S-1/A 1 ds1a.htm AMENDMENT NO. 7 TO FORM S-1 Amendment No. 7 to Form S-1
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As filed with the Securities and Exchange Commission on November 5, 2002
Registration No. 333-99051
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
AMENDMENT NO. 7
TO
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
 
 
WELLCHOICE, INC.
(Exact Name of Registrant as Specified in its Charter)
 
 
Delaware
  
6324
  
71-0901607
(State or Other Jurisdiction of Incorporation or Organization)
  
(Primary Standard Industrial Classification Code Number)
  
(I.R.S. Employer
Identification Number)
11 West 42nd Street
New York, New York 10036
(212) 476-7800
(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)
 
 
Michael A. Stocker, M.D.
Chief Executive Officer
WellChoice, Inc.
11 West 42nd Street
New York, New York 10036
(212) 476-7800
(Name, Address, including Zip Code, and Telephone Number, including Area Code, of Agent for Service)
 
 
Copies to:
 
Ira M. Millstein, Esq.
  
Linda V. Tiano, Esq.
  
Serge Benchetrit, Esq.
Matthew Bloch, Esq.
  
Seth I. Truwit, Esq.
  
Willkie Farr & Gallagher
Weil, Gotshal & Manges LLP
  
WellChoice, Inc.
  
787 Seventh Avenue
767 Fifth Avenue
  
11 West 42nd Street
  
New York, New York 10019
New York, New York 10153
 
New York, New York 10036
  
(212) 728-8000
(212) 310-8000
  
(212) 476-7800
   
 
 
Approximate date of commencement of proposed sale to the public:    As soon as practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨                     
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨                     
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨                     
If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.  ¨
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.
 

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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED NOVEMBER     , 2002
 
13,861,053 Shares
 
 
LOGO
 
WellChoice, Inc.
 
Common Stock
 
 
Prior to this offering, there has been no public market for our common stock. The initial public offering price of our common stock is expected to be between $21.00 and $24.00 per share. Our common stock has been approved for listing on the New York Stock Exchange under the symbol “WC,” subject to official notice of issuance.
 
The shares of common stock are being sold by The New York Public Asset Fund, or the Fund, and The New York Charitable Asset Foundation, or the Foundation. We will not receive any of the proceeds from the shares of common stock sold by the Fund and the Foundation. The Fund and the Foundation will own 95% and 5%, respectively, of our common stock immediately preceding the completion of the offering and will own approximately 79% and 4.2%, respectively, of our common stock immediately after the offering, including one share of Class B common stock owned by the Fund.
 
Our certificate of incorporation prohibits any institutional investor from owning 10% or more of our outstanding voting securities, any noninstitutional investor from owning 5% or more of our outstanding voting securities and any person or entity from owning equity securities representing a 20% or more ownership interest in our company. These ownership restrictions will apply to the shares sold in this offering but will not apply to the Fund. See “Description of Capital Stock” on page 109 for a more detailed discussion of these restrictions.
 
The New York State Superintendent of Insurance has neither approved nor disapproved of these securities or determined if this prospectus is truthful or complete.
 
The underwriters have an option to purchase a maximum of 2,079,158 additional shares from us and the selling stockholders to cover over-allotments of shares.
 
Investing in our common stock involves risks. See “Risk Factors” on page 9.
 
      
Price to
Public
   
Underwriting
Discounts and Commissions
     
Proceeds to the Selling
Stockholders
Per Share
     
$
            
   
$
               
     
$
            
Total
     
 
$                
   
 
$                      
     
 
$                  
 
Delivery of the shares of common stock will be made on or about            , 2002.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
Credit Suisse First Boston
 
UBS Warburg     
  
Bear, Stearns & Co. Inc.
  
Morgan Stanley
Goldman, Sachs & Co.
     
JPMorgan
  
    Salomon Smith Barney
Blaylock & Partners, L.P.
     
    The Williams Capital Group, L.P.
 
The date of this prospectus is             , 2002

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TABLE OF CONTENTS
 
 
 
You should rely only on the information contained in this document or to which we have referred you. We have not authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document.
 
New York and New Jersey insurance laws and New York health regulations require the prior approval of the New York and New Jersey insurance regulators and the New York health regulators for any acquisition of control of WellChoice, where “control” is presumed to exist if a person owns 10% or more of voting common stock. See “Description of Capital Stock—New York and New Jersey Insurance Laws.”
 
In addition, unless otherwise indicated, all financial data presented in this prospectus has been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. You should be aware that the New York State Department of Insurance recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the New York insurance laws and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the New York State Department of Insurance to financial statements prepared in accordance with GAAP in making such determinations. See note 10 to our consolidated financial statements.
 
Dealer Prospectus Delivery Obligation
 
Until                    , 2002 (25 days after the commencement of the offering), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

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PROSPECTUS SUMMARY
 
This summary highlights information contained elsewhere in this prospectus and may not contain all of the information that may be important to you. You should read this entire prospectus carefully, including the information set forth in “Risk Factors,” before making an investment decision. In this prospectus, “WellChoice,” “company,” “we,” “us,” and “our” refer to WellChoice, Inc., a Delaware corporation, and, as the context requires, its subsidiaries including Empire HealthChoice, Inc. following that entity’s conversion from a not-for-profit health service corporation to a for-profit accident and health insurer under the New York insurance laws in a series of transactions described in this prospectus under the caption “The Plan of Conversion.”
 
Our Company
 
We are the largest health insurance company in the State of New York based on PPO and HMO membership. We serve over 4.6 million members throughout our service areas which include the New York City metropolitan area, where we hold a leading market position covering over 20% of the population, upstate New York and New Jersey. We have the exclusive right to use the Blue Cross and Blue Shield names and marks throughout the New York City metropolitan area and one or both of these names and marks in selected counties in upstate New York.
 
We have a long tradition of serving health insurance needs in New York, having operated in the state for 68 years. New York is the third most populous state in the United States, with a total population of approximately 19.0 million, according to the most recent U.S. census. We believe we can significantly increase our market share through focused market efforts on a cost effective basis, given the high population density in selected markets, such as the New York City metropolitan area. Moreover, the New York marketplace presents a diverse customer base which requires a broad range of product offerings and which we believe we are well positioned to serve.
 
We have the largest hospital and physician networks of any health insurer or HMO in our New York State service areas. Our provider networks consist of many of the most well recognized provider organizations and include more physicians listed on New York Magazine’s June 2002 list of Best Doctors than any other health benefits provider.
 
We offer a broad range of products and services to our members, including managed care products and traditional indemnity products, positioning us well to respond to shifts in customer needs and marketplace trends. Our managed care product offerings include health maintenance organizations, or HMOs, preferred provider organizations, or PPOs, and exclusive provider organizations, or EPOs. We offer our products to a broad range of customers, including large groups of more than 500 employees; middle-market groups, ranging from 51 to 500 employees; small groups, ranging from two to 50 employees, and individuals. Over one million of our members are employees of national accounts, including Fortune 500 companies.
 
Since 1995, our current management team has helped reverse reductions in membership and profitability that we experienced between 1988 and 1995, and has delivered an extended period of growth and profitability. Since 1998, we have experienced 15 consecutive quarters of underwriting gain (which we define as premiums earned plus administrative service fees, less cost of benefits provided and administrative expenses). As of June 30, 2002, we had total assets of $2.5 billion and total reserves for policyholders’ protection, or GAAP surplus, of $964.9 million. For the six months ended June 30, 2002, our total revenue was $2.6 billion and our net income was $138.7 million. In May 2002, Standard & Poor’s, or S&P, raised the financial strength and counterparty credit rating of Empire HealthChoice, Inc., or HealthChoice, to “A-,” which represents the third highest of nine S&P ratings categories and is within the “strong” category (“A+,” “A,” and “A-”). This rating is not a recommendation to buy, sell or hold securities and may be revised or withdrawn by S&P at any time.

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The following table illustrates the historical improvement in our operating results and financial condition:
 
    
Year ended December 31,
   
Six months
ended
June 30,
    
1997
   
1998
   
1999
   
2000
   
2001
   
2002
    
(in millions)
Total revenue
   
$
3,424.6
   
$
3,298.0
   
$
3,664.9
   
$
4,233.7
   
$
4,631.2
   
$
2,601.7
Income from continuing operations before income taxes
   
 
48.1
   
 
41.0
   
 
129.3
   
 
120.5
   
 
147.6
   
 
139.8
Net income
   
 
51.9
   
 
42.0
   
 
120.2
   
 
190.4
   
 
131.0
   
 
138.7
Total assets (at end of period)
   
 
1,808.1
   
 
1,837.3
   
 
1,987.4
   
 
2,252.5
   
 
2,449.6
   
 
2,482.3
GAAP surplus (at end of period)
   
 
334.0
   
 
379.5
   
 
502.7
   
 
674.7
   
 
829.3
   
 
964.9
 
Our Strategy
 
Our goal is to be the leading health insurer in the New York marketplace and surrounding areas. During the past several years, we have implemented strategic changes to achieve this goal, including shifting our membership base from purchasers of mainly traditional indemnity products to more innovative managed care products, standardizing our product offerings and consolidating our networks and claims payment systems. We plan to continue to maintain and improve our market position and financial performance by executing the following strategy:
 
 
•
 
Capitalize on Growth Opportunities.
 
 
—
 
Offer a broad spectrum of managed care products in our local markets. We intend to continue to grow our business, particularly in the profitable middle-market group, by maintaining, developing and offering the broad continuum of managed care products that the New York market demands. To accomplish this goal, we will continue to design our products based on freedom in selecting providers, cost sharing, scope of coverage and degree of medical management. We believe that our broad range of products gives us a market advantage that enables us to be the sole managed care provider to many of our customers.
 
 
—
 
Grow our national accounts business. We view national accounts as an attractive growth opportunity as this group represents approximately 38% of employed persons in the United States. We intend to continue to grow this part of our business by capitalizing on our position in the New York City metropolitan area where a significant number of national businesses have offices and through promotion of the BlueCard program. The BlueCard program enables our members to obtain coverage from the networks of other Blue Cross Blue Shield plans across the country, making it possible for us to compete for national accounts business with other non-“Blue” plans with nationwide networks.
 
 
—
 
Expand geographically. We also intend to pursue expansion opportunities, especially those in or adjacent to our current service areas. We believe that we have developed an expertise in systems migration, network development, marketing, underwriting and cost control that is transferable to attractive markets within and outside New York and which positions us to take advantage of opportunities that may arise as the consolidation of the health insurance industry continues.
 
 
•
 
Leverage the Strength of the Blue Cross and Blue Shield Brands. We believe that our license to use the Blue Cross and Blue Shield names and marks gives us a significant competitive advantage in New York, and we intend to continue to promote the value of these brands to attract additional customers and members.

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•
 
Continue to Promote the Use of Medical Information to Offer Innovative Products and Services to Members and Providers. We intend to be a leader in the use of medical information to facilitate and enhance communications and delivery of service among employers, employees and other health care providers. We believe that our members will increasingly desire and demand ready access to a repository of comprehensive, accurate and secure medical and health related information that can be transmitted by the member to physicians and medical institutions. We have implemented a number of programs that position us well to establish a leadership role in this area.
 
 
•
 
Reduce Costs through Operational Excellence. We are seeking to achieve operational excellence by improving delivery of service, customer satisfaction and financial results through zero defects, rapid turnaround times and lower operating costs. We are executing a number of initiatives that we believe will enable us to realize medical and administrative cost savings.
 
Our ability to successfully execute this strategy and achieve our goals, and our business generally, is subject to a number of risks, some of which are beyond our control. These risks include those relating to our business specifically. For example, we could lose our license to use the Blue Cross and Blue Shield names and marks and we are subject to intense competition for customers and providers. Also, our industry is heavily regulated and changes in legislation or regulation may adversely affect us. For a more detailed discussion of these and other risks, see “Risk Factors” beginning on page 9 of this prospectus.
 
The Plan of Conversion
 
In January 2002, the Governor of the State of New York signed into law Chapter One of the New York Laws of 2002, which we refer to as the Conversion Legislation. Under the Conversion Legislation, HealthChoice filed an amended plan of conversion with the New York State Department of Insurance on June 18, 2002 (which was further amended and refiled on September 26, 2002), to convert from a not-for-profit health service corporation to a for-profit accident and health insurer under the New York insurance laws. Under the Conversion Legislation, the plan of conversion must be approved by the New York State Superintendent of Insurance, or Superintendent, on or prior to the effectiveness of this offering. Any such approval by the Superintendent of the plan of conversion will not constitute a recommendation to purchase our common stock. We also have requested approvals from the Superintendent and, where necessary, from the New York State Commissioner of Health, or the Commissioner, the New Jersey Department of Banking and Insurance, the Centers for Medicare and Medicaid Services, or CMS, and the Blue Cross Blue Shield Association, an association of independent Blue Cross and Blue Shield plans (which we have obtained), for certain transactions related to the plan of conversion. On August 6 and 7, 2002, public hearings took place in New York City and Albany, respectively, with respect to the plan of conversion. On October 8, 2002, the Superintendent issued an Opinion and Decision approving the plan of conversion and concluding that the conversion is in compliance with the Conversion Legislation and does not violate any applicable laws or regulations. The approval and conclusions are subject to several conditions, including the approval by the Superintendent, the Commissioner and CMS of certain of the agreements that we will enter into in connection with the conversion. Pursuant to the Conversion Legislation, the Opinion and Decision may be challenged until November 7, 2002, the 30th day following the date of the Opinion and Decision. Judicial review of any challenge to the Opinion and Decision is limited to a finding that the Superintendent acted in an arbitrary or capricious manner in reaching a determination to approve the plan of conversion.
 
In accordance with the plan of conversion, immediately prior to the effectiveness of this offering, HealthChoice will convert from a not-for-profit health services corporation to a for-profit accident and health insurer under the New York insurance laws and the converted HealthChoice will issue all of its authorized capital stock to the Fund and the Foundation. The Fund and the Foundation will then receive their respective shares of our common stock in exchange for the transfer of all of the outstanding shares of HealthChoice to one of our

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direct wholly owned subsidiaries. Empire HealthChoice Assurance, Inc., an existing, for-profit, New York licensed accident and health insurance subsidiary of HealthChoice then will merge with the converted HealthChoice, with HealthChoice surviving under the name “Empire HealthChoice Assurance, Inc.” We refer to the surviving corporation as Empire.
 
