I got the same behavior today using Firefox. Thought I was doing something wrong, so I resorted to using the "attach files" feature.
It used to work fine. Maybe something has changed; new security patch or something.
I have ALWAYS found that to insert an image I have to open the select image dialog twice. The first time I enter it and choose an image the insert button remains greyed out. Second time around it works OK. Because of this I usually don't bother trying to choose an image the first time aound to save time. It has always annoyed me but I've never gotten around to posting about it, but since you have I'm more than happy to add my experience. My setup is Safari 6.1.4 on MacOSX 10.7.5.
Let's hope an FM person monitoring the forum posts will pick this up and look into it now.
Same here... Just close & reopen is the key....
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