Stocks fell in volatile trade on Thursday as investors sold off shares of healthcare companies such as Merck & Co on worries that President Obama's budget proposal will strangle profits.

The plan to expand healthcare coverage and curb costs calls for cutting Medicare payments to private insurers, letting consumers buy cheaper medicines and preventing drug companies from making deals that block generic competition.

Merck was the Dow's biggest weight, down 6.7 percent at $26.04. Health insurers also fell, including Humana , which lost 19.5 percent to $23.64.

They are certainly looking at providing healthcare across the board for everyone, but to pay for that they are looking to obviously reduce revenue for some of the healthcare agencies, said Peter Jankovskis, director of research at OakBrook Investments LLC in Lisle, Illinois.

The Dow Jones industrial average <.DJI> dropped 88.81 points, or 1.22 percent, to 7,182.08. The Standard & Poor's 500 Index <.SPX> shed 12.07 points, or 1.58 percent, to 752.83. The Nasdaq Composite Index <.IXIC> fell 33.96 points, or 2.38 percent, to 1,391.47.

Adding pressure, financial shares trimmed gains after a report showed the number of troubled U.S. banks soared in the fourth quarter, tempering optimism about the prospect of another government bailout for the sector. Among laggards, Citigroup slid 2.4 percent to $2.46.

However, the KBW Bank index <.BKX> rose 1.2 percent to manage its fourth straight day of gains, the longest winning streak for the index since November.

On Nasdaq, biotech companies including Gilead Sciences and Amgen were among the primary laggards, falling 5 and 9.4 percent, respectively.

The S&P Health Care index <.GSPA> fell 5.1 percent.

The government released more bleak news on the economy on Thursday as one report showed the number of U.S. workers continuing to claim jobless benefits notched a fresh record in the second week of February while another showed U.S. orders for long-lasting manufactured goods fell for a sixth straight month in January to a six-year low.

International Business Machines Corp was the top performer on the blue-chip index, as shares surged 3.6 percent to $88.97 after it affirmed its full-year earnings outlook, making it the top gainer in the Dow.

In contrast, shares of General Motors fell 6.7 percent to $2.38 after the auto-maker posted a quarterly loss and said its auditors were likely to cast doubt about its viability.

Shares of Sallie Mae , the largest U.S. student loan group, plunged nearly 31 percent to $5.80 on a proposal in Obama's 2010 budget that would axe the federally guaranteed student loan program.

Trading was moderate on the New York Stock Exchange, with about 1.47 billion shares changing hands, slightly below last year's estimated daily average of 1.49 billion, while on Nasdaq, about 2.32 billion shares traded, just above last year's daily average of 2.28 billion.

Declining stocks outnumbered advancers on the NYSE by 10 to 9 and on the Nasdaq by about 5 to 3.

(Reporting by Leah Schnurr and Chuck Mikolajczak; Editing by James Dalgleish)