The Fund was established under the Conversion Legislation to receive the “public asset,” or the assets representing 95% of the fair market value of HealthChoice and its subsidiaries on the effective date of the conversion. The Foundation is a New York not-for-profit corporation established prior to the effective date of the offering pursuant to the Conversion Legislation for charitable purposes to receive the “charitable asset,” or the assets representing 5% of the fair market value of HealthChoice and its subsidiaries on the effective date of the conversion. See “The Plan of Conversion.”
 
WellChoice was incorporated in Delaware in August 2002. Prior to the completion of the conversion and this offering, WellChoice has not and will not engage in any operations. Our principal executive offices are located at 11 West 42nd Street, New York, New York 10036. Our telephone number is (212) 476-7800.
 
Recent Developments
 
For the nine months ended September 30, 2002, our income from continuing operations before taxes increased 113.9% to $227.0 million, from $106.1 million for the nine months ended September 30, 2001. As of September 30, 2002, total enrollment was approximately 4.6 million and commercial managed care enrollment was 3.8 million (82.6% of total enrollment). Premium revenue increased 8.0%, or $256.0 million, to $3.5 billion for the nine months ended September 30, 2002, from $3.2 billion for the nine months ended September 30, 2001. Administrative service fee revenue increased 24.0%, or $57.8 million, to $298.5 million for the nine months ended September 30, 2002 from $240.7 million for the nine months ended September 30, 2001. See our more detailed discussion of these developments in the section of this prospectus entitled “Recent Developments.”

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The Offering
 
Common stock offered by:
     
The Fund
   
13,168,000 shares
The Foundation
   
     693,053 shares
Total
   
13,861,053 shares
Common stock outstanding after the offering
   
82,300,000 shares of common stock and one share of Class B common stock which will be held by the Fund and will provide the Fund with certain approval rights. See “Description of Capital Stock—Description of Common Stock and Class B Common Stock.”
Use of Proceeds
   
We will not receive any proceeds from the sale of shares by the Fund and the Foundation. If the underwriters exercise their over-allotment option in full, we estimate that the net proceeds to us will be $25.1 million, after deducting the underwriting discount. We would use these funds to pay offering and conversion expenses and for general corporate purposes.
Dividend Policy
   
We currently do not intend to pay cash dividends on our common stock. Any future dividends will be subject to our financial condition, declaration by our board of directors, statutory limitations and other factors described under “Dividend Policy.”
Risk Factors
   
For a discussion of factors you should consider before buying the shares, see “Risk Factors.”
New York Stock Exchange Symbol
   
“WC”
 
About this Prospectus
 
Unless otherwise indicated, the information in this prospectus:
 
 
•
 
assumes an initial public offering price of $22.50 per share (the midpoint of the price range set forth on the front cover of this prospectus); and
 
 
•
 
assumes no exercise of the underwriters’ option to purchase a maximum of 2,079,158 additional shares from us and the selling stockholders to cover over-allotments.
 
In addition, in this prospectus:
 
 
•
 
“Blue Cross” and/or “Blue Shield” refers to BlueCross® and/or BlueShield®, registered service marks of the Blue Cross Blue Shield Association;
 
 
•
 
“BlueCard” refers to BlueCard®, a registered service mark of the Blue Cross Blue Shield Association; and
 
 
•
 
“SARA” refers to SARA®, our registered service mark for our Systematic Analysis Review and Assistance Program.

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Summary Consolidated Financial and Additional Data
 
The summary consolidated financial data presented below is derived from our consolidated financial statements included elsewhere in this prospectus. The financial data as of and for the six months ended June 30, 2001 is unaudited. You should read this summary consolidated financial data together with our financial statements and the related notes and the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
    
Six months ended
June 30,
     
Year ended December 31,
    
2002
     
2001
     
2001
     
2000
     
1999
     
1998
   
1997
    
(in millions)
Revenue:
                                                           
Premiums earned
   
$
2,359.8
 
   
$
2,162.2
 
   
$
4,246.2
 
   
$
3,876.9
 
   
$
3,362.3
 
   
$
3,064.4
   
$
3,152.7
Administrative service fees
   
 
194.3
 
   
 
160.2
 
   
 
322.0
 
   
 
264.9
 
   
 
238.9
 
   
 
171.2
   
 
138.2
Investment income, net(1)
   
 
34.4
 
   
 
37.3
 
   
 
69.3
 
   
 
65.5
 
   
 
58.7
 
   
 
55.6
   
 
49.0
Net realized investment gains (losses)
   
 
(0.4
)
   
 
(5.5
)
   
 
(12.4
)
   
 
22.1
 
   
 
0.2
 
   
 
3.8
   
 
1.3
Other income, net(2)(3)
   
 
13.6
 
   
 
2.8
 
   
 
6.1
 
   
 
4.3
 
   
 
4.8
 
   
 
3.0
   
 
83.4
    
  
  
  
  
  
  
Total revenue
   
 
2,601.7
 
   
 
2,357.0
 
   
 
4,631.2
 
   
 
4,233.7
 
   
 
3,664.9
 
   
 
3,298.0
   
 
3,424.6
Expenses:
                                                           
Cost of benefits provided
   
 
2,057.0
 
   
 
1,915.3
 
   
 
3,738.8
 
   
 
3,426.4
 
   
 
2,944.6
 
   
 
2,721.5
   
 
2,808.1
Administrative expenses(4)(5)
   
 
401.3
 
   
 
370.9
 
   
 
742.8
 
   
 
686.2
 
   
 
587.3
 
   
 
533.2
   
 
568.4
Conversion expenses
   
 
3.6
 
   
 
1.3
 
   
 
2.0
 
   
 
0.6
 
   
 
3.7
 
   
 
2.3
   
 
—  
    
  
  
  
  
  
  
Total expenses
   
 
2,461.9
 
   
 
2,287.5
 
   
 
4,483.6
 
   
 
4,113.2
 
   
 
3,535.6
 
   
 
3,257.0
   
 
3,376.5
    
  
  
  
  
  
  
Income from continuing operations before income taxes
   
 
139.8
 
   
 
69.5
 
   
 
147.6
 
   
 
120.5
 
   
 
129.3
 
   
 
41.0
   
 
48.1
Income tax (expense) benefit(6)
   
 
—  
 
   
 
—  
 
   
 
(0.1
)
   
 
74.5
 
   
 
(9.1
)
   
 
1.0
   
 
3.8
    
  
  
  
  
  
  
Income from continuing operations
   
 
139.8
 
   
 
69.5
 
   
 
147.5
 
   
 
195.0
 
   
 
120.2
 
   
 
42.0
   
 
51.9
Loss from discontinued operations, net of tax(7)
   
 
(1.1
)
   
 
(7.0
)
   
 
(16.5
)
   
 
(4.6
)
   
 
—  
 
   
 
—  
   
 
—  
    
  
  
  
  
  
  
Net income
   
$
138.7
 
   
$
62.5
 
   
$
131.0
 
   
$
190.4
 
   
$
120.2
 
   
$
42.0
   
$
51.9
    
  
  
  
  
  
  
 
    
Pro Forma Information (unaudited)(8)
    
Six months ended
June 30, 2002
     
Year ended
December 31, 2001
    
(in millions, except share and per share data)
Pro forma administrative expenses(9)
   
$
422.1
     
$
784.8
Pro forma income from continuing operations before income taxes
   
 
119.0
     
 
105.6
Pro forma income tax expense(10)
   
 
52.9
     
 
45.5
Pro forma net income
   
 
65.4
     
 
49.3
Pro forma earnings per common share
   
 
0.79
     
 
0.60
Shares used to compute pro forma earnings per share(11)
   
 
82,300,000
     
 
82,300,000

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Six months ended
June 30,
   
Year ended December 31,
    
2002
   
2001
   
2001
   
2000
   
1999
   
1998
   
1997
Additional Data:
                                                 
Medical loss ratio(12)
   
 
87.2%
   
 
88.6%
   
 
88.1%
   
 
88.4%
   
 
87.6%
   
 
88.8%
   
 
89.1%
Medical loss ratio, excluding New York City and New York State PPO(13)
   
 
84.4%
   
 
86.3%
   
 
86.0%
   
 
85.9%
   
 
85.1%
   
 
86.6%
   
 
87.5%
Administrative expense ratio(14)
   
 
15.9%
   
 
16.0%
   
 
16.3%
   
 
16.6%
   
 
16.4%
   
 
16.6%
   
 
17.3%
Administrative expense ratio—premium equivalent basis(15)
   
 
11.1%
   
 
11.7%
   
 
11.7%
   
 
12.6%
   
 
12.7%
   
 
N/A
   
 
N/A
Members (000’s at end of period)(16)
   
 
4,644
   
 
4,365
   
 
4,383
   
 
4,135
   
 
4,161
   
 
4,119
   
 
4,081
    
As of June 30,
   
As of December 31,
    
2002
   
2001
   
2001
   
2000
   
1999
   
1998
   
1997
              
                     (in millions)
Balance Sheet Data:
                                                 
Cash and investments
   
$
1,593.3
   
$
1,432.2
   
$
1,604.3
   
$
1,400.6
   
$
1,330.2
   
$
1,184.0
   
$
1,013.1
Premium related receivables
   
 
402.7
   
 
464.5
   
 
403.5
   
 
447.5
   
 
404.7
   
 
399.3
   
 
484.3
Total assets
   
 
2,482.3
   
 
2,347.4
   
 
2,449.6
   
 
2,252.5
   
 
1,987.4
   
 
1,837.3
   
 
1,808.1
Unpaid claims and claims adjustment expense
   
 
628.1
   
 
734.7
   
 
634.1
   
 
672.4
   
 
591.0
   
 
597.2
   
 
661.7
Total liabilities
   
 
1,517.4
   
 
1,600.2
   
 
1,620.3
   
 
1,577.8
   
 
1,484.7
   
 
1,457.8
   
 
1,474.1
Total reserves for policyholders’ protection(17)
   
 
964.9
   
 
747.2
   
 
829.3
   
 
674.7
   
 
502.7
   
 
379.5
   
 
334.0
  (1)
 
Investment income, net represents total investment income for the period, less investment expenses.
  (2)
 
Other income includes $8.0 million and $6.8 million of gains recorded for the six months ended June 30, 2002 and for the year ended December 31, 2001, respectively, based on insurance carrier settlement offers for electronic data processing, furniture and office equipment lost at the World Trade Center.
  (3)
 
Other income includes a $79.8 million gain from the sale of our home office building located in New York City in 1997.
  (4)
 
Administrative expenses includes $2.4 million and $3.5 million of estimated expenses incurred as a result of the loss of our headquarters located at the World Trade Center that may or may not be reimbursed by our insurance carrier, for the six months ended June 30, 2002 and for the year ended December 31, 2001, respectively.
  (5)
 
Administrative expenses includes $5.3 million of employee-related transition costs incurred in connection with our modernization and outsourcing agreement with IBM for the six months ended June 30, 2002.
  (6)
 
As of December 31, 2000, we reduced our valuation allowance on our deferred tax assets by $71.9 million based on continued, current and projected positive taxable income.
  (7)
 
Represents loss from operations of NexxtHealth, Inc., a development stage subsidiary formed in March 2000 to develop Internet portal software to market to other health benefit companies, which was discontinued in February 2002.
  (8)
 
Following the conversion, HealthChoice will be a for-profit entity and will be subject to state and local taxes as well as federal income taxes at the statutory rate of 35%.
  (9)
 
Includes an estimate of premium and sales and use tax expense as if HealthChoice were a for-profit company of $20.8 million and $42.0 million for the six months ended June 30, 2002 and the year ended December 31, 2001, respectively.

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(10)
 
Includes an estimate of state and local income tax expense as if HealthChoice were a for-profit company of $17.3 million and $13.2 million for the six months ended June 30, 2002 and the year ended December 31, 2001, respectively. Federal income tax expense was computed at the statutory rate of 35%.
(11)
 
Calculated based on number of shares that would have been held by the Fund and the Foundation as of June 30, 2002 and December 31, 2001, after giving effect to the conversion but prior to this offering.
(12)
 
Medical loss ratio represents cost of benefits provided as a percentage of premiums earned.
(13)
 
We present medical loss ratio, excluding New York City and New York State PPO because these accounts differ from our standard PPO product in that they are hospital-only accounts which have lower premiums relative to administrative expense and are retrospectively rated with a guaranteed administrative service fee. In addition, the size of these accounts distorts our performance when the total medical loss ratios are presented.
(14)
 
Administrative expense ratio represents administrative and conversion expenses as a percentage of premiums earned and administrative service fees.
(15)
 
Premium equivalents are obtained by adding to our administrative service fees the amount of claims attributable to these fees, which include our non-Medicare, self-funded (or ASO) health business pursuant to which we provide a range of customer services, including claims administration and billing and membership services. Administrative expense ratio—premium equivalent basis is determined by dividing administrative and conversion expenses by premium equivalents plus premiums earned for the relevant periods. Administrative expense ratio—premium equivalent is a measure that is commonly used in the health benefits industry to allow for a comparison of operating efficiency among companies.
(16)
 
Enrollment as of June 30, 2002 includes 172,000 New York State PPO account members who reside in New York State but outside of our service areas. Prior to this time, these members were enrolled in the New York Blue Cross Blue Shield plan licensed in the area where the members resided and, accordingly, the membership was reported by these plans and not by us. Starting in 2002, in accordance with a change to the contract with New York State, we began administering the entire plan, including those members enrolled outside of our service area, and all members were therefore enrolled in, and reported by, HealthChoice. Accordingly, New York State PPO account members who reside in New York State but outside of our service areas are excluded from enrollment totals for all other periods presented.
(17)
 
Total reserves for policyholders’ protection is the term used to define GAAP surplus (GAAP assets less GAAP liabilities).
 

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RISK FACTORS
 
You should carefully consider the following risks and all other information set forth in this prospectus before investing. These risks and other factors could materially affect our business, results of operations or financial condition and cause the trading price of our common stock to decline. You could lose part or all of your investment.
 
Risks Relating to our Business
 
Our inability to address health care costs and implement increases in premium rates could negatively affect our profitability.
 
