<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 MARCH 31, 1999

                                       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 April 30, 1999:
5,928,967 shares.

--------------------------------------------------------------------------------

<PAGE>

PAULA FINANCIAL
INDEX TO FORM 10-Q

<TABLE>
<CAPTION>

PART I. FINANCIAL INFORMATION                                                                Page
<S>                                                                                          <C>
Item 1.  Financial Statements

           Condensed consolidated balance sheets as of
                  March 31, 1999 and December 31, 1998 (unaudited) ..........................2

           Condensed consolidated statements of income for the three
                  months ended March 31, 1999 and 1998 (unaudited)...........................3

           Condensed consolidated statements of comprehensive income (loss) for
                  the three months ended March 31, 1999 and 1998
                  (unaudited)................................................................4

            Condensed consolidated statements of cash flows for the three months
                  ended March 31, 1999 and 1998 (unaudited)..................................5

           Notes to condensed consolidated financial statements for the three
                  months ended March 31, 1999 (unaudited) ...................................6

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

PART II. OTHER INFORMATION

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

SIGNATURE...................................................................................16

</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>

                                                                                March 31,           December 31,
                                ASSETS                                            1999                  1998
                                                                          ------------------    -----------------
                                                                              (Unaudited)              (*)
<S>                                                                       <C>                   <C>
Investments:
  Fixed maturities, available for sale, at market
     (amortized cost: 1999, $157,548; 1998, $171,379)                            $ 155,070            $ 170,792
  Equity securities, at market
     Preferred stock (cost: 1999, $999; 1998, $999)                                  1,025                1,040
     Common stock (cost: 1999, $5,151; 1998, $3,252)                                 5,050                3,219
  Invested cash, at cost (approximates market)                                       2,898                2,572
                                                                         ------------------    -----------------
        Total investments                                                          164,043              177,623
                                                                         ------------------    -----------------

Cash (restricted: 1999, $1,420; 1998, $1,398)                                        7,459                4,145
Accounts receivable, net of allowance for uncollectible
   accounts (1999, $901; 1998, $901)                                                27,145               26,846
Reinsurance recoverable on paid and unpaid losses and
    loss adjustment expenses                                                        36,079               25,852
Deferred income taxes                                                                6,354                6,306
Other assets                                                                        19,424               14,176
                                                                         ------------------    -----------------
                                                                                 $ 260,504            $ 254,948
                                                                         ------------------    -----------------
                                                                         ------------------    -----------------

                  LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES:

Unpaid losses and loss adjustment expenses                                       $ 137,803            $ 136,316
Unearned premiums                                                                   21,841               20,234
Accrued policyholder dividends                                                         486                  335
Accounts payable and accrued expenses                                               18,455               21,360
Notes payable                                                                        8,142                2,667
                                                                         ------------------    -----------------
                                                                                   186,727              180,912
                                                                         ------------------    -----------------


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: 1999,
     6,338,767; 1998, 6,338,815)                                                        63                   63
Additional paid-in-capital                                                          67,388               67,386
Retained earnings                                                                   11,224               10,182
Accumulated other comprehensive income:
  Net unrealized gain on investments                                                (1,685)                (382)
                                                                         ------------------    -----------------
                                                                                    76,990               77,249
Treasury stock, at cost (1999 and 1998, 409,800 shares)                             (3,213)              (3,213)
                                                                         ------------------    -----------------
                                                                                    73,777               74,036
                                                                         ------------------    -----------------
                                                                                 $ 260,504            $ 254,948
                                                                         ------------------    -----------------
                                                                         ------------------    -----------------

</TABLE>

*  Derived from audited financial statements.

   See notes to condensed consolidated financial statements.


