1. Don't know if it was true, but it was often cited as a reason. It is possible that the water was easily contaminated with the Bay Lake water. In more recent years it has become known about an amoeba which can be found in the common waters in FL (I believe it thrives in relatively still, shallow waters), that can be deadly to humans.
Still, I would have expected the water to be treated regardless.
2. The most likely reason is that it was too small and redundant after Blizzard Beach and Typhoon Lagoon were opened.