Our profitability depends in large part on accurately predicting health care costs and on our ability to manage future health care costs through underwriting criteria, quality initiatives and medical management, product design and negotiation of favorable provider reimbursement rates. The following includes factors that are beyond our control and may adversely affect our ability to predict and manage health care costs:
 
        •     higher than expected utilization of services;
 
        •     an increase in the number of high-cost cases;
 
        •    changes in the population or demographic
              characteristics of members served, including
              aging of the population;
 
        •    medical cost inflation;
   
    •    changes in healthcare practices;
 
    •    cost of prescription drugs and direct to
          consumer marketing by pharmaceutical
          companies; and
 
    •    the introduction of new medical technology
          and pharmaceuticals.
  
  
  
  
  
  
 
In addition to the challenge of managing health care costs, we face pressure to contain prices for our products. Our customer contracts may be subject to renegotiations as customers seek to contain their costs. Alternatively, our customers may move to a competitor to obtain more favorable prices. A limitation on our ability to increase or maintain our prices could result in reduced revenues and earnings which could have an adverse impact on the trading prices of our common stock and the value of your investment.
 
A reduction in enrollment in our health insurance programs could affect our business and profitability.
 
A reduction in the number of members in our health insurance programs could reduce our revenues and profitability. Factors that could contribute to a reduction in membership include:
 
 
•
 
failure to obtain new customers or retain existing customers;
 
 
•
 
premium increases and benefit changes;
 
 
•
 
failure to successfully implement our strategy following this offering;
 
 
•
 
failure to provide innovative products that meet the needs of our customers or potential customers;
 
 
•
 
our exit from a specific market;
 
 
•
 
reductions in workforce by existing customers;
 
 
•
 
negative publicity and news coverage; and
 
 
•
 
a general economic downturn that results in business failures.

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The termination of our license agreements to use the Blue Cross and Blue Shield names and marks would have an adverse effect on our business, financial condition and results of operations.
 
We are a party to license agreements with the Blue Cross Blue Shield Association, an association of independent Blue Cross Blue Shield plans, which entitle us to the exclusive use of the “Cross and Shield,” or Blue Cross and Blue Shield names and marks in ten counties in the New York City metropolitan area and in six counties in upstate New York, the non-exclusive right to use the Blue Cross and Blue Shield names and marks in one upstate New York county, the exclusive use of only the Blue Cross name and mark in seven upstate New York counties and the non-exclusive use of only the Blue Cross name and mark in an additional four upstate New York counties. We use these names and marks to identify our products and services in these licensed counties. Upon the occurrence of any event causing termination of the license agreements, we would cease to have the right to use the Blue Cross and Blue Shield names and marks or the Blue Cross Blue Shield Association’s networks of providers. Although we cannot predict with certainty what effect the loss of those licenses would have on us, we expect that we would lose a substantial portion of our membership. The loss of these licenses would significantly harm our ability to compete in our markets and may require payment of significant monetary penalties to the Blue Cross Blue Shield Association. Furthermore, the Blue Cross Blue Shield Association would be free to issue to another entity, including one of our competitors, a license to use the Blue Cross Blue Shield names and marks in the counties in New York in which we had previously used the Blue Cross and/or Blue Shield names and marks, which would have a material adverse effect on our business, financial condition and results of operations.
 
Events which could result in termination of our license agreements include, among others:
 
 
•
 
failure to maintain our total adjusted capital at 200% of authorized control level risk based capital, as defined by the National Association of Insurance Commissioners risk based capital model act;
 
 
•
 
failure to maintain liquidity of greater than one month of underwritten claims and administrative expenses, as defined by the Blue Cross Blue Shield Association, for two consecutive quarters;
 
 
•
 
failure to satisfy state-mandated statutory net worth requirements;
 
 
•
 
impending financial insolvency; and
 
 
•
 
a change of control not otherwise approved by the Blue Cross Blue Shield Association or a violation of the Blue Cross Blue Shield Association ownership limitations on our capital stock.
 
We have obtained the approval of the Blue Cross Blue Shield Association for the transfer of our licenses to WellChoice that is required in connection with the conversion and this offering.
 
In addition, our certificate of incorporation contains restrictions on transfer and ownership limitations which correspond to the Blue Cross Blue Shield Association’s rules applicable to our licenses of the Blue Cross and Blue Shield names and marks. Our certificate of incorporation (and the Blue Cross Blue Shield Association’s ownership limits) restricts beneficial ownership of our voting capital stock to less than 10% for institutional investors and less than 5% for noninstitutional investors, both as defined in our certificate of incorporation, as well as ownership of equity securities representing ownership interests in our company to less than 20%. Although we believe that these limitations are enforceable under Delaware law, we are not aware of any case in which a court has specifically addressed this issue. If one of our stockholders violates the ownership limitations and a court does not enforce the provisions of our certificate of incorporation or the Fund breaches the voting trust and divestiture agreement, we could lose our licenses to use the Blue Cross and Blue Shield names and marks.
 
Regional concentration of our business may subject us to economic downturns in New York State and, in particular, the New York City metropolitan area.
 
We operate in 28 counties in New York State and substantially all of our revenue is derived from group accounts that have an office in our service areas in New York State or from individual members who reside in the

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state. This concentration of business in New York exposes us to potential losses resulting from a downturn in the economy of New York State and, in particular, New York City. The events of September 11, 2001 and the economic recession have had a negative economic impact on business in New York City as well as New York State. In addition, a nationwide economic downturn could have an adverse impact on our national accounts business. If economic conditions deteriorate, we may experience a reduction in existing and new business, which may have an adverse effect on our business, financial condition and results of operations.
 
In addition, as a high profile, diverse and highly populated city, New York City could be the target of future terrorist attacks, including bioterrorism and other public health threats, which could significantly increase the risks of our business, such as the risk of significant increases in costs of benefits provided following such an event. For example, a bioterrorism attack could cause increased utilization of healthcare services, including physician and hospital services, high-cost prescription drugs and other services.
 
Significant competition from other health care companies could negatively affect our ability to maintain or increase our profitability.
 
Our business operates in a highly competitive environment, both in the states of New York and New Jersey as well as nationally. Our largest competitors in the New York City metropolitan area include national health benefits companies, such as UnitedHealthcare and Aetna, Inc., and regional local health insurers, such as Oxford Health Plans, Inc., Health Insurance Plan of Greater New York and Group Health Incorporated. Our major competitors for national accounts customers include other “Blue” plans as well as UnitedHealthcare, Cigna Corporation and Aetna.
 
Competition in our industry has intensified in recent years, due to more aggressive marketing and pricing practices by other health care organizations, a customer base which focuses on quality while still being price-sensitive and the introduction of new products for which health insurance companies must compete for members. This environment has produced, and will likely continue to produce, significant pressures on the profitability of health insurance companies. Concentration in our industry also has created an increasingly competitive environment, both for customers and for potential acquisition targets, which may make it difficult for us to grow our business. Some of our competitors are larger and have greater financial and other resources than we do. We may have difficulty competing with larger health insurance companies, which can create downward price pressures on provider rates through economies of scale. We may not be able to compete successfully against current and future competitors. In addition, in recent years, the nature and means by which participants in the health care and health insurance industries market products and deliver services have changed rapidly. We believe this trend will continue, requiring us to continue to respond to new and, possibly, unanticipated competitive developments. Competitive pressures faced by us may adversely affect our business, financial condition and results of operations.
 
In order to distribute our products effectively, we must continue to recruit, retain and establish relationships with qualified agents and brokers. Skilled agents and brokers are in high demand and we cannot assure you that we will continue to be able to recruit, retain and establish relationships with such agents and brokers. If such agents and brokers do not help us to maintain our current customer accounts or establish new accounts, our business and profitability could be adversely affected.
 
We face heavy competition from other health benefits plans to enter into contracts with hospitals, physicians and other providers for our provider networks. Consolidation in our industry, both on the provider side and on the health insurer side, only exacerbates this competition.
 
Further, Blue Cross Blue Shield plans share their local provider networks under a BlueCard program allowing enrolled members to obtain service when they travel outside of their home plan’s service areas. Our license agreements with the Blue Cross Blue Shield Association require us to pay administrative fees to any host Blue Cross Blue Shield member plan in exchange for providing these claims and services to our members in their

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service area. BlueCard fees are a significant administrative expense for our business and are not incurred by non-Blue health insurers. As a result, our premium rates may not be as competitive as those of non-Blue plans, to the extent their cost savings are not offset by the expense of securing national provider networks for their members.
 
Future legislation at the federal and state levels also may result in increased competition in our market. While we do not anticipate that any of the current legislative proposals of which we are aware would increase the competition we face, future legislative proposals, if enacted, might do so.
 
Medicare premiums may not keep up with the cost of health care services we provide under our Medicare+Choice product.
 
We offer a Medicare+Choice product through our New York HMO operations conducted by our indirect, wholly owned subsidiary, Empire HealthChoice HMO, Inc., a New York corporation. Under the Medicare+Choice program, Medicare beneficiaries have the option of receiving their care through an HMO instead of the traditional Medicare fee-for-service program. In connection with this product, we receive a fixed per member per month capitation payment from CMS, the federal agency that administers the Medicare program. The capitation payment is established annually based on a legislatively mandated formula that, in general, provides for a 2% annual increase. In addition, we have the ability to change our program on an annual basis. These changes may include a premium payment that is charged to enrolled members and/or reductions in the level of covered services. We currently require that members in some counties contribute toward the cost of their coverage. We bear the risk that the actual cost of covered health services may exceed the amount we receive from CMS and our members. This can happen if the utilization of health care services increases at a faster rate than we expect or if our hospitals and providers demand larger increases than we anticipated. Hospitals, hospital systems and providers that render services to our Medicare+Choice members may decide to cease to participate with us in this particular program or demand increases from us in order to receive a level of reimbursement that is consistent with the reimbursement rates they receive under the traditional Medicare fee-for-service program. As these factors increase costs beyond the 2% annual increase we receive from CMS, we may need to either increase the premium rates charged to our members or decrease covered benefits. These changes may make our product less attractive to Medicare beneficiaries and, as a result, our Medicare+Choice membership could decrease. Our membership could also decrease as a result of our departure from certain counties that we currently serve. Furthermore, our operating results could be adversely affected as a result of, among other things, our inability to obtain adequate rates. In addition, this program is annually the subject of legislation in Congress and we cannot predict what additional rules and requirements may be enacted that will impact our business. The contract to participate in the Medicare+Choice program could also, under certain circumstances, be terminated by the federal government or by us.
 
As a Medicare fiscal intermediary, we are subject to complex regulations. If we fail to comply with these regulations, we may be exposed to criminal sanctions and significant civil penalties.
 
Empire is a fiscal intermediary for the Medicare Part A program and a carrier for the Medicare Part B program, which provide hospital and physician coverage to persons 65 years or older. As a fiscal intermediary, we serve as an administrative agent for the traditional Medicare fee-for-service program and receive reimbursement for certain costs and expenditures, which are subject to adjustment upon audit by CMS. The laws and regulations governing fiscal intermediaries for the Medicare program are complex, subject to interpretation and can expose a fiscal intermediary to penalties for non-compliance. Fiscal intermediaries may be subject to criminal fines, civil penalties or other sanctions as a result of such audits or reviews. In the last five years, while we have not been required to make any payments, a number of Medicare fiscal intermediaries have made significant payments to settle issues raised by such audits or reviews, including, in one case, in excess of $100 million. Our fiscal intermediary unit includes a compliance program and we believe that we are currently in compliance with CMS standards. However, there can be no assurance that our compliance program will be adequate or that regulatory changes or other developments which occur in the future will not result in infractions of the CMS requirements.

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We are dependent on the success of our relationship with IBM for a significant portion of our information system resources.
 
In June 2002, we entered into an agreement with International Business Machines Corporation, or IBM, pursuant to which IBM, through a relationship with deNovis, Inc., a claims payment systems developer, will develop a new claims payment system which will be licensed to us in perpetuity. deNovis, Inc. is a privately held startup company. IBM will also assist us in modernizing our information systems. In addition, under this agreement, a portion of our core applications staff and our data center operations will be outsourced to IBM for a period of ten years. We will materially rely on these developments and improvements of our core technology operations on a going-forward basis. Strategic relationships such as the one we have with IBM can be difficult to implement and maintain, and may not succeed for various reasons including:
 
 
•
 
changes in strategic direction by one or both companies;
 
 
•
 
technical obstacles to developing the technologies;
 
 
•
 
the insolvency, merger or change of control of one of the parties;
 
 
•
 
difficulties in coordinating joint development efforts;
 
 
•
 
difficulties in structuring and maintaining revenue sharing arrangements; and
 
 
•
 
operating differences between the companies and their respective employees.
 
If our relationship with IBM is terminated for any reason or if we are unable to successfully develop and implement the technological improvements and innovations contemplated by the agreement with IBM, we may not be able to find an alternative partner in a timely manner or on acceptable financial terms with whom we will be able to pursue our strategy. As a result, we may not be able to meet the demands of our customers and, in turn, our business, financial condition and results of operations may be harmed.
 
In addition, we intend to fund the modernization expenses incurred in connection with this collaboration with IBM in part through the cost savings we expect to realize as a result of the outsourcing of this project to IBM. Any substantial increase in these expenses, or inability to achieve our anticipated cost savings, could have an adverse effect on our profitability, financial condition and results of operations. While we do not expect to realize cost savings from these improvements in the early years of the project, we anticipate that we will incur the substantial majority of the costs and expenses related to the modernization initiatives in the first four years of the agreement. If we are unsuccessful in implementing these improvements or if these improvements do not meet our customers’ requirements, we may not be able to recoup these costs and expenses and effectively compete in our industry.
 
Some of the risks associated with the collaboration with IBM are anticipated and covered through termination rights clauses and indemnification clauses included under our outsourcing agreement. Nevertheless, we may not be adequately indemnified against all possible losses through the terms and conditions of the agreement. In addition, some of our termination rights are contingent upon payment of a fee, which may be significant.
 
The success of our business depends on developing and maintaining a modernized computer and technology infrastructure.
 
Our business and operations may be harmed if we do not maintain our information systems and the integrity of our proprietary information. We are materially dependent on our information systems for all aspects of our business operations. Malfunctions in our information systems, security breaches or the failure to maintain effective and up-to-date information systems could disrupt our business operations, alienate customers, contribute to customer and provider disputes, result in regulatory violations, increase administrative expenses or lead to other adverse consequences. The use of patient data by all of our businesses is regulated at federal, state and local levels. These laws and rules change frequently and developments require adjustments or modifications

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to our technology infrastructure. These and other material changes affecting our information systems could harm our business, financial condition and results of operations. Also, we cannot assure you that the improvements that we are currently developing with IBM described in the preceding risk factor will be sufficient for us to maintain our competitive position in our industry.
 
