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

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

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

(e)          Medical membership as of September 30, 2003includes 675,048 medical members from the Cobalt acquisition.

(f)            Membership numbers as of September 30, 2002have been reclassified to reflect the zip code of the subscriber ofHealthLink’s commercial insurer accounts. These members were previously included in the commercial insurers’ stateof domicile.  As of September 30, 2002,Missouri and Illinois members would have been higher by 107,940 and 22,999,respectively, while California, Georgia, Texas and Other States would have beenlower by 1,341, 299, 8,635 and 120,664, respectively.

(g)         Central Region - Large Group membershipincludes network access services members, primarily from HealthLink, of1,395,231 and 1,463,119 as of September 30, 2003 and September 30, 2002,respectively.

(h)         ASO Membership represents members for whichthe Company provides administrative services only and does not assume fullinsurance risk.

(i)             Medi-Cal (the California Medicaid program)membership 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.

 

***SpecialtyMembership***

 
|                         |   | **September 30,** |   | **Percent  Change** |   |
|------------------------------|--------|-------------------|--------|---------------------|--------|
|                         |   | **2003 (A)**      |   | **2002**            |   |   |
| Pharmacy Benefits Management |   | 30,634,905        |   | 33,591,088          |   | -8.8 | % |
| Dental                       |   | 3,249,312         |   | 2,704,041           |   | 20.2 | % |
| Life                         |   | 3,039,852         |   | 2,488,062           |   | 22.2 | % |
| Disability                   |   | 609,587           |   | 515,865             |   | 18.2 | % |
| Behavioral Health            |   | 7,206,763         |   | 7,310,429           |   | -1.4 | % |

 

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(A) Specialtymembership as of September 30, 2003 includes 724,782 specialty members from theCobalt acquisition.

 

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***Comparisonof Results of Operations for the Quarter Ended September 30, 2003 to theQuarter Ended September 30, 2002***

 

As a result of the January 31, 2002 acquisition of RightCHOICE, theorganizational structure of the Company changed effective February 1, 2002. Asa result of these changes, the Company has the following two reportablesegments: Health Care and Specialty. (See Note 11 to the Consolidated FinancialStatements for further discussion.) The Health Care segment provides a broadspectrum of network-based health plans, including PPOs, HMOs, POS plans, otherhybrid plans and traditional indemnity products, to large and small employersand individuals as well as other health care-related products, such as vision,preventive care, COBRA and flexible benefits account administration. TheSpecialty business is maintained as a separate segment providing an array ofspecialty products, including pharmacy benefits management, dental, lifeinsurance, disability insurance, behavioral health and workers’ compensationmanaged care services.

 

The following table depicts premium revenue by reportable segment:

 
|                |   | **Quarter Ended September 30,** |      |
|---------------------|--------|---------------------------------|-----------|
| **(In  thousands)** |   | **2003**                        |      | **2002** |   |
| Health Care         |   | $                               | 4,622,614 |   | $ | 4,059,121 |   |
| Specialty           |   | 141,245                         |      | 124,828 |   |
| Consolidated        |   | $                               | 4,763,859 |   | $ | 4,183,949 |   |

 

Premium revenue increased 13.9%, or $580.0 million, to $4,763.9 millionfor the quarter ended September 30, 2003 from $4,183.9 million for thequarter ended September 30, 2002.  Thisgrowth occurred across all regions of the Health Care segment, but was morepronounced in the California and Georgia regions. In addition to an increase ininsured member months of 3.8%, the increase in premium revenue was also due tothe implementation of premium increases across all regions of the Health Caresegment. The increase in the Specialty segment premium revenue of $16.4 millionfor the quarter ended September 30, 2003 is primarily attributable to anincrease in dental revenues of $13.1 million, of which $6.7 million was relatedto the Golden West acquisition.

 

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

 
|                 |   | **Quarter Ended September 30,** |    |
|----------------------|--------|---------------------------------|---------|
| **(In  thousands)**  |   | **2003**                        |    | **2002** |   |
| Health Care          |   | $                               | 187,363 |   | $ | 179,582 |   |
| Specialty            |   | 31,376                          |    | 33,825 |   |
| Corporate and  Other |   | 956                             |    | — |   |
| Consolidated         |   | $                               | 219,695 |   | $ | 213,407 |   |

 

Management services and other revenue increased 3.0%, or$6.3 million, to $219.7 million for the quarter ended September 30,2003 from $213.4 million for the quarter ended September 30, 2002. The increasewas primarily due to an increase in management services revenue from theCalifornia and Georgia regions of the Health Care segment of $13.3 million and$7.7 million,

 

39

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respectively. The increase in the California region resulted from anincrease in administrative services member months of 13.5% and an increase of11.0% in the administrative services per member per month rate. The increase inthe Georgia region resulted from an increase of 11.5% in the administrativeservices per member per month rate. These increases were offset by a decreasein the Central Region of $13.1 million. The decrease in the Central Regionresulted primarily from a decrease in management services revenue from theUNICARE Large Group division of $15.7 million due to lower administrativeservices membership and a decrease in the administrative services per memberper month rate.  In addition, managementservices revenue in the Specialty segment decreased by $2.4 million, which wasprimarily attributable to a decrease in pharmacy benefit management servicesrevenues from non-affiliated clients.

 

Investment income was $65.5 million for the quarter ended September 30,2003, compared to $117.8 million for the quarter ended September 30, 2002,a decrease of $52.3 million or 44.4%. The decrease was primarily due to a decrease in pre-tax investment gainto $1.6 million for the quarter ended September 30, 2003 from $50.6 million forthe same quarter of 2002.  The netrealized gain recorded in the quarter ended September 30, 2002 was a result ofthe Company’s investment in Trigon Healthcare, Inc., which resulted in $64.9million in realized gain.

 

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

 
|               |   | **Quarter Ended September 30,** |      |
|--------------------|--------|---------------------------------|-----------|
| **(In thousands)** |   | **2003**                        |      | **2002** |   |
| Health Care        |   | $                               | 3,701,709 |   | $ | 3,333,648 |   |
| Specialty          |   | 90,396                          |      | 86,680 |   |
| Consolidated       |   | $                               | 3,792,105 |   | $ | 3,420,328 |   |

 

Health care services and other benefits expense increased 10.9%, or$371.8 million, to $3,792.1 million for the quarter ended September30, 2003 from $3,420.3 million for the quarter ended September 30, 2002.The Company’s medical care ratio was 79.6% for the quarter ended September 30,2003 compared to 81.7% for the quarter ended September 30, 2002. The medical careratio attributable to the Health Care segment was 80.1% for the quarter endedSeptember 30, 2003, compared to 82.1% for the quarter ended September 30,2002.  The medical care ratioattributable to the Specialty segment was 64.0% for the quarter ended September30, 2003 compared to 69.4% for the quarter ended September 30, 2002. Healthcare services 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.

 

The Company’s medical care ratio attributable to the Health Caresegment decreased from 82.1% for the quarter ended September 30, 2002 to 80.1%for the quarter ended September 30, 2003, primarily due to price increases inall regions and lapses in accounts with higher-than-average medical careratios.  The medical care ratio for theSpecialty segment decreased to 64.0% for the quarter ended September 30, 2003from 69.4% for the same quarter in 2002. The

 

40

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improvement in the medical care ratio was attributable to favorableclaims trends for dental, life and disability products. The health careservices and other benefits expense included an estimate of claims incurred duringthe period that have not been reported to the Company.  This estimate is actuarially determinedbased on a variety of factors and is inherently subject to a number of highlyvariable circumstances.  Consequently,the actual results could differ materially from the amount recorded in theConsolidated Financial Statements. See “Critical Accounting Policies” for adiscussion of this item and its potential effect on the Company’s reportedresults of operations.

 

Selling expense consists of commissions paid to outside brokers andagents representing the Company.  Theselling expense ratio was 4.0% for each of the quarters ended September 30,2003 and September 30, 2002.

 

The general and administrative expense ratio increased to 12.5% for thequarter ended September 30, 2003 from 12.3% for the quarter ended September 30,2002. The increase in the general and administrative expense ratio resultedprimarily from costs associated with the acquisition of Cobalt, costsassociated with a major site consolidation in the Company’s UNICARE operationsand higher incentive compensation accruals due to better-than-expectedfinancial results.

 

Interest expense decreased $7.6 million to $12.6 million forthe quarter ended September 30, 2003, compared to $20.2 million for the quarterended September 30, 2002.  The decreasein interest expense was primarily due to the reduction in the weighted averageinterest rate (which includes fees associated with the Company’s borrowings andinterest rate swap agreements) for the quarter ended September 30, 2003 of4.1%, compared to 6.1% for the quarter ended September 30, 2002.

 

Other expense, net decreased $6.0 million to $9.1 million forthe quarter ended September 30, 2003, compared to $15.1 million for the quarterended September 30, 2002.  Prior to2003, results of the Company’s insurance general agency subsidiary werereported on a “net basis” in other expense, net.  For the quarter ended September 30, 2003, the results have beenrecorded on a “gross basis,” with external revenue reported in managementservices and other revenue, commissions reported in selling expense and othercosts reported in general and administrative expense.  The impact of this change is a reduction of $4.7 million in otherexpense, net for the quarter ended September 30, 2003. In addition, thedecrease also resulted from lower losses on disposal of fixed assets ofapproximately $4.0 million.

