
Wait until you die in SaGa 2 first, then you'll get to rebuild your party.
To upgrade your skills in SaGa 2, you have to use them. So to increae your hit points, get hit a bunch. To increase your attack, use a weapon a lot. To beef up your magic, use a lot of spells. That's also how FF2 worked, and both games were directed by the game guy as well.
The way formations work is that anyone in the front has strong attacks, but they get hit harder and more often. Players in the back have more defense, but less offense. It affects their speed and other stats as well.