In my previous testing with WMS 3.0.5 I also noticed the smoothStreamingUseSMILBitrates had no effect when added to either HTTPStream(er/s) element in Application.xml. However in my case, changing the system-bitrate in the smil to invalid values, such as "1, 2, and 3" etc.. cause different behavior than with accurate bitrates. But, I think I had faulty media in my tests.
I will investigate and get back to you when I have a useful suggestion.
Could you PM me with a download link to your media with the overlays? It would help with testing. If not, don't worry about it.