 

The Company’s net income for the quarter ended September 30, 2003 was$246.2 million, compared to $211.3 million for the quarter endedSeptember 30, 2002.  Net income for thequarter ended September 30, 2002 included an extraordinary gain of $4.9million, or $0.03 per basic and diluted share. The extraordinary gain was related to the acquisition of MethodistCare,resulting from an excess of the fair value of net assets over acquisitioncosts. Net income for the quarter ended September 30, 2002 also included $30.4million of after-tax realized gains (primarily attributable to the gain fromthe Company’s investment in Trigon Healthcare, Inc.). Earnings per sharetotaled $1.68 and $1.45 for the quarters ended September 30, 2003 and 2002,

 

41

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respectively.  Earnings pershare assuming full dilution totaled $1.63 and $1.38 for the quarters endedSeptember 30, 2003 and 2002, respectively.

 

Earnings per share for the quarter ended September 30, 2003 is basedupon weighted average shares outstanding of 146.6 million shares, excludingpotential common stock, and 150.8 million shares, assuming fulldilution.  Earnings per share for thequarter ended September 30, 2002 is based upon 145.5 million shares, excludingpotential common stock, and 152.8 million shares, assuming full dilution.  The decrease in weighted average sharesoutstanding assuming full dilution primarily resulted from the redemption ofthe Company’s Zero Coupon Convertible Subordinated Debentures.

 

42

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The operating results for the nine months ended September 30, 2003compared to the nine months ended September 30, 2002 were impacted by theRightCHOICE acquisition, which was consummated on January 31, 2002.  Specifically, the Company’s operatingresults for the nine months ended September 30, 2003 include nine months ofoperating results attributable to the acquired RightCHOICE business, whereasthe Company’s operating results for the nine months ended September 30, 2002include only eight months (February 1, 2002 through September 30, 2002) ofoperating results attributable to the acquired RightCHOICE business.  As previously mentioned, Cobalt’s operatingresults are not included in the operating results of the Company for any of theperiods presented in this quarterly report on Form 10-Q. In order to provide amore meaningful comparison of the Company’s results of operations for the firstnine months of 2003 versus the first nine months of 2002, the followingdiscussion presents financial measures that exclude operating resultsattributable to the acquired RightCHOICE business for the month of January2003, which we refer to as “Same-Store.” The Company also uses Same-Storemeasures for purposes of reporting comparative financial results to its Boardof Directors.

 

The following table depicts premium revenue by reportable segment:

 
| **(In  thousands)** |   | **Nine Months Ended****September 30, 2003** |       | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Nine Months  Ended  September 30,  2003 (Same-Store)** |   | **Nine Months  Ended****September 30,  2002** |       |
|---------------------|--------|---------------------------------------------|------------|----------------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|-----------------------------------------------|------------|
| Health Care         |   | $                                           | 13,559,205 |                                                                             | $      | 109,386                                                  |   | $                                             | 13,449,819 |   | $ | 11,532,859 |   |
| Specialty           |   | 407,813                                     |       | 673                                                                              |   | 407,140                                                  |   | 374,843                                       |       |
| Consolidated        |   | $                                           | 13,967,018 |                                                                             | $      | 110,059                                                  |   | $                                             | 13,856,959 |   | $ | 11,907,702 |   |

 

Premium revenue increased 17.3%, or $2,059.3 million, to $13,967.0million for the nine months ended September 30, 2003 from$11,907.7 million for the nine months ended September 30, 2002.  Excluding premium revenue attributable tothe acquired RightCHOICE business of $110.1 million for the month of January 2003,premium revenue increased $1,949.2 million or 16.4%.  Excluding insured membership attributable to the Cobaltacquisition and the acquired RightCHOICE business for the month of January2003, insured member months increased approximately 6.2% for the nine monthsended September 30, 2003 compared to the nine months ended September 30, 2002.This growth in premium revenue occurred across all regions of the Health Caresegment, but was more pronounced in the California and Georgia regions duemainly to an increase in insured member months and the implementation ofpremium increases.

 

43

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

 
| **(In  thousands)**  |   | **Nine Months Ended  September 30, 2003** |    | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Nine Months  Ended****September 30,  2003 (Same-Store)** |   | **Nine Months  Ended****September 30,  2002** |    |
|----------------------|--------|-------------------------------------------|---------|----------------------------------------------------------------------------------|--------|------------------------------------------------------------|--------|-----------------------------------------------|---------|
| Health Care          |   | $                                         | 562,448 |                                                                             | $      | 13,288                                                     |   | $                                             | 549,160 |   | $ | 503,538 |   |
| Specialty            |   | 102,596                                   |    | 173                                                                              |   | 102,423                                                    |   | 102,137                                       |    |
| Corporate and  Other |   | 2,288                                     |    | —                                                                           |   | 2,288                                                      |   | —                                        |    |
| Consolidated         |   | $                                         | 667,332 |                                                                             | $      | 13,461                                                     |   | $                                             | 653,871 |   | $ | 605,675 |   |

 

Management services and other revenue increased 10.2%, or$61.6 million, to $667.3 million for the nine months ended September30, 2003 from $605.7 million for the nine months ended September 30, 2002.Excluding management services and other revenue attributable to the acquiredRightCHOICE business of $13.5 million for the month of January 2003, managementservices and other revenue increased $48.1 million or 7.9%.  Excluding the RightCHOICE acquisition, theincrease in the Health Care segment was primarily due to an increase inmanagement services revenue from the California and Georgia regions of $41.9million and $25.4 million, respectively. The increase in the California regionresulted from an increase in administrative services member months of 13.3% andan increase of 13.4% in the administrative services per member per month rate.The increase in the Georgia region resulted primarily from a 12.7% increase inthe administrative services per member per month rate. These increases werepartially offset by a decrease in the Central Region of $21.7 million on aSame-Store basis. The decrease in the Central Region resulted primarily from adecrease in management services revenue from the UNICARE Large Group divisionof $33.8 million due to lower administrative services membership and a decreasein the administrative services per member per month rate.

 

Investment income was $195.8 million for the nine months endedSeptember 30, 2003, compared to $243.8 million for the nine months endedSeptember 30, 2002, a decrease of $48.0 million or 19.7%. The decrease wasprimarily due to net realized gains for the nine months ended September 30,2003 of $8.6 million as compared to net realized gains for the nine monthsended September 30, 2002 of $49.5 million. Net realized gains for the ninemonths ended September 30, 2002 included a pre-tax investment gain of $64.9million from the Company’s investment in Trigon Healthcare, Inc.  Excluding net realized gains and losses,investment income for the nine months ended September 30, 2003 and 2002 was$187.2 million and $194.3 million, respectively. The $7.1 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.

 

44

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

 
| **(In  thousands)** |   | **Nine Months Ended  September 30, 2003** |       | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Nine Months  Ended****September 30,  2003 (Same-Store)** |   | **Nine Months  Ended****September 30,  2002** |       |
|---------------------|--------|-------------------------------------------|------------|----------------------------------------------------------------------------------|--------|------------------------------------------------------------|--------|-----------------------------------------------|------------|
| Health Care         |   | $                                         | 11,024,310 |                                                                             | $      | 85,730                                                     |   | $                                             | 10,938,580 |   | $ | 9,420,053 |   |
| Specialty           |   | 254,962                                   |       | 334                                                                              |   | 254,628                                                    |   | 264,882                                       |       |
| Consolidated        |   | $                                         | 11,279,272 |                                                                             | $      | 86,064                                                     |   | $                                             | 11,193,208 |   | $ | 9,684,935 |   |

 

Health care services and other benefits expense increased 16.5%, or$1,594.4 million, to $11,279.3 million for the nine months endedSeptember 30, 2003 from $9,684.9 million for the nine months endedSeptember 30, 2002. Excluding health care services and other benefits expenseattributable to the acquired RightCHOICE business of $86.1 million for themonth of January 2003, health care services and other benefits expenseincreased $1,508.3 million or 15.6%, slightly less than the increase in premiumrevenue of 16.4%.

 

The Company’s medical care ratio was 80.8% for the nine months endedSeptember 30, 2003 compared to 81.3% for the nine months ended September 30,2002. The medical care ratio attributable to the Health Care segment was 81.3%for the nine months ended September 30, 2003, compared to 81.7% for the ninemonths ended September 30, 2002. The medical care ratio attributable to theSpecialty segment was 62.5% for the nine months ended September 30, 2003compared to 70.7% for the nine months ended September 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 nine months endedSeptember 30, 2003 remained at 81.3% as compared to 81.7% for the nine monthsended September 30, 2002. This decrease in the medical care ratio isattributable to the implementation of premium increases during the nine monthsended September 30, 2003. The health care services and other benefits expenseincludes an estimate of claims incurred during the period that have not beenreported to the Company.  This estimateis actuarially determined based on a variety of factors and is inherentlysubject to a number of highly variable circumstances.  Consequently, the actual results could differ materially from theamount recorded in the consolidated financial statements. See “CriticalAccounting Policies” for a discussion of this item and its potential effect onthe Company’s reported results of operations.

 

The selling expense ratio increased slightly from 4.0% for the ninemonths ended September 30, 2002 to 4.1% for the nine months ended September 30,2003. Excluding selling expense of $4.7 million and combined premium revenueand management services and other revenue of $123.5

 

45

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million attributable to the acquired RightCHOICE business for the monthof January 2003, the Company’s selling expense ratio was 4.1% for the ninemonths ended September 30, 2003 as compared to 4.0% for the nine months endedSeptember 30, 2002.

 

The general and administrative expense ratio decreased to 12.2% for thenine months ended September 30, 2003 from 13.0% for the nine months endedSeptember 30, 2002. Excluding general and administrative expense of $19.5million and combined premium revenue and management services and other revenueof $123.5 million attributable to the acquired RightCHOICE business for themonth of January 2003, the Company’s general and administrative expense ratiowas 12.2% for the nine months ended September 30, 2003 compared to 13.0% forthe nine months ended September 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 $17.7 million to $38.1 million for thenine months ended September 30, 2003, compared to $55.8 million for the ninemonths ended September 30, 2002.  Thedecrease in interest expense was primarily due to the reduction in the weightedaverage interest rate (which includes fees associated with the Company’sborrowings and interest rate swap agreements) for the nine months endedSeptember 30, 2003 of 4.1%, compared to 6.1% for the nine months endedSeptember 30, 2002.

