10-K

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

(Mark One)
ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                                      TO                                     

COMMISSION FILE NUMBER: 1-12718

HEALTH NET, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE (State or Other Jurisdiction of Incorporation or Organization)	95-4288333 (I.R.S. Employer Identification No.)
21650 OXNARD STREET, WOODLAND HILLS, CA (Address of Principal Executive Offices)	91367 (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 676-6000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

TITLE OF EACH CLASS	NAME OF EACH EXCHANGE ON WHICH REGISTERED
Class A Common Stock, $.001 par value	New York Stock Exchange, Inc.
Rights to Purchase Series A Junior Participating Preferred Stock	New York Stock Exchange, Inc.

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

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

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

        The aggregate market value of the voting stock held by non-affiliates of the registrant at June 28, 2002 was $3,358,623,763 (which represents 125,462,225 shares of Class A Common Stock held by such non-affiliates multiplied by $26.77, the closing sales price of such stock on the New York Stock Exchange on June 28, 2002).

        The number of shares outstanding of the registrant's Class A Common Stock as of March 20, 2003 was 117,721,273 (excluding 13,218,474 shares held as treasury stock).

DOCUMENTS INCORPORATED BY REFERENCE

        Part II of this Form 10-K incorporates by reference certain information from the registrant's Annual Report to Stockholders for the year ended December 31, 2002 ("Annual Report to Stockholders"). Part III of this Form 10-K incorporates by reference certain information from the registrant's definitive proxy statement for the 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 2002.

HEALTH NET, INC.
INDEX TO FORM 10-K

		Page
PART I.
Item 1—Business		1
Health Plan Services Segment		2
	Managed Health Care Operations	2
	Medicare Products	5
	Medicaid Products	5
	Administrative Services Only Business	5
	Indemnity Insurance Products	6
	Pharmacy Benefit Management	6
	Other Specialty Services and Products	6
Government Contracts Segment		7
	TRICARE	7
	TRICARE for Life	8
	Veterans Affairs	9
Other Business		9
	Workers Compensation Administrative Services	9
Provider Relationships and Responsibilities		9
Additional Information Concerning Our Business		11
Service Marks		14
Employees		14
Other Information/Recent and Other Developments		15
Approval of Non-Audit Services		24
Cautionary Statements		24
Item 2—Properties		32
Item 3—Legal Proceedings		32
Item 4—Submission of Matters to a Vote of Security Holders		39
PART II.
Item 5—Market For Registrant's Common Equity and Related Stockholder Matters		40
Item 6—Selected Financial Data		41
Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations		41
Item 7A—Quantitative and Qualitative Disclosures About Market Risk		41
Item 8—Financial Statements and Supplementary Data		41
Item 9—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		41

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PART III.
Item 10—Directors and Executive Officers of the Registrant	41
Item 11—Executive Compensation	41
Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	42
Item 13—Certain Relationship and Related Transactions	44
Item 14—Controls and Procedures	44
PART IV.
Item 15—Exhibits, Financial Statement Schedules, and Reports on Form 8-K	44
Independent Auditors' Report on Schedules	52
Supplemental Schedules	53
Signatures	58
Certifications	60

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PART I

Item 1. Business.

        Health Net, Inc. (together with its subsidiaries, referred to hereinafter as the "Company", "we", "us" or "our") is an integrated managed care organization which administers the delivery of managed health care services. Our health plans and government contracts subsidiaries provide health benefits through our health maintenance organizations ("HMOs"), insured preferred provider organizations ("PPOs") and point-of-service ("POS") plans to approximately 5.4 million individuals in 15 states through group, individual, Medicare, Medicaid and TRICARE programs. Our subsidiaries also offer managed health care products related to behavioral health, dental, vision and prescription drugs. We also, offer managed health care product coordination for workers' compensation insurance program through our employer services group subsidiary. We operate and conduct our HMO and other businesses through our subsidiaries.

        We currently operate within two reportable segments, Health Plan Services and Government Contracts.

        Our current Health Plan Services segment includes the operations of our health plans in Arizona, California, Oregon, Connecticut, New Jersey, New York and Pennsylvania, the operations of our health and life insurance companies which are licensed to sell PPO, POS and indemnity products, as well as auxiliary non-health products such as life and accidental death and disability insurance in 35 states and the District of Columbia, and supplemental or "specialty" programs and services through our behavioral health, dental, vision and pharmaceutical services subsidiaries. We provide these supplemental or "specialty" programs and services to enrollees in our HMOs, as well as to members whose basic medical coverage is provided by non-Health Net companies. These supplemental programs consist of both operations in which we assume underwriting risk in return for premium revenue, and operations in which we provide administrative services only, including certain of the behavioral health programs.

        With approximately 4.0 million at-risk and administrative services only ("ASO") members in our Health Plan Services segment, we are one of the largest managed health care companies in the United States. Our HMOs market traditional HMO products to employer groups and Medicare and Medicaid products directly to individuals. Health care services that are provided to our commercial and individual members include primary and specialty physician care, hospital care, laboratory and radiology services, prescription drugs, dental and vision care, skilled nursing care, physical therapy and behavioral health services. Our HMO service networks include approximately 73,926 primary care physicians and 164,306 specialists.

        Our Government Contracts reportable segment includes government-sponsored managed care plans through the TRICARE programs and other government contracts. The Government Contracts reportable segment administers large, multi-year managed health care government contracts. Certain components of these contracts, including administration and assumption of health care risk, are subcontracted to affiliated and unrelated third parties. The Company administers health care programs covering approximately 1.5 million eligible individuals under TRICARE. The Company has three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Washington and parts of Arizona, Idaho, Louisiana and Texas.

        Prior to 2002, we operated within the following two slightly different segments: Health Plan Services and Government Contracts/Specialty Services. The prior Health Plan Services segment operated through its health plans in the following states: Arizona, California, Connecticut, New Jersey, New York, Oregon and Pennsylvania. During 2000 and most of 2001, the Health Plan Services segment consisted of two regional divisions: Western Division (Arizona, California and Oregon) and Eastern Division (Connecticut, Florida, New Jersey, New York and Pennsylvania). During the fourth quarter of

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2001, we decided that we would no longer view our health plan operations through these two regional divisions. The prior Government Contracts/Specialty Services reportable segment included government-sponsored managed care plans through the TRICARE programs, behavioral health, dental and vision, and managed health care products related to bill review, administration and cost containment for hospitals, health plans and other entities.

        The Company was incorporated in 1990. Our current operations are the result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the FHS Combination, FH Acquisition Corp., a wholly-owned subsidiary of HSI, merged with and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed its name to Foundation Health Systems, Inc. In November 2000, we changed our name from Foundation Health Systems, Inc. to Health Net, Inc.

        Prior to the FHS Combination, the Company was the successor to the business conducted by Health Net of California, Inc., now our HMO subsidiary in California, which became a subsidiary of the Company in 1992, and HMO and PPO networks operated by QualMed, Inc. ("QualMed"), which combined with the Company in 1994 to create HSI. FHC was incorporated in Delaware in 1984.

        Our executive offices are located at 21650 Oxnard Street, Woodland Hills, CA 91367, and our Internet web site address is "www.health.net." We make available free of charge on or through our Internet web site all of our reports on Forms 10-K, 10-Q and 8-K and all amendments thereto as soon as reasonably practicable after electronic filing with the SEC. We also provide electronic or paper copies free of charge upon request. Except as the context otherwise requires, the terms "Company, we, us" and "our" refer to Health Net, Inc. and its subsidiaries.

HEALTH PLAN SERVICES SEGMENT

MANAGED HEALTH CARE OPERATIONS.

        We offer a full spectrum of managed health care products. The Company's strategy is to offer to employers a wide range of managed health care products and services that provide quality care, encourage wellness and assist in containing health care costs. While a majority of our members are covered by conventional HMO products, we are continuing to expand our other product lines, thereby enabling us to offer flexibility to an employer and to tailor our products to an employer's particular needs.

        Our health plan subsidiaries offer members a comprehensive range of health care services, including ambulatory and outpatient physician care, hospital care, pharmacy services, eye care, behavioral health and ancillary diagnostic and therapeutic services. The integrated health care programs offered by our subsidiaries include products offered through both traditional Network Model HMOs (in which the HMOs contract with individual physicians, physician groups and independent or individual practice associations ("IPAs")) and IPA Model HMOs (in which the HMOs contract with one or more IPAs that, in turn, subcontract with individual physicians to provide HMO patient services). Our health plan subsidiaries offer quality care, cost containment and comprehensive coverage; a matrix package which allows employees to select their desired coverage from alternatives that have interchangeable outpatient and inpatient copayment levels; POS programs which offer a multi-tier design that provides both conventional HMO and indemnity-like (in-network and out-of-network) tiers; a PPO-like tier which allows members to self-refer to the network physician of their choice; and a managed indemnity plan which is provided for employees who reside outside of their HMO service areas.

        The pricing of our products is designed to provide incentives to both employers and employees to select and enroll in the products with greater managed health care and cost containment elements. In general, our HMO subsidiaries provide comprehensive health care coverage for a fixed fee or premium

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that does not vary with the extent or frequency of medical services actually received by the member. PPO enrollees choose their medical care from among the various contracting providers or choose a non-contracting provider and are reimbursed on a traditional indemnity plan basis after reaching an annual deductible. POS enrollees choose, each time they receive care, from conventional HMO or indemnity-like (in-network and out-of-network) coverage, with payments and/or reimbursement depending on the coverage chosen. We assume both underwriting and administrative expense risk in return for the premium revenue we receive from our HMO, POS and PPO products. Our subsidiaries have contractual relationships with health care providers for the delivery of health care to our enrollees.

        The following table contains information relating to our HMO and PPO members, POS members, Medicare members and Medicaid members as of December 31, 2002 (our Medicare and Medicaid businesses are discussed below under "Medicare" and "Medicaid Products"):

Commercial HMO and PPO Members	1,931,943	(a)
POS Members	915,300	(b)
Medicare Members (risk only)	176,160
Medicaid Members	874,154

(a)

Includes 37,202 members under our arrangement with The Guardian described elsewhere in this Annual Report.

(b)

Includes 269,594 members under our arrangement with The Guardian described elsewhere in this Annual Report and 285,860 POS members insured by our indemnity insurance operations described below.

        In addition, the following table sets forth certain information regarding our employer groups in the commercial managed care operations of our Health Plan Services segment as of December 31, 2002:

Number of Employer Groups	70,475
Largest Employer Group as % of enrollment	4.5	%
10 largest Employer Groups as % of enrollment	15.4	%

        During 2002, our Health Plan Services segment had health plan operations in Arizona, California, Oregon, Connecticut, New Jersey, New York and Pennsylvania.

        In Arizona, we believe that our commercial managed care operations rank us sixth largest as measured by total membership and fifth largest as measured by size of provider network. Our commercial membership in Arizona was 118,565 as of December 31, 2002, which represented a decrease of approximately 29% during 2002. This decrease is primarily due to planned membership losses in the large group market. Our Medicare membership in Arizona was 38,857 as of December 31, 2002, which represented a decrease of approximately 22% during 2002. We did not have any Medicaid members in Arizona as of December 31, 2002 and 2001.

        The California market is characterized by a concentrated population. We believe that Health Net of California, Inc., our California HMO, is the third largest HMO in California in terms of membership and second largest in terms of size of provider network. Our commercial membership in California as of December 31, 2002 was 1,758,081, which represented a decrease of approximately 4% during 2002. The decrease in commercial membership was primarily due to enrollment decreases within the large group market. Our commercial membership in the small group market in California was 377,525 as of December 31, 2002, which represented an increase of approximately 30% during 2002. Our Medicare membership in California as of December 31, 2002 was 101,884, which represented a decrease of

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approximately 15% during 2002. Our Medicaid membership in California as of December 31, 2002 was 721,270 members, which represented an increase of approximately 11% during 2002.

        We believe that our Oregon operations make us the seventh largest managed care provider in Oregon in terms of membership and the fifth largest HMO in Oregon in terms of size of provider network. Our commercial membership in Oregon was 79,417 as of December 31, 2002, which represented an increase of approximately 5% during 2002. We did not have any members in Medicare or Medicaid in Oregon as of December 31, 2002 and 2001.

        In Connecticut, New Jersey and New York, we market mid-size and large employer group commercial HMO, Medicare and Medicaid products directly. However, for small employer group business in Connecticut, New Jersey and New York, we offer both HMO and POS products through a marketing agreement with The Guardian Life Insurance Company of America ("The Guardian") in which we are doing business as "Healthcare Solutions." Under the agreement, we generally share the profits of Healthcare Solutions equally with The Guardian, subject to certain terms of the marketing agreement related to expenses. The Guardian is a mutual insurer (owned by its policy owners) which offers financial products and services, including individual life and disability income insurance, employee benefits, pensions and 401(k) products. The Guardian is headquartered in New York and has almost 2,400 financial representatives in over 100 general agencies.

        We believe our Connecticut operations make us the second largest managed care provider in terms of membership and the largest in terms of size of provider network in Connecticut. Our commercial membership in Connecticut was 304,456 as of December 31, 2002 (including 55,698 members under the Guardian arrangement), a decrease of approximately 8% since the end of 2001. Our Medicare membership in Connecticut was 28,836 as of December 31, 2002, which represented a decrease of approximately 13% during 2002, and our Medicaid membership in Connecticut was 104,641 as of December 31, 2002, which represented an increase of approximately 14% during 2002.

        We believe our New Jersey operations make us the third largest managed care provider in terms of membership and the largest in terms of size of provider network in New Jersey. Our HMO membership in New Jersey was 299,762 as of December 31, 2002 (including 139,520 members under the Guardian arrangement), which represented an increase of approximately 10% during 2002. Our Medicaid membership in New Jersey was 48,243 as of December 31, 2002, which represented an increase of approximately 9% during 2002. We had no Medicare members in New Jersey as of December 31, 2001 and 2000.

        In New York, we had 248,695 commercial members as of December 31, 2002, which represented a decrease of approximately 5% during 2002. Such membership included 111,578 members under The Guardian arrangement. We believe our New York HMO and PPO operations make us the tenth largest HMO managed care provider in terms of membership and the third largest in terms of size of provider network in New York. Our Medicare membership in New York was 6,583 as of December 31, 2002, which represented an increase of 11% during 2002. We did not have any Medicaid members in New York as of December 31, 2002 and 2001.

        Our commercial membership in eastern Pennsylvania was 38,233 as of December 31, 2002, which represented a decrease of approximately 2% during 2001. We no longer had any Medicare membership in eastern Pennsylvania as of December 31, 2002, while we had 7,561 members as of December 31, 2001. We did not have any Medicaid members in eastern Pennsylvania as of December 31, 2002 and 2001.

        During 2001, we completed our withdrawal from the Ohio, West Virginia and western Pennsylvania markets and no longer have any members in those markets. We notified and received approval from the applicable regulators to withdraw from these markets. We also provided notice of the withdrawals to members, employer groups, providers and brokers in compliance with applicable federal and state

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laws and regulations. We ceased having active membership in West Virginia as of December 31, 2000; in Western Pennsylvania for Medicare + Choice members as of December 31, 2000, and January 31, 2001, for commercial members; and in Ohio as of February 4, 2001.

        We sold our Florida health plan operations effective August 1, 2001. At the time of the sale, our commercial membership in Florida was 98,969, our Medicare membership in Florida was 42,831 and our Medicaid membership in Florida was 24,180. See "Divestitures and Other Investments" below for additional information on the sale of our Florida health plan.

MEDICARE PRODUCTS.

        Our Medicare+Choice plans had a combined membership of approximately 176,160 as of December 31, 2002, compared to 215,813 as of December 31, 2001. We offer our Medicare+ Choice products directly to individuals and to employer groups. To enroll in one of our Medicare+Choice plans, covered persons must be eligible for Medicare. We provide or arrange health care services normally covered by Medicare, in conjunction with a broad range of preventive health care services. The federal Centers for Medicare &Medicaid Services ("CMS") (formerly the Health Care Financing Administration ("HCFA")) pays us a monthly amount for each enrolled member based, in part, upon the "Adjusted Average Per Capita Cost," as determined by CMS' analysis of fee-for-service costs related to beneficiary demographics and other factors. Depending on plan design, we may charge a monthly premium. We also provide Medicare supplemental coverage to about 42,243 members through either individual Medicare supplement policies or employer group sponsored coverage.

        Our California Medicare+Choice product, Seniority Plus, operated by our California health plan, was licensed and certified to operate in 15 California counties as of December 31, 2002. Our other health plan subsidiaries are licensed and certified to offer Medicare+Choice plans in one county in Pennsylvania, three counties in Connecticut, four counties in Arizona and four counties in New York. We withdrew from providing Medicare products in certain markets in 2002 due, in part, to the fact that government Medicare payments in those areas had been increasing at a much lower level than costs of care. We launched a Medicare preferred provider organization product ("PPO") in 2002 under a CMS demonstration product in seven counties in Arizona, 13 counties in Oregon and one county in Washington. Membership in the PPO will be effective January 1, 2003.

MEDICAID PRODUCTS.

        As of December 31, 2002, we had an aggregate of approximately 874,154 Medicaid members compared to 787,584 as of December 31, 2001, principally in California. We also had Medicaid members and operations in Connecticut and New Jersey. To enroll in our Medicaid products, an individual must be eligible for Medicaid benefits under the appropriate state regulatory requirements. Our HMO products include, in addition to standard Medicaid coverage, certain additional services including dental and vision benefits. The applicable state agency pays our HMOs a monthly fee based on a percentage of fee-for-service costs for each Medicaid member enrolled.

ADMINISTRATIVE SERVICES ONLY ("ASO") BUSINESS.

        We also provide third-party administrative services to large employer groups in California, Connecticut, New Jersey and New York. Under these arrangements, we provide claims processing, customer service, medical management and other administrative services without assuming the risk for medical costs. We are generally compensated for these services on a fixed per member per month basis. As of December 31, 2002, we serviced 71,517 members through our ASO business.

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INDEMNITY INSURANCE PRODUCTS.

        We offer insured PPO, POS and indemnity products as "stand-alone" products and as part of multiple option products in various markets. These products are offered by our health and life insurance subsidiaries which are licensed to sell insurance in 35 states and the District of Columbia. Through these subsidiaries, we also offer HMO members auxiliary non-health products such as group life and accidental death and disability insurance.

        Our health and life insurance products are provided throughout most of our service areas. The following table contains membership information relating to our health and life insurance companies' insured PPO, POS, indemnity and group life products as of December 31, 2002:

Insured PPO Members	197,612
POS Members	285,860	(a)
Indemnity Members	6,240
Group Life Members	36,425

(a)

Includes 269,594 members under our arrangement with The Guardian described elsewhere in this Annual Report. (Please note that there were 37,202 Guardian HMO members in addition to the POS members included in the above table.)

PHARMACY BENEFIT MANAGEMENT.

        Pharmacy benefits are managed through a variety of clinical, technological and contractual tools. We seek to provide safe, effective medications that are affordable to our members. We outsource certain capital and labor intensive functions of pharmacy benefit management, such as claim processing. However, we continue to actively utilize all other pharmacy management tools available. Some of the tools used are as follows:

•

Pharmacy benefit design—we have designed and sell three-tier pharmacy products that allow consumer choice while encouraging member financial participation.



•

Clinical programs that improve safety, efficacy and member compliance with prescribed medical treatment.



•

Retail and manufacturer contracts that lower the net cost.



•

Technological tools that automate claim adjudication and payment.



•

Technology that plays a key role in preventing members from receiving drugs that may harmfully interact with other medications they are taking.

OTHER SPECIALTY SERVICES AND PRODUCTS.

        We offer behavioral health, dental and vision products and services as well as managed care products related to cost containment for hospitals, health plans and other entities as part of our Health Plan Services segment.

        Dental and Vision.    We acquired DentiCare of California, Inc. in 1991 and changed the Company's name to Health Net Dental, Inc. ("HND") in 2002. HND provides dental care services under HMO arrangements in California and Hawaii and performs dental administration services for an affiliate company in California. As of December 31, 2002, HND had approximately 415,300 members, of which 64,100 members were beneficiaries under the Medicaid dental programs. HND also participates in the Healthy Families program, under which it serves approximately 102,900 members. HND also provides administrative services to Health Net Life, Inc. ("HNL") for its PPO and Indemnity dental product lines. These products covered 44,300 lives as of December 31, 2002.

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        We provide at-risk vision care services and administrative services under various programs through our wholly owned subsidiary Health Net Vision, Inc. (which changed its name from Foundation Health Vision Services, Inc. d.b.a. AVP Vision Plans in 2002) ("HNV"). HNV operates in California and Arizona and shares a common administrative and information systems platform with HND.. The total number of lives covered under these services were approximately 495,000 members as of December 31, 2002. Of those covered lives, 421,000 members are enrolled in full-risk products and 74,000 lives were covered under administrative services contracts. HNV also provides administrative services to HNL for its PPO and Indemnity vision product lines. These products were launched in 2002 and covered approximately 32,500 lives as of December 31, 2002.

        Both HND and HNV are licensed in California under the Knox-Keene Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"), as Specialized Health Care Service Plans, and compete with other HMOs, traditional insurance companies, self-funded plans, PPOs and discounted fee-for-service plans. The two companies share a common strategy to maximize the value and quality of managed dental and vision care services while appropriately balancing financial risk assumption among providers, members, and other entities to achieve the effective and efficient use of available resources.

        Behavioral Health.    We provide behavioral health services through a subsidiary, Managed Health Network, Inc., and subsidiaries of Managed Health Network, Inc. (collectively "MHN"). MHN holds a license in California under the Knox-Keene Act as a Specialized Health Care Service Plan. MHN offers behavioral health, substance abuse and employee assistance programs ("EAPs") on an insured and self-funded basis to employers, governmental entities and other payers in various states.

        Employers participating in MHN's programs range in size from Fortune 100 companies to mid-sized companies with under 100 employees. MHN's strategy is to extend its market share in the Fortune 500 and health plan markets, through a combination of direct, consultant/broker and affiliate sales. MHN intends to achieve additional market share by broadening its employer products, including using the Internet as a distribution channel and by continuing carve-out product sales, funded on either a risk or ASO basis.

        MHN's products and services were being provided to over 8.0 million individuals as of December 31, 2002, with approximately 2.7 million individuals under risk-based programs, approximately 2.3 million individuals under self-funded programs and approximately 3.0 million individuals under EAP.

        MHN is serving approximately 737 employer groups on a stand-alone basis plus approximately 3,386 groups through other affiliates of ours, primarily in California and the Northeast.

        Headquartered in San Rafael, California, MHN has nationwide operations with full-service clinical intake offices in New York, Dallas, Milwaukee, Las Vegas and Huntington Beach, California.

GOVERNMENT CONTRACTS SEGMENT

        Our Government Contracts reportable segment includes government-sponsored managed care plans through the TRICARE programs and other government contracts.

TRICARE.

        Our wholly-owned subsidiary, Health Net Federal Services, Inc. ("Federal Services") (formerly known as Foundation Health Federal Services, Inc.), administers large, multi-year managed care federal contracts with the United States Department of Defense ("DoD").

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        Federal Services currently administers health care contracts for DoD's TRICARE program covering approximately 1.5 million eligible individuals under TRICARE. Through TRICARE, Federal Services provides eligible beneficiaries with improved access to care, lower out-of-pocket expenses and fewer claims forms. Federal Services currently administers three TRICARE contracts for five regions:

•

Region 11, covering Washington, Oregon and part of Idaho



•

Region 6, covering Arkansas, Oklahoma, most of Texas and most of Louisiana



•

Regions 9, 10 and 12, covering California, Hawaii, Alaska and part of Arizona

        During 2002, enrollment of TRICARE beneficiaries in the HMO option (called "TRICARE Prime") of the TRICARE program for the Region 11 contract increased by 1% to 143,742 while the total estimated number of eligible beneficiaries, based on DoD data, decreased by less than 1% to 236,834. During 2002, enrollment of TRICARE beneficiaries in TRICARE Prime for the Region 6 contract increased by 7% to 445,063 while the total estimated number of eligible beneficiaries, based on DoD data, decreased by 1% to 612,611. During 2002, enrollment of TRICARE beneficiaries in TRICARE Prime for the Regions 9, 10 and 12 contract increased by 4% to 368,971 while the total estimated number of eligible beneficiaries, based on DoD data and excluding Alaska, decreased by less than 1% to 611,789. DoD estimated numbers of eligible beneficiaries are subject to revision when actual numbers become available.

        Under the TRICARE contracts, Federal Services shares health care cost risk with DoD for both gains and losses. Federal Services subcontracts to affiliated and unrelated third parties for the administration and health care risk of parts of these contracts. If all option periods are exercised by DoD and no further extensions of the performance period are made, health care delivery ends on October 31, 2004 for the Region 6 contract, on March 31, 2005 for the Regions 9, 10 and 12 contract, and February 29, 2004 for the Region 11 contract.

        On August 1, 2002, the United States Department of Defense ("DoD") issued a Request For Proposals ("RFP") for the rebid of the TRICARE contracts. The RFP divides the United States into three regions (North, South and West) and provides for the award of one contract for each region. The RFP also provides that each of the three new contracts will be awarded to a different prime contractor. Proposals in response to the RFP for each of the three regions were submitted by Federal Services in January 2003 and it is anticipated that DoD will award the three new TRICARE contracts on or before June 1, 2003. Health care delivery under the new TRICARE contracts will not commence until the expiration of health care delivery under the current TRICARE contracts.

TRICARE FOR LIFE.

        TRICARE For Life ("TFL") was passed by Congress as part of the FY 2001 National Defense Authorization Act (P.L. 106-398) and became Public Law on October 30, 2000. The program was implemented by the DoD on October 1, 2001, restoring TRICARE coverage for all Medicare-eligible retired beneficiaries who are enrolled in Medicare Part B. TFL covers all uniformed services retirees, spouses, and other qualifying dependents and survivors (including certain former spouses) who are Medicare-eligible and enrolled in Medicare Part B, regardless of age. Eligible beneficiaries receive all Medicare-covered benefits plus all TRICARE covered benefits. For most beneficiaries, Medicare will be first payer for all Medicare-covered services and TRICARE will be the secondary payer. TRICARE will pay all Medicare copays and deductibles and cover most of the cost of certain care not covered by Medicare. TFL covers approximately 1.5 million beneficiaries, with approximately 500,000 of those beneficiaries within Federal Services' regions.

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VETERANS AFFAIRS.

        During 2002, Federal Services administered 15 contracts with the U.S. Department of Veterans Affairs to manage community based outpatient clinics in ten states. Federal Services also managed 127 contracts with the U.S. Department of Veterans Affairs, one subcontract for the U.S. Department of Veterans Affairs and one contract with the U.S. Marshals Service for claims re-pricing services.

OTHER BUSINESS

WORKERS' COMPENSATION ADMINISTRATIVE SERVICES.

        Our subsidiaries organized under Health Net Employer Services, Inc. ("HN Employer Services") (formerly known as Employer & Occupational Services Group, Inc.) provide a full range of workers' compensation administrative services to insurers, self-funded employers, third-party claims administrators and public agencies. These services include injury reporting and provider referral, automated bill review and PPO network access, field and telephonic case management, direction of care and practice management. During the first six months of 2002, HN Employer Services offered claim/benefit administration, claim investigation and adjudication, and litigation management through its claims administration subsidiary (which was divested effective July 1, 2002). HN Employer Services is headquartered in Irvine, California and has sales and service offices in Arizona, California, Colorado, Connecticut, Georgia, Illinois, New York, North Carolina, Oregon and Texas. During 2002, HN Employer Services' Managed Care Services unit provided services on more than $1.6 billion of billed charges for medical care for covered beneficiaries of its customers. The unit processed over 2.5 million bills from providers and hospitals located in 50 states and handled nearly 29,000 intake calls resulting in the processing of over 21,000 injury reports and 553 medical care cases referred for case management services and/or utilization review services.

        Effective July 1, 2002, we sold our HN Employer Services claims processing subsidiary, EOS Claims Services, Inc. ("EOS Claims"), to Tristar Insurance Group, Inc. ("Tristar"). In connection with the sale, we received $500,000 in cash, and also entered into a Payor Services Agreement. Under the Payor Services Agreement, Tristar has agreed to exclusively use EOS Managed Care Services, Inc. (one of our remaining HN Employer Services subsidiaries) for various managed care services to its customers and clients. We estimated and recorded a $2.6 million pretax loss on the sale of EOS Claims during the second quarter ended June 30, 2002. As of the date of sale, EOS Claims had no net equity after dividends to its parent company and the goodwill impairment charge taken in the first quarter ended March 31, 2002.

        For the year ended December 31, 2002, HN Employer Services' Managed Care Services unit generated revenues of approximately $47.1 million which are included in "Other income".

PROVIDER RELATIONSHIPS AND RESPONSIBILITIES

PHYSICIAN RELATIONSHIPS.

        Under most of our HMO plans, each member upon enrollment selects a participating physician group ("PPG") or primary care physician from the HMO's provider panel. The primary care physicians and PPGs assume overall responsibility for the care of members. Medical care provided directly by such physicians includes the treatment of illnesses not requiring referral, as well as physical examinations, routine immunizations, maternity and child care, and other preventive health services. The primary care physicians and PPGs are responsible for making referrals (approved by the HMO's or PPG's medical director) to specialists and hospitals. Certain of our HMOs offer enrollees "open panels" under which members may access any physician in the network, or network physicians in certain specialties, without first consulting their primary care physician.

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        The following table sets forth the number of primary care and specialist physicians contracted either directly with our HMOs or through our contracted PPGs as of December 31, 2002:

Primary Care Physicians	73,926
Specialist Physicians	164,306
Total	238,232

        PPG and physician contracts are generally for a period of at least one year and are automatically renewable unless terminated, with certain requirements for maintenance of good professional standing and compliance with our quality, utilization and administrative procedures. In California and Connecticut, PPGs generally receive a monthly "capitation" fee for every member assigned. The capitation fee represents payment in full for all medical and ancillary services specified in the provider agreements. In these capitation fee arrangements, in cases where the capitated PPG cannot provide the health care services needed, such PPGs generally contract with specialists and other ancillary service providers to furnish the requisite services under capitation agreements or negotiated fee schedules with specialists. Outside of California, many of our HMOs reimburse physicians according to a discounted fee-for-service schedule, although several have capitation arrangements with certain providers and provider groups in their market areas.

        For services provided under our PPO and POS products, we ordinarily reimburse physicians pursuant to discounted fee-for-service arrangements.

HOSPITAL RELATIONSHIPS.

        Our health plan subsidiaries arrange for hospital care primarily through contracts with selected hospitals in their service areas. These hospital contracts generally have multi-year terms and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-for-service schedules.

        Covered inpatient hospital care for our HMO members is comprehensive; it includes the services of physicians, nurses and other hospital personnel, room and board, intensive care, laboratory and x-ray services, diagnostic imaging and generally all other services normally provided by acute-care hospitals. HMO or PPG nurses and medical directors are actively involved in discharge planning and case management, which often involves the coordination of community support services, including visiting nurses, physical therapy, durable medical equipment and home intravenous therapy.

COST CONTAINMENT.

        In most HMO plan designs, the primary care physician or PPG is responsible for authorizing all needed medical care except for emergency medical services. We believe that this authorization process reduces inappropriate use of medical resources and achieves efficiencies in cases where reimbursement is based on risk-sharing arrangements.

        To limit possible abuse in utilization of hospital services in non-emergency situations, most of our health plans require that a member obtain certification for specified medical conditions prior to admission as an inpatient, and the inpatient admission is then subject to continuing review during the member's hospital stay. In addition to reviewing the appropriateness of hospital admissions and continued hospital stays, we play an active role in evaluating alternative means of providing care to members and encourage the use of outpatient care, when appropriate, to reduce the cost that would otherwise be associated with an inpatient admission.

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QUALITY ASSESSMENT.

        Quality assessment is a continuing priority for us. Most of our health plans have a quality assessment plan administered by a committee composed of medical directors and primary care and specialist physicians. The committees' responsibilities include periodic review of medical records, development and implementation of standards of care based on current medical literature and community standards, and the collection of data relating to results of treatment. All of our health plans also have a subscriber grievance procedure and/or a member satisfaction program designed to respond promptly to member grievances. Elements of these subscriber grievance procedures and member satisfaction programs are incorporated both within the PPGs and within our health plans.

ADDITIONAL INFORMATION CONCERNING OUR BUSINESS

MARKETING AND SALES.

        Marketing for group health plan business is a three-step process. We first market to potential employer groups and group insurance brokers. We then provide information directly to employees once the employer has selected our health coverage. Finally, we engage members and employers in marketing for member and group retention. Although we market our programs and services primarily through independent brokers, agents and consultants, we use our limited internal sales staff to serve certain large employer groups. Once selected by an employer, we solicit enrollees from the employee base directly. During "open enrollment" periods when employees are permitted to change health care programs, we use direct mail, work day and health fair presentations, telemarketing and outdoor print and radio advertisements to attract new enrollees. Our sales efforts are supported by our marketing division, which engages in product research and development, multicultural marketing, advertising and communications, and member education and retention programs.

        Premiums for each employer group are generally contracted on a yearly basis and are payable monthly. We consider numerous factors in setting our monthly premiums, including employer group needs and anticipated health care utilization rates as forecasted by our management based on the demographic composition of, and our prior experience in, our service areas. Premiums are also affected by applicable regulations that prohibit experience rating of group accounts (i.e., setting the premium for the group based on its past use of health care services) and by state regulations governing the manner in which premiums are structured.

        We believe that the importance of the ultimate health care consumer (or member) in the health care product purchasing process is likely to increase in the future, particularly in light of advances in technology and online resources. Accordingly, we intend to focus our marketing strategies on the development of distinct brand identities and innovative product service offerings that will appeal to potential health plan members.

COMPETITION.

        HMOs operate in a highly competitive environment in an industry currently subject to significant changes from business consolidations, new strategic alliances, legislative reform and market pressures brought about by a better informed and better organized customer base. Our HMOs face substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded plans (including self-insured employers and union trust funds), Blue Cross/Blue Shield plans, and traditional indemnity insurance carriers, some of which have substantially larger enrollments and greater financial resources than we do. We believe that the principal competitive features affecting our ability to retain and increase membership include the range and prices of benefit plans offered, size and quality of provider network, quality of service, responsiveness to user demands, financial stability, comprehensiveness of coverage, diversity of product offerings, and market presence and reputation. The relative importance of each of

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these factors and the identity of our key competitors varies by market. We believe that we compete effectively with respect to all of these factors.

        Our key competitors in California are four large health plans: Kaiser Permanente, Blue Cross of California, PacifiCare Health Systems and Blue Shield of California. Kaiser is the largest HMO in the state and Blue Cross of California is the largest PPO provider in California. All together, these four plans and Health Net account for a majority of the insured market in California. There are also a number of small, regional-based health plans that compete with Health Net primarily in the small business group market segment. The combined membership for these regional plans constitutes approximately 15% of the insured market in the state.

        Our largest competitor in Arizona is Blue Cross/Blue Shield. Our Arizona HMO also competes with United Healthcare, CIGNA, PacifiCare and Aetna. Our Oregon HMO competes primarily against other HMOs including Kaiser, PacifiCare of Oregon, Providence, Regence Blue Cross Blue Shield and Lifewise, and with various PPOs.

        Our HMO in Connecticut competes for business with commercial insurance carriers, Anthem Connecticut, Aetna/U.S. Healthcare, Connecticare and eight other HMOs. Our main competitors in Pennsylvania, New York and New Jersey are Aetna/U.S. Healthcare, Empire Blue Cross, Oxford Health Plans, United Healthcare, Horizon Blue Cross and Keystone Health Plan East.

GOVERNMENT REGULATION.

        We believe we are in compliance in all material respects with all current state and federal regulatory requirements applicable to the businesses being conducted by our subsidiaries. Certain of these requirements are discussed below.

        California HMO Regulations.    California HMOs such as Health Net of California, Inc. ("HN California") and certain of our specialty plans are subject to California state regulation, principally by the Department of Managed Health Care ("DMHC") under the Knox-Keene Act. Among the areas regulated by the Knox-Keene Act are: (i) adequacy of administrative operations, (ii) the scope of benefits required to be made available to members, (iii) procedures for review of quality assurance, (iv) enrollment requirements, (v) composition of policy making bodies to assure that plan members have access to representation, (vi) procedures for resolving grievances, (vii) the interrelationship between HMOs and their health care providers, (viii) adequacy and accessibility of the network of health care providers, (ix) provider contracts, and (x) initial and continuing financial viability of the HMO and its risk-bearing providers. Any material modifications to the organization or operations of HN California are subject to prior review and approval by the DMHC. This approval process can be lengthy and there is no certainty of approval. Other significant changes require filing with the DMHC, which may then comment and require changes. In addition, under the Knox-Keene Act, HN California and certain of our other subsidiaries must file periodic reports with, and are subject to periodic review and investigation by, the DMHC. Non-compliance with the Knox-Keene Act may result in an enforcement action, fines and penalties, and, in egregious cases, limitations on or revocation of the Knox-Keene license.

        Federal HMO Regulations.    Under the Federal Health Maintenance Organization Act of 1973 (the "HMO Act"), services to members must be provided substantially on a fixed, prepaid basis without regard to the actual degree of utilization of services. Premiums established by an HMO may vary from account to account through composite rate factors and special treatment of certain broad classes of members, and through prospective (but not retrospective) rating adjustments. Several of our HMOs are federally qualified in certain parts of their respective service areas under the HMO Act and are therefore subject to the requirements of such act to the extent federally qualified products are offered and sold.

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        Additionally, there are a number of recently enacted federal laws that further regulate managed health care. Recent legislation includes the Balanced Budget Act of 1997 and the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). The purposes of HIPAA are to (i) limit pre-existing condition exclusions applicable to individuals changing jobs or moving to individual coverage, (ii) guarantee the availability of health insurance for employees in the small group market, (iii) prevent the exclusion of individuals from coverage under group plans based on health status, and (iv) establish national standards for the electronic exchange of health information. In December 2000, the Department of Health and Human Services ("DHHS") promulgated regulations under HIPAA related to the privacy and security of electronically transmitted protected health information ("PHI"). The new regulations require health plans, clearinghouses and providers to (a) comply with various requirements and restrictions related to the use, storage and disclosure of PHI, (b) adopt rigorous internal procedures to protect PHI, (c) create policies related to the privacy of PHI and (d) enter into specific written agreements with business associates to whom PHI is disclosed. The regulations also establish significant criminal penalties and civil sanctions for non-compliance. Health Net has completed the majority of work required to be compliant with the HIPAA Privacy Regulations prior to the effective date of April 2003. Further, Health Net is on target to be in compliance with the Transactions and Codesets requirements prior to the effective date of October 2003. The Security regulations have been recently made final and will not be enforced until approximately April 2005, and Health Net has created a Security plan to ensure appropriate compliance prior to the effective date.

        Our Medicare contracts are subject to regulation by CMS. CMS has the right to audit HMOs operating under Medicare contracts to determine the quality of care being rendered and the degree of compliance with CMS' contracts and regulations. Our Medicaid business is also subject to regulation by CMS, as well as state agencies.

        Most employee benefit plans are regulated by the federal government under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Employment-based health coverage is such an employee benefit plan. ERISA is administered, in large part, by the U.S. Department of Labor ("DOL"). ERISA contains disclosure requirements for documents that define the benefits and coverage. It also contains a provision that causes federal law to preempt state law in the regulation and governance of certain benefit plans and employer groups, including the availability of legal remedies under state law. Recently, the DOL adopted regulations under ERISA which mandate certain claims and appeals processing requirements. These regulations became effective starting on July 1, 2002 and fully on January 1, 2003. They will require us to make certain adjustments in our claims systems, but we do not anticipate that the cost of the adjustments will be material from a financial point of view or that the changes will not be able to be made by the stated deadline.

        Other HMO Regulations.    In each state in which our HMOs do business, our HMOs must meet numerous state licensing criteria and secure the approval of state licensing authorities before implementing certain operational changes, including the development of new product offerings and, in some states, the expansion of service areas. To remain licensed, each HMO must continue to comply with state laws and regulations and may from time to time be required to change services, procedures or other aspects of its operations to comply with changes in applicable laws and regulations. In addition, HMOs must file periodic reports with, and their operations are subject to periodic examination by, state licensing authorities. HMOs are required by state law to meet certain minimum capital and deposit and/or reserve requirements in each state and may be restricted from paying dividends to their parent corporations under some circumstances. Several states have increased minimum capital requirements, in response to proposals by the National Association of Insurance Commissioners to institute risk-based capital requirements. Regulations in these and other states may be changed in the future to further increase capital requirements. Such increases could require us to contribute additional capital to our HMOs. Any adverse change in governmental regulation or in the regulatory climate in any state could materially impact the HMOs operating in that state. The HMO

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Act and state laws place various restrictions on the ability of HMOs to price their products freely. We must comply with applicable provisions of state insurance and similar laws, including regulations governing our ability to seek ownership interests in new HMOs, PPOs and insurance companies, or otherwise expand our geographic markets or diversify our product lines.

        Insurance Regulations.    State departments of insurance (the "DOIs") regulate our insurance and third-party administrator businesses under various provisions of state insurance codes and regulations. Our subsidiaries conducting these businesses are subject to various capital reserve and other financial, operating and disclosure requirements established by the DOIs and state laws. These subsidiaries must also file periodic reports regarding their regulated activities and are subject to periodic reviews of those activities by the DOIs. We must also obtain approval from, or file copies with, the DOIs for all of our group and individual insurance policies prior to issuing those policies.

PENDING FEDERAL AND STATE LEGISLATION.

        There are a number of legislative initiatives and proposed regulations currently pending or previously proposed at the federal and state levels which could increase regulation of the health care industry. These measures include a "patients' bill of rights" and certain other initiatives which, if enacted, could have significant adverse effects on our operations. See "Cautionary Statements—Federal and State Legislation" below. For example, one version of the previously proposed "patients' bill of rights" would allow an expansion of liability for health plans. We cannot predict the outcome of any of the pending legislative or regulatory proposals, nor the extent to which we may be affected by the enactment of any such legislation or regulation.

ACCREDITATION.

        We pursue accreditation for certain of our health plans from the National Committee for Quality Assurance ("NCQA") and the Joint Committee on Accreditation of Healthcare Organizations ("JCAHO"). NCQA and JCAHO are independent, non-profit organizations that review and accredit HMOs. HMOs that comply with review requirements and quality standards receive accreditation. Our HMO subsidiaries in California and Arizona have received NCQA accreditation. Certain of our other health plan subsidiaries are in the process of applying for NCQA or JCAHO accreditation. The utilization review activities of our subsidiary, EOS Managed Care Services, are accredited by Utilization Review Accreditation Commission also known as the "American Accreditation Healthcare Commission".

SERVICE MARKS

        We have filed for registration of and maintain several service marks, trademarks and tradenames that we use in our business, including marks and names incorporating the "Health Net" phrase. We utilize these and other marks and names in connection with the marketing and identification of products and services. We believe such marks and names are valuable and material to our marketing efforts.

EMPLOYEES

        We currently employ approximately 9,400 employees, excluding temporary employees. These employees perform a variety of functions, including provision of administrative services for employers, providers and members; negotiation of agreements with physician groups, hospitals, pharmacies and other health care providers; handling of claims for payment of hospital and other services; and provision of data processing services. Our employees are not unionized and we have not experienced any work stoppages since our inception. We consider our relations with our employees to be very good.

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OTHER INFORMATION/RECENT AND OTHER DEVELOPMENTS

DEBT OFFERING.

        On April 12, 2001, we completed an offering of $400 million aggregate principal amount of 8.375 percent Senior Notes due in April 2011. The effective interest rate on the Senior Notes when all offering costs are taken into account and amortized over the term of the Senior Notes is 8.54 percent per annum. The net proceeds of $395.1 million from the Senior Notes were used to repay outstanding borrowings under our then-existing revolving credit facility. On October 4, 2001, we completed an exchange offer for the Senior Notes in which the outstanding Senior Notes were exchanged for an equal aggregate principal amount of new 8.375 percent Senior Notes due 2011 that have been registered under the Securities Act of 1933, as amended.

        The Senior Notes may be redeemed at the option of the Company at a price equal to the greater of (A) 100% of the principal amount of the notes to be redeemed and (B) the sum of the present values of the remaining scheduled payments on the notes to be redeemed (consisting of principal and interest, exclusive of interest accrued through the date of redemption). In calculating the present values of the remaining scheduled payments, the rate in effect on the date of calculation of the redemption price is to be used, discounted to the date of redemption on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the applicable treasury yield plus 40 basis points and with interest accrued through the date of redemption.

FLORIDA OPERATIONS.

        Effective August 1, 2001, we sold our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc. (the "Florida Plan"), to Florida Health Plan Holdings II, L.L.C. In connection with the sale, we received approximately $49 million which consisted of $23 million in cash and approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also sold the corporate facility building used by the Florida Plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We estimated and recorded a $76.1 million pretax loss on the sales of our Florida Plan and the related corporate facility building during the second quarter ended June 30, 2001.

        Under the Stock Purchase Agreement that evidenced the sale (as amended, the "SPA"), we, through our subsidiary, FH Assurance Company ("FHAC"), entered into a reinsurance agreement (the "Reinsurance Agreement") with the Florida Plan. Under the terms of the Reinsurance Agreement, FHAC will reimburse the Florida Plan for certain medical and hospital expenses arising after the sale. The Reinsurance Agreement will cover claims arising from all commercial and governmental health care contracts or other agreements in force as of July 31, 2001 and any renewals thereof up to 18 months after July 31, 2001. The Reinsurance Agreement provides that the Florida Plan will be reimbursed for medical and hospital expenses relative to covered claims in excess of certain baseline medical loss ratios, as follows:

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88% for the six-month period commencing on August 1, 2001;



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89% for the six-month period commencing on February 1, 2002;



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90% for the six-month period commencing on August 1, 2002.

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        The Reinsurance Agreement is limited to $28 million in aggregate payments and is subject to the following levels of coinsurance:

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5% for the six-month period commencing on August 1, 2001;



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10% for the six-month period commencing on February 1, 2002;



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15% for the six-month period commencing on August 1, 2002.

        If the baseline medical loss ratio is less than 90% at the end of the six-month period commencing on August 1, 2002, Health Net is entitled to recover medical and hospital expenses below the 90% threshold up to an amount to not exceed 1% of the total premiums for those members still covered during the six-month period under the Reinsurance Agreement.

        The maximum liability under the Reinsurance Agreement of $28 million was reported as part of loss on assets held for sale as of June 30, 2001, since this was our best estimate of our probable obligation under this arrangement. As the reinsured claims are submitted to FHAC, the liability is reduced by the amount of claims paid. As of December 31, 2002, we have paid out $20.3 million under this Reinsurance Agreement.

