Looking at the source of the email Outlook was sending the local path of the image and not the image. There is a setting in the registry that fixes this. The path below will differ depending on the version of Office you have. 12.0 being Office 2007, 14.0 being Office 2010, and 15.0 being Office 2013.
Open Regedit and browse to the following key...
Value type: REG_DWORD
Value name; Send Pictures With Document
A client of mine was having the error 0x8004010F in Outlook 2010. I repaired the PST and it fixed 30 or so errors but I was still having the issue. I ended up creating a new Outlook profile using the following link...
After creating the new profile I could not open or export the previous PST. I realized she had checked the option Run this program in compatibility mode for: Windows XP checked. Once I unchecked that Outlook 2010 could open & export the previous PST.
If Outlook 2010 is prompting for UAC everytime you open it check to make sure you don't have Run this program in compatibility mode for: or Run this program as an administrator checked.