Yes! It disables all sensor checks by every faction in that system. My belief (aka unsubstantiated guesswork) is that a gamestart NPR is stuck trying to conduct an intercept at gamestart, and disabling the sensors renders that intercept moot.
More typical use of this option is to shut down sensors in a busy but safe system in order to speed up game processing. Sensor checks are probably the chuggiest thing in Aurora, even with transponders enabled.
Another way to use sensor disable is to handwave 'neutral areas' while fighting AI-controlled NPRs. For example, after a homeworld peace expires, you could disable sensors in the Sol system and say that warfare is prevented there by treaty. The AI won't really understand this, but it's a decent way of engaging in conflict with Sol powers without going truely apocalyptic.
However, sensor disabling should be used with caution. There is a very real risk of eliminating Fun™ situations, like the 500,000 tons of space insects that just invaded my home system. There is also a vanishingly low chance of an NPR popping up a closed jump point in that system.