Although there are several types of policies available, when we talk about a single family primary residence, there are essentially two policy types in question:  The Owners Policy and the Lenders Policy.  The owners policy typically requires a higher standard of care and diligence - at least this seems to have been the case during the recent boom years - because the policy remains in force until the property changes hands, and there are more areas of potential claim.

Since the lender's policy in a purchase transaction is generally issued concurrently with the owners policy, the search and curative efforts only need to be performed once, so one could presume that the diligence exercised with relation to the lenders policy would be equal to that of the owners policy.

When the home owner refinances, the common wisdom seems to have concluded that, since due diligence was performed when the property was purchased, and all prior defects are presumed cured, there is no reason to reach back further than that transaction to insure the refinance.  Your story provides evidence that the common wisdom is lacking.

To answer your second question, the new policy doesn't void the prior policy.  However, when the lien insured by the prior policy is satisfied, there is nothing left to insure.  So the obligations of the policy are extinguished with the lien.

I can't say my observations of the industry would apply to all markets, as laws and standards vary.  But it's a pretty safe assessment for the market I work in.