Under the settlement, the states will receive their share of $4 billion in disputed payments and the manufacturers will receive credits against future payments.

The payments resulted from the 1998 national accord that obliges companies to help cover the health bills of ailing smokers.

States, counties and cities have sold nearly $40 billion of bonds backed by the more than $200 billion in payments that U.S. cigarette makers agreed to make to them over time.

So far in 2013, returns on tobacco bonds have largely outperformed the rest of the $3.7 trillion municipal bond market despite concerns expressed by credit rating agencies about the decline in tobacco consumption.

In July Moody's investors service warned that the majority of tobacco bonds sold by U.S. states, counties and cities will default if cigarette consumption keeps falling at a 3 percent to 4 percent annual pace.

In December, California and New York's Nassau County tapped reserve for payments on three different series of state tobacco bonds due to insufficient tobacco settlement revenue.

The 46 states that participated in the 1998 agreement shared $6.15 billion in payments in April, up from $6.03 billion in April 2011, according to the National Association of Attorneys General.

Tobacco companies, including Marlboro cigarette maker Philip Morris, a unit of Altria Group Inc, and Camel cigarette maker R.J. Reynolds, a unit of Reynolds American Inc, have for years disputed the amount of payments they owe after losing market share to companies that did not agree to the 1998 settlement.

"This agreement resolves disputes with a large group of states on financial terms that are fair to the parties and in a way that we believe will lead to a better method for resolving these issues in the future," Denise Keane, Altria Group's executive vice president and general counsel, said in a statement.

The states in the settlement are Alabama, Arizona, Arkansas, California, Georgia, Kansas, Louisiana, Michigan, Nebraska, Nevada, New Hampshire, New Jersey, North Carolina, Tennessee, Virginia, West Virginia and Wyoming. Also settling are Puerto Rico and the District of Columbia, the tobacco companies said.

Philip Morris said it will receive a total of about $450 million in credits toward payments over the next five years. Reynolds said its credits will total more than $1 billion while Newport cigarette maker Lorillard Inc said its credits will be at least $198 million.

The agreement also allows other states to enter the settlement and is subject to approval by a panel that has been arbitrating the dispute over the payments. If they do not join the settlement, the arbitration will continue.

Altria shares closed at $32.59 on Tuesday on the New York Stock Exchange, while Reynolds closed at $41.94 and Lorillard ended at $116.09.

(Reporting by Brad Dorfman; editing by Andrew Hay and Phil Berlowitz)

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