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SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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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, 2001

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

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

Delaware(State or other jurisdiction of
incorporation or organization)

95-4640368(I.R.S. Employer
Identification number)


PAULA FINANCIAL
300 North Lake Avenue, Suite 300
Pasadena, CA 91101(Address of principal executive offices)

(626) 304-0401(Registrant's telephone number, including area code)

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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, 2001: 5,341,979 shares.

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PAULA FINANCIAL  INDEX TO FORM 10-Q

PagePART I. FINANCIAL INFORMATIONItem 1.

Condensed Consolidated Financial StatementsCondensed consolidated balance sheets as of March 31, 2001 (unaudited) and December 31, 2000

2Condensed consolidated statements of operations for the three months ended March 31, 2001 and 2000 (unaudited)

3Condensed consolidated statements of comprehensive income (loss) for the three months ended March 31, 2001 and 2000 (unaudited)

4Condensed consolidated statements of cash flows for the three months ended March 31, 2001 and 2000 (unaudited)

5Notes to condensed consolidated financial statements for the three months ended March 31, 2001 (unaudited)

6Item 2.

Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations

7Item 3.

Quantitative and Qualitative Disclosures About Market Risks

10PART II. OTHER INFORMATIONItem 6.

Exhibits and Reports on Form 8-K

11SIGNATURE

12


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PART I FINANCIAL INFORMATION

Item 1. Financial Statements

PAULA FINANCIAL AND SUBSIDIARIES  Condensed Consolidated Balance Sheets(In thousands, except share data)

|                                                                                                       |                                                                                                  | March 31,
2001                                  |         | December 31,
2000 |        
|------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------ | ----------------------------------------------- | ------- | ----------------- | -------
|
|Assets                                                                                                 |                                                                                                  |                                                 |         |                  
|Investments:                                                                                           |                                                                                                  |                                                 |         |                   |        
|                                                                                                       | Fixed maturities, available for sale, at market (amortized cost: 2001, $111,542; 2000, $135,772) |                                                 | $       | 112,282           |        
|                                                                                                       | Equity securities, at market
Preferred stock (cost: 2001, $1,000; 2000, $1,000)                  |                                                 |         | 857               |        
|                                                                                                       |                                                                                                  | Common stock (cost: 2001, $1,686; 2000, $1,900) |         |                   | 1,236  
|                                                                                                       | Invested cash, at cost (approximates market)                                                     |                                                 |         | 22,061            |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|                                                                                                       |                                                                                                  | Total investments                               |         |                   | 136,436
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|Cash (restricted: 2001, $1,241; 2000, $2,075)                                                          |                                                                                                  |                                                 | 6,694   |                   |        
|Accounts receivable, net of allowance for uncollectible accounts (2001, $1,611; 2000, $1,491)          |                                                                                                  |                                                 | 17,083  |                   |        
|Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses                         |                                                                                                  |                                                 | 23,489  |                   |        
|Deferred income taxes                                                                                  |                                                                                                  |                                                 | 17,310  |                   |        
|Other assets                                                                                           |                                                                                                  |                                                 | 14,322  |                   |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|                                                                                                       |                                                                                                  | $                                               | 215,334 |                   | $      
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|Liabilities and Stockholders' Equity                                                                   |                                                                                                  |                                                 |         |                  
|Liabilities:                                                                                           |                                                                                                  |                                                 |         |                   |        
|Unpaid losses and loss adjustment expenses                                                             |                                                                                                  | $                                               | 138,392 |                   | $      
|Unearned premiums                                                                                      |                                                                                                  |                                                 | 18,410  |                   |        
|Accrued policyholder dividends                                                                         |                                                                                                  |                                                 | 583     |                   |        
|Accounts payable and accrued expenses                                                                  |                                                                                                  |                                                 | 11,893  |                   |        
|Notes payable                                                                                          |                                                                                                  |                                                 | 8,379   |                   |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|                                                                                                       |                                                                                                  |                                                 | 177,657 |                   |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|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: 2001, 6,337,079; 2000, 6,337,079) |                                                                                                  |                                                 | 63      |                   |        
|Additional paid-in-capital                                                                             |                                                                                                  |                                                 | 67,371  |                   |        
|Accumulated deficit                                                                                    |                                                                                                  |                                                 | (23,573 | )                 |        
|Accumulated other comprehensive income (loss):                                                         |                                                                                                  |                                                 |         |                   |        
|                                                                                                       | Net unrealized gain (loss) on investments                                                        |                                                 |         | 97                |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|                                                                                                       |                                                                                                  |                                                 | 43,958  |                   |        
|Treasury stock, at cost (2001, 995,100; 2000, 995,100 shares)                                          |                                                                                                  |                                                 | (6,281  | )                 |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|                                                                                                       |                                                                                                  |                                                 | 37,677  |                   |        
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|                                                                                                       |                                                                                                  | $                                               | 215,334 |                   | $      
|                                                                                                       |                                                                                                  |                                                 |         |                   |        
|* Derived from audited financial statements.                                                           |                                                                                                  |                                                 |         |                   |        

See
notes to condensed consolidated financial statements.

2

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PAULA FINANCIAL AND SUBSIDIARIES  Condensed Consolidated Statements of Operations(In thousands, except share and per share data)

Three Months Ended
March 31,2001

2000(Unaudited)Income:Net premiums earned:Workers' compensation

$
11,351

$
27,415Group medical and life





211Commissions


1,831


1,421Net investment income


2,238


2,507Net realized investment gains (losses)


9


(117
)Other


298


26815,727


31,705Expenses:Losses and loss adjustment expenses incurred


9,572


23,426Dividends provided for policyholders


55


248Operating


5,972


9,54515,599


33,219Equity in net loss of unconsolidated affiliate





(94
)Income (loss) before income taxes


128


(1,608
)Income tax expense (benefit)


8


(575
)Net income (loss)

$
120

$
(1,033
)Earnings per share

$
0.02

$
(0.18
)Weighed average shares outstanding


5,341,979


5,636,977Earnings per shareassuming dilution

$
0.02

$
(0.18
)Weighted average shares outstandingassuming dilution


5,341,979


5,636,977


See notes to condensed consolidated financial statements.

3

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PAULA FINANCIAL AND SUBSIDIARIES  Condensed Consolidated Statements of Comprehensive Income (Loss)(In thousands)

Three Months Ended
March 31,2001

2000(Unaudited)Net income (loss)

$
120

$
(1,033
)Other comprehensive income (loss), net of taxUnrealized gains on investments:Unrealized holding gains arising during period (tax impact: 2001, $601; 2000, $45)


1,166


86Reclassifications adjustment for gains included in net income (loss) (tax impact: 2001, $31; 2000, $26)


60


511,226


137Comprehensive income (loss)

$
1,346

$
(896
)


4

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PAULA FINANCIAL AND SUBSIDIARIES  Condensed Consolidated Statements of Cash Flows(In thousands)

