The default system prompt in the Editor's source code instructs the AI prompt to not output HTML. This can be overriden:

<TelerikEditor @bind-Value="@Value"
                Tools="@Tools"
                EnableAIPrompt="@EnableAIPromptPanel"
                EnableInlineAIPrompt="true"
                Height="500px">
    <EditorSettings>
        <EditorInlineAIPromptSettings SystemPrompt="...Your instructions here..." />
    </EditorSettings>
</TelerikEditor>

However, even when the AI Prompt outputs HTML, on attempting to Insert/Replace that HTML in the Editor, the output is added as plain text in a paragraph element, instead of being added as HTML. It would be nice to have the option to enable inserting/replacing actual HTML.