In addition, to remain competitive, we must maintain an up-to-date e-business organization which enables interactions with customers, brokers, agents, employees and other stakeholders through web-enabling technology. The failure to maintain effective and up-to-date e-business systems could cause disruptions in our operations, the loss of existing customers and difficulty attracting new customers, each of which could adversely affect our business and profitability.
 
We may be unsuccessful in operating as a for-profit public company.
 
Prior to this offering and the consummation of the conversion, we have operated as a not-for-profit health services corporation. The business considerations and decisions made by us during this period may differ from those of a for-profit, publicly held corporation. In addition, prior to the conversion we have not had any stockholders and have not, therefore, been subject to state and local laws and regulations governing corporate affairs, including stockholder rights, or to reporting and filing requirements of the Commission.
 
As a for-profit entity, we will be subject to state and local taxes that we were not previously required to pay. These include premium taxes on most non-HMO insured business and sales and use taxes, as well as state and local income taxes. These and other factors may hinder our ability to compete effectively in our industry and maintain profitability as a public company.
 
We are subject to premium rate restrictions on our Medicare supplemental insurance product which may limit our ability to achieve adequate rates and could affect our profitability.
 
The plan of conversion provides, among other restrictions, that for a period of five years from the effective date of the conversion, we will not raise our premiums by more than 10% per year on our individual Medicare supplemental insurance product offered by Empire in the State of New York without the Superintendent’s prior approval, which may only be granted following a public hearing. In addition, we agreed that with respect to our individual Medicare supplemental policies, rate increases during the sixth, seventh and eighth years following the effective date of the conversion may be implemented upon filing using the “file and use” rate methodology, provided that we have a medical loss ratio of at least 80% (the ratio otherwise applicable to not-for-profit insurers), in contrast to the 75% minimum that is applicable to Medicare supplemental policies issued by for-profit health insurers. These limitations may make it difficult for us to cover the costs of providing these services which could reduce our overall profitability.
 
We are a holding company and will depend on our subsidiaries for cash and the ability of our subsidiaries to pay cash dividends to us is subject to regulatory requirements.
 
WellChoice is a holding company and has no business operations of any significance other than through its subsidiaries. We will depend on our operating subsidiaries for cash and working capital to pay administrative expenses, income taxes and other expenses.
 
The cash we receive from our subsidiaries will consist of fees for administrative and management services, tax sharing payments and dividends. A material deterioration in any of our subsidiaries’ financial condition, earnings or cash flow for any reason could limit such subsidiary’s ability to pay cash dividends or other payments to us, which, in turn, may compromise our liquidity and limit our ability to pay dividends to stockholders, satisfy financial obligations, continue our non-insurance operations or meet competitive pressures or adverse economic conditions. In that event, the value of our stock could be adversely affected.

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The ability of our insurance and HMO subsidiaries to pay dividends to us is subject to regulatory requirements, including state insurance laws and health department regulations and regulatory surplus or admitted asset requirements, respectively. These laws and regulations require the approval of the applicable state insurance department or health regulators in order to pay any proposed dividend over a certain amount. Specifically, any proposed dividend to WellChoice from Empire, which, together with other dividends paid within the preceding twelve month period, exceeds the lesser of 10% of its surplus to policyholders or 100% of adjusted net investment income will be subject to approval by the New York Department of Insurance.
 
The provisions of our Blue Cross and Blue Shield licenses also may limit our ability to obtain dividends or other cash payments from our subsidiaries as they require our licensed subsidiaries to retain certain levels of minimum surplus. In addition, following the conversion, Empire HealthChoice HMO will be held by WellChoice indirectly through Empire. Therefore, Empire HealthChoice HMO’s ability to pay dividends to Empire, and the ability of WellChoice to receive these dividends from Empire, will be subject to Empire and Empire HealthChoice HMO’s respective ability to meet all financial and regulatory requirements applicable to them. Dividends from Empire HealthChoice HMO to Empire in excess of 10% of the admitted assets of Empire HealthChoice HMO will be subject to review and approval by the Department of Insurance and the Department of Health.
 
WellChoice Insurance of New Jersey, Inc. is also owned by WellChoice indirectly through Empire. Thus, proposed dividends to Empire from WellChoice Insurance of New Jersey, which, together with other dividends paid by WellChoice Insurance of New Jersey within the preceding twelve month period, exceeds the greater of 10% of its surplus to policyholders or net income not including realized capital gains will be subject to approval by the New Jersey Department of Banking and Insurance. Dividends from both Empire and WellChoice Insurance of New Jersey are payable only out of earned surplus.
 
A substantial legal liability or a significant regulatory action against us could have an adverse effect on our business, results of operations and financial condition.
 
We are, and may in the future be, a party to a variety of legal actions that affect any business, such as employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims and intellectual property related litigation. In addition, because of the nature of our business, we are subject to a variety of legal and regulatory actions relating to our business operations or to our industry, including the design, management and offering of our products and services. These include, and may in the future include:
 
 
•
 
claims relating to the denial of health care benefits;
 
 
•
 
medical malpractice actions;
 
 
•
 
allegations of anti-competitive and unfair business activities;
 
 
•
 
provider disputes over compensation and termination of provider contracts;
 
 
•
 
disputes related to self-funded business;
 
 
•
 
disputes over co-payment calculations;
 
 
•
 
claims related to the failure to disclose certain business practices; and
 
 
•
 
claims relating to customer audits and contract performance.
 
Recent court decisions and legislative activity may increase our exposure for any of these types of claims. In some cases, substantial non-economic, treble or punitive damages may be sought. The loss of even one of these claims, if it resulted in a significant punitive damages award, could significantly worsen our financial condition or results of operations. This risk of potential liability may make reasonable settlements of claims more difficult to obtain.

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We currently have insurance coverage for some of these potential liabilities. Other potential liabilities may not be recovered by insurance, insurers may dispute coverage or the amount of insurance may not be enough to cover the damages awarded. In addition, certain types of damages, such as punitive damages, may not be covered by insurance and insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.
 
In September 1999, a group of plaintiffs’ trial lawyers publicly announced that they were targeting the managed care industry by way of class action litigation. Since that time, two actions, one purporting to be a class action on behalf of providers and the other brought by the Medical Society of the State of New York, have been commenced against us generally challenging managed care practices, including cost containment mechanisms, disclosure obligations and payment methodologies. We intend to defend vigorously all of these cases. We will incur defense costs and we cannot predict the outcome of these cases. Certain potential liabilities may not be covered by insurance, and a large judgment against us or a settlement could adversely affect our business, financial condition and results of operations.
 
We might incur damages, fines or penalties as a result of the actions of companies to which we subcontract.
 
We subcontract our behavioral healthcare and pharmacy services through contracts with Magellan Behavioral Health Inc. and AdvancePCS, respectively. We could be held responsible for these subcontractors’ performance of these services and their compliance with all applicable laws and regulations in performing these services. If these third parties commit misconduct or act negligently in performing these services or in a manner that violates applicable laws or regulations, we could be exposed to lawsuits for damages, regulatory fines or penalties.
 
A downgrade in our ratings may adversely affect our business, financial condition and results of operations.
 
Claims paying ability and financial strength ratings by recognized rating organizations have become an increasingly important factor in establishing the competitive position of insurance companies and health care companies. Rating organizations routinely review the financial performance and condition of insurers. Each of the rating agencies reviews its ratings periodically and ratings could be downgraded or placed under surveillance or review.
 
We believe independent credit ratings are an important factor in maintaining our financial credibility since ratings information is broadly disseminated and generally used throughout the industry. S&P’s financial strength and counterparty credit rating for HealthChoice is currently “A-.” If our rating is downgraded or placed under surveillance or review, with possible negative implications, the downgrade, surveillance or review could adversely affect our business, financial condition and results of operations. In addition, we anticipate that we will be rated by other recognized rating organizations and we could be adversely affected by ratings from any of those agencies that reflect a negative opinion of our financial strength, operating performance or ability to meet our obligations to our members.
 
Our profitability may be adversely affected if we are unable to maintain our current provider agreements and to enter into other appropriate agreements.
 
Our profitability is dependent in part upon our ability to contract on favorable terms with hospitals, physicians and other health benefits providers. Our agreements with these providers generally have fixed terms which require that we renegotiate them periodically. The failure to maintain or secure new cost-effective health care provider contracts may result in a loss in membership or higher costs of benefits provided. In addition, our inability to contract with providers on favorable terms, or the inability of providers to provide cost-effective care, could adversely affect our business. Large groups of physicians, hospitals and other providers have recently

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begun to collectively renegotiate their contracts with health insurance companies like us. In addition, in recent years physicians, hospitals and other provider groups have begun to consolidate to create hospital networks. This cooperation and/or consolidation among providers increases their bargaining positions and allows the providers to negotiate for higher reimbursement rates from us. For example, we recently reached agreement with the Long Island Hospital Network, a network of ten hospitals located in Long Island, New York that we refer to as LIHN, on the renewal of our provider contract following a controversy with LIHN. LIHN is one of several hospital networks that provide hospital services to our approximately 800,000 members who reside in the Long Island, New York area. Our new agreement with LIHN will increase our reimbursement rates to LIHN. Demands for higher reimbursement rates may lead to increased premium rates, the loss of beneficial hospitals and physicians and a disruption of service for our members, which in turn could cause a decrease in existing and new business. If this practice increases or continues for an extended period of time, it could potentially have an adverse affect on our business, financial condition and results of operations.
 
In addition, we have capitated arrangements for mental health and substance abuse services with Magellan Behavioral Health Inc., which has recently announced that it is exploring refinancing its debt and a comprehensive capital restructuring. The failure of Magellan to continue the current arrangement could result in increased costs for these services as well as the need to obtain another network for services outside our service area.
 
Loss of our New York State or New York City accounts could result in reduced membership and revenue and the need to reallocate or absorb administrative expenses.
 
As of June 30, 2002, our New York State account covered approximately 976,000 members, or 21% of our total membership, and our New York City account covered approximately 806,000 members, or 17.4% of our total members. Both accounts are hospital only, are subject to annual renegotiation of rates, and are subject to periodic renewal based on a competitive bid process that is open to us and to third parties and primarily involves renegotiation with respect to rates. The New York City account is currently under renegotiation based on this competitive bid process. The current rates for the New York State account expire on December 31, 2002, and are in the process of being renegotiated. The loss of one or both of these accounts could result in reduced membership and revenue and would require us to reduce, reallocate or absorb administrative expenses associated with these accounts.
 
Our investment portfolio is subject to varying economic and market conditions, as well as regulation.
 
The market value of our investments varies from time to time depending on economic and market conditions. For various reasons, we may sell certain of our investments at prices that are less than the carrying value of the investments, which would cause us to incur losses and may diminish our risk-based capital or valuations. In addition, in periods of declining interest rates, bond calls and mortgage loan prepayments generally increase resulting in the reinvestment of these funds at the then lower market rates. Our portfolio, which is largely comprised of fixed income securities, has an average credit rating of “AA.” Our marketable equity securities consist of an investment in a S&P 500 index mutual fund, an investment in non-redeemable preferred stock and a direct investment in the stock of WebMD Corp. At June 30, 2002, our investments at fair value, other long-term equity investments and cash and cash equivalents totalled $1,593.3 million. Since that date, despite adverse economic conditions, our portfolio has not changed materially. Our investment portfolio may not produce positive returns in future periods.
 
We are subject to state laws and regulations that require diversification of our investment portfolios and limit the amount our insurance company subsidiaries may invest in certain investment categories, such as below-investment-grade fixed income securities, mortgage loans, real estate and equity investments. Failure to comply with these laws and regulations might cause investments exceeding regulatory limitations to be treated as non-admitted assets for purposes of measuring statutory surplus and risk-based capital and, in some instances, require the sale of those investments.

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A substantial decline in our ceding relationships could have an adverse effect on our business.
 
The rules and license standards of the Blue Cross Blue Shield Association set forth procedures with respect to the provision of insurance to national accounts with employees located in numerous jurisdictions that are covered by more than one Blue Cross Blue Shield licensee. To provide insurance or administrative services to a national account with its principal place of business outside our New York service area, we are required to obtain permission, referred to as ceding, from the Blue Cross Blue Shield Association member plan with a license in the county in which the principal place of business is located. Ceding by member plans is voluntary and there is no guarantee that a member plan will continue to cede business to us. Currently approximately 427,000 national account members, or 9.2% of our total membership, through twelve national accounts, is ceded from six plans. If several of these plans terminated our ceding agreements it could have an adverse effect on our profitability, financial condition and results of operations.
 
If our insurance and claims reserves are inadequate our incurred claims expense would increase and our future earnings could be adversely affected.
 
We are required to estimate the total amount of claims for healthcare services for enrolled members that have not been reported, or received but not yet adjudicated, during any accounting period. Our results of operations depend in large part on our ability to accurately estimate the amount of these claims and effectively manage healthcare costs. These estimates, referred to as claim reserves, are recorded as liabilities on our balance sheet. We estimate claim reserves in accordance with Actuarial Standards of Practice promulgated by the Actuarial Standards Board, the committee of the American Academy of Actuaries that establishes professional guidelines and standards for actuaries to follow. Factors we consider in estimating future payments include existing claims data, medical cost trends, the mix of products and benefits sold, internal processing changes and the amount of time it took to pay all of the benefits for claims from prior periods. To the extent the actual amount of claims expense is greater than the estimated amount of claims expense based on our underlying assumptions, our cost of benefits provided would increase and future earnings could be adversely affected.
 
Acquisitions or investments that we may make could turn out to be unsuccessful.
 
As part of our growth strategy, we may in the future pursue acquisitions of and/or investments in businesses, products and services. The negotiation of potential acquisitions or investments as well as the integration of an acquired or jointly developed business, service or product could result in a substantial diversion of management resources. We could be competing with other firms, many of which have greater financial and other resources, to acquire attractive companies. Acquisitions could result in potentially dilutive issuances of equity securities, the incurrence or assumption of debt and contingent liabilities, amortization of certain identifiable intangible assets, write-offs and other acquisition-related expenses. In addition, we may also fail to successfully integrate acquired businesses with our operations or successfully realize the intended benefits of any acquisition or investment.
 
Covenants in our credit agreement may restrict our operations.
 
