"Place pan in a large pan; add 1 inch of hot water to larger pan." -- Why?
Couldn't I just use a lower temperature setting? 


No, you can't. Ovens are very bad at keeping a constant temperature. Not only is the oven thermostat usually off, it also cycles around its mean temperature a lot. So your food is subjected to constantly changing temperature. 

If you were to set your oven to 100C, you 1) won't get really 100C, and 2) won't get the crust to brown, as the temperature is too low. Instead, you can use the water bath described. In combination with a temperature setting higher than 100C, it will keep the bottom portion of the cheesecake at a constant temperature, and will allow the surface to bake well. 

You will see water bath (i.e. bain marie) recommendations for many types of baked goods, including custards. But when it comes to a cheesecake, it has a second function. At each temperature, there is an equilibrium moisture in the oven air. As long as the equilibrium has not been reached, moisture evaporates at a high rate from every moist surface (your baking good). When this happens to a cheesecake, its top cracks. But when you have an open water surface, it is sufficient to saturate the air, and no (or very little) evaporation happens on the cake surface. You end up with a smooth cheesecake.