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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2003

For the transition period from             to             

Commission File Number: 1-12718

HEALTH NET, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code: (818) 676-6000

Securities Registered Pursuant to Section 12(b) of the Act:

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 x No ¨

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. x

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

The aggregate market value of the voting stock held by non-affiliates of the registrant at June 27, 2003 was $3,827,769,091 (which represents 115,957,864 shares of Class A Common Stock held by such non-affiliates multiplied by $33.01, the closing sales price of such stock on the New York Stock Exchange on June 27, 2003).

The number of shares outstanding of the registrant’s Class A Common Stock as of March 10, 2004 was 112,743,445 (excluding 20,873,729 shares held as treasury stock).

Documents Incorporated By Reference

Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive proxy statement for the 2004 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, 2003.

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HEALTH NET, INC.

INDEX TO FORM 10-K

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PART I

Item  1.     Business.

General

We are an integrated managed care organization that delivers managed health care services. We operate and conduct our businesses through subsidiaries of Health Net, Inc., which is among the nation’s largest publicly traded managed health care companies. In this Annual Report on Form 10-K, unless the context otherwise requires, the terms “Company,” “we,” “us,” and “our” refer to Health Net, Inc. and its subsidiaries.

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 5.3 million individuals in 14 states through group, individual, Medicare, Medicaid and TRICARE programs. We also offer managed health care products related to behavioral health and prescription drugs. In addition, we own health and life insurance companies licensed to sell exclusive provider organization (“EPO”), PPO, POS and indemnity products, as well as auxiliary non-health products such as life and accidental death and disability insurance, in 36 states and the District of Columbia. We currently operate within two reportable segments: Health Plan Services and Government Contracts.

Our Health Plan Services reportable segment includes the operations of our health plans in Arizona, California, Connecticut, New Jersey, New York and Oregon, the operations of our health and life insurance companies and our behavioral health and pharmaceutical services subsidiaries. We have approximately 3.7 million at-risk and 0.1 million administrative services only (“ASO”) members in our Health Plan Services reportable segment. Effective September 30, 2003, we withdrew our commercial health plan from the commercial market in the Commonwealth of Pennsylvania. See “Other Company Information and Recent and Other Developments – Withdrawal of Pennsylvania Health Plan” for additional information regarding our withdrawal from the Pennsylvania commercial market. On October 31, 2003, we consummated the sale of our dental and vision subsidiaries to SafeGuard Health Enterprises, Inc. (“SafeGuard”). Prior to the sale, our dental and vision subsidiaries were included in our Health Plan Services Segment. See “Segment Information – Health Plan Services Segment – Other Specialty Services and Products – Dental and Vision” for additional information regarding the sale of our dental and vision subsidiaries.

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. We administer health care programs covering approximately 1.5 million eligible individuals under TRICARE and currently have three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii, Oklahoma, Oregon, Washington and parts of Arizona, Idaho, Louisiana and Texas. These contracts expire in 2004. In August 2003, we were awarded a new five year contract for the TRICARE North Region that supports nearly 2.8 million Military Health System (“MHS”) eligible participants, including the provision of health care and administrative services for 1.7 million TRICARE eligibles and the provision of administrative services only for 1.1 million other MHS-eligible beneficiaries (active duty personnel and TRICARE/Medicare dual eligible beneficiaries). For additional information regarding the new TRICARE North Region contract, see “Segment Information – Government Contracts Segment – TRICARE.”

On October 31, 2003, we consummated the sale of certain of our workers’ compensation services subsidiaries organized under Health Net Employer Services, Inc. (“HN Employer Services”) to First Health Group Corp. (“First Health”). Prior to the sale, we recorded revenue from our workers’ compensation services subsidiaries as part of other income in our consolidated statements of operations. As such, revenue from these subsidiaries had no impact on our reportable segments’ results of operations. See “Other Company Information and Recent and Other Developments – Sale of Employer Services Group Subsidiary” for additional information regarding the sale of our workers’ compensation services subsidiaries.

