To make this work, you need your LLM-based AI to outperform any other form of generating quests and rewards -- and that performance is measured on things like player enjoyment, game/story progression, exploitability, client system requirements or server operating costs, etc and most of those things are very hard to constrain or optimize for with an LLM right now.
While the costs are hidden from end users and are going down quickly, good LLM's remain very expensive to run and very hard to keep on track compared to other options.
You're trying to big brain something that isn't that complicated or special.
I never said that every interaction with an NPC must necessarily require AI to create a new quest and reward from scratch. Players aren't that savvy. You just generate a pool of quests and assign them to NPCs in the instance. Players who are addicted to loot treadmills will stay in the game and pay for boosts and other rewards as long as there is content to engage them. This more than pays for the AI service.
While the costs are hidden from end users and are going down quickly, good LLM's remain very expensive to run and very hard to keep on track compared to other options.