Thanks Paul but it still embeds the image. I even searched online for more clues and they say the same thing.

Steps:

Insert -- picture from file
Check link to file
Uncheck include with doc
Insert

I even saved it and opened it back up and it is still embedded.

This is in a new document with no formatting. It is Word version 14.7.2. I don't know where else to look. Word 2011 has some strange glitches in it that MS has never worked out. I guess this is one of them.

Any other suggestions?