The image youre refering to is a thumnail of the raw image. If you go up to file, save as you can actually save that 1280 image as a JPG and it will be a small file but also a small image. When you do an actual convert, it uses the full size image and saves it as a TIFF which is an uncompressed image. You can open the TIFF in most software programs such as PHOTOIMPACT or Photoshop and convert the tiff into a .jpg which is a compressed image and you can choose how you want to compress it.
I really like the 12MP fine camera setting myself and don't use RAW much. It just doesn't give you much more than the 12MP Fine setting of the camera.. (4 MEG file sizes)