It's a fair use of isolated storage, if you're comfortable with the caveats.
The first caveat in my mind is that whatever you store in isolated storage on one machine will not be available when the user fires up your app on another machine - you lose the mobility advantage of web applications over desktop installed apps. If the user spends some time configuring their preferences, etc, they will be irritated that they have to do it all over again just because they switched to a different computer to view your web app. To solve this, you should replicate the user's customizations to cloud storage so that it can be copied down to whatever machine they choose to run your web app on. Treat the isolated storage as a performance optimization cache for data that officially lives in the cloud.
I believe Silverlight isolated storage is written to disk in the user's private data area in the file system. \users\\AppData or similar. This will keep it isolated away from other users on the same machine, but will not provide any protection from other programs running for the same user. I don't recall if Silverlight isolated storage is encrypted on disk. I highly doubt it.
A second caveat is that Silverlight isolated storage has a quota limit, and it's fairly small by default (1MB). The quota can be increased with a call to IncreaseQuotaTo(), which will prompt the end user to ok the request.
The third caveat is that if you're going to use local storage as a cache of data that lives in the cloud, you have to manage the data synchronization yourself. If the user makes changes locally, you need to push that up to the storage of authority in the cloud, and you'll have to decide when or how often to refresh the local cache from the cloud, and what to do when both have been changed at the same time (collision).
The browser cookie store is not a great metaphor for describing Silverlight isolated storage. Browser cookies for a given domain are attached to every http request that is made from the client to the server. The cookies are transmitted to the server constantly. The data in Silverlight isostorage is only accessible to the Silverlight code running on the client machine - it is never transmitted anywhere by Silverlight or the browser.
Treat Silverlight's isolated storage as a local cache of cloud data and you should be fine. Treat isostorage as a permanent storage and you'll piss off your customers because the data won't follow them everywhere they can use your web app.