Absolutely NOT according to the NEC. This is specifically DISALLOWED by 394.14

(5) Hollow spaces of walls, ceilings, and attics where such spaces are insulated by loose, rolled, or foamed-in-place insulating material that envelops the conductors

Further, the handbook explains why:

Blown-in, foamed-in, or rolled insulation prevents the dissipation of heat into the free air space, resulting in higher conductor temperature, which could cause insulation breakdown and possible ignition of the insulation. Section 394.12 prohibits installation of knob-and-tube wiring in hollow spaces that have been weatherized.

Richard -

We're in the same situation (up in the Bay Area).

The California State Energy Code differs from the NEC in that it allows insulation over knob and tube provided a licensed electrician inspects the K&T and deems it safe.

You can access a copy of the relevant code at the link to an Energy FAQ site below (it's the second to last question on the "In-Home Work Requirements" section).

I'm still undecided. I'm pretty risk averse, but I also don't want to avoid making my home more energy efficient due to what seems to be (statistically speaking) a very slim chance of fire risk. Especially since I'm looking at some generous rebates for energy upgrades.

Here is a link that might be useful: California Electrical Code

May be I am missing something... how is your electrician upgrading all outlets to be grounded without rewiring them? And if he is rewiring them, why not get rid of the knob and tub all together? I would never live in a house with knob and tube. Who knows what condition non-visible wires are in... and what condition any hidden splices are in... insulating will only make rewiring more difficult. I'd rewire first then insulate.

"I would never live in a house with knob and tube."

you cannot see most of the wiring in a house.

Most of the K&T problems are caused by folks messing around with the K&T.

It tends to work just fine (even if the insulation is brittle) until someone messes with it.

Pre-WWII AC cable is often pretty bad also.
Before the requirement to solder plat the copper wire it reacted with the rubber insulation making it extremely brittle by with time.

A lot of the insulation will fall right off the wire if you move it to replace a switch or receptacle.
Even moving the cable can result in shorts forming.

I often keep the K&T around for that very reason - almost no chance of shorting with the wires so far apart. As long as it's run in an area not covered with insulation (as in a basement), where the entire run is visible and can inspect for good splices. NEC allows for extending existing knob & tube wiring, though not new runs.

'NEC allows for extending existing knob & tube wiring"
Just try to buy pieces.

Other provisions in the code make it impossible to extend.

Like grounding requirements.

It is more of a historical record tat allows K&T to be considered still in accordance wth the NEC in existing installations.

Generally, it isn't a great idea. By the way there is nothng non flammable about cellulose loose fill. It is treated with flame retardant, but just because it doesn't flame up doesn't mean it won't burn. I can assure you, it will. Don't test it using your attic as a laboratory. If you could provide some air space around te wiring to allow it to cool, maybe, but if you are going to all that troible, tear it out and replace it with a two wire system. Better yet get a licensed electrican to do it. Then insulate.

The flammability of the insulation isn't so much of a concern as I stated in my quote from the NEC in the beginning of this long dead thread that you chose to revive. The conductors (and their insulation) of K&T wire requires free space to dissipate heat and it matters not how FIREPROOF the insulation.

As pointed out California gives specific and limited exemption to the NEC requirements (The California Code with small exception incorporates the entire NEC). In California alone, after certifying your K&T wire is intact, free of splices, and otherwise in good condition, you can encase it with fireproof insulation as long as you go through the additional hoops to mark it. As observed, to make that sort of determination probably requires opening the walls anyhow, so you're in the point of why not rewire anyhow (and possibly do a better insulation job that most blown in jobs are anyhow).

Here is the CALIFORNIA EXCEPTION explained (alas the formatting is scrogged by the fact that Houzz provides a deficient formatting code than the old thathomesite/thegardenweb interface did):

324-4. Uses Not Permitted. Concealed knob-and-tube wiring shall not be used, in commercial garages,
theaters and similar locations, motion picture studios, hazardous (classified) locations or in the hollow
spaces or walls, ceilings and attics when such spaces are insulated by loose, rolled, or foamed in place
insulating material [UL]that envelops the conductors.[/UL] Note: Underscored words NOT ADOPTED by State of California.
Exception: This article is not intended to prohibit the installation of insulation where knob-and-tube
wiring is present, provided the following are complied with:
(1) The wiring shall be surveyed by an electrical contractor licensed by the State of California.
Certification shall be provided by the electrical contractor that the existing wiring is in good condition with no
evidence of deterioration or improper over-current protection, and no improper connections or splices.
Repairs, alterations or extensions to the electrical system will require permits and inspections by the authority
having jurisdiction for the enforcement of this code.
(2) The certification form shall be filed with the authority having jurisdiction for the enforcement of this
code and a copy furnished to the property owner.
(3) All accessible areas in the building where insulation has been installed around knob-and-tube wiring
shall be posted with a notice, clearly visible, stating that caution is required when entering these areas.
(4) The insulation shall be noncombustible as defined by Section 415(b) of Part 2 of this Title.
(5) The insulation shall not have any electrical conductive material as part of or supporting the
insulation material.
(6) Nothing in this exception will prohibit the authority, having jurisdiction for the enforcement of this
code, from requiring permits and inspections for the installation of thermal insulation.