 

Other expense, net decreased $19.3 million to $20.7 millionfor the nine months ended September 30, 2003, compared to $40.0 million for thenine months ended September 30, 2002. Prior to 2003, results of the Company’s insurance general agencysubsidiary were reported on a “net basis” in other expense, net.  For the nine months ended September 30,2003, the results have been recorded on a “gross basis,” with external revenuereported in management services and other revenue, commissions reported inselling expense and other costs reported in general and administrativeexpense.  The impact of this change is areduction of $12.8 million in other expense, net for the nine months endedSeptember 30, 2003.  In addition, thedecrease also resulted from lower losses on disposal of fixed assets ofapproximately $8.2 million.

 

The Company’s net income for the nine months ended September 30, 2003was $663.7 million, compared to $523.1 million for the nine monthsended September 30, 2002.  Net incomefor the nine months ended September 30, 2002 included a $38.9 million after-taxrealized gain ($64.9 million less $26.0 million tax) from the Company’sinvestment in Trigon Healthcare, Inc. Net income for the nine months ended September 30, 2002 also included anextraordinary gain of $8.9 million, or $0.06 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. Earningsper share totaled $4.55 and $3.65 for the nine months ended September 30, 2003and 2002, respectively.  Earnings pershare assuming full dilution totaled $4.42 and $3.48 for the nine months endedSeptember 30, 2003 and 2002, respectively.

 

Earnings per share for the nine months ended September 30, 2003 isbased upon weighted average shares outstanding of 146.0 million shares,excluding potential common stock, and

 

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150.1 million shares, assuming full dilution.  Earnings per share for the nine months endedSeptember 30, 2002 is based upon 143.2 million shares, excluding potentialcommon stock, and 150.4 million shares, assuming full dilution.  The slight decrease in weighted averageshares outstanding assuming full dilution primarily resulted from theredemption of the Company’s Zero Coupon Convertible Subordinated Debenturespartially offset by an increase related to the issuance of shares related tothe RightCHOICE acquisition and the Company’s employees stock option andpurchase plans.

 

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***Financial Condition***

 

The Company’s consolidated assets increased by $2,402.7 million, or20.9%, to $13,873.3 million as of September 30, 2003 from $11,470.6 million asof December 31, 2002. The increase in total assets was primarily due to growthin cash and investments of $1,122.0 million as a result of operating cash flowsattributable to net income and an increase in advances on security lendingdeposits. The increase in cash and investments was partially offset by timingof the receipt of receivables. Cash and investments totaled $7.9 billion as ofSeptember 30, 2003, or 56.9% of total assets.

 

Overall claims liabilities, which is comprised of medical claimspayable and reserves for future policy benefits, increased $393.1 million, or14.5%, to $3,098.7 million as of September 30, 2003 from $2,705.6 million as ofDecember 31, 2002. This increase was due to the inclusion of Cobalt’s medicalclaims payable and reserves for future policy benefits of $295.0 million as ofSeptember 30, 2003, an increase in Same-Store medical members of 134,000 and anincrease in per member per month medical claim expense during the nine monthsended September 30, 2003. See “Critical Accounting Policies” for a discussionof medical claims payable and reserves for future policy benefits. As ofSeptember 30, 2003, the Company’s long-term indebtedness was $1,287.4 million,of which $464.0 million was related to the Company’s 6 3/8*%* Notes due 2006 (which includes a fairvalue adjustment of $14.6 million), $349.0 million was related to the Company’s6 3/8*%*Notes due 2012 and $474.4 million was related to the commercial paper program.The 6 3/8*%*Notes due 2012, with an aggregate principal amount at maturity of $350.0million, were issued to partially finance the RightCHOICE acquisition. TheCompany’s revolving credit facility indebtedness of $235.0 million at December31, 2001 was repaid during the year ended December 31, 2002, with $200.0million obtained through the commercial paper program and operating cash of$35.0 million. In the first quarter of 2003, the Company issued an additional$149.9 million in commercial paper (net of repayments made during the quarter)to repurchase Common Stock of the Company. In the third quarter of 2003, theCompany also issued an additional $125.1 million in commercial paper primarilyto finance the purchase of Cobalt (refer to Liquidity and Capital Resources fora discussion of the potential repurchase of the Company’s commercial paper as aresult of the Company’s pending merger with Anthem, Inc.).

 

Stockholders’ equity totaled $5,031.3 million as of September 30, 2003,an increase of $1,054.6 million from $3,976.7 million as of December 31, 2002.The increase was primarily due to net income of $663.7 million for the ninemonths ended September 30, 2003, the net issuance of 5.1 million shares, or$441.4 million, of the Company’s Common Stock related to the acquisition ofCobalt Corporation, a net increase of $231.3 million from the reissuance oftreasury stock related to the Company’s employee 401(k) plan, stock option andstock purchase plans and  an increase innet unrealized gain from investment securities of $71.3 million, net of taxes.Partially offsetting these increases were the repurchase of 3.9 million sharesof the Company’s Common Stock for $268.6 million and net losses from thereissuance of treasury stock of $84.5 million.

 

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***Liquidity andCapital Resources***

 

As of September 30, 2003, consolidated cash and investments were $7.9billion, of which $1.1 billion was in cash and cash equivalents. The Company’sprimary sources of cash are premium and management services revenues andinvestment income.  The Company’s primaryuses of cash include health care claims and other benefits, capitationpayments, income taxes, repayment of long-term debt, interest expense, brokerand agent commissions, administrative expenses, Common Stock repurchases andcapital expenditures.  In addition tothe foregoing, other uses of cash include provider network and systemsdevelopment costs and costs associated with the integration of acquiredbusinesses.

 

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

 

The Company’s strategy for achieving its investment goals is broaddiversification of its investments, both across and within asset classes.  As of September 30, 2003, the Company’sinvestment portfolio consisted primarily of investment grade fixed-incomesecurities.  The Company’s portfolioalso included large capitalization and small capitalization domestic equities,foreign equities, tax-exempt municipal bonds and a small amount ofnon-investment grade debt securities. The fixed-income assets include both short and long-duration securitieswith an attempt to match the Company’s funding needs.  The Company’s investment policy contains limitations regardingconcentration in individual securities and industries and generally prohibitsspeculative and leveraged investments. Cash and investment balances maintained by the Company are sufficient tomeet applicable regulatory financial stability and net worth requirements, includinglicense requirements of the Blue Cross and Blue Shield Association.

 

Net cash provided by operating activities was $790.3 million forthe nine months ended September 30, 2003, compared with $954.1 million for thenine months ended September 30, 2002. Net cash provided by operations for the nine months ended September 30,2003 was due primarily to net income of $663.7 million, an increase inmedical claims payable of $87.0 million due to membership growth and higherhealth care expenses per member per month, an increase in accounts payable andaccrued expenses of $77.8 million attributable to employee compensation relatedaccruals and an increase in other current liabilities of $100.6 million due totiming of pharmaceutical drug and pharmacy rebate payments, increases in drugpurchases and timing of other accruals related to normal operations. Partiallyoffsetting these increases was an increase in receivables, net of $232.1million due to timing of cash receipts, primarily related to pharmacy rebates andmembership growth.

 

Net cash used in investing activities for the nine months endedSeptember 30, 2003 totaled $1,588.5 million, compared with$1,220.6 million for the nine months ended September 30, 2002.

 

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The cash used in the first nine months of 2003 was primarilyattributable to the purchase of investments of $7.9 billion, the acquisitionsof Cobalt and Golden West, net of cash acquired, of 

 

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$405.4 million, and the purchase of property and equipment, net ofsales proceeds, of $96.1 million, which were partially offset by proceeds frominvestments sold of $6.8 billion.

 

Net cash provided by financing activities totaled $528.7 millionin the first nine months of 2003 compared with $258.1 million for the ninemonths ended September 30, 2002.  Thenet cash provided in the first nine months of 2003 was primarily attributableto additional advances on securities lending deposits of $417.1 million, additionaldebt of $274.6 million, of which $125.1 million was used to partially financethe acquisition of Cobalt and the remaining balance was incurred to partiallyfinance the $268.6 million repurchase of Company Common Stock, and the receiptof proceeds from the issuance of Common Stock related to the Company’s employeestock option plans of $105.5 million.

 

Effective March 30, 2001, the Company entered into two new unsecuredrevolving credit facilities allowing aggregate indebtedness of $1.0 billion inprincipal amount. Upon execution of these facilities, the Company terminatedits prior $1.0 billion unsecured revolving facility. Borrowings under thesefacilities (which are generally referred to collectively in this quarterlyreport on Form 10-Q as the Company’s “revolving credit facility”) bear interestat rates determined by reference to the bank’s base rate or to the LondonInterBank Offered Rate (“LIBOR”) plus a margin determined by reference to thethen-current rating of the Company’s senior unsecured long-term debt byspecified rating agencies. One facility, which provides for borrowings not toexceed $750.0 million at any time outstanding, expires as of March 30, 2006,although it may be extended for up to two additional one-year periods undercertain circumstances. The other facility, which provides for borrowings not toexceed $250.0 million at any time outstanding, expires on March 26, 2004. Anyamount outstanding under this facility as of March 26, 2004 may be convertedinto a one-year term loan at the option of the Company and will bear interestat rates determined by reference to the bank’s base rate or LIBOR plus a margindetermined by reference to the then-current rating of the Company’s unsecuredlong-term debt by specified rating agencies, plus 0.125% until paid in full.Loans under the $250.0 million facility are made on a committed basis. Loansunder the $750.0 million facility are made on a committed basis or pursuant toan auction bid process. The $750.0 million facility also contains sublimits forletters of credit and “swingline” loans. Each credit agreement requires theCompany to maintain certain financial ratios and contains restrictivecovenants, including restrictions on the incurrence of additional indebtednessand the granting of certain liens, limitations on acquisitions and investmentsand limitations on changes in control (see Note 6 to the Consolidated FinancialStatements). As of September 30, 2003 and December 31, 2002, there were noamounts outstanding under the revolving credit facility.

