<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 SEPTEMBER 30, 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                                    95-464036
   (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 October 31,
1999: 5,707,467 shares.

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


<PAGE>


PAULA FINANCIAL
INDEX TO FORM 10-Q

<TABLE>
<CAPTION>
                                                                                        Page
                                                                                        ----
<S>                                                                                     <C>
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

         Condensed consolidated balance sheets as of
                September 30, 1999 and December 31, 1998 (unaudited) ......................2

         Condensed consolidated statements of operations for the three
                and nine months ended September 30, 1999 and 1998 (unaudited)..............3

         Condensed consolidated statements of comprehensive income (loss) for
                the three and nine months ended September 30, 1999 and 1998
                (unaudited)................................................................4

          Condensed consolidated statements of cash flows for the nine months
                ended September 30, 1999 and 1998 (unaudited)..............................5

         Notes  to condensed consolidated financial statements for the three
                and nine months ended September 30, 1999 (unaudited).......................6

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

Item 3.  Quantitative and Qualitative Disclosures about Market Risk ......................13

PART II. OTHER INFORMATION

Item 5.  Other Information................................................................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>
                                                                 September 30,         December 31,
                                                                     1999                  1998
                                                                 -------------         ------------
                                                                  (Unaudited)               (*)
<S>                                                              <C>                   <C>
                                 ASSETS
Investments:
   Fixed maturities, available for sale, at market
      (amortized cost: 1999, $140,278; 1998, $171,379)              $134,286              $170,792
   Equity securities, at market
      Preferred stock (cost: 1999, $999; 1998, $999)                     942                 1,040
      Common stock (cost: 1999, $5,151; 1998, $3,252)                  4,368                 3,219
   Invested cash, at cost (approximates market)                        2,299                 2,572
                                                                 -------------         ------------
         Total investments                                           141,895               177,623
                                                                 -------------         ------------

Cash (restricted: 1999, $3,264; 1998, $1,398)                          3,339                 4,145
Accounts receivable, net of allowance for uncollectible
     accounts (1999, $901; 1998, $901)                                30,099                26,846
Reinsurance recoverable on paid and unpaid losses and
     loss adjustment expenses                                         52,835                25,852
Deferred income taxes                                                  7,187                 6,306
Other assets                                                          21,287                14,176
                                                                 -------------         ------------
                                                                    $256,642              $254,948
                                                                 -------------         ------------
                                                                 -------------         ------------

                  LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES:
Unpaid losses and loss adjustment expenses                          $136,862              $136,316
Unearned premiums                                                     21,409                20,234
Accrued policyholder dividends                                           238                   335
Accounts payable and accrued expenses                                 13,200                21,360
Notes payable                                                         13,327                 2,667
                                                                 -------------         ------------
                                                                     185,036               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                                            67,386                67,386
Retained earnings                                                     13,720                10,182
Accumulated other comprehensive income (loss):
   Net unrealized gain (loss) on investments                          (4,510)                 (382)
                                                                 -------------         ------------
                                                                      76,659                77,249
Treasury stock, at cost (1999, 631,300; 1998, 409,800 shares)         (5,053)               (3,213)
                                                                 -------------         ------------
                                                                      71,606                74,036
                                                                 -------------         ------------
                                                                    $256,642                $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 OPERATIONS
                 (In thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                           THREE MONTHS ENDED                   NINE MONTHS ENDED
                                                              SEPTEMBER 30,                        SEPTEMBER 30,
                                                         1999            1998                 1999                 1998
                                                    ------------     ------------         -------------        -----------
                                                              (Unaudited)                           (Unaudited)
<S>                                                 <C>              <C>                  <C>                 <C>
INCOME:
Premiums earned:
   Workers' compensation                                 $18,519          $40,569              $52,522            $105,430
   Group medical and life                                    213              214                  615                 582
Commissions                                                1,302              780                3,278               2,410
Net investment income                                      2,278            2,437                7,419               6,610
Net realized investment gains (losses)                       (31)           1,784               (1,585)              1,731
Other                                                        315              311                  662                 671
                                                     -----------      -----------          -----------         -----------
                                                          22,596           46,095               62,911             117,434
                                                     -----------      -----------          -----------         -----------

EXPENSES:
Losses and loss adjustment
   expenses incurred                                      12,067           32,997               34,481              96,531
Dividends provided for policyholders                        (207)              87                  219                 594
Operating                                                  7,511           10,954               21,562              29,507
                                                     -----------      -----------          -----------         -----------
                                                          19,371           44,038               56,262             126,632
                                                     -----------      -----------          -----------         -----------

