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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period ended March 31, 2004

OR

For the transition period from                      to                     

Commission file number 001-31513

WELLCHOICE, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (212) 476-7800

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. There were 83,673,822 shares of common stock, $0.01 par value, and one share of Class B common stock, $0.01 par value per share, outstanding as of April 14, 2004.

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WellChoice, Inc and Subsidiaries

INDEX TO FORM 10-Q

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WellChoice, Inc. and Subsidiaries

Consolidated Balance Sheets

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Consolidated Balance Sheets

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2004

(Dollars in Thousands)

1. For-Profit Conversion and Initial Public Offering

WellChoice, Inc. (“WellChoice” or the “Company”) was formed in August 2002 as a Delaware Corporation to be the for-profit parent holding company for Empire HealthChoice, Inc. (“EHC”) following the conversion discussed below. WellChoice owns a Health Maintenance Organization (“HMO”) and two health insurance companies through its investment in WellChoice Holdings of New York, Inc. (“WellChoice Holdings”).

On November 7, 2002, EHC converted from a not-for-profit health service corporation to a for-profit accident and health insurer under the New York State insurance laws and the converted EHC issued all its authorized capital stock to the New York Public Asset Fund (the “Fund”) and The New York Charitable Asset Foundation (the “Foundation”). The Fund and the Foundation then received their respective shares of WellChoice common stock in exchange for the transfer of all the outstanding shares of EHC to WellChoice Holdings. Pursuant to the plan of conversion, WellChoice issued 82,300,000 shares to the Fund and the Foundation and completed an initial public offering of 19,199,000 shares of common stock, consisting of 18,008,523 shares that were sold by the Fund and Foundation and 1,190,477 newly issued shares of common stock sold by WellChoice. After deducting the underwriting discount, net proceeds to WellChoice were approximately $27,990.

2. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three month period ended March 31, 2004 are not necessarily indicative of results that may be expected for the year ending December 31, 2004.

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

2. Basis of Presentation (continued)

For further information, refer to the consolidated financial statements and footnotes thereto included in the WellChoice’s Annual Report on Form 10-K for the year ended December 31, 2003 (File No. 001-31513), on file with the Securities and Exchange Commission.

Certain 2003 amounts have been reclassified to conform to the 2004 presentation.

The following table represents total other comprehensive income for the three months ended March 31, 2004 and 2003:

3. Capital Stock

Stock Incentive Plan

The Company’s incentive plan provides for the grant of stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards and cash awards. On March 26, 2003, the Company’s Board of Directors adopted the 2003 Omnibus Incentive Plan (the “2003 Incentive Plan”). In accordance with the 2003 Incentive Plan, a maximum of 6,250,000 shares of common stock may be issued, including 1,875,000 shares solely for issuance under grants of

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

restricted stock awards and restricted stock unit awards. A maximum of 500,000 shares may be issued to non-employee directors. Awards are granted by the Compensation Committee of the Board of Directors. Options vest and expire over terms set by the Committee at the time of grant.

During the three months ended March 31, 2004, the Company granted 4,535 shares of the Company’s stock as restricted stock awards to certain eligible executives valued at the fair value of the stock on the grant date with no cost to the employee. These restricted stock awards vest over a three-year period. The fair value of these awards is being amortized to compensation expense over the vesting period. During the three months ended March 31, 2004, 9,093 shares of restricted stock awards were forfeited. Administrative expense for the three months ended March 31, 2004 includes $927 of compensation expense related to all awards granted through March 31, 2004. Unearned restricted stock compensation as of March 31, 2004 includes $4,223 related to the restricted stock awards.

During the three months ended March 31, 2004, the Company did not grant any additional shares of common stock as restricted stock unit awards to non-employee members of the Board of Directors. Stock units are settled in shares of WellChoice common stock and dividend equivalents. The restricted stock unit awards will 100% vest on February 1, 2005 provided the grantee serves as a Director and has not terminated other than due to retirement, death or disability prior to the vesting date. The fair value of the restricted stock unit awards is being amortized to compensation expense over the vesting period. Administrative expense for the three months ended March 31, 2004 includes $215 of compensation expense related to these awards. Unearned restricted stock compensation as of March 31, 2004 includes $538 related to the restricted stock units.

Employee Stock Purchase Plan

The Company has registered 3,000,000 shares of common stock for the Employee Stock Purchase Plan (“Stock Purchase Plan”), which is intended to provide employees of the Company and certain related companies or corporations with an opportunity to share in the ownership of WellChoice, Inc, and provide a stronger incentive to work for the continued success of the Company. Any employee meeting the eligibility requirements under the Stock Purchase Plan may

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

participate. No employee will be permitted to purchase more than $25 worth of stock in any calendar year, based on the fair market value of the stock at the beginning of each offering period. The purchase price per share is 85% of the lower of the fair market value of a share of common stock on the first day or the last day of the offering period. Employees become participants by electing payroll deductions from 1% to 10% of their base compensation and all or part of any incentive compensation, after-tax. The Company has two offering periods beginning on January 1 and July 1 of each calendar year. The first offering period of the Stock Purchase Plan commenced on January 1, 2004. Payroll deductions of $804 have been accumulated as of March 31, 2004 and will be applied towards the purchase of stock on June 30, 2004, the last day of the offering period (or the 1st business day thereafter). Once purchased, the stock is accumulated in the employee’s investment account.

