EDIT March 9 2013: Here's author Martel's explanation: island served the sole purpose of making the “animal” version of the story harder and harder to believe.
“Many readers assume it is something deeply symbolic they just don’t get, or it’s an hallucination –they need a reason to prop up the fiction.”
But in his own words “religion goes beyond the confines of the reasonable”.
my original answer:
IMHO the island represented how Pi's view of life had changed after he killed the cook:
-according to the insurance guys, there was no such island in reality, suggesting it was a symbol of something, not a real island
-Pi found the island after Richard Parker killed the hyena, which symbolizes Pi killing the cook (and shows that the ordeal at sea had changed Pi forever -- the innocence of his youth was gone)
-initially the island seems like a tranquil paradise but is eventually revealed to be a killer, just like how Pi begins the movie an innocent boy but eventually kills another human being -- and just like how as all of us get older, we inevitably see some of the darker sides of life, and even participate in some of the darkness ourselves
-after finding human teeth in a tree he is sitting in, Pi realizes that the island slowly "digested" someone who tried to stay there before -- symbolizing Pi realizing what will happen if he gets too bogged down in thinking about how he killed the cook (or about other horrors in life)
-then Pi decides that instead of staying on the island (which would represent dwelling on what he did or on life's horrors) he's going to get back on the raft and keep going (which represents moving on with his life)