I've been playing with these settings since day one trying to get a resolution.
On the Telstra version, the maximum message size is 600kb
TBH, I don't feel this has anything to do with it - my One XL, same carrier, was actually set to 300kb (for whatever reason), but it NEVER reduced incoming pictures this much.
It's definitely a ROM issue, not just a 'settings' issue.
Out of interest, anyone in this thread rooted and using a custom ROM? Care to post your experiences?