Where it happens is when the non-insulated wheels on the locomotive and the tender end up on isolated rails at the same time. Basically, MTH steam 3-rail/2-rail locomotives are set up similar to a 2-rail locomotive with the drivers on one side of the locomotive insulated and the wheels on the other side of the tender insulated. The switch is supposed to connect the insulated side to the other side and fails.
We had insulated sections for signal control and this issue showed up on turnouts or when we switched the insulated running rail to the other side on curves (you want the common on the outside of a curve for better contact). The way we fixed it was to make sure that on turnouts both running rails were tied to common and that there was an overlap with switching rails that carried the common on both sides for a short distance in curve transition.
This doesn't seem to be a problem with diesel locomotives.