Equity in net loss of unconsolidated
    affiliate                                               (160)               -                 (430)                  -
                                                     -----------      -----------          -----------         -----------

Income (loss) before income taxes                          3,065            2,057                6,219              (9,198)
Income tax expense (benefit)                                 949              423                1,979              (3,854)
                                                     -----------      -----------          -----------         -----------
      NET INCOME (LOSS)                                   $2,116           $1,634               $4,240             ($5,344)
                                                     -----------      -----------          -----------         -----------
                                                     -----------      -----------          -----------         -----------

Earnings (loss) per share                                  $0.36            $0.26                $0.72              ($0.85)

Weighed average shares outstanding                     5,833,625        6,276,451            5,895,139           6,309,895

Earnings (loss) per share - assuming dilution              $0.36            $0.25                $0.72              ($0.85)

Weighted average shares outstanding -
     assuming dilution                                 5,836,584        6,506,654            5,899,999           6,309,895
</TABLE>

                See notes to consolidated financial statements.
                                       3


<PAGE>


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

<TABLE>
<CAPTION>

                                                         THREE MONTHS ENDED              NINE MONTHS ENDED
                                                           SEPTEMBER 30,                    SEPTEMBER 30,
                                                         1999           1998            1999            1998
                                                     ------------   ------------     -----------     ----------
                                                             (Unaudited)                      (Unaudited)
<S>                                                  <C>            <C>              <C>              <C>
Net income (loss)                                       $2,116          $1,634         $ 4,240         $(5,344)

Other comprehensive income (loss), net of tax:
    Unrealized gains (losses) on investments:
        Unrealized holding gains (losses)
             arising during period (tax impact:
             1999: $496 and $2,073; 1998: $206
             and $169)                                    (962)            400          (4,022)            328
        Reclassifications adjustment for gains
             (losses) included in net income
             (tax impact:  1999: $10 and $54;
             1998:  $510 and $437)                          19            (990)           (106)           (848)
                                                       -------         -------         -------         -------
                                                          (943)           (590)         (4,128)           (520)
                                                       -------         -------         -------         -------
      COMPREHENSIVE INCOME (LOSS)                       $1,173          $1,044         $   112         $(5,864)
                                                       -------         -------         -------         -------
                                                       -------         -------         -------         -------
</TABLE>

See notes to condensed consolidated financial statements.

                                     4
<PAGE>


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

<TABLE>
<CAPTION>
                                                                                       NINE MONTHS ENDED
                                                                                          SEPTEMBER 30,
                                                                                     1999               1998
                                                                                   ---------         ----------
                                                                                          (Unaudited)
<S>                                                                               <C>               <C>
CASH FLOW FROM OPERATING ACTIVITIES:
   Net income (loss)                                                                 $  4,240         $  (5,344)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY
   (USED IN) OPERATING ACTIVITIES:
   Depreciation and amortization                                                        1,343             1,074
   Amortization of fixed maturity premium, net                                            408               600
   Equity in net loss of unconsolidated affiliate                                         430                --
   Loss on sale of property and equipment                                                  33                 7
   (Gain) loss on sales and calls of investments                                        1,585            (1,731)
   Increase in receivables                                                            (29,879)           (7,767)
   (Increase) decrease in deferred income taxes                                         1,246            (2,231)
   Increase in unpaid losses and loss adjustment expenses                                 546            47,042
   Increase (decrease) in accrued policyholder dividends                                  (97)              253
   Increase (decrease) in accounts payable and accrued expenses                        (8,160)            2,502
   Increase in unearned premiums                                                        1,175             7,374
   Other, net                                                                             657              (650)
                                                                                    ---------         ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                                   (26,473)           41,129
                                                                                    ---------         ---------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from sale of common and preferred stocks                                       --             6,423
   Proceeds from sale of available for sale fixed maturities                           28,507            77,879
   Proceeds from maturities and calls of available for sale fixed maturities            4,345             7,026
   Proceeds from sale of property and equipment                                            73                15
   Purchase of preferred and common stocks                                                 --            (4,231)
   Purchase of available for sale fixed maturities                                     (5,645)         (128,744)
   Purchase of property and equipment                                                  (1,349)           (1,430)
   Purchase of book of business                                                          (105)               --
   Purchase of insurance agency                                                        (3,049)             (378)
   Investment in unconsolidated affiliate                                              (5,500)               --
                                                                                    ---------         ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES                                    17,277           (43,440)
                                                                                    ---------         ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Borrowings under line of credit agreement, net                                       9,070                --
   Issuance of notes payable                                                            1,659                --
   Payments on notes payable                                                              (69)             (364)
   Dividends paid                                                                        (703)             (754)
   Exercise of stock options                                                               --               206
   Repurchase of common stock                                                          (1,840)           (1,896)
   Retirement of common stock                                                              (2)               --
   Issuance of common stock                                                                 2                --
                                                                                    ---------         ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                     8,117            (2,808)
                                                                                    ---------         ---------

