The vehicle was designed to be used off road. If you don't engage the low range every so often it has a tendency to freeze up. As long as you can disengage the system (the light goes off) it should be safe to drive just fine.

Try excercising the sytem a few times by engaging and disengaging the low range. This often frees up the components. You can then keep the system in working order by shifting to low range at least every 3 months. Properly exercised the transfer case should engage very smoothly.

You have changed the transfer case fluid, haven't you? As well as the transmission fluid while you are at it?