How to scale video showing the underlying layer/track in the cropped area
You imported the footage with the resolution set in your timeline by choosing set to frame size. Thats not what you want in this case, it adds black bars wherever your footage doesn't fill the frame size set in for the timeline.

Premiere would have kept the correct aspect ratio either way, it doesn't automatically stretch footage thats not the same resolution as the timeline, you would only see distortion if the pixel aspect ratio would differ between timeline and source. Re-import the footage without the set to frame size option and you should be fine.