I'm guessing they want the damaged item to help prevent fraudulent claims, so you can't just say your item was damaged when it wasn't & get your money back for an item you're still using. I'm also guessing this is why the coverage doesn't include lost items, only damaged or stolen. I called the AMEX claims dept and explained that I would have to give the phone to Apple in order to get the less expensive replacement, she made a note in my file and told me any paperwork from Apple saying it was water damaged should be enough. I do have that paper from Apple. We shall see!
Please share when you find out. I'd love to know.