        The SPA included an indemnification obligation for all pending and threatened litigation as of the closing date and certain specific provider contract interpretation or settlement disputes. During the year ended December 31, 2002, we paid $5.7 million in settlements on certain indemnified items. At this time, we believe that the estimated liability related to the remaining indemnified obligations on any pending or threatened litigation and the specific provider contract disputes will not have a material impact to the financial condition of the Company.

        The SPA provides for the following three true-up adjustments that could result in an adjustment to the loss on the sale of the Florida Plan:

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A retrospective post-closing settlement of statutory equity based on subsequent adjustments to the closing balance sheet for the Florida Plan.



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A settlement of unpaid provider claims as of the closing date based on claim payments occurring during a one-year period after the closing date.



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A settlement of the reinsured claims in excess of certain baseline medical loss ratios. Final settlement is not scheduled to occur until the latter part of 2003. The development of claims and claims related metrics and information provided by Florida Health Plan Holdings II, L.L.C. have not resulted in any revisions to the maximum $28 million liability we originally estimated.

        The true-up process has not been finalized and we do not have sufficient information regarding the true-up adjustments to assess probability or estimate any adjustment to the recorded loss on the sale of the Florida Plan as of December 31, 2002.

INVESTMENT IN AMCARECO, INC.

        In 1999, we sold our HMO operations in the states of Louisiana, Oklahoma and Texas to AmCareco, Inc. ("AmCareco"). As part of the transaction, we received shares of AmCareco convertible preferred stock with an aggregate par value of $10.7 million and established an allowance of $4.2 million based on the estimated net realizable value. During 2000, we made additional investments in AmCareco and received subordinated notes totaling $2.6 million. As of June 30, 2002, the net carrying value of our investment in AmCareco was $9.1 million and was included in other noncurrent assets on our condensed consolidated balance sheets. In July 2002, we exercised our rights to draw upon a $2 million letter of credit that was established by AmCareco to secure the redemption of a portion of our preferred stock of AmCareco, resulting in a net investment of $7.1 million in AmCareco after such redemption.

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        In August 2002, the Oklahoma State Health Commissioner determined not to continue AmCareco's license in Oklahoma to operate an HMO due to AmCareco's alleged violations of Oklahoma's prompt-pay law and AmCareco's failure to maintain the minimum net worth requirement to operate an HMO in that state. This license denial became effective October 1, 2002. In September 2002, the Louisiana Department of Insurance upgraded its regulatory control of AmCareco's Louisiana operations from supervision to rehabilitation, and an Order of Liquidation was entered against AmCareco's Louisiana subsidiary on October 21, 2002. Due in part to the actions taken by Oklahoma and Louisiana, the Texas Department of Insurance also commenced a conservatorship process in September 2002 related to AmCareco's operations in Texas, and a competitor was designated to absorb all of the Texas operation's member groups as of November 1, 2002.

        Given the foregoing adverse regulatory actions, AmCareco's operations have been or are in the process of being terminated in all three of these states. These actions have caused us to determine that the carrying value of these assets is no longer recoverable. Accordingly, we wrote off the total carrying value of our investment of $7.1 million during the third quarter ended September 30, 2002.

EOS CLAIMS SERVICES, INC.

        Effective July 1, 2002, we sold our claims processing subsidiary, EOS Claims Services, Inc. ("EOS Claims"), to Tristar Insurance Group, Inc. ("Tristar"). In connection with the sale, we received $500,000 in cash, and also entered into a Payor Services Agreement. Under the Payor Services Agreement, Tristar has agreed to exclusively use EOS Managed Care Services, Inc. (one of our remaining subsidiaries) for various managed care services to it customers and clients.

        We estimated and recorded a $2.6 million pretax loss on the sale of EOS Claims during the second quarter ended June 30, 2002. As of the date of sale, EOS Claims had no net equity after dividends to its parent company and the goodwill impairment charge taken in the first quarter ended March 31, 2002.

INVESTMENT IN MEDUNITE.

        Throughout 2000 and 2001, we provided funding in the aggregate amount of approximately $10 million to MedUnite in exchange for preferred stock of MedUnite. During 2002, we provided approximately $3.4 million in additional funding to MedUnite. In December 2002, MedUnite was sold to ProxyMed, Inc. and we received cash and contingent notes of the buyer in connection with the sale transaction. As a result of the sale, we recorded a $12.4 million charge attributed to the write-off of our investment in MedUnite during the fourth quarter ended December 31, 2002 which included an allowance against the full value of the notes.

INVESTMENT IN NAVIMEDIX.

        During 2000, we secured an exclusive e-business connectivity services agreement from the Connecticut State Medical Society IPA, Inc. ("CSMS-IPA") for $15.0 million. CSMS-IPA is an association of medical doctors providing health care primarily in Connecticut. The amounts paid to CSMS-IPA for this agreement are included in other noncurrent assets, and we periodically assess the recoverability of such assets.

        During 2002, we entered into various agreements with external third parties in connection with this service capability. We entered into a marketing and stock issuance agreement with NaviMedix, Inc. ("NaviMedix"), a provider of online solutions connecting health plans, physicians and hospitals. In exchange for providing general assistance and advise to NaviMedix, we received 800,000 shares of NaviMedix common stock and the right to receive an additional 100,000 earnout shares for each $1 million in certain NaviMedix gross revenues generated during an annualized six month measurement period.

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        In March 2002, we entered into an assignment, assumption and bonus option agreement with CSMS-IPA pursuant to which CSMS-IPA rececived 32,000 shares or 4% of the NaviMedix shares that we received and the right to receive 4% of any of the earnout shares we may realize. Under the agreement, CSMS-IPA is also entitled to receive up to an additional 8.2% of the earnout shares from us depending on the proportion of NaviMedix gross revenue that is generated in the state of Connecticut. In March 2002, we also entered into a cooperation agreement with CSMS-IPA pursuant to which we jointly designate and agree to evaluate connectivity vendors for CSMS-IPA members.

CREDIT AGREEMENTS.

        We have two credit facilities with Bank of America, N.A., as administrative agent, each governed by a separate credit agreement dated as of June 28, 2001. The credit facilities, provide for an aggregate of $700 million in borrowings, consisting of:

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a $175 million 364-day revolving credit facility; and



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a $525 million five-year revolving credit and competitive advance facility.

        We established the credit facilities to refinance our then-existing bank debt and for general corporate purposes, including acquisitions and working capital. The credit facilities allow us to borrow funds:

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by obtaining committed loans from the group of lenders as a whole on a pro rata basis;



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by obtaining under the five-year facility loans from individual lenders within the group by way of a bidding process; and



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by obtaining under the five-year facility letters of credit in an aggregate amount of up to $200 million.

        The credit agreement for the 364-day revolving credit facility was amended on June 27, 2002 to extend the term of this facility for an additional 364 days.

        Repayment.    The 364-day credit facility expires on June 26, 2003. We must repay all borrowings under the 364-day credit facility by June 26, 2003, unless the Company avails itself of a two-year term-out option in the 364-day credit facility. The five-year credit facility expires on June 28, 2006, and we must repay all borrowings under the five-year credit facility by June 28, 2006, unless the five-year credit facility is extended. The five-year credit facility may, at our request and subject to approval by lenders holding two-thirds of the aggregate amount of the commitments under the five-year credit facility, be extended for up to two twelve-month periods to the extent of the commitments made under the five-year credit facility by such approving lenders.

        Covenants.    The credit agreements contain negative covenants, including financial covenants, that impose performance requirements on our operations. The financial covenants in the credit agreements provide that:

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for any period of four consecutive fiscal quarters, the consolidated leverage ratio, which is the ratio of (i) our consolidated funded debt to (ii) our consolidated net income before interest, taxes, depreciation, amortization and other specified items (consolidated EBITDA), must not exceed 3 to 1;



•

for any period of four consecutive fiscal quarters, the consolidated fixed charge coverage ratio, which is the ratio of (i) our consolidated EBITDA plus consolidated rental expense minus consolidated capital expenditures to (ii) our consolidated scheduled debt payments (defined as the sum of scheduled principal payments, interest expense and rent expense) must be at least 1.5 to 1; and

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•

we must maintain our consolidated net worth at a level equal to at least $945 million (less the sum of a pretax charge associated with our sale of our Florida health plan and specified pretax charges relating to the write-off of goodwill) plus 50% of our consolidated net income and 100% of our net cash proceeds from equity issuances.

        The other covenants in the credit agreements include, among other things, limitations on incurrence of indebtedness by our subsidiaries and on our ability to:

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incur liens;



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extend credit and make investments in non-affiliates;



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merge, consolidate, dispose of stock in subsidiaries, lease or otherwise dispose of assets and liquidate or dissolve;



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substantially alter the character or conduct of the business of Health Net, Inc. or any of its "significant subsidiaries" within the meaning of Rule 1-02 under Regulation S-X promulgated by the SEC;



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make restricted payments, including dividends and other distributions on capital stock and redemptions of capital stock if the Company's debt is rated below investment grade by either Standard and Poor's Rating Service or Moody's Investor Services; and



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become subject to other agreements or arrangements that restrict (i) the payment of dividends by any Health Net, Inc. subsidiary, (ii) the ability of Health Net, Inc. subsidiaries to make or repay loans or advances to lenders, (iii) the ability of any subsidiary of Health Net, Inc. to guarantee our indebtedness or (iv) the creation of any lien on property, provided that the foregoing shall not apply to (a) restrictions and conditions imposed by regulatory authorities or (b) restrictions imposed under either the 364-day Revolving Credit Facility or the five-year revolving credit facility.

        Interest and fees.    Committed loans under the credit facilities bear interest at a rate equal to either (1) the greater of the federal funds rate plus 0.5% and the applicable prime rate or (2) LIBOR plus a margin that depends on our senior unsecured credit rating. Loans obtained through the bidding process bear interest at a rate determined in the bidding process. We pay fees on outstanding letters of credit and a facility fee, computed as a percentage of the lenders' commitments under the credit facilities, which varies from 0.130% to 0.320% per annum for the 364-day credit facility and from 0.155% to 0.375% per annum for the five-year credit facility, depending on our senior unsecured credit rating.

        Events of Default.    The credit agreements provide for acceleration of repayment of indebtedness under the credit facilities upon the occurrence of customary events of default.

SHAREHOLDER RIGHTS PLAN.

        On May 20, 1996, our Board of Directors declared a dividend distribution of one right (a "Right") for each outstanding share of our Class A Common Stock and Class B Common Stock (collectively, the "Common Stock"), to stockholders of record at the close of business on July 31, 1996 (the "Record Date"). Our Board of Directors also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the "Distribution Date" the Rights separate from the Common Stock under the circumstances described below and in accordance with the provisions of the Rights Agreement, as defined below, the redemption of the Rights and the expiration of the Rights, and in certain other circumstances. Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights certificates will be distributed. Subject to certain exceptions contained in the Rights Agreement dated as of June 1, 1996 by and between us and Harris Trust and Savings Bank, as Rights Agent (as amended on October 1, 1996 and May 3, 2001, the "Rights Agreement"), the Rights will separate from the Common Stock following any person, together

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with its affiliates and associates (an "Acquiring Person"), becoming the beneficial owner of 15% or more of the outstanding Class A Common Stock, the commencement of a tender or exchange offer that would result in any person, together with its affiliates and associates, becoming the beneficial owner of 15% or more of the outstanding Class A Common Stock or the determination by the Board of Directors that a person, together with its affiliates and associates, has become the beneficial owner of 10% or more of the Class A Common Stock and that such person is an "Adverse Person," as defined in the Rights Agreement. The Rights Agreement provides that certain passive institutional investors that beneficially own less than 17.5% of the outstanding shares of our Class A Common Stock shall not be deemed to be Acquiring Persons.

        The Rights will first become exercisable on the Distribution Date and will expire on July 31, 2006, unless earlier redeemed by us as described below. Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder to purchase from us one one-thousandth of a share of Series A Junior Participating Preferred Stock at a price of $170.00 per one-thousandth share.

        Subject to certain exceptions contained in the Rights Agreement, in the event that any person shall become an Acquiring Person or be declared to be an Adverse Person, then the Rights will "flip-in" and entitle each holder of a Right, other than any Acquiring Person or Adverse Person, to purchase, upon exercise at the then-current exercise price of such Right, that number of shares of Class A Common Stock having a market value of two time such exercise price.

        In addition, and subject to certain exceptions contained in the Rights Agreement, in the event that we are acquired in a merger or other business combination in which the Class A Common Stock does not remain outstanding or is changed or 50% of the assets or earning power of the Company is sold or otherwise transferred to any other person, the Rights will "flip-over" and entitle each holder of a Right, other than an Acquiring Person or an Adverse Person, to purchase, upon exercise at the then current exercise price of such Right, such number of shares of common stock of the acquiring company which at the time of such transaction would have a market value of two times such exercise price.

        We may redeem the Rights until the earlier of 10 days following the date that any person becomes the beneficial owner of 15% or more of the outstanding Class A Common Stock and the date the Rights expire at a price of $.01 per Right.

        In May 2001, we appointed Computershare Investor Services, L.L.C. to serve as the Rights Agent under the Rights Agreement.

        The foregoing summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement, which is incorporated by reference in Exhibits 4.2, 4.3 and 4.4 to this Annual Report.

STOCK REPURCHASE PROGRAM.

        In April 2002, our Board of Directors authorized us to repurchase up to $250 million (net of exercise proceeds and tax benefits from the exercise of employee stock options) of our Class A Common Stock. Pursuant to this repurchase program, we repurchased an aggregate of 10.0 million shares of our Class A Common Stock for aggregate consideration of approximately $249 million as of March 20, 2003. Share repurchases are made under this repurchase program from time to time through open market purchases or through privately negotiated transactions.

        During 2002, we received approximately $48 million in cash and $18 million of tax benefits as a result of option exercises. In 2003, we expect to receive approximately $58 million in cash and $17 million in tax benefits from estimated option exercises during the year. As a result of the $66 million (in 2002) and $75 million (in 2003) aggregate amounts of realized and estimated benefits, our total authority under the stock repurchase program is estimated at $390 million based on the

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authorization we received from our Board of Directors to repurchase $250 million net of exercise proceeds and tax benefits from the exercise of employee stock options.

TRICARE CONTRACTS.

        Our wholly-owned subsidiary, Health Net Federal Services, Inc. ("Federal Services") (formerly known as Foundation Health Federal Services, Inc.), administers large, multi-year managed care federal contracts with the United States Department of Defense ("DoD").

        Federal Services currently administers health care contracts for DoD's TRICARE program covering approximately 1.5 million eligible individuals under TRICARE. Through TRICARE, Federal Services provides eligible beneficiaries with improved access to care, lower out-of-pocket expenses and fewer claims forms. Federal Services currently administers three TRICARE contracts for five regions:

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Region 11, covering Washington, Oregon and part of Idaho



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Region 6, covering Arkansas, Oklahoma, most of Texas, and most of Louisiana



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Regions 9, 10 and 12, covering California, Hawaii, Alaska and part of Arizona

        On August 1, 2002, the DoD issued a Request For Proposals ("RFP") for the rebid of the TRICARE contracts. The RFP divides the United States into three regions (North, South and West) and provides for the award of one contract for each region. The RFP also provides that each of the three new contracts will be awarded to a different prime contractor. Proposals in response to the RFP for each of the three regions were submitted by Federal Services in January 2003 and it is anticipated that DoD will award the three new TRICARE contracts on or before June 1, 2003. Health care delivery under the new TRICARE contracts will not commence until the expiration of health care delivery under the current TRICARE contracts.

        If all option periods are exercised by DoD under the current TRICARE contracts with Federal Services and no further extensions are made, health care delivery ends on February 29, 2004 for the Region 11 contract, on March 31, 2004 for the Regions 9, 10 and 12 contract and on October 31, 2004 for the Region 6 contract. As set forth above, Federal Services is competing for the new TRICARE contracts in response to the RFP.

CHANGE IN EXECUTIVE OFFICERS.

        Effective January 28, 2002, Steven P. Erwin resigned as Executive Vice President and Chief Financial Officer of the Company and Marvin P. Rich was appointed in his place as Executive Vice President, Finance and Operations. Effective August 6, 2002, Jeffrey Bairstow resigned as President of the Company's Government and Specialty Services Division; effective April 30, 2002, Cora Tellez, resigned as President of the Company's Health Plans Division; and effective April 15, 2002, Gary S. Velasquez resigned as President of the Company's Business Transformation and Innovation Services Division. Effective May 24, 2002, Jeffrey Folick became Executive Vice President, Regional Health Plans and Specialty Companies of the Company and effective April 1, 2002, Christopher P. Wing became Executive Vice President, Regional Health Plans and Specialty Companies of the Company and President of the Company's California operations. Finally, effective May 23, 2002, James P. Woys, President of Health Net Federal Services, was designated as an executive officer of the Company.

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LEGISLATION.

        In 2001, the United States Senate and House of Representatives passed separate bills, sometimes referred to as "patients' rights" or "patients' bill of rights" legislation, that sought, among other things, to hold health plans liable for claims regarding health care delivery and improper denial of care. This legislation would have removed or limited federal preemption under the Employee Retirement Income Security Act of 1974 ("ERISA") that currently precludes most individuals from suing health plans for causes of action based upon state law and would enable plan members to challenge coverage and benefits decisions in state and federal courts. Although both bills provided for independent review of decisions regarding medical care, the bills differed on the circumstances and procedures under which lawsuits could be brought against managed care organizations and the scope of their liability. Although Congress did not ultimately enact legislation based on the 2001 bills, and adjourned in 2002 without reconciling the two bills, we expect the issue to be considered again in 2003 and that similar bills will be introduced. If patients' bill of rights legislation is enacted into law, we could be subject to significant additional litigation risk and regulatory compliance costs, which could be costly to us and could have a significant adverse effect on our results of operations. Although we could attempt to mitigate our ultimate exposure to litigation and regulatory compliance costs through, among other things, increases in premiums, there can be no assurance that we would be able to mitigate or cover the costs stemming from litigation arising under patients' bill of rights legislation or the other costs that we could incur in connection with complying with patients' bill of rights legislation.

FIRST OPTION HEALTH PLAN.

        Effective July 30, 1999, a wholly-owned subsidiary of ours merged with and into FOHP, Inc., a then-majority owned subsidiary of ours, which, as a result of the merger, became a wholly-owned subsidiary of the Company. In connection with the merger, the former minority shareholders of FOHP were entitled to receive either $.25 per share or payment rights which entitled the holders to receive as much as $15.00 per payment right on or about July 1, 2001, provided certain hospital and other provider participation and other conditions are met. Also in connection with the merger, certain holders of payment rights were also entitled to receive additional consideration of $2.25 per payment right ("Bonus Consideration") if our New Jersey health plan achieved certain annual returns on common equity and the participation conditions are met. Based on the satisfaction of certain participation and other conditions by the former minority shareholders of FOHP, FOHP has made aggregate payments of approximately $30.4 million to certain holders of payment rights. FOHP is in the process of making the remaining $3.3 million in payments to additional holders of payment rights, subject to such holders submitting appropriate documentation.

ASSET IMPAIRMENT AND RESTRUCTURING CHARGES.

2002 Charges

        During the fourth quarter ended December 31, 2002, we recognized $35.8 million of impairment charges stemming from purchased and internally developed software that was rendered obsolete as a result of our operations and systems consolidation process. In addition, beginning in the first quarter of 2003, internally developed software of approximately $13 million in carrying value will be subject to accelerated depreciation to reflect their revised useful lives as a result of our operations and systems consolidation.

        Effective December 31, 2002, MedUnite, Inc., a health care information technology company, in which we had invested $13.4 million, was sold. As a result of the sale, our original investments were exchanged for $1 million in cash and $2.6 million in notes. Accordingly, we wrote off the original investments of $13.4 million less the $1 million cash received and recognized an impairment charge of $12.4 million on December 31, 2002 which included an allowance against the full value of the notes.

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        During the third quarter ended September 30, 2002, we evaluated the carrying value of our investments available for sale in CareScience, Inc. ("Care Science"). The common stock of CareScience has been consistently trading below $1.00 per share since early September 2002, and is at risk of being delisted. As a result, we have determined that the decline in the fair value of CareScience's common stock was other than temporary. The fair value of these investments was determined based on quotations available on a securities exchange registered with the SEC as of September 30, 2002. Accordingly, we recognized a pretax $3.6 million write-down in the carrying value of these investments which is classified as asset impairment and restructuring charges for the third quarter ended September 30, 2002. Subsequent to the write-down, our new cost basis in our investment in CareScience was $2.6 million as of September 30, 2002. Our remaining holdings in CareScience are included in investments available for sale on the accompanying condensed consolidated balance sheets.

        During the third quarter of 2002, we evaluated the carrying value of our investments in convertible preferred stock and subordinated notes of AmCareco, Inc. arising from a previous divestiture of health plans in Louisiana, Oklahoma and Texas in 1999. Since August 2002, authorities in these states have taken various actions, including license denials and liquidation-related processes, that have caused us to determine that the carrying value of these assets is no longer recoverable. Accordingly, we wrote off the total carrying value of our investment of $7.1 million which was included as a charge in asset impairment and restructuring charges for the third quarter ended September 30, 2002. Our investment in AmCareco had been included in other noncurrent assets on the accompanying condensed consolidated balance sheets.

2001 Charges

        As part of our ongoing general and administrative expense reduction efforts, during the third quarter of 2001, we finalized a formal plan to reduce operating and administrative expenses for all business units within the Company (the "2001 Plan"). In connection with the 2001 Plan, we decided on enterprise-wide staff reductions and consolidations of certain administrative, financial and technology functions. We recorded pretax restructuring charges of $79.7 million during the third quarter ended September 30, 2001 (the "2001 Charge"). As of September 30, 2002, we had completed the 2001 Plan. As of December 31, 2002, we had $3.4 million in lease termination payments remaining to be paid under the 2001 Plan. These payments will be made during the remainder of the respective lease terms.

        Severance and Benefit Related Costs.    During the third quarter ended September 30, 2001, we recorded severance and benefit related costs of $43.3 million related to enterprise-wide staff reductions, which costs were included in the 2001 Charge. These reductions include the elimination of approximately 1,517 positions throughout all functional groups, divisions and corporate offices within the Company. As of September 30, 2002, the termination of positions in connection with the 2001 Plan had been completed and we recorded a modification of $1.5 million to reflect an increase in the severance and related benefits in connection with the 2001 Plan from the initial amount of $43.3 million included in the 2001 Charge to a total of $44.8 million. No additional payments remain to be paid related to severance and benefit-related costs included in the 2001 Charge.

        Asset Impairment Costs.    We also evaluated the carrying value of certain long-lived assets that were affected by the 2001 Plan. The affected assets were primarily comprised of information technology systems and equipment, software development projects and leasehold improvements. We determined that the carrying value of these assets exceeded their estimated fair values. The fair values of these assets were determined based on market information available for similar assets. For certain of the assets, we determined that they had no continuing value to us due to our abandoning certain plans and projects in connection with our workforce reductions.

        Accordingly, we recorded asset impairment charges of $27.9 million consisting entirely of non-cash write-downs of equipment, building improvements and software application and development costs,

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which charges were included in the 2001 Charge. The carrying value of these assets was $6.9 million as of December 31, 2002.

        The asset impairment charges of $27.9 million consist of $10.8 million for write-downs of assets related to the consolidation of four data centers, including all computer platforms, networks and applications into a single processing facility at our Hazel Data Center; $16.3 million related to abandoned software applications and development projects resulting from the workforce reductions, migration of certain systems and investments to more robust technologies; and $0.8 million for write-downs of leasehold improvements.

        Real Estate Lease Termination Costs.    The 2001 Charge included charges of $5.1 million related to termination of lease obligations and non-cancelable lease costs for excess office space resulting from streamlined operations and consolidation efforts. Through December 31, 2002, we had paid $1.7 million of the termination obligations. The remainder of the termination obligations of $3.4 million will be paid during the remainder of the respective lease terms.

        Other Costs.    The 2001 Charge included charges of $3.4 million related to costs associated with closing certain data center operations and systems and other activities which were completed and paid for in the first quarter ended March 31, 2002.

POTENTIAL DIVESTITURES.

        We continue to evaluate the profitability realized or likely to be realized by our existing businesses and operations. We are reviewing from a strategic standpoint which of such businesses or operations, if any, should be divested.

APPROVAL OF NON-AUDIT SERVICES

        The Audit Committee of our Board of Directors has approved the following non-audit services to be performed by Deloitte & Touche LLP, our independent auditor: (1) certain tax services and consultations; (2) actuarial certification services; (3) benefit plan audit services; and (4) certain other miscellaneous non-audit services permitted under Section 10A of the Exchange Act.

CAUTIONARY STATEMENTS

        In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, we are hereby filing cautionary statements identifying important risk factors that could cause our actual results to differ materially from those projected in "forward-looking statements" of the Company made by or on behalf of the Company, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. All statements, other than statements of historical information provided or incorporated by reference herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects" and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, the factors set forth below and the risks discussed in our other filings with the SEC.

        We wish to caution readers that these factors, among others, could cause our actual financial or enrollment results to differ materially from those expressed in any projections, estimates or forward-looking statements relating to the Company. The following factors should be considered in conjunction with any discussion of operations or results by us or our representatives, including any forward-looking discussion, as well as comments contained in press releases, presentations to securities analysts or investors, or other communications by us. You should not place undue reliance on these forward-

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looking statements, which reflect management's analysis, judgment, belief or expectation only as of the date thereof.

        In making these statements, we are not undertaking to address or update each factor in future filings or communications regarding our business or results, nor are we undertaking to address how any of these factors may have caused changes to matters discussed or information contained in previous filings or communications. In addition, certain of these factors may have affected our past results and may affect future results.

HEALTH CARE COSTS.     A large portion of the revenue we receive is expended to pay the costs of health care services or supplies delivered to our members. The total health care costs incurred by us are affected by the number of individual services rendered and the cost of each service. Much of our premium revenue is set in advance of the actual delivery of services, and in certain circumstances before contracting with providers, and the related incurring of the cost, usually on a prospective annual basis. While we attempt to base the premiums we charge at least in part on our estimate of expected health care costs over the fixed premium period, competition, regulations and other circumstances may limit our ability to fully base premiums on estimated costs. In addition, many factors may and often do cause actual health care costs to exceed those costs estimated and reflected in premiums. These factors may include increased utilization of services, increased cost of individual services, catastrophes, epidemics, seasonality, new mandated benefits or other regulatory changes, and insured population characteristics.

        The managed health care industry is labor intensive and its profit margin is low; hence, it is especially sensitive to inflation. Health care industry costs have been rising annually at rates higher than the rate of increase of the Consumer Price Index. Increases in medical expenses or contracted medical rates without corresponding increases in premiums could have a material adverse effect on us.

        RESERVES FOR CLAIMS.    Our reserves for claims are estimates of future costs based on various assumptions. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicious administration of claims, medical costs and other factors. Included in the reserves for claims are estimates for the costs of services which have been incurred but not reported. Estimates are continually monitored and reviewed and, as settlements are made or estimates adjusted, differences are reflected in current operations. Given the uncertainties inherent in such estimates, the actual liability could differ significantly from the amounts reserved. Moreover, if the assumptions on which the estimates are based prove to be incorrect and reserves are inadequate to cover our actual claim costs, our financial condition could be adversely affected.

        PHARMACEUTICAL COSTS.    The costs of pharmaceutical products and services are one of the fastest increasing categories of our health care costs. Thus, in addition to the circumstances and factors that may limit our ability to fully base premiums on estimated costs as mentioned in the health care costs cautionary statements, our HMOs face an even higher risk with pharmaceutical expenses that could have a material adverse effect. The inability to manage pharmaceutical costs could have an adverse effect on our financial condition. In addition, evolving regulation may impact the ability of our HMOs to continue to receive existing price discounts for our membership.

        FEDERAL AND STATE LEGISLATION.    There are frequently legislative proposals before the United States Congress and state legislatures which, if enacted, could materially affect the managed health care industry and the regulatory environment. Recent financial difficulties of certain health care service providers and plans and/or continued publicity of the health care industry could alter or increase legislative consideration of these or additional proposals. These proposals include federal and state "patients' bill of rights" legislation and other initiatives which, if enacted, could have significant adverse effects on our operations. Such measures propose, among other things, to:

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expand health plan exposure to tort and other liability under federal and/or state law, including for coverage determinations, provider malpractice and care decisions;



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restrict a health plan's ability to limit coverage to medically necessary care;



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require third party review of certain care decisions;



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expedite or modify grievance and appeals procedures;



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reduce the reimbursement or payment levels for services provided under government programs such as Medicare or Medicaid;



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mandate certain benefits and services that could increase costs;



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restrict a health plan's ability to select and/or terminate providers; and



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restrict or eliminate the use of prescription drug formularies and potentially related discounting of products for membership.

        We cannot predict the outcome of any of these legislative proposals nor the extent to which we may be affected by the enactment of any such legislation. Legislation or regulation which causes us to change our current manner of operation or increases our exposure to liability could have a material adverse effect on our results of operations, financial condition and ability to compete.

        In addition, in December 2000, the Department of Health and Human Services promulgated regulations under HIPAA related to the privacy and security of electronically transmitted protected health information ("PHI"). The new regulations require health plans, clearinghouses and providers to (a) comply with various requirements and restrictions related to the use, storage and disclosure of PHI, (b) adopt rigorous internal procedures to safeguard PHI and (c) enter into specific written agreements with business associates to whom PHI is disclosed. The regulations also establish significant criminal penalties and civil sanctions for non-compliance. In addition, the regulations could expose us to additional liability for, among other things, violations of the regulations by our business associates. We believe that the costs required to comply with these regulations will be significant and could have a material adverse impact on our business or results of operations.

        PROVIDER RELATIONS.    We contract with physicians, hospitals and other providers as a means to provide access to health care services for our members, to manage health care costs and utilization, and to monitor the quality of care being delivered. In any particular market, providers could refuse to contract with us, demand higher payments or take other actions which could result in higher health care costs, less desirable products for customers and members, insufficient provider access for current members or to support growth, or difficulty in meeting regulatory or accreditation requirements.

        In some markets, certain providers, particularly hospitals, physician/hospital organizations and multi-specialty physician groups, may have significant market positions or even monopolies. Many of these providers may compete directly with us. If these providers refuse to contract with us or utilize their market position to negotiate favorable contracts or place us at a competitive disadvantage, our ability to market our products or to be profitable in those areas could be adversely affected.

        We contract with providers in California and Connecticut primarily through capitation fee arrangements. We also use capitation fee arrangements in areas other than California and Connecticut, but to a lesser extent. Under a capitation fee arrangement, we pay the provider a fixed amount per member on a regular basis and the provider accepts the risk of the frequency and cost of member utilization of services. Providers who enter into capitation fee arrangements generally contract with specialists and other secondary providers to provide services not offered by the primary provider. The inability of providers to properly manage costs under capitation arrangements can result in their financial instability and the termination of their relationship with us. In addition, payment or other disputes between the primary provider and specialists with whom the primary provider contracts can

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result in a disruption in the provision of services to our members or a reduction in the services available. A primary provider's financial instability or failure to pay secondary providers for services rendered could lead secondary providers to demand payment from us, even though we have made our regular capitated payments to the primary provider. Depending on state law, we could be liable for such claims. In California, the liability of our HMO subsidiaries for unpaid provider claims has not been definitively settled. There can be no assurance that our subsidiaries will not be liable for unpaid provider claims. There can also be no assurance that providers with whom we contract will properly manage the costs of services, maintain financial solvency or avoid disputes with secondary providers, the failure of any of which could have an adverse effect on the provision of services to members and our operations.

        GOVERNMENT PROGRAMS AND REGULATION.    Our business is subject to extensive federal and state laws and regulations, including, but not limited to, financial requirements, licensing requirements, enrollment requirements and periodic examinations by governmental agencies. The laws and rules governing our business and interpretations of those laws and rules are subject to frequent change. Existing or future laws and rules could force us to change how we do business and may restrict our revenue and/or enrollment growth, and/or increase its health care and administrative costs, and/or increase our exposure to liability with respect to members, providers or others. In particular, our HMO and insurance subsidiaries are subject to regulations relating to cash reserves, minimum net worth, premium rates, and approval of policy language and benefits. Although these regulations have not significantly impeded the growth of our business to date, there can be no assurance that we will be able to continue to obtain or maintain required governmental approvals or licenses or that regulatory changes will not have a material adverse effect on our business. Delays in obtaining or failure to obtain or maintain governmental approvals, or moratoria imposed by regulatory authorities, could adversely affect our revenue or the number of our members, increase costs or adversely affect our ability to bring new products to market as forecasted. In addition, efforts to enact changes to Medicare could impact the structure of the Medicare program, benefit designs and reimbursement. Changes to the current operation of our Medicare services could have a material adverse effect on our results of operations.

        A significant portion of our revenues relate to federal, state and local government health care coverage programs, such as Medicare, Medicaid and TRICARE programs. Such contracts are generally subject to frequent change including changes which may reduce the number of persons enrolled or eligible, reduce the revenue received by us or increase our administrative or health care costs under such programs. In the event government reimbursement were to decline from projected amounts, our failure to reduce the health care costs associated with such programs could have a material adverse effect on our business. Changes to government health care coverage programs in the future may also affect our willingness to participate in these programs.

        We are also subject to various federal and state governmental audits and investigations. These audits and investigations could result in the loss of licensure or the right to participate in certain programs, or the imposition of fines, penalties and other sanctions. In addition, disclosure of any adverse investigation or audit results or sanctions could negatively affect our reputation in various markets and make it more difficult for us to sell our products and services.

        The amount of government receivables set forth in our condensed consolidated financial statements represents our best estimate of the government's liability under TRICARE and other federal government contracts. In December 2000, our subsidiary, Federal Services, and the United States Department of Defense agreed to a settlement of approximately $389 million for outstanding receivables, of which we received $60 million in December 2000 and the remainder in January 2001. In general, government receivables are estimates and subject to government audit and negotiation. In addition, inherent in government contracts are an uncertainty of and vulnerability to government disagreements. Final amounts we actually receive under government contracts may be significantly greater or less than the amounts we recognize.

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        On August 1, 2002, the United States Department of Defense ("DoD") issued a Request For Proposals ("RFP") for the rebid of the TRICARE contracts. The RFP divides the United States into three regions (North, South and West) and provides for the award of one contract for each region. The RFP also provides that each of the three new contracts will be awarded to a different prime contractor. Proposals in response to the RFP for each of the three regions were submitted by Federal Services in January 2003, and it is anticipated that the DoD will award the three new TRICARE contracts on or before June 1, 2003. Health care delivery under the new TRICARE contracts will not commence until the expiration of health care delivery under the current TRICARE contracts. If all option periods are exercised by the DoD under the current TRICARE contracts with the Company and no further extensions are made, health care delivery ends on February 29, 2004 for the Region 11 contract, on March 31, 2004 for the Regions 9, 10 and 12 contract and on October 31, 2004 for the Region 6 contract.

        INTERNET-RELATED OPERATIONS.    The emergence of the Internet and related new technologies may fundamentally change managed care organizations. In this connection, the Company has previously attempted to develop collaborative approaches with business partners to transform their existing assets and expertise into new e-business opportunities, including the development of net-enabled connectivity among purchasers, consumers, managed care organizations, providers and other trading partners.

        There can be no assurance that we will be able to recognize or capitalize on the Internet-related opportunities or technologies that ultimately prove to be accepted and effective within the managed care industry, the provider communities and/or among consumers. There can also be no assurance that new technologies invested in or developed by us or our business partners will prove operational; that they will be accepted by consumers, providers or business partners; that they will achieve their intended results; that we will recoup our investment in Internet-related technologies or related ventures; or that other technologies will not be more accepted or prove more effective. In addition, we contract with and rely upon third parties for certain Internet-related content, tools and services. We have also contracted to establish links between our web sites and third party web sites. Any failure by those third parties to perform in accordance with the terms of their agreements or to comply with applicable law could adversely impact our Internet operations and services, and could expose us to liability.

        HEALTH CARE COSTS AND PREMIUM PRICING PRESSURES.    Our future profitability will depend in part on accurately predicting health care costs and on our ability to control future health care costs through underwriting criteria, utilization management, product design and negotiation of favorable provider and hospital contracts. Changes in utilization rates, demographic characteristics, the regulatory environment, health care practices, inflation, new technologies, clusters of high-cost cases, continued consolidation of physician, hospital and other provider groups and numerous other factors affecting health care costs may adversely affect our ability to predict and control health care costs as well as our financial condition, results of operations or cash flows. Periodic renegotiations of hospital and other provider contracts, coupled with continued consolidation of physician, hospital and other provider groups, may result in increased health care costs or limit the Company's ability to negotiate favorable rates. In the past few years, large physician practice management companies have experienced extreme financial difficulties (including bankruptcy), which may subject the Company to increased credit risk related to provider groups and cause the Company to incur duplicative claims expense.

        In addition to the challenge of controlling health care costs, the Company faces competitive pressure to contain premium prices. While health plans compete on the basis of many factors, including service and the quality and depth of provider networks, the Company expects that price will continue to be a significant basis of competition. Fiscal concerns regarding the continued viability of programs such as Medicare and Medicaid may cause decreasing reimbursement rates for government-sponsored programs. Our financial condition or results of operations could be adversely affected by significant

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premium decreases by our major competitors or by limitations on the Company's ability to increase or maintain its premium levels.

        MANAGEMENT INFORMATION SYSTEMS.    Our business depends significantly on effective information systems. The information gathered and processed by our management information systems assists us in, among other things, pricing our services, monitoring utilization and other cost factors, processing provider claims, billing our customers on a timely basis and identifying accounts for collection. Our customers and providers also depend upon our information systems for membership verification, claims status and other information. We have many different information systems for our various businesses and these systems require continual maintenance, upgrading and enhancement to meet our operational needs. Moreover, our merger, acquisition and divestiture activity requires frequent transitions to or from, and the integration of, various information management systems. We are in the process of attempting to reduce the number of our systems, to upgrade and expand our information systems capabilities, and to obtain and develop new, more efficient information systems. Any difficulty associated with the transition to or from information systems, any inability or failure to properly maintain management information systems, or any inability or failure to successfully update or expand processing capability or develop new capabilities to meet our business needs, could result in operational disruptions, loss of existing customers, difficulty in attracting new customers, disputes with customers and providers, regulatory problems, increases in administrative expenses and/or other adverse consequences. In addition, we may, from time-to-time, obtain significant portions of our systems-related or other services or facilities from independent third parties which may make our operations vulnerable to adverse effects if such third parties fail to perform adequately.

        COMPETITION.    We compete with a number of other entities in the geographic and product markets in which we operate, some of which other entities may have certain characteristics, capabilities or resources that give them an advantage in competing with us. These competitors include HMOs, PPOs, self-funded employers, insurance companies, hospitals, health care facilities and other health care providers. In addition, financial services or other technology-based companies could enter the market and compete with us on the basis of their streamlined administrative functions. We believe there are few barriers to entry in these markets, so that the addition of new competitors can readily occur. Customers of ours may decide to perform for themselves functions or services currently provided by us, which could result in a decrease in our revenues. Our providers and suppliers may decide to market products and services to our customers in competition with us. In addition, significant merger and acquisition activity has occurred both in our industry and in industries which act as our suppliers, such as the hospital, physician, pharmaceutical and medical device industries. This activity may create stronger competitors and/or result in higher health care costs. Health care providers may establish provider service organizations to offer competing managed care products. To the extent that there is strong competition or that competition intensifies in any market, our ability to retain or increase customers, our revenue growth, our pricing flexibility, our control over medical cost trends and our marketing expenses may all be adversely affected. In September 2002, class certification was granted to the plaintiffs in an action brought against various managed care organizations, including us, on behalf of physicians. See "—Other Information—Legal Proceedings—In re Managed Care Litigation—Provider Track."

        LITIGATION AND INSURANCE.    We are subject to a variety of legal actions to which any corporation may be subject, including employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims, shareholder suits, including for securities fraud, and intellectual property related litigation. In addition, we incur and likely will continue to incur potential liability for claims particularly related to our business, such as failure to pay for or provide health care, poor outcomes for care delivered or arranged, provider disputes, including disputes over withheld compensation, and claims related to self-funded business. Also, there are currently, and may be in the future, attempts to bring class action lawsuits against various managed

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care organizations, including us. In September 2002, class certification was granted to the plaintiffs in an action brought against various managed care organizations, including us, on behalf of physicians. See "—Other Information—Legal Proceedings—In re Managed Care Litigation—Provider Track." Class action lawsuits could expose us to significant potential liability or cause us to make operational changes. In some cases, substantial non-economic or punitive damages are being sought. While we currently have insurance coverage for some of these potential liabilities, others (such as punitive damages), may not be covered by insurance, the insurers may dispute coverage or the amount of insurance may not be sufficient to cover the damages awarded. In addition, insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.

        ADMINISTRATION AND MANAGEMENT.    The level of administrative expense is a partial determinant of our profitability. While we attempt to effectively manage such expenses, including through the development of online functionalities and resources designed to create administrative efficiencies, increases in staff-related and other administrative expenses may occur from time to time due to business or product start-ups or expansions, growth or changes in business, acquisitions, regulatory requirements, including compliance with HIPAA regulations, or other reasons. Administrative expense increases are difficult to predict and may adversely affect results.

        We believe we have a relatively experienced, capable management staff. Loss of certain managers or a number of such managers could adversely affect our ability to administer and manage our business.

        FINANCING CONDITIONS.    Our indebtedness includes $400 million in unsecured senior notes due 2011. We also have in place a $525 million five-year revolving credit and competitive advance facility that expires in June 2006, and a 364-day revolving credit facility that expires in June 2003. See the discussion under the headings "—Other Information—Recent and Other Developments—Debt Offering" and "—Other Information—Recent and Other Developments—Credit Agreements." Accordingly, we are considering our financing alternatives, including renewing or terming out the 364-day credit facility, obtaining a new credit facility and pursuing a public debt offering. Our ability to obtain any financing, whether through renewal of our existing credit facilities, obtaining a new credit facility, issuing public debt or otherwise, and the terms of any such financing are dependent on, among other things, our financial condition, financial market conditions within our industry and generally, credit ratings and numerous other factors. There can be no assurance that we will be able to renew our current credit facilities prior to their expiration, or obtain a new credit facility, on terms similar to those of our current credit facilities or on more favorable terms, if at all, or initiate and complete a public debt offering or otherwise obtain financing on acceptable terms or within an acceptable time, if at all. Failure to renew the existing 364-day credit facility prior to its expiration or to otherwise obtain financing on terms and within a time acceptable to us could, in addition to other negative effects, have a material adverse effect on our operations, financial condition, ability to compete or ability to comply with regulatory requirements.

        MARKETING.    We market our products and services both through sales people employed by us and through independent sales agents. Although we have a number of sales employees and agents, if key sales employees or agents or a large subset of these individuals were to leave us, our ability to retain existing customers and members could be impaired. In addition, certain of our customers or potential customers consider necessary or important the rating, accreditation or certification of us and our subsidiaries by various private or governmental bodies or rating agencies. Certain of our health plans or other business units may not have obtained or may not desire or be able to obtain or maintain the rating, accreditation or certification these customers or potential customers desire, which could adversely affect our ability to obtain or retain business.

        Our marketing efforts may be affected by the significant amount of negative publicity to which the managed care industry has been subject, as well as by speculation and uncertainty relating to merger

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and acquisition activity among companies in our industry. Negative publicity about our industry, or any negative publicity regarding us in particular, could adversely affect our ability to sell our products or services, could require changes to our products or services, or could stimulate additional regulation that adversely affects us. In this regard, some of our subsidiaries have experienced significant negative enrollment trends in certain lines of business. The managed care industry recently has experienced significant merger and acquisition activity, giving rise to speculation and uncertainty regarding the status of companies in our industry. Speculation, uncertainty or negative publicity about us, our industry or our lines of business could adversely affect our ability to market our products.

        POTENTIAL DIVESTITURES.    In 1999, we substantially completed a program to divest certain non-core assets. There can be no assurance that, having divested such non-core operations, we will be able to achieve greater (or any) profitability, strengthen our core operations or compete more effectively in our existing markets. In 2001, we sold our Florida health plan, and in 2002 we sold certain claims processing operations. In addition, we continue to evaluate the profitability realized or likely to be realized by our existing businesses and operations, and we are reviewing from a strategic standpoint which, if any, of our businesses or operations should be divested. Entering into, evaluating or consummating divestiture transactions may entail risks and uncertainties in addition to those which may result from the divestiture-related change in our business operations, including but not limited to extraordinary transaction costs, unknown indemnification liabilities and unforeseen administrative complications, any of which could result in reduced revenues, increased charges, or post-transaction administrative costs or could otherwise have a material adverse effect on our business, financial condition or results of operations.

        MANAGEMENT OF GROWTH.    We have made large acquisitions from time to time and continue to explore acquisition opportunities. Failure to effectively integrate acquired operations could result in increased administrative costs or customer confusion or dissatisfaction. We also may not be able to manage acquisition-related growth effectively if, among other potential difficulties, we are unable to continue to develop processes and systems to support growing operations.

        FINANCIAL OUTLOOK.    From time to time in press releases and otherwise, we may publish forecasts or other forward-looking statements regarding our future results, including estimated revenues, net earnings and other operating and financial metrics. Any forecast of our future performance reflects various assumptions. These assumptions are subject to significant uncertainties, and as a matter of course, any number of them may prove to be incorrect. Further, the achievement of any forecast depends on numerous risks and other factors (including those described in this discussion), many of which are beyond our control. As a result, we cannot assure that our performance will be consistent with any management forecasts or that the variation from such forecasts will not be material and adverse. You are cautioned not to base your entire analysis of our business and prospects upon isolated predictions, but instead are encouraged to utilize the entire publicly available mix of historical and forward-looking information, as well as other available information affecting us and our services, when evaluating our prospective results of operations.

        STOCK MARKET.    Recently, the market prices of the securities of certain of the publicly-held companies in the industry in which we operate have shown volatility and sensitivity in response to many factors, including public communications regarding managed care, legislative or regulatory actions, litigation or threatened litigation, health care cost trends, pricing trends, competition, earning or membership reports of particular industry participants, and acquisition activity. There can be no assurances regarding the level or stability of our share price at any time or the impact of these or any other factors on our stock price.

