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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period ended September 30, 2004

OR

For the transition period from              to             

Commission file number 001-31513

WELLCHOICE, INC.

(Exact name of registrant as specified in its charter)

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

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange

Act).     Yes  x    No  ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 84,005,079 shares of common stock, $0.01 par value, and one share of Class B common stock, $0.01 par value per share, as of October 25, 2004.

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WellChoice, Inc and Subsidiaries

INDEX TO FORM 10-Q

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WellChoice, Inc. and Subsidiaries

Consolidated Balance Sheets

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Consolidated Balance Sheets

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Consolidated Statements of Income

See notes to consolidated financial statements.

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WellChoice, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

See notes to consolidated financial statements.

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Notes to Consolidated Financial Statements

(Unaudited)

September 30, 2004

(Dollars in Thousands)

1. For-Profit Conversion and Initial Public Offering

WellChoice, Inc. (“WellChoice” or the “Company”) was formed in August 2002 as a Delaware corporation to be the for-profit parent holding company for Empire HealthChoice, Inc. (“EHC”) following EHC’s conversion from a not-for-profit health service corporation to a for-profit accident and health insurer. WellChoice owns a health maintenance organization (“HMO”) and two health insurance companies through its investment in WellChoice Holdings of New York, Inc. (“WellChoice Holdings”).

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

On June 21, 2004, the Fund sold 9,075,000 shares of common stock in a secondary public offering. The Company did not receive any proceeds from the offering. As of September 30, 2004, additional paid in capital was reduced by $748 to record expenses incurred as a result of this offering. At September 30, 2004, the Fund owned 52,001,903, or 61.9%, of the shares of common stock issued and outstanding.

2. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three month and nine month periods ended September 30, 2004 are not necessarily indicative of results that may be expected for the year ending December 31, 2004.

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

2. Basis of Presentation (continued)

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

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

Total comprehensive income for the three and nine months ended September 30, 2004 is $72,926 and $182,706, respectively. Total comprehensive income for the three and nine months ended September 30, 2003 is $44,311 and $147,260, respectively.

3. Capital Stock

Stock-based Compensation

The Company’s incentive plan provides for the grant of stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards and cash awards. On March 26, 2003, the Company’s Board of Directors adopted the 2003 Omnibus Incentive Plan (the “2003 Incentive Plan”). In accordance with the 2003 Incentive Plan, a maximum of 6,250,000 shares of common stock may be issued, including 1,875,000 shares solely for issuance under grants of restricted stock awards and restricted stock unit awards. A maximum of 500,000 shares may be issued to non-employee directors. Awards are granted by the Compensation Committee of the Board of Directors. Options vest and expire over terms set by the Committee at the time of grant.

During the three and nine months ended September 30, 2004, the Company granted 264,718 and 269,897 shares of the Company’s stock as restricted stock awards to certain eligible executives valued at the fair value of the stock on the grant date with no cost to the employee. These restricted stock awards vest over a three-year period. The fair value of these awards is being amortized to compensation expense over the vesting period. During the three and nine months ended September 30, 2004, 834 and 9,927, respectively, of previously awarded shares of restricted stock were forfeited by employees who left the Company. Administrative expense for the three and nine months ended

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

September 30, 2004 included $971 and $2,872, respectively, of compensation expense related to all outstanding awards. Unearned restricted stock compensation as of September 30, 2004 included $12,047 related to the restricted stock awards.

During the nine months ended September 30, 2004, the Company granted 11,557 shares of common stock as restricted stock unit awards to non-employee members of the Board of Directors. These restricted stock unit awards will vest over one year subject to the Director’s continued service other than termination due to retirement, death or disability prior to the vesting date. The actual shares underlying these restricted stock unit awards are issuable upon the Director’s termination of service from the Board. Stock units are settled in shares of WellChoice common stock. The fair value of restricted stock unit awards is being amortized to compensation expense over the vesting period. Administrative expense for the three and nine months ended September 30, 2004 included $275 and $690, respectively, of compensation expense related to restricted stock unit awards. Unearned restricted stock compensation as of September 30, 2004 included $518 related to restricted stock units.

A summary of the stock option activity for the nine months ended September 30, 2004 is as follows:

There were no options exercised or expired for the nine months ended September 30, 2004.