Our executive offices are located at 21650 Oxnard Street, Woodland Hills, California 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 such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). Copies of our Corporate Governance Guidelines, Code of Conduct and charters for the Audit Committee, Compensation and Stock Option Committee and Governance Committee of our Board of Directors are also available on our Internet web site. We will provide electronic or paper copies free of charge upon request.

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Segment Information

We currently operate within two reportable segments, Health Plan Services and Government Contracts, each of which are described below. For additional financial information regarding our reportable segments, see Note 15 in the Notes to Consolidated Financial Statements included as part of this Annual Report on Form 10-K.

Health Plan Services Segment

Managed Health Care Operations.

We offer a full spectrum of managed health care products. Our strategy is to offer to employers and individuals a wide range of managed health care products and services that, among other things, provide comprehensive coverage and contain health care costs increases. As of December 31, 2003, approximately 50% of our members were covered by conventional HMO products. We are continuing to expand our other product lines, thereby enabling us to offer flexibility to employer groups and individual insureds.

Our health plans offer members a wide range of health care services that are designed to contain costs and provide comprehensive coverage, including ambulatory and outpatient physician care, hospital care, pharmacy services, behavioral health and ancillary diagnostic and therapeutic services. Our health plans include a matrix package which allows members to select their desired coverage from alternatives that have features such as interchangeable outpatient and inpatient co-payment 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 traditional product 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. For information regarding the marketing and sale of our health plans, see “Additional Information Concerning our Business – Marketing and Sales.”

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 HMOs provide comprehensive health care coverage for a fixed fee or premium 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. We have contractual relationships with health care providers for the delivery of health care to our enrollees.

The following table contains information relating to our commercial large group members (generally defined as an employer group with 50 or more employees), commercial small group (generally defined as an employer group with 2 to 50 employees) and individual members, ASO members, Medicare members and Medicaid members as of December 31, 2003 (our Medicare and Medicaid businesses are discussed below under “Medicare Products” and “Medicaid Products”):

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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, 2003:

During 2003, our Health Plan Services segment had health plan operations in Arizona, California, Oregon, Connecticut, New Jersey, New York and Pennsylvania. On September 30, 2003, we withdrew our commercial health plan from the commercial market in the Commonwealth of Pennsylvania. See “Other Company Information and Recent and Other Developments – Withdrawal of Pennsylvania Health Plan” for additional information regarding our withdrawal from the Pennsylvania market.

Arizona. In Arizona, we believe that our commercial managed care operations rank us seventh largest as measured by total membership and fourth largest as measured by size of provider network. Our commercial membership in Arizona was 119,110 as of December 31, 2003, which represented an increase of approximately 0.5% during 2003. This increase was primarily due to increased sales of our PPO products in the small group and individual market. Our Medicare membership in Arizona was 36,414 as of December 31, 2003, which represented a decrease of approximately 6% during 2003. We did not have any Medicaid members in Arizona as of December 31, 2003 or 2002.

California. We believe that Health Net of California, Inc., our California HMO (“HN California”), 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, 2003 was 1,670,917, which represented a decrease of approximately 5% during 2003. The decrease in commercial membership was solely due to enrollment decreases within the large group market as a result of the loss of the CalPERS members effective January 1, 2003. Our commercial membership in the small group and individual market in California was 559,255 as of December 31, 2003, which represented an increase of approximately 13% during 2003. Our Medicare membership in California as of December 31, 2003 was 99,403, which represented a decrease of approximately 2% during 2003. Our Medicaid membership in California as of December 31, 2003 was 701,994 members, which represented a decrease of approximately 3% during 2003. The decrease in Medicaid membership in California was primarily due to the State changing eligibility requirements for the Medicaid program.

Oregon. We believe that our Oregon operations make us the seventh largest managed care provider in Oregon in terms of membership and the largest HMO in Oregon in terms of size of provider network. Our commercial membership in Oregon was 120,200 as of December 31, 2003, which represented an increase of approximately 51% during 2003. Of these members, approximately 11,000 reside in Washington. Our Medicare membership in Oregon as of December 31, 2003 was 392. We did not have any Medicare members in Oregon as of December 31, 2002. We did not have any Medicaid members in Oregon as of December 31, 2003 or 2002.