 

In April 2002, the Company commenced a commercial paper programproviding for the issuance of up to $1.0 billion in aggregate maturity value ofshort-term indebtedness (known generally as “commercial paper”). The commercialpaper is being issued by the Company without registration under the SecuritiesAct of 1933, as amended (the “1933 Act”) in reliance upon the exemption fromregistration contained in Section 4(2) of the 1933 Act. The commercial paper isissued in denominations of $100,000 or integral multiples of $1,000 in excessthereof and will bear such interest rates, if interest-bearing, or will be soldat such discount from their face amounts, as agreed upon by the Company and thedealer or dealers

 

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acting in connection with the commercial paper program. The commercialpaper may be issued with varying maturities up to a maximum of 270 days fromthe date of issuance. The commercial paper ranks equally with all otherunsecured and unsubordinated indebtedness of the Company. As of September 30,2003 and December 31, 2002, the outstanding commercial paper borrowings totaled$474.4 million and $199.8 million, respectively, with various maturity datesand had interest rates ranging from 1.19% to 1.27% as of September 30, 2003 andinterest rates ranging from 1.60% to 1.65% as of December 31, 2002. Theweighted average yield on the outstanding commercial paper as of September 30,2003 and December 31, 2002 was 1.22% and 1.62%, respectively. The Companyintends to maintain commercial paper borrowings of at least the amountoutstanding at September 30, 2003 for more than one year. Accordingly, forfinancial reporting purposes, the commercial paper has been classified undernon-current liabilities in the Consolidated Balance Sheets. Under the Company’smerger agreement with Anthem, Inc., however, the Company has agreed torepurchase, prior to the closing of the merger with Anthem, any outstandingcommercial paper issued by the Company or any of its subsidiaries.  

 

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

 

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

 

On June 15, 2001, the Company issued $450.0 million aggregate principalamount at maturity of 6 3/8*%* Notes due June 15, 2006 (the “2006 Notes”). The netproceeds of this offering totaled approximately $449.0 million. The netproceeds from the sale of the 2006 Notes were used to repay indebtedness underthe Company’s revolving credit facilities. The 2006 Notes bear interest at arate 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.

 

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

 

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

 

On October 2, 2002, the Company announced that it had elected to redeemthe Debentures as of October 28, 2002. Substantially all of the Debentures weretendered for conversion into the Company’s Common Stock prior to the redemptiondate. Approximately $50,000 principal amount at maturity of the Debentures weresettled in cash. This conversion did not have an extraordinary income statementimpact. (See Note 6 to the Consolidated Financial Statements.) Prior to theCompany’s announcement of its election to redeem the Debentures,Debentureholders in 2002 converted $18.0 million in aggregate principal amountat maturity of the Company’s Debentures with a carrying value (includingaccreted interest) of $12.6 million. In lieu of delivering shares of CommonStock upon conversion of these Debentures, the Company elected to pay cash of$18.9 million, which resulted in an extraordinary after-tax loss of $3.8million, as shown on the Company’s Consolidated Income Statements for the yearended December 31, 2002. In accordance with SFAS No. 145 which was effectivefor fiscal years beginning after May 15, 2002, the Company had determined thatthe extinguishment of debt under its Zero Coupon Convertible SubordinatedDebentures, which were redeemed as of October 28, 2002, did not meet therequirements of unusual or infrequent and therefore would not be included as anextraordinary item with the rescission of FASB Statement No. 4. For the quarterended September 30, 2002, WellPoint reclassified an extraordinary loss of $4.2million, which included a tax benefit of $1.7 million, to interest expense. Forthe nine months ended September 30, 2002, WellPoint reclassified anextraordinary loss of $6.3 million, which included a tax benefit of $2.5million, to interest expense.

 

As a part of a hedging strategy to limit its exposure to variableinterest rate increases, the Company has from time to time entered intointerest rate swap agreements in order to reduce the volatility of interestexpense resulting from changes in interest rates on its variable rate debt. Theswap agreements were contracts to exchange variable-rate interest payments(weighted average rate for the year ended December 31, 2002 of 2.25%) forfixed-rate interest payments (weighted average rate for the year ended December31, 2002 of 7.08%) without the

 

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exchange of the underlying notional amounts. The Company had enteredinto $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 thefair value of the swap agreements at the time of termination and is beingamortized over the term of the original swap agreements. As of September 30,2003, the remaining balance of the swap agreements was $6.5 million. (See Note7 to the Consolidated Financial Statements.)

 

In order to reduce the interest expense associated with the 2006 Notes,the Company, on January 15, 2002, entered into a $200.0 million notional amountinterest rate swap agreement, which matures on June 15, 2006. The swapagreement is a contract to exchange a fixed 6 3/8*%* rate for a LIBOR-based floating rate(weighted average variable rate of 2.51% for the nine months ended September30, 2003).

 

Certain of the Company’s subsidiaries are required to maintain minimumcapital requirements prescribed by various regulatory agencies, including theCalifornia Department of Managed Health Care and the Departments of Insurancein various states, including Georgia, Missouri, Wisconsin and Delaware. As ofSeptember 30, 2003 (or the most recent date with respect to which compliance isrequired), those subsidiaries of the Company were in compliance with allminimum capital requirements.

 

The Company believes that cash flow generated by operations and itscash and investment balances, supplemented by the Company’s ability to borrowunder its existing revolving credit facility, commercial paper program orthrough public or private financing sources, will be sufficient to fundcontinuing operations and expected capital requirements for the foreseeablefuture.

# * *

***Critical AccountingPolicies***

 

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

 

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

 

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*Medical Claims Payable*

 

Medical claims payable includes claims in process as well as provisionsfor the estimate of incurred but not reported claims (“IBNR”) and provisionsfor disputed claims obligations.  As ofSeptember 30, 2003, approximately 90% of the Company’s medical claims payableconsisted of IBNR and claims in process. Such estimates are developed using actuarial principles and assumptionsthat consider, among other things, contractual requirements, historicalutilization trends and payment patterns, benefits changes, medical inflation,product mix, seasonality, membership and other relevant factors.  In developing IBNR, the Company appliesdifferent estimation methods depending on the period for which incurred claimsare being estimated.  For the mostrecent four months, the incurred claims are estimated from the trend analysisbased on per member per month claims trends developed from the experience inpreceding months.  For periods prior tothe most recent four months, the key assumption used in developing theCompany’s IBNR is that the completion factor pattern remains consistent over arolling 12-month period.  The completionfactor is an actuarial estimate, based upon historical experience, of thepercentage of claims incurred during a given period that have been adjudicatedby the Company as of the date of estimation. This approach is consistently applied to each period presented.

 

The completion factors and claims per member per month trend factor arethe most significant factors used in estimating the Company’s IBNR.  The following table illustrates thesensitivity of these factors using September 30, 2003 data and the estimatedpotential impact on the Company’s operating results 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                                  | )%      | $                                                     | 285,000,000 |   | (3 | )% | $ | (11,000,000 | ) |
| (2                                  | )%      | 184,000,000                                           |        | (2 | )% | (8,000,000 | ) |
| (1                                  | )%      | 90,000,000                                            |        | (1 | )% | (4,000,000 | ) |
| 1                                   |  % | (85,000,000                                           | )           | 1 |  % | 4,000,000 |   |
| 2                                   |  % | (167,000,000                                          | )           | 2 |  % | 7,000,000 |   |
| 3                                   |  % | (244,000,000                                          | )           | 3 |  % | 11,000,000 |   |
|                                     |         |                                                       |             |  |  |  |  |  |  |  |  |

 

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

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

 

In addition, assuming a hypothetical 1% difference between theCompany’s September 30, 2003 estimated claims liability and the actual claimsincurred, net income for the three months

 

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ended September 30, 2003 would increase or decrease by $16.5 million,while diluted net income per share would increase or decrease by $0.11 pershare.

 

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

 

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

 

The table below provides a reconciliation of changes in medical claimspayable as of December 31, 2002, 2001 and 2000 during the immediately followingnine-month period:

 
|                                                                |   | **Nine  Months Ended September 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 |   | 244,414                              |      | 176,177 |   | 258,375 |   |
|                                                                |   |                                 |      |   |   |   |   |
| Health care claim expenses incurred during period:                  |   |                                 |      |   |   |   |   |
| Related to current year                                             |   | 11,454,547                           |      | 9,855,058 |   | 6,866,978 |   |
| Related to prior years                                              |   | (398,507                             | )         | (391,380 | ) | (265,367 | ) |
| Total Incurred                                                      |   | 11,056,040                           |      | 9,463,678 |   | 6,601,611 |   |
|                                                                |   |                                 |      |   |   |   |   |
| Health care services payments during period:                        |   |                                 |      |   |   |   |   |
| Related to current year                                             |   | 9,394,778                            |      | 8,096,931 |   | 5,652,258 |   |
| Related to prior years                                              |   | 1,574,289                            |      | 1,143,757 |   | 961,387 |   |
| Total Payments                                                      |   | 10,969,067                           |      | 9,240,688 |   | 6,613,645 |   |
|                                                                |   |                                 |      |   |   |   |   |
| Medical claims payable as of  September 30                     |   | $                                    | 2,753,718 |   | $ | 2,333,787 |   | $ | 1,812,910 |   |

 

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As shown in the table above, for the nine months ended September 30,2003, 2002 and 2001, the amount shown on the line labeled “Health care servicesexpenses incurred during period: Related to prior years” is negative, meaningthat the Company’s actual health care services experience related to prior yearswere less than the estimates previously made by the Company.  This favorable development was primarilyrelated to prior-years’ claims being 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 thatthe actuarially developed health care claims estimates cover obligations underan assumption of moderately adverse conditions.  Adverse conditions are situations in which the actual claims areexpected to be higher than the otherwise estimated value of such claims at thetime of the estimate.  Therefore, inmany situations, the claims amount actually experienced will be less than anestimate that satisfies the actuarial standards of practice.  Adjustments of prior-year estimates mayresult in additional health care services expenses or, as the Companyexperienced during each of the last three years, a reduction in health careservices expenses in the period an adjustment is made.