On October 17, 2002, we entered into a credit and guaranty agreement with The Bank of New York, as Issuing Bank and Administrative Agent, and several other financial institutions as agents and lenders. The credit facility, which cannot exceed $100.0 million, will become effective upon the completion of this offering, subject to our satisfaction of customary closing conditions. The credit agreement contains covenants that will restrict our ability to, among other things, incur secured debt, issue any equity interest which we are obligated to purchase, redeem, retire or otherwise acquire in the future or engage in significant transactions such as mergers or asset sales without the consent of the lenders. The credit agreement also contains financial covenants. These covenants could restrict our operations. In addition, if we fail to make any required payment under our credit agreement or to comply with any of the financial and operating covenants included in the credit agreement, we would be in default which could result in the termination of the credit agreement.

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The health benefits industry is subject to negative publicity, which can adversely affect our profitability.
 
The health benefits industry is subject to negative publicity concerning, among other things, the potential of managed care to limit access to care and provider complaints relating to delivery of service, rates and timing of payment for fees. Negative publicity may result in increased regulation and legislative review of industry practices, which may further increase our costs of doing business and adversely affect our profitability by adversely affecting our ability to market our products and services, requiring us to change our products and services, or increasing the regulatory burdens under which we operate.
 
Risks Relating to our Relationship with the Fund
 
As long as the Fund owns a significant portion of the outstanding shares of our common stock, we will need the Fund’s approval to engage in certain change of control transactions, recapitalizations, restructurings or other similar corporate actions.
 
Following the completion of this offering, the Fund will own 79% of the outstanding shares of our common stock and all of the Class B common stock. Under the voting trust and divestiture agreement, the Fund will deposit in a voting trust all of its shares that exceed one share less than 5% of the outstanding common stock. The Fund will have limited voting rights as to the common stock held in the voting trust, but generally the Fund will be able to direct the vote of these shares freely on a change of control transaction submitted to stockholders. If the matter concerns an employee compensation plan for which stockholder approval is sought, or a precatory stockholder proposal (that is, an advisory proposal made by a stockholder pursuant to Rule 14a-8 under the Securities Exchange Act of 1934 that merely recommends or requests that we or our board of directors take certain actions), the Fund will be able to direct the vote of the trust shares in the same proportions as the shares voted by other holders of our common stock (other than the trustee of the voting trust, the Fund and our directors, officers, trustees of any of our employee benefit plans and those of our affiliates). In addition, the affirmative vote of the Fund, voting separately as the holder of the Class B common stock, subject to certain exceptions, will be required for the following actions that would adversely affect the financial interests, voting rights or transferability of the Fund’s shares of common stock: a recapitalization or restructuring of our capital stock, the creation of a new class of capital stock or the creation of a series of preferred stock and the issuance of additional shares of our capital stock. Consequently, for so long as the Fund owns 5% or more of our stock, the Fund may prevent or delay various significant corporate transactions.
 
The Fund was established under the Conversion Legislation to hold 95% of the fair market value of HealthChoice and its subsidiaries on the effective date of the conversion. The Fund is responsible for maximizing the value of the assets in the Fund and making disbursements to fund various health care initiatives of the State of New York, in accordance with the direction of the Director of the Division of the Budget. The Comptroller of the State of New York will be the sole custodian of the Fund, which will have a five-member board, three of whom will be appointed by the Governor of the State of New York and the remaining two will be appointed by the President of the State Senate and the Speaker of the State Assembly, respectively, all in accordance with the Conversion Legislation.
 
The Fund’s best interests may be different from your best interests and may not conform to our strategy or business goals. You should expect the Fund to vote its shares of our stock on the change of control transactions, recapitalizations, restructurings and similar corporate actions on which it may vote its shares freely in a manner that is in its best interests. Decisions made by, or on behalf of the Fund may be influenced by political or other considerations, including those resulting from future changes in government.
 
A majority of our independent directors will be able to control the outcome of most other matters submitted to our stockholders for a vote, as long as the Fund owns a substantial percentage of our stock.
 
Under the voting trust and divestiture agreement the shares deposited in the voting trust by the Fund will be voted, as to matters other than those described in the preceding risk factor, including in respect of the election

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and removal of our directors, consistent with the recommendations of a majority of the independent members of our board. Accordingly, as long as the Fund owns a significant percentage of our outstanding common stock, our board of directors will be able to control the outcome of most matters brought before our stockholders for a vote. While our board is required to act in a manner consistent with its fiduciary duties under applicable law, it may make recommendations with respect to stockholder voting with which you disagree. In addition, these voting restrictions may operate to make it more difficult to remove members of the board of directors and may have the effect of entrenching management, regardless of their performance.
 
The Fund and the Foundation’s registration rights may limit our ability to raise additional funds through common stock offerings, which could restrict our growth and inhibit our ability to make acquisitions and adversely affect our ability to compete.
 
We may seek to take advantage of acquisition or other investment opportunities that may arise and may desire to access the public equity markets to secure additional capital to pursue one or more of these opportunities. The registration rights agreement with the Fund and the Foundation could limit our ability or make it more difficult for us to raise funds through common stock offerings upon terms we desire or at times when we may require funds.
 
Our failure to raise additional capital when required could:
 
 
•
 
restrict our growth, both internally and through acquisitions;
 
 
•
 
inhibit our ability to invest in technology and other products and services that we may need; and
 
 
•
 
adversely affect our ability to compete in our markets.
 
Our agreements with the Fund and the Foundation do not prevent us from issuing our common stock as consideration to buy another company or from borrowing money or issuing or assuming debt, preferred stock or convertible securities to buy a business. If, however, we want to buy a business for cash and we need to raise money for the acquisition by selling our common stock, provisions in the registration rights agreement granting the Fund and the Foundation, as holders of our common stock, the right to have any of their securities sold at the same time may limit our flexibility.
 
Significant sales of our common stock by the Fund, or the expectation of these sales, could cause our stock price to fall.
 
Pursuant to the voting trust and divestiture agreement, the Fund, as our principal stockholder, is obligated to reduce its ownership of our common stock to certain levels by specified dates. Specifically, the Fund has agreed to reduce its ownership of our shares to less than 50% by the third anniversary of the date of this offering, to less than 20% by the fifth anniversary of the date of this offering and to less than 5% by the tenth anniversary of the date of this offering, in each case subject to extension, which must be approved by the Blue Cross Blue Shield Association, for a reasonable period of time in light of the circumstances then affecting, or expected to affect, the market price of our common stock, and other, automatic extensions as set forth in the voting trust and divestiture agreement we will enter into with the Fund. Significant sales of our common stock by the Fund, or the expectation of these sales, may cause our stock price to fall. The Fund, as our affiliate, is subject to restrictions on resales of our common stock, which may only be sold in a registered offering or in accordance with an exemption for the registration requirements under the Securities Act of 1933, as amended. The Fund has the right to require us, commencing 180 days after the date of this offering, to file registration statements covering the sale of stock by the Fund and the Foundation. Pursuant to Rule 144 under the Securities Act, the Fund and the Foundation will be able to sell limited quantities of  our common stock without a registration statement commencing one year after the date the Fund and the Foundation receive our shares. Each of the Fund and the Foundation has agreed not to offer, sell or otherwise dispose of any shares of capital stock for a period of 180 days from the date of this prospectus. However, the lead underwriter may, in its sole discretion, waive this restriction and allow the Fund and the Foundation to sell shares at any time. Shares of common stock subject to this lock-up agreement will become eligible for sale in the public

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market upon expiration of this agreement, subject to the limitations imposed by Rule 144. Any significant sale of common stock by the Fund, or the expectation of such sales, could cause the market price of our common stock to fall and your investment will be adversely affected.
 
We may not be able to sue, or otherwise enforce our rights against, the Fund due to the doctrine of sovereign immunity.
 
By virtue of the Conversion Legislation, the Fund may be deemed a state entity and, if sued, could invoke the doctrine of sovereign immunity, which prohibits or restricts lawsuits against government agencies, as a defense. An inability to sue the Fund could prevent or hinder us from pursuing rights and remedies for breaches by the Fund under the registration rights agreement or the voting trust and divestiture agreement or for violations of securities laws and regulations.
 
Risks Relating to the Regulation of Our Industry
 
Our business is heavily regulated and changes in state and federal regulations may adversely affect the profitability of our business, our financial condition and results of operations.
 
We are subject to extensive regulation and supervision by the New York State Department of Insurance, or Department of Insurance, and the New York State Department of Health, or Department of Health, with respect to our New York operations, the New Jersey Department of Banking and Insurance, with respect to our New Jersey operations, as well as to regulation by federal agencies with respect to our federal programs. These laws and regulations are subject to amendments and changing interpretations in each jurisdiction.
 
Our insurance subsidiaries are also subject to insurance laws that establish supervisory agencies with broad administrative powers to grant and revoke licenses to transact business and otherwise regulate sales, policy forms and rates, financial reporting, solvency requirements, investments and other practices. Future regulatory action by state insurance authorities could have an adverse effect on the profitability or marketability of our health benefits or managed care products or on our and our subsidiaries’ business, financial condition and results of operations. In addition, because of our participation in government-sponsored programs, such as Medicare, changes in government regulations or policy with respect to, among other things, reimbursement levels, could also adversely affect our and our subsidiaries’ business, financial condition and results of operations.
 
Legislative or regulatory changes that could significantly harm us and our subsidiaries include:
 
 
•
 
new licensing requirements;
 
 
•
 
special rules relating to contracts to administer government programs;
 
 
•
 
limitations on premium levels, premium rating methodologies and underwriting rules and procedures;
 
 
•
 
requirements for prior approval of premium rates;
 
 
•
 
imposition of additional quality assurance procedures;
 
 
•
 
increases in minimum capital, reserves and other financial viability requirements;
 
 
•
 
impositions of fines or other penalties for the failure to promptly pay claims, among other things;
 
 
•
 
surcharges on payments to providers;
 
 
•
 
prohibitions or limitations on transactions with affiliates;
 
 
•
 
prohibitions or limitations on provider financial incentives and provider risk-sharing arrangements;
 
 
•
 
new benefit mandates or eligibility requirements; and

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•
 
limitations on the ability to manage care and utilization due to any “willing provider” and direct access laws that limit or eliminate product features that encourage members to seek services from contracted providers or through referral by a primary care provider.
 
Currently, the federal government and many states, including New York and New Jersey, are considering additional legislation and regulations related to health care plans, including, among other things:
 
 
•
 
requiring coverage of experimental procedures and drugs and liberalized definitions of medical necessity;
 
 
•
 
limiting control of the utilization review and cost management and cost control initiatives of our managed care subsidiaries;
 
 
•
 
requiring that mental health benefits be treated the same as medical benefits;
 
 
•
 
exempting physicians from the antitrust laws that prohibit price fixing, group boycotts and other horizontal restraints on competition;
 
 
•
 
changing the government programs for the uninsured or those who need assistance in paying premiums, including potential mandates that all HMOs or insurers must participate;
 
 
•
 
implementing a state-run single payer system that would partially or largely obviate the current role of private health insurers or HMOs; and
 
 
•
 
restricting or eliminating the use of formularies for prescription drugs.
Moreover, state legislatures and the United States Congress continue to focus on health care issues. Congress is considering various forms of Patients’ Bill of Rights legislation which, if adopted, could fundamentally alter the treatment of coverage decisions under the Employee Retirement Income Security Act of 1974, or ERISA. Additionally, there recently have been legislative attempts to limit ERISA’s preemptive effect on state laws. If adopted, such limitations could increase our liability exposure and could permit greater state regulation of our operations. Other proposed bills and regulations at state and federal levels may impact certain aspects of our business, including agent licensing, corporate governance, permissible investments, market conduct, provider contracting, claims payments and processing and confidentiality of health information. While we cannot predict if any of these initiatives will ultimately become effective or, if enacted, what their terms will be, their enactment could increase our costs, expose us to expanded liability or require us to revise the ways in which we conduct business.
 
Our insurance and HMO subsidiaries are subject to minimum capital requirements. Our failure to meet these standards could subject us to regulatory actions.
 
Our insurance subsidiaries are subject to risk-based capital, or RBC, standards, imposed by the States of New York and New Jersey and the Blue Cross and Blue Shield Association. These rules are based on the RBC Model Act adopted by the National Association of Insurance Commissioners, or NAIC, and require our regulated subsidiaries to report their results of RBC calculations to the departments of insurance in the states in which they are licensed, to the NAIC and to the Blue Cross and Blue Shield Association. Our HMO is subject to minimum capital requirements under state law, based upon a percentage of premium income, and is also subject to RBC standards under the rules of the Blue Cross Blue Shield Association. Failure to maintain required levels of capital or to otherwise comply with the reporting requirements could subject our regulated subsidiaries to corrective action, including state supervision or liquidation. In addition, failure to maintain certain levels of RBC standards could result in the revocation or loss of our Blue Cross Blue Shield license.

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Compliance with the requirements of the Health Insurance Portability and Accountability Act of 1996, or HIPAA, is expected to be costly.
 
HIPAA establishes standards and requirements to facilitate the electronic transmission of certain health information. This federal legislation and regulations issued under it:
 
 
•
 
require health plans, clearinghouses and providers to comply with various requirements and restrictions related to the use, storage and disclosure of protected health information, to adopt rigorous internal procedures to protect protected health information and to enter into specific written agreements with business associates to whom protected health information is disclosed;
 
 
•
 
establish a standardized coding system for medical data which must be applied by all health care plans, among others, transmitting health information in electronic form;
 
 
•
 
require that all health plans have the capacity to accept and/or send standard transactions electronically;
 
 
•
 
require uniform standards for common health care transactions including health care claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments and payment of benefits;
 
 
•
 
establish standards for use of electronic signatures;
 
 
•
 
prohibit health plans from refusing to process or delaying the processing of a transaction that is presented in standard format; and
 
 
•
 
establish a civil monetary penalty for knowing misuse of unique health identifiers and individually identifiable health information.
 
The regulations establish significant criminal penalties and civil sanctions for noncompliance. We believe that we have adequate reserves to cover any expenses we may incur for potential violations. However, violations may occur and future legislation may be implemented or revised to impose greater requirements upon us. The costs associated with HIPAA violations may be significant and may have an adverse impact on our business, financial condition or results of operations.
 
Risks Relating to this Offering
 
The initial public offering price of our common stock may not be indicative of the market price of our common stock after this offering and our stock price could be highly volatile.
 