        DISASTER RECOVERY.    We are in the process of updating our disaster recovery plans which now include the capability of maintaining fully redundant systems for our operations utilizing various alternate sites provided by a national disaster recovery vendor. Before these plans are fully updated, a

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disaster such as fire, flood, earthquake, tornado, power loss, virus, telecommunications failure, break-in or similar event could severely damage or interrupt our systems and operations, result in loss of data, and/or delay or impair our ability to service our members and providers. Even after the plans are updated, there can be no assurance that such adverse effects will not occur in the event of a disaster. Due to the limited availability of electricity in California in past years, where a substantial part of our operations are located, certain of our locations in that state have experienced sporadic periods of electricity outages. A substantial or sustained interruption in the power supplied to our facilities and systems in California or elsewhere could significantly and negatively impact our ability to conduct our business. Any such disaster, power loss or similar event could have a material adverse effect on our business, financial condition and results of operations.

        TERRORIST AND OTHER MALICIOUS ACTIVITY.    We have updated our procedures for dealing with potential terrorist-related activity such as the September 11, 2001 attacks, the anthrax cases in 2001 and potential future events involving malicious activity. Even with such updated procedures, there can be no assurance that such events will not occur or that such events will not materially or negatively affect the Company, including through adverse effects on general economic conditions, industry- and company-specific economic conditions, the price and availability of products or services, the availability or morale of employees, our operations and or its facilities, or the demand for our products and services.

Item 2. Properties.

        We lease office space for our principal executive offices in Woodland Hills, California and our offices in Rancho Cordova, California. Our executive offices, comprising approximately 110,000 square feet, are occupied under a lease expiring December 31, 2004. A significant portion of our California HMO operations are also housed in Woodland Hills, in a separate, 325,000 square foot leased facility. This new, two-building facility was occupied at the end of 2001, under a lease that expires December 31, 2011. Combined rent for our Woodland Hills facilities was approximately $12.8 million in 2002.

        We also lease an aggregate of approximately 440,000 square feet of office space in Rancho Cordova, California for certain Health Plan Services and Government Contract operations. Our aggregate rent obligations under these leases were approximately $5.4 million in 2002. These leases expire at various dates. We also lease a total of approximately 240,000 square feet of office space in Irvine, California and San Rafael, California for certain specialty services operations.

        In addition to the office space referenced above, we lease approximately 120 sites in 22 states, totaling roughly 2 million square feet of space.

        We also own facilities comprising, in the aggregate, approximately 770,000 square feet of space. These facilities include headquarters for our health plan subsidiaries in Arizona and Connecticut, as well as a data processing facility in Rancho Cordova, California.

        We believe that our ownership and rental costs are consistent with those associated with similar space in the applicable local areas. Our properties are well maintained, adequately meet our needs and are being utilized for their intended purposes.

Item 3. Legal Proceedings.

SUPERIOR NATIONAL INSURANCE GROUP, INC.

        We and our former wholly-owned subsidiary, Foundation Health Corporation ("FHC"), which merged into Health Net, Inc. in January 2001, were named in an adversary proceeding, Superior National Insurance Group, Inc. v. Foundation Health Corporation, Foundation Health Systems, Inc.

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and Milliman & Robertson, Inc. ("M&R"), filed on April 28, 2000, in the United States Bankruptcy Court for the Central District of California, case number SV00-14099GM. The lawsuit relates to the 1998 sale of Business Insurance Group, Inc. ("BIG"), a holding company of workers' compensation insurance companies operating primarily in California, by FHC to Superior National Insurance Group, Inc. ("Superior").

        On March 3, 2000, the California Department of Insurance seized BIG and Superior's other California insurance subsidiaries. On April 26, 2000, Superior filed for bankruptcy. Two days later, Superior filed its lawsuit against us, FHC and M&R. Superior alleges in the lawsuit that:

•

the BIG transaction was a fraudulent transfer under federal and California bankruptcy laws in that Superior did not receive reasonably equivalent value for the $285 million in consideration paid for BIG;



•

we, FHC and M&R defrauded Superior by making misstatements as to the adequacy of BIG's reserves;



•

Superior is entitled to rescind its purchase of BIG;



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Superior is entitled to indemnification for losses it allegedly incurred in connection with the BIG transaction;



•

FHC breached the stock purchase agreement relating to the sale of BIG; and



•

we and FHC were guilty of California securities laws violations in connection with the sale of BIG.

        Superior seeks $300 million in compensatory damages, unspecified punitive damages and the costs of the action, including attorneys' fees. In discovery, Superior has offered testimony as to various damages claims, ranging as high as $408 million plus unspecified amounts of punitive damages. We dispute all of Superior's claims, including the entire amount of damages claimed by Superior.

        On August 1, 2000, a motion filed by us and FHC to remove the lawsuit from the jurisdiction of the Bankruptcy Court to the United States District Court for the Central District of California was granted. Pursuant to a June 12, 2002 intra-district transfer order, the lawsuit was transferred to Judge Percy A. Anderson. On August 23, 2002, pursuant to a stipulation filed by Superior and M&R, Superior dismissed all of its claims against M&R. On December 5, 2002, however, Judge Anderson recused himself and issued a second intra-district transfer order. The lawsuit is now pending in the District Court under case number SACV-00-658 (GLT)(MLG) before Judge Gary L. Taylor. We and Superior are completing discovery and are engaged in pretrial motions. On December 20, 2002 Judge Taylor issued an order setting a discovery cut-off date of July 2, 2003 and a trial date to be held in November 2003.

        We intend to defend ourselves vigorously in this litigation. While the final outcome of these proceedings cannot be determined at this time, based on information presently available, we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

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FPA MEDICAL MANAGEMENT, INC.

        Since May 1998, several complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA Medical Management, Inc. ("FPA") at various times between February 3, 1997 and May 15, 1998. The complaints name as defendants FPA, certain of FPA's auditors, us and certain of our former officers, and were filed in the following courts: United States District Court for the Southern District of California; United States Bankruptcy Court for the District of Delaware; and California Superior Court in the County of Sacramento. The complaints allege that we and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between us and FPA, about FPA's business and about our 1997 sale of FPA common stock held by us. All claims against our former officers were voluntarily dismissed from the consolidated class actions in both federal and state court. In early 2000, we filed a motion to dismiss all claims asserted against us in the consolidated federal class actions but have not formally responded to the other complaints. That motion has been withdrawn without prejudice and the consolidated federal class actions have been stayed pending resolution of matters in a related case in which we are not a party.

        We intend to vigorously defend the actions. While the final outcome of these proceedings can not be determined at this time, based on information presently available we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC.

        Physicians Health Services, Inc. ("PHS"), a subsidiary of ours, was sued on December 14, 1999 in the United States District Court in Connecticut by the Attorney General of Connecticut, Richard Blumenthal, acting on behalf of a group of state residents. The lawsuit was premised on the Federal Employee Retirement Income Security Act ("ERISA") and alleged that PHS violated its duties under ERISA by managing its prescription drug formulary in a manner that served its own financial interest rather than those of plan beneficiaries. The suit sought to have PHS revamp its formulary system and to provide patients with written denial notices and instructions on how to appeal. PHS filed a motion to dismiss which asserted that the state residents the Attorney General purported to represent all received a prescription drug appropriate for their conditions and therefore suffered no injuries whatsoever, that his office lacked standing to bring the suit and that the allegations failed to state a claim under ERISA. On July 12, 2000, the court granted PHS' motion and dismissed the action. On March 27, 2002, the United States Court of Appeals for the Second Circuit affirmed the district court's dismissal of the action. On June 25, 2002, the plaintiff filed a petition requesting that the United States Supreme Court review the Second Circuit's decision to affirm dismissal of the case. On October 7, 2002, the United States Supreme Court denied plaintiff's petition for review. As a result, we believe the Company has no further exposure for this case.

IN RE MANAGED CARE LITIGATION

        The Judicial Panel on Multidistrict Litigation ("JPML") has transferred various class action lawsuits against managed care companies, including us, to the United States District Court for the Southern District of Florida for coordinated or consolidated pretrial proceedings in In re Managed Care Litigation, MDL 1334. This proceeding is divided into two tracks, the subscriber track, which includes actions brought on behalf of health plan members, and the provider track, which includes suits brought on behalf of physicians.

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Subscriber Track

        The subscriber track includes the following actions involving us: Pay v. Foundation Health Systems, Inc. (filed in the Southern District of Mississippi on November 22, 1999), Romero v. Foundation Health Systems, Inc. (filed in the Southern District of Florida on June 23, 2000, as an amendment to a suit filed in the Southern District of Mississippi), State of Connecticut v. Physicians Health Services of Connecticut, Inc.(filed in the District of Connecticut on September 7, 2000), and Albert v. CIGNA Healthcare of Connecticut, Inc., et al. (including Physicians Health Services of Connecticut, Inc. and Foundation Health Systems, Inc.) (filed in the District of Connecticut on September 7, 2000). The Pay and Romero actions seek certification of nationwide class actions, unspecified damages and injunctive relief and allege that cost containment measures used by our health maintenance organizations, preferred provider organizations and point-of-service health plans violate provisions of the federal Racketeer Influenced and Corrupt Organizations Act ("RICO") and ERISA. The Albert suit also alleges violations of ERISA and seeks certification of a nationwide class and unspecified damages and injunctive relief. The State of Connecticut action asserts claims against our subsidiary, Physicians Health Services of Connecticut,  Inc., and us that are similar, if not identical, to those asserted in the previous lawsuit which, as discussed above, the United States Court of Appeals for the Second Circuit affirmed dismissal of on March 27, 2002.

        We filed a motion to dismiss the lead subscriber track case, Romero v. Foundation Health Systems, Inc., and on June 12, 2001, the court entered an order dismissing all claims in that suit brought against us with leave for the plaintiffs to re-file an amended complaint. On this same date, the court stayed discovery until after the court ruled upon motions to dismiss the amended complaints and any motions to compel arbitration. On June 29, 2001, the plaintiffs in Romero filed a third amended class action complaint which re-alleges causes of action under RICO, ERISA, common law civil conspiracy and common law unjust enrichment. The third amended class action complaint seeks unspecified compensatory and treble damages and equitable relief. On July 24, 2001, the court heard oral argument on class certification issues. On August 13, 2001, we filed a motion to dismiss the third amended complaint in Romero. On February 20, 2002, the court ruled on our motion to dismiss the third amended complaint in Romero. The court dismissed all claims against us except one ERISA claim. The court further ordered that plaintiffs may file amended complaints, but that no new plaintiffs or claims will be permitted without prior leave of the court. Both plaintiffs and defendants filed motions for reconsideration relating to various parts of the court's dismissal order, which motions were denied. On March 25, 2002, the district court amended its February 20, 2002 dismissal order to include the following statement: "This Order involves a controlling question of law, namely, whether a managed-care subscriber who has not actually been denied care can state a claim under RICO, about which there is substantial ground for difference of opinion and an immediate appeal may materially advance the ultimate termination of this litigation." On April 5, 2002, we joined in a petition to the United States Court of Appeals for the Eleventh Circuit for permission to appeal the question certified by the district court. On May 10, 2002, the Eleventh Circuit denied the petition. On June 26, 2002, the plaintiffs filed with the Court a notice that they will not file an amended complaint against the Company. Health Net filed its answer on July 26, 2002. On July 29, 2002, the Court ordered that the stay of discovery is lifted effective September 30, 2002.

        On September 26, 2002, the Court denied plaintiff Romero's motion for class certification. The Court initially scheduled plaintiff Romero's individual case for trial in May 2003. On October 1, 2002, the Court issued an order referring plaintiff Romero's individual case to mediation. On October 10, 2002, plaintiff Romero filed a motion requesting that the Court reconsider its decision to deny class certification. On November 25, 2002, the Court denied plaintiff Romero's motion for reconsideration. The deadline for plaintiffs to appeal to the Eleventh Circuit the district court's denial of class status expired on December 10, 2002. On January 16, 2003, the district court moved the trial date from May to September 2003. In the interest of avoiding the further expense and burden of continued litigation,

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we resolved the lead subscriber track case for an immaterial amount ($2,500). As a result of this settlement, the Romero and Pay actions will be dismissed with prejudice with no admission of liability. Signed settlement papers were received from plaintiffs on March 20, 2003 and will be submitted to the Court for entry of the Order dismissing the actions. The State of Connecticut and Albert actions remain pending.

Provider Track

        The provider track includes the following actions involving us: Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (filed in the Southern District of Florida on August 17, 2000 as an amendment to a suit filed in the Southern District of Mississippi), California Medical Association v. Blue Cross of California, Inc., PacifiCare Health Systems, Inc., PacifiCare Operations, Inc. and Foundation Health Systems, Inc.(filed in the Northern District of California in May 2000), Klay v. Prudential Ins. Co. of America, et al. (including Foundation Health Systems, Inc.) (filed in the Southern District of Florida on February 22, 2001 as an amendment to a case filed in the Northern District of California), Connecticut State Medical Society v. Physicians Health Services of Connecticut, Inc. (filed in Connecticut state court on February 14, 2001), Lynch v. Physicians Health Services of Connecticut, Inc. (filed in Connecticut state court on February 14, 2001), Sutter v. Health Net of the Northeast, Inc. (D. N.J.) (filed in New Jersey state court on April 26, 2002) and Medical Society of New Jersey v. Health Net,  Inc., et al., (D. N.J.) (filed in New Jersey state court on May 8, 2002).

        On August 17, 2000, a complaint was filed in the United States District Court for the Southern District of Florida in Shane, the lead provider track action in MDL 1334. The complaint seeks certification of a nationwide class action on behalf of physicians and alleges that the defendant managed care companies' methods of reimbursing physicians violate provisions of RICO, ERISA, certain federal regulations and various state laws. The action seeks unspecified damages and injunctive relief.

        On September 22, 2000, we filed a motion to dismiss, or in the alternative to compel arbitration, in Shane. On December 11, 2000, the court granted in part and denied in part our motion to compel arbitration. Under the court's December arbitration order, plaintiff Dennis Breen, the single named plaintiff to allege a direct contractual relationship with us in the August complaint, was compelled to arbitrate his direct claims against us. We filed an appeal in the United States Court of Appeals for the 11th Circuit seeking to overturn the portion of the district court's December ruling that did not order certain claims to arbitration. On April 26, 2001, the court modified its December arbitration order and decided to retain jurisdiction over certain direct claims of plaintiff Breen relating to a single contract. On March 2, 2001, the District Court for the Southern District of Florida issued an order in Shane granting the dismissal of certain claims with prejudice and the dismissal of certain other claims without prejudice, and denying the dismissal of certain claims.

        On March 26, 2001, a consolidated amended complaint was filed in Shane against managed care companies, including us. This consolidated complaint adds new plaintiffs, including Leonard Klay and the California Medical Association (who, as set forth below, had previously filed claims against the Company), and has, in addition to revising the pleadings of the original claims, added a claim under the California Business and Professions Code. On May 1, 2001, we filed a motion to compel arbitration in Shane of the claims of all individual plaintiffs that allege to have treated persons insured by us. On that same date, we filed a motion to dismiss this action. Preliminary discovery and briefing regarding the plaintiffs' motion for class certification has taken place. On May 7, 2001, the court heard oral argument on class certification issues in Shane. On May 9, 2001, the court entered a scheduling order permitting further discovery. On May 14, 2001, Health Net joined in a motion for stay of proceedings in Shane v. Humana, Inc., et al.(including Foundation Health Systems, Inc.) (00-1334-MD) in the United States District Court for the Southern District of Florida pending appeal in the 11th Circuit Court of Appeals. On June 17, 2001, the district court stayed discovery until after the district court

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ruled upon motions to dismiss and motions to compel arbitration. This order staying discovery also applied to other actions transferred to the district court by the Judicial Panel on Multidistrict Litigation, namely California Medical Association v. Blue Cross of California, Inc. et al., Klay v. Prudential Ins. Co. of America, et al., Connecticut State Medical Society v. Physicians Health Services of Connecticut, Inc., and Lynch v. Physicians Health Services of Connecticut, Inc. On June 25, 2001, the 11th Circuit Court of Appeals entered an order staying proceedings in the district court pending resolution of the appeals relating to the district court's ruling on motions to compel arbitration. On March 14, 2002, the 11th Circuit affirmed the district court's ruling on motions to compel arbitration. On March 25, 2002, the plaintiffs filed with the Eleventh Circuit a motion for relief from the stay. We joined in an opposition to plaintiff's motion and joined a petition for rehearing of the arbitration issues before the entire Eleventh Circuit panel. On June 21, 2002, the Eleventh Circuit denied the petition for rehearing. Certain defendants filed a petition with the United States Supreme Court requesting review of a portion of the Eleventh Circuit's decision to affirm the district court's arbitration order. On July 12, 2002, the plaintiffs filed a motion requesting leave to amend their complaint. On July 29, 2002, the Court ordered that the stay of discovery is lifted effective September 30, 2002.

        On September 26, 2002, the Court granted plaintiffs' motion for class certification, initially scheduled trial to begin in May 2003, and granted plaintiffs' request for leave to amend their complaint. The new complaint adds another managed care company as a defendant, adds the Florida Medical Society and the Louisiana Medical Society as plaintiffs, withdraws Dennis Breen as a named plaintiff, and adds claims under the New Jersey Consumer Fraud Act and the Connecticut Unfair Trade Practices Act against defendants other than Health Net. On October 1, 2002, the Court issued an order referring the lead provider track case to mediation. On October 10, 2002, the defendants filed a petition requesting that the Eleventh Circuit review the district court's order granting class status. That same day, the defendants also filed a motion requesting that the district court stay discovery pending ruling on the appeal by the Eleventh Circuit, and pending ruling by the district court on the defendants' motion to dismiss and motions to compel arbitration. On October 15, 2002, the United States Supreme Court agreed to review a portion of the Eleventh Circuit's decision to affirm the district court's arbitration order. On October 25, 2002, Health Net requested that the district court stay discovery against it pending ruling by the Supreme Court on arbitration issues. The district court later denied this request. On February 24, 2003, the Supreme Court heard oral argument on the arbitration issues and that appeal is now under review by the Court. On October 18, 2002, the defendants filed a motion to dismiss the plaintiffs' amended complaint. On November 6, 2002, the district court denied the defendants' October 10, 2002 motion requesting a stay of discovery. On November 26, 2002, the plaintiffs filed a motion with the district court seeking leave to amend their complaint, which motion was denied. The district court has moved the trial date from May to December 2003.

        On November 20, 2002, the Eleventh Circuit granted the defendants' petition for review of the district court's certification decision. On December 2, 2002, the defendants filed a motion with the Eleventh Circuit requesting that it stay discovery pending resolution of the class certification appeal. The Eleventh Circuit denied this motion. On December 30, 2002, defendants filed their brief with the Eleventh Circuit seeking reversal of the district court's grant of class status. Briefing of this appeal was completed on March 13, 2003.

        The CMA action alleges violations of RICO, certain federal regulations and the California Business and Professions Code and seeks declaratory and injunctive relief, as well as costs and attorneys' fees. As set forth above, on March 26, 2001, the California Medical Association was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action.

        The Klay suit is a purported class action allegedly brought on behalf of individual physicians in California who provided health care services to members of the defendants' health plans. The complaint alleges violations of RICO, ERISA, certain federal regulations, the California Business and Professions Code and certain state common law doctrines, and seeks declaratory and injunctive relief,

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and damages. As set forth above, on March 26, 2001, Leonard Klay was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action.

        The CSMS case was originally brought in Connecticut state court against Physicians Health Services of Connecticut, Inc. ("PHS-CT") alleging violations of the Connecticut Unfair Trade Practices Act. The complaint alleges that PHS-CT engaged in conduct that was designed to delay, deny, impede and reduce lawful reimbursement to physicians who rendered medically necessary health care services to PHS-CT health plan members. The complaint, which is similar to others filed against us and other managed care companies, seeks declaratory and injunctive relief. On March 13, 2001, the Company removed this action to federal court. Before this case was transferred to MDL 1334, the plaintiffs moved to remand the action to state court and the federal District Court of Connecticut consolidated this action and Lynch v. Physicians Health Services of Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the complaint.

        The Lynch case was also originally filed in Connecticut state court. This case was purportedly brought on behalf of physician members of the Connecticut State Medical Society who provide health care services to PHS-CT health plan members pursuant to provider service contracts. The complaint alleges that PHS-CT engaged in improper, unfair and deceptive practices by denying, impeding and/or delaying lawful reimbursement to physicians. The complaint, similar to the complaint referred to above filed against PHS-CT on the same day by the Connecticut State Medical Society, seeks declaratory and injunctive relief and damages. On March 13, 2001, we removed this action to federal court. Before this case was transferred to MDL 1334, the plaintiffs moved to remand the action to state court and the federal District Court of Connecticut consolidated this action and CSMS v. Physicians Health Services of Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the complaint.

        On April 26, 2002, plaintiff John Ivan Sutter, M.D., P.A. filed an amended complaint in New Jersey state court joining Health Net of the Northeast, Inc. ("Health Net of the Northeast"), a subsidiary of ours, in an action originally brought against Horizon Blue Cross Blue Shield of New Jersey, Inc., CIGNA Healthcare of New Jersey, Inc. and CIGNA Corp (collectively known as "CIGNA"), United Healthcare of New Jersey, Inc. and United Healthcare Insurance Company and Oxford Health Plans, Inc. The complaint seeks certification of a statewide class of health care providers who render or have rendered services to patients who are members of health care plans sponsored by the defendants.

        Plaintiff alleges that the defendants engage in unfair and deceptive acts and practices which are designed to delay, deny, impede and reduce compensation to physicians. The complaint seeks unspecified damages and sets forth causes of action for breach of contract, breach of the implied duty of good faith and fair dealing, violations of the New Jersey Prompt Payment Act and the Healthcare Information Networks and Technologies Act (the "HINT Act"), reformation, violations of the New Jersey Consumer Fraud Act, unjust enrichment and conversion. On May 22, 2002, the New Jersey state court severed the action filed by Dr. Sutter into five separate cases, including an action against Health Net of the Northeast only. On May 24, 2002, Health Net of the Northeast removed the case against it to federal court. That same day, the CIGNA entities removed plaintiff Sutter's action against them to federal court and the United Healthcare entities removed plaintiff Sutter's action against them to federal court. Plaintiff moved to remand all of these cases to state court and the defendants moved to stay the cases pending ruling by the JPML as to whether these cases should be transferred to MDL 1334 for coordinated or consolidated pretrial proceedings. On July 9, 2002, the federal district court denied plaintiff's motion to remand without prejudice, consolidated the cases against Health Net of the Northeast, the CIGNA entities, and the United Healthcare entities into one case for pretrial proceedings, and stayed the case pending the JPML's ruling on transfer to MDL 1334. On July 18,

38

2002, the JPML transferred this action to MDL 1334 for coordinated or consolidated pretrial proceedings. On September 23, 2002, plaintiff filed in the MDL proceeding a motion to remand to state court. On November 5, 2002, defendants moved to suspend briefing on remand. The district court denied this motion on November 18, 2002, and remand briefing was completed on December 30, 2002.

        On May 8, 2002, the Medical Society of New Jersey filed a complaint in New Jersey state court against us and our subsidiaries, Health Net of the Northeast, Inc., First Option Health Plan of New Jersey, Inc., and Health Net of New Jersey, Inc. (the "Health Net defendants"). Plaintiff brought this action on its own behalf and purportedly on behalf of its physician members and alleges that the Health Net defendants engage in practices which are designed to delay, deny, impede and reduce compensation to physicians. Plaintiff has requested declaratory and injunctive relief and has set forth causes of action for violation of public policy, violations of the New Jersey Consumer Fraud Act, violations of the HINT Act and tortious interference with prospective economic relations. On June 14, 2002, the Health Net defendants removed this case to federal court. On July 3, 2002, the Health Net defendants filed a motion to stay this action pending ruling by the JPML on whether to transfer this case to MDL 1334. On July 15, 2002, plaintiff filed a motion to remand this case to state court. On August 2, 2002, the JPML transferred this case to MDL 1334 for coordinated or consolidated pretrial proceedings.

        We intend to defend ourselves vigorously in all of this JPML litigation. While the final outcome of these proceedings cannot be determined at this time, based on information presently available, we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

MISCELLANEOUS PROCEEDINGS

        We and certain of our subsidiaries are also parties to various other legal proceedings, many of which involve claims for coverage encountered in the ordinary course of our business. While the final outcome of these proceedings cannot be determined at this time, based on information presently available, we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

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

        There were no matters submitted to a vote of the security holders of the Company, either through solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 2002.

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PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.

        The following table sets forth the high and low sales prices of the Company's Class A Common Stock, par value $.001 per share (the "Class A Common Stock"), on The New York Stock Exchange, Inc. ("NYSE") since January 3, 2001.

		HIGH		LOW
Calendar Quarter—2001
	First Quarter	$	26.19	$	17.42
	Second Quarter		21.91		16.35
	Third Quarter		19.72		16.00
	Fourth Quarter		23.99		18.50
Calendar Quarter—2002
	First Quarter	$	27.60	$	20.55
	Second Quarter		30.15		24.70
	Third Quarter		26.79		20.35
	Fourth Quarter		27.57		21.17
Calendar Quarter—2003
	First Quarter (through March 20, 2003)	$	27.90	$	22.60

        On March 20, 2003, the last reported sales price per share of the Class A Common Stock was $26.24 per share.

DIVIDENDS

        We have paid no dividends on the Class A Common Stock during the preceding two fiscal years. We have no present intention of paying any dividends on the Class A Common Stock, although the matter will be periodically reviewed by our Board of Directors.

        We are a holding company and, therefore, our ability to pay dividends depends on distributions received from our subsidiaries, which are subject to regulatory net worth requirements and additional state regulations which may restrict the declaration of dividends by HMOs, insurance companies and licensed managed health care plans. The payment of any dividend is at the discretion of our Board of Directors and depends upon our earnings, financial position (including cash position), capital requirements and such other factors as our Board of Directors deems relevant.

        Under our credit agreements with Bank of America, N.A., as agent, we cannot declare or pay cash dividends to our stockholders or purchase, redeem or otherwise acquire shares of our capital stock or warrants, rights or options to acquire such shares for cash except to the extent permitted under the credit agreements, which are described elsewhere in this Annual Report.

SHARE REPURCHASE PROGRAM

        In April 2002, our Board of Directors authorized us to repurchase up to $250 million (net of exercise proceeds and tax benefits from the exercise of employee stock options) of our Class A Common Stock. As of March 20, 2003, we had repurchased an aggregate of 10.0 million shares of our Class A Common Stock under this repurchase program for aggregate consideration of approximately $249 million. Share repurchases are made under this repurchase program from time to time through open market purchases or through privately negotiated transactions. We plan to use cash flows from operations to fund the share repurchases.

40

        During 2002, we received approximately $48 million in cash and $18 million of tax benefits as a result of option exercises. In 2003, we expect to receive approximately $58 million in cash and $17 million in tax benefits from estimated option exercises during the year. As a result of the $66 million (in 2002) and $75 million (in 2003) aggregate amounts of realized and estimated benefits, our total authority under the stock repurchase program is estimated at $390 million based on the authorization we received from our Board of Directors to repurchase $250 million net of exercise proceeds and tax benefits from the exercise of employee stock options.

HOLDERS

        As of March 20, 2003, there were approximately 1,500 holders of record of Class A Common Stock.

Item 6. Selected Financial Data.

        The information required by this Item 6 is set forth in the Company's 2002 Annual Report to Stockholders on page 1, and is incorporated herein by reference and made a part hereof.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

        The information required by this Item 7 is set forth in the Company's 2002 Annual Report to Stockholders on pages 27 through 47, and is incorporated herein by reference and made a part hereof.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

        The information required by this Item 7A is set forth in the Company's 2002 Annual Report to Stockholders on pages 47 and 48, and is incorporated herein by reference and made a part hereof.

Item 8. Financial Statements and Supplementary Data.

        The information required by this Item 8 is incorporated herein by reference to the Company's 2002 Annual Report to Stockholders and made a part hereof as follows: (1) the consolidated financial statements of Health Net, Inc. and subsidiaries on pages 50 through 85 of the Company's 2002 Annual Report to Stockholders are so incorporated by reference and made a part hereof and (2) the Report of Independent Auditors on page 49 of the Company's 2002 Annual Report to Stockholders is so incorporated by reference and made a part hereof.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

        Not applicable.

PART III

Item 10. Directors and Executive Officers of the Registrant.

        The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 2002, under the captions "Director Nominees," "Information Concerning Current Members of the Board of Directors and Nominees," "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance." Such information is incorporated herein by reference and made a part hereof.

Item 11. Executive Compensation.

        The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31,

41

2002, under the captions "Executive Compensation and Other Information" and "Directors' Compensation For 2002." Such information is incorporated herein by reference and made a part hereof.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        The information regarding security ownership of certain beneficial owners and management required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 2002, under the caption "Security Ownership of Certain Beneficial Owners and Management." Such information is incorporated herein by reference and made a part hereof.

        With respect to securities of the Company authorized for issuance under the Company's Equity Compensation Plans as of December 31, 2002, the following table is provided:

Plan category	(a)	(b)		(c)
	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders (1)	9,302,875	$	21.75	5,650,148
Equity compensation plans not approved by security holders (2)	3,544,974	$	19.26	3,356,944
Total	12,847,849	$	21.06	9,007,092

(1)

Includes all stock option plans of the Company other than the 1998 Stock Option Plan.

(2)

Includes the Company's 1998 Stock Option Plan (the only equity plan not approved by security holders).

1998 Stock Option Plan

        On December 5, 1998, we adopted our 1998 Stock Option Plan. The purposes of the 1998 Stock Option Plan are (1) to align the interests of our stockholders and recipients of awards under the plan by increasing the proprietary interest of award recipients in our growth and success; (2) to attract and retain employees and directors and (3) to motivate employees and directors to act in the long-term best interests of our stockholders. The 1998 Stock Option Plan is administered by the Compensation and Stock Option Committee (the "Compensation Committee") of the Board of Directors or by the Board of Directors. References in this summary of the 1998 Stock Option Plan to the Compensation Committee refer also to the Board of Directors, if and to the extent that the Board of Directors elects to act in an administrative capacity with respect to the plan. The terms of the plan permit the Compensation Committee to delegate some or all of its power and authority under the plan to executive officers of the Company.

        General.    We have reserved for issuance under the 1998 Stock Option Plan a total of 8,256,243 shares of our Class A Common Stock available for awards, including 500,000 shares available for stock awards. The number of available shares is subject to adjustment in the event of a stock split, stock

42

dividend, recapitalization, reorganization, merger, consolidation, combination, exchange of shares, liquidation, spin-off or other similar change in capitalization or event or any distribution to holders of common stock other than a regular cash dividend. If any award granted under the 1998 Stock Option Plan expires or is terminated for any reason, the shares of common stock underlying the award will again be available under the 1998 Stock Option Plan.

        Awards.    Under the 1998 Stock Option Plan, the Compensation Committee may grant awards consisting of stock options and stock appreciation rights ("SARs") to eligible employees and may grant stock awards in the form of restricted stock (which may include associated cash awards) or bonus stock to eligible employees and directors. However, no awards may be granted under the plan to certain highly compensated officers of the Company.

•

Stock options. Stock option awards under the plan consist of stock options which are not intended to qualify as "incentive stock options" under the Internal Revenue Code of 1986, as amended. At the time a stock option is granted, the Compensation Committee determines the number of shares of our Class A Common Stock subject to the option, the exercise price per share of underlying common stock, the period during which the option may be exercised and the restrictions on and conditions to exercise of the option. The exercise price of the option per share of underlying common stock must be at least equal to the fair market value of a share of the common stock on the date the option is granted.



•

Stock appreciation rights.    The Compensation Committee may grant SARs in conjunction with a concurrent or pre-existing stock option award. An SAR entitles the holder to receive, upon exercise of the SAR and surrender of the related stock option, shares of common stock, cash or a combination of stock and cash with an aggregate value equal to the product of



•

the excess of (1) the fair market value of one share of common stock on the date of exercise over (2) the base price of the SAR,

    multiplied by

•

the number of shares of common stock subject to the surrendered stock option.

The base price of an SAR is equal to the exercise price per share of the related stock option. The term, exercisability and other provisions of an SAR are fixed by the Compensation Committee.

•

Stock awards.    The Compensation Committee may award shares of our Class A Common Stock either as a restricted stock award or as bonus stock that is not subject to restriction. Bonus stock awards are vested upon grant. In the case of restricted stock, the Compensation Committee fixes the restrictions, the restriction period and the valuation date applicable to each award. The recipient of a restricted stock award will be unable to dispose of the shares prior to the expiration of the applicable restricted period. Unless otherwise determined by the Compensation Committee, during the restricted period, the recipient is entitled to vote the shares and receive any regular cash dividends on the shares. In connection with any restricted stock award, the Compensation Committee may authorize the payment of a cash award, subject to restrictions and other terms and conditions prescribed by the Compensation Committee, to the holder of the restricted stock, payable at any time after the restricted stock becomes vested. The amount of the cash award may not exceed 100% of the average fair market value of the restricted stock as determined over a period of 60 consecutive trading days ending on the applicable valuation date.

        Change of Control.    In the event of a "Change of Control" (as that term is defined in the 1998 Stock Option Plan) all stock options and SARs outstanding under the 1998 Stock Option Plan will become immediately exercisable in full and the restrictions on all restricted stock awards will lapse. All awards under the plan are required to be evidenced by a written agreement on terms approved by the

43

Compensation Committee, subject to the provisions of the plan. An agreement evidencing stock options or restricted stock granted under the plan may contain provisions limiting the acceleration of the exercisability of options and the acceleration of the lapse of restrictions on restricted stock in connection with a Change of Control as the Compensation Committee deems appropriate to ensure that the penalty provisions applicable to excess parachute payments under the Internal Revenue Code of 1986, as amended, will not apply to any stock, cash or other property received by the award holder from the Company.

        Termination of Employment or Service.    In the event of the termination of employment or service as a director of the holder of an award, other than in the event of a termination or removal for "Cause" (as defined under the 1998 Stock Option Plan), the Compensation Committee may provide for the vesting of the holder's restricted stock, cash awards and stock options under the plan. In the event an award holder is terminated (or removed from the Board of Directors) for "Cause," all of the holder's restricted stock and cash awards under the plan that remain subject to restrictions will be forfeited and all of the holder's stock options under the plan will be terminated.

        Amendment and Termination.    The plan, which is subject to amendment or termination by the Board of Directors, will terminate automatically, unless terminated earlier by the Board of Directors, when shares of our Class A Common Stock are no longer available for the grant of awards under the plan.

Item 13. Certain Relationships and Related Transactions.

        The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 2002, under the caption "Certain Relationships and Related Party Transactions." Such information is incorporated herein by reference and made a part hereof.

Item 14. Controls and Procedures.

        The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of a date within 90 days prior to the filing date of this Annual Report on Form 10-K (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's reports filed or submitted under the Exchange Act.

        Since the Evaluation Date, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect such controls.

PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS

1. FINANCIAL STATEMENTS

        The following consolidated financial statements are incorporated by reference into this Annual Report on Form 10-K from pages 49 through 85 of the Company's 2002 Annual Report to Stockholders:

Report of Deloitte & Touche LLP

44

Consolidated balance sheets as of December 31, 2002 and 2001

Consolidated statements of operations for each of the three years in the period ended December 31, 2002

Consolidated statements of stockholders' equity for each of the three years in the period ended December 31, 2002

Consolidated statements of cash flows for each of the three years in the period ended December 31, 2002

Notes to consolidated financial statements

2. FINANCIAL STATEMENT SCHEDULES

        The following financial statement schedules and accompanying report thereon are filed as a part of this Annual Report on Form 10-K:

Report of Deloitte & Touche LLP

Schedule I—Condensed Financial Information of Registrant (Parent Company Only)

Schedule II—Valuation and Qualifying Accounts and Reserves

45

        All other schedules are omitted because they are not applicable, not required or because the required information is included in the consolidated financial statements or notes thereto which are incorporated by reference into this Annual Report on Form 10-K from the Company's 2002 Annual Report to Stockholders.

3. EXHIBITS

        The following exhibits are filed as part of this Annual Report on Form 10-K or are incorporated herein by reference:

2.1	Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems International, Inc., FH Acquisition Corp. and Foundation Health Corporation (filed as Exhibit 2.5 to the Company's Registration Statement on Form S-4 (File No. 333-19273) on January 6, 1997 and incorporated herein by reference).
3.1	Fifth Amended and Restated Certificate of Incorporation of Health Net, Inc.(filed as Exhibit 3.1 to the Company's Registration Statement on Form S-4 (File No. 333-67258) on August 10, 2001 and incorporated herein by reference).
3.2	Eighth Amended and Restated Bylaws of Health Net, Inc. (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 1-12718) and incorporated herein by reference).
4.1	Form of Class A Common Stock Certificate (filed as Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).
4.2	Rights Agreement dated as of June 1, 1996 by and between Heath Systems International, Inc. and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 1-12718) on July 16, 1996 and incorporated herein by reference).
4.3	Amendment, dated as of October 1, 1996, to the Rights Agreement, by and between Health Systems International, Inc. and Harris Trust and Savings Bank (filed as Exhibit 2 to the Company's Registration Statement on Form 8-A/A (Amendment No. 1) (File No. 1-12718) on May 9, 2001 and incorporated herein by reference).
4.4	Second Amendment to Rights Agreement, dated as of May 3, 2001, by and among Health Net, Inc., Harris Trust and Savings Bank and Computershare Investor Services, L.L.C. (filed as Exhibit 3 to the Company's Registration Statement on Form 8-A/A (Amendment No. 1) (File No. 1-12718) on May 9, 2001 and incorporated herein by reference).
*10.1	Employment Letter Agreement between Foundation Health Systems, Inc. and Karin D. Mayhew dated January 22, 1999 (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999 (File No. 1-12718) and incorporated herein by reference).
*10.2	Letter Agreement dated June 25, 1998 between B. Curtis Westen and Foundation Heath Systems, Inc. (filed as Exhibit 10.73 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.3	Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and Health Systems International, Inc. (filed as Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 (File No. 1-12718) and incorporated herein by reference).

46

*10.4	Amended Letter Agreement between Foundation Health Systems, Inc. and Jay M. Gellert dated as of August 22, 1997 (filed as Exhibit 10.69 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.5	Letter Agreement between Foundation Health Systems, Inc. and Jay M. Gellert dated as of March 2, 2000 (filed as Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.6	Letter Agreement between Health Net, Inc. and Jay M. Gellert dated as of October 13, 2002 (filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (File No. 1-12718) and incorporated herein by reference).
*10.7	Employment Letter Agreement between Managed Health Network and Jeffrey J. Bairstow dated as of January 29, 1998 (filed as Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.8	Employment Letter Agreement between Foundation Health Systems, Inc. and Steven P. Erwin dated March 11, 1998 (filed as Exhibit 10.72 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (File No. 1-12718) and incorporated herein by reference).
*10.9	Employment Letter Agreement between Foundation Health Corporation and Gary S. Velasquez dated May 1, 1996 (filed as Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.10	Employment Letter Agreement between Foundation Health Systems, Inc. and Cora Tellez dated November 16, 1998 (filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.11	Employment Letter Agreement between Health Net, Inc. and Timothy J. Moore, M.D. dated March 12, 2001 (filed as Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (File No. 1-12718) and incorporated herein by reference).
*10.12	Employment Letter Agreement between Health Net, Inc. and Marvin P. Rich dated January 25, 2002 (filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 1-12718) and incorporated herein by reference).
*10.13	Separation, Waiver and Release Agreement between Health Net, Inc. and Steven P. Erwin dated March 15, 2002 (filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 1-12718), and incorporated herein by reference).
*10.14	Separation, Waiver and Release Agreement between Health Net, Inc. and Gary Velasquez dated April 15, 2002 (filed as Exhibit 10.13 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 1-12718) and incorporated herein by reference).
*10.15	Separation, Waiver and Release Agreement between Health Net, Inc. and Cora Tellez dated April 30, 2002 (filed as Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 1-12718) and incorporated herein by reference).
*10.16	Employment Letter Agreement between Health Net, Inc. and Christopher P. Wing dated March 8, 2002 (filed as Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).

47

*10.17	Employment Letter Agreement between Health Net, Inc. and Jeffrey M. Folick dated March 22, 2002 (filed as Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).
*10.18	Form of Severance Payment Agreement dated December 4, 1998 by and between Foundation Health Systems, Inc. and various of its executive officers (filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 1, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.19	Form of Agreement amending Severance Payment Agreement by and between Health Net, Inc. and various of its executive officers (filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.20	Form of Stock Option Agreement utilized for Tier 1 officers of Health Net, Inc. (filed as Exhibit 10.20 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (File No. 1-12718) and incorporated herein by reference).
*10.21	Form of Stock Option Agreement utilized for Tier 2 officers of Health Net, Inc. (filed as Exhibit 10.21 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (File No. 1-12718) and incorporated herein by reference).
†*10.22	Form of Restricted Stock Agreement utilized by Health Net, Inc., a copy of which is filed herewith.
*10.23	Form of Stock Option Agreement utilized for Tier 3 officers of Health Net, Inc. (filed as Exhibit 10.22 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (File No. 1-12718) and incorporated herein by reference).
*10.24	Foundation Health Systems, Inc. Deferred Compensation Plan (filed as Exhibit 10.66 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.25	Foundation Health Systems, Inc. Deferred Compensation Plan Trust Agreement effective September 1, 1998 between Foundation Health Systems, Inc. and Union Bank of California (filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.26	Foundation Health Systems, Inc. Second Amended and Restated 1991 Stock Option Plan (filed as Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.27	Amendment to Second Amended and Restated 1991 Stock Option Plan (filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.28	Foundation Health Systems, Inc. 1997 Stock Option Plan (as amended and restated on May 4, 2000) (filed as Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 1-12718) and incorporated herein by reference).
*10.29	Amendment to Amended and Restated 1997 Stock Option Plan (filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.30	Second Amendment to Amended and Restated 1997 Stock Option Plan (filed as Exhibit 10.25 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).
*10.31	Foundation Health Systems, Inc. 1998 Stock Option Plan (as amended and restated on May 4, 2000) (filed as Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 (File No. 1-12718) and incorporated herein by reference).

48

*10.32	Amendments to Amended and Restated 1998 Stock Option Plan (filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.33	Second Amendment to Amended and Restated 1998 Stock Option Plan (filed as Exhibit 10.28 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).
*10.34	Health Net, Inc. 2002 Stock Option Plan (filed as Exhibit 10.29 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).
*10.35	Health Systems International, Inc. Second Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.31 to Registration Statement on Form S-4 (File No. 33-86524) on November 18, 1994 and incorporated herein by reference).
*10.36	Foundation Health Systems, Inc. Third Amended and Restated Non-Employee Director Stock Option Plan (filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 1-12718) and incorporated herein by reference).
*10.37	Health Net, Inc. Employee Stock Purchase Plan, as amended and restated as of January 1, 2002 (filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 1-12718) and incorporated herein by reference.
*10.38	Foundation Health Systems, Inc. Executive Officer Incentive Plan (filed as Annex A to the Company's definitive proxy statement on March 31, 2000 (File No. 1-12718) and incorporated herein by reference).
*10.39	Health Net, Inc. 401(k) Savings Plan (filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-12718) and incorporated herein by reference).
†*10.40	Amendments through December 31, 2002 made to the Health Net, Inc. 401(k) Savings Plan, a copy of which is filed herewith.
*10.41	Foundation Health Systems, Inc. Supplemental Executive Retirement Plan effective as of January 1, 1996 (filed as Exhibit 10.65 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-12718) and incorporated herein by reference).
*10.42	Managed Health Network, Inc. Incentive Stock Option Plan (filed as Exhibit 4.8 to the Company's Registration Statement on Form S-8 (File No. 333-24621) on April 4, 1997 and incorporated herein by reference).
*10.43	Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan (filed as Exhibit 4.9 to the Company's Registration Statement on Form S-8 (File No. 333-24621) on April 4, 1997 and incorporated herein by reference).
*10.44	1990 Stock Option Plan of Foundation Health Corporation (as amended and restated effective April 20, 1994) (filed as Exhibit 4.5 to the Company's Registration Statement on Form S-8 (File No. 333-24621) on April 4, 1997 and incorporated herein by reference).
*10.45	Foundation Health Corporation Directors Retirement Plan (filed as Exhibit 10.96 to Foundation Health Corporation's Annual Report on Form 10-K for the year ended June 30, 1994 (File No. 1-10540) and incorporated herein by reference).
*10.46	Amended and Restated Deferred -Compensation Plan of Foundation Health Corporation (filed as Exhibit 10.99 to Foundation Health Corporation's Annual Report on Form 10-K for the year ended June 30, 1995 (File No. 1-10540) and incorporated herein by reference).

49

*10.47	Foundation Health Corporation Supplemental Executive Retirement Plan (as Amended and Restated effective April 25, 1995) (filed as Exhibit 10.100 to Foundation Health Corporation's Annual Report on Form 10-K for the year ended June 30, 1995 (File No. 1-10540) and incorporated herein by reference).
*10.48	Foundation Health Corporation Executive Retiree Medical Plan (as amended and restated effective April 25, 1995) (filed as Exhibit 10.101 to Foundation Health Corporation's Annual Report on Form 10-K for the year ended June 30, 1995 (File No. 1-10540) and incorporated herein by reference).
10.49	Five-Year Credit Agreement dated as of June 28, 2001 among the Company, the lenders party thereto and Bank of America, N.A., as Administrative Agent, Issuing Bank and Swingline Lender (filed as Exhibit 10.34 to the Company's Registration Statement on Form S-4 (File No. 333-67258) on August 10, 2001 and incorporated herein by reference).
10.50	364-Day Credit Agreement dated as of June 28, 2001 among the Company, the lenders party thereto and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.35 to the Company's Registration Statement on Form S-4 (File No. 333-67258) on August 10, 2001 and incorporated herein by reference).
10.51	First Amendment to 364-Day Credit Agreement dated as of June 27, 2002 among the Company, the lenders party thereto and Bank of America, N.A. as Administrative Agent (filed as Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (file No. 1-12718) and incorporated herein by reference).
10.52	First Amendment to Office Lease, dated May 14, 2001, between Health Net (a California corporation) and LNR Warner Center, LLC (filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 1-12718) and incorporated herein by reference).
10.53	Lease Agreement between HAS-First Associates and Foundation Health Corporation dated August 1, 1988 and form of amendment thereto (filed as Exhibit 10.20 to Foundation Health Corporation's Registration Statement on Form S-1 (File No. 33-34963) on May 17, 1990 and incorporated herein by reference).
10.54	Office Lease dated September 20, 2000 by and among Health Net of California, Inc., DCA Homes, Inc. and Lennar Rolling Ridge, Inc. (filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 (File No. 1-12718) and incorporated herein by reference).
10.55	Purchase Agreement dated as of April 9, 2001, by and among the Company, JP Morgan, a division of Chase Securities Inc., Banc of America Securities LLC, Fleet Securities, Inc., Mizuho International plc, Salomon Smith Barney Inc. and Scotia Capital (USA) Inc. (filed as Exhibit 10.44 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (File No. 1-12718) and incorporated herein by reference).
10.56	Stock Purchase Agreement dated January 19, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
10.57	Amendment to Stock Purchase Agreement dated February 2, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.2 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).

