Did my cousin doing the right thing with her kids?

It is healthier than teaching them nudity is something to be ashamed of and having them develop a psycho-social sort of complex over it. A child raised as a nudist doesn't pay much attention to it. A child raised to believe nudity equals sex grows into a preoccupied easily distracted adult that is an easy marketing target. The most important criteria in a situation like the one mentioned in the question, is the attitude of the parent.