What you describe seems to be in order.
Are you playing The Quest? It won't work with The Quest Classic.
How large is the image file? It should be 49208 bytes (give or take a few bytes).
You are right only drag and drop works, it worked what I described when I wrote it, it seems iTunes have changed. (I've updated the text.)
Have you synced your device after you've dropped the folder in?
(And finally, have you paged over all available head images in game? I'm sure you have, just checking.
)