Without the lockout switch operated, it ignores slight differences from 60.00 and instead looks for a dip in frequency or a substantially low frequency (indicating an overload) and sheds the load then. When frequency returns to a normal range for the generator it re-energizes the load.
What your situation tells me is that your generator is doing extremely well in terms of frequency stability and the SMM isn't able to distinguish between utility and generator power. The SMM works well for me in a situation where I don't want to lock out the load on generator unless there's an overload condition, but I may take it apart to see if the same overheating issue exists.
Generac, who sent two engineers to my house, one came from the Whitewater plant and the other came from Waukesha HQ to look at my installation, replaced my SMM (4th replacement in 90 days plus, all 'good' units in hindsight). Table 2, page 4 of the manual and further explained on Page 9 says (without qualification to load being light or overloaded), that with the lockout position set to on, while on generator; "Power is NOT available on module output (contactor output). Contactor is OPEN" The highlighter (upper case) words are how they are in the manual. We went on generator, lockout switch on. We had a 5 ton A/C on. We had every light (5200 sq ft home) on, and a car charging and though my lights dimmed twice. Once when the generator took the load and then a second time when the SMM came out of it's 5 minute auto-delay and while on generator gave the EVSE all 32 amps it wanted. We could hear the generator scream for it's mother on both instances but the SMM never once dropped the load.
Here's where it turned into a 3 Stooges situation. I bought the SMM in October of 2018. I installed it in front of an electric car charger (EVSE). I don't want my car or the EVSE to take power while on gen as a general rule. I have other cars, so I can always manage. But I loved the idea that by flipping a switch I could change my mind. I noticed through my monthly load tests, that things weren't going as planned/designed. I was getting txt's from the car about it's charging in a time when it shouldn't be. I asked for help from my Generac Service Provider, they went silent, they told me that I had to pay labor. I said; "take my money". They never showed and disappeared. I wrote two more Generac service providers in my area, offering to PAY for them to look at it to see where I screwed up in the installation. One never showed, one never returned any calls. I then went to Generac directly. Got no where. Filed a complaint with the Attorney General consumer protection division. In the meantime, I posted my problem here. Went back and forth, replaced the module. Saw the 7000 came out. Replaced it with that one. None of them came with the fancy addendum that said the switch does nothing that I learned after some time on THIS forum. My first SMM was bought in October of 2018. The technical bulletin came out in January of 2017. The technical addendum that is dated January 2017 says to ignore the switch, it does nothing. I gave up, I had my answer, a very kind member here who I won't identify but his initials are Mattyman, posted the addendum here online. Thank you Matty. See July 11, 2019 posts. At this point, I was pissed and just gave up. My mental note was to replace it with a PMM someday. I ran extra wire so I could use them for the PMM control wire. But wait, there's more. Generac finally called me after the AG complaint hit them. They sent two guys out, with a new SMM. There SMM didn't have the addendum either and I tried to tell them about it but they assured me that I misunderstood the addendum and that it will operate as the manual and logic suggests. It is, afterall, a lockout switch. I let them test. They said my SMM, the 3rd one, is also broken. They replaced it. Tested. No change. At this point while they were replacing the SMM I found the addendum on THIS forum and printed it for them. I handed it to them. Silence. I'll skip the rest because it is even more bizarre. But here's how it ended; They reimbursed me for the SMM, $500 to cover the cost of installing it. Left the SMM in place, but they did offer to remove it. And, I got a shirt AND a hat.