Try moving that file, and C&P mine into a new /etc/pam.d/kdm, restart runlevel 5 (telinit 3, login as root, and telinit 5), and see if that fixes it.
I am not very familiar with PAM, but mine should be secure enough for a login. The parts that I really don't understand are the pam_env.so, I think that if you looked at the common-* files, they would match up with mine pretty much.
There might be something in your log files that will help you figure out what is going on. I believe that KDM does report to syslog.