The initial public offering price of our common stock is based on numerous factors and may not be indicative of the market price of our common stock after this offering. These factors include:
 
 
•
 
variations in actual or anticipated operating results;
 
 
•
 
changes in or failure to meet earnings estimates of securities analysts;
 
 
•
 
market conditions in the health care industry;
 
 
•
 
regulatory actions and general economic and stock market conditions;
 
 
•
 
the availability for sale, or sales, of a significant number of shares of our common stock in the public market, including by the Fund; and
 
 
•
 
reaction to our plan of conversion.
 
These and other factors may have a significant effect on the market price of our common stock after this offering. Accordingly, the market price of our common stock may decline below the initial public offering price.

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State laws and regulations, provisions of our certificate of incorporation and bylaws and our agreements with the Fund could delay, deter or prevent a takeover attempt that stockholders might consider to be in their best interests and may make it more difficult to replace members of our board of directors and have the effect of entrenching management.
 
Provision of state laws and our certificate of incorporation and bylaws and our agreements with the Fund may delay, defer, prevent or render more difficult a takeover attempt that our stockholders might consider to be in their best interests. For instance, they may prevent our stockholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future.
 
After the conversion, we will be regulated as an insurance holding company and will be subject to the insurance holding company acts of the states in which our subsidiaries are domiciled and licensed, presently New York and New Jersey, as well as similar provisions included in the New York health regulations. The holding company acts and regulations for the states of New York and New Jersey and the health regulations of New York restrict the ability of any person to obtain control of an insurance company or HMO without prior regulatory approval. Under those statutes and regulations, without such approval (or an exemption), no person may acquire any voting security of a domestic insurance company or HMO, or an insurance holding company which controls an insurance company or HMO, or merge with such a holding company, if as a result of such transaction such person would “control” the insurance holding company, insurance company or HMO. “Control” is generally defined as the direct or indirect power to direct or cause the direction of the management and policies of a person and is presumed to exist if a person directly or indirectly owns or controls 10% or more of the voting securities of another person.
 
Our license agreements with the Blue Cross Blue Shield Association require that our certificate of incorporation contain certain provisions, including ownership limitations. The Blue Cross Blue Shield Association ownership limits restrict beneficial ownership of our voting capital stock to less than 10% for institutional investors and less than 5% for noninstitutional investors, both as defined in our certificate of incorporation. In addition, no person may beneficially own shares of our common stock or other equity securities, or a combination thereof, representing a 20% or more ownership interest, whether voting or non-voting, in our company. (The Blue Cross Blue Shield Association has agreed to waive the ownership limitations for the Fund, provided that the Fund agrees to the terms of the voting trust and divestiture agreement described in “Certain Relationships and Related Transactions—The Fund and the Foundation.”) Our certificate of incorporation prohibits ownership of our capital stock in excess of these Blue Cross Blue Shield Association ownership limits without prior approval of the Blue Cross Blue Shield Association. This provision in our certificate of incorporation cannot be changed without the vote of holders of at least 75% of our common stock voting as a single class.
 
Other provisions included in our certificate of incorporation and bylaws as well as voting rights granted to the Fund, as the holder of our Class B common stock, and provisions of the voting trust and divestiture agreement, may also have anti-takeover effects and may delay, defer or prevent a takeover attempt that our stockholders might consider to be in their best interests. In particular, our certificate of incorporation and bylaws:
 
 
•
 
permit our board of directors to issue one or more series of preferred stock;
 
 
•
 
divide our board of directors into three classes serving staggered three-year terms;
 
 
•
 
limit the ability of stockholders to remove directors;
 
 
•
 
restricts the ability of our stockholders, other than the Fund as holder of the Class B common stock, to act by written consent;
 
 
•
 
impose restrictions on stockholders’ ability to fill vacancies on our board of directors;
 
 
•
 
prohibit stockholders from calling special meetings of stockholders;

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•
 
impose advance notice requirements for stockholder proposals and nominations of directors to be considered at meetings of stockholders; and
 
 
•
 
impose restrictions on stockholders’ ability to amend our certificate of incorporation and bylaws.
 
In addition, under the voting trust and divestiture agreement, the Fund has agreed, in each case subject to certain exceptions, not to acquire additional shares of our common stock, not to solicit proxies from our stockholders or become a participant in any proxy solicitation, not to tender its shares in response to any tender or exchange offer that is opposed by a majority of our independent directors, and not to sell its shares to any person if, to the knowledge of the members of the board of the Fund, such person (either before or after giving effect to such sale) would hold more than the 10% (in the case of an institution) or 5% (in the case of a non-institution) of our outstanding voting stock.
 
These voting and other restrictions may operate to make it more difficult to replace members of our board of directors and may have the effect of entrenching management regardless of their performance.
 
We may lose tax benefits as a result of the conversion or this offering which could expose us to significant additional tax liability and may have an adverse impact on our cash flow and reported operating results.
 
We have benefited from certain favorable aspects of our tax designation over the years. Specifically, we have reported our income for tax purposes using certain beneficial rules afforded to Blue Cross Blue Shield member plans under Section 833 of the Code and, in addition, have substantial tax loss and credit carryovers. Specifically, at June 30, 2002, our regular tax loss carryovers were approximately $524 million and our alternative minimum tax credit carryforward was approximately $96 million. In connection therewith, on October 1, 2002 we submitted a request for a ruling from the Internal Revenue Service to the effect that our ability to utilize our tax loss and credit carryovers will not be limited by the conversion. This ruling request is currently pending and we do not anticipate receiving a response from the Internal Revenue Service before this offering is completed.
 
No assurance can be given, however, that this ruling will be obtained and that we will retain the availability of our tax losses and credit carryovers without limitation. In addition, no assurance can be given that we will retain our Section 833 benefits. No authority directly addresses whether a conversion transaction of the type we contemplate will render the Section 833 benefit unavailable. We are 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 Section 833 benefits. Moreover, even if neither the conversion nor the offering results in a loss of these benefits or a limitation on the use of our tax losses and credit carryovers, subsequent sales of shares of our common stock, including sales by the Fund and/or Foundation, could result in such a limitation. Any loss of the tax benefits attributable to Section 833 of the Code or to our tax losses and credit carryovers could result in significant additional tax liability for us and, in addition, may have an adverse impact on our cash flow and reported operating results. We believe that subsequent to the conversion, our effective federal income tax rate for financial reporting purposes will approximate the 35% statutory rate.
 
Following our conversion into a for-profit entity, we will be subject to state and local taxes that we were not previously required to pay, including premium taxes on most non-HMO insured business, sales and use taxes (recorded as administrative expenses) and state and local income taxes. If we had been a for-profit company for all of 2001, we would have incurred approximately $42.0 million in premium and sales and use taxes and approximately $13.2 million in state and local income taxes for the year ended December 31, 2001.
 
Risks Relating to the Plan of Conversion and the Conversion Legislation
 
The plan of conversion is still subject to review and challenge.
 
On June 18, 2002, HealthChoice submitted the plan of conversion to the New York State Department of Insurance for review by the Superintendent (and on September 26, 2002 HealthChoice further amended and refiled this plan). Pursuant to the plan of conversion, HealthChoice requested that the Superintendent approve its conversion from a not-for-profit health services corporation to a for-profit accident and health insurer, under the New York insurance laws. On August 6 and 7, 2002, a public hearing took place with respect to the plan of

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conversion. On October 8, 2002, the Superintendent issued an Opinion and Decision approving the plan of conversion and concluding that the conversion is in compliance with the Conversion Legislation and does not violate any applicable laws or regulations. The approval and conclusions are subject to several conditions, including the approval by the Superintendent, the Commissioner and CMS of certain of the agreements that we will enter into in connection with the conversion. Pursuant to the Conversion Legislation, the Opinion and Decision may be challenged until November 7, 2002, the 30th day following the date of the Opinion and Decision. The 30-day challenge period may not expire prior to the completion of this offering. We cannot predict whether any action (in addition to the one described below) challenging the plan of conversion or the Opinion and Decision or other aspects of the conversion will be commenced either prior to or after the completion of this offering or what aspect of the plan of conversion or the Opinion and Decision an action might challenge. In the event that the Opinion and Decision is challenged, a successful challenge could result in monetary damages, a modification of the plan or the approval of the plan being set aside in full or in part. A successful challenge would likely result in substantial uncertainty relating to the terms and effectiveness of the plan, including our conversion, the issuance of our common stock in the conversion or the sale of our common stock sold in this offering. A substantial period of time might be required to reach a determination. Such developments could seriously undermine our efforts to raise capital in order to remain competitive in our service areas and/or markets. This would have an adverse impact on our ability to conduct our business and could have an adverse impact on prevailing market prices of our common stock and the value of your investment.
 
Litigation challenging the Conversion Legislation could adversely affect the terms of the plan of conversion and the price of our common stock.
 
Litigation may be filed challenging the Conversion Legislation on the ground that the legislation is unconstitutional. The Conversion Legislation provides that any such litigation must receive expedited judicial review. However, a substantial period of time could be required to reach a determination. On August 21, 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 the Conversion Legislation on several constitutional 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 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. The complaint seeks a permanent injunction enjoining the conversion or portions of the conversion. On September 20, 2002, we responded to this complaint by moving to dismiss the plaintiffs’ complaint in its entirety on several grounds. Our motion is returnable on November 14, 2002 and we expect to orally argue the motion in the fourth quarter of 2002. If the plaintiffs are successful there could be substantial uncertainty as to the terms and effectiveness of the plan of conversion, including the conversion of HealthChoice into a for-profit corporation, the issuance of the shares of our common stock in the conversion, or the sale of our common stock sold in this offering. See “Business—Litigation.” In addition, new litigation challenging the Conversion Legislation could also be filed after the date of this offering. Such developments could have an adverse impact on our ability to conduct our business and could have an adverse impact on prevailing market prices of our common stock or the value of your investment.

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FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements that include information about possible or assumed future sales, results of operations, developments, regulatory approvals or other circumstances. These statements may be found in the sections of this prospectus entitled “Risk Factors,” “Business—Company Overview,” “—Industry Overview,” “—The New York Marketplace,” “—Our Strategy” and “—Customers,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this prospectus. Statements that use the terms “believe,” “expect,” “plan,” “intend,” “estimate,” “anticipate,” “project,” “may,” “will,” “shall,” “should” and similar expressions, whether in the positive or negative, are intended to identify forward-looking statements.
 
All forward-looking statements in this prospectus reflect our current views about future events and are based on assumptions and subject to risks and uncertainties. Consequently, actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in “Risk Factors” and elsewhere in this prospectus.
 
In addition, health benefits companies operate in a highly competitive, constantly changing environment that is significantly influenced by very large organizations that have resulted from business combinations, aggressive marketing and pricing practices of competitors and regulatory oversight. The following is a summary of factors, the results of which, either individually or in combination, if markedly different from our planning assumptions, could cause our results to differ materially from those expressed in any forward-looking statements contained in this prospectus:
 
 
•
 
trends in health care costs and utilization rates;
 
 
•
 
ability to secure sufficient premium rate increases;
 
 
•
 
competitor pricing below market trends of increasing costs;
 
 
•
 
increased government regulation of health benefits and managed care;
 
 
•
 
significant acquisition or divestitures by major competitors;
 
 
•
 
introduction and use of new prescription drugs and technologies;
 
 
•
 
a downgrade in our financial strength ratings;
 
 
•
 
litigation or legislation targeted at health benefits companies;
 
 
•
 
ability to contract with providers consistent with past practice;
 
 
•
 
general economic downturns;
 
 
•
 
major disasters; and
 
 
•
 
epidemics.
 
Except as required by applicable law, including the securities laws of the United States, we do not intend to update or revise any forward-looking statements.

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USE OF PROCEEDS
 
We will not receive any proceeds from the sale of shares of common stock being offered hereby by the Fund and the Foundation.
 
If the underwriters exercise their over-allotment option in full, we estimate that the net proceeds to us will be $25.1 million, after deducting the underwriting discount. We expect to use any proceeds from the exercise of the over-allotment option to pay offering and conversion expenses and for general corporate purposes. Pending the use of the net proceeds as described above, we intend to invest the net proceeds in short-term, interest-bearing, investment grade investments.
 
We will pay all of our expenses in connection with this offering (including the expenses of the selling stockholders), which we anticipate will be approximately $5.7 million.
 
DIVIDEND POLICY
 
We do not expect to pay any cash dividends for the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and the expansion of our business.
 
Our ability to pay dividends is dependent on cash dividends from our subsidiaries. Our subsidiaries are subject to regulatory surplus requirements and additional regulatory requirements, which may restrict their ability to declare and pay dividends or distributions to us. Any proposed dividend to WellChoice from Empire, which, together with other dividends paid within the preceding twelve month period, exceeds the lesser of 10% of its surplus to policyholders or 100% of adjusted net investment income, will be subject to approval by the Department of Insurance. Any proposed dividend to Empire from WellChoice Insurance of New Jersey, which, together with other dividends paid within the preceding twelve month period, exceeds the greater of 10% of its surplus to policyholders or net income not including realized capital gains will be subject to approval by the New Jersey Department of Banking and Insurance. Dividends from both Empire and WellChoice Insurance of New Jersey must be paid from earned surplus. Dividends from Empire HealthChoice HMO to Empire in excess of 10% of the admitted assets of Empire HealthChoice HMO will also be subject to review and approval by the New York Department of Insurance, the Department of Health and the New Jersey Department of Banking and Insurance. These dividends can only be paid from earned surplus.
 
HealthChoice has sought the consent of the Superintendent to pay a dividend of $225.0 million to WellChoice simultaneously with the effectiveness of this offering.
 
In addition, borrowings undertaken in the future may restrict our ability to pay dividends without the consent of lenders. In the event we are able to declare dividends on our common stock in the future, any such declaration would be at the discretion of our board of directors.
 
Our board of directors will take into account such matters as general business conditions, our financial results, capital requirements, contractual, legal and regulatory restrictions on the payment of dividends by us to our stockholders or by our subsidiaries to us and any such other factors as our board of directors may deem relevant.

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CAPITALIZATION
 
The following table sets forth, as of June 30, 2002, HealthChoice’s capitalization on an actual basis and WellChoice’s capitalization on an adjusted basis to give effect to the consummation of the transactions contemplated by the plan of conversion.The conversion will be accounted for as a reorganization using the historical carrying values of HealthChoice’s assets and liabilities. Immediately following the conversion, HealthChoice’s unassigned reserves will be reclassified to par value of common stock and additional paid-in capital. Concurrently, HealthChoice will become a wholly owned subsidiary of WellChoice. The costs of the conversion will be recognized as an expense.
 