|                                                                                            |                                                                           | Three Months Ended
March 31, |       
|------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | ---------------------------- | ------
|
|
|Cash flow from operating activities:                                                        |                                                                           |                              |       
|                                                                                            | Net income (loss)                                                         |                              | $     
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |                                                                           |                              |       
|                                                                                            | Depreciation and amortization                                             |                              |       
|                                                                                            | Amortization of fixed maturity premium, net                               |                              |       
|                                                                                            | Equity in net loss of unconsolidated affiliate                            |                              |       
|                                                                                            | Loss on sale of property and equipment                                    |                              |       
|                                                                                            | (Gain) loss on sales and calls of investments                             |                              |       
|                                                                                            | (Increase) decrease in receivables                                        |                              |       
|                                                                                            | (Increase) decrease in deferred income taxes                              |                              |       
|                                                                                            | Decrease in unpaid losses and loss adjustment expenses                    |                              |       
|                                                                                            | Increase in accrued policyholder dividends                                |                              |       
|                                                                                            | Increase (decrease) in accounts payable and accrued expenses              |                              |       
|                                                                                            | Increase in unearned premiums                                             |                              |       
|                                                                                            | Other, net                                                                |                              |       
|                                                                                            |                                                                           |                              |       
|Net cash provided by (used in) operating activities                                         |                                                                           |                              | (8,501
|                                                                                            |                                                                           |                              |       
|Cash flows from investing activities:                                                       |                                                                           |                              |       
|                                                                                            | Proceeds from sale of available for sale fixed maturities                 |                              |       
|                                                                                            | Proceeds from maturities and calls of available for sale fixed maturities |                              |       
|                                                                                            | Proceeds from sale of common stock                                        |                              |       
|                                                                                            | Proceeds from sale of property and equipment                              |                              |       
|                                                                                            | Purchase of available for sale fixed maturities                           |                              |       
|                                                                                            | Purchase of property and equipment                                        |                              |       
|                                                                                            |                                                                           |                              |       
|Net cash provided by (used in) investing activities                                         |                                                                           |                              | 24,262
|                                                                                            |                                                                           |                              |       
|Cash flows from financing activities:                                                       |                                                                           |                              |       
|                                                                                            | Payments on note payable to bank                                          |                              |       
|                                                                                            | Repurchase of common stock                                                |                              |       
|                                                                                            |                                                                           |                              |       
|Net cash used in financing activities                                                       |                                                                           |                              | (4,500
|                                                                                            |                                                                           |                              |       
|Net increase in cash and invested cash                                                      |                                                                           |                              | 11,261
|Cash and invested cash at beginning of period                                               |                                                                           |                              | 17,494
|                                                                                            |                                                                           |                              |       
|Cash and invested cash at end of period                                                     |                                                                           | $                            | 28,755
|                                                                                            |                                                                           |                              |       

See
notes to condensed consolidated financial statements.

5

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PAULA FINANCIAL AND SUBSIDIARIES  Notes to Condensed Consolidated Financial Statements  For the Three Months Ended March 31, 2000 (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 and New Mexico.

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

Operating
results for the three months ended March 31, 2001 are not necessarily indicative of the results to be expected for the year ended December 31, 2001. 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,
2000.

6

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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").

The
Company's revenues consist primarily of premiums earned from workers' compensation insurance underwriting, 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, 2001 and 2000, were $21.1 million and $33.5 million, respectively. Commission income is earned from Pan Am's distribution of insurance for insurers other than PICO
and PAULA Assurance Company ("PACO"). Net investment income represents earnings on the Company's investment portfolio, less investment expenses. Other income consists of various 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
expenses, as well as general and administrative expenses, which are less closely related to premium volume.

The
following combined ratio information is derived from the insurance subsidiaries, PICO and PACO, GAAP operating results:

3/31/01

3/31/00Loss ratio

84.3
%
84.8
%Expense ratio

32.3
%
27.2
%Policyholder dividend ratio

0.5
%
0.9
%Combined ratio

117.1
%
112.9
%


The
Company's revenues are seasonal, and have historically 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

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Results of Operations for the Three Months Ended March 31, 2001 Compared to the Three Months Ended March 31, 2000:

Gross premiums written.The Company's premiums written for the three months ended March 31, 2001 decreased 37.1%
to $21.1 million from $33.5 million for the comparable 2000 period. The decrease is largely attributable to geographic regions where the Company has elected to cease writing business,
primarily Texas and Florida. In the 2000 period, these regions accounted for 25% of gross written
premium compared to 2% in 2001. Rate increases on the Company's California book of business averaged 23% in the first quarter of 2001.

Net premiums earned.The Company's net premiums earned for the three months ended March 31, 2001 decreased 58.9%
to $11.4 million from $27.6 million for comparable 2000 period. In the first quarter of 2001, the Company ceded approximately 30% of its earned premium under two quota share agreements
which were not in effect in the 2000 period.

