I would try initiating the merge from Outlook instead - select some
contacts, then start with Outlook Tools|Mail Merge... If you have trouble
doing that, the chances are that there is a problem to do with permissions
in your "temp" file folder.

It's also worth verifying that
a. Outlook is set up as the Contact List application in IE Tools|Internet
Options|Programs
b. the folder is configured to be in the Outlook Address Book in the
appropriate tab in the Properties for your Contacts folder.

NB the list of fields available when you initiate from Outlook is different
from the list when you initiate from Word, and some of the field names are
different as well.

Peter Jamieson