I have the same problem with my rear brakes.

1)At what thickness should the pads be replaced?

I'm not sure what the minimum thickness should be but there are wear indicators on the outer brake pad that cause the brakes to squeak when it's time to change them. The problem arises is if the pads don't wear evenly inner to outer then you don't realize that your inner pads are much more worn on the inside.

2)When I asked the service rep why the S40 rear pads wear out so quickly, he the pads used on the rear are not as thick as the pads used on the front. Sounds like bull to me.

Yup that's BS. There is actually a service bulletin from Volvo to the dealership that informs them that there is a problem. You can ask your dealer for a copy of it. It appears that there is an issue with the interface between the brake pad and the caliper that it sits in that is causing the pads to wear prematurely in the rear. That's about all I could get out of them on what the problem was. It sounds like more of a bad design problem than anything else.

What one dealer told me on how the issue is being resolved is that there was an issue on prior S40/V40's and now they have fixed it in the car plant, but there isn't anything they can do for me other than give me replacement pads. But if they continue to wear prematurely that doesn't really help.

3) How much should it cost to replace the pads?
I don't know how much the labor is to change pads, but if you do them yourself you can buy the pads from the dealership for I believe ~$30. That's what I did.

What to do about this??? I'm not sure I've also contacted Volvo customer service and they really weren't any help. They basically supported the dealerships. If you happen to get in touch with someone that is of more help please let me know via this message board.