Personally, I like the system used in Gothic or Jedi Knight 2 : Jedi Outcast the most where it is more skill based in real life than just hack and slash where as "oooh, look at me, I am higher level than you therefore I can automatically win". I like the approach where levels CAN help a lot, but a low level character can also beat a cocky high level character not really caring to fight seriously.
Although, that would be almost impossible to do with renderings and stuff which is currently what you are working with.
