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You will see four choices:
1. Internet
2. Local intranet
3. Trusted sites
4. Restricted sites
Click on Internet. Then in the section that reads "Security level for this zone" click custom Level.
A window should pop up that reads "Security Settings" at the top. The first setting options are "ActiveX controls and plug-ins". Here are the settings I use to disable Flash from downloading and asking me if I want to install it.
Download signed ActiveX controls > Disable
Download unsigned ActiveX controls > Disable
Initialize and script ActiveX controls not marked as safe > Disable
It was the "Download signed ActiveX controls" that made the difference. I had that set to prompt and Flash would download and ask if I wanted to install it. Doh! Now it don't :)
Now when we go to sites that use Flash and we don't have it installed, we get a pop up telling us that the page might not look right because of our security settings. Just click ok and happy surfing.