This is the recommended method of merging images to Word® documents when using a publicly accessible image.

Syntax{{IncludePicture:URLFieldName}}
ValueURLFieldName is the field's name from the Template Builder window that contains the image URL.
NotesThe file type must be JPG or PNG.

The file must be publicly accessible (not stored in Salesforce®) via a URL and not be subject to anti-scraping protection.

Usage
{{IncludePicture:Product_Logo_URL}}

On merge, it becomes: