TinyArmy, it sounds to me like your SIL is buying into the very prevalent idea that the more paranoid your parenting the better.
You must see danger everywhere be constantly vigilant and always taking every possible minute action to protect the children.
Someone with a more positive laid back approach, such a yourself it sounds, would presume 'the flatmate is a really good friend of my sis's, they known him a long time and really trust him with their kids, so I'm comfortable to presume he'll be OK with ours.'
The more paranoid/vigilant approach is 'I don't know him, he's a stranger to us therfore we must not take a risk.'
Your SIL is not wrong to think like this, many parents do now, as this thread shows, but also I don't think YABU to feel very hurt.
It is basically a judgement on you, your lifestyle and the decisions you make for your own kids.
Neiether of you are actually unreasonable, she can make the deciosns for her kids but it is hurtful to you.
You are just different.
But for what's it's worth, I'd rather be like you, and I think your kids sound like they are getting the much better deal and having a wonderful childhood
.