Northeast. Our Northeast operations are conducted in Connecticut, New Jersey and New York. For our large employer group business, we directly market commercial HMO, PPO and POS products in Connecticut, commercial HMO and POS products in New Jersey and commercial HMO, PPO and POS products in New York. For small employer group business in Connecticut, New Jersey and New York, we offer HMO, PPO and POS products through a marketing agreement with The Guardian in which we are doing business under the brand name “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 approximately 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 253,502 as of December 31, 2003 (including 45,489 members under The Guardian arrangement), a decrease of approximately 17% since the end of 2002. This decrease was primarily due to planned attrition in the large group segment. Our Medicare membership in Connecticut was 27,357 as of December 31, 2003, which represented a decrease of approximately 5% during 2003, and our Medicaid membership in Connecticut was 98,486 as of December 31, 2003, which represented a decrease of approximately 6% during 2003.

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We believe our New Jersey operations make us the third largest managed care provider in terms of membership and the fourth largest in terms of size of provider network in New Jersey. Our HMO membership in New Jersey was 294,360 as of December 31, 2003 (including 153,681 members under The Guardian arrangement), which represented a decrease of approximately 2% during 2003. Our Medicaid membership in New Jersey was 45,046 as of December 31, 2003, which represented a decrease of approximately 7% during 2003. We did not have any Medicare members in New Jersey as of December 31, 2003 or 2002.

We believe our New York HMO and PPO operations make us the tenth largest HMO managed care provider in terms of membership and the sixth largest in terms of size of provider network in New York. In New York, we had 271,498 commercial members as of December 31, 2003, which represented an increase of approximately 9% during 2003. Such membership included 115,986 members under The Guardian arrangement. Our Medicare membership in New York was 5,673 as of December 31, 2003, which represented a decrease of 14% during 2003. We did not have any Medicaid members in New York as of December 31, 2003 or 2002.

Medicare Products.

Our Medicare+Choice plans had a combined membership of approximately 169,239 as of December 31, 2003, compared to 176,160 as of December 31, 2002. On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 was signed into law. As a result of this legislation, Medicare private market plans will change their name from Medicare+Choice to Medicare Advantage. The name change will be transitioned in 2004 and 2005 and become fully effective in 2006. See “Government Regulation – Federal Legislation and Regulation – Medicare Legislation” and “Risk Factors – Our businesses are highly regulated” for additional information regarding the Medicare legislation.

We offer our Medicare+Choice products directly to individuals and through 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 plus a broad range of health care services not covered by traditional Medicare programs. The federal Centers for Medicare & Medicaid Services (“CMS”) 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 approximately 36,821 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, 2003. Our other health plan subsidiaries are licensed and certified to offer Medicare+Choice plans in three counties in Connecticut, four counties in Arizona and four boroughs in the City of New York. We offer a Medicare preferred provider organization product (“Medicare PPO”) under a CMS demonstration product in seven counties in Arizona, 13 counties in Oregon and one county in Washington. We began enrolling members in the Medicare PPO effective January 1, 2003.

Medicaid Products

As of December 31, 2003, we had an aggregate of approximately 845,526 Medicaid members (including approximately 99,633 members in our Healthy Families program described below) compared to 874,154 members as of December 31, 2002, 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.

Our California HMO, HN California, participates in the State Children’s Health Insurance Program (“SCHIP”), which, in California, is known as the Healthy Families program. SCHIP was designed as a federal/state partnership, similar to Medicaid, with the goal of expanding health insurance to children whose families earn too much money to be eligible for Medicaid, but not enough money to purchase private insurance. Member premiums, which range from $4 to $9 per child, per month, are subsidized by the State of California. California receives two-thirds of the funding for the program from the federal government.

Administrative Services Only Business

We provide ASO products 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

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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, 2003, we had 87,767 members through our ASO business.

Indemnity Insurance Products

We offer insured PPO, POS, EPO 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 36 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.

Other Specialty Services and Products

We offer pharmacy benefits, behavioral health, dental and vision products and services (through strategic relationships with third parties) 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.

