Hi there,
Unfortunately I experienced that too, there is a bug in iOS 10, definitely. I contacted Apple Support via chat and after 15 minutes chatting they asked if they can call me to discuss. They did and I spoke to one person before eventually my problem was escalated to a manager. I spent almost an hour on phone with them, explained everything slowl 10 times, sent screenshots when on chat. I also allowed them to connect remotely to my iMac so I could show them my screen and smart paylists in iTunes and showed them how I copy them to my iPhone and them explained how I set artwork pictures for every smart playlists. And I got exactly the same problem as others: can see artwork pictures for every smart playlists when I enter that smart playlists but not on a "Playlists" screen. Also, interestingly, I can see artwork pictures on a main "Library" screen under "Recently added".
They tried to convince me that is "expected behaviour" but I kindly told them I do not buy that BS - everything worked fine in previous versions of iOS. Eventually they said they will pass it to engineering team and will call me back with an update next week. So, guys, I will update here as soon as I hear from them.
For now, anyone experiencing the same issue please contact Apple Support and get this reported here https://getsupport.apple.com/GetproductgroupList.action. Please.
Regards,