50

10.58	Second Amendment to Stock Purchase Agreement dated February 8, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.3 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
10.59	Third Amendment to Stock Purchase Agreement dated February 16, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.4 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
10.60	Fourth Amendment to Stock Purchase Agreement dated February 28, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.5 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
10.61	Fifth Amendment to Stock Purchase Agreement dated May 1, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.6 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
10.62	Sixth Amendment to Stock Purchase Agreement dated June 4, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.7 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
10.63	Seventh Amendment to Stock Purchase Agreement dated June 29, 2001 by and between Health Net, Inc. and Florida Health Plan Holdings II, L.L.C. (filed as Exhibit 10.8 to the Company's Current Report on Form 8-K dated August 1, 2001 (File No. 1-12718) and incorporated herein by reference).
†11.1	Statement relative to computation of per share earnings of the Company (included in Exhibit 13.1 to this Annual Report on Form 10-K under Note 2 to the consolidated financial statements on page 61 of Health Net, Inc.'s 2002 Annual Report to Stockholders).
†12.1	Statement relative to computation of ratio of earnings to fixed charges—consolidated basis, a copy of which is filed herewith.
†13.1	Selected portions of the Health Net, Inc. 2002 Annual Report to Stockholders, a copy of which portions are filed herewith.
†21.1	Subsidiaries of the Company, a copy of which is filed herewith.
†23.1	Consent of Deloitte & Touche LLP, a copy of which is filed herewith.
†99.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

*

Management contract or compensatory plan or arrangement required to be filed (and/or incorporated by reference) as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K.

†

A copy of the exhibit is being filed with this Annual Report on Form 10-K.

(b)

Reports on Form 8-K

        No Current Reports on Form 8-K were filed by the Company during the fourth quarter ended December 31, 2002.

51

INDEPENDENT AUDITORS' REPORT ON SCHEDULES

To the Board of Directors and Stockholders of
Health Net, Inc.
Woodland Hills, California

        We have audited the consolidated financial statements of Health Net, Inc. (the "Company") as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002, and have issued our report thereon dated February 13, 2003; such financial statements and report are included in your 2002 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedules of Health Net, Inc., listed in Item 15(a)(2). These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

        As discussed in Note 1 to the financial statement schedule of condensed financial information of registrant, the Company changed its method of accounting for goodwill and other intangible assets upon adoption of the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."

/s/ Deloitte & Touche LLP
Los Angeles, California
February 13, 2003

52

SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)

HEALTH NET, INC.
CONDENSED BALANCE SHEETS
(Amounts in thousands)

				December 31, 2002			December 31, 2001
ASSETS
Current Assets:
	Cash and cash equivalents			$	204,537		$	101,550
	Investments—available for sale				2,520			3,316
	Other assets				10,237			10,190
	Notes receivable due from subsidiaries				23,007			54,603
	Due from subsidiaries				70,746			126,473
		Total current assets			311,047			296,132
Property and equipment, net					47,171			43,707
Goodwill, net					394,784			394,784
Other intangible assets, net					10,618			11,970
Investment in subsidiaries					1,745,014			1,607,264
Other noncurrent deferred taxes					20,641			54,918
Notes receivable due from subsidiaries					2,435			2,435
Other noncurrent assets					66,905			92,285
		Total Assets		$	2,598,615		$	2,503,495
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
	Due to subsidiaries			$	72,330		$	93,635
	Intercompany notes payable				1,651			35,052
	Deferred taxes				33,822			24,732
	Other current liabilities				100,795			114,786
		Total current liabilities			208,598			268,205
	Intercompany notes payable — long term				641,498			438,549
	Revolving credit facility and capital leases				—			195,182
	Senior notes payable				398,821			398,678
	Other noncurrrent liabilities				40,649			37,369
		Total Liabilities			1,289,566			1,337,983
Commitments and contingencies
Stockholders' Equity:
	Common stock and additional paid-in capital				730,626			662,867
	Restricted common stock				1,913			—
	Unearned compensation				(1,441	)		—
	Retained earnings				826,379			597,753
	Common stock held in treasury, at cost				(259,513	)		(95,831	)
	Accumulated other comprehensive gain				11,085			723
		Total Stockholders' Equity			1,309,049			1,165,512
			Total Liabilities and Stockholders' Equity	$	2,598,615		$	2,503,495

See accompanying note to condensed financial statements.

53

HEALTH NET, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Amounts in thousands)

			Year Ended December 31,
			2002			2001			2000
REVENUES:
	Net investment income		$	5,725		$	8,168		$	6,574
	Other income			1,984			2,659			5,011
	Administrative service agreements			252,373			154,266			126,346
		Total revenues		260,082			165,093			137,931
EXPENSES:
	General and administrative			235,310			145,429			126,486
	Amortization and depreciation			15,727			28,460			30,847
	Interest			47,954			66,301			98,618
	Net loss on sale of businesses and properties			—			71,724			409
	Asset impairment and restructuring charges			36,736			13,217			—
		Total expenses		335,727			325,131			256,360
Loss from continuing operations before income taxes and equity in net income of subsidiaries				(75,645	)		(160,038	)		(118,429	)
Income tax benefit				25,596			59,214			43,819
Equity in net income of subsidiaries				278,675			187,353			238,233
Net income			$	228,626		$	86,529		$	163,623

See accompanying note to condensed financial statements.

54

HEALTH NET, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Amounts in thousands)

		Year Ended December 31,
		2002			2001			2000
NET CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES		$	84,814		$	(55,976	)	$	23,569
CASH FLOWS FROM INVESTING ACTIVITIES:
	Sales of investments		—			7,496			10,888
	Maturities of investments		—			1,000			825
	Purchases of investments		—			(5,108	)		(9,121	)
	Net purchases of property and equipment		(24,908	)		(11,762	)		(32,312	)
	Other assets		3,846			(15,311	)		(8,626	)
Net cash used in investing activities			(21,062	)		(23,685	)		(38,346	)
CASH FLOWS FROM FINANCING ACTIVITIES:
	Net (decrease) increase in checks outstanding, net of deposits		(5,707	)		(275	)		5,982
	Net borrowings from subsidiaries		201,144			256,260			69,023
	Proceeds from exercise of stock options and employee stock purchases		49,524			10,449			5,794
	Proceeds from issuance of notes and other financing arrangements		50,000			601,076			250,000
	Repayment of debt		(245,410	)		(777,532	)		(522,807	)
	Repurchase of common stock		(159,676	)		—			—
	Dividends received from subsidiaries		168,000			163,496			159,503
	Capital contributions to subsidiaries		(18,640	)		(88,514	)		(45,525	)
Net cash provided by (used in) financing activities			39,235			164,960			(78,030	)
Net increase (decrease) in cash and cash equivalents			102,987			85,299			(92,807	)
Cash and cash equivalents, beginning of period			101,550			16,251			109,058
Cash and cash equivalents, end of period		$	204,537		$	101,550		$	16,251
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid		$	38,188		$	46,501		$	87,023
Income taxes paid			76,647			24,154			9,694
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of restricted stock		$	1,913		$	—		$	—
Notes and stocks received on sale of businesses			224			26,000			—
Settlement of intercompany notes payable through dividends from subsidiaries			—			62,337			—
Settlement of intercompany notes receivable through capital contributions to subsidiaries			—			(55,063	)		(33,000	)

See accompanying note to condensed financial statements.

55

HEALTH NET, INC.
NOTE TO CONDENSED FINANCIAL STATEMENTS

NOTE 1—BASIS OF PRESENTATION

        Health Net, Inc.'s ("HNT") investment in subsidiaries is stated at cost plus equity in undistributed earnings (losses) of subsidiaries. HNT's share of net income (loss) of its unconsolidated subsidiaries is included in consolidated income using the equity method. This condensed financial information of registrant (parent company only) should be read in conjunction with the consolidated financial statements of Health Net, Inc. and subsidiaries.

        Effective January 1, 2001, HNT merged its wholly owned subsidiary, Foundation Health Corporation, with and into HNT, thereby terminating the separate existence of Foundation Health Corporation. As a result, condensed financial information of registrant (parent company only) for the year ended December 31, 2000 has been restated to reflect this merger.

        Certain amounts in the prior periods have been reclassified to conform to the 2002 presentation. The reclassifications have no effect on total revenues, total expenses, net earnings or stockholders' equity as previously reported.

        Effective, January 1, 2002, HNT adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets" which, among other things, eliminates amortization of goodwill and other intangibles with indefinite lives. Goodwill amortization expense was $0, $12.2 million and $12.1 million for the years ended December 31, 2002, 2001 and 2000, respectively.

56

SUPPLEMENTAL SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
HEALTH NET, INC.

(Amounts in thousands)

		Balance at beginning of period		Charged to costs and expenses		Credited to other accounts (1)			Deductions (2)			Balance at end of period
2002:
Allowance for doubtful accounts:
	Premiums receivable	$	14,595	$	5,475	$	(6,106	)				$	13,964
2001:
Allowance for doubtful accounts:
	Premiums receivable	$	19,822	$	3,573	$	(8,106	)	$	(694	)	$	14,595
2000:
Allowance for doubtful accounts:
	Premiums receivable	$	21,937	$	13,779	$	(15,894	)	$	—		$	19,822

(1)

Credited to premiums receivable on the Consolidated Balance Sheets.

(2)

The amount for 2001 is the result of the sale of one of our subsidiaries.

57

SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

HEALTH NET, INC.
By:	/s/  MARVIN P. RICH Marvin P. Rich Executive Vice President, Finance and Operations
Date: March 24, 2003

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

SIGNATURE	TITLE	DATE
/s/  JAY M. GELLERT Jay M. Gellert	President and Chief Executive Officer and Director (Principal Executive Officer)	March 24, 2003
/s/  MARVIN P. RICH Marvin P. Rich	Executive Vice President, Finance and Operations (Principal Accounting and Financial Officer)	March 24, 2003
/s/  J. THOMAS BOUCHARD J. Thomas Bouchard	Director	March 24, 2003
/s/  GOV. GEORGE DEUKMEJIAN Gov. George Deukmejian	Director	March 24, 2003
/s/  THOMAS T. FARLEY Thomas T. Farley	Director	March 24, 2003
/s/  GALE S. FITZGERALD Gale S. Fitzgerald	Director	March 24, 2003
/s/  PATRICK FOLEY Patrick Foley	Director	March 24, 2003

58

/s/  ROGER F. GREAVES Roger F. Greaves	Director	March 24, 2003
/s/  RICHARD W. HANSELMAN Richard W. Hanselman	Director	March 24, 2003
/s/  RICHARD J. STEGEMEIER Richard J. Stegemeier	Director	March 24, 2003
/s/  BRUCE G. WILLISON Bruce G. Willison	Director	March 24, 2003

59

CERTIFICATIONS

        I, Jay M. Gellert, certify that:

1.

I have reviewed this annual report on Form 10-K of Health Net, Inc.;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)

Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c)

Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)

All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 24, 2003 /s/  JAY M. GELLERT Jay M. Gellert
President and Chief Executive Officer

60

        I, Marvin P. Rich, certify that:

1.

I have reviewed this annual report on Form 10-K of Health Net, Inc.;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)

Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c)

Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)

All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 24, 2003 /s/  MARVIN P. RICH Marvin P. Rich
Executive Vice President, Finance and Operations

61

QuickLinks

PART I

Item 1. Business.

Item 2. Properties.
Item 3. Legal Proceedings.

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

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Item 6. Selected Financial Data.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Item 8. Financial Statements and Supplementary Data.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

PART III

Item 10. Directors and Executive Officers of the Registrant.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions.
Item 14. Controls and Procedures.

PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

EX-10.22

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Exhibit 10.22

FORM OF RESTRICTED STOCK AGREEMENT

        This Restricted Stock Agreement (this "Restricted Stock Agreement") is made and entered into as of [Date] (the "Date of Grant"), by and between Health Net, Inc., a Delaware corporation (the "Company"), and [Name] (the "Recipient").

        WHEREAS, the Compensation and Stock Option Committee (the "Committee") of the Board of Directors (the "Board") of the Company has approved the grant of Restricted Stock, as hereinafter defined, to the Recipient as set forth below under the Company's [Year] Stock Option Plan (the "Plan"). Capitalized terms used but not defined herein shall have the meanings set forth in the Plan.

        NOW, THEREFORE, in consideration of the covenants and agreements herein contained and intending to be legally bound hereby, the parties agree as follows:

        1.      Grant of Restricted Stock. The Company hereby grants to the Recipient [Number] restricted shares (the "Restricted Stock") of the Class A Common Stock, par value $.001 per share (the "Common Stock") of the Company, subject to all of the terms and conditions of this Restricted Stock Agreement. As a condition of the effectiveness of this grant, the Recipient shall pay to the Company as soon as practicable the par value in cash for each share of Restricted Stock subject to this grant. The Recipient's grant and record of share ownership shall be kept on the books of the Company, until the restrictions on transfer have lapsed pursuant to Sections 2 or 3 below. Shares that have become vested pursuant to Sections 2 or 3 below may be evidenced by stock certificates, at the request of the Recipient, which certificates shall be registered in the name of the Recipient and delivered to Recipient within ten (10) days of such request.

        2.      Lapse of Restrictions. Except as otherwise provided in Section 3 hereof, the restrictions on transfer set forth in Section 4 hereof shall lapse (the "Vesting Date") with respect to all shares of the Restricted Stock on the [Number] anniversary of the Grant Date.

        3.      Termination of Service.

        (a)  If prior to the Vesting Date, the Recipient's employment or service with the Company is terminated by either the Recipient or the Company for any reason (a "Termination Event"), then all shares of Restricted Stock not yet vested shall be immediately forfeited at such time, and the Company shall return to the Recipient an amount equal to the par value of the Restricted Stock which was paid by the Recipient to the Company as described in Section 1 above.

        (b)  If the Recipient violates the terms of Section 5 of this Agreement (a "Breach Event"), in addition to being subject to all remedies in law or equity that the Company may assert, then at any time thereafter the Company, in its sole and absolute discretion, may, with respect to any Restricted Stock that has vested within six (6) months of the Recipient's termination of employment: (i) to the extent that the Restricted Stock is beneficially owned by the Recipient, reacquire from the Recipient, in return for an amount equal to the par value of the Restricted Stock which was paid by the Recipient to the Company as described in Section 1 above, any or all of the shares of Restricted Stock; and (ii) to the extent that the Restricted Stock has been sold, assigned or otherwise transferred by the Recipient, recover from the Recipient an amount equal to the Gain Realized (as defined in Section 5 below) from such sale, assignment or transfer.

        (c)    Upon the occurrence of a Breach Event, the Company may elect to purchase all or any portion of the Restricted Stock pursuant to this Section 3 by delivery of written notice (the "Repurchase Notice") to the Recipient within ninety (90) days after the occurrence of such Breach Event.

        4.      Restrictions on Transfer. Unless earlier vested pursuant to Section 2 above, shares of Restricted Stock may not be transferred or otherwise disposed of by the Recipient prior to [Date], including by way of sale, assignment, transfer, pledge or otherwise except by will or the laws of descent and distribution.

        5.      Employment/Association with Company Competitor. The Recipient hereby agrees that, during (i) the six-month period following a termination of the Recipient's employment with an Employer that entitles the Recipient to receive severance benefits under an agreement with or the policy of the Company or (ii) the twelve-month period following a termination of the Recipient's employment with an Employer that does not entitle the Recipient to receive such severance benefits (the period referred to in either clause (i) or (ii), the "Noncompetition Period"), the Recipient shall not undertake any employment or activity (including, but not limited to, consulting services) with a Competitor (as defined below), where the loyal and complete fulfillment of the duties of the competitive employment or activity would call upon the Recipient to reveal, to make judgments on or otherwise use any confidential business information or trade secrets of the business of the Company or any Subsidiary to which the Recipient had access during the Recipient's employment with the Employer. In addition, the Recipient agrees that, during the Noncompetion Period applicable to the Recipient following termination of employment with the Employer, the Recipient shall not, directly or indirectly, solicit, interfere with, hire, offer to hire or induce any person, who is or was an employee of the Company or any of its Subsidiaries during the 12 month period prior to the date of such termination of employment, to discontinue his or her relationship with the Company or any of its Subsidiaries or to accept employment by, or enter into a business relationship with, the Recipient or any other entity or person. In the event that the Recipient breaches the covenants set forth in this first paragraph of Section 5, it shall be considered a Breach Event under Section 3 above.

        For purposes of this Section 5: "Gain Realized" shall equal the difference between (x) the par value paid by the Recipient for the Restricted Stock and (y) the greater of the Fair Market Value (as defined in the Plan) of the Common Stock representing the Restricted Stock (I) on the date of transfer of such Restricted Stock or (II) on the date such competitive activity with a Competitor was commenced by the Recipient; and "Competitor" shall refer to any health maintenance organization or insurance company that provides managed health care or related services similar to those provided by the Company or any Subsidiary.

1

        It is hereby further agreed that if any court of competent jurisdiction shall determine that the restrictions imposed in this Section 5 are unreasonable (including, but not limited to, the definition of Market Area or Competitor or the time period during which this provision is applicable), the parties hereto hereby agree to any restrictions that such court would find to be reasonable under the circumstances.

        The Recipient acknowledges that the services to be rendered by the Recipient to the Company are of a special and unique character, which gives this Agreement a peculiar value to the Company, the loss of which may not be reasonably or adequately compensated for by damages in an action at law, and that a material breach or threatened breach by the Recipient of any of the provisions contained in this Section 5 will cause the Company irreparable injury. Recipient therefore agrees that the Company may be entitled, in addition to the remedies set forth above in this Section 5 and any other right or remedy, to a temporary, preliminary and permanent injunction, without the necessity of proving the inadequacy of monetary damages or the posting of any bond or security, enjoining or restraining Recipient from any such violations or threatened violations.

        6.      Rights as a Stockholder. The Company shall hold in escrow all dividends, if any, that are paid with respect to the shares of Restricted Stock until all restrictions on such shares have lapsed. Recipient agrees that the right to vote any shares for which the restrictions on transfer set forth in Section 4 hereof have not yet lapsed (the "Unvested Shares") will be held by the Company and, accordingly, the Employee shall execute an irrevocable proxy in favor of the Company for all shares of Restricted Stock in the form supplied by the Company.

        7.      Notices. Any notice or communication given hereunder shall be in writing and shall be given by fax or first class mail, certified or registered with return receipt requested, and shall be deemed to have been duly given three (3) days after mailing or twenty-four (24) hours after transmission of a fax to the following addresses:

To the Recipient at:	[Name] [Address]
To the Company at:	Health Net, Inc. 21650 Oxnard Street Woodland Hills, California 91367 Attention: General Counsel

or to such other address as any party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt.

        8.      Securities Laws Requirements. The Company shall not be obligated to transfer any shares of Common Stock from the Recipient to another party, if such transfer, in the opinion of counsel for the Company, would violate the Securities Act of 1933, as amended from time to time (the "Securities Act") (or any other federal or state statutes having similar requirements as may be in effect at that time). Further, the Company may require as a condition of transfer of any shares to the Recipient that the Recipient furnish a written representation that he or she is holding the shares for investment and not with a view to resale or distribution to the public. The Company either has or will file an appropriate Registration Statement on Form S-8 (or other applicable form), and has taken or will take such actions as necessary to keep the information therein current from time to time, in order to register the Restricted Stock under the Securities Act and shall use its commercially reasonable efforts to cause such Registration Statement to become effective and to maintain the effectiveness of such registration.

        9.      Protections Against Violations of Restricted Stock Agreement. No purported sale, assignment, mortgage, hypothecation, transfer, pledge, encumbrance, gift, transfer in trust (voting or other) or other disposition of, or creation of a security interest in or lien on, any of the shares of Restricted Stock by any holder thereof in violation of the provisions of this Restricted Stock Agreement or the Certificate of Incorporation or the By-Laws of the Company, shall be valid, and the Company will not transfer any of said shares of Restricted Stock on its books nor will any of said shares of Restricted Stock be entitled to vote, nor will any dividends be paid thereon, unless and until there has been full compliance with said provisions to the satisfaction of the Company. The foregoing restrictions are in addition to and not in lieu of any other remedies, legal or equitable, available to enforce said provisions.

        10.  Taxes. The Recipient understands that he or she (and not the Company) shall be responsible for any tax obligation that may arise as a result of the transactions contemplated by this Restricted Stock Agreement and shall pay to the Company the amount determined by the Company to be such tax obligation at the time such tax obligation arises. If the Recipient fails to make such payment, the number of shares necessary to satisfy the tax obligations shall be forfeited. The Recipient shall promptly notify the Company of any election made pursuant to Section 83(b) of the Code.

THE RECIPIENT ACKNOWLEDGES THAT IT IS THE RECIPIENT'S SOLE RESPONSIBILITY AND NOT THE COMPANY'S TO FILE TIMELY THE ELECTION UNDER SECTION 83(b) OF THE CODE, IN THE EVENT THAT THE RECIPIENT DESIRES TO MAKE THE ELECTION.

        11.  Change of Control. Section 6.8 of the Plan provides for the acceleration of exercisability of the Vesting Date applicable to the Restricted Stock in the event of a Change in Control, as such term is defined in the Plan. The Recipient hereby acknowledges that the Committee retains the right to determine whether the acceleration of vesting provided for in said Section 6.8 shall have occurred with respect to the Restricted Stock (notwithstanding the provisions of such Section 6.8) in those instances (unless otherwise determined by the Board) in which (A) the holders of the Common Stock immediately prior to a Consummated Transaction or Control Purchase (as defined in the Plan) own more than 50% of the voting common stock of the surviving corporation immediately after such Consummated Transaction or Control Purchase, (B) the holders of all classes of common stock of the Company immediately prior to a Consummated Transaction or Control Purchase own more than 50% of the total equity of the surviving corporation immediately after such Consummated Transaction or Control Purchase, (C) the Consummated Transaction or Control Purchase does not result in a Board Change and (D) the Consummated Transaction or Control Purchase does not result in a substantial change in the executive officers of the Company.

2

        12.  Failure to Enforce Not a Waiver. The failure of the Company to enforce at any time any provision of this Restricted Stock Agreement shall in no way be construed to be a waiver of such provision or of any other provision hereof.

        13.  Governing Law. This Restricted Stock Agreement shall be governed by and construed according to the laws of the State of Delaware without regard to its principles of conflict of laws.

        14.  Amendments. This Restricted Stock Agreement may be amended or modified at any time only by an instrument in writing signed by each of the parties hereto, and approved by the Committee. The Board may terminate or amend the Plan at any time; provided, however, that the termination or any modification or amendment of the Plan shall not, without the consent of the Recipient, affect the rights of the Recipient under this Restricted Stock Agreement.

        15.  Survival of Terms. This Restricted Stock Agreement shall apply to and bind the Recipient and the Company and their respective permitted assignees and transferees, heirs, legatees, executors, administrators and legal successors.

        16.  Agreement Not a Contract for Services; Rights to Terminate Employment. Neither the grant of the Restricted Stock, this Restricted Stock Agreement nor any other action taken pursuant to this Restricted Stock Agreement shall constitute or be evidence of any agreement or understanding, express or implied, that the Recipient has a right to continue to provide services as an officer, director, employee or consultant of the Company and/or the Employer for any period of time or at any specific rate of compensation. Nothing in the Plan or in this Restricted Stock Agreement shall confer upon the Recipient the right to continue in the employment of an Employer or affect any right which an Employer may have to terminate the employment of the Recipient. The Recipient specifically acknowledges that the Employer intends to review the Recipient's performance from time to time, and that the Company and/or the Employer has the right to terminate the Recipient's employment at any time, including a time in close proximity to the Vesting Date, for any reason, with or without cause. The Recipient acknowledges that upon his or her termination of employment with an Employer for any reason, then all shares of Restricted Stock not yet vested shall be immediately forfeited at such time, and the Company shall return to the Recipient an amount equal to the par value of the Restricted Stock which was paid by the Recipient to the Company as is set forth in Section 3 of this Restricted Stock Agreement.

        17.  Decisions of Board or Committee. The Board or the Committee shall have the right to resolve all questions which may arise in connection with the Restricted Stock. Any interpretation, determination or other action made or taken by the Board or the Committee regarding the Restricted Stock, the Plan or this Restricted Stock Agreement shall be final, binding and conclusive.

        18.  Failure to Execute Agreement. This Restricted Stock Agreement and the Restricted Stock granted hereunder is subject to the Recipient returning a counter-signed copy of this Restricted Stock Agreement to the designated representative of the Company on or before 60 days after the date of its distribution to the Recipient. In the event that the Recipient fails to so return a counter-signed copy of this Agreement within such 60-day period, then this Restricted Stock Agreement and the Restricted Stock granted hereunder shall automatically become null and void and shall have no further force or effect.

        IN WITNESS WHEREOF, the parties hereto have executed and delivered this Restricted Stock Agreement on the day and year first above written. The undersigned hereby accepts and agrees to all the terms and provisions of the foregoing Restricted Stock Agreement and to all the terms and provisions of the Health Net, Inc. 1998 Stock Option Plan, as amended to date, incorporated by reference herein.

Health Net, Inc.

Name:

Title:

THE UNDERSIGNED RECIPIENT HEREBY EXPRESSLY ACKNOWLEDGES AND AGREES THAT HE/SHE IS AN EMPLOYEE AT WILL AND MAY BE TERMINATED BY THE EMPLOYER AT ANY TIME, WITH OR WITHOUT CAUSE.

The undersigned hereby accepts and agrees to all the terms and provisions of the foregoing Restricted Stock Agreement and to all the terms and provisions of the Health Net, Inc. 1998 Stock Option Plan, as amended to date, incorporated by reference herein.

Recipient:

[Name]

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FORM OF RESTRICTED STOCK AGREEMENT

EX-10.40

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Exhibit 10.40

        The following three amendments to the Health Net, Inc. 401(k) Savings Plan (as amended and restated effective January 1, 2001) constitute all amendments to such plan made through December 31, 2002:

AMENDMENT NUMBER ONE
TO THE
HEALTH NET, INC. 401(K) SAVINGS PLAN
(As Amended and Restated effective January 1, 2001)

        The Health Net, Inc. 401(k) Savings Plan (the "Plan") is amended effective September 30, 2001 as follows:

        Section 8.5(a) of the Plan is amended to delete the phrase "Unless a Participant or a Beneficiary elects an optional form of distribution described in subsection (b)," as it appears therein.

        1.      Subsection (b) of Section 8.5 of the Plan is hereby deleted in its entirety (redesignating each subsequent subsection and each reference thereto accordingly).

        2.      Section 8.5(d) of the Plan is amended to substitute the phrase "the payment of a lump sum shall be made" for the phrase "the payment of a lump sum shall be made, or installment or annuity payments shall commence, as the case may be," as it appears in the first sentence thereto.

        3.      Section 8.6 of the Plan is hereby deleted in its entirety (redesignating each subsequent Section and each reference thereto accordingly).

AMENDMENT NUMBER TWO
TO THE
HEALTH NET, INC. 401(K) SAVINGS PLAN
(As Amended and Restated effective January 1, 2001)

        The Health Net, Inc. 401(k) Savings Plan (the "Plan") is amended, effective as of January 1, 2002, except as otherwise provided, as follows:

        1.      Effective as of January 1, 2001, subsection (11) of Article 2 of the Plan is amended to insert the phrase ", a qualified transportation fringe benefit plan described in section 132(f) of the Code" after the phrase "or any other qualified cash or deferred arrangement described in section 401(k) of the Code" as it appears therein.

        2.      Section 4.2(a) of the Plan is amended to (I) to add the phrase "(or such higher percentage as deemed necessary to conform to the Company's payroll practices)" after the phrase "and not more than 17 percent (17%) of such Participant's Compensation"; (II) to substitute the phrase "as designated by the Participant either on his or her application form or by telephone or such electronic means as may be prescribed by the Committee, as described in Section 3.2" for the phrase "as designated by the Participant on his or her application pursuant to Section 3.2" as it appears at the end of the first sentence thereof and (III) to add a new sentence at the end thereof to read as follows:

Notwithstanding the foregoing, the Committee may from time to time specify a limit on Salary Deferral Contributions made for the benefit of some or all Participants who are Highly Compensated Employees which is less than 17% of such Participant's Compensation.

        3.      Effective as of December 1, 2002, Section 4.2 of the Plan is further amended to add a new subsection at the end thereof to read as follows:

        (c)    Catch-Up Contributions. Each Participant who is eligible to make Salary Deferral Contributions for a payroll period pursuant to subsection (a) above and who has, or will attain age 50 before the close of the current Plan Year shall be eligible to have Salary Deferral Contributions made in addition to those described in subsection (a) above in accordance with, and subject to the limitations of, section 414(v) of the Code ("Catch-Up Contributions"). Such Catch-Up Contributions shall not be taken into account for purposes of Section 4.2 or 7.5 of the Plan. The Plan shall not be treated as failing to satisfy the provisions of the Plan implementing the requirements of section 401(k)(3), 401(k)(11), 401(k)(12), 410(b) or 416 of the Code, as applicable, by reason of such Catch-Up Contributions.

        4.      Section 4.5 of the Plan is amended to delete subsections (c), (d)(3) and (e)(3) in their entirety (renumbering and redesignating each subsequent subsection and reference thereto).

        5.      Section 4.5(c)(2) (as renumbered) of the Plan is amended to add the phrase "(including any Matching Contributions made under Section 14.3)" after the phrase "the nearest one-hundredth of one percent (.01%), of the Matching Contributions" as it appears in the first sentence thereof.

        6.      The first sentence of Section 5.1 of the Plan is amended in its entirety to read as follows:

If an Employee receives an "eligible rollover distribution" (within the meaning of section 402(c)(4) of the Code) from an employees' trust described in section 401(a) of the Code which is exempt from tax under section 501(a) of the Code, a qualified annuity plan described in section 403(a) of the Code, an annuity contract described in section 403(b) of the Code, an individual retirement account or annuity described in section 408(a) or 408(b) of the Code or an eligible plan under section 457(b) of the Code which is maintained by a state, a political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state, then such Employee may contribute to this Plan an amount not in excess of the eligible rollover distribution; provided, however, that, if any portion of an eligible rollover distribution includes after-tax contributions, such after-tax contributions may be rolled over to this Plan pursuant to this Section 5.1 only to the extent that such after-tax contributions are transferred on behalf of the Employee directly from a qualified defined contribution plan described in section 401(a) or 403(a) of the Code.

        7.      Section 5.2 of the Plan is amended to add a new phrase at the end thereof to read as follows:

        and shall not be required to accept such a contribution to the extent that it consists of property other than cash.

        8.      Section 6.2(a) of the Plan is amended to add the phrase "and existing investment funds may be removed," after the phrase "Additional investment funds may be established" as it appears in the last sentence thereof.

        9.      Section 7.5(1) of the Plan is amended (I) substitute the dollar amount "$40,000" for the dollar amount "$30,000" as it appears therein and (II) to substitute the percentage "one hundred (100%)" for the percentage "twenty-five (25%)" as it appears therein.

        10.  Section 8.2(c)(C) of the Plan is amended (I) to substitute the number "6" for the number "12" as it appears therein and (II) to delete the last sentence thereof in its entirety.

        11.  Effective for distributions commencing after the earlier of (i) the date which occurs 90 days following the date a summary is furnished to Plan participants describing the elimination of optional forms of benefit in accordance with Treasury Regulation section 1.411(d)-4(e)(1)(ii) and (ii) January 1, 2004 (whichever date occurs first, the "Elimination Effective Date"), Section 8.5(a) of the Plan is amended to delete the phrase "Unless a Participant or a Beneficiary elects an optional form of distribution described in subsection (b)," as it appears therein.

        12.  Effective as of the Elimination Effective Date, subsection (b) of Section 8.5 of the Plan is hereby deleted in its entirety (redesignating each subsequent subsection and each reference thereto accordingly).

        13.  Section 8.5(c) of the Plan is amended to delete the last sentence therein in its entirety.

        14.  Effective as of the Elimination Effective Date, Section 8.5(d) of the Plan is amended to delete the phrase ", or installment or annuity payments shall commence, as the case may be," as it appears in the first sentence thereto.

        15.  The first sentence of Section 8.5(e) of the Plan is amended in its entirety to read as follows:

In the case of a distribution that is an "eligible rollover distribution" within the meaning of section 402(c)(4) of the Code, a distributee may elect that all or any portion of such distribution to which he or she is entitled shall be directly transferred from the Plan to an individual retirement account described in section 408(a) of the Code, an individual retirement annuity described in section 408(b) of the Code, an annuity plan described in section 403(a) of the Code, a qualified trust described in section 401(a) of the Code, an annuity contract described in section 403(b) of the Code or an eligible plan under section 457(b) of the Code which is maintained by a state, political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state which agrees to separately account for amounts transferred into such plan from this Plan; provided, however, that, in the case of any eligible rollover distribution that includes the Participant's After-Tax Account, a distributee may elect to transfer the After-Tax Account portion of such eligible rollover distribution only to an individual retirement account or annuity described in section 408(a) or (b) of the Code, or to a qualified defined contribution plan described in section 401(a) or 403(a) of the Code that agrees to account separately for amounts directly transferred into such plan from this Plan, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible.

        16.  Effective as of the Elimination Effective Date, Section 8.6 of the Plan is hereby deleted in its entirety (redesignating each subsequent Section and each reference thereto accordingly).

        17.  Section 14.2(b) of the Plan is amended in its entirety to read as follows:

        (b)  Special Rules. For the purposes of determining the accrued benefit or account balance of a Participant under this Article 14, the accrued benefit or account balance of any person who has not performed services for an employer at any time during the 1-year period ending on the determination date shall not be taken into account. Furthermore, any person who received a distribution from a plan (including a plan that has terminated) in the aggregation group during the 1-year period ending on the last day of the preceding Plan Year shall be treated as a Participant in such plan, and any such distribution shall be included in such Participant's account balance or accrued benefit, as the case may be; provided, however, that in the case of a distribution made for a reason other than a Participant's separation from service, death or Disability, this sentence shall be applied by substituting "5-year period" for "1-year period".

        18.  Section 14.3 of the Plan is amended to substitute the phrase "Profit Sharing and Matching Contributions" for the phrase "Employer contributions" as it appears in the first sentence thereof.

AMENDMENT NUMBER THREE
TO THE
HEALTH NET, INC. 401(k) SAVINGS PLAN
(as amended and restated effective January 1, 2001)

        The Health Net, Inc. 401(k) Savings Plan (the "Plan") is amended, effective as of January 1, 1997, as follows:

        1.      Subsection (11) of Article 2 of the Plan is amended to add a new sentence at the end thereof to read as follows:

Compensation, as defined in this subsection (11) and in Sections 4.5(c)(5), 7.5, 9.6 and 14.2(a)(4) of the Plan, shall include amounts not available to a Participant in cash because such amounts are used to purchase group health coverage under a cafeteria plan described in section 125 of the Code that requires participants in such plan to certify that they have other health coverage in order to receive cash rather than group health coverage, provided that such Participant's Employer does not request or collect information regarding the Participant's other health co/5verage as part of the enrollment process for the cafeteria plan.

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Exhibit 10.40

EX-12.1

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Exhibit 12.1

Health Net, Inc.

Calculation of Ratio of Earnings to Fixed Charges—Consolidated Basis

(amount in thousands, except ratios)

	Year Ended December 31,
	2002			2001			2000			1999			1998
Income from continuing operations	$	356,495		$	137,350		$	262,747		$	244,008		$	(254,154	)
Interest expense		40,226			54,940			87,930			83,808			92,159
Amortization of debt expense		2,738			3,280			3,395			3,170			1,100
Interest portion of rental expense(a)		7,903			8,403			7,470			7,350			7,545
Earnings	$	407,362		$	203,973		$	361,542		$	338,336		$	(153,350	)
Fixed Charges (Total of interest expense, amort. and interest portion of rental expense)	$	50,867		$	66,623		$	98,795		$	94,328		$	100,804
Ratio of earnings to fixed charges		8.0	x		3.1	x		3.7	x		3.6	x		(b	)

(a)

Interest portion of rental expense is estimated to be 15%.

(b)

No ratio is shown for 1998 because earnings were insufficient to cover fixed charges by $153.4 million.

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Exhibit 12.1

EX-13.1

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Exhibit 13.1

Financial Highlights

Health Net, Inc.

			Year ended December 31,
			2002			2001(2)		2000(2)		1999(2)			1998(2)
			(Amounts in thousands, except per share data)
STATEMENT OF OPERATIONS DATA(1):
REVENUES
	Health plan services premiums		$	8,584,418		$	8,576,202	$	7,609,625	$	7,353,958		$	7,460,276
	Government contracts			1,498,689			1,339,066		1,265,124		1,104,101			998,581
	Net investment income			65,561			78,910		90,087		67,588			70,523
	Other income			52,875			70,282		111,719		122,240			99,489
		Total revenues		10,201,543			10,064,460		9,076,555		8,647,887			8,628,869
EXPENSES
	Health plan services			7,161,520			7,241,185		6,322,691		6,061,642			6,196,596
	Government contracts			1,450,808			1,321,483		1,196,532		1,082,317			992,589
	General and administrative			857,201			868,925		942,316		973,235			1,107,037
	Selling			199,764			186,143		158,031		137,444			132,096
	Depreciation and amortization			70,192			98,695		105,899		112,041			128,093
	Interest			40,226			54,940		87,930		83,808			92,159
	Asset impairment, merger, restructuring and other costs			60,337			79,667		—		11,724			240,053
	Net loss (gain) on assets held for sale and sale of businesses and properties			5,000			76,072		409		(58,332	)		(5,600	)
		Total expenses		9,845,048			9,927,110		8,813,808		8,403,879			8,883,023
Income (loss) from operations before income taxes and cumulative effect of changes in accounting principle				356,495			137,350		262,747		244,008			(254,154	)
Income tax provision (benefit)				118,928			50,821		99,124		96,226			(88,996	)
Income (loss) before cumulative effect of changes in accounting principle				237,567			86,529		163,623		147,782			(165,158	)
Cumulative effect of changes in accounting principle, net of tax				(8,941	)		—		—		(5,417	)		—
Net income (loss)			$	228,626		$	86,529	$	163,623	$	142,365		$	(165,158	)
BASIC EARNINGS (LOSS) PER SHARE:
Income (loss) from operations			$	1.91		$	0.70	$	1.34	$	1.21		$	(1.35	)
Cumulative effect of changes in accounting principle				(0.07	)		—		—		(0.05	)		—
Net			$	1.84		$	0.70	$	1.34	$	1.16		$	(1.35	)
DILUTED EARNINGS (LOSS) PER SHARE:
Income (loss) from operations			$	1.89		$	0.69	$	1.33	$	1.21		$	(1.35	)
Cumulative effect of changes in accounting principle				(0.07	)		—		—		(0.05	)		—
Net			$	1.82		$	0.69	$	1.33	$	1.16		$	(1.35	)
Weighted average shares outstanding:
Basic				124,221			123,192		122,471		122,289			121,974
Diluted				126,004			125,186		123,453		122,343			121,974
BALANCE SHEET DATA:
Cash and cash equivalents and investments available for sale			$	1,850,139		$	1,766,154	$	1,533,637	$	1,467,142		$	1,288,947
Total assets				3,466,677			3,559,647		3,670,116		3,696,481			3,863,269
Revolving credit facilities and capital leases				—			195,182		766,450		1,039,352			1,254,278
Senior notes payable				398,821			398,678		—		—			—
Stockholders' equity(3)				1,309,049			1,165,512		1,061,131		891,199			744,042
OPERATING CASH FLOW			$	420,023		$	546,484	$	366,163	$	297,128		$	100,867

(1)

See Note 3 to the Consolidated Financial Statements for discussion of dispositions during 2002 and 2001 impacting the comparability of information. In addition, we sold our non-affiliate pharmacy benefits management operations, our health plans in Utah, Washington, New Mexico, Louisiana, Texas and Oklahoma, our two hospitals, a third-party administrator subsidiary and a PPO network subsidiary in 1999.

(2)

Certain amounts have been reclassified to conform to the 2002 presentation. The reclassifications have no effect on total revenues, total expenses, net earnings or stockholders' equity as previously reported. The reclassifications reflect changes in our organizational structure as discussed in Notes 1 and 2 to the Consolidated Financial Statements.

(3)

No cash dividends were declared in each of the years presented.

1

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

        Health Net, Inc. (formerly named Foundation Health Systems, Inc.) (together with its subsidiaries, the Company, we, us or our) is an integrated managed care organization that administers the delivery of managed health care services. We are one of the nation's largest publicly traded managed health care companies. Our health plans and government contracts subsidiaries provide health benefits through our health maintenance organizations (HMOs), preferred provider organizations (PPOs) and point of service (POS) plans to approximately 5.4 million individuals in 15 states through group, individual, Medicare, Medicaid and TRICARE (formerly known as the Civilian Health and Medical Program of the Uniformed Services (CHAMPUS)) programs. Our subsidiaries also offer managed health care products related to behavioral health, dental, vision and prescription drugs. We also offer managed health care product coordination for workers' compensation insurance programs through our employer services group subsidiary. We also own health and life insurance companies licensed to sell PPO, POS and indemnity products, as well as auxiliary non-health products such as life and accidental death and disability insurance in 35 states and the District of Columbia.

        We currently operate within two reportable segments: Health Plan Services and Government Contracts. Our current Health Plan Services reportable segment includes the operations of our health plans in the states of Arizona, California, Connecticut, New Jersey, New York, Oregon and Pennsylvania, the operations of our health and life insurance companies and our behavioral health, dental, vision and pharmaceutical services subsidiaries. We have approximately 3.9 million at-risk members in our Health Plan Services reportable segment.

        Our Government Contracts reportable segment includes government-sponsored managed care plans through the TRICARE programs and other government contracts. The Government Contracts reportable segment administers large, multi-year managed health care government contracts. Certain components of these contracts are subcontracted to unrelated third parties. The Company administers health care programs covering approximately 1.5 million eligible individuals under TRICARE. The Company has three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Washington and parts of Arizona, Idaho, Louisiana and Texas.

        Revenues of our employer services group operating segment are included in "Other income."

        Please refer to Notes 1 and 2 to the consolidated financial statements for discussion on the changes to our reportable segments.

        Prior to 2002, we operated within two slightly different segments: Health Plan Services and Government Contracts/Specialty Services. During 2000 and most of 2001, the Health Plan Services segment consisted of two regional divisions: Western Division (Arizona, California and Oregon) and Eastern Division (Connecticut, Florida, New Jersey, New York and Pennsylvania). During the fourth quarter of 2001, we decided that we would no longer view our health plan operations through these two regional divisions. The Government Contracts/Specialty Services reportable segment included government-sponsored managed care plans through the TRICARE programs, behavioral health, dental and vision, and managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities.

27

        Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, L.L.C. The Florida health plan had approximately 166,000 members at the close of the sale. See "Net Loss on Assets Held for Sale and Sale of Businesses and Properties."

        This discussion and analysis and other portions of this 2002 Annual Report to Stockholders and our Annual Report on Form 10-K for the year ended December 31, 2002 (the Form 10-K) contain "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, that involve risks and uncertainties. All statements other than statements of historical information provided herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects" and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, the matters described in the "Cautionary Statements" section and other portions of the Form 10-K and the risks discussed in our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which reflect management's analysis, judgment, belief or expectation only as of the date hereof. Except as required by law, we undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report.

RESULTS OF OPERATIONS

CONSOLIDATED OPERATING RESULTS

        Our net income for the year ended December 31, 2002 was $228.6 million or $1.82 per diluted share, compared to the same period in 2001 of $86.5 million or $0.69 per diluted share. Our net income for the year ended December 31, 2000 was $163.6 million, or $1.33 per diluted share.

        Included in our results for the year ended December 31, 2002 is a pretax loss of $65.3 million comprised of the following:

•

$35.8 million for impairment of purchased and internally developed software assets as a result of our operations and systems consolidation,



•

$3.6 million for an other-than temporary decline of an investment available for sale,



•

$7.1 million write-off of our investments in AmCareco, Inc. which arose from a previous divestiture,



•

$2.6 million estimated loss on the sale of our claims processing subsidiary,



•

$2.4 million for impairment of a property held for sale in Trumbull, Connecticut,



•

$1.5 million true-up adjustment of our 2001 restructuring plan, and



•

$12.4 million write-off of our investment in MedUnite.

        Included in our results for the year ended December 31, 2001 are a loss of $76.1 million for the sales of our Florida health plan and related corporate facility building and costs of $79.7 million related to our 2001 restructuring plan.

        See "Asset Impairment and Restructuring Charges" and "Net Loss on Assets Held for Sale and Sale of Businesses and Properties."

28

        The table below and the discussion that follows summarize the Company's performance in the last three fiscal years.

			Year ended December 31,
			2002			2001(1)			2000(1)
			(Amounts in thousands, except per member per month data)
REVENUES:
	Health plan services premiums		$	8,584,418		$	8,576,202		$	7,609,625
	Government contracts			1,498,689			1,339,066			1,265,124
	Net investment income			65,561			78,910			90,087
	Other income			52,875			70,282			111,719
		Total revenues		10,201,543			10,064,460			9,076,555
EXPENSES:
	Health plan services			7,161,520			7,241,185			6,322,691
	Government contracts			1,450,808			1,321,483			1,196,532
	General and administrative			857,201			868,925			942,316
	Selling			199,764			186,143			158,031
	Depreciation			61,832			61,073			67,260
	Amortization			8,360			37,622			38,639
	Interest			40,226			54,940			87,930
	Asset impairment and restructuring charges			60,337			79,667			—
	Net loss on assets held for sale and sale of businesses and properties			5,000			76,072			409
		Total expenses		9,845,048			9,927,110			8,813,808
Income from operations before income taxes and cumulative effect of a change in accounting principle				356,495			137,350			262,747
Income tax provision				118,928			50,821			99,124
Income before cumulative effect of a change in accounting principle				237,567			86,529			163,623
Cumulative effect of a change in accounting principle, net of tax				(8,941	)		—			—
Net income			$	228,626		$	86,529		$	163,623
Health plan services medical care ratio				83.4	%		84.4	%		83.1	%
Government contracts cost ratio				96.8	%		98.7	%		94.6	%
Administrative ratio(2)				10.6	%		10.8	%		13.1	%
Selling costs ratio(3)				2.3	%		2.2	%		2.1	%
Health plan services premiums per member per month (PMPM)(4)			$	186.98		$	176.58		$	162.22
Health plan services PMPM(4)			$	155.99		$	149.12		$	134.78

(1)

Certain amounts have been reclassified to conform to the 2002 presentation. The reclassifications have no effect on total revenues, total expenses, net earnings or stockholders' equity as previously reported. The reclassifications reflect changes in our organizational structure as discussed in Notes 1 and 2 to the Consolidated Financial Statements.

