1. Yes, I recommend backing up. I recommend a backup be to an external removable media- the reason being as you say- if the hard drive fails. How you do this depends on your system- what drive type is available.
2. No, I do NOT recommend turning off System Restore! The only exception to this is when you want to drop off restore points intentionally for possible malware infection. As I previously said, a back up and a restore are not the same thing. There are times when something like an update has caused a problem that can be easily fixed by doing a System Restore- no need to do a full backup.
From TechNet:
Q. How is System Restore different from Backup?
A. System Restore monitors only a core set of specified system and application file types (e.g. .exe, .dll etc), while Backup Utility typically backs up all files including users personal data files, ensuring a safe copy stored either on the local disk or to another medium. System Restore does not monitor changes to or recover users' personal data files such as documents, graphics, e-mail, and so on. While system data contained in System Restore's restore points are available to restore to for only a limited period (restore points older than 90 days are deleted by default), backups made by the Backup Utility can be recovered at any time."
If you use, Windows XP Pro, the Backup utility is on the system, If it's the Home version, then the CD is required. More on backup here:
http://www.microsoft.com/windowsxp/using/setup/learnmore/bott_03july14.mspx