NET DECREASE IN CASH AND INVESTED CASH                                                 (1,079)           (5,119)
Cash and invested cash at beginning of period                                           6,717            19,452
                                                                                    ---------         ---------
CASH AND INVESTED CASH AT END OF PERIOD                                              $  5,638         $  14,333
                                                                                    ---------         ---------
                                                                                    ---------         ---------
</TABLE>

See notes to condensed consolidated financial statements.

                                     5
<PAGE>


                        PAULA FINANCIAL AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
       FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 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 and nine months ended September 30, 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. 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, 2000 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 September 30, 1999 would not
have been 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 consist 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 September 30,
1999 and 1998, were $31.2 million and $38.9 million, respectively. Gross
premiums written for the nine months ended September 30, 1999 and 1998, were
$89.4 million and $116.7 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 consist 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 AND NINE MONTHS ENDED SEPTEMBER 30, 1999
COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998:

GROSS PREMIUMS WRITTEN. The Company's gross premiums written for the three
months ended September 30, 1999 decreased 19.9% to $31.2 million from $38.9
million for the comparable 1998 period. The Company's gross premiums written
for the nine months ended September 30, 1999 decreased 23.4% to $89.4 million
from $116.7 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 7.7% growth in gross premiums written in other states.
The growth was particularly strong in Texas and New Mexico.

NET PREMIUMS EARNED. The Company's net premiums earned for the three months
ended September 30, 1999 decreased 54.1% to $18.7 million from $40.8 million
for comparable 1998 period and decreased 49.9% to $53.1 million for the nine
months ended September 30, 1999 from $106.0 million for the comparable 1998
period. The decline in net premiums earned is due to the factors discussed
above related to gross premiums written, as well as the impact of $11.2
million in premiums ceded during the three months ended September 30, 1999
and $32.9 million in premiums ceded during the nine months ended September
30, 1999 under a reinsurance arrangement which became effective October 1,
1998.

COMMISSION INCOME. For the three months ended September 30, 1999 commission
income was $1.3 million compared to $0.8 million for the comparable 1998
period, a 66.9% increase. For the nine months ended September 30, 1999
commission income was $3.3 million compared to $2.4 million for the
comparable 1998 period, a 36.0% increase. The increase is due to the
acquisition by Pan Am of two new California offices which was effective April
30, 1999, as well as 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 decreased 6.5% to $2.3 million
for the three months ended September 30, 1999 from $2.4 million for the
comparable 1998 period. Net investment income increased 12.2% to $7.4 million
for the nine months ended September 30, 1999 from $6.6 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 $163.5 million for the nine months ended September 30, 1999 from $152.3
million for the comparable period in 1998. The Company's average yield on its
portfolio was 6.1% for the nine month period in 1999 and 5.8% for the nine
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.

NET REALIZED INVESTMENT GAINS AND LOSSES. There were no significant net
realized investment losses for the three months ended September 30, 1999
while the comparable 1998 period had a net gain of $1.8 million. Net realized
investment losses were $1.6 million for the nine months ended September 30,
1999 compared to a $1.7 million gain for the comparable 1998 period. As
discussed above, in the third quarter of 1998, the Company repositioned a
portion of its investment portfolio from tax


                                       8
<PAGE>


exempt to taxable securities. This resulted in a $1.8 million gain for the
quarter. The 1999 nine month period includes the realization of an "other
than temporary" decline of $1.6 million on a non-performing investment in the
second quarter.

LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The Company's net loss ratio
for the three months ended September 30, 1999 decreased to 64.4% from 80.9%
for the comparable 1998 period. The 1999 loss ratio includes 1.9% of
unfavorable development on prior accident years. The Company's net loss ratio
for the nine months ended September 30, 1999 decreased to 64.9% from 91.1%
for the comparable 1998 period. The 1999 loss ratio includes the benefit of
0.9% in favorable development on prior accident years. The 1999 loss ratios
are also significantly impacted by the reinsurance treaty entered into in the
fourth quarter of 1998. The loss ratios for the nine months of 1998 include
the impact of 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.

