. . .wait, there's an illusionist in your tower? Where? The tower's not that big, and I'm pretty sure I talked to everyone. I know there's a musician and dancer on the throne dais, there's the 3 runners by the door, there's Sassan in the master suite. Alchemist in the alchemy garden, trainer in the arena, necromancer and limb vendor in the summoning circle, and the enchanter in the workshop (and his wife if you happen to choose Wesson).
As for NPC's. . . I kind of wondered if the guy in High Hall who thinks he's a goblin might actually be one, who was 'transformed' by an illusionist (or actually changed by some other magic)?
As for the person who wondered about people recognizing you after changing your appearance. . . it seems throughout the story that many characters can sense a dragon aura about you. . . Rhode sees it outside the Maxos temple, presumably powerful wizards like Zalandor can. We know that the gypsy in broken valley knows, and ZixZax the Almost Wise could tell.
So, if you change your appearance, but the character can see your aura, then it makes sense they'd know you. . . there's only one dragon knight left, after all.