TM has to be prepared for anything. By using case-sensitive for its backup filesystem, it won't screw up the works in the event that the user backs up a case-sensitive source volume.
Yep, that's the key, right there.
If you have a main hard drive that is formatted without case-sensitivity, you can format a Time Machine backup disk without case sensitivity and you'll be fine. However, if the drive you're backing up is case sensitive, the TM backup must also be case sensitive.
FWIW, Macs have not been case sensitive since System 1.0. (in fact, even before that; the Lisa's operating system was not case sensitive either). By default, any computer you buy from Apple is not case sensitive.
The only reason the case sensitive option exists is for Unix developers who are using some Unix or Linux software that expects it.
In a case sensitive file system, the file names "letter-to-mom.doc", "Letter-to-Mom.doc", and "letter-to-Mom.doc" are all different filenames, and you can have all three in the same folder. In a case-insensitive file system, those three names are all considered the same.
Generally speaking, case sensitive filesystems can be a big hassle for both administrators and users. In the past, Unix filesystems have mostly been case sensitive, so there are Unix applications that rely on this (for example, by renaming an old preference file to Prefs instead of prefs and then creating a new prefs file in its place).
They originally existed because on early systems--UNIX was developed on a PDP computer with a 1.5MB hard drive--long filenames took up a lot of space. (In fact, many early filesystems had limitations of six character filenames.) Case sensitivity was a way to create more files with short filenames--you could use "Data", "DATA", and "data" as three different names. If you have a limited number of characters, you don't want to rename a preferences file from "preferences" to "preferences-old"; the names are too long. So instead you rename it from "prefs" to "Prefs" and then create a new "prefs" file.
On modern filesystems, case sensitivity tends to be a Very Bad Thing. Nowadays you'd only want to make a Mac file system case-sensitive if you had a clear and compelling reason to do so.
