Now, I don't know much about codes and regulations, and I'm new to working on my own home, but this screams "fire hazard" to me, so I want more input before I install a bulb and continue to use this. Is this okay to have insulation next to something that gets hot? Why is/isn't it?
This is a good question - seeing some insulation in your light fixture can be a bit of a shock.
Think about it, though. Those incandescent bulbs are inside a glass globe. One of the best features of an incandescent bulb is its ability to turn electricity into heat. What's that heat going to do when it's trapped inside the globe - it's going to melt the wiring or catch the ceiling on fire.
The silver reflective foil reflects heat and light away from the ceiling material and the insulation helps keep whatever heat doesn't get reflected from moving through and melting your wire's insulation which could result in a short and the whole house getting really hot and a visit from the fire department.