Hi Joseph Fitzgerald,
Thank you for reaching out. Based on the information provided, it appears that while you have selected 3rd option auto download and notify to install, the issue might persist due to the automatic maintenance feature being enabled. This feature could be overriding your policy and installing the downloaded updates without manual intervention.
Could please refer to the image below for guidance. Disabling this feature can ensure that updates are not installed automatically.
Additionally, when creating your VM, ensure that the update settings are configured to manual updates rather than automatic OS updates. This setting might also be causing the policy override issue.
Image for your reference
For further details, refer to the provided documentation.
If you have more inquiries or require more assistance, please mention me in a comment. I'm happy to help you out!