I responded to a post on the Path of Exile forums and found the topic stimulating enough to want to share it here. The question was what sort of death penalty Path of Exile should implement. In the likely event you don't know what Path of Exile is, it's a F2P action-RPG currently in development that clearly draws a lot of inspiration from Diablo 2.
Here is my take:
I don't think death penalties have much of a place in action RPGs. You are almost certainly going to die at some point. You are probably going to have times where your particular class/build/gear is at a distinct disadvantage against particular foes and die a LOT. Having a penalty on top of that can get frustrating fast, especially if it's something that's going to contribute to you continuing to die (lowered stats, loss of gear, loss of xp/levels) or is so painful you'd rather log off than keep playing.
You never want to put your players in a position where they'd choose to stop playing because it's no longer fun. They might not come back. Earth and Beyond had one of the silliest death penalties ever -- an xp penalty that faded while you were logged off. If you died, your best bet was to log off the game and come back tomorrow. How's that for incentive to play? How's E&B doing these days? Yeah.
Rather than a penalty, why not do something different? Maybe you are stuck in the netherworld and have to complete a random puzzle to outwit Death and return. Or a mini game. That might get tiresome if you have to do it a lot in succession, but still, it would be different.
Or maybe you appear in the spirit world as a spirit, and have to fight your way out using ghostly versions of your skills and equipment, and can earn xp (but no loot) by doing so rather than losing it. Death becomes a learning experience, and a player stuck fighting enemies too strong for them and dying over and over will have the opportunity to level up while recovering from death (assuming they're dying a lot) and maybe overcome the enemies.
The real penalty of a death in a game is loss of time. That loss can be expressed in a lot of ways, from losing xp or gear to suffering a stat penalty that slows you down. The end result is always the same -- a loss of the player's time or progress. There are plenty of ways to inflict that loss of time without generating frustration at the same time. The simplest is to force a respawn further back in the game and force the player to run back. Sometimes simple is best, but it would be nice to see something more inventive here.
What do other people like (or dislike) in death penalties for RPGs?