<PAGE>

                    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 0-23181

                                 PAULA FINANCIAL
             (Exact name of registrant as specified in its charter)

               DELAWARE                               95-4640368
    (State or other jurisdiction of                 (I.R.S. Employer
     incorporation or organization)              identification number)

                                 PAULA FINANCIAL
                        300 NORTH LAKE AVENUE, SUITE 300
                               PASADENA, CA 91101
                    (Address of principle executive offices)

                                 (626) 304-0401
              (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.
                                 Yes  X     No     
                                     ---        ---

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. Number of shares of Common
Stock, $.01 par value, outstanding as of close of business on June 30, 1998:
6,337,815 shares.


<PAGE>

PAULA FINANCIAL
INDEX TO FORM 10-Q


PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
                                                                                       PAGE
                                                                                       -----
<S>      <C>                                                                           <C>
Item 1.  Financial Statements

         Condensed consolidated balance sheets as of
             December 31, 1997 and June 30, 1998 (unaudited) ..........................  2

         Condensed consolidated statements of operations for the three and six
             months ended June 30, 1997 and 1998 (unaudited)...........................  3

         Condensed consolidated statements of comprehensive income (loss) for
             the three and six months ended June 30, 1997 and 1998 (unaudited).........  4

          Condensed consolidated statements of cash flows for the six months
             ended June 30, 1997 and 1998 (unaudited)..................................  5

          Notes to condensed consolidated financial statements for the three and
             six months ended June 30, 1998 (unaudited) ...............................  6

Item 2.   Management's Discussion and Analysis of Consolidated Financial
            Condition and Results of Operations........................................  8

PART II. OTHER INFORMATION

           Item 4.  Submission of Matters to a Vote of Security Holders ..............  13
           Item 6.  Exhibits and Reports on Form 8-K..................................  13

SIGNATURE.............................................................................  14
</TABLE>

<PAGE>

PART I     FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS

                        PAULA FINANCIAL AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                        (In thousands, except share data)

<TABLE>
<CAPTION>
                                                             December 31,       June 30,
            ASSETS                                               1997             1998
                                                             ------------       -----------
                                                                  (*)           (Unaudited)
<S>                                                             <C>               <C>
Investments:
   Fixed maturities, available for sale, at market
      (amortized cost: 1997, $112,294; 1998, $138,935)          $114,525          $141,029
   Equity securities, at market
      Preferred stock (cost: 1997, $3,019; 1998, $7,204)           3,112             7,536
      Common stock (cost: 1997, $5,546; 1998, $5,546)              5,545             5,549
   Invested cash, at cost (approximates market)                   14,682             7,927
                                                                --------          --------
         Total investments                                       137,864           162,041
                                                                --------          --------

Cash (restricted: 1997, $1,491; 1998, $1,654)                      4,770             1,848
Accounts receivable, net of allowance for uncollectible
     accounts (1997, $600; 1998, $607)                            24,320            32,355
Reinsurance recoverable on paid and unpaid losses and
     loss adjustment expenses                                      6,394             7,844
Deferred income taxes                                              3,247             5,872
Other assets                                                      11,669            13,902
                                                                --------          --------
                                                                $188,264          $223,862
                                                                --------          --------
                                                                --------          --------

                       LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES:
Unpaid losses and loss adjustment expenses                      $ 77,784          $110,161
Unearned premiums                                                 15,390            25,509
Accrued policyholder dividends                                         -               165
Accounts payable and accrued expenses                              9,814            10,272
Notes payable                                                        456               139
                                                                --------          --------
                                                                 103,444           146,246
                                                                --------          --------


STOCKHOLDERS' EQUITY:
Preferred Stock, $0.01 par value.  Authorized 4,058,823
    shares, none issued and outstanding                                -                 -
Common stock, $0.01 par value
   (Authorized 15,000,000 shares, issued and outstanding:
      1997, 6,321,177; 1998, 6,337,815)                               63                64
Additional paid-in-capital                                        67,176            67,386
Retained earnings                                                 16,048             8,563
Accumulated other comprehensive income:                                                   
   Net unrealized gain on investments                              1,533             1,603
                                                                --------          --------
                                                                  84,820            77,616
                                                                --------          --------
                                                                $188,264          $223,862
                                                                --------          --------
                                                                --------          --------
</TABLE>
*  Derived from audited financial statements.

    See notes to condensed consolidated financial statements.


                                       2
<PAGE>
                                       
                         PAULA FINANCIAL AND SUBSIDIARIES 
                  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 
                   (In thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                   THREE MONTHS ENDED                 SIX MONTHS ENDED
                                                          JUNE 30,                          JUNE 30,
                                                   -------------------                 -----------------
                                                  1997              1998             1997              1998
                                                  ----              ----             ----              ----
                                                         (Unaudited)                         (Unaudited)
<S>                                               <C>              <C>             <C>              <C>
INCOME:                                          
Premiums earned:                                 
   Workers' compensation                            $23,893           $37,041         $41,303          $64,861 
   Group medical and life                               249               194             475              369 
Commissions                                             782               913           1,716            1,630 
Net investment income                                 1,282             2,119           2,499            4,173 
Net realized investment losses                            -               (83)              -              (53)
Other                                                   198               161             347              360 
                                                  ---------        ----------      ----------       ----------
                                                     26,404            40,345          46,340           71,340 
                                                  ---------        ----------      ----------       ----------
EXPENSES:                                                                                                      
Losses and loss adjustment                                                                                     
   expenses incurred                                 16,999            42,736          28,447           63,534 
Dividends provided for policyholders                   (202)               84             309              507 
Operating                                             7,935             9,922          14,752           18,554 
                                                  ---------        ----------      ----------       ----------
                                                     24,732            52,742          43,508           82,595 
                                                  ---------        ----------      ----------       ----------
Income (loss) before income taxes                     1,672           (12,397)          2,832          (11,255)
Income tax expense (benefit)                            294            (4,396)            538           (4,277)
                                                  ---------        ----------      ----------       ----------

      NET INCOME (LOSS)                              $1,378           $(8,001)         $2,294          $(6,978)
                                                  ---------        ----------      ----------       ----------
                                                  ---------        ----------      ----------       ----------

Earnings (loss) per share                             $0.72            $(1.26)          $1.21           $(1.10)

Weighed average shares outstanding                1,902,077         6,331,285       1,903,000        6,326,894 

Earnings (loss) per share - assuming dilution         $0.34            $(1.26)          $0.56           $(1.10)

Weighted average shares outstanding -
     assuming dilution                            4,098,739         6,331,285       4,099,662        6,326,894 
</TABLE>

See notes to condensed consolidated financial statements.


                                       3
<PAGE>

                        PAULA FINANCIAL AND SUBSIDIARIES
        CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
                                 (In thousands)



<TABLE>
<CAPTION>
                                                   THREE MONTHS ENDED                 SIX MONTHS ENDED
                                                          JUNE 30,                          JUNE 30,
                                                   -------------------                 -----------------
                                                  1997              1998             1997              1998
                                                  ----              ----             ----              ----
                                                         (Unaudited)                         (Unaudited)
<S>                                               <C>              <C>             <C>              <C>
Net income (loss)                                   $1,378           ($8,001)        $2,294           ($6,978)

Other comprehensive income, net of tax: 
  Unrealized gains (losses) on investments:   
    Unrealized holding gains
      arising during period (tax impact:
      1997: $308 and $43; 1998: $14 and $45)           598                27             84                86 
    Reclassifications adjustment for gains
      (losses) included in net income (tax 
       impact:  1997: $0 and  $0; 1998: 
       $0 and $9)                                         -                -              -               (16)
                                                  ---------        ----------      ----------       ----------
                                                        598                27              84               70
                                                  ---------        ----------      ----------       ----------
  COMPREHENSIVE INCOME (LOSS)                        $1,976           ($7,974)         $2,378          ($6,908)
                                                  ---------        ----------      ----------       ----------
                                                  ---------        ----------      ----------       ----------
</TABLE>

See notes to condensed consolidated financial statements.


                                       4
<PAGE>

                        PAULA FINANCIAL AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                              SIX MONTHS ENDED            
                                                                                   JUNE 30,               
                                                                              ----------------            
                                                                         1997                    1998     
                                                                         ----                    ----     
                                                                                  (Unaudited)             
<S>                                                                     <C>                    <C>        
CASH FLOW FROM OPERATING ACTIVITIES:                                                                      
   Net income (loss)                                                     $ 2,294                ($6,978)  
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET                                                         
   CASH PROVIDED BY OPERATING ACTIVITIES:                                                                 
   Depreciation and amortization                                             621                    684   
   Amortization of fixed maturity premium, net                               326                    440   
   Loss on sale of property and equipment                                     13                      4   
   Loss on sales and calls of investments                                      -                     53   
   Increase in accounts receivable                                        (9,495)               (10,383)  
   (Increase) decrease in deferred income taxes                              757                 (2,661)  
   Increase in unpaid losses and loss adjustment expenses                  9,252                 32,377   
   Increase (decrease) in accrued policyholder dividends                    (395)                   165   
   Increase in accounts payable and accrued expenses                       2,649                    458   
   Increase in unearned premiums                                           2,709                 10,119   
   Other, net                                                               (637)                (1,167)  
                                                                        --------               --------   
NET CASH PROVIDED BY OPERATING ACTIVITIES                                  8,094                 23,111   
                                                                        --------               --------   
CASH FLOWS FROM INVESTING ACTIVITIES:                                                                     
   Proceeds from sale of available for sale fixed maturities                   -                  3,787   
   Proceeds from maturities and calls of available for sale                                               
     fixed maturities                                                      4,494                  2,920   
   Proceeds from sale of property and equipment                              (29)                    19   
   Purchase of preferred and common stocks                                (2,183)                (4,231)  
   Purchase of available for sale fixed maturities                       (10,152)               (33,795)  
   Purchase of property and equipment                                       (588)                  (870)  
   Purchase of insurance agency                                              (20)                     -   
                                                                        --------               --------   
NET CASH USED IN INVESTING ACTIVITIES                                     (8,478)               (32,170)  
                                                                        --------               --------   
                                                                                                          
CASH FLOWS FROM FINANCING ACTIVITIES:                                                                     
   Borrowings under line of credit agreement, net                          1,871                      -   
   Payments on notes payable                                              (1,682)                  (317)  
   Dividends paid                                                              -                   (507)  
   Exercise of stock options                                                   -                    206   
   Sale of common stock                                                       14                      -   
   Retirement of common stock                                                (39)                     -   
                                                                        --------               --------   
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                          164                   (618)  
                                                                        --------               --------   
                                                                                                          
NET DECREASE IN CASH AND INVESTED CASH                                      (220)                (9,677)  
Cash and invested cash at beginning of period                             10,707                 19,452   
                                                                        --------               --------   
CASH AND INVESTED CASH AT END OF PERIOD                                  $10,487                 $9,775   
                                                                        --------               --------   
                                                                        --------               --------   
</TABLE>
See notes to condensed consolidated financial statements.


                                       5
<PAGE>

                        PAULA FINANCIAL AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
          FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1998 (UNAUDITED)


NOTE A - BASIS OF PRESENTATION

PAULA Financial and subsidiaries (the "Company") is an integrated insurance 
organization specializing in the production, underwriting and servicing of 
workers' compensation and accident and health insurance primarily for 
agribusiness clients in California, Arizona, Oregon, Idaho, Alaska, Texas, 
Florida and New Mexico.

The accompanying unaudited condensed consolidated financial statements of the 
Company have been prepared in accordance with generally accepted accounting 
principles ("GAAP") for interim financial information and with the 
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they 
do not include all of the information and footnotes required by GAAP for 
complete financial statements. In the opinion of management, all adjustments, 
including normally occurring accruals, considered necessary for a fair 
presentation have been included.

Operating results for the three and six months ended June 30, 1998 are not 
necessarily indicative of the results to be expected for the year ended 
December 31, 1998. 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, 1997.


NOTE B - ADOPTION OF NEW ACCOUNTING STANDARDS

During the first quarter of 1998, the Company adopted the provisions of 
Financial Accounting Standards Board ("FASB") Statement No. 130, "Reporting 
Comprehensive Income" ("SFAS 130"). SFAS 130 requires companies to report 
comprehensive income and its components in a financial statement and display 
the accumulated balance of other comprehensive income separately from 
retained earnings and additional paid-in-capital. Comprehensive income 
includes all changes in equity during a period except those resulting from 
investments by stockholders and distributions to stockholders. In accordance 
with the interim reporting requirements of SFAS 130, the Company has included 
condensed consolidated statements of comprehensive income in the accompanying 
condensed consolidated financial statements.

Also, during the first quarter of 1998, the Company adopted the provisions of 
FASB Statement No. 131, "Disclosures about Segments of an Enterprise and 
Related Information: ("SFAS 131"). This statement specifies revised 
guidelines for determination of an entity's operating segments and the type 
and level of financial information to be disclosed. Based on the guidance 
included in SFAS 131, the Company has determined that it operates in a single 
segment: the production, underwriting and servicing of workers' compensation 
and accident and health insurance.


                                       6
<PAGE>

                        PAULA FINANCIAL AND SUBSIDIARIES
          NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT.)


NOTE C - NEW ACCOUNTING STANDARDS NOT YET ADOPTED

During the fourth quarter of 1997, the American Institute of Certified Public 
Accountants issued Statement of Position No. 97-3, "Accounting by Insurance 
and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3"). SOP 
97-3 addresses the recognition and measurement of assets and liabilities 
related to guaranty funds and other assessments. SOP 97-3 is effective for 
fiscal years beginning after December 31, 1998, although early adoption is 
encouraged. The Company has not determined the impact of SOP 97-3 and has not 
yet adopted SOP 97-3.


                                       7
<PAGE>


PART I    FINANCIAL INFORMATION

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


OVERVIEW

The Company is a California-based specialty underwriter and distributor of 
commercial insurance products which, through its subsidiary PAULA Insurance 
Company ("PICO"), is one of the largest underwriters specializing in workers' 
compensation insurance products and services for the agribusiness industry. 
The Company sells complementary products through the Company's insurance 
agency subsidiaries (collectively "Pan Am"), including group health and life 
products provided by the Company's subsidiary PAULA Assurance Company 
("PACO"), and third-party claims administration services provided by the 
Company's subsidiary Pan Pacific Benefit Administrators, Inc.

The Company's revenues have consisted primarily of premiums earned from 
workers' compensation insurance underwriting, premiums earned from group 
medical insurance, commission income, net investment income and other income. 
Premiums earned during a period represent the portion of direct premiums 
written for which all or a portion of the coverage period has expired, net of 
reinsurance. Premiums written for the three months ended June 30, 1998 and 
1997, were $38.8 million and $23.4 million, respectively. Premiums written 
for the six months ended June 30, 1998 and 1997, were $77.8 million and $45.9 
million, respectively. Commission income is earned from Pan Am's distribution 
of insurance for insurers other than PICO and PACO. Net investment income 
represents earnings on the Company's investment portfolio, less investment 
expenses. Other income consists of third party administration fees and other 
miscellaneous items.

The Company's expenses have consisted of losses and loss adjustment expenses 
incurred, dividends provided for policyholders and operating expenses. Losses 
include reserves for future payments for medical care and rehabilitation 
costs and indemnity payments for lost wages. Loss adjustment expenses include 
expenses incurred in connection with services provided by third parties, 
including expenses of independent medical examinations, surveillance costs, 
and legal expenses as well as staff and related expenses incurred to 
administer and settle claims. Loss and loss adjustment expenses are offset in 
part by estimated recoveries from reinsurers under excess of loss reinsurance 
treaties. Operating expenses include commission expenses to third party 
insurance agencies and other expenses that vary with premium volume, such as 
premium taxes, state guaranty fund assessments and underwriting and marketing 
expense, as well as general and administrative expenses, which are less 
closely related to premium volume.

The Company's revenues are seasonal, and have tended to be highest in the 
second and third quarters of each year. This is due primarily to the 
seasonality of the size of the workforce employed by the Company's 
agribusiness clients.


                                       8
<PAGE>



RESULTS OF OPERATIONS:

PREMIUMS WRITTEN. The Company's premiums written for the three months ended 
June 30, 1998 increased 66.1% to $38.8 million from $23.4 million for the 
comparable 1997 period. The Company's premiums written for the six months 
ended June 30, 1998 increased 69.6% to $77.8 million from $45.9 million for 
the comparable 1997 period. The growth in premiums written was primarily 
attributable to the net addition of new policyholders and increased 
policyholder payrolls. The Company's growth is particularly strong in 
California and Texas.

PREMIUMS EARNED. For the reasons described above for premiums written, the 
Company's premiums earned for the three months ended June 30, 1998 increased 
54.2% to $37.2 million from $24.1 million for comparable 1997 period and 
increased 56.1% to $65.2 million for the six months ended June 30, 1998 from 
$41.8 million for comparable 1997 period.

COMMISSION INCOME. Commission income has remained consistent with the 1997 
periods. For the three months ended June 30, 1998 commission income was $0.9 
million compared to $0.8 million for the comparable 1997 period. Commission 
for the six months ended June 30, 1998 was $1.6 million compared to $1.7 
million for the comparable 1997 period.

NET INVESTMENT INCOME. Net investment income increased 65.3% to $2.1 million 
for the three months ended June 30, 1998 from $1.3 million for the comparable 
1997 period. Net investment income increased 67.0% to $4.2 million for the 
six months ended June 30, 1998 from $2.5 million for the comparable 1997 
period. The increase was the result of significant cash flow increases from 
PICO's underwriting activity and the proceeds from the Company's initial 
public offering in October 1997. Average invested assets increased to $147.6 
million for the six months ended June 30, 1998 from $88.8 million for the 
comparable period in 1997. The Company's average yield on its portfolio was 
5.7% for the six month period in 1998 and 5.6% for the six month period in 
1997.

LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The Company's loss ratio for 
the three months ended June 30, 1998 increased to 114.8% from 70.4% for the 
comparable 1997 period. The Company's loss ratio for the six months ended 
June 30, 1998 increased to 97.4% from 68.1% for the comparable 1997 period. 
The increase in loss ratios from the 1997 periods is largely attributable to 
actions taken by the Company to increase loss reserves on the 1997 and 1998 
accident years by a total of $14.8 million in the second quarter of 1998. Of 
the total reserve increase, $5.0 million related to the 1997 accident year 
with the remaining $9.8 million allocated to 1998.

In the last two quarters the Company has seen reserve development on the 1997 
year for California business in excess of its expectations given prior year 
reserving trends. The reserve adjustment, expressed as a percentage of 1997 
and six months 1998 combined premiums implies a pricing deficiency for the 
period. The Company began to address this early in 1998 through rate 
increases and non-renewal activity. However, the Company will not begin to 
see the benefit from these activities until the latter part of 1998 and 1999. 
The reserve strengthening for the 1998 accident year assumes that 1997 trends 
also impact 1998, as 1997 effective date policies continue to expire through 
the end of this year.


                                       9
<PAGE>

Taking into consideration this reserve strengthening, the Company's 1997 
accident year loss ratio for its workers compensation business was 78.9% and 
the 1998 accident year loss ratio through June 30, 1998 was 87.3%. The 1997 
accident year loss ratio for the workers compensation business at December 
31, 1997 was 72.1%.

DIVIDENDS PROVIDED FOR POLICYHOLDERS. With the advent of open rating in 
California and an emphasis in most states in which the Company operates on, 
among other things, competitive pricing at inception, the Company's dividends 
provided for policyholders decreased significantly commencing in late 1995. 
Dividends provided for policyholders as a percentage of premiums earned for 
the three months ended June 30, 1998 was 0.2%. Because the ratio for the 1997 
period includes a reduction in the accrual for prior policy years, a 
comparison to the 1998 ratio is not meaningful. Dividends provided for 
policyholders as a percentage of premiums earned for the six months ended 
June 30, 1998 of 0.8% is consistent with 0.7% for the comparable 1997 period. 
During the first quarter of 1998, the Company paid $0.3 million in 
policyholder dividends related to certain Arizona policies in which the loss 
experience developed better than anticipated. The Company does not anticipate 
paying significant policyholder dividends in the future.

OPERATING EXPENSES. Operating expenses increased 25.0% to $9.9 million for 
the three months ended June 30, 1998 from $7.9 million for the comparable 
1997 period primarily due to a $1.5 million increase in commissions paid to 
unaffiliated agencies. Operating expenses increased 25.8% to $18.6 million 
for the six months ended June 30, 1998 from $14.8 million for the comparable 
1997 period largely due to a $3.4 million increase in variable expenses, 
principally commissions.

INCOME TAXES. Income tax benefit for the three months ended June 30, 1998 was 
$4.4 million compared to an income tax expense of $0.3 million for the 
comparable 1997 period. Income tax benefit for the six months ended June 30, 
1998 was $4.3 million compared to income tax expense of $0.5 million for the 
comparable 1997 period. The effective combined income tax rates for the six 
months ended June 30, 1998 and 1997 were (38.0%) and 19.0%, respectively. 
These rates vary from the combined statutory rate due to the significant 
portion of the Company's investment portfolio consisting of tax-exempt 
securities.

NET INCOME (LOSS). Net loss for the three months ended June 30, 1998 was $8.0 
million compared to net income of $1.4 million for the comparable 1997 
period. Net loss for the six months ended June 30, 1998 was $7.0 million 
compared to net income of $2.3 million for the comparable 1997 period. The 
net loss in the 1998 periods is attributable to actions taken by the Company 
to increase loss reserves on the 1997 and 1998 accident years by a total of 
$14.8 million in the second quarter of 1998.


                                      10
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES:

As a holding company, PAULA Financial's principal sources of funds are 
dividends and expense reimbursements from its operating subsidiaries, and 
proceeds from the sale of its capital stock. PAULA Financial's principal uses 
of funds are capital contributions to its subsidiaries, payment of operating 
expenses and dividends to its stockholders.

California law places significant restrictions on the ability of the 
insurance subsidiaries to pay dividends to PAULA Financial. Based on these 
restrictions and the Company's results for the year ended December 31, 1997, 
PAULA Financial would be able to receive $6.4 million in dividends in 1998 
from its insurance subsidiaries without obtaining prior regulatory approval 
from the California Department of Insurance ("DOI"). No dividends were paid 
by the insurance subsidiaries to PAULA Financial during the six months ended 
June 30, 1998.

The Company retained $16.6 million from the proceeds of its initial public 
offering at the parent company level in various investment grade securities. 
The Company previously announced its intention to contribute $11.8 million of 
this amount to PICO to support its underwriting activities. The Company will 
make this contribution by the end of August 1998. Management believes that 
the remaining offering proceeds, funds available under the Credit Agreement 
described below, and expense reimbursements and dividends from its operating 
subsidiaries will be sufficient to meet the parent company's normal operating 
cash needs for at least eighteen months.

In March 1997, PAULA Financial entered into the Credit Agreement with a 
commercial bank providing PAULA Financial with a revolving credit facility of 
$15.0 million until December 31, 1999. At such time PAULA Financial may elect 
to convert all or a portion of the borrowings then outstanding under such 
facility into a term loan payable in quarterly installments and maturing on 
December 31, 2001. Each of PAULA Financial's non-insurance subsidiaries has 
guaranteed all obligations of PAULA Financial under the Credit Agreement. As 
of June 30, 1998, no amounts were outstanding under this facility.

The Company's investments consist primarily of taxable and tax-exempt United 
States government and other investment grade securities and investment grade 
fixed maturity commercial paper and, to a lesser extent, equity securities. 
The Company does not generally invest in below investment grade fixed 
maturity securities, mortgage loans or real estate. The Company has invested 
in the equity securities of two founders of the PAULA Trading Company (an 
affiliated agency) other than Pan Am as a part of the parent company's 
investment portfolio.

As of June 30, 1998, the carrying value of the Company's fixed maturity 
securities portfolio was $141.0 million of which $131.5 million was rated. Of 
the rated fixed maturities portfolio 96.5% was rated "A" or better by S&P, 
Moody's or Fitch.

California workers' compensation insurance companies are required to maintain 
some of their investments on deposit with the California DOI for the 
protection of policyholders. Other states in which PICO is licensed have also 
required PICO to post deposits for the protection of those states' 
policyholders. Pursuant to applicable state laws, PICO had, as of June 30, 
1998, securities with a par value of $78.3 million held by authorized 
depositories pursuant to these deposit requirements. In addition to the 
deposits, the Company's insurance company operating subsidiaries must 
maintain 


                                      11
<PAGE>

regulated levels of capital and surplus in relation to premiums written and 
the risks retained by the subsidiaries.

YEAR 2000 CONSIDERATIONS

The Company is currently working to resolve the potential impact of the year 
2000 on the processing of date-sensitive information systems. The Company 
believes that it has identified substantially all of its application software 
programs which require modification in order to become year 2000 compliant 
and has a formal plan to correct and test the programs affected by the 
conversion from a two-digit year to a four-digit year. The Company expects 
the early phases of the project to be completed during late 1998. The final 
phase of the project is scheduled to be completed by the third quarter of 
1999. The review of systems also included the identification of vendors that 
may have a significant impact on the Company's operations and their expected 
completion of any conversions. Based on preliminary information, costs of 
addressing potential problems are not currently expected to have a material 
adverse impact on the Company's financial position, results of operations or 
cash flows in future periods. However, if the Company or its vendors are 
unable to resolve such processing issues in a timely manner, it could result 
in a material financial risk. Accordingly, the Company plans to devote the 
necessary resources to resolve all significant year 2000 issues in a timely 
manner.

FORWARD-LOOKING STATEMENTS

The discussions above contain statements that constitute "forward-looking 
statements" within the meaning of Section 27A of the Securities Act of 1933, 
as amended and Section 21E of the Securities and Exchange Act of 1934, as 
amended. The words "believe," "estimate," "expect," "intend," "anticipate," 
and similar expressions and variations thereof identify certain of such 
forward-looking statements, which speak only as of the dates on which they 
are made. PAULA Financial undertakes no obligation to publicly update or 
revise any forward-looking statement, whether as a result of new information, 
future events, or otherwise. Readers are cautioned that any such 
forward-looking statements are no guarantees of future performance and 
involve risks and uncertainties, and that actual results may differ 
materially from those indicated in the forward-looking statements as a result 
of various factors. Readers are cautioned not to place undue reliance on 
these forward-looking statements.


                                      12
<PAGE>

PART II.  OTHER INFORMATION


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

           The Company held its 1998 Annual Meeting of Stockholders on 
Wednesday May 27, 1998 for the purpose of electing four directors. At the 
Meeting, the Company's stockholders re-elected Messrs. Bradley K. Serwin, 
Gerard Vecchio and Ronald W. Waisner to the Company's Board of Directors for 
three year terms and elected Mr. Robert A. Puccinelli to the Company's Board 
of Directors for a one year term. The other five members of the Company's 
Board of Directors continue to serve the remainder of their respective three 
year terms.

           The election of directors was the only matter before the Meeting. 
The following table shows the number of shares voted for each nominee for 
director and the number of shares withheld for each director:

<TABLE>
<CAPTION>
Nominee                    Shares Voted for Election    Shares Withheld
-------                    -------------------------    ---------------
<S>                                  <C>                        <C>    
Robert A. Puccinelli                 5,574,615                  18,221
Bradley K. Serwin                    5,572,756                  20,080
Gerard Vecchio                       5,565,695                  27,141
Ronald W. Waisner                    5,574,013                  18,823
</TABLE>

Item 6:  Exhibits and Reports on Form 8-K:

         (a)      Exhibits.

                  11.  Computation of Earnings Per Share
  
                  27.  Financial Data Schedule.

         (b)      Reports on Form 8-K.

                  There were no reports filed on Form 8-K during the three
                  months ended June 30, 1998.


                                      13
<PAGE>

                                  SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as 
amended, the Registrant has duly caused this Quarterly Report on Form 10-Q to 
be signed on its behalf by the undersigned thereunto duly authorized.

Date:  August 12, 1998                 PAULA FINANCIAL



                                       By:  /s/ James A. Nicholson
                                            -----------------------------------
                                       Senior Vice President and Chief 
                                       Financial Officer


                                      14