I think the reason we don't see this so much is that modern games tend to revolve around a particular element. For example, Alone in the Dark allows the user to grab items from the environment and combine them to make things. This is great, fun, and works well, but the rest of the game seems tacked on around this mechanic. Similarly, City of Heroes is an MMORPG with extensive character creation. The character creation is elaborate, enjoyable, and truly worthy of praise, but the rest of the game plays out like just another MMORPG. Time Shift has bullet time, which works good, but the rest of the game is a FPS without a purpose. All in all, it seems that whenever a new element is added to game play, so much effort is spent on perfecting that element that the rest of the game is forgetten. This is exactly why adding sex to a video game is going to be a nearly insurmountable task.
The first conclusion we can draw is that the first game to do so will be horrible. It's possible that the sexual elements will be well done, but the rest of the game will suffer from neglect. The game will be lambasted for its mediocrity, and since it's main element is sexuality, the media will blame the sexuality for creating a poor game.
The second problem is that, like most new mechanics, it will need a lot of tuning. How do you incorporate sexuality in a game in a way that is enjoyable, reasonable, not offensive, and adds to the rest of the game? This is a delicate balancing act, akin to the use of violence in video games, and we still fight over "how much is too much".
The last problem, and possibly the most significant, is that a unique mechanic like this will ultimately become the main selling feature of the game. However, society has shown time and again that it prefers sexuality to be subtle. We all have and desire sex, but we rarely come out and say it, certainly in public. We tell tall tales, make lude jokes, and otherwise reference it, but to speak its name and give details is considered obscene and offensive. The difference between subtlety and frankness becomes the difference between art and obscenity.
Now take that subtle subject and make it the main feature in a video game (still widely considered a leisure entertainment with no redeeming artistic qualities), complete with the usual touting in trailers, press releases, and conferences, and watch the media hounds feast on it. Everyone from Jack Thompson to the ESRB and even state legislatures will challenge it. To take something so sacred and make a game out of it (especially if it involves "mash X to reach climax") will have people decrying it as pornography, obscenity, and every other death-letter imaginable. An AO rating will be the least of their worries.
Even doing it right, as LotRD may have done, will be met with consternation. How do we keep this away from the kids? (Which assumes the answer to the ever-unanswered question, "What's acceptable for kids to see?") What about homosexuality? What about teenage pregnancies, unwanted pregnancies, abortions, divorces? So many people have differing opinions of these, and their opinions can be so extreme that they believe nobody should be able to do, think, or see those things themselves. For example, if homosexuality isn't addressed, the homosexual community will accuse it of ignoring them or encouraging heterosexuality as the only acceptable way. Include homosexuality, and many religious groups will claim that it's sinful and will turn people gay. (e.g. Bioshock) Include marriage and the same situation will be several times more controversial.
The key to including sexuality is to handle it with maturity, but few people are mature or secure in their own sexuality -- especially those in the demographics most likely to play video games. Outside of the demographic that would play the game, there are many more people who would comment on the game (from reporters, to reviewers and critics, to watchdog groups, to legislatures) who may themselves be immature or insecure and will misunderstand or otherwise be offended by even a mature discussion of sexuality.
Games have gotten away with violence and coarse language because, as much as our society claims to be disgusted with it, it's extremely tolerant of it. Sex, despite being perhaps far more necessary than either violence or specific language, is viewed with far less tolerance. To successfully add even a modicum of well done, mature sexual content will be to hold ones own feet to the fire and brimstone that society will unquestionably bring forth. As a game designer, that may be a risk worth taking, but as a producer, that sounds like a poor investement.
I would like nothing better than to see sexuality be included in video games in a mature manner. But given the video game industry's record with violence, coarse language, and especially sexuality, it's unlikely to ever happen. Most games have trouble forming a compelling story around WWII; how are they ever going to handle a subject as delicate as sex? And if they do, how will they convince society of its merits? The video game industry and society in general both have a long way to go before we'll ever be able to make more than breathless references to sexuality in video games.