                                       2

<PAGE>

                        PAULA FINANCIAL AND SUBSIDIARIES
                   CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                 (In thousands, except share and per share data)

<TABLE>
<CAPTION>

                                                           THREE MONTHS ENDED
                                                                MARCH 31,
                                                           1999            1998
                                                     ------------    ------------
                                                             (Unaudited)
      <S>                                            <C>             <C>
      INCOME:
      Net premiums earned:

        Workers' compensation                            $16,502         $27,820
        Group medical and life                               185             175
      Commissions                                            832             717
      Net investment income                                2,740           2,054
      Net realized investment gains                          101              30
      Other                                                  207             199
                                                     ------------    ------------
                                                          20,567          30,995
                                                     ------------    ------------

      EXPENSES:
      Losses and loss adjustment
        expenses incurred                                 11,238          20,798
      Dividends provided for policyholders                   151             423
      Operating                                            7,176           8,632
                                                     ------------    ------------
                                                          18,565          29,853
                                                     ------------    ------------

      Equity in net loss of unconsolidated
        affiliate                                            (84)              -
                                                     ------------    ------------

      Income before income taxes                           1,918           1,142
      Income tax expense                                     639             119
                                                     ------------    ------------
            NET INCOME                                    $1,279          $1,023
                                                     ------------    ------------
                                                     ------------    ------------

      Earnings per share                                   $0.22           $0.16

      Weighed average shares outstanding               5,928,995       6,322,455

      Earnings per share - assuming dilution               $0.22           $0.15

      Weighted average shares outstanding -
        assuming dilution                              5,937,049       6,799,951

</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    
                                                            MARCH 31,           
                                                        1999          1998      
                                                     -----------    ----------  
                                                           (Unaudited)          
      <S>                                            <C>            <C>
      Net income                                         $1,279        $1,023   
                                                                                
      Other comprehensive income (loss),                                        
       net of tax                                                              
        Unrealized gains on investments:                                       
           Unrealized holding gains (losses)                                   
             arising during period (tax impact:          (1,106)           59  
             1999, $570; 1998, ($31))  
           Reclassifications adjustment for gains
             included in net income    
             (tax impact:  1999, $101; 
                   1998,  $9)                              (197)          (16)  
                                                     -----------    ----------  
                                                         (1,303)           43   
                                                     -----------    ----------  
            COMPREHENSIVE INCOME (LOSS)                    ($24)       $1,066   
                                                     -----------    ----------  
                                                     -----------    ----------  

</TABLE>

See notes to condensed consolidated financial statements.


                                       4

<PAGE>

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

<TABLE>
<CAPTION>

                                                                                   THREE MONTHS ENDED
                                                                                        MARCH 31,
                                                                                1999                1998
                                                                         ----------------    ----------------
                                                                                     (Unaudited)
<S>                                                                      <C>                 <C>
CASH FLOW FROM OPERATING ACTIVITIES:
   Net income                                                                     $1,279              $1,023
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY 
   (USED IN) OPERATING ACTIVITIES:
   Depreciation and amortization                                                     395                 336
   Amortization of fixed maturity premium, net                                       139                 153
   Equity in net loss of unconsolidated affiliate                                     84                   -
   Loss on sale of property and equipment                                              4                   4
   Gain on sales and calls of investments                                          (101)                (30)
   Increase in accounts receivable                                               (9,839)             (8,024)
   (Increase) decrease in deferred income taxes                                      623               (240)
   Increase in unpaid losses and loss adjustment expenses                          1,487               7,023
   Increase in accrued policyholder dividends                                        151                  82
   Increase (decrease) in accounts payable and accrued expenses                  (2,905)                 768
   Increase in unearned premiums                                                   1,607              10,220
   Other, net                                                                      (338)               (982)
                                                                         ----------------    ----------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                              (7,414)              10,333
                                                                         ----------------    ----------------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from sale of available for sale fixed maturities                      14,146               3,285
   Proceeds from maturities and calls of available for sale fixed                  2,728               1,202
      maturities