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 claims processing. However, we continue to actively utilize all other pharmacy management tools available. Some of the tools used are as follows:

Behavioral Health. We provide behavioral health services through our wholly-owned subsidiary, Managed Health Network, Inc., and subsidiaries of Managed Health Network, Inc. (collectively “MHN”). MHN holds a license in California under the Knox-Keene Health Care Service Plan Act of 1975 (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 self-funded basis.

MHN’s products and services were being provided to over 7.1 million individuals as of December 31, 2003, with approximately 2.6 million individuals under risk-based programs, approximately 2.1 million individuals under self-funded programs and approximately 2.4 million individuals under EAP. MHN is serving approximately 803 employer groups on a stand-alone basis plus approximately 49,487 groups through other affiliates of MHN, primarily in California and the Northeast.

In 2003, MHN’s total revenues were $223 million. Of that amount, $133 million represented revenues from business with MHN affiliates and $90 million represented revenues from non-affiliate business.

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

Dental and Vision. On October 31, 2003, we consummated the sale of our dental and vision subsidiaries, Health Net Dental, Inc. (“Health Net Dental”) and Health Net Vision, Inc. (“Health Net Vision”) to SafeGuard. In addition, we entered

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into an assumption reinsurance agreement to transfer full responsibility for the stand alone dental and vision policies of Health Net Life Insurance Company to SafeHealth Life Insurance Company (“SafeHealth Life”). As a result of the sale, we no longer underwrite or administer stand alone dental and vision products. We continue to make available to our current and prospective members private label dental products through a strategic relationship with SafeGuard and private label vision products through a strategic relationship with EyeMed Vision Care LLC (“EyeMed”). The stand alone dental products are underwritten and administered by SafeGuard companies and the stand alone vision products are underwritten by Fidelity Security Life Insurance Company and administered by EyeMed. In connection with these sales, we received approximately $14.8 million in cash. We also transferred $2.1 million in cash and $2.1 million in liabilities to SafeHealth Life under the assumption reinsurance agreement.

As of October 31, 2003, Health Net Dental had approximately 418,500 members, of which 61,700 members were beneficiaries under the Medicaid dental programs. As of October 31, 2003, Health Net Vision provided services to approximately 159,600 members. Of those covered lives, 99,100 members were enrolled in full-risk products and 60,500 lives were covered under administrative services contracts. As of October 31, 2003, Health Net Life Insurance Company had approximately 49,400 dental PPO and indemnity members and 53,600 vision PPO and indemnity members.

Our dental and vision subsidiaries had $47.4 million of revenues and $1.9 million of income before income taxes for the ten months ended October 31, 2003. As of October 31, 2003, our dental and vision subsidiaries had a combined total of $4.3 million in net equity, which we recovered through the sales proceeds. Health Net Life Insurance Company had $15.9 million of stand alone dental and vision product revenues and related income before income taxes of $0.7 million for the ten months ended October 31, 2003. Prior to being sold, our dental and vision subsidiaries and the stand alone dental and vision product business of Health Net Life Insurance Company were reported as part of our Health Plan Services reportable segment.

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. (“HNFS”), administers large, multi-year managed care federal contracts with the U.S. Department of Defense (the “Department of Defense”).

HNFS currently administers health care contracts for the Department of Defense’s TRICARE program covering approximately 1.5 million eligible individuals under TRICARE. Through TRICARE, HNFS provides eligible beneficiaries with improved access to care, lower costs and improved quality.

HNFS currently administers three TRICARE contracts for five regions:

Eligible beneficiaries in the TRICARE program are able to choose from a variety of program options. They can choose to enroll in TRICARE Prime, which is similar to a conventional HMO plan, or they can select, on a case-by-case basis, to utilize TRICARE Extra, which is similar to a conventional PPO plan, or TRICARE Standard, which is similar to a conventional indemnity plan.

