There has been no activity to redeem miles (which is pro rata so counts as activity in all accounts) hence the only account that has been active in 3 years is Member 1. The moment they drop to Blue, their account remains fine but Member 2 now triggers 'no activity for 3 years and no status members, I need to be reset'. Member 1 retains their miles, Member 2's miles get zapped.
Yep, that's the way I read it. I would suspect it would be an unusual set of circumstances for most members, especially those on here, but you obviously hear of some (as we've seen here the last few months).