The Heading n style family is a bit special. It is not made of "ordinary" paragraph styles. Internally LO Writer knows they are intended for outline headings. Note you can define your own paragraph styles to participate in outline numbering, but those are offered "out-of-the-box" for this purpose, without the need of defining ones.
Since they are a bit special, as mentioned above, LO Writer forbids to create a mess through the style settings. This explains why the Outline level is grayed out. The special aspect of the family is managed through Tools>Outline Numbering (or Chapter Numbering in recent versions) as a whole, i.e. you also set the relationship between levels here (mainly the number of components and the style of these in the numbering). Doing so in this specialised dialog avoids having to fiddle with the individual styles of the family, which is really inconvenient and not user-friendly if you revamp your numbering.
You have to go through this pain if you add your own outline styles, for example if you need different sequences like numbers for main text chapters and letters for appendices. But this is advance Writer use and I don't think you're presently ready for that.
As Writer is released, Heading 1 is intended for chapters (as @floris v remarked) with the rest of the family for deeper headers (sub-chapters, sections, ...). One reason I could see for Heading 2 as chapter style would be using Heading 1 for a more global structure than chapter, like "Book" in a complex document about various semi-independent topics. It would call for particular numbering structure but it is perfectly legitimate. All Heading n are collected to build the TOC and the layout for the levels in the TOC are controlled by Contents n style family. Thus Content 1 can be configured to center the heading of Heading 1 if it relates to a book and all other Content n left aligned for chapters and sections (Heading n n>1).
In your case, don't mix document structure and appearance. Follow a strict organisation of ideas, topics or subjects giving the headings the correct Heading n: all Heading 2 are sub-parts of the preceding Heading 1, the same for 3 vs. 2, etc. If you want all headings look the same, edit the various paragraph styles so that they have the same characteristics. This way, if your reviewers ask for differentiation, you don't need to restyle your headings, you only change the paragraph styles. It is fast, convenient and versatile.
A last remark: Heading n as built-in are not that great, yes, but provide a fair first step towards nice looking document, kind of trade-off between the diverging expectations of all LO users. Obtaining a breath-cutting look is a matter of style optimisation requiring artistic skills and this is usually not compatible with hot deadlines.
EDIT 2018-08-26 to answer questions in comment below
You don't assign styles in Tools>Outline Numbering/Chapter Numbering because ... (more)
