I've quickly checked the behavior of this feature. Just for clarification, if anyone else reads this, the collapsing of code blocks is not related to the language server feature introduced by dafny-lang/dafny#1483.
The selection of collapsible blocks is a feature that VSCode provides automatically. The range/block that will be collapsed together is solely based on the code's indentation.

For example, if the out-parameters are declared on the same level as the method signature, the arrow is displayed at the line of the return:

That is why the body has its own arrow. Collapsing now will lead to the desired result:

An alternative would be leaving the out parameters on the same line as the method keyword:

But I guess this is undesired if there are as many out parameters as in your example.

The language server may provide the folding ranges. However, I guess this needs some (extensive) user testing on how practicable it is compared to the current behavior. The symbol table can only be reliably computed if the document can be resolved. If it fails to resolve due to syntax/resolution errors, the language server relocates the symbols from the last successful resolution based on the user edits.
I will prepare a PR for further experiments.

Edit: I've experimented a little bit with the folding ranges. I've placed the folding right on the line of the last out-parameter:


But we can consider if it makes sense to set another folding indicator on the method signature as well. I have to note that we can't place a folding indicator on line X but only collapse starting from line X + 1 or any other position. The indicator will always be placed on the line where the folding starts.