Ok, here's a nice meaty sample document (https://docs.google.com/open?id=0B4qT-cHb903mS3k3bjZoTV95Slk) that I should be able to leave out there just about forever. It's large because it includes CC pictures as sample figures. I'm also including the notes section of it that should have enough information to recreate what I did or at least get you close to solving your issue - the document just provides a "live" example so you can look at field codes, etc. but the important values are documented here.
Chapter titles are formatted as Heading 1, and chapter numbering is done by having the cursor within the first chapter name, going to the Home tab, selecting the multi-level list button/dropdown and selecting a numbering format.
To keep Word from making the Table of Contents into Chapter 1, click into the Contents heading, select the multi-level list button, and change the formatting there to None. I did this after I had already right-clicked on the Notes chapter heading and told it to restart numbering at 1. This was a bit squirrely, as it initially had the chapter numbering in the figures off by one. Inserting a Next Page Section Break (Page Layout tab, Page Setup section, Breaks dropdown) after the Table of Contents then redoing the chapter numbering (e.g. resetting start at 1, etc.) seemed to take care of this after I changed the Heading 1 Style to have a page break before it, which caused the chapter numbering to reset to default including the Table of Contents.
Pictures were simply copied and pasted, then the text wrapping was set to Square to make them float, then they were dragged around a bit. They’re not anchored to spots in the text though they probably should be.
Picture Captions were added by right-clicking the picture and selecting Insert Caption; the caption numbering was set to Automatic and told to include chapter numbers (which is where setting chapter numbering comes in up above).
A bunch of this is actually controlled by Fields, press Alt-F9 to see the field codes. It’s likely worth noting that the field codes for my captions are “Figure {STYLEREF 1 \s}-{SEQ Figure * ARABIC \s 1}", the \s doesn’t appear to be well documented, at least not within the STYLEREF info. Additional information here: http://wordfaqs.mvps.org/styleref.htm
UPDATE: It looks like this MSDN page may be the best reference relevant to this: http://msdn.microsoft.com/en-us/library/aa163918%28v=office.10%29.aspx
In particular, the "\s 1" tells the field code to restart the figure numbering at the most recent heading of the specified level (here, level 1).
Best Answer
{ STYLEREF 1 } is looking for a paragraph with the built-in style "Heading 1" (in English language versions of Word - if you are using another language version the heading styles may be named differently).
So if you don't have one of those, the { STYLEREF } field will flag the error you are seeing.