XBMC does netflix through plugins. I believe Hulu has a plugin as well. They aren't the fanciest, but they work.
ISO's and HD movie playback will work fine in XBMC. That's what it's made for. Openelec or XBMCBuntu should work great on this setup.
XBMC plug in is just a stream pass through, requires your PC for playback. Basically logs into the PC and the movie is played on a minimized windows and then streamed to the XBMC. IT does work well but it's can cut out if your bandwidth sucks.
Your better off playing netflix natively on the HTPC if your using windows and loading XBMC as an app from windows. Using XBMC netflix plugin though XBMC live is not worth it.
I would love for XBMC to get native netflix support.... maybe one day.