<PAGE>   1


                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                        
                                   FORM 10-Q

(Mark One)

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 1998

                                       OR

[ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934

For the transition period from ______________________ to _______________________

                         Commission File Number: 0-19594

                          INSURANCE AUTO AUCTIONS, INC.
                          -----------------------------
             (Exact name of registrant as specified in its charter)

Illinois                                            95-3790111
--------------------------------------------------------------------------------
(State or other jurisdiction              (I.R.S. Employer Identification No.)
of incorporation or organization)            

850 East Algonquin Road, Suite 100, Schaumburg, Illinois              60173-3855
--------------------------------------------------------------------------------
(Address of principal executive offices)                              (Zip Code)
                  

                                 (847) 839-3939
--------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)


         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
                                                    |X|  Yes        | | No


                      APPLICABLE ONLY TO CORPORATE ISSUERS

Number of shares outstanding of each of the issuer's classes of common stock, as
of June 30, 1998:

               Class                              Outstanding June 30, 1998
               -----                              -------------------------

    Common Stock, $0.001 Par Value                    11,314,604 shares


<PAGE>   2


                                                     
                                      INDEX

                          INSURANCE AUTO AUCTIONS, INC.
<TABLE>

<CAPTION>
                                                                                               PAGE NUMBER
                                                                                               -----------

<S>                                                                                               <C>
PART I.  FINANCIAL INFORMATION..............................................................      3

Item 1.  Financial Statements (Unaudited)...................................................      3

         Condensed Consolidated Balance Sheets
              as of June 30, 1998 and December 31, 1997.....................................      3
         Condensed Consolidated Statements of Operations for the
              Three Month and Six Month Periods ended June 30, 1998 and June 30, 1997.......      4
         Condensed Consolidated Statements of Cash Flows for the
              Six Month Periods ended June 30, 1998 and June 30, 1997.......................      5
         Notes to Condensed Consolidated Financial Statements...............................      6

Item 2.  Management's Discussion and Analysis of Financial Condition
              and Results of Operations.....................................................      7


Item 3.  Quantitative and Qualitative Disclosures about Market Risk.........................     14


PART II.  OTHER INFORMATION.................................................................     14

Item 1.  Legal Proceedings..................................................................     14

Item 2.  Changes in Securities..............................................................     14

Item 3.  Defaults upon Senior Securities....................................................     14

Item 4.  Submission of Matters to a Vote of Security Holders................................     14

Item 5.  Other Information..................................................................     15

Item 6.  Exhibits and Reports on Form 8-K...................................................     15

SIGNATURES        ..........................................................................     16

</TABLE>
                                       2

<PAGE>   3



                          INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                               June 30,     December 31,
                                                                1998            1997
                                                                ----            ----
                                                            (Unaudited)
<S>                                                           <C>          <C>         
ASSETS

Current assets:
     Cash and cash equivalents                              $ 12,213,000   $  9,634,000
     Accounts receivable, net                                 31,873,000     28,992,000
     Inventories                                              13,515,000     11,762,000
     Other current assets                                      1,455,000      1,868,000
                                                            ------------   ------------
         Total current assets                                 59,056,000     52,256,000
                                                            ------------   ------------

Property and equipment, at cost, net                          21,335,000     20,778,000

Deferred income taxes                                          2,603,000      2,603,000

Other assets, principally goodwill, net                      130,803,000    131,435,000
                                                            ------------   ------------

                                                            $213,797,000   $207,072,000
                                                            ============   ============

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
     Current installments of long-term debt                 $    201,000   $  2,034,000
     Accounts payable                                         20,380,000     16,319,000
     Accrued liabilities                                       7,479,000      7,698,000
     Income taxes                                              1,878,000        497,000
                                                            ------------   ------------
         Total current liabilities                            29,938,000     26,548,000
                                                            ------------   ------------

Long-term debt, excluding current installments                20,190,000     20,246,000
Accumulated postretirement benefit obligation                  3,656,000      3,831,000
Deferred income taxes                                          5,235,000      5,235,000
                                                            ------------   ------------

         Total liabilities                                    59,019,000     55,860,000
                                                            ------------   ------------

Shareholders' equity:
Preferred stock, par value of $.001 per share 
     Authorized 5,000,000 shares; none issued                       --             --
Common stock, par value of $.001 per share
     Authorized 20,000,000 shares; issued and outstanding
     11,314,604 and 11,299,561 shares as of June 30,
     1998 and December 31, 1997, respectively                     11,000         11,000
Additional paid-in capital                                   132,009,000    131,809,000
Retained earnings                                             22,758,000     19,392,000
                                                            ------------   ------------

         Total shareholders' equity                          154,778,000    151,212,000
                                                            ------------   ------------

                                                            $213,797,000   $207,072,000
                                                            ============   ============
</TABLE>
See accompanying notes to condensed consolidated financial statements

