I think it's just a case of there being many more games that output 720p, relatively speaking, than 1080i (which I think is limited to Dragon's Lair). Sure, there aren't many 720p games, but there is a non-trivial amount.
I think the conversion is dependent on your TV. If it can upconvert to 1080i it will, otherwise it would just display the 480p. 480p is native for the vast majority of Xbox games (The Thing, Hitman 2 and Kung-Fu Chaos are 480i exceptions), but 480i and 480p are always offered, and 720p is just another setting for some games (THPS4 is one), offered for those who have it available (it's probably easier to program than 1080i).
Allen, that sounds correct, the only issue is, the dashboard is set to 720P-NO. So the XBox won't send out 720P. And in my scenerio, the TV will not even display it, no conversion. I will simply get a blank screen. Thanks for reply though!