Under TRICARE Prime, enrollees pay an enrollment fee (which is zero for active duty participants and their dependents) and select a primary care physician from a designated provider panel. The primary care physicians are responsible for making referrals to specialists and hospitals. Except for active duty family members who have no co-payment charges, TRICARE Prime enrollees pay co-payments each time they receive medical services from a civilian provider. TRICARE Prime enrollees may opt, on a case-by-case basis, for a point-of-service option in which they are allowed to self-refer but incur a deductible and a co-payment.

Under TRICARE Extra, eligible beneficiaries may utilize a TRICARE network provider but incur a deductible and co-payment which is greater than the TRICARE Prime co-payment. Under TRICARE Standard, eligible beneficiaries may

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utilize a TRICARE authorized provider who is not a network provider but pay a higher co-payment than under TRICARE Prime or TRICARE Extra.

During 2003, enrollment of TRICARE beneficiaries in TRICARE Prime for the Region 11 contract increased by 4.4% to 150,004, while the total estimated number of eligible beneficiaries, based on data from the Department of Defense, increased by 4.5% to 248,078. During 2003, enrollment of TRICARE beneficiaries in TRICARE Prime for the Region 6 contract increased by 1.2% to 388,658, while the total estimated number of eligible beneficiaries, based on data from the Department of Defense, increased by 5.6% to 646,836. During 2003, enrollment of TRICARE beneficiaries in TRICARE Prime for the Regions 9, 10 and 12 contract increased by 4% to 383,829 while the total estimated number of eligible beneficiaries, based on data from the Department of Defense and excluding Alaska, decreased by 2.5% to 596,361. Department of Defense estimated numbers of eligible beneficiaries are subject to revision when actual numbers become available. TRICARE beneficiaries do not “enroll” in either TRICARE Extra or TRICARE Prime, rather, they select, on a case-by-case basis, to utilize either, both or neither of these options during any given year. As such, there is no enrollment data available for the TRICARE Extra and TRICARE Standard options.

On August 21, 2003, the Department of Defense announced the award to us of a new TRICARE contract for the North Region, one of three regional contracts. The North Region contract supports nearly 2.8 million participants, including 1.7 million TRICARE eligibles for which we provide health care and administrative services and 1.1 million MHS-eligible beneficiaries (active duty personnel and TRICARE/Medicare dual eligible beneficiaries) for which we provide administrative services only. This contract covers Connecticut, Delaware, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Vermont, Virginia, West Virginia, Wisconsin and the District of Columbia. In addition, the contract covers a small portion of Tennessee, Missouri and Iowa.

We will end the delivery of health care under our existing Region 11 contract on May 31, 2004, our existing Region 9, 10 and 12 contract on June 30, 2004, and our existing Region 6 contract on October 31, 2004. Health care delivery will begin on the new North Region contract on July 1, 2004 for the area that was previously Regions 2 and 5 and September 1, 2004 for the area that was previously Region 1.

There are certain differences in the economic structure of the new TRICARE contract for the North Region as compared to our expiring TRICARE contracts. The expiring contracts included a fixed price for health care costs for the term of the contracts, subject to adjustment based primarily on the number of TRICARE eligibles and utilization of services within military hospitals and clinics, with underruns and overruns of our fixed price provision borne 70% by the government and 30% by us. The new contract includes a target price for the cost reimbursed health care costs which is negotiated annually during the term of the contract, with underruns and overruns of our target price provision borne 80% by the government and 20% by us. Under our expiring contracts, the administrative price is fixed, whereas under the new contract certain components of the administrative price are subject to volume-based adjustments.

With respect to cash flow, under the expiring contracts we are paid monthly based on incurred claims with an annual reconciliation of the risk sharing provision. Under the new contract, we will be paid within five days for each claims run based on paid claims with an annual reconciliation of the risk sharing provision. Under the expiring contracts, we are responsible for providing pharmaceutical benefits, claims processing for TRICARE and Medicare dual eligibles and certain marketing and education services that we will not provide under the new contract. Under the expiring contracts and the new contract, the administrative price is paid on a monthly basis, one month in arrears.

We believe that the changes in the economic structure of the new contract, when compared to our expiring contracts, should reduce our risk related to the ability to accurately project our profitability over the term of the new contract.