                                       3


<PAGE>   4



                          INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>

                                                    Three Month Periods               Six Month Periods
                                                       Ended June 30,                    Ended June 30,
                                                       --------------                    --------------
                                                        (Unaudited)                       (Unaudited)

                                                  1998            1997              1998             1997
                                                  ----            ----              ----             ----
<S>                                           <C>              <C>              <C>              <C>     
Net Sales:
     Vehicle sales                            $  51,894,000    $  44,990,000    $  99,063,000    $  90,146,000
     Fee income                                  23,506,000       20,988,000       44,895,000       43,717,000
                                              -------------    -------------    -------------    -------------
                                                 75,400,000       65,978,000      143,958,000      133,863,000
Cost and expenses:
     Cost of sales                               56,375,000       49,682,000      108,466,000      103,736,000
     Direct operating expenses                   13,132,000       11,506,000       25,129,000       22,879,000
     Amortization of acquisition costs              954,000          945,000        1,898,000        1,895,000
     Special charges                                   --            750,000        1,564,000          750,000
                                              -------------    -------------    -------------    -------------

         Earnings from operations                 4,939,000        3,095,000        6,901,000        4,603,000

Other (income)expense:
     Interest expense                               537,000          669,000        1,064,000        1,405,000
     Interest (income)                             (222,000)        (241,000)        (396,000)        (399,000)
                                              -------------    -------------    -------------    -------------

         Earnings before income taxes             4,624,000        2,667,000        6,233,000        3,597,000

Income taxes                                      2,127,000        1,147,000        2,867,000        1,547,000
                                              -------------    -------------    -------------    -------------

         Net earnings                         $   2,497,000    $   1,520,000    $   3,366,000    $   2,050,000
                                              =============    =============    =============    =============

Earnings per share:
     Basic                                    $         .22    $         .13    $         .30    $         .18
                                              =============    =============    =============    =============
     Diluted                                  $         .22    $         .13    $         .30    $         .18
                                              =============    =============    =============    =============

Weighted average shares outstanding
     Basic                                       11,312,000       11,291,000       11,309,000       11,290,000
                                              =============    =============    =============    =============
     Diluted                                     11,459,000       11,299,000       11,409,000       11,306,000
                                              =============    =============    =============    =============
</TABLE>

See accompanying notes to condensed consolidated financial statements 


                                       4


<PAGE>   5


                          INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<CAPTION>

                                                                                      Six Month Periods
                                                                                        Ended June 30,
                                                                                        --------------
                                                                                    1998            1997
                                                                                ------------    ------------
<S>                                                                             <C>             <C>        
Cash flows from operating activities:
Net earnings                                                                    $  3,366,000    $  2,050,000
Adjustments to reconcile net earnings to net cash
   provided by operating activities:
     Depreciation and amortization                                                 4,292,000       3,947,000
     Loss on disposal of fixed assets                                                 59,000            --
     Change in assets and liabilities (net of effects of acquired companies):
     (Increase) decrease in:
       Accounts receivable, net                                                   (2,443,000)      4,775,000
       Inventories                                                                (1,753,000)       (597,000)
       Other current assets                                                          413,000       1,588,000
       Other assets                                                                   54,000        (137,000)
     Increase (decrease) in:
       Accounts payable                                                            4,061,000         455,000
       Accrued liabilities                                                          (371,000)       (477,000)
       Income taxes payable                                                        1,381,000         503,000
                                                                                ------------    ------------
         Total adjustments                                                         5,693,000      10,057,000
                                                                                ------------    ------------

     Net cash provided by operating activities                                     9,059,000      12,107,000
                                                                                ------------    ------------

Cash flows from investing activities:
   Capital expenditures                                                           (2,810,000)     (1,572,000)
   Payments made in connection with acquired companies,
      net of cash acquired                                                        (1,806,000)       (132,000)
                                                                                ------------    ------------

      Net cash used in investing activities                                       (4,616,000)     (1,704,000)
                                                                                ------------    ------------

Cash flows from financing activities:
   Proceeds from issuance of common stock                                            200,000          67,000
   Principal payments of long-term debt                                           (2,064,000)     (7,084,000)
                                                                                ------------    ------------

Net cash used in financing activities                                             (1,864,000)     (7,017,000)
                                                                                ------------    ------------

Net increase in cash                                                               2,579,000       3,386,000

Cash and cash equivalents at beginning of period                                   9,634,000       5,888,000
                                                                                ------------    ------------

Cash and cash equivalents at end of period                                      $ 12,213,000    $  9,274,000
                                                                                ============    ============

Supplemental disclosures of cash flow information: 
   Cash paid during the year for:
     Interest                                                                   $    929,000    $  3,150,000
                                                                                ============    ============
     Income taxes                                                               $  1,487,000    $  1,043,000
                                                                                ============    ============
</TABLE>

See accompanying notes to condensed consolidated financial statements.


