Yeah, they make you pay full price if you're still in contract at all phone companies...she can get an upgrade through my.tmobile.com to the g1 for $200 I think if the promo is still going. Personally it's just better to get a prepaid and ride out the contract. Hit slickdeals.com and look for the tmobile promos available; most are 1 year contracts with a free or cheap smartphone (blackberry,wing etc.)
We never buy insurance...the prepaids are so cheap there's no reason with tmob
Also keep in mine she cannot use a verizon phone (CDMA) on Tmob's network (GSM). Even other GSM carriers (sprint, at&t) lock thier phones so they cannot be used on other provider's networks.
Good luck with the hunt!