I have search the forum, but did not come across this problem, wonder if anyone can give me clues to how to start troubleshooting it.
'99 VehiCross with 3.5L, 4L30 and manual hubs installed by previous owner that i keep in 4x4 position at all times, started exhibiting this behavior several months ago:
In 4H TOD light behaves as expected displaying 0/3 - 3/3 of the front wheel lights and "AUTO" in the mid section. The car does feel like the actual wheels are engaging accordingly. Came in really handy on show/ice road last weekend.
In 4L the indicator is expected to show 3/3 front wheel indicators and "Auto" in the mid section is expected to go away. And this neither does happen. TOD indicator shows "Auto" AND 1/3 - 3/3 of the front wheel lights, which does not make sense as the car is obviously in the 4L mode.
Around the same time as the problem started my mechanic switched manual hubs to 2x4 position when replacing torn CV Boots (is it possible to damage sensors while at it?) and i did drive 50-100 miles like that (could this damage sensors?). Recently (after the problem was originally discovered) I replaced the 4L30 transmission with a brand new one which did not have any effect on the problem. It seems like ISUZU dealers in the Bay area are all gone and I am looking for any advice that may help me figure out a fix.

The only thought I have is wondering if all the electrical connections for the t-case are good. It can't hurt to dive under there and check all the connectors and wiring from the tranny and t-case.