                                       5


<PAGE>   6


                          INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

1.     GENERAL


       The unaudited condensed consolidated financial statements of Insurance
       Auto Auctions, Inc. and its subsidiaries (collectively, the "Company")
       have been prepared on the same basis as the audited consolidated
       financial statements and, in the opinion of the Company, reflect all
       adjustments (consisting of normal recurring adjustments) necessary for a
       fair presentation for each of the periods presented. The results of
       operations for interim periods are not necessarily indicative of results
       for full fiscal years.

       As contemplated by the Securities and Exchange Commission ("SEC") under
       Rule 10-01 of Regulation S-X, the accompanying consolidated financial
       statements and related notes have been condensed and do not contain
       certain information that will be included in the Company's annual
       consolidated financial statements and notes thereto. For further
       information, refer to the consolidated financial statements and notes
       thereto included in the Company's annual report on Form 10-K for the year
       ended December 31, 1997

2.     INCOME TAXES

       Income taxes were computed using the effective tax rate estimated to be
       applicable for the full fiscal year, which is subject to ongoing review
       and evaluation by the Company.


3.     NET EARNINGS PER SHARE

       Reconciliations of the numerators and denominators of the basic and
       diluted earnings per share computations for the three months and six
       months ended June 30, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>


                                         Three Month Period Ended June 30,1998              Three Month Period Ended June 30,1997
                                         -------------------------------------              -------------------------------------
                                                                      Per Share                                         Per Share
                                       Earnings         Shares          Amount           Earnings       Shares           Amount
                                       --------         ------          ------           --------       ------           -------

<S>                                   <C>             <C>              <C>               <C>             <C>             <C>
Basic Earnings per Share
     Net earnings                     $2,497,000      11,312,000       $   0.22          $1,520,000      11,291,000      $   0.13
                                                                       ========                                          ========
Effect of Dilutive Securities                                                   
     Stock options                           --          147,000             --                  --           8,000            --
                                      -----------------------------------------          ----------------------------------------
Diluted Earnings per Share                                                      
     Income available to                                                        
     common stockholders plus                                                   
     assumed conversions              $2,497,000      11,459,000       $   0.22          $1,520,000      11,299,000      $   0.13
                                      =========================================          ========================================
                                                                                
<CAPTION>                                                                       
                                                                                
                                          Six Month Period Ended June 30,1998                Six Month Period Ended June 30,1997
                                          -----------------------------------                -----------------------------------
                                                                      Per Share                                         Per Share
                                       Earnings         Shares          Amount           Earnings         Shares          Amount 
Basic Earnings per Share               --------         ------          ------           --------         ------          ------
     Net earnings                     $3,366,000      11,309,000       $   0.30          $2,050,000     11,290,000        $  0.18
                                                                      =========                                           =======
                                                                                
Effect of Dilutive Securities                                                   
     Stock options                            --         100,000             --                  --         16,000             --
                                      -----------------------------------------          ----------------------------------------
Diluted Earnings per Share                                                      
     Income available to                                                        
     common stockholders plus                                                   
     assumed conversions              $3,366,000      11,409,000         $ 0.30          $2,050,000     11,306,000        $  0.18
                                      =========================================          ========================================
</TABLE>



4.     COMPREHENSIVE INCOME


       In June 1997, the Financial Accounting Standards Board issued Statement
       of Financial Accounting Standards No. 130, "Reporting Comprehensive
       Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and
       display of comprehensive income and its components in a full set of
       general-purpose financial statements. SFAS 130 is effective for financial
       statements for fiscal years beginning after December 15, 1997 and was
       adopted by the Company in the three months ended March 31, 1998. Adoption
       of SFAS 130 did not have a material impact on the Company's consolidated
       financial position, results of operations, or liquidity.


5.      SPECIAL CHARGES


       During the first quarter of 1998, a settlement agreement was entered into
       by the Company resolving all outstanding differences between Insurance
       Auto Auctions, Inc. and Bradley Scott, who has resigned as a director and
       Chairman of the Board. In the settlement agreement, various agreements
       were terminated (including agreements providing for compensation and
       certain benefits through June 30, 1999, and all outstanding stock
       options). Per the settlement agreement, the Company made a lump-sum
       payment of $700,000 to Scott. This included a bonus payment for 1997 of
       $126,000 pursuant to a 1996 agreement between the Company and Scott. The
       difference of $574,000 was



                                       6
<PAGE>   7




        recorded as a special charge in first quarter 1998. In addition,
        McKinsey & Co. had been retained to assist the Company in identifying
        and developing additional customer-valued services, focusing on
        opportunities to add value to the insurance industry's automobile claims
        process and reduce costs for these organizations. The scope of the work
        completed also included the evaluation and development of new business
        offerings that leverage the company's current competencies, geographic
        presence and assets. The cost of the project of $990,000 was recorded as
        a special charge in first quarter 1998.

        During the second quarter of 1997, the Company settled a securities
        class action lawsuit that had been pending against the Company and
        certain of its present and former officers and directors, in the United
        States District Court for the Central District of California. The
        litigation was settled for $3.75 million, the substantial portion of
        which was paid by the Company's directors' and officers' liability
        insurance company. The difference of $750,000 was recognized as a
        special charge to earnings in the second quarter of 1997. In February
        1998, the settlement was approved by the court.




ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS.

The discussion in this section contains forward-looking information that is
subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected, expressed or implied by such
forward looking information. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in "Factors
That May Affect Future Results" below. Among these risks are quality and
quantity of inventory available from suppliers, competition, dependence on key
insurance company suppliers, governmental regulation, weather conditions and
market value of salvage.


OVERVIEW

              The Company offers insurance companies and other vehicle suppliers
cost-effective salvage processing solutions through a variety of different
methods of sale, including fixed fee consignment, purchase agreement and
percentage of sale consignment. Under the purchase agreement sales method, the
vehicle is owned by the Company and the sales price of the vehicle is recorded
in revenue. Under the fixed fee and percentage of sale consignment sales
methods, the vehicle is not owned by the Company and only the fees associated
with the processing and sale of the vehicle are recorded in net sales. By
assuming some of the risk inherent in owning the salvage vehicle instead of
selling on a consignment basis, the Company is potentially able to increase
profits by improving the value of the salvage vehicle prior to the sale.


              Under the purchase agreement method, IAA generally pays the
insurance company a pre-determined percentage of the Actual Cash Value ("ACV")
to purchase the vehicle, pursuant to a purchase agreement. ACV's are the
estimated pre-accident fair value of a vehicle, adjusted for additional
equipment, mileage and other factors. Because the Company's purchase price is
fixed by contract, changes in ACV's or in the market or auction prices for
salvage vehicles have an impact on the profitability of the sale of vehicles
under the purchase agreement method. However, if increases in used car prices
and ACV's are not associated with a corresponding increase in prices at salvage
auctions, there can be a negative impact on the profitability of purchase
agreement sales.


              The Company has adjustment and risk-sharing clauses in its
standard purchase agreement contracts designed to provide some protection to the
Company and its customers from certain unexpected, significant changes in the
ACV/salvage price relationship. The Company has renegotiated or terminated all
significant purchase agreement contracts not conforming to the Company's
standards for this type of agreement, converting customers to either a fixed fee
consignment or percent of sale consignment contract



                                       7
<PAGE>   8



whenever possible. However, the Company continues to offer purchase agreements
to those customers who select it.

              Since its initial public offering, the Company has grown primarily
through a series of acquisitions to now include 48 locations as of June 30,
1998. In February of 1998, the Company acquired Auto Disposal Company. ADC
operated two pools in Alabama.

              The Company's operating results are subject to fluctuations,
including quarterly fluctuations, that can result from a number of factors, some
of which are more significant for sales under the purchase agreement method. See
"Factors That May Affect Future Results" below for a further discussion of some
of the factors that affect or could affect the Company's business, operating
results and financial condition.


RESULTS OF OPERATIONS

Three Months Ended June 30, 1998 Compared to the Three Months Ended June 30,
1997

              Net sales of the Company increased to $75,400,000 for the three
months ended June 30, 1998, from $65,978,000 for the same three month period in
1997. Unit volume increased 2%, compared to the same period in 1997. The
relatively flat volumes are the result of fewer units being available for sale
as compared to the prior period. This was due to the Company's decision in 1997
to terminate specific, unprofitable purchase agreements and the comparatively
mild winter in many parts of the Country, resulting in fewer "total loss"
accidents. The purchase agreement sales method of processing accounted for 31%
of total volume, compared with 30% for the same period in 1997.

              Gross profit increased 17% to $19,025,000 for the three months
ended June 30, 1998, from $16,296,000 for the same period in 1997. Gross profit
per unit of $165 for the three months ended June 30, 1998 was 15% higher than
for the comparable period of 1997. The increase in gross profit is the result of
historically strong seasonal margins, the Company's decision to renegotiate or
terminate specific, unprofitable purchase agreements and the Company's focus on
increasing profitability by insuring its services are properly valued in the
market place.

              Direct operating expenses increased to $13,132,000 for the three
months ended June 30, 1998, from $11,506,000 for the same period in 1997. Direct
operating expenses per unit increased to $114 for the three months ended June
30, 1998, as compared to $102 for the same period in 1997. The increase reflects
the funding commitment made by the Company to identify, develop and pilot new
services that would streamline the automobile claims process and greatly reduce
costs for insurance companies as well as a general increase in operating
expenses.

              Amortization of acquisition costs increased to $954,000 for the
three months ended June 30, 1998 from $945,000 for the comparable period in
1997. The increase was due to the acquisition of Auto Disposal Company in
February 1998.

              Interest expense decreased to $537,000 for the three months ended
June 30, 1998, from $669,000 for the same period in 1997. The change in interest
expense was attributable to a decrease in long-term debt as a result of the
Company's repayment of several notes payable to sellers related to certain
acquisitions. Interest income decreased to $222,000 for the three month period
ended June 30, 1998, from $ 241,000 for the comparable period in 1997.