(2)

The administrative ratio is computed as the sum of general and administrative (G&A) and depreciation expenses divided by the sum of health plan services premium revenues and other income.

(3)

The selling cost ratio is computed as selling expenses divided by health plan services premium revenues.

(4)

PMPM is calculated based on total at-risk member months and excludes ASO member months.

ENROLLMENT INFORMATION

        The table below summarizes the Company's at-risk insured and ASO enrollment information for the last three fiscal years.

	2002	Percent Change		2001	Percent Change		2000
	(Amounts in thousands)
Health Plan Services:
Commercial	2,847	(4.6	)%	2,985	(0.4	)%	2,996
Federal Program	176	(18.5	)%	216	(20.6	)%	272
State Programs	874	10.9	%	788	18.3	%	666
Continuing Plans	3,897	(2.3	)%	3,989	1.4	%	3,934
Discontinued Plans	—	—		—	(100.0	)%	3
Total Health Plan Services	3,897	(2.3	)%	3,989	1.3	%	3,937
Government Contracts:
TRICARE PPO and Indemnity	503	(1.0	)%	508	(9.6	)%	562
TRICARE HMO	958	(0.1	)%	959	6.4	%	901
Total Government Contracts	1,461	(0.4	)%	1,467	0.3	%	1,463
ASO	72	(7.7	)%	78	(6.0	)%	83

29

2002 Membership Compared to 2001 Membership

        Commercial membership decreased by 138,000 members or 5% at December 31, 2002 compared to the same period in 2001. The net decrease in commercial membership is primarily due to planned exits from unprofitable large employer group accounts offset by increases in enrollment in key products and markets that we have been targeting in an effort to achieve a greater product diversity. These changes have resulted in the following:

•

Net decrease in California of 72,000 members as a result of a 172,000 member decrease in our large group HMO market. This decline reflects disenrollment of our HMO members due to premium rate increases averaging 14% from December 2001. Membership declines in California Public Employees' Retirement System (CalPERS) accounted for 55,000 members of the decline in the large group market. This decline is partially offset by a 100,000 membership increase in our PPO/POS products in the small group and individual markets,



•

Decrease in Arizona of 49,000 members as a result of membership decreases in our large group HMO market. This decline reflects disenrollment of our HMO members due to premium rate increases averaging 17% from December 2001,



•

Decrease in New York of 13,000 members as a result of membership decreases in our large group HMO market. This decline reflects disenrollment of our HMO members due to premium rate increases averaging 17% from December 2001, and



•

Decrease in Connecticut of 28,000 members in our large group is offset by an increase in New Jersey of 28,000 members in our small group.

        During April 2002, CalPERS announced that we would no longer be one of the health insurance carriers available to its members. Effective January 1, 2003, the remaining 175,000 members from CalPERS were no longer enrolled in any of our plans.

        We have been targeting greater product and segment diversity, and we expect our product mix to continually change as we add membership in small group and individual markets.

        Membership in the federal Medicare program decreased by 40,000 members or 18% at December 31, 2002 compared to the same period in 2001. The decrease in the federal Medicare program membership is primarily due to planned exits from unprofitable counties as follows:

•

Decrease in California of 17,000 members, including 9,000 CalPERS members who were not offered the Medicare risk product,



•

Decrease in Arizona of 11,000 members because we closed enrollment in that state effective January 2002 to avoid adverse selection from a change in one of our competitors' benefits, and



•

Decrease in Pennsylvania of 8,000 members as our withdrawal from the Pennsylvania Medicare program was completed in December 2002.

        Membership in the Medicaid programs increased by approximately 86,000 members or 11% at December 31, 2002, compared to the same period for 2001, primarily due to the following:

•

Increase in California of 70,000 members, primarily from strong promotions by the State of California of the Healthy Families program. The Healthy Families program provides health insurance to children from low-income families, and



•

Increase in Connecticut and New Jersey of 16,000 members due to expansion of Medicaid eligible population.

        Government contracts covered approximately 1.5 million eligible individuals under the TRICARE program at December 31, 2002 and 2001. Dependents of active-duty military personnel and retirees and their dependents are automatically eligible to receive benefits under the TRICARE program. Any changes in the eligibility reflect the timing of when the individuals become eligible. We expect the call up of reservists to meet the nation's heightened military activities to increase the number of eligibles.

2001 Membership Compared to 2000 Membership

        Commercial membership decreased by approximately 11,000 members or less than 1% at December 31, 2001, compared to the same period for 2000, primarily due to the following:

•

Decrease of 109,000 members in Florida due to the sale of the Florida health plan effective August 1, 2001,



•

Decrease of 132,000 members in Arizona primarily due to membership losses in the large group market. The loss of the State of Arizona employer group accounted for 65,000 of the membership loss,



•

Combined decreases of 43,000 members in Oregon and Connecticut in the large group market attributable to premium rate increases, partially offset by



•

Increase of 206,000 members in California, primarily due to enrollment increases of 103,000 members within the small group market most notably as a result of the growth of 84,000 members in our PPO product in 2001, 41,000 members in individual growth, and 60,000 members in the large group market, and



•

Increase of 67,000 members in New Jersey due to membership increases equally distributed between the small group and large group markets.

30

        Membership in the federal Medicare program decreased by approximately 56,000 members or 21% at December 31, 2001 compared to the same period for 2000 primarily due to the following:

•

Decrease of 45,000 members in Florida due to the sale of the Florida health plan effective August 1, 2001, and



•

Decrease of 11,000 members in Arizona due to our exit from unprofitable counties.

        Membership in state programs (including Medicaid) increased by approximately 122,000 members or 18% at December 31, 2001 compared to the same period for 2000 primarily due to the following:

•

Increase of 115,000 members in California primarily in Los Angeles County,



•

Increase of 29,000 members in Connecticut and New Jersey, partially offset by



•

Decrease of 22,000 members in Florida due to the sale of the Florida health plan effective August 1, 2001.

        Discontinued plans in 2000 included our membership in Washington. We no longer had any membership in this plan as of December 31, 2001.

        Government contracts covered approximately 1.5 million eligible individuals under the TRICARE program at December 31, 2001 and 2000. Dependents of active-duty military personnel and retirees and their dependents are automatically eligible to receive benefits under the TRICARE program. Any changes in the eligibility reflect the timing of when the individuals become eligible.

HEALTH PLAN SERVICES PREMIUMS

2002 Compared to 2001

        Health Plan Services premiums increased $8.2 million or 0.1% for the year ended December 31, 2002 as compared to the same period in 2001. Our Health Plan Services premiums, excluding the Florida health plan sold effective August 1, 2001, increased by $348.0 million or 4% for the year ended December 31, 2002 as compared to the same period in 2001, primarily due to the following:

•

Increase in commercial premiums of $327.9 million or 6% for the year ended December 31, 2002 as compared to the same period in 2001 is due to a 13% increase in premiums on a PMPM basis partially offset by a 7% decrease in member months. The premium increases on a PMPM basis were in large, small and individual groups across all states averaging 11%, 13% and 7%, respectively. The majority of the decrease in member months were from non-renewal of members in our large group HMO product in California and Arizona, offset by



•

Decrease in Medicare risk premiums of $157.3 million or 10% for the year ended December 31, 2002 as compared to the same period in 2001 is due to a 16% decrease in member months, partially offset by a 7% increase in premium yields on a PMPM basis. The decrease in member months is from exiting certain unprofitable counties and the sale of our Florida health plan, and



•

Increase in Medicaid premiums of $173.0 million or 18% for the year ended December 31, 2002 as compared to the same period in 2001 is due to a 15% increase in member months and a 3% increase in premiums on a PMPM basis. These increases are primarily from membership increases in the Healthy Families program in California.

2001 Compared to 2000

        Health Plan Services premiums increased $966.6 million or 13% for the year ended December 31, 2001 compared to the same period in 2000 primarily due to the following:

•

Increase in commercial premiums of $718.5 million or 15% is due to average commercial premium rate increases of 11% combined with a 4% increase in member months. Excluding Arizona, all our health plans experienced growth in commercial membership,



•

Increase in the federal health program of $41.3 million or 3% is due to an 8% increase in the premium yield which reflects the Medicare+Choice reimbursement increase that was effective January 1, 2001, partially offset by a 5% decrease in member months, and



•

Increase in state health programs of $211.2 million or 28% is driven by rate increases of 8% in California and a 20% increase in member months for the year ended December 31, 2001.

        Our 10 largest employer groups accounted for approximately 15% of premium revenue for the years ended December 31, 2002, 2001 and 2000, respectively. Our premium revenue from the federal Medicare program accounted for 17%, 21% and 23% of premium revenue for the years ended December 31, 2002, 2001 and 2000, respectively. Our premium revenue from the state Medicaid programs accounted for 13%, 11% and 10% of premium revenue for the years ended December 31, 2002, 2001 and 2000, respectively.

GOVERNMENT CONTRACTS REVENUES

2002 Compared to 2001

        Government Contracts revenues increased by $159.6 million or 11.9% for the year ended December 31, 2002 as compared to the same period in 2001. This increase is primarily due to increases in risk sharing revenues from increased health care estimates and higher change order costs. In addition, heightened military activity during 2002 contributed to the revenue increase.

31

        On August 1, 2002 the United States Department of Defense (DoD) issued a Request For Proposals (RFP) for the rebid of the TRICARE contracts. The RFP divides the United States into three regions (North, South and West) and provides for the award of one contract for each region. The RFP also provides that each of the three new contracts will be awarded to a different prime contractor. We submitted proposals in response to the RFP for each of the three regions in January 2003 and it is anticipated that the DoD will award the three new TRICARE contracts on or before June 1, 2003. Health care delivery under the new TRICARE contracts will not commence until the expiration of health care delivery under the current TRICARE contracts.

        If all option periods are exercised by DoD under the current TRICARE contracts with us and no further extensions are made, health care delivery ends February 29, 2004 for the Region 11 contract, on March 31, 2004 for the Regions 9, 10 and 12 contract and on October 31, 2004 for the Region 6 contract. As set forth above, we are competing for the new TRICARE contracts in response to the RFP.

2001 Compared to 2000

        Government Contracts revenues increased $73.9 million or 5.8% for the year ended December 31, 2001 compared to the same period in 2000. The increase is primarily due to a $40.1 million increase in TRICARE revenue from increased change order activity and a $30.2 million increase from successful negotiation on new extension pricing.

NET INVESTMENT INCOME

2002 Compared to 2001

        Investment income declined by $13.3 million or 16.9% for the year ended December 31, 2002 as compared to the same period in 2001. This decline is primarily a result of continued declines in interest rates of an average of 97 basis points in the year ended December 31, 2002, as compared to the same period in 2001 partially offset by higher average cash and investment balances.

        During the year ended December 31, 2002, we sold $5.0 million, par value, of WorldCom (MCI) bonds and recognized a pretax loss of $3.2 million, included in net investment income.

2001 Compared to 2000

        Investment income decreased by $11.2 million or 12.4% for the year ended December 31, 2001 compared to the same period in 2000. This decrease was due to declining interest rates. The decrease in the average yield for 2001 is reflective of the Federal Reserve's continued lowering of interest rates.

        In the latter part of the fourth quarter of 2001, we began to reposition certain of our investable assets within our regulated health plans to increase investment income by investing in investments with longer durations. This resulted in an over 75% increase in investments available for sale as of December 31, 2001 from December 31, 2000.

OTHER INCOME

2002 Compared to 2001

        Other income is primarily comprised of revenues from our employer services group subsidiary. Other income decreased by $17.4 million or 24.8% for the year ended December 31, 2002 compared to the same period in 2001. This decrease is primarily due to a decline in business volume and sale of our claims processing subsidiary effective July 1, 2002.

2001 Compared to 2000

        Other income decreased by $41.4 million or 37.1% for the year ended December 31, 2001 compared to the same period in 2000. This decrease is primarily due to a decline in business volume from certain customers that decided to perform their claims processing and bill review functions in-house.

HEALTH PLAN SERVICES COSTS

2002 Compared to 2001

        Total health plan services costs decreased by $79.7 million or 1.1% for the year ended December 31, 2002 as compared to the same period in 2001 primarily due to the disposition of the Florida health plan effective August 1, 2001. Total Health Plan Services costs on a PMPM basis increased to $155.99 or 5% for the year ended December 31, 2002 from $149.12 for the same period in 2001. Excluding the Florida health plan, the health plan services costs increased by $242.6 million or 3.5% for the year ended December 31, 2002, primarily due to the following:

•

Increase in commercial health care costs of $258.5 million or 6% for the year ended December 31, 2002 as compared to the same period in 2001 is due to a 13% increase in health care costs on a PMPM basis as a result of higher hospital unit cost trends, partially offset by a 7% decrease in member months,



•

Decrease in Medicare risk health care costs of $162.9 million or 11% for the year ended December 31, 2002 as compared to the same period in 2001 is due to a 16% decrease in member months, partially offset by a 5% increase in health care costs on a PMPM basis as a result of higher hospital unit cost trends, and

32

•

Increase in Medicaid health care costs of $147.9 million or 19% for the year ended December 31, 2002 as compared to the same period in 2001 is due to a 15% increase in member months and a 4% increase in health care costs on a PMPM basis as a result of increased hospital and physician utilization.

        Our Health Plan Services MCR decreased to 83.4% for the year ended December 31, 2002 from 84.4% for the same period in 2001. The improvement in our Health Plan Services MCR is due to a continued focus on pricing discipline combined with pricing increases above the health care cost trend for our Medicare products. The increase in our overall Health Plan Services premiums on a PMPM basis of 6% as compared to the same period in 2001 outpaced the increase in our overall health care costs on a PMPM basis of 5% as compared to the same period in 2001. In addition to the pricing increases, we have been de-emphasizing the large group market, which has had higher MCRs, which also contributed to the decline in the MCRs.

2001 Compared to 2000

        Health Plan Services MCR increased to 84.4% for the year ended December 31, 2001 compared to 83.1% for the same period in 2000. Total Health Plan Services costs on a PMPM basis increased to $149.12 or 11% for the year ended December 31, 2001 from $134.78 for the same period in 2000 primarily due to a 10% increase in commercial health care costs on a PMPM basis. This increase was primarily due to increases in inpatient and outpatient hospital costs of 9% for the year ended December 31, 2001 from the same period in 2000 reflecting significant shifts from dual risk to shared risk and fee-for-service contracts and a 10% increase in pharmacy costs on a PMPM basis due to increased pricing and utilization.

GOVERNMENT CONTRACTS COSTS

2002 Compared to 2001

        Government Contracts costs increased by $129.3 million or 9.8% for the year ended December 31, 2002 compared to the same period in 2001. This increase is primarily due to increases in health care estimates and higher administrative and health care change order costs. In addition, heightened military activity during 2002 has contributed to the increase in health care costs.

        Government Contracts cost ratio decreased to 96.8% for the year ended December 31, 2002 as compared to 98.7% for the same period in 2001. The 188 basis point improvement is primarily due to risk sharing revenue increases attributable to an increase in services provided to TRICARE eligibles.

2001 Compared to 2000

        The Government Contracts costs increased by $125.0 million or 10.4% for the year ended December 31, 2001 compared to the same period in 2000. The Government Contracts cost ratio increased to 98.7% for the year ended December 31, 2001 as compared to 94.6% for the same period in 2000.

        The increase is primarily due to a change in the copay requirement for certain TRICARE contracts where the copay requirement for dependents of a service person is eliminated resulting in additional health care costs that must be paid by us to the provider.

GENERAL AND ADMINISTRATIVE COSTS

2002 Compared to 2001

        The administrative expense ratio decreased to 10.6% for the year ended December 31, 2002 compared to 10.8% for the same period in 2001. During the third quarter of 2001, we implemented a restructuring plan to consolidate certain administrative, financial and technology functions (the 2001 Plan). The 2001 Plan included the elimination of approximately 1,500 positions. In 2002, we began to realize operating and administrative expense reductions attributed to the 2001 Plan. The decrease is partially offset by higher information technology (IT) costs for our systems consolidation project, including severance costs for such project.

2001 Compared to 2000

        The administrative expense ratio decreased to 10.8% for the year ended December 31, 2001 from 13.1% for the same period in 2000. This decrease was attributable to our ongoing efforts to control our G&A costs including implementation of a restructuring plan in the third quarter of 2001.

SELLING COSTS

2002 Compared to 2001

        Selling costs consist of broker commissions paid to brokers and agents and sales incentives paid to our sales associates. We separated selling costs from G&A expenses to better reflect the shift in our commercial health plan mix to small group. The selling costs ratio (selling costs as a percentage of Health Plan Services premiums) increased to 2.3% for the year ended December 31, 2002 compared to 2.2% for the same period in 2001. This increase is due to our commercial health plan mix shifting to small group with its higher selling costs.

33

2001 Compared to 2000

        The selling costs ratio increased to 2.2% for the year ended December 31, 2001 compared to 2.1% for the same period in 2000. This increase is due to our commercial health plan mix shifting to small group with its higher selling costs.

AMORTIZATION AND DEPRECIATION

2002 Compared to 2001

        Amortization and depreciation expense decreased by $28.5 million or 28.9% for the year ended December 31, 2002 compared to the same period in 2001. This decrease is primarily due to the decrease in amortization expense of $27.6 million due to the cessation of goodwill amortization as a result of adopting Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002.

        There was an increase of $2.0 million in depreciation expense due to accelerated depreciation of certain capitalized software based on revised useful lives as a result of our systems consolidation project. This is offset by a decrease of $1.3 million in depreciation primarily due to asset impairments included in asset impairment and restructuring charges recorded in September 2001.

2001 Compared to 2000

        Amortization and depreciation expense decreased by $7.2 million or 6.8% for the year ended December 31, 2001 from the same period in 2000. This decrease was primarily due to a $3.9 million decrease in depreciation expense from asset impairments included in the restructuring charges recorded in the third quarter of 2001 and the sale of the Florida health plan also in the third quarter of 2001. The remaining decrease is primarily due to various leasehold improvements, personal computer equipment and software being completely depreciated prior to or during 2001. The effect of the suspension of the depreciation on the corporate facility building in Florida was immaterial for the year ended December 31, 2001.

INTEREST EXPENSE

2002 Compared to 2001

        Interest expense decreased by $14.7 million or 26.8% for the year ended December 31, 2002 compared to the same period in 2001. This decrease resulted from the repayment of the entire outstanding balance of $195.2 million on our revolving credit facility in 2002.

2001 Compared to 2000

        Interest expense decreased by $33.0 million or 37.5% for the year ended December 31, 2001 from the same period in 2000. This decrease in interest expense reflects a $172.6 million decrease in long-term debt from December 31, 2000 and a lower average borrowing rate of 7.1% in 2001 compared to the average borrowing rate of 7.6% in 2000.

ASSET IMPAIRMENT AND RESTRUCTURING CHARGES

        This section should be read in conjunction with Note 14, and the tables contained therein, to the consolidated financial statements.

2002 Charges

        During the fourth quarter ended December 31, 2002, pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we recognized $35.8 million of impairment charges stemming from purchased and internally developed software that were rendered obsolete as a result of our operations and systems consolidation process. In addition, beginning in the first quarter of 2003, internally developed software of approximately $13 million in carrying value will be subject to accelerated depreciation to reflect their revised useful lives as a result of our operations and systems consolidation.

        Effective December 31, 2002, MedUnite, Inc., a health care information technology company, in which we had invested $13.4 million, was sold. As a result of the sale, our original investments were exchanged for $1 million in cash and $2.6 million in notes. Accordingly, we wrote off the original investments of $13.4 million less the $1 million cash received and recognized an impairment charge of $12.4 million on December 31, 2002 which included an allowance against the full value of the notes.

        During the third quarter ended September 30, 2002, pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115), we evaluated the carrying value of our investments available for sale in CareScience, Inc. The common stock of CareScience, Inc. has been consistently trading below $1.00 per share since early September 2002 and is at risk of being delisted. As a result, we determined that the decline in the fair value of CareScience's common stock was other than temporary. The fair value of these investments was determined based on quotations available on a securities exchange registered with the SEC as of September 30, 2002. Accordingly, we recognized a pretax $3.6 million write-down in the carrying value of these investments which was classified as asset impairment and restructuring charges during the third quarter ended September 30, 2002. Subsequent to the write-down, our

34

new cost basis in our investment in CareScience, Inc. was $2.6 million as of September 30, 2002. Our remaining holdings in CareScience, Inc. are included in investments-available for sale on the consolidated balance sheets.

        Pursuant to SFAS No. 115 and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures", we evaluated the carrying value of our investments in convertible preferred stock and subordinated notes of AmCareco, Inc. arising from a previous divestiture of health plans in Louisiana, Oklahoma and Texas in 1999. Since August 2002, authorities in these states have taken various actions, including license denials and liquidation-related processes, that caused us to determine that the carrying value of these assets was no longer recoverable. Accordingly, we wrote off the total carrying value of our investment of $7.1 million which was included in asset impairment and restructuring charges during the third quarter ended September 30, 2002. Our investment in AmCareco had been included in other noncurrent assets on the consolidated balance sheets.

2001 Charges

        As part of our ongoing general and administrative expense reduction efforts, during the third quarter of 2001, we finalized a formal plan to reduce operating and administrative expenses for all business units within the Company (the 2001 Plan). In connection with the 2001 Plan, we decided on enterprise-wide staff reductions and consolidations of certain administrative, financial and technology functions. We recorded pretax restructuring charges of $79.7 million during the third quarter ended September 30, 2001 (2001 Charge). As of September 30, 2002, we had completed the 2001 Plan. As of December 31, 2002, we had $3.4 million in lease termination payments remaining to be paid under the 2001 Plan. These payments will be made during the remainder of the respective lease terms.

Severance and Benefit Related Costs—During the third quarter ended September 30, 2001, we recorded severance and benefit related costs of $43.3 million related to enterprise-wide staff reductions, which costs were included in the 2001 Charge. These reductions include the elimination of approximately 1,517 positions throughout all functional groups, divisions and corporate offices within the Company. As of September 30, 2002, the termination of positions in connection with the 2001 Plan had been completed and we recorded a modification of $1.5 million to reflect an increase in the severance and related benefits in connection with the 2001 Plan from the initial amount of $43.3 million included in the 2001 Charge to a total of $44.8 million. No additional payments remain to be paid related to severance and related benefit-related costs included in the 2001 Charge.

Asset Impairment Costs—Pursuant to SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," we evaluated the carrying value of certain long-lived assets that were affected by the 2001 Plan. The affected assets were primarily comprised of information technology systems and equipment, software development projects and leasehold improvements. We determined that the carrying value of these assets exceeded their estimated fair values. The fair values of these assets were determined based on market information available for similar assets. For certain of the assets, we determined that they had no continuing value to us due to our abandoning certain plans and projects in connection with our workforce reductions.

        Accordingly, we recorded asset impairment charges of $27.9 million consisting entirely of non-cash write-downs of equipment, building improvements and software application and development costs, which charges were included in the 2001 Charge. The carrying value of these assets was $6.9 million as of December 31, 2002.

        The asset impairment charges of $27.9 million consisted of $10.8 million for write-downs of assets related to the consolidation of four data centers, including all computer platforms, networks and applications into a single processing facility at our Hazel Data Center; $16.3 million related to abandoned software applications and development projects resulting from the workforce reductions, migration of certain systems and investments to more robust technologies; and $0.8 million for write-downs of leasehold improvements.

Real Estate Lease Termination Costs—The 2001 Charge included charges of $5.1 million related to termination of lease obligations and non-cancelable lease costs for excess office space resulting from streamlined operations and consolidation efforts. Through December 31, 2002, we had paid $1.7 million of the termination obligations. The remainder of the termination obligations of $3.4 million will be paid during the remainder of the respective lease terms.

Other Costs—The 2001 Charge included charges of $3.4 million related to costs associated with closing certain data center operations and systems and other activities which were completed and paid for in the first quarter ended March 31, 2002.

35

NET LOSS ON ASSETS HELD FOR SALE AND SALE OF BUSINESSES AND PROPERTIES

2002 Dispositions

        During the third quarter ended September 30, 2002, we entered into an agreement, subject to certain contingency provisions, to sell a corporate facility building in Trumbull, Connecticut. Accordingly, pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we recorded a pretax $2.4 million estimated loss on assets held for sale consisting entirely of non-cash write-downs of building and building improvements. The carrying value of these assets after the write-downs was $7.7 million as of December 31, 2002. The effect of the suspension of the depreciation on this corporate facility building was immaterial for the year ended December 31, 2002. We expect the sale to close no later than September 30, 2003. This corporate facility building stopped being used in our operations during 2001.

        Effective July 1, 2002, we sold our claims processing subsidiary, EOS Claims Services, Inc. (EOS Claims), to Tristar Insurance Group, Inc. (Tristar). In connection with the sale, we received $500,000 in cash, and also entered into a Payor Services Agreement. Under the Payor Services Agreement, Tristar has agreed to exclusively use EOS Managed Care Services, Inc. (one of our remaining subsidiaries) for various managed care services to its customers and clients. We estimated and recorded a $2.6 million pretax loss on the sale of EOS Claims during the second quarter ended June 30, 2002. We did not record any adjustments to the estimated pretax loss on the sale during the second half of 2002. EOS Claims, excluding the $2.6 million pretax loss on the sale, had total revenues of $7.2 million and income before income taxes of $0.1 million for the year ended December 31, 2002, total revenues of $15.3 million and loss before income taxes of $(3.2) million for the year ended December 31, 2001 and total revenues of $19.0 million and loss before income taxes of $(3.1) million for the year ended December 31, 2000.

        As of the date of sale, EOS Claims had no net equity after dividends to its parent company and the goodwill impairment charge taken upon adoption of SFAS No. 142 in the first quarter ended March 31, 2002. EOS Claims revenue through the date of the sale was reported as part of other income on the consolidated statements of operations.

2001 Dispositions

        Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc. (the Plan), to Florida Health Plan Holdings II, L.L.C. In connection with the sale, we received approximately $49 million which consisted of $23 million in cash and approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We estimated and recorded a $76.1 million pretax loss on the sales of our Florida health plan and the related corporate facility building during the second quarter ended June 30, 2001. Included in the pretax loss amount are the following:

•

Non-cash asset impairment charges totaling $40.8 million consisting of $18.5 million for goodwill impairment on the Florida health plan, $4.4 million write-down to its fair value of the corporate facility building owned by one of our subsidiaries and used by the Florida health plan, $15.3 million write-off for other contractual receivables and $2.6 million write-off of an unrealizable deferred tax asset related to the Florida health plan;



•

Obligations under the terms of the amended definitive agreement to provide up to $28 million of reinsurance to guarantee against claims costs in excess of certain medical care ratio levels of the Florida health plan for the 18-month period subsequent to the close of the sale; and



•

Other accrued costs resulting from the sale of the Florida health plan totaling $7.3 million.

        Under the Stock Purchase Agreement that evidenced the sale (as amended, the SPA), we, through our subsidiary FH Assurance Company (FHAC), entered into a reinsurance agreement (the Reinsurance Agreement) with the Plan. Under the terms of the Reinsurance Agreement, FHAC will reimburse the Plan for certain medical and hospital expenses arising after the Florida health plan sale. The Reinsurance Agreement will cover claims arising from all commercial and governmental health care contracts or other agreements in force as of July 31, 2001 and any renewals thereof up to 18 months after July 31, 2001. The Reinsurance Agreement provides that the Plan will be reimbursed for medical and hospital expenses relative to covered claims in excess of certain baseline medical loss ratios, as follows:

•

88% for the six-month period commencing on August 1, 2001;



•

89% for the six-month period commencing on February 1, 2002;



•

90% for the six-month period commencing on August 1, 2002.

36

        The Reinsurance Agreement is limited to $28 million in aggregate payments and is subject to the following levels of coinsurance:

•

5% for the six-month period commencing on August 1, 2001;



•

10% for the six-month period commencing on February 1, 2002;



•

15% for the six-month period commencing on August 1, 2002.

        If the baseline medical loss ratio is less than 90% at the end of the six-month period commencing on August 1, 2002, Health Net is entitled to recover medical and hospital expenses below the 90% threshold up to an amount to not exceed 1% of the total premiums for those members still covered during the six-month period under the Reinsurance Agreement.

        The maximum liability under the Reinsurance Agreement of $28 million was reported as part of loss on assets held for sale as of June 30, 2001, since this was our best estimate of our probable obligation under this arrangement. As the reinsured claims are submitted to FHAC, the liability is reduced by the amount of claims paid. As of December 31, 2002, we have paid out $20.3 million under this agreement.

        The SPA included an indemnification obligation for all pending and threatened litigation as of the closing date and certain specific provider contract interpretation or settlement disputes. During the year ended December 31, 2002, we paid $5.7 million in settlements on certain indemnified items. At this time, we believe that the estimated liability related to the remaining indemnified obligations on any pending or threatened litigation and the specific provider contract disputes will not have a material impact to the financial condition of the Company.

        The SPA provides for the following three true-up adjustments that could result in an adjustment to the loss on the sale of the Plan:

•

A retrospective post-closing settlement of statutory equity based on subsequent adjustments to the closing balance sheet for the Plan.



•

A settlement of unpaid provider claims as of the closing date based on claim payments occurring during a one-year period after the closing date.



•

A settlement of the reinsured claims in excess of certain baseline medical loss ratios. Final settlement is not scheduled to occur until the latter part of 2003. The development of claims and claims related metrics and information provided by Florida Health Plan Holdings II, L.L.C. have not resulted in any revisions to the maximum $28 million liability we originally estimated.

        The true-up process has not been finalized and we do not have sufficient information regarding the true-up adjustments to assess probability or estimate any adjustment to the recorded loss on the sale of the Plan as of December 31, 2002.

        The Florida health plan, excluding the $76.1 million loss on net assets held for sale, had premium revenues of $339.7 million and a net loss of $11.5 million and premium revenues of $505.3 million and a net loss of $33.4 million for the years ended December 31, 2001 and 2000, respectively. At the date of sale, the Florida health plan had $41.5 million in net equity. The Florida health plan was reported as part of our Health Plan Services reportable segment.

2000 Dispositions

        Net loss on sale of businesses and properties for the year ended December 31, 2000 was comprised of a gain on sale of a building in California of $1.1 million, and loss on sale of HMO operations in Washington due to a purchase price adjustment of $1.5 million.

INCOME TAX PROVISION

2002 Compared to 2001

        The effective income tax rate was 33.4% for the year ended December 31, 2002 compared with 37.0% for the same period in 2001. The decrease of 3.6 percentage points in the effective tax rates is primarily due to the following:

•

The adoption of SFAS No. 142 and the cessation of goodwill amortization caused the tax rate to decrease by 2.1 percentage points. The majority of our goodwill amortization has historically been treated as a permanent difference that was not deductible for tax purposes and which increased the effective tax rate,



•

A decrease of 1.1 percentage points related to the tax benefit arising from the sales of a claims processing subsidiary and MedUnite, Inc.

        The effective tax rate for the year ended December 31, 2002 differed from the statutory federal tax rate of 35.0% due primarily to state income taxes, tax-exempt investment income, business divestitures and tax return examination settlements.

2001 Compared to 2000

        The effective income tax rate was 37.0% for the year ended December 31, 2001 compared with 37.7% for the same period in 2000. The rate declined due to examination settlements.

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CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

        Effective January 1, 2002, we adopted SFAS No. 142 which, among other things, eliminates amortization of goodwill and other intangibles with indefinite lives. Intangible assets, including goodwill, that are not subject to amortization will be tested for impairment annually or more frequently if events or changes in circumstances indicate that we might not recover the carrying value of these assets.

        We identified the following six reporting units with goodwill within our businesses: Health Plans, Government Contracts, Behavioral Health, Dental & Vision, Subacute and Employer Services Group. In accordance with the transition requirements of SFAS No. 142, we completed an evaluation of goodwill at each of our reporting units upon adoption of this Standard. We used an independent third-party professional services firm with knowledge and experience in performing fair value measurements to assist us in the impairment testing and measurement process. As a result of these impairment tests, we identified goodwill impairment at our behavioral health subsidiary and at our employer services group subsidiary in the amounts of $3.5 million and $5.4 million, respectively. Accordingly, we recorded an impairment charge of goodwill of $8.9 million, net of tax benefit of $0, which has been reflected as a cumulative effect of a change in accounting principle in the consolidated statement of operations for the first quarter ended March 31, 2002. As part of our annual goodwill impairment test, we completed an evaluation of goodwill with the assistance of the same independent third-party professional services firm at each of our reporting units as of June 30, 2002. No goodwill impairments were identified in any of our reporting units. We will perform our annual goodwill impairment test as of June 30 in future years. Refer to Note 2 of the Notes to Condensed Consolidated Financial Statements for more information on our goodwill.

IMPACT OF INFLATION AND OTHER ELEMENTS

        The managed health care industry is labor intensive and its profit margin is low; hence, it is especially sensitive to inflation. Increases in medical expenses or contracted medical rates without corresponding increases in premiums could have a material adverse effect on the Company.

        Various federal and state legislative initiatives regarding the health care industry continue to be proposed during legislative sessions. If further health care reform or similar legislation is enacted, such legislation could impact the Company. Management cannot at this time predict whether any such initiative will be enacted and, if enacted, the impact on the financial condition or results of operations of the Company.

        The Company's ability to expand its business is dependent, in part, on competitive premium pricing and its ability to secure cost-effective contracts with providers. Achieving these objectives is becoming increasingly difficult due to the competitive environment. In addition, the Company's profitability is dependent, in part, on its ability to maintain effective control over health care costs while providing members with quality care. Factors such as health care reform, regulatory changes, increased cost of medical services, utilization, new technologies and drugs, hospital costs, major epidemics and numerous other external influences may affect the Company's operating results. Accordingly, past financial performance is not necessarily a reliable indicator of future performance, and investors should not use historical records to anticipate results or future period trends.

        The Company's HMO and insurance subsidiaries are required to maintain reserves to cover their estimated ultimate liability for expenses with respect to reported and unreported claims incurred. These reserves are estimates of future costs based on various assumptions. Establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience, which in the past has resulted, and in the future could result, in loss reserves being too high or too low. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicious administration of claims, medical costs and other factors. Future loss development or governmental regulators could require reserves for prior periods to be increased, which would adversely impact earnings in the periods in which such additional reserves are accrued. In light of present facts and current legal interpretations, management believes that adequate provisions have been made for claims and loss reserves.

        We contract with physician providers in California and Connecticut primarily through capitation fee arrangements for our HMO products. We also use capitation fee arrangements in areas other than California and Connecticut to a lesser extent. Under a capitation fee arrangement, we pay the provider a fixed amount per member on a regular basis and the provider accepts the risk of the frequency and cost of member utilization of services. The inability of providers to properly manage costs under capitation arrangements can result in financial instability of such providers. Any financial instability of capitated providers could lead to claims for unpaid health care against us, even if we have made our regular payments to the capitated providers. Depending on state law, we may or may not be liable for such claims. The California agency that until July 1, 1999

38

acted as regulator of HMOs, had issued a written statement to the effect that HMOs are not liable for such claims. In addition, recent court decisions have narrowed the scope of such liability in a manner generally favorable to HMOs. However, ongoing litigation on the subject continues among providers and HMOs, including the Company's California HMO subsidiary.

        In June 2001, the United States Senate passed legislation, sometimes referred to as "patients' rights" or "patients' bill of rights" legislation, that seeks, among other things, to hold health plans liable for claims regarding health care delivery and improper denial of care. The United States House of Representatives passed similar legislation in August 2001. Although both bills provide for independent review of decisions regarding medical care, the bills differ on the circumstances under which lawsuits may be brought against managed care organizations and the scope of their liability. If patients' bill of rights legislation is enacted into law, we could be subject to significant additional litigation risk and regulatory compliance costs, which could be costly to us and could have a significant effect on our results of operations. Although we could attempt to mitigate our ultimate exposure to litigation and regulatory compliance costs through, among other things, increases in premiums, there can be no assurance that we would be able to mitigate or cover the costs stemming from litigation arising under patients' bill of rights legislation or the other costs that we could incur in connection with complying with patients' bill of rights legislation.

LIQUIDITY AND CAPITAL RESOURCES

        The Company believes that cash from operations, existing working capital, lines of credit, and funds from any potential divestitures of business are adequate to fund existing obligations, introduce new products and services, and continue to develop health care-related businesses. The Company regularly evaluates cash requirements for current operations and commitments, and for capital acquisitions and other strategic transactions. The Company may elect to raise additional funds for these purposes, either through additional debt or equity, the sale of investment securities or otherwise, as appropriate.

        The Company's investment objective is to maintain safety and preservation of principal by investing in high-quality, investment grade securities while maintaining liquidity in each portfolio sufficient to meet the Company's cash flow requirements and attaining the highest total return on invested funds.

        Government health care receivables are best estimates of payments that are ultimately collectible or payable. Since these amounts are subject to government audit, negotiation and appropriations, amounts ultimately collected may vary significantly from current estimates. Additionally, the timely collection of such receivables is also impacted by government audit and negotiation and could extend for periods beyond a year. Amounts receivable under government contracts were $78.4 million and $99.6 million as of December 31, 2002 and 2001, respectively. The decrease is primarily due to cash received on bid price adjustments and change orders.

OPERATING CASH FLOWS

2002 Compared to 2001

        Net cash provided by operating activities was $420.0 million at December 31, 2002 compared to $546.5 million at December 31, 2001. The decrease in operating cash flows of $126.5 million was due primarily to the following:

•

A net decrease in cash flows from amounts receivable/payable under government contracts of $299.1 million for the year ended December 31, 2002 as compared to the same period in 2001. This is primarily due to cash collections in January 2001 of $329 million of the outstanding TRICARE receivables as part of our global settlement with the United States Department of Defense. Of the $389 million global settlement, $60 million had been received in December 2000. The net settlement amount of $284 million, after paying vendors, providers and amounts owed back to the government, was applied to the continuing operating needs of the three TRICARE contracts and to reducing the outstanding balance of our then-outstanding debt on the revolving credit facility, and



•

A net decrease in cash flows from reserves for claims and other settlements of $70.0 million for the year ended December 31, 2002 as compared to the same period in 2001. This is primarily due to higher paid claims driving inventories down, shared risk reserves reduction and higher EDI and auto adjudication rates, partially offset by



•

A net increase in net income plus amortization and depreciation and non-cash charge items of $82.5 million, and



•

A net increase in cash collections from premiums receivable, unearned premiums and other assets of $148.1 million.

39

        As part of our ongoing general and administrative expense reduction efforts, during the third quarter of 2001, we finalized a formal plan to reduce operating and administrative expenses for all business units within the Company (the 2001 Plan). In connection with the 2001 Plan, we decided on enterprise-wide staff reductions and consolidations of certain administrative, financial and technology functions. As of December 31, 2002, we had completed the 2001 Plan and recorded a $1.5 million true-up adjustment in severance and related benefit costs. During 2002, we paid out $26.4 million in total for the 2001 Plan.

2001 Compared to 2000

        Net cash provided by operating activities was $546.5 million at December 31, 2001 compared to $366.2 million at December 31, 2000. The $180.3 million increase in operating cash flows was due primarily to the increase in cash collection on the outstanding TRICARE receivables as part of our global settlement, partially offset by a decrease in unearned premiums due to timing of cash receipts, primarily from Medicaid and Medicare, of approximately $84.7 million net of the effects of the Florida health plan disposition. In December 2000, our subsidiary, Health Net Federal Services, Inc., and the Department of Defense agreed to a settlement of approximately $389 million for outstanding receivables related to our three TRICARE contracts and for the completed contract for the CHAMPUS Reform Initiative. Approximately $60 million of the settlement amount was received in December 2000. The majority of the remaining settlement was received on January 5, 2001, reducing the amounts receivable under government contracts on the Company's balance sheets. The receivable items settled by this payment included change orders, bid price adjustments, equitable adjustments and claims. These receivables developed as a result of TRICARE health care costs rising faster than the forecasted health care cost trends used in the original contract bids, data revisions on formal contract adjustments, and routine contract changes for benefits. The net settlement amount of $284 million, after paying vendors, providers and amounts owed back to the government, was applied to the continuing operating needs of the three TRICARE contracts and to reducing the outstanding balance of debt on the revolving credit facility.

INVESTING ACTIVITIES

2002 Compared to 2001

        Net cash used in investing activities was $182.9 million during the year ended December 31, 2002 as compared to net cash used in investing activities of $517.6 million during the same period in 2001. The $334.7 million decrease in cash flows used in investing activities is primarily due to the following:

•

A decrease of $252.6 million in net purchases of investments. During 2001, we repositioned a portion of our investable assets into investment vehicles with longer durations within our regulated health plans in order to increase investment income,



•

A decrease of $53.5 million in cash disposed in the sale of businesses, net of cash received, and



•

A decrease of $24.2 million in net purchases of property and equipment.

2001 Compared to 2000

        Net cash used in investing activities was $517.6 million for December 31, 2001 compared to net cash used in investing activities of $61.9 million for December 31, 2000. This increase in cash used in investing activities of $455.7 million is primarily due to $422.5 million increase in net purchases of investments. During the fourth quarter of 2001, we started to reposition our investments within our regulated plans to increase investment income which resulted in increased purchases of investments with longer durations.

        Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, L.L.C. In connection with the sale, we received approximately $49 million which consisted of $23 million in cash, before net cash sold of $83.1 million, and approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also sold the corporate facility building used by our former Florida health plan to DGE Properties, L.L.C. for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We recorded a $76.1 million pretax loss on the sales of our Florida health plan and the related corporate facility building during the second quarter ended June 30, 2001.

        As part of the Florida sale agreement, there will be a series of true-up processes that will take place during 2003 that could result in additional loss or gain. The true-up process has not been finalized and we do not have sufficient information regarding the true-up adjustments to assess probability or to estimate any adjustment to the recorded loss on the sale of the Plan as of December 31, 2002.

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        Throughout 2000, 2001 and the first quarter of 2002, the Company provided funding in the amount of approximately $13.4 million in exchange for preferred stock in MedUnite, Inc., an independent company, funded and organized by seven major managed health care companies. MedUnite, Inc. provides online internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment. The funded amounts were included in other noncurrent assets. Effective December 31, 2002, MedUnite, Inc. was sold. See Note 3 to the consolidated financial statements.

        During 2000, we secured an exclusive e-business connectivity services contract from the Connecticut State Medical Society IPA, Inc. (CSMS-IPA) for $15.0 million. CSMS-IPA is an association of medical doctors providing health care primarily in Connecticut. The amounts paid to CSMS-IPA for this agreement are included in other noncurrent assets, and we periodically assess the recoverability of such assets.

        In 1995, the Company entered into a five-year tax retention operating lease for the construction of various health care centers and a corporate facility. Upon expiration in May 2000, the lease was extended for four months through September 2000 whereupon the Company settled its obligations under the agreement and purchased the leased properties which were comprised of three rental health care centers and a corporate facility for $35.4 million. The health care centers are held as investment rental properties and are included in other noncurrent assets. The corporate facility building was used in operations and included in property and equipment prior to being sold as part of the Florida sale. The buildings are being depreciated over a remaining useful life of 35 years.

FINANCING ACTIVITIES

2002 Compared to 2001

        Net cash used in financing activities was $305.6 million during the year ended December 31, 2002 as compared to $166.0 million during the same period in 2001. The change was primarily due to the repurchase of 6,519,600 shares of our common stock during 2002 for $159.7 million offset by the increase of $39.1 million in proceeds received from the exercise of stock options and employee stock purchases. We also paid down our revolving credit facility by an additional $18.9 million over 2001.

        In April 2002, our Board of Directors authorized us to repurchase up to $250 million (net of exercise proceeds and tax benefits from the exercise of employee stock options) of the Company's Class A Common Stock. During 2002, we received approximately $48 million in cash and $18 million in tax benefits as a result of option exercises. In 2003, we expect to receive approximately $58 million in cash and $17 million in tax benefits from estimated option exercises during the year. As a result of the $66 million (in 2002) and $75 million (in 2003) in realized and estimated benefits, our total authority under our stock repurchase program is estimated at $390 million based on the authorization we received from our Board of Directors to repurchase $250 million (net of exercise proceeds and tax benefits from the exercise of employee stock options). Share repurchases are made under this repurchase program from time to time through open market purchases or through privately negotiated transactions. We use cash flows from operations to fund the share repurchases. As of February 13, 2003, we repurchased 8,364,600 shares at an average price of $24.83 per share pursuant to this program.

2001 Compared to 2000

        Net cash used in financing activities was $166.0 million at December 31, 2001 compared to $268.1 million at December 31, 2000. This decrease in net cash used in financing activities of $102.1 million was primarily due to lower net repayment of funds previously drawn under the Company's credit facility in 2001 compared to 2000.

        On April 12, 2001, we completed our offering of $400 million aggregate principal amount of 8.375 percent Senior Notes due in April 2011. The effective interest rate on the notes when all offering costs are taken into account and amortized over the term of the note is 8.54 percent per annum. The net proceeds of $395.1 million from the Senior Notes were used to repay outstanding borrowings under our then-existing revolving credit facility. On October 4, 2001, we completed an exchange offer for the Senior Notes in which the outstanding Senior Notes were exchanged for an equal aggregate principal amount of new 8.375 percent Senior Notes due 2011 that have been registered under the Securities Act of 1933, as amended.

        Scheduled principal repayments on the senior notes payable for the next five years are as follows (amounts in thousands):

Contractual Cash Obligations	Total		2003	2004	2005	2006	2007	Thereafter
Senior notes	$	400,000						$	400,000

41

        The Senior Notes are redeemable, at our option, at a price equal to the greater of (A) 100% of the principal amount of the Senior Notes to be redeemed; (B) and the sum of the present values of the remaining scheduled payments on the Senior Notes to be redeemed consisting of principal and interest, exclusive of interest accrued through the date of redemption, at the rate in effect on the date of calculation of the redemption price, discounted to the date of redemption on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the applicable treasury yield plus 40 basis points plus accrued interest to the date of redemption.

