Prime for the Regions 9, 10 and 12 contract increaseddecreased by 8%6% to 378,945356,106 while the total estimated number of eligible beneficiaries, based on DoD data and excluding Alaska, decreasedincreased by 4%1% to 608,105.612,523. DoD estimated numbers of eligible beneficiaries are subject to revision when actual numbers become available.

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        Under the TRICARE contracts, Federal Services shares health care cost risk with DoD for both gains and losses. Federal Services subcontracts to affiliated and unrelated third parties for the administration and health care risk of parts of these contracts. If all option periods are exercised by DoD and no further extensions of the performance period are made, health care delivery ends on October 31, 2002 for the Region 6 contract, on March 31, 2003 for the Regions 9, 10 and 12 contract, and February 28, 200229, 2004 for the Region 11 contract. The DoD Authorization Act for government fiscal year 2001 authorized DoD to extend the term of the current TRICARE contracts for an additional two years. Federal Services and DoD have not discussed the modifications to the contracts for the additional two-year extension. However, if theThe additional two-year extension iswas added to the three contractsRegion 11 contract and, if all option periods are exercised, the period of health care delivery would extend to February 29, 2004 for2004. If the additional two-year extension is added to the Region 116 contract and the Regions 9, 10 and 12 contract and all option periods are exercised, the period of health care delivery would extend to October 31, 2004 for the Region 6 contract and March 31, 2005 for the Regions 9, 10 and 12 contract. Federal Services also expects to compete for the rebid of those contracts.

    In September, 2000, Federal Services and DoD agreed to settle Federal Services' litigation of the award of the TRICARE contract for Regions 2 and 5 to a competitor of Federal Services, the claim of Federal Services' for bid and proposal costs under the procurement for Regions 2 and 5, and the administrative close-out of the completed contract for New Orleans and Base Realignment and Closure (BRAC) sites.

        In December 2000, Federal Services and DoD agreed to a settlement of approximately $389 million for outstanding receivables related to Federal Services' three current contracts for DoD's TRICARE program and for the completed contract for the CHAMPUS (Civilian Health and Medical Program of the Uniformed Services) Reform Initiative. Approximately $60 million of the settlement amount was received in December 2000. Federal Services received the remainder of the settlement in January 2001. The settlement amounts will bewere used, among other things, to pay vendors, providers and amounts owed back to the government, and will bewere applied to the continuing operating needs of the three TRICARE contracts. The settlement agreement also providesprovided for additional payments during 2001 and 2002 for costs that have not yet been incurred.

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

VETERANS AFFAIRS.    During 2000,2001, Federal Services administered 1211 contracts with the U.S. Department of Veterans Affairs to manage Community Based Outpatient Clinicscommunity based outpatient clinics in 6six states. Federal servicesServices also manages 28managed 55 contracts with the U.S. Department of Veterans Affairs, one subcontract for the U.S. Department of Veterans Affairs and one contract with the U.S. Marshals Service for claims re-pricing services.

SPECIALTY SERVICES DIVISION
Specialty Services

        The Company's Specialty Services Division offersWe offer behavioral health, dental vision and pharmacy benefit managementvision products and services as well as managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities.

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        DENTAL AND VISION.    ThroughWe acquired DentiCare of California, Inc. ("DentiCare"), (which is in the Company operates aprocess of changing its name to Health Net Dental, Inc.) in 1991. DentiCare provides dental care services under an HMO arrangement in California and Hawaii and performs dental administrativeadministration services for an affiliate company in California, serving in the aggregate approximately 487,000 enrollees as of December 31, 2000. This enrollment includes 109,006 enrollees who are beneficiaries under Medicaid dental programs, of which 30,780 enrollees are beneficiaries of Hawaii's Medicaid program. DentiCare is also a participant in California's Healthy Families Program, serving 72,063 members. Acquired by the Company in 1991, DentiCare has grown from total revenues in 1992 of $24 million to approximately $49 million forCalifornia. For the year ended December 31, 2000.2001, DentiCare's total revenues were $49 million for services it provided for approximately 478,000 members, of which 72,600 members were beneficiaries under the Medicaid dental programs. DentiCare also participates in the Healthy Families program, under which it serves approximately 89,600 members.

        Operating onWe provide at-risk vision care services and administrative and information system platforms in common with DentiCare isservices under various programs through our wholly owned subsidiary Foundation Health Vision Services, Inc., d.b.a. AVP Vision ServicesPlans ("AVP") (which is in the process of changing its name to Health Net Vision, Inc.). AVP operates in California and Arizona and provides at-riskshares a common administrative and administrative services under various programs that result in the delivery of vision benefits to over 583,000 enrollees. Total revenues from AVP operations

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forinformation systems platform with DentiCare. For the year ended December 31, 20002001, total revenues were approximately $9 million. Since its acquisition by the Company in 1992, AVP has grown from 30,000The total number of lives covered enrollees tounder these services reached approximately 318,000 enrollees505,000 members as of December 31, 2001. Of those covered lives, 380,400 members are enrolled in full-risk products and 265,000 enrollees124,600 lives were covered under administrative services contracts as of December 31, 2000.contracts.

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

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

        MHN provides managed behavioral health programs to employers, governmental agencies and public entitlement programs, such as TRICARE and Medicare. Employer group sizesEmployers participating in MHN's programs range in size from Fortune 100 companies to mid-sized companies with 200 employees. MHN's strategy is to extend its market share in the Fortune 500, health plan and TRICARE markets through a combination of direct, consultant/broker and affiliate sales. MHN intends to achieve additional market share through broadening its employer products, including using the Internet as a distribution channel, pursuing upcoming TRICARE procurement opportunities with Federal Services and continuing carve-out product sales, funded on either a risk or administrative-services-only ("ASO")ASO, basis.

        MHN's products and services were being provided to over 9.410.4 million individuals as of December 31, 2000,2001, with approximately 3.03.2 million individuals under risk-based programs, approximately 2.53.6 million individuals under self-funded programs and approximately 3.93.6 million individuals under EAP programs.employee assistance programs ("EAPs").

        In 2000,For the year ended December 31, 2001, these products and services generated revenues of approximately $270$248 million, of which approximately $200$156 million derived from risk-based programs, including approximately $99$25 million derived from TRICARE, approximately $23$26 million derived from ASO programs and approximately $44$41 million derived from employee assistance programs.EAPs.

        MHN has approximately 1,3001,200 full-time equivalent employees serving approximately 2,100 employer groups on a stand alone basis plus approximately 34,000 groups through Companyother affiliates of ours, primarily in California and the Northeast.

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

        WORKERS' COMPENSATION ADMINISTRATIVE SERVICES.    The Company'sOur subsidiaries organized under Employer & Occupational Services Group, Inc. ("EOS"EOSG") provide a full range of workers' compensation administrative services to insurers, self-funded employers, third-party claims administrators and public agencies. These services include injury reporting and provider referral, automated bill review and PPO network access, field and telephonic case management, direction of care and practice management, claim/benefit administration, claim investigation and adjudication, litigation management and employer personnel services. EOSservices (which were discontinued in 2001). EOSG has regional offices in Arizona, California, Colorado, Connecticut, Florida, Illinois, Kansas, North Carolina, Oregon and Texas. During 2000, EOS'2001, EOSG's Managed Care Services unit provided services on more than $1.3$1.1 billion of billed charges for medical care for

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covered beneficiaries of its customers. The unit processed over 2.51.9 million bills from providers and hospitals located in 50 states and handled nearly 95,00037,000 intake calls resulting in the processing of over 63,00023,000 injury reports and 57,0004,400 medical care cases referred for case management services and/or utilization review services. EOS'EOSG's Claims Administration Services unit handled more than 31,000 claims, with aggregate benefit payments by its payor customers in excess of $34 million. Also, EOS' Employment Services unit, a temporary staffing and direct placement service for managed care, workers' compensation and information technology specialists, placed 851 temporary assignments and had 4,600 personnel available for assignment in 14 states.43,000 claims. For the year 2000, EOS'ended December 31, 2001, EOSG's Managed Care Services, Claims Administration Services and Employment Services units generated revenues of approximately $75$46.2 million, $19$15.2 million and $9$3.2 million, respectively.