Veterans Affairs

During 2003, HNFS administered 15 contracts with the U.S. Department of Veterans Affairs to manage community based outpatient clinics in 12 states. HNFS also managed 20 other contracts with the U.S. Department of Veterans Affairs in 135 locations and one contract with the U.S. Marshals Service for claims re-pricing services. Total revenues for our veterans affairs business were approximately $17.1 million as of December 31, 2003, representing a 70.6% increase over 2002.

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Provider Relationships and Responsibilities

Physician Relationships

Under many of our HMO plans and POS plans, and primarily in California, members are required to select a participating physician group (“PPG”) and a primary care physician from within that group. In our other plans, including most of our plans outside of California, members may be required to select a primary care physician from the broader HMO network panel of primary care physicians. Some HMO “open access” plans and PPO plans do not require the member to select a primary care physician. 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, and may include 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 as required under the terms of our various plans) 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.

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, 2003:

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 to it. 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. Our Connecticut HMO has a capitation contract with the Connecticut Medical Society IPA. However, all administration, referral authorization and claims administration is performed by our Connecticut health plan. Physicians are paid on a fee-for-service basis and reinsurance is provided by Health Net Services (Bermuda), Ltd., a wholly-owned subsidiary of the Company, to the IPA if claims exceed a specified aggregate limit. Outside of California and Connecticut, most 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 or annual terms with automatic renewals 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 hospital-based 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.

Ancillary and Other Provider Relationships

Our health plan subsidiaries arrange for ancillary and other provider services, such as ambulance, laboratory, radiology and home health primarily through contracts with selected providers in their service areas. These contracts

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generally have multi-year terms or annual terms with automatic renewals and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-for-service schedules. In certain cases, these provider services are included in contracts our health plan subsidiaries have with PPGs and hospitals.

Cost Containment

In most HMO plan designs, either the primary care physician or the treating specialist is responsible for obtaining authorization from either the health plan or the PPG for most medical services (except for emergency 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, all 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, such as outpatient services and home-based care.

Quality Assessment

Quality assessment is a continuing priority for us. All 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 our group health business is a three-step process. We first market to potential employer groups and group insurance brokers and consultants. 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 a variety of techniques to attract new enrollees, including, without limitation, direct mail, work day and health fair presentations and telemarketing. 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 us 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.

New Branding Initiative

In 2004, we plan to rollout a new branding initiative called “the Rosetta Stone.” The new branding initiative is based on the premise that consumers need more and better clinical information so that they can make better informed decisions

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about their health care, based on their own preferences. As the Rosetta Stone allowed Egyptologists to decipher hieroglyphics, Health Net’s Rosetta Stone suite of products will enable our members to decipher the often bewildering language of health care. The initiative incorporates three primary elements: Decision Power, a Hospital Comparison Report and Evidence Based Medicine. Decision Power will provide Health Net members with a broad range of electronic and telephonic interactive modes of acquiring information about key health care issues. The Hospital Comparison Report will allow members to compare hospital clinical and cost performance for a variety of common procedures. Evidence Based Medicine will bring to members substantial data on evidence-based standards of care. We believe that the Rosetta Stone suite of products could provide us with a differentiated position in the health care marketplace.

Health Net One Systems Consolidation Project

We have initiated a project to convert a number of information systems in our health plan business to a single system environment. At the completion of the project, we will consolidate various systems into one general ledger system, one core claims system, one data warehouse system and one core web system. In addition, we will reduce our number of surround information systems to 16 and consolidate our data centers to a single site with a tested backup facility. Key actions completed on the Health Net One systems consolidation project to date include consolidation to a single general ledger, consolidation of health plan portals and conversion of Arizona’s core claims system. In late 2003, we converted to a common eligibility database and in 2004 plan to convert to a common provider database and to convert the California and Oregon core claims system.

We believe that completion of the Health Net One systems consolidation project will improve customer/client service and communication, realize operational and cost efficiencies and improve our decision making capability. In addition, we believe that completion of the project will enable us to improve our claims turnaround time, auto adjudication rate and electronic data interchange and Internet capabilities. However, there are risks associated with the Health Net One systems consolidation project. See “Risk Factors – The failure to effectively maintain our management information systems could adversely affect our business.”