Earnings Per Share

For the three months ended March 31, 2004 and 2003, earnings per share amounts, on a basic and diluted basis, have been calculated based upon the weighted-average common shares outstanding for the year.

Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share includes the dilutive effect of all stock options, and restricted stock awards, using the treasury stock method. Under the treasury stock method, the exercise of stock options and restricted stock unit awards is assumed, with the proceeds used to purchase common stock at the average market price for the period. The difference between the number of shares assumed issued and number of shares assumed purchased represents the dilutive shares.

Pro Forma Disclosure

The Company accounts for stock-based compensation using the intrinsic method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, if the exercise price is equal to the fair market value of the shares at the date of the grant, the Company recognizes no compensation expense related to stock options. For

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

grants of restricted stock awards and restricted stock unit awards, unearned compensation, equivalent to the fair value of the shares at the date of grant, is recorded as a separate component of shareholders’ equity and subsequently amortized to compensation expense over the vesting period. The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended.

For purposes of pro forma disclosures, compensation expense is increased for the estimated fair value of the options amortized over the options’ vesting periods. The Company’s pro forma information is as follows:

4. Income Taxes

WellChoice and its subsidiaries file a consolidated federal income tax return. WellChoice currently has a tax sharing agreement in place with all of its subsidiaries. In accordance with the Company’s tax sharing agreement, the Company’s subsidiaries pay federal income taxes to WellChoice based on a separate company calculation.

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

4. Income Taxes (continued)

The significant components of the provision for income tax expense are as follows:

A reconciliation of income tax computed at the federal statutory tax rate of 35% to total income tax is as follows:

As a result of the conversion to a for-profit accident and health insurance company in 2002, the Company’s subsidiary, EHC became subject to state and local taxes, which resulted in the recognition of $4,721 of New York State franchise tax for the three months ended March 31, 2003. In May 2003, the New York State Legislature enacted legislation that eliminated the net income portion of the New York State franchise tax applicable to every insurance company other than life insurance companies effective January 1, 2003. Accordingly, the Company’s tax provision for the three months ended March 31, 2004 includes no provision for New York State franchise taxes related to EHC.

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

4. Income Taxes (continued)

Prior to January 1, 1987, EHC was exempt from federal income taxes. With the enactment of the Tax Reform Act of 1986, EHC, and all other Blue Cross and Blue Shield plans, became subject to federal income tax. Among other provisions of the Internal Revenue Code, these plans were granted a special deduction (the “833(b) deduction”) for regular tax calculation purposes.

The 833(b) deduction is calculated as the excess of 25% of the incurred claim and claim adjustment expenses for the tax year over adjusted surplus, as defined, limited to taxable income. The amount of 833(b) deductions utilized in each tax year is accumulated in an adjusted surplus balance. Once the cumulative adjusted surplus balance exceeds the 833(b) deduction for the current taxable year, the deduction is eliminated. As a result of the 833(b) deduction, EHC has incurred no regular tax liability, but in profitable years has paid taxes at the alternative minimum tax rate of 20%.

During the fourth quarter of 2002, the Company reevaluated its tax position for financial statement purposes related to EHC’s ability to utilize the Section 833(b) deduction and determined that when EHC converted to a for-profit entity, its ability to utilize the Section 833(b) deduction was uncertain. No authority directly addresses whether a conversion transaction will render the 833(b) deduction unavailable. The Company is aware, however, that the Internal Revenue Service has taken the position related to other Blue Cross Blue Shield plans that a conversion could result in the inability of a Blue Cross Blue Shield plan to utilize the 833(b) deduction. In light of the absence of governing authority, while the Company continues to take the deduction on its tax returns after the conversion, the Company has assumed, for financial statement reporting purposes, that the deduction will be disallowed.

The Company’s regular tax loss carryforwards for income tax purposes of $177,000 expire between the years 2004 and 2023. The Company’s alternative minimum tax credit carryforward for income tax purposes of $137,000 has no expiration date.

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

5. Investments

The Company participates in a securities lending program, whereby certain securities from its portfolio are loaned to qualified brokers in exchange for cash collateral, at least equal to the 102% of the market value of the securities loaned. The securities lending agent indemnifies the Company against loss in the event of default by the borrower. Income generated by the securities lending program is reported as a component of net investment income. As of March 31, 2004 $336,985 of fixed maturity securities were loaned under the program.

6. Pension Benefits and Other Postretirement Employee Benefits

Net pension income for the Company’s defined benefit plans included the following components:

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

6. Pension Benefits and Other Postretirement Employee Benefits (continued)

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“Modernization Act”) was signed into law. The Modernization Act introduced a voluntary Medicare Part D prescription drug benefit and created a new 28% federal subsidy for the sponsors of the postretirement prescription drug benefits that are at least actuarially equivalent to the new Medicare Part D benefit. Under SFAS No. 106-1, Accounting for Postretirement Benefits Other Than Pensions, sponsors must consider two new features in measuring the Accumulated Postretirement Benefit Obligation (“APBO”) and net periodic postretirement benefit cost. In accordance with SFAS No. 106-1, the Company made a one-time election to defer recognition of the impact on SFAS No. 106 accounting. Any measures of APBO and net periodic postretirement benefit cost in the financial statements and the related footnotes for the three months ended March 31, 2004 do not reflect the effects of the Modernization Act. Currently, specific authoritative guidance on accounting for the federal subsidy is pending and that guidance when issued could require the Company to change previously reported information. However, the Company does not anticipate that the adoption of SFAS 106-1 will materially affect its financial statements.

