That error simply means the user who is on the receiving end of the PM has set in his profile for email notification on PMs, but the script has failed to send the email for some reason. The actual PM is internal to phpBB, and will still be sent.
Yahoo's hosting should indeed provide you with access to a mail server, does this error occur when new user's register ?
As for upgrading, If you have no mods installed (and this is not a forum installed by clicking a button in your hosting control panel, you actually installed it properly),
Backup the database and the forum files.
Download the changed files package from the downloads page
Extract this package's contents to your hard disk.
Extract the zip file contents which is relevant for your board version (ex. if its from 2.0.5, then 2.0.5_to_2.0.10.zip) to your hard disk, and upload those files, and the 'install' folder into the root forum folder directory.(overwriting files)
Point your browser to the ../install/update_to_210.php
Delete the 'install' and 'contrib' directories.
Also, if you don't have access to a mail server, you could prevent the forum from attempting to send emails. The instructions are posted by Graham here