Competition

We operate in a highly competitive environment in an industry currently subject to significant changes from business consolidations, new entrants in the marketplace, 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. The development and growth of companies offering Internet-based connections between health care professionals, employers and members, along with a variety of services, could also create additional competitors. 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 these factors and the identity of our key competitors varies by market. Over the past several years, a health plan’s ability to interact with employers, members and other third parties (including health care professionals) via the Internet has become a more important competitive factor. To that end, we have made technology investments to enhance our electronic interactions with third parties. We believe that we compete effectively against other health care industry participants.

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 California 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 16% 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, Aetna and Humana. 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.

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

Accreditation

We pursue accreditation for certain of our health plans from the National Committee for Quality Assurance (“NCQA”), the Joint Committee on Accreditation of Healthcare Organizations (“JCAHO”) and the Utilization Review Accreditation Commission (“URAC”). NCQA, JCAHO and URAC are independent, non-profit organizations that review and accredit HMOs. HMOs that comply with review requirements and quality standards receive accreditation. Our California HMO subsidiary has received NCQA accreditation, our Connecticut, New Jersey and New York subsidiaries have received JCAHO accreditation and our Arizona subsidiary has received URAC accreditation. Certain of our health plan subsidiaries are in the process of applying for NCQA or JCAHO accreditation.

Government Regulation

Our business is subject to comprehensive state and federal regulation throughout the United States in the jurisdictions in which we do business. These laws and regulations restrict how we conduct our businesses and result in additional burdens and costs to us. We believe we are in compliance in all material respects with all current state and federal laws and regulations applicable to our business. Certain of these laws and regulations are discussed below.

Federal Legislation and Regulation

Medicare Legislation. On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “MMA”) was signed into law. This complex legislation made many significant structural changes to the Medicare program. Of special interest to us and other companies with Medicare contracts is that funding has been increased to the Medicare+Choice program in 2004 and 2005. Under the MMA, the name of the Medicare private market plans will be changed from Medicare+Choice to Medicare Advantage. The transition for the name change will occur over 2004 and 2005 and become fully effective in 2006. The MMA added a voluntary prescription drug benefit that will be available to Medicare beneficiaries starting January 1, 2006. Medicare Advantage plans will be able to offer the voluntary prescription drug benefit. The MMA also authorized a Medicare-endorsed prescription drug card program that will be offered on a voluntary basis and will provide Medicare beneficiaries access to prescription drug discounts. We have applied to participate in this program. It is currently expected that these drug cards will be available mid-2004 and will be in effect until the voluntary prescription drug benefit program is fully implemented in 2006.

The MMA changes the methodology for payment to private plans beginning in 2006, when a form of competitive bidding among the private plans will begin. The first bids are due in June 2005. The MMA also authorized regional PPOs and other features with the intent to provide a private market option on a broader scale across the United States. Many significant parts of this Medicare reform legislation will need to be addressed through the regulatory process. For example, the geographic boundaries of the regional PPOs are yet to be determined. Drafting of the regulations has begun and it is expected that regulations will be issued mid-2004. We expect that the regulations will provide many clarifications to the legislation and a clearer picture of the impact of the MMA will then emerge.

We are engaged in intensive evaluation of this legislation and intend to pursue opportunities either enhanced or created by the law. In particular, we are pursuing a strategy to reinvest increased funding under the MMA by filing new benefit plans in certain markets and evaluating the possibility of expanding Medicare+Choice product offerings in certain markets. We have also restructured our Medicare program management team in an effort to build infrastructure to capitalize on opportunities presented by the MMA. The restructured Medicare program management team has been designed to increase our capability for effective execution on growth and cost management initiatives in response to opportunities presented by the MMA and the Medicare program generally.

