There are several issues at play.
First there is a difference between good practice and what can legally be required. Here the question has to do with what can legally be required not what is good practice.
We have a system of laws that requires that laws, including building regulations, be adopted according to a process. When you give the Fire Marshall, Building Official, or other individual the ability to impose new requirements (think laws) without due process I suggest that you have a legal problem. So instead of a system of laws do we now have an autocrat? While the initial reason for giving an autocrat power may have been well intentioned, over time we lose our rights.
Can we find a solution that respects our legal system?
I believe that any provision in the building code that gives an individual the authority to unilaterally impose new rules, is an affront to our legal system.
We should base any criteria on science and not justify it simply because that is the way we have always done it. I mentioned an electrical engineer because I think it is likely that he could develop a testing protocol that could find shorts resulting from water in the wiring. This could allow some circuits to be energized without starting a fire. This would be cheaper than replacing all the wiring. If there are shorts, then it could justify replacing the wire. Contaminants in the water may or not be a safety concern. We should base our decisions on the science not on our emotional reaction.
If the original wiring was nob and tube then it would appear that there would be no trapped water under the sheathing.
Maybe the answer is for the NEC, or other standard, that is properly adopted to adopt some objective criteria. If NEC was to address this issue, I expect that engineers and other technical experts would help to understand what is the real problem.