   Proceeds from sale of property and equipment                                       15                  19
   Purchase of preferred and common stocks                                             -             (3,183)
   Purchase of available for sale fixed maturities                               (4,980)             (9,367)
   Purchase of property and equipment                                              (490)               (506)
   Purchase of book of business                                                    (105)                   -
   Investment in unconsolidated affiliate                                        (5,500)                   -
                                                                         ----------------    ----------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES                                5,814             (8,550)
                                                                         ----------------    ----------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Borrowings under line of credit agreement, net                                  5,500                   -
   Payments on notes payable                                                        (25)               (277)
   Dividends paid                                                                  (237)               (253)
   Exercise of stock options                                                           -                  50
   Issuance of common stock                                                            2                   -
                                                                         ----------------    ----------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                5,240               (480)
                                                                         ----------------    ----------------

NET INCREASE IN CASH AND INVESTED CASH                                             3,640               1,303
Cash and invested cash at beginning of period                                      6,717              19,452
                                                                         ----------------    ----------------
CASH AND INVESTED CASH AT END OF PERIOD                                          $10,357             $20,755
                                                                         ----------------    ----------------
                                                                         ----------------    ----------------

See notes to condensed consolidated financial statements.

</TABLE>

                                       5

<PAGE>

                        PAULA FINANCIAL AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
              FOR THE THREE MONTHS ENDED MARCH 31, 1999 (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, New Mexico and Nevada.

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 months ended March 31, 1999 are not necessarily
indicative of the results to be expected for the year ended December 31, 1999.
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, 1998.

NOTE B - ADOPTION OF NEW ACCOUNTING STANDARDS

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 15, 1998, although early adoption is encouraged. The
Company adopted SOP 97-3 effective January 1, 1999. The impact of adoption was
not material.

NOTE C - NEW ACCOUNTING STANDARDS NOT YET ADOPTED

In June 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for fiscal years
beginning after June 15, 1999 and establishes standards for the reporting for
derivative instruments. It requires changes in the fair value of a derivative
instrument and the changes in fair value of assets or liabilities hedged by that
instrument to be included in income. To the extent that the hedge transaction is
effective, income is equally offset by both investments. Currently changes in
fair value of derivative instruments and hedged items are reported in net
unrealized gain (loss) on securities. The Company has not yet adopted SFAS 133.
However, the effect of adoption on the condensed consolidated financial
statements at March 31, 1999 would not be material.


                                       6

<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").

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.
Gross premiums written for the three months ended March 31, 1999 and 1998, were
$29.5 million and $39.0 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 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.


                                       7

<PAGE>

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THE
THREE MONTHS ENDED MARCH 31, 1998:

GROSS PREMIUMS WRITTEN. The Company's premiums written for the three months
ended March 31, 1999 decreased 24.2% to $29.5 million from $39.0 million for the
comparable 1998 period. The decrease in gross premiums written relates primarily
to the declines in the Company's large account business in California. This was
partially offset by rate increases in California and a 9% growth in gross
premiums written in other states.

NET PREMIUMS EARNED. The Company's net premiums earned for the three months
ended March 31, 1999 decreased 40.4% to $16.7 million from $28.0 million for
comparable 1998 period. The decline in net premiums earned is due principally to
the impact of $10.5 million in premiums ceded in the first quarter of 1999 under
a reinsurance arrangement which became effective October 1, 1998.

COMMISSION INCOME. For the three months ended March 31, 1999 commission income
was $0.8 million compared to $0.7 million for the comparable 1998 period, a
16.0% increase. The increase is primarily a result of increased premiums placed
with insurance carriers other than PICO and PACO which generates non-risk fee
income for the Company. Commissions paid to Pan Am on PICO and PACO business are
eliminated in the Company's consolidated financial statements.

NET INVESTMENT INCOME. Net investment income increased 33.4% to $2.7 million for
the three months ended March 31, 1999 from $2.1 million for the comparable 1998
period. The increase was the result of cash flow increases from PICO's
underwriting activity in 1998. Average invested assets increased to $172.4
million for the three months ended March 31, 1999 from $140.4 million for the
comparable period in 1998. The Company's average yield on its portfolio was 6.4%
for the three month period in 1999 and 5.9% for the three month period in 1998.
The average yield on the Company's investment portfolio increased over the
related 1998 period due to a repositioning of the investment portfolio from
tax-exempt securities to taxable securities in the third quarter of 1998.

LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The Company's net loss ratio 
for the three months ended March 31, 1999 decreased to 67.4% from 74.3% for 
the comparable 1998 period. The 1999 loss ratio includes the benefit of 1.3% 
in favorable development on prior accident years while the loss ratio for the 
1998 period includes 5.0% of adverse development on prior accident years. The 
decrease in the 1999 loss ratio is due principally to the significant impact 
of the reinsurance treaty entered into in the fourth quarter of 1998.

DIVIDENDS PROVIDED FOR POLICYHOLDERS. Dividends provided for policyholders as a
percentage of premiums earned for the three months ended March 31, 1999 was 0.9%
compared to 1.5% for the comparable 1998 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.


                                       8

<PAGE>

OPERATING EXPENSES. Operating expenses decreased 16.9% to $7.2 million for the
three months ended March 31, 1999 from $8.6 million for the comparable 1998
period. Variable expenses include the benefit of $2.2 million in ceding
commissions received in the first quarter of 1999 in conjunction with the
reinsurance arrangement which was effective in the fourth quarter of 1998.
Excluding the benefit of the ceding commissions, operating expenses in 1999
would have increased $0.8 million over the 1998 period due principally to
increased salary and related expenses.

INCOME TAXES. Income tax expense for the three months ended March 31, 1999 was
$0.6 million compared to $0.1 million for the comparable 1998 period. The
effective combined income tax rates for the three months ended March 31, 1999
and 1998 were 33.3% and 10.4%, respectively. The difference in the effective tax
rates is due to a repositioning of the investment portfolio from tax-exempt
securities to taxable securities in the third quarter of 1998.

EQUITY IN NET LOSS OF UNCONSOLIDATED AFFILIATE. The equity in net loss of
unconsolidated affiliate in the first quarter of 1999 represents the Company's
share of the net loss of Altus Insurance Holdings, LLC in the first quarter of
1999. The Company is accounting for this investment using the equity method.

LIQUIDITY AND CAPITAL RESOURCES:

As a holding company, PAULA Financial's principal sources of funds are dividends
and expense reimbursements from its operating subsidiaries, proceeds from the
sale of its capital stock and income from its investment portfolio. PAULA
Financial's principal uses of funds are capital contributions to its
subsidiaries, payment of operating expenses, investments in new ventures,
dividends to its stockholders and repurchase of Company common stock.

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, 1998, PAULA Financial
would be able to receive $5.4 million in dividends in 1999 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 three months ended March 31, 1999.

Management believes that the remaining proceeds from the Company's initial
public offering held at the parent company level, 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
operating cash needs for at least twelve 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. The Company is currently in discussions with the bank to renew and extend
the Credit Agreement at the end of its initial term in December 1999. Each of
PAULA Financial's non-insurance subsidiaries has guaranteed all obligations of
PAULA Financial under the Credit Agreement. As of April 30, 1999, $9.6 million
was outstanding under this facility. This use of the Credit Agreement was for
repurchase of the Company's common stock and investments in new ventures.


                                       9

<PAGE>

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 March 31, 1999, the carrying value of the Company's fixed maturity
securities portfolio was $155.1 million of which $153.5 million was rated. Of
the rated fixed maturities portfolio 94.4% was rated "A" or better by S&P,
Moody's or Fitch. In December 1998, the issuer of a $2.0 million par value bond
held by PICO declared Chapter 11 bankruptcy. At that time, the Company ceased
accruing investment income and realized an "other than temporary" decline of
$0.1 million on this bond. The carrying value of this bond at the end of 1998
was $1.6 million based on market values obtained from the Company's investment
advisor. The Parent purchased the bond from PICO in March 1999 in exchange for
cash and marketable securities held by the Parent. As of March 31, 1999, this
bond continued to have a carrying value of $1.6 million based on market values
obtained from the Company's investment advisor. In response to further
developments, in April 1999 the Company was informed by its investment advisor
that the ultimate recoverability of the bond could be as low as 30% of its par
value. The Company is continuing to monitor the status of the bankruptcy
proceedings, which are still in the early stages. At this time, the Company is
unable to predict the magnitude of any additional "other than temporary"
declines on this security.