        On June 28, 2001, we refinanced our previous $1.5 billion revolving credit facility with credit agreements for two new revolving syndicated credit facilities, with Bank of America, N.A. as administrative agent, that replaced the $1.5 billion credit facility. The new credit facilities, provide for an aggregate of $700 million in borrowings, consisting of:

•

a $175 million 364-day revolving credit facility; and



•

a $525 million five-year revolving credit and competitive advance facility.

        We established the credit facilities to refinance our then-existing bank debt and for general corporate purposes, including acquisitions and working capital. The credit facilities allow us to borrow funds:

•

by obtaining committed loans from the group of lenders as a whole on a pro rata basis;



•

by obtaining under the five-year facility loans from individual lenders within the group by way of a bidding process; and



•

by obtaining under the five-year facility letters of credit in an aggregate amount of up to $200 million.

        The 364-day credit facility was amended on June 27, 2002, to extend the existing credit agreement for an additional 364-day period. We must repay all borrowings under the 364-day credit facility by June 26, 2003, unless the Company avails itself of a two-year term-out option in the 364-day credit facility. The five-year credit facility expires in June 2006, and we must repay all borrowings under the five-year credit facility by June 28, 2006, unless the five-year credit facility is extended. The five-year credit facility may, at our request and subject to approval by lenders holding two-thirds of the aggregate amount of the commitments under the five-year credit facility, be extended for up to two 12 month periods to the extent of the commitments made under the five-year credit facility by such approving lenders. Swingline loans under the five-year credit facility are subject to repayment within no more than seven days.

        The credit agreements provide for acceleration of repayment of indebtedness under the credit facilities upon the occurrence of customary events of default such as failing to pay any principal or interest when due; providing materially incorrect representations; failing to observe any covenant or condition; judgments against us involving in the aggregate an unsecured liability of $25 million or more not paid, vacated, discharged, stayed or bonded pending appeal within 60 days of the final order; our non-compliance with any material terms of HMO or insurance regulations pertaining to fiscal soundness and not cured or waived within 30 days, solvency or financial condition; the occurrence of specified adverse events in connection with any employee pension benefit plan of ours; our failure to comply with the terms of other indebtedness with an aggregate amount exceeding $40 million such that the other indebtedness can be or is accelerated; or a change in control of the Company.

        The maximum amount outstanding under the new facilities during 2002 was $120 million and the maximum commitment level was $700 million at December 31, 2002.

        The credit agreements contain negative covenants, including financial covenants, that impose performance requirements on our operations. The financial covenants in the credit agreements provide that:

•

for any period of four consecutive fiscal quarters, the consolidated leverage ratio, which is the ratio of (i) our consolidated funded debt to (ii) our consolidated net income before interest, taxes, depreciation, amortization and other specified items (consolidated EBITDA), must not exceed 3 to 1;



•

for any period of four consecutive fiscal quarters, the consolidated fixed charge coverage ratio, which is the ratio of (i) our consolidated EBITDA plus consolidated rental expense minus consolidated capital expenditures to (ii) our consolidated scheduled debt payments, (defined as the sum of scheduled principal payments, interest expense and rent expense) must be at least 1.5 to 1; and



•

we must maintain our consolidated net worth at a level equal to at least $945 million (less the sum of a pretax charge associated with our sale of the Florida Health Plan and specified pretax charges relating to the write-off of goodwill) plus 50% of our consolidated net income and 100% of our net cash proceeds from equity issuances.

42

        The other covenants in the credit agreements include, among other things, limitations on incurrence of indebtedness by subsidiaries of Health Net, Inc. and on our ability to:

•

incur liens;



•

extend credit and make investments in non-affiliates;



•

merge, consolidate, dispose of stock in subsidiaries, lease or otherwise dispose of assets and liquidate or dissolve;



•

substantially alter the character or conduct of the business of Health Net, Inc. or any of its "significant subsidiaries" within the meaning of Rule 1-02 under Regulation S-X promulgated by the SEC;



•

make restricted payments, including dividends and other distributions on capital stock and redemptions of capital stock if the Company's debt is rated below investment grade by either Standard and Poor's Rating Service or Moody's Investor Services; and



•

become subject to other agreements or arrangements that restrict (i) the payment of dividends by any Health Net, Inc. subsidiary, (ii) the ability of Health Net, Inc. subsidiaries to make or repay loans or advances to lenders, (iii) the ability of any subsidiary of Health Net, Inc. to guarantee our indebtedness or (iv) the creation of any lien on property, provided that the foregoing shall not apply to (a) restrictions and conditions imposed by regulatory authorities, or (b) restrictions imposed under either the 364-day Revolving Credit Facility or the five-year Revolving Credit Facility.

        As of December 31, 2002 and 2001, we were in compliance with the covenants of the credit facilities.

        Committed loans under the credit facilities bear interest at a rate equal to either (1) the greater of the federal funds rate plus 0.5% and the applicable prime rate or (2) LIBOR plus a margin that depends on our senior unsecured credit rating. Loans obtained through the bidding process bear interest at a rate determined in the bidding process. We pay fees on outstanding letters of credit and a facility fee, computed as a percentage of the lenders' commitments under the credit facilities, which varies from 0.130% to 0.320% per annum for the 364-day credit facility and from 0.155% to 0.375% per annum for the five-year credit facility, depending on our senior unsecured credit rating.

        We lease office space under various operating leases. In addition, we have entered into long-term service agreements with third parties. As of December 31, 2002, there are seven years remaining on these service agreements with minimum future commitments totaling $61.4 million. These lease and service agreements are cancelable with substantial penalties. Our future minimum lease and service fee commitments are as follows (amounts in thousands):

2003	$	61,614
2004		54,286
2005		38,594
2006		32,930
2007		30,836
Thereafter		90,140
Total minimum commitments	$	308,400

CRITICAL ACCOUNTING POLICIES

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principle areas requiring the use of estimates include revenue recognition, reserves for claims and other settlements, reserves for contingent liabilities, amounts receivable or payable under government contracts and recoverability of long-lived assets. Accordingly, we consider accounting policies on these areas to be critical in preparing our consolidated financial statements. A significant change in any one of these amounts may have a significant impact on our consolidated results of operations and financial condition. A more detailed description of the significant accounting policies that we use in preparing our financial statements is included in the notes to our consolidated financial statements which are described elsewhere in this Annual Report to Stockholders for the year ended December 31, 2002.

REVENUE RECOGNITION

        Health plan services premiums include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, for which premiums are based on a predetermined prepaid fee, Medicaid revenues based on multi-year contracts to provide care to Medicaid recipients, and revenue under Medicare risk contracts to provide care to enrolled Medicare recipients. Revenue is recognized in the month in which the related enrollees are entitled to health care services. Premiums collected in advance of the month in which enrollees are entitled to health care services are recorded as unearned premiums.

43

        Government Contracts revenues are recognized in the month in which the eligible beneficiaries are entitled to health care services or in the month in which the administrative services are performed or the period that coverage for services is provided. Government contracts also contain cost and performance incentive provisions which adjust the contract price based on actual performance. Revenue under government contracts is subject to price adjustments attributable to inflation and other factors. The effects of these adjustments are recognized on a monthly basis, although the final determination of these amounts could extend significantly beyond the period during which the services were provided.

        From time to time, we make adjustments to our revenues based on retroactivity. These retroactivity adjustments reflect changes in the number of enrollees subsequent to when the revenue is billed. We estimate the amount of future retroactivity each period and accordingly adjust the billed revenue. The estimated adjustments are based on historical trends, premiums billed, the volume of contract renewal activity during the period and other information. We refine our estimates and methodologies as information on actual retroactivity becomes available.

        On a monthly basis, we estimate the amount of uncollectible receivables to reflect allowances for doubtful accounts. The allowances for doubtful accounts are estimated based on the creditworthiness of our customers, our historical collection rates and the age of our unpaid balances. During this process, we also assess the recoverability of the receivables, and an allowance is recorded based upon their net realizable value. Those receivables that are deemed to be uncollectible, such as receivables from bankrupt employer groups, are fully written off against their corresponding asset account, with a debit to the allowance to the extent such an allowance was previously recorded.

HEALTH CARE SERVICES

        The cost of health care services is recognized in the period in which services are provided and includes an estimate of the cost of services which have been incurred but not yet reported. Such costs include payments to primary care physicians, specialists, hospitals, outpatient care facilities and the costs associated with managing the extent of such care. We estimate the amount of the provision for service costs incurred but not reported using standard actuarial methodologies based upon historical data including the period between the date services are rendered and the date claims are received and paid, denied claim activity, expected medical cost inflation, seasonality patterns and changes in membership. The estimates for service costs incurred but not reported are made on an accrual basis and adjusted in future periods, as required. We consider adjustments to prior period estimates to be a change in estimate. Accordingly, we include such adjustments in the current period. Such estimates are subject to the impact of changes in the regulatory environment and economic conditions. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts provided. While the ultimate amount of claims and losses paid are dependent on future developments, management is of the opinion that the recorded reserves are adequate to cover such costs. These estimated liabilities are reduced by estimated amounts recoverable from third parties for subrogation.

        As our estimates for health care costs are based on actuarially developed estimates, incurred claims related to prior years may differ from previously estimated amounts. The table below summarizes our amounts incurred in prior years for Health Plan Services and Government Contracts health care costs which have been expensed in the current year. Negative amounts result when claim payments related to prior years are less than our previously estimated amounts.

			Year Ended December 31,
			2002			2001			2000
			(Dollars in thousands)
Prior year incurred amounts expensed in the current year:
	Health Plan Services		$	11,654		$	(5,238	)	$	(22,310	)
	Government Contracts			(7,456	)		(18,686	)		(5,807	)
		Total	$	4,198		$	(23,924	)	$	(28,117	)
Prior year incurred amounts expensed in the current year as a percent of current year expenses:
	Health Plan Services			0.2	%		(0.1	)%		(0.4	)%
	Government Contracts			(0.5	)%		(1.4	)%		(0.5	)%
		Total		0.1	%		(0.3	)%		(0.4	)%

        Our HMOs in California and Connecticut generally contract with various medical groups to provide professional care to certain of its members on a capitated, or fixed per member per month fee basis. Capitation contracts generally include a provision for stop-loss and non-capitated services for which we are liable. Professional capitated contracts also generally contain provisions for shared risk, whereby the Company and the medical groups share in the variance between actual costs and predeter-

44

mined goals. Additionally, we contract with certain hospitals to provide hospital care to enrolled members on a capitation basis. Our HMOs in other states also contract with hospitals, physicians and other providers of health care, pursuant to discounted fee-for-service arrangements, hospital per diems, and case rates under which providers bill the HMOs for each individual service provided to enrollees.

        We assess the profitability of contracts for providing health care services when operating results or forecasts indicate probable future losses. Significant factors that can lead to a change in our profitability estimates include margin assumptions, risk share terms and non-performance of a provider under a capitated agreement resulting in membership reverting to fee-for-service arrangements with other providers. Contracts are grouped in a manner consistent with the method of determining premium rates. Losses are determined by comparing anticipated premiums to the total of health care related costs less reinsurance recoveries, if any, and the cost of maintaining the contracts. Losses, if any, are recognized in the period the loss is determined and are classified as Health Plan Services. We had premium deficiency reserves of $0 and $1.7 million as of December 31, 2002 and 2001, respectively.

        We have risk-sharing arrangements with certain of our providers related to approximately 1,471,000 members primarily in the California commercial market. Shared-risk arrangements provide for our providers and us to share in the variance between actual costs and predetermined goals. Our health plans in Connecticut, New Jersey and New York market to small employer groups through a marketing agreement with The Guardian Life Insurance Company of America. We have approximately 270,000 members under this agreement. In general, we share equally in the profits of the marketing agreement, subject to certain terms of the marketing agreement related to expenses, with The Guardian Life Insurance Company of America.

RESERVES FOR CONTINGENT LIABILITIES

        In the course of our operations, we are involved on a routine basis in various disputes with members, health care providers, and other entities, as well as audits by government agencies that relate to our services and/or business practices. We and several of our competitors were named as defendants in a number of significant class action lawsuits alleging violations of various federal statutes, including the Employee Retirement Income Security Act of 1974 and the Racketeer Influenced Corrupt Organization Act.

        We recognize an estimated loss from such loss contingencies when we believe it is both probable that a loss will be incurred and that the amount of the loss can be reasonably estimated. Our loss estimates are based in part on an analysis of potential results, the stage of the proceedings, our relevant insurance coverage, consultation with outside counsel and any other relevant information available. While the final outcome of these proceedings can not be determined at this time, based on information presently available we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition. In addition, the ultimate outcome of these loss contingencies cannot be predicted with certainty and it is difficult to measure the actual loss, if any, that might be incurred.

GOVERNMENT CONTRACTS

        Amounts receivable under government contracts are comprised primarily of estimated amounts receivable under these cost and performance incentive provisions, price adjustments, and change orders for services not originally specified in the contracts. These receivables develop as a result of TRICARE health care costs rising faster than the forecasted health care cost trends used in the original contract bids, data revisions on formal contract adjustments and routine contract changes for benefit adjustments.

        Amounts receivable or payable under government contracts are based on three TRICARE contracts in five regions which include both amounts billed and estimates for amounts to be received under cost and performance incentive provisions, price adjustments and change orders for services not originally specified in the contracts.

        These change orders arise because the government often directs us to implement changes to our contracts before the scope and/or value is defined or negotiated. We start to incur costs immediately, before we have proposed a price to the government. In these situations we make no attempt to estimate and record revenue. Our policy is to collect and defer the costs incurred. Once we have submitted a cost proposal to the government, we will record the costs and the appropriate value for revenue, using our best estimate of what will ultimately be negotiated. Such estimates are determined based on information available as well as historical performance and collection of which could extend for periods beyond a year. Differences, which may be material, between the amounts estimated and final amounts collected are recorded in the period when determined.

45

GOODWILL

        We test goodwill for impairment annually based on the estimated fair value of the reporting units which comprise our Health Plan Services and Government Contracts reportable segments. We test for impairment on a more frequent basis in cases where events and changes in circumstances would indicate that we might not recover the carrying value of goodwill. Our measurement of fair value was based on utilization of both the income and market approaches to fair value determination. We used an independent third-party professional services firm with knowledge and experience in performing fair value measurements to assist us in the impairment testing and measurement process. The income approach was based on a discounted cash flow methodology. The discounted cash flow methodology is based upon converting expected cash flows to present value. Annual cash flows were estimated for each year of a defined multi-year period until the growth pattern becomes stable. The expected interim cash flows expected after the growth pattern becomes stable were calculated using an appropriate capitalization technique and then discounted. The market approach used a market valuation methodology which included the selection of companies engaged in a line (or lines) of business similar to the Company to be valued, an analysis of the comparative operating results and future prospects of the Company in relation to the guideline companies selected. The market price multiples are selected and applied to the Company based on the relative performance, future prospects and risk profiles of the Company in comparison to the guideline companies. Methodologies for selecting guideline companies include the exchange methodology and the acquisition methodology. The exchange methodology is based upon transactions of minority-interests in publicly traded companies engaged in a line (or lines) of business similar to the Company. The public companies selected are defined as guideline companies. The acquisition methodology involved analyzing the transaction involving similar companies that have been bought and sold in the public marketplace. There are numerous assumptions and estimates underlying the determination of the estimated fair value of our reporting units, including certain assumptions and estimates related to future earnings based on current and future initiatives. If these initiatives do not accomplish their targeted objectives, the assumptions and estimates underlying the goodwill impairment tests could be adversely affected and have a material effect upon our results of operations or financial condition.

RECOVERABILITY OF LONG-LIVED ASSETS AND INVESTMENTS

        We periodically assess the recoverability of our long-lived assets including property and equipment and other long-term assets and investments where events and changes in circumstances would indicate that we might not recover the carrying value. Significant judgment is required during the determination of the estimated fair values of the long-lived assets and assessment of other-than-temporary decline in value, if applicable. We make certain assumptions regarding estimated future cash flows from the long-lived assets, other economic factors and, if applicable, the eventual disposition of the long-lived assets. If the carrying value of these long-lived assets is deemed to be not fully recoverable, such assets are impaired and written down to their estimated fair values.

STATUTORY CAPITAL REQUIREMENTS

        Certain of the Company's subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. As of December 31, 2002, we estimated that our regulated subsidiaries had more than $825 million in statutory net worth, or more than $425 million in excess of current regulatory requirements. We generally manage our aggregate regulated subsidiary capital against 150% of Risk Based Capital (RBC) Company Action Levels, although RBC standards are not yet applicable to all of our regulated subsidiaries. Certain subsidiaries must maintain ratios of current assets to current liabilities pursuant to certain government contracts. The Company believes it is in compliance with these contractual and regulatory requirements in all material respects.

        As necessary, we make contributions to and issue standby letters of credit on behalf of our subsidiaries to meet risk-based capital or other statutory capital requirements under state laws and regulations. Our parent company contributed $10.5 million to certain of its subsidiaries to meet capital requirements during the year ended December 31, 2002. Except for the $10.5 million capital contribution, our parent company did not make any capital contributions to its subsidiaries to meet risk-based capital or other statutory capital requirements under state laws and regulations during the year ended December 31, 2002 or thereafter through the date of the filing of this Annual Report to Stockholders.

        Effective January 1, 2001, certain of the states in which our regulated subsidiaries operate adopted the codification of statutory accounting principles. As of December 31, 2002, the adoption of the codification of statutory accounting principles did not have a material impact on

46

the amount of statutory capital or related capital contributions required to meet risk-based capital and other minimum capital requirements.

        Legislation has been or may be enacted in certain states in which the Company's subsidiaries operate imposing substantially increased minimum capital and/or statutory deposit requirements for HMOs in such states. Such statutory deposits may only be drawn upon under limited circumstances relating to the protection of policyholders.

        As a result of the above requirements and other regulatory requirements, certain subsidiaries are subject to restrictions on their ability to make dividend payments, loans or other transfers of cash to the Company. Such restrictions, unless amended or waived, limit the use of any cash generated by these subsidiaries to pay obligations of the Company. The maximum amount of dividends which can be paid by the insurance company subsidiaries to the Company without prior approval of the insurance departments is subject to restrictions relating to statutory surplus, statutory income and unassigned surplus. Management believes that as of December 31, 2002, all of the Company's health plans and insurance subsidiaries met their respective regulatory requirements.

HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 (HIPAA)

        The purposes of HIPAA are to (i) limit pre-existing condition exclusions applicable to individuals changing jobs or moving to individual coverage, (ii) guarantee the availability of health insurance for employees in the small group market, (iii) prevent the exclusion of individuals from coverage under group plans based on health status, and (iv) establish national standards for the electronic exchange of health information. In December 2000, the Department of Health and Human Services (DHHS) promulgated regulations under HIPAA related to the privacy and security of electronically transmitted protected health information (PHI). The new regulations require health plans, clearinghouses and providers to (a) comply with various requirements and restrictions related to the use, storage and disclosure of PHI, (b) adopt rigorous internal procedures to protect PHI, (c) create policies related to the privacy of PHI and (d) enter into specific written agreements with business associates to whom PHI is disclosed. The regulations also establish significant criminal penalties and civil sanctions for non-compliance. Health Net has completed the majority of work required to be compliant with the HIPAA Privacy Regulations prior to the effective date of April 2003. Further, Health Net is on target to be in compliance with the Transactions and Codesets requirements prior to the effective date of October 2003. The Security regulations have been recently made final and will not be enforced until approximately April 2005, and Health Net has created a Security plan to ensure appropriate compliance prior to the effective date.

Quantitative and Qualitative Disclosures About Market Risk

        The Company is exposed to interest rate and market risk primarily due to its investing and borrowing activities. Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and in equity prices. Interest rate risk is a consequence of maintaining fixed income investments and variable rate liabilities. The Company is exposed to interest rate risks arising from changes in the level or volatility of interest rates, prepayment speeds and/or the shape and slope of the yield curve. In addition, the Company is exposed to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer's credit rating or credit perception may affect the value of financial instruments.

        The Company has several bond portfolios to fund reserves. The Company attempts to manage the interest rate risks related to its investment portfolios by actively managing the asset/liability duration of its investment portfolios. The overall goal for the investment portfolios is to provide a source of liquidity and support the ongoing operations of the Company's business units. The Company's philosophy is to actively manage assets to maximize total return over a multiple-year time horizon, subject to appropriate levels of risk. Each business unit has additional requirements with respect to liquidity, current income and contribution to surplus. The Company manages these risks by setting risk tolerances, targeting asset-class allocations, diversifying among assets and asset characteristics, and using performance measurement and reporting.

        The Company uses a value-at-risk (VAR) model, which follows a variance/covariance methodology, to assess the market risk for its investment portfolio. VAR is a method of assessing investment risk that uses standard statistical techniques to measure the worst expected loss in the portfolio over an assumed portfolio disposition period under normal market conditions. The determination is made at a given statistical confidence level.

47

        The Company assumed a portfolio disposition period of 30 days with a confidence level of 95 percent for the 2002 computation of VAR. The computation further assumes that the distribution of returns is normal. Based on such methodology and assumptions, the computed VAR was approximately $5.3 million as of December 31, 2002.

        The Company's calculated value-at-risk exposure represents an estimate of reasonably possible net losses that could be recognized on its investment portfolios assuming hypothetical movements in future market rates and are not necessarily indicative of actual results which may occur. It does not represent the maximum possible loss nor any expected loss that may occur, since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in the Company's investment portfolios during the year. The Company, however, believes that any loss incurred would be substantially offset by the effects of interest rate movements on the Company's liabilities, since these liabilities are affected by many of the same factors that affect asset performance; that is, economic activity, inflation and interest rates, as well as regional and industry factors.

        In addition to the market risk associated with its investments, the Company has some interest rate market risk due to its floating rate borrowings. Notes payable totaled $398.8 million as of December 31, 2002 with a related interest rate of 8.375%. The interest rate on borrowings under the revolving credit facility, for which there are none as of December 31, 2002, is subject to change because of the varying interest rates that apply to borrowings under the credit facilities. See a description of the credit facilities under "Liquidity and Capital Resources."

        The floating rate borrowings, if any, are presumed to have equal book and fair values because the interest rates paid on these accounts are based on prevailing market rates. The fair value of our fixed rate borrowing as of December 31, 2002 was approximately $458 million which was based on bid quotations from third-party data providers. The following table presents the expected cash outflows relating to market risk sensitive debt obligations as of December 31, 2002. These cash outflows include both expected principal and interest payments consistent with the terms of the outstanding debt as of December 31, 2002.

		2003		2004		2005		2006		2007		Thereafter		Total
		(Amounts in millions)
Fixed-rate borrowing:
	Principal	$	—	$	—	$	—	$	—	$	—	$	400.0	$	400.0
	Interest		33.5		33.5		33.5		33.5		33.5		117.3		284.8
Cash outflow on fixed-rate borrowing		$	33.5	$	33.5	$	33.5	$	33.5	$	33.5	$	517.3	$	684.8

48

Report of Management

        The management of Health Net, Inc. (the "Company") is responsible for the integrity and objectivity of the consolidated financial information contained in this Annual Report. The consolidated financial statements and related information were prepared in accordance with accounting principles generally accepted in the United States of America and include certain amounts that are based on management's best estimates and judgments.

        The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of a date within 90 days prior to the filing date of this Annual Report (the "Evaluation Date")). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's reports filed or submitted under the Exchange Act. Since the Evaluation Date, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect such controls.

        The Company engaged Deloitte & Touche LLP as its independent auditors to audit the Company's consolidated financial statements and to express their opinion thereon. Their audits include reviews and tests of the Company's internal controls to the extent they believe necessary to determine and conduct the audit procedures that support their opinion. Members of that firm also have the right of full access to each member of management in conducting their audits. The report of Deloitte & Touche LLP appears below.

        The Company's Board of Directors has an Audit Committee composed solely of independent directors. The Audit Committee meets periodically with management, the internal auditors and Deloitte & Touche LLP to oversee and monitor the work of each and to inquire of each as to their assessment of the performance of the others in their work relating to the Company's financial statements. Both the independent and internal auditors have, at all times, the right of full access to the Audit Committee, without management present, to discuss any matter they believe should be brought to the attention of the Audit Committee.

/s/  JAY M. GELLERT    
Jay M. Gellert
President and Chief Executive Officer /s/  MARVIN P. RICH    
Marvin P. Rich
Executive Vice President, Finance and Operations

Report of Independent Auditors

To the Board of Directors and Stockholders of
Health Net, Inc.
Woodland Hills, California

        We have audited the accompanying consolidated balance sheets of Health Net, Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Health Net, Inc. and subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

        As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets upon adoption of the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."

/s/  DELOITTE & TOUCHE LLP     
Los Angeles, California
February 13, 2003

49

Consolidated Balance Sheets

Health Net, Inc.

		December 31,
		2002			2001
		(Amounts in thousands)
ASSETS
Current Assets:
	Cash and cash equivalents	$	841,164		$	909,594
	Investments—available for sale		1,008,975			856,560
	Premiums receivable, net of allowance for doubtful accounts (2002—$13,964; 2001—$14,595)		166,068			183,824
	Amounts receivable under government contracts		78,404			99,619
	Reinsurance and other receivables		108,147			136,854
	Deferred taxes		78,270			72,909
	Other assets		91,376			82,583
Total current assets			2,372,404			2,341,943
Property and equipment, net			199,218			253,063
Goodwill, net			762,066			764,381
Other intangible assets, net			22,339			37,433
Deferred taxes			—			23,359
Other noncurrent assets			110,650			139,468
Total Assets		$	3,466,677		$	3,559,647
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
	Reserves for claims and other settlements	$	1,036,105		$	1,054,025
	Health care and other costs payable under government contracts		224,235			258,136
	Unearned premiums		178,120			166,842
	Accounts payable and other liabilities		263,590			276,523
Total current liabilities			1,702,050			1,755,526
Revolving credit facility and capital leases			—			195,182
Senior notes payable			398,821			398,678
Deferred taxes			9,705			—
Other noncurrent liabilities			47,052			44,749
Total Liabilities			2,157,628			2,394,135
Commitments and contingencies
Stockholders' Equity:
	Preferred stock ($0.001 par value, 10,000 shares authorized, none issued and outstanding)		—			—
	Class A common stock ($0.001 par value, 350,000 shares authorized; issued 2002—130,506 shares; 2001—126,879 shares)		131			127
	Class B non-voting convertible common stock ($0.001 par value, 30,000 shares authorized; none issued and outstanding)		—			—
	Restricted common stock		1,913			—
	Unearned compensation		(1,441	)		—
	Additional paid-in capital		730,495			662,740
	Treasury Class A common stock, at cost (2002—9,864 shares; 2001—3,194 shares)		(259,513	)		(95,831	)
	Retained earnings		826,379			597,753
	Accumulated other comprehensive income		11,085			723
Total Stockholders' Equity			1,309,049			1,165,512
Total Liabilities and Stockholders' Equity		$	3,466,677		$	3,559,647

See accompanying notes to consolidated financial statements.

50

Consolidated Statements of Operations

Health Net, Inc.

			Year Ended December 31,
			2002			2001		2000
			(Amounts in thousands, except per share data)
REVENUES
	Health plan services premiums		$	8,584,418		$	8,576,202	$	7,609,625
	Government contracts			1,498,689			1,339,066		1,265,124
	Net investment income			65,561			78,910		90,087
	Other income			52,875			70,282		111,719
		Total revenues		10,201,543			10,064,460		9,076,555
EXPENSES
	Health plan services			7,161,520			7,241,185		6,322,691
	Government contracts			1,450,808			1,321,483		1,196,532
	General and administrative			857,201			868,925		942,316
	Selling			199,764			186,143		158,031
	Depreciation			61,832			61,073		67,260
	Amortization			8,360			37,622		38,639
	Interest			40,226			54,940		87,930
	Asset impairment and restructuring charges			60,337			79,667		—
	Net loss on assets held for sale and sale of businesses and properties			5,000			76,072		409
		Total expenses		9,845,048			9,927,110		8,813,808
Income from operations before income taxes and cumulative effect of a change in accounting principle				356,495			137,350		262,747
Income tax provision				118,928			50,821		99,124
Income before cumulative effect of a change in accounting principle				237,567			86,529		163,623
Cumulative effect of a change in accounting principle, net of tax				(8,941	)		—		—
Net income			$	228,626		$	86,529	$	163,623
Basic earnings per share:
Income from operations			$	1.91		$	0.70	$	1.34
Cumulative effect of a change in accounting principle				(0.07	)		—		—
Net			$	1.84		$	0.70	$	1.34
Diluted earnings per share:
Income from operations			$	1.89		$	0.69	$	1.33
Cumulative effect of a change in accounting principle				(0.07	)		—		—
Net			$	1.82		$	0.69	$	1.33
Weighted average shares outstanding:
	Basic			124,221			123,192		122,471
	Diluted			126,004			125,186		123,453

See accompanying notes to consolidated financial statements.

51

Consolidated Statements of Stockholders' Equity

Health Net, Inc.

		Common Stock
		Class A			Class B
										Additional Paid-in Capital		Restricted Common Stock
		Shares	Amount		Shares		Amount
		(Amounts in thousands)
Balance at January 1, 2000		123,429	$	124	2,138		$	2		$	643,372
Comprehensive income:
	Net income
	Change in unrealized depreciation on investments, net of tax of $343
Total comprehensive income
Exercise of stock options including related tax benefit		314									4,683
Conversion of Class B to Class A		2,138		2	(2,138	)		(2	)
Employee stock purchase plan		113									1,111
Balance at December 31, 2000		125,994		126	—			—			649,166
Comprehensive income:
	Net income
	Change in unrealized depreciation on investments, net of tax of $2,865
Total comprehensive income
Exercise of stock options including related tax benefit		820		1							12,495
Employee stock purchase plan		65									1,079
Balance at December 31, 2001		126,879		127							662,740
Comprehensive income:
	Net income
	Change in unrealized appreciation on investments, net of tax of $5,741
Total comprehensive income
Exercise of stock options including related tax benefit		3,504		4							66,904
Repurchases of common stock
Issuance of restricted stock		80										$	1,913
Amortization of restricted stock
Employee stock purchase plan		43									851
Balance at December 31, 2002		130,506	$	131	—		$	—		$	730,495	$	1,913

See accompanying notes to consolidated financial statements.

52

					Common Stock Held in Treasury
												Accumulated Other Comprehensive (Loss) Income
		Unearned Compensation								Retained Earnings
					Shares		Amount								Total
		(Amounts in thousands)
Balance at January 1, 2000					(3,194	)	$	(95,831	)	$	347,601	$	(4,069	)	$	891,199
Comprehensive income:
	Net income										163,623					163,623
	Change in unrealized depreciation on investments, net of tax of $343												515			515
Total comprehensive income																164,138
Exercise of stock options including related tax benefit																4,683
Conversion of Class B to Class A																—
Employee stock purchase plan																1,111
Balance at December 31, 2000					(3,194	)		(95,831	)		511,224		(3,554	)		1,061,131
Comprehensive income:
	Net income										86,529					86,529
	Change in unrealized depreciation on investments, net of tax of $2,865												4,277			4,277
Total comprehensive income																90,806
Exercise of stock options including related tax benefit																12,496
Employee stock purchase plan																1,079
Balance at December 31, 2001					(3,194	)		(95,831	)		597,753		723			1,165,512
Comprehensive income:
	Net income										228,626					228,626
	Change in unrealized appreciation on investments, net of tax of $5,741												10,362			10,362
Total comprehensive income																238,988
Exercise of stock options including related tax benefit																66,908
Repurchases of common stock					(6,670	)		(163,682	)							(163,682	)
Issuance of restricted stock		$	(1,913	)												—
Amortization of restricted stock			472													472
Employee stock purchase plan																851
Balance at December 31, 2002		$	(1,441	)	(9,864	)	$	(259,513	)	$	826,379	$	11,085		$	1,309,049

See accompanying notes to consolidated financial statements.

53

Consolidated Statements of Cash Flows

Health Net, Inc.

		Year Ended December 31,
		2002			2001			2000
		(Amounts in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	228,626		$	86,529		$	163,623
Adjustments to reconcile net income to net cash provided by operating activities:
	Amortization and depreciation		70,192			98,695			105,899
	Loss on assets held for sale and sale of businesses and properties		5,000			76,072			409
	Asset impairments		58,817			27,760			—
	Cumulative effect of a change in accounting principle		8,941			—			—
	Other changes		213			3,656			10,035
Changes in assets and liabilities, net of effects of dispositions:
	Premiums receivable and unearned premiums		29,489			(79,658	)		(10,472	)
	Other assets		42,682			3,672			105,659
	Amounts receivable/payable under government contracts		(12,686	)		286,407			(71,087	)
	Reserves for claims and other settlements		(16,564	)		53,426			87,946
	Accounts payable and other liabilities		5,313			(10,075	)		(25,849	)
Net cash provided by operating activities			420,023			546,484			366,163
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of investments			347,944			246,617			31,912
Maturities of investments			359,528			586,922			272,611
Purchase of investments			(826,033	)		(1,204,667	)		(253,141	)
Net purchases of property and equipment			(45,314	)		(69,512	)		(86,853	)
Cash (paid) received from the sale of businesses and properties			(5,474	)		(58,997	)		3,505
Net purchases of restricted investments and other			(13,542	)		(17,941	)		(29,943	)
Net cash used in investing activities			(182,891	)		(517,578	)		(61,909	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock purchases			49,524			10,449			5,794
Proceeds from issuance of notes payable and other financing arrangements			50,000			601,102			250,033
Repurchases of common stock			(159,676	)		—			—
Repayment of debt and other noncurrent liabilities			(245,410	)		(777,598	)		(523,885	)
Net cash used in financing activities			(305,562	)		(166,047	)		(268,058	)
Net (decrease) increase in cash and cash equivalents			(68,430	)		(137,141	)		36,196
Cash and cash equivalents, beginning of year			909,594			1,046,735			1,010,539
Cash and cash equivalents, end of year		$	841,164		$	909,594		$	1,046,735
SUPPLEMENTAL CASH FLOWS DISCLOSURE:
Interest paid		$	38,188		$	46,501		$	87,023
Income taxes paid			76,647			24,154			9,694
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of restricted stock		$	1,913		$	—		$	—
Notes and stocks received on sale of businesses			224			41,000			—
Securities moved from available for sale investments to restricted investments			58,156			—			—
Securities moved from restricted investments to available for sale investments			77,635			—			—

See accompanying notes to consolidated financial statements.

54

Notes to Consolidated Financial Statements

NOTE 1—Description of Business

        The current operations of Health Net, Inc. (referred to herein as the Company, we, us, our or HNT) are a result of the April 1, 1997 merger transaction involving Health Systems International, Inc. and Foundation Health Corporation.

        We are an integrated managed care organization that administers the delivery of managed health care services. We are one of the nation's largest publicly traded managed health care companies. Our health plans and government contracts subsidiaries provide health benefits through our health maintenance organizations (HMOs), preferred provider organizations (PPOs) and point of service (POS) plans to approximately 5.4 million individuals in 15 states through group, individual, Medicare, Medicaid and TRICARE (formerly known as the Civilian Health and Medical Program of the Uniformed Services (CHAMPUS)) programs. Our subsidiaries also offer managed health care products related to behavioral health, dental, vision and prescription drugs. We also offer managed health care product coordination for workers' compensation insurance programs through our employer services group subsidiary. We also own health and life insurance companies licensed to sell PPO, POS and indemnity products, as well as auxiliary non-health products such as life and accidental death and disability insurance in 35 states and the District of Columbia.

        We currently operate within two reportable segments: Health Plan Services and Government Contracts. Our current Health Plan Services reportable segment includes the operations of our health plans in the states of Arizona, California, Connecticut, New Jersey, New York, Oregon and Pennsylvania, the operations of our health and life insurance companies and our behavioral health, dental, vision and pharmaceutical services subsidiaries. We have approximately 3.9 million at-risk members in our Health Plan Services reportable segment.

        Our Government Contracts reportable segment includes government-sponsored managed care plans through the TRICARE programs and other government contracts. The Government Contracts reportable segment administers large, multi-year managed health care government contracts. Certain components of these contracts are subcontracted to unrelated third parties. The Company administers health care programs covering approximately 1.5 million eligible individuals under TRICARE. The Company has three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Washington and parts of Arizona, Idaho, Louisiana and Texas.

        On August 1, 2002, the United States Department of Defense (DoD) issued a Request For Proposals (RFP) for the rebid of the TRICARE contracts. The RFP divides the United States into three regions (North, South and West) and provides for the award of one contract for each region. The RFP also provides that each of the three new contracts will be awarded to a different prime contractor. We submitted proposals in response to the RFP for each of the three regions in January 2003 and it is anticipated that the DoD will award the three new TRICARE contracts on or before June 1, 2003. Health care delivery under the new TRICARE contracts will not commence until the expiration of health care delivery under the current TRICARE contracts.

        If all option periods are exercised by the DoD under the current TRICARE contracts with us and no further extensions are made, health care delivery ends February 29, 2004 for the Region 11 contract, on March 31, 2004 for the Regions 9, 10 and 12 contract and on October 31, 2004 for the Region 6 contract. As set forth above, we are competing for the new TRICARE contracts in response to the RFP.

        During the fourth quarter of 2002, changes we made in our organizational structure, in the interrelationships of our businesses and internal reporting resulted in changes to our reportable segments. Assigned responsibilities for applicable segment managers have changed as follows:

•

One segment manager for the health plans has oversight responsibility for our behavioral health, dental and vision subsidiaries. These business units had been previously overseen by our Government Contracts/Specialty Services segment manager.



•

One discrete segment manager has oversight responsibility for the Government Contracts segment. Unlike our previous organizational structure, this segment manager does not have oversight responsibility for any of our other specialty services companies.



•

One discrete segment manager has oversight responsibility for the employer services group operating segment. This segment manager does not have oversight responsibility for any of our other specialty services companies.

55

        The interrelationships of services and products among our health plans, behavioral health and dental and vision subsidiaries have changed as follows:

•

Effective July 1, 2002, our behavioral health subsidiaries no longer provide behavioral health services to our members in our government-sponsored managed care plans and other government contracts.



•

We increased our efforts to jointly market our behavioral health services and products with our health plan members.



•

Our government contracts subsidiary received a change order to its TRICARE contracts to provide administrative services only (ASO) type of services (known as TRICARE For Life). This change has generated additional revenues and expenses that have changed the business and product mix of the government contracts operating segment.

        Revenues from our employer services group operating segment are included in "Other income."

        We believe that our revised reportable segments presentation properly represents our chief operating decision maker's view of our financial data.

        Prior to 2002, we operated within two segments: Health Plan Services and Government Contracts/Specialty Services. The Health Plan Services segment operated through its health plans in the following states: Arizona, California, Connecticut, New Jersey, New York, Oregon and Pennsylvania. During 2000 and most of 2001, the Health Plan Services segment consisted of two regional divisions: Western Division (Arizona, California and Oregon) and Eastern Division (Connecticut, Florida, New Jersey, New York and Pennsylvania). During the fourth quarter of 2001, we decided that we would no longer view our health plan operations through these two regional divisions. The Government Contracts/Specialty Services reportable segment included government-sponsored managed care plans through the TRICARE programs, behavioral health, dental and vision, and managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities.

NOTE 2—Summary of Significant Accounting Policies

Consolidation and Basis of Presentation

        The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Reclassifications

        Certain amounts in the 2001 and 2000 consolidated financial statements and notes to the consolidated financial statements have been reclassified to conform to the 2002 presentation as a result of changes in our organizational structure. The reclassifications have no effect on total revenues, total expenses, net earnings or stockholders' equity as previously reported.

        The reclassifications impact our consolidated statements of operations in the following ways:

•

We have redefined our two reportable segments—Health Plan Services and Government Contracts;



•

Operations from our specialty companies, including our behavioral health, dental and vision subsidiaries, are now included in Health Plan Services reportable segment;



•

Revenues from our employer services group subsidiary are now included in other income. These revenues had previously been included in revenues from our Government Contracts/Specialty Services reportable segment;



•

Other income is now reported separately from net investment income;



•

Sales incentives and broker commissions are shown as "Selling expenses," which are separated from general and administrative (G&A) expenses; and



•

G&A expenses for Government Contracts are included in Government Contract costs.

        On our consolidated balance sheets, "Reserves for claims and other settlements" now include only those reserves and other settlements for our health plans, health and life insurance companies, behavioral health, dental and vision subsidiaries. Reserves for our TRICARE and other government contracts are reported in "Health care and other costs payable under government contracts."

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal areas requiring the use of estimates include the determination of allowances for doubtful accounts, reserves for claims and other settlements, reserves for professional and general liabilities (including litigation reserves), amounts receivable or payable under government contracts, remaining reserves for restructuring and other charges, and assumptions when determining net realizable values on long-lived assets.

56

Revenue Recognition

        Health plan services premium revenues include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, which premiums are based on a predetermined prepaid fee, Medicaid revenues based on multi-year contracts to provide care to Medicaid recipients, revenue under Medicare risk contracts to provide care to enrolled Medicare recipients, and revenues from behavioral, dental and vision services. Revenue is recognized in the month in which the related enrollees are entitled to health care services. Premiums collected in advance are recorded as unearned premiums.

        Government contracts revenues are recognized in the month in which the eligible beneficiaries are entitled to health care services or in the month in which the administrative services are performed or the period that coverage for services is provided. Government contracts also contain cost and performance incentive provisions which adjust the contract price based on actual performance, and revenue under government contracts is subject to price adjustments attributable to inflation and other factors. The effects of these adjustments are recognized on a monthly basis, although the final determination of these amounts could extend significantly beyond the period during which the services were provided. Amounts receivable under government contracts are comprised primarily of estimated amounts receivable under these cost and performance incentive provisions, price adjustments, and change orders for services not originally specified in the contracts.

        These change orders arise because the government often directs us to implement changes to our contracts before the scope and/or value is defined or negotiated. We start to incur costs immediately, before we have proposed a price to the government. In these situations, we make no attempt to estimate and record revenue. Our policy is to collect and defer the costs incurred. Once we have submitted a cost proposal to the government, we will record the costs and the appropriate value for revenue, using our best estimate of what will ultimately be negotiated. These receivables develop as a result of TRICARE health care costs rising faster than the forecasted health care cost trends used in the original contract bids, data revisions on formal contract adjustments and routine contract changes for benefit adjustments.

        In December 1999, the Securities and Exchange Commission issued, then subsequently amended, Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements." SAB 101, as amended, provides guidance on applying accounting principles generally accepted in the United States of America to revenue recognition issues in financial statements. We adopted SAB 101 effective October 1, 2000. The adoption of SAB 101 did not have a material effect on our consolidated financial position or results of operations.

Health Plan Services

        The cost of health care services is recognized in the period in which services are provided and includes an estimate of the cost of services which have been incurred but not yet reported. Such costs include payments to primary care physicians, specialists, hospitals, outpatient care facilities and the costs associated with managing the extent of such care. We estimate the amount of the provision for service costs incurred but not reported using standard actuarial methodologies based upon historical data including the period between the date services are rendered and the date claims are received and paid, denied claim activity, expected medical cost inflation, seasonality patterns and changes in membership. The estimates for service costs incurred but not reported are made on an accrual basis and adjusted in future periods as required. Any adjustments to the prior period estimates are included in the current period. Such estimates are subject to the impact of changes in the regulatory environment and economic conditions. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts provided. While the ultimate amount of claims and losses paid are dependent on future developments, management is of the opinion that the recorded reserves are adequate to cover such costs. These estimated liabilities are reduced by estimated amounts recoverable from third parties for subrogation.

        Our HMOs, primarily in California and Connecticut, generally contract with various medical groups to provide professional care to certain of its members on a capitated, or fixed per member per month fee basis. Capitation contracts generally include a provision for stop-loss and non-capitated services for which we are liable. Professional capitated contracts also generally contain provisions for shared risk, whereby the Company and the medical groups share in the variance between actual costs and predetermined goals. Additionally, we contract with certain hospitals to provide hospital care to enrolled members on a capitation basis. Our HMOs also contract with hospitals, physicians and other providers of health care, pursuant to discounted fee-for-service arrangements, hospital per diems, and case rates under which providers bill the HMOs for each individual service provided to enrollees.

57

        We assess the profitability of contracts for providing health care services when operating results or forecasts indicate probable future losses. Contracts are grouped in a manner consistent with the method of determining premium rates. Losses are determined by comparing anticipated premiums to estimates for the total of health care related costs less reinsurance recoveries, if any, and the cost of maintaining the contracts. Losses, if any, are recognized in the period the loss is determined and are classified as Health Plan Services. We had premium deficiency reserves of $0 and $1.7 million as of December 31, 2002 and 2001, respectively.

Cash and Cash Equivalents

        Cash equivalents include all highly liquid investments with a maturity of three months or less when purchased.

        We and our consolidated subsidiaries are required to set aside certain funds for restricted purposes pursuant to regulatory requirements. As of December 31, 2002 and 2001, the restricted cash and cash equivalents balances totaled $4.3 million and $4.4 million, respectively, and are included in other noncurrent assets.

Investments

        Investments classified as available for sale are reported at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, net of income tax effects. The cost of investments sold is determined in accordance with the specific identification method and realized gains and losses are included in investment income.

        Certain long-term debt investments are held by trustees or agencies pursuant to state regulatory requirements. These investments totaled $1.3 million and $1.4 million as of December 31, 2002 and 2001, respectively, and are included in other noncurrent assets. Short-term investments held by trustees or agencies pursuant to state regulatory requirements were $109.1 million and $86.1 million as of December 31, 2002 and 2001, respectively, and are included in investments available for sale (see Note 11). Market values approximate carrying value as of December 31, 2002 and 2001.

        During 2002, we recorded an impairment charge of $3.6 million related to an other-than-temporary decline in the fair value of certain investments available for sale (see Note 14).

Government Contracts

        Amounts receivable or payable under government contracts are based on three TRICARE contracts in five regions which include both amounts billed ($7.2 million and $17.4 million of net receivables at December 31, 2002 and 2001, respectively) and estimates for amounts to be received under cost and performance incentive provisions, price adjustments and change orders for services not originally specified in the contracts. Such estimates are determined based on information available as well as historical performance and collection of which could extend for periods beyond a year. Differences, which may be material, between the amounts estimated and final amounts collected are recorded in the period when determined.

        In December 2000, our subsidiary, Health Net Federal Services, Inc., and the DoD agreed to a settlement of approximately $389 million for outstanding receivables related to our three TRICARE contracts and for the completed contract for the CHAMPUS Reform Initiative. Approximately $60 million of the settlement amount was received in December 2000. The remaining settlement amount was received on January 5, 2001.

        Additionally, health care and other costs payable under government contracts include approximately $193.1 million and $224.0 million for health care services already provided under these contracts as of December 31, 2002 and 2001, respectively.

