As far as I know the statute is two years, and her statement to the police is protected by the litigation privilege (Civil Code Section 47) and by her Constitutional right to petition the government for redress of grievances. These defenses will only work if effectively raised by her attorney. Before seeking to hire an attorney, she should forward the lawsuit to her homeowners' or renters' insurance carrier to see whether they will defend her. If she does have to retain an attorney, it is likely that the officer would have to pay her attorney fees, since the lawsuit appears (from the facts as you've stated them) to be completely meritless.

The officer's lawsuit is what is known as a SLAP suit (Strategic Lawsuit Against Public Participation) and completely barred by Civil Code section 47. If your sister does not have insurane coverage to defend the action she will need to retain counsel to file a demurrer to the complaint. While Mr. Stone is correct (that she should tender defense of the action to her homeowners or renter's insurer), keep in mind that a response MUST be filed within 30 days of the summons and complaint having been served on her, so she may not have time to receive a response from an insurance company. If a response is not filed on your sister's behalf within the 30-day time limited, a default judgment may be entered against her notwithstanding the expiration of the statute of limitation or the fact that the action is barred.

I've never heard of a defamation lawsuit being covered by insurance, whether that is renter's insurance or homeowner's insurance.

To answer your question directly, the statute of limitations for a slander or defamation claim is not two years. It is one year. (Code Civ. Proc., sect. 340, subd. (c).)

Those are great cases to defend, because they are subject to California's SLAPP statute. That is a special statute that allows a defendant to file a special motion to strike at the outset of the litigation. If successfull, the case is dismissed, and the plaintiff is ordered to pay the defendant's attorney's fees.