 

Health care claims are usually described as having a “short tail,”which means that they are generally paid within a few months of the memberreceiving service from the physician or other health care provider.  Based on the Company’s historical claim payment patterns, less than 5%of the medical claims payable as of the end of any given year is outstanding atthe end of the following year. Management expects that substantially allof the development of the 2002 estimate of medical claims payable will be knownduring 2003.

 

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

 

Health care services and other benefits expense includes the costs ofhealth care services, capitation expenses and expenses related to risk-sharingagreements with participating physicians, medical groups and hospitals andincurred losses on the Company’s disability and life products. The costs ofhealth care services are accrued as services are rendered, including anestimate for claims incurred but not yet reported.

 

For many of the Company’s HMO plans (including substantially all of itsCalifornia HMO plans), the Company contracts with physicians, hospitals andother health care providers through capitation fee arrangements as a means tomanage health care costs. The Company has

 

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two general types of capitation arrangements. The predominant type isthe so-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 capitationarrangements, the health care provider does not assume the risk of the member’sutilization of any hospital-based services. The second type is the so-called“global” capitation arrangement. Under global capitation arrangements, the Companyalso pays the health care provider, such as a participating medical group, afixed amount per member per month. However, under global capitationarrangements, the health care provider generally assumes the risk of themember’s utilization of all health care services (subject to certain limitedexceptions and state regulatory requirements). As of September 30, 2003 andDecember 31, 2002, the Company had approximately eight and 10 global capitationarrangements, respectively, covering approximately 160,000 and 179,000 members,respectively. In addition, one of the Company’s subsidiaries owns a 51% equityinterest in a community health partnership network (the “CHPN”) operating inthe greater Atlanta area. The CHPN is a locally based equity venture betweenthe Company’s subsidiary and local physician and hospital groups. The Company’ssubsidiary has entered into a global capitation arrangement with the CHPN. Asof September 30, 2003 and December 31, 2002, approximately 566,000 and 535,000members, respectively, were covered by this arrangement.

 

For the quarters ended September 30, 2003 and 2002, the Company’scapitation expenses of $389.9 million and $363.9 million, represented 10.3% and10.6%, respectively, of the Company’s total health care services and otherbenefits expense. For the nine months ended September 30, 2003 and 2002, theCompany’s capitation expenses of $1,164.1 million and $1,112.6 million,represented 10.3% and 11.5%, respectively, of the Company’s total health careservices and other benefits expense. As of September 30, 2003 and December 31,2002, the Company’s capitation expenses payable of $97.3 million and $137.0million represented 3.5% and 5.7%, respectively, of the Company’s total medicalclaims payable. Cobalt’s medical claims payable as of September 30, 2003 of$244.2 million includes $0.5 million of capitation expenses payable,representing only 0.2% of Cobalt’s medical claims payable.

 

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

 

*Reserves for Future Policy Benefits*

 

The estimate of reserves for future policy benefits relates to life anddisability insurance policies written in connection with health care contracts.Reserves for future life benefit

 

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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 September 30, 2003 andDecember 31, 2002, the reserves for future policy benefits were $345.0 millionand $283.2 million, respectively.

 

*Intangible Assets and Goodwill*

 

The Company has made several acquisitions in the past several yearsthat included a significant amount of goodwill and other intangible assets.Under generally accepted accounting principles in effect through December 31,2001, these assets were amortized over their useful lives, and were testedperiodically to determine if they were recoverable from operating earnings onan undiscounted basis over their useful lives.

 

In June 2001, the Financial Accounting Standards Board issued Statementof Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No.141”) and Statement of Financial Accounting Standards No. 142, “Goodwill andOther Intangible Assets” (“SFAS No. 142”). SFAS No. 141 requires that allbusiness combinations initiated after June 30, 2001 be accounted for using thepurchase method. The provisions of SFAS No. 141 also apply to all businesscombinations consummated after June 30, 2001. SFAS No. 142, which becameeffective for fiscal years beginning after December 15, 2001, eliminatesamortization of goodwill and other intangible assets with indefinite usefullives. Rather, these assets are subject to impairment tests at least annually.The Company is required to make estimates of fair value and apply certainassumptions, such as a discount factor in applying these annual impairmenttests. Such estimates could produce significantly different results if otherassumptions, which could also be considered reasonable, were to be used. Intangibleassets with definite useful lives are being amortized using a straight-linebasis or the timing of related cash flows over periods ranging from 1.5 to 25years. An intangible asset subject to amortization must be reviewed forimpairment pursuant to Statement of Financial Accounting Standards No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

The Company adopted SFAS No. 142 on January 1, 2002 and, accordingly,no longer amortizes goodwill and other intangible assets with indefinite usefullives. In accordance with SFAS No. 142, the Company completed the transitionalevaluation of its goodwill and other intangible assets at January 1, 2002 andthe annual evaluation at December 31, 2002, and determined that there was noimpairment loss. As of September 30, 2003 and December 31, 2002, total goodwilland other intangible assets were $3.1 billion and $2.4 billion, respectively.The Cobalt acquisition added approximately $0.7 billion of goodwill and otherintangible assets to the balance at September 30, 2003. (See Note 5 to theConsolidated

 

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Financial Statements for further discussion of the Company’s goodwilland other intangible assets.)

 

*Investments*

 

As of September 30, 2003, the Company’s current investment securities(including securities on loan pursuant to securities lending transactions) atfair value, totaled $6.6 billion, of which 88.9% was invested in fixed-incomesecurities and the remaining 11.1% was invested in equity securities. As ofDecember 31, 2002, the Company’s current investment securities (includingsecurities on loan pursuant to securities lending transactions) at fair valuetotaled $5.3 billion, of which 89.6% was invested in fixed-income securitiesand the remaining 10.4% was invested in equity securities. These investmentsecurities are generally used to support current operations and, accordingly,have been classified as current assets. The Company’s long-term investments asof September 30, 2003 and December 31, 2002 were $160.7 million and $134.3million, respectively, and consisted primarily of restricted assets, certainequities and other investments. Total current and long-term investmentscomprised 49.1% and 47.2% of total assets as of September 30, 2003 and December31, 2002, respectively.

 

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

 

The Company regularly evaluates the appropriateness of investmentsrelative to its internal investment guidelines. The Company operates withinthese guidelines by maintaining a well-diversified portfolio, both across andwithin asset classes. The Company has from time to time retained an independentconsultant to advise the Company on the appropriateness of its investmentpolicy. The Company performs a quarterly evaluation of its investmentsecurities, using both quantitative and qualitative factors to determinewhether a decline in investment value is other-than-temporary. When a declinein an investment’s fair value is determined to be other-than-temporary, a lossis recorded against investment income. When determining whether a decline in aninvestment’s fair value is other-than-temporary, the Company considers the extentand duration to which a security’s market value has been less than its cost,the financial condition and future earnings potential of the issuer,recommendations and opinions from outside investment managers and the currenteconomic environment. For the quarter ended September 30, 2002, the Companyrecorded investment losses that the Company believed to be other-than-temporaryof approximately $5.8 million. The Company did not record any investment lossesthat the Company believed to be other-than-temporary for the quarter endedSeptember 30, 2003.  For the nine monthsended September 30, 2003 and 2002, the Company recorded investment losses thatthe Company believed to be other-than-temporary of approximately $29.3 millionand $25.4 million, respectively. The Company believes that it has performed anadequate review for impairment of the investment portfolio and that investmentsare carried at fair value. Changing economic and market conditions in thefuture, however, may cause the Company to reassess its judgment regardingimpairment,

 

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which could result in realized losses relating to other-than-temporarydeclines being charged against future income.

 

As of September 30, 2003 and December 31, 2002, net unrealized gainsfrom the Company’s fixed-income securities totaled $162.6 million and $184.5million, respectively, primarily resulting from a general decrease in interestrates. The Company had a net unrealized gain in its equity securities portfolioas of September 30, 2003 of $86.9 million and a net unrealized loss of $49.5million as of December 31, 2002. The Company believes that these fluctuationsare temporary as a result of current market conditions.

 

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***Factors That MayAffect Future Results of Operations***

 

Certain statements contained herein, such as statements concerningpotential or future medical care ratios, pending acquisitions and otherstatements regarding matters that are not historical facts, are forward-lookingstatements (as such term is defined in the Securities Exchange Act of 1934, asamended). Such statements involve a number of risks and uncertainties thatcould cause actual results to differ materially from those projected. Factorsthat could cause actual results to differ materially from those projectedinclude, but are not limited to, those discussed below and those discussed fromtime to time in the Company’s various filings with the Securities and ExchangeCommission.

