This is because the old iPhone pricing model was a relatively good deal for contracted AT&T customers. AT&T has brought the iPhone in line Windows smartphones, the BlackBerries, etc.
This hurts. The 16GB model costs $299 for customers without a current AT&T contract, $499 for contracted customers.
Ok, but AT&T also extends the contract of an existing customer when they buy an iPhone. How can they do that if you're not getting some kind of compensatory value?
Well, here's the trick. I bet you were wondering what the "contract-free" $699 iPhone was about. Why would anyone every buy that? Why does that price point exist?
Well, think about it. Remember AT&T is extending your contract. What is it they're giving in return? The answer is $200 off the $699 price. In other words, a second level of subsidy.
AT&T may not intend to sell any phones at the $699 price point, but they need that price point so they can say customers are being compensated for their contract extensions.
Now, what happens when you lose or break your iPhone? Do you have to pay $699, or will AT&T offer you the $499 "subsidized" phone along with a contract extension? Might that depend on how much time you have on your contract?
The old iPhone plan, from a consumer perspective, was vastly better than the new, fully evil, AT&T iPhone plan. The good guys lost.