I'm seriously starting to want an actual LRR game about Grim and the spikey-haired protagonist out for revenge on him, now.
Concerning the ethical quandaries surrounding uber-AI: You don't actually need individual AI for each and every ninja to make them appear to be separate beings, and you certainly don't need to give them the actual ability to feel pain. Make a single AI that's basically the world's most awesome game master. His primary function is to give the people who play his game a good time, and since we're talking about sapient AI, he can probably tell whether you're the sort of guy who enjoys mildly challenging gameplay that doesn't get in the way of the narrative or brutal and unforgiving gameplay that makes you feel like the God of Video Games when you finally overcome it, or whatever other playstyle you prefer.
The solution to most AI problems is "make the AI want to do whatever we want it to do."