The question can be extended further: What if the NPCs were smart enough to design digital systems capable of housing a game much like the one they are in? This would not be recursion in the sense of ancestors and descendants within a species, but actual recursion in the domain of speciation.
Working backward, how can we know for sure that we aren't God's RPG, and, more importantly, what difference would there be between that scenario and the ancient middle eastern conceptualization of the monotheistic creation?
The bidirectionality of this scenario was examined on the screen by writer-director David Cronenberg in his 1999 film eXistenZ, staring Jude Law, Jennifer Jason Leigh, and Ian Holm (recommended).
Regarding the sub-question, "Will this qualify them to be an AI?" that depends on two things.
- How one defines intelligence, a somewhat slippery word to define 1
- What facilities and propensities are imbued into the hardware and software that bring the NPCs to artificial life.
Regarding whether the children of the NPCs qualify as AI, definitively yes if the parents qualify and the children are adequate replicas or artificially genetic improvements.
Might this be realized in the future? That depends on a number of things.
- Will the earth avert global extinction events?
- Will humanity accidentally exterminate itself? 2
Some call all of this science fiction or Futurism. I do not. Such things are gradually developing and have been for at least the duration of my life. I've been an interested spectator in this very real drama.
 The philosophic question of whether super-human intelligence humans can't possess is a prerequisite to characterizing human intelligence is well represented in cybernetic literature reaching as far back as Charles Babbage and perhaps further in the early biochemical interests of Abu Mūsā Jābir ibn Hayyān. Defining what intelligence means is more than looking at functional MRIs or running tests in Python. If we define intelligence as the ability to collaborate, ants and even bacteria may be more intelligent than humans. If we define intelligence as the ability to efficiently construct artifices of benefit to the species, bees exceed humans. Humans can determine mathematically that hexagonal rooms are 1.7 times more efficient than square rooms in terms of construction materials, but is it intelligence that, having determined that ratio centuries ago, humans continue to waste materials on square rooms? We don't see bacteria, ants, or bees shooting narcotics either. In some respects, by some definitions of intelligence, humans would qualify as the dominant morons of all terrestrial life forms.
 "Darwin's dice have rolled badly for Earth. The human species is, in a word, an environmental abnormality. Perhaps a law of evolution is that intelligence usually extinguishes itself." — Harvard U Professor 1955 and Pulitzer Prize winner for General Nonfiction, New York Times Magazine, May 30th, 1993, Is Humanity Suicidal?