Entirely true.
Tried, tested, and working fine on my iPhone 3G and now my iPhone 4.
I don't like full screen photos when someone phones, I prefer the thumbnails.
The only way to get the thumbnails is to edit your contacts in Address Book and then sync the contacts to the iPhone.
If you go into your contacts on the iPhone itself, choose "edit" and select a photo of someone that is already stored on the device, then you get a full screen contact photo when that person calls.
If you don't believe me, that's your call ... I'm trying to be helpful.
I know it works for me, and I got the information from another UK Mac site/forum when I asked, "How do you get the little pictures like the iPhone advert contacts".