                Income taxes increased to $2,127,000 for the three months ended
June 30, 1998, from $1,147,000 for the comparable period in 1997. This increase
is the result of the increase in earnings and an increase in the Company's
effective tax rate. The Company's effective tax rate for the three months ended
June 30, 1998 was 46%. The effective tax rate is subject to ongoing review and
evaluation by the Company.



                                       8
<PAGE>   9



              The Company's net earnings were $2,497,000 for the three months
ended June 30, 1998, a 64% increase from $1,520,000 for the comparable period in
1997. This was also a 28% increase from $1,948,000, excluding special charges
for the comparable period in 1997.


 Six Months Ended June 30, 1998 Compared to the Six Months Ended June 30, 1997

              Net sales of the Company increased to $143,958,000 for the six
months ended June 30, 1998, from $133,863,000 for the same six month period in
1997, an 8% increase. Unit volume for the six months ended June 30, 1998, was
230,000, as compared to 231,000 for the same period in 1997. The relatively flat
volumes are the result of fewer units being available for sale as compared to
the prior period. This was due to the Company's decision in 1997 to terminate
specific, unprofitable purchase agreements and the comparatively mild winter in
many parts of the Country, resulting in fewer "total loss" accidents. The
purchase agreement sales method of processing accounted for 30% of total volume,
compared with 31% for the same period in 1997.


              Gross profit increased to $35,492,000 for the six months ended
June 30, 1998, from $30,127,000 for the same period in 1997, an 18% increase.
Gross profit per unit of $154 for the six months ended June 30, 1998 was 18%
higher than for the comparable period of 1997.

              Direct operating expenses increased to $25,129,000 for the six
months ended June 30, 1998, from $22,879,000 in 1997, a 10% increase. The
increase reflects the funding commitment made by the Company to identify,
develop and pilot new services that would streamline the automobile claims
process and greatly reduce costs for insurance companies as well as a general
increase in operating expenses.


              Amortization of acquisition costs increased slightly to $1,898,000
for the six month period ended June 30, 1998 from $1,895,000 for the comparable
period in 1997.


               During the first quarter of 1998, a settlement agreement was
entered into by the Company resolving all outstanding differences between
Insurance Auto Auctions, Inc. and Bradley Scott, who has resigned as a director
and Chairman of the Board. In the settlement agreement, various agreements were
terminated (including agreements providing for compensation and certain benefits
through June 30, 1999, and all outstanding stock options). Per the settlement
agreement, the Company made a lump-sum payment of $700,000 to Scott. This
included a bonus payment for 1997 of $126,000 pursuant to a 1996 agreement
between the Company and Scott. The difference of $574,000 was recorded as a
special charge in first quarter 1998.

              McKinsey & Co. had been retained to assist the Company in
identifying and developing additional customer-valued services, focusing on
opportunities to add value to the insurance industry's automobile claims process
and reduce costs for these organizations. The scope of the work completed also
included the evaluation and development of new business offerings that leverage
the company's current competencies, geographic presence and assets. The cost of
the project of $990,000 was recorded as a special charge in first quarter 1998.

              Interest expense decreased to $1,064,000 for the six months ended
June 30, 1998, from $1,405,000 for the same period in 1997. The change in
interest expense was mostly attributable to a decrease in long-term debt as a
result of the Company's repayment of the proceeds from long term borrowings
under the Company's $15,000,000 Revolving Line of Credit Facility and several
notes payable to sellers related to certain acquisitions and the reclassfication
of bank charges from interest expense to direct operating expenses.

              Interest income was $396,000 for the six month period ended June
30, 1998, versus $399,000 for the comparable period in 1997.



                                       9
<PAGE>   10


              Income taxes increased to $2,867,000 for the six months ended June
30, 1998, from $1,547,000 for the comparable period in 1997. This increase is
the result of the increase in earnings and a higher estimated effective tax
rate. The Company's effective tax rate for the six months ended June 30, 1998
was 46%. The effective tax rate is subject to ongoing review and evaluation by
Management.

              The Company's net earnings were $3,366,000 for the six months
ended June 30, 1997, a 64% increase from the comparable period in 1997 of
$2,050,000. Net earnings per common share increased to 30 cents per share in
1998 versus 18 cents per share in 1997. Net earnings excluding the special
charge were $4,211,000, or 37 cents per share, for the first six months of 1998.


FINANCIAL CONDITION AND LIQUIDITY


              At June 30, 1998, the Company had current assets of $59,056,000,
including $12,213,000 of cash and cash equivalents and current liabilities of
$29,938,000. The Company had working capital of $29,118,000 at June 30, 1998, a
$3,410,000 increase from December 31, 1997.

              At June 30, 1998, the Company's indebtedness consisted mostly of
8.6% Senior Notes approximating $20,000,000. There were no borrowings
outstanding on the Revolving Line of Credit Facility at June 30, 1998.