7. Restructuring

During the second quarter of 2002, in connection with the Company’s Information Technology outsourcing agreement with IBM, the Company began the implementation of a restructuring plan relating to its information technology personnel. Certain employees were involuntarily terminated in accordance with a plan of termination, certain employees were retained by the Company and certain employees were transitioned to IBM. Severance and other costs accrued at June 30, 2002 relating to the plan of termination were $5,351. Payments related to these costs of approximately $5,170 were made through March 31, 2004. To help retain its employees and to help IBM retain its newly transitioned employees, the Company offered stay bonuses for these individuals. The estimated cost of these bonuses assuming all individuals remain with the Company or IBM through the required dates, which range from 2003 to 2004, is approximately $9,003. Through March 31, 2004, approximately $8,846 was expensed for these bonuses. Through March 31, 2004 payments of $4,210 were made.

In November 2002, as part of the Company’s continuing focus on increasing overall productivity, and in part as a result of the implementation of the technology outsourcing strategy, the Company continued streamlining certain operations and adopted a plan to terminate approximately 500 employees across all segments of its business. Severance and other costs of $13,472 were accrued

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

7. Restructuring (continued)

relating to the plan. In March of 2004, the Company expensed an additional $649 related to an adjustment to the estimated severance and other compensation costs previously accrued. Through March 31, 2004, payments related to these costs of $13,786 were made. In the effort to facilitate the restructuring plan certain employees were offered stay bonuses. The Company recognizes the costs of these stay bonuses as these employees provide service. Through March 31, 2004 approximately $1,101 was expensed for these bonuses. Payments of $580 related to these bonuses were made through March 31, 2004.

During the third quarter of 2003, Management determined that based on current and projected occupancy requirements, the Company would not receive economic benefit from certain unoccupied leased office space. As a result, the Company recognized an administrative expense of $13,367. Based on additional information obtained during the first quarter of 2004, the Company further reduced the fair market value of estimated sublease rentals and recognized an additional administrative expense of $1,110 for the three months ended March 31, 2004.

8. Contingencies

The Company is subject to a number of lawsuits, investigations and claims, some of which are class actions arising out of the conduct of its business. The Company believes that it has meritorious defenses in all of these matters and intends to vigorously defend its respective positions. The outcome of these matters is not currently predictable and the damages, if any, are also uncertain. The Company is also involved in and is subject to numerous claims, contractual disputes and uncertainties in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial condition.

9. Segment Information

WellChoice has two reportable segments: commercial managed care and other insurance products and services. The commercial managed care segment includes group preferred provider organization, or PPO, health maintenance organization, or HMO (including Medicare+Choice), exclusive provider organization, or EPO, and other products (principally dental only coverage and includes point of service products) as well as the Company’s New York City and New York State

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

9. Segment Information (continued)

PPO business. The New York City and New York State PPO business accounts for approximately 32% of the Company’s earned premium for the three months ended March 31, 2004.

The other insurance products and services segment consists of the Company’s traditional indemnity products, Medicare supplemental, individual hospital only, state sponsored individual plans, government mandated individual plans and government contracts with CMS to act as a fiscal intermediary for Medicare Part A program beneficiaries and as a carrier for Medicare Part B program beneficiaries.

Income from continuing operations before income tax expense for the three months ended March 31, 2004 include administrative expenses of $883 and $227, for the managed care and other insurance products and services segments, respectively, related to unoccupied leased office space, see footnote 7.

The reportable segments follow the Company’s method of internal reporting by products and services. Administrative expenses, investment income and other income, but not assets, are allocated to the segments. There are no intersegment sales or expenses.

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

9. Segment Information (continued)

The following table presents our revenue from external customers by products and services:

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Report of Independent Accountants

To the Board of Directors of

          WellChoice, Inc.

We have reviewed the accompanying consolidated balance sheet of WellChoice, Inc. and subsidiaries (the “Company”) as of March 31, 2004, and the related consolidated statements of income and cash flows for the three-month periods ended March 31, 2004 and 2003. These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.

We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of the Company as of December 31, 2003, and the related consolidated statements of income, stockholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated February 2, 2004, we expressed an unqualified opinion on those financial statements. In our opinion the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

New York, New York

April 9, 2004

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The following discussion and analysis presents a review of WellChoice, Inc. and its subsidiaries (collectively, the “Company”) for the three months ended March 31, 2004 and 2003. This review should be read in conjunction with the consolidated financial statements and other data presented herein as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 on file with the Securities and Exchange Commission.

The statements contained in this discussion include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, or the PSLRA. When used in this Quarterly Report on Form 10-Q and in future filings by the Company with the Securities and Exchange Commission, in our press releases, presentations to securities analysts or investors, and in oral statements made by or with the approval of one of our executive officers, the words or phrases “believes,” “anticipates,” “intends,” “will likely result,” “estimates,” “projects” or similar expressions are intended to identify such forward-looking statements. Any of these forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the results discussed in the forward-looking statements.

The discussion of risks described in “Item 1 – Business” and “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2003 and the following discussion contain certain cautionary statements regarding our business that investors and others should consider. These discussions are intended to take advantage of the “safe harbor” provisions of the PSLRA. Except to the extent otherwise required by federal securities laws, in making these cautionary statements, we are not undertaking to address or update each factor in future filings or communications regarding our business or operating results, and are not undertaking to address how any of these factors may have caused results to differ from discussions or information contained in previous filings or communications. In addition, any of the matters discussed below may have affected our past, as well as current, forward-looking statements about future results. Any or all forward-looking statements in this report and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors discussed below will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from those expressed in our communications.

