That's the recommended setup. Registered should be everyone's primary user group with all the basic permissions you want all users to have. For anything you don't want them to have, be sure to use Not Set (No) rather than Never, which should never be used except in excruciating circumstances, such as for banned users. Other user groups, such as Administrative, should be secondary, with an explicit Allow on permissions you did not give to the Registered user group that you want them to have.
That is indicative that it is in a format that the server itself (not XenForo) cannot process.
Does it occur on all images, or one specific image.
It sounds like whomever is hosting your site has some issues on the server end.