Apparently they replace the whole thing...
I went into the Apple store in downtown Toronto to ask a similar question (my 3G iPod doesn't have enough juice to last one direction of my subway commute!), and was told that for $90 (I think that was the price), they would take my old iPod and give me a refurb 3G on the spot. This seems like an odd way of doing things, but when I questioned them more, I was assured this was the way they did things. Not sue how they deal with the laser etching on the back...