Overview

We are the largest health insurance company in the State of New York based on total preferred provider organization, or PPO, and health maintenance organization, or HMO, membership, which includes members under our insured and administrative services only, or ASO, plans. We provide managed care and traditional indemnity products to approximately 4.9 million members. We have licenses with the Blue Cross Blue Shield Association which entitle us to the exclusive use of the Blue Cross and Blue Shield names and marks in ten counties in the New York City metropolitan area and in six counties in upstate New York, the non-exclusive right to use the Blue Cross and Blue Shield names and marks in one upstate New York county, the exclusive right to only the Blue Cross name and mark in seven upstate New York counties and the non-exclusive right to only the Blue Cross name in four upstate New York counties. We

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market our products and services using these names and marks in our New York service areas. We also market our managed care products in 16 counties in New Jersey under the WellChoice brand.

We offer our products and services to a broad range of customers, including large groups of more than 500 employees; middle market groups, ranging from 51 to 500 employees; small groups, ranging from two to 50 employees and individuals. Over one million of our members are covered through our national accounts, generally large, multi-state companies, including many Fortune 500 companies. Our principal health products are offered both on an insured and, except with respect to HMO products, self-funded, or ASO basis and, in some instances, a combination of insured and self-funded, which includes minimum premium arrangements. Minimum premium arrangements provide coverage under separate self-funded and insured group contracts. Benefit payments made under the self-funded contract up to a pre-established limit are the responsibility of the group, and accordingly, no premium is recorded by us for these payments. Benefit payments under the insured contract and charges for risk, profit and administration of the group’s benefit plan are recorded as premium. Groups enrolled under minimum premium arrangements are reported as insured members.

Our revenue primarily consists of premiums earned and administrative service fees derived from the sale of managed care and traditional indemnity health benefits products to employer groups and individuals. Premiums are derived from insured contracts and administrative service fees are derived from self-funded contracts, under which we provide a range of customer services, including claims administration and billing and membership services. Revenue also includes administrative service fees earned under the BlueCard program for providing members covered by other Blue Cross and Blue Shield plans with access to our network providers, reimbursements under our government contracts with the Centers for Medicare and Medicaid Services, or CMS, to act as a fiscal intermediary for Medicare Part A program beneficiaries and a carrier for Medicare Part B program beneficiaries, investment income and net realized investment gains or losses.

Our cost of benefits provided expense consists primarily of claims paid and claims in process and pending to physicians, hospitals and other healthcare providers and includes an estimate of amounts incurred but not yet reported. Administrative expenses consist primarily of compensation expenses, premium taxes and commission payments to brokers and other overhead business expenses.

We report our operating results as two business segments: commercial managed care and other insurance products and services. Our commercial managed care segment accounted for 87.9% of our membership as of March 31, 2004. Our commercial managed care segment includes group PPO, HMO (including Medicare+Choice), EPO, and other products (principally dental-only coverage and includes POS) as well as our PPO business under our accounts with New York City and New York State. Our other insurance products and services segment consists of our indemnity and individual products. Our indemnity products include traditional indemnity products and government contracts with CMS to act as a fiscal intermediary and carrier. Our individual products include Medicare supplemental, state sponsored plans, government mandated individual plans and individual hospital-only. We allocate administrative expenses, investment income and other income, but not assets, to our segments. Except when otherwise specifically stated or where the context requires, all references in this document to our membership include both our insured and ASO membership. Our New York City and New York State PPO account members are covered under insured plans.

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Based upon the higher level of payments from CMS as a result of the recently enacted Medicare Prescription Improvement and Modernization Act, in March 2004, we eliminated the premiums payable by members of our Medicare+Choice program in Rockland and Westchester counties, reduced the premium payable by members in Nassau and Suffolk counties and increased benefits available to New York City members. The increase in payments from CMS will not have a material impact on operations, as they will be utilized either to provide additional benefits or as a reduction in premiums payable by members.

Our future results of operations will depend in part on our ability to predict and control health care costs through underwriting criteria, utilization management, product design and negotiation of favorable provider and hospital contracts. Our ability to contain such costs may be adversely affected by 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, acts of terrorism and bioterrorism or other catastrophes, including war, and numerous other factors. Our inability to mitigate any or all of the above-listed or other factors may adversely affect our future profitability.

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Selected Membership Data and Results of Operations

The following table sets forth selected membership data as of the dates set forth below:

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The following table sets forth results of operations for each of our segments for the periods set forth below:

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Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

As of March 31, 2004, total enrollment was 4.9 million members, a 0.9% increase from March 31, 2003. The increase in overall enrollment was driven by a 4.7% increase in commercial managed care enrollment, offset by a 20.4% decrease in other insurance products and services enrollment. The net increase in overall enrollment was the result of:

Our self-funded enrollment increased 7.4%, or approximately 130,000 members, and at March 31, 2004 represented approximately 38.6% of our total enrollment, 38.2% of commercial managed care enrollment, and 41.6% of other insurance product and services enrollment. The migration of insured business to self-funded arrangements as well as new self-funded enrollment resulted in the increase in self-funded enrollment. The migration to self-funded enrollment consisted of approximately 35,000 members from insured large group PPO and 47,000 members from indemnity products. New self-funded national account enrollment accounted for 58,000 members. We expect self-funded enrollment to continue to increase throughout 2004 through the continued migration of insured business to self-funded arrangements and new self-funded accounts. Although the trend to self-funded business will reduce our insured premium and claim volume, we do not expect the trend to have a material impact on net income.

As of March 31, 2004, our New York State account covered approximately 995,000 members, or 20.5% of our total membership and 23.3% of our commercial managed care

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membership, and our New York City account covered approximately 820,000 members, or 16.9% of our total membership and 19.2% of our commercial managed care membership. We provide hospital-only coverage under both of these accounts. The pricing of our products provided to New York State and New York City has historically been renegotiated annually. With respect to the New York State account, effective January 1, 2003, we agreed to new retention or administrative expense pricing covering a three-year period through December 31, 2005, though both parties retain the right to terminate the contract upon six months’ notice. For over two years, the New York City account has been subject to a competitive bid process in which we have participated, relating to a five-year contract. At this time, there is no official timetable for awarding the five-year contract. In October 2003, we agreed to new rates with the New York City account for the period from July 1, 2003 through June 30, 2004. We are negotiating with the New York City account for renewal rates for the period from July 1, 2004 through June 30, 2005. The loss of one or both of the New York State and New York City accounts would result in reduced membership and revenue and require us to reduce, reallocate or absorb administrative expenses associated with these accounts.

Total revenue increased 7.2%, or $92.5 million, to $1,384.6 million for the three months ended March 31, 2004, from $1,292.1 million for the three months ended March 31, 2003 primarily due to an increase in premium and administrative service fee revenue.

Premium revenue increased $79.0 million, or 6.8%, to $1,245.6 million for the three months ended March 31, 2004, from $1,166.6 million for the three months ended March 31, 2003. The increase in premium revenue was the result of growth in our commercial managed care segment. Commercial managed care premium revenue was $1,066.2 million for the three months ended March 31, 2004, a 10.9% increase compared to the three months March 31, 2003. The net increase in commercial managed care premium revenue was the result of the following:

The premium growth in commercial managed care was partially offset by the anticipated decline in our other insurance products premium. The decrease in other insurance products premium was the result of enrollment losses, and to a lesser extent, the migration of insured indemnity contracts to self-funded contracts and minimum premium arrangements.

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The following table sets forth our premium revenue on a per member per month or PMPM basis:

The increase in total and commercial managed care premium, on a PMPM basis, for the three months ended March 31, 2004 is the result of premium rate increases and increased cost of benefits provided on our retrospectively rated products. The PMPM premium increase in commercial managed care excluding the New York City and New York State PPO for the three months ended March 31, 2004 is the result of premium rate increases. Other insurance products and services PMPM premium increased for the three months ended March 31, 2004 due primarily to declining membership in lower priced products and rate increases.

Administrative service fee revenue increased 11.3%, or $12.3 million, to $121.2 million for the three months ended March 31, 2004, from $108.9 million for the three months ended March 31, 2003. The increase was primarily due to the following:

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Investment income, net of investment expenses, which consists predominantly of interest and dividend income of $14.1 million for the year three months ended March 31, 2004 was consistent with the three months ended March 31, 2003 investment income of $13.4 million. Net realized gains of $3.5 million for the three months ended March 31, 2004 were the result of net gains on the sale of equity and corporate bond investments and an increase in the market value of warrants classified in our balance sheet as other long-term equity investments. Net realized gains of $3.1 million for the three months ended March 31, 2003 was primarily the result of net gains on government and corporate bond sales.

Other income, net for the three months ended March 31, 2004 was $0.2 million compared to other income, net of $0.1 million for the three months ended March 31, 2003.

Total cost of benefits provided increased 6.4%, or $63.6 million, to $1,062.9 million for the three months ended March 31, 2004, from $999.3 million for the three months ended March 31, 2003. This reflects a 8.8% increase in costs of benefits provided on a PMPM basis, offset by a 2.2% decline in member months due to the migration of membership from fully-insured to self-funded contracts and the conversion to minimum premium arrangements.

The following table sets forth our cost of benefits provided on a per member per month or PMPM basis:

The total medical loss ratio decreased to 85.3% for the three months ended March 31, 2004, from 85.7% for the three months ended March 31, 2003. Cost of benefits provided for the three months ended March 31, 2004 and 2003 included $0.3 million and $11.7 million, respectively, of favorable prior period reserve development on prospectively rated contracts. The increase in total and commercial managed care cost of benefits provided, on a PMPM basis, for the three months ended March 31, 2004 was the result of medical cost increases particularly in inpatient and outpatient facility costs. Other insurance products and services PMPM cost of benefits provided increased to $160.69 for the three months ended March 31, 2004 due primarily to declining membership in lower cost products.

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Administrative expenses increased 7.0%, or $14.7 million, to $224.5 million for the three months ended March 31, 2004, from $209.8 million for the three months ended March 31, 2003 due to the following:

Income from continuing operations before income taxes increased 17.1%, or $14.2 million, to $97.2 million for the three months ended March 31, 2004, from $83.0 million for the three months ended March 31, 2003. This improvement was primarily driven by commercial managed care membership and rate increases. Income tax expense of $38.0 million and $35.3 million reduced net income to $59.2 million and $47.7 million, respectively, for the three months ended March 31, 2004 and 2003.