Employee Stock Purchase Plan

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

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

may participate. No employee will be permitted to purchase more than $25 worth of stock in any calendar year, based on the fair market value of the stock at the beginning of each offering period. The purchase price per share is 85% of the lower of the fair market value of a share of common stock on the first day or the last day of the offering period. Employees become participants by electing payroll deductions from 1% to 10% of their base compensation and all or part of any incentive compensation, after-tax. The Company has two offering periods beginning on January 1 and July 1 of each calendar year. The first offering period of the Stock Purchase Plan commenced on January 1, 2004. Payroll deductions of $1,998 had been accumulated and applied towards the purchase of 66,729 shares of common stock on June 30, 2004, the last day of the offering period. Payroll deductions of $736 have been accumulated as of September 30, 2004 and will be applied towards the purchase of stock on December 31, 2004 (or the first business day thereafter). Once purchased, the stock is accumulated in the employee’s investment account.

Earnings Per Share

For the three months and nine months ended September 30, 2004 and 2003, earnings per share amounts, on a basic and diluted basis, have been calculated based upon the weighted-average common shares outstanding for the year.

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

Pro Forma Disclosure

The Company accounts for stock-based compensation using the intrinsic method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, if the exercise price is equal to the fair market value of the shares at the date of the grant, the Company recognizes no compensation expense related to stock options or shares issued under the stock purchase plan. For grants of restricted stock awards and restricted stock unit awards, unearned compensation, equivalent to the fair value of the shares at the date of grant, is recorded as a separate component of shareholders’ equity and subsequently amortized to compensation expense over the vesting period.

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended. For purposes of pro forma disclosures, compensation expense is increased for the estimated fair value of the options amortized over the options’ vesting periods. The Company’s pro forma information is as follows:

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WellChoice, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

3. Capital Stock (continued)

The denominator for basic and diluted earnings per share for the three and nine months ended September 30, 2004 is as follows:

4. Accounting for Costs Associated with Exit or Disposal Activities

During the third quarter of 2003, management determined that based on current and projected occupancy requirements, the Company would not receive economic benefit from certain unoccupied leased office space. Management intends to market this space for sublease. In accordance with FAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” the Company recognized an administrative expense of $13,367 for the three and nine months ended September 30, 2003, representing the net present value difference between the fair value of estimated sublease rentals and the remaining lease obligation for this space. These costs were included in other liabilities at September 30, 2003. Based on additional information obtained during the first quarter of 2004, the Company further reduced the fair market value of estimated sublease rentals and recognized an additional administrative expense of $1,110 for the nine months ended September 30, 2004.

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

5. Market Stabilization Pools

The Company is required to participate in Market Stabilization and Stop Loss Pools (“Pools”) as established by the State of New York. Contributions and recoveries under the Pools are estimated based upon information received by the administrator of the Pools and are adjusted as new information becomes known. In August 2003, the New York Insurance Department clarified the manner and extent to which the policyholders are to receive the benefit of the funds in the second quarter of 2003 received relating to Medicare Supplemental Pool years 2000 through 2002. As a result, the Company recorded a premium refund liability of $19,659 and recognized $15,223 as income in the three months ended September 30, 2003. Pool recoverables included in miscellaneous receivables were $33,861 and $21,753 at September 30, 2004 and 2003, respectively.

6. Income Taxes

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

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

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

6. Income Taxes (continued)

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

As a result of the conversion to a for-profit accident and health insurance company in 2002, EHC adjusted its deferred tax assets for temporary differences related to its liability for state and local taxes which resulted in the recognition of a $5,374 deferred tax asset. In May 2003, the New York State Legislature enacted legislation that eliminated the net income portion of the New York State franchise tax applicable to every insurance company other than life insurance companies, effective January 1, 2003. As a result, the Company’s tax provision for the nine months ended September 30, 2003 was increased $653, reflecting the reversal of the $5,374 deferred tax asset and $4,721 of franchise taxes incurred attributed to the three month period ended March 31, 2003.

During the second quarter of 2004, the Company reached a settlement with the Internal Revenue Service (“IRS”) related to the valuation of the Company’s former headquarters sold in 1997. The Company had obtained an independent appraisal of the property as of January 1, 1987 (the date the Company became subject to federal income taxes) to support its value for the property. The Company recorded a contingent tax expense of approximately $9,200 to reflect its best estimate of the ultimate settlement with the IRS. The final settlement amount was $3,500 and as a result, the Company’s tax provision for the nine months ended September 30, 2004 was decreased by $5,687.

