When I played SWAT4, I remember being glad the game put me back at the beginning of the level every time I lost, just because it kept me from doing this.

In games like SWAT4, the core game mechanism is planing your moves upfront and not the action part. If you fail, your whole plan failed and let the player continue at this point would ruin the whole core game mechanism. You can think about it like 'Create a plan and test it out, while the test will include some random outcomes, you can't plan upfront' game.

Racing games sometimes use a mechanic known as "rubber banding", whereas cars behind you get faster while those ahead of you keep a slower pace to allow you to always catch up with the lead while keeping up the pressure from your pursuers. The biggest challenge with this approach is not to make this too obvious to the player since it can easily break immersion if cars behind you suddenly drive alot faster.

This approach of adaptive difficulty level has been implemented in valves L4D (AI director). The hard part of this approach is to measure the level of challenge of the player. I got really cool experiences in MMORPGs where my team got almost, just only almost, wiped and those experiences were the most satisfying ones.

In other words, you need to push the player off the cliff just enough, so that he can hang there for a moment before you drag him back on safe ground.

the "Carrot vs. the Stick" principle.

Too often game designers start with the stick, trying to punish the player all the time, even trying to enforce the player to play the game in a certain way. But you just need to remember, that the player will not like punishment or any restriction at all, he want to have a cool, still challenging, experience.

The big problem with challenges is, that it depends a lot on the indiviual. There are people who dislike challenges at all (they what to play/read an interactive story) and people who really seek hard challenges (people who like roguelikes). In my opinion, the acceptance of a hard challenge depends a lot on its duration and accessibility. Once you fail, you want immediatly to start over. If you need to spend a lot of time to retry the challenge, or the challenge was too time consuming, that a restart just let you feel sick, then the player will most likely abort it and leave.

An other observation is, that a hard challenge don't necessarily need an high reward, because beating this challenge is quite satisfying on its own, though a missing reward could kill the experience. Therefor some special reward would really help.

One of my NPCs died

Losing an NPC is a interesting as its seems like an always reload situation. Take XCOM for example did any us actually carry on if we lost a character during a round? Or did we just automatically reload that turn?

But what can you do as the designer? Make it so that npc are immortal? That way the player can always use them later on. But the player still has one less character to do the mission with and depending on how far a long they in the mission they might as well reload.

There could be content that requires a dead NPC like turning them into cyborgs or zombies. But do you tell the player that before hand or keep it a secret and risking them experiencing those customization options?

Is there any situation or design that would convince the player to accept losing an NPC?

I was thinking about a game where killing isnt the idea -- and neither is YOU dying like a fly all the time for seemingly the least mistake (particularly if you go through the threats for the first time and dont know where the 'suprises are - versus the game idiocy of static choreographed situations that will do exactly the same thing over and over til you DO figure that situation out )

To have alot more outcomes for your 'mistakes' which themselves just change your game situation and offer different problems not to solve. (versus "GAME OVER - reload the save and try again"...)

You mess up in a combat and you get wounded (and stay that way) and now you cant do half the things you could do and the ones you can are impaired requiring you to change your goals and usage of tactics to be more conservative or use avoidance... possibly to be more creative if you arent in that state too frequently or there are too many different modified states )

But that all depends on many more options of actions (and many different situations with their own sets of actions)

which in turn depends on expected results (closer to things working/reacting/manipulated more like real world to pick things to do - not arbitrary 'sorry you cant do that' limitations) - alot more factors involved and needing adaquate visualization of all the factors to know what is going on/to read that richer environment (game companies dont like complexity, and players prefer to be lazy too - so as long as the companies sell the current pablum.....)