 

Completion of the Company’s pending merger with Anthem, Inc. iscontingent upon, among other things, receipt of necessary approvals fromcertain federal and state agencies and from the stockholders of both companieson or before November 30, 2004.  Broadlatitude in administering the applicable regulations is given to the federaland state agencies from which WellPoint and Anthem must seek approvals.  There can be no assurance that the companieswill obtain these approvals.  As acondition to approval of the transaction, regulatory agencies may seek toimpose requirements or limitations or costs on the way that the combinedcompany conducts business after consummation of the transaction.  If the Company or Anthem were to agree toany material requirements or limitations in order to obtain any necessaryapprovals, such requirements or limitations or additional costs could adverselyaffect the combined company’s ability to integrate the operations of theCompany with those of Anthem, and could result in a material adverse effect onthe combined company’s revenues or results of operations.

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors.  The lawsuit, whichis entitled *Abramsv. WellPoint Health Networks Inc., et al*., alleges that theCompany’s directors breached their fiduciary duties to stockholders byapproving an Agreement and Plan of Merger with Anthem, Inc. while in possessionof non-public information regarding the Company’s financial results for thethird quarter of 2003.  The lawsuitseeks to enjoin the Company from consummating the merger with Anthem, Inc.,unless the Company adopts and implements a process for obtaining the highestpossible price for stockholders, and to rescind any terms of the Agreement andPlan of Merger that have already been implemented.

 

The Company’s operations are subject to substantial regulation byfederal, state and local agencies in all jurisdictions in which the Companyoperates. Many of these agencies have increased their scrutiny of managedhealth care companies in recent periods or are expected to increase theirscrutiny as newly passed legislation becomes effective. From time to time, theCompany and its subsidiaries receive requests for information from regulatoryagencies or are notified that such agencies are conducting reviews,investigations or other proceedings with respect to certain of the Company’sactivities. The Company also provides insurance products to Medicare andMedicaid beneficiaries in various states, including to Medi-Cal beneficiariesin various California counties under contracts with the California Departmentof Health Services (or delegated local agencies), and provides administrativeservices to the Centers for Medicare and Medicaid Services in variouscapacities (including serving as the largest

 

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Medicare Part A fiscal intermediary). There can be no assurance thatacting as a government contractor in these circumstances will not increase therisk of heightened scrutiny by such government agencies or that such scrutinywill not have a material adverse effect on the Company, either through negativepublicity about the Company or through an adverse impact on the Company’sresults of operations. In addition, profitability from this business may beadversely affected by inadequate premium rate increases due to governmentalbudgetary issues. Future actions by any regulatory agencies may have a materialadverse effect on the Company’s business.

 

In connection with the Cobalt, RightCHOICE and Cerulean transactions,the Company incurred significant additional indebtedness to fund the cashpayments made to the acquired companies’ stockholders. In addition, the Companymay incur additional indebtedness to fund potential future acquisitions. Thisexisting or new indebtedness may result in a significant percentage of theCompany’s cash flow being applied to the payment of interest, and there can beno assurance that the Company’s operations will generate sufficient future cashflow to service this indebtedness. The Company’s current indebtedness, as wellas any indebtedness that the Company may incur in the future (such asindebtedness incurred to fund repurchases of its Common Stock or to fundpotential future acquisitions), may adversely affect the Company’s ability tofinance its operations and could limit the Company’s ability to pursue businessopportunities that may be in the best interests of the Company and itsstockholders.

 

As part of the Company’s business strategy, the Company has acquiredsubstantial operations in new geographic markets over the last seven years.These businesses, some of which include substantial indemnity-based insuranceoperations, have experienced varying profitability or losses in recent periods.Since the relevant dates of acquisition of Cerulean, RightCHOICE, MethodistCareand Cobalt, the Company has continued to work extensively on the integration ofthese businesses. However, there can be no assurances regarding the ultimatesuccess of the Company’s integration efforts or regarding the ability of theCompany to maintain or improve the results of operations of the acquiredbusinesses. The Company has incurred and will, among other things, need tocontinue to incur considerable expenditures for provider networks, distributionchannels and information systems in addition to the costs associated with theintegration of these acquisitions. The integration of these complex businessesmay result in, among other things, temporary increases in claims inventory orother service-related issues that may negatively affect the Company’srelationship with its customers and contribute to increased attrition of suchcustomers. The Company’s results of operations could be adversely affected inthe event that the Company experiences such problems or is otherwise unable toimplement fully its expansion strategy.

 

The Company and certain of its subsidiaries are subject to capitalsurplus requirements by the California Department of Managed Health Care, theCalifornia, Delaware, Georgia, Missouri and Wisconsin Departments of Insurance,various other state Departments of Insurance and the Blue Cross and Blue ShieldAssociation. Although the Company believes that it is currently in compliancein all material respects with all applicable requirements, there can be noassurances that applicable requirements will not be increased in the future.

 

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

 

In June 2000, the California Medical Association filed a lawsuit inU.S. district court in San Francisco against Blue Cross of California (“BCC”).The lawsuit alleges that BCC violated the Racketeer Influenced and CorruptOrganizations Act (“RICO”) through various misrepresentations to andinappropriate actions against health care providers. In late 1999, a number ofclass-action lawsuits were brought against several of the Company’s competitorsalleging, among other things, various misrepresentations regarding their healthplans and breaches of fiduciary obligations to health plan members. In August2000, the Company was added as a party to *Shanev. Humana*, *et al*., aclass-action lawsuit brought on behalf of health care providers nationwide. Inaddition to the RICO claims brought in the California Medical Associationlawsuit, this lawsuit also alleges violations of 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 

 

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11th Circuit held a hearing on September 11, 2003 on the Company’smotion. A mediator has been appointed by Judge Moreno and the parties arecurrently conducting court-ordered mediation.

 

In March 2002, the American Dental Association and three individualdentists filed a lawsuit in U.S. district court in Chicago against the Companyand BCC. This lawsuit alleges that WellPoint and BCC engaged in conduct thatconstituted a breach of contract under ERISA, trade libel and tortiousinterference with contractual relations and existing and prospective businessexpectancies. The lawsuit seeks class-action status. The Company filed a motion(which was granted in July 2002) with the federal Judicial Panel onMultidistrict Litigation requesting that the proceedings in this case beconsolidated with a similar action brought against other managed care companiesthat has been consolidated with the *Shane*lawsuit.

 

InMay 2003, a lawsuit entitled *Thomas, et al.v. Blue Cross and Blue Shield Association*, *et al.*was filed in the U.S. DistrictCourt in the Southern District of Florida. The attorneys representing theplaintiffs in the lawsuit are primarily the attorneys representing theplaintiffs in the *Shane*litigationdescribed above. The defendants in *Thomas*arethe Company, the Blue Cross and Blue Shield Association and all of the othercurrent Blue Cross and Blue Shield licensees. The lawsuit alleges that each ofthe defendants engaged in similar activities and conduct as that alleged in the*Shane*litigation.

 

In July 2001, two individual physicians seeking to represent a class ofphysicians, hospitals and other providers brought suit in the Circuit Court ofMadison County, Illinois against HealthLink, Inc., which is now a subsidiary ofthe Company as a result of the acquisition of RightCHOICE. The physiciansallege that HealthLink breached the contracts with these physicians by engagingin the practices of “bundling” and “down-coding” in its processing and paymentof provider claims. The relief sought includes an injunction against thesepractices and damages in an unspecified amount. This litigation was dismissedwithout prejudice at the request of the plaintiffs in February 2003. A similarlawsuit was brought by physicians (including one of the physicians in the casedescribed above) in the same court in Madison County, Illinois, on behalf of anationwide class of providers who contract with Blue Cross and Blue Shieldplans against the Blue Cross and Blue Shield Association and another Blue CrossBlue Shield plan. The complaint recites that it is brought against thoseentities and their “unnamed subsidiaries, licensees, and affiliates,” listing alarge number of Blue Cross and Blue Shield plans, including “Alliance BlueCross Blue Shield of Missouri.” The plaintiffs also allege that the plans havesystematically engaged in practices known as “short paying,” “bundling” and“down-coding” in their processing and payment of subscriber claims. Blue CrossBlue Shield of Missouri has not been formally named or served as a defendant inthis lawsuit. The Blue Cross and Blue Shield Association was dismissed as adefendant in this lawsuit in August 2002.

 

OnMarch 26, 2003, a lawsuit entitled *Irwin v.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

 

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pharmacybenefit management companies (such as the Company’s subsidiary that doesbusiness under the tradename WellPoint Pharmacy Management) engage in unfairpractices such as negotiating discounts in prices of drugs from pharmacies and negotiating rebatesfrom drug manufacturers and retaining such discounts and rebates for their ownbenefit.  The complaint also allegesthat drugs are included in formularies in exchange for rebates and that thedefendants charge patient co-payments that exceed the actual cost of genericdrugs.

 

In early 2003, a lawsuit entitled *Knechtv. Cigna, et al.*was filed in U.S. District Court in Oregon.  This litigation has subsequently beentransferred to Judge Moreno of the U.S. District Court for the SouthernDistrict of Florida.  This litigation isa putative class action lawsuit on behalf of chiropractors in the westernUnited States.  The Company is a nameddefendant in the lawsuit.  The lawsuitalleges that each of the defendants engaged in similar activities and conductas that alleged in the *Shane*litigation.

 

In October 2003, a lawsuit entitled *Solomon,et al. v. Cigna, et al.*was filed in the U.S. District Court in theSouthern District in Florida.  TheCompany is a named defendant in this lawsuit, although the Company has not yetbeen served.  This lawsuit is also aputative class action brought on behalf of chiropractors, podiatrists andcertain other types of health care practitioners nationwide.  This lawsuit also alleges that thedefendants engaged in similar activities and conduct as that alleged in the *Shane* litigation.

 

The Company’s future results will depend in part on its ability toaccurately predict health care costs and to control future health care coststhrough product and benefit design, underwriting 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, operatein a highly competitive environment that has undergone significant change inrecent years as a result of business consolidations, new strategic alliances,aggressive marketing practices by competitors and other market pressures.Additional increases in competition (including competition from

 

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market entrants offering Internet-based products and services) couldadversely affect the Company’s financial condition, cash flows or results ofoperations.

