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1)   If you sell out of a contract to invest in a longer dated contract, the longer dated contract is going to be more expensive.  At least if these were to work just like futures.  So if someone is consistently reinvesting into another contract, they are going to be losing money progressively over time.

Right, its called a negative roll yield. Its is the reason leveraged and inverse ETF's only track daily returns and lose over longer periods. A true solution to this problem would catch on pretty quick.. newish products try to improve with fancier rolling methods.

2)   Possibility of front-running and gaming the trades with a tool:
If trades are reallocating their investments one a year, there may be some risk of other traders looking for the same entry points to front-run and drive up the market price.  Through data-mining and analytics the front-runners may see a pattern forming where the tool may start to show seasonality, where certain times of the year people are more prone to reallocate.  (eg. they may look at the period where the most downloads happened for the tool and see that 6-8 months later are when these people tend to reinvest)  So these front-runners will drive up the price, making it even more expensive than stated in #1. Not a doom and gloom scenario by any stretch, but its not optimal.

Longs and shorts would both be reallocating, so you can predict there will be more volume, but not necessarily the direction. That's why there's more volume at the closing call auction than during the continuous trading throughout the day (lots of reallocation), and the closing price on the spot market is often used as the settlement price for the futures contract (so it can converge efficiently as they roll). That said, other schemes for calculating the settlement price are used too, and manipulation of settlement prices definitely happens.

In another issue, prediction markets that use a currency hedge, will be confronted with poorly overlapping markets.  Prediction markets and its corresponding hedge will likely expire on different schedules/timetables.  A prediction market for the winner of the World Cup, may end before the prediction market for the Truthcoin/USD market. In this scenario, speculators are once again stuck, now in a currency market, an event they are not very interested in trading in.

I've been wondering if implicit submarket closing could somehow alleviate this. Its a tough issue; it can be waved away if we rely on arbitrageurs, but that increases transaction costs.

#b) the Unlocking Limit.  As a result, the market will be frozen to any trades.  To be able to trade within the market, a trader must offer a price that brings #c) percentage change (absolute value) lower than 3.5%.  In other words, this trader must offer a price better than $270 - $290, or else his trade won't go through.  $270 because in absolute value terms its still abs(-3.5%). 
Since everyone else will be frozen out of the market, unless they can offer a better bid/ask that will bring the absolute value %percentage change lower, in this situation the incentives are offered so that someone will be able to profit if purchased BTC at a lower price. They are guaranteed a checkpoint to cash out. If someone offers a price higher that does not bring the last transacted price %change lower, then the trade is rejected by the code. Speculators have to trade within this declining %percentage window, which gets incrementally smaller with each trade.

The person who buys at the lower price will only be able to profit if they can sell later to someone else. That's not an arbitrage opportunity, so actually there's no guarantee of a checkpoint to cash out. The person who buys at the lower price is taking on risk and betting that more speculators will come in the future (more may not come, so the window may or may not get smaller).

What drives expiring contracts to converge on the spot price is delivery arbitrage. In the non-expiring scheme you describe, there is no delivery arbitrage, and thus no real reason for the price to converge to the peg. In that aspect, it is similar to the first version of BitUSD, which relied on self-fulfilling expectations to drive the peg. The later version of the peg mechanism is based on a repurchase agreement. The repurchase agreement incentivizes sellers to come back later and place bids; without it, potential buyers would always be wondering whether or not they'll be the last buyers.