Liquidity and Capital Resources

WellChoice is a holding company and depends on its subsidiaries for cash and working capital to pay expenses. WellChoice receives cash from its subsidiaries from administrative and management service fees, as well as tax sharing payments and dividends. On January 22, 2004, the New York State Superintendent of Insurance, or Superintendent, approved the payment of a dividend to WellChoice from Empire in the amount of $120.0 million, which was paid on February 11, 2004. This dividend has been accounted for as an equity transfer from a subsidiary to the parent of a consolidated group.

At March 31, 2004, the stand alone balance sheet of the WellChoice, Inc. was comprised of the following: total investments and cash and cash equivalents of $525.9 million, investment in subsidiaries, receivables and other assets of $1,256.7 million, accounts payable and accrued expenses of $119.5 million, capital lease obligations and other liabilities of $165.0 million and stockholders’ equity of $1,498.1 million.

Our subsidiaries’ primary source of cash is from premiums and fees received and investment income. The primary uses of cash include healthcare benefit expenses, brokers’ and agents’ commissions, premium taxes and administrative expenses. We generally receive premium revenues in advance of anticipated claims for related healthcare services.

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Our investment policies are designed to provide liquidity to meet anticipated payment obligations and to preserve principal. We believe the composition of our marketable investment portfolio is conservative, consisting primarily of high-rated, fixed income securities with the objective of producing a consistently growing income stream and maximizing risk-adjusted total return. Our fixed income portfolio is comprised of U.S. government securities, corporate bonds, asset-backed bonds and mortgage-related securities. The average credit rating of our fixed income portfolio as of March 31, 2004 was “AA+.” A portion of the fixed income portfolio is designated as short-term and is intended to cover near-term cash flow needs. Our marketable equity portfolio as of March 31, 2004 consisted of an investment in a mutual fund indexed to the S&P 500, our common stock investment in WebMD and equity investments held in our nonqualified deferred compensation plans. As of March 31, 2004 our marketable equity portfolio was 3.7% of the total marketable investment portfolio.

In October 2003, we renewed our existing credit and guaranty agreement with The Bank of New York, as Issuing Bank and Administrative Agent, and several other financial institutions as agents and lenders, which provides us with a credit facility. We are able to borrow under the credit facility, subject to customary conditions, for general working capital purposes. The total outstanding amounts under the credit facility cannot exceed $100.0 million. The facility has a term of 364 days with a current maturity date of October 15, 2004, subject to extension for additional periods of 364 days with the consent of the lenders. Borrowings under the facility will bear interest, at our option, at The Bank of New York’s prime commercial rate (or, if greater, 0.50% plus the federal funds rate) as in effect from time to time plus a margin of between zero and 1.0%, or LIBOR plus a margin of between 1.125% and 2.250%, with the applicable margin to be determined based on our financial strength rating. As of March 31, 2004, there were no funds drawn against this line of credit.

The credit facility contains covenants that limit our ability to issue any equity interest which is not issued on a perpetual basis or in respect of which we shall become liable to purchase, redeem, retire or otherwise acquire any such interest, including any class of redeemable preferred stock. However, the credit facility does not restrict us from paying dividends on our common stock or repurchasing or redeeming shares of our common stock. Covenants under the credit facility also impose limitations on the incurrence of secured debt, creation of liens, mergers, asset sales, transactions with affiliates and material amendments of material agreements, as defined in the credit facility without the consent of the lenders. In addition, the credit facility contains certain financial covenants. Failure to comply with any of these covenants will result in an event of default, which could result in the termination of the credit facility.

We believe that cash flow from our operations and our cash and investment balances, including the proceeds of the dividends mentioned above, will be sufficient to fund continuing operations and capital expenditures for the foreseeable future based on current assets and projected future cash flows.

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Three months ended March 31, 2004 compared to three months ended March 31, 2003

Cash from operating activities of $119.5 million for the three months ended March 31, 2004 decreased $5.8 million compared to cash from operating activities for the three months ended March 31, 2003 of $125.3 million.

Cash provided by investing activities increased $144.3 million to $143.2 million for the three months ended March 31, 2004, from cash used in investing activities of $1.1 million for the three months ended March 31, 2003. During the first quarter of 2004, we made a strategic decision to shorten the duration of our fixed income portfolio. Cash from these sales was reinvested in cash equivalents.

Net cash used in financing activities of $1.0 million and $0.8 million for the three months ended March 31, 2004 and 2003, respectively, reflects payments for capital lease obligations.

IBM Agreement

In June 2002, we entered into a ten-year agreement with IBM to enhance and modernize our systems applications and operate our data center and technical help desk. Our payments to IBM for operating our data center and technical help desk will be based upon actual utilization of services billed at the rates established in the agreement.

Pursuant to the IBM agreement, we have undertaken to work jointly with IBM to enhance and modernize our systems applications. Some of the systems application software development will be performed overseas from IBM’s offices in Bangalore, India or, in the event this facility becomes unavailable during the life of the agreement, services will be provided from a replacement facility. These applications include technological enhancements based on the

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ongoing requirements of our business and solutions developed based upon our specifications. We will own the software developed by IBM under the agreement, other than the claims payment system described below.

