Gas or electric?
1) Electric heater can be completely covered with insulation except TP valve. Set electric heater on insulated surface. Insulate pipes completely right down to tank.
2) Gas heater is different.
No insulation over combustion area, or gas valve, or air inlet or. No insulation on top of tank that will interfere with venting of dangerous combustion products including odorless CO gas. Foam insulation on pipes should stop 10" short of tank top. No insulation within 6" of the 3-4" inch galvanized vent pipe.
Here's photo with gas water heater insulation tips:http://waterheatertimer.org/images/Insulate-gas-water-heater.jpghttp://waterheatertimer.org/9-ways-to-save-with-water-heater.html
3) Tankless gas. No insulation on box. No pipe insulation within 12". No insulation near vent pipe.
4) How much clearance between heater and chimney?? Not sure what that means. Is that the water heater vent stack? Or where vent stack goes into chimney stack? No insulation on gas flue pipes. Or within 6 inches of 3-4" water heater vent pipes
5) Is insulation fireproof? Everything burns if it's hot enough. If you throw insulation into backyard fire, paper and foil will burn away and insulation kind of falls apart in the heat. Fiberglass insulation cannot be set on fire with a match. Foam pipe insulation will burn.