Update: I contacted EW again regarding this issue and sent them the two videos above. Took them a few days to get back to me - apparently I was transferred to one of their "Engineers".
In the meantime I did the unspeakable - I flipped the o-ring over. Instead of having the "lip" face inwards towards the hub (pic 1), I flipped it so that the "lip" goes towards the cassette (pic 2). It doesn't make any sense to me to orient it this way but why not give it a try anyway. Well, issue solved, freehub spinning as intended

Just to be sure before posting this "fix" online, I wanted to confirm with EW that this is actually the correct way to install them. Today, they sent me a video of how to install the o-ring on this type of hub. It is indeed the correct way: lip needs to face outwards! Pic 2 is a screencap from their video.
It's still not making much sense to me since I thought the "lip" is there to cover the hub/bearings but I guess this is the way it is intended.