Automatic sensitivity label on existing labeled documents and emails

Good question. It really comes down to how those 1000 documents got the "Confidential" label in the first place.

If users manually applied "Confidential" to those documents, nothing happens. Your new auto-labeling policy won't touch them. Microsoft is firm on this one. Automatic labeling does not override manually applied labels. Period.

Now if "Confidential" was applied through an auto-labeling policy or as a default label, that's a different story. "Highly Confidential" sits higher in the label priority order, so the new policy will upgrade those documents. One thing to keep in mind though. The documents still need to match the conditions on your new policy. If those files still contain credit card numbers, they'll get relabeled. If the data's been removed, the policy won't flag them.

Worth mentioning that Exchange works a little differently here. There's a setting in auto-labeling policies called "Automatically replace existing labels that have the same or lower priority." Turn that on and it'll override even manually labeled emails. That option only exists for email though. SharePoint and OneDrive don't have it.

Microsoft covers the override behavior in detail here: https://learn.microsoft.com/purview/apply-sensitivity-label-automatically#will-an-existing-label-be-overridden