And does sparring simulate reality?
Some degree of reality yes.
"Real life" fighting comes in many forms, sparring simulates whatever you want. Most of the time this is designed around 1-on-1 unarmed fights. That's not the only form of sparring though. Sparring in fencing would prepare you better for a sword fight then not sparring. Sparring with sticks for a stick fight. You can do 2-on-1 sparring... there is / was even a promotion somewhere that promoted 5-on-5 fights, and another I think that did 3-on-3 in a obstacle course like environment. Military training often involves exercises designed to simulate a real battlefield, which is essentially a form of "sparring" with different words used for it.
At the end of the day nothing is ever going to give you reality though. Some people are going to freeze up, panic, etc. as soon as the safeties are turned off or a situation happens that wasn't planned.
At the end of the day I don't think most of us are "really" preparing for a real situation, most people don't get into those. The people that do it's going to matter more for though, and for them sparring should resemble reality as much as possible. Which a lot of the time is going to mean more situational sparring, but still sparring.