Yeah, you can let the service lapse and resume it, you just can't take the phone elsewhere. T-Mobile is taking on some risk there, to be sure.
As far as why you would immediately switch -- T-Mobile is not losing money on these phone subsidies in the aggregate (they are in some cases, to be sure). They're pricing the subsidies into their carrier rates. If this went through, they'd likely have to cut the subsidies and engage in pure competition on pre-paid mobile rates. I know some HN readers read that last line and go, "good," but the fact of the matter is that people who are buying subsidized phones on pre-paid plans are generally poor credit risks generally and phones lose a huge amount of their value the second you open the shrink-wrap so they're not very worthwhile as security for a secured loan, so by unbundling these two, T-Mobile starts to compete with everybody else on rates for service and somebody else steps in to handle the leases on phones, and if you look at that market segment, the answer in the US as to who is most prepared to take over that business, the answer is _Rent-A-Center_. The total cost to buy a PS5 Slim is $500, the total cost to get a PS5 Slim through my nearest Rent-A-Center is $1,349.50. Again, I am sure that T-Mobile is not advocating for this out of charity, but I'm not as convinced as some around here that this form of unbundling would be an unmitigated good thing.
EDIT: And to your point of, well wouldn't pre-paid operators all switch to a contract model, I don't think "you can't get phone service without a contract" is what people who are advocating for this reform want, and the primary customer for a pre-paid plan is someone who is too large a credit risk to get a 12-month contract through someone else. I said primary customer, if you want to tell me you're a great credit risk but you're on prepaid as an ideological stance, just pretend I already know that about you.