HIPAA. The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and the implementing regulations that have been adopted in connection therewith impose new obligations for issuers of health insurance coverage and health benefit plan sponsors. The purposes of HIPAA are to:

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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 regulations, consisting of privacy regulations, transactions and codeset requirements and security regulations require health plans, clearinghouses and providers to:

The regulations also establish significant criminal penalties and civil sanctions for non-compliance. Health Net completed the work required to be compliant with the HIPAA Privacy Regulations prior to the effective date of April 14, 2003. Further, Health Net was ready to send and receive compliant Transactions and Codesets prior to the effective date of October 16, 2003. The Security regulations have a compliance date of April 2005 and Health Net has created a security plan to ensure appropriate compliance prior to the effective date. We spent approximately $6.7 million in 2003 and expect to spend approximately $1.6 million in 2004 on HIPAA related expenses.

Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Financial Modernization Act of 1999 generally requires insurers to provide customers with notice regarding how their personal health and financial information is used and the opportunity to “opt out” of certain disclosures before the insurer shares non-public personal information with a non-affiliated third party. Like HIPAA, this law sets a “floor” standard, allowing states to adopt more stringent requirements governing privacy protection.

Federal HMO Act. 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.

ERISA. 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. In 2002, the DOL adopted regulations under ERISA which mandated certain claims and appeals processing requirements. These regulations became fully effective on January 1, 2003 and, during 2003, we made certain adjustments in our claims systems to comply with these regulations. The cost of the adjustments was not material from a financial point of view.

Miscellaneous. Our Medicare contracts are subject to regulation by CMS. CMS has the right to audit HMOs and PPOs 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, and is generally examined on a periodic basis by such state agencies.

California Laws and Regulations

Health Insurance Act of 2003. In October 2003, the Governor of California signed the Health Insurance Act of 2003 (the “California Health Insurance Act”) which requires all California employers employing more than 200 employees to pay a fee or show proof of health insurance or other acceptable health coverage for both employees and their dependents. The California Health Insurance Act will become effective January 1, 2006. On January 1, 2007, the requirements of the California Health Insurance Act will extend to employers of 20 to 199 employees, except that those employers will not be required to provide coverage for their employees’ dependents and employers of 20 to 49 employees will be exempt from

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the California Health Insurance Act unless certain tax credit legislation is enacted. To date, no such tax credit has been proposed or enacted. If an employer elects to pay a fee rather than provide coverage, the fee will be used by the State to contract with private health carriers to provide health coverage to those who are not covered by their employer.

The California Chamber of Commerce and other business groups have qualified an initiative referendum for the November 2004 ballot to repeal the California Health Insurance Act. Should the referendum fail, some of these groups have indicated that they may sue to overturn substantial portions of the Act based on arguments that these provisions violate Federal law. No assurances can be given as to whether the initiative referendum will successfully overturn the legislation, or whether subsequent litigation will do so. In the event the California Health Insurance Act survives challenge, it may provide us and other health plans with potential additional markets, but it is uncertain at this time whether such additional business, if any, will be forthcoming.

California HMO Regulations. California HMOs, such as HN California and our behavioral health plan, MHN, 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:

Any material modifications to the organization or operations of HN California and MHN 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 MHN 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.

California Assembly Bill 1455. Assembly Bill 1455 (“AB 1455”) was signed into law on September 28, 2000, amending and adding several sections to the Knox-Keene Act. AB 1455 increased the interest rate that health care service plans must pay on uncontested claims not paid promptly within the required time period and granted the DMHC additional authority to impose monetary penalties and other sanctions on health plans engaging in certain “unfair payment practices” (as defined in AB 1455). AB 1455 also required the DMHC to adopt regulations regarding provider dispute resolution by health care service plans. The final regulations, which address both claims reimbursement and provider dispute resolution procedures, took effect on August 25, 2003 and the DMHC advised health care service plans to implement them for all services provided on and after January 1, 2004. On November 12, 2003, the California Healthcare Association (“CHA”) filed a petition for writ of mandate in the Superior Court, County of Sacramento, challenging certain requirements of the AB 1455 regulations regarding timely filing of claims, reasonable and customary charges and timely filing of disputes. We are continuing to comply with all aspects of AB 1455 pending final resolution of CHA’s challenge.

Other HMO Laws and Regulations.