    PHARMACY BENEFIT MANAGEMENT.  Pharmacy benefits are managed through a variety of clinical, technological and contractual tools. The Company seeks to provide safe, effective medications that are affordable to its members. The Company outsources certain capital intensive functions of pharmacy benefit management, such as claim processing. However, the Company continues to actively utilize all other pharmacy management tools available. Some of the tools used are as follows:

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Pharmacy Benefit Design—the Company has designed and sells three-tier pharmacy products that allow consumer choice while encouraging member financial participation.

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

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Retail and manufacturer contracts that lower the net cost.

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Technological tools that automate claim adjudication and payment; technology also plays a key role in preventing members from receiving drugs that may harmfully interact with other medications being taken.

    HEALTH SERVICES INFORMATION.  Health Benchmarks, Inc. ("HBI"), formerly the Company's Quality Initiatives Division, was incorporated in 1999 as a wholly-owned subsidiary of the Company. HBI is a health services information company which provides services to the managed care sector, employers and the pharmaceutical industry. These services include data management (data warehouse tools) and data analysis, pharmacoeconomic analysis, Phase III and IV clinical trial support, and disease management programs and services that support National Committee for Quality Assurance ("NCQA") and Health Plan Employer Data and Information Set ("HEDIS") initiatives. HBI assists decision-makers in allocating health resources cost-effectively through evidence-based programs. HBI also supports certain quality assessment activities of the Company's health plans. In addition, HBI designs, implements and administers performance-based contracting programs for hospitals and physicians on behalf of managed care companies. In 2000, HBI generated approximately $8 million in revenues.

BUSINESS TRANSFORMATION AND INNOVATION SERVICES DIVISION
Business Transformation and Innovation Services

        The Company'sOur Business Transformation and Innovation Services Division oversees all aspects of the Company'sour information technology operations and business process redesign efforts, seeking to make the Company'sour operational processes as efficient as possible through the use of enabling technology, such as the Internet. The Company believesWe believe that the Internet and related new technologies will fundamentally change managed care organizations. The Business Transformation and Innovation Services Division focuses on theour strategic direction of the Company in light of the Internet and related technologies and pursues opportunities consistent with suchour strategic direction. Currently, the Division is developing collaborative approaches with business partners to transform their existing assets and expertise into new e-business opportunities. The Company believesWe believe that net-enabled connectivity among purchasers, consumers, managed care organizations, providers and other trading partners ishas increased in recent years, providing a prerequisite tobasis for creating and capturing e-business opportunities. The Company isWe are developing business

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concepts to take advantage of those market opportunities that provide value to consumers, purchasers of benefits and the providers of medical and health care services.

        INNOVATION SERVICES.    The Business Transformation and Innovation Services Division includes the Company'sour New Ventures Group, which develops technological tools to stream-line health care processes, empower consumers and reduce administrative burdens for members, beneficiaries, physicians, hospitals and employers. In this connection, the Company haswe have undertaken, among other things, the following initiatives:

        Questium.    In 2000, the Company'sOur subsidiary, Questium, Inc. ("Questium"), launched the website www.questium.com which is a health care consumer website, www.questium.com, that links health plan members directly with their personal health benefit information. The Questium website allows health plan members to customize their own web page and gain access to information and services such as customized health news and updates, and individual health coverage information, such as co-payment levels and out-of-pocket maximums. In the first half of 2001, Questium believes thatCertain health plan members will beare also able use the Questium website to refill mail order prescriptions online and view their individual medical histories from their health plan records. As of the date hereof, theThe Questium website also offers, among other things, access to general consumer information, such as a health encyclopedia, alternative

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care and clinical trial information, and online health evaluation tools, such as a health risk calculator and weight-loss guide.

    A second phase, Questium 2.0, will offer employees and their dependents access, from either a PC at home or through their office desktop, to an integrated package of health/fitness, emotional health, work/life, personal growth and employee development services. The Company expects to add these services to its Questium consumer portal offering by partnering with industry leaders. These services are expected to become available in summer, 2001.

        Provider/Payor Connectivity.    Provider/payor connectivity solutions will enable health care providers and health care payors, including delegated medical groups, to electronically exchange administrative, financial and clinical information. The CompanyWe began the MedUnite initiative in 1999 to develop a provider/payor connectivity solution. MedUnite has subsequently come to include six other nationally prominent health plans. MedUnite operates as its owna stand-alone enterprise in which the Company retains an approximately 15%we retain a minority ownership interest. MedUnite, which is scheduleddesigned to beginprovide on-line internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment, commenced pilot operations in California and on the East Coast in March, 2001. The Company, through itsThrough our subsidiary, Health Net of the Northeast, Inc. (formerly Physicians Health Services, Inc.), iswe also employingemploy another provider/payor connectivity solution in the Northeast. This solution is supported by NaviMedix, Inc. ("NaviMedix") and currently has more than 5,000provides Internet-based connectivity services to physicians using Internet-based services in the tri-state area of Connecticut, New York and New Jersey. We hold a minority equity position in NaviMedix.

        Online Enrollment and Billing.    OnlineWe continue to develop online enrollment and billing initiatives are nearing completion for the Company'sour commercial health plan and TRICARE lines of business. These initiatives permit health plan members/beneficiaries to enroll in health coverage, pay applicable fees, and select a primary care physician using the Internet. Additionally, the Company'sour member services and enrollment employees will perform enrollment and billing activities through the Internet using these innovative solutions. Both enrollment and billing initiatives are scheduled to begincommenced pilot operations in April, 2001.

        MANAGEMENT INFORMATION SYSTEMS.    Effective information technology systems are critical to the Company'sour operations. The Company'sOur information technology systems include several computer systems, each utilizing a combination of packaged and customized software and a network of online terminals. The information technology systems gather and store data on the Company'sour members and physician and hospital providers. The systems contain all of the Company'sour necessary membership and claims-processing capabilities as well as marketing and medical utilization programs. These systems provide the Companyus with an integrated system of billing, reporting, member services and claims processing, and the ability to examine member encounter information for the optimization of clinical outcomes. In this connection, as set forth above, the Company iswe are in the process of developing and

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implementing online enrollment and billing solutions for the Company'sour health plan and TRICARE operations, which the Company believeswe believe will simplify and expedite administrative functions.

PROVIDER RELATIONSHIPS AND RESPONSIBILITIES

        PHYSICIAN RELATIONSHIPS.    Upon enrollment inUnder most of the Company'sour HMO plans, each member upon enrollment selects a participating physician group ("PPG") or primary care physician from the HMO's provider panel. The primary care physicians and PPGs assume overall responsibility for the care of members. Medical care provided directly by such physicians includes the treatment of illnesses not requiring referral, as well as physical examinations, routine immunizations, maternity and child care, and other preventive health services. The primary care physicians and PPGs are responsible for making referrals (approved by the HMO's or PPG's medical director) to specialists and hospitals. Certain Companyof 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 atheir primary care physician.

        The following table sets forth the number of primary care and specialist physicians contracted either directly with whom the Company'sour HMOs (and certain of such HMOs' PPGs) wereor through our contracted PPGs as of December 31, 2000 in each of the Company's Health Plan Divisions:2001:

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        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 the Company'sour quality, utilization and administrative procedures. In California and Connecticut, PPGs generally receive a monthly "capitation" fee for every member served.assigned. The capitation fee represents payment in full for all medical and ancillary services specified in the provider agreements. The non-physician component of all hospital services is covered by a combination ofIn these capitation and/or per diem charges. In such capitatedfee arrangements, in cases where the capitated providerPPG cannot provide the health care services needed, such providersPPGs generally contract with specialists and other ancillary service providers to furnish the requisite services pursuant tounder capitation agreements or negotiated fee schedules with specialists. ManyOutside of the Company'sCalifornia, many of our HMOs outside California reimburse physicians according to a discounted fee-for-service schedule, although several HMOs 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.    The Company's HMOsOur health plan subsidiaries arrange for hospital care primarily through contracts with selected hospitals in their service areas. SuchThese hospital contracts generally provide forhave multi-year terms and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-for-service schedules.

