1) What, specifically, is 1000'-on-top, and when does it apply? I know the visibility and separation requirements but I don't understand the concept of the rule.
1000'-on-top exists in Canada but it is rarely used. It is an IFR clearance that allows you to select a VFR altitude for your route of flight. You are still under IFR but ATC no longer has to provide you with separation in most of the cases, only traffic information.
Suppose the following scenario: You are cruising IFR at 6000' in moderate low level turbulence and based on PIREPs and GFS, you estimate that 8000 or 10 000, would provide you with a smoother ride. Unfortunately, there is traffic on the same route, same direction 2000' above about the same speed, ATC cannot clear you to climb at 10 000' until proper separation is ensured. IF you are in VMC conditions, you can request a clearance to maintain 1,000 feet on top and climb to 8 500'. ATC will provide you with traffic information only and you will be able to climb to 8 500 or 10 500. If after half an hour, you estimate that you won't be able to maintain VMC, you ask ATC for a "hard" altitude and providing that separation can be assured, ATC may clear you for lets say 10 000'.
It is an extra tool in the toolbox but it is rarely used by pilots in Canada.
It is the canadian equivalent to the american VFR on Top IFR clearance
FAA:
VFR ON TOP
Transport Canada:
1000-ft-on-top IFR Flight
2) Can ATC vector you at altitudes below MOCA when radar identified. I seem to read conflicting rulings on this one.
If the MVA (minimum vectoring altitude) is below the published MOCA, ATC can vector you below the published MOCA.