Property and Equipment

        Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method over the lesser of estimated useful lives of the various classes of assets or the lease term. The useful life for buildings and improvements is estimated at 35 to 40 years, and the useful lives for furniture, equipment and software range from two to eight years (see Note 5).

        Effective January 1, 1999, we adopted Statement of Position 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" and changed our method of accounting for the costs of internally developed computer software. The change involved capitalizing certain consulting costs, payroll and payroll-related costs for employees related to computer software developed for internal use and subsequently amortizing such costs over a three to five-year period. The Company had previously expensed such costs.

        Expenditures for maintenance and repairs are expensed as incurred. Major improvements which increase the estimated useful life of an asset are capitalized. Upon the sale or retirement of assets, the recorded cost and the related accumulated depreciation are removed from the accounts, and any gain or loss on disposal is reflected in operations.

        During 2002 and 2001, we recorded impairment charges of $35.8 million and $27.9 million, respectively, for certain information technology-related assets (see Note 14).

58

Goodwill and Other Intangible Assets

        Goodwill and other intangible assets arise primarily as a result of various business acquisitions and consist of identifiable intangible assets acquired and the excess of the cost of the acquisitions over the tangible and intangible assets acquired and liabilities assumed (goodwill). Identifiable intangible assets consist of the value of employer group contracts, provider networks and non-compete agreements.

        In July 2001, the Financial Accounting Standards Board (FASB) issued two new pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 is effective as follows: (a) use of the pooling-of-interest method is prohibited for business combinations initiated after June 30, 2001; and (b) the provisions of SFAS No. 141 also apply to all business combinations accounted for by the purchase method that are completed after June 30, 2001 (that is, the date of the acquisition is July 2001 or later). Transition provisions that applied to business combinations completed before July 1, 2001 that were accounted for by the purchase method had no impact on us.

        Effective January 1, 2002, we adopted SFAS No. 142 which, among other things, eliminates amortization of goodwill and other intangibles with indefinite lives. Intangible assets, including goodwill, that are not subject to amortization will be tested for impairment annually or more frequently if events or changes in circumstances indicate that we might not recover the carrying value of these assets. The impairment test follows a two-step approach. The first step determines if the goodwill is potentially impaired; the second step measures the amount of the impairment loss, if necessary. Under the first step, goodwill is considered potentially impaired if the value of the reporting unit is less than the reporting unit's carrying amount, including goodwill. Under the second step, the impairment loss is then measured as the excess of recorded goodwill over the fair value of goodwill, as calculated. The fair value of goodwill is calculated by allocating the fair value of the reporting unit to all the assets and liabilities of the reporting unit as if the reporting unit was purchased in a business combination and the purchase price was the fair value of the reporting unit.

        We identified the following six reporting units with goodwill within our businesses: Health Plans, Government Contracts, Behavioral Health, Dental & Vision, Subacute and Employer Services Group. In accordance with the transition requirements of SFAS No. 142, we completed an evaluation of goodwill at each of our reporting units upon adoption of this Standard. We also re-assessed the useful lives of our other intangible assets and determined that they properly reflect the estimated useful lives of these assets. As a result of these impairment tests, we identified goodwill impairment at our behavioral health subsidiary and at our employer services group subsidiary in the amounts of $3.5 million and $5.4 million, respectively. Accordingly, we recorded an impairment charge to goodwill of $8.9 million, net of tax benefit of $0, which was reflected as a cumulative effect of a change in accounting principle in the consolidated statement of operations during the first quarter ended March 31, 2002. As part of our annual goodwill impairment test, we completed an evaluation of goodwill with the assistance of the same independent third-party professional services firm at each of our reporting units as of June 30, 2002. No further goodwill impairments were identified in any of our reporting units. We will perform our annual goodwill impairment test as of June 30 in future years.

        Our measurement of fair value was based on utilization of both the income and market approaches to fair value determination. We used an independent third-party professional services firm with knowledge and experience in performing fair value measurements to assist us in the impairment testing and measurement process. The income approach was based on a discounted cash flow methodology. The discounted cash flow methodology is based upon converting expected cash flows to present value. Annual cash flows were estimated for each year of a defined multi-year period until the growth pattern becomes stable. The interim cash flows expected after the growth pattern becomes stable were calculated using an appropriate capitalization technique and then discounted. The market approach used a market valuation methodology which included the selection of companies engaged in a line (or lines) of business similar to the Company to be valued and an analysis of the comparative operating results and future prospects of the Company in relation to the guideline companies selected. The market price multiples are selected and applied to the Company based on the relative performance, future prospects and risk profiles of the Company in comparison to the guideline companies. Methodologies for selecting guideline companies include the exchange methodology and the acquisition methodology. The exchange methodology is based upon transactions of minority interests in publicly traded companies engaged in a line (or lines) of business similar to the Company. The public companies selected are defined as guideline companies. The acquisition methodology involved analyzing the transaction involving similar companies that have been bought and sold in the public marketplace.

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        The following table illustrates the effect of adopting SFAS No. 142 on net income as previously reported (amounts in millions, except per share data):

	Years Ended December 31,
	2002			2001		2000
Reported income before cumulative effect of a change in accounting principle	$	237.5		$	86.5	$	163.6
Add back: Goodwill amortization (net of tax effect)		—			25.7		26.5
Adjusted income before cumulative effect of a change in accounting principle		237.5			112.2		190.1
Reported cumulative effect of a change in accounting principle, net of tax		(8.9	)		—		—
Adjusted net income	$	228.6		$	112.2	$	190.1

	Years Ended December 31,
	2002			2001		2000
BASIC EARNINGS PER SHARE:
Reported income before cumulative effect of a change in accounting principle	$	1.91		$	0.70	$	1.34
Add back: Goodwill amortization (net of tax effect)		—			0.21		0.22
Adjusted income before cumulative effect of a change in accounting principle		1.91			0.91		1.56
Reported cumulative effect of a change in accounting principle, net of tax		(0.07	)		—		—
Adjusted net income	$	1.84		$	0.91	$	1.56

	Years Ended December 31,
	2002			2001		2000
DILUTED EARNINGS PER SHARE:
Reported income before cumulative effect of a change in accounting principle	$	1.89		$	0.69	$	1.33
Add back: Goodwill amortization (net of tax effect)		—			0.20		0.21
Adjusted income before cumulative effect of a change in accounting principle		1.89			0.89		1.54
Reported cumulative effect of a change in accounting principle, net of tax		(0.07	)		—		—
Adjusted net income	$	1.82		$	0.89	$	1.54

        The changes in the carrying amount of goodwill by reporting unit are as follows (amounts in millions):

	Health Plans			Behavioral Health			Dental/Vision		Subacute			Employer Services Group			Total
Balance at January 1, 2001	$	741.7		$	3.9		$	0.7	$	6.1		$	38.8		$	791.2
Amortization		(25.8	)		(0.4	)		—		(0.2	)		(1.2	)		(27.6	)
Other adjustments		0.8			—			—		—			—			0.8
Balance at December 31, 2001		716.7			3.5			0.7		5.9			37.6			764.4
Impairment losses		—			(3.5	)		—		—			(5.4	)		(8.9	)
Reclassification from other intangible assets		6.9			—			—		—			—			6.9
Goodwill written off related to sale of business unit		—			—			—		—			(0.3	)		(0.3	)
Balance at December 31, 2002	$	723.6		$	—		$	0.7	$	5.9		$	31.9		$	762.1

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        As part of adopting SFAS No. 142, we transferred $6.9 million of other intangible assets to goodwill since they did not meet the new criteria for recognition apart from goodwill. These other intangible assets were acquired through our previous purchase transactions. In addition, other intangible assets as of December 31, 2002 decreased from December 31, 2001 due to removal of fully amortized intangible assets.

        The intangible assets that continue to be subject to amortization using the straight-line method over their estimated lives are as follows (amounts in millions):

	Gross Carrying Amount		Accumulated Amortization			Net Balance		Amortization Period (in years)
As of December 31, 2002:
Provider networks	$	35.7	$	(15.9	)	$	19.8	14-40
Employer groups		92.9		(90.4	)		2.5	11-23
Other		1.5		(1.5	)		—
	$	130.1	$	(107.8	)	$	22.3
As of December 31, 2001:
Provider networks	$	35.7	$	(14.2	)	$	21.5	14-40
Employer groups		92.9		(85.2	)		7.7	11-23
Other		29.0		(20.8	)		8.2	40
	$	157.6	$	(120.2	)	$	37.4

        Estimated annual pretax amortization expense for other intangible assets for each of the next five years ended December 31 is as follows (amounts in millions):

2003	$	2.7
2004		2.7
2005		2.5
2006		2.0
2007		1.6

Concentrations of Credit Risk

        Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, investments and premiums receivable. All cash equivalents and investments are managed within established guidelines which limit the amounts which may be invested with one issuer. Concentrations of credit risk with respect to premiums receivable are limited due to the large number of payers comprising our customer base. Our 10 largest employer groups accounted for 56%, 57% and 36% of premiums receivable and 15% of premium revenue as of December 31, 2002, 2001 and 2000, respectively, and for the years then ended.

Earnings Per Share

        Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of shares of common stock outstanding during the periods presented. Diluted EPS is based upon the weighted average shares of common stock and dilutive common stock equivalents (stock options) outstanding during the periods presented.

        Common stock equivalents arising from dilutive stock options are computed using the treasury stock method; in 2002, 2001 and 2000, this amounted to 1,784,000, 1,994,000 and 982,000 shares, respectively.

        Options to purchase an aggregate of 2.6 million, 6.5 million and 4.6 million shares of common stock were considered anti-dilutive during 2002, 2001 and 2000, respectively, and were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common stock for each respective period. These options expire through December 2012 (see Note 7).

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Fair Value of Financial Instruments

        The estimated fair value amounts of cash equivalents, investments available for sale, trade accounts and notes receivable and notes payable approximate their carrying amounts in the financial statements and have been determined by us using available market information and appropriate valuation methodologies. The carrying amounts of cash equivalents approximate fair value due to the short maturity of those instruments. The fair values of investments are estimated based on quoted market prices and dealer quotes for similar investments. The fair value of notes payable is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt with the same remaining maturities. The carrying value of long-term notes receivable, nonmarketable securities and revolving credit facilities approximate the fair value of such financial instruments. The carrying values of the senior notes payable were $398.8 million and $398.7 million and the fair values were $458 million and $415 million as of December 31, 2002 and 2001, respectively. Considerable judgment is required to develop estimates of fair value. Accordingly, the estimates are not necessarily indicative of the amounts we could have realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

        In June 1998, the FASB issued, then subsequently amended, SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133, as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards requiring that all derivatives be recorded in the balance sheet as either an asset or liability measured at fair value and that changes in fair value be recognized currently in earnings, unless specific hedge accounting criteria are met. We adopted SFAS No. 133, as amended, effective January 1, 2001. The adoption of SFAS No. 133 had no effect on our consolidated financial position or results of operations.

Stock-Based Compensation

        In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure" (SFAS No. 148). SFAS No. 148 amended SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), to provide alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, "Interim Financial Reporting," to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of Opinion 25.

        SFAS No. 123 encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. As permitted under SFAS No. 123, we have elected to continue accounting for stock-based compensation under the intrinsic value method prescribed in APB Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value method, compensation cost for stock options is measured at the date of grant as the excess, if any, of the quoted market price of our stock over the exercise price of the option. We apply APB Opinion No. 25 and related Interpretations in accounting for our plans (see Note 7). Accordingly, no compensation cost has been recognized for our stock option or employee stock purchase plans. Had compensation cost for our plans been determined based on the fair value at the grant dates of options and employee purchase rights consistent with the method of SFAS No. 123, our net income and earnings per

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share would have been reduced to the pro forma amounts indicated below for the years ended December 31 (amounts in thousands, except per share data):

		2002			2001			2000
Net income, as reported		$	228,626		$	86,529		$	163,623
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects			315			—			—
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards subject to SFAS No. 123, net of related tax effects			(15,674	)		(19,135	)		(6,922	)
Net income, pro forma		$	213,267		$	67,394		$	156,701
Basic earnings per share
	As reported	$	1.84		$	0.70		$	1.34
	Pro forma		1.72			0.55			1.28
Diluted earnings per share
	As reported		1.82			0.69			1.33
	Pro forma		1.69			0.54			1.27

        The weighted average fair value for options granted during 2002, 2001 and 2000 was $9.40, $9.14 and $5.18, respectively. The fair values were estimated using the Black-Scholes option-pricing model. The following weighted average assumptions were used in the fair value calculation for 2002, 2001 and 2000, respectively: (i) risk-free interest rate of 3.21%, 4.88% and 5.97%; (ii) expected option lives of 3.8 years, 3.6 years and 4.2 years; (iii) expected volatility for options of 47.2%, 55.9% and 63.7%; and (iv) no expected dividend yield.

        As fair value criteria was not applied to option grants and employee purchase rights prior to 1995, and additional awards in future years are anticipated, the effects on net income and earnings per share in this pro forma disclosure may not be indicative of future amounts.

Restricted Stock

        During 2002, we entered into Restricted Stock Agreements with certain employees and issued 80,000 shares of nonvested common stock. The shares issued pursuant to the agreements are subject to restrictions on transfers, voting rights and certain other conditions. Upon issuance of the 80,000 shares pursuant to the agreements, an unamortized compensation expense equivalent to the market value of the shares on the date of grant was charged to stockholders' equity as unearned compensation. This unearned compensation will be amortized over the five-year restricted period. Compensation expense recorded for these restricted shares during the year ended December 31, 2002 was $472,000.

        We become entitled to an income tax deduction in an amount equal to the taxable income reported by the holders of the restricted shares when the restrictions are released and the shares are issued. Restricted shares are forfeited if the employees terminate prior to the lapsing of restrictions. We record forfeitures of restricted stock, if any, as treasury share repurchases and any compensation cost previously recognized is reversed in the period of forfeiture.

Comprehensive Income

        SFAS No. 130, "Reporting Comprehensive Income," establishes standards for reporting and presenting comprehensive income and its components. Comprehensive income includes all changes in stockholders' equity (except those arising from transactions with stockholders) and includes net income and net unrealized appreciation (depreciation), after tax, on investments available for sale. Reclassification adjustments for net gains (losses) realized, net of tax, in net income were $3.0 million, $0.8 million and $(0.04) million for the years ended December 31, 2002, 2001 and 2000, respectively.

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Recently Issued Accounting Pronouncements

        In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This interpretation will significantly change current practice in the accounting for, and disclosure of, guarantees. This interpretation's initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. See Note 3 for indemnification guarantee disclosure on pending and threatened litigation related to the sale of our Florida health plan completed on August 1, 2001.

        In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" (Issue 94-3). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. A fundamental conclusion reached by the FASB in SFAS No. 146 is that an entity's commitment to a plan, by itself, does not create an obligation that meets the definition of a liability. Therefore, SFAS No. 146 eliminates the definition and requirements for recognition of exit costs in Issue 94-3. SFAS No. 146 also establishes that fair value is the objective for initial measurement of any exit or disposal liability. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002.

        Effective January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and some provisions of Accounting Principles Board (APB) Opinion 30, "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 sets new criteria for determining when an asset can be classified as held-for-sale as well as modifying the financial statement presentation requirements of operating losses from discontinued operations. See Notes 3 and 14 for asset impairments recorded in 2002.

        In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143). SFAS No. 143 provides accounting standards for closure or removal-type costs similar to the costs of nuclear decommissioning, but it applies to other industries and assets as well. The adoption of SFAS No. 143 on January 1, 2003 did not have a material effect on our consolidated financial position or results of operations.

Taxes Based on Premiums

        We provide services in certain states which require premium taxes to be paid by us based on membership or billed premiums. These taxes are paid in lieu of or in addition to state income taxes and totaled $24.2 million in 2002, $24.9 million in 2001 and $21.6 million in 2000. These amounts are recorded in general and administrative expenses on our consolidated statements of operations.

Income Taxes

        We record deferred tax assets and liabilities based on differences between the book and tax bases of assets and liabilities. The deferred tax assets and liabilities are calculated by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse (see Note 10).

NOTE 3—Assets Held for Sale, Acquisitions and Divestitures

        The following summarizes acquisitions, strategic investments, and dispositions made by us during the years ended December 31, 2002, 2001 and 2000.

2002 Transactions

        During the third quarter ended September 30, 2002, we entered into an agreement, subject to certain contingency provisions, to sell a corporate facility building in Trumbull, Connecticut. Accordingly, pursuant to SFAS No. 144, we recorded a pretax $2.4 million estimated loss on assets held for sale consisting entirely of non-cash write-downs of building and building improvements. The carrying value of these assets after the write-downs was $7.7 million as of December 31, 2002. The effect of the suspension of the depreciation on this corporate facility building was immaterial for the year ended December 31, 2002. We expect the sale to close no later than September 30, 2003. This corporate facility building stopped being used in our operations during 2001.

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        Effective July 1, 2002, we sold our claims processing subsidiary, EOS Claims Services, Inc. (EOS Claims), to Tristar Insurance Group, Inc. (Tristar). In connection with the sale, we received $500,000 in cash, and also entered into a Payor Services Agreement. Under the Payor Services Agreement, Tristar has agreed to exclusively use EOS Managed Care Services, Inc. (one of our remaining subsidiaries) for various managed care services to its customers and clients. We estimated and recorded a $2.6 million pretax loss on the sale of EOS Claims during the second quarter ended June 30, 2002. EOS Claims had total revenues of $7.2 million and income before income taxes of $0.1 million for the year ended December 31, 2002, total revenues of $15.3 million and loss before income taxes of $3.2 million for the year ended December 31, 2001 and total revenues of $19.0 million and loss before income taxes of $3.1 million for the year ended December 31, 2000.

        As of the date of sale, EOS Claims had no net equity after dividends to its parent company and the goodwill impairment charge taken upon adoption of SFAS No. 142 in the first quarter ended March 31, 2002. EOS Claims revenue through the date of the sale was reported as part of other income on the consolidated statements of operations.

        During 2000, we secured an exclusive e-business connectivity services contract from the Connecticut State Medical Society IPA, Inc. (CSMS-IPA) for $15.0 million. CSMS-IPA is an association of medical doctors providing health care primarily in Connecticut. The amounts paid to CSMS-IPA for this agreement are included in other noncurrent assets, and we periodically assess the recoverability of such assets.

        During 2002, we entered into various agreements with external third parties in connection with this service capability. We entered into marketing and stock issuance agreement with NaviMedix, Inc. (NaviMedix), a provider of online solutions connecting health plans, physicians and hospitals. In exchange for providing general assistance and advice to NaviMedix, we received 800,000 shares of NaviMedix common stock and the right to receive an additional 100,000 earnout shares for each $1 million in certain NaviMedix gross revenues generated during an annualized six-month measurement period.

        In March 2002, we entered into an assignment, assumption and bonus option agreement with CSMS-IPA pursuant to which CSMS-IPA received 32,000 shares or 4% of the NaviMedix shares that we received and the right to receive 4% of any of the earnout shares we may realize. Under the agreement, CSMS-IPA is also entitled to receive up to an additional 8.2% of the earnout shares from us depending on the proportion of NaviMedix gross revenue that is generated in Connecticut.

        In March 2002, we entered into a cooperation agreement with CSMS-IPA pursuant to which we jointly designate and agree to evaluate connectivity vendors for CSMS-IPA members.

        NaviMedix provides connectivity services to our subsidiary, Health Net of the Northeast, Inc. under a three-year term which expires in 2004.

2001 Transactions

        Effective August 1, 2001, we sold our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc. (the Plan), to Florida Health Plan Holdings II, L.L.C. In connection with the sale, we received approximately $49 million which consists of $23 million in cash and approximately $26 million in a secured six-year note bearing 8% interest per annum. We also sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing 8% interest per annum. We estimated and recorded a $76.1 million pretax loss on the sales of our Florida health plan and the related corporate facility building during the second quarter ended June 30, 2001.

        Under the Stock Purchase Agreement that evidenced the sale (as amended, the SPA), we, through our subsidiary FH Assurance Company (FHAC), entered into a reinsurance agreement (the Reinsurance Agreement) with the Plan. Under the terms of the Reinsurance Agreement, FHAC will reimburse the Plan for certain medical and hospital expenses arising after the Florida health plan sale. The Reinsurance Agreement will cover claims arising from all commercial and governmental health care contracts or other agreements in force as of July 31, 2001 and any renewals thereof up to 18 months after July 31, 2001. The Reinsurance Agreement provides that the Plan will be reimbursed for medical and hospital expenses relative to covered claims in excess of certain baseline medical loss ratios, as follows:

•

88% for the six-month period commencing on August 1, 2001;



•

89% for the six-month period commencing on February 1, 2002;



•

90% for the six-month period commencing on August 1, 2002.

        The Reinsurance Agreement is limited to $28 million in aggregate payments and is subject to the following levels of coinsurance:

•

5% for the six-month period commencing on August 1, 2001;

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•

10% for the six-month period commencing on February 1, 2002;



•

15% for the six-month period commencing on August 1, 2002.

        If the baseline medical loss ratio is less than 90% at the end of the six-month period commencing on August 1, 2002, Health Net is entitled to recover medical and hospital expenses below the 90% threshold up to an amount to not exceed 1% of the total premiums for those members still covered during the six-month period under the Reinsurance Agreement.

        The maximum liability under the Reinsurance Agreement of $28 million was reported as part of loss on assets held for sale as of June 30, 2001, since this was our best estimate of our probable obligation under this arrangement. As the reinsured claims are submitted to FHAC, the liability is reduced by the amount of claims paid. As of December 31, 2002, we have paid out $20.3 million under this agreement.

        The SPA included an indemnification obligation for all pending and threatened litigation as of the closing date and certain specific provider contract interpretation or settlement disputes. During the year ended December 31, 2002, we paid $5.7 million in settlements on certain indemnified items. At this time, we believe that the estimated liability related to the remaining indemnified obligations on any pending or threatened litigation and the specific provider contract disputes will not have a material impact to the financial condition of the Company.

        The SPA provides for the following three true-up adjustments that could result in an adjustment to the loss on the sale of the Plan:

•

A retrospective post-closing settlement of statutory equity based on subsequent adjustments to the closing balance sheet for the Plan.



•

A settlement of unpaid provider claims as of the closing date based on claim payments occurring during a one-year period after the closing date.



•

A settlement of the reinsured claims in excess of certain baseline medical loss ratios. Final settlement is not scheduled to occur until the latter part of 2003. The development of claims and claims related metrics and information provided by Florida Health Plan Holdings II, L.L.C. have not resulted in any revisions to the maximum $28 million liability we originally estimated.

        The true-up process has not been finalized and we do not have sufficient information regarding the true-up adjustments to assess probability or estimate any adjustment to the recorded loss on the sale of the Plan as of December 31, 2002.

        The Florida health plan, excluding the $76.1 million loss on net assets held for sale, had premium revenues of $339.7 million and a net loss of $11.5 million and premium revenues of $505.3 million and a net loss of $33.4 million for the years ended December 31, 2001 and 2000, respectively. At the date of sale, the Florida health plan had $41.5 million in net equity. The Florida health plan was reported as part of our Health Plan Services reportable segment.

2000 Transactions

        We sold a property in California and received cash proceeds of $3.5 million and recognized a gain of $1.1 million, before taxes.

        During 1999, we completed the sale of our HMO operations in Washington. As part of the final sales true-up adjustment, we recorded a loss on the sale of our Washington HMO operations of $1.5 million, before taxes, during 2000.

        In 1995, we entered into a five-year tax retention operating lease for the construction of various health care centers and a corporate facility. Upon expiration in May 2000, the lease was extended for four months through September 2000 whereupon we settled our obligations under the agreement and purchased the leased properties which were comprised of three rental health care centers and a corporate facility for $35.4 million. The health care centers are held as investment rental properties and are included in other noncurrent assets. The corporate facility building used by our Florida health plan was sold to DGE Properties LLC concurrent with the sale of our Florida health plan. The buildings are being depreciated over a remaining useful life of 35 years.

        Beginning in 2000, we provided funding in the amount of approximately $13.4 million in exchange for preferred stock and notes in MedUnite, Inc., an independent company, funded and organized by seven major managed health care companies. MedUnite, Inc. provides online internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment. The funded amounts were included in other noncurrent assets. Effective December 31, 2002, MedUnite, Inc. was sold. As a result of the sale, our original investments were exchanged for $1 million in cash and $2.6 million in notes. Accordingly, we wrote off the original investments of $13.4 million less the $1 million cash received and recognized an impairment charge of $12.4 million on December 31, 2002 which included an allowance against the full value of the notes (see Note 14).

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NOTE 4—Investments

        As of December 31, the amortized cost, gross unrealized holding gains and losses and fair value of our available-for-sale investments were as follows:

	2002
	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses			Carrying Value
	(Amounts in thousands)
Mortgage-backed securities	$	330,710	$	4,553	$	(241	)	$	335,022
Asset-backed securities		32,450		92		—			32,542
U.S. government and agencies		394,990		4,309		(1	)		399,298
Obligations of states and other political subdivisions		60,521		1,815		—			62,336
Corporate debt securities		169,161		7,733		(1	)		176,893
Other securities		2,814		153		(83	)		2,884
	$	990,646	$	18,655	$	(326	)	$	1,008,975

	2001
	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses			Carrying Value
	(Amounts in thousands)
Mortgage-backed securities	$	317,226	$	2,469	$	(796	)	$	318,899
U.S. government and agencies		245,260		2,399		(332	)		247,327
Obligations of states and other political subdivisions		63,737		668		(290	)		64,115
Corporate debt securities		211,988		1,366		(1,268	)		212,086
Other securities		16,123		364		(2,354	)		14,133
	$	854,334	$	7,266	$	(5,040	)	$	856,560

        As of December 31, 2002, the contractual maturities of our available-for-sale investments were as follows:

	Cost		Estimated Fair Value
	(Amounts in thousands)
Due in one year or less	$	92,035	$	92,611
Due after one year through five years		454,021		465,421
Due after five years through ten years		58,486		59,859
Due after ten years		52,770		53,367
Mortgage-backed securities		330,710		335,022
Equity securities (no maturity)		2,624		2,695
Total available for sale	$	990,646	$	1,008,975

        Proceeds from sales of investments available for sale during 2002 were $347.9 million, resulting in realized gains and losses of $8.8 million and $2.2 million, respectively. Proceeds from sales of investments available for sale during 2001 were $246.6 million, resulting in realized gains and losses of $3.8 million and $2.4 million, respectively. Proceeds from sales of investments available for sale during 2000 were $31.9 million, resulting in realized gains and losses of $.04 million and $.1 million, respectively.

NOTE 5—Property and Equipment

        Property and equipment comprised the following as of December 31:

	2002		2001
	(Amounts in thousands)
Land	$	13,182	$	15,100
Internal use software and leasehold improvements under development		9,875		14,315
Buildings and improvements		87,275		91,409
Furniture, equipment and software		478,406		511,090
		588,738		631,914
Less accumulated depreciation		389,520		378,851
	$	199,218	$	253,063

NOTE 6—Financing Arrangements

        Senior notes payable, revolving credit facility and capital leases and other financing arrangements comprised the following as of December 31:

	2002		2001
	(Amounts in thousands)
Senior notes payable—noncurrent	$	398,821	$	398,678
Revolving credit facility, unsecured		—		195,000
Capital leases		—		182
Total credit facility and capital leases	$	—	$	195,182

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        The weighted average annual interest rate on our financing arrangements was approximately 7.6%, 7.1% and 7.9% for the years ended December 31, 2002, 2001 and 2000, respectively.

Senior Notes Payable

        On April 12, 2001, we completed our offering of $400 million aggregate principal amount of 8.375 percent Senior Notes due in April 2011 at a discount of $1.4 million. The proceeds, net of discount and other issuance costs, of $395.1 million from the Senior Notes were used to repay outstanding borrowings under our then-existing revolving credit facility. Effective October 4, 2001, we completed an exchange offer for the Senior Notes in which the outstanding Senior Notes were exchanged for an equal aggregate principal amount of new 8.375 percent Senior Notes due 2011 that have been registered under the Securities Act of 1933, as amended.

        The Senior Notes are redeemable, at our option, at a price equal to the greater of (A) 100% of the principal amount of the Senior Notes to be redeemed; (B) and the sum of the present values of the remaining scheduled payments on the Senior Notes to be redeemed consisting of principal and interest, exclusive of interest accrued through the date of redemption, at the rate in effect on the date of calculation of the redemption price, discounted to the date of redemption on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the applicable treasury yield plus 40 basis points plus accrued interest to the date of redemption.

        Scheduled principal repayment on the senior notes payable for the next five years is as follows (amounts in thousands):

Contractual Cash Obligations	Total		2003	2004	2005	2006	2007	Thereafter
Senior notes	$	400,000	—	—	—	—	—	$	400,000

Revolving Credit Facility

        On June 28, 2001, we entered into credit agreements for two new revolving syndicated credit facilities with Bank of America, N.A. as administrative agent, that replaced our previous credit facility. The new facilities, provide for an aggregate of $700 million in borrowings, consisting of a $175 million 364-day revolving credit facility and a $525 million five-year revolving credit and competitive advance facility. Under the five-year facility, we can obtain letters of credit in an aggregate amount of up to $200 million. The 364-day credit facility was amended on June 27, 2002, to extend the existing credit agreement for an additional 364-day period. We must repay all borrowings under the 364-day credit facility by June 26, 2003, unless the Company avails itself of a two-year term-out option in the 364-day credit facility. The five-year credit facility expires in June 2006, and we must repay all borrowings under the five-year credit facility by June 28, 2006. The five-year credit facility may be extended at our request under certain circumstances for up to two twelve-month periods. Swingline loans under the five-year credit facility are subject to repayment within seven days. Committed loans under the credit facilities bear interest at a rate equal to either (1) the greater of the federal funds rate plus 0.5% and the applicable prime rate or (2) LIBOR plus a margin that depends on our senior unsecured credit rating. Loans obtained through the bidding process bear interest at a rate determined in the bidding process. The credit agreements provide for acceleration of repayment of indebtedness under the credit facilities upon the occurrence of customary events of default such as failing to pay any principal or interest when due; providing materially incorrect representations; failing to observe any covenant or condition; judgments against us involving in the aggregate an unsecured liability of $25 million or more not paid, vacated, discharged, stayed or bonded pending appeal within 60 days of the final order; our non-compliance with any material terms of HMO or insurance regulations pertaining to fiscal soundness and not cured or waived within 30 days, solvency or financial condition; the occurrence of specified adverse events in connection with any employee pension benefit plan of ours; our failure to comply with the terms of other indebtedness with an aggregate amount exceeding $40 million such that the other indebtedness can be or is accelerated; or a change in control. As of December 31, 2002, we had no outstanding balances under these credit facilities. The maximum amount outstanding under the facilities during 2002 was $120 million and the maximum commitment level is $700 million as of December 31, 2002. The credit agreements contain negative covenants, including financial covenants that impose performance requirements on our operations and other covenants, including, among other things, limitations on incurrence of indebtedness by subsidiaries of Health Net, Inc. As of December 31, 2002, we were in compliance with the covenants of the credit facilities.

        The previous credit facility for $1.5 billion was established in July 1997 with Bank of America (as Administrative Agent for the Lenders thereto, as amended in April, July, and November 1998, March 1999, and September 2000 (the Amendments)). At our election, and

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subject to customary covenants, loans were initiated on a bid or committed basis and carried interest at offshore or domestic rates, at the applicable LIBOR Rate plus margin or the bank reference rate. Actual rates on borrowings under the credit facility varied, based on competitive bids and our unsecured credit rating at the time of the borrowing. The maximum amount outstanding under the previous credit facility during 2001 was $766 million.

NOTE 7—Stock Option and Employee Stock Purchase Plans

        We have various stock option plans which cover certain employees, officers and non-employee directors, and an employee stock purchase plan under which substantially all of our full-time employees are eligible to participate. The stockholders have approved these plans except for the 1998 Stock Option Plan which was adopted by our Board of Directors. During 2002, the stockholders approved the 2002 Stock Option Plan. During 2002, we issued 80,000 shares of restricted stock (see Note 2). During the second quarter ended June 30, 2002, certain option grants under the 1997 and 1998 plans became vested as a result of our stock attaining a closing market price of $25 for 20 consecutive trading days pursuant to an acceleration clause in the plans.

        Under our various employee stock option plans and our non-employee director stock option plan, we grant options at prices at or above the fair market value of the stock on the date of grant. The options carry a maximum term of up to 10 years and in general vest ratably over three to five years, except for certain option grants under the 1997 and 1998 plans where vesting is accelerated by virtue of attaining certain performance targets. We have reserved a total of 21.9 million shares of our Class A Common Stock for issuance under the stock option plans. As of December 31, 2002, 3.0 million outstanding options had accelerated vesting provisions.

        Under our Employee Stock Purchase Plan, we provide employees with the opportunity to purchase stock through payroll deductions. Eligible employees may purchase on a monthly basis our Class A Common Stock at 85% of the lower of the market price on either the first or last day of each month.

        Stock option activity and weighted average exercise prices for the years ended December 31 are presented below:

	2002				2001				2000
	Number of Options		Weighted Average Exercise Price		Number of Options		Weighted Average Exercise Price		Number of Options		Weighted Average Exercise Price
Outstanding at January 1	13,106,184		$	18.25	12,219,782		$	17.83	12,284,417		$	20.47
Granted	4,873,731			23.74	5,439,036			22.79	3,932,353			9.54
Exercised	(3,504,250	)		13.57	(820,247	)		11.52	(314,384	)		17.73
Canceled	(1,707,816	)		21.40	(3,732,387	)		25.05	(3,682,604	)		17.86
Outstanding at December 31	12,767,849		$	21.06	13,106,184		$	18.25	12,219,782		$	17.83
Exercisable at December 31	5,567,079				3,364,436				4,890,364

        The following table summarizes the weighted average exercise price and weighted average remaining contractual life for significant option groups outstanding at December 31, 2002:

		Options Outstanding				Options Exercisable
Range of Exercise Prices		Number of Options	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Number of Options	Weighted Average Exercise Price
$	6.69 - $11.63	1,547,883	5.50	$	8.77	1,109,735	$	9.26
	12.00 - 12.94	1,407,739	1.96		12.93	1,407,406		12.93
	13.81 - 22.63	1,585,851	8.11		20.75	381,253		18.07
	22.64 - 22.88	2,345,663	9.48		22.64	37,500		22.80
	23.02	3,091,203	7.49		23.02	1,246,879		23.02
	23.49 - 36.25	2,789,510	6.94		28.99	1,384,306		31.33
$	6.69 - $36.25	12,767,849	6.95	$	21.06	5,567,079	$	19.45

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NOTE 8—Capital Stock

        We have two classes of Common Stock. Our Class B Common Stock has the same economic benefits as our Class A Common Stock but is non-voting. As of December 31, 2002, there were 120,642,000 shares of our Class A Common Stock outstanding and no shares of our Class B Common Stock outstanding.

Shareholder Rights Plan

        On May 20, 1996, our Board of Directors declared a dividend distribution of one right (a Right) for each outstanding share of our Class A Common Stock and Class B Common Stock (collectively, the Common Stock), to stockholders of record at the close of business on July 31, 1996 (the Record Date). Our Board of Directors also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the "Distribution Date," the Rights separate from the Common Stock under the circumstances described below and in accordance with the provisions of the Rights Agreement, as defined below, the redemption of the Rights, and the expiration of the Rights and in certain other circumstances. Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights Certificates will be distributed. Subject to certain exceptions contained in the Rights Agreement (as amended), the Rights will separate from the Common Stock following any person, together with its affiliates and associates (an Acquiring Person), becoming the beneficial owner of 15% or more of the outstanding Class A Common Stock, the commencement of a tender or exchange offer that would result in any person, together with its affiliates and associates, becoming the beneficial owner of 15% or more of the outstanding Class A Common Stock or the determination by the Board of Directors that a person, together with its affiliates and associates, has become the beneficial owner of 10% or more of the Class A Common Stock and that such person is an "Adverse Person," as defined in the Rights Agreement.

        The Rights will first become exercisable on the Distribution Date and will expire on July 31, 2006, unless earlier redeemed by us as described below. Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder, upon the occurrence of a Distribution Date, to purchase from us one one-thousandth of a share of Series A Junior Participating Preferred Stock, at a price of $170.00 per one-thousandth share.

        Subject to certain exceptions contained in the Rights Agreement, in the event that any person shall become an Acquiring Person or be declared an Adverse Person, then the Rights will "flip-in" and entitle each holder of a Right, other than any Acquiring Person or Adverse Person, to purchase, upon exercise at the then-current exercise price of such Right, that number of shares of Class A Common Stock having a market value of two times such exercise price.

        In addition and subject to certain exceptions contained in the Rights Agreement, in the event that we are acquired in a merger or other business combination in which the Class A Common Stock does not remain outstanding or is changed or 50% of our assets or earning power is sold or otherwise transferred to any other person, the Rights will "flip-over" and entitle each holder of a Right, other than an Acquiring Person or an Adverse Person, to purchase, upon exercise at the then-current exercise price of such Right, that number of shares of common stock of the acquiring company which at the time of such transaction would have a market value of two times such exercise price.

        We may redeem the rights until the earlier of 10 days following the date that any person becomes the beneficial owner of 15% or more of the outstanding Class A Common Stock and the date the Rights expire at a price of $.01 per Right.

        We entered into Amendment No. 1 to the Rights Agreement to exempt the FHS Combination and related transactions from triggering the separation of the Rights. In addition, the amendment modified certain terms of the Rights Agreement applicable to the determination of certain "Adverse Persons."

        In 2001, we entered into Amendment No. 2 to the Rights Agreement. The amendment provides that certain passive institutional investors that beneficially own less than 17.5% of the outstanding shares of our common stock shall not be deemed to be "Acquiring Persons," as defined in the Rights Agreement. The amendment also provides, among other things, for the appointment of Computershare Investor Services, L.L.C. as the Rights Agent.

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Stock Repurchase Program

        In April 2002, our Board of Directors authorized us to repurchase up to $250 million (net of exercise proceeds and tax benefits from the exercise of employee stock options) of our Class A Common Stock. As of December 31, 2002, we had repurchased an aggregate of 6,669,600 shares of our Class A Common Stock under this repurchase program for aggregate consideration of approximately $163.7 million. Share repurchases are made under this repurchase program from time to time through open market purchases or through privately negotiated transactions.

NOTE 9—Employee Benefit Plans

Defined Contribution Retirement Plans

        We and certain of our subsidiaries sponsor defined contribution retirement plans intended to qualify under Section 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended (the Code). Participation in the plans is available to substantially all employees who meet certain eligibility requirements and elect to participate. Employees may contribute up to the maximum limits allowed by Sections 401(k) and 415 of the Code, with Company contributions based on matching or other formulas. Our expense under these plans totaled $9.4 million, $8.4 million and $8.6 million for the years ended December 31, 2002, 2001 and 2000, respectively.

Deferred Compensation Plans

        Effective May 1, 1998, we adopted a deferred compensation plan pursuant to which certain management and highly compensated employees are eligible to defer between 5% and 90% of their regular compensation and between 5% and 100% of their bonuses, and non-employee Board members are eligible to defer up to 100% of their directors compensation. The compensation deferred under this plan is credited with earnings or losses measured by the mirrored rate of return on investments elected by plan participants. Each plan participant is fully vested in all deferred compensation and earnings credited to his or her account. The employee deferrals are invested through a trust.

        Prior to May 1997, certain members of management, highly compensated employees and non-employee Board members were permitted to defer payment of up to 90% of their compensation under a prior deferred compensation plan (the Prior Plan). The Prior Plan was frozen in May 1997 at which time each participant's account was credited with three times the 1996 Company match (or a lesser amount for certain participants) and each participant became 100% vested in all such contributions. The current provisions with respect to the form and timing of payments under the Prior Plan remain unchanged.

        As of December 31, 2002 and 2001, the liability under these plans amounted to $24.9 million and $23.1 million, respectively. These liabilities are included in other noncurrent liabilities on our consolidated balance sheets. Our expense under these plans totaled $2.4 million, $2.3 million and $2.8 million for the years ended December 31, 2002, 2001 and 2000, respectively.

Pension and Other Postretirement Benefit Plans

Retirement Plans—We have an unfunded non-qualified defined benefit pension plan, the Supplemental Executive Retirement Plan (adopted in 1996). This plan covers key executives, as selected by the Board of Directors, and non-employee directors. Benefits under the plan are based on years of service and level of compensation.

Postretirement Health and Life Plans—Certain of our subsidiaries sponsor postretirement defined benefit health care plans that provide postretirement medical benefits to directors, key executives, employees and dependents who meet certain eligibility requirements. Under these plans, we pay a percentage of the costs of medical, dental and vision benefits during retirement. The plans include certain cost-sharing features such as deductibles, co-insurance and maximum annual benefit amounts which vary based principally on years of credited service.

        SFAS No. 132 "Employers' Disclosures about Pension and Other Postretirement Benefits" (SFAS No. 132), revised and standardized employers' disclosures about pension and other postretirement benefit plans. We disclosed the information required by SFAS No. 132 by aggregating retirement plans into the "Pension Benefits" category and postretirement plans into the "Other Benefits" category.

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        The following table sets forth the plans' funded status and amounts recognized in our financial statements:

		Pension Benefits						Other Benefits
		2002			2001			2002			2001
		(Amounts in thousands)
Change in benefit obligation:
	Benefit obligation, beginning of year	$	16,980		$	14,174		$	5,209		$	6,446
	Service cost		836			1,132			316			221
	Interest cost		969			1,031			369			331
	Plan amendments		—			—			—			(1,626	)
	Benefits paid		(738	)		(725	)		(217	)		(161	)
	Actuarial (gain) loss		(3,081	)		1,368			1,053			(2	)
	Projected benefit obligation, end of year	$	14,966		$	16,980		$	6,730		$	5,209
Change in fair value of plan assets:
	Plan assets, beginning of year	$	—		$	—		$	—		$	—
	Employer contribution		738			725			217			161
	Benefits paid		(738	)		(725	)		(217	)		(161	)
	Plan assets, end of year	$	—		$	—		$	—		$	—
	Funded status of plans	$	(14,966	)	$	(16,980	)	$	(6,730	)	$	(5,209	)
	Unrecognized prior service cost		3,581			4,040			285			315
	Unrecognized gain		(3,763	)		(956	)		(170	)		(1,345	)
	Net amount recognized as accrued benefit liability	$	(15,148	)	$	(13,896	)	$	(6,615	)	$	(6,239	)

        We have multiple postretirement medical benefit plans. The Health Net plan is non-contributory for employees retired prior to December 1, 1995 who have attained the age of 62; employees retiring after December 1, 1995 who have attained age 62 contribute from 25% to 100% of the cost of coverage depending upon years of service. We have two other benefit plans that we have acquired as part of the acquisitions made in 1997. One of the plans is frozen and non-contributory, whereas the other plan is contributory by certain participants.

        The components of net periodic benefit costs for the years ended December 31, 2002, 2001 and 2000 are as follows:

	Pension Benefits									Other Benefits
	2002			2001			2000			2002			2001			2000
	(Amounts in thousands)
Service cost	$	836		$	1,132		$	1,174		$	316		$	221		$	595
Interest cost		969			1,031			972			369			331			388
Amortization of prior service cost		459			459			469			31			31			(6	)
Amortization of unrecognized gain		(274	)		(141	)		(165	)		(122	)		(168	)		(82	)
		1,990			2,481			2,450			594			415			895
Subsidiary plan curtailment credit		—			—			—			—			(2,176	)		—
Net periodic benefit expense (income)	$	1,990		$	2,481		$	2,450		$	594		$	(1,761	)	$	895

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        One of our subsidiaries recorded a curtailment gain of $2,176,000 during the year ended December 31, 2001 due to termination of certain benefits in accordance with plan amendments.

        The weighted average annual discount rate assumed was 6.5% and 7.0% for the years ended December 31, 2002 and 2001, respectively, for both pension plan benefit plans and other postretirement benefit plans. Weighted average compensation increases of between 2.0% to 6.0% for the years ended December 31, 2002 and 2001 were assumed for the pension benefit plans.

        For measurement purposes, depending upon the type of coverage offered, an 11.0% to 15.0% annual rate of increase in the per capita cost covered health care benefits was assumed for 2002, and 7.0% to 8.5% was assumed for 2001. These rates were assumed to decrease gradually to between 5.0% to 5.5% in 2009 for 2002 and to between 5.0% and 5.5% in 2008 for 2001.

        A one percentage point change in assumed health care cost trend rates would have the following effects for the year ended December 31, 2002:

	1-percentage point increase		1-percentage point decrease
	(Amounts in thousands)
Effect on total of service and interest cost	$	106	$	(85	)
Effect on postretirement benefit obligation	$	920	$	(753	)

        We have no minimum pension liability adjustment to be included in comprehensive income.

NOTE 10—Income Taxes

        Significant components of the provision for income taxes are as follows for the years ended December 31:

		2002		2001			2000
		(Amounts in thousands)
Current:
	Federal	$	81,533	$	583		$	18,459
	State		15,433		16,254			10,349
Total current			96,966		16,837			28,808
Deferred:
	Federal		12,093		42,618			64,644
	State		9,869		(8,634	)		5,672
Total deferred			21,962		33,984			70,316
Total provision for income taxes		$	118,928	$	50,821		$	99,124

        A reconciliation of the statutory federal income tax rate and the effective income tax rate on income is as follows for the years ended December 31:

	2002		2001		2000
Statutory federal income tax rate	35.0	%	35.0	%	35.0	%
State and local taxes, net of federal income tax effect	4.6		3.6		4.0
Tax exempt interest income	(0.1	)	(1.1	)	(0.9	)
Goodwill and intangible assets amortization	0.1		6.0		3.3
Examination settlements	(5.9	)	(7.2	)	(2.3	)
Other, net	(0.3	)	0.7		(1.4	)
Effective income tax rate	33.4	%	37.0	%	37.7	%

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        Significant components of our deferred tax assets and liabilities as of December 31 are as follows:

	2002			2001
	(Amounts in thousands)
DEFERRED TAX ASSETS:
Accrued liabilities	$	51,818		$	48,556
Insurance loss reserves and unearned premiums		5,019			4,953
Tax credit carryforwards		834			3,154
Accrued compensation and benefits		26,782			34,964
Net operating loss carryforwards		42,492			52,128
Other		13,513			10,391
Deferred tax assets before valuation allowance		140,458			154,146
Valuation allowance		(16,664	)		(16,813	)
Net deferred tax assets	$	123,794		$	137,333
DEFERRED TAX LIABILITIES:
Depreciable and amortizable property	$	40,840		$	35,810
Other		14,389			5,255
Deferred tax liabilities	$	55,229		$	41,065

        In 2002, 2001 and 2000, income tax benefits attributable to employee stock option transactions of $18.2 million, $2.8 million and $0.5 million, respectively, were allocated to stockholders' equity.

