When Prudential Financial invests the death benefits owed to survivors of U.S. troops killed in battle, the money comes from a source with deep pockets: the federal government.

After a service member dies in combat - including the more than 4,000 who have been killed in Iraq and Afghanistan - the Department of Veterans Affairs sends Prudential the full amount of each family's life insurance coverage, usually $400,000.

The government has paid Prudential $1.7 billion for these benefits since 2003, when the war in Iraq began, according to information provided by the VA.

Prudential holds that taxpayer money, invests it and reaps the gains.

Here's how it works: If survivors request a lump-sum payment of the death benefit, Prudential opens a retained-asset account, a quasi-checking account that allows families to draw money when they are ready to spend it.

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Until the money is used, it stays in Prudential's corporate account. There, the insurer invests it, mostly in bonds, making returns as much as eight times what it is paying out to holders of the retained-asset account.

What this means is that Prudential is investing - and profiting from - death benefits owed to service members' families, using money provided by the government.

"They have what appears to be a nice sweetheart deal with the federal government," says Michael Powers, a professor of risk management and insurance at Temple University in Philadelphia. "This strikes me as the same sort of thing as those classic stories of the government paying hundreds of dollars for a wrench or a toilet seat."

Ninety-five percent of survivors paid by Prudential ask for lump-sum payments, the VA says. Since 1999, the company has sent out more than 60,000 Alliance Account checkbooks, instead of checks, covering more than $7 billion in death benefits when families asked for full payouts.

On average, Prudential holds about 16 percent of survivors' money for at least a year, according to the company. As of June 30, Prudential had $662 million belonging to military families in its general account, the VA says.

Prudential's general account earned 4.2 percent interest in the first half of 2010, regulatory filings show. The company paid survivors holding Alliance Accounts 0.5 percent in the same period.