I think this is a great idea. I was at the State Championship yesterday and Bolivar had more fans there than we have in our whole county, yet we are in the same division.
This wouldn't make it easier for smaller schools to compete with bigger schools, only easier for smaller schools to play with smaller schools. The smaller schools wouldn't even be playing the bigger schools in the post-season. There would be no regions with a few schools dominating year after year because they have 950 students, while the other schools have 450.
It would also make it even tougher for the big schools in easy regions to get to state year after year.
I'm sure that's happened at least once in every state's history, but it doesn't happen often.
BTW the population of TN is way bigger than KY, a class system is not needed there yet.