'Internal lens reflection' is 'lens flare'. It gives the game optical realism as though filmed through a camera. 'Depth based colour grading' is, I presume from the name, adjusting a pixel's colour based on the depth in the scene. When you have 3D data, you can do interesting post-processing on things like normal and distance to change hue, saturation, intensity, or whatever. In this case, you can add atmospherics based on depth, shifting the hue and darkening things. Ye Olde Fog was such an application of adjusting a pixel value by depth. I don't know the specifics of this particular KZ effect though. nAo may have something specific in mind.
Nope. As archangelmorph rightly says, the problem is more in the display. The display is made up of discrete pixels which each has a colour. Graphics are rendered as discrete pixels of separate colours to show on these displays. Jaggies appear when pixels contrast heavily. If you have a white slope against a black background, each white pixel will stand clear against the black and you'll see the stepping, whether that slop is made of 1 polygon or 1 million.
The solution is either to have such small pixels that you can't see the stepping - which probably won't occur for decades if ever, or to make sure the contrast between pixels isn't too strong. When you view a photo on a display, jaggies are hard to come by. This is because each pixel is shaded by an amount of different surfaces. On a computer rendering, each pixel is made out of 100% one surface. Thus in the white slope example, a pixel either shows the white slope or the black background. If you were photographing the slope, that pixel would have a degree of white slope in it, and a degree of background, and it's intensity will be an average. Antialiasing does this. It takes multiple samples and averages the results. A photo can have what amounts to basically 'infinite' samples in creating it's average, as it's made of photons, which gives smooth gradients. Computers have to calculate samples, and that means not so smooth gradients. 2x AA mean, in the above example, either white pixels, black pixels, or 50% grey pixels. A gradient shows two colour steps. 4x AA adds 25% and 75% intensity, with four colour steps on gradients. This is how we can determine the amount of AA in a game - find an area of jaggies, a slightly off-horizontal or off-vertical line, and see how many colour steps it has. These colour steps are of less contrast that the two original colours, but can still be visible.
Infinite AA won't fix the problem either. Photographs can still show jaggies on our displays. Car programmes are a good example, with the inside view often showing a bright outside through the window, and a jaggy window frame. Gameshows with horizontal lighting on steps are another culprit. HD will reduce these issues, but won't make them go away.
