I am replying to my own post... different user name because I could not get into my other account.
1. I found an old text I sent to a friend where I found the previous solution. In the render settings the default box is checked "use no proxies" so that is why the video files were not rendering out. Uncheck that box and you're good.
2. Open the comp in Adobe Media encoder and render it out there... preview window shows proxies being embeded in preview window!
Hope this helps someone new to After Effects from banging their head against the wall in the future.
Just to further clarify your own answer, Proxy files are, by default, not rendered when output. Proxies are designed to be used as a temporary substitute of a more complex resource/comp to save render time during the design phase, or as a temporary substitute for a resource that is not yet available. As you have discovered, you can choose to render WITH proxies enabled within the render settings of the Render Queue.
But there is a problem with your workflow here, I think. If you want to use a footage replacement permanently, for designing AND rendering, then there's no reason to use a proxy at all. Use "Replace Footage" for the item in the project window, rather than setting a Proxy, and you don't need to worry about what will and won't render.