The text box method requires too much trial and error. And I want to be able to see the preprinted material while I am composing the letter.

I hit on a method something like your second suggestion. Instead of pasting the image in the header itself, I make it into a watermark. Your suggestion seems to be a little better in that it is a little easier to delete.

I was hoping that I would be able to code the image as hidden, but that didn't work.

In Visio, and I imagine in Publisher, it is easy to mark any object as non-printing. That makes it very easy to "see" the image and guide the text around it. In Publisher, if I recall correctly, you can draw an outline and get the test to flow around it. I suppose this can be done in Word, too, but it is much more difficult to make the images stay put.

It's a pity that Microsoft doesn't allow images to be hidden. That solve this problem very neatly.