 

The Company is dependent on the services of independent agents andbrokers in the marketing of its health care plans, particularly with respect toindividuals, seniors and small employer group members. Such independent agentsand brokers are typically not exclusively dedicated to the Company and mayfrequently also market health care plans of the Company’s competitors. TheCompany faces intense competition for the services and allegiance ofindependent agents and brokers.

 

As a result of the Company’s acquisitions, the Company operates on aselect geographic basis nationally and offers a spectrum of health care andspecialty products through various risk-sharing arrangements. The Company’shealth care products include a variety of managed care offerings as well astraditional fee-for-service coverage. With respect to product type,fee-for-service products are generally less profitable than managed careproducts. A component of the Company’s expansion strategy is to transition overtime the traditional insurance members of the Company’s acquired businesses tomore managed care products.

 

With respect to the risk-sharing nature of products, managed careproducts that involve greater potential risk to the Company generally tend tobe more profitable than management services products and those managed careproducts where the Company is able to shift risks to employer groups.Individuals and small employer groups are more likely to purchase the Company’shigher-risk managed care products because such purchasers are generally unableor unwilling to bear greater liability for health care expenditures. Typically,government-sponsored programs involve the Company’s higher-risk managed careproducts. Over the past few years, the Company has experienced a slight declinein margins in its higher-risk managed care products and to a lesser extent onits lower-risk managed care and management services products. This decline isprimarily attributable to product mix change, product design, competitivepressure and greater regulatory restrictions applicable to the small employergroup market. From time to time, the Company has implemented price increases incertain of its managed care businesses. While these price increases are intendedto improve 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 wholly owned subsidiaries operates as a pharmacybenefit manager (“PBM”) under the trade name WellPoint Pharmacy Management. ThePBM industry faces a number of risks and uncertainties in addition to thosefacing the Company’s core health plan business. Such risks and uncertaintiesinclude the application of federal and state anti-remuneration laws (generallyknown as “anti-kickback” laws), whether PBMs operate as fiduciaries under theEmployee Retirement Income Security Act of 1974 (“ERISA”) and are in compliancewith their fiduciary obligations under ERISA in connection with the developmentand implementation of items such as formularies, preferred drug listings and therapeuticintervention programs, and potential liability regarding the use ofpatient-identifiable medical information. In addition, a number of federal andstate legislative proposals are being

 

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considered that could affect a variety of PBM industry practices, suchas 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 the Company’s investment assets are ininterest-yielding debt securities of varying maturities or equity securities.The value of fixed-income securities is highly sensitive to fluctuations inshort- and long-term interest rates, with the value decreasing as such ratesincrease and increasing as such rates decrease. In addition, the value ofequity securities can fluctuate significantly with changes in marketconditions. Changes in the value of the Company’s investment assets, as aresult of interest rate fluctuations, can affect the Company’s results ofoperations and stockholders’ equity. There can be no assurances that interestrate fluctuations will not have a material adverse effect on the results ofoperations or financial condition of the Company.

 

The Company’s operations are dependent on retaining existing employees,attracting additional qualified employees and achieving productivity gains fromthe Company’s investment in technology. The Company faces intense competitionfor qualified information technology personnel and other skilled professionals.There can be no assurances that an inability to retain existing employees orattract additional employees will not have a material adverse effect on theCompany’s results of operations.

 

Prior to the Company’s acquisition of the GBO, John Hancock Mutual LifeInsurance Company (“John Hancock”) entered into a number of reinsurancearrangements with respect to personal accident insurance and the occupationalaccident component of workers’ compensation insurance, a portion of which wasoriginated through a pool managed by Unicover Managers, Inc. Under thesearrangements, John Hancock assumed risks as a reinsurer and transferred certainof such risks to other companies. These arrangements have become the subject ofdisputes, including a number of legal proceedings to which John Hancock is aparty. The Company believes that it has a number of defenses to avoid anyultimate liability with respect to these matters and believes that suchliabilities were not transferred to the Company as part of the GBO acquisition.However, if the Company were to become subject to such liabilities, the Companycould suffer losses that might have a material adverse effect on its financialcondition, results of operations or cash flows.

 

In December 2000, a wholly owned subsidiary of the Company completedits acquisition of certain mail order pharmaceutical service assets and nowconducts business as a mail order pharmacy. The pharmacy business is subject toextensive federal, state and local regulations which are in many instancesdifferent from those under which the Company’s core health plan businesscurrently operates. The failure to properly adhere to these and otherapplicable regulations could result in the imposition of civil and criminalpenalties, which could adversely affect the Company’s results of operations orfinancial condition. In addition,

 

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pharmacies are exposed to risks inherent in the packaging anddistribution of pharmaceuticals and other health care products. Although theCompany maintains professional liability and errors and omissions liabilityinsurance, there can be no assurances that the coverage limits under suchinsurance programs will be adequate to protect against future claims or that theCompany will be able to maintain insurance on acceptable terms in the future.

 

Following the terrorist attacks of September 11, 2001, there have beenvarious incidents of suspected bioterrorist activity in the United States. Todate, these incidents have resulted in related isolated incidents of illnessand death. However, federal and state law enforcement officials have issuedpublic warnings about additional potential terrorist activity involvingbiological and other weapons. If the United States were to experience morewidespread bioterrorist or other attacks, the Company’s covered medicalexpenses could rise and the Company could experience a material adverse effecton its results of operations, financial condition and cash flow.

 

In April and May 2002, one of the Company’s wholly owned subsidiariesacting as a pharmacy benefit management business under the trade name WellPointPharmacy Management received two administrative subpoenas duces tecum issued bythe U.S. Attorney’s Office in Boston Massachusetts. The Company does notbelieve that its pharmacy benefit management business is presently a target ofinvestigation by the U.S. Attorney. The subpoenas appear to focus primarily onWellPoint Pharmacy Management’s relationship with TAP Pharmaceuticals,including TAP’s drugs Lupron and Prevacid. The Company has responded to thesubpoenas by producing certain requested documents. The Company believes thatit is in compliance in all material respects with all laws and regulationsapplicable to the pharmacy benefit management business.

 

As a result of the general nationwide economic downturn, many statesare currently experiencing budget deficits. State legislators are exploring avariety of alternatives to address this situation. In order to address the budgetshortfalls, various states may propose reductions in payments received byMedicaid managed care providers such as the Company. Alternatively, statelegislators may seek to impose greater state taxes. Any significant reductionin payments received by the Company in connection with its Medicaid managedcare business could have a material adverse effect on the Company’s results ofoperations or financial condition. Additionally, any increase in state taxescould prolong or exacerbate the current economic downturn, which could in turnhave a material adverse effect on the Company’s results of operations orfinancial condition. Budget cutbacks could also result in reduced employmentlevels in public sector accounts for which the Company provides insured or administrativeservices products.

 

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***Review byIndependent Accountants***

 

With respect to the unaudited consolidated financial information ofWellPoint Health Networks Inc. for the three-month and nine-month periods endedSeptember 30, 2003 and 2002, PricewaterhouseCoopers LLP(“PricewaterhouseCoopers”) reported that they have applied limited proceduresin accordance with professional standards for a review of such information.  However, their separate report dated October26, 2003 appearing herein states that they did not audit and they do notexpress an opinion on that unaudited consolidated financial information.  Accordingly, the degree of reliance on theirreport on such information should be restricted in light of the limited natureof the review procedures applied. PricewaterhouseCoopers is not subject to the liability provisions ofSection 11 of the Securities Act of 1933 for their report on the unauditedconsolidated financial information because that report is not a “report” or a“part” of the registration statement prepared or certified byPricewaterhouseCoopers within the meaning of Sections 7 and 11 of the Act.

 

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ITEM 3.                             Quantitativeand Qualitative Disclosures About Market Risk

 

The Company regularly evaluates its asset and liability interest raterisks, as well as the appropriateness of investments, relative to its internalinvestment guidelines. The Company operates within these guidelines by maintaininga well-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.

 

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

 

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

 

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

 

*Interest Rate Risk*

 

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

 

As of September 30, 2003, the Company’s current investment securities(including securities on loan pursuant to securities lending transactions) atfair value, totaled $6.6 billion, of which 88.9% was invested in fixed-incomesecurities and the remaining 11.1% was invested in equity securities. TheCompany has evaluated the net impact to the fair value of its fixed-incomeinvestments from a hypothetical change in all interest rates of 100, 200 and300 basis points (“bp”). In doing so, optionality was addressed through MonteCarlo simulation of the price behavior of securities with embedded options. Inaddressing prepayments on mortgage-backed securities, the model follows thenormal market practice of estimating a non-interest rate sensitive component(primarily related to relocations) and an interest-sensitive component(primarily related to refinancings) separately. The model is based onstatistical techniques applied to historical prepayment and market data, andthen incorporates forward-looking mortgage market research and judgments aboutfuture prepayment behavior. Changes in the fair value of the investmentportfolio, net of tax, are reflected in the balance sheet through stockholders’equity. The results of this analysis as of September 30, 2003 are shown in thetable below. The table also shows the change in valuation of the $200.0 millionnotional amount 6 3/8*%*fixed for LIBOR-based floating interest rate swap agreement as of September 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                    |   | $                                                                | (174.4 | ) | $ | (353.3 | ) | $ | (530.5 | ) |
| Valuation  of Interest Rate Swap Agreement |   | (4.9                                                             | )      | (9.7 | ) | (14.3 | ) |
|                                       |   | $                                                                | (179.3 | ) | $ | (363.0 | ) | $ | (544.8 | ) |

 

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

 

*Interest Rate Swap Agreements*

 

On January 15, 2002, the Company entered into a $200.0 million notionalamount interest rate swap agreement with respect to its 2006 Notes. The swapagreement is a contract to exchange a fixed 6 3/8*%* rate for a LIBOR-based floating rate.For the nine months ended September 30, 2003 and 2002, the Company recognizedsettlement income of $6.0 million and $4.5 million from this swap agreement.(See Note 7 to the Consolidated Financial Statements.)

