Your own assumptions are a bit flawed. As you lose weight, it is almost impossible to retain all of your lean body mass (muscle)... you'll lose some of that too. So, you don't have to worry about "lopping off a limb." (and skin fold tests are less accurate than BMI - they can be off by 2% to 10% depending on the experience of the practitioner performing the test and taking the measurements.)

BMI is a "guideline." However, I believe it is a fairly accurate guideline. About the only groups that I believe it does not pertain too are fit bodybuilders and highly trained athletes that obviously are lean and possess a lot of strength (football running backs come to mind.) For the rest of us, it's a difficult job to try and justify why it wouldn't accurately classify us into an appropriate group... morbidly obese, obese, overweight, normal, or underweight. BMI isn't the only gauge I use to assess my fitness (or lack of it) but it's still a very useful tool.