Commission income.For the three months ended March 31, 2001 commission income increased 28.9% to
$1.8 million compared to $1.4 million for the comparable 2000 period. The increase is primarily a result of increased premiums placed with insurance carriers other than PICO and PACO.
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 10.7% to $2.2 million for the three months ended
March 31, 2001 from $2.5 million for the comparable 2000 period. Average invested assets decreased to $143.2 million for the three months ended March 31, 2001 from
$159.5 million for the comparable period in 2000. The Company's average yield on its portfolio was 6.3% in both 2001 and 2000.

Losses and loss adjustment expenses incurred.The Company's net loss ratio for the three months ended March 31,
2001 decreased to 84.3% from 84.8% for the comparable 2000 period.

Operating expenses.Operating expenses decreased 37.4% to $6.0 million for the three months ended
March 31, 2001 from $9.5 million for the comparable 2000 period. Operating expenses in the 2001 period include the benefit of $1.5 million in ceding commissions received in
conjunction with the Company's quota share agreements.

Income taxes.Income tax expense for the three months ended March 31, 2001 was $8,000 compared to income tax
benefit of $0.6 million for the comparable 2000 period. The effective combined income tax rates for the three months ended March 31, 2001 and 2000 were 6.3% and 35.8%, respectively. The
effective tax rate in the 2001 period is below the statutory rate due to the impact of tax exempt investment income.

Equity in net loss of unconsolidated affiliate.The equity in net loss of unconsolidated affiliate represents the
Company's share of the net loss of Montlake Insurance Holdings, LLC ("Montlake"). Based on Montlake's unfavorable 2000 operating results, specifically adverse loss development at their Bermuda
captive, which is in run-off, as of December 31, 2000, the Company reduced the carrying value of its investment in Montlake to $0. The Company was 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 and proceeds from
the sale of its capital stock. PAULA Financial's principal uses of funds are capital contributions to its subsidiaries, payment of operating expenses and repurchase of Company common stock.

8

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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, 2000, PAULA Financial would not be able to receive dividends in 2001 from PICO without obtaining prior regulatory approval from the California Department of
Insurance ("DOI"). No dividends were paid by PICO to PAULA Financial during the three months ended March 31, 2001.

The
Company has been in the process of liquidating PACO. This process was substantially completed in the first quarter of 2001. Consequently, in March 2001, PAULA Financial
received a $4.0 million dividend from PACO.

As
of December 31, 2000, the Company had an outstanding balance on its bank term loan of $11.3 million. PAULA Financial has always been and remains current on the term
loan's regularly scheduled principal and interest payments. However, since December 31, 1999, the Company had been out of compliance with certain debt covenants associated with the term loan.
On January 30, 2001, the Company and the lender completed negotiations and executed an amendment to the credit agreement. The amendment included waivers of all prior covenant violations and
modified selected covenants going forward. Under the terms of the amendment, the Company will make principal payments totaling $6.9 million during 2001 with the remaining principal balance of
$4.4 million due on December 31, 2001. The required March 31, 2001 payment of $4.5 million was made by PAULA Financial primarily with the proceeds from the PACO dividend
payment.

Each
of PAULA Financial's non-insurance subsidiaries has guaranteed all obligations of PAULA Financial under the credit agreement. Additionally, the Company has pledged as
collateral its stock in PICO.

The
Company's operating cash flows in the first quarter of 2000 were positively impacted by the receipt of a $42.0 million reinsurance settlement.

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 March 31, 2001, the carrying value of the Company's fixed maturity securities portfolio was $112.3 million with 96.8% of the portfolio rated "A" or better by S&P,
Moody's or Fitch.

California
workers' compensation insurance companies are required to maintain some of their investments on deposit with the California DOI for the protection of policyholders. Other
states in which PICO is licensed have also required PICO to post deposits for the protection of those states' policyholders. Pursuant to applicable state laws, PICO had, as of March 31, 2001,
securities with a par value of $132.0 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.

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,"

9

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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, 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.

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, 2000.

10

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PART II. OTHER INFORMATION

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



11

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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 11, 2001 |  | PAULA FINANCIAL
|------------------ |  | ---------------
|                   |  | By:            

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