We anticipate that the systems applications will be integrated with a new claims payment system being developed by deNovis, a privately-held, start-up company, in coordination with IBM. The new claims payment system will be licensed to us when it is completed. The development of the system has been delayed by deNovis and as a result we do not expect the system to be ready for acceptance by us in accordance with its specifications any earlier than the fall of 2006. IBM may be unable to deliver our claims system in accordance with our contract or at all, in which event we would likely continue to use our existing claims payment system, but would need to invest significant funds to update that system over the mid- to long-term or otherwise transition to another claims payment system. We do not believe the delay in the development of the deNovis system or a failure to deliver the system at all will have a material impact on our operations because our existing claims payment system is adequate to meet our needs in the near term.

Market Stabilization Pools

The New York State Community Rating Law requires insurers and HMOs writing small employer (groups with less than 50 eligible employees) and individual (non-group) business to participate in certain market stabilization pools. Under the Community Rating Law there are two major Pools: a pool for direct pay and small group contracts excluding Medicare Supplemental contracts (“non-Med Supp Pool”) and a pool for Medicare Supplemental contracts (“Med Supp Pool”). Both Pools operate on a calendar year basis.

For Pool years prior to 1996, payments to and from the Pools were based on demographic data submitted by insurers. The non-Med Supp Pool also contained a component that reimbursed insurers for a portion of claim costs related to certain specified medical conditions. Effective January 1, 1996, the Community Rating Law was amended. The Community Rating Law, as amended, changed the pooling mechanism from one based on demographics and specified medical conditions to a method based on the experience for approximately fifty medical markers on medical conditions.

The revised Community Rating Law required that the demographic and specified medical conditions approach be phased out over a four-year period. The revised methodology is complex and, as a result, implementing regulations were not issued until 2002. During this period, an interim method to distribute the portion of the Pools based on the new methodology for non-Med Supp Pool funds was developed for Pool years 1996 through 1998. Also during this time, the New York State Insurance Department (“NYSID”) determined that the demographic approach was permissible under the 1996 law and would continue to be the method used for the Med Supp Pool.

Distributions from the non-Med Supp Pool have been made through 1998 and distributions from the Med Supp Pool have been made for years through 1997 and for the years 2000 through the third quarter of 2003. In addition, partial distributions were received for Med Supp Pool years 1998 through 1999.

Contributions and recoveries under the Pools are estimated based on interpretations of applicable regulations and are recorded as an addition or a reduction to cost of benefits provided. These estimates are adjusted as new information becomes known and such adjustments are

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included in current period operations. As of March 31, 2004, the NYSID had not provided the non-Med Supp information necessary to determine if we would receive or owe money to the pools for the periods for which distributions have not been made. Consequently, we had not established a receivable or payable for non-Med Supp Pool years 1999 through 2003 and through the three months ended March 31, 2004. For Med Supp Pool years 1998 through 1999, we had not established a receivable or payable due to the general uncertainty surrounding the ultimate disposition of payments to or receipts from the Pools. Our ultimate payment to or receipts from these Pools may have a material impact to our financial statements.

Regulatory and Other Developments

Empire is subject to capital and surplus requirements under the New York insurance laws and the capital and surplus licensure requirements established by the Blue Cross Blue Shield Association. Each of these standards is based on the NAIC’s RBC Model Act, which provides for four different levels of regulatory attention depending on the ratio of a company’s total adjusted capital (defined as the total of its statutory capital, surplus, asset valuation reserve and dividend liability) to its risk-based capital. The capital and surplus level required to meet the minimum requirements under the New York insurance laws and Blue Cross Blue Shield Association licensure requirements applicable to Empire is 200% of Risk-Based Capital Authorized Control Level. Empire exceeds the New York minimum capital and surplus requirements and the Blue Cross Blue Shield Association capital and surplus licensure requirements.

Capital and surplus requirements for Empire HealthChoice HMO, Inc., our HMO subsidiary which is directly owned by Empire, are regulated under a different method set forth in the New York Department of Health’s HMO regulations. The regulations require that Empire HealthChoice HMO currently maintain reserves of five percent of its annual premium income. Empire HealthChoice HMO, with respect to its operations in New York, meets the financial reserve standards of the New York Department of Health. The Department of Health has issued revised regulations that would increase the required reserves gradually over the next six years to twelve and one half percent of annual premium income. The regulations, as proposed, will affect all HMOs and we expect we will meet the revised standards. Empire HealthChoice HMO is also subject to the Blue Cross Blue Shield Association capital and surplus licensure requirement which is applicable to Empire and satisfies that requirement.

Our New Jersey operations are not subject to the Blue Cross Blue Shield Association capital and surplus licensure requirement. At March 31, 2004, WellChoice Insurance of New Jersey met the minimum capital and surplus requirements of the New Jersey Department of Banking and Insurance.

Regulation of financial reserves for insurers and HMOs is a frequent topic of legislative and regulatory scrutiny and proposals for change. It is possible that the method of measuring the adequacy of our financial reserves could change and that could affect our financial condition. However, any such change is likely to affect all companies in the state.

The ability of our insurance and HMO subsidiaries to pay dividends to us is subject to regulatory requirements, including state insurance laws and health department regulations and regulatory surplus or admitted asset requirements, respectively. These laws and regulations require the approval of the applicable state insurance department or health regulators in order to pay any proposed dividend over a certain amount.

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The provisions of our Blue Cross and Blue Shield licenses also may limit our ability to obtain dividends or other cash payments from our subsidiaries as they require our licensed subsidiaries to retain certain levels of minimum surplus and liquidity.

