I'd heard, with some surprise and disbelief, that the Consulates were accepting S1's for visa applications but that is not the same thing as it being accepted in lieu of private health insurance when applying for ones TIE in Spain.
The S1 is only proof of health cover from UK once it's registered with INSS but that is something which can only be done with residency so it's putting the cart before the horse.
Until we see first hand evidence of an S1 being accepted in that scenario it must therefore be regarded as speculation or downright misinformation.