Regardless I just don't think that 7 mediumn bombers (Rumaniian at that) should be able to inflict double digit damage.
Me too, just give exact steps to reproduce it. I don't see it to happen. I was not even close to reproduce it in the save you provided.
Not sure what you mean by "protected" as I admit I never had a PVO AA regiment in Stalingrad because of the bug.
You could still build them and they were not useless.
By the way, as you can see my intercepting fighter airbase is only 3 hexes away not 4. So just how close does it need to be anyway?
There are many factors, range is among them. The close it is the better chance them to intercept.
1. Was it a bug that was causing them to not change equipment from the 76mm AA gun to the 85mm AA gun?
Yes, there was a bug for support unit upgrade. Especially those attached to the cities.
2. Has this bug been fixed in the latest patch (1.06.22) so that they will now change equipment and build up to strength in a reasonable period of time (3 to 5 turns)?
Yes, it should be fixed.
3. If not what can I do to "protect" my industry?
Nothing new. Build AA in the cities. AA is very powerful in WITE (I'd say even too powerful). Station your PVO air bases nearby. Even if LB could reach your rear cities, they are most probably will be unescorted