        As of December 31, 2002, we had federal and state net operating loss carryforwards of approximately $96.7 million and $165.8 million, respectively. The net operating loss carryforwards expire between 2003 and 2019. Limitations on utilization may apply to approximately $36.4 million and $65.6 million of the federal and state net operating loss carryforwards, respectively. Accordingly, valuation allowances have been provided to account for the potential limitations on utilization of these tax benefits.

NOTE 11—Regulatory Requirements

        All of our health plans as well as our insurance subsidiaries are required to periodically file financial statements with regulatory agencies in accordance with statutory accounting and reporting practices. Under the California Knox-Keene Health Care Service Plan Act of 1975, as amended, California plans must comply with certain minimum capital or tangible net equity requirements. Our non-California health plans, as well as our health and life insurance companies, must comply with their respective state's minimum regulatory capital requirements and, in certain cases, maintain minimum investment amounts for the restricted use of the regulators which, as of December 31, 2002 and 2001, totaled $5.6 million and $5.9 million, respectively. Short-term investments held by trustees or agencies pursuant to state regulatory requirements were $109.1 million and $86.1 million as of December 31, 2002 and 2001, respectively. Also, under certain government regulations, certain subsidiaries are required to maintain a current ratio of 1:1 and to meet other financial standards.

        As a result of the above requirements and other regulatory requirements, certain subsidiaries are subject to restrictions on their ability to make dividend payments, loans or other transfers of cash to us. Such restrictions, unless amended or waived, limit the use of any cash generated by these subsidiaries to pay our obligations. The maximum amount of dividends which can be paid by the insurance company subsidiaries to us without prior approval of the insurance departments is subject to restrictions relating to statutory surplus, statutory income and unassigned surplus. Management believes that as of December 31, 2002, all of our health plans and insurance subsidiaries met their respective regulatory requirements.

NOTE 12—Commitments and Contingencies

LEGAL PROCEEDINGS

SUPERIOR NATIONAL INSURANCE GROUP, INC.

        We and our former wholly-owned subsidiary, Foundation Health Corporation (FHC), which merged into Health Net, Inc. in January 2001, were named in an adversary proceeding, Superior National Insurance Group, Inc. v. Foundation Health Corporation, Foundation Health Systems, Inc. and Milliman & Robertson, Inc. (M&R), filed on April 28, 2000, in the United States Bankruptcy Court for the Central District of California, case number SV00-14099GM. The lawsuit relates to the 1998 sale of Business Insurance Group, Inc. (BIG), a holding company of workers' compensation insurance companies operating primarily in California, by FHC to Superior National Insurance Group, Inc. (Superior).

        On March 3, 2000, the California Department of Insurance seized BIG and Superior's other California insurance subsidiaries. On April 26, 2000, Superior filed for bankruptcy. Two days later, Superior filed its lawsuit against us, FHC and M&R. Superior alleges in the lawsuit that:

•

the BIG transaction was a fraudulent transfer under federal and California bankruptcy laws in that Superior did not receive reasonably equivalent value for the $285 million in consideration paid for BIG;



•

we, FHC and M&R defrauded Superior by making misstatements as to the adequacy of BIG's reserves;



•

Superior is entitled to rescind its purchase of BIG;



•

Superior is entitled to indemnification for losses it allegedly incurred in connection with the BIG transaction;



•

FHC breached the stock purchase agreement relating to the sale of BIG; and

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•

we and FHC were guilty of California securities laws violations in connection with the sale of BIG.

        Superior seeks $300 million in compensatory damages, unspecified punitive damages and the costs of the action, including attorneys' fees. In discovery, Superior has offered testimony as to various damages claims, ranging as high as $408 million plus unspecified amounts of punitive damages. We dispute all of Superior's claims, including the entire amount of damages claimed by Superior.

        On August 1, 2000, a motion filed by us and FHC to remove the lawsuit from the jurisdiction of the Bankruptcy Court to the United States District Court for the Central District of California was granted. Pursuant to a June 12, 2002 intra-district transfer order, the lawsuit was transferred to Judge Percy A. Anderson. On August 23, 2002, pursuant to a stipulation filed by Superior and M&R, Superior dismissed all of its claims against M&R. On December 5, 2002, however, Judge Anderson recused himself and issued a second intra-district transfer order. The lawsuit is now pending in the District Court under case number SACV-00-658 (GLT)(MLG) before Judge Gary L. Taylor. We and Superior are completing discovery and are engaged in pretrial motions. On December 20, 2002, Judge Taylor issued an order setting a discovery cutoff date of July 2, 2003 and a trial date to be held in November 2003.

        We intend to defend ourselves vigorously in this litigation. While the final outcome of these proceedings cannot be determined at this time, based on information presently available, we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

FPA MEDICAL MANAGEMENT, INC.

        Since May 1998, several complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA Medical Management, Inc. (FPA) at various times between February 3, 1997 and May 15, 1998. The complaints name as defendants FPA, certain of FPA's auditors, us and certain of our former officers, and were filed in the following courts: United States District Court for the Southern District of California; United States Bankruptcy Court for the District of Delaware; and California Superior Court in the County of Sacramento. The complaints allege that we and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between us and FPA, about FPA's business and about our 1997 sale of FPA common stock held by us. All claims against our former officers were voluntarily dismissed from the consolidated class actions in both federal and state court. In early 2000, we filed a motion to dismiss all claims asserted against us in the consolidated federal class actions but have not formally responded to the other complaints. That motion has been withdrawn without prejudice and the consolidated federal class actions have been stayed pending resolution of matters in a related case in which we are not a party.

        We intend to vigorously defend the actions. While the final outcome of these proceedings cannot be determined at this time, based on information presently available, we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC.

        Physicians Health Services, Inc. (PHS), a subsidiary of ours, was sued on December 14, 1999 in the United States District Court in Connecticut by the Attorney General of Connecticut, Richard Blumenthal, acting on behalf of a group of state residents. The lawsuit was premised on the Federal Employee Retirement Income Security Act ("ERISA") and alleged that PHS violated its duties under ERISA by managing its prescription drug formulary in a manner that served its own financial interest rather than those of plan beneficiaries. The suit sought to have PHS revamp its formulary system and to provide patients with written denial notices and instructions on how to appeal. PHS filed a motion to dismiss which asserted that the state residents the Attorney General purported to represent all received a prescription drug appropriate for their conditions and therefore suffered no injuries whatsoever, that his office lacked standing to bring the suit and that the allegations failed to state a claim under ERISA. On July 12, 2000, the court granted PHS' motion and dismissed the action. On March 27, 2002, the United States Court of Appeals for the Second Circuit affirmed the district court's dismissal of the action. On June 25, 2002, the plaintiff filed a petition requesting that the United States Supreme Court review the Second Circuit's decision to affirm dismissal of the case. On October 7, 2002, the United States Supreme Court denied plaintiff's petition for review. As a result, we believe the Company has no further exposure for this case.

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IN RE MANAGED CARE LITIGATION

        The Judicial Panel on Multidistrict Litigation (JPML) has transferred various class action lawsuits against managed care companies, including us, to the United States District Court for the Southern District of Florida for coordinated or consolidated pretrial proceedings in In re Managed Care Litigation, MDL 1334. This proceeding is divided into two tracks, the subscriber track, which includes actions brought on behalf of health plan members, and the provider track, which includes suits brought on behalf of physicians.

Subscriber Track

        The subscriber track includes the following actions involving us: Pay v. Foundation Health Systems, Inc. (filed in the Southern District of Mississippi on November 22, 1999), Romero v. Foundation Health Systems, Inc. (filed in the Southern District of Florida on June 23, 2000, as an amendment to a suit filed in the Southern District of Mississippi), State of Connecticut v. Physicians Health Services of Connecticut, Inc. (filed in the District of Connecticut on September 7, 2000), and Albert v. CIGNA Healthcare of Connecticut, Inc., et al. (including Physicians Health Services of Connecticut, Inc. and Foundation Health Systems, Inc.) (filed in the District of Connecticut on September 7, 2000). The Pay and Romero actions seek certification of nationwide class actions, unspecified damages and injunctive relief and allege that cost containment measures used by our health maintenance organizations, preferred provider organizations and point-of-service health plans violate provisions of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) and ERISA. The Albert suit also alleges violations of ERISA and seeks certification of a nationwide class and unspecified damages and injunctive relief. The State of Connecticut action asserts claims against our subsidiary, Physicians Health Services of Connecticut, Inc., and us that are similar, if not identical, to those asserted in the previous lawsuit which, as discussed above, the United States Court of Appeals for the Second Circuit affirmed dismissal of on March 27, 2002.

        We filed a motion to dismiss the lead subscriber track case, Romero v. Foundation Health Systems, Inc., and on June 12, 2001, the court entered an order dismissing all claims in that suit brought against us with leave for the plaintiffs to re-file an amended complaint. On this same date, the court stayed discovery until after the court ruled upon motions to dismiss the amended complaints and any motions to compel arbitration. On June 29, 2001, the plaintiffs in Romero filed a third amended class action complaint which re-alleges causes of action under RICO, ERISA, common law civil conspiracy and common law unjust enrichment. The third amended class action complaint seeks unspecified compensatory and treble damages and equitable relief. On July 24, 2001, the court heard oral argument on class certification issues. On August 13, 2001, we filed a motion to dismiss the third amended complaint in Romero. On February 20, 2002, the court ruled on our motion to dismiss the third amended complaint in Romero. The court dismissed all claims against us except one ERISA claim. The court further ordered that plaintiffs may file amended complaints, but that no new plaintiffs or claims will be permitted without prior leave of the court. Both plaintiffs and defendants filed motions for reconsideration relating to various parts of the court's dismissal order, which motions were denied. On March 25, 2002, the district court amended its February 20, 2002 dismissal order to include the following statement: "This Order involves a controlling question of law, namely, whether a managed-care subscriber who has not actually been denied care can state a claim under RICO, about which there is substantial ground for difference of opinion and an immediate appeal may materially advance the ultimate termination of this litigation." On April 5, 2002, we joined in a petition to the United States Court of Appeals for the 11th Circuit for permission to appeal the question certified by the district court. On May 10, 2002, the 11th Circuit denied the petition. On June 26, 2002, the plaintiffs filed with the Court a notice that they will not file an amended complaint against the Company. Health Net filed its answer on July 26, 2002. On July 29, 2002, the Court ordered that the stay of discovery is lifted effective September 30, 2002.

        On September 26, 2002, the Court denied plaintiff Romero's motion for class certification. The Court initially scheduled plaintiff Romero's individual case for trial in May 2003. On October 1, 2002, the Court issued an order referring plaintiff Romero's individual case to mediation. On October 10, 2002, plaintiff Romero filed a motion requesting that the Court reconsider its decision to deny class certification. On November 25, 2002, the Court denied plaintiff Romero's motion for reconsideration. The deadline for plaintiffs to appeal to the 11th Circuit the district court's denial of class status expired on December 10, 2002. On January 16, 2003, the district court moved the trial date from May to September 2003.

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Provider Track

        The provider track includes the following actions involving us: Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (filed in the Southern District of Florida on August 17, 2000 as an amendment to a suit filed in the Southern District of Mississippi), California Medical Association v. Blue Cross of California, Inc., PacifiCare Health Systems, Inc., PacifiCare Operations, Inc. and Foundation Health Systems, Inc. (filed in the Northern District of California in May 2000), Klay v. Prudential Ins. Co. of America, et al. (including Foundation Health Systems, Inc.) (filed in the Southern District of Florida on February 22, 2001 as an amendment to a case filed in the Northern District of California), Connecticut State Medical Society v. Physicians Health Services of Connecticut, Inc. (filed in Connecticut state court on February 14, 2001), Lynch v. Physicians Health Services of Connecticut, Inc. (filed in Connecticut state court on February 14, 2001), Sutter v. Health Net of the Northeast, Inc. (D. N.J.) (filed in New Jersey state court on April 26, 2002) and Medical Society of New Jersey v. Health Net, Inc., et al., (D. N.J.) (filed in New Jersey state court on May 8, 2002).

        On August 17, 2000, a complaint was filed in the United States District Court for the Southern District of Florida in Shane, the lead provider track action in MDL 1334. The complaint seeks certification of a nationwide class action on behalf of physicians and alleges that the defendant managed care companies' methods of reimbursing physicians violate provisions of RICO, ERISA, certain federal regulations and various state laws. The action seeks unspecified damages and injunctive relief.

        On September 22, 2000, we filed a motion to dismiss, or in the alternative to compel arbitration, in Shane. On December 11, 2000, the court granted in part and denied in part our motion to compel arbitration. Under the court's December arbitration order, plaintiff Dennis Breen, the single named plaintiff to allege a direct contractual relationship with us in the August complaint, was compelled to arbitrate his direct claims against us. We filed an appeal in the United States Court of Appeals for the 11th Circuit seeking to overturn the portion of the district court's December ruling that did not order certain claims to arbitration. On April 26, 2001, the court modified its December arbitration order and decided to retain jurisdiction over certain direct claims of plaintiff Breen relating to a single contract. On March 2, 2001, the District Court for the Southern District of Florida issued an order in Shane granting the dismissal of certain claims with prejudice and the dismissal of certain other claims without prejudice, and denying the dismissal of certain claims.

        On March 26, 2001, a consolidated amended complaint was filed in Shane against managed care companies, including us. This consolidated complaint adds new plaintiffs, including Leonard Klay and the California Medical Association (who, as set forth below, had previously filed claims against the Company), and has, in addition to revising the pleadings of the original claims, added a claim under the California Business and Professions Code. On May 1, 2001, we filed a motion to compel arbitration in Shane of the claims of all individual plaintiffs that allege to have treated persons insured by us. On that same date, we filed a motion to dismiss this action. Preliminary discovery and briefing regarding the plaintiffs' motion for class certification has taken place. On May 7, 2001, the court heard oral argument on class certification issues in Shane. On May 9, 2001, the court entered a scheduling order permitting further discovery. On May 14, 2001, Health Net joined in a motion for stay of proceedings in Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (00-1334-MD) in the United States District Court for the Southern District of Florida pending appeal in the 11th Circuit Court of Appeals. On June 17, 2001, the district court stayed discovery until after the district court ruled upon motions to dismiss and motions to compel arbitration. This order staying discovery also applied to other actions transferred to the district court by the Judicial Panel on Multidistrict Litigation, namely California Medical Association v. Blue Cross of California, Inc. et al., Klay v. Prudential Ins. Co. of America, et al., Connecticut State Medical Society v. Physicians Health Services of Connecticut, Inc., and Lynch v. Physicians Health Services of Connecticut, Inc. On June 25, 2001, the 11th Circuit Court of Appeals entered an order staying proceedings in the district court pending resolution of the appeals relating to the district court's ruling on motions to compel arbitration. On March 14, 2002, the 11th Circuit affirmed the district court's ruling on motions to compel arbitration. On March 25, 2002, the plaintiffs filed with the 11th Circuit a motion for relief from the stay. We joined in an opposition to plaintiff's motion and joined a petition for rehearing of the arbitration issues before the entire 11th Circuit panel. On June 21, 2002, the 11th Circuit denied the petition for rehearing. Certain defendants filed a petition with the United States Supreme Court requesting review of a portion of the 11th Circuit's decision to affirm the district court's arbitration order. On July 12, 2002, the plaintiffs filed a motion requesting leave to amend their complaint. On July 29, 2002, the Court ordered that the stay of discovery is lifted effective September 30, 2002.

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        On September 26, 2002, the Court granted plaintiffs' motion for class certification, initially scheduled trial to begin in May 2003, and granted plaintiffs' request for leave to amend their complaint. The new complaint adds another managed care company as a defendant, adds the Florida Medical Society and the Louisiana Medical Society as plaintiffs, withdraws Dennis Breen as a named plaintiff, and adds claims under the New Jersey Consumer Fraud Act and the Connecticut Unfair Trade Practices Act against defendants other than Health Net. On October 1, 2002, the Court issued an order referring the lead provider track case to mediation. On October 10, 2002, the defendants filed a petition requesting that the 11th Circuit review the district court's order granting class status. That same day, the defendants also filed a motion requesting that the district court stay discovery pending ruling on the appeal by the 11th Circuit, and pending ruling by the district court on the defendants' motion to dismiss and motions to compel arbitration. On October 15, 2002, the United States Supreme Court agreed to review a portion of the 11th Circuit's decision to affirm the district court's arbitration order. On October 25, 2002, Health Net requested that the district court stay discovery against it pending ruling by the Supreme Court on arbitration issues. The district court later denied this request. On October 18, 2002, the defendants filed a motion to dismiss the plaintiffs' amended complaint. On November 6, 2002, the district court denied the defendants' October 10, 2002 motion requesting a stay of discovery. On November 26, 2002, the plaintiffs filed a motion with the district court seeking leave to amend their complaint, which motion was denied. The district court has moved the trial date from May to December 2003.

        On November 20, 2002, the 11th Circuit granted the defendants' petition for review of the district court's certification decision. On December 2, 2002, the defendants filed a motion with the 11th Circuit requesting that it stay discovery pending resolution of the class certification appeal. The 11th Circuit denied this motion. On December 30, 2002, defendants filed their brief with the 11th Circuit seeking reversal of the district court's grant of class status.

        The CMA action alleges violations of RICO, certain federal regulations and the California Business and Professions Code and seeks declaratory and injunctive relief, as well as costs and attorneys' fees. As set forth above, on March 26, 2001, the California Medical Association was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action.

        The Klay suit is a purported class action allegedly brought on behalf of individual physicians in California who provided health care services to members of the defendants' health plans. The complaint alleges violations of RICO, ERISA, certain federal regulations, the California Business and Professions Code and certain state common law doctrines, and seeks declaratory and injunctive relief, and damages. As set forth above, on March 26, 2001, Leonard Klay was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action.

        The CSMS case was originally brought in Connecticut state court against Physicians Health Services of Connecticut, Inc. (PHS-CT) alleging violations of the Connecticut Unfair Trade Practices Act. The complaint alleges that PHS-CT engaged in conduct that was designed to delay, deny, impede and reduce lawful reimbursement to physicians who rendered medically necessary health care services to PHS-CT health plan members. The complaint, which is similar to others filed against us and other managed care companies, seeks declaratory and injunctive relief. On March 13, 2001, the Company removed this action to federal court. Before this case was transferred to MDL 1334, the plaintiffs moved to remand the action to state court and the federal District Court of Connecticut consolidated this action and Lynch v. Physicians Health Services of Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the complaint.

        The Lynch case was also originally filed in Connecticut state court. This case was purportedly brought on behalf of physician members of the Connecticut State Medical Society who provide health care services to PHS-CT health plan members pursuant to provider service contracts. The complaint alleges that PHS-CT engaged in improper, unfair and deceptive practices by denying, impeding and/or delaying lawful reimbursement to physicians. The complaint, similar to the complaint referred to above filed against PHS-CT on the same day by the Connecticut State Medical Society, seeks declaratory and injunctive relief and damages. On March 13, 2001, we removed this action to federal court. Before this case was transferred to MDL 1334, the plaintiffs moved to remand the action to state court and the federal District Court of Connecticut consolidated this action and CSMS v. Physicians Health Services of Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the complaint.

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        On April 26, 2002, plaintiff John Ivan Sutter, M.D., P.A. filed an amended complaint in New Jersey state court joining Health Net of the Northeast, Inc. (Health Net of the Northeast), a subsidiary of ours, in an action originally brought against Horizon Blue Cross Blue Shield of New Jersey, Inc., CIGNA Healthcare of New Jersey, Inc. and CIGNA Corp (collectively known as CIGNA), United Healthcare of New Jersey, Inc. and United Healthcare Insurance Company and Oxford Health Plans, Inc. The complaint seeks certification of a statewide class of health-care providers who render or have rendered services to patients who are members of health care plans sponsored by the defendants.

        Plaintiff alleges that the defendants engage in unfair and deceptive acts and practices which are designed to delay, deny, impede and reduce compensation to physicians. The complaint seeks unspecified damages and sets forth causes of action for breach of contract, breach of the implied duty of good faith and fair dealing, violations of the New Jersey Prompt Payment Act and the Healthcare Information Networks and Technologies Act (the HINT Act), reformation, violations of the New Jersey Consumer Fraud Act, unjust enrichment and conversion. On May 22, 2002, the New Jersey state court severed the action filed by Dr. Sutter into five separate cases, including an action against Health Net of the Northeast only. On May 24, 2002, Health Net of the Northeast removed the case against it to federal court. That same day, the CIGNA entities removed plaintiff Sutter's action against them to federal court and the United Healthcare entities removed plaintiff Sutter's action against them to federal court. Plaintiff moved to remand all of these cases to state court and the defendants moved to stay the cases pending ruling by the JPML as to whether these cases should be transferred to MDL 1334 for coordinated or consolidated pretrial proceedings. On July 9, 2002, the federal district court denied plaintiff's motion to remand without prejudice, consolidated the cases against Health Net of the Northeast, the CIGNA entities, and the United Healthcare entities into one case for pretrial proceedings, and stayed the case pending the JPML's ruling on transfer to MDL 1334. On July 18, 2002, the JPML transferred this action to MDL 1334 for coordinated or consolidated pretrial proceedings. On September 23, 2002, plaintiff filed in the MDL proceeding a motion to remand to state court. On November 5, 2002, defendants moved to suspend briefing on remand. The district court denied this motion on November 18, 2002, and remand briefing was completed on December 30, 2002.

        On May 8, 2002, the Medical Society of New Jersey filed a complaint in New Jersey state court against us and our subsidiaries, Health Net of the Northeast, Inc., First Option Health Plan of New Jersey, Inc., and Health Net of New Jersey, Inc. (the Health Net defendants). Plaintiff brought this action on its own behalf and purportedly on behalf of its physician members and alleges that the Health Net defendants engage in practices which are designed to delay, deny, impede and reduce compensation to physicians. Plaintiff has requested declaratory and injunctive relief and has set forth causes of action for violation of public policy, violations of the New Jersey Consumer Fraud Act, violations of the HINT Act and tortious interference with prospective economic relations. On June 14, 2002, the Health Net defendants removed this case to federal court. On July 3, 2002, the Health Net defendants filed a motion to stay this action pending ruling by the JPML on whether to transfer this case to MDL 1334. On July 15, 2002, plaintiff filed a motion to remand this case to state court. On August 2, 2002, the JPML transferred this case to MDL 1334 for coordinated or consolidated pretrial proceedings.

        We intend to defend ourselves vigorously in all of this JPML litigation. While the final outcome of these proceedings cannot be determined at this time, based on information presently available, we believe that the final outcome of such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

Miscellaneous Proceedings

        We and certain of our subsidiaries are also parties to various other legal proceedings, many of which involve claims for coverage encountered in the ordinary course of our business. While the final outcome of these procedings cannot be determined at this time, based on information presently available, we believe that the final outcome of all such proceedings will not have a material adverse effect upon our results of operations or financial condition. However, our belief regarding the likely outcome of such proceedings could change in the future and an unfavorable outcome could have a material adverse effect upon our results of operations or financial condition.

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Operating Leases and Other Commitments

        We lease administrative office space under various operating leases. Certain leases contain renewal options and rent escalation clauses.

        On September 30, 2000, Health Net of California, Inc. entered into an operating lease agreement to lease office space in Woodland Hills, California for substantially all of its operations. As of December 31, 2001, Health Net of California, Inc. completed its relocation into the new facilities. The new lease is for a term of 10 years. The total future minimum lease commitments under the lease are approximately $80.3 million.

        In February 1999, we entered into a long-term service agreement for 10 years with an external third-party to receive mail order, network claims processing and other pharmacy benefit management services. Future minimum commitments are approximately $24 million and are included in the table below.

        In December 1998, we entered into a long-term services agreement with an external third-party to provide call center operation services to our members for a period of 10 years. Future minimum commitments are approximately $37 million and are included in the table below.

        These leases and service agreements are cancelable with substantial penalties.

        Future minimum commitments for operating leases and service agreements as of December 31, 2002 are as follows:

	(Amounts in thousands)
2003	$	61,614
2004		54,286
2005		38,594
2006		32,930
2007		30,836
Thereafter		90,140
Total minimum commitments	$	308,400

        Rent expense totaled $52.7 million, $56.0 million and $49.8 million in 2002, 2001 and 2000, respectively. Service expense totaled $18.8 million, $17.4 million and $14.1 million in 2002, 2001 and 2000, respectively.

NOTE 13—Related Parties

        One current director of the Company was a partner in a law firm which received legal fees totaling $0.2 million, $0.4 million and $0.3 million in 2002, 2001 and 2000, respectively. Such law firm is also an employer group of the Company from which the Company receives premium revenues at standard rates. This director retired from the law firm in 2000. One current director was an officer of IBM which the Company paid $6.9 million, $7.0 million and $16.7 million for products and services in 2002, 2001 and 2000, respectively. This director retired from IBM in 2000. This director is also a director of a temporary staffing company which the Company paid $1.9 million in 2000. Another current director is also a director of another temporary staffing company which the Company paid $11,000 in 2001. Another current director is also a director of a travel services company which the company paid $16,000 in 2002.

        A director of the Company was paid $70,000 in consulting fees in 2000 due to various services provided to the Company in connection with the closing of its operations in Pueblo, Colorado.

        During 1998, three executive officers of the Company, in connection with their hire or relocation, received one-time loans from the Company aggregating $775,000 which ranged from $125,000 to $400,000 each. The loans accrue interest at the prime rate and each is payable upon demand by the Company in the event of a voluntary termination of employment of the respective officer or termination for cause. Of the loans made in 1998, $283,333, $283,334 and $125,000 were forgiven in 2000, 2001 and 2002, respectively. During 1999, three executive officers of the Company, in connection with their hire or relocation, received one-time loans from the Company aggregating $550,000 which ranged from $100,000 to $300,000 each. Two of the loans totaling $250,000 and a $60,000 portion of a third loan made during 1999 were forgiven by the Company in 2000, and $60,000 was forgiven by the Company in 2002. During 2001, two executive officers of the Company, in connection with their hire or relocation, received one-time loans from the Company aggregating $200,000. One of the loans totaling $150,000 was forgiven by the Company in 2002. The loans accrue interest at the prime rate and each is payable upon demand by the Company in the event of a voluntary termination of employment of the respective officer or termination for cause.

        The principal and interest of the loans will be forgiven by the Company at varying times between one and five years after the date of hire or relocation of the respective officers. As of December 31, 2002, the aggregate outstanding principal balance of the remaining two loans was $230,000.

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NOTE 14—Asset Impairment and Restructuring Charges

        The following sets forth the principal components of asset impairment and restructuring charges for the years ended December 31:

	2002		2001		2000
	(Amounts in millions)
Severance and benefit related costs	$	—	$	43.3	$	—
Asset impairment costs		35.8		27.9		—
Investment write-offs		23.0		—		—
Real estate lease termination costs		—		5.1		—
Other costs		—		3.4		—
		58.8		79.7		—
Modifications to prior year restructuring plans		1.5		—		—
Total	$	60.3	$	79.7	$	—

2002 CHARGES

        During the fourth quarter ended December 31, 2002, pursuant to SFAS No. 144, we recognized $35.8 million of impairment charges stemming from purchased and internally developed software that were rendered obsolete as a result of our operations and systems consolidation process. In addition, beginning in the first quarter of 2003, internally developed software of approximately $13 million in carrying value will be subject to accelerated depreciation to reflect their revised useful lives as a result of our operations and systems consolidation.

        Effective December 31, 2002, MedUnite, Inc., a health care information technology company, in which we had invested $13.4 million, was sold. As a result of the sale, our original investments were exchanged for $1 million in cash and $2.6 million in notes. Accordingly, we wrote off the original investments of $13.4 million less the $1 million cash received and recognized an impairment charge of $12.4 million on December 31, 2002 which included an allowance against the full value of the notes.

        During the third quarter ended September 30, 2002, pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115), we evaluated the carrying value of our investments available for sale in CareScience, Inc. The common stock of CareScience, Inc. has been consistently trading below $1.00 per share since early September 2002 and is at risk of being delisted. As a result, we determined that the decline in the fair value of CareScience's common stock was other than temporary. The fair value of these investments was determined based on quotations available on a securities exchange registered with the SEC as of September 30, 2002. Accordingly, we recognized a pretax $3.6 million write-down in the carrying value of these investments which was classified as asset impairment and restructuring charges during the third quarter ended September 30, 2002. Subsequent to the write-down, our new cost basis in our investment in CareScience, Inc. was $2.6 million as of September 30, 2002. Our remaining holdings in CareScience, Inc. are included in investments-available for sale on the consolidated balance sheets.

        Pursuant to SFAS No. 115 and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures," we evaluated the carrying value of our investments in convertible preferred stock and subordinated notes of AmCareco, Inc. arising from a previous divestiture of health plans in Louisiana, Oklahoma and Texas in 1999. Since August 2002, authorities in these states have taken various actions, including license denials and liquidation-related processes, that caused us to determine that the carrying value of these assets was no longer recoverable. Accordingly, we wrote off the total carrying value of our investment of $7.1 million which was included as a charge in asset impairment and restructuring charges during the third quarter ended September 30, 2002. Our investment in AmCareco had been included in other noncurrent assets on the consolidated balance sheets.

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2001 CHARGES

        The following table summarizes the charges we recorded in 2001:

			2001 Activity
	2001 Charges		Cash Payments			Non-cash			Balance at December 31, 2001		Expected Future Cash Outlays
	(Amounts in millions)
Severance and benefit related costs	$	43.3	$	(20.5	)	$	—		$	22.8	$	22.8
Asset impairment costs		27.9		—			(27.9	)		—		—
Real estate lease termination costs		5.1		(0.3	)		—			4.8		4.8
Other costs		3.4		(0.4	)		(2.3	)		0.7		0.7
Total	$	79.7	$	(21.2	)	$	(30.2	)	$	28.3	$	28.3

			2002 Activity
	Balance at December 31, 2001		Cash Payments			Non-cash		Modification		Balance at December 31, 2002		Expected Future Cash Outlays
	(Amounts in millions)
Severance and benefit related costs	$	22.8	$	(24.3	)	$	—	$	1.5	$	—	$	—
Real estate lease termination costs		4.8		(1.4	)		—		—		3.4		3.4
Other costs		0.7		(0.7	)		—		—		—		—
Total	$	28.3	$	(26.4	)	$	—	$	1.5	$	3.4	$	3.4

        As part of our ongoing general and administrative expense reduction efforts, during the third quarter of 2001, we finalized a formal plan to reduce operating and administrative expenses for all business units within the Company (the 2001 Plan). In connection with the 2001 Plan, we decided on enterprise-wide staff reductions and consolidations of certain administrative, financial and technology functions. We recorded pretax restructuring charges of $79.7 million during the third quarter ended September 30, 2001 (2001 Charge). As of September 30, 2002, we had completed the 2001 Plan. As of December 31, 2002, we had $3.4 million in lease termination payments remaining to be paid under the 2001 Plan. These payments will be made during the remainder of the respective lease terms.

Severance and Benefit Related Costs—During the third quarter ended September 30, 2001, we recorded severance and benefit related costs of $43.3 million related to enterprise-wide staff reductions, which costs were included in the 2001 Charge. These reductions include the elimination of approximately 1,517 positions throughout all functional groups, divisions and corporate offices within the Company. As of September 30, 2002, the termination of positions in connection with the 2001 Plan had been completed and we recorded a modification of $1.5 million to reflect an increase in the severance and related benefits in connection with the 2001 Plan from the initial amount of $43.3 million included in the 2001 Charge to a total of $44.8 million. No additional payments remain to be paid related to severance and benefit related costs included in the 2001 Charge.

Asset Impairment Costs—Pursuant to SFAS No. 121, we evaluated the carrying value of certain long-lived assets that were affected by the 2001 Plan. The affected assets were primarily comprised of information technology systems and equipment, software development projects and leasehold improvements. We determined that the carrying value of these assets exceeded their estimated fair values. The fair values of these assets were determined based on market information available for similar assets. For certain of the assets, we determined that they had no continuing value to us due to our abandoning certain plans and projects in connection with our workforce reductions.

        Accordingly, we recorded asset impairment charges of $27.9 million consisting entirely of non-cash write-downs of equipment, building improvements and software application and development costs, which charges were included in the 2001 Charge. The carrying value of these assets was $6.9 million as of December 31, 2002.

        The asset impairment charges of $27.9 million consist of $10.8 million for write-downs of assets related to the consolidation of four data centers, including all computer platforms, networks and applications into a single processing facility at our Hazel Data Center; $16.3 million related to abandoned software applications and development projects resulting from the workforce reductions, migration of certain systems and investments to more robust technologies; and $0.8 million for write-downs of leasehold improvements (see Note 15 for segment information).

82

Real Estate Lease Termination Costs—The 2001 Charge included charges of $5.1 million related to termination of lease obligations and non-cancelable lease costs for excess office space resulting from streamlined operations and consolidation efforts. Through December 31, 2002, we had paid $1.7 million of the termination obligations. The balance of the termination obligations of $3.4 million will be paid during the remainder of the respective lease terms.

Other Costs—The 2001 Charge included charges of $3.4 million related to costs associated with closing certain data center operations and systems and other activities which were completed and paid during in the first quarter ended March 31, 2002.

NOTE 15—Segment Information

        SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" (SFAS No. 131), establishes annual and interim reporting standards for an enterprise's reportable segments and related disclosures about its products, services, geographic areas and major customers. Under SFAS No. 131, reportable segments are to be defined on a basis consistent with reports used by our chief operating decision maker to assess performance and allocate resources. The Company's reportable segments are business units that offer different products to different classes of customers.

        We currently operate within two reportable segments: Health Plan Services and Government Contracts. Our current Health Plan Services reportable segment includes the operations of our health plans in the states of Arizona, California, Connecticut, New Jersey, New York, Oregon and Pennsylvania, the operations of our health and life insurance companies and our behavioral health, dental, vision and pharmaceutical services subsidiaries.

        Our Government Contracts reportable segment includes government-sponsored multi-year managed care plans through the TRICARE programs and other government contracts.

        The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies, except intersegment transactions are not eliminated.

        During the fourth quarter of 2002, changes we made in our organizational structure, in the interrelationships of our businesses and internal reporting resulted in changes to our reportable segments.

        Certain 2001 and 2000 amounts have been reclassified to conform to the 2002 presentation as a result of changes in our organizational structure. See Notes 1 and 2.

83

        Presented below are segment data for the three years in the period ended December 31 (amounts in thousands).

2002

	Health Plan Services		Government Contracts			Corporate And Other(1)			Total
Revenues from external sources	$	8,584,418	$	1,498,689		$	—		$	10,083,107
Intersegment revenues		46,657		—			(46,657	)		—
Investment income		75,976		33			(10,448	)		65,561
Other income		3,327		6			49,542			52,875
Interest expense		5,687		5			34,534			40,226
Depreciation and amortization		48,012		2,599			19,581			70,192
Asset impairment and restructuring charges		27,837		(1,676	)		34,176			60,337
Loss on sale of businesses and properties		—		—			5,000			5,000
Segment profit (loss)		397,657		45,216			(21,041	)		421,832
Segment assets		3,048,608		405,193			12,876			3,466,677

2001

	Health Plan Services		Government Contracts		Corporate And Other(1)			Total
Revenues from external sources	$	8,576,202	$	1,339,066	$	—		$	9,915,268
Intersegment revenues		60,950		—		(60,950	)		—
Investment income		90,936		430		(12,456	)		78,910
Other income		2,044		24		68,214			70,282
Interest expense		5,843		20		49,077			54,940
Depreciation and amortization		62,233		2,131		34,331			98,695
Asset impairment and restructuring charges		53,115		3,591		22,961			79,667
Loss on sale of businesses and properties		—		—		76,072			76,072
Segment profit (loss)		290,343		18,524		(15,778	)		293,089
Segment assets		3,039,981		403,271		116,395			3,559,647

2000

	Health Plan Services		Government Contracts		Corporate And Other(1)			Total
Revenues from external sources	$	7,609,625	$	1,265,124	$	—		$	8,874,749
Intersegment revenues		126,601		179		(126,780	)		—
Investment income		97,113		952		(7,978	)		90,087
Other income		2,816		87		108,816			111,719
Interest expense		2,821		—		85,109			87,930
Depreciation and amortization		64,947		3,764		37,188			105,899
Loss on sale of businesses and properties		—		—		409			409
Segment profit (loss)		295,280		65,868		(97,992	)		263,156
Segment assets		3,149,047		405,790		115,279			3,670,116

(1)

Includes intersegment eliminations and results from our corporate entities and employer services group subsidiary.

        Prior to January 1, 2002, our basis of measurement of segment profit or loss was pretax income or loss after allocation of budgeted costs for our corporate shared services to each of our reportable segments, Health Plan Services and Government Contracts. Shared service expenses include costs for information technology, finance, operations and certain other administrative functions.

        Beginning January 1, 2002, we implemented several initiatives to reduce our general and administrative (G&A) expenses. At that time, we changed our methodology from allocating budgeted costs to allocating actual expenses incurred for corporate shared services to more properly reflect segment costs. Our chief operating decision maker now uses the

84

segment pretax profit or loss subsequent to the allocation of actual shared services expenses as its measurement of segment performance. We changed our methodology of determining segment pretax profit or loss to better reflect management's revised view of the relative costs incurred proportionally by our reportable segments. Certain prior period balances have been reclassified to conform to our chief operating decision maker's current view of segment pretax profit or loss.

        A reconciliation of the total reportable segments' measures of profit to the Company's consolidated income before income taxes and cumulative effect of a change in accounting principle for the years ended December 31, 2002, 2001 and 2000 is as follows (amounts in thousands):

	2002			2001			2000
Total reportable segment profit	$	442,873		$	308,867		$	361,148
Loss from corporate and other entities		(21,041	)		(15,778	)		(97,992	)
		421,832			293,089			263,156
Asset impairment and restructuring charges		(60,337	)		(79,667	)		—
Net loss on assets held for sale and sale of businesses and properties		(5,000	)		(76,072	)		(409	)
Income before income taxes and cumulative effect of a change in accounting principle as reported	$	356,495		$	137,350		$	262,747

        Loss from other corporate entities and employer services group subsidiary, which are not part of our Health Plan Services and Government Contracts reportable segments, are excluded from our measurement of segment performance. Other corporate entities include our facilities, warehouse, reinsurance and surgery center subsidiaries. Asset impairment, restructuring charges and net loss on assets held for sale and sale of businesses and properties are excluded from our measurement of segment performance since they are unusual items and are not managed within either of our reportable segments.

NOTE 16—Quarterly Information (Unaudited)

        The following interim financial information presents the 2002 and 2001 results of operations on a quarterly basis (in thousands, except per share data).

2002

		March 31		June 30		September 30		December 31
Total revenues		$	2,469,818	$	2,505,964	$	2,577,650	$	2,648,111
Income from operations before income taxes and cumulative effect of a change in accounting principle			89,841		97,237		104,567		64,850
Net income			49,814		64,735		69,024		45,053
BASIC EARNINGS PER SHARE
	Net income	$	0.40	$	0.52	$	0.55	$	0.37
DILUTED EARNINGS PER SHARE
	Net income	$	0.40	$	0.51	$	0.55	$	0.36

2001

		March 31		June 30			September 30		December 31
Total revenues		$	2,488,124	$	2,546,703		$	2,544,939	$	2,484,694
Income (loss) from operations before income taxes			67,328		(22,548	)		3,691		88,879
Net income (loss)			42,415		(14,205	)		2,326		55,993
BASIC EARNINGS (LOSS) PER SHARE
	Net income (loss)	$	0.35	$	(0.12	)	$	0.02	$	0.45
DILUTED EARNINGS (LOSS) PER SHARE
	Net income (loss)	$	0.34	$	(0.12	)	$	0.02	$	0.45

85

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Exhibit 13.1

Financial Highlights Health Net, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Report of Management
Report of Independent Auditors
Consolidated Balance Sheets Health Net, Inc.
Consolidated Statements of Operations Health Net, Inc.
Consolidated Statements of Stockholders' Equity Health Net, Inc.
Consolidated Statements of Cash Flows Health Net, Inc.
Notes to Consolidated Financial Statements

EX-21.1

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Exhibit 21.1

Health Net, Inc. (DE)(95-4288333) (All Subsidiaries wholly owned unless otherwise indicated)
•	Health Net of California, Inc. (CA)(95-4402957)
	–	Health Net Life Insurance Company (CA)(73-0654885)
•	Health Net of the Northeast, Inc. (DE)(06-1116976)
	–	FOHP, Inc. (NJ)(22-3314813)
		>	Health Net of New Jersey, Inc. (NJ)(22-3241303)
		>	First Option Health Plan of Pennsylvania, Inc. (PA)(52-1935749)
		>	FOHP Agency, Inc. (NJ)(22-3409934)
	–	Physicians Health Services (Bermuda) Ltd. (Bermuda)(98-0153069)
	–	Health Net of Connecticut, Inc. (CT)(06-1084283)
	–	Health Net of New York, Inc. (NY)(06-1174953)
	–	Health Net Insurance of New York, Inc. (NY)(13-3584296)
	–	Health Net Insurance Services, Inc. (CT)(06-1254380)
	–	Health Net Insurance of Connecticut, Inc. (CT)(06-1434898)
	–	PHS Real Estate, Inc. (DE)(06-1467640)
		>	PHS Real Estate II, Inc. (DE)(06-1459019)
•	Questium, Inc.(DE)(68-0443608)
•	QualMed, Inc. (DE)(84-1175468)
	–	QualMed Plans for Health of Colorado, Inc. (CO)(84-0975985)
	–	Health Net Health Plan of Oregon, Inc. (OR)(93-1004034)
•	HSI Eastern Holdings, Inc. (PA)(23-2424663)
	–	Greater Atlantic Health Service, Inc. (DE)(23-2632680)
		>	Health Net of Pennsylvania, Inc. (PA)(23-2348627)
		>	Greater Atlantic Preferred Plus, Inc. (PA)(23-2665783)
		>	Employ Better Care, Inc. (PA) (23-2697017)
•	HSI Advantage Health Holdings, Inc. (DE)(23-2867299)
	–	QualMed Plans for Health of Ohio and West Virginia, Inc. (OH)(25-1803681)
	–	QualMed Plans for Health of Western Pennsylvania, Inc. (PA)(23-2867300)
	–	Pennsylvania Health Care Plan, Inc. (PA)(25-1516632)
•	FH-Arizona Surgery Centers, Inc. (AZ)(86-0836312)
•	FH Surgery Limited, Inc. (CA)(68-0390434)
•	FH Surgery Centers, Inc. (CA)(68-0390435)
	–	Greater Sacramento Surgery Center Limited Partnership (CA) (68-0343818)*
•	Foundation Health Facilities, Inc. (CA)(68-0390438)
•	FH Assurance Company (Cayman Islands)(98-0150604)
•	Foundation Health Warehouse Company (CA)(68-0357852)
•	Memorial Hospital of Gardena, Inc. (CA)(33-0466850)
•	East Los Angeles Doctors Hospital, Inc. (CA)(95-3275451)
•	Health Net Vision, Inc. (CA)(77-0067022)
•	Health Net Dental, Inc. (CA)(94-2197624)
•	Managed Alternative Care, Inc. (CA)(95-4205929)
•	American VitalCare, Inc. (CA)(22-2646452)
•	Health Net Federal Services, Inc. (DE)(68-0214809)
	–	Health Net Federal Services of Hawaii, Inc. (HI) (99-0240224)
•	Health Net Pharmaceutical Services (CA)(68-0295375)
•	Intercare, Inc. (AZ)(86-0660443)
•	Health Net of Arizona, Inc.(AZ)(36-3097810)
•	Managed Health Network, Inc. (DE)(95-4117722)
	–	Health Management Center, Inc. (MA) (04-2742159)
	–	Health Management Center, Inc. of Wisconsin (WI)(39-1528989)
	–	HMC PPO, Inc. (MA)(04-3237484)
	–	Managed Health Network (CA)(95-3817988)
	–	MHN Reinsurance Company of Arizona (AZ)(95-4361727)
	–	MHN Services (CA)(95-4146179)
		>	MHN Services IPA, Inc. (NY)(13-4027559)

• Health Net Employer Services, Inc. (formerly known as Employer & Occupational Services Group, Inc.) (CA)(33-0854987)

– Health Net Plus Managed Care Services, Inc. (formerly known as EOS Managed Care Services) (CA)(68-0303353)

– Health Net Services, Inc. (formerly known as EOS Services) (DE)(94-3037822)

– Health Net CompAmerica, Inc. (formerly known as CompAmerica, Inc.) (DE)

• Gem Holding Corporation (UT)(87-0445881)

– Gem Insurance Company (UT)(87-0451573)

• National Pharmacy Services, Inc. (DE)(84-1301249)

– Integrated Pharmacy Systems, Inc. (PA)(23-2789453)**

• QualMed Plans for Health of Pennsylvania, Inc. (PA)(23-2456130)

*

FH Surgery Centers, Inc. and FH Surgery Limited, Inc. own general and limited partnership units, respectively, representing slightly over 50% of the total equity of Greater Sacramento Surgery Center Limited Partnership (which specific percentage fluctuates from time to time)

**

National Pharmacy Services, Inc. owns approximately 90% of the outstanding common stock.

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Exhibit 21.1

EX-23.1

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Exhibit 23.1

INDEPENDENT AUDITORS' CONSENT

        We consent to the incorporation by reference in Registration Statement Nos. 333-99337, 333-68387, 333-48969, 333-35193, 333-24621, 33-90976, and 33-74780 of Health Net, Inc. on Form S-8 of our reports dated February 13, 2003 (which reports express an unqualified opinion and include an explanatory paragraph relating to a change in the method of accounting for goodwill and intangible assets upon adoption of the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"), appearing in and incorporated by reference in this Annual Report on Form 10-K of Health Net, Inc. for the year ended December 31, 2002.

/s/ DELOITTE & TOUCHE LLP

Los Angeles, California

March 21, 2003

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INDEPENDENT AUDITORS' CONSENT

EX-99.1

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Exhibit 99.1

Certification of CEO and CFO Pursuant to
18 U.S.C. Section 1350,
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

        In connection with the Annual Report of Health Net, Inc. (the "Company") on Form 10-K for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Jay M. Gellert, as Chief Executive Officer of the Company, and Marvin P. Rich, as Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)

The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and



(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/  JAY M. GELLERT Jay M. Gellert
Chief Executive Officer
March 24, 2003

/s/  MARVIN P. RICH Marvin P. Rich
Chief Financial Officer
March 24, 2003

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Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002