Baron,
The bad rap on VRO's seems to be with older motors where the system tried to vary the oil ratio based on rpms. It appears that that OMC fixed this in the mid 90's and added the Smart Gauges. Doesn't mean the system can't have problems. Here's a good read:

http://continuouswave.com/whaler/reference/VRO.html

This article talks about water in the tank like you found. It also talks about air leaks in the system causing the no-oil light at idle speeds.

At this point, I see no reason to bypass the system - just something else that needs to be monitored/maintained.

Do post what you find to be the problem.