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

        COST CONTAINMENT.    In most HMO plan designs, the primary care physician or PPG is responsible for authorizing all needed medical care except for emergency medical services. By coordinating care through such physicians in cases where reimbursement includes risk-sharing

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arrangements, the Company believesWe believe that this authorization process reduces inappropriate use of medical resources is reduced and achieves efficiencies are achieved.in cases where reimbursement in based on risk-sharing arrangements.

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

        QUALITY ASSESSMENT.    Quality assessment is a continuing priority for the Company.us. Most of the Company'sour health plans have a quality assessment plan administered by a committee comprisedcomposed 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 the Company'sour health plans also have a subscriber grievance procedure and/or a member satisfaction program designed to respond promptly to member grievances. AspectsElements of suchthese subscriber grievance procedures and member servicessatisfaction programs take placeare incorporated both within the PPGs and within the Company'sour health plans.

DIVESTITURES
AND OTHER INVESTMENTS

    FLORIDA OPERATIONS.  In January,        Effective August 1, 2001, the Company entered into a definitive agreement to sell itswe sold our Florida health plan, for $48known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, L.L.C. In connection with the sale, we received

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approximately $49 million, consisting of $23 million in cash and $25approximately $26 million in the form of a secured five-yearsix-year note bearing 8% interest. Although the Company has entered intointerest at a definitive agreement for the sale, consummationrate of the sale is subject to various conditions and certain regulatory approvals. The Company anticipates closing the sale in the second quarter of 2001. The Companyeight percent per annum. We also agreed to sellsold the corporate facility building used by itsour Florida health plan under defined terms which requireto DGE Properties, LLC for $15 million, payable by a secured five-year note bearing interest at a rate of eight percent per annum. We estimated and recorded a $76.1 million pretax loss on the Company to financesales of our Florida health plan and the sale over five years.

    OHIO, WEST VIRGINIA AND WESTERN PENNSYLVANIA OPERATIONS.  In 2000, the Company decided to exit the Ohio, West Virginia and Western Pennsylvania markets in which it operated. In this connection, the Company provided notice of intention to withdraw from such service areas to the appropriate regulators. As of February, 2001, the Company no longer had any members in such markets. Upon completion of its withdrawal efforts, the Company intends to dissolve its subsidiaries operating in such markets and to recover any remaining capital.

    COLORADO OPERATIONS.  In November, 1999, the Company commenced the transition of its membership in Colorado to PacifiCare of Colorado, Inc. ("PacifiCare-CO") pursuant to a definitive agreement with PacifiCare-CO. Pursuant to the definitive agreement, PacifiCare-CO offered replacement coverage to substantially all of the Company's Colorado HMO membership and PacifiCare Life Assurance Company issued replacement indemnity coverage to substantially all of the Company's Colorado POS membership. The transition of membership in Colorado was completed inrelated corporate facility building during the second quarter ended June 30, 2001. Under the terms of 2000.

    WASHINGTON OPERATIONS.  In December, 1999,the Florida sale agreement and certain reinsurance and indemnification obligations of the Company, soldthere will be a series of true-up processes that will take place through 2002 that could result in additional loss or gain recognition which was not able to be estimated as of December 31, 2001.

        Throughout 2000 and 2001, we provided funding in the capitalaggregate amount of approximately $10 million to MedUnite in exchange for preferred stock of QualMed Washington Health Plan, Inc.,MedUnite. We hold a minority ownership interest in MedUnite. During the Company's HMO subsidiary in the state of Washington ("QM-Washington"), to American Family Care Inc. ("AFC"). AFC assumed control of the health-plan license and acquired the Medicaid and Basic Health Plan membership of QM-Washington. The commercial HMO membership of QM-Washington was transitioned to PacifiCare of Washington, Inc. ("PacifiCare-WA"), Premera Blue Cross and Blue Cross of Idaho pursuant to definitive agreements with such companies. As part of such agreements, PacifiCare-WA offered replacement coverage to QM-Washington's HMO and POS groups in western Washington, Premera Blue Cross offered replacement coverage to substantially all of QM-Washington's HMO and POS group membership in

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eastern Washington and Blue Cross of Idaho offered replacement coverage for certain members who reside in Idaho. The transition of membership in Washington and Idaho was completed in the secondfirst quarter of 2000.2002, we provided approximately $2.2 million in additional funding to MedUnite. The funded amounts are included in other noncurrent assets. For additional information about MedUnite, see the discussion under "Government Contracts and Specialty Services segment—Business Transformation and Innovation Services—Innovation Services—Provider/Payor Connectivity" above.

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        During 2000, we secured an exclusive e-business connectivity services agreement from the Connecticut State Medical Society IPA, Inc. (CSMS-IPA) for $15.0 million. CSMS-IPA is an association of medical doctors providing health care primarily in Connecticut. The amounts paid to CSMS-IPA for this agreement are included in other noncurrent assets. During 2001, we continued to develop this service capability.

        CERTAIN OTHER OPERATIONS.    The Company continuesWe continue to evaluate the profitability realized or likely to be realized by itsour existing businesses and operations, and isare reviewing from a strategic standpoint which of such businesses or operations, if any, should be divested.

ADDITIONAL INFORMATION CONCERNING THE COMPANY'SOUR BUSINESS

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

        Premiums for each employer group are generally contracted for on a yearly basis and are payable monthly. NumerousWe consider numerous factors are considered by the Company in setting itsour monthly premiums, including employer group needs and anticipated health care utilization rates as forecasted by the Company'sour management based on the demographic composition of, and the Company'sour prior experience in, itsour 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.

        The Company believesWe 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, the Company intendswe intend to focus itsour marketing strategies on the

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development of distinct brand identities and innovative product service offerings that will appeal to potential Health Planhealth plan members.

        COMPETITION.    HMOs operate in a highly competitive environment in an industry currently subject to significant changes from business consolidations, new strategic alliances, legislative reform and market pressures brought about by a better informed and better organized customer base. The Company'sOur 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 the Company. The Company believeswe do. We believe that the principal competitive features affecting itsour ability to retain and increase membership include the range and prices of benefit plans offered, 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 featuresfactors and the identity of our key competitors varies by market. The Company believesWe believe that it competeswe compete effectively with respect to all of these factors.

        We face competition from a variety of sources in the California health plan market. Kaiser Foundation Health Plan ("Kaiser") is the largest HMO in California and is a competitor of the Companyours in the California HMO industry. In addition to Kaiser, the Company'sour other HMO competitors include PacifiCare of California, California Care (Blue Cross)Cross of California) and Blue Shield.Shield of California. There are also a number of other types of competitors including self-directed plans, traditional indemnity insurance plans, and other managed care plans. Despite the concentration of membership in the large health plans, the competitive environment in the state is also impacted by small, regional-based HMOs, whose

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combined membership the Company believeswe believe constitutes approximately 20-25% of the market. In addition, the Company competeswe compete in California against a variety of PPOs.

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

        The Company's HMOsOur HMO in Connecticut competecompetes for business with commercial insurance carriers, Anthem Connecticut, Aetna/U.S. Healthcare, Connecticare and more than eight other HMOs. The Company'sOur main competitors in Pennsylvania, New York and New Jersey are Aetna/U.S. Healthcare, Empire Blue Cross, Oxford Health Plans, United Healthcare, Horizon Blue Cross and Keystone Health Plan East. The Company's HMO operations in Florida compete for business with Humana Medical Plan, United Healthcare, Health Options and Prudential HealthCare, among others. In January, 2001, the Company entered into a definitive agreement for the sale of its Florida health plan. See "Divestitures."

    In 2000, the Company decided to exit the Ohio, West Virginia and Western Pennsylvania markets in which it operated and provided notice of intention to withdraw from such service areas to the appropriate regulators. The Company ceased having active membership in such markets as of February, 2001.

