We recently released knowledge base article http://support.microsoft.com/kb/982954 addressing an issue with certain MPEG-2 files inserting into PowerPoint. There were a few workarounds we suggest. One of which is installing an MPEG-2 codec.
PowerPoint cannot insert a video from the selected file. Verify that the necessary codec for this media format is installed, and then try again.
However, there's actually a neat little trick you can do to get these MPEG-2 videos to insert, then play in PowerPoint 2010. Basically, you just need to downgrade the video to a 2007 video object. There's not a downgrade button or anything like that but you just need to insert the video into a legacy presentation (*.ppt) that will be in [Compatibility Mode], insert the video there. If you have an existing file that is already a native (*.pptx; *.pptm) presentation and you want to insert the video there, just copy and paste the video from the legacy presentation (*.ppt) then insert into your native presentation (*.pptx).
Steps to successfully insert the video into PowerPoint 2010.
1. Start a new session of PowerPoint 2010.
2. Click on the Save button on the Quick Access Toolbar in the upper left above the File tab.
3. Change the 'Save as type' drop-down box toPowerPoint 97-2003 Presentation (*.ppt).
This will put you in Compatibility Mode
4. Choose a location to save the file and click the Save button
5. Click on the Insert tab and click the Video icon.
6. Select the MPEG-2 video you received the error on before and click the Insert button.
7. Right-click on the video and choose Copy. You could also press CTRL+C; or under the Home tab, click on Copy on the left side of the Ribbon.
8. Open the presentation (*.pptx) file you received the error on earlier, then right-click inside the slide you want the video inserted, and under the Paste Options choose the icon on the left (Use Destination Theme). You could also press CTRL+V; or under the Home tab, click the Paste icon on the left side of the Ribbon.
9. See if you can now play the video.
10. If the video plays, right-click the video and click Upgrade Media Object.
11. In the Media Object Upgrade dialog box click on the Upgrade button.