"...described the sensor as possibly being damaged by hitting this cage thingy inside the diff..."

Unlikely. If the sensor hits the vane, the vane gets trashed. I helped rebuild a 740 diff where exactly this happened (due to a misadjusted sensor). We cleaned out the metal chips (and it had a ton...), removed the cluster, disassembled and installed a new vane, and buttoned it up. Setting the sensor depth is a minor chore.

That car now has about 3 years and 70,000 miles on the repair without further incident and no noise.

Check your rear end oil for metal flakes. A magnet will easily grab them.

"...due to the diff moving slighlty from side to side..."

Nahhhh.... Stuff doesn't move around that much. And if it does, you have more serious problems than the speedo.

"...have someone put the sensor in with max shim space & gradually move it in until the speedo is observed working..."

Your mechanic should get the depth specs (and shims) from your local, friendly, helpful dealer. You'll need long feeler gauges for proper depth adjustment, and they're inserted through the filler plug hole.

If he strikes out, I can dig through my stuff and find the numbers.

"...sensor be able to pick up the signals from a greater distance than what the specs call for?"

Probably. Some margin of error is always factored into specs. But beyond a foot or two, it's hopeless.

"...strange that Volvo would put the speed sensor inside the diff with all that goes on in there..."

Perhaps. Personally, I think it's pretty good engineering. This electronic design has no moving parts, and counts wheel revs directly (= vehicle speed) regardless of rear end ratio or tranny type. Overall, the electronic speedo is probably less troublesome than the mechanical design — and probably cheaper, too (one size fits all).

Hopefully your mechanic has confirmed that the wiring and connectors are intact (connector at sensor can get very grungy). Is he sure it's not the speedometer head?