        GOVERNMENT REGULATION.    The Company believes it isWe believe we are in compliance in all material respects with all current state and federal regulatory requirements applicable to the businessbusinesses being conducted by itsour subsidiaries. Certain of these requirements are discussed below.

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

13

under the Knox-Keene Act, HN California and certain of our other Company subsidiaries must file periodic reports with, and are subject to periodic review and investigation by, the DMHC. Non-compliance with the Knox-Keene Act may result in an enforcement action, fines and penalties, and, in egregious cases, limitations on or revocation of the Knox-Keene license.

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

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        Additionally, there are a number of recently enacted federal laws that further regulate managed health care. SuchRecent legislation includes the Balanced Budget Act of 1997 and the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). The purposes of HIPAA are to (i) limit pre-existing condition exclusions applicable to individuals changing jobs or moving to individual coverage, (ii) guarantee the availability of health insurance for employees in the small group market, (iii) prevent the exclusion of individuals from coverage under group plans based on health status and (iv) establish national standards for the electronic exchange of health information. In December, 2000, the Department of Health and Human Services ("DHHS") promulgated certain regulations under HIPAA related to the privacy and security of individually identifiable health information, referred to aselectronically transmitted protected health information or "PHI"("PHI"). The new regulations require health plans, clearinghouses and providers to (a) comply with various requirements and restrictions related to the use, storage and disclosure of PHI, (b) adopt rigorous internal procedures to protect PHI and (c) enter into specific written agreements with business associates to whom PHI is disclosed. The regulations also establish significant criminal penalties and civil sanctions for non-compliance. In addition, the regulations could expose the Companyus to additional liability for, among other things, violations of the regulations by itsour business associates. In February, 2001, the DHHS stated that the regulations in their current form would require compliance by April, 2003. The Company believesWe believe that the costs required to comply with thethese regulations under HIPAA will be significant and maycould have a material adverse impact on the Company'sour business or results of operations.

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

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

        Other HMO Regulations.    In each state in which the Company doesour HMOs do business, our HMOs must meet numerous state licensing criteria and secure the approval of state licensing authorities before implementing certain operational changes, including the development of new product offerings and, in some states, the expansion of service areas. To remain licensed, each HMO must continue to comply

14

with state laws and regulations and may from time to time be required to change services, procedures or other aspects of its operations to comply with changes in applicable laws and regulations. In addition, HMOs must file periodic reports with, and their operations are subject to periodic examination by, state licensing authorities. HMOs are required by state law to meet certain minimum capital and deposit and/or reserve requirements in each state and may be restricted from paying dividends to their parent corporations under certainsome circumstances. Several states have increased minimum capital requirements, pursuantin response to proposals by the National Association of Insurance Commissioners to institute risk-based capital requirements. Regulations in these and other states may be changed in the future to further increase equitycapital requirements. Such increases could require the Companyus to contribute additional capital to itsour HMOs. Any adverse change in governmental regulation or in the regulatory climate in any state could materially impact the HMOs operating in that state. The HMO Act and state laws place various restrictions on the ability of HMOs to price their products freely. The CompanyWe must comply with certainapplicable provisions of state insurance and similar laws, including regulations governing the Company'sour ability to seek ownership interests in new HMOs, PPOs and insurance companies, or otherwise expand itsour geographic markets or diversify itsour product lines.

        Insurance Regulations.    State departments of insurance (the "DOIs") regulate our insurance and third-party administrator business conducted by certain subsidiaries of the Company (the "Insurance Subsidiaries") pursuant tobusinesses under various provisions of state insurance codes and regulations promulgated thereunder. The Insurance Subsidiariesregulations. Our subsidiaries conducting these businesses are subject to various capital reserve and other financial, operating and disclosure requirements established by the DOIs and state laws. The Insurance SubsidiariesThese subsidiaries must also file periodic reports regarding their activities regulated by the DOIsactivities and are subject to periodic reviews of those activities by the DOIs. The CompanyWe must also obtain approval

15

from, or file copies with, the DOIs for all of itsour group and individual insurance policies prior to issuing those policies.

        PENDING FEDERAL AND STATE LEGISLATION.    There are a number of legislative initiatives and proposed regulations currently pending at the federal and state levellevels which could increase regulation of the health care industry. Such legislation includes "managed care reform,"These measures include a "patients' bill of rights" and certain other initiatives which, if enacted, could have significant adverse effects on the Company'sour operations. See "Item 4—Cautionary"Cautionary Statements—Federal and State Legislation."Legislation" below. For example, one version of the proposed "patients' bill of rights" would allow a subscriber to hold an employer liableexpansion of liability for damages alleged under subscriber's health plan. If enacted, such initiative could significantly impact employer choices in health plan coverage. The Companyplans. We cannot predict the outcome of any of the pending legislative or regulatory proposals, nor the extent to which the Companywe may be affected by the enactment of any such legislation or regulation.

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

SERVICE MARKS

    The Company's        We have filed for registration of and maintain several service marks, and/or trademarks include, among others: THE ACUTE CARE ALTERNATIVE®, Alliance 2000^sm, Alliance 1000^sm, Asthmawise^sm, AVP^sm, AVP Vision Plans^sm, BabyWell^sm, BEING WELL®, CARECAID®, CMP®, COMBINED CARE®, COMBINED CARE PLUS^sm, COMMUNITY MEDICAL PLAN, INC. and design®, A CURE FOR THE COMMON HMO®, Feetbeat Worksite Walking Program^sm, FIRM SOLUTIONS®, FLEX ADVANTAGE®, FLEX NET^sm, FOUNDATION HEALTHtradenames that we use in our business, including marks and design®, FOUNDATION HEALTH GOLD®, Foundation Health Systems^sm, HANK®, HANK and design®, HEALTH NET®, Health Net ACCESS^sm, Health Net Comp.24^sm, Health Net ELECT^sm, Health Net INSIGHT^sm, Health Net OPTIONS^sm, Health Net SELECT^sm, Health Net Seniority Plus^sm, Health Smart and design^sm, Healthworks (stylized)^sm, Heart & Soul^sm, IMET and design®, Indian design®, INDIVIDUAL PREFERRED PPO®, InterCare^sm, InterComp^sm, InterFlex^sm, Inter Mountain Employers Trust^sm, InterPlus^sm, LIFE WITH DIGNITY AND HOPE®, MAKING QUALITY HEALTH CARE AFFORDABLE®, M.D. Health Plan Personal Medical Management^sm, Onnames incorporating the Road to Good Health^sm, PHYSICIANS HEALTH SERVICES®, QUALASSIST®, QUALADMIT®, QUALCARE®, QUALCARE PREFERRED®, QUAL-MED®, QUALMED^sm, QUALMED HEALTH & LIFE INSURANCE COMPANY®, QUALMED PLANS FOR HEALTH®, Rapid Access^sm, SENIOR SECURITY®, SENIOR VALUE®, Someone at Your Side^sm, Sun/Mountain design®, The Final Piece of the Healthcare Puzzle^sm, VitalLine^sm, VITALTEAM®, WELL MANAGED CARE RIGHT FROM THE START®, WELL REWARDS®, Well Woman^sm, Wise Choice^sm, WORKING WELL TOGETHER®, and Your Partner in Healthy Living^sm, and certain designs related to the foregoing.

    The Company utilizes"Health Net" phrase. We utilize these and other marks and names in connection with the marketing and identification of products and services. The Company believesWe believe such marks and names are valuable and material to itsour marketing efforts.

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EMPLOYEES

        The CompanyWe currently employsemploy approximately 11,0009,800 employees, excluding temporary employees. SuchThese employees perform a variety of functions, including provision of administrative services for employers,

16

providers and members,members; negotiation of agreements with physician groups, hospitals, pharmacies and other health care providers,providers; handling of claims for payment of hospital and other services, and providingservices; provision of data processing services. The Company'sOur employees are not unionized and the Company haswe have not experienced any work stoppage since its organization. The Company considers itsour inception. We consider our relations with itsour employees to be very good.

