Hi Gene,
I’m working with WP 2.5.1, and I do not have to upload an image to my server before inserting it into a post or page. When I go to Write -> Post or Write -> Page, there is an area underneath where you add the title that says Add Media and has an icon for inserting an image, a video, music, etc. If you click on the first icon on the left, a window will open where you can choose a file to upload by browsing your hard drive. WP will upload it automatically at this point. Hope that helps.