They will get stuck, and they might quit then, but from the rink's perspective, they've gotten another session enrollment before s/he left. I hate to be crass, but the reality is that the pressure will stay on the coach, or a less-strict instructor will be assigned to the next level, which seems to be what happened in the example you gave.
That's why I liked my last rink: if enough of my group lesson students re-signed, they became the core of my next group session. If they were in Basic 6, and 6 out of 8 students passed, those six (if they all signed up again) would form my Basic 7 class of the following session.
The skaters who remained behind went to a different instructor, who would move them up to my class if they mastered everything in Basic 6 by the third week. I liked that system because it put the onus on the skaters to meet the standard. Typically, the kids who didn't move up were the ones who were never at the rink except for lesson time, leaving as soon as the class was over. The process gave them a concrete goal to work towards, and any students who needed a different style of instruction were given a break from the same coach.
Another thing that helped was that the Director made the goals and standards very clear and consistent for everyone.
The program was busting at the seams, so we rarely had to combine classes.
As for parents thinking that the coaches are just being mean by not passing the kids, that could be true. I always let parents know at the halfway point when I think a skater isn't going to be able to move up by the end of the session. I have a frank discussion with both the parents and the skaters. I give clear reasons on what needs more work and why they'll probably be held back. I also explain that the element(s) are vital building blocks and it's frustrating to be stuck, but it's better to be stuck for one session building the foundation rather than being stuck for a year while trying to paint the roof, lol. Truthfully, I don't get paid enough for group lessons to take that time, but I actually do want skaters to stick it out. It's a valuable life lesson to overcome an obstacle or discouragement.