The Blue Cross and Blue Shield license agreements also contain other requirements and restrictions regarding our operations and our use of the Blue Cross and Blue Shield names and marks. These requirements and restrictions are subject to change from time to time. New requirements or restrictions could have a material adverse effect on our business, results of operations and financial condition. Upon the occurrence of any event causing termination of the license agreements, we would cease to have the right to use the Blue Cross and Blue Shield names and marks in the Blue Cross Blue Shield licensed territory, which would have a material adverse effect on our business. Events which could result in termination of our license agreements include failure to meet the minimum surplus and liquidity levels set forth above as well as a change of control not otherwise approved by the Blue Cross Blue Shield Association or a violation of the Blue Cross Blue Shield Association ownership limitations on our capital stock.

Each license requires an annual fee to be paid to the Blue Cross Blue Shield Association, a national trade association of Blue Cross Blue Shield licensees, the primary function of which is to promote and preserve the integrity of the Blue Cross Blue Shield names and marks, as well as to provide certain coordination among the member plans. The annual fee is determined based on premiums earned from products using the Blue Cross and Blue Shield names and marks and from a per-contract charge for self-funded membership.

Investments

We classify all of our fixed maturity and marketable equity investments as available for sale and, accordingly, they are carried at fair value. The fair value of investments in fixed maturities and marketable equity securities are based on quoted market prices. Unrealized gains and losses on available for sale securities are reported as a separate component of other comprehensive income, net of deferred income taxes. The amortized cost of fixed maturities, including certain trust preferred securities, is adjusted for amortization of premiums and accretion of discounts to maturity, which is included in investment income. Amortization of premiums and discounts on collateralized mortgage obligations are adjusted for prepayment patterns using the retrospective method. Investment income is shown net of investment expenses. The cost of securities sold is based on the specific identification method. When the fair value of any investment is lower than its cost and such a decline is determined to be other than temporary, the

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cost of the investment is written down to fair value and the amount of the write down is charged to net income as a realized loss.

Short-term investments consist principally of U.S. treasury bills, commercial paper and money market investments. We consider securities with maturities greater than three months and less than one year at the date of purchase as short-term investments. The fair value of short-term investments is based on quoted market prices.

Other long-term equity investments, include joint ventures, which are accounted for under the equity method, and derivative instruments, which are accounted for at fair value.

Our insurance company subsidiaries are subject to state laws and regulations that require diversification of their investment portfolios and limit the amount that may be invested in certain investment categories, such as below-investment-grade fixed income securities, mortgage loans, real estate and equity investments. Failure to comply with these laws and regulations might cause investments exceeding regulatory limitations to be treated as non-admitted assets for purposes of measuring statutory surplus and risk-based capital and, in some instances, require the sale of those investments.

Critical Accounting Estimates

The following is an explanation of our accounting policies considered most significant by management. These accounting policies require us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information is known. Actual results could differ materially from those estimates.

Revenue Recognition

Our membership contracts generally have one-year terms and are subject to cancellation upon 60 days written notice. Premiums are generally due monthly and are recognized as revenue during the period in which we are obligated to provide services to our members. We record premiums received prior to such periods as unearned premiums. We record unpaid premium as a receivable, net of an allowance for doubtful accounts. Premiums recorded for groups with retrospectively rated arrangements are based upon the actual and estimated claims experience of these groups. Future adjustments to the claims experience of these groups will result in changes in premium revenue. Our estimated claim experience is based on a number of factors, including prior claims experience. We continually review these estimates and adjust them based on actual claims experience. Any changes in these estimates are included in current period results. Funds received from these groups in excess of premiums recorded are reflected as liabilities on our balance sheet.

We recognize administrative service fees during the period in which the related services are performed. Administrative service fees consist of revenues from the performance of administrative services for self-funded contracts, reimbursements from our contracts with CMS under which we serve as an intermediary for the Medicare Part A program and a carrier for the Medicare Part B program, and fees earned under the BlueCard program. We record the revenue earned under our contracts with CMS net of an allowance for an estimate of disallowed expenses.

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Cost of Benefits Provided

Cost of benefits provided includes claims paid, claims in process and pending, and an estimate for unreported claims for charges for healthcare services for enrolled members during the period. These costs include payments to primary care physicians, specialists, hospitals, pharmacies, outpatient care facilities and the costs associated with administering such care. Costs of benefits are recorded net of pharmacy rebates, coordination of benefits and pool recoveries.

We are required to estimate the total amount of claims that have not been reported or that have been received, but not yet adjudicated, during any accounting period. These estimates, referred to as unpaid claims on our balance sheet, are recorded as liabilities.

We estimate claim reserves in accordance with Actuarial Standards of Practice promulgated by the Actuarial Standards Board, the committee of the American Academy of Actuaries that establishes the professional guidelines and standards for actuaries to follow. A considerable degree of judgment is involved in estimating reserves. We make assumptions regarding the propriety of using existing claims data as the basis for projecting future payments. Factors we consider include medical cost trends, the mix of products and benefits sold, internal processing changes and the amount of time it took to pay all of the benefits for claims from prior periods. To the extent the actual amount of these claims differs from the estimated amount based on our underlying assumptions, our subsequent financial statements may be materially impacted.

The Unpaid Claims and Claims Adjustment Expense shown in our balance sheet as of March 31, 2004 consisted of the following components ($ in millions):