I would say it works the same way as with any other custom fields etc., If you 'merge', you retain existing + add new ones, if you replace you basically overwrite everything that exists on the destination sever, with the backed up settings.
I personally, like to use the merge option, if it is a running system. Although it creates more work, I like being able to go back, test the new settings that come over, and delete the ones I do not need.
Oviously if you are starting with a brand new site, then, replace might be a good way to go.
Prasanna Adavi, PMP, MCTS http://thinkepm.blogspot.com