I\'m currently creating a Word document by generating HTML and changing the header information to display as a .doc file. It\'s a poor man\'s method, but it works just fine
That's a tough one, Word isn't able to handle data: base64 encoded images in HTML, at least that's the outcome in this question and this MSDN discussion.
You have three options:
Create a folder in the location of the document, store it alongside the document, and reference images relatively ()
Work with absolute URLs or file paths (even more sucky)
Look into the new Word > 2003 XML based file format(s), it is definitely possible there.
The only other option I can think of is actually creating a native Word file, e.g. using OpenOffice.