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 March 31, 1999, securities with a par
value of $84.5 million held by authorized depositories pursuant to these deposit
requirements. In addition to the deposits, the Company's insurance company
operating subsidiaries must maintain regulated levels of capital and surplus in
relation to premiums written and the risks retained by the subsidiaries.

In early 1999, the Company made an investment in the recently formed Altus
Insurance Holdings, LLC, the parent company of Altus Casualty Company Ltd.
("Altus"), a specialty workers' compensation insurance company. The Company
invested $5.5 million and has the option to acquire additional equity and
provide quota-share reinsurance to Altus through PICO. The Company is accounting
for its investment in Altus using the equity method.

In March 1999, the Company announced that Pan Am had agreed to purchase the
insurance agency assets of the Sacramento and Stockton, California offices of
CAPAX for approximately $2.9 million. The Company funded the transaction with
$1.3 million in cash and $1.1 million in CAPAX securities which were owned by
the Company. The balance of $0.5 million is due on May 1, 2001 and is subject to
a downward earnout adjustment. The transaction closed as of April 30, 1999.


                                       10

<PAGE>

YEAR 2000 CONSIDERATIONS

THE FOLLOWING IS A YEAR 2000 READINESS DISCLOSURE STATEMENT.

OVERVIEW. The Company's Year 2000 Project (the "Project") is steadily
proceeding. The Project involves resolving the potential impact of the Year 2000
on the processing of date-sensitive information by the Company's internal
computer systems and equipment and by the computer systems and equipment
utilized by third parties with whom the Company maintains material
relationships.

The Company believes that it has identified substantially all of its own
information technology systems ("IT Systems") and non-information technology
(embedded technology) systems ("Non-IT Systems") which require modification in
order to become Year 2000 compliant. In addition, the Company believes that it
has identified those third parties whose inability to handle date-sensitive
processing could materially and adversely impact the Company if corrective
action is not taken in a timely manner.

The Company has identified five major internal IT Systems which require
attention as part of the Project: General Ledger ("GL"), Agency Operations
("Agency"), Underwriting, which includes policy issuance, maintenance of policy
records, billing and auditing ("Underwriting"), Claims Adjudication ("Claims")
and Third Party Administration, which includes life insurance and accident and
health insurance policy issuance, maintenance and billing operations ("TPA").
The Company's approach to each of these systems differs based on the Company's
use of the system and whether the system was purchased from a third party or
developed in-house.

GL SYSTEM. The Company has completed in-house construction and testing of a new
GL system which is Year 2000 compliant.

AGENCY SYSTEM. The Company has completed the process of out-sourcing its Agency
System needs to James G. Parker Insurance Associates ("Parker"), one of the
founders of the PAULA Trading Company. Parker utilizes an agency software system
provided by a third party vendor which is Year 2000 compliant according to a
written statement received from the vendor.

UNDERWRITING SYSTEM. The Company's in-house Underwriting system is not yet fully
Year 2000 compliant. The Company has therefore chosen to make its existing
Underwriting system Year 2000 compliant using a technique known as "windowing,"
which is a solution that will work for many years, but not permanently.
Windowing is faster and requires less testing than permanent solutions. The
Company believes permanent solutions are not necessary in light of the new
system under development.

The Company has purchased a software tool to perform the windowing project and
has retained several consultants familiar with the software tool to perform the
project. The consultants will work under the supervision of the Company's
information services staff. The Company has identified the programs to be
modified, prioritized those programs based on their earliest expected date of
failure and has begun using the software tool to perform the correction to the
programs. The Company has prepared a testing environment to perform the
corrective procedures and to test the results in a realistic data environment.


