<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 March  31, 1997

                                       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)


<TABLE>
<S>                                                                                      <C>                    
California                                                                                     95-3790111
---------------------------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization)       (I.R.S. Employer Identification No.)

1270 West Northwest Highway, Palatine, Illinois                                                     60067
---------------------------------------------------------------------------------------------------------
(Address of principal executive offices)                                                       (Zip Code)
</TABLE>

                                (847) 705-9550
--------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)


--------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)

     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 March 31, 1997:

     Class                                       Outstanding March 31, 1997

Common Stock, $0.001 Par Value                        11,291,617 shares


<PAGE>   2


                                     INDEX

                         INSURANCE AUTO AUCTIONS, INC.


                                                                     PAGE NUMBER

PART I.   FINANCIAL INFORMATION ..........................................   3

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

          Condensed Consolidated Balance Sheets
            as of March 31, 1997 and December 31, 1996 ...................   3
          Condensed Consolidated Statements of Earnings for the
            Three Month Periods ended March 31, 1997 and March 31, 1996 ..   4
          Condensed Consolidated Statements of Cash Flows for the
            Three Month Periods ended March 31, 1997 and March 31, 1996 ..   5
          Notes to Condensed Consolidated Financial Statements ...........   6

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

PART II.  OTHER INFORMATION .............................................   13

Item 1.   Legal Proceedings and Other Matters ...........................   13

Item 2.   Changes in Securities .........................................   13

Item 3.   Defaults upon Senior Securities ...............................   13

Item 4.   Submission of Matters to a Vote of Security Holders ...........   13

Item 5.   Other Information .............................................   13

Item 6.   Exhibits and Reports on Form 8-K ..............................   13

SIGNATURES ..............................................................   14



                                       2


<PAGE>   3



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



<TABLE>
<CAPTION>
                                                                          March 31,           December 31, 
                                                                            1997                  1996 
                                                                       --------------       --------------
<S>                                                                    <C>                  <C>
ASSETS                                                                                                     
                                                                                                           
Current assets:                                                                                            
 Cash and cash equivalents                                             $    4,899,000       $    5,888,000 
 Accounts receivable, net                                                  33,920,000           34,371,000 
 Inventories                                                               10,959,000           10,162,000 
 Other current assets                                                       2,387,000            3,630,000 
                                                                       --------------       --------------
       Total current assets                                                52,165,000           54,051,000 
                                                                                                           
Property and equipment, at cost, net                                       21,207,000           21,596,000 
                                                                                                           
Other assets, principally goodwill, net                                   135,248,000          136,157,000 
                                                                       --------------       --------------
                                                                                                           
                                                                       $  208,620,000       $  211,804,000 
                                                                       ==============       ==============
                                                                                                           
LIABILITIES AND SHAREHOLDERS' EQUITY                                                                       
                                                                                                           
Current liabilities:                                                                                       
 Current installments of long-term debt                                    $2,517,000           $2,571,000 
 Accounts payable                                                          20,904,000           18,014,000 
 Accrued liabilities                                                        9,962,000           11,801,000 
 Income taxes                                                               1,828,000            1,986,000 
                                                                       --------------       --------------
       Total current liabilities                                           35,211,000           34,372,000 
                                                                                                           
Long-term debt, excluding current installments                             26,223,000           30,843,000 
                                                                       --------------       --------------
                                                                                                           
      Total liabilities                                                    61,434,000           65,215,000 
                                                                       --------------       --------------
                                                                                                           
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                                                    
11,291,617, and 11,282,838, shares as of March 31, 1997                                                    
   and December 31, 1996, respectively                                         11,000               11,000 
 Additional paid-in capital                                               131,748,000          131,681,000 
 Retained earnings                                                         15,427,000           14,897,000 
                                                                       --------------       --------------
                                                                                                           
      Total shareholders' equity                                          147,186,000          146,589,000 
                                                                       --------------       --------------
                                                                                                           
                                                                       $  208,620,000       $  211,804,000 
                                                                       ==============       ==============
</TABLE>


See accompanying notes to condensed consolidated financial statements.

                                       3


<PAGE>   4



                         INSURANCE AUTO AUCTIONS, INC.
                                AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
                                  (UNAUDITED)






<TABLE>
<CAPTION>

                                                     Three Month Periods
                                                        Ended March 31,    
                                              ----------------------------------
                                                  1997                   1996
                                              -----------            -----------
<S>                                          <C>                    <C>
Net sales:                    
 Vehicle sales                               $ 45,156,000           $ 52,659,000
 Fee income                                    22,729,000             20,157,000
                                              -----------            -----------
                                               67,885,000             72,816,000
Cost and expenses:                    
 Cost of sales                                 54,053,000             57,949,000
 Direct operating expenses                     11,374,000             11,955,000
 Amortization of acquisition costs                950,000                927,000
                                              -----------            -----------
                    
    Earnings from operations                    1,508,000              1,985,000
                    
Other (income) expense:                    
 Interest expense                                 736,000                808,000
 Interest (income)                               (158,000)              (154,000)
                                              -----------            -----------
                    
    Earnings before income taxes                  930,000              1,331,000
                    
Income taxes                                      400,000                572,000
                                              -----------            -----------
                    
    Net earnings                                 $530,000               $759,000
                                              ===========            ===========
                    
Net earnings per common and common                    
 equivalent shares outstanding               $        .05           $        .07
                                              ===========            ===========
                    
Weighted average common and common                    
 equivalent shares outstanding                 11,312,000             11,339,000
                                              ===========            ===========
</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>
                                                                                         Three Month Periods
                                                                                            Ended March 31,
                                                                                   -------------------------------
                                                                                          1997             1996
<S>                                                                                <C>               <C>
Cash flows from operating activities:
  Net earnings                                                                     $    530,000      $    759,000
                                                                                   ------------      ------------
Adjustments to reconcile net earnings to net cash
  provided by operating activities:
    Depreciation and amortization                                                     2,089,000         2,016,000
    Change in assets and liabilities (net of effects of
    acquired companies):
      (Increase) decrease in:
         Accounts receivable, net                                                       451,000          (458,000)
         Inventories                                                                   (797,000)         (530,000)
         Other current assets                                                         1,243,000           627,000
           Other assets                                                                 (41,000)           (2,000)
       Increase (decrease) in:
         Accounts payable                                                             2,890,000         3,833,000
         Accrued liabilities                                                         (1,828,000)          (88,000)
         Income taxes                                                                  (158,000)          572,000
                                                                                   ------------      ------------
             Total adjustments                                                        3,849,000         5,970,000
                                                                                   ------------      ------------

             Net cash provided by operating activities                                4,379,000         6,729,000
                                                                                   ------------      ------------
Cash flows from investing activities:
  Capital expenditures                                                                 (750,000)       (1,792,000)
  Payments made in connection with acquired companies                                   (97,000)       (1,429,000)
                                                                                   ------------      ------------

             Net cash used in investing activities                                     (847,000)       (3,221,000)
                                                                                   ------------      ------------
Cash flows from financing activities:
  Proceeds (payment) of line of credit and notes payable                             (4,488,000)        4,458,000
  Payment of notes payable to acquired companies                                       (100,000)       (1,793,000)
  Proceeds from issuance of common stock                                                 67,000            52,000
                                                                                   ------------      ------------

             Net cash provided by (used in) financing activities                     (4,521,000)        2,717,000
                                                                                   ------------      ------------

             Net (decrease) increase in cash                                           (989,000)        6,225,000

Cash and cash equivalents at beginning of period                                      5,888,000         7,182,000
                                                                                   ------------      ------------

Cash and cash equivalents at end of period                                        $   4,899,000     $  13,407,000
                                                                                   ============      ============

Supplemental disclosures of cash flow information:
  Cash paid during the year for:
    Interest                                                                      $   1,261,000     $   1,090,000
    Income taxes                                                                        558,000            18,000
                                                                                   ============      ============

</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 management, 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 footnotes
     thereto included in the Company's annual report on Form 10-K for the year
     ended December 31, 1996.


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 management.


3.   NET EARNINGS PER SHARE

     Net earnings per share is based on the weighted average number of shares
     of common and common share equivalents outstanding.


4.   RECENT DEVELOPMENTS

     The Financial Accounting Standards Board has recently issued Statement No.
     128, "Earnings per Share" (Statement No. 128), issued in March 1997 and is
     effective for interim and annual periods ending after December 15, 1997.
     The Company will adopt Statement No. 128 in the fourth quarter of 1997.
     Statement No. 128 requires the presentation of "Basic" earnings per share
     which represents net earnings divided by the weighted average share
     outstanding excluding the effects of common stock equivalents.  Dual
     presentation of "Diluted" earnings per share reflecting the dilutive
     effects of all common stock equivalents as determined by the treasury
     stock method, will also be required.  The Diluted presentation is similar
     to the historical presentation of fully diluted earnings per share.
     Management believes the adoption of Statement No. 128 will not have a
     material impact on the Company's financial position or results of
     operations.




                                       6


<PAGE>   7


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.  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 the Company's Annual Report on Form 10-K for the year ended
December 31, 1996 and this Form 10Q.  Among these risks are legislative acts,
weather conditions, market value of salvage declining, management changes,
outcome of litigation, competition, quality and quantity of inventory available
from suppliers, and dependence on key insurance company suppliers.


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 the purchase agreement.  ACVs are the
estimated pre-accident fair value of a vehicle, adjusted for additional
equipment, mileage and other factors.  Until the significant rise in used car
prices and ACVs during 1995, the conversion from consignment sales to purchase
agreement sales generally benefited the Company.  During 1995, however, used
car prices and ACVs rose significantly.  Despite the increase in used car
prices and ACVs, prices at salvage auctions did not increase correspondingly.
Because the Company's purchase price is fixed by contract, the increased ACVs
can and has reduced profitability on the sale of vehicles under the purchase
agreement method.

     The Company has renegotiated some of its purchase agreement contracts and
is seeking to renegotiate certain others. If the relationship between ACVs and
salvage prices remains at its present level, the Company may continue to
encounter reduced profitability from purchase agreement contracts until they
expire or are renegotiated. The Company continues to offer purchase agreements
to those customers who select it, but generally at a lower percentage of ACV
than previously offered to customers, based on current vehicle values.  The
Company has added adjustment and risk-sharing clauses to its new standard
purchase agreements designed to provide some protection to the Company
and its customers from certain unexpected, significant changes in the
ACV/salvage price relationship.

     Since its initial public offering, the Company has grown mostly through
acquisitions.  From 1993 to mid 1995, the Company acquired numerous salvage
pools (the "Acquisitions") strategically located throughout the United States.
In 1996, the Company acquired one pool and developed one new site.
Acquisitions continue to be a key part of the Company's strategic plan for
growth.

     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" in the Company's Annual Report on

                                       7


<PAGE>   8

Form 10-K for the year ended December 31, 1996 and this Form 10Q for 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 March 31, 1997 Compared to the Three Months Ended March 31,
1996
   
     Net sales of the Company decreased to $67,885,000 for the three months
ended March 31, 1997, from $72,816,000 for the same three month period in 1996,
a 6% decrease. Net sales were lower due to the conversion of selected purchase
agreements to the consignment agreement method of sale and pressures on gross
profit. These pressures were the result of the decline in the average sales
prices of salvage and a reduction in the availability of higher value salvage
resulting from insurance companies emphasis on repairing newer, less damaged
vehicles. Unit volume increased 4%, compared to the same period in 1996.
Existing facilities volume increased by 4%, while net sales growth from
existing facilities decreased by 6%. These changes are the same as for the
Company overall, when compared to the same period in 1996, as there were no
significant acquisitions or new facility startups during 1996. The purchase
agreement sales method of processing accounted for 37,000 vehicles, or 31% of
total volume, down 9% from the same period in 1996.

     Cost of sales decreased to $54,053,000 for the three months ended 1997,
from $57,949,000 for the same period in 1996, a 7% decrease.  The decrease in
cost of sales was substantially a result of decreased purchase agreement volume
resulting from the conversion of selected purchase agreements to consignment
agreements. Cost of sales as a percentage of net sales remained at 80%.  This
was the result of higher prices per car being paid due to increased Actual Cash
Values (ACVs), while selling prices of salvage vehicles were lower.

     Direct operating expenses decreased to $11,374,000 for the three months
ended March 31, 1997, from $11,955,000 for the same period in 1996, a 5%
decrease.  The decrease is the result of management's continued emphasis on the
reduction of direct operating expenses. Direct operating expenses as a
percentage of net sales were flat, compared to the same period in 1996.
Amortization of acquisition costs associated with the Acquisitions increased to
$950,000 for the three month period ended March 31, 1997 from $927,000 for the
comparable period in 1996, as a result of the amortization of goodwill for the
acquisition made in 1996.

     Interest expense decreased to $736,000 for the three months ended March
31, 1997, from $808,000 for the same period in 1996.  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 ("the Facility").

     Interest income increased to $158,000 for the three month period ended
March 31, 1997, from $154,000 for the comparable period in 1996.

     Income taxes decreased to $400,000 for the three months ended March 31,
1997, from $572,000 for the comparable period in 1996. This decrease is
primarily the result of the decrease in earnings. The Company's effective tax
rate for the three months ended March 31, 1997 was 43%. The effective tax rate
is subject to ongoing review and evaluation by Management.

     The Company's net earnings were $530,000 for the three months ended March
31, 1997, a 30% decrease from the comparable period in 1996 of  $759,000.



                                       8


<PAGE>   9


FINANCIAL CONDITION AND LIQUIDITY

     At March 31, 1997, the Company had current assets of  $52,165,000,
including $4,899,000 of cash and cash equivalents, current liabilities of
$35,211,000 and working capital of $16,954,000. The $2,725,000 decrease in
working capital from December 31, 1996, was principally related to the
repayment of long term borrowings under the Facility.

     On April 4, 1997, the Company refinanced this revolving credit agreement
on similar terms with a different bank. The $15,000,000 facility is unsecured,
bears interest at the bank's prime rate or LIBOR, as defined, and matures on
April 1, 2000.

     At March 31, 1997, the Company's indebtedness consisted mostly of 8.6%
Senior Notes approximating $20,000,000, a post-retirement benefits liability
relating to the Underwriters Salvage Company acquisition of approximately
$4,087,000, amounts due to the sellers related to an acquisition aggregating
$3,632,000 with imputed interest at 7.5% and amounts due to the sellers of
smaller acquisitions aggregating $1,372,000 which bear interest at 8.0%. There
were no borrowings outstanding on the Facility at March 31, 1997.

     Capital expenditures were approximately $750,000 for the three months
ended March 31, 1997.  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 through acquisitions and new facility
start-ups.  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

     The Financial Accounting Standards Board has recently issued Statement No.
128, "Earnings per Share" (Statement No. 128), issued in March 1997 and is
effective for interim and annual periods ending after December 15, 1997.  The
Company will adopt Statement No. 128 in the fourth quarter of 1997.  Statement
No. 128 requires the presentation of "Basic" earnings per share which
represents net earnings divided by the weighted average share outstanding
excluding the effects of common stock equivalents.  Dual presentation of
"Diluted" earnings per share reflecting the dilutive effects of all common
stock equivalents as determined by the treasury stock method, will also be
required.  The Diluted presentation is similar to the historical presentation
of fully diluted earnings per share.  Management believes the adoption of
Statement No. 128 will not have a material impact on the Company's financial
position or results of operations.

     In August 1995, the Registrant was named as a defendant in two lawsuits
filed by Registrant shareholders.  The first suit was filed in the U.S.
District Court for the Central District of California.  This suit alleges
violations of the federal securities laws and purports to seek damages on
behalf of a class of shareholders who purchased the Registrant's common stock
during the period of July 27, 1994 through August 4, 1995.  In August 1996, the
federal court denied certification of the plaintiff class on the ground that
the named plaintiff was not an adequate class representative.  However, on
January 6, 1997, the federal court certified a new plaintiff shareholder to
represent the class alleged.  The Registrant believes that this lawsuit is
without merit and intends to continue to defend against it vigorously.



                                       9


<PAGE>   10


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 ("ACVs") 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 effect 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.  These factors are further aggravated in the event the Company fails to
renegotiate purchase agreement contracts that are volume and mix dependent on
availability of these types of sales.  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; the Company's expense levels are
relatively fixed.  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 margins.  Factors which can
effect 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 and 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.  The decreases in the quality and quantity of inventory and in
particular the availability to 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.

     Dependence on Key Insurance Company Suppliers.  Historically, a limited
number of insurance companies has accounted for a substantial portion of the
Company's revenues.  For example, in 1996, vehicles supplied by the Company's
three largest suppliers accounted for approximately 49% of the Company's unit
sales.  The largest suppliers, Allstate Insurance ("Allstate") and State Farm
Insurance, each accounted for approximately 20% of the Company's unit sales.  A
number of other insurance company suppliers have also contributed to the
profitability of the Company including 20th Century Insurance.  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.  In recent times,
increased ACVs on which the Company's costs are based have reduced the
profitability that the Company realizes on purchase agreement contracts.  The
Company has renegotiated and continues to attempt to renegotiate its agreements
with certain of these suppliers.  There can be no assurance, however, that the
Company can renegotiate the terms of these agreements on terms favorable to the
Company.  The failure to renegotiate some or all of these agreements could have
a material adverse effect on the Company's operating results and financial
condition.  In addition, further increases in ACVs or declines in the market or
auction prices

                                       10


<PAGE>   11

for salvage vehicles could have a material adverse effect on the Company's
business, operating results and financial condition.

     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 the reintroduction of the Torres
Bill on January 1, 1997 in California has had a negative effect on the
Company's fourth quarter 1996 results due to buyer reluctance concerning
inspection and retitling procedures.  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.

     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, 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.

     Provision of Services as a National or Regional Supplier.  The provision
of services to insurance company suppliers on a national or regional basis
requires that the Company expend 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.

     Recent Management Changes.  There has recently been turnover in certain
key positions in the Company.  Additions of new personnel and departures of
existing personnel, particularly in key positions, can be disruptive, which
could have a material adverse effect upon the Company's business, operating
results and financial condition.

     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

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<PAGE>   12

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.
Finally, the Company has experienced a period of significant expansion that
has placed a strain upon its management systems and resources.  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 nonhazardous 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 expenditures 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 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.

     Pending Litigation.  In August 1995, the Company was named as a defendant
in a lawsuit filed by Registrant shareholders in the United States District
Court for the Central District of California.  The lawsuit alleges violations
of the federal securities laws and purports to seek damages on behalf of a
class of shareholders who purchased the Registrant's common stock during the
period of July 27, 1994 through August 4, 1995.  While class certification was
initially denied in August of 1996, a new class representative was presented to
the court and the class was ultimately certified in January 1997.  Discovery is
proceeding for this lawsuit which is currently scheduled for trial in July
1997.  Although the Company believes the lawsuit is without merit and intends
to defend against it vigorously, there can be no assurance that the Company
will achieve a successful result in this litigation. The Company has incurred
and expects to continue to incur legal expenses until this litigation is
resolved and the outcome could have a material adverse effect on the Company's
business, operating results and financial condition.


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<PAGE>   13


PART II.  OTHER INFORMATION.

ITEM 1.  LEGAL PROCEEDINGS.

(a)  The Registrant has been named as a defendant in a lawsuit filed by
     Registrant shareholders in the United States District Court for the
     Central District of California (in which two of the Registrant's
     directors and one former officer and director are also defendants).
     The lawsuit alleges violations of the federal securities laws and
     purports to seek damages on behalf of a class of shareholders who
     purchased the Registrant's common stock during the period of   July
     27, 1994 through August 4, 1995.  In August 1996, class
     certification was initially denied.  A new class representative was
     presented and the class was ultimately certified in January 1997.
     The Registrant believes the lawsuit is without merit and intends to
     defend against it vigorously.  See Note 8 to the Registrant's
     Consolidated Financial Statements in the Company's Annual Report on
     Form 10-K for the year ended December 31, 1996.

(b)  The registrant was named as a defendant in a lawsuit filed by
     registrant shareholders in the State of California.  Class
     certification was denied and the lawsuit dismissed in August, 1996.


ITEM 2.  CHANGES IN SECURITIES.  NONE

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.  NONE

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE ON SECURITY HOLDERS.  NONE

ITEM 5.  OTHER INFORMATION.  NONE

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

         (a)  EXHIBITS.  NONE

         (b)  REPORTS ON FORM 8-K.  NONE


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<PAGE>   14


                                   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: May 15, 1997       By:    /s/ Linda C. Larrabee
     -------------              -----------------------------------------------
                         Name:  Linda C. Larrabee
                         Title: Senior Vice President, Chief Financial Officer
                                     and Secretary

                                (Duly Authorized Officer and Principal Financial
                                     and Accounting Officer)



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