Aetna Inc slashed its full-year earnings forecast on Monday because of higher-than- projected medical costs, sending its shares down more than 5 percent as the health insurer also posted a 28 percent drop in second-quarter net income.

The No. 3 U.S. health insurer said it underestimated claims for late last year, which hurt earnings this quarter and led Aetna to underprice its 2009 business. At the same time, it reported a spike in medical costs this year.

The bottom line is they just did not price appropriately for 2009 and it will have some impact in 2010, said David Heupel, portfolio manager with Thrivent Investment Management.

Aetna, one of the largest providers of employer-based insurance, has boosted its enrollment while rivals struggle with such gains. Some analysts have worried the gains may be a sign Aetna is sacrificing profit margins to grab market share.

Aetna expects 2009 operating earnings of $2.75 to $2.90 per share. In June, it lowered its full-year outlook to $3.55 to $3.70 per share from an initial forecast of $3.85 to $3.95.

Even after the company cut its forecast in June, some on Wall Street expected the health insurer would reduce its forecast again as industry-wide concerns over medical costs and underpricing catch up to the company.

The company's shares slumped 12 percent in premarket trading after the earnings announcement, but pared losses once the market opened. They were down 5.5 percent at $24.99 in morning trading on the New York Stock Exchange.

Oppenheimer & Co analyst Carl McDonald said, the stock probably will not stay down for long, because it feels like Aetna has finally lowered its earnings base enough.

Our sense is that there is significant money that's been sitting on the sidelines waiting for this event before entering the stock, McDonald said in a research note.

Quarterly net income fell to $346.6 million, or 77 cents per share, from $480.5 million, or 97 cents per share, a year earlier.

Excluding items, earnings of 68 cents per share fell 10 cents short of the average estimate of analysts, according to Reuters Estimates.

Revenue rose 10 percent to nearly $8.7 billion, compared with the analyst estimate of about $8.6 billion.

Hartford, Connecticut-based Aetna said higher medical costs stemmed from the use of more services in the emergency room, laboratory and preventive services, which is a continuation of issues cited earlier this year.

Aetna spent 86.8 percent of its premium revenue on medical costs in the quarter, up from 81.9 percent a year ago. It had to spend $65 million pretax to cover claims from prior periods, mostly in 2008.

Not fully appreciating the 2008 baseline and the increasing trend in 2009 clearly put our prices behind where they needed to be, Chief Financial Officer Joseph Zubretsky said in an interview.

For commercial plans serving employers, it expects to spend between 84 percent and 84.5 percent of premiums on medical costs for the year -- up from 81.8 to 82.4 percent previously.

Aetna's total membership stood at 19.05 million at the end of June, up 9 percent from a year ago. But it projected membership at slightly less than 19 million at year end. Looking ahead, Zubretsky said Aetna was willing to forgo membership growth to make sure it hits target profit margins.

If we believe we cannot remediate a certain account back to its target margin, we will allow it to lapse, the CFO said.

Speaking on a conference call with analysts, Aetna Chief Executive Officer Ron Williams declined to comment on a report in the Wall Street Journal that said the company was shopping its pharmacy benefit business, citing unnamed sources.

Rival insurer WellPoint Inc announced plans to sell its pharmacy benefit unit to Express Scripts Inc for $4.68 billion in April, sparking speculation other insurers would follow suit.

Through Friday, Aetna shares had fallen 7 percent this year, underperforming most rivals. Aetna also reported higher-than-expected medical costs for the first quarter.

(Reporting by Lewis Krauskopf, editing by Derek Caney and Andre Grenon)

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