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

6. Income Taxes (continued)

Prior to January 1, 1987, EHC was exempt from federal income taxes. With the enactment of the Tax Reform Act of 1986, EHC, and all other Blue Cross and Blue Shield plans, became subject to federal income tax. Among other provisions of the Internal Revenue Code, these plans were granted a special deduction (the “833(b) deduction”) for regular tax calculation purposes The 833(b) deduction is calculated as the excess of 25% of the incurred claim and claim adjustment expenses for the tax year over adjusted surplus, as defined, limited to taxable income. The amount of 833(b) deductions utilized in each tax year is accumulated in an adjusted surplus balance. Once the cumulative adjusted surplus balance exceeds the 833(b) deduction for the current taxable year, the deduction is eliminated. As a result of the 833(b) deduction, EHC incurred no regular tax liability, but in profitable years, paid taxes at the alternative minimum tax rate of 20%. The Company’s ability to utilize the 833(b) deduction was exhausted in 2003.

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

The Company has no regular tax loss carryforwards. The Company’s alternative minimum tax credit carryforward for income tax purposes of $232,000 has no expiration date.

7. Investments

The Company participates in a securities lending program, whereby certain securities from its portfolio are loaned to qualified brokers in exchange for cash collateral, at least equal to the 102% of the market value of the securities loaned. The securities lending agent indemnifies the Company against loss in the event of default by the borrower. Income generated by the securities lending program is reported as a component of net investment income. As of September 30, 2004, $239,077 of fixed maturity securities were loaned under the program.

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

8. Pension Benefits and Other Postretirement Employee Benefits

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

Other postretirement employee benefits expense included the following components:

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“Modernization Act”) was signed into law. The Modernization Act introduced a voluntary Medicare Part D prescription drug benefit and created a new 28% federal subsidy for the sponsors of the postretirement prescription drug benefits that are at least actuarially equivalent to the new Medicare Part D benefit. The current measurements of accumulated postretirement benefit obligation and net periodic postretirement benefit cost do not reflect any amount associated with the subsidy as

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

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

WellChoice is unable, at this time, to conclude whether the benefits provided by the plan are actuarially equivalent to Medicare Part D under the Modernization Act.

9. Restructuring

During the second quarter of 2002, in connection with the Company’s information technology outsourcing agreement with IBM, the Company began the implementation of a restructuring plan relating to its information technology personnel. Certain employees were involuntarily terminated in accordance with a plan of termination, certain employees were retained by the Company and certain employees were transitioned to IBM. Severance and other costs accrued at June 30, 2002 relating to the plan of termination were $5,351. During the nine months ended September 30, 2004, the Company expensed an additional $209 related to an adjustment to the estimated severance and other compensation costs previously accrued. Payments related to these costs of approximately $5,533 were made through September 30, 2004. To help retain its employees and to help IBM retain its newly transitioned employees, the Company offered stay bonuses for these individuals. The Company recognizes the costs of these stay bonuses as these employees provide service. Administrative expense for the nine months ended September 30, 2004 and 2003, included $604 and $3,780, respectively, related to these bonuses.

In November 2002, as part of the Company’s continuing focus on increasing overall productivity, and in part as a result of the implementation of the technology outsourcing strategy, the Company continued streamlining certain operations and adopted a plan to terminate approximately 500 employees across all segments of its business. Severance and other costs of $13,472 were accrued relating to the plan. In March 2004, the Company expensed an additional $649 related to an adjustment to the estimated severance and other compensation costs previously accrued. Through September 30, 2004, payments related to these costs of $14,106 were made. In the effort to facilitate the restructuring plan certain employees were offered stay bonuses. The Company recognizes the costs of these stay bonuses as these employees provide service. Administrative expense for the nine months ended September 30, 2004 and 2003, included $225 and $635, respectively, related to these bonuses.

10. Contingencies

Consumers Union of U.S., Inc. et. al. On August 20, 2002, Consumers Union of U.S., Inc., the New York Statewide Senior Action Council and several other groups and individuals filed a lawsuit in New York Supreme Court challenging Chapter One of the New York Laws of 2002, which the Company refers to as the Conversion Legislation, on several constitutional

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

10. Contingencies (continued)

grounds, including that it impairs the plaintiffs’ contractual rights, impairs the plaintiffs’ property rights without due process of law, and constitutes an unreasonable taking of property. In addition, the lawsuit alleges that Empire HealthChoice, Inc., or HealthChoice, has violated Section 510 of the New York Not-For-Profit Corporation Law and that the directors of HealthChoice breached their fiduciary duties, among other things, in approving the plan of conversion. On September 20, 2002, the Company responded to this complaint by moving to dismiss the plaintiffs’ complaint in its entirety on several grounds. On November 6, 2002, pursuant to a motion filed by plaintiffs, the New York Supreme Court issued a temporary restraining order temporarily enjoining and restraining the transfer of the proceeds of the sale of common stock issued in the name of, or on behalf of, the Fund or the Foundation to the State or any of its agencies or instrumentalities. The court also ordered that such proceeds be deposited in escrow with The Comptroller of the State of New York pending the hearing of the application for a preliminary injunction. The court did not enjoin WellChoice, HealthChoice or the other defendants from completing the conversion or our initial public offering. On March 6, 2003, the court delivered its decision dated February 28, 2003, in which it dismissed all of the plaintiffs’ claims in the complaint.

