I think yo meant to say:
"2. create username and password using .htaccess in the panel".
It can be confusing that WebDAV is on the same page with the .htaccess "auto-generation" stuff, but they are very different things, and one should be careful not to "use" the WebDAV stuff on the page when trying to use .htaccess from within the Control Panel.
That said, your advice on saving any existing .htaccess for subsequent merging with the .htaccess file created by the panel for Apache authentication and/or hotlink protection is right on the money! .