Out of TES, it's hard to say but I like Oblivion and Morrowind almost equally but for different reasons. I like oblivion's take because you actually had npcs with schedules and all that, was definitely an improvement, but the essential NPCs were something I didn't like a lot, and that NPCs usually only had 1 unique thing of dialogue and there wasn't much to say to them.
I like morrowind because even though they don't have voice acting, the NPCs feel like they have more personality with their dialogue, the dialogue from Caius Cosades alone beats out all the npc dialogue from either oblivion or skyrim IMO. I also like being able to ask certain things to NPCs, like what services there are in town, the politics behind that town, and even scouts that would tell you about outposts and places of interest in the ashlands.
Yeah, they were like walking encylopedias at times, you could do with a little less options, just for the sake of not having npcs saying the exact same thing all the time. But is npcs with all the same knowledge really more immersion breaking than every guard taking an arrow to the knee and quitting adventuring? I mean, that's a pretty specific line of dialogue that every guard happens to say.
I'd take NPCs with hordes of information and some of them repeating the same mundane directions or services question over NPCs that don't say anything interesting, don't talk about rumours and all say the same opening line.
Personally, I think Fallout New Vegas (though not made by bethesda, it's the same style of game and most assets used and software is bethesda's) did NPCs the best. Nobody was essential (except kids, but there were very few of them), and you could kill any quest giver anywhere, but what would happen is you would get a "X Quest Failed" notice, so then you could decide for yourself if you wanted to reload, or that the quest was probably for a faction or person you weren't going to work with anyway.
One of the great things about New Vegas is that there were so many quests, and it was literally impossible to do them all because lots of times quests for one faction would have you kill a quest giver for another faction, therefore barring you out of those line of quests. You could actually join any faction you wanted, side with any of them, and decide who takes control at the end of the game. You could even work for them all for the most part and try to do as many quests for each side as you can until you are forced to start taking out guys from another side.
Okay just gotta say, awesome Avatar. Absolutely love that show.
But yeah, the messages were a good route IMO. Also see above in my reference to Fallout New Vegas, that was probably one of the better approaches for essential NPCs. You get the message, but you actually get the name of the quest failed notice, so then if you really wanted to see if it was gonna screw you over later, you could go online and check the quest if you really wanted.
Or just make a judgement call, lets say you were working for the NCR and you got a mission that had you kill a legion guy, and then you got a quest failed, you could decide for yourself are you gonna reload so you dont block that quest, or continue playing because it was obviously a quest for the legion and you know you aren't going to side with them.