Please read this table together with the sections of this prospectus entitled “Selected Consolidated Financial and Additional Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes of HealthChoice included in this prospectus.
 
      
As of June 30, 2002
      
HealthChoice Historical
     
WellChoice
Pro forma
      
(in millions, except share data)
Long-term debt, including current portion(1)
     
$
0.0
     
 
$    0.0
Stockholders’ equity:(2)
                  
Common stock, $0.01 per share value, 225,000,000 shares authorized; 82,300,000 shares issued and outstanding
     
 
—  
     
 
0.8
Class B common stock, $0.01 per share value, one share authorized; one share issued and outstanding
     
 
—  
     
 
0.0
Preferred stock, $0.01 per share value, 25,000,000 shares authorized; none issued and outstanding
     
 
—  
     
 
—  
Additional paid-in capital
     
 
—  
     
 
951.2
Retained earnings(3)
     
 
952.0
     
 
0.0
Accumulated other comprehensive income
     
 
12.9
     
 
12.9
      
    
Total stockholders’ equity(2)
     
$
964.9
     
$
964.9
      
    
(1)
 
We currently maintain letters of credit, including a $25.0 million unsecured letter of credit from a group of financial institutions to support our lease obligation for our Brooklyn, New York facility. As of June 30, 2002, there were no funds drawn against the existing letters of credit. On October 17, 2002, we entered into a $100.0 million credit facility with a syndicate of banks which will replace our existing letter of credit agreement and the existing $25.0 million letter of credit will be deemed issued under the new credit facility. The credit facility will become effective on the date of this prospectus, subject to our satisfaction of customary closing conditions.
(2)
 
Historically referred to as reserves for policyholders’ protection.
(3)
 
Historically referred to as unassigned reserves.

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DILUTION
 
If the underwriters exercise their over-allotment option, you will experience dilution because our net tangible book value per share will decrease. Our net tangible book value as of June 30, 2002, was $964.9 million, or approximately $11.72 per share. Net tangible book value per share represents the amount of tangible assets reduced by the total liabilities, divided by the number of shares of common stock that we have assumed to be outstanding after giving effect to the conversion, but prior to the completion of this offering. After giving effect to the conversion and the sale of the 15,940,211 shares in this offering (including 1,190,477 shares sold by us) at an assumed public offering price of $22.50 per share (assuming the exercise by the underwriters of their over-allotment option in full) after deducting estimated underwriting discounts and commissions and the estimated offering expenses payable by us, our net tangible book value as of June 30, 2002, would have been $984.3 million, or $11.79 per share. This represents an immediate increase in pro forma net tangible book value to existing stockholders of $0.07 per share and an immediate dilution in net tangible book value of $10.71 per share to new investors.
 
Dilution per share represents the difference between the price per share to be paid by new investors and the net tangible book value per share immediately after this offering (assuming the exercise by the underwriters of their over-allotment option in full). The following table illustrates this per share dilution:
 
Assumed initial public offering price per share
          
$
22.50
Net tangible book value per share after giving effect to the conversion, but prior to the completion of this offering
   
$
11.72
       
    
      
Increase per share attributable to new investors
   
 
0.07
       
    
      
Net tangible book value per share after this offering and the exercise of the over-allotment option in full
          
 
11.79
           
Dilution per share to new investors
          
$
10.71
           

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SELECTED CONSOLIDATED FINANCIAL AND ADDITIONAL DATA
 
We derived the following selected consolidated financial and additional data for the six months ended June 30, 2002 and the five years ended December 31, 2001 from the consolidated financial statements and related notes of HealthChoice and its subsidiaries which were audited by Ernst & Young LLP. We derived the following selected consolidated financial and additional data for the six months ended June 30, 2001 from unaudited financial statements, which include all adjustments, consisting of normal recurring accruals, which we consider necessary for a fair presentation of the financial position and the results of operations for this period. You should read the selected consolidated financial and additional data together with the consolidated financial statements of HealthChoice and its subsidiaries and related notes and the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historically, HealthChoice was the parent company for all of our businesses.
 
    
Six months ended
June 30,
     
Year ended December 31,
    
2002
     
2001
     
2001
     
2000
     
1999
     
1998
   
1997
    
(in millions)
Revenue:
                                                           
Premiums earned
   
$
2,359.8
 
   
$
2,162.2
 
   
$
4,246.2
 
   
$
3,876.9
 
   
$
3,362.3
 
   
$
3,064.4
   
$
3,152.7
Administrative service fees
   
 
194.3
 
   
 
160.2
 
   
 
322.0
 
   
 
264.9
 
   
 
238.9
 
   
 
171.2
   
 
138.2
Investment income, net(1)
   
 
34.4
 
   
 
37.3
 
   
 
69.3
 
   
 
65.5
 
   
 
58.7
 
   
 
55.6
   
 
49.0
Net realized investment gains (losses)
   
 
(0.4
)
   
 
(5.5
)
   
 
(12.4
)
   
 
22.1
 
   
 
0.2
 
   
 
3.8
   
 
1.3
Other income, net(2)(3)
   
 
13.6
 
   
 
2.8
 
   
 
6.1
 
   
 
4.3
 
   
 
4.8
 
   
 
3.0
   
 
83.4
    
  
  
  
  
  
  
Total revenue
   
 
2,601.7
 
   
 
2,357.0
 
   
 
4,631.2
 
   
 
4,233.7
 
   
 
3,664.9
 
   
 
3,298.0
   
 
3,424.6
Expenses:
                                                           
Cost of benefits provided
   
 
2,057.0
 
   
 
1,915.3
 
   
 
3,738.8
 
   
 
3,426.4
 
   
 
2,944.6
 
   
 
2,721.5
   
 
2,808.1
Administrative expenses(4)(5)
   
 
401.3
 
   
 
370.9
 
   
 
742.8
 
   
 
686.2
 
   
 
587.3
 
   
 
533.2
   
 
568.4
Conversion expenses
   
 
3.6
 
   
 
1.3
 
   
 
2.0
 
   
 
0.6
 
   
 
3.7
 
   
 
2.3
   
 
—  
    
  
  
  
  
  
  
Total expenses
   
 
2,461.9
 
   
 
2,287.5
 
   
 
4,483.6
 
   
 
4,113.2
 
   
 
3,535.6
 
   
 
3,257.0
   
 
3,376.5
    
  
  
  
  
  
  
Income from continuing operations before income taxes
   
 
139.8
 
   
 
69.5
 
   
 
147.6
 
   
 
120.5
 
   
 
129.3
 
   
 
41.0
   
 
48.1
Income tax (expense)
benefit(6)
   
 
—  
 
   
 
—  
 
   
 
(0.1
)
   
 
74.5
 
   
 
(9.1
)
   
 
1.0
   
 
3.8
    
  
  
  
  
  
  
Income from continuing operations
   
 
139.8
 
   
 
69.5
 
   
 
147.5
 
   
 
195.0
 
   
 
120.2
 
   
 
42.0
   
 
51.9
Loss from discontinued operations, net of tax(7)
   
 
(1.1
)
   
 
(7.0
)
   
 
(16.5
)
   
 
(4.6
)
   
 
—  
 
   
 
—  
   
 
—  
    
  
  
  
  
  
  
Net income
   
$
138.7
 
   
$
62.5
 
   
$
131.0
 
   
$
190.4
 
   
$
120.2
 
   
$
42.0
   
$
51.9
    
  
  
  
  
  
  
 
    
Pro forma Information (unaudited)(8)
    
Six months ended
June 30, 2002
   
Year ended
December 31, 2001
    
(in millions, except share
and per share data)
Pro forma administrative expenses(9)
   
$
422.1
   
$
784.8
Pro forma income from continuing operations before income taxes
   
 
119.0
   
 
105.6
Pro forma income tax expense(10)
   
 
52.9
   
 
45.5
Pro forma net income
   
 
65.4
   
 
49.3
Pro forma earnings per common share
   
 
0.79
   
 
0.60
Shares used to compute pro forma earnings per share(11)
   
 
82,300,000
   
 
82,300,000

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Six months ended
June 30,
   
Year ended December 31,
    
2002
   
2001
   
2001
   
2000
   
1999
   
1998
   
1997
Additional Data:
                                                 
Medical loss ratio(12)
   
 
87.2%
   
 
88.6%
   
 
88.1%
   
 
88.4%
   
 
87.6%
   
 
88.8%
   
 
89.1%
Medical loss ratio, excluding New York City and New York State PPO(13)
   
 
84.4%
   
 
86.3%
   
 
86.0%
   
 
85.9%
   
 
85.1%
   
 
86.6%
   
 
87.5%
Administrative expense ratio(14)
   
 
15.9%
   
 
16.0%
   
 
16.3%
   
 
16.6%
   
 
16.4%
   
 
16.6%
   
 
17.3%
Administrative expense ratio—premium equivalent basis(15)
   
 
11.1%
   
 
11.7%
   
 
11.7%
   
 
12.6%
   
 
12.7%
   
 
N/A
   
 
N/A
Members (000’s at end of
period)(16)
   
 
4,644
   
 
4,365
   
 
4,383
   
 
4,135
   
 
4,161
   
 
4,119
   
 
4,081
    
As of June 30,
   
As of December 31,
    
2002
   
2001
   
2001
   
2000
   
1999
   
1998
   
1997
    
(in millions)
Balance Sheet Data:
                                                 
Cash and investments
   
$
1,593.3
   
$
1,432.2
   
$
1,604.3
   
$
1,400.6
   
$
1,330.2
   
$
1,184.0
   
$
1,013.1
Premium related receivables
   
 
402.7
   
 
464.5
   
 
403.5
   
 
447.5
   
 
404.7
   
 
399.3
   
 
484.3
Total assets
   
 
2,482.3
   
 
2,347.4
   
 
2,449.6
   
 
2,252.5
   
 
1,987.4
   
 
1,837.3
   
 
1,808.1
Unpaid claims and claims adjustment expense
   
 
628.1
   
 
734.7
   
 
634.1
   
 
672.4
   
 
591.0
   
 
597.2
   
 
661.7
Total liabilities
   
 
1,517.4
   
 
1,600.2
   
 
1,620.3
   
 
1,577.8
   
 
1,484.7
   
 
1,457.8
   
 
1,474.1
Total reserves for policyholders’ protection(17)
   
 
964.9
   
 
747.2
   
 
829.3
   
 
674.7
   
 
502.7
   
 
379.5
   
 
334.0
  (1)
 
Investment income, net represents total investment income for the period, less investment expenses.
  (2)
 
Other income includes $8.0 million and $6.8 million of gains recorded for the six months ended June 30, 2002 and for the year ended December 31, 2001, respectively, based on insurance carrier settlement offers for electronic data processing, furniture and office equipment lost at the World Trade Center.
  (3)
 
Other income includes a $79.8 million gain from the sale of our home office building located in New York City in 1997.
  (4)
 
Administrative expenses includes $2.4 million and $3.5 million of estimated expenses incurred as a result of the loss of our headquarters located at the World Trade Center that may or may not be reimbursed by our insurance carrier, for the six months ended June 30, 2002 and for the year ended December 31, 2001, respectively.
  (5)
 
Administrative expenses includes $5.3 million of employee-related transition costs incurred in connection with our modernization and outsourcing agreement with IBM for the six months ended June 30, 2002.
  (6)
 
As of December 31, 2000, we reduced our valuation allowance on our deferred tax assets by $71.9 million based on continued, current and projected positive taxable income.
  (7)
 
Represents loss from operations of NexxtHealth, Inc., a development stage subsidiary formed in March 2000 to develop Internet portal software to market to other health benefit companies, which was discontinued in February 2002.
  (8)
 
Following the conversion, HealthChoice will be a for-profit entity and will be subject to state and local taxes as well as federal income taxes at the statutory rate of 35%.
  (9)
 
Includes an estimate of premium and sales and use tax expense as if HealthChoice were a for-profit company of $20.8 million and $42.0 million for the six months ended June 30, 2002 and the year ended December 31, 2001, respectively.

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(10)
 
Includes an estimate of state and local income tax expense as if HealthChoice were a for-profit company of $17.3 million and $13.2 million for the six months ended June 30, 2002 and the year ended December 31, 2001, respectively. Federal income tax expense was computed at the statutory rate of 35%.
(11)
 
Calculated based on number of shares that would have been held by the Fund and the Foundation as of June 30, 2002 and December 31, 2001, after giving effect to the conversion but prior to this offering.
(12)
 
Medical loss ratio represents cost of benefits provided as a percentage of premiums earned.
(13)
 
We present medical loss ratio, excluding New York City and New York State PPO because these accounts differ from our standard PPO product in that they are hospital-only accounts which have lower premiums relative to administrative expense and are retrospectively rated with a guaranteed administrative service fee. In addition, the size of these accounts distorts our performance when the total medical loss ratios are presented.
(14)
 
Administrative expense ratio represents administrative and conversion expenses as a percentage of premiums earned and administrative service fees.
(15)
 
Premium equivalents are obtained by adding to our administrative service fees the amount of claims attributable to these service fees, which include our non-Medicare, self-funded (or ASO) health business pursuant to which we provide a range of customer services, including claims administration and billing and membership services. Administrative expense ratio—premium equivalent basis is determined by dividing administrative and conversion expenses by premium equivalents plus premiums earned for the relevant periods. Administrative expense ratio—premium equivalent is a measure that is commonly used in the health benefits industry to allow for a comparison of operating efficiency among companies.
(16)
 
Enrollment as of June 30, 2002 includes 172,000 New York State PPO account members who reside in New York State but outside of our service areas. Prior to this time, these members were enrolled in the New York Blue Cross Blue Shield plan licensed in the area where the members resided and, accordingly, the membership was reported by these plans and not by us. Starting in 2002, in accordance with a change to the contract with New York State, we began administering the entire plan, including those members enrolled outside of our service area, and all members were therefore enrolled in, and reported by, HealthChoice. New York State PPO account members who reside in New York State but outside of our service areas are excluded from enrollment totals for all other periods presented.
(17)
 
Total reserves for policyholders’ protection is the term used to define GAAP surplus (GAAP assets less GAAP liabilities).

