@josh
Yes, it’s possible to arc through a piece of heat-shrink – but not real likely. The voltages are in the 300-400V range (roughly), which should be OK with heat-shrink for a while, at least.
I’m also a bit surprised that you can hear a little low-energy spark jump over the noise of the motor & exhaust. Are you certain you’re hearing an arc, and not some mechanical collision that’s impairing the ignition?