However, the February 28, 2003 decision granted two of the plaintiffs, Consumers Union and one other group, leave to replead the complaint to allege that the Conversion Legislation violates the State Constitution on the ground that it is a local law granting an exclusive privilege, immunity and/or franchise to HealthChoice. On April 1, 2003, the remaining plaintiffs filed an amended complaint, asserting the State constitutional claim as suggested in the court’s decision. The amended complaint seeks to invalidate the Conversion Legislation and, for the first time, to rescind our initial public offering. On May 28, 2003, the defendants filed motions to dismiss the amended complaint in its entirety, for failure to state a claim. On October 1, 2003, the court dismissed all claims against the individual members of the board of directors of HealthChoice, but denied defendants’ motions to dismiss the amended complaint. In its decision, the court stated that the plaintiffs’ decision to limit their request for preliminary relief in their original complaint to restraining the disposition of the selling stockholders’ proceeds of the initial public offering, but not to block the offering, may affect such ultimate relief as may be granted in the action, but was not a reason to dismiss the amended complaint.

The parties appealed the February 28, 2003 and the October 1, 2003 decisions and on May 20, 2004, the New York State Appellate Division, First Department, unanimously upheld the lower court’s decisions on (a) February 28, 2003 to dismiss all of the plaintiffs’ claims in the initial complaint and (b) October 1, 2003 to deny defendants’ motion to dismiss the amended complaint. In addressing the plaintiffs’ allegation that the Conversion Legislation is prohibited by the State Constitution and therefore invalid, the court rejected the defendants’ position that the Conversion Legislation does not fall within the constitutional prohibition. The court stated that the language of the constitutional

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

10. Contingencies (continued)

prohibition, at least facially, provides no support for an exception for the Conversion Legislation. On June 24, 2004, all parties filed motions before the Appellate Division requesting that the cases be certified for immediate review by the New York State Court of Appeals to determine whether the Appellate Division’s May 20, 2004 decision was proper. On October 12, 2004, the Appellate Division granted these motions and the Company expects the Court of Appeals to hear the appeal.

The parties have agreed to stay the lower court proceedings, pending resolution of all appeals of both motions. Pursuant to a stipulation, pending the final disposition of the appeals, the proceeds of any sale of any of our stock issued in the name of, or on behalf of, the Fund or the Foundation, shall be transferred to The Comptroller of the State of New York, to be held in escrow in a separate interest bearing account.

Thomas, et al. v. Empire, et al. In May 2003, this putative class action was commenced in the United States District Court for the Southern District of Florida, Miami Division against the Blue Cross Blue Shield Association, Empire and substantially all of the other Blue plans in the country. The named plaintiffs have brought this case on their own behalf and also purport to bring it on behalf of similarly situated physicians and seek damages and injunctive relief to redress their claim of economic losses which they allege is the result of defendants, on their own and as part of a common scheme, systemically denying, delaying and diminishing claim payments. More specifically, plaintiffs allege that the defendants deny payment based upon cost or actuarial criteria rather than medical necessity or coverage, improperly downcode and bundle claims, refuse to recognize modifiers, intentionally delay payment by pending otherwise payable claims and through calculated understaffing, use explanation of benefits, or EOBs, that fraudulently conceal the true nature of what was processed and paid and, finally, by use of capitation agreements which they allege are structured to frustrate a provider’s ability to maximize reimbursement under the capitated agreement. The plaintiffs allege that the co-conspirators include not only the named defendants but also other insurance companies, trade associations and related entities such as Milliman and Robertson (actuarial firm), McKesson (claims processing software company), National Committee for Quality Assurance, Health Insurance Association of America, the American Association of Health Plans and the Coalition for Quality Healthcare. In addition to asserting a claim for declaratory and injunctive relief to prevent future damages, plaintiffs assert several causes of action based upon civil RICO and mail fraud.

The plaintiffs have subsequently amended their complaint, adding several medical societies as additional plaintiffs a cause of action based upon an assignment of benefits, adding several additional defendants including WellChoice, Inc. and two of its other subsidiaries,

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

10. Contingencies (continued)

WellChoice Insurance of New Jersey, Inc. and Empire HealthChoice HMO, Inc. and dropping their direct RICO claim, but instead base their RICO claim solely on a conspiracy theory.