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Overview
 
We are the largest health insurance company in the State of New York based on total PPO and HMO membership which includes members under our insured and ASO plans. We offer managed care and traditional indemnity products to over 4.6 million members. We have licenses with the Blue Cross Blue Shield Association which entitle us to the exclusive use of the Blue Cross and Blue Shield names and marks in ten counties in the New York City metropolitan area and in six counties in upstate New York, the non-exclusive right to use the Blue Cross and Blue Shield names and marks in one upstate New York county, the exclusive right to only the Blue Cross name and mark in seven upstate New York counties and the non-exclusive right to only the Blue Cross name in four upstate New York counties. We market our products and services using these names and marks in our New York service areas. We also market our managed care products in 16 counties in New Jersey under the WellChoice brand.
 
Our revenue primarily consists of premiums earned and administrative service fees derived from the sale of managed care and traditional indemnity health benefits products to employer groups and individuals. Premiums are derived from insured contracts and administrative service fees are derived from self-funded contracts, under which we provide a range of customer services, including claims administration and billing and membership services. Revenue also includes administrative service fees earned under the BlueCard program for providing members covered by other Blue Cross Blue Shield plans with access to our network providers, reimbursements under our government contract with the Centers for Medicare and Medicaid Services, or CMS, to act as a fiscal intermediary for Medicare Part A program beneficiaries and a carrier for Medicare Part B program beneficiaries, and investment income.
 
Our cost of benefits provided expense consists primarily of claims paid and claims in process and pending to physicians, hospital and other healthcare providers and includes an estimate of amounts incurred but not yet reported. Administrative expenses consist primarily of compensation expenses, commission payments to brokers and other overhead business expenses.
 
We report our operating results as two business segments: commercial managed care and other insurance products and services. Our commercial managed care segment accounted for 79.4% of our membership as of June 30, 2002. Our commercial managed care segment includes group PPO, HMO (including Medicare+Choice) and EPO products as well as our New York City and New York State PPO business. Our other insurance products and services segment consists of our indemnity and individual products. Our indemnity products include traditional indemnity products and government contracts with CMS to act as a fiscal intermediary. Our individual products include Medicare supplemental, state sponsored plans, government mandated individual plans and individual hospital-only. We allocate administrative expenses, investment income and other income, but not assets, to our segments. Except when otherwise specifically stated or where the context requires, all references in this prospectus to our membership include both our insured and ASO membership. Our New York City and New York State members are covered under insured plans.
 
Critical Accounting Policies and Estimates
 
The following is an explanation of our accounting policies considered most significant by management. These accounting policies require us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information is known. Actual results could differ materially from those estimates.
 
Revenue Recognition
 
Our membership contracts generally have one year terms and are subject to cancellation upon 60 days written notice. Premiums are generally due monthly and are recognized as revenue during the period in which we are obligated to provide services to our members. We record premiums received prior to such periods as unearned premiums. We record premiums earned net of an allowance for doubtful accounts. Premiums recorded

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for groups with certain funding arrangements are based upon the actual and estimated claim experience of these groups. Future adjustments to the claims experience of these groups will result in changes in premium revenue. Our estimated claim experience is based on a number of factors, including our prior claims experience. These estimates are continually reviewed and adjusted based on actual claims experience. Any changes in these estimates are included in current period results. Funds received from these groups in excess of premiums recorded are reflected as liabilities on our balance sheet.
 
We recognize administrative service fees during the period the related services are performed. Administrative service fees consists of revenues from the performance of administrative services for self-funded contracts, reimbursements from our contract with CMS under which we serve as an intermediary for the Medicare Part A program and a carrier for the Medicare Part B program and fees earned under the BlueCard program. The revenue earned under our contract with CMS is recorded net of an allowance for an estimate of disallowed expenses.
 
Cost of Benefits Provided
 
Cost of benefits provided includes claims paid, claims in process and pending, and an estimate for unreported claims for charges for healthcare services for enrolled members during the period. We are required to estimate the total amount of claims that have not been reported or that have been received, but not yet adjudicated, during any accounting period. These estimates, referred to as unpaid claims on our balance sheet, are recorded as liabilities on our balance sheet.
 
We estimate claim reserves in accordance with Actuarial Standards of Practice promulgated by the Actuarial Standards Board, the committee of the American Academy of Actuaries that establishes professional guidelines and standards for actuaries to follow. Factors we consider in estimated future payments include existing claims data, medical cost trends, the mix of products and benefits sold, internal processing changes and the amount of time it took to pay all of the benefits for claims from prior periods. To the extent the actual amount of these claims is greater than the estimated amount based on our underlying assumptions, such differences would be recorded as additional cost of benefits provided in subsequent accounting periods and our future earnings would be adversely affected. To the extent the claims experience is less than estimated based on our underlying assumptions, such differences would be recorded as a reduction in cost of benefits provided in subsequent accounting periods.
 
Taxes
 
We account for income taxes using the liability method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to the difference between the financial reporting and tax basis of assets and liabilities. We record a valuation allowance to reduce our deferred tax asset to the amount we believe is more likely than not to be realized. This determination, which requires considerable judgment, is based on a number of assumptions including an estimate of future taxable income. If future taxable income or other factors are not consistent with our expectations, an adjustment to our deferred tax asset may be required in the future. Any such adjustment would be charged or credited to income in the period such determination was made.
 
Impact of Conversion
 
The historical financial statements included in this prospectus reflect HealthChoice as the parent company of all of our subsidiaries. In the conversion, immediately prior to the effectiveness of this offering, HealthChoice will have:
 
 
•
 
converted from a not-for-profit health services corporation to a for-profit accident and health insurer under the New York insurance laws;
 
 
•
 
issued 95% and 5% of its capital stock to the Fund and the Foundation, respectively, which in turn will have transferred those shares to a direct, wholly owned subsidiary of WellChoice in exchange for a corresponding amount of shares of WellChoice common stock; and
 
 
•
 
merged with the converted HealthChoice’s existing wholly owned accident and health insurance subsidiary, with HealthChoice surviving as “Empire HealthChoice Assurance, Inc.”

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As a result, immediately prior to the completion of this offering, the Fund and the Foundation will own all of our capital stock and WellChoice will be the parent holding company of all of its direct and indirect subsidiaries.
 
The conversion will be accounted for as a reorganization using the historical carrying values of HealthChoice’s assets and liabilities. Immediately following the conversion, HealthChoice’s unassigned reserves will be reclassified to par value of common stock and additional paid-capital. See “Capitalization.” Concurrently, HealthChoice will become a wholly owned subsidiary of WellChoice. The costs of the conversion will be recognized as an expense. We started incurring conversion-related expenses in 1998 when HealthChoice first began paying fees and expenses of advisors to the Superintendent in connection with the New York State Department of Insurance’s consideration of our original draft plan of conversion. Through June 30, 2002, we incurred conversion and offering expenses of $12.2 million. We estimate that we will incur an additional $11.8 million of conversion and offering expenses through completion of the offering.
 
As part of the plan of conversion we have agreed to several temporary premium rate restrictions for certain categories of our individual members that could impact our future financial results. For example, we agreed that, with respect to premium rates applicable to our individual Medicare supplemental policies and our individual Direct Pay voluntary indemnity policies, we will comply with certain provisions of the New York insurance laws in effect on December 31, 1999, relating to rate increases for persons covered under policies issued by Article 43 insurers, for a period of five years and three years, respectively, following the effective date of the conversion. Our individual Medicare supplemental policies covered approximately 126,000 of our members at June 30, 2002 and accounted for approximately $122.4 million of revenue for the six months ended June 30, 2002, and $257.8 million of revenue for the year ended December 31, 2001. Our individual Direct Pay voluntary indemnity policies covered approximately 21,000 of our members at June 30, 2002 and accounted for approximately $16.5 million of revenue for the six months ended June 30, 2002, and $36.1 million of revenue for the year ended December 31, 2001. Under the provisions of the New York insurance laws in effect on December 31, 1999, rate increases of up to 10% annually may be implemented upon filing, so long as we have a medical loss ratio of at least 80%. Additional increases will require the prior approval of the Superintendent following a public hearing. There is no assurance that the Superintendent would approve any such rate approval request and the failure to obtain such approvals could impact our results of operations. Under the plan of conversion, we have also agreed that with respect to individual Medicare supplemental policies, rate increases during the sixth, seventh and eighth years following the effective date of conversion may be implemented upon filing under the “file and use” methodology, provided we have a medical loss ratio of at least 80% (the ratio otherwise applicable to not-for-profit insurers) in contrast to the 75% minimum that is applicable to Medicare supplemental policies issued by for-profit health insurers. See “The Plan of Conversion” for a further discussion of the plan of conversion.
 
Upon completion of this offering, as a public company, our expenses will increase as we will be subject to a number of rules and regulations to which we were not subject as a not-for-profit health services corporation. For example, we will have to prepare and file periodic reports with the Securities and Exchange Commission, mail reports and proxy statements to our stockholders and hold annual stockholder meetings. We also will incur additional costs, such as stock exchange listing fees, and it is also likely that certain existing costs, such as directors’ and officers’ insurance, will increase when we are a public company. In addition, we will become subject to state and local taxes, including state premium tax as described below.
 
We have benefited from certain favorable tax attributes over the years. HealthChoice has reported its income for tax purposes using certain beneficial rules afforded Blue Cross and Blue Shield plans under Section 833 of the Internal Revenue Code, or the Code. Among other provisions of the Code, these plans were granted a special deduction, the 833(b) deduction, for regular tax calculation purposes. As a result of this deduction, HealthChoice currently incurs no regular tax liability but, in profitable years, pays taxes at the alternative minimum tax rate of 20%. 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, but limited to taxable income. The amount of 833(b) deductions utilized in each tax year is accumulated in an adjusted surplus balance. Once the

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cumulative adjusted surplus balance exceeds the 833(b) deduction for the current taxable year, the deduction is eliminated. Based on HealthChoice’s 2001 federal income tax return, HealthChoice could reduce regular taxable income in future years by approximately $315 million as a result of the 833(b) deduction. The availability of this deduction, however, will depend on future claim and claim adjustment expenses. It is unclear under existing law whether, after the conversion and this offering, our tax status under Section 833 will remain intact, and no assurance can be given that HealthChoice will retain its Section 833 benefits after the conversion. We believe that subsequent to the conversion, our effective federal income tax rate for financial reporting purposes will approximate the 35% statutory rate.
 
We have substantial tax loss and credit carryovers. At June 30, 2002, our regular tax loss carryforwards were approximately $524 million and our alternative minimum tax credit carryforward was approximately $96 million. It is unclear under existing law whether, after the conversion and this offering, such carryovers will continue to be available without limitation. In connection therewith, we are seeking a ruling from the Internal Revenue Service to confirm that our ability to utilize our tax loss and credit carryovers will not be limited by the conversion. No assurance can be given, however, that this ruling will be obtained or that we will retain the availability of our tax losses and credit carryovers without limitation. Moreover, even if neither the conversion nor the offering results in a loss of these benefits or a limitation on the use of our tax losses and credit carryovers, subsequent sales of shares of our common stock, including sales by the Fund and/or the Foundation, could result in such a limitation, which would have an adverse impact on our cash flow and reported operating results.
 
The tax consequences if we were to lose one or all of these tax attributes is difficult to estimate because they are interdependent and rely heavily on our future taxable income. For further discussion of tax considerations in connection with the conversion and the offering, see the section titled “Material U.S. Federal Income Tax Consequences of the Conversion to WellChoice” and “Risk Factors—We may lose tax benefits as a result of the conversion or this offering which could expose us to significant additional tax liability and may have an adverse impact on our cash flow and reported operating results.”
 
Additional State and Local Taxes
 
Following the conversion, we will become a for-profit entity and we will be subject to state and local taxes that we were not previously required to pay. These include premium taxes on most non-HMO insured business and sales and use taxes (which are recorded as administrative expenses), as well as state and local income taxes.
 
If we had been a for-profit company for all of 2001, we would have incurred approximately $42.0 million in premium and sales and use taxes and approximately $13.2 million in state and local income taxes for the year ended December 31, 2001. These estimates do not include recoupment of premium taxes through premium rate increases or the benefit from any effort to convert accounts from insured to self-funded arrangements. We intend to maintain our insurance contracts as competitively priced and, accordingly, the market for our products will determine the extent to which we can recover these additional expenses after the conversion.
 
Long Island Hospital Network
 
As noted previously, we recently reached agreement with the Long Island Hospital Network, which provides medical services to many of our approximately 800,000 members who reside in the Long Island, New York area, on the renewal of our provider contract with LIHN. Under the renewed agreement, we will reimburse LIHN for services at higher rates than were in effect previously. In addition, the publicity that surrounded the negotiations with LIHN resulted in a decline in our membership enrollment in this area. However, we believe that the resolution of this uncertainty will enable us to recapture our market position and that the impact of the renewal of our agreement with LIHN will not be material to our overall financial results.
 
Discontinued Operations
 
In February 2002, we discontinued the operations of NexxtHealth, Inc., a development stage subsidiary formed in March 2000 to develop Internet portal software to market to other health benefit companies. We discontinued these operations as part of our overall strategy to outsource certain technology functions.

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Capitated Provider Arrangements
 
Our costs of benefits provided under capitated arrangements are not significant. Payments under capitated arrangements totaled $74.3 million and $50.3 million for the year ended December 31, 2001 and six months ended June 30, 2002, respectively, representing 2.0% and 2.4% of total cost of benefits provided for each period, respectively.
 
We currently maintain a single global capitation arrangement to provide hospital and medical benefits for approximately 1,000 members enrolled in our Medicare+Choice product. Payments made under this arrangement totaled $7.0 million and $3.8 million for the year ended December 31, 2001 and the six months ended June 30, 2002, respectively. The net income earned under this arrangement was approximately $1.3 million and $0.7 million for the year ended December 31, 2001 and the six months ended June 30, 2002, respectively.
 
We also have capitated arrangements with service providers for certain disease management programs and utilization management services. At June 30, 2002, we had approximately 56,000 members under a capitated utilization management program for eye care services and 4,000 members under capitated disease management programs.
 
Other capitated arrangements are in place to manage and assume risk for certain benefits covered under specific products. The following sets forth the membership and respective benefits under these capitated arrangements at June 30, 2002:
 
Benefit
     
Membership
      
(in thousands)
Mental health
     
1,626
Laboratory services
     
402
Vision
     
354
Hearing
     
141
Dental
     
87
 
Approximately 35% of our membership is provided one or more benefits under a capitated program.

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Selected Membership Data and Results of Operations
 
The following table sets forth selected membership data as of the dates set forth below: