It's just doing a string compare of the characters. If you set "Percent different from last password = 50", then if more than half of the characters in the new password are the same as the old password, then it will fail. You can also choose to ignore the order of characters.
"Percent different from last password
Specifies the percentage of characters a new password must contain that differ from characters in the previous password. If the value is set to 100, the new password may contain no characters that were in the previous password, unless Ignore sequence when checking for differences is set to 0. For examples of how this parameter works with Ignore sequence when checking for differences selected, see the following table."