In October 2003, the action was transferred to District Court Judge Federico Moreno, who also presides over Shane v. Humana, et al., a class-action lawsuit brought against other insurers and HMOs on behalf of health care providers nationwide. The Thomas case involves allegations similar to those made in the Shane action. In the Shane case, the 11^th Circuit Court of Appeals, on September 1, 2004, upheld class certification as to RICO related claims but decertified a class as to state law claims. On October 15, 2004, the Shane defendants filed a petition for a writ of certiorari, seeking U.S. Supreme Court review of the 11^th Circuit decision.

On June 14, 2004, the court ordered the commencement of discovery. The defendants filed motions to dismiss on October 4, 2004, which are pending before the court. Meanwhile, class certification discovery is to be concluded by December 31, 2004, by which date plaintiffs are to file their motion for class certification.

Solomon, et al. v. Empire, et al. In November 2003, this putative class action was commenced in the United States District Court for the Southern District of Florida, Miami Division against the Blue Cross Blue Shield Association, Empire and substantially all other Blue plans in the country. This case is similar to Thomas, et al. v. Empire, et al, except that this case is brought on behalf of certain ancillary providers, such as podiatrists, psychologists, chiropractors and physical therapists. Like the Thomas plaintiffs, the Solomon plaintiffs allege that the defendants, on their own and as part of a common scheme, systematically deny, delay and diminish payments to these providers. The plaintiffs’ allegations are similar to those set forth in Thomas but also include an allegation that defendants have subjected plaintiffs claims for reimbursement to stricter scrutiny than claims submitted by medical doctors and doctors of osteopathy. Plaintiffs are seeking compensatory and monetary damages and injunctive relief. The complaint was subsequently amended to add several new parties, including WellChoice, Inc. and two of its other subsidiaries, WellChoice Insurance of New Jersey, Inc. and Empire HealthChoice HMO, Inc.

By an Order dated January 7, 2004, the case was transferred to Judge Moreno, but not consolidated with the other pending actions. The Court, on its own initiative, deemed this action a “tag along” action to the Shane litigation, and ordered the case closed for statistical purposes and placed the matter in a civil suspense file.

On June 14, 2004, the court ordered the commencement of discovery. The defendants filed motions to dismiss on August 27, 2004 which are pending before the court. Meanwhile, class

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

10. Contingencies (continued)

certification discovery is to be concluded by December 31, 2004, by which date plaintiffs are to file their motion for class certification.

The Company intends to vigorously defend all these proceedings; however, their ultimate outcomes cannot presently be determined.

Other. The Company is also involved in and is subject to numerous claims, contractual disputes and uncertainties in the ordinary course of business. The Company believes that it has meritorious defenses in all of these matters and intends to vigorously defend its respective positions. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial condition.

11. Segment Information

WellChoice has two reportable segments: commercial managed care and other insurance products and services. The commercial managed care segment includes group preferred provider organization, or PPO, health maintenance organization, or HMO (including Medicare+Choice), exclusive provider organization, or EPO, and other products (point of service products and dental only coverage). The Company’s New York City and New York State PPO business accounted for approximately 34.2% of the Company’s earned premium for the nine months ended September 30, 2004.

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

Income from continuing operations before income tax expense for the nine months ended September 30, 2004 included administrative expenses of $883 and $227, for the commercial managed care and other insurance products and services segments, respectively, related to unoccupied leased office. Income from continuing operations before income tax expense for the nine months ended September 30, 2003 included administrative expenses of $10,717 and $2,650, for the commercial managed care and other insurance products and services segments, respectively, related to unoccupied leased office space, see footnote 4.

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

11. Segment Information (continued)

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

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Notes to Consolidated Financial Statements (continued)

(Unaudited)

(Dollars in Thousands)

11. Segment Information (continued)

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

12. Subsequent Events

In June 2002, the Company entered into a ten-year outsourcing agreement with IBM. In September 2003, the section of the agreement that provides for IBM to assist the Company in developing new information technology systems was amended. The original agreement required the Company to purchase $65,000 of modernization services and equipment from IBM over a five-year term. Effective September 2003, the Company’s purchase requirement was reduced to $55,000 and the term extended to seven years. On October 27, 2004, the agreement was amended and the remainder of the Company’s purchase requirement was eliminated. In addition, IBM and the Company have terminated the agreement related to the development of a new claims payment system.

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