              Capital expenditures were approximately $2,810,000 for the six
months ended June 30, 1998. These capital expenditures primarily included
upgrading and expanding the Company's management information system and the
Company's facilities. The Company currently leases most of its facilities and
other properties.

              The Company believes that cash generated from operations and its
borrowing capacity will be sufficient to fund capital expenditures and provide
adequate working capital for operations for the next twelve months. Part of the
Company's plan is continued growth possibly through new facility start-ups,
acquisitions, and the development of new claims processing services. At some
time in the future, the Company may require additional financing. There can be
no assurance that additional financing, if required, will be available on
favorable terms.

              The Company's operating results have not historically been
materially affected by inflation.


RECENT DEVELOPMENTS


              Statement of Financial Accounting Standards ("S.F.A.S.") No. 131,
"Disclosures about Segments of an Enterprise and Related Information", was
issued in June 1997 and is effective for fiscal years beginning after December
15, 1997. S.F.A.S. NO. 131 establishes new standards for disclosing information
about operating segments. Adoption of this statement did not have a material
impact on the Company's financial position, results of operations, or liquidity.

         In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Others
Postretirement Benefits" "(SFAS 132)" which amends the disclosure requirements
of Statements No. 87, "Employers' Accounting for Pensions", No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits", and No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." SFAS 132 is effective for fiscal
years beginning after December 15, 1997. Adoption of this statement did not have
a material impact on the Company's financial position, results of operations, or
liquidity.

         The Company has conducted a review of its computer systems to identify
the systems that could be affected by the "Year 2000" issue. Based on the
results of that review, modifications were made to the




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<PAGE>   11


Company's systems. The Company believes its computer systems are Year 2000
compliant in all material respects, based on the results of the review and the
successful implementation of the modifications. Total estimated costs incurred
in modifying the Company's systems were not material and were expensed as
incurred.

         Effective December 1, 1993, the Company entered into a national sales
agreement with Allstate Insurance Company ("Allstate") that, as subsequently
modified, established the Company as Allstate's preferred provider of salvage
processing services. The Company agreed to purchase salvage and theft recovered
vehicles from Allstate, or sell such vehicles on behalf of Allstate, in various
geographic markets throughout the Country. Local Allstate management is
responsible for deciding who will be the provider of automotive salvage services
for their geographic area of responsibility. The national agreement provides
specific guidelines as to the general terms and structure to which any local
agreement must conform. These agreements typically have terms of one or two
years, but are generally subject to termination by either party upon 30 days
notice. For the fiscal year ended December 31, 1997, vehicles purchased from, or
sold on behalf of, Allstate accounted for approximately 17% of the Company's
total unit sales, making Allstate the Company's second largest supplier of
vehicles for auction.

              Allstate has recently invited the Company to submit a proposal to
provide automobile salvage services for Allstate locations across the country,
effective January 1, 1999. The Company understands that Allstate has requested
this proposal as part of a comprehensive review of Allstate's automobile salvage
disposition practices. The Company is working aggressively to maintain and
increase the amount of business it receives from Allstate and to maintain the
profitability of that business. However, no assurance can be given as to the
results of Allstate's review, and the Company may receive less, or less
profitable, business from Allstate than it currently does. A significant
reduction of Allstate business, or a significant reduction in the profitability
of that business, would have a material adverse affect or could affect the
Company's business, operating results and financial condition.



FACTORS THAT MAY AFFECT FUTURE RESULTS

              The Company operates in a changing environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.

              Quarterly Fluctuations. The Company's operating results have in
the past and may in the future fluctuate significantly depending on a number of
factors, some of which are more significant for sales under the purchase
agreement method. These factors include changes in the market value of salvage
vehicles, attendance at salvage auctions, delays or changes in state title
processing, fluctuations in Actual Cash Values ("ACV's") of salvage vehicles,
changes in regulations governing the processing of salvage vehicles, general
weather conditions and the availability and quality of salvage vehicles. The
Company is also dependent upon receiving a sufficient number of total loss
vehicles as well as recovered theft vehicles to sustain its profit margins.
Factors which can affect the number of vehicles received include: reduction of
policy writing by insurance providers which would affect the number of claims
over a period of time and changes in direct repair procedures that would reduce
the number of newer less damaged total loss vehicles that tend to have the
higher salvage values. Additionally in the last few years there has been a
declining trend in theft occurrences. As a result, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as any indication of future
performance. In addition, revenues for any future quarter are not predictable
with any significant degree of accuracy; while the Company's operating expense
levels do not vary significantly with changes in volume. If revenue levels are
below expectations, operating results are likely to be adversely affected. Due
to all of the foregoing factors, it is likely that in some future quarters the
Company's operating results will be below the expectations of public market
analysts and investors.