OTHER INFORMATION/RECENT DEVELOPMENTS

        DEBT OFFERING.    On April 12, 2001, we completed our offering of $400 million aggregate principal amount of 8.375 percent Senior Notes due in April 2011. The net proceeds of $395.1 million from the Senior Notes were used to repay outstanding borrowings under our then-existing revolving credit facility. On October 4, 2001, we completed an exchange offer for the Senior Notes in which the outstanding Senior Notes were exchanged for an equal aggregate principal amount of new 8.375 percent Senior Notes due in 2011 that have been registered under the Securities Act of 1933, as amended.

        FLORIDA OPERATIONS.    Effective August 1, 2001, we sold our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, L.L.C. In connection with the sale, we received approximately $49 million, consisting of $23 million in cash and approximately $26 million in the form of a secured six-year note bearing interest at a rate of eight percent per annum. We also sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing interest at a rate of eight percent per annum. We estimated and recorded a $76.1 million pretax loss on the sales of our Florida health plan and the related corporate facility building during the second quarter ended June 30, 2001. Under the terms of the Florida sale agreement and certain reinsurance and indemnification obligations of the Company, there will be a series of true-up processes that will take place through 2002 that could result in additional loss or gain recognition which was not able to be estimated as of December 31, 2001.

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

•

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



•

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

        We established the credit facilities to refinance our then-existing credit facility and to finance any lawful general corporate purposes, including acquisitions and working capital. The credit facilities allow us to borrow funds:

•

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



•

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



•

by obtaining under the five-year facility swingline loans in an aggregate amount of up to $50 million that may be requested on an expedited basis; and



•

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

        Repayment.    The 364-day credit facility expires on June 27, 2002. We must repay all borrowings under the 364-day credit facility by June 27, 2004. The five-year credit facility expires in June 2006, and

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we must repay all borrowings under the five-year credit facility by, June 28, 2006, unless the five-year credit facility is extended. The five-year credit facility may, at our request and subject to approval by lenders holding two-thirds of the aggregate amount of the commitments under the five-year credit facility, be extended for up to two twelve-month periods to the extent of the commitments made under the five-year credit facility by such approving lenders. Swingline loans under the five-year credit facility are subject to repayment within no more than seven days.

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

•

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



•

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



•

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

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

•

incur liens;



•

extend credit and make investments;



•

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



•

engage in transactions with affiliates;



•

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



•

make restricted payments, including dividends and other distributions on capital stock and redemptions of capital stock; and



•

become subject to other agreements or arrangements that restrict (i) the payment of dividends by any Health Net, Inc. subsidiary, (ii) the ability of Health Net, Inc. subsidiaries to make or repay loans or advances to us, (iii) the ability of any subsidiary of Health Net, Inc. to guarantee our indebtedness or (iv) the creation of any lien on our property.

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

17

facility and from 0.155% to 0.375% per annum for the five-year credit facility, depending on our senior unsecured credit rating.

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

        SHAREHOLDER RIGHTS PLAN.    On May 20, 1996, our Board of Directors declared a dividend distribution of one right (a "Right") for each outstanding share our Class A Common Stock and Class B Common Stock (collectively, the "Common Stock"), to stockholders of record at the close of business on July 31, 1996 (the "Record Date"). Our Board of Directors also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the "Distribution Date" the Rights separate from the Common Stock under the circumstances described below and in accordance with the provisions of the Rights Agreement, as defined below, the redemption of the Rights and the expiration of the Rights, and in certain other circumstances. Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights certificates will be distributed. Subject to certain exceptions contained in the Rights Agreement dated as of June 1, 1996 by and between us and Harris Trust and Savings Bank, as Rights Agent (as amended on October 1, 1996 and May 3, 2001, the "Rights Agreement"), the Rights will separate from the Common Stock following any person, together with its affiliates and associates (an "Acquiring Person"), becoming the beneficial owner of 15% or more of the outstanding Class A Common Stock, the commencement of a tender or exchange offer that would result in any person, together with its affiliates and associates, becoming the beneficial owner of 15% or more of the outstanding Class A Common Stock or the determination by the Board of Directors that a person, together with its affiliates and associates, has become the beneficial owner of 10% or more of the Class A Common Stock and that such person is an "Adverse Person," as defined in the Rights Agreement. The Rights Agreement provides that certain passive institutional investors that beneficially own less than 17.5% of the outstanding shares of our Class A Common Stock shall not be deemed to be Acquiring Persons.

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

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

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

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

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

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

        CHARTER AMENDMENT AND RESTATEMENT.    Effective May 7, 2001, the Company amended and restated its Certificate of Incorporation to eliminate the separation of its Board of Directors into three separate classes and to replace it with a Board of Directors that is elected on an annual basis, and to eliminate a section relating to the removal of directors that was no longer applicable given the class elimination. Such amendment and restatement was approved by the affirmative vote of over eighty percent (80%) of the outstanding shares of Class A Common Stock of the Company at its 2001 Annual Meeting of Stockholders. A copy of the complete Certificate of Incorporation as so amended and restated is included as an Exhibit to this Annual Report.

        CHANGE IN EXECUTIVE OFFICER:    Effective January 28, 2002, Steven P. Erwin resigned as Executive Vice President and Chief Financial Officer of the Company and Marvin P. Rich was appointed in his place as Executive Vice President, Finance and Operations.

        LEGISLATION.    In 2001, the United States Senate and House of Representatives passed separate bills, sometimes referred to as "patients' rights" or "patients' bill of rights" legislation, that seek, among other things, to hold health plans liable for claims regarding health care delivery and improper denial of care. This legislation would remove or limit federal preemption under the Employee Retirement Income Security Act of 1974 ("ERISA") that currently precludes most individuals from suing health plans for causes of action based upon state law and would enable plan members to challenge coverage and benefits decisions in state and federal courts. Although both bills provide for independent review of decisions regarding medical care, the bills differ on the circumstances and procedures under which lawsuits may be brought against managed care organizations and the scope of their liability. Congress will attempt to reconcile the two bills in a conference committee. If patients' bill of rights legislation is enacted into law we could be subject to significant additional litigation risk and regulatory compliance costs, which could be costly to us and could have a significant adverse effect on our results of operations. Although we could attempt to mitigate our ultimate exposure to litigation and regulatory compliance costs through, among other things, increases in premiums, there can be no assurance that we would be able to mitigate or cover the costs stemming from litigation arising under patients' bill of rights legislation or the other costs that we could incur in connection with complying with patients' bill of rights legislation.

        FOHP.    Effective July 30, 1999, a wholly-owned subsidiary of ours merged with and into FOHP, Inc., a then-majority owned subsidiary of ours, which, as a result of the merger, became a wholly-owned subsidiary of the Company. In connection with the merger, the former minority shareholders of FOHP were entitled to receive either $.25 per share or payment rights which entitle the holders to receive as much as $15.00 per payment right on or about July 1, 2001, provided certain hospital and other provider participation and other conditions are met. Also in connection with the merger, certain holders of payment rights will also be entitled to receive additional consideration of $2.25 per payment right ("Bonus Consideration") if our New Jersey health plan achieves certain annual returns on common equity and the participation conditions are met. In July and August 2001, based on the satisfaction of certain participation and other conditions by the former minority shareholders of FOHP, FOHP made aggregate payments of approximately $21.0 million to certain holders of payment rights. FOHP will make up to an additional $6.7 million in payments to additional holders of payment rights, subject to such holders submitting appropriate documentation. A determination on the satisfaction of the conditions for payment of the Bonus Consideration will be made in 2002.

        ASSET IMPAIRMENT, RESTRUCTURING AND OTHER CHARGES.    As part of our effort to reduce ongoing selling, general and administrative expenses, during the third quarter of 2001, we initiated a formal plan to reduce operating and administrative expenses for all of our business units

19

(the "2001 Plan"). Under the 2001 Plan, we decided on enterprise-wide staff reductions and consolidations of certain administrative, financial and technology functions. We recorded pretax restructuring charges of $79.7 million in connection with the 2001 Plan during the third quarter ended September 30, 2001 (the "2001 Charge").