 

The Company has from time to time entered into additional interest rateswap agreements in order to reduce the volatility of interest expense resultingfrom changes in interest rates. As of December 31, 2001, the Company hadentered into $200.0 million of floating to fixed-rate swap agreements, whichconsisted of a $150.0 million notional amount swap agreement at 6.99% and a$50.0 million notional amount swap agreement at 7.06%. As of December 31, 2001,the Company also had $235.0 million of LIBOR-based floating rate debtoutstanding. In September 2002, the Company terminated these two fixed-rateswap agreements with an aggregate cash settlement of $17.6 million, of which$1.8 million was accrued interest and the remaining $15.8 million representedthe fair value of the swap agreements at the time of termination and is beingamortized over the term of the original swap agreements. As of September 30,2003, the remaining balance of the swap agreements was $6.5 million. (See Note7 to the Consolidated Financial Statements for further discussion.)

 

*Equity Price Risk*

 

As of September 30, 2003, the Company’s equity securities werecomprised primarily of domestic stocks. Assuming an immediate decrease of 10%in market value, as of September 30, 2003, the hypothetical pre-tax loss infair value of stockholders’ equity is estimated to be approximately $73.7million.

 

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ITEM 4.                             Controlsand Procedures

 

The Company maintains “disclosure controls and procedures,” as suchterm is defined under Rule 13a-14(c) of the rules and regulations under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”).  These disclosure controls and procedures aredesigned to ensure that information required to be disclosed in the Company’sExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the rules and forms of the Securities and ExchangeCommission (the “SEC”), and that such information is accumulated andcommunicated to the Company’s management, including its Chief Executive Officerand Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosures.  As ofSeptember 30, 2003, the Company has carried out an evaluation under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness 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 has been no change in the Company’s internal control overfinancial reporting during the period covered by this quarterly report on Form10-Q that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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PART II.  OTHER INFORMATION

 

ITEM 1.                             LegalProceedings

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors.  The lawsuit, whichis entitled *Abramsv. WellPoint Health Networks Inc., et al*., alleges that theCompany’s directors breached their fiduciary duties to stockholders byapproving an Agreement and Plan of Merger with Anthem, Inc. while in possessionof non-public information regarding the Company’s financial results for thethird quarter of 2003.  The lawsuitseeks to enjoin the Company from consummating the merger with Anthem, Inc.,unless the Company adopts and implements a process for obtaining the highest possibleprice for stockholders, and to rescind any terms of the Agreement and Plan ofMerger that have already been implemented.

 

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 6.                             Exhibitsand Reports on Form 8-K

 

(a)           Exhibits

 

See Exhibit Index.

 

(b)          Reports on Form 8-K

 

On July 22, 2003, the Company furnished a current report on Form 8-Kdated July 22, 2003, which attached a copy of the Company’s press release datedJuly 22, 2003 regarding the Company’s earnings for the quarter ended June 30,2003.

 

On August 1, 2003, the Company furnished a current report on Form 8-Kdated July 29, 2003, which attached the text of certain information providedand to be provided by the Company during various investor conferences.

 

On August 11, 2003, the Company furnished a current report on Form 8-Kdated August 11, 2003 disclosing reclassified medical membership data of theCompany as of March 31, 2002, June 30, 2002, September 30, 2002, December 31,2002, March 31, 2003 and June 30, 2003.

 

On September 8, 2003, the Company furnished a current report on Form8-K dated September 8, 2003, which attached the text of certain informationprovided and to be provided by the Company during various investor conferences.

 

74

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The information furnished pursuant to the current reports on Form 8-Kdescribed above was intended to be furnished under Item 12 of the Form 8-K andis not to be considered “filed” under the Securities Exchange Act of 1934, asamended, nor shall it be incorporated by reference into this filing or futurefilings by the Company under the Securities Act of 1933, as amended or underthe Securities Exchange Act of 1934, as amended, unless the Company expresslysets forth in such future filing that such information is to be considered“filed” or incorporated by reference therein.

 

75

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**SIGNATURES**

 

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

 
|                    |   |                                                            |
|-------------------------|--------|-----------------------------------------------------------------|
|                    |   | **WELLPOINT HEALTH  NETWORKS INC.**                             |
|                    |   | Registrant                                                      |
|                    |   |                                                            |
|                    |   |                                                            |
| Date: November 14, 2003 |   | By:                                                        | /s/ LEONARD D. SCHAEFFER |   |
|                    |   | Leonard D. Schaeffer                                            |
|                    |   | Chairman of the Board of Directors  and Chief Executive Officer |
|                    |   |                                                            |
|                    |   |                                                            |
| Date: November 14, 2003 |   | By:                                                        | /s/ DAVID C. COLBY |   |
|                    |   | David C. Colby                                                  |
|                    |   | Executive Vice President  and Chief Financial Officer           |
|                    |   |                                                            |
|                    |   |                                                            |
| Date: November 14, 2003 |   | By:                                                        |  /s/ KENNETH C. ZUREK |   |
|                    |   | Kenneth C. Zurek                                                |
|                    |   | Senior Vice President, Controller  and Taxation                 |
|                         |        |                                                                 |  |  |  |  |

# * *

76

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# ***EXHIBIT INDEX***

 
| **Exhibit  Number** |   | **Exhibit**                                                                                                                                                                                                                                                                                                                                      |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.01                |   | Amended and Restated  Recapitalization Agreement dated as of March 31, 1995 by and among the  Registrant, Blue Cross of California, Western Health Partnerships and Western  Foundation for Health Improvement, incorporated by reference to Exhibit 2.1  to the Registrant’s Registration Statement on Form S-4 dated April 8,  1996. |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 2.02                |   | 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).                                                     |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 2.04                |   | Agreement and Plan of  Merger dated as of October 26, 2003 among Anthem, Inc., Anthem Holding Corp.  and the Registrant, incorporated by reference to Exhibit 2.1 to the  Registrant’s Current Report on Form 8-K dated October 27, 2003 (File No.  001-13083).                                                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 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.                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.01               |   | Cobalt Corporation Equity  Incentive Plan, incorporated by reference to Exhibit 10.7 of Cobalt  Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2002.                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.02               |   | Blue Cross Controlled  Affiliate License Agreement dated September 24, 2003 by and among the Blue  Cross and Blue Shield Association (the “BCBSA”), Blue Cross & Blue Shield                                                                                                                                                       |

 

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|   |   | United of Wisconsin and  the Registrant.                                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                       |
| 10.03  |   | Blue Shield Controlled Affiliate  License Agreement dated September 24, 2003 by and among the BCBSA, Blue Cross  & Blue Shield United of Wisconsin and the Registrant. |
|   |   |                                                                                                                                                                       |
| 10.04  |   | Blue Cross Controlled  Affiliate License Agreement dated September 24, 2003 by and among the BCBSA,  United Government Services, LLC and the Registrant.                   |
|   |   |                                                                                                                                                                       |
| 10.05  |   | Blue Shield Controlled  Affiliate License Agreement dated September 24, 2003 by and among the BCBSA,  United Government Services, LLC and the Registrant.                  |
|   |   |                                                                                                                                                                       |
| 10.06  |   | Blue Cross Controlled  Affiliate License Agreement dated September 24, 2003 by and among the BCBSA,  Compcare Health Services Insurance Corporation and the Registrant.    |
|   |   |                                                                                                                                                                       |
| 10.07  |   | Blue Shield Controlled  Affiliate License Agreement dated September 24, 2003 by and among the BCBSA,  Compcare Health Services Insurance Corporation and the Registrant.   |
|   |   |                                                                                                                                                                       |
| 10.08  |   | Blue Cross Controlled  Affiliate License Agreement dated October 6, 2003 by and among the BCBSA,  Claim Management Services, Inc. and the Registrant.                      |
|   |   |                                                                                                                                                                       |
| 10.09  |   | Blue Shield Controlled  Affiliate License Agreement dated October 6, 2003 by and among the BCBSA,  Claim Management Services, Inc. and the Registrant.                     |
|   |   |                                                                                                                                                                       |
| 10.10  |   | WellPoint 401(k)  Retirement Savings Plan Generally Effective January 1, 2002 (As Amended  through March 1, 2002) executed on October 10, 2003.                            |
|   |   |                                                                                                                                                                       |
| 10.11  |   | Distribution Option  Amendment to the WellPoint 401(k) Retirement Savings Plan dated July 24,  2003.                                                                       |
|   |   |                                                                                                                                                                       |
| 10.12  |   | Amendment to the WellPoint  401(k) Retirement Savings Plan dated October 10, 2003.                                                                                         |
|   |   |                                                                                                                                                                       |
| 10.13  |   | WellPoint Health Networks  Inc. Officer Change-in-Control Plan (As amended and restated through December  4, 2001) (as revised in October 2003).                           |
|   |   |                                                                                                                                                                       |
| 10.14  |   | WellPoint Health Networks  Inc. Supplemental Executive Retirement Plan (As restated effective November  4, 2001) (As amended October 24, 2003).                            |
|   |   |                                                                                                                                                                       |
| 10.15  |   | Amendment to the WellPoint  401(k) Retirement Savings Plan (As Amended Through October 10, 2003) dated  November 13, 2003.                                                 |
|   |   |                                                                                                                                                                       |
| 10.16  |   | Description of HTH Manager  Long-Term Incentive Plan for D. Mark Weinberg dated September 2003.                                                                            |
|   |   |                                                                                                                                                                       |
| 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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