This idea is insanity. It takes FOREVER to level a Pirate to Max, and gaining Legendary and Famed stuff etc would be soooo messed up to lose. No one would step into PVP or any dangerous PVE ever again. The only way this idea works... THE ONLY WAY... is if set-backs never affected level. There would also have to be a personal Stash/Bank that each player could use so you can store your personal valuables (famed/legendary etc) so you don't lose them during battles, except for the ones you were using DURING the battle (which STILL is a stretch but that's as far as I'm willing to go with this xD). Which brings me to my next point of making Famed/Legendary items a bit more common AND have a specific boss to farm for specific items. That way you know who to farm and know that there's a decent chance you'll get yer stuff back. There would also need to be a Time System in place for prison, so you don't have to log off every time yer character goes into prison (cause we don't all have 10 max levels yah know?!?!). Also, being "Permanently Deleted" should be off the table entirely, unless you wanna make leveling a character 10x easier.
There's my opinion on the matter. I feel it's reasonable, me still being someone who hasn't gone insane from "Max Level Life" (I'm not a max yet).