> The template doesn't insert an asterisk if the indexterm text breaks

because a linebreak isn't a space.

you could use use

translate(.,' 
','**')

to translate both spaces and newlines to *

But you'd get two * if there is any white space at end of line so
probably you'd be better with

translate(normalize-space(.),' ','*')

so you replace any run of white space by a single * or use xpath2 where
you can express that more directly as

replace(.,'\s+','*')

David