Step One: You Die
Problem with that is that it's unforgiving like a mother fu... nk... Anyways. The gameplay gives you a reason to run (Good), but more reason to want to kill (Get the bastard). I see that this is going to turn into a ramble-fest, so I'll cut right to the new idea.
Step One: Death
Step Two: Take a hidden roll to check against your Constitution/Willpower.
Step Three: Take a permanent defect from the fight, along with a level loss.
Permanent Defects include: Bad Arm (Less effective arm), Limp(Slower movement), Soft Spot(Higher crit chance against you), Stubborn Limb(Limb will go from fine to handicapped randomly), Loss of Limb(Inability to use said limb), Loss of Eye(Higher perception checks), etc
Once an amount of defects have been gained, that is equal to (and maxing out at) 1/10th of your level, you will instead begin to lose 2-4 extra levels per death; which brings the level loss to 3-5 levels per death. If you do not have enough levels than you will permanently die.
This way, when you die (which you will), you will still be given a major and permanent reason to avoid death, but you won't lose all your time and investment because your keys locked and you went off a cliff, or you got knife in the throat when you weren't looking. There's still a way to die permanently, but it gets harder to reach the more you put into your character. It shouldn't be too unbalanced for the higher levels, because the higher your level the more likely you are to have died multiple times.
I'd like to hear some of your comments.