I noticed that my server kept changing to bay-m.hotmail.com instead of just m.hotmail.com.
After multiple attempts of adding and removing, I somehow managed to get the server to stay m.hotmail.com...I configured it manually and this time it stuck. I was still getting plain text as the only option though under message format and the emails. In the settings I changed Message Size limit to max and then under general settings I changed Load Linked images to Always load. After multiple refreshes it started coming in as html.
I'm still not sure why i plain text is the only option in the Message format box, since under server policy is says Allow HTML email.
Hope this helps.