Do you need an insurance Isa?

You could be forgiven for thinking there are only two flavours of individual savings accounts (Isas): stocks and shares and cash. However, as Tony Blair would no doubt be keen to point out, there is a third way - the insurance Isa.

Insurance Isas have failed to capture the public's imagination in the same way as their Isa peers. This is in part down to confusion about what they offer. Despite its name, an insurance Isa is not a protection product.

"There will be a very small amount of cover but an insurance Isa is a savings vehicle," says Suzanne Moore, spokeswoman for the Association of British Insurers (ABI). "If you're looking for cover, an insurance Isa will not be high on your list."

Most of the insurance Isas on the market, including those offered by AXA Sunlife and Pearl Assurance feature a nominal death benefit of 1%. This means that if the Isa holder dies, their estate will receive 101% of the value of the fund at that time. In the early years of investing, this will not be enough to provide for any surviving family.

Insurance Isas got their name simply because they invest in the funds traditionally offered by insurance companies - usually with-profits funds and unitised funds - although Norwich Union has a wider range. In this way they are very similar to endowment policies.

Endowments have received bad press in recent years but with-profits funds still appeal to people who want to take more risk than the building society, but don't want to invest in the stock market. It is this middle ground that insurance Isas are designed to occupy.

Co-operative Insurance Services (CIS), the biggest player in the insurance Isa world, points out that in 2000, cautious investors could have been justified in steering clear of a volatile stock market.

Cis estimates that a £1,000 investment in its Platinum Plus Isa on 1 January 2000 had a value of £1,062.07 on 1 January this year. In contrast, the same amount invested in an average FTSE-100 tracker unit trust would have fallen in value to £909.33.

Like its Isa cousins, an insurance Isa can be held as a mini account or a component of a maxi Isa. Whichever you choose, there is a maximum investment limit of £1,000 per year.

Insurance Isas are offered by a handful of companies, mostly life companies and friendly societies. There are fewer than 20 insurance Isas on the market and just two of these meet the CAT-standards - the Druids Sheffield Friendly Society Isa and AXA Sunlife Direct's Wealth Builder account. Many have high minimum investment levels and strict rules on closing the account.

To earn a Cat mark, an insurance Isa must fulfil the following criteria; the annual charge can be no greater than 3% of the value of the fund and there must be no other charges; the minimum premium should be no greater than £250 as a lump sum or £25 a month; there should be no specific surrender penalties and the surrender value should reflect, over time, the value of the underlying assets of the fund.

One use for Isas is to back interest-only mortgages and a saver who might otherwise use an endowment could be inclined to opt for an insurance Isa.

This may be to their advantage as all income is paid tax free, but insurance Isas have their limitations.

The low investment level means that at current growth rates - around 6% - the Isa could only realistically be expected to pay off a mortgage of £50,000 over 25 years. Of course, if you are a couple buying a house together that figure will be doubled, making it a more realistic proposition.