                                       11

<PAGE>

The windowing project is proceeding on its revised schedule and the Company
expects the windowing project, involving correction and testing of all necessary
Underwriting system programs, to be completed during the end of the second
quarter of 1999.

The Company is currently constructing a new in-house Underwriting system that
will be Year 2000 compliant, but this new system is not expected to address the
Company's Year 2000 issues in a timely fashion.

CLAIMS SYSTEM. The Company's Claims system is licensed from a third party
vendor. The Claims system uses two distinct products, one for claims telephonic
reporting and one for claims adjudication. The Company has added custom features
to the standard version of each of the products provided by the vendor. The
Company's current version of these two system products are not Year 2000
compliant.

The Company has received delivery of a standard upgrade to its Claims
adjudication system which is Year 2000 compliant, according to the vendor, which
is currently being tested by the Company. The Company and the vendor have
identified customized features which must be added to the upgraded Claims
adjudication system and the vendor has agreed to perform the customization. The
Company expects the customization to be completed during June 1999 and final
installation, testing and training to be complete by early in the third quarter
of 1999.

The Company has determined that it cannot modify the programs of the existing
version of the Claims system to make it Year 2000 compliant. However, the
Company does not believe that continuing to utilize the non-Year 2000 compliant
version of the Claims adjudication system through the third quarter of 1999 will
materially impair operations. The Company expects to implement the customized
upgrade early during the third quarter. If necessary, the Company will commence
using the "standard" version of the claims system upgrade it has already
received and is currently testing.

The Company's Claims telephonic reporting system will not be made Year 2000
compliant by the vendor. As scheduled, the Company has modified its Claims
telephonic reporting system to properly process claims during 1999, but this
modification will not allow claims processing in 2000. The Company has chosen to
move to a vendor maintained, Year 2000 compliant, mainframe-based telephonic
reporting system. This is expected to be effective during the middle of the
second quarter of 1999.

TPA SYSTEM. The Company has licensed a third party claims administration
software product that the Company uses for all TPA functions. The Company has
completed the installation and testing of the vendor provided Year 2000 upgrade
to this software.

NON-IT SYSTEMS. The Company has addressed its primary Year 2000 issues relating
to Non-IT Systems by purchasing a new IBM mainframe computer to run its IT
Systems. The Company intends to extend the capacity of this new mainframe as
necessary. The Company's old IBM mainframe will be relegated to a back-up role
as more functions are moved to the new mainframe during 1999. The Company has
received, installed and tested an upgrade to both mainframes' operating systems
and has obtained satisfactory evidence that these upgraded operating systems are
Year 2000 compliant from IBM's Internet website.


                                       12

<PAGE>

The Company is continuing to inventory its other Non-IT Systems as part of the
Project. These systems include the Company's personal computer network,
telephone switching equipment and other office equipment. Once these systems are
inventoried, the Company will prioritize the impact of their failure due to Year
2000 issues and then begin testing and correcting to bring them into Year 2000
compliance. The Company expects the inventory and prioritization phases to be
completed by the middle of the second quarter of 1999 and corrective action to
be completed by the middle of the third quarter of 1999, a delay of
approximately 60 days from previous disclosures.

The Company does not believe that it is materially exposed to any
Company-specific Non-IT System Year 2000 issues other than those addressed by
purchasing a new mainframe computer due to the nature of the Company's business.
The Company has no material property, plant or equipment.

THIRD PARTY YEAR 2000 ISSUES. The Company has made good progress in obtaining
Year 2000 compliance assurances from third parties with whom the Company has
material trading arrangements, or upon whom the Company relies to a material
extent in its normal operations. The Company will continue working to satisfy
itself that each third party performing important functions for the Company has
taken necessary measures to ensure that their IT and Non-IT Systems will be Year
2000 compliant in a timely manner. The Company believes it will suffer no
material disruption of its operations from its trading partners' Year 2000
issues. The Company has not, and will not, attempt to assess the Year 2000
compliance of regulatory authorities, statistical rating bureaus or public
utilities as the Company cannot cause such entities to increase their efforts to
become Year 2000 compliant.