        The 2001 Charge included severance and benefits related costs of $43.3 million in connection with the enterprise-wide staff reductions. These reductions include the elimination of 1,517 positions throughout all of our functional groups, divisions and corporate offices within the Company.

        The 2001 Charge also included asset impairment charges of $27.9 million consisting entirely of non-cash write downs of equipment, building improvements and software application and development costs; charges of $5.1 million related to the termination of lease obligations and non-cancelable lease costs for excess office space resulting from streamlined operations and consolidation efforts; and charges of $3.4 million related to costs associated with consolidating certain information technology systems and functions and other activities which are expected to be completed in the first quarter of 2002. No changes to the 2001 Plan are expected.

        We plan on funding the expected future cash outlays with cash flows from operations. We expect the 2001 Plan to be substantially completed by September 30, 2002. As of December 31, 2001, 916 of the 1,517 positions have been eliminated. It is anticipated that elimination of the remaining 601 positions will be completed by September 30, 2002.

        FHC MERGER.    Effective January 1, 2001, Health Net, Inc. merged its wholly-owned subsidiary, Foundation Health Corporation, with and into Health Net, Inc., thereby terminating the separate existence of Foundation Health Corporation.

CAUTIONARY STATEMENTS

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

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

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

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

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

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

        PHARMACEUTICAL COSTS.    The costs of pharmaceutical products and services are increasing faster than the costs of other medical products and services. Thus, our HMOs face ever higher pharmaceutical expenses. The inability to manage pharmaceutical costs could have an adverse effect on our financial condition.

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

•

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



•

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



•

require third party review of certain care decisions;



•

expedite or modify grievance and appeals procedures;



•

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



•

mandate certain benefits and services that could increase costs;



•

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

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•

restrict or eliminate the use of prescription drug formularies.

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

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

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

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

        We contract with providers in California and Connecticut primarily through capitation fee arrangements. We also use capitation fee arrangements in areas other than California and Connecticut, but to a lesser extent. Under a capitation fee arrangement, we pay the provider a fixed amount per member on a regular basis and the provider accepts the risk of the frequency and cost of member utilization of services. Providers who enter into capitation fee arrangements generally contract with specialists and other secondary providers to provide services not offered by the primary provider. The inability of providers to properly manage costs under capitation arrangements can result in their financial instability and the termination of their relationship with us. In addition, payment or other disputes between the primary provider and specialists with whom the primary provider contracts can result in a disruption in the provision of services to our members or a reduction in the services available. A primary provider's financial instability or failure to pay secondary providers for services rendered could lead secondary providers to demand payment from us, even though we have made our regular capitated payments to the primary provider. Depending on state law, we could be liable for such claims. In California, the liability of our HMO subsidiaries for unpaid provider claims has not been definitively settled. There can be no assurance that our subsidiaries will not be liable for unpaid provider claims. There can also be no assurance that providers with whom we contract will properly manage the costs of services, maintain financial solvency or avoid disputes with secondary providers, the failure of any of which could have an adverse effect on the provision of services to members and our operations.

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

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

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

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

        INTERNET-RELATED OPERATIONS.    We believe that the Internet and related new technologies will fundamentally change managed care organizations. Our Business Transformation and Innovation Services Division focuses on our strategic direction in light of the Internet and related technologies and pursues opportunities consistent with that strategic direction. The division is developing collaborative approaches with business partners to transform their existing assets and expertise into new e-business opportunities. We believe that net-enabled connectivity among purchasers, consumers, managed care organizations, providers and other trading partners is a prerequisite to creating and capturing e-business opportunities. We are developing business concepts to take advantage of those market opportunities that provide value to consumers, purchasers of benefits and the providers of medical and

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health care services. See "Government Contracts and Specialty Services Segment—Business Transformation and Innovation Services—Innovation Services" for a description of certain of our Internet initiatives.

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

        MEDICAL MANAGEMENT.    Our profitability is dependent, to a large extent, upon our ability to manage health care costs. Our ability to manage costs depend, in turn, on a number of factors, including, without limitation, our degree of success in making accurate cost projections, achieving appropriate benefit design, employing utilization review and case management programs, and securing appropriate risk-sharing arrangements with providers while providing members with quality health care. For example, high out-of-network utilization of health care providers and services may have significant adverse effects on our ability to manage health care costs and member utilization of health care. There can be no assurance that we will be able to continue to manage medical costs sufficiently to maintain profitability in our product lines.

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

        COMPETITION.    We compete with a number of other entities in the geographic and product markets in which we operate, some of which other entities may have certain characteristics, capabilities or resources that give them an advantage in competing with us. These competitors include HMOs, PPOs, self-funded employers, insurance companies, hospitals, health care facilities and other health care providers. In addition, financial services or other technology-based companies could enter the market and compete with us on the basis of their stream-lined administrative functions. We believe

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there are few barriers to entry in these markets, so that the addition of new competitors can readily occur. Customers of ours may decide to perform for themselves functions or services currently provided by us, which could result in a decrease in our revenues. Our providers and suppliers may decide to market products and services to our customers in competition with us. In addition, significant merger and acquisition activity has occurred both in our industry and in industries which act as our suppliers, such as the hospital, physician, pharmaceutical and medical device industries. This activity may create stronger competitors and/or result in higher health care costs. Health care providers may establish provider service organizations to offer competing managed care products. To the extent that there is strong competition or that competition intensifies in any market, our ability to retain or increase customers, our revenue growth, our pricing flexibility, our control over medical cost trends and our marketing expenses may all be adversely affected.

        LITIGATION AND INSURANCE.    We are subject to a variety of legal actions to which any corporation may be subject, including employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims, shareholder suits, including for securities fraud, and intellectual property related litigation. In addition, we incur and likely will continue to incur potential liability for claims particularly related to our business, such as failure to pay for or provide health care, poor outcomes for care delivered or arranged, provider disputes, including disputes over withheld compensation, and claims related to self-funded business. Also, there are currently, and may be in the future, attempts to bring class action lawsuits against various managed care organizations, including us, which could expose us to significant potential liability or cause us to make operational changes. In some cases, substantial non-economic or punitive damages are being sought. While we currently have insurance coverage for some of these potential liabilities, others (such as punitive damages), may not be covered by insurance, the insurers may dispute coverage or the amount of insurance may not be sufficient to cover the damages awarded. In addition, insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.

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

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

        FINANCING CONDITIONS.    Our indebtedness includes $400 million in unsecured senior notes due 2001 and amounts outstanding under a $525 million five-year credit facility that expires in June 2006 and a 364-day revolving credit facility that expires in June 2002. See the discussion under the headings "Other Information/Recent Developments—Debt Offering" and "Other Information/Recent Developments—Credit Agreements". Accordingly, we are considering our financing alternatives, including renewing or terming out the 364-day credit facility, obtaining a new credit facility and pursuing a public debt offering. Our ability to obtain any financing, whether through renewal of our existing credit facilities, obtaining a new credit facility, issuing public debt or otherwise, and the terms of any such financing are dependent on, among other things, our financial condition, financial market conditions within our industry and generally, credit ratings and numerous other factors. There can be no assurance that we will be able to renew our current credit facility prior to its expiration, or obtain a new credit facility, on terms similar to those of our current credit facility or on favorable terms, if at

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all, or initiate and complete a public debt offering or otherwise obtain financing on acceptable terms or within an acceptable time, if at all. Failure to renew the existing 364-day credit facility prior to its expiration or to otherwise obtain financing on terms and within a time acceptable to us could, in addition to other negative effects, have a material adverse effect on our operations, financial condition, ability to compete or ability to comply with regulatory requirements.

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

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

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

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

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

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assurances regarding the level or stability of our share price at any time or the impact of these or any other factors on our stock price.

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

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

ITEM 2. PROPERTIES

        The Company leasesWe lease office space for itsour principal executive offices in Woodland Hills, California and itsour offices in Rancho Cordova, California.

