The defensive replacement hierarchy works in conjunction with the Defensive Replacement managerial settings. When the managerial settings apply, the manager uses the hierarchies.
When looking to bring in players for defensive replacement, the manager will scan the appropriate hierarchy starting at the top. As soon as he finds the incumbent, he stops and moves to the next position. If he finds another player in the hierarchy first and the player is eligible to enter the game (i.e. not used yet and above his auto rest fatigue level), this player will enter for defensive purposes.
The manager does not check to see if he's better defensively -- he's relying on your hierarchy that has been set. If you run into a situation where you don't want a player being pulled for defensive purposes, you can always uncheck his Defensive Replacement box on the Player Settings page.