I thought the issue with Bagwell and the Astros was that they had played him in the World Series (limited/token pinch hitting, I believe) and then in the next spring training it was decided that his injury was too disabling to play for the remainder of his contract.  The insurance company contended that his condition did not deteriorate between the WS to ST and since the team was able to use him in the WS, he was indeed able to play for the team and they did not need to pay the insurance policy.

I read up on these policies a bit when the Bagwell suit was filed last year, and can provide a little general info.  Policy terms are going to vary, of course, depending on what the ins. company and the team negotiate, but in general, the term of the insurance policy is the same as the contract with the player. (3 year contract = 3 year ins. policy.)  However, pay-out features may be limited to one season, depending on the length of the player contract.  I don't believe that the team would recoup all of his salary for the covered season, but it would come darn close.  And, of course, the contracts do have exclusions to not cover injuries to body parts already known to be injured.

The real hitch is that the player usually must be deemed "totally disabled," under a def. that usually favors the insurance company, and insurance company docs usually have the final say in this sort of thing.  Finally, "totally disabled" usually means "permanently disabled", but not always.  (I believe this was the case with the Astros policy on Bagwell.)

Regarding Bagwell, I know that the Astros sued CIGNA - the insurance carrier - for breach of contract and eventually settled for an undisclosed sum.  However, if memory serves, one of the complications in that matter was that Bagwell would not agree that he was totally disabled.  Made it very tricky for the 'Stros to file a successful claim with their carrier when Bagwell was commenting to the media that he hoped to play still.  

Just to give you an idea of the numbers involved, Bagwell's salary for 2006 was $17 m., and the Astros were looking to recoup $15.6 m. of that from CIGNA.  Their policy premium for this coverage was $2.4 m., although I'm not sure if this was over several years or just the premium for 2006.