July 27 (Bloomberg) -- Aetna Inc., the third-largest U.S. health insurer, cut its full-year earnings forecast for the second time in two months as rising medical costs eroded revenue gains from selling lower-priced policies.

Aetna’s net income for the second quarter fell 28 percent from a year earlier, the Hartford, Connecticut-based insurer reported today. The results, after adjustment for pension costs and a legal settlement, missed analyst estimates by 10 cents a share.

Chief Executive Officer Ronald Williams said in a statement that medical costs were “not fully captured in 2009 pricing.” In June, Aetna said the recession was raising expenses by spurring workers to use benefits before they lose their jobs. U.S. unemployment has continued to mount, last month reaching 9.5 percent, the highest in 26 years.

“It is tempting to conclude that the cut to earnings outlook is the ‘last shoe’ to drop,” setting Aetna up for earnings growth, said Matthew Borsch, a Goldman Sachs Group Inc. analyst in New York, in a note to clients. “However, it’s worth noting the company still showed growth” in accounts where pricing was the most aggressive, Borsch wrote.

Eliminating Overhang

Aetna fell 72 cents, or 2.7 percent, to $25.72 at 4 p.m. in New York Stock Exchange composite trading. The company has lost 9.8 percent this year.

Investor worries that health-care legislation in Washington will hurt the industry have weighed down managed-care shares, Carl McDonald, an Oppenheimer & Co. analyst in New York, said today in a note. The guidance cut “should eliminate most of the overhang that has limited the stock to the mid-$20s range over the last five months,” he wrote.

Aetna is raising premiums and trying to control costs through measures such as audits of high-volume hospitals or doctors, the company said in its statement. While rates in a quarter of contracts are already locked in for 2010, the company expects to benefit in the first quarter, Williams said on a conference call with analysts. Aetna’s willing to forego new business to be more profitable, he said.

“We have a sound business model that with hindsight was not adapted quickly enough to a changing environment,” said Williams, who called the quarterly results “disappointing across many dimensions.”

Net income dropped to $346.6 million, or 77 cents a share, from $480.5 million, or 97 cents, a year earlier, according to the statement. Adjusted profit of 68 cents a share missed the 78-cent average estimate of 14 analysts in a Bloomberg survey. Revenue rose 11 percent to $8.67 billion.

Forecast Cut

With today’s statement, the company has shaved its full- year forecast by more than $1 since February. Aetna said it expects 2009 earnings of $2.75 to $2.90 a share, compared with $3.55 to $3.70 given June 2.

Williams praised the company’s diversification, even as he declined to comment on a report in The Wall Street Journal that Aetna was exploring a sale of its drug-benefits unit.

“We believe we have a very sound strategy around integration,” he said. “It’s continued to differentiate us in the marketplace.”

Aetna is the second-worst performer this year among the six stocks in the Standard & Poor’s 500 managed-care index, losing 9.8 percent through today. UnitedHealth Group Inc., based in Minnetonka, Minnesota, and WellPoint Inc., based in Indianapolis, are the two largest insurers by sales.

Enrollment Rises

Enrollment in medical plans rose 9.1 percent to 19.1 million, in contrast with rivals such as UnitedHealth that have predicted falling membership as unemployment rises. Aetna said it spent 86.8 percent of premium revenue on medical cost for patients, a jump from 81.9 percent last year. Analysts follow the measure as a predictor of profitability.

The company has been hurt by “less conservative” pricing that attracted business last year and hasn’t kept pace with expenses, said Ana Gupte, an analyst with Sanford C. Bernstein & Co. in New York, in a July 16 note to clients.

The higher costs were driven partly by doctors and hospitals ordering more expensive care, said Joseph Zubretsky, Aetna’s chief financial officer, in a phone interview. While overall volumes have dropped as workers lose benefits, the patients that remain are getting more procedures, and costlier ones, he said. Doctors are ordering pricier digital mammograms in place of traditional breast screenings, Zubretsky said, giving one example.

‘Natural Reaction’

“The economic environment has clearly caused a change in provider behavior,” Zubretsky said. “Utilization is down and there is capacity in these facilities and we think the natural reaction is for provider to increase the intensity.”

The insurer is studying its claims to try to understand an increase in treatment “that is different from past patterns,” said Fred Laberge, an Aetna spokesman, in a phone interview.

“It’s not that people are going to the doctor more but when they are going, they’re having more services per office visit,” he said. “You go to the doctor’s because you have a sore throat, and instead of getting one test, a blood test or whatever, you’re getting three.”

In response, Aetna will be conducting “more focused” audits and make more attempts at recovering costs where claims seem unduly high, Laberge said. The company has also changed rules for determining when multiple procedures during the same patient’s visit are justified. That doesn’t necessarily mean Aetna is seeking to deny more claims, he said.

“We want to do what’s right for our members,” he said.

To contact the reporter on this story: Alex Nussbaum in New York anussbaum1@bloomberg.net.

Last Updated: July 27, 2009 16:38 EDT