    The Woodland Hills facility, with Our executive offices, comprising approximately 425,000115,000 square feet, is leased pursuant to two leases. The aggregate rent for the two leases for 2000 was approximately $11.8 million. The Company's principal executive offices are located in the Woodland Hills facility, as are muchoccupied under a lease expiring December 31, 2004. A significant portion of the Company's California HMO operations. The lease for theour California HMO operations covering approximately 310,000 square feet, expires on December 31, 2001. The Company will relocate its California HMO operations to a new facilityare also housed in Woodland Hills, pursuant toin a recently executed ten-yearseparate, 325,000 square foot leased facility. This new, two-building facility was occupied at the end of 2001, under a lease for approximately 290,000 square feet. During the first six years of the lease for the new facility, the Company can reduce the amount of leased square footage by up to a maximum of 32%, by paying certain unamortized costs of improvements and commissions. The separate lease for the Company's executive officesthat expires December 31, 2004, and contains a renewal option.2011. Combined rent for our Woodland Hills facilities was approximately $12.1 million in 2001.

        The Company and its subsidiariesWe also lease an aggregate of approximately 410,000 square feet of office space in Rancho Cordova, California. The Company'sOur aggregate rent obligations under these leases were approximately $6.4$6.6 million in 2000.2001. These leases expire at various dates through January 2003. The Rancho Cordova facilities house certain operations of our California HMO and our Government Contracts, Contracts/Specialty Services and California HMO operations.

    The Companysegment. We also leaseslease a total of approximately 250,000 square feet of office space in Irvine, California and San Rafael, California for certain Specialty Servicesspecialty services operations.

        In addition to the Company's office space referenced above, the Company and its subsidiarieswe lease approximately 130120 sites in 2322 states, comprisingtotaling roughly 1.51.47 million square feet of space.

        In addition, the Company ownsWe also own facilities comprising, in the aggregate, approximately 1.1 million850,000 square feet of space. These facilities include headquarters for the Company'sour health plan subsidiaries in Arizona Connecticut and Florida,Connecticut, as well as a data processing facility in Rancho Cordova, California. The Company is currently considering the sale of certain care centers in California and Arizona and unoccupied office buildings in Colorado and California.

        Management believesWe believe that itsour ownership and rental costs are consistent with those available forassociated with similar space in the applicable local area. The Company'sareas. Our properties are well maintained, considered adequateadequately meet our needs and are being utilized for their intended purposes.

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ITEM 3. LEGAL PROCEEDINGS

SUPERIOR NATIONAL INSURANCE GROUP, INC.

    The Company        We and itsour former wholly-owned subsidiary, Foundation Health Corporation ("FHC")(FHC), which merged into Health Net, Inc. in January 2001, were named in an adversary proceeding,Superior National Insurance Group, Inc. v. Foundation Health Corporation, Foundation Health Systems, Inc. and Milliman & Robertson, Inc. ("M&R") (M&R), filed on April 28, 2000, in the United States Bankruptcy Court for the Central District of California, case number SV00-14099GM. The lawsuit relates to the 1998 sale of Business Insurance Group, Inc. (BIG), a holding company of workers' compensation companies operating primarily in California, ("BIG"), by FHC to Superior National Insurance Group, Inc. ("Superior")(Superior).

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

Superior alleges that in the lawsuit that:

•

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



•

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



•

Superior is entitled to rescind its purchase of BIG; that



•

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



•

FHC breached the Stock Purchase Agreement; and that



•

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

        Superior seeks $300 million in compensatory damages, unspecified punitive damages and the costs of the action, including attorneys' fees.

        On August 1, 2000, a motion filed by the Companyus and FHC to remove the lawsuit from the jurisdiction of the Bankruptcy Court to the United States District Court for the Central District of California was granted, and thegranted. The lawsuit is now pending in the District Court under case number SACV00-0658 GLT. The parties are currently engaged in discovery. On January 1, 2001, FHC was merged into the Company.

        The Company intendsWe intend to defend itselfourselves vigorously in this litigation.

FPA MEDICAL MANAGEMENT, INC.

        Since May 1998, several complaints (the "FPA Complaints") have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible subordinated debentures and options to purchase common stock of FPA Medical Management, Inc. ("FPA")(FPA) at various times between February 3, 1997 and May 15, 1998. The FPA Complaintscomplaints name as defendants FPA, certain of FPA's auditors, the Companyus and certain of the Company'sour former officers. The FPA Complaintscomplaints allege that the Companywe and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between the Companyus and FPA, about FPA's business and about the Company'sour 1997 sale of FPA common stock held by the Company.us. All claims against the Company'sour former officers were voluntarily dismissed from the consolidated class actions in both federal and state court. The Company hasIn early 2000, we filed a motion to dismiss all claims asserted against itus in the consolidated federal class actions but hashave not formally responded to the other complaints. The Company intendsThat motion has been withdrawn without prejudice and the consolidated federal class actions have been stayed pending resolution of matters in a related case in which we are not a party. We intend to vigorously defend the actions.

BAJA INC. V. LOS ANGELES MEDICAL MANAGEMENT CORP., EAST LOS ANGELES DOCTORS HOSPITAL FOUNDATION, INC.

    In September 1983, a lawsuit was filed in Los Angeles Superior Court by Baja Inc. ("Baja") against East Los Angeles Doctors Hospital Foundation, Inc. ("Hospital") and Century Medicorp ("Century") arising out of a multi-phase written contract for operation of a pharmacy at the Hospital during the period September 1978 through September 1983. In October 1992, Foundation Health Corporation, now a subsidiary of the Company, acquired the Hospital and Century, and thereafter continued the vigorous defense of this action. In August 1993, the Court awarded Baja $549,532 on a portion of its claim. In December 1994, the Court concluded that Baja also could seek certain additional damages subject to proof. On July 5, 1995, the Court awarded Baja an additional $1,015,173 (plus interest) in lost profits damages. In October 1995, both of the parties appealed. The Court of Appeal reversed portions of the judgment, directing the trial court to conduct additional hearings on Baja's damages. In January 2000, after further proceedings on the issue of Baja's lost profits, the Court awarded Baja $4,996,019 in addition to the previous amounts, plus prejudgment interest. The Company

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has satisfied substantially all of the judgment, and the parties recently resolved their remaining issues related to the interest awarded on the judgment, which the Company was appealing.

ROMERO (FORMERLY PAY) V. FOUNDATION HEALTH SYSTEMS, INC.

    On November 22, 1999, a complaint was filed in the United States District Court for the Southern District of Mississippi in a lawsuit entitled Pay v. Foundation Health Systems, Inc. (2:99CV329). The complaint seeks certification of a nationwide class action and alleges that cost containment measures used by the Company's health maintenance organizations, preferred provider organizations and point-of-service health plans violate provisions of the federal Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal Employee Retirement Income Security Act ("ERISA"). The action seeks unspecified damages and injunctive relief.

    The case was stayed on January 25, 2000, pending the resolution of various procedural issues involving similar actions filed against Humana Inc. On June 23, 2000, the plaintiffs filed amended complaints in a Humana action that had been consolidated pursuant to the multi-district litigation statute in the Southern District of Florida to add claims against other managed care organizations, including the Company. On October 23, 2000, the court allowed the plaintiffs to further amend the complaint against the Company to add two new named plaintiffs and withdraw the originally named plaintiff, Kerrie Pay, from the action. Consequently, this case will now be entitledRomero v. Foundation Health Systems, Inc. On October 23, 2000, the Judicial Panel on Multi-District Litigation ruled that the action originally filed against the Company in the Southern District of Mississippi should be consolidated, for purposes of pre-trial proceedings only, with other cases pending against managed care organizations in the United States District Court for the Southern District of Florida in Miami. The Company has filed a motion to dismiss the case. Briefing on the motion to dismiss has been completed and the matter is currently pending before the court. Preliminary discovery and briefing regarding the plaintiff's motion for class certification has also been completed and the hearing on class certification has been scheduled for May 8, 2001. The Company intends to vigorously defend the action.