              Quality and Quantity of Inventory Available from Suppliers. The
Company is dependent upon receiving a sufficient number of total loss vehicles
as well as recovered theft vehicles to sustain its profit


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<PAGE>   12



margins. Factors which can affect the number of salvage vehicles received
include reduction of policy writing by insurance providers which would affect
the number of claims over a period of time, the changes in direct repair
procedures that would reduce the number of newer less damaged total loss
vehicles that tend to have higher salvage values and general weather conditions.
For example, a comparatively mild winter can result in fewer "total loss"
accidents, causing fewer vehicles to be available for sale by the Company. The
decreases in the quality and quantity of inventory and in particular the
availability of newer and less damaged vehicles are further aggravated under the
purchase agreement method of salvage and can have a negative impact on the
operating results and financial condition of the Company.

              Competition. Historically, the automotive salvage industry has
been highly fragmented. As a result, the Company faces intense competition for
the supply of salvage vehicles from vehicle suppliers, as well as competition
from processors of vehicles from other regional salvage pools. These regional
salvage pools generally process vehicles under the fixed fee consignment method
and generally do not offer the full range of services provided by the Company.
The salvage industry has recently experienced consolidation, however, and the
Company believes its principal publicly-held competitor is Copart, Inc. Copart,
Inc. has effected a number of acquisitions of regional salvage pools and
competes with IAA in most of IAA's geographic markets. Due to the limited number
of vehicle suppliers, competition for salvage vehicles from Copart and regional
suppliers is intense. It is also possible that the Company may encounter further
competition from existing competitors and new market entrants that are
significantly larger and have greater financial and marketing resources. Other
potential competitors could include used car auction companies, providers of
claims software to insurance companies, certain salvage buyer groups and
insurance companies, some of which presently supply auto salvage to IAA. While
most insurance companies have abandoned or reduced efforts to sell salvage
without the use of service providers such as the Company, they may in the future
decide to dispose of their salvage directly to customers. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not have a material adverse effect on its business, operating results and
financial condition.

              Dependence on Key Insurance Company Suppliers. Historically, a
limited number of insurance companies have accounted for a substantial portion
of the Company's revenues. For example, in 1997, vehicles supplied by the
Company's three largest suppliers accounted for approximately 46% of the
Company's unit sales. The largest suppliers, State Farm Insurance, Allstate
Insurance ("Allstate"), and Farmers Insurance, each accounted for approximately
19%, 17%, and 10%, respectively, of the Company's unit sales. A number of other
insurance company suppliers, including 20th Century Insurance, have also
contributed to the profitability of the Company. A loss or reduction in the
number of vehicles from any of these suppliers, or adverse change in the
agreements that such suppliers have with the Company, could have a material
adverse effect on the Company's business, operating results and financial
condition.

              Purchase Agreement Method of Sale. The Company has entered into a
number of purchase agreements, including agreements with its most significant
insurance suppliers, that obligate the Company to purchase most salvage vehicles
offered to it at a formula percentage of ACV. Increases in ACV's associated with
flat or declining market or auction prices for salvage vehicles could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company has adjustment and risk-sharing clauses in its
standard purchase agreement contracts designed to provide some protection to the
Company and its customers from certain unexpected, significant changes in the
ACV/salvage price relationship.


              Governmental Regulation. The Company's operations are subject to
regulation, supervision and licensing under various federal, state and local
statutes, ordinances and regulations. The acquisition and sale of totaled and
recovered theft vehicles is regulated by state motor vehicle departments in each
of the locations in which the Company operates. Changes in governmental
regulations or interpretations of existing regulations can result in increased
costs, reduced salvage vehicle prices and decreased profitability for the
Company. For example, the Company believes legislation currently being
considered by Congress could have a negative impact on the number of buyers
attending an auction as well as increase some of the 



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<PAGE>   13



costs to those buyers. This legislation could increase governmental regulation
of certain operations of the Company. In addition to the regulation of sales and
acquisitions of vehicles, the Company is also subject to various local zoning
requirements with regard to the location of its auction and storage facilities.
These zoning requirements vary from location to location. Failure to comply with
present or future regulations or changes in existing regulations could have a
material adverse effect of the Company's business, operating results and
financial condition.

              Provision of Services as a National or Regional Supplier. The
provision of services to insurance company suppliers on a national or regional
basis require that the Company expends resources and dedicate management to a
small number of individual accounts, resulting in a significant amount of fixed
costs. The development of a referral based national network service, in
particular, has required the devotion of financial resources without immediate
reimbursement of such expenses by the insurance company suppliers.

              Integration and Expansion of Facilities. The Company seeks to
increase sales and profitability through acquisition of other salvage auction
facilities, new site expansion and the increase of salvage vehicle volume at
existing facilities. There can be no assurance that the Company will continue to
acquire new facilities on terms economical to the Company or that the Company
will be able to add additional facilities on terms economical to the Company or
that the Company will be able to increase revenues at newly acquired facilities
above levels realized prior to acquisition. The Company's ability to achieve
these objectives is dependent, among other things, on the integration of new
facilities, and their information systems, into its existing operations, the
identification and lease of suitable premises and the availability of capital.
There can be no assurance that this integration will occur, that suitable
premises will be identified or that additional capital will be available to fund
expansion and integration of the Company's business. Any delays or obstacles in
this integration process could have a material adverse effect on the Company's
business, operating results and financial condition. Furthermore, the Company
has limited sources of additional capital available for acquisitions, expansions
and start-ups. The Company's ability to integrate and expand its facilities will
depend on its ability to identify and obtain additional sources of capital to
finance such integration and expansion. In the future, the Company will be
required to continue to improve its financial and management controls, reporting
systems and procedures on a timely basis and expand, train and manage its
employee work force. The failure to improve these systems on a timely basis and
to successfully expand and train the Company's work force could have a material
adverse effect on the Company's business, operating results and financial
condition.

              Volatility of Stock Price. The market price of the Company's
common stock has been and could continue to be subject to significant
fluctuations in response to various factors and events, including variations in
the Company's operating results, the timing and size of acquisitions and
facility openings, the loss of vehicle suppliers or buyers, the announcement of
new vehicle supply agreements by the Company or its competitors, changes in
regulations governing the Company's operations or its vehicle suppliers,
environmental problems or litigation.

              Environmental Regulation. The Company's operations are subject to
federal, state and local laws and regulations regarding the protection of the
environment. In the salvage vehicle auction industry, large numbers of wrecked
vehicles are stored at auction facilities for short periods of time. Minor
spills of gasoline, motor oils and other fluids may occur from time to time at
the Company's facilities and may result in soil, surface water or groundwater
contamination. Petroleum products and other hazardous materials are contained in
aboveground or underground storage tanks located at certain of the Company's
facilities. Waste materials such as waste solvents or used oils are generated at
some of the Company's facilities and are disposed of as non or hazardous wastes.
The Company believes that it is in compliance in all material respects with
applicable environmental regulations and does not anticipate any material
capital expenditure for environmental compliance or remediation. Environmental
laws and regulations, however, could become more stringent over time and there
can be no assurance that the Company or its operations will not be subject to
significant compliance costs in the future. To date, the Company has not
incurred expenditures for preventive or remedial action with respect to
contamination or the use of hazardous



                                       13
<PAGE>   14



materials that have had a material adverse effect on the Company's results of
operations or financial condition. The contamination that could occur at the
Company's facilities and the potential contamination by previous users of
certain acquired facilities create the risk, however, that the Company could
incur substantial expenditures for preventive or remedial action, as well as
potential liability arising as a consequence of hazardous material
contamination, which could have a material adverse effect on the Company.





ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. INAPPLICABLE


PART II.  OTHER INFORMATION.


ITEM 1.  LEGAL PROCEEDINGS. INAPPLICABLE

ITEM 2.  CHANGES IN SECURITIES.  INAPPLICABLE

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.  INAPPLICABLE

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE ON SECURITY HOLDERS.




              At the Annual Meeting of Shareholders of the Company held June 17,
1998, the shareholders (i) elected eight directors to serve on the Company's
Board of Directors, and (ii) ratified the Company's appointment of KPMG Peat
Marwick LLP to serve as the Company's independent auditors for the fiscal year
ended December 31, 1998. Shareholders holding 10,232,618 shares of Common Stock,
representing 90.5% of the total number of shares outstanding and entitled to
vote at the meeting, were present in person or by proxy at the meeting.



The vote for nominated directors was as follows:

 Director                           Votes for                  Votes Withheld
 --------                           ---------                  --------------

 James P. Alampi                    10,224,034                        8,584
 Maurice A. Cocca                   10,224,034                        8,584
 Susan B. Gould                      9,355,234                      877,384
 Christopher G. Knowles              9,355,414                      877,204
 Melvin R. Martin                    9,354,434                      878,184
 Thomas J. O'Malia                   9,355,434                      877,184
 Glen E. Tullman                    10,223,834                        8,784
 John K. Wilcox                     10,223,434                        9,184


The vote for ratifying the appointment of KPMG Peat Marwick LLP was as follows:
For: 10,229,653; Against: 1,001; and Withheld: 1,964.





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ITEM 5.  OTHER INFORMATION.  INAPPLICABLE



ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

         (a)     EXHIBITS.

                27.1  Financial Data Schedule




         (b)    REPORTS ON FORM 8-K. A report on Form 8-K dated as of April 6,
                1998 was filed with the Commission to report a settlement
                agreement between the Company and its former Chairman Bradley S.
                Scott under Item 5, Other Events.







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<PAGE>   16



                                   SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


                                            INSURANCE AUTO AUCTIONS, INC.




Date: August 14, 1998                       By:      /s/ Linda C. Larrabee
      ---------------                          ---------------------------
                                            Name:    Linda C. Larrabee
                                            Title:   Senior Vice President, 
                                                     Chief Financial Officer and
                                                     Secretary

                                                     (Duly Authorized Officer
                                                      and Principal Financial
                                                      Officer)



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                                  EXHIBIT INDEX




EXHIBIT NO.
----------

27.1              Financial Data Schedule














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