I have 1 email address policy in place that does not apply to contacts. If
however I add a contact and the "Automatically update e-mail addresses based
on email address policy" is checked they receive an internal email address
along with the smtp address that I create for them. It would appear that
this check box overrides the email address policy, as described below. Is
this conclusion correct?

When a recipient has "Automatically update e-mail addresses based on email
address policy" enabled, all primary e-mail addresses (default reply
addresses) of e-mail address types will always be set from the e-mail
address policy. This means that if you edit the primary address to be a
different e-mail address, it will always revert back to the one specified in
the e-mail address policy.

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