Isos are essentially digital versions of the disks, used to back up your disks in a digital format. ROMs if you will. And as we all know, sharing and downloading ROMs is called piracy. In your case, as you use UMD disks, you bought your games or got them from a friend or what not, so you need not worry about being called a pirate.
This explanation is misleading at best. ISO images aren't necessarily used to back up discs, and they're not necessarily illegal. Many Linux distributions are distributed in ISO format, and while ISOs can be burned to a CD, they can also be mounted for other purposes. Microsoft distributes a lot of their stuff on the MSDN in ISO format; I just downloaded Access for my Database course and that was an ISO image. I mounted it using Daemon Tools and installed, easy as cake.
So theoretically, you could have some legal use for an ISO image. However, when you're discussing the PSP and ISO images in the same sentence, you tend to be talking about piracy. That's not always the case, though.