Implementation of the smart transformer concept is critical for the deployment of IIoT-based smart grids. Top manufacturers of power electrics develop and adopt online monitoring systems. Such systems become part of high-voltage grid and unit transformers. However, furnace transformers are a broad category that this change does not affect yet. At the same time, adoption of diagnostic systems for furnace transformers is relevant because they are a heavy-duty application with no redundancy. Creating any such system requires a well-founded mathematical analysis of the facility’s condition, carefully selected diagnostic parameters, and setpoints thereof, which serve as the condition categories. The goal hereof was to create an expert system to detect insulation breach and its expansion as well as to evaluate the risk it poses to the system; the core mechanism is mathematical processing of trends in partial discharge (PD). We ran tests on a 26-MVA transformer installed on a ladle furnace at a steelworks facility. The transformer is equipped with a versatile condition monitoring system that continually measures apparent charge and PD intensity. The objective is to identify the condition of the transformer and label it with one of the generally recognized categories: Normal, Poor, Critical. The contribution of this paper consists of the first ever validation of a single generalized metric that describes the condition of transformer insulation based on the online monitoring of the PD parameters. Fuzzy logic algorithms are used in mathematical processing. The proposal is to generalize the set of diagnostic variables to a single deterministic parameter: insulation state indicator. The paper provides an example of calculating it from the apparent charge and PD power readings. To measure the indicativeness of individual parameters for predicting further development of a defect, the authors developed a method for testing the diagnostic sensitivity of these parameters to changes in the condition. The method was tested using trends in readings sampled whilst the status was degrading from Normal to Critical. The paper also shows a practical example of defect localization. The recommendation is to broadly use the method in expert systems for high-voltage equipment monitoring.