When CoC d20 first came out someone else suggested this. I will say what I said then... I think sanity rules make sense in D&D if and only if your world starts from the notion that certain things don't exist. In FR everyone knows that orcs exist, everyone knows that dragons exist. Therefore, while someone might be scared when they run into either one, it is not going to be a mind-blowing experience. Even Cthulhu himself, rising from the depths, will be horribly frightening, but your average realms adventurer will merely turn and yell, "Egads, a sea monster!" Now there might be some exceptions to this. There are indeed some monsters so horrific in appearance that they might cause some sanity loss to look upon (usually treated in the rules with fear effects). But with magic commonplace, there is no, "By Mystara, how can that thing possibly exist?" The answer to anyone who has seen anything is, invariably, magic.
My best example to you is the year 1200 here on Earth. A knight is out riding and runs into a dragon (bear with me here). Does he go mad at the mere sight of what surely is a dragon, something that cannot possibly exist but by which he is confronted? No. He grew up hearing stories about knights slaying dragons. He is surprised to see one since few others have ever even claimed to have seen one. He might be so scared he pisses his armor. But go mad? No.
Science has made it possible for us to go mad when confronted with nightmare creatures. Science has taught us that such creatures do not, and in some cases cannot, exist. Magic cannot exist. Therefore, when we see something we cannot explain by science, it strains our sanity to imagine that all we have been taught might be wrong.
Just my two cents.