Here is the same object, same image map but now connected to the Mesh Displacer on the Mesh Modifier tab of the imported object.
No need to change the Render Method now. Leave at "Default".
The shadows are correct and reflect the displacement.
Object and map have to be very high res or it looks like this.
Remember that you must disconnect and reconnect the Image Shader from the Object again and again after making changes
in the Image Map Shader. Terragen still cannot read those changes and display in the 3D Preview.
If you forget that you might think your setup is not working.
CHeers, Klaus