Insurer UnitedHealth Group Inc is in talks to buy the U.S. Northeast operations of rival Health Net Inc, sources familiar with the situation said on Friday.

The discussions still could fall apart without an agreement, the sources cautioned. The negotiations do not include Health Net's business in Arizona, for which the insurer is still seeking a buyer.

Health Net has been conducting a strategic review of its operations in the Northeastern United States and Arizona for several months.

Health Net and UnitedHealth declined to comment.

California-based Health Net, which provides health benefits to about 6.6 million people, suffered a blow earlier this week when it lost a major military contract. Its stock plunged more than 14 percent on Tuesday.

Late on Monday, the U.S. Department of Defense said it would drop Health Net and Humana Inc as vendors for multibillion-dollar contracts, replacing them with rivals Aetna Inc and UnitedHealth.

For Health Net, we believe the loss of the Tricare contract is a significant blow, but may free up management to pursue strategic alternatives now that uncertainty around the business has lifted, Wachovia analyst Matt Perry said in a research report earlier this week.

Minneapolis-based UnitedHealth, the largest U.S. health insurer by market value, provides services to about 70 million people.

Health Net shares closed at $13.47, up $1.09, or 8.8 percent on the New York Stock Exchange. UnitedHealth shares shed 0.6 percent to close at $25.09, also on the NYSE.

(Reporting by Jessica Hall; editing by Tim Dobbyn and Andre Grenon)

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