COSTS. The total cost associated with required program modifications, software
upgrades and equipment purchases to become Year 2000 compliant is not expected
to be material to the Company's financial position, results of operations or
cash flows. The Company's total budget for its Year 2000 compliance program,
which began in 1997, is $875,000. This estimate does not include the Company's
potential share of Year 2000 costs that may be incurred by the Company's trading
partners which the Company may choose to bear to increase the likelihood of
their timely Year 2000 compliance.

Of the total budget amount, $80,000 was spent in 1997, $300,000 was spent in
1998, $191,000 was spent in the first quarter of 1999 and $304,000 will be spent
during the remaining nine months of 1999. The costs associated with the
Company's new Underwriting System are not included in the Year 2000 budget. The
Company is utilizing cash flow from operations to fund its Year 2000 budget
needs.

CONTINGENCIES. The Company continues to review its alternatives in the event
that it is not able to complete its Year 2000 compliance plans in a timely
manner. These alternatives include, without limitation, purchasing third party
insurance company software packages, acceleration of the construction of the
Company's new Underwriting system and outsourcing the non-compliant Company
functions to third parties. Each of these alternatives is less advantageous to
the Company than its current Year 2000 compliance plan and, if required, could
have an adverse effect on the Company's financial position, results of
operations or cash flows.


                                       13

<PAGE>

RISKS. The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, financial condition and cash flow. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of regulatory authorities, statistical
rating bureaus and public utilities, the Company is unable to determine at this
time whether the consequences of Year 2000 failures will have a material impact
on the Company's results of operations, financial condition or cash flows. The
Company believes the Project will significantly reduce the Company's level of
uncertainty about the Year 2000 problem.

CONSULTANTS. The Company has not used the services of independent Year 2000
consultants to assess its IT System and Non-IT System needs, although the
Company is utilizing the services of independent consultants in its Underwriting
System windowing project and in constructing its new Underwriting system. The
Company continues to review its Year 2000 program with its outside auditors on a
regular basis.

FORWARD-LOOKING STATEMENTS

In connection with, and because it desires to take advantage of the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995, the
Company cautions readers to recognize the existence of certain forward-looking
statements in this Form 10-Q and in any other statement made by, or on behalf
of, the Company, whether or not in future filings with the Securities and
Exchange Commission. Forward-looking statements are statements not based on
historical information and which relate to future operations, strategies,
financial results or other developments. Some forward-looking statements may be
identified by the use of terms such as "expects," "believes," "anticipates,"
"intends," or "judgment." Forward-looking statements are necessarily based upon
estimates and assumptions that are inherently subject to significant business,
economic and competitive uncertainties, many of which are beyond the Company's
control and many of which, with respect to future business decisions, are
subject to change. Examples of such uncertainties and contingencies include,
among other important factors, those affecting the insurance industry in
general, such as the economic and interest rate environment, legislative and
regulatory developments and market pricing and competitive trends, and those
relating specifically to the Company and its businesses, such as the level of
its insurance premiums and fee income, the claims experience of its insurance
products, the performance of its investment portfolio, the successful completion
by the Company of its Year 2000 compliance program, acquisitions of companies or
blocks of business, and the ratings by major rating organizations of its
insurance subsidiaries. These uncertainties and contingencies can affect actual
results and could cause actual results to differ materially from those expressed
in any forward-looking statements made by, or on behalf of, the Company. The
Company disclaims any obligation to update forward-looking information.


                                       14

<PAGE>

PART II.  OTHER INFORMATION

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

         (a)      Exhibits.

                  10.35    Asset Purchase Agreement among PAULA Financial, Pan
                           American Underwriters, Inc. and CAPAX Management &
                           Insurance Services and its subsidiaries dated April
                           30, 1999.

                  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 March 31, 1999.


                                       15

<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:  May 7, 1999                  PAULA FINANCIAL

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









                                       16