What is the grammatical error in the following sentence: "That, in itself, can be a shock"?The MS Word grammar check says it should be 'it' instead...

The sentence that you present for revision: "That, in
itself, can be a shock" has no grammatical errors. The problem with MS Word is that it
sometimes attempts to fix grammar mistakes based on specific contexts under which it is
programmed. This being said, do not trust a self-correcting computer program 100%. The
margin of error is always there.

If you were to write
"That, in it, can be a shock" it would take the sentence out of context because it would
be referring to something inside something else that "can be a
shock". Yet, it is understood that what the sentence meant to say was that the subject
of the sentence which is referred to with the demonstrative adjective "that" is indeed
what "can be a shock".

So, keep rolling. You are doing
well! Read the article included in this answer so you can see how grammar checkers
aren't always reliable.