Martin,
It sounds like the compression is nothing to worry about.
It seems to be almost certainly ignition related; is there any way you could borrow a coil from a similar engine ( Mercruiser of the same year would be the same I imagine). It doesn't look to be anything unusual on the enclosed drawings
http://www.marinepartsexpress.com/VP_Schematics/GAS/5.OGL-A-B-C-D-E_5.7GL-A-B-C-D-E/IGNITION%20SYSTEM Or even ask the local Volvo agent to lend you one, and if it works you'll pay for it; you've already paid them to sort it out and what they have done/ charged you for clearly hasn't worked ! I'm not certain whether the non marine version of the coil and module are the same. If the thermal cutout is getting as hot as you mentioned, something has too low a resistance/ is allowing too high a current; it could be the coil, if it's shorting out internally on the primary windings, the internal resistance will be low. Plus that would give a weak spark from the secondary windings.
Did they change the lead from the coil to the distributor, not just the plug leads?
Did they change the rotor arm ?( If the distributor cap was corroded, the arm would have been as well.
Graham