This paper presents a novel method for the power transformer insulation coordination, based on the risk of failure analysis due to lightning surges, that uses its insulation strength volt– time curve and a limit–state surface formulation. The limit–state surface is derived in a novel way, from the optimal number of systematic numerical simulations of transformer terminal overvoltages—emanating from station impinging lightning surges—while accounting for the transformer insulation volt–time curve and surge arresters protective characteristics and disposition. The proposed method further employs a state-of-the-art transmission line (TL) and substation equipment models for lightning-surge transient analysis, constructed in the EMTP software package. It also uses the electrogeometric model of lightning attachment to TLs, in order to estimate the expected number of direct lightning strikes, along with a bivariate statistical distribution of lightning currents. The main aspects of the proposed method are demonstrated by means of the computational example featuring an air-insulated substation power transformer lightning insulation coordination. Simulation results exhibit many benefits of the proposed method. Sensitivity analysis further reveals different influences that the various model parameters have on the transformer insulation coordination design.