A condition based failure rate estimation method for transformer internal latent fault analysis is proposed. The method is used to develop time-varying transformer outage model for operational risk assessment purpose. Firstly， the operating mechanism in developing process of transformer internal latent fault is analyzed， and some comments are given on the existing aging models of transformer internal insulation. Then， dissolved gas analysis（DGA） outcome is used as an indicator to classify transformer's operating condition. The multi-state Markov process based mathematical estimation model is proposed to estimate the failure rate. Finally， a numerical test is presented.