Quote - I think the real problem is the body parts themselves are not colliding, but actually passing through each other.

Exactly. To answer your original question, the future of dynamic clothing may be unconnected with the cloth itself, but to extend simulation technology to the figures. It's all very well having an accurate cloth simulation (and we all know situations where it isn't very accurate - yet), but when this cloth is interacting with flesh which is apparently made from solid plastic, part of the equation is missing.