DIVIDENDS PROVIDED FOR POLICYHOLDERS. Dividends provided for policyholders as
a percentage of premiums earned for the three months ended September 30, 1999
was (1.1%) compared to 0.2% for the comparable 1998 period. Dividends
provided for policyholders as a percentage of premiums earned for the nine
months ended September 30, 1999 was 0.4% compared to 0.6% for the comparable
1998 period.

OPERATING EXPENSES. Operating expenses decreased 31.4% to $7.5 million for
the three months ended September 30, 1999 from $11.0 million for the
comparable 1998 period. Variable expenses include the benefit of $2.3 million
in ceding commissions received in the third 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 for
the three months ended September 30, 1999 would have decreased $1.1 million
or 10.1% over the 1998 period. Operating expenses decreased 26.9% to $21.6
million for the nine months ended September 30, 1999 from $29.5 million for
the comparable 1998 period. Variable expenses include the benefit of $6.9
million in ceding commissions received in the first nine months 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 for the nine months ended September 30, 1999 would have
decreased $1.1 million or 3.6% over the 1998 period.

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

INCOME TAXES. Income tax expense for the three months ended September 30,
1999 was $0.9 million compared to $0.4 million for the comparable 1998
period. Income tax expense for the nine months ended September 30, 1999 was
$2.0 million compared to an income tax benefit of $3.9 million for the
comparable 1998 period. The effective combined income tax rates for the nine
months ended September 30, 1999 and 1998 were 31.8% and 41.9%, 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.


                                       9
<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,
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 nine months ended
September 30, 1999.

Management believes that 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. Each of PAULA Financial's non-insurance subsidiaries has
guaranteed all obligations of PAULA Financial under the Credit Agreement. As
of October 31, 1999, $12.2 million was outstanding under this facility and
$2.8 million was available for use. This use of the Credit Agreement was for
repurchase of the Company's common stock and investments in new ventures.

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.

As of September 30, 1999, the carrying value of the Company's fixed maturity
securities portfolio was $134.3 million of which $134.0 million was rated. Of
the rated fixed maturities portfolio 95.1% 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.
In the second quarter of 1999, based on information received from its
investment advisor, the Company realized an additional "other than temporary"
decline of $1.6 million. As of September 30, 1999, this bond had a carrying
value of $0.3 million based on market values obtained from the Company's
investment advisor.


                                       10
<PAGE>


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 September
30, 1999, securities with a par value of $121.4 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 Montlake
Insurance Holdings, LLC, formerly known as Altus Insurance Holdings, LLC, the
parent company of Montlake Casualty Company Ltd. ("Montlake"), formerly known
as Altus Casualty Company Ltd., 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 Montlake through
PICO. The Company is accounting for its investment in Montlake using the
equity method.

Effective July 1, 1999, PICO entered into a quota share agreement with
Montlake whereby PICO will assume a portion of the business written by
Montlake.

On April 30, 1999, the Company closed the transaction to purchase the
insurance agency assets of the Sacramento and Stockton, California offices of
CAPAX. The transaction was previously announced in March 1999. The assets
were purchased for approximately $2.9 million and 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.

YEAR 2000 CONSIDERATIONS

THE FOLLOWING IS A YEAR 2000 READINESS DISCLOSURE STATEMENT.

The Company's Year 2000 Project (the "Project") is substantially completed.
The Company believes that it has identified and corrected its information
technology systems and non-information technology (embedded technology)
systems which required 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 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.

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 $1,100,000, an increase of
$75,000 from previous disclosures. 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.


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<PAGE>


Of the total budget amount, $80,000 was spent in 1997, $300,000 was spent in
1998, $661,000 was spent in the first nine months of 1999 and $59,000 will be
spent during the remaining three months of 1999. The Company is utilizing
cash flow from operations to fund its Year 2000 budget requirements.

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 has significantly reduced the
Company's level of uncertainty about the Year 2000 problem.

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.


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<PAGE>


Item 3:  Quantitative and Qualitative Disclosures About Market Risk.

         There have been no significant changes since the annual report Form
10-K filed for the year ended December 31, 1998.

PART II.  OTHER INFORMATION

Item 5:  Other Information

         As previously disclosed, in the third quarter of 1999, Mr. Andrew M.
Slavitt resigned as an employee of the Company. In October 1999, he also
resigned his director position.

Item 6:  Exhibits and Reports on Form 8-K:
         (a) Exhibits.

               10.36 PAULA Insurance Company Workers' Compensation Quota
                     Share Reinsurance Agreement Placement Slip effective
                     July 1, 1999 between PICO and Montlake Casualty
                     Company Ltd.

               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 September 30, 1999.


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<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:  November 12, 1999                  PAULA FINANCIAL

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


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