Update: I managed to complete the mission and stop the AI collisions. What worked for me was changing the flightplans of SARAH and LIONCUB to instruct them to follow DOG flight at a distance of 2500m and 1000m, respectively. I also set SARAH to follow DOG flight at the same altitude, but LIONCUB follows at 200ft above DOG flight.
Turning off wake turbulence made no difference in the outcome. I also made the coastline and target waypoints VIP points.
SignorMagnifico's post in Frog-7 Campaign Mission 5: Unable to Complete due to AI Midair Collision; "SARAH 1 has been Lost in Action" was marked as the answer