I've finally found a good excuse to implement something using Silverlight 2.0 within my web product.  After spending about 3-4 hours attempting to get my Silverlight app to talk to a local web service, I found out something that hopefully will save you some time.  First a little about my environment.  I'm using IIS 7.0 on a 64 bit machine.  I have IIS setup with two sites for my Silverlight development, the first hosts my web service, the second hosts the web site containing my Silverlight application.  I have my hosts file setup as follows

127.0.0.1   webservice
127.0.0.1   website

Then in IIS I bind the the web sites to those host names.

After setting up the clientaccesspolicy.xml file in my webservice site to allow Silverlight to access I just couldn't get my Silverlight app to talk to my web service.  I tried this in both IE and Firefox with no luck.  After doing a little testing, I found it worked when I used the development web server (I think this was formally called cassini) it also seemed to work when when I used the host name "localhost".  Next I fired up fiddler and watched the network traffic.  Anytime I used cassini or local host, the clientaccesspolicy.xml was downloaded and the call to the web service succeeded.  If I tried this through my site, no request was made.

After trying a number of things I found I was able to get this working by opening the security settings within Internet Explorer

Tools->Internet Options->Security Tab, then click on Local Intranet and add my two sites.  This seemed to do the trick for both Internet Explorer and Firefox.

Hope this saves you a bit of time

-ec