SHANE V. FOUNDATION HEALTH SYSTEMS, INC.

    On August 17, 2000, a complaint was filed in the United States District Court for the Southern District of Florida in a lawsuit entitled Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (00-1334-MD). The complaint seeks certification of a nationwide class action on behalf of physicians and alleges that the defendant managed care companies' methods of reimbursing physicians violate provisions of the RICO, ERISA, certain federal regulations and various state laws. The action seeks unspecified damages and injunctive relief. On September 22, 2000, the Company filed a motion to dismiss, or in the alternative to compel arbitration. On December 11, 2000, the court granted in part and denied in part the Company's motion to compel arbitration. Under the court's order, the single named plaintiff to allege a direct contractual relationship with the Company is compelled to arbitrate his direct claims against the Company. The Company has filed an appeal in the United States Court of Appeals for the 11^th Circuit seeking to overturn the portion of the district court's ruling that did not order certain claims to arbitration. On March 2, 2001, the District Court for the Southern District of Florida issued an order granting the dismissal of certain claims with prejudice and the dismissal of certain other claims without prejudice, and denying the dismissal of certain claims. On March 26, 2001, a consolidated amended complaint was filed in this action against managed care companies, including the Company. This consolidated complaint adds new plaintiffs, including Leonard Klay and the California Medical Association (who, as set forth below, had previously filed claims against the Company), and has, in addition to revising the pleadings of the original claims, added a claim under the California Business and Professions Code. The Company intends to file a motion to dismiss the consolidated amended complaint. Preliminary discovery and briefing regarding the plaintiffs' motion for class certification has taken place and the hearing on plaintiff's motion for class certification

19

is currently scheduled for May 7, 2001. In light of the filing of the March 26, 2001 consolidated complaint, additional class discovery and briefing may occur and the hearing on class certification may be rescheduled. The Company intends to vigorously defend the action.

STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC.

        Physicians Health Services, Inc. ("PHS")(PHS), a subsidiary of the Company,ours, was sued on December 14, 1999 in the United States District Court in Connecticut by the Attorney General of Connecticut, Richard Blumenthal, acting on behalf of a group of state residents. The lawsuit was premised on ERISA, and alleged that PHS violated its duties under that ActERISA by managing its prescription drug formulary in a manner that served its own financial interest rather than those of plan beneficiaries. The suit sought to have PHS revamp its formulary system, and to provide patients with written denial notices and instructions on how to appeal. PHS filed a motion to dismiss which asserted that the state residents the Attorney General purported to represent all received a prescription drug appropriate for their conditions and therefore suffered no injuries whatsoever, that his office lacked standing to bring the suit and that the allegations failed to state a claim under ERISA. On July 12, 2000, the court granted PHS' motion and dismissed the action. The State of Connecticut has filed an appeal. The Company intendsappealed the dismissal and argument on the appeal was held before the United States Court of Appeals for the Second Circuit on May 1, 2001. We intend to vigorously defend the action.

    Meanwhile,IN RE MANAGED CARE LITIGATION

        The Judicial Panel on September 7,Multidistrict Litigation has transferred various class action lawsuits against managed care companies, including us, to the United States District Court for the Southern District of Florida for coordinated or consolidated pretrial proceedings inIn re Managed Care Litigation, MDL 1334. This proceeding is divided into two tracks, the subscriber track, which includes actions brought on behalf of health plan members, and the provider track, which includes suits brought on behalf of physicians. We intend to vigorously defend all actions in MDL 1334.

Subscriber Track

        The subscriber track includes the following actions involving us:Pay v. Foundation Health Systems, Inc. (filed in the Southern District of Mississippi on November 22, 1999),Romero v. Foundation Health Systems, Inc. (filed in the Southern District of Florida on June 23, 2000 as an amendment to a suit filed in the Attorney GeneralSouthern District of Mississippi), State of Connecticut Richard Blumenthal, filed another lawsuit againstv. Physicians Health Services of Connecticut, Inc. ("PHS-CT"). This new suit also names (filed in the District of Connecticut on September 7, 2000), andAlbert v. CIGNA Healthcare of Connecticut, Inc., et al. (including Physicians Health Services of Connecticut, Inc. and Foundation Health Systems, Inc., Anthem Blue Cross) (filed in the District of Connecticut on September 7, 2000). ThePay and Blue ShieldRomero actions seek certification of CT, Anthem Health Plans, Inc., CIGNA Healthcarenationwide class actions, unspecified damages and injunctive relief, and allege that cost containment measures used by our health maintenance organizations, preferred provider organizations and point-of-service health plans violate provisions of CT, Inc., Oxford Health Plansthe federal Racketeer Influenced and Corrupt Organizations Act (RICO) and the federal Employee Retirement Income Security Act (ERISA). TheAlbert suit also alleges violations of CT, Inc. as defendants,ERISA and seeks certification of a nationwide class and unspecified damages and injunctive relief. TheState of Connecticut action asserts claims against PHS-CTour subsidiary, Physicians Health Services of Connecticut, Inc., and the Companyus that are similar, if not identical, to those asserted in the previous lawsuit that was dismissed, as discussed above, on July 12, 2000. On November 30, 2000,

        We filed a motion to dismiss the clerk oflead subscriber track case,Romero v. Foundation Health Systems, Inc., and on June 12, 2001, the Judicial Panel on Multi-District Litigationcourt entered an order conditionally transferringdismissing all claims in that suit brought against us with leave for the plaintiffs to re-file an amended complaint. On this casesame date, the court stayed discovery until after the court rules upon motions to dismiss the United States District Courtamended complaints and any motions to compel arbitration. On June 29, 2001, the plaintiffs inRomero filed a third amended class action complaint which re-alleges causes of action under RICO, ERISA, common law civil conspiracy and common law unjust enrichment. The third amended class action complaint seeks unspecified compensatory and treble damages and equitable relief. On July 24, 2001, the court heard oral argument on class certification issues. On August 13, 2001, we filed a motion to dismiss the third amended complaint inRomero. On February 20, 2002, the court ruled on our motion to dismiss the

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third amended complaint inRomero. The court dismissed all claims against us except one ERISA claim. The court further ordered that plaintiffs may file amended complaints no later than March 20, 2002, but that no new plaintiffs or claims will be permitted without prior leave of the court. Both plaintiffs and defendants have filed motions for reconsideration relating to various parts of the court's dismissal order.

Provider Track

        The provider track includes the following actions involving us:Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (filed in the Southern District of Florida on August 17, 2000 as an amendment to be consolidated for pretrial proceedings only with the other cases against managed care organizations pending in that court. The clerk of the Judicial Panel on Multi-District Litigation stayed the conditional transfer order on December 15, 2000 pending briefing and argument concerning whether transfer is appropriate. The Connecticut District Court has stayed the case pending the outcome of the Judicial Panel on Multi-District Litigation proceedings. The Company intends to vigorously defend the action.

ALBERT V. PHYSICIANS HEALTH SERVICES OF CONNECTICUT, INC.

    On September 7, 2000, a complaint wassuit filed in the United States District Court for the District of Connecticut in a lawsuit entitled Albert v. CIGNA Healthcare of Connecticut, Inc., et al. (including Physicians Health Services of Connecticut, Inc. and Foundation Health Systems, Inc.) (300CV1717-CJS). The complaint seeks certification of a nationwide class action and alleges that the defendant managed care companies' various practices violate provisions of the federal Employee Retirement Income Security Act ("ERISA"). The action seeks unspecified damages and injunctive relief. On November 30, 2000, the clerk of the Judicial Panel on Multi-District Litigation entered an order conditionally transferring this case to the United States District Court for the Southern District of Florida to be consolidated for pre-trial proceedings only with the other cases against managed care organizations pending in that court. The clerk of the Judicial Panel on Multi-District Litigation stayed the conditional transfer order on December 18, 2000 pending briefing and argument concerning whether transfer is appropriate. The plaintiff is objecting to transfer. The Company intends to vigorously defend the action.

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