To elaborate for the uninitiated, that means they are storing it in plaintext somewhere.
When you do the password change it asks you for the old one, that's how it knows.
So it asks for old + new, checks old is correct against the hash, and then compares old + new likeness.
So it all happens in memory.
So, it can hash any proposed password and compare the history to make it's not been seen $recently (as an exact match, since it's comparing hashes).
It could also perform some minor permutations of any new password, and do the same history check to make sure you're not just changing the first or last character or digit. I don't know if it does this, but it could.