I must agree with MuwuM. Levels and the unit should be impartial, since they are two separate things. With the default leveling boost, a unit gains +50% max HP, +50% max EP, +50% armor, and +20% sight. A swordman has 700 HP, 20 armor, and 10 sight. An elite swordman would have 1050 HP, 30 armor, and 12 sight. A guard has 950 HP, 40 armor, and 10 sight, inferior in all but armor, to the elite swordman (though an elite guard, needing 4 kills, would have 1425 HP, 60 armor, and 12 sight).
Not to mention the issue with morphing that is just meant to morph between forms of units (such Ishmaru mentioned).
On the issue of the actual bug report itself, yeah, the level should be correctly applied when morphing.
As for whether it should be configurable, I'm all for more modder choice, though don't see any application in current mods to change how it already keeps the killcount. After all, you could be in the army or the delta force, but personal experience in battles would persist regardless of which you have.