There is no need to cluster IIS. Using load balancing should provide what you need. Load Balancing provides a single IP address for both servers. If one server goes down then the other server will take over all processing. This is done by the load balancing device or NLB way before you get to Biztalk. By removing one server from the load balancing you should not get 404 errors as all traffic should be redirected to the operating server.
The isolated host instances will publish messages to the MessageBoxDb. Any In-Process host instance on any server can process that message.
By removing Server1 from the load balancing should redirect all traffic to Server2, but the in-process host instances on Server1 will continue to process messages. By stopping the host instances on Server1 will mean only the in-process host instances on Server2 will be processing messages.
What type of load balancing are you using? NLB or hardware device?